Is It Illegal To Run An Insolvent Company?

May 8, 2023 / FAQs

Insolvency is a problem faced by many companies. This isn’t always due to mismanagement; in fact, this is often not the case. Changes in a market, or even a local economy, plus the reluctance of directors to wind up their companies when they face financial difficulty, is a common scenario. However, directors in such a scenario may wonder whether running an insolvent company is illegal. This is not an unreasonable question to ask, as it can be easy to accidentally fall afoul of wrongful trading laws if a director doesn’t handle an insolvent company properly. Naturally, this can cause a host of problems, even if the infraction is not purposeful.

In this article, Clarke Bell will discuss whether it is illegal to run an insolvent company, how you could be affected, and what your options are for dealing with an insolvent company.

What makes a company insolvent?

Insolvency is a term given to companies that essentially have more liabilities than assets. More specifically, if a company cannot afford to pay off its debts were they to become due, it would be considered insolvent. Once a company is in this state of financial distress, a certain level of caution must be taken. Directors of such companies are obliged to act in the interests of creditors, rather than shareholders. Failure to uphold this obligation can and often does result in legal implications, as we will discuss later. That said, insolvency doesn’t always mean directors must cease trading immediately. Trading while insolvent falls under one of two categories, depending on the company’s situation. These categories are insolvent trading and wrongful trading.

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Insolvent trading

Insolvent trading refers to companies that do exactly that – trade while insolvent. This is a category that usually applies to companies that will realistically only be insolvent temporarily. This could apply to companies that can improve their cash flow through cost-cutting or obtaining new business, or other means of making a company profitable once again. Assuming a company can reasonably become solvent once again by implementing a viable business plan or undergoing restructuring, such that it can afford to repay its creditors when payments are due, its insolvent status will be considered temporary. As such, it would not be illegal to continue trading for as long as this is true.

Wrongful trading

If a company’s insolvency is not temporary, continuing trading as normal will fall under the second category – wrongful trading. Whereas insolvent trading can be carried out without the risk of legal punishment, the same cannot be said for wrongful trading. In fact, it is a very serious offence, one that can have severe penalties for guilty directors.

Wrongful trading is a term that applies to insolvent companies that continue trading, despite knowing that the company is both insolvent and has no reasonable chance of returning to a state of solvency. Wrongful trading also applies to scenarios wherein directors allow a company’s debt to continue rising, despite having no means of making repayments. Oftentimes, this happens in conjunction with the previous example.

Consequences of wrongful trading

If directors of an insolvent company continue trading when they shouldn’t, they could face serious legal consequences. These consequences can apply even if directors commit wrongful trading for a brief time. Assuming directors place their company into liquidation, or certain other insolvency procedures, an investigation will take place. This investigation will be conducted by the appointed liquidator, and will assess the company’s finances, alongside the conduct of directors. If any evidence of misconduct or wrongful trading is discovered, it will be detailed in the report sent to the Insolvency Service, which will decide on what penalties, if any, should be applied.

If the Insolvency Service decides to apply penalties, directors may face one or more of a selection. This selection of potential consequences includes the following:

  • The disqualification of a director’s license for a period of between 2-15 years. This includes a ban on holding leadership positions for other companies.
  • Directors must pay a fine depending on the severity of the case.
  • Directors may assume liability for outstanding company debt.
  • A prison sentence for serious cases.

What you can do if your company is insolvent

If your company is insolvent, you have a couple of options depending on your particular situation. Once you have identified that your company is insolvent, you should act quickly but carefully. This will help you avoid accusations of misconduct from your creditors, and falling afoul of laws regarding trading while insolvent.

Company Voluntary Arrangement

A Company Voluntary Arrangement (CVA) is an option for insolvent companies with the potential to get back on track. Directors that choose to use this procedure can appoint a licensed insolvency practitioner to act essentially as a negotiator. In this role, the insolvency practitioner will aim to reach a new agreement with a company’s creditors, one that will result in more favourable terms for the company, lessening the financial burden it must bear. This could be through delaying payments, or spreading them out over a longer period of time. If the company has capable leadership and a viable path to solvency, it is likely that creditors will view a CVA favourably.

Creditors’ Voluntary Liquidation

If a company cannot reach an agreement with its creditors, or it has no chance of returning to solvency, a Creditors’ Voluntary Liquidation (CVL) might be the next best option. This procedure offers directors of such companies an efficient means to close, while ensuring directors can uphold their obligations to creditors and offering certain legal protections. To begin with, directors may appoint an insolvency practitioner of their choosing, allowing them to select one that suits their company best. This insolvency practitioner will assume the role of liquidator, which involves identifying assets and their value, disposing of them, and distributing the proceeds amongst creditors. Once all distributions have been made, the company will be wound up and removed from the Companies House register. At this point, any debts that remain outstanding will be written off, unless they are secured by a personal guarantee.

In addition to this, a CVL will prevent creditors from taking legal action against a company once the procedure begins. This effectively acts as protection against a winding-up petition and compulsory liquidation. Furthermore, as directors undertake a CVL voluntarily, it demonstrates a willingness to act to the benefit of creditors. This reduces the risk of accusations of misconduct being made, and can act as a good defence if any are levelled. If you would like to know more about Creditors’ Voluntary Liquidations, read our complete guide to the process.

Let Clarke Bell help

If your company is struggling with debt problems, don’t go it alone; let Clarke Bell be there to help. We have more than 28 years of experience in helping companies find the best solutions to their financial problems, whether it be liquidation or otherwise, and we can do the same for you. Don’t hesitate to contact us today for a free, no-obligation consultation and find out exactly what we can do for you.