How do you manage an insolvent company? When a company becomes insolvent the directors need to be aware that their obligations change from looking after the interests of the shareholders to looking after the interests of the creditors. So, this is a critical difference to the way directors must think when their limited company becomes insolvent.
How does a Company Become Insolvent
So, how does a company become insolvent? In very simple terms a company becomes insolvent when it can longer pay its bills, when due. You may have plenty of assets and this may eventually become relevant later on. Insolvency can also be determined by assessing the difference in value between assets and debts, but initially the ability to pay your bills when due is the most important. It really is as simple as that. Failure of an insolvent company can result in winding up petitions, county court action and statutory demands to name but a few.
Directors duty to keep creditors updated
As a director of an insolvent company you also have a duty to keep creditors updated regarding overdue invoice payments so it is important to maintain communication notes between you and the creditor. If you do receive funds and want to pay creditors then you need to be careful not to show preference to one creditor over another. As far as payments to creditors are concerned in theory you should pay all creditors fairly on a pair plus basis which literally translates into ‘on equal footing’ but in this case, means proportionate to the size of the debts.
Practically, however, it is very difficult to maintain this as you will always have one creditor more important than another. Your thinking has to change in as much you must ask yourself is paying one creditor and not another in the best interests of the creditors overall. For example where you have a major supplier and they are refusing to deliver supplies which are needed to complete a ‘job’ that, once completed, will release a lot of funds that will benefit all creditors. If so you may pay this supplier as you have deemed them to be an ‘essential creditor’. It is wise in these conditions to keep a central log of these decisions, as to why one creditor was paid over another if you are asked later if the worst comes to the worst.
Proof of Insolvency
Legal action such as county court judgments can act as a distinct stake in the ground acting as ‘proof of insolvency’. This may become relevant later on if the company goes into insolvent liquidation or is forced into a compulsory liquidation. The reason is that: if as a director you continue to trade and increase the size of the company debts in the period when you knew, or should reasonably have known, the company would end in an insolvent liquidation. You may be made personally liable for the debts accrued during this period. The county court judgement acts as proof of insolvency which should act as a warning flag. This continued trading is called wrongful insolvent trading but in fact, there is no such thing as wrongful trading in law; it is better to think of wrongful trading as irresponsible trading.
For example, irresponsible trading can mean taking a payment for an order for goods or services knowing you cannot provide the; or taking out a loan in the company name knowing the company is insolvent and the company fails anyway. So directors need to be very careful when considering borrowing their way out of an insolvent situation.
Negotiating with creditors in an insolvent trading situation is often a tricky situation as creditors may have lost confidence in the company and director’s ability to pay. Always keep creditors informed as you have a legal responsibility to keep creditors informed but unfortunately a lot of directors admit to ‘burying their heads in the sand’. To avoid this situation send them regular and frequent updates even if you do not have anything to report. Also just as important is to not over promise payments unless you are 100% certain you can deliver them. Nothing angers a creditor more than being a payment only for it to be missed.
Once creditors get angry they have a range of ‘weapons in their armoury’ including:
- County court demands
- Statutory demands
- Seizing assets
- Winding up petition
If these ‘weapons’ are deployed it is very difficult, but not impossible to get negotiations back on track so try to avoid these events if at all possible. Managing insolvent situations can be tricky and I advise engaging an insolvency professional to help guide you through the process as it can be a legal minefield. The worst thing you can do when faced with these ‘weapons’ is to put your head in the sand and hope the situation will get better by itself; it won’t.