As a company director in the United Kingdom, it is crucial to understand the implications of trading while insolvent or trading while in liquidation. It is also important to understanding the legal framework surrounding it. When a company faces financial difficulties and is unable to meet its financial obligations, the concept of insolvent trading becomes a critical consideration.
In this guide, we will explore the topic of insolvent trading from the perspective of UK company directors, providing insights into the legal implications, potential consequences, and circumstances under which trading while insolvent may be permissible.
Understanding Insolvent Trading in the UK
Insolvent trading, as defined under UK law, refers to the act of continuing business operations while a company is unable to pay its debts as they fall due. The key legislation governing insolvent trading in the UK is found in the Insolvency Act 1986, which aims to protect creditors’ interests and promote responsible corporate conduct.
Legal Duties and Consequences
As a director, it is crucial to be aware of your legal fiduciary duties regarding insolvent trading. Breaching these duties can lead to severe consequences. Here are key points to consider:
- Duty to Act in the Best Interests of Creditors: Under the Insolvency Act 1986, directors have a duty to act in the best interests of the company’s creditors when they have knowledge or ought to have concluded that there is no reasonable prospect of avoiding insolvent liquidation.
- Personal Liability for Company Debts: If a director is found to have engaged in wrongful or fraudulent trading, they may become personally liable for the company’s debts. This means that directors could be required to contribute to the company’s assets, potentially facing financial consequences.
Consequences of Wrongful and Fraudulent Trading
Wrongful Trading
Wrongful trading occurs when directors continue to trade while knowing (or reasonably should have known) that there was no reasonable prospect of avoiding insolvent liquidation. The consequences of wrongful trading can be severe and may include:
- Personal Liability: Directors may become personally liable for the company’s debts incurred during the period of wrongful trading. This means that they may be required to contribute to the company’s assets to repay creditors.
- Disqualification: Directors found guilty of wrongful trading may face disqualification from acting as a director for a specified period. Disqualification can have long-lasting implications for future business ventures.
Fraudulent Trading
Fraudulent trading involves intentionally carrying on business with the intent to defraud creditors or any other fraudulent purpose. Consequences of fraudulent trading can include:
- Personal Liability: Directors found guilty of fraudulent trading may become personally liable for the company’s debts. They may be required to contribute to the company’s assets and face potential legal action.
- Criminal Charges: Fraudulent trading is a serious offense and can lead to criminal charges against directors. Conviction may result in fines, imprisonment, or both.
Consider Entering Into a Creditors Voluntary Liquidation (CVL)
Another option for insolvent companies is Creditors Voluntary Liquidation (CVL). This process allows directors and shareholders to voluntarily wind up the company’s affairs. The appointment of a liquidator in a CVL aims to maximize the return to creditors by selling the company’s assets. It provides a formal and regulated process for liquidation, ensuring transparency and fairness.
Conclusion
As a company director in the United Kingdom, understanding the implications of trading while insolvent is essential to fulfil your legal duties and protect your interests. Insolvent trading can have severe consequences, including personal liability for company debts. It is crucial to seek professional advice promptly if you suspect your company is insolvent, as there are formal processes available, such as administration, a Company Voluntary Arrangement (CVA), or Creditors Voluntary Liquidation (CVL
Contact one of our professional advisors here at Company Doctor today if you are worried that you may be trading whilst you are insolvent to discuss your options.
References
The primary sources for this article are listed below.
https://www.legislation.gov.uk/ukpga/2006/46/section/993
Details of our standards for producing accurate, unbiased content can be found in our editorial policy here.
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FAQs
What is an example of wrongful trading?
Wrongful trading occurs when directors continue to trade while knowing or reasonably should have known that there was no reasonable prospect of avoiding insolvent liquidation. An example of wrongful trading would be if a director, despite being aware of the company’s deteriorating financial situation, continues to take on new orders, incur debts, or make payments to certain creditors while neglecting others, thereby worsening the overall position of the company and its creditors.
What is the penalty for wrongful trading in the UK?
The penalty for wrongful trading can have serious consequences for directors. If found guilty of wrongful trading, directors may become personally liable for the company’s debts incurred during the period of wrongful trading. They can be required to contribute to the company’s assets to repay creditors. Additionally, directors found guilty of wrongful trading may face disqualification from acting as a director for up to 15 years, which can significantly impact their ability to be involved in future business ventures.
Who can bring an action for wrongful trading?
The power to bring an action for wrongful trading primarily lies with the appointed liquidator or administrator. These professionals are responsible for investigating the company’s financial affairs during insolvency proceedings. However, in certain circumstances, shareholders, creditors, or even the Secretary of State for Business, Energy and Industrial Strategy can also bring an action for wrongful trading if they believe the directors have breached their duties.
Is it illegal to trade at a loss?
No, it is not illegal to trade at a loss. Many businesses face temporary losses or periods of financial difficulty due to various factors such as market conditions, competition, or unexpected events. Trading at a loss becomes problematic when the company is insolvent and unable to meet its financial obligations as they fall due. Directors have a duty to act in the best interests of the company and its creditors during times of insolvency. If the directors continue trading while knowing there is no reasonable prospect of avoiding insolvent liquidation, it may be considered wrongful trading, which can lead to legal consequences. It is essential for directors to seek professional advice in such situations to understand their obligations and potential options for resolving the company’s financial difficulties.
