Wrongful or insolvent trading: Can directors be personally liable?
Wrongful trading occurs when company directors continue to trade past the point when they knew or should have known that there was no reasonable prospect of avoiding insolvent liquidation and in addition they did not attempt to minimise potential loss to the company’s creditors at every step.
It is an offence under section 214 of the Insolvency Act 1986, with the possibility of directors being made personally liable for losses during the period of any wrongful trading. Unlike fraudulent trading, there is no requirement to prove intent to defraud.
What is wrongful trading?
When a company continues to carry on its ordinary business after it has become unable to pay its debts as they fall due, directors are guilty of wrongful trading. Usually, those involved are hoping that business will improve and that they will return to profitability.
Wrongful trading is not an intention to defraud creditors, but is a failure on the directors’ part to carry out their duties and cease trading, either as a result of poor judgment or because of a belief that they can ride out the difficulties.
If the directors knew that the company was insolvent but carried on trading with no intention to pay their debts, such as staff salaries or suppliers’ invoices, they may be guilty of fraudulent trading.
Defining wrongful trading
The point at which the company becomes unable to pay its debts are crucial in determining whether wrongful trading has taken place, as this is the date at which the directors should have ceased to trade if they should also have known that there was no prospect of avoiding insolvency.
In some situations, it may be reasonable to hold out hope of a recovery. A director’s level of knowledge in assessing whether insolvency is inevitable is that which a director with a reasonable general level of skill should have, however, if a director has additional specialist knowledge, for example in accounting or finance, they will be held to a higher standard.
In the event that wrongful trading is proved, a director with a higher skill level may be required to pay a higher level of compensation.
Proceedings for wrongful trading
A wrongful trading claim can be brought by a liquidator or an administrator once a company has gone into insolvent liquidation or administration. A liquidator will usually try to determine from the point at which the company became insolvent and closely examine any transactions carried out after that point.
Unsecured creditors are also able to bring wrongful trading proceedings, and it is open to them to band together to bring a claim in order to reduce legal costs.
Directors’ liability for wrongful trading
Where it can be shown that wrongful trading has taken place, a director may face personal liability for any losses that have occurred because of the continued trading past the point of insolvency.
They will be required to contribute to the company from their own assets and may also be disqualified from acting as a director for up to 15 years.
The Coronavirus Business Interruption Loan Scheme (CBILS) was introduced by the government to provide financial assistance to small and medium-sized businesses that were struggling as a result of the pandemic. It is currently set to run until 31 March 2021.
Banks are not allowed to ask for personal guarantees in respect of CBILS borrowing of up to £250,000.
Directors should take care when applying to the CBILS, as they will be required to certify both that their business has been adversely affected by Covid-19 and that it was not in difficulty prior to December 2019.
If a business subsequently fails, insolvency practitioners may look closely at the circumstances surrounding any loans with a view to recovering funds from a director in person in the event that a fraudulent claim has been made.
Directors’ personal liability for Bounce Back Loans
The Bounce Back Loan Scheme (BBLS) was introduced following the CBILS to channel funds through more quickly to smaller businesses.
Funds of up to 25 per cent of turnover, up to a maximum of £50,000, are available, underwritten by the government and with no requirement for a personal guarantee.
While this means that there is no personal liability for a correctly used BBLS if a business fails, it is important that directors do not breach their duties and that they use the funds in the permitted way.
The BBLS is given on the understanding that it will provide an economic benefit to a business. It could be legitimately used to pay salaries, debts and borrowing or to purchase stock.
When signing the loan agreement, directors are required to certify that their business is not in difficulty, ie. that it can pay its debts when they are due and that its assets are valued at more than its liabilities.
A director could potentially have personal liability for a BBLS debt where the funds were not used in accordance with the agreement, for example, by repaying a director’s loan account, or where preferential payments are made to some creditors while others are left out, for instance, by repaying debts that have been personally guaranteed by directors, while leaving unsecured creditors unpaid.
A note about the temporary suspension of wrongful trading
Wrongful trading has temporarily been suspended for two periods during the disruption caused by the pandemic in an attempt to give directors a chance to deal with temporary difficulties and return businesses to profitability.
The first period ran from March to 30 September 2020 and the second from 26 November 2020 to 30 April 2021.
Directors must still take care not to breach their duties and to behave responsibly, for example by considering whether in taking on new debt, they will realistically be able to repay it in the future. They should consider the interests of their creditors when making decisions and act reasonably, with due care and skill and in good faith.
When the suspension is lifted, insolvency practitioners will no doubt be looking carefully at all aspects of director behaviour during the last months of trading.
It should be noted that fraudulent trading, misfeasance and sanctions for breach of directors’ duties has not been suspended.
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The above information is for general guidance on your rights and responsibilities and is not legal advice. If you need more details on your rights or legal advice about what action to take, please contact a legal advisor.