Claims Against Directors After Insolvency: Wrongful Trading, Preferences and Misfeasance

When a company enters liquidation or administration, the office holder has a duty to investigate what happened to its assets. Where money or property left the company in the period before failure, or where the directors kept trading past the point of no return, the office holder can bring claims personally against the directors and against those who received the money.

These claims are usually document driven, and they are usually winnable or defensible on the contemporaneous record rather than on recollection.

Wrongful Trading

Under section 214 of the Insolvency Act 1986, a director can be ordered to contribute to the company's assets if, at some point before the insolvency, they knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation, and they did not then take every step to minimise loss to creditors.

Three things decide these cases. First, the date on which the director should have known, which is fixed with hindsight but judged on what a reasonably diligent person with that director's functions and knowledge would have concluded. Second, whether steps were taken after that date, which is where taking and following professional advice, cutting costs, stopping new credit and calling board meetings all count. Third, the increase in net deficiency between that date and liquidation, because the contribution is measured by the loss caused, not by the total debts.

The most effective defence is a documented one: minutes, forecasts, an insolvency practitioner's engagement, and evidence that the directors were monitoring the position rather than hoping.

Preferences

Under section 239, a payment or other step that puts a creditor in a better position than they would have been in on liquidation can be reversed where the company was insolvent at the time and was influenced by a desire to prefer that creditor.

The look back is six months for an unconnected creditor and two years where the creditor is connected, which includes directors, their families and associated companies. Where the recipient is connected, the desire to prefer is presumed, and the burden shifts to the director to rebut it.

Typical examples are repaying a director's loan, clearing a facility that the director has personally guaranteed, or paying a family company ahead of the general body of creditors while other suppliers go unpaid.

The defence is usually commercial pressure. A payment made because the supplier would otherwise have stopped delivering, and the business needed the goods to keep trading, is not influenced by a desire to prefer. That defence needs evidence from the time, not an explanation constructed afterwards.

Transactions at an Undervalue

Under section 238, a gift or a transaction for significantly less than the value given by the company can be set aside where it occurred within two years of the onset of insolvency and the company was insolvent at the time or became so as a result.

The classic instance is a sale of the business or key assets to a new company owned by the same people for a nominal sum. Where the sale was properly valued and documented, the claim fails. Where the price was picked to suit the buyer, it does not.

There is a statutory defence where the transaction was entered into in good faith for the purpose of carrying on the business and there were reasonable grounds for believing it would benefit the company.

Transactions Defrauding Creditors

Section 423 covers transactions at an undervalue entered into for the purpose of putting assets beyond the reach of creditors or otherwise prejudicing their interests. It has no look back limit, does not require the company to have been insolvent, and can be used by a victim of the transaction as well as by an office holder. Property transferred into a spouse's sole name at the point trouble appeared is the recurring fact pattern.

Misfeasance and Breach of Duty

Section 212 provides a summary procedure for claims that a director has misapplied company money or property or breached a fiduciary or other duty. It is not a separate cause of action so much as a route to bring the ordinary duties in the Companies Act 2006 before the insolvency court.

Common allegations include unauthorised remuneration, dividends paid when there were no distributable profits, personal expenditure through the company, and diverting corporate opportunities to another entity. Dividends paid out of profits that did not exist are frequently recharacterised as loans and reclaimed in full.

Overdrawn Directors Loan Accounts

The simplest and most common claim of all. Money drawn from the company beyond salary and lawful dividends is a debt owed to the company, and the liquidator can demand it. Directors often discover that dividends they treated as income are unlawful because the accounts did not support them, converting years of drawings into an immediate liability.

Funding, Assignment and Timing

Office holders can assign these claims to litigation funders, who then pursue them commercially. That is why a claim can arrive from a company you have never dealt with, and why the absence of funds in the estate is no longer a reason to assume nothing will happen.

Claims can also be pursued alongside disqualification, which is covered in director disqualification proceedings.

What to Do When the Letter Arrives

Do not answer detailed factual questions from memory. Gather the records first: bank statements, management accounts, board minutes, correspondence with accountants and the file relating to any pre pack or asset sale. Establish the dates that matter, including the onset of insolvency and the date of each challenged transaction. Check whether the claim is in time. Consider directors and officers insurance, which frequently responds to misfeasance claims.

Then take advice before responding, because the first letter usually sets the shape of the whole case.

Instructing Counsel Directly

You can instruct a barrister without a solicitor to advise on the merits, to respond to the liquidator, to negotiate a settlement and to defend proceedings. Panel members with a litigation extension can also conduct the defence, which keeps the cost proportionate where the sums claimed are modest.

Send the correspondence and a chronology through the insolvency disputes page, or read about our counsel on the insolvency barristers page.

Related reading: compulsory liquidation explained and how to stop a winding up petition.