Chris is an Insolvency Practitioner regulated by the ICAEW since 2014,.
He is experienced in contentious insolvency with excellent analytical skills and strong knowledge of both general and technical insolvency matters.
Understanding wrongful trading is crucial if you’re a UK company director facing potential insolvency.
Wrongful trading occurs when directors continue trading despite knowing there is no reasonable prospect of avoiding insolvent liquidation.
This guide will clarify wrongful trading under the Insolvency Act 1986, distinguish it from fraudulent trading, and outline steps to avoid personal liability.
By grasping your legal obligations and seeking professional advice early, you can protect both yourself and your business. Let’s explore how proactive measures safeguard your interests and provide peace of mind.
Wrongful trading is a civil offence under section 214 of the Insolvency Act 1986. It occurs when company directors continue trading despite knowing, or having reasonable grounds to know, that there is no realistic prospect of avoiding insolvent liquidation. This situation arises from negligence or misjudgement rather than intentional deceit. Under UK company law, directors must act in the best interests of creditors once insolvency becomes a foreseeable risk.
The legal framework for wrongful trading combines both objective and subjective assessments. Objectively, it considers what a reasonably diligent person with the director’s general knowledge and experience would have concluded. Subjectively, it evaluates the specific director’s actual knowledge and expertise. This dual approach means directors with financial acumen may be held to a higher standard than those without such backgrounds.
Wrongful trading ensures directors do not recklessly gamble with creditors’ money when a company’s financial future is bleak. Directors must take proactive steps to minimise potential losses to creditors, demonstrating due diligence and responsibility in their decision-making processes.
Wrongful Trading vs. Fraudulent Trading: Key Differences
The main difference between wrongful and fraudulent trading lies in intent. Wrongful trading involves negligence or recklessness without intent to defraud, while fraudulent trading requires a deliberate intent to deceive creditors. Here are the core differences:
Differences
Wrongful Trading
Fraudulent Trading
Intention
Unintentional
Involves a deliberate intent to defraud creditors
Burden of Proof
A civil offence with a lower standard of proof, focusing on what a director “knew or ought to have concluded.”
Demands a higher standard, requiring proof of dishonesty
Severity of Penalties
Can lead to personal financial liability and disqualification.
Carries more severe consequences, including criminal charges and potential imprisonment.
Not every challenging business decision is fraudulent. For example, continuing operations in hopes of recovery isn’t inherently wrongful unless it’s clear insolvency is unavoidable.
When Directors Become Personally Liable
Directors become personally liable for wrongful trading when they continue trading despite knowing there is no reasonable prospect of avoiding insolvent liquidation. This liability arises under section 214 of the Insolvency Act 1986, which holds directors accountable if they fail to take every step a reasonably diligent person would have taken to minimise potential losses to creditors.
The legal threshold for wrongful trading is based on what directors should know about their company’s financial situation. This involves both an objective and subjective assessment of the director’s knowledge, skill and experience. For instance, a director with a financial background may be expected to foresee insolvency risks earlier than someone without such expertise.
If found liable, directors may face personal contribution orders, requiring them to pay into the insolvent estate. To protect themselves, directors should meticulously document decision-making processes and seek professional advice early. This documentation can prove that they acted responsibly and took necessary steps to mitigate losses, potentially shielding them from personal liability.
Recognising Signs of Insolvency
Recognising the early signs of insolvency is crucial for directors to avoid wrongful trading claims. If a company cannot pay bills on time, has mounting debts or faces increasing pressure from creditors, it may be trading insolvently. These indicators suggest that immediate action is necessary to prevent severe consequences.
Here are some common warning signs of insolvency:
Consistent late payments: Struggling to meet payment deadlines regularly.
Mounting debts: A noticeable increase in outstanding liabilities.
Final demands: Receiving frequent final notices from suppliers or service providers.
Creditor pressure: Facing persistent demands or threats of legal action from creditors.
Acting swiftly when these signs appear is essential. Ignoring them increases the risk of wrongful trading claims, where directors could be held personally liable for continuing to trade while insolvent. By recognising these signs early and seeking professional advice, directors can protect themselves and their company proactively.
Risks and Consequences of Continuing to Trade
Continuing to trade when insolvency conditions are apparent can have severe ramifications for directors. Creditors may initiate claims against the company, worsening financial difficulties and making recovery increasingly challenging. Additionally, obtaining further credit becomes problematic as lenders are wary of extending credit to distressed companies.
