How to Avoid Wrongful Trading in Insolvency

The wrongful or fraudulent trading provisions of the Insolvency Act 1986 place a responsibility on directors of failed companies to contribute to the company's assets.

Even though claims against directors for wrongful trading are not that common, with only just a little over 5 per cent of directors disqualified following insolvency proceedings, wrongful trading can still prove a risk to directors of companies facing insolvency.

Section 214 of the Insolvency Act states that if before a company is wound up, a director knew or ought to have known that there was no real chance of the company being able to avoid insolvent liquidation, and then from then on they failed to do whatever they could practicably do to minimise loss to creditors, then the court may force a director to make a personal contribution towards the company's debts.

The situation is assessed against the standard of a reasonable diligent person who has the experience, skill and knowledge expected of a director, together with any additional experience, skill and knowledge that the individual is in possession of.

In other words, it's all about negligence rather than dishonesty. Dishonesty is classed as fraudulent trading, and this is dealt with under Section 213 of the Act. We'll look at that in a separate article. For now, let's look at ways directors facing insolvency can avoid a claim being made against them for wrongful trading.

Keep appropriate accounting records

Without sufficient accounting records and where returns and payments are not made on time to Companies House and HMRC, the road ahead for a director in insolvency is not going to look too good. Providing you keep accurate and up to date records and make sure that everything is filed and paid on time, the court will look more favourably upon you.

Never use company funds or assets for personal benefit

Making use of company funds or assets for personal gain will be classed as wrongful trading as this obviously does not constitute doing everything practical to ensure creditors do not lose out. Be sure to document any drawings on company funds and that such drawings are only made for valid reasons. In addition, you should never draw excessive salaries or dividends during times of financial difficulty.

Be open with creditors

It is vital not to attempt to hide things with suppliers or anyone you owe money to. Being upfront about your situation and seeking practical ways to resolve payment issues will be looked upon favourably by the court.

Do not delay ceasing trading

If you are aware that there is little possibility of repaying debts then you should case trading immediately. If you continue to use credit services in the knowledge that there is no prospect of settling the accounts then this will be considered wrongful trading.

Take professional advice

If as soon as you realise there is a serious issue you seek professional advice from insolvency specialists then the court will take this into favourable consideration.

Avoiding director disqualification

The ramifications of director disqualification are very serious indeed. Not only does it involve a ban from running any company in the UK, directors who have been disqualified are also not permitted to act as school governors or charity trustees and are not allowed to retain membership of professional bodies.

It is therefore crucial to take professional advice as soon as there is even the slightest inkling of financial difficulties within your business. If you are worried about anything, why not talk in the first instance on an informal basis to your bookkeepers? They'll be able to give you an idea as to whether it's time to talk to insolvency experts or perhaps look at company rescue solutions.

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