Wrongful Trading

2nd January 2018
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Wrongful Trading

Predicted low levels of UK economic growth coupled with inflation could affect the number of corporate insolvencies in 2018 and 2019. Our solicitors therefore take a moment to discuss wrongful trading and provide legal insight to individual company directors who may be concerned about personal liability for wrongful trading.

Wrongful Trading – a basic premise

A wrongful trading order is made under s.214, Insolvency Act 1986 – but can only be made if and after a company goes into insolvent liquidation.

If a director of a company has concluded (or should have concluded) that there is no reasonable prospect of the company avoiding an insolvent liquidation, they have a duty from that point forward to take every step which a reasonably diligent person would take to minimise potential loss to the company’s creditors (by, for example, taking steps to appoint a liquidator, ceasing to trade or ceasing to incur expenses and thereby the exposure of creditors).

If, after the company has gone into insolvent liquidation and a liquidator is appointed, it appears to the liquidator that a director has breached the duty to take every step which a reasonably diligent person would take to minimise potential loss to the company’s creditors, the liquidator may apply for a court order requiring the director to make a contribution to the company’s asset pool, so as to increase the size of the asset pool that is available for distribution to creditors.

What contribution can a director be ordered to pay?

The consequences of wrongful trading are compensatory (rather than punitive). The contribution which a director can be ordered to make to the pool available for distribution to creditors is (generally) limited to the increase in the deficiency to creditors caused by the director’s decision to continue trading. So if a supplier to the company is owed £100, but then the company’s director, after concluding there is no reasonable prospect of the company avoiding insolvent liquidation, incurs a further £100 debt with that supplier, the director’s liability will not be £200, but will be limited to the £100 incurred after the director knew that the company no longer had any reasonable prospect of avoiding insolvency.

Proving wrongful trading – the court’s approach

In any wrongful trading claim, a court will need to ascertain at what point in time the director concluded (or ought to have concluded) that there was no reasonable prospect of the company avoiding insolvent liquidation. In doing so a court a will:

  1. assume the director is a reasonably diligent person;
  2. take into account the general knowledge, skill and experience that may reasonably be expected of a person carrying on the functions that the director in question is carrying out; and
  3. take into account the general knowledge, skill and experience that the director in question in fact has.

Criteria (b) and (c) above mean that Chief Financial Officers and directors entrusted with finance related roles or who have finance related qualifications and experience, can generally be at more risk of a wrongful trading order.

Once a court, applying the above criteria, ascertains the point in time that a director had (or ought to have had) the requisite knowledge, it must then decide whether, from that point in time onward, the director took every step with a view to minimising the loss to company’s creditors. If the director did not, the court may order the director to contribute to the company’s asset pool to the extent that the director’s conduct increased the loss to creditors.

Examples of the types of scenarios that have led to successful claims for wrongful trading against company directors include:

  • directors being paid a salary beyond the point where it was no longer possible to avoid insolvent liquidation; and
  • company accounts being in such a state so as to make it impossible to determine the company’s solvency.

Wrongful trading tips for company directors

It is crucial that directors recognise at an early stage that a company may be in financial trouble or worse, be at risk of insolvent liquidation. Signs could include:

  • late filing of accounts;
  • demands from creditors that cannot be met;
  • substantial liabilities or payments falling due in the near future that the company has no reasonable prospect of meeting out of its existing reserves (or via further finance raising); or
  • anything else that would indicate the company cannot pay its debts as they fall due.

Should the prospect of wrongful trading be a concern for a company’s directors in view of a company’s financial position, the directors should consider taking steps such as:

  • agreeing achievable payment plans with any major creditors that cannot be paid on their usual terms;
  • making extra efforts to get money in via debt recovery action;
  • preparing 12 month cashflow forecasts and reviewing and updating them regularly – up to date financial information should always be on hand or be capable of being produced reasonably quickly;
  • if appropriate, putting in place a more rigorous financial reporting and monitoring procedure, for example financial reports are provided to the directors on a weekly basis, with the directors meeting each week to discuss any actions required;
  • securing further finance where the cashflow forecasts do not show that the company is expected to trade profitably or will be able to pay its debts;
  • monitoring the company’s position via regular board meetings;
  • taking advice from external professionals (solicitors and accountants) and acting on that advice; and
  • speaking to insolvency professionals.

The taking of such steps by the directors can increase a company’s prospects of insolvency and survival, and also help directors facing insolvent trading claims to defend themselves by showing they took sufficient steps to minimise the loss to creditors.

South Bank Legal is a London commercial law firm specialising in advising company directors of their duties and in defending claims brought against them. For a confidential discussion about any the issues discussed above, please feel free to get in touch.

Corporate Law