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Insolvent liquidation

04 October 2007
Insolvent liquidation

What are a company director's obligations to creditors if the firm gets into financial difficulties? Bryn Robertson of Davenport Lyons solicitors advises

The problem

I'm a company director. We're experiencing serious cash-flow problems and can't pay our creditors. I suspect we may go into insolvent liquidation. Will I be held personally liable for the debt of the company?

The Law

"Wrongful trading" as set out in section 214 of the Insolvency Act 1986 applies when a company has entered into insolvent liquidation and the conduct and affairs of its directors will be investigated. In particular, a liquidator will see if there was a time at which a director knew, or should have realised, that the company's creditors were likely to go unpaid. From that moment he can be personally liable unless he does everything reasonably possible to minimise creditors' losses.

Objectively, the law assumes a minimum standard of skill and care that can be expected of any director. Subjectively, the law will take into account his particular skills and what can be expected of him in that context, in addition to the basic minimum standards.

If a director is found liable for wrongful trading, he will not receive a criminal record. The purpose of the legislation is to compensate creditors for the loss caused by the director's conduct, with the guilty director being ordered to make a payment. The courts can also disqualify him for up to 15 years.

Where a claim is brought for wrongful trading against a number of directors, the position of each director is individually assessed.

Expert advice

The key priority for a director who realises that the company cannot avoid going into insolvent liquidation is to minimise potential loss to creditors. He should raise the problem with the rest of the board immediately and then seek advice from an insolvency practitioner and solicitor.

As the interests of creditors are paramount, the directors cannot, for example, enter into an agreement to distribute the company's assets to shareholders without proper provision for all creditors. Neither should directors choose to pay friendly creditors ahead of others, nor take any arrears of salary, dividends, pension payments or repay directors' loan accounts.

To avoid wrongful trading, directors may have to cease trading. This can happen without resorting to one of the insolvency procedures if the company is solvent and can pay off all its debts. If not, the directors must instigate a formal insolvency procedure.

Check list

  • If in financial difficulty, hold regular full board meetings, ensure commercial decisions are reported in full in the minutes and ensure that accounts are properly managed.
  • Consider preparing cash-flow forecasts over certain periods and then updating them in light of actual results - take into account past performance, current conditions and future prospects.
  • Ensure directors have up-to-date financial information.
  • If you suspect the company will go into insolvent liquidation, seek professional advice from a solicitor and insolvency practitioner.
  • Don't incur further credit until such advice is received.
  • Take every step to minimise losses to all creditors equally.
  • Do not: pay out shareholders or distribute profits without proper provision for all the creditors pay friendly creditors ahead of others take arrears of salary, dividends, pension payments or repay directors' loan accounts.

Beware!

A director found liable for wrongful trading can be ordered to pay a contribution to the assets of the company, which may compromise all the debts in the worst-case scenario, followed by a disqualification of up to 15 years.

Contacts

Davenport Lyons solicitors

020 7468 2600

brobertson@davenportlyons.com

îƒ" The Insolvency Service

www.insolvency.gov.uk/

îƒ" Institute of Directors

www.iod.com

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