With the “Credit Crunch” slowing the economy it is an appropriate time to consider the liability of Directors for what is usually described as “Wrongful Trading”

When a Company goes into insolvent liquidation the Court has power, on the application of the Liquidator, to declare that a person who is, or was, a Director of the Company, is to be liable to make a contribution to the Company’s assets (Section 214 of the Insolvency Act 1986).

The basic requirement for this Section to apply is that “at some time before the commencement of the winding up of the Company that person knew or ought to have concluded that there was no reasonable prospect that the Company would avoid going into insolvent liquidation”.  However, the Section provides that the Court shall not make a Declaration under this Section with respect to any person if it is satisfied that (after he/she knew, or ought to have concluded, that there was no reasonable prospect of avoiding insolvent liquidation), that person took every step with a view to minimising the potential loss to the Company’s creditors, as he ought to have taken. 

In Section 214 “Director” is specifically stated to include a Shadow Director*. 

If the Directors consider that a Company is getting into financial difficulties it is important to have up-to-date financial information so that they can keep the Company’s financial position under review. 

If insolvent liquidation cannot be avoided then Directors must act “with a view to minimising the potential loss to the Company’s creditors”.  What action they will need to take will depend very much upon the Company’s individual circumstances and Directors should seek legal advice or the advice of an Insolvency Practitioner. 

When the Court judges whether a Director should have concluded that insolvent liquidation  cannot be avoided or should have taken certain steps the Court has to assume that the conclusions he ought to reach and the steps he ought to take are those which would be reached or taken by a reasonably diligent person having the general knowledge, skill and experience that may be reasonably be expected if a person carrying out the same functions as that director as well as the general knowledge, skill and experience he actually has. 

Directors should carefully record their consideration of these issues and decisions taken.

How we can help

In the past the general advice was often to cease trading if the Company was insolvent, but following the Enterprise Act and the encouragement of a “rescue culture” it may be more appropriate for a Company to go into administration to try to preserve the Company’s goodwill.  If administration is the appropriate course an Insolvency Practitioner will be required.

However, the danger with this ‘rescue culture’ is that where Directors decide, even on full consideration of the relevant issues, that the Company should continue trading they will still be put under the spotlight if things go wrong. This approach may therefore be seen as encouraging Directors to put themselves at more of a risk and unless they act with full and proper advice, they may be exposing themselves to a greater risk of liability. Until full and proper legal advice or other professional advice has been obtained, to minimise Directors potential liability the Directors should, so far as possible, avoid incurring any further liability to creditors.

* NOTE 1:  A Shadow Director is defined as “a person in accordance with whose directions or instructions the Directors of the Company are accustomed to act (but so that a person is not deemed to be a Shadow Director by reason only that the Directors act on advice given by him in a professional capacity)”. 

NOTE 2:     This note is only intended to give a broad overview of the law relating to ‘wrongful trading’ and should not be used as a basis for action except to seek further advice which will depend very much on the particular circumstances of your Company.

If you require advice about the issues touched in this note, please contact either: 

Alexa Beale

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