The attraction of being a director of a limited liability company in the UK is the legal protection from personal liability when your company fails, provided you acted reasonably, responsibly and within the law.
So should companies facing uncertainty and financial difficulty continue to trade whilst insolvent?
A company is insolvent under section 123 of The Insolvency Act 1986 when it cannot pay its debts. This can be either:
- When it is unable to pay its debts when they become due; or,
- The company has more liabilities than assets on its balance sheet
There may be a fine line between wrongful trading and insolvent trading. An insolvent company does not need to be indefinitely insolvent and there are times when problems stem from customers not paying up their own debts on time. If money owed to the company exceeds its creditors temporarily, then an investigation would show that there was no intent to act irresponsibly.
What is Wrongful Trading?
Wrongful trading is a civil offence under the Insolvency Act 1986. It is when a company continues to trade knowing there is no hope of recovery. It can only apply in terminal insolvency, after formal insolvency proceedings such as administration or liquidation.
Wrongful trading is a serious offence because the directors know their company is insolvent and will never be able to pay its creditors in a timely manner. It is even worse if the directors act irresponsibly and allow the level of creditors to increase during this period.
Can directors be liable for losses resulting from Wrongful Trading?
Yes – whether or not you have the job title of ‘director,’ you can still be held liable for wrongful trading if you are acting in the capacity of director.
Only those acting as directors of limited companies will be investigated for wrongful trading. If a director is found to be acting on behalf of a shadow director who has previously been disqualified or is bankrupt then the penalties (which can include imprisonment) are severe.
What are the signs?
When a company enters liquidation proceedings, the liquidator determines if wrongful trading has occurred. They investigate the conduct of all directors who held office in the three years prior to ensure they acted responsibly and took steps to mitigate creditor losses. If there is sufficient evidence, directors can be held personally liable for the company’s debts to creditors and can be disqualified from becoming a director for a maximum of 15 years.