Wrongful trading

Poor cash flow may be a sign of a struggling business and in those circumstances directors need to proceed cautiously otherwise they could potentially find themselves in all sorts of trouble.

Directors of limited companies are not always aware that their personal assets could still be at risk if their business folds leaving a stream of creditors.

If it can be proven that a director ignored the warning signs his firm was about to fold and carried on trading whilst amassing debt, the director could be penalised out of their own pocket.  This is known as wrongful trading.  When a company goes under, the directors may be at risk of the liquidator bringing a claim against them under section 214 of the Insolvency Act 1986 alleging they have engaged in ‘wrongful trading’. If found liable, they may be ordered to make a contribution to the company’s assets.

What directors often fail to realise is that there is a lower burden of proof needed to prove wrongful trading than there is to prove fraudulent trading, which theoretically makes it easier for the liquidator to gain an order for wrongful trading.

That said, it is still a difficult claim to bring, but that won’t eliminate the risk of allegations being made which need investigating and rebutting.  This places directors in a tough position and there is evidence that some start insolvency proceedings before they are perhaps necessary.

If your business is in financial crisis you should:

1. Hold regular board meetings and report the commercial decisions of directors in full in the company’s minutes;
2. Ensure you have up-to-date information on your financial affairs – don’t wait for telltale signs such as a demand from a creditor, a winding up petition or notice from the bank of an interest payment; and...
3. Carefully monitor your lender’s financial compliance covenants.

As ever, seeking early legal advice is always a director’s best option.  Getting things wrong can be disastrous.