July 28th, 2011
Directors owe a duty of care to the company’s creditors. If a company continues to trade when it is insolvent, its directors can be held personally accountable if their actions cause financial loss to any of the company’s creditors.
You will also be liable under any personal guarantees.
What do I do if my company is in financial difficulty?
Directors must use their judgement and known facts to establish whether the company is, or is about to become or is insolvent
They must establish whether or not a problem is only on a short-term basis and will be rectified by trading on, or means terminal failure, or something in the middle ground. Directors must be cautious, they should not do anything (writing cheques, committing the company to any action, paying creditors, taking deposits etc) without seeking professional advice.
In many situations one of the direct or indirect causes of insolvency is management failure. This may be accompanied by a lack of control, poor record keeping and a lack of accurate financial information.
Accurate and up-to-date accounts are vital in determining a company’s solvency.
How do I tell if my company is insolvent?
A company is insolvent on a cash-flow basis if it is unable to pay its debts as they fall due, or fails to satisfy a judgment debt. There is a second balance sheet test for solvency which asks.
The cash-flow test
Many companies will fail the cash-flow test on a short-term basis at some time in their existence. Temporary cash flow problems may be caused by
- The failure of a customer to settle a debt on time.
- Overtrading (having too much cash tied up in stock and debtors).
- As a course of a delay in refinancing.
- Not making the required sales to break even.
- Having to make unscheduled payments.
Short-term cash flow problems can be corrected by trading on or after rearranging overdrafts or loan finance.
The balance-sheet test
Very simply do the business liabilities exceed the business assets, taking into account the value of assets with the company in a distressed financial position and providing for all contingent costs, losses and provisions.
If a company does fail its balance sheet test, the directors must act to protect the interests of its creditors to avoid any allegations being made of wrongful trading under the Insolvency Act.
If the company is insolvent directors should take the following steps:
- Obtain and document professional advice and their actions and responses.
- Ensure that the company’s accounts are up to date with a full list of assets, debtors and creditors
- Consider whether any part of the company is worth saving.
- Discuss whether it will be possible to make a formal or informal arrangement with creditors.
- If the company cannot be saved the directors should put it into liquidation.
The accounts should be prepared on a break-up basis which means the fixed and current assets are valued to their net-realisable value.
To avoid personal liability for their actions when a company is in financial difficulties its directors should be careful not to:
- Dispose of company assets at undervalue.
- Show one creditor preference to the detriment of another.
- Accept customer deposits or payments on account if completion is uncertain.
Most important of all if a company is insolvent directors need a licensed insolvency practitioner