When receiving enquiries from directors of distressed companies, we often find that very little is known about wrongful trading and fraudulent trading, their consequences, and how they differ from each other. We are grateful to Stacey Jones (Partner) and Laurens Zhang from the Restructuring and Insolvency Team at our good friends BDB Pitmans for this article that explains it all, and gives some pointers on how directors can avoid wrongful and/or fraudulent trading.
What is wrongful trading?
“Wrongful trading is a concept introduced by the Insolvency Act 1986 (“the Act”) which aims to make company directors more responsible for the management of the companies they run. It is not specifically defined but occurs where a director of a company is aware that there is no reasonable prospect of the company avoiding insolvency but allows the company to continue to trade, resulting in loss to the company’s creditors. When a director has allowed the company to wrongfully trade until the point it enters a formal insolvency procedure (such as liquidation or administration), the director may be ordered by the court to contribute to the assets of the company.
What is fraudulent trading?
Fraudulent trading is both a civil head of claim under the Act and a criminal offence under the Companies Act 2006 (CA 2006). It is also an offence under the Fraud Act 2006 which effectively extends the scope of the offence to people who are “outside the reach of the CA 2006”.
Fraudulent trading occurs where if, during the winding up (i.e. liquidation) or administration of a company, any business of the company has been carried out with the intention to defraud creditors, or for any other fraudulent purpose.
In a civil context, there is a two-stage test to prove fraudulent trading. The first test involves showing the director’s (or other relevant person’s) knowledge of the circumstances – i.e. what did the director (or other relevant person) know? The second test involves showing that the conduct was dishonest by the standards of ordinary decent people. As with all civil claims, the standard of proof is on the balance of probabilities.
In a criminal context, an intention to commit fraud is required meaning dishonesty must be shown. Consequently, along with proving other requirements, the same two-stage test mentioned above will apply. As with all criminal offences, the standard of proof is beyond a reasonable doubt, thus, significantly more onerous than the civil standard.
What are the consequences of fraudulent trading?
The court may order the defendant to personally contribute to the company’s assets although it cannot be punitive in nature. Where multiple persons are found liable for fraudulent trading, the amount of control that each party held over the company and the benefit they received from fraudulent trading will be considered by the court when apportioning liability.
A person held liable for fraudulent trading under the Act may also be disqualified as a director under the Company Directors Disqualification Act 1986.
In a criminal context, a person convicted of fraudulent trading can, on indictment, face up to 10 years’ imprisonment and/or an unlimited fine. On summary conviction a maximum of 12 months’ imprisonment and/or an unlimited fine can be imposed.
Key differences between wrongful trading and fraudulent trading
- Wrongful trading claims can only be brought against directors or shadow directors whereas fraudulent trading may be brought against any person who was knowingly a party to the fraudulent trading.
- The standard of proof is different. In fraudulent trading, the insolvency practitioner must prove dishonesty on the part of the defendant. This is harder than proving that the company continued to trade, thus increasing losses, when there was no prospect of the company avoiding insolvency (i.e. wrongful trading).
- Wrongful and fraudulent trading can both result in directors having to make a financial contribution to the assets of the company and effectively being held personally liable for some of the company fines/debts, but only fraudulent trading may result in criminal action against the director.
How can wrongful trading and fraudulent trading be avoided?
Where a director can show he took every step with a view to minimising the potential loss to the company’s creditors as he ought to have taken once becoming aware that the company had no prospects of avoiding insolvency, the court will not find him liable for wrongful trading. Such steps could include: seeking professional financial advice (e.g. from an accountant), obtaining legal advice, ceasing unnecessary trading, and chasing company debtors to pay outstanding debts. It is also advisable for directors to record all decisions made along with detailed reasoning for each decision.
Directors in particular should always be aware of fraudulent trading and take proactive steps to ensure fraudulent trading is not occurring by monitoring company financial records and scrutinising the decisions of directors at board meetings. Where fraudulent trading is suspected, it is advisable to contact solicitors at the earliest opportunity.”
At what point should an Insolvency Practitioner be contacted?
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. We can also provide the advice about measures to mitigate the possibility of wrongful trading.
In addition, we often work closely with insolvency and restructuring solicitors such as Stacey Jones and Laurens Zhang at BDB Pitmans. So, if you are concerned about wrongful trading or fraudulent trading, and need legal advice, either contact them direct or we will put you in touch.
A business’s financial problems often 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 is 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 at that stage 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 many 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 contact us or call one of our offices for an initial free of charge, confidential and no obligation discussion.
Also, K&W Recovery, trading as Antony Batty and Company, Thames Valley:
