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What Does Trading While Insolvent Mean?

Seasoned company directors become familiar with the idea of putting shareholders first. Therefore, it is often a surprise for them to realise a fundamental shift in responsibility at the point of insolvency.

As soon as a director realises the company is officially insolvent, that primary responsibility shifts from shareholders to creditors. 

In reality, this moment of transition can be a grey area for directors. Some opt to continue trading despite their company situation. However, laws exist around continuing to trade whilst insolvent, as we shall discuss.

What Does Trading While Insolvent Mean?, What Does Trading While Insolvent Mean?, HBG Advisory

Trading While Insolvent: Explanation

When a business is going under, it keeps operating even though it knows it can’t pay its debts.

When a business becomes insolvent, it:

  • no longer can afford to pay its creditors as and when they fall due;
  • Its liabilities exceed its assets.

How do I determine if my business is insolvent or not?

Once a limited company that acts as the entity to trade the business is aware it is insolvent. The directors then must protect the interests of the companies creditor, not the shareholders. Company directors must understand their position clearly, as ignorance is no defence if matters worsen. Directors duties and responsibilities are now under scrutiny.

 

If you are assured you can maintain trading, then clearly understand directors trading out of insolvency and failing.

(a) If your debt is more significant than £750

(b) If you have already violated the terms of a loan agreement by not paying.

UK Corporate Law and Insolvency

The Insolvency Act 1986 is the central core of how insolvency law in the UK is, especially in regards to trading whilst insolvent:

  • Extortionate credit transactions – Section 244 – Obtaining finance on credit when in the knowledge of the insolvency of a limited company operating a business;
  • Transaction at an undervalue Section 238 – A director sells part of the company for less than its market value in the preceding insolvency;
  • Wrongful tradingSection 214 – a director knowingly with intent continues trading, with the knowledge of not having the ability to pay creditors;
  • Preferences: Section 239 – A director prefers to pay one individual over another, demonstrating a preference to any other creditor.

Is Trading While Insolvent Illegal or a Criminal Offence?

Wrongful trading, if proven, is judged a civil offence.

While fraudulent trading is judged a criminal.

The fundamental law is from Section 214 of the Insolvency Act 1986, Wrongful Trading. 

The key phrase for directors here is:

Before the start of the liquidation of the company, this person knew or should have determined there was no chance the company would avoid insolvency.

Meaning the director knew about the situation, but went ahead anyway. So the director failed to put the interests of creditors first.

Risks for Directors While Trading Insolvent

  • Carrying on trading while having no intent to make payment

Directors must not commit to any new contracts and continue trading when they know your company’s financial position and are unable to pay creditors.

  • Selling assets for less than market value.

Selling assets at an undervalue to raise funds quickly and repay your debts might seem like a good idea. But, if the company enters liquidation, the asset value has reduced, and creditors face receiving less money potentially. Notably, a court can instruct that the transactions are reversed.

  • Repaying debt fraudulently

If you repay debts by dishonest transactions, you cannot fulfil or use misleading information to obtain loans? You could face conviction of fraudulent trading. Unlike wrongful trading, fraudulent trading is a criminal offence that could lead to a custodial sentence and personal liability for company debts.

  • Repaying some creditors and not others

Company directors remain bound to act in the best interests of the company creditors. However, should they pay creditors while excluding others is considered a preference (Preferential Payment)? 

Penalties directors face

Company directors found guilty of improper trading could be disqualified for up to 15 years, in addition to being personally liable for some or all corporate debt.

Covid-19: Suspension of wrongful trading liability provisions

The government suspended wrongful trading via the Corporate Insolvency and Governance Act 2020 (the Act), which came into force on June 26th 2020.

These provisions ended on June 30th 2021, meaning standard rules apply to wrongful trading.

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What Does Trading While Insolvent Mean?, What Does Trading While Insolvent Mean?, HBG Advisory
What Does Trading While Insolvent Mean?, What Does Trading While Insolvent Mean?, HBG Advisory
What Does Trading While Insolvent Mean?, What Does Trading While Insolvent Mean?, HBG Advisory
What Does Trading While Insolvent Mean?, What Does Trading While Insolvent Mean?, HBG Advisory
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