What is wrongful trading? All the information you need

director wrongful tradingWrongful trading happens when a company’s directors persist in trading operations despite knowing or having reason to believe that the company was unlikely to escape financial ruin or insolvency.

Typically, a director is bound to act in the best interests of the company and its shareholders. Nevertheless, in cases of insolvency, a director’s primary duty shifts to safeguarding the interests of the company’s creditors.

When a director suspects that the company is or may become insolvent, whether based on financial statements or cash flow, they are required to do everything within their power to minimize losses for the creditors.

This paramount obligation to creditors is derived from both a legal duty and indirectly from the Insolvency Act of 1986.

If a director allows the company to accumulate further debts while being aware, or reasonably should have been aware, of the company’s insolvency without taking the necessary steps to mitigate creditor losses, they may become personally liable for the financial damages suffered by the company’s creditors starting from the moment they realized or should have realized the insolvency situation.

The court will not demand a director to contribute to the company’s assets if, after they initially recognised or should have recognised that insolvency was inevitable, they diligently pursued all measures to minimise potential losses for the company’s creditors, as they ought to have done.

What does wrongful trading mean for directors?

Wrongful trading carries significant implications for directors, particularly regarding the penalties they may face. This term signifies a scenario where a company’s directors, in the presence of insolvency or an imminent financial collapse, persist in business operations without taking appropriate measures to protect creditors’ interests.

Directors usually bear a fiduciary duty to act in the company’s and shareholders’ best interests, but once a company becomes insolvent, their primary responsibility shifts to safeguarding creditors’ rights. Wrongful trading places directors at risk of personal liability for the losses suffered by the company’s creditors, commencing from the moment they should have reasonably recognized the insolvency situation and failed to act prudently to mitigate creditor losses.

This concept underscores the critical need for directors to be acutely aware of the legal consequences of their actions in managing a company’s financial health during turbulent times.

The key points to consider

  • Shift in Director’s Duty: When a company faces insolvency, a director’s primary duty shifts from advancing the company’s success to safeguarding the interests of creditors.
  • Cessation Not Always Optimal: While this shift might make directors contemplate an immediate halt to company operations, it’s important to note that ceasing business isn’t always in the best interests of creditors.
  • Continuing Business Operations: Companies may find it appropriate to keep trading, especially when dealing with cash flow issues or if there’s a reasonable expectation of securing additional funding in the near future.
  • Directorial Decision Accountability: Even if the directors’ decision to continue trading ultimately proves to be incorrect, resulting in the company’s inability to overcome financial difficulties or secure additional funding, it does not automatically result in criticism of the directors’ actions or personal liability.
  • Reasonable and Prudent Decision-Making: It’s crucial for directors to demonstrate that their decision-making, at the time, was reasonable, prudent, and justifiable. To do this, they must stay well-informed about the company’s situation, seek professional advice, regularly monitor developments, and hold frequent meetings for discussion and evaluation.
  • Thorough Documentation: Directors should meticulously document their decisions, offering vital evidence if questions arise. This proactive approach increases the likelihood that a director’s actions will be seen as reasonable and in line with the expectations of a reasonable person in their position.
  • Objective Evaluation: Directors are evaluated not only based on their individual knowledge, skills, and experience but also against an objective benchmark, reflecting what would be expected from a reasonable person in a similar directorial role.
  • Adequate Financial Information: It’s important to note that a lack of accurate financial information is not an excuse. Directors should ensure they have the necessary financial information and implement reasonable financial controls.
  • Court’s Discretion: In the event of a successful legal action against a director for wrongful trading, the amount they may be ordered to pay as a contribution, following a finding of wrongful trading, is entirely at the discretion of the court.

How can we help?

At Business Insolvency Helpline, our dedicated team comprises seasoned and licensed Insolvency Practitioners 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.

Insolvency & Restructuring Expert at Business Insolvency Helpline | + posts

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.

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