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What is insolvent trading?

Insolvency is when a business is considered unable to pay its debts. Insolvent trading is when a business continues to trade and go about daily life whilst it has run out of funds. To understand insolvent trading, you will need to recognise what makes a business insolvent. Some ways you can test for current or imminent insolvency include: 

  • the cash flow test - by assessing a business’ cash flow, you will be able to calculate if it has enough funds to meet payments (eg staff wages, utility bills, and finance repayments). If cash flow is expected to run out, this is a red flag that your business is likely to fail without extra income to replenish cash flow 

  • the balance sheet test - a business’ balance sheet is essentially an inventory of the business’ assets (eg equipment, machinery, property, and investments). This also includes intangible property that can generate financial value when realised (eg patents and copyright agreements). If a business’ liabilities outweigh its assets, this shows that the business is in danger and is due to become insolvent if it continues on the same track 

It is important to note that a business may not be insolvent permanently and indefinitely. By conducting a suitable restructuring exercise, such as a Fast Track Company Voluntary Arrangement (CVA), a regular CVA, or putting the business into administration, the business could be returned to a healthy position. Alternatively, you may wish to sell your business and attract a buyer who is cash-rich and highly skilled in the business’ sector or product, making them better placed to operate the company. 

What is wrongful trading?

Wrongful trading is when a business continues to trade after the company’s directors realise or should have realised that insolvency administration or insolvent liquidation is inevitable. This is typically due to poor judgement when a director is hoping for the situation to resolve. 

Directors may also be guilty of the more serious offence of fraudulent trading if they carry out wrongful trading with dishonest intent (ie intent to do so for fraudulent purposes). For example, if proof is found that a director continues trading with no intention to make repayments, they may be found guilty of fraudulent trading. 

If you are liquidating your company, it is common practice to launch an investigation into director conduct to ensure that all directorial duties were fulfilled. If a licensed insolvency practitioner finds evidence of fraudulent trading, this will be reported to the courts. Fraudulent trading is a criminal offence. 

What are the consequences of wrongful trading?

If a director is found guilty of intentionally defrauding creditors, they could be disqualified as a company director for a maximum of 15 years and may be fined. They will also be at risk of being held liable for company debts. 

If you find yourself in this situation during the liquidation process, seek advice from a licensed insolvency practitioner. Cases of wrongful or fraudulent trading are treated seriously by the courts, so it is crucial to seek expert advice concerning insolvency before falling foul of the law and committing a serious offence.

For more information, read Insolvency, Insolvency in Scotland, and Liquidation. If you want to close your company or are in the process of closing your company, and want to find out more, read Closing a limited company and follow our Checklist for closing your company. If you have any questions or concerns, do not hesitate to Ask a lawyer.

Julian Pitts
Julian Pitts
Managing Partner at Fast Track CVA

Julian is a Managing Partner at Fast Track CVA, a business recovery specialist with over 40 years’ hands-on insolvency experience, working with SMEs facing unprecedented operational and financial challenges.

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