Under the Insolvency Act 1986, directors are required to cease trading once their company is insolvent. Continuing business activities without attempting to minimise creditor losses can lead to directors being personally liable to contribute financially to the company’s assets due to what is known as ‘wrongful trading.’

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 recognise 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 can be personally responsible for the company’s debts if they let the business keep incurring debts when they knew, or should have known, it couldn’t avoid going bust. However, the court might not hold a director personally liable if they prove that, after realising the company was heading for insolvency, they took all necessary actions to reduce the possible losses to creditors.

For this reason, directors should carefully record all their actions from the moment they become aware of the state of insolvency.

Contribution to Company Assets

In addition to personal liability, directors may be required to contribute to the company’s assets to cover unpaid debts. This can involve returning salaries or dividends received when the company was insolvent or contributing personal funds to reduce the company’s debt.

Disqualification from Directorship

Wrongful trading can disqualify directors for up to 15 years. This prevents them from holding any directorial position in a registered company, protecting the public and creditors from potential future misconduct.

Civil Liability for Wrongful Trading

Directors may face civil liabilities under sections 214 and 246ZB of the Insolvency Act 1986. This doesn’t just mean paying fines; it can also involve compensating the company or its creditors for the financial harm caused by continued trading during insolvency.

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

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.

FAQs on Wrongful Trading

Yes, directors can be held liable if they ought to have known the company was heading towards insolvency. It’s about what they should have known, given the circumstances, not just what they actually knew.

Directors should closely monitor the company’s financial health, seek professional advice early, and take decisive action to minimise losses to creditors if insolvency seems likely. Keeping detailed records of all decisions and the reasons behind them is also crucial.

Insolvency practitioners investigate the directors’ conduct before and after the company became insolvent. They assess whether wrongful trading occurred and can initiate claims against directors to recover losses for creditors.