What is Wrongful or Fraudulent Trading?

Concerned about wrongful trading?

As a company director you’ll need to be clearly aware of the rules in this area, as the penalties can be severe.

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definition of wrongful trading

What is Wrongful Trading by Directors?

When a company becomes insolvent, directors have a legal responsibility 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 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.

Not putting creditors first when insolvent means you are guilty of wrongful trading.

Directors Liability

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.

Creditors Come First

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.

Penalties

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?

Wrongful trading is a civil, not a criminal, offence as per the Insolvency Act 1986 and the Companies Act 2006. Fraudulent Trading, on the other hand, is a crimimal offence as well as a civil liability.

As such it would be triable either in the magistrates’ court or the Crown Court.

Insolvency Act 1986, 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.

Burden of Proof

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.

What Defence Can Be Accused for Wrongful Trading

As a director you’ll need to be able to demonstrate that you took every step possible to minimise the loss to creditors once you understood your financial situation.

Claiming ignorance – for example of the company’s financial affairs – will not be considered sufficient since it’s a responsibility of a director to know these things.

It is also considered the onus of directors to prove that they took steps to minimise any potential loss to creditors, and not that of the liquidator to prove that they did.

How to Avoid Wrongful Trading

Directors should take care to record all actions – once the point of insolvency is realised – in meticulous form and including emails, phone calls and and actions taken.

Demonstrating awareness of and adherence to the law is the key factor in offering sufficient evidence to the insolvency practitioner.

Above all, take no actions which show preference to either yourself, a staff member, or a creditor.

Taking professional advice early is a key way to protect yourself, rather than waiting until it’s too late.

FAQ’s

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 is the Definition of Trading Insolvently?

This is when a director becomes aware of the company’s insolvency but nevertheless continues to trade.

Can you Trade while in Liquidation?

You cannot. Liquidation means the end of the company, the sale of its assets, and the eventual dissolution of its status as a company at Companies House.

Can Directors be Personally Liable in a Limited Company?

Yes they can, where evidence is found of wrongful or fraudulent trading the directors can be found personally liable for some or all of the company debts.