What is Insolvent Trading?
One of the most common questions we are asked by the directors of struggling companies concerns the risks of insolvent trading. Many directors know this is something they need to be careful about, but often they are unsure exactly what it means and what the potential repercussions could be.
Insolvent trading is the process of continuing the day-to-day operations of a business when it is no longer able to pay its debts. Broadly speaking, a business becomes insolvent when:
- It can no longer afford to pay its debts when they become due;
- Its assets no longer cover its liabilities.
You can find out if your business is insolvent using this free test. The risk is that by continuing to trade, you will incur further debts that the business won’t able to repay, potentially leaving your creditors further out of pocket. For this reason, it’s essential company directors have a good understanding of the financial health of their business and seek help as soon as they think the business could be insolvent.
As the director of an insolvent company, there are certain duties and responsibilities you must uphold. Failure to do so and if the business does enter an insolvency procedure that ends up in the termination of the company, you could be made personally liable for a proportion of the company’s debts.
Is Insolvent Trading a Criminal Offence?
Trading while insolvent in itself is not an offence. If you contact professional advisers as soon as the company becomes insolvent and they advise you that it is in the best interests of the creditors, the business and its employees to continue to trade, this could be a legitimate course of action. This will only be the case where the advisers believe the business is viable and can make a full recovery.
Insolvent trading becomes an offence where there is no reasonable prospect of saving the company and you continue to trade long after it should have been obvious that there was no way out. If the business does fail, the actions you took while the business was insolvent will be scrutinised and could give rise to accusations of ‘wrongful trading’. Wrongful trading is a civil offence.
Is Insolvent Trading the Same as Wrongful Trading?
No. Insolvent trading can be wrongful trading, but insolvent trading can also be a legitimate way of trying to turn the company’s fortunes around. The courts will typically find directors guilty of wrongful trading where they ‘close their eyes to the reality of the company’s position’ and it’s clear that continuing to trade will not maximise the creditor’s position.
According to section 214 Insolvency Act 1986, wrongful trading occurs when company directors continue to trade when:
- They knew, or ought to have known, that there was no reasonable prospect of avoiding insolvent liquidation;
- They did not take every step with a view to minimising the potential loss to the company’s creditors.
To avoid accusations of wrongful trading, company directors must be found to have acted reasonably and responsibly in the time preceding the company’s liquidation. They must also have put the creditors’ interests first. Once they are aware the company is insolvent, company directors should:
- Seek the advice of professional advisers (turnaround or insolvency practitioners) at their earliest opportunity. You should not delay as the actions of directions are judged from the moment they knew or should have known their company was insolvent.
- Evaluate the viability of the businesses using accurate and up to date financial information. That includes establishing future cash-flow needs, assessing the market and considering the sale of non-profitable assets.
- Ensure frequent board meetings are held and detailed minutes are taken of the proceedings along with the reasons for any decisions made.
- Discuss the company’s credit facilities with the financers to establish whether further funding is available to meet future cash-flow requirements.
- Inform major creditors of the company’s financial position on a regular basis and seek their support for the continuation of trading.
Being able to demonstrate that these steps have been taken gives directors of failed companies the very best chance of avoiding accusations of wrongful trading.
What are the Penalties for Trading While Insolvent?
When a company enters an insolvency proceeding such as administration, creditors’ voluntary liquidation or compulsory liquidation, the insolvency practitioner will always investigate the conduct of all the directors who held office during the previous three years. The purpose of the investigation is to ensure the directors have acted responsibly and taken the necessary action to mitigate creditor losses. This information is then presented to the government’s Insolvency Service, which will decide whether further action needs to be taken.
If it is found that the directors did not act in the best interests of the creditors, or worse still, acted completely irresponsibly, they could be made personally liable for debts the company cannot pay. It could also lead to a director disqualification of up to 15 years.
Is there a Statute of Limitations on Insolvent Trading?
Unless another time-frame is specified by the court then the limitation period for commencing proceedings against directors suspected of wrongful trading is six years. Therefore, you will not be charged after the six-year limitation period has passed.
How to Prevent Insolvent Trading
It would not be in anyone’s best interests if every company ceased trading and closed down at the first sign of financial trouble. However, if you are experiencing some level of financial distress then you must exercise caution and act before the situation worsens. As we have seen, trading while insolvent can bring accusations of wrongful trading, so the best course of action is to avoid insolvency altogether.
Some of the actions you should take to avoid insolvent trading include:
(a) Improving your cash-flow
Even a business that is trading profitably is in danger of becoming insolvent if it is unable to make payments when they become due. There are a number of simple steps you can take to improve your cash-flow situation. That includes:
- Invoicing your customers regularly and on time
- Chasing debts and never letting late payments go unchallenged
- Avoiding overtrading
- Holding less stock
- Renegotiating with suppliers
- Exploring alternative finance options like invoice financing
- Selling underused or unprofitable assets
(b) Keeping in contact with creditors
If you are struggling to pay your creditors on time then rather than burying your head in your sand, you should talk to your creditors, explain your situation and try to renegotiate the payment deadline or discuss a payment plan. If you owe your creditors more than £750 then they can issue a statutory demand against your company and petition to order the company in liquidation. Maintaining regular contact will help to reduce the likelihood of that happening.
(c) Reducing your overheads
If you’re struggling financially then it’s essential you review your overheads to see if savings can be made without reducing your ability to operate effectively. Potential savings include:
- Staff costs – reducing overtime and staff hours is usually preferable to making redundancies
- Premises costs – consider moving to smaller, cheaper premises or even subletting part of your existing premises
- Advertising costs and R&D – these are two costs that can be reduced quickly
(d) Seek professional advice
Don’t wait until your financial problems are out of control and the insolvency of your business is inevitable before you seek help. Taking timely advice from turnaround practitioners will give you the best chance to save your business and avoid insolvent trading.
What are the Guidelines for Insolvent Company Directors?
As the director of an insolvent company, you have certain duties and responsibilities you must meet. If you fail to uphold those responsibilities then you could be accused of wrongful trading and held personally liable for company debts. Engaging in any of the following practices while you are in control of the affairs of an insolvent company will greatly increase the risks:
- Carrying on trading with no intention of repaying
You must not continue to enter into new contracts and trade when you know you have no reasonable prospect of repaying your creditors.
- Attempting to repay debts through fraudulent means
If you try to repay debts through dishonest transactions you cannot fulfil or using misleading information to obtain loans then you could be convicted of fraudulent trading. Unlike wrongful trading, fraudulent trading is a criminal offence that could lead to a custodial sentence as well as personal liability for company debts.
- Selling assets for less than market value
You might think that selling assets at a reduced price to raise funds quickly and repay your debts would be an accepted practice. However, it could lead to your creditors receiving less of the money they are owed on liquidation. The court can reverse such transactions and order you to refund the proceeds of the sale.
- Repaying some creditors and not others
Company directors are obliged to act in the best interests of the creditors as a whole. Making payments to some creditors and not others is called showing ‘preference’. As an example, you may choose to repay a personally guaranteed loan or pay a supplier you know personally. The court can reverse such payments and order the creditor to refund the money.
The expert advice you Need
Although understand and adhering to your responsibilities as the director of an insolvent company might be confusing, the advice and assistance of our team can help you avoid personal liability and facilitate the best possible outcome for your business. For a free and confidential initial consultation, please call us on 08000 746 757, email firstname.lastname@example.org or call our senior consultant Sue directly on 07949 969 006.