Article by

Craig Donnelly

The number of businesses in Scotland facing financial distress is on the rise. That’s according to recent figures released by the Accountant in Bankruptcy, the Scottish Government agency that oversees individual and business insolvency.

In February 2024, 94 companies went into liquidation, a rise of 9 per cent compared to February 2023. In the last full quarter from 1 October-31 December 2023, 292 companies appointed a liquidator, an increase of 7.4 per cent when compared to the same period in 2022.

Significantly, the statistics showed a rise of almost a third in the number of Scottish companies that became insolvent during the same period compared to pre-pandemic levels in 2019.

Whereas during the pandemic temporary legislation required creditors to cut their debtors some slack, lenders are now taking a harder line when it comes to repayments.

This is just one example of the financial challenges of running a business. Directors of companies have a range of responsibilities, some of which are placed upon them by the Companies Act 2006.

Prioritising the success of the company for the benefit of shareholders is one of these responsibilities. However, when a business is facing insolvency, the duties of a director changes.

Creditors take precedence in insolvency situations and directors must consider their interests and act in a way which minimises any potential losses they may suffer. Directors must also consider the interests of other key parties, including employees and shareholders. Balancing their potentially competing interests can be difficult.

In my line of work I deal with people who are directors of companies across a whole variety of sectors. All too often I find they have the same thing in common – an unrealistic belief that they can trade their company out of financial difficulty.

Continuing to operate when there is no reasonable prospect of a company avoiding liquidation is known as wrongful trading.

Directors who continue to trade an insolvent company knowing that it can’t pay its debts could be guilty of the offence of fraudulent trading. Examples of fraudulent trading include taking orders you know cannot be fulfilled or accepting credit with no intention or ability to make repayments.

In the face of insolvency, directors must ensure that they stay informed about the company’s financial affairs, attend board meetings and document their decisions. This should allow them to demonstrate that they have acted with reasonable skill, care and diligence whilst navigating the company through the difficult times.

The consequences for directors not complying with their duties can be severe. Individuals can be found personally liable for the company’s debts. They can also be disqualified from acting as a director for up to 15 years and may find themselves in court charged with committing a criminal offence.

Those convicted of fraudulent trading can be sentenced to up to ten years in prison, given an unlimited fine, or both.

Given these penalties, directors who fear their company is unable to pay its debts should obtain expert advice from a lawyer or accountant with experience in insolvency matters. It’s important to be able to demonstrate that the situation, and the director’s responsibilities, are being taken seriously and to take the right steps for everyone involved.

Craig Donnelly, Commercial Litigation Director, Holmes Mackillop