Wrongful trading is a legal concept in the context of insolvency law, primarily in the United Kingdom, which deals with the responsibilities of company directors when a company becomes insolvent. It is important to note that the specific legal provisions and definitions related to wrongful trading may vary from one jurisdiction to another.
In the UK, wrongful trading is governed by Section 214 of the Insolvency Act 1986. Wrongful trading occurs when a company director continues to trade the company when they knew or should have known there was no reasonable prospect of avoiding insolvent liquidation and fails to take appropriate action to minimize potential losses to the company’s creditors.
Key points related to wrongful trading include:
- Insolvency: Wrongful trading typically arises when a company is insolvent, meaning it cannot pay its debts as they become due.
- Knowledge or Should Have Known: Directors are expected to understand the company’s financial situation reasonably. If they are aware, or if they should have been aware, that the company could not avoid insolvent liquidation, they may be liable for wrongful trading.
- Continuing to Trade: Wrongful trading usually involves the directors allowing the company to continue its business operations even when it is clear that the company is insolvent.
- Minimizing Losses: If it is determined that wrongful trading has occurred, the court may order the director(s) to contribute personally to the company’s assets to help satisfy its debts. The goal is to ensure that the director(s) do not exacerbate the losses suffered by creditors by continuing to trade when there is no reasonable prospect of recovery.
- Defenses: Directors can defend themselves against allegations of wrongful trading by demonstrating that they took all reasonable steps to minimize losses to creditors once they became aware of the company’s insolvency.
Wrongful trading is distinct from fraudulent trading, which involves knowingly carrying on a business intending to defraud creditors. Wrongful trading focuses on the director’s awareness of the company’s financial position and actions in response to that knowledge.
It’s essential for directors of financially troubled companies to seek legal advice and consider their obligations carefully to avoid potential liability for wrongful trading or other insolvency-related offenses. The laws and regulations regarding wrongful trading can be complex, and the consequences for directors can be significant, including personal liability for the company’s debts.