What is trading while insolvent?

It is not uncommon for a company to be trading while insolvent; this will often be the case for many startup companies.

The Insolvency Act defines a company as insolvent if:

  • The company fails to pay its debts as they fall due
  • The company’s liabilities on the balance sheet exceed its total assets

Continuing to trade where either of these statements applies, means the company is, technically, trading while insolvent. If the latter statement is the case, when producing annual accounts, the directors will be required to make a “going concern” statement. A director uses this to set out the reason they will continue trading while insolvent, and their strategy for trading out of insolvency. It is important to be realistic at this stage and identify parameters where you are at risk of slipping into being liable for wrongful trading penalties.

What is wrongful trading?

Should your company have no hope of trading out of insolvency, the directors are at risk of committing the offence of wrongful trading. In examples of wrongful trading, there is, typically, no intent to defraud the creditors on the director’s behalf, but a case of poor judgement. Wrongful trading takes effect from the point the directors ought to have known the company was insolvent, with no prospect of recovery. Therefore, if the company is insolvent and the board continues to trade, the directors could become personally liable to contribute to the company assets.

Not realising the company could not trade out of insolvency is not a sufficient defence. However, this will be measured by the type of work you are carrying out. For example, an accountant would be held to a much higher standard than a mechanic. The only defence, where it has been established the company has been trading while insolvent with no hope of recovery, is to demonstrate you have taken every step to minimise losses to company creditors.

Difference between wrongful trading and fraudulent trading

While wrongful trading is only a civil offence, fraudulent trading is a criminal offence. The main issue is the intent. To prove fraudulent trading, it is necessary to show that the directors willingly and knowingly carried on business affairs. Also, that they had no intent to pay their debts.

An example of fraudulent trading would be a car garage taking a series of deposits with the intention to wind up the company the following week, and not deliver goods.

What are the consequences of wrongful trading?

Directors who are found to have committed the offence of wrongful trading will be liable to contribute to the assets of the company. This will be calculated concerning the actual detriment of creditors, from the point the company had no hope of trading out of insolvency.

If found guilty, a director may face disqualification under the company director disqualification act. Even if the appointed liquidator does not bring the wrongful trading action, the insolvency service may seek a compensation order. This would mean you are personally liable to make a contribution to the assets of the liquidation.

Advice if you may be trading while insolvent

Speaking to a professional is the best possible advice. If you believe your company has cash flow problems and is heading for financial difficulty, you must initiate preventative measures. Trading while insolvent is not an offence in itself. However, once you become aware, you must minimise losses for creditors. It is often time to take advice as to whether an insolvency process such as company administration or creditors voluntary liquidation.

You should not:

  • Take delivery of goods you know you will not be able to pay for
  • Make preferential payments to creditors, particularly friends and family, or future business associates
  • Dispose of assets outside the normal course of business without professional advice

If you are in doubt of the current position of your company, you should seek professional advice which can be obtained confidentially from one of our BusinessRescueExperts.