23 November 2015: All too often, directors are unaware of the risks of continuing to trade at a time when the company is considered to be insolvent. Wrongful trading is a common trap that directors fall into when the business is struggling. No one ever teaches directors about the consequence of business failure, and why would they when they concentrate on making the company a success.
What is wrongful trading?
The technical jargon is “where a director knew, or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation” (Section 214 of the Insolvency Act 1986). The consequences of breaching Section 214 is that the directors can be made personally liable for those debts incurred during the period where wrongful trading has occurred.
You may be surprised to know many businesses are currently operating whilst insolvent but won’t necessarily be in breach of Section 214. If the directors can evidence that they took every step, with a view to minimising potential losses to the company’s creditors, they may not be held personally liable for the company’s debts. However, the onus is on the directors to prove what steps were taken; when and why.
If you (or a client) find themselves in this position, these following practical steps may well help you at a later date to avoid any allegations that the company traded wrongfully.
- Document the decisions made by you and your fellow directors. This may be done by holding regular board meetings.
- Speak to your accountant and ask for their professional assistance in providing financial information on a regular basis, so that they are fully informed about the financial position of the company.
- Monitor your cash flow projections to ensure the company continues to operate in a positive cash flow manner going forward. You should avoid the situation where historic debts continue to increase.
- Watch out for the unexpected (e.g. loss of significant contract or unanticipated liabilities). This may mean your original strategy will need to be altered or even scrapped.
- Make sure the staff in your organisation follow your plan of action, as you are ultimately held responsible if things go wrong.
- Don’t be afraid to seek specialist professional advice from an Insolvency Practitioner. We are here to help.
In summary, whilst there is ample case law on this specific area of the Insolvency Act, fundamentally, alarm bells should be ringing for directors if the company is unable to pay debts as they fall due and no attempt is being made to minimise the loss to creditors. After all, two wrongs don’t make a right.