Wrongful trading

The UK government rolled out unprecedented levels of support during the pandemic to protect businesses from collapse. The temporary lifting of wrongful trading legislation came into play in November 2020 and revoked personal liability arising from wrongful trading for directors. With the number of monthly insolvencies growing at a rapid rate, directors of struggling companies must be increasingly mindful of their conduct.

What is wrongful trading?

Wrongful trading occurs when the director of a company continues to trade when they know, or ought to know, that there is no reasonable prospect of the company avoiding insolvent liquidation or an insolvent administration.

Under normal trading circumstances, a director’s duty is to promote the success of the company for its shareholders. When it becomes apparent the company is insolvent, the director’s primary duties flip to protecting the position of the company’s creditors.

From a legal perspective, directors must show that they have taken all necessary steps to minimise losses to creditors in order to avoid being personally liable for wrongful trading.

How can directors be

personally liable for wrongful trading?

Under section 214 of the Insolvency Act 1986, liquidators and administrators can bring claims against directors of insolvent businesses who have not acted to protect the interests of creditors.

Such claims can often result in arduous court proceedings and, if successful, a personal contribution for the value of creditors losses must be made by the director(s). Should the director not have sufficient capital to make the necessary contribution, the insolvency practitioner can enforce the realisation of assets, including their residential property. In some cases, they may be disqualified to act as a director and could even face imprisonment.

What is the current position?

The temporary measures introduced in the Corporate Insolvency and Governance Act removed the personal liability associated with wrongful trading for directors. The measures expired on 30 June 2021.

They were enforced between 1 March 2020 and 30 September 2020, and later on 26 November 2020. Directors who have continued to trade a potentially insolvent entity outside of these periods may be liable for prosecution. Insolvency practitioners will be scrutinising directors’ conduct in the period leading up to insolvency, with a view to establishing liability claims.

What precautions can be taken?

Some vital actions that directors of struggling businesses should take to avoid being liable for wrongful trading include:

• preparing cash flow forecasts to consider the extent to which creditors’ positions are affected by continuing to trade;
• holding regular board meetings where the financial viability of the company is discussed and documented; and
• taking advice from restructuring and legal professionals if there is uncertainty with regards to insolvency.