What is the reality of trading while insolvent? Debbie Cockerton navigates you through these dangerous waters
To an insolvency practitioner the expression “trading whilst knowingly insolvent” is used on a daily basis. However, if you are a director of a limited company and you are met with this expression this may cause you some stress.
Owners of a business may be hit by cash flow problems as their clients may be reluctant to pay out, especially this time of the year. Or there could be a slow down, with incoming orders and any cash reserves that a company may have had being quickly diminished. There is also the danger of increasing overheads, with rates going through the roof from April 2017.
Business owners always ask themselves if this is just a short-term blip – or if this is the start of a spiralling end to their much-worked-for business.
The phones may not be as busy and orders are thin on the ground. Suppliers are constantly chasing for money, the bank is pressing for repayment of the overdraft and there is always the wages, rent and utilities to pay, even before the director takes any wages. “Why are we doing this?” many people ask themselves.
The main sections of the Insolvency Act 1986 (IA1986) that a business owner needs to understand and to be aware of are:
- Wrongful trading (Section 214 IA1986)
- Transaction at an undervalue (Section 238 IA1986)
- Preferences (Section 239 (IA1986)
If the business continues to trade when they are insolvent, the directors of the business can become personally liable to contribute to the assets of the company and could be faced with a fine, imprisonment and/or a disqualification order.
So what constitutes ‘insolvent’ (most people think that their business is just going through a rough patch) and what is ‘wrongful trading’ all about?
Under Section 123 IA1986, insolvency is the definition of inability to pay debts which outlines the following:
- If a creditor who is owed over £750 has served on the company registered office a statutory demand requiring the company to pay the sum due and the company has for three weeks neglected to pay the sum, secure or compound it.
- If in England and Wales, execution or other process issued on a judgment, decree, or order of any court is returned unsatisfied in whole, or in part.
- It is proved to the satisfaction of the court that the company is unable to pay its debts, as they fall due.
- The value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities
A wrongful trading action can be brought against the directors, and that includes shadow and de facto directors. To be found guilty of the offence, the court will need to see that the officer of the company ought to have concluded that the company had no realistic prospect of avoiding insolvent liquidation.
The courts will need to see that the company debts and liabilities have been incurred and increased, when there was no prospect of the debts being met and if the director “knew or ought to have concluded” that there was no reasonable prospect that the company would avoid going into insolvent liquidation.
So what can the directors do to protect themselves? The courts will look to see that the director took every step with a view to minimising the potential loss to the company as he ought to have taken. In layman’s terms this means:
- Prepare up-to-date management accounts.
- Make sure that the books and records are kept up-to-date.
- Regularly monitor the situation.
- Consult with the bank.
- Document any decision to continue to trade.
- Avoid dissipation of assets.
- Do not sell assets at undervalue.
- Do not prefer any creditors over others.
- Do not incur new credit.
- Do not take deposits if you aware that the order will not be fulfilled.
- Resignation is not an option!
So, if after taking all these steps the situation does not improve you should arrange to see an insolvency practitioner, who will be able to guide you down the correct path. This does not mean that all directors will face prosecution if the business is struggling and becomes insolvent. The courts will look at what the directors did and the manner in which the company traded, as well as what could be reasonably be expected of a person in that position with the particular director’s experience and knowledge.
If a client’s business is struggling then the earlier they take advice from an insolvency practitioner the more choices they will have. And they may also be able to continue along a very narrow pathway of not committing an offence under the Insolvency Act 1986.
- Debbie Cockerton is a partner at DCA Business recovery. Call 01702 344 558 or email email@example.com. To take advantage of DCA’s UK Recovery Helpline, which operates seven days a week (8am to 8pm), call 0800 066 2540
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