A number of legal systems make provision for companies trading while insolvent to be unlawful in certain circumstances, and provide for
directors to become personally liable for a company's debts if they have acted improperly. In most legal systems, the liability in respect of unlawful transactions only extends for a certain period of time prior to the company going into liquidation.
UK law
Under
UK insolvency law, trading once a company is legally insolvent can trigger several provisions of the
Insolvency Act 1986, including:
*
Wrongful trading
Wrongful trading is a type of civil wrong found in UK insolvency law, under Section 214 Insolvency Act 1986. It was introduced to enable contributions to be obtained for the benefit of creditors from those responsible for mismanagement of the inso ...
– Section 214
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Transaction at an undervalue – Section 238
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Preferences – Section 239
*Extortionate credit transactions – Section 244
A limited company becomes
insolvent when it can no longer pay its bills when due, or its liabilities—including
contingent liabilities such as
redundancy payments—outweigh the company’s assets. This is a critical point in the lifespan of a company as it denotes when the
directors' responsibilities move from the interests of
shareholders to the interests of
creditors. It also means that the directors need to be extremely careful when considering whether to continue to trade, or not. Any director who knows that the company is insolvent and makes the decision to continue to
trade
Trade involves the transfer of goods and services from one person or entity to another, often in exchange for money. Economists refer to a system or network that allows trade as a market.
Traders generally negotiate through a medium of cr ...
, and in doing so increases the debts of the company can be made liable for the company debts.
In the UK, directors are exposed in respect of transaction at an undervalue, preferences, and extortionate credit transactions if the transaction occurred: a) while the company was insolvent; and b) within 2 years before the onset of liquidation if the transaction was with a connected person, and 6 months if the transaction was with an unconnected person.
Directors who continue to trade while insolvent may face disqualification under the
Company Directors Disqualification Act 1986.
Under the provision of this act, when a company goes into
liquidation
Liquidation is the process in accounting by which a Company (law), company is brought to an end. The assets and property of the business are redistributed. When a firm has been liquidated, it is sometimes referred to as :wikt:wind up#Noun, w ...
, the liquidator must make a report to the Disqualification Unit of the
Department for Business, Innovation and Skills on the conduct of all directors. If the liquidator has come across any conduct which makes the director unfit to be involved in the management of a company in the future (which things would include trading while insolvent) the Department for Business, Innovation and Skills will apply to the Court for an order disqualifying the director or directors from acting as a
company director for a certain period of time.
Other countries
Many other countries have similar laws, often referred to as 'insolvent trading' or
wrongful trading
Wrongful trading is a type of civil wrong found in UK insolvency law, under Section 214 Insolvency Act 1986. It was introduced to enable contributions to be obtained for the benefit of creditors from those responsible for mismanagement of the inso ...
.
See also
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UK company law
British company law regulates corporations formed under the Companies Act 2006. Also governed by the Insolvency Act 1986, the UK Corporate Governance Code, European Union Directive (European Union), Directives and court cases, the company is th ...
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US insolvency law
References
{{reflist
Insolvency law of the United Kingdom
Business law
United Kingdom company law