What are the risks of trading while insolvent?

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How can you protect yourself from the risks of trading while insolvent?

If your business can’t meet its debts on time or lacks ample assets for its obligations, it’s likely insolvent. As a company director, your legal duty is to act in the creditors’ best interests.

If your business has little chance of recovery or trading further won’t benefit creditors, cease trading and promptly seek professional advice.

Trading while aware of or should be aware of the business’s insolvency, with slim chances of recovery, exposes you to various risks. Here, we examine those risks and explore your options.

What does it mean by trading while insolvent?

Trading while insolvent happens when you persist in daily business operations, like accepting customer orders and deposits and seeking company credit, despite being unable to settle debts and having liabilities surpassing assets.

This can lead to violations of various sections of the Insolvency Act 1986, so it’s crucial to grasp the associated risks.

If you persist in trading while insolvent, harming your creditors, and the business enters a formal insolvency process, the ‘veil of incorporation’ safeguarding limited company directors can be removed. This may lead to personal repayment to creditors and disqualification from future roles as a company director.

My company is insolvent: Do I have to stop trading right away?

While not every insolvent company must cease trading immediately, a considerable number will. Not every insolvent company is beyond recovery. Just because a company is insolvent doesn’t automatically mandate closure.

Cash flow issues often affect SMEs, and an otherwise viable business may face temporary difficulties in settling debts, perhaps due to a delayed customer payment or unexpected costs causing a shortfall in cash flow.

In such a situation, a licensed insolvency practitioner may advise the company to keep trading if they assess it has the potential for a complete recovery.

Crucially, this is not a decision for you to make independently. Seeking guidance from a licensed insolvency practitioner and adhering to their instructions can shield you from allegations of wrongful trading in case the business faces failure.

If advised by an insolvency practitioner to continue trading, ensure regular board meetings with documented minutes to discuss your situation.

Additionally, have a well-defined and attainable plan to swiftly restore the business to profitability. This plan should unmistakably demonstrate that continuing to trade aligns with the best interests of the business’s creditors.

Potential risks for directors to know who trades while insolvent?

Engaging in trade while insolvent poses risks for company directors. If you opt for this path, meticulously document your decisions and consistently act in the creditors’ best interests.

Importantly, you should not:

Sell company assets below their market value.
Accept payments from customers when aware the work cannot be fulfilled.
Transfer assets from the insolvent company.
Favour specific creditors over others in payments.
Draw a substantial salary the company cannot sustain.
Utilise company funds for personal expenses.

If you trade while insolvent and later enter Liquidation or Administration, an insolvency practitioner will scrutinise your conduct before and during insolvency.

If they discover wrongful trading or unsatisfactory actions, you could:

Personally bear responsibility for any extra losses incurred by your creditors.
Face a ban on serving as a company director for up to 15 years.
Potentially encounter criminal charges if proven to engage in fraudulent trading, deliberately defrauding creditors by continuing to trade.

If there’s insufficient evidence of wrongful trading or it’s deemed too expensive or time-consuming to pursue, the insolvency practitioner may opt for the misfeasance route to compensate the company’s creditors.

Misfeasance arises when the company faces financial harm due to directors’ decisions. If proven, you may incur a financial penalty matching the losses the company incurred due to your actions.

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Do you need help?

Trading while insolvent carries significant risks and can lead to severe legal and financial consequences for company directors.

Hence, it’s crucial to understand your responsibilities as a director and promptly seek professional advice when you have concerns about your business’s financial health. Call today for a free, no-obligation consultation with one of our experts.

David Jackson

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.