Wrongful Trading

A wrongful trading claim can be brought against directors, or former directors, of insolvent companies. The offence of wrongful trading does, therefore, arise in a corporate insolvency context and is a statutory offence under sections 214 and 246ZB of the Insolvency Act 1986 (“IA 1986”), regarding liquidations and administrations respectively.

Wrongful trading claims are brought by insolvency office-holders pursuant to the aforementioned provisions of the IA 1986 with a view to obtaining an order that the director(s) or former director(s) of a company must contribute to the insolvent company’s assets for the benefit of the company’s creditors.

A claim for wrongful trading can be brought against a director or shadow director of a company if a company has entered insolvent liquidation and, before the administration or liquidation of that company commences, the director knew or ought to have concluded that there was no reasonable prospect that the company would avoid entering insolvent liquidation or administration (s. 214(2)(b) IA 1986). The individual must have been a director or shadow director of the company at the time they had or ought to have had the requisite knowledge (s. 214(2)(c).

Importantly, if a director who knew that their company had no reasonable prospect of avoiding insolvent liquidation or administration took every step possible with a view to minimising the potential loss to the company’s creditors (s. 214(3) IA 1986), it would be a defence to a wrongful trading claim and a court would not make an order against the director.

Should you require assistance in bringing or defending wrongful trading proceedings, or for advice on the risks of such proceedings being brought and/or any alternative options available, please contact our team for an initial discussion.

Both liquidators and administrators can bring claims for wrongful trading and can also assign wrongful trading claims to third parties, for example, a creditor.

Sections 214 and 246ZB IA 1986 are drafted such that a wrongful trading claim can only be brought against current and former directors of a company, as well as shadow directors of the company.

The individual against whom the wrongful trading claim is made must have been a director of the company at the time that the individual knew, or ought to have known, that there was no reasonable prospect of the company avoiding insolvent liquidation or administration.

Importantly, an individual will only be liable under s. 214 IA 1986 if it can be shown, on a net basis, that the company is worse off as a result of the company continuing to trade.

A claim for wrongful trading is brought by way of an application notice.

In accordance with usual practice, a witness statement in support of the application, together with any supporting documents enclosed within an exhibit, should be filed with court and served on the respondent.

In order to ensure that the application is made properly and is procedurally compliant, we would recommend seeking legal advice and our Restructuring & Insolvency team is well placed to assist.

Directors liable of wrongful trading can be held personally liable for the company’s debts.  In such cases, the court will often order the director to make such a contribution to the assets of the company as the court thinks proper, which is usually a financial contribution for which the director is personally liable.

In considering the quantum of the contribution the director is ordered to make to the company’s assets, the court will consider:

• the increase in the net deficiency of the company’s assets from the time when the director first knew, or should have known, that there was no reasonable prospect of the company avoiding insolvent liquidation or insolvent administration, to the date of entering insolvent liquidation or insolvent administration;

• the loss to the company pursuant to s. 241(1) IA 1986; and

• the availability of a defence pursuant to s. 241(3) IA 1986.

A finding of wrongful trading may also expose a director to disqualification proceedings, resulting in a director’s disqualification order. If a disqualification order is made, it means the director who is the subject of the order is unable to act as a company director. The director would also likely to suffer damage to both their personal and professional reputation.

To bring a successful wrongful trading claim, the applicant must demonstrate the following elements to the satisfaction of the court:

1. The company has entered insolvent liquidation
2. The director knew or ought to have known before the commencement of the winding-up of the company that there was no reasonable prospect that the company would avoid going into insolvent liquidation or insolvent administration;
3. The director has not taken every reasonable step to minimise the loss to the company’s creditors; and
4. The individual was a director of the company at the time they had the relevant knowledge that the company would not avoid insolvent liquidation or insolvent administration.

There is no requirement to prove dishonesty for the purpose of bringing a wrongful trading claim, but the insolvency office-holder will need to evidence to the satisfaction of the court that the director engaged in wrongful trading and that the company’s creditors suffered a loss they would otherwise not have suffered but for the directors’ actions in continuing to trade the company.

If a wrongful trading claim is brought by the liquidator or administrator of a company, the recoveries from the claim will be distributed in accordance with the statutory waterfall of payments in an insolvency.

S214 IA 1986: “Wrongful trading”

• “Subject to subsection (3) below, if in the course of the winding-up of a company it appears that subsection (2) of this section applies in relation to a person who is or has been a director of the company, the court, on the application of the liquidator, may declare that that person is to be liable to make such contribution (if any) to the company’s assets as the court thinks proper.

• This subsection applies in relation to a person if—
  1. the company has gone into insolvent liquidation,
  2. 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 [or entering insolvent administration], and
  3. that person was a director of the company at that time.

• The court shall not make a declaration under this section with respect to any person if it is satisfied that after the condition specified in subsection (2)(b) was first satisfied in relation to him that person took every step with a view to minimising the potential loss to the company’s creditors as ([on the assumption that he had knowledge of the matter mentioned in subsection (2)(b)]) he ought to have taken.

• For the purposes of subsections (2) and (3), the facts which a director of a company ought to know or ascertain, the conclusions which he ought to reach and the steps which he ought to take are those which would be known or ascertained, or reached or taken, by a reasonably diligent person having both—
  1. the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company, and
  2. the general knowledge, skill and experience that that director has.

• The reference in subsection (4) to the functions carried out in relation to a company by a director of the company includes any functions which he does not carry out but which have been entrusted to him.

• For the purposes of this section a company goes into insolvent liquidation if it goes into liquidation at a time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of the winding-up.

(6A) For the purposes of this section a company enters insolvent administration if it enters administration at a time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of the administration.]

• In this section “director” includes a shadow director.

• This section is without prejudice to section 213.”

s246ZB IA 1986 Wrongful trading: administration:

• “Subject to subsection (3), if while a company is in administration it appears that subsection (2) applies in relation to a person who is or has been a director of the company, the court, on the application of the administrator, may declare that that person is to be liable to make such contribution (if any) to the company’s assets as the court thinks proper.

• This subsection applies in relation to a person if—
  1. the company has entered insolvent administration,
  2. at some time before the company entered administration, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid entering insolvent administration or going into insolvent liquidation, and
  3. the person was a director of the company at that time.

• The court must not make a declaration under this section with respect to any person if it is satisfied that, after the condition specified in subsection (2)(b) was first satisfied in relation to the person, the person took every step with a view to minimising the potential loss to the company’s creditors as (on the assumption that the person had knowledge of the matter mentioned in subsection (2)(b)) the person ought to have taken.

• For the purposes of subsections (2) and (3), the facts which a director of a company ought to know or ascertain, the conclusions which the director ought to reach and the steps which the director ought to take are those which would be known or ascertained, or reached or taken, by a reasonably diligent person having both:

1. 1. the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company, and
   2. the general knowledge, skill and experience that that director has.

• The reference in subsection (4) to the functions carried out in relation to a company by a director of the company includes any functions which the director does not carry out but which have been entrusted to the director.
• For the purposes of this section:
  1. a company enters insolvent administration if it enters administration at a time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of the administration;
  2. a company goes into insolvent liquidation if it goes into liquidation at a time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of the winding-up.

• In this section “director” includes shadow director.

• This section is without prejudice to section 246ZA.”