As businesses face financial difficulties, company directors must manage their companies with diligence and care. One of the most serious risks they encounter during insolvency is the possibility of a wrongful trading claim. Wrongful trading occurs when directors continue to trade, knowing there’s no reasonable prospect of avoiding insolvency. The implications of such claims can be devastating, both legally and financially, for those involved. In this article, we explore the legal framework surrounding wrongful trading and discuss the financial implications for directors.

When might wrongful trading claims arise?

Wrongful trading claims typically arise when a company has entered liquidation, and the appointed liquidator reviews the conduct of its directors in the lead-up to insolvency. If the liquidator finds evidence that directors failed to take appropriate action to cease trading or mitigate losses to creditors, they may pursue a claim. Directors need to be aware that even if they were acting in good faith or under a lot of pressure, they could still be held liable if they didn’t fulfil their legal obligations.

Legal consequences of wrongful trading

The legal and financial implications of wrongful trading claims can be substantial for directors, affecting their liability, insurance protections and even their careers. Some of the most significant risks include:

  • Personal liability for directors

One of the most serious legal implications of wrongful trading is personal liability. If a director is found guilty of wrongful trading, they may be ordered to contribute to the company’s assets, which could then be distributed to creditors. This can involve substantial sums, and directors may have to use their personal assets to make these contributions.

Unlike corporate debt, which is usually limited to the assets of the business, wrongful trading claims hold directors personally responsible. In extreme cases, this could lead to directors facing personal bankruptcy if unable to meet the court’s demands.

  • Disqualification from directorship

Directors found guilty of wrongful trading may also face disqualification under the Company Directors Disqualification Act 1986. A director can be banned from acting as a director or being involved in the management of a company for up to 15 years, depending on the severity of their conduct. That can have long-lasting career implications, particularly for individuals who rely on directorship roles in multiple businesses.

  • Legal costs and defences

Defending a wrongful trading claim can be a costly and time-consuming process. Directors will need to present a strong defence, which often requires detailed financial evidence showing that they acted responsibly. The burden of proof lies with the liquidator, but if the director’s actions are deemed negligent, they can still be held liable. Furthermore, even if directors can successfully defend themselves, they may still be responsible for their legal costs, which can be significant.

Financial implications of wrongful trading

The financial consequences of wrongful trading can be far-reaching for directors, impacting their personal finances, insurance coverage and assets. Key risks include:

  • Personal financial risk

The financial implications of wrongful trading claims are severe. If a director is found liable, they may be required to personally contribute to the company’s debts. This can be financially crippling, especially if the debts are substantial. The court will assess how much the director must pay, but this amount will often reflect the increased losses to creditors caused by the director’s decision to continue trading.

  • Director and Officer Liability Insurance (D&O Insurance)

To mitigate potential losses from wrongful trading claims, many directors invest in Directors and Officers (D&O) liability insurance. However, while D&O insurance provides some protection, it may not cover wrongful trading claims in all circumstances. Policies typically have exclusions, and it’s important that directors fully understand what their policy covers. In some cases, D&O insurance may only cover the legal costs of defending a claim rather than the financial liabilities associated with wrongful trading.

  • Risk to personal assets

When a director is found personally liable, their assets may be at risk. This includes property, savings, investments and other key assets. The director’s financial future can be severely impacted, particularly if their assets are not protected. In the UK, there are limited options for shielding personal assets from these types of claims, making it important for directors to carefully consider the risks before continuing to trade while insolvent.

Steps directors should take to avoid wrongful trading claims

To reduce the risk of wrongful trading claims, directors can take proactive steps to safeguard their position and demonstrate responsible management, including:

  • Seeking professional advice early

One of the best ways to avoid wrongful trading claims is to seek professional insolvency advice at the earliest sign of financial distress. Engaging with an insolvency practitioner can help directors understand their legal obligations and take appropriate action to reduce creditor losses. Early intervention may allow the company to enter a formal restructuring process, such as administration or a Company Voluntary Arrangement (CVA), which can preserve business value and protect the directors from personal liability.

  • Keeping detailed records

Directors should also keep detailed records of all financial decisions and the rationale behind them, particularly when the business is struggling. These records can serve as valuable evidence in the event of a wrongful trading claim, showing that directors took reasonable steps to act in the company’s best interests.

  • Implementing financial controls

Strong financial controls can help directors make informed decisions about the viability of their business. Regularly reviewing cash flow, forecasting future financial performance and acting swiftly when issues arise can prevent directors from inadvertently breaching their duties.

Safeguarding against the risks of wrongful trading

The legal and financial implications of wrongful trading claims are profound. Directors can face personal liability, disqualification and severe reputational damage if found guilty. Given the potentially devastating financial consequences, directors must act responsibly and get expert insolvency advice if they suspect their company may be approaching insolvency. By taking proactive steps to protect both the company and creditors, directors can avoid the risks associated with wrongful trading claims.

Need expert insolvency advice?

If you’re concerned about the risks of wrongful trading and need expert guidance, we’re here to help. At Leading Insolvency Practice, our team of insolvency specialists can offer practical advice to protect you and your business. Call us on 0800 246 1845 or email us at mail@leading.uk.com to schedule a confidential consultation. Don’t wait until it’s too late – get the professional support you need today.