Insolvent Trading: What Directors Need to Know

Financial pressure is one of the most challenging situations a business owner can face. When a company begins experiencing cash flow difficulties, directors need to understand their responsibilities and take proactive steps to assess the company’s position.

Continuing to trade while insolvent, or taking on new obligations when there is no reasonable prospect of meeting them, can expose directors to personal liability.

The key message for directors is simple: financial difficulty does not mean a business must immediately close, but it does mean directors must act carefully, responsibly and proactively.

What Is Reckless Trading?

Under section 135 of the Companies Act 1993, directors must not allow a company to operate in a way that creates a substantial risk of serious loss to creditors.

The focus is not simply whether a company is experiencing difficulties. Businesses regularly face challenges, changing markets and periods of uncertainty.

The question is whether directors are taking unreasonable risks that could significantly worsen the position of creditors.

Legitimate business decisions involve calculated risks. However, continuing to trade where:

• The company is insolvent or close to insolvency.
• There is no reasonable prospect of recovery.
• Creditors are likely to suffer further losses.

may create a risk of personal liability for directors.

Directors Must Continually Assess the Company’s Position

When a company experiences financial pressure, directors are expected to make ongoing and informed assessments of the company’s position.

This includes considering:

• Current cash flow.
• Future income and trading prospects.
• Ability to pay creditors.
• Available funding options.
• The likelihood of recovery.
• The impact on creditors.

Where circumstances indicate increasing financial difficulty, directors should respond promptly and ensure the position of creditors does not continue to deteriorate.

In these situations, the interests of creditors become increasingly important.

Directors Must Consider New Obligations Carefully

Section 136 of the Companies Act 1993 also provides that directors must not agree to the company taking on an obligation unless they reasonably believe the company will be able to meet that obligation.

Examples may include:

• Entering into new contracts.
• Taking on additional debt.
• Continuing to purchase goods or services on credit.

Directors need to have a reasonable basis for believing the company can meet these commitments.

The Importance of Documenting Decisions

When a company is facing financial difficulty, directors should carefully document:

• The company’s financial position.
• The issues being considered.
• Advice received.
• Options reviewed.
• Proposed actions and recovery plans.

A plan to continue trading should be realistic and supported by evidence. Decisions are often reviewed with the benefit of hindsight, so maintaining clear records of the decision-making process is important.

Understanding Solvency

For a company to be considered solvent, it generally needs to satisfy two key tests.

Trading Solvency (Liquidity)

The company must be able to pay its debts as they fall due in the normal course of business.

This considers whether the company has sufficient cash flow to meet its ongoing obligations.

Balance Sheet Solvency

The value of the company’s assets must exceed the value of its liabilities, including relevant contingent liabilities.

A company may have valuable assets but still experience cash flow difficulties. Equally, a company may have positive cash flow while carrying significant balance sheet issues.

Both aspects need to be considered.

Seek Advice Early

When a company is experiencing financial difficulty, early advice can provide directors with a clearer understanding of their position and available options.

A licensed insolvency practitioner can assist with:

• Assessing financial circumstances.
• Reviewing restructuring options.
• Developing recovery strategies.
• Understanding director obligations.
• Considering formal insolvency processes where appropriate.

The earlier challenges are identified, the more opportunity there may be to protect value and achieve the best possible outcome.

About the Author

Hamish Pryde BBS, CA (PP) is a Chartered Accountant, Public Practitioner and Licensed Insolvency Practitioner (IP47). He advises business owners, directors and stakeholders on accounting, business advisory, restructuring and insolvency matters.

Hamish Pryde BBS, CA (PP)
Chartered Accountant | Licensed Insolvency Practitioner (IP47)
Principal – Pryde Accounting & Advisory Limited

A Director’s Duty to Creditors When Insolvency Is Approaching

When a company begins experiencing financial difficulty, directors face some of the most challenging decisions they will make in business.

A director’s focus normally sits with promoting the best interests of the company. However, when insolvency becomes a real possibility, directors must also consider the interests of creditors and take steps to ensure their decisions do not worsen the position of those creditors.

This can be a complex judgement call.

A company may be experiencing significant cash flow pressure, yet there may still be a realistic pathway to recovery. A temporary financial setback, new funding opportunity, restructure or improvement in trading conditions may mean continuing to trade is in the best interests of creditors.

Alternatively, continuing to trade without a reasonable prospect of recovery may increase creditor losses.

The key question is whether the directors’ decisions are reasonable, prudent and justifiable based on the information available at the time.

What Should Directors Consider When Insolvency Is a Possibility?

Directors should actively assess the company’s financial position and consider:

Ensure Financial Information Is Accurate and Current

Directors need reliable information to make informed decisions. This includes understanding:

• Current cash flow.
• Outstanding creditor obligations.
• Future income expectations.
• Available funding options.
• The company’s overall financial position.

Hold Regular Board Meetings and Document Decisions

Directors should ensure important discussions, decisions and reasons are properly recorded.

Good documentation demonstrates that directors have actively considered the company’s position and acted responsibly.

Obtain Professional Advice

Independent advice can provide valuable perspective and help directors understand:

• The company’s financial position.
• Available restructuring options.
• Potential risks.
• Director obligations.

Consider Whether Continuing to Trade Is Appropriate

Directors should regularly assess whether there is a realistic prospect of recovery or whether alternative options should be considered.

Explore Funding and Restructuring Options

Depending on the circumstances, options may include:

• Additional funding.
• Negotiated creditor arrangements.
• Restructuring operations.
• Selling parts of the business.
• A formal insolvency process.

Manage Cash Flow Carefully

Cash flow decisions become increasingly important when a company is under pressure.

Directors should carefully consider new commitments and ensure decisions are based on realistic expectations.

Early Advice Creates More Options

One of the biggest misconceptions about insolvency advice is that it is only required when a business has reached the point of failure.

In reality, early advice can often provide more opportunities.

Depending on the circumstances, options may include:

• Restructuring the business.
• Negotiating with creditors.
• Improving cash flow management.
• Selling the business or parts of the business.
• Developing a recovery plan.
• Considering formal insolvency options.

The earlier challenges are identified, the greater the opportunity to protect value and achieve the best possible outcome for stakeholders.

A Practical Approach to Insolvency Advice

At Pryde Accounting & Advisory Limited, we understand that financial difficulty is a challenging time for directors, employees, creditors and families.

Our role is not simply to manage formal insolvency appointments. We also provide practical advice to help directors understand their position, assess options and make informed decisions.

Hamish Pryde is a Chartered Accountant, Public Practitioner and Licensed Insolvency Practitioner, with experience advising businesses through financial challenges, restructuring and recovery.

Seeking advice early allows more options to be considered and gives stakeholders the best chance of achieving a positive outcome.

About the Author

Hamish Pryde BBS, CA (PP) is a Chartered Accountant, Public Practitioner and Licensed Insolvency Practitioner (IP47). He advises business owners, directors and stakeholders on accounting, business advisory, restructuring and insolvency matters.

Hamish Pryde BBS, CA (PP)
Chartered Accountant | Licensed Insolvency Practitioner (IP47)
Principal – Pryde Accounting & Advisory Limited