In the UK, wrongful trading arises when directors of a financially distressed company continue to operate it despite having knowledge or sufficient grounds to believe that avoiding insolvency is improbable.

We will delve into more details about this topic in the sections below.

Wrongful Trading

What is Wrongful Trading?

Wrongful trading occurs when directors continue trading after they knew, or should have known, there was no reasonable prospect of avoiding insolvency.

The key characteristics are as follows:

  1. Directors continue operating the company despite knowing or having reason to believe it is insolvent.
  2. Directors must have actual or constructive knowledge of the company’s insolvency. Constructive knowledge arises when directors ought to have known the company’s financial situation and that insolvency was imminent.
  3. Directors must recognize that there is ‘no reasonable prospect’ of the company avoiding insolvent liquidation.

What are the Consequences of Wrongful Trading?

The consequences of wrongful trading include:

  • Personal Liability for Directors: Directors may face personal liability for the company’s debts, potentially using their assets to pay off the company’s obligations, based on their involvement in the insolvency and its impact on creditors.
  • Contribution to Company Assets: Courts can require directors to compensate for losses through contributions to the company’s assets, considering their financial status and the effect of their actions on the company.
  • Disqualification from Directorship: Directors can be banned from holding directorial positions for up to 15 years, aiming to protect creditors and promote responsible corporate governance.
  • Civil Liability: Directors may incur civil liabilities for their role in the company’s financial decline, as outlined in sections 214 and 246ZB of the Insolvency Act 1986.
  • Criminal Charges: In severe cases, particularly involving fraud, directors could face criminal charges, leading to imprisonment or fines.

Examples of Wrongful Trading

The list provided below is not a definitive list but covers the most common types of director conduct which may amount to wrongful trading and warrant further investigation by the liquidator:

  1. A director paying his own salary whilst PAYE/NI for employees is not paid;
  2. Buying goods on credit when there is no means to pay for them;
  3. Using customer deposits for cash-flow purposes with no means of supplying goods;
  4. Repaying personal guarantees in preference to other creditors;
  5. Failing to pay HMRC when other creditors are being paid;
  6. Continuing to trade claiming VAT and either not being registered for VAT, or not paying VAT;
  7. Any transfer or sale of assets at anything less than a fair and reasonable commercial value.

Key Considerations in Wrongful Trading

When a company is insolvent, directors need to focus on the interests of creditors, not just the company’s success. This might mean rethinking whether to keep the business running.

Sometimes, it’s better for the creditors if the company keeps trading. This could be due to short-term cash flow issues or expected funding. A wrong decision later doesn’t automatically mean directors are at fault.

Directors should make decisions that seem sensible at the time. This involves staying informed about the company’s situation, taking advice from experts, and regularly reviewing their decisions.

It’s vital to keep detailed records of why decisions were made. This helps show that directors were acting thoughtfully and can be crucial if their decisions are questioned later.

Directors are judged by their own skills and what a reasonable person in their position would do. They need to know enough about the company’s finances and have good financial controls in place.

If a court finds a director guilty of wrongful trading, it is up to the discretion of the court what amount the director may be ordered to pay.