What Are a Director’s Duties When a Company Has Debt

When a company carries debt, the responsibilities of its directors become more can become more closely scrutinised. Directors are subject to statutory duties under the Companies Act 2006 and these obligations do not disappear when a is company faced with financial difficulty, or is facing the prospect of insolvency.

Understanding how directors duties change when a company has debt is essential to avoiding personal liability and ensuring lawful decision making.

General duties of directors

Directors owe a core set of legal duties to the company regardless of its financial position. These duties are primarily set out in the Companies Act 2006 and apply to all directors, whether executive or non executive. When a company has debt but remains solvent, these obligations continue to be assessed by reference to the company as a whole, rather than individual creditors.

The key general duties include:

• Acting within the company’s constitution and only exercising powers for their proper purpose
  • Promoting the success of the company for the benefit of its members as a whole
  • Exercising independent judgment and not simply following the wishes of others
  • Exercising reasonable care, skill and diligence, judged by both objective and subjective standards
  • Avoiding situations where personal interests conflict with those of the company
  • Not accepting benefits from third parties arising from their role as director
  • Declaring any interest in proposed transactions or arrangements with the company

The impact of financial distress

When a company begins to experience serious financial difficulty, the practical application of directors duties changes. This shift does not require formal insolvency proceedings to have started. It is enough that insolvency is probable or that the company is on the verge of being unable to meet its obligations as they fall due.

At this stage, directors must take particular care to protect the interests of creditors. This involves a change in focus and a higher standard of scrutiny over decisions that could worsen the company’s financial position.

In circumstances of financial distress, directors should focus on the following:

• Prioritising the interests of creditors over those of shareholders
  • Closely monitoring cash flow and short-term liquidity
  • Avoiding actions that increase creditor losses, including unnecessary trading losses
  • Refraining from taking on further credit without a realistic repayment plan
  • Ensuring decisions are properly considered, documented and justifiable
  • Taking early professional advice on insolvency and restructuring options

Wrongful trading and personal liability

One of the most significant risks for directors of an indebted company is wrongful trading. This occurs when directors continue to trade at a point where they knew, or ought to have known, that there was no reasonable prospect of the company avoiding insolvent liquidation or administration.

If wrongful trading is established, a court can order directors to make a personal contribution to the company’s assets. The test is partly objective and partly subjective, taking into account the knowledge, skill and experience that may reasonably be expected of a director in that position.

It is important to note that wrongful trading is not about the existence of debt itself. It is about the failure to respond appropriately to mounting financial difficulty.

Fraudulent trading and misfeasance

More serious still is fraudulent trading. This involves carrying on business with intent to defraud creditors or for any fraudulent purpose. Fraudulent trading can give rise to civil liability and criminal sanctions. Directors found liable may face fines, disqualification and even imprisonment.

Directors may also be liable for misfeasance, which broadly covers breaches of duty or misuse of company property. In the context of debt, this can include favouring certain creditors improperly, extracting value from the company, or failing to keep proper financial records.

Practical steps directors should take

When a company has significant debt or is under financial pressure, directors should act proactively and cautiously. Key steps include:

1. Regularly reviewing up to date financial information, including cash flow forecasts
2. Holding and minuting board meetings that properly consider the company’s financial position
3. Avoiding preferential payments or transactions at undervalue
4. Seeking professional advice from insolvency practitioners or legal advisers at an early stage
5. Considering formal restructuring options where appropriate

Seeking advice is not a sign of failure. In many cases, it is strong evidence that directors are acting responsibly and in good faith.

In summary

Debt does not in itself place directors in breach of their duties. However, when debt becomes unmanageable or insolvency looms, the legal landscape changes significantly. Directors must be alert to the point at which creditor interests take priority and must adjust their conduct accordingly.

Failure to do so can result in serious personal consequences. Conversely, directors who remain informed, cautious and well advised can often navigate financial difficulty lawfully and, in some cases, steer the company back to stability.