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Wrongful trading is a section under the Insolvency Act 1986 that involves directors, knowingly making transactions in and out of the business, with the knowledge that the company is insolvent. If directors are found guilty under the Insolvency Act, they can be made personally liable for creditor debts.
What is wrongful trading
Investigations into directors’ conduct will be carried out if a company enters liquidation and any director who held office prior to the commencement of liquidation will be scrutinised. Any evidence of wrongful trading will be gathered throughout the investigations carried out by the liquidator and, if sufficient evidence is found, it will be submitted to the insolvency service. The insolvency service may then disqualify the director from holding office again for a maximum of 15 years. Directors found guilty of wrongful trading may also find themselves personally liable for debts run up in the company and may even find themselves criminally prosecuted if there is evidence of criminal wrong-doing.
What constitutes wrongful trading?
- Enter into credit agreements with a supplier knowing the company will be unable to honour repayment terms.
- Deliberately amass unreasonably high debts at the detriment to creditors.
- Pay themselves an unreasonably high salary when the company is unable to afford it.
- Continue to take deposits from members of the public if they are aware the order will be unfulfilled.
- Build up of excessive VAT, NIC or PAYE debts, because money that should be put aside for them, is spent elsewhere.
- Continue to take delivery of stock materials and goods whilst knowing the company is unable to make payments for them.
Company directors should have a good understanding of what is happening within the company, especially the accounts within the business. Not only will this help directors maintain control of the business, it will also enable them to make more informed decisions and avoid any troubles with wrongful trading. If not, it can have serious repercussions which could mean the disqualification of company directors for up to 15 years.
Directors can be protected from any accusations of wrongful trading, as long as they are comfortable and well organised with finances, giving liquidators no reason to doubt that there has been anything other than good conduct.
Avoiding wrongful trading
Once a director becomes aware that their company is insolvent it is imperative that they take steps to minimise creditor losses in order to protect themselves from wrongful trading accusations. If for instance, directors ignore the indications and carry on taking deposits for goods or services that the company will be unable to complete, they are putting themselves at risk of wrongful trading action. It is imperative for directors to take advice from a licensed insolvency practitioner during the early warning signs of insolvency, as they will be able to advise on the best course of action.
It is also good practice to maintain good communication with creditors and make thorough notes of any conversation or correspondence had with them, including name, department, date and what action may have resulted.
Wrongful trading action is avoidable if professional advice is sought early enough and a degree of common sense is exercised. If you are a director of an insolvent company and are still trading, consider the following:
- Do not delay taking action. If you wait until legal actions have been taken against the company, it will be much harder to defend against accusations.
- If your plan is to trade out of your company’s insolvent position, produce a cash-flow forecast showing exactly how you plan on doing this. Once the cash flow forecast is complete the directors may find there are insufficient resources for the continuation of trade and should seek advice from a licensed insolvency practitioner.
- When deciding on comfortable repayments to offer creditors, be sensible and make sure they are affordable. Unfulfilled promises of payment may be used against you in a wrongful trading action.
- If the company has HMRC and VAT debts, you may be granted “time to pay” in order to clear the arrears. When drafting a time to pay proposal, ensure you include a detailed cash-flow and be sensible about repayment amounts.
- If the company has any worrying legal actions, we will be able to advise you on the best course of action.
- Finally, and most importantly, if a sensible cash-flow forecast has been completed and the results indicate the company being insolvent, action must be taken straight away. Other options will need to be considered at this point such as administration, liquidation (including pre-pack liquidation), or a company voluntary arrangement.
Wrongful trading is a serious issue which can have severe repercussions on company directors. It involves directors knowingly making transactions, while also knowing that the company will not be able to fulfil its business transactions. For example, collecting deposits, without the intention of completing the necessary work. It can lead to directors being banned for up to 15 years as well, as potentially being held personally liable for any company debts.
How we can help
If you are concerned about wrongful trading within your company and are unsure if you are committing the offence, it’s important to act as quickly as possible. We can help guide you on what constitutes wrongful trading and talk you through the best possible responses during a liquidation.