Search for

Wrong footed?

31 Dec 08

Malcolm Holmes on the care needed to avoid “wrongful trading”

by Malcolm Holmes

At every turn we hear of a slowing economy, a lack of credit available to businesses and lack of liquidity. In these difficult times a company director needs to be ever more vigilant as regards the financial state of his company.

That may sound trite but in the event of insolvency, failure to have done so could lead to a court, on application by the liquidator, declaring the director personally liable to contribute to the assets of the company where “wrongful trading” has occurred.

The wrongful trading provisions of the Insolvency Act 1986 come into play where a company has gone into insolvent liquidation and at some earlier time the director knew or ought to have concluded that there was no reasonable prospect of the company avoiding insolvent liquidation.

A director may be found liable in these circumstances unless the court is satisfied that he subsequently took every step with a view to minimising the potential loss to the company’s creditors that he ought to have taken.

His performance is therefore subject to scrutiny on a number of levels: what should he have known; when did he know it, or ought he to have known it; and thereafter what should he have then done about it. In determining these matters, the standard by which a director will be judged is that of a reasonably diligent person having not just the knowledge, experience and skill of the director in question, but also that which could be

reasonably expected of a person carrying out the same functions as are carried out by the director in relation to the company.

 

What constitutes a reasonable prospect of avoiding insolvent liquidation? A director must have a real belief that it is reasonably likely that insolvency can be avoided.

 

This is a subjective issue which will vary depending on the circumstances but, by way of example, a firm indication from the company’s shareholders and/or investors that they will continue to invest in and support the company might, if reasonably considered to be genuine, constitute a reasonable prospect of avoiding an insolvent liquidation.

As stated above, liability will not be imposed if a director takes every step with a view to minimising the potential loss to the company’s creditors once he knows or concludes that insolvent liquidation is the only reasonable prospect for the company.

 

Note the very high standard to be attained. There is no qualification as to taking reasonable steps – the director must demonstrate that he took every step to minimise losses.

Clearly, the most definitive step a board of directors can take to minimise loss is to cease to trade, but this will not necessarily always be the right approach in every instance.

Certain circumstances may justify continuing to trade for a short time, for example, to enable the company to close a substantial order.

Trading out of difficulties generally is, however, risky and should only be attempted after careful thought and with appropriate professional advice. Equally risky is resignation, as it will be difficult for a director to establish that he took every step to minimise losses if, at the crucial time, he is not in a position to influence events.

What can a director do to minimise his risk? In simple terms he must at all times keep a close eye on the company’s performance and prospects so that he can anticipate solvency concerns.

In particular, he may consider the following precautions:

• ensuring that the company has proper accounting and reporting systems in place and that the financial information the board receives is sufficient;

• Not relying solely on historical accounting information but monitoring trading projections and question underlying assumptions;

• Ensuring he keeps an accurate contemporaneous record of his own activities;

• Ensuring regular board meetings are convened and significant commercial decisions properly minuted, including consideration of the benefits and risks of such decisions;

• Seeking independent advice as soon as he has concerns regarding the company’s current position or prospects; and

• Ensuring his concerns are put to the board without delay.

Page No: 65

Tags

Related Articles

Practice Web Tower (link opens in new window)Advertisement