What every director needs to know

Depending on the outcome of the investigation, actions can be taken by an insolvency practitioner that require the directors to compensate the company on a financial basis. The official receiver may also take action leading to a director’s disqualification based on their conduct. 

Wrongful trading and fraudulent trading

Many companies are at risk of trading whilst insolvent. However, if there is no prospect of the company returning to solvency and you continue to trade, this becomes a matter of wrongful trading.

At the point of insolvency, a director is expected to take every action to limit losses to creditors. Failure to do so will result in the directors being required to make a contribution to the insolvent estate of the company.

They may also potentially face directors’ disqualification. Statistically, there is more likely to be a wrongful trading claim where a director has continued to trade, waiting for a winding up petition to be issued against the company. In this situation, a more proactive approach would be to place the company into voluntary liquidation.

Fraudulent trading is different from wrongful trading in several ways:

  • It is a criminal offence, as opposed to a civil matter.
  • Intent to trade to the detriment of creditors must be demonstrated.

A good example of fraudulent trading is taking deposits from clients, when already planning to enter insolvency, with no intention of delivering goods.

The bottom line to avoid claims for wrongful trading and fraudulent trading is, if you even remotely believe the company is insolvent, you must consider all steps you can take to limit the losses to creditors.

Preference payments

Preference payments are where specific creditors are given preferential treatment over the main body of creditors. This refers to the time the company is insolvent. It must be demonstrated that there is a desire to prefer one party over the main body of creditors. Therefore, preference payments are particularly prevalent where:

  •   Payments are made to connected parties, such as family members.
  • Payments are made to the directors or shareholders or the company.
  • You intend to start a new company, and payments are made to suppliers you wish to use moving forward.

In the company investigation process, the insolvency practitioner may seek to recover funds. This can be from either the party who has benefited from the payment, or the directors of the company for allowing the payments to be made.

Payments made under true duress, along with payments made to employees of your business, which they are contractually due, cannot be considered to be preference payments.

Transaction at undervalue

A transaction at undervalue is where a company asset is given away or sold for significantly less than its actual value. The intention behind this is to stop directors from stripping the company of its assets ahead of entering formal insolvency. When looking at this, from the company investigation perspective, this will also include lumps of cash taken from the company bank account without cause.

If it is necessary to transfer assets out of the company ahead of insolvency, professional advice should be obtained. In such circumstances, it may be more appropriate to take the pre-pack sale route, for example.

Before transferring assets, a professional valuation should be procured, and it should be clear that no other buyers are willing to pay more for the business than the connected party. The monies should also be set aside appropriately, avoiding the risk of making preference payments as described above.

Overdrawn directors loan account

Whilst an overdrawn directors loan account may be a part of tax planning, to keep your own tax affairs efficient, this becomes an issue upon liquidation. If the company does not have sufficient reserves to enable the declaration of dividends and you only submit payroll at the tax free limits, this can leave you in a position where you loan account begins to spiral.

As a director, you are entitled to make a living. Generally, it is the reason you set the company up in the first place. Being tax efficient at the expense of leaving yourself open to having to repay monies to the company, however, should be avoided.

Directors Disqualification

The above aspects of company investigation can lead to a financial contribution being required to the insolvent estate. The official receiver will also be considering whether directors disqualification is also appropriate.

If an order is made, or you take an undertaking, you will be unable to act as a director for a period of 2-15 years. Depending on the specifics of the case, you may also be ordered to make a contribution to the insolvent estate under a disqualification order.

Conclusion

Once a company enters liquidation or administration, the insolvency practitioner has a statutory duty to complete a full company investigation. They must also take any necessary actions to recover monies for creditors. If you can provide evidence that transactions were in the best interest of the company, an insolvency practitioner should not pursue you any further.

If you have any concerns about the proper way to wind down your company, our BusinessRescueExperts can advise on how to stay on the right side of the regulations.