One of the questions I’m asked most often is deceptively simple:
“When do I actually have to stop trading?”
Directors expect there to be a red line… perhaps the company’s liabilities exceed its assets, perhaps HMRC is overdue, perhaps the bank account is at its overdraft limit.
In practice, none of those facts, on its own, answers the question.
A company can be insolvent and still have a viable rescue… equally, a company can have positive net assets on paper and be in serious trouble because it cannot pay this week’s salaries.
The real question is whether continuing to trade is a sensible course that protects the interests of creditors as a whole, or whether it is simply making their position worse.
Start with cash…
Can the company pay its debts as they fall due?
Look at what has to be paid over the next few weeks, not just what is sitting in the bank today. Look at the wages and PAYE, VAT, rent, finance payments, essential suppliers, insurance, loan repayments and overdue creditors already demanding payment.
Then look at what is genuinely coming in. This is why I always like a short-term cashflow forecast.
But, surely, cashflow insolvency doesn’t automatically mean close tomorrow, does it?
A company may be unable to pay its debts today but have a realistic solution within its grasp. A large debtor might pay in two weeks’ time, HMRC may agree a Time to Pay (TTP), a shareholder may inject some cash, surplus assets might be sold, the bank could provide a little more support. The point is that if there’s a credible route through the problem, continuing to trade may be entirely sensible.
But the word ‘credible’ really matters. “I hope something will turn up” isn’t a credible rescue plan.
And what about the balance sheet?
The other familiar insolvency test asks whether the value of the company’s assets is less than its liabilities, taking account ‘contingent’ and ‘prospective’ liabilities.
That matters, but balance sheets need interpretation, a machine with a book value of £200,000 might realise £70,000, stock may be obsolete, debtors doubtful. On the other hand, a profitable business may possess goodwill that doesn’t appear in the accounts at all.
So don’t make a major decision by glancing at the net-assets figure in the last statutory accounts.
Are creditors getting better or worse off?
This is where the focus needs to sharpen.
As financial distress deepens, directors have to give increasing weight to creditors’ interests. The Supreme Court made that clear in BTI 2014 LLC v Sequana SA. Where a company is insolvent or bordering on insolvency, creditors’ interests become part of the directors’ decision-making, and the more serious the financial difficulty becomes, the greater the weight those interests carry. (Supreme Court UK)
Ask a simple question:
“If we trade for another month and the rescue fails, are creditors likely to be better off or worse off?”
Suppose the company is losing £25,000 every month, buying more goods on credit and using new customer deposits to fund old liabilities.
Without a credible turnaround, continuing may simply deepen the hole.
That’s very different from a company that is temporarily short of cash but trading profitably and expecting a £200,000 debtor next week.
Wrongful trading isn’t simply “trading while insolvent”
This is another common misunderstanding.
Section 214 of the Insolvency Act 1986 does not say that directors become personally liable merely because the company traded while insolvent. Wrongful trading concerns the circumstances in which a director may be ordered to contribute to the company’s assets where the statutory test is met. It’s also why documenting decisions matters.
Write things down
When a company is in genuine difficulty, hold proper board meetings, record the current cash position, creditor pressure, updated forecasts, assumptions behind the rescue plan, professional advice received, funding discussions, major payments proposed and why continuing to trade is expected to improve rather than worsen creditors’ position.
Minutes written at the time are far more persuasive than somebody trying to reconstruct their reasoning eighteen months later.
Watch selective payments
Directors under pressure naturally want to pay whoever is shouting loudest.
Sometimes paying a particular creditor is commercially necessary, the typical example is an essential supplier may need paying to keep the factory open.
But be particularly careful where payment also benefits a director – or those ‘connected to them – personally. Paying a creditor because the director has given a personal guarantee is an obvious example.
The decision needs to be for the company and its creditors, not simply to protect the director.
Takeaway checklist
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Can wages be paid on time?
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Can tax and essential suppliers be paid?
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What does the next 13 weeks look like?
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Are debtor receipts genuinely collectible?
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Is the underlying business profitable?
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Is there a specific, funded rescue plan?
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When will that plan succeed or fail?
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Are losses increasing each week?
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Is new credit being taken with no realistic means of repayment?
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Are customer deposits being used to plug historic losses?
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Are creditors as a whole likely to be better off if trading continues?
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Are directors making payments that reduce their own personal exposure?
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Are board decisions being properly recorded?
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Has independent insolvency advice been taken early enough?
Final thought
There is no magic moment when a warning light flashes red and tells a director to stop. That’s why these situations are so very difficult. You need to keep asking whether there remains a realistic route to rescue and whether continuing to trade is protecting value rather than destroying it.
Sometimes the right answer is to keep going, sometimes it’s to restructure quickly, and sometimes the hardest decision, stopping before the position gets worse, is the one that best protects creditors, employees and the director too.
#CompanyInsolvency #DirectorsDuties #WrongfulTrading #BusinessRescue #Cashflow #Turnaround #InsolvencyAdvice
01902 672323
paul@midlandsbusinessrecovery.co.uk