Where to begin?
When a company gets into significant financial difficulties, the only option might be to enter an insolvency process. A qualified insolvency practitioner will need to be involved to ensure everything is appropriately followed. There are specific rules surrounding the processes of administration or liquidation, and various investigations will take place.
The insolvency practitioner will take control of the company and be responsible for the investigations. In the event of issues arising as to the conduct of directors, a separate investigation will need to be conducted.
If you are the director of a business facing insolvency, you may be personally liable for some financial aspects. Furthermore, if you are found guilty of misconduct or fraudulent or wrongful trading, there could be consequences, such as a fine or disqualification.
There are certain activities by directors, which could lead to a targeted investigation, such as:
Companies may go through certain cashflow challenges at various points, so there is a risk that you may end up trading whilst insolvent. However, it only becomes known as wrongful trading when your business continues to operate once it has past the point of no return, and insolvency is fundamental and permanent.
The directors of the business have a responsibility to all creditors to limit their losses. If they fail to do this, there is the possibility they may need to contribute towards the business. Other penalties might be imposed too, such as a fine or being disqualified as a director.
Wrongful trading is more likely to occur when a business is waiting to be issued with a winding up petition. If that is the case, it would be more advisable to enter voluntary liquidation instead, which would reduce the wrongful trading risk.
Fraudulent trading is more serious than wrongful trading, in that it is a criminal offence rather than a civil one. For the trading to be classified as fraudulent, it must be clear that there has been an intent to trade, which would be detrimental to the creditors. For example, you could continue to take deposits from customers without there being any intention or possibility of delivering the goods and services that the deposit was supposed to secure.
To prevent against any accusations of wrongful or fraudulent trading, it is crucial that if there is any threat of insolvency whatsoever, the directors put in place any considerations and measures to limit any losses by creditors.
A preference payment is one that is made by a business to a specific creditor, essentially giving them special treatment over other creditors. It usually occurs when the company is in financial difficulty or is indeed insolvent, and most likely scenarios are as follows:
• Director’s loans are repaid, or other payments are made to directors or shareholders before any external creditors
• Payments are made first (or are the only payments) to connected parties such as family members
• Certain suppliers are repaid who will continue to supply when a future business is set up
Any payments made from contractual obligation, such as employee salaries or those made under evidence of duress, would not be considered a preference payment.
If any preference payments are determined, it will likely be the case that the insolvency practitioner will seek to recover the funds as part of the investigation. The Directors could be liable for the repayment, or equally, it might be requested from the recipient.
Transactions at undervalue
A transaction at undervalue is when the company sells an asset at a price significantly lower than the market value, or indeed gives it away. A transaction at undervalue can be for one of several benefits. For example, the directors might be stripping out all the assets in advance of insolvency. Alternatively, there may be a desire to set up another very similar company afterwards, and the directors might be trying to secure equipment at a discounted price.
If assets need to be transferred before insolvency, it is always advisable to seek expert help. There are options available such as a Pre-Pack Sale, and requires a professional valuation and assurances that there is no one willing to pay a higher price for the items.
Overdrawn director’s loan account
Efficient tax planning can involve the use of directors’ Loans, but they must be considered as part of an insolvency process. Debts can begin to spiral if not adequately managed. Still, it is important not to prioritise repaying a director’s loan over other creditors, as this could fall into the category of preference payments.
If you have been involved in any of the actions listed above, it is possible that as a director, you will be required to make a financial contribution towards the insolvent company. Furthermore, depending on the severity of the issue, a director’s disqualification might be appropriate. A disqualification can last from 2 to 15 years.
If you are entering into liquidation or administration, an insolvency practitioner will be required, and they will conduct a full investigation. As part of the investigation, the directors’ actions will be considered, and if needed, more consideration will be made. Provided everything was done in good faith, there should be no repercussions for the directors. If you believe your business is in financial difficulty, contact the experts at 1st Business Rescue, who will be able to guide you through the complicated process.