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Wrongful Trading

Definition and Legal Requirement

Wrongful Trading is when a company’s Directors continued to trade when they knew, or ought to have known that there was no reasonable prospect of an avoiding insolvent liquidation or administration and that they did not take every step with a view to minimising the potential loss to the company’s creditors as they ought to have taken. The Directors are subject to a subjective and objective test to assess culpability.

Once a company enters Liquidation, the appointed Liquidator is required to investigate whether Wrongful Trading occurred. This will be done by collating and analysing the company’s financial statements, books & records and bank statements.

For a Wrongful Trading claim to be successful it will be necessary to fix a point in time when the Directors knew or should have concluded that the company would not avoid insolvent Liquidation or Administration.  Having identified that point it is then necessary to quantify the trading losses that occurred subsequently.

Ramifications

When an Administrator or Liquidator establishes a Wrongful Trading claim, there are a number of ramifications, the most important being:

  • Details of Wrongful Trading will form part of the Directors’ conduct report that the Administrator or Liquidator is required to submit to the Insolvency Service. This will have some impact upon the Insolvency Service’s decision to commence disqualification proceedings; and
  • The Directors may be made liable in part or in full for the company’s debts.

Defence

If it can be demonstrated that the Directors put the interests of creditors first and not for their own, the claim may be defeated.

Frequently Asked Questions

There are numerous examples of behaviour that a liquidator will look for when seeking to establish Wrongful Trading. Evidence that may suggest Wrongful Trading include a history of trading losses, having a balance sheet showing a deficiency of assets over a number of years, failing to pay VAT / PAYE and NIC when due and building up arrears, aged creditors showing debts due of 3 months or over and County Court or High Court proceedings.
The first part of the test is objective. This looks to what a reasonably diligent director in the Director’s position should have known and what action they should have taken. The second part of the test is subjective. This looks to apply the findings of the first test to the Director’s actual knowledge, skill and experience.
The defence to a Wrongful Trading claim is that Director took every step to minimise the potential loss to creditors. The burden of proof lies with the defence. Such steps might include making an injection of capital from personal funds, making attempts to raise finance and negotiating to sell the business.
There are various measures that could have been put into place to demonstrate that every step was taken to ensure that creditors interests were sought to be preserved. These would include such things as holding regular board meetings to discuss the company’s finances and noting decision that were made in the interests of creditors, making sure that financial records were updated and obtaining professional advice.
Fraudulent Trading has broadly the same requirements as a Wrongful Trading claim. However, there is a higher burden of proof in that it must be shown that there was an intention to defraud. As a result, Fraudulent Trading is harder to prove. As with Wrongful Trading, the penalties for Fraudulent Trading are compensatory in nature. A Fraudulent Trading case may lead to criminal prosecution by the authorities.