Directors must be vigilant to avoid Wrongful Trading

Directors must be vigilant to avoid Wrongful Trading

How can Insolvency Practitioners help distressed and insolvent companies reduce/avoid the risk of Wrongful Trading?

Wrongful trading is all about a business continuing to trade with the knowledge that the business is insolvent, and so as soon as a company’s directors realise that their business is insolvent, or unavoidably falling into insolvency, they are at a potential risk of wrongful trading and personal liability action. However, the earlier an Insolvency Practitioner is appointed, the sooner the directors can be alerted to the risk of wrongful trading and advised as to what measures they can take to minimise/prevent such action subsequently being taken. In this article we first remind ourselves what constitutes wrongful trading, before detailing what Insolvency Practitioners can do to help reduce/avoid the risk.

What is Wrongful Trading?

Wrongful Trading, as set out in section 214 of the Insolvency Act, 1986, occurs when:

  1. Directors know the business is insolvent, and
  2. They continue trading with knowledge of insolvency and do so without any realistic prospect of paying creditors going forward.

Insolvency Practitioners, when appointed, are obliged by law to investigate insolvent companies for evidence of wrongful trading. Wrongful trading is a civil, rather than a criminal offence. However, the consequences can still be severe and include directors being held personally liable for company debts and/or banned from acting as the director of a limited company for a period of up to 15 years.

What steps can directors take to avoid Wrongful Trading and Personal Liability?

To reduce the risk of wrongful trading directors need to seek professional advice quickly. Appropriate professional advisers include: insolvency practitioners, accountants or solicitors.

Frequently, appointing an insolvency practitioner is a director-led process. When a company director becomes aware that their business is insolvent, their duties as directors shifts away from the company to the company’s creditors. Their duty is now to protect their creditors’ interests and place these above those of the company. It is failure to do this could see the director being accused of wrongful trading.

The first action we take is to work out the point in time that the directors knew the business was insolvent. All businesses are different, some have sophisticated financial planning programmes, others just look to see if the bank account is overdrawn!

When that has been decided we then look to see how the directors have reacted to this insolvency. Again, this varies from person to person. Some will go on to take further professional advice (usually their accountant, initially, who more often than not makes the introduction to an Insolvency Practitioner), others just stick their heads in the sand and hope the problem will go away. This latter route is asking for trouble and puts the directors potentially at risk from Wrongful Trading.

Once the point at which insolvency has occurred has been established, we always recommend the following steps should be taken to minimise the loss to creditors and therefore mitigate the risk of Wrongful Trading and Personal Liability.

  • Maintain detailed financial forecasts. This will allow the financial position and viability of the business to be accurately and constantly evaluated, helping potential liquidity issues to be identified and will help to ensure that no creditors are given preferential treatment.
  • Hold regular board meetings. Detailed records of board decisions should be kept, along with an analysis of the company’s finances and an explanation as to why a decision to continue to trade was made.

We will then talk through with the directors what efforts they have made to obtain further finance for the business, and how much the business needs to survive, whilst examining what the problems are. In this way, we can ascertain whether the problem is just a blip, or whether the business has a terminal problem which is incapable of being resolved within the current business. If the latter, then we will recommend a formal insolvency procedure.

At what point should an Insolvency Practitioner be contacted?

Elaine Wilkins from Antony Batty in Bournemouth point out “We always say the earlier we are contacted, the more we can do to help. If directors spot that things are going wrong, then we might be able to advise on measures to help a business turn itself around and avoid insolvency” The advice above about measures to mitigate the possibility of wrongful trading if insolvency is the outcome still holds good.

A business’s financial problems normally start with a demand for payment of some kind from a creditor (although there are many other reasons why problems begin, such as a bad debt being incurred or significant shocks like the Covid pandemic or rapidly increasing inflation). We always advise that dialogue is opened up with the creditor(s) so that they understand why “it’s not business as usual.” There needs to be a discussion on when payment can be made, maybe via a payment plan, for example. The key point is to engage with creditors so that they can make informed decisions on any future trading.

By enlisting the help and advice of a licensed insolvency practitioner, directors are demonstrating their desire to do what is best for their outstanding creditors. We can obviously get involved at this stage, prior to any formal appointment, however, we do make it clear that the business is still the directors’ and we are only providing advice and not acting as shadow directors.

Talk to our Insolvency Practitioners if you are worried about Wrongful Trading

Given the financial shocks that may companies have faced recently, from the pandemic through to rapid inflation, rising interest rates, supply chain issues and Brexit related problems, insolvencies have increased and it is likely that we will see a rise in Wrongful Trading actions.

If you are concerned about the financial position of your company and are worried about Wrongful Trading, please call us at our Bournemouth office on 01202 923009 for an initial free of charge, confidential and no obligation discussion.

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