What Are the Consequences of Trading While Insolvent?
Still trading under financial pressure? Learn the consequences of trading while insolvent and what directors must do to protect themselves.
Legal advice for directors
Trading while insolvent is a critical risk for any company director. The legal consequences can be severe, including personal liability, criminal prosecution, and disqualification. Here’s what every director needs to know and how to protect yourself.
What does “trading while insolvent” mean?
A company is insolvent if it cannot pay its debts as they fall due, or if its liabilities exceed its assets. When insolvency is likely or has occurred, directors’ duties shift: a director must prioritise the interests of creditors over those of shareholders. Failing to do so can have serious legal repercussions.
The legal risks: What can happen?
If directors continue to trade when they knew, or should have known, that there was no reasonable prospect of avoiding insolvency, they may be personally liable for the company’s losses. This is known as “wrongful trading” under the Insolvency Act 1986.
- Personal Liability: The court can order directors to contribute to the company’s assets
- Defence: Directors must prove they took every step to minimise creditor losses. This is a high standard and requires clear, proactive action
If directors carry on business with intent to defraud creditors or for any fraudulent purpose, they risk both civil and criminal penalties.
- Criminal offence: Up to 10 years’ imprisonment, a fine, or both under the Companies Act 2006
- Civil Liability: The court can order compensation to the company’s creditors
Directors found to have traded while insolvent may be disqualified from acting as a director for 2 to 15 years under the Company Directors Disqualification Act 1986.
- Acting while disqualified is a criminal offence
- Personal liability for company debts incurred during disqualification
When a company is insolvent or on the verge of insolvency, directors must give appropriate weight to the interests of creditors. Breaching this “creditor duty” can result in claims for compensation, even before wrongful trading liability is triggered.
- Personal guarantees: If you’ve guaranteed company debts, you may be called upon to pay.
- Tax debts: HMRC can make directors personally liable for certain tax debts in cases of avoidance or “phoenixism”
- Misfeasance claims: Directors may be liable for misapplying company property or breaching fiduciary duties
How can directors protect themselves?
1: Keep financial information up to date
Monitor your company’s financial health closely and regularly.
2: Seek independent professional advice
At the first sign of trouble, consult solicitor or an insolvency practitioner. Taking advice is not a defence, but it is essential for responsible conduct.
3: Hold and document board meetings
Record all decisions, especially those relating to financial distress and creditor interests.
4: Act promptly
If insolvency is unavoidable, take every step to minimise losses to creditors. This may mean ceasing trading and starting insolvency proceedings.
5: Avoid preferential or undervalue transactions
Do not favour certain creditors or transfer assets at undervalue as these actions can be challenged in insolvency.
Need expert guidance?
Trading while insolvent is a high-risk situation for directors. The law expects you to act swiftly and responsibly, putting creditors first when insolvency is likely. The best protection is vigilance, early action, and seeking expert advice.
If you are concerned about your company’s financial position, seek independent legal and financial advice immediately.
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