Failing to understand the concept of trading insolvent can bring serious consequences for a company and its stakeholders, including charges of wrongful tradingTrusted 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 Is Insolvent Trading?

Insolvent trading, also known as “trading while insolvent,” refers to a situation in which a company continues to trade despite being unable to pay its debts as they fall due. 

Trading whilst insolvent can occur when a company’s liabilities exceed its assets, meaning that it needs more resources to meet its financial obligations. 

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.

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.

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?

Wrongful trading is a civil rather than a criminal offence, carrying potential fines, penalties and directorial disqualification of up to 15 years. It can mean directors face personal liability for corporate debts.

Fraudulent trading, on the other hand, is a criminal offence in the UK. It occurs when a company’s directors continue to trade a company with the intent to defraud its creditors or for any fraudulent purpose. 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. 

What are the UK Laws Concerning Trading Whilst Insolvent?

There are 4 types of potential insolvent trading under the Insolvency Act 1986 which may lead to financial and/or other legal liabilities for directors, which are:-

  • Wrongful trading: Section 214Trusted 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 238Trusted 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 239Trusted 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 244Trusted 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.

How to Avoid Trading Insolvent

Here are some practical steps that a company can take to prevent trading insolvent:

  1. Seek professional financial advice: Work with a financial advisor or accountant to identify potential financial risks and develop mitigation strategies.
  2. Monitor cash flow: Regularly reviewing and monitoring cash flow can help a company identify potential problems early and take corrective action.
  3. Plan for unexpected events: A company needs to have financial contingency plans in case of unforeseen circumstances.
  4. Stay current with financial obligations: A company needs to stay current with its financial obligations, including paying bills on time and meeting debt repayment schedules.
  5. Communicate with creditors: If a company has difficulty meeting its financial obligations, it is essential to communicate with creditors and explore potential solutions, such as negotiating payment plans.
  6. Keep accurate financial records: Accurate financial records can also help identify potential financial problems early on and allow for corrective action.

What are the Risks for Directors Trading Whilst Insolvent

There are several risks for directors who continue to trade a company while it is insolvent in the UK. These risks include:

  1. Personal liability: Directors who continue to trade a company while it is insolvent can be held personally liable for the company’s debts. This means that they may be required to pay the debts out of their own pocket.
  2. Financial penalties: Directors who engage in wrongful or fraudulent trading may face financial penalties, including fines and compensation orders.
  3. Criminal charges: In cases of fraudulent trading, directors can face criminal charges and imprisonment.
  4. Damage to reputation: Directors who are found to have engaged in wrongful or fraudulent trading may damage their personal and professional reputations, which can have long-term consequences.

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.

Summary

Insolvent trading happens when a company keeps on going despite the state of insolvency. Many directors are either unaware of insolvency or aware but don’t wish to accept that the company has failed. For directors, it’s a risky situation that could result in more serious consequences than simply closing the company. Sound advice and prompt action are needed.

FAQs

What to do if you think a company is trading insolvent?

If you think your company is trading insolvent, it is important to seek legal advice from a qualified professional. You should keep careful notes of your actions before then.

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.