The risks of trading whilst insolvent

There must be a strategy in place for businesses that are trading when dealing with insolvency – this must be clearly achievable and show ability to return the company to profitability in the short term.

 

Without this, as a Director, you could face serious consequences. Read about what the risks of trading whilst insolvent are and how The Insolvency Experts can help.

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What does trading whilst insolvent mean?

Trading whilst insolvent means that a company is continuing with its daily operations and trading whilst unable to pay debts owed, or having liabilities that outweigh their assets. 

Firstly, in this type of situation, it is imperative that any decision by a board of directors to continue to trade an insolvent company, is fully explained in writing with justification and reasoning. 

Additionally, the directors must be aware that in the event of the company eventually entering a formal insolvency process (such as Liquidation), their actions will be fully scrutinised by the Liquidator or Administrator. If it is concluded that the rationale was not sound, they will face the potential for further action. 

 

What is Wrongful Trading?

Section 214 of the Insolvency Act 1986 deals with Wrongful Trading:

Under this section, Directors may become personally liable to contribute (i.e. pay towards) to the assets of a company if the company was allowed to continue trading at a time when a Director knew (or ought to have known) that there was no reasonable prospect of the Company avoiding insolvent liquidation.

If wrongful trading is proven, the directors can then be held liable to pay compensation equivalent to the estimated losses incurred by the company. This is calculated from the point that they “knew” or “ought to have concluded” the insolvency of the company to the point of formal insolvency. 

Depending on the size of the company and length of time between the two, these losses could be significant.

 

Is trading while insolvent illegal or classed as a criminal offence?

Trading whilst insolvent is technically a civil offence, not a criminal offence. This is when wrongful trading is discovered and it is apparent that the director of the company was acutely aware that the company was going to become insolvent, and yet continued to operate.

If directors begin to trade in unethical ways to attempt to recover from insolvency, this may enter the territory of fraudulent trading. Fraudulent trading is illegal and classed as a criminal offence.

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

There are a lot of different factors that indicate that a business is going to become insolvent. It is important that directors keep a close eye on these areas to avoid trading whilst insolvent.

Key indicators of imminent company insolvency are:

• Issues with results of a cash flow test, including it showing previous refusal of credit, threatened legal action and consistent harassment for payment by creditors.
• Debts outstanding to creditors, such as lending companies, banks or HMRC. HMRC debts are typically the most serious, so it is important to keep up with payments.
• Business mismanagement is often another key indicator of imminent insolvency. Wrong or delayed financial decisions being made by directors can be a severe warning sign of insolvency.

If you suspect that your company is heading towards insolvency, it is imperative that you contact an insolvency professional as soon as possible.

 

Laws regarding trading whilst insolvent

The Insolvency Act 1986 dictates the laws surrounding trading whilst insolvent. The 4 main areas that a business director should be aware of include:

Wrongful Trading – This is where a director continues trading whilst being aware that there was no reasonable prospect of the company avoiding insolvent liquidation, and causes additional loss to the company and its creditors. 

Undervalue Transaction – A transaction at undervalue is when a business asset is sold for less than its true value. If transactions at undervalue are entered into by a company that later becomes insolvent, it can result in serious repercussions for company directors who may be viewed as deliberately diverting assets away from creditors.

Preferences – Preferences are payments made by an insolvent company to one of its creditors within a specified time period before entering liquidation. The payment must also have been made with the intention to place that creditor in a better position than they would have otherwise been in, in the event of the debtor entering insolvency (“the Desire”). Again, this can result in serious repercussions for company directors.

Extortionate Credit Transactions – An extortionate credit transaction occurs when someone provides credit to the company where the terms of the credit require grossly exorbitant repayments to be made or where it otherwise grossly contravenes ordinary principles of fair dealing.

 

Risks for directors trading whilst insolvent

If you enter a formal insolvency process, such as Creditors Voluntary Liquidation (CVL) or Administration, the insolvency practitioner in charge will conduct an investigation into director conduct to ensure no wrongful trading took place.

If it is found that a director has traded wrongfully whilst insolvent, hasn’t made appropriate attempts to bring the business out of insolvency or has worsened the outcome to creditors by failing to deal properly with the company’s affairs, they will be reprimanded.

The main risks for directors in this case are as follows:

• Directors are made personally liable for the additional losses and will have to repay it themselves.
• Directors are disqualified from acting as a company director for up to 15 years.
• Directors may be investigated for fraudulent trading, which is a serious criminal offence.

It is never worth risking trading whilst insolvent. Insolvency professionals can help you to work through financial issues with the most appropriate insolvency process and protect you from personal liability.

 

 

What is Misfeasance and Breach of Duty?

A lesser used method of obtaining financial recompense against directors is that of Misfeasance or Breach of Duty. 

In certain circumstances, when proof of wrongful trading cannot be obtained, is disputed, or is too costly and/or time consuming to pursue, the misfeasance route can be pursued by the Insolvency Practitioner as a method of obtaining a suitable settlement for the benefit of the company’s creditors. 

Misfeasance is effectively the company suffering financially due to the actions taken by directors and, if proven, it can also lead to a financial penalty equivalent to the losses incurred by the company as a result of those actions. 

Overall, if the company is insolvent, it is imperative that independent advice is obtained from the company accountant or insolvency experts. This will provide some level of protection for directors if the advice is acted upon and it can limit the potential for personal exposure should the company eventually end up in a formal insolvency situation

 

How The Insolvency Experts can help if you are at risk of trading whilst insolvent

For advice on trading whilst insolvent, or for more information on directors duties and help during the insolvency process, get in touch with The Insolvency Experts today.

You can talk to our insolvency practitioners directly for advice on what to do when dealing with insolvency on 0300 303 8284.