Wrongful Trading – Directors Beware!

Caution Directors

Despite the FTSE 100 hitting record highs for years, in the real world many SMEs continue to struggle with cash-flow in the continuing difficult economic climate. Some companies will inevitably go insolvent as a result.  No one likes to plan for the worst, but Directors need to.

‘Wrongful Trading’ (s.214 Insolvency Act 1989) is a type of action that a liquidator can bring against a Director personally where the Director knew or ought to have known that insolvency was likely without reasonable prospects of avoiding insolvency and continued to trade despite this.

Directors should therefore take protective and prudent action to monitor cash-flow carefully and keep a keen eye on the business in order to avoid or minimise the risk of claims being made against them personally, should their company eventually go into insolvency.   The good news is that Directors can use a statutory defence to wrongful trading (s.214(3) Insolvency Act 1989) provided that they take ‘every step’ to minimise the potential loss to creditors.  Each case will, of course, turn on its facts.

Whilst the Insolvency Act 1989 does not list what “every step” is, recent case sets out some useful pointers which Directors should be mindful of, especially if they recognise their company is loss making or in financial trouble:

  • Seeking professional advice early on and on a continuing basis e.g. from legal, insolvency or accounting professionals;
  • Formulate a business plan with the advice of experts/professionals;
  • Monitor the business accounts, ensure that accounts are continuously up to date and that they are readily available;
  • Always keep your creditors informed of the business’ position.

By taking these steps, the company directors can minimise the risk of claims made against them personally by liquidators seeking to obtain a contribution towards the company’s assets.   Following these steps prior to insolvency can also help businesses that may be struggling to improve their financial situation, helping them to manage their business effectively and may ultimately help them to avoid insolvency.