Is it illegal to run an insolvent company? This is an issue around which there is much confusion. This is because there are two types of trading when a company is insolvent: insolvent trading and wrongful trading. Whilst the two seem very similar, they are in fact very different things with very different consequences.
An insolvent company is a company with cash flow problems and books that are in arrears. This is in accordance with the Insolvency Act of 1986. Now, if a company is insolvent but the directors believe this to be only temporary and they carry on trading with the hope of making the company profitable again, this is known as insolvent trading. Insolvency can be a temporary state especially if the company is owed an amount of money that exceeds the amount they owe to their creditors. So trading whilst insolvent is not necessarily illegal if the directors believe they will have the means to pay their creditors in a reasonable amount of time.
Wrongful trading however, is a serious offence which is punishable by law. Wrongful trading differs from insolvent trading in that the directors know that their company is insolvent, they know it will not be a temporary state and they have no way to pay the debts they owe their creditors. Wrongful trading could also be proven if the directors willfully allow the amount of debt to increase whilst they are trading. There are statutory rules and regulations that deem wrongful trading unlawful.
The legal implications of wrongful trading
When a company enters into liquidation (which is a common occurrence for companies that are insolvent) a liquidator will be appointed who must conduct an investigation into the company. If, during the nature of this investigation they find signs of wrongful trading, the directors of the company will be prosecuted. Fines can be handed out or even prison sentences. Directors can also be held personally responsible for debts sustained during wrongful trading and could be banned from directing a limited company for anywhere up to 15 years.
If you are a director of an insolvent company and are unsure what your next steps should be, contact us at Clarke Bell. We can help you assess what course of action you should take, providing quality business insolvency advice which allows you to move forward in the best way whilst adhering to the law. Contact us today.