Wrongful trading occurs when a company’s directors persist in trading despite knowing, or reasonably concluding, that the company faced no viable prospect of avoiding insolvent liquidation or administration.
Normally, directors are bound to act in the best interests of the company and shareholders. However, in insolvency, the duty shifts to prioritising the interests of the company’s creditors.
If a director anticipates or observes signs of insolvency, whether on the balance sheet or cash flow basis, they must take essential measures to minimise creditor losses. This obligation arises from both common law and indirectly from the Insolvency Act 1986.
Directors may be personally liable for losses incurred by creditors if they permit the company to accumulate liabilities after knowing or should have known about insolvency, without taking necessary steps to minimise losses.
The court won’t demand a director’s contribution to assets if, after realising or should have realised insolvency was unavoidable, they diligently took every step to minimise potential losses to the company’s creditors.
The key points to consider
- Upon insolvency, a director’s primary duty shifts from promoting the company’s success to acting in the best interests of creditors. This shift has significant implications and may lead directors to consider the immediate cessation of trading. However, discontinuing a company’s business might not always be in the creditors’ best interests.
- A company may find it appropriate to persist in trading, perhaps to navigate through financial challenges (in the case of a cash flow problem) or when securing additional funding seems likely in the near future. If the outcome proves unfavorable—such as unsuccessful trading or the failure to secure additional funding—it doesn’t necessarily result in criticism or personal liability for the directors.
- Crucially, directors must demonstrate that, at the time of decision-making, their actions were reasonable, prudent, and justifiable. Staying fully informed, seeking professional advice, monitoring the situation regularly, and holding frequent discussions for evaluation are imperative. Precise and comprehensive minutes of decisions must be maintained as evidence in case questions arise. In such instances, it is more likely that a director will be considered to have acted reasonably, aligning with the expectations of a reasonable person in their position.
- A director’s judgment is evaluated not only based on their knowledge, skill, and experience but also against an objective standard—what would be expected from a reasonable person in the same directorial role. However, insufficient information is not an excuse, and directors must ensure they acquire the necessary financial information and implement reasonable financial controls.
- In the event of a successful wrongful trading action against a director, the court has full discretion in determining the amount to be ordered for contribution.
How can we help?
At Business Insolvency Helpline, our dedicated team of licensed Insolvency Practitioners are ready to provide tailored guidance in alignment with your unique business situation. Don’t hesitate to reach out to either Steve Jones, or one of our licensed Insolvency Practitioners, your business’s well-being is our priority. Contact us on 01246 912052 today or complete an online enquiry form.
With over three decades of experience in the business and turnaround sector, Steve Jones is one of the founders of Business Insolvency Helpline. With specialist knowledge of Insolvency, Liquidations, Administration, Pre-packs, CVA, MVL, Restructuring Advice and Company investment.