What are the risks of trading while insolvent?

How can you protect yourself from the risks of trading while insolvent?

If your business cannot pay its debts when they’re due or does not have enough assets to cover its liabilities, the likelihood is that it is insolvent. At this point, it becomes your legal duty as a company director to act in the best interests of your creditors. If your business has no hope of recovering or if continuing to trade will not lead to better returns for your creditors, you should stop trading and seek professional advice immediately.

If you continue to trade when you know or should know the business is insolvent and it has little chance of recovery, you open yourself up to a range of risks. Here we take a look at those risks and discuss your options.

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What does trading while insolvent mean?

Trading while insolvent occurs when you continue the day-to-day activities of your business, such as taking customer orders and deposits and obtaining company credit, when it’s unable to pay its debts and its liabilities are greater than its assets. This action can cause you to breach several parts of the Insolvency Act 1986, so you must understand the risks. 

If you continue to trade while insolvent to the detriment of your creditors and the business subsequently enters a formal insolvency process, the ‘veil of incorporation’ that protects the directors of limited companies can be lifted. You could be made to repay creditors from your own pocket and be disqualified from acting as a company director in the future.

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My company is insolvent: Do I have to cease trading immediately?

While not every company which is insolvent will need to immediately cease trade, many will.

Not every company that becomes insolvent is beyond rescue. Just because a company is insolvent, doesn't mean it will necessarily need to close down. Cash flow problems are common among SMEs and an otherwise viable business might temporarily be unable to pay its debts if a customer pays an invoice late, for example, or if an unexpected cost causes a cash flow shortfall. 

In this instance, a licensed insolvency practitioner may recommend that the company continues to trade if they believe it can make a full recovery. Importantly, this is not a decision you should make yourself. Seeking advice from a licensed insolvency practitioner and following their directions can protect you from accusations of wrongful trading if the business fails.    

If an insolvency practitioner recommends that you continue to trade, you must have regular minuted board meetings to discuss your position. You should also have a clear plan to return the business to profitability quickly. That plan must be clearly achievable and show that continuing to trade is in the best interests of the business’s creditors.

What are the risks for directors who trade while insolvent?

Trading while insolvent is a risky business for company directors. If this is the route you take, you should document your decisions very carefully and act in the best interests of your creditors at all times. Crucially, you should not:

• Transfer assets away from the insolvent company
• Pay certain creditors ahead of others
• Sell company assets for less than their market value
• Collect payments from customers despite knowing the work cannot be completed
• Take a high salary that the company cannot afford
• Use company money to fund personal expenses

If you trade while insolvent and subsequently enter Liquidation or Administration, an insolvency practitioner will investigate your conduct leading up to and during the insolvency. If they find that you traded wrongfully while insolvent or that your actions were not satisfactory, you could:

• Become personally liable for any additional losses made by your creditors
• Be banned from acting as a company director for up to 15 years
• Face criminal charges if fraudulent trading is proven (you continued to trade with the intent of purposefully defrauding your creditors)  

If there’s not enough proof of wrongful trading or it’s considered to be too costly or time-consuming to pursue, the insolvency practitioner can choose to take the misfeasance route to compensate the company’s creditors.

Misfeasance occurs when the company suffers financially due to the directors’ decisions. If misfeasance is proven, you can receive a financial penalty equivalent to the losses the company made as a result of your actions.

Need advice?

Trading while insolvent is fraught with risk and can have serious legal and financial repercussions for company directors. That’s why you should be aware of your responsibilities as a director and always seek professional advice as soon as you have concerns about the financial health of your business. Call today for a free, no-obligation consultation with one of our experts.