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When a company is in financial difficulty, directors often turn to an insolvency practitioner for advice. A common misunderstanding is assuming that the insolvency practitioner acts for the director personally. Under the law of England and Wales, that is not the case.
Once a company is insolvent, or likely to become insolvent, an insolvency practitioner’s primary duty is to act in the interests of the company’s creditors as a whole. They do not act for the director, even if the director initially sought their advice. This distinction is critical and frequently gives rise to disputes.
This case illustrates how insolvency practitioner claims can arise, how they are assessed by the courts, and how a careful review of the financial evidence can lead to a more proportionate settlement.
Background
Our client was the sole director and shareholder of a small grocery business that suffered a sustained drop in income during the COVID-19 period. As trading conditions worsened, she became concerned about whether the company could continue to operate and what her legal responsibilities were as a director.
Under English law, when a company is solvent, directors owe their duties primarily to the company and its shareholders. However, where insolvency is probable, directors must begin to consider the interests of creditors. This shift in focus often creates uncertainty for small business owners.
To understand her position, our client approached an insolvency practitioner for advice on the available options, including whether the company should continue trading or be closed. She sought guidance on potential personal liability, creditor interests and compliance with her duties as a director.
The insolvency practitioner concluded that the company was insolvent and proceeded to place it into an insolvency process.
After the insolvency, our client was shocked to learn proceedings were issued against our her personally by the very insolvency practitioner she approached.
The Claim Brought Against the Director
The insolvency practitioner brought a claim valued at approximately £130,000. It was alleged that our client had misapplied company funds and had committed misfeasance and breaches of fiduciary duties.
In simple terms, the claim alleged that our client had improperly benefited herself at the expense of the company’s creditors.
The specific allegations were that she had:
- Paid herself approximately £104,000 from company funds
- Caused the company to pay around £20,000 to a bank towards her personal mortgage
- Transferred a company-owned motor vehicle to her partner
It was alleged that these transactions took place when the company was insolvent or close to insolvency. The insolvency practitioner argued that the payments amounted to transactions at an undervalue and/or preferences, meaning that our client was said to have put herself in a better position than other creditors.
The claim sought repayment of these sums to the insolvent estate for the benefit of creditors totalling approximately £130,000 and potentially legal costs if our client was to lose at trial.
Our Instruction and Initial Assessment
IMD Corporate was instructed after the claim had already been issued. Our first task was to assess whether the claim was supported by a proper analysis of the company’s financial position and whether continuing the litigation was proportionate.
Insolvency practitioners are required to act in the interests of creditors, which includes considering whether the cost and risk of litigation is justified by the likely recovery.
We reviewed the pleadings, supporting documents and the company’s financial records. It quickly became clear that the claim focused almost entirely on money leaving the company, without examining the director’s full financial dealings with the business.
We advised our client that, given the cost of director liability litigation, a commercial settlement approach was likely to be preferable if the evidence supported it.
Forensic Review of the Financial Evidence
We carried out a detailed forensic review of the financial records. This included:
- Reviewing company bank statements and the director’s personal bank records
- Examining money transferred both out of, and into, the company
- Assessing the timing of transactions in relation to the alleged insolvency date
This review showed that while our client had made certain personal payments from company funds, she had also paid significant sums into the business from her own personal account.
Those personal contributions reduced the net effect of the payments relied upon in the claim. When the full financial picture was considered, it was not clear that the company’s overall position had been worsened in the way alleged.
This weakened the insolvency practitioner’s case on misfeasance, preference and transactions at an undervalue. Importantly, the original claim did not take these counter-payments into account.
Settlement Strategy and Outcome
The insolvency practitioner initially made a without prejudice offer of around £110,000. In our view, that figure did not reflect the financial evidence, the litigation risks or the duty to act proportionately in the interests of creditors.
Following without prejudice negotiations, and shortly before trial, the matter settled on the basis that our client would:
- Pay a £15,000 lump sum, and
- Pay £75,000 split over 3 years to ease its financial burden.
The settlement represented a reduction from the amount originally claimed and avoided the uncertainty and expense of a contested trial.
Key Legal and Practical Points
1. Insolvency practitioners act for creditors, not directors
Once insolvency arises, practitioners must act in the collective interests of creditors. They do not advise or protect directors personally.
2. Claims must be based on the full financial picture
Misfeasance, preference and undervalue claims may require a holistic assessment of all financial movements, not just payments out of the company.
3. Forensic analysis can change the outcome
A detailed review of both company and personal accounts often reveals a very different position from that presented in the initial claim.
4. Settlement is often the most sensible route
In many insolvency cases, settlement preserves value for creditors and avoids disproportionate legal costs.
5. Early legal advice is critical for directors
Directors should obtain independent legal advice as soon as insolvency becomes a concern.
Conclusion
This case highlights the importance of understanding how insolvency law operates in practice. While directors often approach insolvency practitioners for guidance, those practitioners ultimately owe their duties to creditors.
Please do not hesitate to contact us should you require advice in respect of a similar issue or if you are served with proceedings for breach of fiduciary duties.
This article is for general information only and does not constitute legal or professional advice. Please note that the law may have changed since this article was published.