Most company directors have heard the phrase ‘trading whilst insolvent’ or ‘wrongful trading’, but what does it actually mean?
A Liquidator can take an action for wrongful trading under Section 214 of The Insolvency Act 1986 against a director, if it can be shown that he;
knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation.
This also applies to shadow directors, more of which can be read about in our earlier blog entry here. A successful wrongful trading action taken by a Liquidator can result in a director being made personally liable for the company’s debts which occurred after he ought to have realised that the company was insolvent.
So, how would a director know his company is insolvent? The definition of insolvency, as stated in Section 123 of The Insolvency Act 1986 can be summarised as;
- The inability of the company to pay its debts as they fall due
- The value of the company’s assets being less than the amount of its liabilities.
All this law is very well and good, but practically, what can a director look out for to indicate that his company may be insolvent? Some common indications of insolvency are listed below;
- The company is failing to pay its creditors on time, resulting in County Court Judgements building up.
- Payments to HM Revenue & Customs in respect of VAT or PAYE are not made on time and arrears are starting to build up.
- Filing at Companies House is not up to date as accounting duties fall by the wayside whilst the company deals with pressing cash flow issues and creditor pressure.
- The bank starts returning the company’s cheques as unpaid due to constraints on the company’s cash flow and the overdraft limit is regularly exceeded.
It is a director’s responsibility to act in the best interests of the company and ensure that the creditors’ position is not worsened by a prolonged period of trade following the onset of insolvency. It is good practice for a director to regularly review the company’s financial position and ensure that they take specialist advice when needed.