The point of setting up as a limited company is that doing so limits the personal liability of directors. However, if the business falls into insolvency, the Liquidator or Administrator has a duty to examine directors' conduct. If it is found that wrongful trading occurred, directors could become personally liable for the organisation's debts. This guide provides everything you need to know about wrongful trading. If you need legal advice, we are only a phone call or email away.
What is Wrongful Trading?
Wrongful trading occurs when company directors allow the business to continue operating despite knowing (or should have known) that insolvency is inevitable. Unlike fraudulent trading, wrongful trading is not a criminal offence but can lead to significant civil penalties and personal liabilities. Liability is dealt with in sections 214 and 246ZB of the Insolvency Act (IA) 1986.
What Actions Constitute Wrongful Trading?
Wrongful trading includes:
- Continuing to trade while insolvent
- Incurring further debts knowing the company cannot pay them
- Failing to file for insolvency in a timely manner
- Misleading creditors about the company's financial health
- Not filing up-to-date company accounts on time
Is an Insolvent Company Always Guilty of Wrongful Trading?
The Court would not make an order for wrongful trading if a director took "every step" to minimise creditors' losses once they realised that insolvency was inevitable.
"Every step" could include:
- Consulting with creditors and professional advisors such as an Insolvency law Solicitor early on.
- Preparing and promptly filing up-to-date accounts.
- Preparing accurate cash flow and profit and loss forecasts.
Determining when to commence insolvency procedures is critical in avoiding allegations of wrongful trading. Seeking legal advice on this point is crucial and will protect the directors' best interests.
Other key ways to avoid liability for wrongful trading include:
- Having regular board meetings to ensure everyone understands the company's situation and acts appropriately with suppliers and other creditors.
- Documenting ways creditors, suppliers, and customers have been kept informed of the company's financial situation.
- Being mindful of the test in section 214 of the IA 1986, which requires a director to act with necessary judgment when deciding whether to continue trading. The skills and experience of the director will be considered and this is a part objective, part subjective test.
The Consequences of Wrongful Trading
If you are found to have committed wrongful trading, this can result in:
Civil Liability
Sections 214 and 246ZB of the IA1986 potentially expose directors (and shadow directors) of companies that go into liquidation or administration to a risk of personal liability in respect of the insolvent company's debts.
Disqualification
When acting in the insolvency of a company, an Insolvency Practitioner must present a report to the Secretary of State highlighting any aspects of directors' conduct that require further investigation. Wrongful trading is an example of misconduct, and the Secretary of State may bring a civil claim. If successful, the Court could order a director to be disqualified from acting as a company director for two to fifteen years.
Is Ignorance of Wrongful Trading an Excuse?
No, as the Court would expect a company director to seek professional advice to ensure they are complying with their statutory duties and not engaging in wrongful trading.
Who is Classed as a 'Director' of a Company?
When a company is set up, the initial shareholders typically decide who the director/s should be. They do not have to be company employers, although in larger companies, the directors may form the C-suite and hold key positions such as Chief Marketing Officer (CMO), Chief Operating Officer (COO), or Chief Executive Officer (CEO).
The Companies Act 2006 states a director is a person occupying the director position, even if 'director' is not part of their job title.
A person can also be 'connected' to the company under section 249 of the IA 1996, which reads:
"249. "Connected" with a company.
For the purposes of any provision in this Group of Parts, a person is connected with a company if—
(a) he is a director or shadow director of the company or an associate of such a director or shadow director, or
(b) he is an associate of the company;
and "associate" has the meaning given by section 435 in Part XVIII of this Act."
An associated person could be a director's spouse, relative, or relative of the director's spouse or partner.
The definition of being 'connected' with a company is important as an Insolvency Practitioner can more easily challenge transactions related to company connections.
What Can a Director Do if They are Concerned About Wrongful Trading?
The most positive step a director who fears they will be accused of wrongful trading can take is to instruct an experienced Insolvency Law Solicitor to advise them as soon as they know insolvency is inevitable. A Solicitor can advise a director on:
- Their statutory duties
- When to begin the insolvency process.
- Steps to ensure no wrongful trading allegations can be reported to the Secretary of State
What Action Can Creditors Take Regarding Wrongful Trading?
Unsecured creditors, either individually or as a group, can bring a claim for wrongful trading. However, discussing the cost implications of bringing such an action with the administrator or liquidator and an experienced Insolvency Law Solicitor is crucial.
What is Fraudulent Trading?
Section 213 and section 246ZA of the Insolvency Act 1986 provide the following definitions of fraudulent trading:
213.— Fraudulent trading.
(1) If in the course of the winding up of a company it appears that any business of the company has been carried on with intent to defraud creditors of the company or creditors of any other person, or for any fraudulent purpose, the following has effect.
(2) The court, on the application of the liquidator may declare that any persons who were knowingly parties to the carrying on of the business in the manner above-mentioned are to be liable to make such contributions (if any) to the company's assets as the court thinks proper.
246ZA Fraudulent trading: administration
(1) If while a company is in administration it appears that any business of the company has been carried on with intent to defraud creditors of the company or creditors of any other person, or for any fraudulent purpose, the following has effect.
(2) The court, on the application of the administrator, may declare that any persons who were knowingly parties to the carrying on of the business in the manner mentioned in subsection (1) are to be liable to make such contributions (if any) to the company's assets as the court thinks proper.
Section 246ZA came into force on 1 Oct 2015.
Fraudulent trading is a criminal offence and carries a custodial sentence.
How is the Cause of the Failure of a Company Determined?
The appointed Administrator or Liquidator will investigate the cause of the insolvency and prepare a report. Directors' conduct and other factors such as market or consumer changes and rapid cost increases will be carefully examined.
How We Can Help
If you are a director and are worried about being investigated by an Insolvency Practitioner the Insolvency team at Witan Solicitors can advise and represent you. We also help creditors who believe there has been wrongful trading and want legal advice on approaching the liquidator to bring a claim.
As experts in insolvency law, Witan Solicitors can provide expert advice and representation if you are being investigated for wrongful or fraudulent trading. Contact us on 0330 173 6983 or send us an email for more information.
