Running a small business is a journey filled with ups and downs. While most directors focus on growth and success, recent landmark legal decisions—specifically the Supreme Court’s ruling in BTI v Sequana—have clarified exactly how your responsibilities change if the road gets a little bumpy.
Understanding these “three stages” isn’t about being fearful; it’s about having a clear map so you can make confident, informed decisions at every turn.
Stage 1: Business as Usual (Solvent & Stable)
When your company is financially healthy and can pay its bills on time, your primary duty is to promote the success of the company for the benefit of its shareholders.
- Your Focus: Growing the business and delivering value to members.
- Creditor Interests: At this stage, creditors don’t have a “distinct” say in your decision-making. As long as you are paying debts in the ordinary course of business, you are fulfilling your obligations.
- Action Step: Maintain “financial fitness” – keep accurate records and up-to-date management accounts to ensure you stay in this stage.
Stage 2: The “Twilight Zone” (Bordering on Insolvency)
This stage is triggered when insolvency becomes imminent or probable, or if a specific transaction might put you in that position. This is often called the “twilight zone” because the path ahead is uncertain.
- The “Sliding Scale”: Your duties now undergo a “shift”. You must begin to balance the interests of your creditors against those of your shareholders.
- The Rule of Weight: This isn’t a “cliff edge” where you suddenly ignore shareholders. Instead, it’s a sliding scale: the more “parlous” or precarious your financial state becomes, the more weight you must give to the interests of your creditors.
- “Skin in the Game”: Directors should ask: who risks the greatest damage if this decision fails? As assets dwindle, it is the creditors who have the most “skin in the game”.
- Action Step: Stop and seek advice. This is the time to double check and challenge your business plans and forecasts. Decisions should be made based on whether there is a realistic “light at the end of the tunnel”.
Stage 3: The Point of No Return (Insolvency is Inevitable)
If the company reaches a point where insolvent liquidation or administration is unavoidable, the landscape changes fundamentally.
- Creditor Paramountcy: At this far end of the scale, shareholders’ interests effectively “drop out of the picture”. Because they no longer have a residual economic interest (the shares are likely worthless), your duty is now to treat the company’s interests as equivalent to those of the creditors alone.
- Wrongful Trading Risk: Once liquidation is inevitable, you have a statutory duty to take “every step” to minimise potential losses to creditors. Failing to do so can lead to personal liability.
- Action Step: You must prioritise the creditor body as a whole. Avoid “last roll of the dice” gambles that risk remaining assets.
Practical Tips for Every Director
Regardless of which stage your company is in, following these best practices will help protect both the business and your personal position:
- Stay Informed: You have a legal duty to know your company’s financial position. Don’t wait for year-end accounts; use regular management accounts and cash-flow forecasts.
- Document Everything: Hold regular board meetings to discuss financial health. Record your decisions in detailed minutes, specifically noting why you believe a decision is in the best interests of the company (and its creditors, if applicable).
- Be Wary of Dividends: A dividend that is technically “lawful” under the Companies Act can still be a breach of duty if the company is in Stage 2 or 3.
- Know the Ratification Limit: Normally, shareholders can “forgive” or ratify a director’s mistake. However, once you enter Stage 2, shareholders are disabled from ratifying a breach of duty that harms creditors.
- Get Specialist Input Early: The “tipping point” between these stages is often only clear in the “rear-view mirror” of a courtroom. Early professional advice is your best defence in demonstrating you acted with honesty and integrity.
If you’re concerned about your company’s financial position or your duties as a director, our team is here to help you navigate these stages safely. Don’t ignore the situation, reach out for help.
