This article will explain the concept of wrongful trading in detail, and how this may affect you if you’re the director of an insolvent company.
Wrongful Trading: Definition
Wrongful trading is where directors continue trading despite being aware that the company is insolvent. It imeans directors have failed in their duty to take steps to prevent losses to company creditors.
The wrongful trading provisions were created as a statutory offence so creditors could recover money from directors who wilfully traded irresponsibly (and acted without care or consideration for the creditors) and in doing so increased the debts to them.
Section 214, Insolvency Act 1986
Wrongful trading or ‘trading irresponsibly’ is covered in Section 214 of the Insolvency Act 1986. For this reason, industry professionals often refer to it simply as ‘Section 214.’
Designed as a counterpart to fraudulent trading, the principle of wrongful trading is that the director of a UK limited company becomes fully aware of their company’s insolvency yet does not act in a way that minimises the loss to business creditors.
Under Section 214, wrongful trading is defined when a director of a company allows the business to trade past the point where they:
- ‘knew, or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation’;
- ‘did not take “every step with a view to minimising the potential loss to the company’s creditors’.
Companies Act 2006, Section 993
Where fraud is concerned, the Companies Act 2006 makes clear that every person ‘knowingly a party to the carrying on of the business in that manner’ can be held accountable. The penalties could be up to 10 years imprisonment and/or a fine.
The full wording is here.
Is Wrongful Trading a Criminal Offence?
Wrongful trading, which is based on negligence or irresponsibility, is a civil offence. While it is a serious matter and can lead to directorial disqualification, it’s significantly less serious than the knowing attempt to defraud creditors implied by fraudulent trading.
When a director sets up to deliberately defraud creditors it is known as fraudulent trading. Covered in Section 213 of the Insolvency Act, fraudulent trading is crucially not applicable to merely directors but to “any persons who were knowingly parties to the carrying on of the business”.
It is covered by Section 993 of the Companies Act 2006 which lists fraudulent trading as a criminal offence which could be punished by up to ten years in prison. It also renders guilt parties personally liable for contributions to the company assets.
Wrongful Trading Liability
The wrongful trading laws apply to limited company directors (whose appointment is registered with Companies House) but also to:
- De facto directors – A director who, while not officially appointed, makes the decisions of a director. He/She may be treated by other directors as a director, and may sign company documents
- Shadow Directors – A shadow director is someone who acts in a position of influence behind the scenes as a director, while having another carry out the actions for him. An example of this could be where a director has received a disqualification order but then appoints his partner as director and continues to function in the role.
Directors Disqualification – Any wrongful trading that has been identified as ‘blameworthy, or dishonest’ may lead to a director being disqualified for 2-15 years and or fined and in the worst cases imprisonment.
Fraudulent trading penalties can run far higher because the amounts to be repaid do not necessarily stop with the money defrauded, but may include compensation, and a punitive element. There will also be legal costs.
What Actions Constitute Wrongful Trading?
There are three distinct parts to be considered when assessing wrongful trading and they are:
- Has the company ended in an insolvent liquidation
- Prior to the start of the company winding up should the director have concluded the company could not have avoided ending in an insolvent liquidation
- Was the individual a director or regarded as a shadow director
The list provided below is not a definitive list but it is simply provided to show the most commonly reported incidents whilst the company was insolvent that will warrant further investigation by any liquidator:
- A director repaying a director loan made to the company whilst other creditors were not paid;
- Repayment of a loan to a family member;
- A director paying his own salary whilst PAYE/NI for employees was not paid;
- Buying goods on credit when there is no means to pay for them;
- Buying a company car on finance;
- Using customer deposits for cash-flow purposes with no means of supplying goods;
- Repaying bank personal guarantees over other creditors;
- Not keeping proper accounting records;
- Falsification of company records;
- Fraudulent trading;
- Failing to pay HMRC when other creditors are being paid;
- Continuing to trade claiming VAT and either not being registered for VAT, or not paying VAT;
- Any transfer or sale of assets at anything less than a fair and reasonable commercial value.
Suspension of wrongful trading Liability
As a means of protecting limited company directors, the UK government suspended wrongful trading provisions as of 1st March 2020.
These are now reinstated as of July 1st 2021.
Help is at Hand
If you have concerns over wrongful trading and would like to speak with an insolvency practitioner, or need advice on personal matters arising from an insolvent company; you can contact us on 08000 746 757.