Many company directors in the UK have never faced the prospect of being unable to pay their creditors, nor having to deal with insolvency. But 2020 has been a year of firsts for many businesses across the UK. For directors, it’s tough enough to admit there is a problem and to seek advice. It’s even tougher if they are not sure how company insolvency works and what is expected of them. Getting company insolvency advice is the first step.
When is a company considered insolvent?
If a business is struggling with debt and can’t pay their creditors, it is facing insolvency. There are three principal tests that will determine the outcome:
- Cash flow test – unable to pay bills when they are due, whether it is immediately or in the future.
- Balance sheet test – the company’s assets are less than the liabilities. Work-in-progress and stock levels must not be exaggerated, nor should any owed debts that are unlikely to be received.
- Legal action test – are there any outstanding court orders, statutory demands or CCJs against the company? If a company has reached this stage, it may end up in compulsory liquidation, i.e. the creditors have issued a court order to wind up the company.
If the business has failed any of the above tests, it is considered insolvent. If it has failed the legal action test, trading must cease immediately in order to prioritise the interests of the creditors. It is advisable that if insolvent, directors should avoid making any preference payments, i.e. paying any particular creditor over other creditors. This could potentially mean disqualification as a director and being held personally responsible for the debt.
A director’s responsibilities during company insolvency
First and foremost, if a company is insolvent, seek professional company solvency advice from a licensed insolvency practitioner and take action immediately. Directors must ensure that the interests of the creditors are prioritised and that no additional debt is incurred.
An insolvent company’s assets or any funds remaining in bank accounts do not belong to the directors or shareholders; they belong to the company. There are certain activities that directors of insolvent companies must avoid, in accordance with the Insolvency Act 1986. Appointed company insolvency liquidators are legally obliged to investigate and report on the directors’ conduct during the process. However, there are certain actions directors can take to mitigate the potential outcome.
Be upfront and honest with creditors – once facing insolvency, as a director it’s important to be upfront and honest with creditors. It is a director’s responsibility to minimise the creditors’ risk. Ensuring creditors always receive accurate information in a timely manner, and communicating with them effectively and regularly, will help keep the process on a professional level.
Seek professional advice – when facing insolvency, it can be difficult to know when the best time to cease trading is. There is a difference between entering into business recovery options agreed with creditors to a company going into formal liquidation. An insolvency practitioner (IP) will be able to guide you on the timing to avoid any wrongful trading accusations.
Ensure there is a written record of any meetings – make sure there is a written record of any meetings, be it with shareholders, the company’s board or creditors. If a company is struggling with debt, there will probably have been many meetings with the board of directors, shareholders, accountants and other personnel before arriving at the conclusion of insolvency. It is important that any discussions, any resolution steps to reverse the debt situation and any decisions are noted down for reference at a later date.
Keep financial records clear and concise – the more up to date and clear the company’s financial records are, the easier it is for directors and the IP to see the overall situation. Detailed, accurate financial records may also help in shortening the insolvency liquidation process.
Avoid incurring further debt or credit – avoid taking on any more company debt by continuing to trade when facing potential insolvency, and avoid further credit. A director may think it’s a good idea to get credit in order to try and reverse insolvency. However, not only could it be considered an act of wrongful trading, it is not prioritising the creditors’ position. The aim is to cut expenditure and not increase it.
Protect and preserve the company’s assets – as mentioned above, any assets or monies in the bank belong to the company, not to the directors. If any director attempts to sell a company asset, they will be accused of misconduct during the liquidator’s investigation. Moving the assets to a different company or letting creditors have assets in lieu of payment is also considered misconduct. It is the directors’ duty to ensure that all assets and remaining funds in bank accounts are protected. It is a good idea to have them secure and insured.
Avoid investing your own money into the company – as a director, avoid investing personal money into the business. Being a limited company, and therefore a separate legal entity, a director is exempt from liability. However, if personal money has been invested or a director has acted wrongfully, the director will be held personally liable.
Consider claiming liquidation redundancy – if a director is employed by the company and made PAYE payments, that director is entitled to claim liquidation redundancy from the government.
Complete as much of the legal paperwork as possible – it is always a good idea to ensure that all VAT, annual and tax returns are completed and submitted to HMRC. This will demonstrate to the liquidator and creditors that as a director, you have acted in a proper manner.
A director’s duties during liquidation
Once an insolvent company enters the liquidation process, a director has certain duties, such as:
- To provide the liquidator with all relevant information pertaining to the company’s affairs
- To provide details of all the company’s liabilities and assets
- To secure and preserve the company’s assets to hand over to the liquidator
- To secure and protect the company’s accounts, records, bank statements, insurance policies and any other relevant documents relating to its liabilities and assets.
Having been a director of a liquidated company does not automatically stop you from becoming a director of another company, albeit with restrictions in accordance with HMRC’s guidelines. However, if the director’s conduct is considered unlawful or improper and they are disqualified, they are not allowed to be a director of another company in accordance with the Company Directors’ Disqualification Act 1986.
Company insolvency is not something that any business wants to deal with; however, the sooner a financial problem is recognised, the sooner it can be dealt with and the more potential the company has to recover. For more information on how our professional insolvency practitioners may be able to help your business, contact us today.