Failing to understand the concept of trading insolvent can bring serious consequences for a company and its stakeholders, including charges of wrongful trading[1]Trusted Source – Legislation- Insolvency Act 1986, Wrongful trading against directors.

It is crucial to be aware of the signs of financial distress and act in accordance with the law should the company become insolvent.

Our complete guide will explain what trading whilst insolvent means, the warning signs, the consequences, and how directors can avoid it in the first place.

Trading While Insolvent

What Does Trading Whilst Insolvent Mean?

Trading whilst insolvent means that a business continues to operate even when it is unable to pay its debts as they fall due. In simpler terms, the business doesn’t have enough money to cover its outstanding bills or financial obligations.

In the UK, trading while insolvent can have serious legal implications, especially for company directors. This is a significant concern that warrants careful consideration and immediate action if a business finds itself in this situation.

Because insolvency means a company must prioritise creditors’ interests first, continuing to trade when aware the company has no future represents a breach of directorial responsibility.

What is an example of insolvent trading?

For example, if a company has debts of £75,000 but only has assets worth £50,000, it is insolvent and should not continue to trade. If it does continue to trade and take on additional debts, it would be considered to be trading insolvent.

What is Classed as Wrongful Trading?

As defined in Section 214 of the Insolvency Act 1986 (the Act), wrongful trading is the chief consequence of insolvent trading in UK law.

Wrongful trading refers to the situation where a director allows the company to continue trading while it is insolvent or fails to take steps to prevent the company from incurring further debts. 

When a company goes into liquidation, the Official Receiver (or insolvency practitioner) must submit a report to the Department for Business, Enterprise and Regulatory Reform (DBEER) where they see evidence of unfit conduct.

Under the Act, the court has the power to declare that a director is personally liable for the company’s debts if it is found that the director knew, or ought to have known, that there was no reasonable prospect that the company would avoid going into insolvent liquidation. The director failed to take every step that ought to be taken to minimize the potential loss to the company’s creditors.

If a director is found to have breached their duties concerning wrongful trading, they may be disqualified from acting as a director and may be subject to fines and even imprisonment. 

Is Trading Whilst Insolvent Illegal?

Trading whilst insolvent is a civil offence in the UK, not a criminal offence. However, it can still have serious consequences for company directors. If a company goes insolvent and the liquidator or administrator can prove that the directors continued to trade whilst the company was insolvent, the directors may be held personally liable for the company’s debts. They may also be disqualified from acting as directors in the future.

Fraudulent trading, on the other hand, is a criminal offence in the UK. It occurs when company directors knowingly trade a company whilst insolvent with the intent to defraud its creditors. This can include actions such as hiding or destroying company records, making false or misleading statements about the company’s financial health, or engaging in transactions that are designed to defraud creditors.

If a company is found to have engaged in fraudulent trading, the directors can be personally liable for the company’s debts and can face criminal charges, including imprisonment.

CharacteristicTrading whilst insolventFraudulent trading
Criminal offence?NoYes
Intent required?NoYes
Personal liability for debts?YesYes
Potential penalties?Fines, penalties, and directorial disqualificationFines, penalties, directorial disqualification, and imprisonment

What are the UK Laws Concerning Trading Whilst Insolvent?

In the UK, the Insolvency Act 1986 outlines four specific types of trading that may result in financial and/or other legal liabilities for directors. These are:

  • Wrongful trading: Section 214[2]Trusted Source – Legislation- Insolvency Act 1986, Wrongful trading – where a director knowingly continues trading knowing or where they should know that the company cannot avoid insolvency.
  • Transaction at an Undervalue Section 238[3]Trusted Source – Legislation- Insolvency Act 1986, Transactions at an undervalue – where a director sells company assets for less than market value in the period preceding insolvency.
  • Preferences: Section 239[4]Trusted Source – Legislation- Insolvency Act 1986, Preferences – where a director has favoured 1 or more creditors over others, rather than treating all creditors the same.
  • Extortionate Credit Transactions: Section 244[5]Trusted Source – Legislation- Insolvency Act 1986, Extortionate Credit Transactions – Whether credit from a finance provider has been obtained by a director already aware of the company’s insolvency.

