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Wrongful trading and the personal liability of Directors of an insolvent Company

07 April 2017 - 14:20

Directors may ask, is my Company insolvent and will I be personally liable for its debts?

There are 2 standard tests to establish whether or not a Company is insolvent:

Balance Sheet test

A Company is deemed insolvent where its liabilities exceed its assets.

Cash flow test

If a Company cannot pay its debts as and when they fall due it is insolvent.

Directors of Limited Companies have the protection of limited liability.  If their Company enters insolvent liquidation they are not automatically held liable for its debts, except where they have given personal guarantees to creditors.

The issue for Directors arises where they continue to trade their Company after it fails either of the above 2 tests and where there is no reasonable prospect of avoiding liquidation.

It is therefore essential that when a Company becomes insolvent its Directors seek advice from a Licensed Insolvency Practitioner.

In reality many businesses do trade after becoming insolvent.  This does not automatically lead to personal liability.  If they successfully turn the Company around then the Directors should of course be applauded for bravely persevering through the adversity.

If the Directors do decide that there is a realistic chance that they can turn their Company around despite its technical insolvency they should take the following steps in order to ensure that they are protected if, despite their best endeavours, they are unable to avoid liquidation:

  • Take and minute advice from professionals such as the Company accountant and/or a Licensed Insolvency Practitioner
  • Take all reasonable steps to ensure that creditors positions do not deteriorate
  • Where possible and practical negotiate with any creditors where credit terms have been exceded to agree extended payment conditions
  • Review all overheads including staffing levels and Directors remuneration with a view to making any necessary savings
  • Review the Company’s position on a regular basis – ideally weekly, at very least monthly, to ensure that it is moving in the right direction.

If, having taken all of the above steps, Directors feel that creditor pressure is such that the decision whether to place the Company into liquidation will soon be taken out of their hands, then it is advisable to request advice from a Licensed Insolvency Practitioner regarding the possibility of taking other steps to save the business.

The Licensed Insolvency Practitioner will be able to discuss saving the Company via a Company Voluntary Arrangement (CVA), or looking to take the business on without the burden of the current debt via a Creditors’ Voluntary Liquidation (CVL) or pre-pack Administration.

If you would like to discuss the responsibilities of Company Directors when faced with the possibility of insolvency please feel free to call Steve Ford on 01455 699737 or 07718 133927 at any time.  Alternatively, please complete this contact form and Steve will give you a call back ASAP.