Who Can Bring a Claim for Wrongful Trading?
Wrongful trading refers to actions or omissions made by one or more company directors when a company is in difficulty or is insolvent.
When a company is heading down the road to insolvency, directors have defined legal duties and obligations to protect creditors’ interests.
Wrongful trading can arise if a director fails to act with due diligence when conducting the company’s business.
Wrongful trading is not necessarily deliberate. It can be the result of mismanagement, neglect or trusting a co-director in a difficult situation or a genuine error or oversight.
Wrongful trading is broadly defined. Many clear examples can be cited, but a judgement of wrongful trading relies on the court’s interpretation of the individual situation.
If you’re a director and your company is failing, it’s crucial to take expert and prompt advice to ensure you don’t engage in wrongful trading.
What is Wrongful Trading?
Wrongful trading, sometimes referred to as ‘trading irresponsibly, is a civil offence under section 214 of the Insolvency Act 1986.
Wrongful trading refers to a situation where company directors have continued to trade beyond a point where they knew or could have reasonably been expected to know that the company was failing and did not take every step to minimise creditor losses.
If a company is on the point of insolvency or is insolvent, there are specific actions by the directors classed as wrongful trading.
The period of trading pre-insolvency, sometimes called ‘the twilight zone’, changes the directors’ position. The director’s duty becomes solely to the creditors rather than to the company.
Directors can become personally liable for the company debts if they fail to execute their duties with diligence and care.
Directors found guilty of wrongful trading can also be fined and/or barred from acting as a company director for a specified period.
Egregious cases of wrongful trading may result in a prison sentence.
What Actions Are Considered Wrongful Trading?
Wrongful trading can be deliberate, but it’s often due to mismanagement in a difficult situation rather than a deliberate attempt to defraud.
Here are examples of actions taken by directors that may be considered wrongful trading.
- Exceeding credit limits on business financing or being refused further credit.
- Accepting credit from suppliers when there is no reasonable prospect of repayment
- Receiving deposits from customers when delivery of the goods or services they have purchased is in doubt
Paying contractors or other creditors late or trying to delay payments unreasonably.
Failure to file the company’s annual accounts at Companies House.
Falling behind on tax payments and accumulating arrears.
Failure to make VAT payments.
Capital and Cash Flow
Persistent cash flow problems or lack of working capital.
Failure to adhere to the PAYE scheme as required for employers and neglecting to pay tax and/or National Insurance contributions.
Paying excessive salaries to the director, which the company cannot afford.
Who can Bring a Claim for Wrongful Trading?
The Small Business Enterprise and Employment Act 2015 made numerous changes to the insolvency rules. One amendment was to increase the powers of an administrator or liquidator.
Before the new Act, only liquidators could bring proceedings for wrongful trading. If the company entered administration and the administrator suspected wrongful trading, the administrator’s only recourse was to refer the case for liquidation. The administrator could not act on suspicion of wrongful trading themselves.
The goal behind the new legislation was to make it easier to bring a claim for wrongful trading rather than introducing more causes of action.
Now, both a liquidator and an administrator can bring a claim for wrongful trading. They can also assign this right to a third party, such as a creditor.
Unsecured creditors, either individually or as a group, can also bring claims against directors. Unsecured creditors, who sit further down the pecking order than secured creditors, often feel overlooked in the repayment hierarchy during a debtor’s insolvency.
Clubbing together with other unsecured creditors and bringing an action for wrongful trading as a group helps relieve the costs burden and makes litigation more accessible.
What is the Difference between Wrongful Trading and Fraudulent Trading?
Wrongful trading typically covers situations where mismanagement or omission by directors compromises the creditors’ interests. In most cases, wrongful trading is not deliberate.
The court will apply a test of reasonableness to the director’s behaviour. Suppose an action or omission could reasonably have been expected to prejudice creditor interests, and a director should have known this. In that case, wrongful trading can still be present.
Fraudulent trading centres on determining that the directors clearly knew the business was failing and continued to trade knowing they could not meet obligations to creditors, actively diminishing creditor interests.
What Should You Do if You’re Concerned About Wrongful Trading?
Directors of a company potentially heading towards insolvency may be reasonably concerned that their behaviour may unwittingly stray into the territory of wrongful trading. A director may also be worried about the actions of another company director.
Taking professional advice at an early stage can help directors avoid the pitfalls of wrongful trading.
The mere act of taking legal advice demonstrates to a liquidator or administrator that the directors are making every effort to protect creditor interests by acting with diligence and care.
Directors must take expert advice without delay if they suspect their company is failing and may become insolvent. Prompt action can protect their position and help avoid any accusations or claims for wrongful trading.
Helix Law’s specialist team offers swift, strategic advice to directors concerned about insolvency and wrongful trading.
Directors must be fully aware of the consequences of wrongful and fraudulent trading. Not only may allegations of wrongful trading have far-reaching repercussions for the company, but also the director’s reputation, personal assets, and the ability to serve as a company director in future.