Trading whilst insolvent is a legal term referring to a business continuing to trade despite being insolvent. If unaddressed, it can lead to much bigger problems later down the line. Directors have a legal responsibility to keep creditor losses to a minimum. As such, if directors knowingly trade whilst insolvent, they could be held personally liable for company debts.
What is trading whilst insolvent?
Trading whilst insolvent is when a company continues trading despite the directors knowing that it has become insolvent and has no future. There are two ways of defining insolvency: when a company can no longer keep up with day-to-day payments, or if the liabilities on its balance sheet outweigh its assets. The latter of which is called ‘balance sheet insolvency’.
How do I know if my company is insolvent?
Defined by section 123 of The Insolvency Act 1986, a company is deemed insolvent if it can no longer meet its day-to-day obligations, or if on the balance sheet, its liabilities outweigh its assets.
While some companies may find themselves ‘balance sheet insolvent’ depending on their incomings and outgoings affecting cash flow, the companies can still function and trade efficiently; able to repay their liabilities when they fall due.
Some common indications of insolvency include a company’s inability to pay its creditors on time, or when there is a build-up of County Court Judgements (CCJs).Understand if your company is solvent or insolvent
What are the potential consequences?
When a company enters a liquidation procedure such as compulsory or Creditors Voluntary Liquidation (CVL), the liquidator will investigate the conduct of directors who held office in the period before the company’s demise.
The liquidator will consider:
- If directors acted responsibly before and during the insolvency.
- Whether directors took appropriate action to mitigate creditor losses.
The information is then collated and presented to the insolvency service, who ultimately decide whether any further action needs taking or punishments issuing to the directors.
Suppose there is sufficient evidence that directors could have exercised a reasonable degree of foresight, or they’re deemed to have acted irresponsibly. In that case, they may find themselves personally liable for the company’s debt. The insolvency service may even issue a disqualification, which can result in individuals being banned from acting as a company director for up to 15 years.
Additionally, if the liquidator finds you have traded whilst insolvent, it could lead to accusations of wrongful trading.
What is wrongful trading?
Along with trading whilst insolvent, you may have heard the term ‘wrongful trading’. Wrongful trading involves directors continuing to trade through an insolvent company while knowing that the company is insolvent. Consequently, directors found to have committed wrongful trading could lose the limited company’s limited liability protection.More on wrongful trading
What to do if trading whilst insolvent
If you think your business may be trading whilst insolvent, or you believe that could soon become the case, it’s crucial you act as quickly as possible and establish whether the business is insolvent. Contact us as soon as possible; depending on your company’s circumstances we can either help with a recovery strategy or discuss company closure options. Speak to one of our friendly, experienced initial advisors for free, professional, confidential, and impartial advice with no obligation, and we’ll help you decide the best route forward. The faster you act, the smaller the risk of any accusations during any investigation.
How can I protect myself?
To avoid any accusations of trading whilst insolvent, it’s vital to seek insolvency advice as a company director. As soon as you’re aware you cannot meet your liabilities, you need to find the best solution for your company and its creditors.
Once a director becomes aware their company is insolvent, they have a duty of care to minimise creditor losses. To protect themselves, directors should avoid doing anything which could be to the detriment of company creditors, including:
- Taking company money to fund personal luxuries such as cars or holidays.
- Collecting an unreasonably high salary which the company cannot afford.
- Transferring assets from the insolvent company for free or significantly less than valued; attempting to exclude them from future insolvency proceedings.
- Paying creditors in preference to others.
- Collecting deposits from clients, knowing that works can’t be completed.
How we can help
If your company is insolvent and cannot repay its liabilities, speak to us and we will help find you the best way forward.
- Close the insolvent company
Sometimes, the company’s debts may be of such a level that it’s unfeasible or impossible to continue trading. In which case, you can choose to close the company through a Creditors Voluntary Liquidation (CVL). Closing the company writes off the associated debts.
More on closing through liquidation
- Repay your company’s debt in monthly instalments
Depending on the volume of the company’s debt, you may be able to pay it back in affordable, monthly instalments. You can do this through a Company Voluntary Arrangement (CVA). The arrangement involves repaying a portion of your company’s unsecured debts, usually over a period of five years. Afterwards, the remaining debt is written off.
More on Company Voluntary Arrangements
- Restructure the company through administration
If your company’s debts are substantial enough that repaying them isn’t feasible, you could explore administration. Administration involves a licenced insolvency practitioner taking control of the company, restructuring it to make it more appealing to any potential buyers.
More on administration
Trading whilst insolvent, or a business’ inability to repay its creditors when repayments fall due, is a serious issue. While occasionally, directors can find themselves unknowingly trading whilst “balance sheet insolvent”, the company must still be able to repay its debts on time. If the company is unable to, the directors can face serious repercussions, such as incurring personal liability for company debts, and possible disqualification from acting as a director for up to 15 years.
While there is some crossover between trading whilst insolvent and wrongful trading, the latter occurs when directors know their company has traded whilst insolvent and continue trading through the company without taking the necessary steps to tackle the insolvency. If liquidators find that wrongful trading has occurred, they can hold the directors personally liable for the company’s debts. Accusations of wrongful trading can sometimes lead to allegations of fraudulent trading.
If a company is ‘balance sheet insolvent’ it must have a feasible way of repaying creditors when repayments fall due. For example: if an incoming payment is due that exceeds the amount the company owes, allowing them to pay for the outgoings.
However, depending on the business’ circumstances, it may breach the Insolvency Act 1986. If you, as director, do not act in the company’s best interests and take the necessary steps to minimise creditor losses, then you can find yourself facing wrongful trading accusations.
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