Is Wrongful Trading The Same As Insolvent Trading?
Wrongful trading is not the same as insolvent trading. Wrongful trading is when directors allow a company to continue trading when they knew, or ought to have known, that there was no reasonable prospect of avoiding insolvent liquidation, making the position to be suffered by creditors worse. Insolvent trading is trading whilst insolvent but without the near certainty of liquidation resulting.
Wrongful Trading – Section 214 of the Insolvency Act
Under Section 214 of the Insolvency Act 1986, wrongful trading is a civil offence. It provides for a claim to compensation that can be pursued by a liquidator against directors personally for losses to creditors if they failed to minimise those losses once it became clear the company couldn’t avoid liquidation. Directors are judged by what they knew or should have known at the time.
Once insolvency looms, directors must take a hard look at the financial situation and consider whether it’s in creditors’ best interests to continue. If the business has no real hope of survival, continuing to take on new liabilities or trading as if all is well can amount to wrongful trading.
Is Wrongful Trading Just Like Insolvent Trading?
No, wrongful trading is not just like insolvent trading. Insolvent trading unlike wrongful trading is not unlawful.
Insolvent trading does not make liquidation inevitable because a director may make changes to the business after insolvency has been triggered with a view to returning to profit and ceased trading activities that were leading to losses.
If directors take all reasonable steps to reduce losses to creditors, such as seeking professional advice, cutting costs, or attempting to restructure debt, they may avoid personal liability. In fact, courts often give directors credit for genuine efforts to turn things around or minimise damage.
Keep Detailed Records of Key Decisions Taken
It is important for a director who is trading a company whilst insolvent to document their considerations when taking important decisions that affect the company’s trading activities, so they can later justify what they have done.
The consequences of wrongful trading can be serious. If a liquidator proves that wrongful trading occurred, the court can order the directors to contribute personally to the assets of the company.
To avoid or potentially defend allegations of wrongful trading, directors should keep detailed records, regularly assess solvency, and seek advice as soon as trouble arises. Being proactive and transparent is key. Turning a blind eye or sticking your head in the sand will not assist.
In conclusion, wrongful trading is about failing to act when a company is clearly beyond rescue. Directors don’t need to be perfect, but they do need to be responsible. By understanding their duties and acting early, directors can avoid personal liability and navigate difficult times more safely.