For directors, the legal implications of engaging in any of these types of trading are significant. Penalties can range from being held personally responsible for the company’s debts to disqualification as a director for up to 15 years. Additionally, some offences like fraudulent trading can result in criminal charges, which may include fines or imprisonment.

What are the The Risks of Trading Whilst Insolvent?

Trading whilst insolvent is a serious offence with significant consequences for company directors.

The risks include:

  1. Personal liability: Personal liability for the company’s debts: Under Section 214 of the Insolvency Act 1986, directors can be held personally liable for the company’s debts if they continue to trade while the company is insolvent. This can have a devastating impact on a director’s personal finances, leading to bankruptcy in extreme cases.
  2. Disqualification from being a director: Directors who trade whilst insolvent can be disqualified from being a director for up to 15 years. This can significantly hinder their professional future, limiting opportunities for governance roles in the UK and internationally.
  3. Criminal charges for fraudulent trading: Under Section 246ZD of the Insolvency Act 1986, directors can face criminal charges for fraudulent trading if they intentionally defraud creditors. This can lead to imprisonment and substantial fines.
  4. Damage to reputation: When a company goes into insolvency, the matter becomes public. This can damage the director’s professional reputation and make it difficult to secure future employment or business opportunities.

It is important for directors to be aware of their responsibilities and to seek professional advice if they have concerns about the financial health of their company. Trading while insolvent can have serious legal and financial consequences for both the company and its directors.

What to Do if a Company is Trading Insolvently?

Insolvency practitioner Chris Andersen offers the following advice for directors:

  • Take professional advice immediately: our first consultation is always free and without obligation.
  • Ensure you understand your statutory obligations to prioritise creditor interests if your company is insolvent. If unsure of your company’s position, take our insolvency test.
  • Keep accurate notes of every action you take.
  • Prepare financial records for meetings with your accountant or an insolvency practitioner.
  • Don’t pay anyone, including yourself, until you understand your legal position.

How do I know if my company is or is going to become insolvent?

Identifying whether your company is at risk of insolvency involves looking at two key aspects: current financial state and warning signs for future vulnerability.

  • Can your company cover its bills as they fall due?
  • Are there frequent delays in payments to suppliers or employees?
  • Is there a consistent need for borrowing to cover operating expenses?
  • Do your liabilities (debts) outweigh your assets (what you own)?
  • Has there been a significant decrease in the value of your assets?
  • Are there large contingent liabilities (potential future debts) looming?
  • Is your company generating enough profit to cover expenses and debt repayments?
  • Has there been a decline in profitability over time?

Remember, early detection and proactive action are crucial when facing potential insolvency. Don’t hesitate to seek professional help if you identify any concerning signs.

FAQs

If a limited company’s directors are found to have traded wrongfully, they can be held personally liable for the company’s debts and may be disqualified from acting as a company director for up to 15 years.

The two primary tests are the cash flow test and the balance sheet test. If your company cannot pay its debts as they fall due, or if liabilities exceed assets, it is likely trading insolvent.

Cease trading immediately to avoid accumulating further debt and consult legal and financial advisors. You may also need to inform creditors and consider formal insolvency procedures like administration or liquidation.

Securing additional financing while trading insolvent is risky and may expose directors to personal liability. Any attempt to do so should be undertaken with extreme caution and professional advice.

Recovery is challenging but not impossible. It often involves a significant restructuring of debts, operations, and possibly the business model. Professional advice is crucial for navigating this complicated process.

References

The primary sources for this article are listed below, including the relevant laws and Acts which provide their legal basis.

You can learn more about our standards for producing accurate, unbiased content in our editorial policy here.

  1. Trusted Source – Legislation- Insolvency Act 1986, Wrongful trading
  2. Trusted Source – Legislation- Insolvency Act 1986, Wrongful trading
  3. Trusted Source – Legislation- Insolvency Act 1986, Transactions at an undervalue
  4. Trusted Source – Legislation- Insolvency Act 1986, Preferences
  5. Trusted Source – Legislation- Insolvency Act 1986, Extortionate Credit Transactions