What does this mean for directors if their business becomes insolvent? What should they do?
In March this year, the Business Secretary, Alok Sharma suspended wrongful trading provisions so that directors could continue to trade through the Coronavirus pandemic, even if they were facing insolvency, without the concern that they would be investigated for wrongful trading. This suspension ended on 30th September 2020.
As set out in section 214 of the Insolvency Act, 1986, wrongful trading occurs when companies continue to carry on trading when they are insolvent – simply defined as being unable to pay their debts when they fall due. The Insolvency Act made it an offence for a company director to continue to trade if they are aware that their business is unavoidably heading towards liquidation. This means that directors should not continue trading whilst insolvent to the detriment of the company’s creditors or they will fall foul of the wrongful trading provisions, which can lead to a director being found personally liable.
Now that directors are no longer protected by the suspension of the wrongful trading rules, even though the pandemic is far from over, it is essential that they are aware of the steps they need to follow if their business becomes insolvent.
When does a company become insolvent?
It sounds obvious, and it ought to be the case that all directors should know. In our experience, however, especially in smaller owner-managed businesses, this is not always known or fully understood. Knowing the signs means that action can be taken, and the earlier the better. Here are the main reasons for insolvency:
- Cash flow insolvency. When a company cannot pay its debts on time, it is cashflow insolvent. If it continues to trade, the director(s) could be personally liable under wrongful trading rules.
- Balance sheet insolvency. This is when a company’s liabilities exceed its assets. To be able to know this, directors must have accurate and up to date management accounts.
- Creditor Enforcement. This occurs when a creditor enforces their rights against the company, usually for unpaid debts, and the enforcement is not satisfied.
- Statutory Demand. If a statutory demand is served on a company by a creditor, and the debt is not satisfied or secured to the creditor’s satisfaction, or legitimately disputed within 21 days, then the company is insolvent.
The key issue is that if a director of a company becomes aware that any of the points above have been reached, then the company is insolvent and action must be taken because the interests of the company’s creditors now come first. Continuing to trade in the full knowledge that any (some or all) of these points have been reached will be seen as wrongful trading. This is where personal liability comes in.
How can a director of a company be found personally liable?
When a company becomes insolvent, it can often attract an investigation by the Insolvency Service, which can result in personal liability. The main ways that a director can be found personally liable are:
- If the director allows the company to continue to trade when there is no reasonable prospect of the company avoiding an insolvent liquidation or administration.
- If the directors fail to take every possible step after this point has been reached to minimise any further potential losses to the company’s creditors.
- If the company carries on trading with the intent to defraud its creditors or the creditors of any other person.
- If, because of breaching their duties as a director they are found guilty of misfeasance.
What should a company director do to avoid Wrongful Trading and Personal Liability?
As of 1st October 2020, wrongful trading is no longer suspended (and ignorance of this fact is no defence), so in order to reduce the chance of being investigated for wrongful trading if insolvency strikes, we advise that directors should:
- Proceed with caution if they notice that their company is having financial difficulties.
- Quickly raise concerns about the company’s finances with their accountants or fellow directors.
- Seek advice from a professional, such as an insolvency practitioner, as soon as possible, to limit their personal liability if insolvency does strike. This will help to prove that they were acting in the best interests of the company by seeking advice.
- Make sure that all decisions that are made throughout any period of financial difficulty are properly documented and that regular board meetings are held with issued minutes. These are always asked for in an investigation and if they are not there or properly documented, it does not look good.
Talk to us if you are worried about wrongful trading
Given the financial shock that the pandemic has given many thousands of businesses, and the fact the suspension of Wrongful Trading has ended (even though the pandemic is not over), it is likely that we will see a sharp increase in directors being investigated for it at insolvency.
If you are concerned about the financial position of your company or would like to discuss wrongful trading further please contact Clive Fortis or Elaine Wilkins at our Bournemouth office. www.antonybatty.com