Governance in Financial Distress: Strengthening Decision‑Making as Insolvency Approaches

Financial distress is a defining test of governance. It compresses timeframes, intensifies scrutiny and exposes weaknesses in reporting, oversight and decision‑making. While directors’ duties do not change, the context in which they are exercised becomes more demanding, and the consequences of poor governance become more acute. Decisions made during this period are routinely examined by insolvency practitioners, creditors, regulators and courts, often with the benefit of hindsight and detailed forensic analysis.

Boards that navigate distress effectively do so by lifting the formality, discipline and transparency of their processes. They recognise that governance is not a procedural formality but a strategic risk function that directly influences outcomes for the company, its stakeholders and the directors themselves.

Understanding the Company’s Position with Accuracy and Discipline

A board cannot discharge its duties in distress without a clear and current understanding of the company’s financial position. This requires:

• accurate liquidity reporting, including short‑term cashflow forecasts

• visibility over creditor exposure, including overdue liabilities and pressure points

• assessment of contingent liabilities, including litigation, guarantees and tax exposures

• realistic evaluation of restructuring options, not aspirational or management‑driven optimism

Distress exposes the limitations of informal reporting structures. Boards must insist on reliable information, challenge assumptions and ensure that management is providing a candid assessment of the company’s position. Where internal reporting is inadequate, directors should seek external financial or restructuring advice to ensure decisions are made on a sound evidentiary basis.

Directors’ Duties and the Shift Toward Creditor Interests

As financial pressure escalates, directors must apply their duties with heightened care. The law does not impose new duties in the zone of insolvency, but it does require directors to consider the interests of creditors when insolvency becomes a real possibility.

This requires:

• active interrogation of solvency, not passive acceptance of management’s view

• careful consideration of the impact of decisions on creditors

• ensuring decisions are made on a fully informed basis

• maintaining detailed records of deliberations and advice received

Boards should assume that their decisions may later be reviewed in detail. Contemporaneous records demonstrating informed, reasoned decision‑making are often the strongest protection against allegations of breach.

Managing Conflicts and Related‑Party Dealings

Related‑party dealings attract particular scrutiny in any subsequent insolvency process. Transactions involving directors, shareholders or connected entities are frequently challenged as unreasonable director‑related transactions, uncommercial transactions or unfair preferences.

Boards should:

• identify conflicts early

• ensure conflicted directors abstain where appropriate

• obtain independent advice on related‑party dealings

• document the commercial rationale for any transaction

• ensure the company receives fair value

The absence of clear records is often treated as evidence that proper governance was not followed.

Restructuring Pathways and Strategic Decision‑Making

Distress requires boards to consider a range of restructuring pathways, including:

• informal workouts with key creditors

• refinancing or recapitalisation

• safe harbour strategies

• asset sales or operational restructuring

• contingency planning for voluntary administration or liquidation

Each pathway carries different implications for stakeholders, and boards must ensure they understand the legal, commercial and practical consequences of each option. Early engagement with restructuring advisers allows directors to test assumptions, evaluate alternatives and make decisions that are defensible if later scrutinised.

Stakeholder Management and Communication

Distress often brings competing pressures from financiers, major creditors, shareholders, employees and regulators. Boards must manage these dynamics carefully, ensuring that:

• communications are accurate and consistent

• negotiations are documented

• commitments are not made without proper authority

• the company does not mislead stakeholders about its financial position

Poor communication can create additional exposure, including misleading or deceptive conduct claims.

Preparing for the Possibility of External Administration

If insolvency becomes unavoidable, the period immediately preceding the appointment of external administrators is often the most heavily examined. Boards should:

• ensure decisions are properly documented

• understand the implications of voluntary administration, receivership or liquidation

• avoid transactions that may later be challenged

• manage stakeholder communications with care

• seek specialist advice on the timing and process of any appointment

A structured, well‑advised approach significantly reduces exposure to claims involving insolvent trading, voidable transactions and other post‑appointment challenges.

How We Can Assist

If your organisation is experiencing financial pressure or approaching the zone of insolvency, early and informed guidance can materially influence the outcome. We advise directors, shareholders, creditors and insolvency practitioners on the full spectrum of issues that arise during financial distress — from assessing solvency and navigating restructuring options to managing stakeholder negotiations and preparing for potential external appointments.

Our work spans commercial litigation, shareholder and director disputes, misleading or deceptive conduct claims, urgent applications, and the full range of insolvency‑related disputes, including unfair preferences, voidable transactions and director‑related dealings.

Explore our related areas of practice:

• Commercial Litigation

• Shareholder & Director Disputes

• Misleading or Deceptive Conduct

• Urgent Applications & Injunctions

• Insolvency‑Related Disputes

Disclaimer

This publication provides general information only and may not reflect the most recent legal developments. It is not legal advice and should not be relied upon as such. You should obtain specific advice tailored to your circumstances before taking or refraining from any action.