Understanding the concept, consequences, and legal implications of wrongful trading in the UK.

What is Wrongful Trading?

Wrongful trading occurs when directors continue trading after they know or should know; there is no reasonable prospect of avoiding insolvency[1]Trusted Source – GOV.UK – Insolvency Act 1986, Section 214.

Under the Insolvency Act 1986, directors must 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.’

Crucially, wrongful trading liability is not contingent upon directors knowingly acting improperly. The landmark case of Re Produce Marketing Consortium Ltd (1989) [2]Trusted Source – Wikipedia – Re Produce Marketing Consortium Ltd established the principle that directors can be held liable for wrongful trading even if they did not have actual knowledge of the company’s insolvency, provided they ought to have known based on the information available to them.

The key characteristics of wrongful trading 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.
Wrongful Trading

What are the Consequences of Wrongful Trading?

The consequences of wrongful trading could include:

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.

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.

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.

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.

What Do Liquidators Need to Prove in a Wrongful Trading Claim?

To succeed in a wrongful trading claim, liquidators or administrators must establish three key elements:

  1. Tipping point: The liquidator must identify the specific moment when the director knew or should have known that the company could not avoid insolvent liquidation or administration. This is known as the “tipping point.”
  2. Director’s lack of skill or knowledge: The liquidator must demonstrate that a reasonable director, with the same level of skill, knowledge, and experience as the director in question, would have recognized that the company was approaching the tipping point. This helps establish that the director’s actions or inaction were unreasonable given their expertise.
  3. Financial loss: The liquidator must prove that the director’s failure to act reasonably at or before the tipping point resulted in financial losses for the company and its creditors. This involves showing what steps a reasonable director would have taken to mitigate damages and how those actions would have reduced the overall financial impact.

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.

References

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 our standards for producing accurate, unbiased content in our editorial policy here.

  1. Trusted Source – GOV.UK – Insolvency Act 1986, Section 214
  2. Trusted Source – Wikipedia – Re Produce Marketing Consortium Ltd