Many companies will experience short-term trading and cashflow issues during their lifetime. If these become significant and the company is unable to recover, then the Directors may need to consider placing the company into insolvency.
In law, a company is insolvent when:
- The company is no longer able to pay its debts when they become due (the cashflow test).
- The company has liabilities which are in excess of its assets (the balance sheet test).
An Insolvency practitioner will normally be appointed to take control of the company when the Directors consider that it is insolvent.
It should be noted that as a company moves towards insolvency, the directors are required to act in the interest of the company’s creditors.
The directors can be at risk from the concepts of:
- Wrongful Trading – continuing to trade when the directors should have known that the company had no reasonable prospect of avoiding insolvent liquidation.
- Breach of duty – the directors didn’t act in the best interests of the company.
- Piercing the Corporate Veil – if the company has been improperly used, the company as a separate entity will be ignored and the underlying ownership will be considered (although in practice this will often not be used).
HMRC will often be a major creditor of a company being put into insolvency.
To recover its debt:
- Although rare to happen, action could be brought against the director for a breach of duty by the company.
- Where misconduct is suspected, the liquidator will be appointed by the creditors to seek to recover property.
- From 1 December 2020, HMRC re-acquired Crown Preference regarding the taxes the company collects for HMRC.
- Any unpaid social security contributions (plus interest and penalties) can be recovered from the company’s officers, although this is normally only used when there is fraud or neglect.
It is therefore important that the Directors regularly review the company’s performance to ensure they are aware of any move towards insolvency at the earliest opportunity.
If you are experiencing any trading or cashflow difficulties, do speak to your usual Lambert Chapman Partner.
The views expressed in this article are the personal views of the Author and other professionals may express different views. They may not be the views of Lambert Chapman LLP. The material in the article cannot and should not be considered as exhaustive. Professional advice should be sought in connection with any of the issues contained in the article and the implementation of any actions.