Beware Of Trading When Your Company Is Insolvent

Continuing to trade while your company is technically insolvent could lead to big problems for the directors, as it could lead to limited liability no longer applying, and leave them on the hook personally for outstanding debts.

A company would be considered insolvent if it cannot pay its debts when they fall due, or its liabilities exceed its assets. There are two specific legal tests that can be applied to check if a company is insolvent:

• The Cash Flow Test (Insolvency Act 1986): the company can’t pay its bills, suppliers, HMRC or lenders on time. This would include juggling payments such as VAT or PAYE, or you’re ignoring letters from creditors.
• The Balance Sheet Test (Insolvency Act 1986): The company’s total liabilities, including contingent and future ones, are greater than its total assets.

If either of these tests are met, then the company is likely to be insolvent, even if the company is still able to trade day-to-day.

What happens if you continue to trade and meet these tests?

If you continue to trade while insolvent, it isn’t automatically illegal. But if you take on new debts or contracts while you know you can’t meet existing obligations, it can cross into wrongful trading or fraudulent trading, or both. When this line is crossed, it could carry personal consequences for directors.

For example, the detail related to Wrongful Trading under the Insolvency Act 1986, highlights that directors should have known or ought to have known that the company had no reasonable prospect of avoiding insolvency.

If you continued to trade, then you could be made personally liable for debts as a director of the business from that point onwards, and/or potentially disqualified as a director for up to 15 years. Ignorance isn’t a defence, as directors are expected to keep adequate financial records so they constantly understand their company’s solvency position.

When does it become Fraudulent Trading?

Fraudulent Trading under the same Act is where you continue trading and intentionally defraud creditors, or for any other fraudulent purpose, it then becomes a criminal offence. Under these circumstances, you could be held personally liable for debts and fines, and face up to 10 years in prison.

Under the Company Directors Disqualification Act 1986, the Insolvency Service can disqualify you for between 2 and 15 years if they find you are not considered a “fit and proper” person, which includes trading while insolvent.

Ordinarily, a limited company means the company’s debts are separated from you personally. But under the circumstances mentioned above, you can be held personally responsible for losses to creditors. But if you suspect your company could be close to the line, then there are a few things you should do:

• Stop incurring new debts.
• Record concerns in a board meeting, and call one if there isn’t one planned.
• Seek professional insolvency advice from a licenced insolvency practitioner.
• Maintain accurate records to show you acted prudently, which can provide some protection for you.
• Consider restructuring the company through administration, a Company Voluntary Agreement (CVA), or liquidation if it becomes necessary.
• Monitor cashflow weekly and monthly.
• Take early advice so you prove you have acted responsibly which means you can avoid personal risk and perhaps even rescue the business.

We can help you meet your obligations

If you have any concerns about the solvency of your business, then speak to your accountant as soon as possible. So, please get in touch and we would be happy to give you the guidance you need.