Wrongful trading

Wrongful trading - a practice when the company's board of directors continue to conduct business trading despite being insolvent, i.e. unable to cover the company's debts as they fall due. Under the provisions of Insolvency Act 1986, directors who know or should have known that the company could not avoid going into insolvent liquidation, under certain circumstances, may be held liable to contribute to the company's assets as the company is being liquidated (Marshall Cavendish Corporation 2006, p. 166).

In comparison to fraudulent trading, in wrongful trading there is no intent to defraud the company's creditors but rather an element of poor judgement of company's condition, hope that things will improve in spite of spiralling downwards and/or directors’ failure to conduct their duties in a diligent and meticulous manner (ACCA 2013, p. 248-249).

The concept of wrongful trading (as well as fraudulent trading) was established in order to secure the creditors from negligence and raise standards among directors by penalising immoral conduct.

Wrongful trading in general

Section 214 of Insolvency Act 1986 provides a set of requirements that need to be met for the directors to be found responsible for participating in wrongful trading:

1. Company has been put into liquidation;
2. The person concerned knew or should have known that the prospect of liquidation is inevitable at some time before liquidation started;
3. The person concerned was a member of the board of directors at that moment;
4. Liquidator has filed appropriate application to the court.

If all the above demands are satisfied, the court may recognise the directors as responsible for wrongful trading and award contributions to the company's assets (V. Finch 2002, p. 698-699).

Directors defence against wrongful trading

Upon the commencement of insolvent liquidation, the following factors may act in favour of the directors to avoid their personal liability towards the company's assets (D.J. Keenan 2005, p. 391-393):

• Minutes of the board meetings were made in an accurate and precise manner so that they show that the directors performed their duties properly.
• Any difficulties or struggles were discussed at board meetings thoroughly and in timely manner and the directors acted unanimously. In case someone from the board wished to stop the business, the overruling majority might find it difficult to justify the decision to maintain trading.
• In moments of difficulties or doubts regarding the financial condition of the company, the directors sought professional accounting advice.
• The board of directors acquired adequate financial information such as forecasts, even if they happened to be incorrect.
• All auditors’ guidance and recommendations were considered and attempts have been made in order to implement them.

Wrongful trading — recommended articles

Statutory obligation — Voluntary Termination — Minute book — Bank secrecy — Internal audit — Accounting Convention — Accounting manual — Interim injunction — Fiscal Agent

References

• Association of Chartered Certified Accountants (Great Britain) (2013), ACCA Paper F4 - Corp and Business Law (GLO) Practice and Revision Kit, BPP Learning Media, London
• Finch V. (2009), Corporate Insolvency Law: Perspectives and Principles, Cambridge University Press, Cambridge
• Hood P. (2012), Principles of Lender Liability, Oxford University Press, Oxford
• Keenan D. J. (2011), Smith & Keenan's Company Law, Pearson Education Limited, Harlow, Essex
• Keenan D.J., Bisacre J.B. (2005), Smith & Keenan's Company Law with Scottish Supplement, Pearson Education Limited, Harlow, Essex
• Marshall Cavendish Corporation (2006), Company Law, Routledge-Cavendish, Abingdon
• Mokal R.J. (2000), An Agency Cost Analysis of the Wrongful Trading Provisions: Redistribution, Perverse Incentives and the Creditors' Bargain, The Cambridge Law Journal
• Pettet B. (2005), Company Law, Pearson Education Limited, Harlow, Essex

Author: Maksymilian Piaskowski