What is trading while insolvent and how can you protect yourself as a company director?
The directors of insolvent companies (companies that cannot pay their debts) have a legal duty to act in the best interests of their creditors. In most cases, that means ceasing trading as soon as your company is insolvent to prevent you from building up further debts and worsening your creditors’ positions.
If you continue to trade while insolvent, you must seek professional advice and have a clear and realistic plan to return the company to profitability quickly. If you don’t, it can have serious implications for your company and you personally.
What is trading while insolvent?
Trading while insolvent is continuing to run the business as normal even though it is insolvent. The company is technically insolvent if it cannot pay its debts when they’re due or if the value of its liabilities is greater than its assets.
Continuing to trade while the company is insolvent is not an offence in itself. If you intend to keep trading, you must call a meeting of the directors and fully explain why you have made the decision in writing. You should also seek professional advice to guide your decision and ensure you prioritise your creditors’ interests.
The risk is that if you continue trading while insolvent and the company subsequently enters a formal insolvency process, such as Liquidation or Administration, your decision to trade and actions as directors will be scrutinised very closely. If the liquidator or administrator finds that your decision was flawed or you did not act in accordance with insolvency law, you could face further action.
Is trading while insolvent illegal?
If you continue to trade when the company is insolvent despite knowing it has no realistic prospect of a recovery, you are committing a civil offence called wrongful trading. The penalties for wrongful trading include fines, personal liability for company debts and disqualification from operating as a company director for up to 15 years.
If you continue to trade an insolvent company and engage in deliberate activities designed to defraud your creditors, you are stepping into the territory of fraudulent trading. Fraudulent trading is a criminal offence and can lead to a custodial sentence. Examples of fraudulent trading include taking customer orders you cannot fulfil, hiding company assets or accepting additional credit with no intention of making the repayments.
What must you not do if you continue to trade an insolvent company?
If you seek advice from an insolvency practitioner and they believe the company can make a full recovery by continuing to trade, you must put a clear plan in place. You should also hold regular minutes board meetings to discuss your position and the reasons why you’re making the decisions you are. That can help to protect you from accusations of wrongful trading if the business fails.
There are also a few things you should be careful to avoid, including:
- Selling company assets for less than their market value or transferring them to connected parties such as family members.
- Paying certain creditors ahead of others, such as family members or a loan that’s secured by a personal guarantee, rather than treating all creditors the same.
- Taking a high salary that the company cannot afford.
- Entering into credit agreements where the credit is provided at unfair rates to the detriment of your creditors.
- Using company money to pay for personal expenses or to benefit your family and friends.
- Trading fraudulently and deliberately worsening the position of your creditors.
You could face penalties if you engage in any of these types of trading during or leading up to your company’s insolvency.
What are the penalties for trading while insolvent?
If your business fails and you enter liquidation or administration, the insolvency practitioner managing the process must investigate your conduct. They will want to understand your role in the company’s failure, the reasons you chose to continue to trade and whether your actions worsened the position of creditors.
If they find any evidence of misconduct, wrongful or fraudulent trading, you could face the following penalties:
Financial penalties
Fines, penalties and compensation orders are all potential consequences if you have not carried out your duties as a company director.
Personal liability for company debts
You can be made personally liable to repay some or all of your company’s debts if you continue to trade while insolvent and worsen the position of your creditors. In extreme cases, your personal assets could be seized and you may even face sequestration if you cannot pay.
Director disqualification
You could be banned from acting as a director or officer of a company for up to 15 years. The length of the ban will depend on the severity of the misconduct. That can limit your opportunities to take senior roles in limited companies.
Criminal charges
If you continue trading while insolvent with the deliberate intention to defraud your creditors, you could be handed a substantial fine and even a prison sentence.
Need advice?
Given the risks of trading while insolvent, it’s something you should approach very carefully. If your company is insolvent or heading that way, contact a business debt expert immediately. They will discuss your financial issues with you and help you determine the most appropriate route forward. Contact our experts for a free, same-day consultation or arrange a meeting at one of our offices throughout Scotland.
