UK Founder Series: Insolvency Considerations for Directors and Investor Representatives

Orrick's Founder Series offers monthly top tips for UK startups on key considerations at each stage of their lifecycle, from incorporating a company through to possible exit strategies. The Series is written by members of our market-leading London Technology Companies Group (TCG) team, with valued contributions from practitioners across Orrick's recognised practice areas. Our Band 1-ranked London TCG team successfully completed over 350 financings and tech M&A transactions in 2023 & 2024 totalling $5B+ and has dominated the European venture capital tech market for over 9 years in a row (Pitchbook, Q2 2025). View previous series instalments here.

Directors face heightened duties and personal risk when a company approaches insolvency. Case law has developed an expectation of directors to shift their focus from the best interests of shareholders to those of the company's creditors. This has been referred to as a ‘sliding scale’ depending on the company’s financial position. Recent cases (Sequana, BHS) have clarified the scope and consequences of these duties, but grey areas remain. In this instalment of Orrick's Founder Series, our Restructuring team explains the "zone of insolvency", consequences for directors if there is a breach of duty and key steps directors or investor representatives can take to protect themselves.

What is the “zone of insolvency”?

The zone of insolvency describes the period when a company is not yet insolvent but is close to it – where insolvency is imminent, or a formal process (like administration or liquidation) is reasonably likely. In this ‘zone,’ directors’ duties begin to shift:

• Instead of focusing mainly on shareholders, directors must balance shareholders’ and creditors’ interests.
• As financial distress deepens, creditors’ interests take priority.
• Mismanaging this shift can expose directors to personal liability, claims from insolvency officeholders and potential disqualification.

When is a company insolvent?

Under section 123 IA 1986, a company is deemed insolvent if:

• It is unable to pay its debts as they fall due (cash flow insolvency), or
• If its liabilities exceed the value of its assets (balance-sheet insolvency).

How is the zone different?

The zone of insolvency begins earlier, when the company is bordering on insolvency or where an insolvent liquidation or administration is probable.

Why it’s tricky in practice

It’s often unclear when a company crosses into this zone. Directors concerned about the company’s position should:

• Review financials regularly – including future and contingent liabilities.
• Document decisions and reasoning.
• Seek professional advice early to mitigate risks and demonstrate they acted responsibly.

Directors’ duties

Directors’ duties are primarily codified under the Companies Act 2006, which requires them to act in good faith, promote the success of the company and exercise reasonable care, skill and diligence. These duties apply to appointed directors and to shadow or de facto directors. However, once insolvency becomes probable, imminent or inevitable, directors must consider whether any particular course of action is in the best interests of creditors as a whole. ^[1]

Key areas of risk for directors include:

• Wrongful trading: A director may face personal liability for wrongful trading under section 214 of the Insolvency Act 1986 (liquidation) or section 246ZB of the Insolvency Act 1986 (administration) where they continue to trade from a point when they knew, or ought to have known, that there was no reasonable prospect of avoiding insolvent liquidation or administration. The court will then assess whether directors took “every step” to minimise losses to creditors. This includes monitoring financial forecasts, seeking professional advice and taking corrective action when distress becomes apparent. If the court is satisfied that this occurred, it may make a declaration that the director(s) are personally liable for the loss arising from the period that trading continued.The court will not make a declaration if a director took every step with a view to minimising the potential loss to the company’s creditors (e.g. voluntary commencement of an insolvency procedure).
• Misfeasance (breach of duty): Section 212 of the Insolvency Act 1986 provides a remedy for a company in liquidation to bring a misfeasance claim against directors who have carried out their duties in a way that causes harm or loss to the company – including the misuse of assets, neglect of creditor interests, misconduct harming the company or creditors. This may include the authorisation of a preference transaction or transaction at an undervalue (detailed below) The court may order repayment, restoration of property or compensation.
• Fraudulent trading: A director may face personal liability for fraudulent trading under section 213 of the Insolvency Act 1986 (liquidation) or section 246ZB of the Insolvency Act 1986 (administration) if they are found to have carried on any business with the intent to defraud creditors of for a fraudulent purpose. Insolvency practitioners are required to prove that the directors had intent, knowledge and acted dishonestly.

  Note – any person guilty of fraudulent trading also commits a criminal offence whereby the sanction could be imprisonment, a fine or both.

• Preference transactions: A director should be mindful in making selective payments or transfers that may prefer one creditor over others without clear commercial justification. A payment may be challenged as a preference if it places a creditor in a better position than others, was made with the company’s positive desire to prefer one creditor over another, took place within the statutory look-back period (six months for non-connected parties, two years for connected parties) and the company was insolvent at the time or became insolvent as a result.
• Transactions at an undervalue: Disposals of company assets at less than fair market value are particularly vulnerable, especially if made to directors, family members or other connected parties. Insolvency is presumed in these cases unless rebutted, and any such transaction within two years before insolvency may be set aside by the court.
• Misfeasance trading: Recently, the courts have confirmed that directors may be liable for continuing to trade the business of the company in breach of duty and under section 212 of the Insolvency Act 1986. This is referred to as misfeasance trading. The key difference between misfeasance trading and wrongful trading (see above) is the test regarding insolvency. In most cases, a company’s insolvency is likely to be deemed to have started earlier for misfeasance trading than wrongful trading and it is therefore, possible that a greater contribution to the company’s deficit may be recovered from the directors.

Across all of the risks outlined above, the threshold question is often what directors “knew or ought to have known” about the company’s financial position. This is a fact-sensitive test that reinforces the importance of robust governance, including the maintenance of decision-making records. Recent case law has confirmed where a company faces a liability claim of such magnitude that its solvency depends on successfully challenging that claim, the duty to consider the best interests of creditors arises where directors know, or ought to know, that there is at least a real prospect of the challenge to that claim failing. ^[2]

What consequences can directors face for breach of duty?

