No company director wants to have to face up to the prospect of their business becoming insolvent. But directors have a duty to act in a certain way, in accordance with the relevant legislation, should their company find itself in a position where it can no longer pay its debts.
A company is deemed insolvent when it can’t pay bills when they become due or it has more liabilities than assets on its balance sheet.
In 2019, there were 17,196 underlying company insolvencies, a 6.8% increase on 2018 and the highest level of underlying insolvencies since 2013, according to The Insolvency Service. In 2020, that figure could well be higher again amid the coronavirus crisis which has seen businesses forced to close while still accruing liabilities.
A company that is insolvent doesn’t necessarily have to close down – but directors will need to take action that allows the business to continue trading. You should seek out professional advice from a qualified third party, e.g. an authorised insolvency practitioner who will work with you to help you navigate the path that is right for your business in light of its finances.
Do you have a duty to your shareholders or creditors?
When you start a company, you’re driven by a desire to generate a profit for the business’ shareholders – but the priority shifts when liabilities outstrip debts.
At the point of insolvency, your legal responsibilities shift from shareholders to your creditors, and your behaviour must be seen to demonstrate this.
In practice, this means doing what you can to recoup your creditors’ money, as well as acting, to the best of your ability, in a way which does not deepen your debt. Taking out additional credit when you know you may be insolvent, for example, can be interpreted as wrongful trading and can lead to both disqualification as well as personal liability for the paying back of a company’s debts.
Meanwhile, removing assets from premises or selling assets to another company at less than full price – known as a transaction at an undervalue – could also be deemed a breach of duty to creditors.
The key legislation regarding directorial conduct in insolvent situations is the Insolvency Act 1986. To ensure you stay on the right side of the legislation, you should engage with an insolvency practitioner or seek other professional advice at the earliest opportunity.
Does the company have to cease trading?
At the point of insolvency, your company doesn’t have to cease trading, provided that you take one of the following options:
- Contact all your creditors to see if you can reach an informal agreement
- Enter into a company voluntary arrangement (CVA)
- Put the company into administration, offering some respite from creditor action
Alternatively, you also have the option of liquidating (‘winding up’) your company. This means the company is closed down and its assets are sold and distributed to its creditors.
An informal agreement with your creditors comprises paying your debt on different terms. This is typically used when you’re experiencing temporary financial difficulties and there is no immediate threat of formal action by any of your creditors.
However, an informal agreement is not legally binding and a creditor can withdraw the agreement at any time.
If you wanted to seek greater assurance over payment terms, you might wish to broker a CVA. This is a binding agreement between a financially troubled company and its creditors for payment of all, or part of, the company’s debts over an agreed period.
Meanwhile, by handing over your company to an insolvency practitioner (the ‘administrator’), you are protected from your creditors taking legal action to recover their debts or start compulsory liquidation without the permission of the court.
The administrator would seek to restore the company’s viability and settle debts with creditors.
Could you be personally liable for any debts?
Directors’ personal guarantees act as security provided by the director of a business for company borrowing.
A diverse range of lenders may ask for a personal guarantee to be signed to give them the additional protection that, if the company cannot afford to repay the liability, they will be able to recover the debt from the director personally.
In the case of a company becoming insolvent, if a debt that’s been secured by a personal guarantee is not repaid in full, the creditor can then pursue the director(s) who signed the guarantee personally for the remainder of the debt.
A specialist in contract law is the best person to speak to see if you have a valid challenge should a personal guarantee be called in.
Take out personal guarantee insurance
Your best option for dealing with a personal guarantee, should it be enforced in line with the law, is to have preemptively taken out personal guarantee insurance when securing finance or a loan for your company.
With personal guarantee insurance, you can cover up 80% of your risk, so you’re personally protected as you plan the future funding and growth of your business. For more information on what personal guarantee insurance entails, speak to one of Purbeck’s specialists today on 0208 004 7252.