What-are-the-legal-risks-when-a-company-becomes-insolvent

Can litigation be taken against a company director if the business fails? 

A business reaches insolvency when it is unable to meet its debts as they fall due. If your company is insolvent or you are facing financial challenges with the possibility of insolvency, it understandably creates a stressful and concerning situation.

However, avoiding the issue won’t help. Various legal risks require your attention. With the appropriate approach and professional assistance, you can either steer your business out of insolvency or facilitate a proper closure without the risk of legal actions being taken against you.

 

What are the warning signs to look out for?

The sooner you recognise the risk of insolvency, the greater the opportunity to avert it and safeguard yourself from possible repercussions. 

There are numerous warning signs of insolvency to be vigilant about, including but not limited to:

  • Growing creditor pressure and the possibility of legal action
  • Difficulty in meeting staff payment obligations
  • Suppliers denying credit, an overdraft at its limit, and absence of alternative credit facilities
  • Ongoing cash flow crises
  • Continuous management of persistent issues within your business


If you identify these indicators in your business, seek professional assistance promptly. Continuing to trade despite being aware that the business cannot settle its debts may lead to substantial fines, personal liability for company debts, and potential disqualification from acting as a company director in the future.

 

Do insolvent companies have to cease trading?

If you suspect that your company is insolvent, your legal responsibilities as a company director undergo a shift. You are obligated to act in the best interests of your creditors, typically necessitating an immediate cessation of trading to minimise their losses.

A licensed insolvency practitioner might determine that trading can persist if the company has the potential to regain profitability shortly or if continuing operations would likely enhance the returns for creditors.

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What are the legal risks during insolvency?

1. Personal guarantees:

When establishing a company, it’s quite common for a company director to provide a personal guarantee to secure financing. If the business can meet its financial obligations, there’s no issue. However, in the event of a company default, you may become personally responsible for the entire amount.

2. Wrongful trading:

If you are aware or reasonably should be aware, that the business is unable to settle its debts, yet you persist in trading and contribute further losses to the company, you may be accused of wrongful trading. In the case of wrongful trading, you may be required to contribute from your personal funds to compensate the creditors for the company’s assets.

3. Preference payments:

Another risk arises when making preferential payments to one or more creditors while the business is insolvent. A preferential payment is a payment to a connected company or a business operated by a friend or family member, placing that business in a more favourable position than the creditors as a whole. In such instances, the preferential payment may be invalidated, and you could be held personally responsible for those debts.

4. Transaction at Undervalue:

A transaction at undervalue takes place when you sell a business asset for less than its actual value, diverting assets away from your creditors. Engaging in such a transaction during or in the period leading up to insolvency may result in a fine, personal liability for company debts and disqualification as a director.

5. Asset disposal:

As part of their responsibilities, insolvency practitioners examine whether you have disposed of company assets while insolvency is ongoing. If they discover any questionable transactions, they have the authority to undo the asset disposal and return it to your company before selling it for the advantage of your creditors. If the insolvency practitioner is unable to retrieve the asset, they may pursue compensation for the creditors from you.

6. Misfeasance and breach of duty:

Misfeasance occurs when your company’s finances are adversely affected by your actions. This encompasses actions such as misusing company property, providing unauthorised loans to directors, or drawing high salaries that the company cannot afford. It may result in a financial penalty equivalent to the losses incurred and disqualification from holding office.

7. Fraudulent trading:

This risk emerges when the directors of an insolvent company operate the business with the intent to defraud creditors. One instance of fraudulent trading is entering into credit agreements despite knowing that the business will be unable to repay the funds. Unlike the other legal risks discussed, fraudulent trading is a criminal offence and can result in prison sentences of up to 10 years, along with fines, personal liability for company debts, and director disqualifications.

8. Beware of the risks:

If your company undergoes liquidation due to insolvency, a liquidator will scrutinise the directors’ actions both before and during the insolvency. If a director is discovered to have engaged in any of these trading offences, the liquidator will document it in their report. Subsequently, they will submit the report to the Insolvency Service, and actions may be initiated against you.

Need help?

At Vanguard Insolvency, our insolvency professionals can assist you in addressing financial challenges and ensure compliance with UK insolvency laws to mitigate these critical risks. Feel free to get in touch with our team to schedule a free, same-day consultation at one of our offices across the UK.

Senior Partner at Vanguard Insolvency Practitioners | Website | + posts

I am an insolvency professional with a distinguished career specialising in commercial insolvency, adeptly navigating Creditors Voluntary Liquidation, Company Voluntary Arrangements, and Company Administrations. With a comprehensive understanding of insolvency laws and an unwavering commitment to ethical practices.