What Is Insolvent Trading?

It’s important to be aware that insolvent trading can breach the terms of the UK’s Insolvency Act. Continuing to trade whilst insolvent can be classed as ‘wrongful trading’, and this can lead to serious legal repercussions.

UK law offers provisos that allow companies to continue trading legally, even if they are insolvent. These are formal legal procedures, such as a company voluntary arrangement or entering administration, which should be discussed first with a licensed insolvency practitioner.

In this article, the expert team at Irwin Insolvency explains what insolvent trading is, when it’s illegal, and how you can legally continue trading while insolvent.

Contact Irwin Insolvency for More Information on Insolvent Trading

What Does Insolvent Trading Mean?

If your company is facing financial difficulty, you might consider trading while insolvent if attempting to save the business. But what do we mean by the term ‘insolvent trading’?

To understand, let’s first define what it means to be insolvent. The UK’s Insolvency Act 1986 lays down the legal framework for dealing with insolvencies, and it defines insolvency as an inability to pay debts as and when they arise.

This means if your company cannot pay its suppliers or creditors, it has become insolvent. This can occur due to a downturn in business, poor financial planning, bad business management, a struggling economy, and other reasons either within or outside of the directors’ control.

The Insolvency Act 1986 states that insolvency can also occur if ‘a company’s assets are less than the amount of its liabilities’. This means that even if the company’s assets were to be sold, they wouldn’t cover the cost of its debts.

Insolvency isn’t a legal or even formal procedure; it’s simply a ‘state of being’. If your company’s accounts are in the red or if you can no longer pay your suppliers or creditors, you are considered to be insolvent.

To summarise, insolvent trading occurs when a company continues trading while insolvent. If your company cannot pay its debts but continues to offer its services or sell goods to customers, you are deemed to be trading while insolvent.

Deliberately continuing to trade while insolvent can have serious legal implications. For this reason, it’s important that you speak to a licensed insolvency practitioner if you believe your company has become insolvent.

Is Trading While Insolvent Illegal?

A state of insolvency doesn’t automatically preclude that a company will be shut down and liquidated. Indeed, if you are running a large operation you may not realise that the company has become insolvent until you discover that there isn’t enough cash to pay your suppliers.

This means that trading while insolvent isn’t necessarily illegal. This is the case if you have yet to fully comprehend that your business is struggling. Importantly, it is illegal to continue trading while insolvent once you are aware of the state of insolvency your company now holds.

It may be tempting to continue trading, especially if you believe that you can turn the company’s fortunes around in the short term. However once a company becomes insolvent, the directors’ duty of care is no longer with the shareholders, but with the creditors who are owed money.

Continuing to trade while insolvent can result in a company taking on more debt, thereby becoming less able to pay its creditors. In this respect, trading while insolvent can become a case of wrongful trading under the Insolvency Act 1986.

There are however certain circumstances when the company can legally continue trading while insolvent. These formal insolvency procedures require the company to enter into arrangements with its creditors or take on an administrator. However, if you simply continue trading as normal once you are aware of the insolvency, then you are acting illegally.

What is Wrongful Trading and the Insolvency Act?

The concept of wrongful trading was legally introduced to the UK when the Insolvency Act 1986 was passed in parliament. Wrongful trading is sometimes also referred to as insolvent trading, because it can only occur when the company trades illegally while insolvent.

Wrongful trading occurs if the company directors are proven to have continued trading after they realised the company is going to fold. For example, if the directors know the company is going to be liquidated but choose to continue selling products to customers, they may have committed wrongful trading.

The emphasis is very much on the directors to act above board and to do everything they can to minimise the chance of further financial loss for their creditors. Wrongful trading can also occur if – through mismanagement – the directors did not realise that the company was insolvent but continued trading anyway, thereby leading to further losses. In this case, it’s assumed that the directors should have taken more responsibility for the company than they did, and that they did not do everything within their power to keep the company solvent.

A case of wrongful trading can only be brought against a director once the company has been liquidated. During the liquidation process, the liquidator will investigate the actions of the directors that led to the company becoming insolvent. They will also assess the actions of the directors during insolvency and liquidation proceedings, and determine if any wrongful or fraudulent trading may have occurred.

If the liquidator has reason to believe that the directors have not acted in the best interests of the company and have committed wrongful trading, the Insolvency Service can commence proceedings against them. The consequences of wrongful trading can be severe, and directors can find themselves disqualified from taking up future directorial positions for several years. Directors may also find that they have become personally liable for any losses that occurred when the company was trading insolvent, and they may be required to pay back the creditors out of their own funds or assets.

It should be noted that wrongful trading is different from fraudulent trading. Illegal company trading is considered to be fraudulent if there is a heavy burden of proof that the directors deliberately intended to defraud its creditors or customers.

