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Director liability explained
Directors are not normally personally responsible for their company’s debts, but wrongful trading is one of the exceptions. If a company ends up in insolvent liquidation or administration, a court can order a director to pay money into it for trading on after the point when they knew, or ought to have concluded, that there was no reasonable prospect of avoiding that outcome. This guide explains the test, the defence, who brings claims, how wrongful trading differs from fraudulent trading and the warning signs to act on.
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In short
On a liquidator’s or administrator’s application, a court can order a director to contribute to the company’s assets (Insolvency Act 1986, s.214 or s.246ZB) if the company entered insolvent liquidation or administration and, before that, the director knew or ought to have concluded there was no reasonable prospect of avoiding it. Insolvency alone is not enough. Taking every step to minimise creditors’ potential loss is a defence.
Under section 214 of the Insolvency Act 1986, the court may, on the liquidator’s application, declare that a director must make “such contribution (if any) to the company’s assets as the court thinks proper”. Three conditions apply:
Section 246ZB has applied the same test to insolvent administrations since 1 October 2015, on the administrator’s application. Both apply in England, Wales and Scotland; Northern Ireland’s equivalent is Article 178 of the Insolvency (Northern Ireland) Order 1989.
What a director ought to have concluded, and the steps they ought to have taken, are judged against a reasonably diligent person with the general knowledge, skill and experience reasonably expected of someone in the director’s role, plus the director’s own (s.214(4)). Functions entrusted to a director count even if never carried out (s.214(5)), and Insolvency Service guidance is clear that inactive and non-executive directors are accountable.
Any contribution goes into the company’s assets for creditors as a whole. In Grant v Ralls [2016] EWHC 243 (Ch), the High Court held that the starting point is whether trading on after the key date increased the net deficiency to unsecured creditors; losses that would have followed from the insolvency anyway are excluded. On making a declaration, the court can also rank debts the company owes that director behind all other debts (s.215(4)), and a s.213 or s.214 declaration can lead to disqualification for up to 15 years (Company Directors Disqualification Act 1986, s.10).
“Moment of no return” is shorthand, not statutory language: the Act’s test is “no reasonable prospect” of avoiding insolvent liquidation or administration. In BTI 2014 LLC v Sequana SA [2022] UKSC 25, Lord Reed described s.214 as applying “where insolvent liquidation or administration is inevitable” (para 98).
Insolvency alone is not the test. In Grant v Ralls, Snowden J said that trading on while insolvent does not by itself make a director liable, even one who knows it. He adopted the words of Lewison J in Re Hawkes Hill Publishing Co Ltd [2007] BCC 937: “The question is not whether the directors knew or ought to have known that the company was insolvent. The question is whether they knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation.”
The answer depends on “rational expectations of what the future might hold”, not hindsight (Hawkes Hill, quoted in Ralls). A company’s prospects of raising capital from an outside investor may well be relevant, which matters to founders relying on a funding round, but liability has followed where directors had no rational basis for expecting the hoped-for rescue. In Ralls, that point came by the end of August 2010, after a promised investment repeatedly failed to arrive; the directors’ continued faith in the investor “can only have been based on hope and optimism”.
The court must not make a declaration if it is satisfied that, after the test was first met, the director took every step with a view to minimising the potential loss to the company’s creditors that they ought to have taken (s.214(3); s.246ZB(3) in administration).
In Ralls the court called this “a high hurdle” and construed it strictly: directors must show that trading on was designed to minimise the risk of loss to individual creditors, not just to reduce the overall deficiency. The defence failed because continued trading paid the bank and some existing creditors while new creditors went unpaid.
Yet no contribution was ordered. The defence looks at the process directors put in place, but the contribution looks at loss caused, and it was not proved that trading on materially increased the net deficiency. A follow-up judgment also refused a contribution for the costs of the insolvency.
Wrongful trading needs no dishonesty: Sequana describes s.214 as a duty to take reasonable care to minimise creditors’ potential loss, judged objectively (para 94). Fraudulent trading requires intent to defraud or a fraudulent purpose, and reaches anyone knowingly party to it, not only directors.
