What is wrongful trading: Am I at risk?
Wrongful trading is often misunderstood, but something that all company directors whose company faces financial constraints should be mindful of. Dishonesty is not a pre-requisite for wrongful trading, so even a well-intentioned director can be caught out.
It is therefore important that if the directors are in any doubt they seek proper advice. While the reality is that wrongful trading claims are rare (due to the sheer forensic accounting work the liquidator/administrator needs to do to prove them), the risk is a sobering one that should not be ignored.
Only company directors, including shadow and de-facto directors, can be held liable for wrongful trading. This can happen if the company goes into insolvent liquidation or insolvent administration, they knew or ought to have concluded before the liquidation/administration commenced that there was no reasonable prospect of avoiding it, and 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.
If they are found liable for wrongful trading, a director will be personally accountable to contribute to the company’s assets to replace the loss to creditors, as this caused by them allowing the company to continue trading after the above point in time.
A director will not be liable if once they knew (or ought to have known) that there was no reasonable prospect of avoiding insolvency, they took every step to try and minimise the potential loss to creditors.
The Court has made it clear that ‘every step’ means every step. A director may lose the ability to run this defence where they allowed trading to continue and either one set of creditors were paid over others (as well as being a potential preference) and/or historic creditors were paid while new unpaid debts were incurred.
In practical terms, a director will only be liable for wrongful trading if, on a net basis, the company is worse off as a result of them allowing it to continue trading. If the Court finds there was wrongful trading, it will (as the case law currently stands) generally quantify the director’s liability as follows:
- By assessing the increase in the net asset deficiency for the period from when the directors first knew (or ought to have known) that there was no reasonable prospect of avoiding insolvency, up until it went into insolvent liquidation/administration
- By establishing whether, over that period, there has been an increase in the net deficiency. The maximum quantum will be the amount of that increase (if there has been no increase then there will be no liability)
For the purposes of wrongful trading, the balance sheet test of insolvency is applied. This means that a company goes into insolvent liquidation/insolvency administration if, when it goes into liquidation/administration, its assets are not sufficient to pay off its debts, other liabilities and expenses of the liquidation/administration.
For more information, get in touch with Frank Bouette or give us a call on 0345 070 6000.