What is Wrongful Trading by a Director?
What is Wrongful Trading? Wrongful Trading is trading whilst insolvent without having reasonable prospect of avoiding insolvent liquidation. However, a Director is not necessarily liable for such loss caused if he or she took every step to minimise the loss.
Two things need to happen therefore for a Director to be liable to creditors upon a company going into insolvent liquidation in such circumstances: 1) there needs to be a loss to creditors after the date at which the wrongful trading commenced and 2) the loss suffered by creditors was not minimised.
In most cases the company in question is already insolvent at the point when the foreseability of insolvency is deemed inevitable but it need not be.
A company that is not insolvent can still inevitably go into liquidation. An example would be a change of market conditions that leads to a company having no future.
With that in mind it is not inconceivable that a solvent company could be the focus subsequently of a wrongful trading claim by a liquidator but it would be the exception rather than the rule.
Wrongful Trading or Insolvent Trading: Which is the Unlawful Act?
The short answer is Wrongful Trading is the unlawful act as set out in Section 214 of the Insolvency Act 1986. Insolvent Trading or trading whilst insolvent would be part of the evidence of an act of Wrongful Trading, however it is not necessarily an unlawful act. It depends upon the facts of the case.
So what is the difference between the two? There is no statutory recognition afforded to Insolvent Trading. Whilst undesirable in many instances it is not necessarily unlawful.
Wrongful Trading is an action that can only be undertaken by a person occupying the position of Director of a limited company.
That position of “Director” can be determined in a number of ways, being official (recognised at Companies House and in a company’s statutory register), de facto or shadow as set out in the Companies Act.
Wrongful trading is the act by Directors of a period of trading in which debts and liabilities are incurred and typically increase, whilst having no reasonable prospect of a company avoiding insolvent liquidation.
It is the action by Directors of accepting credit when it is highly unlikely that the same would be discharged due to the financial position of a company.
Wrongful Trading only applies to company Directors, whereas Insolvent Trading can be undertaken by individuals such as sole traders.
The Solvency Test
There are two tests for solvency defined in Section 123 of the Insolvency Act 1986, being 1) are your assets exceeded by your liabilities and 2) are you failing to discharge your debts as and when they fall due. If you satisfy either criteria then you are technically insolvent in accordance with the definition of the same in the legislation.
Are you insolvent? Check out the Oliver Elliot Solvency Calculator to find out.
What is Wrongful Trading Risk?
What is the risk? Well if you are accused by a liquidator of a company of Wrongful Trading then as Director you could be personally liable for the damage the company suffered during a period of Wrongful Trading – so do not do it!! If in any doubt take professional advice at the earliest possible opportunity.
Often such advice can be obtained without charge for an initial consultation with a Licensed Insolvency Practitioner.
What is Wrongful Trading Covid-19 Suspension?
…temporarily suspending wrongful trading provisions retrospectively from 1 March 2020 for three months for company directors so they can keep their businesses going without the threat of personal liability
Today’s measures will also reduce the burden on business, giving bosses much-needed breathing space to keep their workers employed and their companies going.
What is Wrong with Wrongful Trading?
The duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company.
Section 172(3) of the Companies Act 2006
… 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
The Wrongful Trading Trade-Off