In the United States, there is no personal liability for directors that trade while insolvent. However, in some other countries, such as the United Kingdom and Australia, there can be a range of penalties spanning from fines or a ban on leading future companies to criminal proceedings. While the concept of trading while insolvent does not exist in the United States, numerous laws still exist that regulate bankruptcy and debt in general. Understanding the potential consequences begins with learning what exactly trading while insolvent means.
What Is Trading While Insolvent?
There are two main ways that a company can become insolvent: inability to pay debts when they’re due or when the company’s liabilities exceed its assets. Once a business is insolvent, directors must shift their focus from taking care of shareholders to protecting the companies they owe money to.
In some countries, continuing daily business operations — commonly referred to as “trading” — when a business can’t pay its debts leaves company directors on the hook for any new debts taken on. It can also leave them open to civil or criminal charges.
The Rules About Trading While Insolvent
While the rules vary depending on a country’s laws, there may be provisions for businesses to continue trading while insolvent if the debt falls under a certain threshold and if the terms of the loan agreement haven’t been violated. Ultimately, the responsibility falls on the shoulders of the company’s director to remain fully aware of the company’s financial position at all times. If there’s any question that the company may be insolvent, the director should consult an expert in the field. Knowingly trading while insolvent can leave you vulnerable to penalties and the possibility of criminal charges if there’s proof of fraudulent trading.
Wrongful vs. Fraudulent Trading
If a company continues trading while insolvent, the insolvency practitioner in charge is required to send a report to the courts. This will help them decide whether the trading was wrongful or fraudulent. The distinction determines whether the offense is civil, which carries fines and penalties, or fraudulent, which could end in jail time.
Wrongful trading occurs when a company continues carrying out its normal business operations despite its directors and managers being aware that the company is insolvent and going out of business. It’s a civil offense. The managers and directors could be banned from retaining a similar position in any company for many years. They may be held personally responsible for company debts.
In the case of fraudulent trading, a company continues with its operations intending to deceive its creditors. Once a company is insolvent and facing liquidation, all of the actions and conduct of its management team and directors will be scrutinized as the company is liquidated.
Knowingly accepting lines of credit, accepting customers’ payments even though orders won’t be fulfilled or trying to get as much money as possible before liquidation all leave a company vulnerable to fraud charges. Likewise, selling assets below market value during the time before liquidation could also raise red flags.
Even in countries where trading while insolvent is illegal, it may or may not be deemed criminal. In any case, it is a serious situation with potentially severe consequences. If you’re controlling the operations of an insolvent company, you could be held liable for company debts even if you resign. The statute of limitations extends for several years. Any previous directors and even holding companies can be charged depending on the findings of the courts.
Avoid engaging in business operations without a clear, concrete plan to repay company debts. Do not try to sell assets below market value or pay off debts using dishonest transactions like taking customer orders that you know the company can’t fulfill or getting a loan using false or misleading information. The civil penalties can be severe. If a court can prove that the actions are fraudulent, you could face time in prison in some countries.