If you’re the Director of a Limited Company that is struggling to meet its liabilities when they fall due, you have a duty of care and a responsibility to consider whether you need to stop trading. It isn’t viable to continue accruing further business debts and late payments charges. Continuing to avoid payment of debts will end in County Court Judgments and Winding Up Petitions. There may still be hope to turn your business around, if you press the pause button for a while, take stock of your situation and access the services of a Business Turnaround advisor. However, if you do decide that the most sensible solution is to stop trading completely, you will then need to also make a decision about what will be the best way to close the company. Whatever your decision, it’s very important to be aware of your responsibilities as a Director to ensure you aren’t unknowingly breaking the law.
Is my Business Insolvent?
Your Limited Company is insolvent if:
- it cannot pay its debts as they fall due;
- it does not have enough assets, that if sold would pay off all of the liabilities in full; or
- it cannot pay its debts as they fall due and it does not have enough assets to sell to pay off the debts in full.
If you are unsure whether your business meets the criteria for insolvency, take an insolvency test with a qualified professional. If you’re struggling with cash-flow and working capital to grow your business, but do not have any business debts, or have a small amount of debt that you are able to pay on time each month, this does not mean your company is insolvent, in fact, exploring external funding options could help you to improve the stability of your company. Always create a solid business plan before taking on any business debt.
What does the law say about insolvent companies?
Any company that was formed under the Companies Act 2006 will find that the term insolvency is relevant to their Director’s responsibilities. The Insolvency Act 1986 has been in place for over 30 years of course, but more recently laws regarding insolvency have been more transparent.
It’s a Director’s duty to keep their business solvent in a number of ways; not accruing debt beyond affordability, being sensible with spending on assets and overheads, taking action to encourage new sales as well as maintaining existing customer relationships; and managing cash-flow. However, if a business runs into trouble, it is also the Director’s duty and responsibility to minimise losses for all concerned, including their creditors.
Wrongful and fraudulent trading
When a business owner continues to place orders on account, to spend out on company credit cards and accrue debts that they know they will not be able to repay, this is known as “wrongful trading”. Likewise, when a company continues to trade at a loss unreasonably, it could be seen as wrongful trading. Many start-up companies will make a loss in their first year as they build the business, and so long as plans are in place to make the business profitable as soon as possible, this is not an offence. However, it’s important to carefully monitor monthly profit and loss to ensure the business plan is still viable.
If loans and credit accounts are obtained by entering falsified accountancy information such as adding extra turnover or exaggerated profit and loss forecasts, this is known as “Fraudulent Trading” under the Insolvency Act 1986 section 213, because the Director is defrauding their creditors. It is not always the Director that is solely accountable for wrongful or fraudulent trading, anyone that is involved in financial transactions in the business could be held culpable too.
Misfeasance is a term that describes the act of a Director continuing to take money from the business for their own personal use, meaning that there are not enough funds to pay creditors. If a Director puts their own financial needs first when debts are overdue, it is an offence that could lead to fines, disqualification or imprisonment.
Directors of insolvent companies that have employees must also take into account the Employment Rights Act 1996 to ensure that they are not breaching their employer duties with regard to salary, benefit payments and notice periods. If a Director is thought to be fraudulently trading and has taken no steps to minimise losses to the creditors and employees, as per the Insolvency Act 2000, they could be disqualified. This is particularly relevant to Directors whom have a track record of previously failed companies.
The general consensus with insolvency law is that reasonable steps should always be taken to try to rescue a company if at all possible. If it is not appropriate to continue, steps should be taken to minimise losses to creditors. R2B Business Solutions are on hand to offer insolvency and business turnaround advice whenever it’s needed. Contact us today for a free consultation.