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 avoiding insolvency and that they did not take steps with a view to minimising the potential loss to the company’s creditors. The Directors are subject to a subjective and objective test to assess culpability.
Once a company enters Administration or Liquidation, the appointed Administrator or Liquidator is required by law 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.
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.
If it can be demonstrated that the Directors put the interests of creditors first and not for their own, the claim may be defeated.
What Are Examples of Wrongful Trading?
There are numerous examples of behaviour that an Administrator or liquidator will look for when seeking to establish Wrongful Trading. These 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.
How are the Objective and Subject Test Applied?
The first part of the test is objective. This looks to what a competent 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.
What is the Defences to a Wrongful Trading claim and How Can They be Demonstrated?
The defence to a Wrongful Trading claim is that Director’s took every step to minimise the potential loss to creditors. The burden of proof lies with the defence. This would include making an injection of capital from personal funds, making attempts to raise finance and negotiating to sell the business.
How Can the Defence to a Wrongful Trading Claim be Demonstrated?
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.
What is the Difference between Wrongful Trading and Fraudulent Trading?
Fraudulent Trading has broadly the same requirements as a Wrongful Trading claim. However, there is a higher burden of proof in that in 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.
Has There Been a Suspension of Liability for Wrongful Trading?
Yes. The government has passed emergency legislation to protect Directors who have been subject to unforeseen circumstances arising from the pandemic. This provides that a Director is not responsible for the worsening of a company’s financial position or its creditors in the event that this occurred during the period 1 March 2020 to 30 June 2021. This may, of course be subject to change.
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