Wrongful trading: FAQs
This article is based on UK law.
Wrongful trading
In cases of insolvent liquidation, a director or shadow director
can be required to contribute towards the debts or liabilities of a
company. This provision does not merely apply to “trading”
activity: any act, or failure to act, that either increases or does
not minimise losses to creditors can lead to liability.
The level of personal contribution will be determined by the
court; it will reflect the extent to which the company’s assets
have been depleted by the director’s conduct.
A court may make a contribution order if a liquidator can
show that before winding-up began the person knew or ought to have
concluded that there was no reasonable prospect of the company
avoiding insolvent liquidation. The only defence open to a director
in these circumstances will be that they took every step they could
to minimise the potential loss to a company’s creditors. The onus
will be on the director to prove this defence.
What if I resigned from the company. Will I still be
liable?
Resigning will not, by itself, remove liability. In some
circumstances, directors will be liable for all debts incurred up
to their resignation.
Directors who resigned knowing insolvent liquidation was
inevitable will, in principle, only be “safe” if they can show they
acted on that knowledge – i.e. took steps to protect their
interests and those of creditors. They must have tried to persuade
the other directors to follow what they believed to be the right
course, perhaps using the threat of resignation as a negotiating
tool. They must have expressed their views at a board meeting,
preferably after producing a reasoned paper for the board, and made
sure the minutes accurately recorded their views. In other words,
the resignation must be capable of being seen as a response to a
refusal to listen – the last resort of a responsible director.
A director who resigns in an attempt to avoid any future
liability but continues to be involved with the management of the
company as a shadow director may still be liable.
What standards will I be judged by?
In the first instance, a director is judged by the standards of
the “reasonable” director. This means they will be deemed to have
the general knowledge, skill and experience that can be reasonably
expected of a person carrying out the functions of a director. The
mere fact that their own knowledge, skill and experience were
inadequate for their role cannot be relied on as a defence. On top
of that basic standard, a director will also be judged against the
general knowledge, skills and experience they in fact possess.
Judgments about the extent of these standards will be made case by
case, taking into account both objective and subjective criteria.
Directors with professional qualifications (e.g. accountants) may
find that their professional body takes disciplinary action or at
least seeks explanations of a director’s conduct, particularly in
relation to the signing off of previous years’ accounts and the
concept of a “going concern”.
How are shadow directors defined?
The key point is that shadow directors can be liable
for wrongful trading and be ordered to contribute to the assets of
an insolvent company. A holding or parent company can be classed as
a shadow director in certain circumstances; so can private equity
houses and banks.
Liability arises when the shadow director’s influence extends to
the whole board. For example, a dominant investor can be a shadow
director if the whole board, and not just the investor’s
representative on the board, was acting on its directions.
Are non-executives liable?
As their involvement may be critical when a company runs into
difficulties, non-executive directors may find that they are as
much at risk under the wrongful trading provisions as executive
directors. This will depend on the circumstances of each case, but
getting good advice early is key.
What will the court do?
Once liability is established, the court can order a director to
“make such contribution (if any) to the company’s assets as it
thinks proper”. It has complete discretion over the amount. In each
case, it is likely to assess the difference between the actual net
deficiency to creditors and what it would have been on the date
when liquidation first appeared inevitable.
The court should also take account of the level of culpability
of a particular director and recognise that other factors may have
caused the deterioration in the net deficiency.
If it makes a declaration under the wrongful trading provisions,
the court may also make an order to disqualify the director from
being in any way concerned in the management of a company for a
minimum period of two years.
What can I do to protect myself?
In summary, it is to act responsibly and with integrity. Take an
active role in monitoring the company’s financial performance and
never be afraid to raise concerns about solvency. Make sure what
you say, and what you are told in response, are recorded. If fellow
directors refuse to accept that the company is wrongfully trading,
take no part in incurring further indebtedness.
Insist that any advice you and the board take is noted. It may
be vital in disproving allegations by a liquidator and show that
you and your fellow directors had reasonable grounds to believe
insolvency could be avoided.
