What is wrongful trading in insolvency?

When a company becomes insolvent, the directors must act in the best interests of the company’s creditors and minimise their losses. If you continue to trade an insolvent company when it’s no longer viable and incur further debts as a result, you could be on the receiving end of a wrongful trading claim. 

What is wrongful trading?

Wrongful trading occurs when the directors of an insolvent company continue to trade when they knew, or should have known, that the company had no realistic prospect of recovery. If the company continues to trade and incurs further debts before entering into insolvent Liquidation or Administration, the directors could be held personally liable for those losses. 

Wrongful trading is covered by Section 214 of the Insolvency Act 1986. Although it’s a civil offence rather than a criminal offence like fraudulent trading, it’s still a serious matter that can have far-reaching consequences for directors. If you are trading a company that you know to be insolvent and are worried about claims of wrongful trading, you should get advice from our team of licensed insolvency practitioners immediately.

What’s the difference between wrongful trading and insolvent trading?

Continuing to trade an insolvent company is not necessarily an unlawful act. As a company director, you may honestly believe that the financial problems the business is experiencing are short-term and that you can turn things around by continuing to trade.

The key here is that you should not make the decision to carry on trading yourself. You should always follow the recommendations of a licensed insolvency practitioner. If an insolvency practitioner advises that the company continues to trade then as long as you carry out your legal duties and act in the best interests of the company’s creditors, you’ll typically be free from wrongful trading claims, even if the company subsequently fails. 

Insolvent trading only becomes wrongful trading when:

• You continue to trade when there’s no realistic prospect that the company can recover
• You fail to take steps to minimise creditor losses
• You do not fulfil your legal duties as a company director

What counts as wrongful trading?

Wrongful trading is the overall term to describe a variety of offences that directors may be held liable for when trading an insolvent company. Examples include:

• Paying yourself an unreasonably high salary when the company cannot afford it 
• Entering into credit agreements with suppliers despite knowing the company will not be able to repay them
• Amassing high debts to your creditors’ detriment
• Continuing to take orders from customers despite knowing you will not be able to fulfil them
• Building up VAT, National Insurance or PAYE arrears and spending the money you could use for them elsewhere 
• Taking deliveries of stock, materials and goods that you cannot pay for

How can I avoid wrongful trading?

There may be situations where directors are legitimately unaware that their business is insolvent. However, ignorance is not a defence for wrongful trading. For this reason, you must monitor the company’s financial situation closely and seek advice from an insolvency practitioner at the first sign that your company is in serious financial difficulty. If you bury your head in the sand and hope the company’s fortunes will change, it will be more difficult to defend yourself against wrongful trading accusations later on.   

You must also show that you were reasonable and justified in your decision to continue trading. You can do that by taking professional advice and meeting regularly with fellow directors and shareholders. You should minute your meetings to show why you made your decisions. 

It’s also good practice to keep in regular communication with your creditors. Make sure they are aware of your situation and keep notes of your correspondence in case questions arise at a later date. You should also be very wary of repaying some creditors ahead of others, as so-called ‘preference payments’, which put one creditor in a better position than the creditor group as a whole, can also lead to personal liability issues.

What are the potential consequences of wrongful trading?

Once a company enters insolvent Liquidation or Administration, an investigation will begin into the conduct of the directors. The liquidator or administrator will scrutinise the directors’ actions in the period leading up to and during the insolvency and look for any evidence of wrongful trading.

If they find evidence of any breaches that give rise to a claim, the liquidator or administrator can pursue the company directors on behalf of the company. They can apply to the court for a declaration that makes one or all of the directors personally liable to contribute to the assets of the company for the benefit of its creditors. The Insolvency Service can also disqualify directors who are found guilty of wrongful trading for a maximum period of 15 years.

Is my company insolvent?

Being able to identify when your company is insolvent is the first step to protecting yourself from wrongful trading claims. An insolvent company is one that:

• Cannot pay its bills when they are due; and/or
• Has liabilities that exceed its assets

If your company satisfies either of these criteria then it is technically insolvent. In terms of the practical signs that your company is struggling, you might: 

• Experience regular cash flow problems
• Struggle to pay your employees
• Be under constant creditor pressure
• Have ongoing legal action against the company
• Have escalating tax debts
• Spend more time fighting fires than focusing on the day-to-day running of your business

If you recognise these financial struggles in your company, you should seek immediate professional advice. Insolvency is serious and you have a legal obligation to put your creditors first. 

Need someone to speak to?

If your company is struggling financially and you think it might be insolvent, get in touch with our team of licensed insolvency practitioners for a free consultation. We can advise you on the best route forward and help you act in a way that protects you from wrongful trading claims.