How Did Wrongful Trading Go Wrong?

How did wrongful trading go wrong? The remedy of wrongful trading has existed in the statute book since the Insolvency Act 1986 sprouted and was given royal assent. Its introduction followed from the Cork Report and was to encourage a responsible approach to business risk-taking:

A balance has to be struck. No one wishes to discourage the inception and growth of businesses, although both are unavoidably attended by risks to creditors. Equally a climate should exist in which downright irresponsibility is discouraged and in which those who abuse the privilege of limited liability can be made personally liable for the consequences of their conduct.

An avalanche of wrongful trading claims never descended even as a series of recessions hit over the subsequent periods. For such a prominent provision with such laudable objectives, it is conceivably concerning how wrongful trading seems perhaps to have largely become a wrong without a workable remedy.

Cases of wrongful trading do not appear regularly in the reported case listings as one might anticipate for such a central plank of the insolvency legislation aimed at addressing neglectful director conduct. It features prominently in insolvency textbooks and Insolvency Practitioners will routinely caution over-optimistic directors of insolvent companies against trading further when liquidation is not merely a possible prospect on the horizon but coming to it from the nearest corner.

Does Wright v Chappell Suggest Wrongful Trading Is Going Right?

For some the recent case of Wright & Ors v Chappell & Ors [2024] EWHC 1417 might mean wrongful trading has turned the corner. 

In Wright v Chappell an order for compensation was made that two of the parties were to contribute £6.5 million each. However, the success of the liquidators does not camouflage the difficulties in bringing wrongful trading claims for run-of-the-mill cases. 

An absence of funding can be a fundamental stumbling block to merely starting such claims, never mind seeing them through to trial.

Yet even in this case, which was unusually large and high profile, the difficulties were evident with the potential likely quantum in dispute for wrongful trading at trial being £70.1 million. After allowing for some adjustments, although the winning liquidators did make it to the chequered flag, it was not until the judge had written more than 500 pages and confined the compensation under Section 214 of the Insolvency Act 1986 to £13 million.

The articles which subsequently sprouted included:

• Former BHS directors hit with multi-million pound ‘wrongful trading’ ruling
• Largest-ever award for wrongful trading
• 5 key takeaways from the landmark wrongful trading decision in Re BHS Group Limited

However, in the archives, pessimistic articles include:

• Wrongful trading claims: a central plank or dead in the water?
• Why Is Wrongful Trading A Minefield?
• No compensation for wrongful trading – where did it all go wrong?

No doubt Wright v Chappell was an achievement for the liquidators and their legal team. But the fact that it was deemed such an achievement may be said to highlight what is wrong with wrongful trading. A remedy in legislation perhaps should not be deemed A) by many to be difficult to deploy, B) done successfully (at trial) once in a blue moon and C) such a success when it is done. 

Even the level of compensation awarded perhaps tells its own story. Since its conception and inception almost 40 years ago this is the maximum award and achieved in one of the UK’s larger corporate insolvencies.

Is A Wrongful Trading Claim All That Hard?

It may be argued a claim for wrongful trading is not so hard to bring. 

In theory, it is perhaps an arguable point, particularly if you are looking to consider claims of wrongful trading without an order for compensation. But what on earth is the utility of those?

Once you consider the statutory defence listed in Section 214(3) of the Insolvency Act 1986, you might see why it is not an easy threshold to meet.

Even if it were to be shown that with the right training and approach, it is not so hard, perhaps nevertheless a notable feature in the context of insolvency litigation is its lack of popularity. Other claims such as misfeasance and antecedent transactions are undertaken with far greater alacrity. 

Wrongful Trading’s Terminology

Having a cursory glance through the 500 odd pages of Wright v Chappell and you might have second thoughts about how accessible a wrongful trading claim is to a liquidator. 

The principles behind the provision are simple enough until you consider the somewhat imprecise nature of terms the statute does not define:

… no reasonable prospect of avoiding insolvent liquidation…

… person took every step with a view to minimising the potential loss to the company’s creditors…

If you delve into the case law you will obtain some clues, particularly on what is every step for wrongful trading. However, each case is different and the relevant steps will be case-dependent. What constitutes a “step” is also a concept up for some potential discussion.

To flip matters on their head, the notion a director would seek to maximise the potential losses for creditors is a curious proposition; perhaps one that is sufficiently reckless as to merit consideration instead for fraudulent trading. Perhaps the default position might be that a savvy director will be able to show that they took steps to minimise potential losses.

Then of course there is the matter of “potential losses”. At the point a director is looking to wrestle the company away from the rocks, most if not all losses are likely to be potential losses. Many directors may continue to trade beyond the point of no return at some level in the real hope and intention that things might get better. It may not be too troublesome for a director to dismiss arguments alleging that the actions they took did not look to minimise potential losses when they have acted with the best of intentions. 

Looking at the “every step” part; on the face of it might appear a high hurdle for a director vault. However, the suggestion that many directors facing insolvency would take any steps without a view to minimising the losses might seem remarkable as well.

Conclusion

There seems to be little doubt that the absence of funding options for notoriously unpredictable claims like wrongful trading may hamper their use by Insolvency Practitioners seeking to deploy their skillset and maybe hoping for a pat on the back that an asset-creating liquidator may duly deserve. 

It is axiomatic that funding for litigation is a perennial problem for liquidators who seek to bring claims to swell the assets of insolvent companies and achieve better returns for creditors. Smaller wrongful trading claims are unlikely to be of much interest to litigation funders given the risks involved and the unpredictable nature of the returns. This appears at the heart of why wrongful trading went wrong. The need to fund insolvency investigations and investigations is not some trivial matter or even merely confined to wrongful trading. Other claims such as misfeasance could also be at risk. 

So the government could consider providing a funding solution to take into account the ironic position that a director can trade a company out of all its assets and this might even leave them less exposed to a wrongful trading claim. Because without finance a liquidator cannot bring a wrongful trading claim and creditors often (not unreasonably) will not run the risk of throwing good money after bad. Such a position represents the unsatisfactory potential for abuse. 

However, it seems that wrongful trading may warrant revision by providing statutory definitions as to what is meant by “every step”. The current position whereby a director who has failed in their basic duty to keep proper books and records and yet still could have taken every step, perhaps seems counter-intuitive. It might seem surprising this may not have hampered more directors in their defence of a wrongful trading allegation.

The late Gabriel Moss QC’s in his article “No compensation for wrongful trading – where did it all go wrong?“ said:

It is a disgrace to our jurisprudence that, on the basis of a series of first instance cases, a director can get away with wrongful trading as long as the net deficiency to creditors does not increase.

Is it not time to right the wrong?