A recent ruling in the High Court has shifted the responsibility from the liquidator, to the company director, to prove every step has been taken to minimise wrongful trading and possible creditor losses in an insolvency situation. The High Court has confirmed that company directors must do everything they can to minimise liabilities as soon they become aware an insolvent liquidation cannot be avoided.
The ruling was made when a Registrar was asked to determine the circumstances in which a director could be ordered to make a contribution towards an insolvent company’s assets. Until very recently, it was argued that the liquidator should prove the director had failed to take every step he or she ought to have taken. However, the judge in the case said that given all the facts are known to a director about a company’s position, it is therefore “right and appropriate for them to justify continued trading in those circumstances.”
This judgement ups the ante for company directors as it not only makes them responsible for taking every possible step to minimise creditor losses if their business is failing, but also to prove they have done so in court. The result will be an increase in focus on the behaviour of directors in similar cases in the future.
The law on Wrongful Trading as it stands
Section 214 of the 1986 Insolvency Act allows a liquidator to apply to the court for a declaration that a current or former director of a company must make a contribution to the company’s assets if there is evidence of wrongful trading. Such a declaration can be made if it can be proved the director knew, or ought to have known, that the company was heading towards insolvent liquidation.
The only defence to this charge is if the director can prove he or she took every step to minimise the potential loss to the company’s creditors. If this can be proven, the director will not have to contribute to the company’s assets or pay compensation for breaches of their director’s duties. The requirement to take ‘every step’ applies to all creditors, and not just a chosen few.
The implications in cases of fraud
The ‘every step’ test could also apply in cases where a director fails to properly investigate suspicious circumstances in the business which may impact the company’s bottom line and push it towards insolvency, even if the fraudulent act is not the fault of the director.
Acts of fraud are rife in UK companies, and many of these acts can detrimentally affect a business’s cash flow and push it towards insolvency. If a director fails to act on information which indicates an act of fraud is taking place or fails to follow fraud prevention policies, they could find themselves in hot water if the company becomes insolvent. In this case, they will need to consider how they can justify their failure to act to the liquidator. If they are unable to do so, they could find themselves personally liable should the company be subject to insolvent liquidation at a later date.
All directors should understand their duty of care to act in the best interests of the company. If they ignore their obligations or show a fair attitude to investigating acts that could damage the company, they could find themselves liable for creditor debts. Their defence against such an outcome is to act reasonably, investigate frauds as and when they arise and take ‘every step’ to minimise creditor losses.
For more information about your obligations if your company becomes insolvent, or for advice and assistance to turn around a struggling company before it goes too far, please get in touch with the turnaround specialists here at Company Debt.