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Wrongful Trading

Directors of companies often make the mistake of believing that they are immune from liability for the acts of their company. However, there are occasions in which directors can be exposed to personal liability for acts taken on behalf of a company. One such occasion is where directors allow a company to trade when they knew, or should have known, that there was no reasonable prospect of the company avoiding an insolvent liquidation. This is known as wrongful trading. 

Directors of companies often make the mistake of believing that they are immune from liability for the acts of their company. However, there are occasions in which directors can be exposed to personal liability for acts taken on behalf of a company. One such occasion is where directors allow a company to trade when they knew, or should have known, that there was no reasonable prospect of the company avoiding an insolvent liquidation. This is known as wrongful trading. 

The law on wrongful trading was created to protect creditors and in an attempt to maintain the integrity of the business environment. The law aims to reflect the fact that directors of companies should carry out their duties with skill, care and act responsibly. If a company enters into financial difficulties, its directors should consider the law on wrongful trading before allowing the company to incur any further debts or liabilities.

Payment from the director’s personal assets

The liquidator of a company can take action against directors who they feel should be held to account for wrongful trading. Where wrongful trading is proven, or admitted, the directors in question may be liable to make a contribution to the company’s assets – typically by way of a payment to the company out of the director’s personal assets.

A director’s defence to a claim of wrongful trading is that ‘he or she took every step with a view to minimising the potential loss to the company’s creditors as he ought to have taken’. The points below would act as evidence for a director seeking to rely on this defence.

Disqualification

In addition to making a contribution to the company’s assets from their own personal assets, directors who commit the offence of wrongful trading may be disqualified form acting as a company director for a period of up to 15 years.

Disqualification prevents a director being involved with the promotion, formation or management of a company or a limited liability partnership.

Whilst disqualification does not directly affect the personal assets of a director, it could greatly reduce the potential to take employment and earn an income in future.

Reducing the chance of a claim for wrongful trading

If you are a director of a company and it becomes apparent to you that your company is in financial difficulties, the following steps should be taken in order to reduce the risk of subsequently facing a claim for wrongful trading:

DO

  • Take advice from professionals (e.g. a solicitor, accountants or insolvency practitioner) immediately, and make sure that any advice is both documented and followed. The Courts have ruled that this would be the most valuable evidence to show that you acknowledged the situation and took steps to minimise the risk to creditors.
  • Hold regular board meetings and ensure that all the directors are present. Ignorance of the company’s financial situation is not a defence to wrongful trading. If your company is in trouble, make it your business to find out exactly to what extent, and what, if anything, can be done to resolve the situation.
  • Distribute minutes as soon as possible after board meetings. Again, these are evidence of steps being taken by the directors to minimise the loss to the company’s creditors.
  • Compile a list of all possible sources of funding for the company. Identify a point on that list where, if that funding is not obtained, it is clear that the company will no longer have any reasonable prospect of avoiding insolvent liquidation. If at any point before that it seems the company has no reasonable prospect of avoiding insolvent liquidation, stop trading immediately and take professional advice.

DO NOT

  • Ignore the fact that company accounts are being filed late and that creditors are demanding payment. Both of these are indications that the company may be insolvent. As noted above, ignorance is not a defence to wrongful trading. If a reasonable director should have known that the company had no reasonable prospect of avoiding insolvent liquidation, liability for wrongful trading could be established.
  • Delay raising any issues with other directors of the company. Discussing issues at an early stage will enable the company to take relevant legal and financial advice.
  • Let the company incur any substantial new liabilities, unless they are essential and in the best interests of the company.
  • Resign to get away from the issue, as this will not absolve you of any potential liability. As a director, you have responsibility to minimise the loss to your company’s creditors. If it seems that the company cannot continue to trade and meet its debts as and when they fall due, contact professionals who can put the company into administration or liquidation.

Companies experiencing difficulty in paying debts as and when they fall due should not continue to trade without considering the issue of wrongful trading. Ignoring the risk of personal liability is reckless and can lead to serious consequences. Awareness and consideration of the points set out above is essential for any company director, especially during this economic downturn.

Sam Lyon is an Associate Solicitor in Burnetts' Corporate Law team. For further information about wrongful trading, contact Sam Lyon on 01228 552222. 

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Published: Monday 11th May 2009
Categorised: Corporate Law

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