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What is Wrongful trading?

Vince Green, Head of Recovery Solutions
22/12/2021
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Wrongful trading occurs when a company’s directors have continued to trade when they knew, or should have concluded, that there was no reasonable prospect that the company would avoid insolvent liquidation or insolvent administration.

Ordinarily, a director is under a duty to act in the best interests of a company and its shareholders. However, when a company becomes insolvent, a director must act primarily in the interests of a company’s creditors.

If a director considers that a company may be or become insolvent, either on a balance sheet or cash flow basis, they are obliged to take all necessary steps to minimise losses to creditors. This overriding duty to creditors arises both from a common law duty and indirectly from the Insolvency Act 1986.

If a director allows a company to continue to incur liabilities, they may incur personal liability for the losses sustained by a company’s creditors from the point the directors knew, or should have known, that the company was insolvent and that they did not take the necessary steps to minimise creditor losses.

The court will not require a director to contribute to the assets if (after the time when they first concluded, or ought to have done, that insolvency would not be avoided) they took every step intending to minimise the potential loss to the company's creditors, as ought to have been taken.

The key points to consider

  • Upon insolvency, a director’s primary obligation shifts from promoting the success of a company to acting in the best interests of creditors. This has significant implications and may well cause directors to consider that the company should cease trading immediately. However, the cessation of a company’s business is not always in the best interests of its creditors.
  • A company may consider it appropriate to continue trading, possibly to trade through its difficulties (if it is a cash flow problem) or where it is likely that further funding will be obtained in the not too distant future. The fact that the directors’ decision turns out to be wrong, in that the company is unsuccessful in trading through its difficulties or further funding is not obtained, does not necessarily lead to criticism of a director’s actions and personal liability.
  • It is important, that the directors show that, at the time, their decision making was reasonable, prudent and justifiable. They should therefore keep themselves fully informed of the situation, take professional advice, regularly monitor the situation and meet regularly to discuss and evaluate. In doing so, they must clearly and carefully minute their decisions to provide evidence as a backup if questions arise. In such cases, it is more likely to be considered that a director has acted reasonably and has taken a course of action that a reasonable director in their position would have taken.
  • A director is judged not only according to their own knowledge, skill and experience but also by an objective test, namely what would be expected from a reasonable person carrying on the same functions as a director. However, it is important that poor information for a director is no excuse. A director should obtain the necessary degree of financial information and introduce reasonable financial controls.
  • If an action taken against a director for wrongful trading is successful, then the amount that may be ordered to pay by way of the contribution on a finding of wrongful trading is left entirely to the Court’s discretion.

How Crowe can help

At Crowe, we have a team of experienced and licensed Insolvency Practitioners who can advise you on the best course of action, depending on your business’s circumstances. Please get in touch with either Vince Green or Steven Edwards who are licensed Insolvency Practitioners, or your usual Crowe contact.

Contact us

Vince Green
Vince Green
Head of Recovery Solutions
Kent