Company insolvencies in 2023 were just over 25,000, the highest since 1993 and 14% higher than 2022. Of these, the number of Creditors’ Voluntary Liquidations was the highest since records began in 1960. This trend in the year to September 2024 is continuing and insolvent companies in this period account for 55 out of every 10,000 companies registered which is higher than during the Covid-19 pandemic, with the main casualties being in the Construction, Wholesale/ Retail trade, and Accommodation/ Food Services.
With these figures in mind, and the pressure on businesses likely to increase next year with the increase in Employers’ National Insurance contributions and the Minimum Wage, it is timely to remind directors of the 4 key sins they should seek to avoid when their company is facing insolvency.
When a company becomes insolvent, directors must navigate a complex landscape of legal and ethical responsibilities. The Insolvency Act 1986 outlines four key “sins” that directors must try to avoid, minimising exposure to personal liability and potential director disqualification. Understanding these sins and the role of an Insolvency Practitioner (IP) can help directors manage their company’s financial situation more effectively.
What are the 4 Key Sins to avoid and the potential consequences for failing to do so?
- Wrongful Trading
Wrongful trading occurs when a director continues to trade with knowledge of insolvency, or should have known, that there is no reasonable prospect of avoiding insolvency. This is normally a civil offence and can result in directors or those in control of a Company’s business being made personally liable for the company’s debts. Director Disqualification is also a possibility. In extreme cases, criminal charges may be brought against the directors.
- Fraudulent Trading
Fraudulent trading is a criminal offence where a director knowingly carries on business with the intent to defraud creditors. This can include actions such as concealing assets or falsifying records to avoid paying debts.
If convicted, directors can face imprisonment for fraudulent trading, as well as facing the consequences of wrongful trading.
(Take a look at our article on the difference between wrongful and fraudulent trading.)
- Creditor Preferences
Directors must not prefer one creditor over others. This means they cannot pay off creditors to the detriment of others without a commercial reason, as it can be seen as an attempt to favour some creditors over others. Such preferences can be reversed by the Courts, and this offence can lead to personal liability for company debts as well as director disqualification.
- Transactions at an Undervalue
Directors must ensure that any transactions involving the disposal of company assets (if any) are made at a fair value. Selling assets at an undervalue can be seen as an attempt to defraud creditors and again can lead to personal liability and also director disqualification.
These penalties are designed to protect creditors and ensure that directors act responsibly and in the best interests of the company and its creditors.
How can an Insolvency Practitioner help?
An Insolvency Practitioner (IP) is a licensed professional who specialises in advising and supporting companies facing financial difficulties. Here’s how an IP can assist in helping directors in avoiding these key sins:
- Early Intervention: An IP can provide early advice on the company’s financial situation, helping directors make informed decisions before the situation worsens.
- Guidance: IPs can offer legal guidance on the implications of continuing to trade, ensuring directors understand their responsibilities and the risks involved.
- Turnaround Advice: IPs can help develop a realistic financial forecast, recommend a plan to improve cashflow and reduce costs, and help negotiations with creditors to reduce the pressure of debts and improve the financial position.
- Restructuring Advice: IPs can help directors explore options for restructuring the company, such as a Company Voluntary Arrangements (CVAs) or Administration, to avoid insolvent liquidation.
- Asset Management: IPs can assist in managing and realising company assets in a way that maximises returns for creditors, ensuring transactions are conducted at fair value.
- Compliance Monitoring: IPs can monitor the company’s compliance with legal requirements, helping directors avoid wrongful trading and other breaches of duty, as defined in the Insolvency Act 1986.
By working with an Insolvency Practitioner, directors can navigate the complexities of insolvency more effectively, ensuring they meet their legal obligations and protect the interests of creditors and stakeholders.
Advice for Directors
Directors must always be aware of their company’s financial position. Pleading ignorance is no excuse. Indeed, failure to recognise that a company is in financial difficulties or already insolvent is likely to be seen as irresponsible, negligent and proof of ‘unfit conduct’ by the directors.
One thing we know for certain is that the sooner under pressure directors act, the better the chance of survival. Figures from R3 (the Association of Business Recovery Professionals), for example, show that over 40% of insolvent businesses are rescued by Insolvency Practitioners. Options range from providing access to finance in order to help turnaround, to the breathing space that insolvency procedures such as Company Voluntary Arrangements and Administrations provide. Liquidation is not inevitable.
In addition, the earlier directors talk to an Insolvency Practitioner the quicker they can be advised on what measures to take to avoid breaching their responsibilities.
