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Wrongful trading – the risks facing directors when the company is insolvent Wrongful trading – the risks facing directors when the company is insolvent

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May 24

Wrongful trading – the risks facing directors when the company is insolvent

Written by Jonathan Mortimer
Partner

DDI: 01423 726608
M: 07850 993952
E: jonathan.mortimer@raworths.co.uk

A guide for directors: what you should know before accepting the appointment.

This is article 8 from a series of 10 written by Jonathan Mortimer, a Dispute Resolution Partner at Raworths. The guide is written from the viewpoint of where things may become contentious and involve legal proceedings. It presents a snapshot of the some of the legal issues which impact upon directors. It is not a substitute for taking specific legal advice on a particular set of circumstances.

8. Wrongful trading – the risks facing directors when the company is insolvent

When a company’s finances take a turn for the worst, a director has to be aware more than ever of their duties.  Perhaps the company only pays suppliers when letters of claim are received, legal proceedings are frequently issued by customers or creditors even serve a statutory demand with a view to winding-up the business.

It may also be the case that the company’s management accounts are showing an insolvent balance sheet or the company is delaying filing its accounts at Companies House to avoid market rumours of financial problems.  In such circumstances, a director must make a judgment call as to whether the business can safely continue to trade or whether the company should be placed into a form of insolvency.

Get the decision wrong and the director can have a personal liability for what is known as wrongful trading.  The legal test is whether you as a director knew or ought to have come to the conclusion that there was no reasonable prospect that the company would avoid going into a liquidation or administration.

If the company then falls into that insolvency, any liquidator or administrator has the right to ask a court to direct that a director has to make a contribution to the company’s assets.  That contribution can be equal to the additional loss caused to the company by prolonging its trading when insolvency was effectively inevitable.

Importantly, no dishonesty as such is required merely a misjudgement.

The only defence available is that the director took every step to minimise the potential loss to creditors.  These decisions can be very difficult for directors.

Understandably, directors do not want to expose themselves to personal liability but pulling the plug too early not only makes the loss of the company in its present form guaranteed but also premature action could actually damage the interests of creditors who might have received full payment long term.

So how do you avoid not only the company having financial difficulties but also yourself as a director personally?  Here are some key points:

  • make sure there are regular board meeting in which the financial problems are properly discussed and addressed
  • take professional advice which could include a lawyer, an accountant, or an insolvency practitioner
  • put in place a workable and realistic restructuring plan
  • make sure that your decisions and advice received are fully recorded in writing.

Some directors may ask:  “what is to stop me simply resigning and walking away from the problem?”  The answer is that it is not always the solution.

A director can still be on the hook for wrongful trading for the period in which they were a director.  If you do have doubts as to the financial standing of the company and your fellow directors do not agree with you then the best advice may well be to resign, curtail your potential liability and leave it to the remaining directors to make difficult decisions as to the company’s future.

A guide for directors: What you should know before accepting the appointment.

Links to other articles in the full series can be found here when they are published:

  1. You have been appointed – but what kind of director are you?
  2. The top 5 things directors do wrong – including the consequences
  3. The Board of Directors cannot agree anything
  4. Shareholders – the director’s ultimate master
  5. Directors’ loan accounts – the best overdraft you can get?
  6. Personal liability – so much for limited liability
  7. Becoming a non-executive director – the risk free option?
  8. Wrongful trading – the risks facing directors when the company is insolvent
  9. The wound-up company – it’s not all over yet for directors
  10. The phoenix that rises from the ashes – the company which refuses to die

Jonathan Mortimer has significant experience dealing with contentious company matters including the issues covered in this guide. Jonathan can be contacted by email at jonathan.mortimer@raworths.co.uk or telephone 01423 566 666. Raworths is based in Harrogate, North Yorkshire.

Published on 1 May 2024

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