Understanding wrongful trading and how to avoid it

What is wrongful trading? Is it the same as fraudulent trading?

Although often grouped together, wrongful trading differs from fraudulent trading in several ways. Firstly, unlike fraudulent trading, wrongful trading is not a criminal act, although there are serious consequences for those found guilty of either act.

While fraudulent trading is often calculated and deliberate in nature, many instances of wrongful trading are committed without any intention to do so by directors. However, as the director of a limited company, it is your responsibility to understand what constitutes wrongful trading, and to take the necessary steps to ensure you do not fall foul of these rules.

Wrongful trading and insolvency

Wrongful trading constitutes an act, or a series of acts, committed by an insolvent company. It is important to note here that it is only when a company is terminally insolvent that allegations of wrongful trading can be brought against it.

Once a company realises it is insolvent, and there is no reasonable chance of the company recovering, its directors must take steps to minimise the impact the company’s insolvency will have on creditors. This means directors should not partake in any activity which may worsen their creditors’ positions such as taking out additional borrowing, or disposing of company assets.

In order to prevent further damage being done to the company’s financial position, it is often highly advised for the company to cease trading immediately - although it is not always this cut and dry. In some instances, trade may be allowed to continue if it can be demonstrated that this activity will increase the potential returns for creditors as a whole. However, this is a highly complex area and therefore professional advice should be sought before any action is taken.

What actions are classed as wrongful trading?

One of the most common acts of wrongful trading is making what is known as a ‘preference payment.’ This is where a company favours one creditor over another when paying back money owed. An example of this is paying monies owed to friends and family members ahead of your other suppliers or creditors. When knowingly insolvent, it is typically advised that the company refrains from making payments to any creditor in order to safeguard against claims of unfair preference.

Other acts of wrongful trading include:

• Trading while knowingly insolvent
• Prioritising paying loans which have been personally guaranteed
• Continuing to take credit (from lenders or suppliers) when you know there is little chance of you being able to pay this money back
• Taking deposits for items you will not be able to supply

This list is not exhaustive, so if you are in any doubt as to whether your actions are likely to be construed as wrongful trading, you should seek professional advice as a matter of urgency.

What are the consequences of wrongful trading?

As previously stated, wrongful trading is only applicable when a company is insolvent and recovery is not possible. This means that a licensed insolvency practitioner will be appointed in order to handle the company’s liquidation. It is a part of the insolvency practitioner’s role to investigate the conduct of the directors in the time leading up to the company’s decline into insolvency. If evidence is discovered that points to wrongful trading, the insolvency practitioner is duty bound to forward these concerns to the Insolvency Service who will investigate these allegations further.

If you are found guilty of wrongful trading, action can be taken against you on a personal level. The transactions in question could be ‘voidable’ and directors may be personally asked to make a financial contribution in order to make up for the loss incurred.

How can I avoid wrongful trading?

Your obligations as director of an insolvent company are varied and can be extremely complicated. What is clear, however, is that any director in this position must take swift action to clarify their position and understand the possible repercussions of continuing to trade.

Handpicked Accountants can match you up with a trusted and reliable accountant in your area. For companies beginning to experience cash flow worries, an accountant can provide the advice needed to turn the situation around; alternatively, you may be referred to an insolvency expert, such as an insolvency practitioner, should the situation be beyond redemption. Call the Handpicked Accountants team today on 0800 063 9258 to speak to our specialist advisers.