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Limited company directors have a legal duty to always do what is in the best interest of the company and its creditors and in the event of the company becoming insolvent, they have a responsibility to keep losses to creditors at a minimum. Continuing to trade while insolvent, which could result in greater losses to creditors, can have serious consequences.
The Insolvency Act section 1986 outlines trading whilst insolvent, wrongful trading and fraudulent trading – all terms determining a state of trading. It is essential that directors are aware of these and manage their companies within the law.
Trading whilst insolvent
Because there are different ways of identifying if a company is insolvent, often limited companies may find themselves trading whilst insolvent.
If a company is balance sheet insolvent, it means that the company’s liabilities exceed the value of its assets. For new limited companies, or companies that have a small asset base and perhaps depend on borrowing, they can be trading while insolvent for years without any consequence, as the company is working and functioning. Some companies may also find themselves insolvent on a regular basis. Depending on how your cash flow works and how your incoming and outgoing payments work, you could be balance sheet insolvent regularly but able to function and trade efficiently.
Another indication of insolvency is where a company cannot meet its liabilities as they fall due – cash flow insolvent.
If you are a director and know your company is trading whilst insolvent and it is not a situation where the business can continue or recover, you then begin to run into wrongful trading, where the consequences can be severe.
Wrongful trading is a serious situation which can result in severe repercussions for company directors. Wrongful trading occurs when directors choose to continue trading, despite being knowingly insolvent, or when they should have known they are insolvent, with no chance of recovery.
If directors continue to trade their company, which results in the position of creditors worsening, they could lose the protection of limited liability. This is known as wrongful trading, which is a civil offence and in addition to directors potentially being held personally liable for company debts they could also be banned from being a director for up to 15 years.
A company trading fraudulently is doing so to deceive and defraud creditors and customers. A director managing a company to purposefully take credit from suppliers and customers knowing that they will not be repaid commits a criminal offence and directors can be punished with steep fines and could even face prison time depending on the severity of the fraud. They could also be held personally liable for company debts and be banned from being a director for up to 15 years.
Wrongful trading and fraudulent trading are serious issues which must be taken seriously. Although some businesses can successfully trade while technically insolvent, this can quickly become wrongful trading and could even lead to fraudulent trading.
How we can help
If you are a director and are worried that you are trading whilst insolvent, or you believe you could be accused of wrongful trading or fraudulent trading, it’s vital to seek advice as quickly as possible. Contact us without delay – we can let you know where you stand, and what steps you need to take to ensure you stay on the right side of the law.