When your company is struggling it is important not to make mistakes as that could lead to failure. In addition, if your company does fail then some mistakes can lead to personal liability, directors’ disqualifications, and even criminal sanctions. The Company Directors Disqualification Act 1986 has far-reaching powers to ban “unfit” directors from being involved in running a company. So, if a company director doesn’t act properly, they can be made liable for the company’s debts and be disqualified from being a director.
Below are the most common mistakes that directors make that can lead to insolvency for their business. Of course, there are many reasons why a business fails but we are talking here about becoming insolvent and owing money as opposed to not being successful and having to close.
Common Mistakes
- Not managing cash flow regularly – this is the most common problem. Directors often are brilliant at doing deals, winning business etc., but the boring numbers bit, not so much! Too much work can cause insolvency in what is known as overtrading. You take on work, pay lots of workers/suppliers etc., and then suddenly run out of cash before the job is finished. Or simply the directors do not realise that cash is going out of the door. Companies with poor financial controls are sometimes the target of fraudsters and thieves!
- “Robbing Peter to Paul” – If you find yourself moving money around the company or between companies/departments then you are depriving parts of your company of cash. This should set alarm bells ringing.
- Ignoring legal threats – This is an obvious one but any legal threat against a company must be taken seriously, especially if it is a demand for money or compensation.
- Taking unnecessary legal action – we do have enquiries from directors that have taken legal action which has been ruled by their hearts and not their heads. In the end, they have either lost or not had costs awarded in their favour. The other problem with legal action is it can take up huge amounts of management time, so you need to be pretty sure you are going to win or just cut your losses and move on.
- Not making redundancies when needed – it can be really difficult to make people redundant, but it is necessary sometimes. It is in fact possible to get a loan from the government to cover the costs of redundancy if it can be shown that it would save other jobs by doing so and avoid insolvency.
- Trying to borrow yourself out of trouble – is very common. It isn’t advisable to borrow money in order to pay HMRC unless you can guarantee that it can be paid back. This is often because lenders to directors often request a personal guarantee attached. Remember company debts aren’t your debts.
- Giving too much credit to a long-time customer – Ask yourself why are they suddenly giving you loads of work but not paying on time.
- Taking on premises that are too flash/expensive for the business – this is also very common and is a result of overconfidence. Appreciate it isn’t always possible but try and negotiate break clauses in leases or just sign up short term.
Serious mistakes that can get you into trouble personally.
Any of the below mistakes can land you with personal liability problems, disqualification or criminal sanctions:
- Taking deposits for new work when you know you do not have the resource to do the work and feel “something will come up”. This could be construed as what is termed “wrongful trading”. If it can be proved then it is likely that the directors will be personally liable for the debts and will face disqualification. It is quite rare for directors to be found guilty of wrongful trading but nonetheless, directors need to be careful.
- Moving assets from one company to another without due consideration. This is in breach of the Insolvency Act 1986 and is called a transaction at an undervalue. If the company goes into liquidation or administration, then the insolvency practitioner can get this reversed. If the transaction cannot be reversed, then the directors will be ordered to make up the difference.
- Thinking because you own the company, that the money in the company’s bank account is yours! The company is a separate legal entity and maybe controlled by you, but you do not own the money in its accounts. This perception can lead to poor decision-making.
- Paying off a friend/relative at the expense of other creditors such as HMRC. As above this can be reversed by a court. The test here is the desire to make someone better off. Just paying one loud creditor ahead of another is not the same thing.
- Taking out excessive monies from the company when you know or “should have known” that the company was insolvent. This is an obvious one really and may well lead to disqualification and personal liability issues, especially if a large amount of tax is owed.
- Borrowing money from the company to fund your lifestyle. This means that you owe the company money and if it does go into an insolvency process you will be required to pay this back and that can even lead to bankruptcy.
- Setting up a new company with the same/similar name with a view to carrying on the business of a liquidated company. Doing this is actually a criminal offence, believe it or not, as it is deceptive and can cause confusion among customers and creditors. It can only be done by leave of the court or with the liquidators permission.
- Not acting in the best interest of creditors. This covers a multitude of actions including all of the above. So think if your actions are putting your business at risk and making the creditors situation worse. If a company is insolvent the directors have a duty to act in the best interest of the creditors, not the shareholders!
- Not filing accounts or registering for VAT. This can lead to disqualification and fines.
How do you avoid these mistakes?
The best advice is to TAKE ADVICE from professionals! (Like us here at Company Rescue!) A great deal of initial advice is free, and accountants and insolvency/turnaround practitioners will know much more about cash flow, money and insolvency than most directors and will be able to spot problems. Remember, they have heard hundreds of directors say everything is going to be fine, my business is profitable and will survive etc. What have you got to lose?
If I recognise that the company has a big problem, what will they advise?
Accountants will advise close monitoring and reporting of cash flow to keep a check on the situation. Remember Cash is King. You can be making profits but running out of cash. If there is a lot of pressure from creditors then Turnaround Practitioners or Insolvency Practitioners will be able to help by setting out your options. They can evaluate the company and are able to negotiate with creditors to give your company breathing space.
If you need to go down a formal insolvency process, then there are 3 main options:
A Company Voluntary Arrangement allows all or part of the debts to be packaged up and spread over a long period of say 3-5 years. Directors remain in control.
An Administration can lead to the sale of the business. This is a more radical solution. It can save jobs and allow the business to continue even if the company doesn’t.
A Liquidation means the immediate end of the company and debts being written off. Note that it is however possible to restart the business by buying the assets at a fair price.
Interesting Related Article: “What is a bailout? Reasons why companies are bailed out“