| Claim | Who brings it | What must be shown | Outcome |
|---|---|---|---|
| Wrongful trading (s.214; s.246ZB) | Liquidator or administrator | No reasonable prospect of avoiding insolvent liquidation or administration, and no “every step” defence | Contribution to the company’s assets |
| Fraudulent trading (s.213; s.246ZA) | Liquidator or administrator | Intent to defraud creditors, or any fraudulent purpose; knowingly a party | Contribution; also a crime carrying up to ten years’ imprisonment (Companies Act 2006, s.993) |
| Misfeasance (s.212) | Official receiver, liquidator, any creditor, or a contributory with permission | An officer misapplied or kept company money or property, or breached a fiduciary or other duty | Repayment, restoration or compensation |
| Transaction at an undervalue (s.238, England and Wales) | Liquidator or administrator | Gift or deal at significantly less than value within 2 years before the onset of insolvency, while unable to pay debts or made so by the deal (s.240); good-faith business defence | Order restoring the position |
| Preference (s.239, England and Wales) | Liquidator or administrator | Creditor or guarantor put in a better position by a company influenced by a desire to do so (presumed if connected); within 6 months before the onset of insolvency, or 2 years if connected, while unable to pay debts or made so by it | Order restoring the position, including reviving a guarantor’s obligations (s.241) |
Directors’ ordinary duties shift earlier. Under Sequana, once a company is insolvent or bordering on insolvency, or insolvent liquidation or administration is probable, directors must consider creditors’ interests, giving them more weight as things worsen (Lord Reed, paras 11 to 13; the rule is preserved by section 172(3) of the Companies Act 2006). That applies before s.214 does (para 94), and a creditor can pursue a breach under s.212.
Since 1 October 2015, liquidators and administrators can assign wrongful trading, fraudulent trading, undervalue and preference claims, with their proceeds, to third parties (s.246ZD). Office-holders must also report to the Secretary of State on the conduct of everyone who was a director in the three years before the insolvency, to help decide on disqualification (CDDA 1986, s.7A).
The Insolvency Service’s company health check uses two tests: can the company pay its debts as they fall due, and are its liabilities greater than its assets? Section 123 of the Insolvency Act uses the same tests and also treats a creditor’s formal written demand for more than £750, left unpaid for three weeks, as inability to pay. Warning signs the guidance lists include suppliers sending reminders, threatening or starting recovery action, putting accounts on stop or demanding payment in advance, and arrears with HMRC.
Directors’ and officers’ (D&O) insurance is designed for claims against directors personally. Subject to the policy wording, it can typically respond to defence costs and, depending on the wording, to a claim brought by a liquidator or administrator. Points to check:
Whether a policy would meet a court-ordered contribution depends on its terms. Apex arranges D&O insurance for founders and company directors: see D&O insurance for startups, D&O defence costs and investigations cover, what a founder is personally liable for and our founder insurance overview.
No. Being insolvent on a cash-flow or balance-sheet basis is not enough by itself. The question is whether the director knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation or administration. The High Court in Grant v Ralls [2016] EWHC 243 (Ch) noted that many companies show a deficit from time to time yet have a real prospect of recovering, and directors are judged on rational expectations at the time, not hindsight.
The liquidator (section 214) or, if the company is in administration, the administrator (section 246ZB) applies to court. Creditors cannot bring the claim themselves. Since 1 October 2015 the liquidator or administrator can assign the claim, including its proceeds, to a third party under section 246ZD. Creditors can, however, bring misfeasance applications under section 212 in a liquidation, for example for breach of a director’s duty to consider creditors’ interests.
The Act sets no fixed sum: the court orders “such contribution (if any)” to the company’s assets “as the court thinks proper”. In Grant v Ralls the High Court held that the starting point is the increase in the company’s net deficiency to unsecured creditors caused by trading on after the key date. Losses that would have happened anyway because of the insolvency are excluded, and in that case no contribution was ordered at all.
Not for the period you were in office. Section 214 asks whether you were a director at the time you knew or ought to have concluded there was no reasonable prospect of avoiding insolvent liquidation or administration. Insolvency Service guidance says directors remain responsible for decisions taken while in office after resigning, and the office-holder’s conduct report covers everyone who was a director in the three years before the insolvency.
No. In Great Britain, section 12 of the Corporate Insolvency and Governance Act 2020 told courts to assume directors were not responsible for any worsening of the company’s or creditors’ financial position between 1 March and 30 September 2020. Regulations applied the same rule from 26 November 2020 to 30 June 2021. Some companies, such as insurers and banks, were excluded, and the measures covered only wrongful trading contributions under sections 214 and 246ZB.
It may, subject to the policy wording. D&O insurance can typically respond to defence costs for claims against directors personally and, depending on the wording, to claims brought by a liquidator or administrator. Policies commonly exclude deliberate fraud or dishonesty and may contain insolvency-related exclusions. Cover needs to be in place before financial problems start, so it is best arranged while the company is healthy.
D&O insurance has to be in place before problems start. Tell us about the company and the board and we’ll find cover that fits, subject to the policy terms. Or call 0117 325 0027.
Get a quote Call 0117 325 0027Apex Insurance Brokers Limited is authorised and regulated by the Financial Conduct Authority. Registered in England and Wales, company number 07014570. This page is general information, not legal or tax advice on your individual circumstances, and it does not guarantee that cover will be available or on what terms.
