New Guide to Trading Whilst Insolvent from KSA CompanyRescue

3 January 2009

"I have heard that trading whilst insolvent will lead to disqualification of the directors, is that true"?

Recent turmoil in the UK economy will lead to more and more companies facing uncertainty and financial difficulty. As a director you are protected from the consequence of a failed company by the “veil of incorporation”, PROVIDED that you acted reasonably, responsibly and within the law.

The key points to remember are if your company is insolvent, the directors have to take care. Under UK law, trading whilst insolvent can breach several provisions of the Insolvency Act 1986 which may have the effect of making directors of a company personally liable to contribute to the assets of a company.

The main provisions of the Insolvency Act 1986 that you should be aware of are:

Wrongful trading - Section 214 Insolvency Act 1986:

Transaction at an undervalue - Section 238 Insolvency Act 1986

Preference - Section 239 Insolvency Act 1986 (Unfair Preferences in Scotland s243)

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 become personally liable to contribute to the company's assets and help meet the deficit to unsecured creditors if the company's financial position is made worse by the directors continuing to trade, instead of putting the company immediately into liquidation.

In other words that veil of incorporation can be lifted and the directors’ protection removed. Then you may face wrongful trading accusations and possibly even directors disqualification.

How do I avoid personal liability?

Make sure that you read our guides to wrongful trading and is our company insolvent. 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 as well as budgets for profit and loss.

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 its 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, ask for time to pay tax and had carefully thought things through.

If the company’s performance continues to weaken and for example the board cannot meet redundancy payments, then more radical surgery may be required such as administration, company voluntary arrangement or it may be time to liquidate if the company is not viable and cannot be restructured.

The liability in respect of other transactions only extends for a certain period of time prior to the company going into liquidation. Directors are exposed in respect of transaction at an undervalue, preferences for example if the transaction occurred: a) whilst the company was insolvent; and b) within 2 years before the onset of liquidation if the transaction was with a connected person, and 6 months if the transaction was with an unconnected person.

What if we HAVE traded whilst knowingly insolvent?

Directors who continue to trade whilst insolvent may face disqualification under the Company Directors Disqualification Act 1986 if the company goes into liquidation.

Under the provision of the Act, when a company goes into liquidation, the liquidator must make a report to the Disqualification Unit of the Department of Trade and Industry on the conduct of all directors or shadow directors. This is called a "D report" and most often these are mildly negative or positive.

If the liquidator has discovered wrongful trading or conduct which in his or her opinion, makes the directors unfit to be involved in the management of a company in the future DBERR, (was DTI) may apply to the Court for an order disqualifying the director or directors from acting as a company director for a certain period.

It should be noted that director’s disqualifications are still relatively rare (there are only around 1,000-1,500 per year) but with a special web site to stop rogue directors www.companieshouse.gov.uk continuing to act illegally.

In the early part of this decade 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. In other words rather than take 3-5 years to proceed with actions by the state followed by, say, an 8 year ban, the director can elect to admit liability immediately for say a 2-3 year ban.

So what is your advice to avoid trading whilst insolvent, wrongful trading and possible personal liability?

If it smells off it generally is OFF is the best place to start!!

Acting sensibly, reasonably and responsibly is always the best policy for directors of limited companies. If the company has cashflow problems, ACT, hold meetings, regularly, prepare financial information, plan to do deals with creditors or a CVA, introduce new money, and take salary sacrifices. These can all help, but if the business condition starts to deteriorate, 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 info@companyrescue.co.uk or call free of charge on 0800 9700539