When a company is insolvent, its directors have a number of legal responsibilities which must be adhered to during this time. One of these is to prioritise the interests of creditors over the interests of the company’s directors and shareholders, and ensure no action is taken which could worsen their position.
In reality this means that the company should not obtain any further debt or borrowing, nor should it sell any of its assets, and extreme care should be taken when making payments to creditors. During insolvency, these types of transactions are known as ‘antecedent transactions’ and can be challenged by the appointed insolvency practitioner or liquidator should a company enter into formal insolvency proceedings.
Understanding antecedent transactions
- Transactions at Undervalue: A transaction at undervalue is where company assets are sold for nil consideration, or for consideration which is significantly less than their true market value. Transactions can be challenged going back two years prior to the company entering into insolvency proceedings and it must be shown that the company was insolvent at the time of the transaction being made, or that the transaction itself caused the company to become insolvent. Insolvency, however, will be presumed if the transaction was made to a connected party. The courts can demand the company is to be restored to the position it was in prior to the transaction taking place through any order the court sees fit to achieve this outcome.
- Preference Payments: A preference payment occurs when a transaction is made by a company which results in a creditor being placed in a more favourable position than they would have been had the payment not been made to the detriment of other unsecured creditors. The payment must have been made within six months of the company entering into formal insolvency proceedings, although this time limit is extended to two years if the payment was made to a connected party. As with a transaction at undervalue, the company must have been insolvent at the time of the payment being made, or the payment itself must have caused the company to become insolvent. A desire to prefer the recipient creditor also needs to be proven, although this desire is presumed if the payment was made to a connected party. If preference is established, the courts can order the payment to be reversed, putting the company back to the position it was in prior to the preference payment being made.
- Transactions Defrauding Creditors: unlike a transaction at undervalue, there is no time limit on how far back a potentially fraudulent transactions can be challenged. However, intention to defraud and to put assets out of the reach of creditors must be proven for a challenge to be successful. Likewise, the company does not need to be in formal insolvency proceedings for a challenge to be lodged; any creditor who thinks they have been unfairly prejudiced due to a transaction defrauding creditors can apply to the court to have the transaction reversed.
What are the legal obligations when a company becomes insolvent?
It is often the case that the company must cease trading in order to preserve its remaining value and shield creditors from any further losses. However, depending on the position of the company, this can be something of a grey area, therefore expert insolvency advice should always be sought as soon as a company becomes knowingly insolvent to ensure directors are remaining compliant with their obligations.
Failure to adhere to these legal obligations when a company is knowingly insolvent – or its directors ought to have concluded that there was no realistic prospect of the company avoiding insolvent liquidation – can have serious consequences.
If found guilty, directors can find themselves being made personally liable for some or all of the company’s debt, risk being disqualified from acting as the director of another company for up to 15 years, face a fine, or even imprisonment in the most serious of cases.
How to stay on the right side of the law when insolvent
By seeking the services of a licensed insolvency practitioner at the earliest signs of financial and/or operational trouble, you are demonstrating your desire to comply with your legal duties as the director of an insolvent company and place your creditors’ interests at the forefront.
When a company enters an insolvent liquidation process, the appointed liquidator is duty bound to investigate the conduct of its directors in the time leading up to it becoming insolvent. If a company becomes insolvent and its directors continue to trade on regardless until it is forced into compulsory liquidation, this will not reflect as favourably on the directors as it would if they took the decision to voluntary liquidate their insolvent business.
A licensed insolvency practitioner will be able to help you understand your current position and explore the potential options open to you and your company. This could involve embarking on a restructuring process to stabilise the company and get it back on a solid financial footing, or taking the necessary steps to close the business down if its problems are insurmountable. Whichever path is taken, however, your creditors interests will be prioritised and their recoveries maximised as far as possible.
About the author - Chris is a senior insolvency expert at Scotland Liquidators. Chris has vast experience of assisting company directors and sole traders with all manner of financial and operational problems.
