Director’s Duties – Insolvent trading and the risk for directors (Part 3)

November 23, 2016

Unfortunately sometimes a business being operated by a company becomes financially unviable through no fault of the directors.

Generally, where the company has been responsibly managed, the debts of the company will stay with the company and can only be satisfied with company assets and will not fall to the directors to repay personally.

But insolvent trading is an exception to this rule. If, as a director, you allow the company to continue trading even when you suspect it is unable to pay its debts when they fall due, you can become personally liable for any debts incurred after this point, as well as potentially facing civil and criminal penalties.

Even if you have employed someone to oversee the financial position of the company, it is your responsibility to ensure that that person provides you with adequate information for you to ascertain if the company is solvent.

Common signs of insolvency which you should watch out for as a director include:

1. low cash flow or operating profits;
2. inability to pay suppliers and other creditors on time;
3. inability to extend lines of credit;
4. inability to meet loan repayments or stay within overdraft limits; and
5. creditors threatening to, or actually taking, legal action to recover money the company owes.

If you notice any of these signs it is time to sit down and analyse:

1. the cash flow of the company to determine whether the current and expected future cash flow will be sufficient to meet the current and future debts of the company; and
2. the overall position of the company in terms of total assets vs total debts.

If, after undertaking this analysis, you determine the company is insolvent, you must prevent any further debts being incurred including those that would be incurred in the ordinary course of running the business, for example rent and use of utilities.

If you determine the company is solvent you may continue trading. It is important the analysis you undertake is thorough, documented and supported by the figures and reasonable assumptions you have relied on.

If the company later becomes insolvent you may need this analysis to defend claims that you allowed the company to trade while it was in fact insolvent.

Read Part 4 here

Read Part 2 here