Wrongful Trading vs Fraudulent Trading
A company is insolvent when it is unable to pay bills as they fall due or when the company’s liabilities exceed the total value of its assets. When this happens, directors must cease trading immediately as trading insolvently can lead to allegations of wrongful trading or to the more serious claims of fraudulent trading. This is when directors deliberately tried to avoid paying creditors and is a criminal offence. Wrongful trading and fraudulent trading are offences under the Insolvency Act 1986 and the Companies Act 2006 respectively.
What is Wrongful Trading?
When a company becomes insolvent, directors have a responsibility and a duty to inform shareholders and to seek independent professional advice from a licensed insolvency practitioner (IP). In many cases, directors are overly-optimistic about the business and its future, wanting to believe that things will improve and this is the why they continue to trade. Here, their objective is to trade the company out of trouble despite their responsibility to put creditors’ interests first and to limit their exposure to even more debt.
Directors of Insolvent Companies Need to Understand Their Duties
When directors continue to trade past the point when they knew or should have known that there was no reasonable prospect of avoiding insolvency and they fail to minimise the potential loss to the company’s creditors, it is clearly a case of wrongful trading. There is typically no intent defraud creditors, simply poor judgement or the failure of directors to carry out their responsibilities
When the company becomes insolvent, the interests of the company’s creditors as a whole must be at the forefront of directors’ actions and no preference should be shown to some creditors more than others as this will result in directors being questioned by the IP about the reasons for these actions.
What are the Penalties for Wrongful Trading?
Directors who are found guilty of wrongful trading while the company is insolvent face potential disqualification for up to 15 years, plus other fines and penalties. He or she may also be held personally liable for company debts.
Is Wrongful Trading a Criminal Offence?
Although not a criminal offence, wrongful trading is a civil offence that is taken seriously by the courts. Directors who claim that they were unaware that the company was in financial distress may be viewed as irresponsible and this defence supports and will be used as proof of unfit director conduct, adding to the seriousness of the situation.
What Law Pertains to Wrongful Trading? (Section 214)
Section 214 Insolvency Act 1986 visible here covers the laws surrounding wrongful trading. It’s principle focus is that directors need to ensure they did everything possible to maximise the return for the company creditors.
What is Fraudulent Trading?
Wrongful trading is a less serious and more common offense than fraudulent trading, which can lead to a custodial sentence, director disqualification and financial penalties.
Directors involved in a Creditors Voluntary Liquidation or a compulsory liquidation process are always questioned by the IP as he or she must conduct an investigation and send a report to the Secretary of State on director conduct leading up to the company’s insolvency. If fraudulent trading is suspected, directors have acted deliberately to avoid payment of company liabilities by continuing to trade, accepting supplier credit or taking payment on credit from customers knowing that orders will be unfulfilled prior to liquidation. Selling company assets for “undervalue” or lower than their market value prior to the liquidation is also considered suspect by the investigating IP.
The intention to defraud creditors in this way requires a heavy burden of proof (it must be proven that directors knowingly continued to trade with no intention of paying their debts) and the IP will carry out a thorough investigation to discover the truth.