The Risks of Soldiering On
By Nat Young, Senior Solicitor specialising in Insolvency and Dispute Resolution
In business, determination is normally a virtue. However, if a company hits hard times, there are risks with just soldiering on. By trying to trade through difficulties, directors can even expose themselves to personal liability.
If there is a downturn in a company’s financial position, the instinct of the directors is normally to try and turn it round. This is often the right approach. However, it can also mean that the directors carry on trading long after the company is legally insolvent.
Sometimes, directors do not even realise the company is insolvent. Legal insolvency does not mean a company is past the point of no return, or that any insolvency procedure has begun. In reality there are two types of insolvency, and both are compatible with the company having a viable future. Cash flow insolvency is when a company is unable to pay its debts as and when they fall due, regardless of its assets. Balance sheet insolvency is when the liabilities of the company exceed its assets, even if it has no difficulty paying debts due now.
Whether a company is insolvent is important, as directors of solvent companies answer to the shareholders, while directors of insolvent companies also need to consider the interests of the company’s creditors. The fact a company is legally insolvent does not mean directors have to stop trading immediately, but it does expose them to potential claims, particularly if the company ends up in liquidation.
The most obvious claim in these circumstances is for wrongful trading, where the court decides the directors have traded for too long, causing loss to the creditors. However, there are many other potential claims. Perhaps the dangerous area is directors’ remuneration. In owner-managed companies, there is a tendency for directors to pay themselves first, then account for the payments later. This may not cause problems while the company is solvent, but can result in the director facing clawback of remuneration at a later date – either on the grounds it consisted of unlawful dividends, or on the grounds it is a director’s loan that needs to be repaid.
As a result, directors need to be very careful when trying to trade through difficulties. If there is any prospect that the company is legally insolvent, they should always take – and follow – professional advice.
Please note the contents of this article are given for information only and must not be relied upon. Legal advice should always be sought in relation to specific circumstances.