The reputational damage for directors is significant. Persisting in trading under these conditions can tarnish a director’s professional standing, making future business ventures difficult. The stress of managing an insolvent company can also take a personal toll, affecting mental health and personal relationships. Directors must weigh these risks carefully and consider seeking professional advice to navigate such challenging times responsibly.
Potential Penalties Under the Insolvency Act
Under the Insolvency Act 1986, wrongful trading can result in significant penalties for directors who fail to act responsibly when their company faces insolvency. The most common penalty is a contribution order, requiring directors to personally pay funds into the insolvent estate to compensate creditors for losses incurred due to continued trading beyond the point of no return.
Directors may also face disqualification from holding directorships, a measure intended to protect the public and business community from individuals deemed unfit to manage a company. Disqualification periods vary based on the severity of misconduct.
Director Disqualification Periods
Disqualification Period
Case Type
2 to 5 years
Typically for less severe cases where directors failed in their duties without malicious intent.
6 to 10 years
For more serious breaches, including negligence that significantly harmed creditors.
11 to 15 years
Reserved for the most egregious cases, often involving fraudulent activities or repeated misconduct.
Understanding these penalties highlights the importance of proactively addressing financial distress and seeking professional advice early. Ignoring warning signs jeopardises the company and places directors at significant personal risk.
How to Act Responsibly and Seek Professional Advice
To protect yourself from personal liability as a director, act responsibly and seek professional advice early. Here’s a step-by-step guide to help you navigate potential insolvency issues:
Hold Regular Board Meetings: Schedule frequent meetings to assess the company’s financial health. Document discussions and decisions meticulously, as these records can demonstrate your proactive approach.
Review Financials Meticulously: Regularly scrutinise financial statements to identify signs of distress. This vigilance helps you make informed decisions and avoid wrongful trading.
Consult Insolvency Practitioners: Engage with a licensed insolvency practitioner at the earliest sign of trouble. Their expertise can guide you in taking the necessary steps to minimise creditor losses.
Document Decisions: Keep detailed minutes of all board meetings and decisions. This documentation can be vital if your actions are later scrutinised.
Avoid Incurring New Debt: If insolvency is likely, refrain from taking on additional debt the company cannot repay.
Seeking early professional advice reduces personal risk and often uncovers viable solutions to financial challenges. Directors who act swiftly and responsibly can usually mitigate penalties or even avoid them altogether.
If you’re worried about potential wrongful trading, our licensed insolvency practitioners and business rescue specialists can explain your duties as a director and outline the steps you should take. Call us free on 0800 074 6757 for confidential advice.
Wrongful Trading FAQs
When should a director seek insolvency advice?
A director should seek insolvency advice when they suspect financial difficulties that could lead to insolvency. Early intervention can help identify viable solutions and demonstrate responsible conduct, potentially protecting against personal liability for wrongful trading.
Does wrongful trading apply to non-executive directors?
Yes, wrongful trading can apply to non-executive directors. All directors, regardless of their role, must act in the best interests of creditors when insolvency is likely. Non-executive directors must exercise due diligence and know the company’s financial health.
Is there a minimum debt threshold for wrongful trading?
No, there is no minimum debt threshold for wrongful trading. The focus is whether directors continued trading when they knew or should have known there was no reasonable prospect of avoiding insolvent liquidation, regardless of the debt amount.
Does resigning as a director remove liability?
Resigning as a director does not automatically remove liability for wrongful trading. If a director’s actions contributed to the company’s financial distress before their resignation, they may still be held accountable for those actions.
How long can a director be disqualified for wrongful trading?
A director can be disqualified for wrongful trading for a period ranging from 2 to 15 years. The length of disqualification depends on the severity of the misconduct and the impact on creditors.
What’s the difference between wrongful trading and insolvent trading?
Wrongful trading refers to continuing business operations when there is no reasonable prospect of avoiding insolvency. Under UK law, insolvent trading is not a separate legal concept but describes the condition in which a company cannot meet its debts as they fall due.
Can personal liability be reduced if directors partially comply?
Partial compliance may reduce personal liability if directors demonstrate they took reasonable steps to minimise creditor losses. Documenting decisions and seeking professional advice are crucial in showing efforts to comply with legal duties.
