The recent High Court case of Re Ralls Builders Ltd [2016] EWHC 243(Ch) has highlighted the vexed issue of when directors may be held personally liable for wrongful trading in the twilight zone before a company enters a formal insolvency procedure.

If the solvency of a company is in question, the directors must consider and, when appropriate, act in the interests of the company’s creditors. If the company goes into insolvent liquidation, to avoid incurring personal liability for wrongful trading under section 214 of the Insolvency Act 1986, the directors must be able to demonstrate that they:

“Took every step with a view to minimising the potential loss to the company’s creditors as (assuming him to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation) he ought to have taken.”

In practical terms this means that the directors should, on a continuing basis throughout such period:-

• Fully document the company’s financial position on a regular basis – in a substantial business, this is likely to mean management accounts prepared monthly, preparing a budget for the current and forthcoming financial years, assessing actual performance compared to forecasted budget projections and analysing the reason(s) for variance and keeping budget and cashflow forecast projections regularly updated.

• Before incurring fresh credit, satisfy themselves that the company will have the capacity to repay such credit within the terms agreed with the creditor. Again, the basis for this satisfaction should be documented (e.g. – by reference to the cashflow forecast at the time of scheduled repayment).

• Where they are in doubt as to the company’s continued ability to pay its debts as they fall due, they should engage appropriate professional advice to undertake a review of the company’s financial position and the viability of the potential courses of action being considered by the directors – in the first instance, this may be the company’s own accountants.

• Fully assess and document all options reasonably open to them, balancing the respective merits and risks of each course of action. This includes the degree of probability that it will be successfully implemented and the reason for following or not following a particular course of action.