When a business is facing financial difficulties and is unable to pay its debts, a director has a difficult decision to make. While it is possible to exit a limited company with outstanding debts, directors cannot simply “walk away” without following the correct legal procedures.
As a limited company, directors are not usually personally liable for paying any business debts, as the company is a separate legal entity. However, directors may become personally liable if they have engaged in wrongful or fraudulent trading, breached their duties, or provided personal guarantees for company borrowing.
There are several key considerations to be aware of before choosing to close your business, and as an insolvency practitioner, I’ll explain the ins and outs of this process, along with the legal responsibilities you, as a director, will need to conduct in order to close your business.
When does company debt become unmanageable?
Most businesses will have some debt, which may be in the form of loans, overdrafts, credit with suppliers or credit cards, monies owed to employees or sub-contractors, to name a few. Insolvency may arise when a business is unable to pay its debts as they fall due or when the total amount of current debts is higher than the current assets.
There are two main ways in which insolvency can be assessed when a business may be unable to pay its debts. Cashflow insolvency and balance sheet insolvency.
Balance sheet insolvency is when a business (on paper) has more current liabilities (creditors) than the value of its current assets.
Cashflow insolvency, on the other hand, occurs when a company is unable to pay its debts when they are due.
This can happen even if the business has valuable assets, particularly if those assets are tied up and cannot easily be converted into cash.
As a director, during insolvency, your obligations shift from shareholder focus to focusing on how creditors are impacted by your decision. The focus needs to be on minimising the loss to creditors. During normal proceedings, when times are good, a director’s obligations are to expand and promote the business to the profit of the shareholders, insolvency obligates you to act to minimise losses to creditors and avoid worsening the company’s financial position.
Obligations of directors will vary depending on the situation; however, in the event of insolvency, directors should:
- Keep accurate financial records.
- Monitor cash flow closely and avoid continuing to trade where it would worsen the company’s financial position.
- Seek professional advice (e.g. an insolvency practitioner).
- Consider formal insolvency procedures if necessary.
- Ensure no creditors are paid ahead of others unfairly (preferential treatment).
- Not transfer assets below market value.
- Not repay connected parties (e.g. themselves or family) in priority.
What are your options?
Option 1 – Continue trading
If your company is expecting incoming funds, which will help to minimise current debts, then your business may continue trading to fulfil secured contracts. This is usually only an appropriate option when there is a realistic prospect of recovery.
However, directors must proceed with caution. If trading continues and the company’s financial position worsens, this may lead to wrongful trading if the director knew (or ought to have known) that insolvency was unavoidable and failed to take steps to minimise losses to creditors. In such cases, directors can be held personally liable for those losses. If a director chooses to continue trading, keeping detailed financial reports and cashflow reviews is important for demonstrating that decisions are being made in the best interests of the creditors.
Option 2 – Closing the company informally
In some cases, directors may consider walking away from a company without formally closing it. In this situation, creditors will continue to chase outstanding debts, Companies House may issue penalties for unfiled accounts and confirmation statements, and the company may be struck off the register.
However, this does not resolve the underlying debts. Creditors can object to a strike-off application, and in some cases, the company may be restored to the register at a later date.
This approach carries significant risk for directors. Failing to act within creditors’ interests, allowing debts to increase unnecessarily, and attempting to avoid repayments can result in directors facing investigation and other potential consequences. Leaving a company in limbo by ignoring creditors and abandoning the business is rarely a suitable or compliant solution for directors looking to exit an insolvent company.
Option 3 – Formal insolvency
When a company is insolvent and is unable to recover, entering a formal insolvency procedure is often the most appropriate course of action. There are 3 options for formal insolvency which ensure a company is closed legally and transparently, helping to protect directors from further risk, provided they have acted appropriately.
Creditors Voluntary Liquidation (CVL), where creditors appoint an insolvency practitioner like Revive Business Recovery to liquidate the company. The practitioner is usually contacted by a director when the company becomes insolvent.
Compulsory Liquidation, which follows a winding-up order issued by the court, typically after unpaid debts.
Administration, where an attempt is made to rescue the company or to achieve a better outcome for the creditors than liquidation.
Option 4 – Seek professional advice from an insolvency practitioner
Seeking advice at an early stage can help directors make the best decision for the company.
An insolvency practitioner can:
- Assess the company’s financial position
- Explain available options
- Help avoid wrongful trading
- Guide directors through the correct legal process
Early advice often leads to better outcomes for both the company and its creditors and can significantly reduce the risk of personal liability for directors.
What does “dealing with it properly” look like?
When closing a company with outstanding debts, it’s important to follow a formal and compliant process. Simply dissolving a company is not suitable where debts remain, as creditors can object to the application or take further action to recover what they are owed.
Instead, using a formal insolvency procedure, such as a Creditors’ Voluntary Liquidation (CVL), ensures that debts are dealt with properly, directors fulfil their legal duties, and the company is closed in an orderly and compliant manner.
Seeking help for an insolvent business is not a sign of failure, but a responsible decision that can minimise financial risk and protect you from potential personal liability. Insolvency practitioners like Revive Business Recovery are experienced experts in providing the right options for your company so you can make the right decision in the best interests of your creditors.
