Trading insolvent – director’s duties and responsibilities
There are two questions which directors need to ask themselves when checking to see whether their company is technically insolvent:
- Is the value of the company’s liabilities bigger than the value of its assets?
- Is the company unable to discharge its debts (its obligations to its creditors) as and when they fall due?
If the honest answer to either questions is ‘yes’ then the company is technically insolvent in accordance with the definition in the Insolvency Act 1986.
Under UK law, if a company is trading insolvent, a director may be liable for wrongful trading. Wrongful trading occurs when directors allow debts and liabilities to be incurred and, typically, increase, whilst having no reasonable prospect of being able to pay the debt back. If the director knows or should have known that the company cannot avoid becoming insolvent then he or she must cease to trade immediately and take steps to liquidate the company.
Directors must make an early decision on whether the business should cease to trade. Failure to do so can result in the directors having to contribute personally to the company's losses and in being heavily investigated. The director of a company which is facing financial difficulty should ensure that there is a reasonable prospect that the company will avoid insolvent liquidation before being party to any decision to trade on.
Directors of companies experiencing financial difficulty should never ignore the early warning signs that can threaten a company’s survival and should therefore take the following steps:
- Ensure that they meet regularly to discuss current events
- Utilise accurate and up-to-date accounting information to assess day-to-day cash flow
- Keep detailed records of all discussions at meetings
- Ensure that any decision to continue trading is reviewed on a frequent basis
- Seek expert advice if the viability of the business is in doubt
Directors may escape liability for wrongful trading if they can prove that adequate steps were taken to minimise the losses to creditors after it became apparent that the company was insolvent.
It’s vital that, as a company director, you are fully aware of the signs, responsibilities and consequences.