Fraudulent trading is also assessed once a company is liquidated. If the directors are found to have acted fraudulently, the Insolvency Service will investigate them. Fraudulent trading is considered much more serious than wrongful trading, but it’s also more difficult to prove.

Can a Company Trade While Insolvent?

We’ve already established that it’s illegal to simply carry on trading as normal if your company has become insolvent. This can be deemed to be wrongful trading under the Insolvency Act 1986, and directors should strive to avoid this scenario if they are worried about their company’s financial situation.

However, it’s important to note that insolvency doesn’t have to end with liquidation. It’s in the best interests of the company, its shareholders, employees and creditors if it can become solvent again and, rather paradoxically, the only way to do this is to continue trading.

The Insolvency Act 1986 sets out a legal framework that allows companies to continue trading while insolvent. These formal insolvency procedures often buy the company time, stop creditors from harassing them for payments, and allow for a reorganisation of the business and its debts. Throughout the procedures, the company will be allowed to continue trading, as this is fundamental to maintaining its customer base while re-establishing a positive cash flow.

There are two primary insolvency procedures that allow a company to legally trade while insolvent. These are:

  • Company voluntary arrangements (CVA)
  • Administration

Let’s take a look at these insolvency options in more detail.

Company Voluntary Arrangements (CVA)

A company voluntary arrangement (CVA) is a formal agreement between a company and its creditors. The primary aim of a CVA is to restructure and reorganise the company’s debts, a process that generally involves debts being consolidated into one manageable sum.

A CVA lasts for 12 months, during which time creditors can no longer chase the company for payments. This buys the company time to restructure and recover from insolvency by continuing to trade. At the same time, the creditors benefit from debts being repaid.

Administration

Entering into administration allows a company to continue trading while insolvent, and also allows a company to be reorganised, restructured and saved from insolvency. Entering into administration involves the company directors surrendering control of the business, and placing it into the hands of an appointed administrator.

The administrator – generally a licensed insolvency practitioner – attempts to return the company to a state of solvency. This can mean making tough decisions, such as streamlining the company or making employees redundant, but the ultimate goal is to save the business and allow it to continue trading.

If you’re unsure what steps to take in order to continue legally trading once becoming insolvent, you should speak to a professional insolvency advisor. They will be able to recommend which insolvency procedure is best for your company’s financial situation.

If formal insolvency procedures fail and the business cannot be sold or saved, the final option is liquidation. If a company is going through the liquidation process, it cannot continue to trade. There are two types of liquidation that can occur when a company is insolvent: voluntary or compulsory liquidation.

Creditors’ voluntary liquidation occurs when the company directors and creditors agree that the best way forward is to close down the company. Assets are sold in order to pay the company’s creditors, and the business is struck from the Companies House register.

Compulsory liquidation occurs when the company’s creditors act to have the business closed down against the wishes of the directors. This is usually only a last resort, and the creditors force the closure of the business in order to recoup the money owed to them.

During the liquidation process, the liquidator will assess and report on the actions of the company directors. This includes reporting on any actions that led to the company becoming insolvent, and any illegal, fraudulent or wrongful trading that took place before or during insolvency.

Once the company has been liquidated, the company directors can face legal action if they are deemed to have been trading illegally while the company was insolvent. This can lead to convictions, disqualification and other penalties under the terms of the Insolvency Act 1986. However, if you have acted above board and have not traded illegally while insolvent, it’s unlikely you will be found of any wrongdoing if the company is liquidated.

How Do You Know If You Are Trading Insolvent?

It’s important to understand when your company might find itself in a position where it is trading while insolvent or is likely to become insolvent soon. If your company can no longer pay its debts as and when they arise, you are in a state of insolvency, but there are other signs to watch out for too, including:

  • Creditors chasing you for payment
  • You are unable to pay wages, pension contributions, etc.
  • You are unable to pay taxes
  • You fail the cash flow or balance sheet tests

Insolvency can be caused by any number of different factors, many of which may be out of your direct control. The best way to stay solvent is to plan for solvency. Don’t wait until the business has become insolvent or is trading while insolvent to act, because it’s much more difficult to return to a state of solvency after this.

Insolvency practitioners offer solvency planning and provide advice for directors that can help you to remain solvent. Long-term business planning, as opposed to short-term action plans, is essential if you want to remain competitive and profitable long into the future.

Contact Irwin Insolvency for More Information on Insolvent Trading

Irwin Insolvency has over 25 years’ experience providing expert advice to struggling businesses and companies. Our team of insolvency practitioners has the experience and knowledge to help you tackle insolvency.

If you need to know more about trading while insolvent or wrongful trading and the Insolvency Act, contact Irwin Insolvency for more information.

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About the author

Gerald Irwin

Gerald Irwin is founder and director of Sutton Coldfield-based licensed insolvency practitioners and business advisers, Irwin Insolvency. He specialises in corporate recovery, insolvency, rescue and turnaround.