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 the correct name for the civil offence entered into when directors fail to minimise losses to company creditors, subsequent to realising their company is insolvent.
Under Section 214, wrongful trading is defined as 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 to minimise the potential loss to the company’s creditors.
The wrongful trading provisions were created so that corporate creditors could recover money from directors who wilfully traded irresponsibly (and acted without care or consideration to creditors) and in doing so increased their debts.
When it is ascertained by a court that a director failed to comply with their duty to minimise potential losses to creditors , the director can be held personally liable for an amount the court deems ‘proper’.
What is Classed as Wrongful Trading?
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 repays a director’s 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.
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.
Fraudulent trading is a criminal offence which can a prison sentence of up to 10 years.
What is 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.
What are the Consequences of Wrongful and Fraudulent Trading?
Wrongful trading can carry the following consequences:
- Directors Disqualification for up to 15 years – 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.
- Fines may be issued to directors
- Directors can be held personally liable for some or all of the company debts
Fraudulent trading carries a potential prison sentence of 10 years. The penalties can also 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.
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.
All Company Debt insolvency content is written by our licensed insolvency practitioners.
The primary sources for this article are listed below, including the relevant laws and Acts which provide their legal basis.
You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy here.
- GOV.UK “Section 214 Insolvency Act 1986”
- GOV.UK “Section 246ZB Insolvency Act 1986”