It’s never a great time when a company starts to get into trouble and it can seem like there are a million and one things to think about but as a director, there are five that should be right at the top of your agenda.
Trading whilst insolvent. There are two types of insolvency; Balance sheet and Cash flow. In the Balance sheet test the company is insolvent if its debts exceed its assets, with the Cash Flow test insolvency is when a company does not have enough free cash to pay its creditors when their invoices become due.
Directors have a responsibility to ensure they are fully acquainted with all the facts regarding the running of their business and if it looks like a company could fail either of these tests then they have a duty to protect their creditors and stop trading if they don’t then they could be accused of wrongful trading.
If you are not sure whether your company could be going insolvent then please make sure you take advice as early as possible.
Once it looks like a company might become insolvent then there are temptations that may seem like a good idea, especially if you are going to lose money but that could end up getting you into a lot of hot water and as such are definitely to be avoided.
Fraudulent trading. This is an extension to wrongful trading in that the director specifically continues to trade with the intention of defrauding creditors. An example of Fraudulent Trading would be the ‘Long Game’ where the company orders a large number of goods on credit shortly before going bust in the full knowledge that the supplier will never get the full amount of their invoices. This then leads on to…
Transactions at undervalue. As the company gets into trouble directors can be tempted to sell off assets for less than they are worth. Sometimes this is a vain attempt to avoid failing the cash flow test, to pay employees or suppliers when due. Sometimes, however, it is a cynical attempt to get value from a company by selling off assets undervalue to an associate with the aim of taking possession again later. A transaction at undervalue is often a natural progression from the long game and is definitely to be avoided, even when it is done for good intentions or due to a misplaced sense of optimism.
Misfeasance. This is the act of taking money out of a company for purposes other than company business. In its simplest form it could be taking petty cash, withdrawing money from the bank or transferring money into a personal account but in all cases, it is prejudicial to the creditors’ interests and not to be indulged in. Similarly taking goods or services for use, either in a personal capacity or to start a new business in case the old one folds fall under the same remit. Giving a director a sudden and unexpectedly generous pay rise or paying an unscheduled and unwarranted large dividend are other examples where a liquidator may take a dim view of the directors’ conduct.
Preference. We’ve all got a list of suppliers that we like and some we aren’t too keen on. Some may be friends or relatives that we’d like to make sure don’t lose money. Some suppliers may suggest paying off their debt in the old company before other creditors on the promise that they will open up a credit account for a new venture. These are all examples of giving preference to one debt or another. As a director, you have a duty towards all creditors and you must not pay any of them off in preference to any other as you could be called to account.
Insolvency isn’t a desirable state of affairs but neither is it the end of the world. Life can begin again after a winding up and directors can go on to have successful business careers but if they indulge in any of the above then they face the prospect of being banned from directorships for a considerable period.
Anyone thinking that they have a great wheeze to get money out of an ailing company would be wise to think again. It’s fair to say that any experienced liquidator will have seen all the methods under the sun and if they suspect foul play will no doubt take a dim view when they report to the courts.
If you find yourself facing a possible insolvency situation then take qualified, experienced advice from a licenced insolvency practitioner. Things may not be as bad as you think, but even if they are then they will be able to advise you of what to do as well as what things you should not do!