Wrongful Trading Insolvency Act - What is it?
What is Wrongful Trading (Insolvency Act 1986)?
Wrongful trading is a concept under Section 214 of the Insolvency Act 1986. It refers to a situation where the directors of a company continue to trade when they knew, or ought to have known, that there was no reasonable prospect of avoiding insolvent liquidation.
The purpose of wrongful trading provisions is to discourage directors from carrying on a business when it is clear that the company cannot avoid going into insolvency. This is because it may further worsen the financial position of creditors.
If a director is found to have engaged in wrongful trading, they may be held personally liable for the company’s debts and may face other sanctions.
Key points regarding wrongful trading under the Insolvency Act 1986 include:
- Knowledge or ought to have known: Directors are expected to exercise reasonable diligence and awareness of the company’s financial situation. If they continue to trade when the company is insolvent or likely to become insolvent, they may be held liable.
- Reasonable prospect of avoiding insolvent liquidation: Directors need to assess whether there is a reasonable prospect of the company avoiding insolvency. If there is no such prospect, and they continue trading, it may be considered wrongful.
- Personal liability: If wrongful trading is proven, directors may be personally liable to contribute to the company’s assets. This means they may have to pay for some or all of the company’s debts out of their own personal assets.
- Defences: Directors may have defences if they can demonstrate that they took every step to minimise the potential loss to creditors, or that they reasonably believed there was a prospect of avoiding insolvent liquidation.
It’s important to note that wrongful trading is distinct from fraudulent trading, where there is evidence of dishonesty or intent to defraud creditors. Wrongful trading is more concerned with the director’s awareness of the company’s financial situation and whether they took appropriate action in response to that knowledge.
Steps to Avoid Wrongful Trading
Directors must take steps with a view to minimising the potential loss to the company’s creditors. Outlined below are steps that a company could take to avoid wrongful trading:
Regular Financial Monitoring:
- Directors should regularly review the company’s financial statements, cash flow, and other key indicators to stay informed about its financial health.
Seek Professional Advice:
- Directors should seek advice from qualified professionals, such as insolvency practitioners, to assess the company’s financial viability and explore restructuring options.
Develop a Contingency Plan:
- Having a contingency plan in place allows directors to respond promptly to financial difficulties, considering alternative funding, negotiations with creditors, or restructuring.
- Directors should document their decision-making processes, demonstrating that decisions were made with due care and diligence.
Hold Regular Board Meetings:
- Regular board meetings facilitate discussions on financial matters and enable informed decision-making.
Implement Cost Controls:
- Directors should implement cost controls to manage expenses effectively and preserve the company’s financial resources.
Stay Informed about the Business Environment:
- Directors need to stay abreast of industry trends and market conditions, adapting to changes that may impact the company’s financial stability.
The key to avoiding wrongful trading (Insolvency Act) lies in acting responsibly, using knowledge, skill, and experience, and making decisions that prioritise the long-term viability of the business.
Directors’ Obligations to Creditors
Directors have several obligations to creditors. These obligations are primarily aimed at ensuring fairness and transparency in the treatment of creditors, especially when a company is facing financial difficulties. The duties of directors to creditors include:
- Directors owe a fiduciary duty to act in the best interests of the company. Whilst this duty is owed to the company itself, it indirectly benefits creditors by preserving the company’s value.
Duty to Avoid Fraudulent Trading:
- Directors must not engage in fraudulent trading, which involves carrying on the business with the intent to defraud creditors. This is a more serious offense than wrongful trading and may lead to criminal charges.
Duty to Avoid Wrongful Trading:
- Directors must not allow the company to trade whilst insolvent. They should not continue to trade if there is no reasonable prospect of avoiding insolvent liquidation.
Duty to Exercise Care, Skill, and Diligence:
- Directors are required to exercise reasonable care, skill, and diligence in managing the company’s affairs. This includes making informed decisions about the company’s financial position to avoid actions that could harm creditors.
Duty to Preserve Company Assets:
- Directors must take steps to preserve the company’s assets for the benefit of all stakeholders, including creditors. Diligent asset management helps maximise the resources available to satisfy creditor claims.
Duty to Keep Proper Books and Records:
- Directors are obligated to maintain accurate and up-to-date accounting records. Proper financial records are crucial for assessing the company’s financial health and ensuring fair treatment of creditors in case of insolvency.
Duty to Avoid Unfair Preferences:
- Directors must not give preferences to certain creditors over others when the company is insolvent or becomes insolvent as a result of the preference. Transactions that unfairly favour one creditor can be set aside by the courts.
Duty to Consider the Interests of Creditors in Insolvency:
- In times of financial distress, directors should consider the interests of creditors as a whole. This may involve seeking professional advice, engaging in negotiations with creditors, and exploring restructuring options.
Duty to Communicate:
- Directors should maintain open communication with creditors, keeping them informed about the company’s financial situation. Transparent communication fosters trust and may lead to negotiated solutions.
Duty to Cease Trading:
- When it becomes clear that the company cannot avoid insolvency, directors should consider whether it is in the best interests of creditors to cease trading and commence insolvency proceedings.
Failure to fulfil these obligations may lead to legal consequences, including personal liability for directors and potential legal actions by creditors. It is crucial for directors to act responsibly, seek professional advice when needed, and prioritize the fair treatment of all creditors in accordance with applicable laws and regulations.
Legal Implications and Defences for Wrongful Trading (Insolvency Act)
If a company faces insolvency despite directors’ best efforts, they may still be accused of wrongful trading. In such cases, directors can rely on certain defences, including demonstrating that:
- The company or person took every step with a view to minimising the potential loss to creditors.
- The person carrying the company reasonably believed there was a prospect that the company could avoid insolvent liquidation.
Personal Liability and Company Assets
Section 214 of the Insolvency Act 1986 grants the court power to make an order for a person to contribute to the company’s assets as the court thinks proper. This means that directors may face personal liability, contributing to the company’s debts out of their own assets.
It’s important to note that not only formal directors, but also shadow directors (those whose instructions the formal directors are accustomed to follow), may be held liable for wrongful trading. This extends the scope of personal liability to those who exert significant influence over the company’s decision-making.
Why choose Expert Commercial Law?
Our team take the stress out of finding you a solicitor to assist on your insolvency law matter. We have assisted many UK businesses and individuals in finding the right litigation team for their case.
We only connect you with the best solicitors
All of the solicitors on our panel have the experience and expertise required to take on your case. Each solicitor is vetted before being allowed onto our panel. We only select the best in the business.
All of our solicitor firms are authorised and regulated by the Solicitors Regulation Authority (SRA) and offer a range of funding options for your case. All solicitors are registered in England and Wales.
We are not a firm of solicitors; however, we have a panel of commercial law solicitors who are authorised and regulated by the SRA. If you contact us in relation to a commercial law case, we will pass your case onto a panel law firm.
If you contact us in relation to a commercial law case, we will pass your case on to a panel firm. Panel firms pay fees which contribute to the running of our website and marketing. We will never charge you for passing on your case.
Please contact us to speak to a member of our team using the form below or call us today.
Schedule Your Free Consultation
Please note, we are not a firm of solicitors; however, we maintain a panel of trusted and regulated legal experts. If you contact us in relation to a commercial law case, we will pass your case onto a panel firm in return for a fee from our panel firms. We will never charge you for passing on your case to a panel firm.