Wrongful Trading was introduced by The Insolvency Act of 1986 to build on the notion of fraudulent trading. It’s a much more common offense, as it’s not a criminal act and is often done unwittingly.
What is wrongful trading?
Wrongful trading or ‘trading irresponsibly’ is a civil offense and is covered by section 214 of the Insolvency Act 1986.
It occurs when company directors have continued to trade when:
- “They knew, or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation”
- They did not take “every step with a view to minimising the potential loss to the company’s creditors”
Directors must be found to have acted reasonably and responsibly in the time preceding the company’s insolvency to avoid wrongful trading proceedings. They must always have put creditors’ interests first, and not worked for their own benefit.
If directors are found guilty of wrongful trading, they can be held personally liable for the company’s debts from the point they knew the company was insolvent.
In some cases, they can also be disqualified from being a director, fined, or even imprisoned.
What constitutes wrongful trading?
The liquidator determines if wrongful trading has occurred. This occurs during their assessment of the director’s conduct and there is a six-year limitation period.
Examples they’ll look for:
- Not filing annual returns at Companies House
- Failing to file annual or audited accounts at Companies House
- Not operating the PAYE scheme correctly, failing to pay PAYE and NIC when due, and building up arrears
- Failing to operate the VAT scheme correctly and building up arrears
- Taking excessive salaries that the company cannot afford
- Repaying a director loan made to the company while other creditors were not paid
- Trading while insolvent
- Taking credit from suppliers when there was ‘no reasonable prospect’ of paying the creditor on time
- Wilfully piling up debt
- Taking deposits from customers when you know the product or service will not be delivered.
A company will be at risk of being accused of wrongful trading if it has engaged in any of the above.
To avoid this, it must always act in the creditors’ best interest. This even means prioritising their payments over personal and bank guarantees.
It’s important to note that wrongful trading can only apply in terminal insolvency, this means it can only apply when the business is no longer viable.
It will only begin after formal insolvency proceedings, such as liquidation or administration.
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About the author
Iain Bould is the head of our Commercial Litigation department.
Iain has over 28 years of experience in Commercial Debt Recovery having worked in both Private Practice and Industry and brings a pragmatic and commercial approach to recovering debts. With extensive experience working across all industry sectors, Iain has particular expertise in working with Insolvency Practitioners in advising and recovering outstanding insolvent company ledgers.
If you need any advice or further information please contact Iain at firstname.lastname@example.org