It may not be a question that you thought you’d have to ask yourself, but as a Director, part of your legal undertaking requires you to ensure that the business remains solvent and trades within its means. Operating outside of these boundaries could see the company being declared insolvent, struck off and you, as a Director, being penalised or disqualified – meaning you cannot be a Director again (normally for a defined period).
Whilst we’ve seen some high profile business failures over the years – the likes of Lehman brothers for instance – the reality is that SMEs and specifically owner managed business are the ones most at risk of finding themselves trading illegally. This is primarily due to the fact that they lack the financial resilience of larger, well established firms and are more easily rocked by events outside their control. This is also compounded by the traditional method of personal income extraction for owner directors.
What is illegal trading
Illegal trading is whereby you knowingly continue trading despite being unable to meet your pre-existing financial commitments and/or undertake further commitments. In particular;
- You continue drawing money for yourself (especially through dividends) when the business cannot pay its creditors
- You continue to accept credit when there is little chance of being able to repay it
- You transfer assets at below market value if you believe the company to be in trouble
- You accept new business and deposits from customers where there is a high chance that you will be unable to deliver the goods and/or services
As we covered in this blog post on wrongful or fraudulent trading, the actions of the Directors play a major part in determining whether the activities were knowingly and deliberately entered into or merely continued in good faith, in the expectation that the situation could be turned around.
How can I avoid trading illegally?
It’s important to understand that there are peaks and troughs in business which may take you to the brink, or even beyond it during the financial year. It is how you act in these periods and what the mid-term picture looks like that makes the difference. For instance, if you have genuine concerns about solvency, either immediately or into the near future, you should:
- Only accept new business if you know you can service/supply it
- Not pay any dividends – if you pay yourself through salary and dividends, you need to be aware that taking dividends at a time whereby there is a likelihood that creditors cannot be repaid, would be seen as negligence and therefore could constitute illegal trading
- Continue to be even handed in payment of creditors – do not show preference to any single supplier
- Maintain open dialogue with customers, staff and suppliers alike. Whilst you don’t want to worry anyone, being open and honest can ensure people are more willing to be flexible if needs be
- Seek advice – speak to your accountant or an insolvency practitioner. Insolvency practitioners are not only there for those for whom its too late. They’re actually a source of great advice for those sailing close to the wind and can, in some cases, help you trade out of a difficult period.
It’s difficult because at the same time, you may be thinking that you can turn it around, but without any certainty, carrying on can at this stage could be the decision that lands you in trouble, even if your intentions are good. So it’s essential to stay on top of your figures, both management accounts and cash flow, and act appropriately.
If you’re concerned about your business’ financial health and fear you may be at risk of insolvency, please feel free to contact us today for a confidential discussion. Where relevant or necessary, we can introduce you to insolvency practitioners who will help you avoid the pitfalls above.