A common concern for Directors approaching insolvency is whether they may be held personally liable for company debts under the Wrongful Trading provisions of Section 214 of the 1986 Insolvency Act. Here, we examine this law and its potential effects.
What does the law on Wrongful Trading actually say?
Wrongful Trading occurs when a company’s Directors continue to trade when they know or should have concluded that there is no reasonable prospect that the company will avoid insolvent liquidation or insolvent administration and where creditors have suffered increased losses as a result. These are civil rather than criminal proceedings.
The background to the law
Under normal circumstances, a Director is under a duty to act in the best interests of the Company and its shareholders. However, when the Company becomes insolvent, this duty changes so that the Director must thereafter act primarily in the interests of the Company’s creditors.
Once the Director concludes that a company may be or will become insolvent, either on a balance sheet or cash flow basis, they are obliged to take all necessary steps to minimise losses to creditors. This overriding duty to creditors arises both under a common law duty and also indirectly from the 1986 Insolvency Act.
By what standards is a Director’s conduct judged?
Directors are obviously not all equal in terms of their knowledge, experience and skills. Nevertheless, in the context of Wrongful Trading allegations, a director should expect to be judged not only according to their own background, but also by an objective test: what would be expected from a reasonable person carrying on the same functions as a Director?
In addition, Directors with certain professional qualifications and backgrounds, such as accountants and commercial lawyers, are likely to be held to the highest standards.
Directors should also be aware that pleading that they lacked sufficient information is not a viable excuse. No matter the business, a Director should obtain the necessary degree of financial data, ensure that reasonable financial controls are introduced, and demonstrate that they made appropriate efforts to do so.
How much could a Director be asked to contribute?
If an action taken against a Director for Wrongful Trading is successful, the amount that may be ordered to pay by way of the contribution to the insolvent estate is entirely at the Court’s discretion, but it will be calculated by reference to the additional losses suffered by the creditors after the Company was allowed to continue trading after it should not have.
The penalty will be to make good some or all of these additional losses. Sometimes, the Court will decide that some of the responsibility for these losses is attributable to factors beyond the Director’s control and apply a discount, but potentially the personal liability could be all of the additional losses.
Who counts as a Director?
It is not just those persons shown as Directors at Companies House who are held accountable by Section 214. The legislation also provides for action to be taken against de facto Directors, who have acted as Directors without formally being appointed, and ‘shadow’ Directors, who are defined as persons on whose instructions Directors and other senior staff are accustomed to act.
Is continuing to trade and incurring further losses always Wrongful Trading?
A Company and its Directors could believe it is appropriate to continue trading, possibly to trade through its difficulties (if for example it is a temporary cash flow problem) or where it is likely that sufficient additional funding can be obtained in the not too distant future. The fact that the Directors’ decision turns out to be wrong and that the Company is unsuccessful in avoiding insolvency, does not necessarily lead to criticism of a Director’s actions and personal liability for Wrongful Trading.
What steps can a Director take to avoid Wrongful Trading?
It is vital that a Director can show that, at the time, their decision-making was reasonable, prudent and justifiable. To do this they should:
- keep themselves up-to-date and fully informed about the Company’s situation;
- take independent advice from an insolvency professional;
- regularly monitor the situation;
- meet regularly to discuss and evaluate the situation;
- clearly and carefully minute their decisions to provide evidence as a backup if questions arise; and
- keep available any supporting documentation which influenced their decisions.
Having followed this course of action, it is much more likely that a Director will be considered to have acted reasonably.
Take advice early
Taking independent expert advice as early as possible is a key defence against the risk of Wrongful Trading. Seeking this advice is not just about the Director’s personal interests; it also offers the best prospect of a positive resolution of financial issues. The earlier this takes place, the more options that will be available.
How we can help
We have extensive experience assisting business owners and directors, and we will always work with you to find the best solution for you and your business.
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 020 3326 6454 and we will arrange for a call with one of our Partners.