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If your business cannot meet its liabilities, it may face insolvency. The law can pursue directors of insolvent companies if their conduct amounts to wrongful trading. This article will look at what directors of potentially insolvent companies should know about wrongful trading so you can limit your liability.
What is Wrongful Trading?
Wrongful trading is a civil claim the law permits liquidators and administrators of insolvent companies to bring against directors. Liquidators and administrators are two types of insolvency practitioners that take over the affairs of an insolvent company either at the company’s request or a successful order made by one of its creditors.
Liquidators and administrators have broad powers to manage the company’s affairs. Their primary objective is to manage the company for the maximal benefit of its creditors rather than its shareholders. To this end, they can review the conduct of the company’s directors in the lead-up to the company’s insolvency to determine if their conduct fell below the standards imposed by law. If it does, the court can order the directors to personally contribute to the company’s assets.
How is Wrongful Trading Defined?
Only directors can face liability for wrongful trading claims. Therefore, the law cannot hold you liable if you are just a shareholder. However, while you may not be officially a director, you may be a shadow or de facto director.
The liquidator or administrator must prove to the court that the directors failed to take every step to minimise the potential loss to the company’s creditors when the company could not be rescued from insolvency. We can break this down into four elements, all of which the liquidator or administrator must prove.
| Element | Explanation |
| The point of no return. | This refers to establishing that at some point before insolvency proceedings began, there was a point at which the company could not be rescued. |
| The reasonable conclusion. | At that point, it was reasonable to conclude the company could not be rescued. |
| Directors’ failure to reach the conclusion. | The directors failed to reach that conclusion. |
| Absence of a defence | The directors did not take every step available to them to minimise the potential loss to the company. |
The first two elements are usually self-evident when a company is either in insolvent liquidation or administration. That is to say, the liquidator can point back in time and identify when the company’s performance could not be turned around. However, if the company can still be rescued – for instance, through a capital injection or asset sale – there is no claim for wrongful trading.
Reasonably Diligent Person Test
Before attaching liability to a director, the court considers whether a reasonably competent director would have decided their company is beyond the point of no return.
However, if the director holds particular skills or experience that suggests they should be held to a higher standard, the court will do so. This means that all directors have to meet a minimum threshold of competency, such as by:
- reviewing accounts;
- holding board meetings; and
- evaluating if they should enter into additional credit agreements.
If the liquidator or administrator convinces the court that the director failed to meet the reasonably diligent person test, liability follows unless the director can satisfy the every step defence.
The Every Step Defence
A director will avoid liability if they can demonstrate that when the company reached the point of no return, they took every step to minimise the potential loss to its creditors. The key word here is “every step”. If there are avenues that the directors could feasibly have taken but did not, they are unlikely to establish a defence.
Taking “every step” can include:
- voicing concerns about the company’s finances at regular board meetings and convening ad hoc meetings to raise the issue further;
- obtaining independent financial and legal advice, including instructing an insolvency practitioner to advise on the feasibility of continuing to trade;
- ensuring all financial information and data are accurate and up-to-date;
- reducing expenses and liabilities; and
- cancelling existing lines of credit and not incurring further credit.
You should also note that wrongful trading does not require the court to find evidence of dishonesty. However, mere negligence or failing to take a specific action can be sufficient to establish liability. This differs from fraudulent trading, where dishonesty is an essential ingredient.
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Sanctions For Wrongful Trading
The court has the power to order directors liable to contribute to the company’s assets. The court typically assesses how much the company lost at the point of no return due to the liable director’s conduct as a starting point.
Where the court finds two or more directors liable, it can make a contribution order on joint and several bases. Alternatively, it can apportion a contribution order based on the extent of each director’s liability.
The Process for Bringing a Wrongful Trading Claim?
Liquidators and administrators generally initiate the claim by making a court application. For example, if your company is insolvent, you may hear a wrongful trading claim called a Section 214 Claim. If your company is in administration, it is called a Section 246ZB Claim. These refer to the two pieces of law under the Insolvency Act 1986 that enable the liquidator and administrator to bring the claim.
The liquidator or administrator must convince the court that your conduct constituted wrongful trading on the balance of probabilities and that you had no defences. ‘On the balance of probabilities’ means that the court must conclude that it is more likely than not that your conduct amounted to wrongful trading.
Key Takeaways
Liquidators and administrators often scutinise a director’s conduct before the company’s insolvency. In particular, liquidators and administrators look to see if the directors’ conduct amounted to wrongful trading. This refers to directors failing to take appropriate steps when they decided they:
- could not rescue the company; and
- did not adequately minimise the extent of the company creditors’ loss.
The liquidator or administrator may apply to the court seeking a contribution order if they believe the directors are liable. If the court is convinced, it can order the directors to contribute to the company’s assets at an appropriate value.
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Frequently Asked Questions
Directors may be liable for wrongful trading if, when a distressed company could not be rescued from insolvency, the director failed to take every step to minimise the potential loss to the company’s creditors.
A court can find any director liable for wrongful trading. If you are just a shareholder, you cannot be found liable. However, if your conduct suggests you exercised significant control over the company, even where you are not a named director, the court may conclude you are, in fact, a director.
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