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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.

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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.

What are the Rules Surrounding Trading Whilst Insolvent?

If you don’t have enough to make repayments but the debt remains small, it may be possible to continue trading without breaking the law. However where the following conditions are met, you must stop immediately and contact an insolvency practitioner.

(a) If your debt is greater than £750

(b) If you have violated the terms of a loan agreement already by not paying.

If you believe your company may be insolvent, we recommend using our simple and instant corporate insolvency test here.

Is Trading While Insolvent Illegal or a Criminal Offence?

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.

Wrongful Trading

Where that can be proven the director can be convicted of Wrongful Trading which is a civil offence carrying penalties of directorial disqualification of 2-15 years, fines and, in severe cases, imprisonment.

Directors Risks While Trading Insolvent

Once a company is in liquidation, one of the tasks of the insolvency practitioner is to investigate the actions of the directors in the period prior to insolvency. This is the point at which wrongful trading is usually discovered, commonly by the IP hired by company creditors to get their money back.

Can Directors Be Held Personally Liable?

For directors, one of the most serious consequences of wrongful trading may be the fact of being held personally liable for company debt. Whilst insolvency laws are generally there to keep a clear line between corporate and personal finances, wrongful trading is one of the rare instances where this veil can be breached.

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.  

Can a Company in Administration Continue to Trade?

When a company goes into administration it usually does so to allow for a period of restructuring, and with the hope that it will return to profitability. Because of this, trading administrations are common, meaning the business keeps on running as usual, with the intention of maintaining continuity.

Administration also places a legal ring fence (moratorium) around the company, to protect it from any creditor threats while the process unfolds.

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.

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.

Do You Need Help with Insolvency or Directorial Liability Charges?

Contact us for a free, no-strings-attached conversation in the strictest confidence. Use the live chat, or call 08000 746 757.