I have heard that trading insolvently is a criminal offence, which will lead to disqualification of the directors.
Trading while insolvent is NOT a criminal offence in the UK. The criminal offence is Fraudulent Trading. The risk is that continuing to trade while insolvent can lead to the civil offence of Wrongful Trading and Director Disqualification.
First we need to establish if the company is insolvent, there are 3 criteria from the Insolvency Act 1986 which are used.
This final test also known as the “Legal Action Test” is basically proof of the inability to pay.
So, trading whilst insolvent is a legal term used to describe a business which continues trading when it is insolvent. This action can lead to a breach of several provisions of the Insolvency Act 1986. So, it is important to take care and know the risks if your business is struggling.
If the company IS insolvent, and if the board of the company continues to trade whilst it is insolvent, the directors of the company may face penalties.
The directors have a duty to act in the best interest of creditors and not make the situation worse. As such, they should be taking advice on how to remedy the situation. This could involve putting the company into administration or liquidation.
Personal risk for the director happens if the company enters terminal insolvency such as administration or liquidation.
The “veil of incorporation” can be lifted and the directors protection removed. As a director of an incorporated company you are protected from the consequence of a failed company, provided that you acted reasonably, responsibly and within the law. Failure to do so could make directors personally liable for the company’s debt.
Wrongful trading occurs when company directors have continued to trade when they knew, or ought to have known that there was no reasonable prospect of avoiding insolvency. In addition, they did not take every step with a view to minimising the potential loss to the company’s creditors.
Wrongful trading or ‘trading irresponsibly’ is a civil offence and is covered by section 214 of the Insolvency Act 1986.
If successfully pursued by a liquidator, directors can be held personally liable for the company’s debts incurred during that period. For a full breakdown of the legal test, the burden of proof, and director liability, please read our comprehensive guide: What is wrongful trading?
The liquidator will file what is a called a D1 form with the Insolvency Service recommending that the director is disqualified from being a director. It is a criminal offence to become or act like a director in a company while the disqualification period is in force. This can be from 2-15 years.
It should be noted that directors disqualifications are still relatively rare (there are only around 1,000-1,500 per year). However, due to some high profile disqualifications, they are much more in the public domain.
Government policy was also beefed up with the introduction of the Insolvency Act 2000. Part of that legislation was designed to speed up the disqualification process and increase the volume of directors disqualifications.
In a “fast track” approach directors can admit they have acted wrongly in return for lower penalties.
A potential “preference” occurs when a company pays a specific creditor or group of creditors(s) and by doing so makes that creditor “better off” than the majority of other creditors, before going into a formal insolvency like administration or liquidation. However, the second important test is that there must be a “desire” to make that particular creditor better off. A preference payment can be reversed in liquidation. This will mean that a court order can be made that demands the recipient to repay the money. However, if they cannot then the court can demand that the director makes a contribution and/or a compenstation payment to the company to restore its position.
A transaction at an undervalue is when an asset is transferred for no payment or sold at below their true value. The transaction becomes a problem if the company is insolvent, as any transfer at an undervalue is, in effect, depriving the creditors of money owed to them. Again this can be reversed by a court and so the recipient of the asset can be ordered to pay the difference between what they paid and the market value. If the recipient cannot pay then the directors can be forced to make up the difference.
Make sure that you read our guides to wrongful trading. You should also have up to date management accounts and financial information. It would make sense in such scenarios to have a daily cashflow model.
Secondly, make sure that you are fully aware of the current position: for example as a sales director you MUST know the financial position even if it’s not your area of interest.
Have regular minuted board meetings to discuss the position, question the cashflow and numbers, and take decisions to act. This will help protect you and underpins why you were taking the decisions to continue trading.
If the company’s performance continues to weaken, and for example the board cannot meet redundancy payments, then more radical surgery may be required. This could be taking action such as putting the company into administration, or a company voluntary arrangement. If the company is not viable and cannot be restructured then liquidation is the answer.
Worried about insolvent trading?
Call our licensed Insolvency Practitioners for confidential advice.
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So what is your advice to avoid trading whilst insolvent, wrongful trading and possible personal liability?
If it smells off it usually is OFF is the best place to start!! A classic wrongdoing is taking deposits for work that you KNOW cannot be carried out and using the proceeds to pay off debt.
Acting sensibly, reasonably, and responsibly is always the best policy for directors of limited companies. If the company has cashflow problems then you must ACT. So,
These can all help, but if the business condition starts to worsen further, then ACT quickly, get professional advice and set out a plan.
We are happy to discuss the content of this guide with any director or advisor to a company, simply email help@ksagroup.co.uk or call free of charge on 08009700539
We are experts in business rescue, corporate rescue and company rescue, we can help sole traders, partners and directors.
Written ByKeith Steven
Turnaround Director
Keith is the Turnaround Director of RMT Accountants & Business Advisors. Prior to being acquired by RMT his company KSA Group has undertaken more than 300 CVA led rescues. Read our case studies to see how.
