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.

Wrongful Trading

The legal interpretation of wrongful trading is concerned with insolvency not fraud. Directors have a duty to be aware of their company's financial position, meaning that to claim they did not know the company was insolvent is not a defence.

This is best illustrated by the Insolvency act sec. 214 (2b) 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".

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 no 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.

When Does a Company Become Insolvent?

There can be no argument that a company has become insolvent if total net assets and therefore its equity has gone into deficit. However insolvency generally arrives sooner than this.

If you follow the link to the example of a Figurewizard balance sheet forecast you will see net current assets, subtitled "working capital". Here if the total value of cash, plus cash convertible assets such as accounts receivable and stock in trade (current assets) are less than than the value of liabilities payable within one year (current liabiliities) then the company is technically insolvent.

Because this is a clear signal that the company's financial position will inevitably cause it to run out of cash, it would become imperative to plan to take action in order to resolve such a situation.

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 Cash Flow

Properly planning a business starts with ensuring that projected sales, margins overheads and investment will deliver not only success but financial security too. That means planning must ensure that the business will never run out of cash – That is what leads to insolvency regardless of profits.

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

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