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The tipping point into insolvency – and how to identify it

Mandeep Kaur Virdee

When a company is struggling financially, it can be difficult to judge whether the change in circumstances is temporary or permanent. The company itself is a separate legal body, but directors have duties that they must abide by under the Companies Act 2006.

Among other duties, a director must have regard to:

  • the likely consequences of any decision in the long term
  • the interests of the company’s employees
  • the need to foster the company‘s business relationships with suppliers, customers and others
  • the impact of the company’s operations on the community and the environment
  • the desirability of the company maintaining a reputation for high standards of business conduct
  • the need to act fairly as between members of the company

Section 123 of the Insolvency Act 1986 contains two principal tests for insolvency.

Section 123(1) of the Act sets out a cash flow test, which defines the insolvency of a company by its inability to pay its debts as and when they fall due.

Section 123(2) of the Act is a balance sheet test, which defines a company to be insolvent when ‘the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities’.

There is a very good reason why directors need to be aware of when their business has reached the tipping point. If appropriate action is not taken when the company is in the onset of insolvency, a director can be held personally liable for debts that then accrue. Under the Insolvency Act 1986, actions ultimately detrimental to the business taken by a director who ignores the tipping point can be deemed to be Unlawful Trading, Wrongful Trading, Transactions at an Undervalue, or Preference claims (paying one creditor in preference to another, knowing that the business is insolvent).

These are all very serious actions and a director may face civil and criminal sanctions. Directors can also be subject to disqualification, which means that they cannot be a company director for a specified period. In extreme cases, that disqualification can be permanent.

If you are worried that you might be getting close to the tipping point or want to take early advice about the options, our specialist team can help you. If necessary, we can put you in touch with the right people either to restructure the business or to close it down properly.

For further advice, contact Mandeep Kaur Virdee on 01276 686222 or by email on Mandeep.virdee@herrington-carmichael.com.

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