The NED’s Role When a Company Faces Insolvency or Financial Distress

By Adrian Lawrence FCA, founder of NED Capital · Part of the Board Governance Hub

Most of a non-executive director’s work is done when the company is healthy — overseeing strategy, challenging management, strengthening governance. But the moment that tests a board most is the one no one wants: when the company runs into serious financial difficulty and insolvency becomes a real possibility. At that point the role of a non-executive changes in an important and often misunderstood way. The duties shift, the stakes rise, and the decisions the board takes — and records — can have consequences for the directors personally. A non-executive who understands this in advance is far better placed to act well when it matters; one who does not can find themselves exposed.

This article explains how a non-executive director’s role and duties change as a company approaches insolvency, what the board must do, and where personal risk arises. It is general governance guidance, not legal advice: insolvency is a technical area of law, and any director facing a real prospect of insolvency should take specialist legal and insolvency advice immediately and in their own name. The purpose here is to help non-executives understand the territory before they are ever in it.

The Shift From Shareholders to Creditors

In normal times, a director’s overriding duty under the Companies Act 2006 is to promote the success of the company for the benefit of its members as a whole — in practice, its shareholders. But when a company becomes insolvent, or insolvency becomes probable, that duty changes: the directors must begin to act in the interests of the company’s creditors, because it is the creditors’ money that is now at risk. This is sometimes called the creditor duty, and the UK’s highest court has confirmed that it exists and that it is engaged as a company slides towards insolvency. For a board, the practical effect is profound. Decisions that would have been perfectly proper when the company was solvent — paying a dividend, favouring one creditor over another, taking on more risk to chase a recovery — may become improper once the creditor duty is engaged. A non-executive needs to recognise when the company is approaching that line, because the board’s whole frame of reference changes once it is crossed.

Recognising the line is itself a challenge, because distress rarely announces itself cleanly. It builds through tightening cash, breached or near-breached covenants, pressure from suppliers, and optimistic forecasts that keep being missed. One of the most valuable things a non-executive brings in this period is the independence to name the situation honestly when the executive team, understandably close to the business and hopeful of a turnaround, may be reluctant to. Asking the uncomfortable question — are we actually solvent, and can we be sure we can pay our debts as they fall due — is exactly the kind of challenge a NED exists to provide.

The Risk of Wrongful Trading

The specific personal risk that focuses directors’ minds in this situation is wrongful trading. Under the Insolvency Act 1986, if a company goes into insolvent liquidation or administration and, at some earlier point, a director knew or ought to have concluded that there was no reasonable prospect of avoiding that outcome, the director can be made personally liable to contribute to the company’s assets — unless they took every step they ought to have taken to minimise the potential loss to creditors. The test is not whether a director acted dishonestly; it applies to honest directors who simply carried on too long. Crucially, the standard expected takes account of the skills a director actually has as well as those reasonably expected of someone in the role — so a non-executive with a financial background may be held to a higher standard on the financial questions. The lesson for a NED is that, once insolvency is a real risk, continuing to trade is not a neutral act: either there is a reasonable prospect of avoiding insolvent liquidation, in which case the board can continue while taking steps to protect creditors, or there is not, in which case continuing can create personal liability. Knowing which, and documenting the basis for the board’s view, is central.

What the Board Must Do

When a company enters this zone, there are concrete things a well-run board does, and a non-executive should press for all of them. First, get the real financial position in front of the board — current and forecast cash flow, the true creditor position, and a clear-eyed assessment of the facilities and covenants — and insist that it is realistic rather than hopeful. Second, take professional advice early: specialist insolvency and legal advice, taken before decisions are made rather than after, is both the right thing to do and strong evidence that the directors acted responsibly. Third, meet more often and keep proper minutes: as distress deepens, the board should convene frequently, consider the position afresh each time, and record what it knew, what advice it took, and why it decided as it did. Fourth, actively consider the options — refinancing, new investment, a sale, a restructuring, or a formal insolvency process — rather than drifting. And fifth, keep the interests of creditors squarely in view in every decision once the creditor duty is engaged. For a non-executive, the role through all of this is to ensure the board actually does these things, to bring independent judgement to the assessment, and to make sure the hard questions are asked and answered.

The Value of the Minute

It is worth dwelling on documentation, because it is where non-executives most often protect both the creditors and themselves. If the company does fail and a liquidator or the courts later examine the board’s conduct, the question will be what the directors knew and what they did about it at each point. A clear minute — showing that the board considered the financial position honestly, took advice, weighed the options, and had a genuine basis for believing there was a reasonable prospect of recovery at the time it decided to continue — is the best evidence that the directors behaved properly. For a non-executive who raised concerns or pressed for advice, it is also the record that they did so. This is not about building a defensive paper trail for its own sake; it is that good process and good evidence are the same thing. A board that thinks clearly, takes advice and records its reasoning is both acting in creditors’ interests and protecting its directors, and a non-executive should be the one insisting the minutes capture it.

When a NED Should Consider Resigning — and When Not To

Non-executives sometimes assume that resigning is the way to limit their exposure as a company falters. It is rarely that simple. Resigning does not erase liability for the period a director was in office, and walking away at the moment a company most needs independent oversight can itself be a failure of the role. In most cases the better course is to stay and insist the board does the right things — takes advice, protects creditors, and acts responsibly — because that is both the proper discharge of the duty and the best protection against a later claim. There are situations where resignation becomes appropriate: where the rest of the board is set on a course the non-executive believes is wrong and cannot shift it, where advice is being ignored, or where staying would mean being party to something improper. Even then, a NED should take their own advice before resigning and should record their reasons. The general principle holds: a non-executive’s value in a crisis is in staying engaged and holding the board to proper conduct, not in stepping back from it. Where a board needs genuine strength added at this point, our turnaround and restructuring NED work and our guidance on appointing a NED for a turnaround address exactly that need.

Frequently Asked Questions

Do a non-executive director’s duties change as a company nears insolvency?

Yes. When insolvency becomes probable, directors — executive and non-executive alike — must begin to act in the interests of creditors rather than shareholders, because it is creditors’ money now at risk. Decisions that were proper when the company was solvent may become improper once this creditor duty is engaged.

Can a non-executive be personally liable for wrongful trading?

Potentially, yes. If a company enters insolvent liquidation or administration and a director continued trading when they knew or ought to have known there was no reasonable prospect of avoiding it, they can be ordered to contribute personally — unless they took every step to minimise loss to creditors. It applies to honest directors who carried on too long.

Should a NED resign if the company is heading for insolvency?

Usually not. Resigning does not remove liability for the period in office, and leaving when oversight is most needed can be a failure of the role. The better course is generally to stay, insist the board takes advice and protects creditors, and record the reasoning — resigning only where a wrong course cannot be changed.

What should the board do first?

Get a realistic picture of cash flow and the creditor position in front of the board, take specialist insolvency and legal advice early, meet frequently and minute decisions properly, and actively consider the options rather than drifting. A non-executive’s job is to make sure the board actually does these things.

NED Capital | Sister practice of FD Capital | ICAEW practising certificate held by Adrian Lawrence FCA. This article is general guidance and not legal advice.