Why Is Wrongful Trading A Minefield?

In this article we’ll consider why Wrongful Trading is a minefield and:

• Where it may have gone wrong
• Why it is the minefield
• How it is a minefield

Here we go.

Did Wrongful Trading Ever Stand A Chance?

The late Gabriel Moss QC in Insolvency Intelligence in 2017 in his article “No compensation for wrongful trading – where did it all go wrong?“ was fairly frank:

… the central idea remains the same: directors should be deterred from causing debtor companies to take on liabilities which they have no reasonable prospect of paying. If that occurs, then subject to the statutory criteria for liability, compensation should be available for creditors whose debts have been wrongfully incurred. … 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. He can take on millions of pounds worth of new creditors, who have no reasonable prospect of being paid, but as long as he pays off old creditors and maintains a balance in terms of the net deficit, he will escape liability for wrongful trading.

Why is Wrongful Trading a minefield?

The simple answer appears to be because of how the legislation is drafted.

Instead of creating certainty as with so much legislation, it fleshes out a provision to prescribe a remedy for a wrong. However, the legislative framework appears peppered with a series of subjective and qualified provisions cobbled together. Proving a case of Wrongful Trading is no simple feat. Some commentators and practitioners disagree and even may consider it a doddle.

However, most practitioners do not appear to relish racing off to the Insolvency courts with Wrongful Trading listed as the chief remedy sought.

There is a view held by some that the good cases never come close to seeing the door of the Court; the bad cases get consigned to the Wrongful Trading dustbin faster than Michael Schumacher or Aryton Senna in their heyday overtook competitors sliding around a wet circuit.

Certainly, either the facts can be found to fit evidentially within the Section 214 jurisdiction or they do not. If they cannot, perhaps better to find that incinerator with alacrity.

Wrongful Trading Overview

In many respects, Wrongful Trading is a provision that has features of the tort of negligence. It is not the same thing but looking at what is negligence can provide some insight.

Negligence requires a duty of care to exist that is breached. Wrongful trading is about the duty of a UK company Director who acts contrary to the requirements to look after the interests appropriately of creditors when trading whilst insolvent.

Negligence requires a loss. Wrongful trading requires a loss.

Negligence requires causation ie. the linkage of the act to the loss. Wrongful trading requires a wrongful act of trading in a certain way at a certain time in a company’s history that causes a loss.

Whilst it might be clear a company Director who trades beyond the point at which it was inevitable insolvent Liquidation would result, is likely to have questions to answer about Wrongful Trading; it still certainly does not mean an order from the Court for compensation will sprout.

Let’s have a look at what the legislation says in black and white.

Wrongful Trading In Section 214 Of The Insolvency Act 1986

Part 1: Compensation

Subject to subsection (3) below, if in the course of the winding up of a company it appears that subsection (2) of this section applies in relation to a person who is or has been a director of the company, the court, on the application of the liquidator, may declare that that person is to be liable to make such contribution (if any) to the company’s assets as the court thinks proper.

This starting point is that if Wrongful Trading (as defined in subsection 2 of Section 214 of the Insolvency Act 1986) arises then it is not the case the Court will order the Director to make a contribution; the Court may do so. It is not inevitable as the Court has a discretion.

Part 2: Wrongful Trading Defined

This subsection applies in relation to a person if—
(a) the company has gone into insolvent liquidation,
(b) at some time before the commencement of the winding up of the company, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation, and
(c) that person was a director of the company at that time;

The subjectivity of part 2 of the Wrongful Trading provision is highlighted in bold above. What a person “ought” to conclude is recognised in subsection 4 of Section 214 of the Insolvency Act 1986. This considers what a Director both ought to know based on their actual skillset and the skills they should as a reasonably competent Director be able to execute. The legislation requires adequate consideration of both this objective and subjective test to assess the knowledge of the relevant Director.

Part 3: The Wrongful Trading Every Step Defence

This subsection says:
The court shall not make a declaration under this section with respect to any person if it is satisfied that after the condition specified in subsection (2)(b) was first satisfied in relation to him that person took every step with a view to minimising the potential loss to the company’s creditors as on the assumption that he had knowledge of the matter mentioned in subsection (2)(b) he ought to have taken.

An awful lot of deployment of the word “satisfied”, is it not? The instruction to the Court is qualified. The Court appears to have free reign to determine what it takes to be “satisfied”.

Subjective Assessment Of The Wrongful Trading Provision

Given the Wrongful Trading provision is constructed with such elements of conceivable subjectivity it appears when the legislation was put in place, it was drafted to protect a company Director from in effect automatic liability resulting from insolvent trading culminating in an insolvent Liquidation. It was clearly not intended to shift company liabilities from the company to the Director personally.

However, the protection provided to company Directors means those charged with the responsibility for pursuing claims of Wrongful Trading ie. Liquidators may have to walk an uncertain tightrope to successfully prosecute a case. The subjectivity means a Liquidator pursuing such potential transgressions by company Directors will want to ensure that in their view they can comfortably persuade the Court.

However, no two people think the same about all matters. Even judges disagree, hence why an appeal system exists and people can be successful in overturning a lower Court’s decision.

Oliver Elliot Observation

Wrongful Trading is indeed a minefield. Whilst the ambiguity in assessing how the legislation under Section 214 of the Insolvency Act 1986 is going to be put into effect prevails, it cuts both ways.

Hard as it might be for a Liquidator to bring a Wrongful Trading action seeking compensation for the ultimate benefit of creditors, a company Director still typically has to grapple with the every step defence dilemma and the same subjectivity issues. So it is not all one-way traffic.