In 2020, under the Corporate Insolvency and Governance Act, existing wrongful trading provisions were suspended.
This was to allow businesses to continue trading throughout the pandemic without the threat of company directors being held personally liable should the business become insolvent.
Essentially, during the pandemic, a number of businesses that would otherwise be viable found themselves in financial difficulty.
As such, the wrongful trading provisions were amended to provide that company directors and other responsible office-holders are “not responsible for any worsening of the company’s financial position”.
However, these temporary provisions came to an end in the summer, which means that the issue of wrongful trading is once again front and centre in everyone’s mind.
If you are concerned about wrongful trading in the wake of the coronavirus pandemic – especially with the new powers given to the Insolvency Service to tackle unfit directors – here’s everything you need to know about wrongful trading, how it works, and what steps you need to take to avoid it...
What is wrongful trading?
First things first, what is wrongful trading anyway?
The Insolvency Act 1986 has several provisions to protect creditors. Specifically, section 214 on wrongful trading requires company directors to assess the likely prospect of avoiding insolvency.
Wrongful trading occurs when a company trades “beyond the point at which insolvency proceedings were inevitable”, leaving those responsible liable to legal action if there is evidence that creditors have incurred losses as a result. According to the 1986 Act, it occurs when company directors have continued to trade when:
- “They knew, or ought to have concluded that there was no reasonable prospect of avoid insolvency liquidation”
- They did not take “every step with a view to minimising the potential loss to the company’s creditors”
Essentially, directors must be found to have acted reasonably and responsibly in the time prior to the company’s insolvency to avoid wrongful trading accusations, and they must always have put creditors’ interests first, rather than worked for their own benefit.
How is wrongful trading determined?
When a company becomes insolvent, the insolvency practitioner will determine if wrongful trading has occurred by assessing the director’s conduct. Examples of behaviour or actions they will be looking for include the following:
- Not filing annual returns at Companies House.
- Not filing annual or audited accounts at Companies House.
- Failing to pay PAYE, NIC and VAT and building up arrears.
- Taking excessive salaries that the company cannot afford.
- Repaying a directors’ loan while other companies were not paid.
- Trading whilst insolvent.
- Taking credit from suppliers when they couldn’t pay creditors on time.
- Taking deposits from customers knowing that the product wouldn’t be delivered.
- Wilfully piling up debt.
If you have engaged in any of the above behaviour, you will be at risk of being accused of wrongful trading.
How to avoid wrongful trading
Quite simply, the best way to avoid wrongful trading accusations is to always act lawfully and in the best interests of your creditors.
If you become aware that your company is insolvent, you must take steps to minimise creditor losses right away. You should also contact an insolvency practitioner as soon as the early warning signs of insolvency show so that they can advise the best course of action.
Finally, it is also good practice to maintain communication with your creditors and keep track of any correspondence and resulting action, so you have a record of what has happened when.
Key points for directors
As we all begin to navigate the new normal, including the withdrawal of government support measures and the exit from lockdown restrictions, it’s important to be on you’re A-game and ensure you are completely brief on the current financial position of your company.
Key ways to do this include the following:
- Holding regular boarding meetings to consider the financial and trading horizon and take notes of any decisions made.
- Maintaining detailed financial forecasts so you can accurately evaluate the financial position and viability of the business.
- Ensuring you have a clear plan of action to deal with any potential cash flow issues.
- Keeping a close eye on your cash flow forecast and how things are progressing.
- Seeking advice early should your business show signs of distress.
- Ensuring that no creditors are given preferential treatment.
What to do if you are concerned about wrongful trading
If you remain concerned about wrongful trading or are aware that your business is struggling financially, it’s imperative to consult insolvency experts and try to act pre-emptively.
There are many options you could try to turn things around and take back control, including time to pay arrangements, company voluntary arrangements, pre-pack administration or even a creditors’ voluntary liquidation if you are left with no further options but to close the business down.
However, above all, it’s important to demonstrate that you have always acted responsibly and appropriately – and your insolvency practitioner will be able to guide you further on this.
How McAlister & Co can help
At McAlister & Co, we are business rescue and recovery experts. There’s nothing we don’t know about how to improve the financial position of your business, whilst all the while making sure you are acting in the best interests of your creditors.
So, if you are concerned about wrongful trading in the wake of the COVID-19 pandemic, contact our team today for help and advice on what to do next.