Continuing to trade while insolvent may see a director charged with reckless trading resulting in personal liability for the debts incurred by the company.
Under section 135 of the Companies Act 1993, a director of a company must not cause or allow the business of that company to be carried on in a manner that is likely to create a substantial risk of serious loss to the company’s creditors.
The focus is on whether the manner in which the company’s business is carried out has created a substantial risk of serious loss to creditors. The law distinguishes between legitimate business risks and illegitimate business risks. The fact that a company faces cashflow difficulties does mean that directors are required to cease business immediately. However, if a company is insolvent, or close to insolvency and the directors continue to operate the company in circumstances where there is no reasonable prospect of a turnaround and in a manner likely to create a substantial risk of serious loss to creditors, that will involve illegitimate risk-taking.
Therefore, where a company is experiencing financial difficulties, its Board is required to complete ongoing “sober assessments” of the company, including the company’s future income and prospects and determine whether to continue to trade. Where circumstances exist that should draw the attention of an ordinary and prudent director to the possibility of serious loss to creditors (such as an inability to pay creditors on time, a working capital deficit, or negative cash flows), the Board must quickly respond to adverse changes in the company’s financial position and ensure that the position of creditors does not deteriorate over time. In those circumstances the interests of the company’s creditors are paramount.
The Companies Act further states, under section 136, a director must not agree to the company incurring an obligation (e.g. a debt) unless the director reasonably believes that the company will be able to perform the obligation.
From a practical perspective, the directors should document their considerations and proposed actions that establishes the plan to arrest the insolvent situation and return the company to profitable trading and solvency. This plan must be credible and is often judged in hindsight.
For your company to be technically solvent you must satisfy both of the following:
Trading solvency/liquidity - the company is able to pay its debts as they become due in the normal course of business; and
Balance sheet solvency - the value of the company's assets is greater than the value of its liabilities, including contingent liabilities.
If you cannot satisfy the solvency test, talk to a licensed insolvency practitioner sooner than later.