Knowing the nuances of insolvency law is vital for Company Directors, not only for legal compliance but also for upholding professional integrity and safeguarding personal and corporate reputations. Fraudulent trading and wrongful trading are two issues that come up again and again in this context. The two may sound much the same, but they are distinct legal concepts with different thresholds for liability, defences and consequences for Directors.
The consequences of getting behind with HMRC payments
VAT and PAYE are taxes collected by a business on behalf of HMRC. It’s not the Company’s money and HMRC rightly expects the amounts owing to be paid on time when they are due. With regular PAYE and VAT payment deadlines, it’s simple for HMRC to track when a Company misses a monthly or quarterly payment and it takes the collection of overdue amounts extremely seriously.
It takes the late or non-payment of VAT and PAYE very seriously. From the beginning of April 2025, daily interest of 4% plus the Bank of England base rate is payable on an overdue tax debt from the date it was due until it’s paid in full. There may be penalties on top of this.
In contrast to other creditors, HMRC can also take action against a delinquent Company without having to go to Court first to prove the validity of the debt. So, speed of action is essential.
What is fraudulent trading?
This offence occurs under Section 213 of the Insolvency Act 1986. The intention is to penalise those who deliberately set out to defraud creditors.
Standard of proof
The legal standard of proof is high. There must be evidence of actual dishonesty or intent to deceive. This is a criminal as well as a civil offence and actions can be brought not just against Directors, but against anyone who was knowingly party to the fraudulent conduct.
Consequences
There are a number of unpleasant consequences for those found guilty. They may be ordered to contribute to the Company’s assets for the benefit of creditors. Criminal prosecution can also result in fines or imprisonment, as well as disqualification from acting as a Director for up to fifteen years.
Examples
- Directors continuing to incur credit when they know their Company is unable to pay existing debts and have no realistic plan to settle the Company’s liabilities, with the intention of deceiving creditors.
- Producing and submitting false financial statements or records deliberately to mislead stakeholders.
- Setting up “phoenix companies” to avoid debts or to facilitate the transferring of assets out of the failing business prior to insolvency for personal benefit or to prevent creditors from recovering their debts.
Proving fraudulent trading
- Direct evidence of dishonesty is required; negligence or poor business judgment, without intent to deceive, isn’t enough.
- Both company officers and third parties (not limited to Directors) can be found liable if they were “knowingly party” to the conduct. The recent Bilta UK decision confirms this.
- The burden of proof is higher than for wrongful trading. The Courts demand a clear demonstration of fraudulent intent.
What is wrongful trading?
This offence is set out in Section 214 of the Insolvency Act 1986. It’s a purely civil action aimed at Directors who allow a Company to continue trading when they knew, or ought to have known, that there was no reasonable prospect of avoiding insolvent liquidation and who fail to take every step possible to minimise potential loss to creditors.
Standard of proof
This is based on the “reasonable person” test: what a reasonably diligent person, having the general knowledge, skill, and experience that may reasonably be expected of someone carrying out the same functions, would have concluded and done in the same circumstances.
Consequences
If found liable, Directors can be ordered by the Court to make a personal contribution to the Company’s assets and are at risk of disqualification. However, wrongful trading is not a criminal offence; it’s a purely civil liability.
Examples
- Directors continuing to accept new orders or incur debts when insolvency is imminent, hoping the situation will improve, despite no realistic basis for such optimism.
- Failing to properly monitor the Company’s financial position and to seek professional advice at the first sign of significant trouble.
- Not taking steps such as reducing expenses, ceasing trading, or entering into negotiations with creditors when it becomes clear that the Company cannot pay its debts as they are demanded.
Proving wrongful trading
- There is no need to prove dishonesty or intent to defraud, only that the Director’s actions fell below the standard of care required by the Insolvency Act.
- Wrongful trading claims can only be brought against Directors, including de facto and ‘shadow directors’
- The Court will consider all the circumstances, including whether the Director took “every step” to minimise creditor losses, as required by Section 214.
Key differences between fraudulent and wrongful trading
Both offences relate to the conduct of business prior to insolvency, but there are several important differences.
Intent
- Fraudulent trading requires actual dishonesty and intent to defraud.
- Wrongful trading is based on negligence or failure to act diligently, regardless of intent.
Scope of liability
- Fraudulent trading can apply to any person involved in the fraud (including non-Directors).
- Wrongful trading applies only to Directors.
Standard of proof
- The threshold for proving fraudulent trading is considerably higher, due to its criminal element.
- Wrongful trading is a civil matter and is judged on the balance of probabilities.
Consequences
- Fraudulent trading can lead to both civil and criminal penalties, including imprisonment.
- Wrongful trading results only in civil liability.
Purpose
- Fraudulent trading is about punishing intentional wrongdoing.
- Wrongful Trading is about holding Directors accountable for failing to take action to protect creditors once insolvency is unavoidable.
Directors’ duties and responsibilities
Directors must be vigilant, especially when their Company shows signs of significant financial distress. The difference between fraud and a simple error in judgment can hinge on record-keeping, timely advice and transparency. Requirements include:
Maintaining proper books and records
Detailed, up-to-date financial records evidence Directors’ efforts to act responsibly. They also support informed decision-making.
Monitoring financials
Regularly review trading and financial health. Watch for warning signs such as mounting debt, declining revenues and persistent cash flow issues.
Seeking professional advice early
Engaging with the right professionals for advice as soon as you have concerns can make the difference between demonstrating due diligence and falling foul of the law.
Acting decisively
If insolvency appears unavoidable, Directors must consider taking steps to protect creditors’ interests, such as entering Administration or proposing a Company Voluntary Arrangement (CVA).
Transparency
Keep shareholders, creditors and other stakeholders informed. Transparency may help mitigate losses and demonstrate good faith.
While both fraudulent and wrongful trading can have severe consequences for individuals involved in a Company nearing insolvency, understanding the difference is crucial for Directors.
Directors must act prudently, seek advice early and document their decision-making. By promoting a culture of vigilance and responsibility, they can reduce the risk of liability.
At Opus, we have extensive experience assisting business owners and directors with concerns and challenges, and we will always work with you to find the best solution for you and your business. If you would like to speak to Opus, one of our Partners would be more than happy to have a non-obligatory, confidential chat with you. We can be contacted at rescue@opusllp.com or call us on 0203 995 6380 and we will arrange for a call with one of our specialists.