Directors of struggling business must be careful to avoid incurring personal liability for Wrongful Trading. Accusations of Wrongful Trading may be brought by liquidators in the event of insolvency under Section 214 of the Insolvency Act 1986 (the Act).
Wrongful Trading is a serious offence which can lead to directors becoming personally liable to contribute to the company’s assets and meet its obligations to unsecured creditors.
However, there is often confusion about when Wrongful Trading occurs and whether trading through financial difficulties will necessarily land directors in hot water if the business does not eventually recover.
Wrongful Trading and Insolvent Trading
‘Wrongful Trading’, as defined under the Act, is not the same thing as ‘Trading While Insolvent’ or ‘Insolvent Trading’ which of itself is not defined in legislation. However, Insolvent Trading can be evidence that Wrongful Trading has taken place.
There are two main ingredients required for Wrongful Trading are that:
i) The person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation; and
ii) The person failed to take every step with a view to minimising the potential loss to the company’s creditors.
Insolvent Trading can occur technically before a company is legally insolvent because insolvency is only loosely defined in Section 123 of the Act as:
i) The company is unable to pay its debts as they fall due; or
ii) The value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities.
If a company cannot pay its creditors as its liabilities fall due then it could be deemed insolvent but the directors may not be acting unlawfully by continuing to trade. For example, if it is purely a cash flow issue caused by slow payments from debtors, companies will often be able to trade through these situations and successfully recover without further problems.
If on the other hand the company’s liabilities exceed it assets, creditors are unpaid as liabilities fall due and there is no reasonable prospect of avoiding insolvent liquidation but the directors continue to increase liabilities such as trade credit, then it is much more likely that directors will be accused of Wrongful Trading.
If a company reaches a position whereby it could be deemed technically insolvent but the directors are confident that the company can survive, continuing to trade may be in the best interests of the creditors. This is a matter of judgement but directors concerned about the company’s position or their own individual exposure to potential liabilities should seek professional advice to help assess any Wrongful Trading risk.