• Restoration and clawback: Insolvency practitioners can apply to the court to unwind preference or undervalue transactions, requiring the return of assets or repayment of funds.
• Contribution to company assets/personal liability: If the court finds that fraudulent or wrongful trading has taken place or a director has breached their duty to the company, the court may declare that a director make a contribution to the company’s assets or restore such loss arising from any breach of duty.
• Disqualification: In the event that the conduct of a director has fallen below the standard expected of a reasonable director, the individual may be disqualified from acting as a director for a maximum of 15 years upon an application under the Company Directors Disqualification Act 1986.
• Reputational and commercial impact: Even where legal sanctions are not imposed, directors may face reputational damage, loss of investor confidence and restrictions on future business opportunities.

Directors should adopt a cautious and proactive approach when signs of distress emerge. This means actively monitoring the company’s financial position, seeking early professional advice, avoiding selective payments or distressed disposals unless justifiable, and ensuring that all decisions are properly recorded in detailed board minutes. Maintaining a clear paper trail not only demonstrates that directors acted in good faith and with creditors’ interests in mind but also provides the best defence should their conduct later be challenged.

Key steps that UK directors can take to protect themselves:

• Seek independent legal and financial advice early: Where signs of financial distress emerge, directors should seek specialist legal and/or financial advice from an insolvency practitioner as soon as possible. They can advise the directors with respect to their duties and ensure that they do not take action that could result in personal liability. Advisers can also assist in identifying areas of risk where directors could potentially be in breach of their duties and provide guidance in dealing with circumstances that many directors may not have experienced. Any such advice received should be documented and fully considered in any decision-making process.
• Monitor financial position actively: A company’s financial position can deteriorate rapidly, and it may not always be immediately apparent when a company enters the “zone of insolvency.” Key indicators of insolvency include distressed cash flow, covenant breaches, customer/supplier insolvency, liquidity stress, large contingent liabilities, and wider sector/market disruption. Boards should therefore meet as frequently as is reasonable in the circumstances (even daily if financial distress is particularly acute) to consider whether the company is insolvent and to assess whether there remains a reasonable prospect of avoiding an insolvent liquidation or administration. It is advisable to keep up to date with the company’s valuation and balance sheet information, and, where financial difficulty is present, this may include consideration of weekly management accounts.
• Hold regular board minutes and maintain full records of decisions: If a company does enter into an insolvency process, the appointed liquidator or administrator will scrutinise the conduct of the directors prior to the insolvency to consider whether there are any potential actions that could be brought arising from actions or transactions that took place prior to any insolvency. They are also required to submit a report to the Secretary of State for Business and Skills with respect to their conduct.

  In order to demonstrate adherence to directors’ duties, it is important that board minutes and/or contemporaneous records reflect consideration of all proposed transactions or steps to be taken, together with any professional advice received. This is particularly important in relation to repayment of debt obligations, contracts to be entered into or disposal of any assets. A lack of documentation can be used as evidence against directors, increasing the risk of personal liability if their decisions are later challenged. ^[3]

• Review insurance policies and ensure they are up-to-date and sufficient: Directors are at higher risk of being personally sued by creditors, regulators or other stakeholders during bankruptcy or insolvency. Having D&O insurance in place helps protect against these claims. If the company is exhibiting signs of financial difficulty or potential insolvency, directors should check the terms of their D&O coverage to ensure it is active and understand exactly what it covers or excludes. The amount insured should be sufficient to cover potential claims which can increase during restructuring, and directors should confirm that all current directors, officers and newly appointed board members are included.

Run-off (or “tail”) coverage provides protection for directors after they leave the company or after the company ceases trading and may be valuable if a liquidation or sale is likely.

Directors should inform their insurers as soon as they become aware of circumstances that could lead to a claim, as failure to notify can invalidate coverage. Maintaining detailed records of all communications with insurers and advisers regarding insurance can help reduce the risk of personal liability.

Practical takeaways for investor representatives:

• Stay actively engaged: When a company is insolvent or in the zone of insolvency, investor directors should ensure they are actively reviewing the company’s financial health, transactions and board decisions. Active oversight helps identify problems early, demonstrates fulfilment of duties, and, where appropriate, allows directors to express and record disagreement with proposed actions.
• Speak up and document concerns: In an insolvency context, failing to challenge questionable decisions can expose investor representatives to scrutiny. If a proposed action or decision could harm creditors or is not in the company's best interests, concerns should be raised and formally recorded in board minutes or correspondence.
• Recuse yourself when appropriate: Recusal helps avoid conflicts of interest and demonstrates that directors are adhering to their duties. If board decisions involve repaying debt to your investor, step back from the discussion and decline to vote. During insolvency, directors are under greater scrutiny, and following these practices helps demonstrate compliance with legal duties.

Conclusion

As financial pressures mount, the responsibilities of directors evolve rapidly, and the risks of missteps increases. Recognising the shift in duties when a company enters the zone of insolvency is critical, not only to safeguard the business but also to protect directors from personal liability and reputational harm. Proactive engagement, robust governance and early professional advice can make the difference between navigating distress effectively and facing severe consequences.

For directors and investor representatives, vigilance, transparency and a willingness to adapt are essential. If your company is approaching financial distress, reach out to our team who will help you understand your duties, manage risk and protect both your position and your business.

[1] BTI 2014 LLC v Sequana S.A. and others [2022] UKSC 25

[2] Hunt v Singh [2023] EWHC 1784 (Ch)

[3] Re BHS Group Ltd [2023] EWHC 2873 (Ch)