Wrongful Trading: A Director’s Guide to Duties and Avoiding Liability

What Is Wrongful Trading?

Under Section 214 of the Insolvency Act 1986, wrongful trading occurs when directors continue to trade despite knowing (or reasonably ought to have known) that there is no reasonable prospect of avoiding insolvency. Unlike fraudulent trading, wrongful trading does not require intent to deceive, it often arises from poor judgment or a failure to act.

If proven, a liquidator can pursue directors personally to contribute to the company’s debts, making this one of the most serious risks for directors during financial distress.

When Can Wrongful Trading Occur And When Do Directors Need to Consider Creditors Interests?

In the fairly recent case of Sequana (BTI v Sequana [2022] UKSC 25) the issue of directors’ duties was reviewed, and some extremely helpful guidance was provided by the Courts.

It should be noted that when a Company is solvent, the duties of the directors are solely to the Company, i.e. its shareholders, to make a profit and hence a return to those shareholders. Directors are therefore free to be entrepreneurial in nature.

However, when a Company is insolvent or bordering upon insolvency, the directors also have a duty to the creditors to make sure that the creditors exposure is limited and their interests are protected.

The key issue therefore is when does this “creditor duty” arise. This was dealt with comprehensively in Sequana, which:

1. Affirmed the existence of the duty to consider the interests of creditors;

2. Clarified that it is engaged where the directors know, or ought to know, that the company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable;

3. Explained that the interests of creditors are engaged, and will diverge from those of the shareholders:

• • if liquidation is inevitable, (in this scenario creditors' interests are paramount); and,
  • prior to that, there will be a fact sensitive balancing exercise to weigh up the competing interests of creditors and shareholders by reference to the degree of distress.

What Are the Duties of Directors When This Happens?

When insolvency is likely, or has occurred, directors’ duties shift from shareholders to creditors. Key responsibilities will include:

• Ceasing reckless trading: Avoid incurring new debts you know cannot be repaid.
• Preserving company assets: Prevent dissipation of value that could benefit creditors.
• Seeking professional advice: Engage insolvency practitioners or legal advisors early.
• Maintaining accurate records: Document board decisions, financial assessments, and advice received.
• Acting collectively: Ensure all directors are involved in decision-making and understand their obligations.

What Liabilities Could the Directors Face?

Section 214 of The Insolvency Act 1986 says that if the directors knew or should have known that the Company was going to go into liquidation, but did not take action at that time, and continued to trade, then any increase in the deficiency to creditors will become a personal liability of the directors.

A wrongful trading claim therefore has two parts:

1. When did the directors know, or should have known, that there was no reasonable prospect of the Company avoiding insolvent liquidation.

2. What was the increase in deficiency to creditors between, when the directors should have put it into liquidation, and when they did.

In respect point 1, Sequana provides some useful guidance and makes clear that the bar for this is very high, and it is engaged when the directors no

longer have a rational basis for continuing to trade, and insolvency is inevitable.

In respect of point 2, the “knowledge date” first needs to be established, which is the date that the directors knew, or ought to have known, that insolvent liquidation was unavoidable. Any liquidator would then need to determine what the deficiency to creditors was as that date.

This figure is then compared to the actual deficiency as at the date of the actual liquidation. If the deficiency is higher at the actual date of liquidation, then the quantum of the claim against the directors is the difference between these two amounts.

Therefore, by definition, once of the best defences against wrongful trading is to ensure that the deficiency to creditors does not increase. Even if it could be established that directors should have wound up the Company sooner, if the deficiency has not increased, there is no claim against the directors, or rather the quantum of the claim is nil, which amounts to the same thing.

Is There a Defence Against Wrongful Trading?

Section 214 (3) of The Insolvency Act 1986, says that the Court shall not make an order against the director if it is satisfied that they took every step to minimise the potential loss to the creditors.

This was looked at in the recent case of BHS Group Limited [2024] EWHC 1417 (Ch). In that case the judge commented that it is not enough for a director to show they continued trading with the aim to reduce the net deficit of a company; the burden is on the directors to demonstrate that they intended to minimise the risk of loss to individual creditors, and that they took every step to do so.

The court also said that while what constitutes “every step” will depend on the facts, “if the director does not take insolvency advice or consider whether insolvency proceedings should be taken immediately, it will be more difficult for the directors to demonstrate that they properly considered whether continuing to trade would reduce the deficiency, and what the risks were to individual creditors”.

However, it is not sufficient to rely on the fact that the directors took professional advice. It is the duty of the directors themselves, and not their advisers, to decide whether there is a reasonable prospect of avoiding insolvent liquidation.

Practical Steps

The first obvious step would be to take professional advice from a licensed insolvency practitioner, or an insolvency specialist solicitor.

Other practical steps would include:

1. Ensure that the Board of Directors regularly monitor the Company’s cashflow, perhaps every fortnight, or monthly at a minimum.

2. The information relied upon should be retained, the discussions that the directors have, and the conclusions they reach, should be recorded in formal board minutes.

3. The directors should ensure that they regularly monitor their duties and assess whether the Knowledge Condition could be satisfied.

4. Regularly take professional advice. However,  it is the duty of the directors to form their own view on when the Knowledge Condition arises. This cannot be delegated to professional advisors.

5. The directors should record exactly what steps they are taking to minimise the risk of loss to creditors.

6. Ensure that each director informs themselves fully of the affairs and dealings of the Company, including receiving and carefully   considering appropriate management information. That management information should also be critically reviewed as to its accuracy and that it can be relied upon.

7. The directors should also consider Directors & Officers insurance cover.

8. If the situation is deteriorating and insolvency is looking inevitable, take prompt action to cease to trade and take formal insolvency action.

Conclusion

Wrongful trading is not about punishing directors for business failure, it is about holding them accountable for failing to act responsibly when insolvency was inevitable. By recognising warning signs, prioritising creditors, and documenting prudent steps, directors can significantly reduce the risk of being pursued by a liquidator.

If you are concerned about wrongful trading and would like a meeting to discuss your situation please do not hesitate to contact us on 01326 340 579 or email us at help@purnells.co.uk.