What is Wrongful Trading?
In the UK, wrongful trading arises when directors of a financially distressed company continue to operate it despite having knowledge or sufficient grounds to believe that avoiding insolvency is improbable.
We will delve into more details about this topic in the sections below.
What is Wrongful Trading?
Wrongful trading, also known as insolvent trading, is a legal concept in the United Kingdom that refers to the actions of company directors when their company faces financial distress or insolvency. It occurs when directors continue trading despite knowing, or having reason to believe, that the company is unlikely to avoid insolvent liquidation.
The key characteristics are as follows:
- Continuation of Trading: Directors continue operating the company despite knowing or having reason to believe it is insolvent.
- Knowledge of Insolvency: 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.
- No Reasonable Prospect of Avoiding Insolvency: Directors must recognize that there is no reasonable prospect of the company avoiding insolvent liquidation. This means there is no realistic chance of trading out of financial difficulties or securing additional funding to prevent insolvency.
What are the Consequences of Wrongful Trading?
The consequences of wrongful trading include:
Personal Liability for Directors
Directors found guilty of wrongful trading may face personal liability for the company’s debts. They could be required to use their own assets to settle the company’s financial obligations. The court assesses their role in the insolvency and the impact on creditors.
Contribution to Company Assets
Courts can order directors to contribute to the company’s assets, compensating for losses caused by their wrongful actions. This takes into account the directors’ financial status and their actions’ effect on the company.
Disqualification from Directorship
Guilty directors might be banned from holding any directorial position for up to 15 years. This measure aims to protect creditors and encourage responsible corporate governance.
Can Incur a Civil Liability
Wrongful trading can result in civil liabilities for directors, holding them accountable for their part in the company’s financial downfall under under section 214 and section 246ZB of the Insolvency Act 1986
In extreme cases, especially where fraud is involved, directors might face criminal charges, which could lead to imprisonment or fines.
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:
- A director paying his own salary whilst PAYE/NI for employees is not paid;
- Buying goods on credit when there is no means to pay for them;
- Using customer deposits for cash-flow purposes with no means of supplying goods;
- Repaying personal guarantees in preference to other creditors;
- 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.
Key Considerations in Wrongful Trading
Obligation Shift in Insolvency: 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.
Deciding to Continue Trading: 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.
Making Reasonable Decisions: 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.
Importance of Record-Keeping: 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.
Judging Directors’ Actions: 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.
Financial Responsibility if Wrongful Trading is Proven: If a court finds a director guilty of w