Insolvent trading refers to a company that is unable to meet debts when they fall due, that continues to incur debt. Determining the period of trading while insolvent is a complex question of law and accounting. Company directors have a duty to prevent insolvent trading, and the consequences of such activities can attract civil penalties, compensation proceedings or even criminal charges.
This article will not address the complex, interdisciplinary technicalities of insolvent trading. Instead, it will focus on providing practical insights on insolvent trading from the perspective of insolvency practitioners.
What factors are considered in determining insolvency?
- Cash flow
- Balance sheets
- Asset values (realisability)
- Fund-raising capability
- Overall financial circumstances
Practical signs of insolvent trading
When an insolvency practitioner takes control of a distressed company, there are several signs that indicate the entity may have traded while insolvent. These include:
- Outstanding tax obligations
- Difficulty obtaining supplies from creditors
- Untidy stock
- Ongoing disputes
- Disorganised books and records
- Repayment plans with creditors
- Correspondence explaining financial issues
Creditor actions as an indicator of insolvency
- Creditors refusing further supply
- Creditors removing stock (retention of title)
- Creditors commencing a winding up application
- Creditors placing the debtor on cash on delivery
The practical realities of pursuing an insolvent trading claim
Most insolvent trading claims are pursued by liquidators. The vast majority are settled outside of court. Only a handful of judgments have been handed down, largely due to the intangible nature of these claims. The high cost of litigation combined with the risk of a director filing a defense often renders pursuit of these claims impractical.
Negotiating an insolvent trading claim
An appointed liquidator can negotiate insolvent trading claims (against the relevant party) on behalf of creditors. The appointee’s primary concern is commercial viability (cost vs benefit). Practically speaking, the vast cost associated with these claims usually outweighs the benefit. Any settlement that is negotiated must stand up to creditor scrutiny (commerciality).
The takeaway
Insolvent trading is a common occurrence, with distinct warning signs. It is important to remain alert and pragmatic, both as a creditor and as a director.
