Wrongful Trading: A Comprehensive Guide For UK Directors
Wrongful Trading: A Comprehensive Guide For UK Directors
Under UK law, directors are required to act in the best interests of the company and its creditors, especially during periods of financial distress.
Wrongful trading occurs when directors continue to operate the company despite knowing there is no realistic chance of avoiding insolvency, thereby breaching their legal duties.
In this helpful guide, we explore the key aspects of wrongful trading, including its definition, legal framework under the Insolvency Act 1986, the distinction between wrongful and fraudulent trading, and the potential consequences for directors.
What is wrongful trading?
Wrongful trading happens when directors continue to run a company despite knowing it can’t avoid insolvency.
If found guilty of wrongful trading, directors can be held personally liable for the company’s debts.
This legal safeguard protects creditors from further losses by stopping directors from piling on more debt or prolonging operations when insolvency is inevitable.
Example of wrongful trading
A company is struggling financially, and the directors know it can’t pay its debts or recover. Despite this, they continue to take on new debts, hoping for improvement. When the company eventually goes into liquidation, creditors are left out of pocket, and the directors’ decision to keep trading has only made their financial situation worse.
Wrongful trading and the Insolvency Act 1986
Wrongful trading is governed by the Insolvency Act 1986. Section 214 is the cornerstone of wrongful trading law in the UK, providing the framework for liquidators to pursue claims against directors who have failed in their duties.
Under the Act, directors must take every reasonable step to minimise potential losses to creditors once they realise insolvency is unavoidable.
To make a successful claim under s214, the claimant must be able to prove that:
- The company director(s) knew, or should have reasonably known, that the company could not avoid liquidation
- Despite this knowledge, the director(s) continued to trade, which led to further financial losses for creditors
- The director(s) failed to take ‘reasonable steps’ to minimise creditor losses.
Who can make a wrongful trading claim?
A wrongful trading claim is typically made by a liquidator or administrator of an insolvent company to recover money for the company’s creditors.
If the claim is successful, individual creditors may indirectly benefit as the recovered funds are added to the total amount available to be distributed among them.
However, unsecured creditors rank lower than secured creditors in the insolvency process and often receive nothing when the final funds are distributed.
The Small Business Enterprise and Employment Act 2015, gave creditors the right to bring claims against directors for wrongful trading. By teaming up with other unsecured creditors and pursuing a collective claim, these unsecured creditors may improve their chances of recovering some money.
Consequences of wrongful trading
Directors who fail to act appropriately when a company is insolvent risk significant personal liability.
For example, in a landmark legal judgement in June 2024, a judge granted the largest-ever award for wrongful trading in the UK. The claim, against two former directors of collapsed retailer BHS, was made by the company’s liquidators. This was a significant win for the liquidators and serves as a cautionary tale for directors.
Potential consequences of wrongful trading for directors
Being found guilty of wrongful trading can have significant and far-reaching consequences for directors, impacting their financial standing and future opportunities.
- Financial liability: Directors can be held personally liable for the debts incurred during the period of wrongful trading. The court may order directors to contribute to the company’s assets to compensate creditors, which can result in substantial personal financial loss.
- Disqualification as a director: Directors may face disqualification from holding a directorship in any company for up to 15 years.
- Reputational damage: Being found guilty of wrongful trading can significantly damage a director’s professional reputation. It can make it difficult for them to secure future roles in corporate management or other business ventures, as they may be viewed as untrustworthy or incompetent.
- Personal and professional stress: Facing a wrongful trading claim, with its potential for severe financial and professional consequences, can be highly stressful and affect a director’s personal life and wellbeing.
- Legal costs: Defending against a wrongful trading claim can be costly, involving significant legal fees and expenses.
- Potential criminal investigation: While wrongful trading is not a criminal offence, it can lead to scrutiny that uncovers other illegal activities, such as fraud. If such activities are found, directors could face criminal charges in addition to civil penalties.
- Reduced confidence in the company: Discovering that wrongful trading has occurred can lead to a loss of trust and confidence in the company and its management. This could affect creditors’ willingness to extend credit to other companies managed by the same directors.
Potential consequences of wrongful trading for creditors
Wrongful trading also has significant implications for creditors, often leaving them in a precarious financial position.
- Cashflow problems: The inability to collect timely payments can disrupt the creditor’s operations, making it harder for them to meet their financial obligations, such as paying suppliers and employees or servicing debt. As the company continues to accrue debts it cannot pay, creditors may find themselves further out of pocket and left struggling with their own cash flow issues.
