What are the legal implications of trading while insolvent?

Guest blog for company directors

Limited company directors take on a range of legal duties associated with running their business and must comply with strict regulations. A company’s financial health is at the heart of these responsibilities and directors are expected to be aware of its financial status at all times. This is because, if the business becomes insolvent, their legal duties change. The team at HM3 Legal is experienced at spotting contract red flags that can prove costly and resolving disputes (including between shareholders) which can derail a business.

A company can be cash flow insolvent, which means it is unable to pay its bills when they become due, but it can also be balance sheet insolvent, and this means the company’s liabilities are greater in value than its assets. If you have cash flow questions, a lawyer can help facilitate prompt payment and put in place measures to protect the business from late payments.

Unfortunately, research shows that the number of companies in England and Wales ceasing to trade in 2023 in hit a 30-year-high, recording 25k company insolvency registrations.

Ramifications of wrongful trading

Trading while insolvent can lead to allegations of misconduct for company directors, with potentially serious legal repercussions that may affect several aspects of their lives. If a director knows their company has entered insolvency, or crucially, it is believed that they should have known, it can lead to the following:

  • Personal liability for some or all, of the company’s debts.
  • Disqualification for up to 15 years.
  • If disqualified, being barred from certain professions and office-holdings.

Personal liability for company debts

Personal liability can become an issue for company directors if they have continued to trade when their company was insolvent. If doing so caused additional financial loss for their creditors, for example, they may become liable for these.

Other forms of misconduct can also lead to personal liability, including taking an excessive salary that cannot be supported by the company. Essentially, if their creditors’ position is worsened by any director actions or negligence then they may be held liable on a personal level.

Director disqualification

Directors can be disqualified for 2-15 years for trading while insolvent. This means they cannot take on the office of director or be involved in forming, marketing, or running a company.

Disqualification can also impact other areas of life for directors and may prevent them from entering professions including accountancy and law. If disqualified, they may also be barred from taking on other roles, such as becoming a pension trustee or school governor.

Prison sentence

Directors who continue to trade with the intention of defrauding creditors can face up to 10 years in prison.

What should a director do if insolvency is a threat?

Rather than carrying on trading when insolvent, a director must turn their attention to their creditors’ interests and protect them from further financial loss. It is advisable to be cautious about trading when a company experiences financial decline, and to seek a professional assessment of its financial status at an early stage.

Being aware of the risks and legal implications of trading while insolvent and seeking expert assistance in a timely manner demonstrates that a director has their creditor interests in mind, and can reduce the likelihood of wrongful trading allegations being made. For directors under investigation, seek legal advice from specialist litigation experts to discuss personal ramifications and regarding the commercial implications for the business. The HM3 Legal team can assist in both areas.

To reduce the potential for trading whilst insolvent a director should understand the company’s financial position at all times, so a decline can be readily identified and acted upon.

Writing the minutes of board meetings can also protect directors from the most serious allegations as it records the decisions made by the board as a whole, and the reasons for making them.

Insolvent trading can carry severe sanctions

Wrongful trading is a civil offence that carries severe implications for company directors. If there is an intentional element to defraud creditors by continuing to trade in insolvency, this is fraudulent trading, which is a criminal offence.

The legal implications, therefore, of trading an insolvent company are severe but they can be managed with awareness and an understanding of the company’s finances, and by being proactive as a Director including addressing cash flow concerns before they accumulate. The specialist Commercial Debt Recovery team at HM3 Legal protect companies against late payment.

About the author

Shaun Barton is a partner at Company Closure and boasts a wealth of experience in helping directors of distressed companies understand their options. A director-facing adviser, Shaun is often the first point of contact for business owners in financial distress, consistently delivering expert advice when it is needed the most.

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