Wrongful trading and fraudulent trading can both be issues of concern to companies potentially facing liquidation. But there’s a very significant legal difference between them.
So, what exactly is wrongful trading?
Defined as a civil offence under Section 214 of the Insolvency Act 1986, wrongful trading constitutes trading when company directors “knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation” and where they did not take “every step with a view to minimising the potential loss to the company’s creditors”.
In other words, to avoid accusations of wrongful trading, directors must be able to demonstrate that they acted reasonably and responsibly at all times, and that they always put creditors’ interests before their own.
Should they not be able to demonstrate this, they can be held personally liable for the company’s debts, in a 180-degree turnaround from the usual position governing limited companies. In more serious cases, the individuals involved can be disqualified from being a director or even criminally prosecuted, though the latter is relatively uncommon.
What can lead to accusations of wrongful trading?
The liquidator, who must be a qualified insolvency practitioner, has the responsibility of deciding whether a company has traded wrongfully. If such an accusation is not brought within six years of liquidation, then the company’s directors are in the clear.
A number of actions might contribute to the liquidator deciding that wrongful trading has taken place.
Not filing annual returns or annual accounts at Companies House would certainly be a major red flag, as would failing to pay PAYE and NIC on time. Similarly, any delinquency in making VAT payments would tend to suggest that the directors were not trading in a responsible manner.
More subtly, the authorities take a dim view of directors continuing to draw substantial salaries from failing businesses or prioritising directors’ loans over paying creditors.
Equally, arranging credit with suppliers when there is little chance of paying the debt is seen as irresponsible behaviour, bordering on the fraudulent, as is taking deposits from customers who may not subsequently receive their goods.
However, there is a much more serious offence called fraudulent trading, which is a criminal rather than civil offence.
So, what exactly are the differences?
All about fraudulent trading
The key difference between wrongful and fraudulent trading is intent on the part of the directors to deceive customers or creditors. It is worth pointing out that in law “intent” is demonstrated by a person’s actions: the law does not attempt to investigate their actual desires or motivations.
In other words, if your behaviour suggests that you had fraudulent intentions, then you would be guilty of fraudulent trading even if you had not deliberately set out to defraud anyone.
It is also worth noting that an extensive investigation would need to take place before charges of fraudulent trading could be brought. Following the investigation, the Insolvency Service (an executive agency of the Department for Business, Energy and Industrial Strategy) would need to satisfy itself that the directors had deliberately maximised the inflow of money into the company despite being aware that it was on its last legs.
In general, an accusation of fraudulent trading will follow an allegation of wrongful trading, so it is not possible to have traded fraudulently without also having traded wrongfully.
As might be expected, the penalties for fraudulent trading are significantly more severe, and always involve a criminal record upon conviction. In addition to a fine or prison sentence, directors can expect a lengthy disqualification and to be held liable for a substantial proportion of the failed company’s debts.
Needless to say, both wrongful and fraudulent trading can have a huge impact on your life, finances and career. So what can you do if you are a director of a company that appears to be heading inexorably towards bankruptcy?
How to avoid wrongful and fraudulent trading
If your company is in a precarious financial position, your best option is to arrange a Company Voluntary Arrangement (CVA).
When you take out a CVA, you remain in control of your business rather than handing the reins over to a receiver. What’s more, you receive protection against legal action for your debts while you, with our expert assistance, attempt to negotiate a settlement with your creditors.
In general, most creditors will accept some proportion of what they are owed, expressed as a number of pennies in the pound, to discontinue legal action against you and allow you to remain in business. They have a strong motivation to do so as they are guaranteed to receive a portion of the debt, whereas as unsecured creditors they could wind up with nothing if the company goes bust.
At the same time, you can consolidate all your payments to different debtors into a single monthly payment, which will make financial planning much easier and free up money to boost your cash flow.
More importantly, you get time to turn the business round, which could mean refocusing your marketing efforts, shedding excess staff, moving to smaller premises or changing suppliers for key contracts to cut costs.
If it’s primarily tax debts that you are tripping you up, we can assist you in negotiating a Time to Pay (TTP) arrangement with HMRC. This can cover all aspects of your outstanding tax: corporation tax, VAT or PAYE, and will usually result in a payment plan over 12 months.
In general, it is only possible to have one Time to Pay arrangement at any one time, and HMRC will not hesitate to bankrupt you if you fail to make any of the agreed payments. So, it’s important to be realistic upfront about what you can afford.
Of course, HMRC is under no obligation to agree a TTP arrangement and will not do so unless you can present a convincing argument. They will particularly want evidence that the business is climbing out of a trough rather than in an inexorable decline and will expect you to show real understanding of the severity of your situation.
Cash flow crises need not mean the end for your business
When you’re faced with bills you cannot pay, it’s easy to simply carry on and put your head in the sand. As you can see, this is absolutely the worst thing you can do.
By continuing to pretend that everything will improve and conducting business as normal, you could easily find yourself accused of wrongful trading and could even inadvertently cross the threshold into the criminal conduct of insolvent trading.
Instead, you should make sure you speak to an expert at the first sign of trouble. If you have ongoing and seemingly insurmountable cash flow issues, they can offer advice to keep you in business.