Wrongful Trading: What It Is and How to Avoid It
Wrongful trading, often known as “trading irresponsibly,” is a civil wrong covered by Section 214 of the 1986 Insolvency Act. As a result, industry professionals frequently refer to it as simply “Section 214.”
The premise of wrongful trading is that a director of a UK limited company becomes fully aware of their firm’s insolvency, but does not act in a way that minimizes the loss to business creditors. It was created as a counter-measure to fraudulent trading.
Wrongful trading is described by Section 214 as when a firm’s director allows the company to trade past the point where it:
‘knew, or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation’; ‘
did not take “every step with a view to minimising the potential loss to the company’s creditors’.
Wrongful Trading Vs. Fraudulent Trading
Wrongful trading differs from fraudulent trading in numerous ways, despite the fact that they are typically lumped together. To begin with, unlike fraudulent trading, wrongful trading is not a criminal offense, though individuals found guilty of either crime face substantial consequences.
While fraudulent trading is frequently calculated and deliberate, many instances of wrongful trading are undertaken by directors without their full understanding of what they were doing.
As a director of a limited business, however, it is your job to understand what constitutes wrongful trading and to implement the proper precautions to avoid breaching these regulations. HMRC and the law do not accept ignorance as much of defence!
An act, or a set of acts, committed by an insolvent corporation is known as wrongful trading. It is vital to emphasize that claims of unlawful trading can only be filed against a firm when it is terminally insolvent.
When a business realizes it is insolvent and has no reasonable hope of recovery, its directors should take actions to reduce the impact of the company’s insolvency will have on its creditors. This means that directors should avoid doing anything that could put their creditors in a worse position, such as taking on more debt or selling firm assets.
To avoid further financial harm to creditors (as it is all about them once insolvency looms), it is frequently recommended that the company halt trade immediately – albeit this is not always the case. Trade may well be allowed to continue in some cases if it can be proven that this activity will raise the prospective returns for all creditors. However, because this is a highly complex issue, professional counsel should be sought before taking any action.
What are Considered Wrongful Trading Actions?
Making a so-called “preferred payment” is one of the most typical forms of improper trading. When it comes to paying back money owed, this is when a firm favours one creditor above another. Paying money owing to friends and family members before paying your other suppliers or creditors is an example of this.
When a corporation is knowingly insolvent, it is usually recommended that it make no payments to any creditors in order to avoid undue preference claims. Obviously, some creditors will push harder for payment than others, but it will still be up to the directors to do the right thing and ensure everyone is considered equally.
Other common examples of wrongful trading include:
- Trading while knowingly insolvent
- Paying down loans that have been personally guaranteed before addressing other debts.
- Taking out more credit (from lenders or suppliers) when you know you won’t be able to pay it back
- Accepting deposits for products you won’t be able to deliver, or for work you will not be able to complete.
This list is not an exhaustive one. If you are unsure if your activities could be interpreted as wrongful trading, you should obtain professional advice as soon as possible, preferably before an insolvency is a foregone conclusion.
What Are the Penalties for Wrongful Trading?
Wrongful trading only applies when a company is insolvent and there is no way to save it. This means that the company’s liquidation will be overseen by a licensed insolvency practitioner. Investigating the behaviour of the directors in the period leading up to the company’s insolvency is an element of the insolvency practitioner’s job.
If evidence of wrongful trading is discovered, the insolvency practitioner is required to report this to the Insolvency Service, which will investigate the claims further. If you are proven to be guilty of wrongful trading, you may face personal consequences. The transactions in question may be voidable, and directors may be compelled to make a personal financial contribution to compensate for the loss.
Avoiding Wrongful Trading Accusations
As a director of an insolvent corporation, you have a wide range of responsibilities that can be quite challenging. What is evident is that any director in this situation must move quickly to clarify their stance and understand the potential consequences of continuing to trade.
An experienced accountant, like those who make up the Pearl Lemon Accountants team, can help businesses that are experiencing cash flow problems by giving them the guidance they need to get back on track, avoiding insolvency, and wrongful trading headaches, altogether.