What is Insolvent Trading?

Concerned about insolvent trading?

In this article we’ll explore the subject in depth, covering it’s meaning, whether it’s a criminal offence, and what your best course of action should be?

As one of the most common questions we are asked by the directors of struggling companies, 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. We explain more below.

Insolvent Trading - Insolvency Act

What is the Definition of Insolvent Trading?

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.

At the moment of insolvency, a directors fundamental responsibilities change. They are no longer to shareholders but to company creditors and it is to protect them that the laws around wrongful and insolvent trading have evolved.

Can an Insolvent Company Still Trade?

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.    

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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 it 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?

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.

Can Directors Be Held Personally Liable?

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?

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.  

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 [email protected] or call our senior consultant Sue directly on 07949 969 006.  

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