- Delays in payment: Even if a wrongful trading claim is pursued, the process can be lengthy. Creditors may experience delays in receiving payment while the claim is being resolved, which can further strain their own financial situation.
- Legal costs: While creditors can benefit from a wrongful trading claim, they may also face legal costs and complexities. These costs can eat into any eventual recovery, reducing the net benefit.
- Risk of insolvency: For some creditors, especially smaller businesses, the financial strain caused by delayed payments or bad debt due to wrongful trading could push them towards insolvency. If the creditor is heavily reliant on the payments from the insolvent company, the impact of non-payment can be severe, potentially leading to the creditor’s own financial collapse.
Is wrongful trading a criminal offence?
Wrongful trading is not a criminal offence. Instead, it is a civil matter.
So, while it is a serious breach of a director’s duties, it does not involve criminal prosecution, and directors will not face criminal charges or imprisonment.
The lack of criminal penalties does not diminish the seriousness of wrongful trading, as the financial repercussions can be significant. Wrongful trading can also lead to disqualification from serving as a director in the future.
The difference between wrongful and fraudulent trading
While wrongful and fraudulent trading involve the improper conduct of a company’s directors, they are distinct actions with different legal implications.
Intent | Burden of proof | Consequences | |
Wrongful trading | Wrongful trading does not require proof of intent to defraud. It focuses on whether the directors continued to trade, knowing that insolvency was inevitable. | The liquidator must show that the directors knew, or should have known, the company was insolvent, and that they failed to take reasonable steps to minimise creditor losses. | Directors may be held personally liable for losses and may face disqualification, but are not subject to criminal prosecution. |
Fraudulent trading | Fraudulent trading involves the intent to defraud creditors. It occurs when directors knowingly carry out business with the intention of deceiving creditors or obtaining financial gain through dishonest means. | The standard of proof for fraudulent trading is higher because it requires demonstrating that the directors acted with fraudulent intent. | Fraudulent trading can lead to both civil and criminal penalties. Directors may face personal liability for losses, criminal charges, and imprisonment. |
Directors' duties and wrongful trading
Directors have a range of duties under UK law, which become particularly important when a company faces financial difficulties. Understanding these duties is crucial for avoiding wrongful trading claims.
General director duties
- Duty to act in the company’s best interests: Directors must prioritise the company’s interests, which includes its shareholders and creditors, especially in times of financial distress.
- Duty to exercise reasonable care, skill, and diligence: Directors are expected to make informed decisions and take appropriate steps to protect the company’s financial health.
- Duty to avoid conflicts of interest: Directors must avoid situations where their personal interests conflict with the company’s.
- Duty to consider the interests of creditors: When insolvency is imminent, directors’ duties shift towards protecting the interests of creditors rather than shareholders.
Duties specific to avoiding wrongful trading
When a company is approaching insolvency, directors have specific responsibilities to avoid wrongful trading claims, including:
- Monitoring the company’s financial position: Directors must closely monitor the company’s financial health and take immediate action if there are signs of insolvency.
- Seeking professional advice: If directors are uncertain about the company’s financial situation, they should seek professional advice from insolvency practitioners or legal advisors.
- Cease trading if necessary: If there is no reasonable prospect of avoiding insolvency, directors should cease trading to prevent further losses to creditors.
Directors who breach their duties and engage in wrongful trading may be held personally liable for the company’s debts. This can result in significant financial penalties and, in some cases, disqualification from serving as a director for up to 15 years.
Defending against a wrongful trading claim
Directors facing a wrongful trading claim under s214 have several potential defences.
Understanding and effectively leveraging these defences is crucial for directors who find themselves in this situation.
- Reasonable belief: If a director can show that they genuinely believed there was a reasonable prospect of avoiding insolvency, they may avoid liability.
- Taking reasonable steps: Directors who can demonstrate that they took all possible steps to minimise losses to creditors may successfully defend against a wrongful trading claim.
- Reliance on professional advice: If directors acted based on professional advice, this could be a strong defence, provided that the advice was reasonable and appropriate under the circumstances.
Directors should maintain thorough records of their decision-making processes and the advice they receive to support these defences if a wrongful trading claim arises.
Contact our wrongful trading lawyers today
Need expert support with a wrongful trading claim? Our specialist insolvency solicitors are here to help you achieve the best outcome.
With our 30 years’ experience, our team have unrivalled expertise assisting directors, creditors, insolvency professionals, and other stakeholders on wrongful trading matters.
For your free consultation, contact our insolvency solicitors today on 020 7467 3980 or complete the enquiry form on this page.