Life can very quickly become difficult for a director of a company in financial difficulty. Often directors will continue to trade in the sincerely held belief that they can trade out of the situation.
The legal definition is such that a company is insolvent when it is unable to pay its debts and this can occur it two ways;
- Cash flow insolvency exists when a company is unable to pay its debts as and when they fall due, regardless of company assets.
- Balance sheet insolvency occurs when the liabilities of the company exceed its assets even though there may be no difficulty in paying debts that are due currently.
There is some overlap in the definitions and, put simply, the cash flow test takes a short term view and the balance sheet test looks at the longer term.
Clearly, applying these criteria strictly, your business may already have been insolvent at some stage in the past – along with many other small and medium enterprises. But have you realised that trading whilst the company is insolvent means that directors run a significantly greater risk of personal liability than would normally be the case?
Directors can of course be personally liable for ‘wrongful trading’ but successful actions are statistically rare. However, a liquidator will also specifically examine a director’s transactions with the company which will include payment of remuneration, any assets sold to a connected party and whether a director’s loan account (as a creditor) has been repaid in preference to other creditors to name but three.
In our experience, in owner-managed companies there may be a mindset of directors paying themselves first and accounting for these payments later. If the company has been managed in an informal way, records may contain a significant number of unexplained transactions between the director and the company. If it can be demonstrated, for instance, that directors have not considered the interests of creditors in an insolvent situation, then there is the possibility of an action for misfeasance.
This is not an exhaustive list and any of these issues (and more) may turn into a personal liability on the part of the director. There is also no suggestion that companies cannot trade through their difficulties but directors do need to demonstrate greater care and consider any implications of their actions even if they remain confident that any problems are short term.
Should your company be experiencing financial difficulty, then for increased peace of mind, now may be the time to seek professional advice and ensure the most beneficial outcome for all of the stakeholders. An initial consultation with EWS is free of charge. Contact us.