It is covered under Sections 213 and section 246ZB of the Insolvency Act 1986 and it constitutes a criminal offence under section 993 of the Companies Act 2006. The Insolvency Practitioner, acting as liquidator, may refer a suspected case to the criminal enforcement team at the Insolvency Service.
There will be a thorough investigation and it must be proven that directors involved in fraudulent trading have a clear intention to deceive and defraud creditors and most likely, have attempted to extract money from the business before it is liquidated.
Clearly, there are numerous important responsibilities for directors and these extend to when they believe insolvency is likely. Although they may make every effort to save the business, this must not be at the expense of creditors.
Listed Companies and Fraudulent Trading
Further, directors of listed companies have additional duties when it comes to fraudulent trading. They must abide by the Market Abuse Regulation (MAR), Listing Rules, AIM Rules for Companies, Prospectus Rules, the Financial Services and Markets Act 2000 and the Financial Services Act 2012, where these relate to misleading the market.
In particular, directors must not deliberately fail to disclose details of financial problems or dishonestly conceal these. This can also carry its own penalties as if a company does not make necessary disclosure under MAR, for example, then the regulator, the Financial Conduct Authority, may suspend trading and impose sanctions.
What are the Penalties for Fraudulent Trading?
Fraudulent Trading is a serious charge and a director should seek legal advice if they are told of an investigation.
The penalties are severe – if tried by magistrates, the maximum sentence for fraudulent trading is six months in jail, an unlimited fine or both.
If tried at the Crown Court, this rises to a maximum of 10 years in jail, an unlimited fine, or both. In addition, directors could be held personally liable for company fines and debts and face disqualification as company directors for up to 15 years.
Fraudulent Trading vs. Wrongful Trading
When a company goes into liquidation, an insolvency practitioner acting as liquidator will seek to find out why and will see if there is evidence of either fraudulent or wrongful trading.
There are both similarities and differences – fraudulent trading is a criminal offence, whereas wrongful trading is a civil offence. Both only apply when a company is in is in liquidation or administration and are concerned with the time prior to the formal insolvency procedure
Wrongful trading is covered under section 214 and section 246ZB of the Insolvency Act 1986, and these mean that once a director is aware insolvency is unavoidable, then they have a duty to minimise loss to the company’s creditors.
To be liable under section 214, it must be shown that the company is worse off by continuing to trade and that this has impacted on creditors. Therefore, timing as to when the company ceased trading, is a key issue and the Insolvency Practitioner will be examining whether the company was allowed to trade for too long. Wrongful trading is normally identified when the insolvency practitioner reviews accounts and sees that losses have been steadily increasing and there is no prospect of recovery – yet the business was allowed to keep trading.
However, while wrongful trading is a lesser offence, it too carries stiff penalties. If guilty of wrongful trading, a director could lose their limited liability rights, which could then mean they become personally liable to creditors for the amounts owed. They could also face disqualification from being a company director for up to 15 years.
A further difference is that wrongful trading affects company directors, although this includes so-called ‘shadow directors’ who are individuals not filed at Companies House, but who are directors through their actions. Meanwhile, fraudulent trading extends to anyone who is knowingly party to carrying on the business with intent to defraud.
Overall, wrongful trading is more commonplace and the liquidator may accept a defence from directors if they are able to show that they did seek to minimise harm to creditors at a reasonably early stage. Fraudulent trading is generally more difficult to prove as dishonesty needs to be proven.
Impact of Covid-19 and Wrongful Trading
A further point to bear in mind is the impact of Covid-19 on wrongful trading. Because many more businesses were under pressure, the government introduced the Corporate Insolvency and Governance Act 2020, to provide firms with more support. This included a provision that any losses which incurred because of the pandemic, between 1 March 2020 to 30 September 2020, will not be considered for the purposes of wrongful trading.
Liquidation – the Need for Transparency
In the event of insolvency, directors will be required to be available to answer questions and provide information as required to the insolvency practitioner, who will be alert to possible dishonesty. They will also need to produce as much documentary evidence as possible through company accounts and other records.
They should try to evidence how they have dealt with debt problems and made efforts to be straightforward in their communications with creditors and have not favoured one over another. Equally, they should not falsely suggest to creditors that they will be paid when this is not possible.
If assets have been sold off prior to liquidation, then directors need to show these achieved a market value.It is the liquidator’s duty to investigate for evidence of wrongful and fraudulent trading and if necessary, they will take action and directors could at worst, end up in court.