Directors concerned about insolvency should understand wrongful trading, fraudulent trading and their consequences. Such trading can have severe consequences for your business, your reputation and even your personal life.
The Insolvency Act of 1986 introduced wrongful trading to build on the notion of fraudulent trading. It’s a much more common offence, as it’s not a criminal act and often done unwittingly.
A more technical explanation can be found in Section 214 of the Insolvency Act 1986
It is important to understand if your company enters insolvency.
What is Wrongful Trading?
Wrongful trading 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. In addition, they did not take every step with a view to minimising the potential loss to the company’s creditors.
Wrongful trading or ‘trading irresponsibly’ is a civil offence and is covered by section 214 of the Insolvency Act 1986
Essentially, 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.
What actions constitute wrongful trading?
The liquidator, who must be an insolvency practitioner, determines if wrongful trading has occurred. This occurs during their mandatory assessment of the director’s conduct. There is a six-year limitation period, so you will not be charged after this time has passed.
Examples of behaviour or actions 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.
- Not paying money into the company’s pension fund
You will be at risk of being accused of wrongful trading if you have engaged in any of the above.
How can you avoid been accused of wrongful trading?
Apart from obviously not doing what is in the above list it is wise to “show your workings” when making decisions that could be construed as wrongful trading.
Directors must demonstrate that their decisions were reasonable, sensible, and justifiable. Thus, they should stay informed, seek competent advice, monitor the situation, and meet regularly to discuss and review. Any decision to pay a creditor ahead of someone else should be documented. It may well be that a particular creditor is “de facto secured” in that if they were not paid then the whole company would fail. An example of this might be paying a web hosting company that is threatening to shut down your mission critical website.
What are the penalties for wrongful trading?
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.
It’s important to note that wrongful trading can only apply in terminal insolvency.
Put simply, 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.
However, if there is no insolvency event and you still partake in suspicious behaviour, be very careful. Keep records of all actions concerning these points, as well as of board and shareholder meetings. This may protect you in the future.
How we can help if you are concerned
We can advise you on your options as a way to reduce the risk of being accused of wrongful trading.
Options include
There are many options available, all of which could help demonstrate you acted reasonably and appropriately for the situation. It’s best to try these, as you cannot be charged with wrongful trading until your business has ceased to trade (usually through voluntary or compulsory liquidation).