How does a director avoid creating a preference?
Common sense dictates that if the decision to pay someone who is pressing for cash makes you feel uneasy, there may well be a problem in store.
A safe route is to ensure that all creditors are treated equally and if that is not possible for whatever reason, a director should ensure that there is a strong commercial reason for one creditor being paid in preference to others. For example, a board may wish to pass a resolution to XZY Ltd, because it maximises the interests of all creditors to pay XZY Ltd because they are the only supplier of something essential to the business.
By paying XZY Ltd, operations can continue to generate debtors/cash but it would be somewhat cavalier to make such a decision on a specific occasion without weighing up the impact/consequences of doing so. In such cases, an independent insolvency practitioner can provide invaluable advice.
A director may ask if it is acceptable to sell a company’s assets to another company because the selling company is insolvent and about to cease trading. There are many aspect to consider and one is the effect of section 238 of the Insolvency Act 1986 which deals with transactions at less than full value.
If a company is no longer viable and the director believes that it has no future, it can be tempting to sell/transfer assets to another entity, frequently under the director’s control.
If the company has assets that belong to say a bank or finance company such assets cannot be sold/transferred without explicit written approval. If the assets are unencumbered and sold at less then fair value, or transferred for no payment, there is a potential breach of section 238 of the Insolvency Act 1986 i.e. a transaction at undervalue.
This applies in the case of a company where the company enters administration or liquidation.
Where the company has, at a relevant time, two years if a connected party, and six months if an unconnected party, entered into a transaction with any person at an undervalue, the IP may apply to court for an order under this section.
The court will make an order as it thinks fit and if the IP has any input, it usually means an order to restore the company to the position before that transaction. Thus, the court has the power to reverse a sale/movement of assets.
This could also lead to an investigation into a director’s actions, any breach of fiduciary duties and possibly wrongful trading.
Typical examples of company assets:
- Company cars
- Computer hardware
- Office furniture
- Office buildings
What happens if my director’s loan account is overdrawn?
A director’s loan account records the money invested in the company and instances where personal cash has been used to pay for business expenses.
However, an IP often encounters a situation where a director has withdrawn money from a company and, as at date of insolvency, thereby creating a debtor that requires to be repaid to the company. Sometimes an overdrawn loan account is large and poses a financial problem for the director.
Should the company enter formal insolvency proceedings, the ramifications of having an overdrawn director’s loan account are quite serious. The IP will require the director to repay the monies owing to the business. Depending upon the size of loan, this may not cause an issue, but if one cannot repay, for whatever reason, personal bankruptcy may ensue.
You are required to keep proper records of all transactions in relation to a director’s loan account and this takes on greater importance if it is overdrawn. Disclosure must be made in the company accounts of :
- The balance of each overdrawn director’s loan account.
- The largest level that the loan reached during the company’s financial year.
Early engagement with the IP is of paramount importance and, once the balance has been agreed, a repayment arrangement should be negotiated. There may be good reason why an overdrawn loan can be reduced and advice should be sought from the company’s normal financial adviser and/or an IP who is not appointed to deal with the company.