Company trading while insolvent

Hello! I am Gemma, your friendly legal assistant here at Lawyer Destroyer. I can certainly explain what happens in this situation and help you understand your options.

When your company cannot pay its debts as they fall due, or its liabilities are greater than its assets, the company is considered legally insolvent. Depending on the exact circumstances, continuing to trade when your company is in this position carries serious risks for you personally as a director.

Whose interests come first:

Normally, a company director has a legal duty to promote the success of the business for the benefit of its shareholders. However, the moment you know, or ought to know, that the company is insolvent, this duty flips. Your primary legal obligation is now to protect the creditors, which means the people and businesses you owe money to. You must do everything possible to minimise the financial losses they might suffer.

The main risks of continuing to trade:

Wrongful trading:
If a liquidator is later appointed to close down your company, they will look closely at when the company became insolvent and how you acted afterwards. If they believe you knew, or should have known, that there was no reasonable prospect of avoiding going bust, but you kept trading and losing money anyway, they can accuse you of wrongful trading. The serious consequence here is that you could be ordered by a court to pay out of your own pocket to top up the company funds and compensate the creditors.

Fraudulent trading:
If you continue trading with the deliberate intention of avoiding paying off debts or defrauding your creditors, this is known as fraudulent trading. This is much more serious than wrongful trading. It is both a civil matter, meaning you could be personally liable for the company debts, and a criminal offence, which can lead to a fine or even a prison sentence.

Director disqualification:
A liquidator must also report on your conduct as a director to the government. If they find that your behaviour has been unfit, for example by continuing to trade at the expense of creditors while ignoring the obvious financial reality, you could be banned from acting as a company director for up to 15 years.

Practical next steps:

If you suspect your company is insolvent or heading that way, you need to act very carefully to protect both the creditors and yourself. Here is a sensible order of action:

1. Hold a board meeting. Sit down with any other directors to formally discuss the financial position. Make sure you keep thorough written notes or minutes of these meetings, recording exactly what you discussed and the reasons behind your decisions. This is crucial evidence to show you acted responsibly.

2. Do not incur new credit. Be extremely careful about taking on new loans, signing new contracts, or ordering supplies on credit if you know you cannot pay for them.

3. Treat all creditors equally. Do not pay off one favourite supplier, or a loan to a friend or family member, while ignoring the tax office or other creditors. This is known as a preference payment and can be reversed later by a liquidator, causing you much more trouble.

4. Speak to an expert immediately. Bring in a licensed insolvency practitioner or an accountant to review your finances. They will help you figure out if the business can genuinely be saved, perhaps through restructuring or an arrangement with your creditors, or whether you need to stop trading immediately and place the company into liquidation to prevent further losses.

Taking early action is the single best way to protect yourself from personal liability. If you need help finding an insolvency specialist to talk to, just let me know and we can point you in the right direction.