Directors who have been trading for many years become deeply accustomed to the concept of putting shareholders first. It is often a surprise, therefore, for them to realise that, at the point of insolvency, there’s a fundamental shift in responsibility.
As soon as a director becomes away that the company is officially insolvent, that primary responsibility shifts from shareholders to creditors.
In actuality, this moment of transition can be something of a grey area for directors, some of whom opt to continue trading despite the knowledge of their company situation. There are, however, strict laws around continuing to trade whilst insolvent, as we shall discuss.
Trading While Insolvent: Definition
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.
There are 4 key places whether the Insolvency Act 1986, the core document describing insolvency law in the UK, refers to trading whilst insolvent
- Wrongful trading: Section 214 – This is where a director knowingly continues trading while recognising that the company cannot avoid insolvency.
- Transaction at an undervalue: Section 238 – Where a director sells part of the company for less than its market value in the period preceding insolvency.
- Preferences: Section 239 – Where a director shows preference to paying one individual over another, rather than putting the creditors as a while first.
- Extortionate credit transactions – Section 244 – Whether credit from a finance provider has been obtained by a a director already aware of the company’s insolvency.
Is Trading While Insolvent Illegal or a Criminal Offence?
Wrongful trading is is a civil offence. Fradulent trading is considered a criminal one.
The basic law is from Section 214 of the Insolvency Act 1986, Wrongful Trading.
The key phrase for directors here is:
“At some time before the commencement of the winding up of the company, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation.”
This means that the director was aware of the situation, but chose to continue nevertheless. This means his actions did not put the interests of creditors first.
Risks for Directors While Trading Insolvent
- 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.
Company directors found guilty of wrongful trading could face disqualification for up to 15 years, in addition to being held personally liabile for some or all of the corporate debts.
Covid-19: Suspension of wrongful trading liability provisions
As part of the UK government’s business support during COVID-19, wrongful trading was suspended via the The Corporate Insolvency and Governance Act 2020 (the Act) which came into force on 26 June 2020.
These provisions came to an end on June 30th 2021, meaning that normal rules apply when it comes to wrongful trading.
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