Wrongful and Fraudulent Trading: Understanding Directors’ Liability in Corporate Bankruptcy

Understanding Directors' Liability in Corporate Bankruptcy

UK law places significant responsibilities on company directors regarding corporate insolvency, especially during periods of financial distress. When a company faces bankruptcy, directors must ensure they act in the best interests of creditors.

However, if they allow the company to continue trading while insolvent, they risk being personally liable for wrongful or fraudulent trading. These are serious offences under the Insolvency Act 1986, and directors must understand the legal implications, including civil liability in corporate bankruptcy.

We explore what constitutes wrongful and fraudulent trading, directors’ liabilities, and how solicitors can defend those accused of such actions.

Wrongful Trading Under the Insolvency Act 1986

Wrongful trading occurs when a director continues to trade despite knowing or having reasonable grounds to believe that the company cannot avoid insolvent liquidation. According to Section 214 of the Insolvency Act 1986, directors can be personally liable if they fail to take appropriate steps to minimise the loss to creditors once they become aware of the company’s insolvency. It often leads to significant civil liability in corporate bankruptcy situations.

The critical element in wrongful trading cases is the point at which the director “knew or ought to have known” that insolvency was unavoidable. Courts will scrutinise the director’s actions during this period to determine whether they acted reasonably and responsibly.

Directors cannot simply rely on wishful thinking or unfounded optimism; they are expected to take decisive actions, such as halting trading, seeking professional insolvency advice, or exploring rescue options like administration.

Legal Consequences

Directors found guilty of wrongful trading can face severe financial penalties. The court may order the director to make a personal contribution to the company’s assets to compensate creditors. It means that directors can be personally liable for the company’s debts, effectively losing limited liability protection and facing civil liability in corporate bankruptcy.

Additionally, directors guilty of wrongful trading may face disqualification under the Company Directors Disqualification Act 1986, preventing them from holding any directorial position for up to 15 years.

Fraudulent Trading Under the Insolvency Act 1986

Under Section 213 of the Insolvency Act 1986, fraudulent trading is a more severe offence than wrongful trading. It involves deliberately continuing to trade with the intent to defraud creditors or for any fraudulent purpose. This applies to directors and other company officers who knowingly engage in fraudulent activities, which not only brings criminal implications but also civil liability in corporate bankruptcy.

Unlike wrongful trading, which focuses on whether the director acted reasonably in light of the company’s insolvency, fraudulent trading requires evidence of intentional deceit. For example, directors might deliberately incur debts they know the company cannot repay or mislead creditors about its financial health.

Legal Consequences

If fraudulent trading is proven, the penalties are even more severe. Directors may be personally liable for all the company’s debts, not just the amounts owed to specific creditors. In addition to financial liability, directors can face criminal charges, leading to imprisonment.

Fraudulent trading can also result in disqualification as a director for up to 15 years, with the possibility of a prison sentence of up to 10 years under Section 993 of the Companies Act 2006. Fraudulent trading significantly increases the scope of civil liability in corporate bankruptcy.

How Solicitors Can Defend Directors

Defending directors accused of wrongful or fraudulent trading requires thoroughly examining the facts and circumstances surrounding the company’s financial difficulties. Solicitors play a crucial role in building a defence, focusing on proving that the director acted reasonably and responsibly.

Challenging the Timeline of Insolvency

One of the primary defence strategies is to challenge the timeline of insolvency. Solicitors scrutinise the financial records and argue that the director did not “know or ought to have known” the company was insolvent when it continued trading. It can involve presenting evidence of legitimate efforts to keep the company solvent, such as securing additional funding or exploring restructuring options.

Proving the Director Acted in Good Faith

In wrongful trading cases, solicitors can argue that the director acted in good faith and took reasonable steps to minimise losses to creditors. It could include reducing overheads, negotiating with creditors, or seeking professional insolvency advice. Courts are often more lenient when directors can demonstrate they acted responsibly, even if the company eventually became liquidated. Acting in good faith can sometimes reduce the civil liability in corporate bankruptcy cases, though it does not entirely remove the risks.

Defending Against Fraudulent Trading Allegations

In fraudulent trading cases, the defence focuses on disproving the element of intent. Solicitors may argue that the director did not knowingly act with the intent to defraud creditors and that any misleading or misjudged actions were the result of poor business decisions rather than fraudulent intent. The burden of proof lies with the claimant, meaning they must demonstrate beyond reasonable doubt that the director acted with dishonest intent, which is often challenging to prove.

Negotiating Settlements

In some cases, solicitors may advise negotiating a settlement with the liquidator or administrator to avoid lengthy court proceedings. It could involve a financial settlement to compensate creditors, thereby mitigating personal liability. Solicitors skilled in insolvency law can often negotiate favourable terms for directors, potentially avoiding disqualification, criminal penalties, or overwhelming civil liability in corporate bankruptcy.

Conclusion

Wrongful and fraudulent trading are serious offences under UK law, with significant financial and legal consequences for directors. The key difference between the two lies in intent—wrongful trading focuses on negligence, while fraudulent trading requires evidence of deliberate fraud. Directors accused of either offence face the prospect of personal liability, disqualification, and even imprisonment in severe cases.

However, directors can mitigate these risks with the right legal defence. Solicitors play an essential role in defending against wrongful and fraudulent trading allegations, challenging timelines, and proving that directors acted in good faith.

In a complex area of law like insolvency, early legal advice is crucial to minimise exposure and protect directors’ personal and professional futures, particularly regarding reducing civil liability in corporate bankruptcy.