Business directors around the UK are currently facing major uncertainty, much of which is related to the prospect of Brexit. At the same time, the law is fixed and it is quite clear on the matter of directors’ responsibilities in general and, in particular, in relation to the issue of companies continuing to trade when they are insolvent. Here is a simple explanation of the key facts directors need to know.
What is trading when insolvent?
Trading insolvent is carrying on with business as usual when the company is unable to pay its creditors. It is a situation which is clearly unsustainable over the long term and can lead to behaviours for which a director or directors can be held personally liable. Directors should be aware that they have the following mandatory responsibilities.
The responsibility to treat all creditors equally
Directors may be aware that in situations where individuals are dealing with debt, they can use a technique sometimes called snowballing, which is that they make the minimum payments on all debts and use any excess disposable income to make extra payments on the debt with the highest interest. This technique in and of itself can be used by companies to reduce their debts, but only if they are solvent enough to make at least the minimum payments to all creditors and to trade solvently for the foreseeable future. In a situation where a company is insolvent, all creditors have equal (and proportionate) rights to a company’s available funds and/or any funds it can raise. Likewise, directors have to treat personally-guaranteed loans and loans from private individuals (e.g. loans from family members) in the same way as other loans.
The responsibility to conduct sales of assets in an appropriate way
While selling assets at a discount may be held to be appropriate if a company needs to raise a small amount of money very quickly, such an approach should be both justified and transparent. Generally speaking however, any sale of assets should be conduct in the same way as it would be if a company were financially healthy and should aim to raise as much money as possible.
The responsibility to pay back debts using legal and ethical means
In tight situations there can be a temptation to get creative with the accounts or to use other, legally-questionable (or just straightforward illegal) means to pay back debts. Avoid these at all costs (literally and metaphorically). Realistically in all probability this will just make a difficult situation even worse.
The responsibility to address the problem
It really is that simple. Attempting to carry on with businesses as though nothing was wrong will, at best, do nothing to address the problem. At worst, it will simply add to the problem and make it even harder to deal with when the time comes.
Ignoring these responsibilities can have serious consequences, such as directors being held to be personally liable for company debts (even if they have not personally guaranteed them) and/or being banned from holding a directorship for up to 15 years.
In this context, it should be remembered that the term “director” is a definition rather than a job title. That is to say that an individual can be held to be a director if they exercise the sort of authority expected of a director, for example exercising any degree of executive control over company management or providing instructions to the named directors. This means that anyone involved in the running of a company in any way has the same responsibilities as the official directors and is potentially exposed to the same liability and penalties as they are.