What is Wrongful Trading

In law fraudulent and wrongful trading are two entirely different matters. It is important for any company director to understand the difference.

Definition of Wrongful Trading

Trading while insolvent describes wrongful trading. Negative net assets in the balance sheet represnts positive insolvency, negative net current assets (working capital), cashflow insolvency.

In either event, it is the responsibity of the directors and shadow directors to take steps to ensure that creditors are paid on time. If not, the insolvency act allows for directors to lose their protection under limited liability. 

Wrongful trading concerns a directors' responsibilities towards ensuring that the financial position of a business will avoid the prospect of trading while insolvent. Ignorance is not a defence. This is best illustrated by sec. 214 (2b) of the the Insolvency act that states:

"…at some time before the commencement of the winding up of the company, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation."

Note the words "...ought to have concluded".

What is Insolvency

There can be no argument that a company has become insolvent if by the end of its financial year net assets / equity are in deficit but what really matters is the point at which insolvency occurred and what if anything was done about it.

The balance sheet is key. If net assets or net current assets fall into deficit, action must be taken to ensure the business will have access to enough cash to continue to pay its way until solvency has been restored.

The Companies and Insolvency acts.

All lilmited companies are subject to the Companies act 2006. Directors' responsibilities under the act include their statutory duties towards protecting the best interests of the company and its members.

Crucially that changes at the point at which a company becomes insolvent. The responsibilities of directors then change from protecting its members under the Companies act to protecting its creditors under the Insolvency act.

As ignorance is not a defence, any director is well advised to plan and forecast the financial performance of the company (which is what Figurewizard makes possible) for the financial year ahead to reasonably conclude there will be no immediate risk or expectation of insolvency.

Contribution Orders under Wrongful Trading

A liquidator who is of the opinion that there is a case to answer in respect of wrongful trading can apply to a court for an order requiring individual directors of the company to make financial contributions towards the creditors of the company. 

The scale of contributions are decided by the court and depending on perceived culpability will range from the nominal to substantial. Persons who have not been appointed as directors but who are regarded by the court as having acted as such (shadow directors) can also be ordered to make contributions.

Wrongful Trading and Financing.

It is the case that a company with negative working capital can still argue that it is not insolvent if it has sufficient financing to enable it to continue to meet its liabilities.

Such financing however will have to be long term if it is to be credible. Loans that are repayable within a year must always be disregarded as their due dates make them short term financing (i.e. payable 1 year or less) which is already contributing to the insolvent position.

It should be noted that bank overdrafts are also considered to be short term financing. That is because overdrafts are repayable on demand and cannot therefore ever be regarded as long term financial arrangements.

The links below will take you to important working (interactive) examples showing hiow this can be done using Figurewizard.

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