Wrongful trading and trading while insolvent: a guide for directors

What is wrongful trading?

Wrongful trading is a civil claim under section 214 of the Insolvency Act 1986 that can make a director contribute to an insolvent company's assets for trading on after they knew, or ought to have concluded, that insolvent liquidation or administration could not be avoided.

Section 214 applies in a liquidation, and since 1 October 2015 an administrator can bring the same claim under section 246ZB. It reaches shadow directors as well as appointed ones, and it only arises once the company has actually gone into insolvent liquidation or administration, meaning its assets do not cover its debts and the costs of the procedure.

No dishonesty is needed. The court asks what the director knew, or should have worked out, about the company's prospects and what they then did, which is why the claim can reach honest directors who simply held on too long.

Is trading whilst insolvent illegal?

Trading whilst insolvent is not illegal in itself, because UK company and insolvency law does not require directors to stop the moment a company becomes insolvent; the risk begins once there is no reasonable prospect of avoiding insolvent liquidation or administration.

A company is insolvent when it cannot pay its debts as they fall due, or when its liabilities are greater than its assets, the two tests in section 123 of the Insolvency Act 1986. Insolvent trading is not, by itself, a criminal offence in the UK, and the courts accept that directors may properly keep an insolvent company trading to work its way out of difficulty, even taking some loss-making work in the hope of future profit. The High Court repeated that principle in Re Ralls Builders Ltd [2016] EWHC 243 (Ch).

What changes is whose interests come first. Once a company is insolvent or close to it, directors must have proper regard to creditors' interests, and the worse the position, the more weight those interests carry: the Supreme Court said so in BTI 2014 LLC v Sequana SA [2022] UKSC 25, explaining the duty that section 172(3) of the Companies Act 2006 preserves. GOV.UK's guidance for directors puts it in practical terms: protect the company's assets, treat creditors alike, and do not make their position worse.

When does trading while insolvent become wrongful trading?

Trading while insolvent becomes wrongful trading from the point at which a director knew, or a reasonably diligent director in their position ought to have concluded, that the company had no reasonable prospect of avoiding insolvent liquidation or insolvent administration.

Being insolvent is not, on its own, the test. In Re Ralls Builders the court stressed that the question is whether the directors knew or ought to have concluded there was no reasonable prospect of avoiding insolvent liquidation, judged on what they knew or should have known at the time, without hindsight.

Section 214(4) sets the standard: a reasonably diligent person with the general knowledge, skill and experience expected of someone doing that director's job, and with the knowledge, skill and experience the director actually has. The first limb is a minimum every director must meet, including for duties entrusted to them that they never carried out. The second raises the bar for directors who know more, such as a qualified accountant acting as finance director.

Courts also give weight to whether the directors took professional advice and what they were told. Signs that the point may be close include these.

• HMRC arrears building up, or a Time to Pay arrangement that has failed. Our guide for a company that cannot pay HMRC covers the options.
• A statutory demand served on the company, or a winding-up petition, that the company cannot pay.
• Suppliers moving the company onto cash-on-delivery terms, or the bank refusing further lending.
• Management accounts showing losses with no realistic plan or funding to reverse them.

What is the every step defence to wrongful trading?

The every step defence in section 214(3) of the Insolvency Act 1986 clears a director who shows that, from the moment they should have seen insolvent liquidation coming, they took every step they ought to have taken to minimise the potential loss to creditors.

It is a high hurdle. The court reads "every step" strictly, and in Re Ralls Builders the directors lost the defence because of the way they kept trading: the bank and some existing creditors were paid, at the expense of new creditors who were never paid at all. The court held that trading on must be set up to protect individual creditors, as well as to reduce the overall shortfall.

Because the defence looks at the steps themselves, a director who acted properly can rely on it even if the losses still grew. That is why the record matters. Board minutes, current figures and the advice you took are the evidence a court will see long after the event, and we set out the practical steps further down this page.

Who brings a wrongful trading claim against a director?

A wrongful trading claim is brought by the company's liquidator under section 214 or its administrator under section 246ZB of the Insolvency Act 1986, or by a third party the office-holder has assigned the claim to; creditors cannot bring one themselves.

Section 246ZD lets a liquidator or administrator assign the claim, along with fraudulent trading, preference and undervalue claims, to a third party who then pursues the director. When the liquidator or administrator brings the claim, any money recovered goes into the company's assets for the unsecured creditors as a whole, so no single creditor gets more from it than the others.

The starting point is the office-holder's investigation. Under section 7A of the Company Directors Disqualification Act 1986, the liquidator or administrator must send the Insolvency Service a report on the conduct of everyone who was a director in the three years before the insolvency, within three months, and Statement of Insolvency Practice 2 sets the standard for that investigation. In a compulsory liquidation the Official Receiver does this work.

How much can a director be ordered to pay for wrongful trading?

A director found liable for wrongful trading pays whatever contribution to the company's assets the court thinks proper under section 214(1), with no fixed sum or cap, and courts usually start from how much the company's deficiency to unsecured creditors grew while trading continued.

The contribution is compensatory: it aims to put the company back where it would have been if trading had stopped at the right time. There must be a causal link between the continued trading and the loss, and losses the company would have suffered anyway on entering insolvency are left out. In Re Ralls Builders the court found that the directors ought to have concluded by 31 August 2010 that insolvent liquidation could not be avoided, yet ordered no contribution, because trading on until the administration in October 2010 had not made the deficiency materially worse.

Section 215 gives the court further powers. It can make the liability a charge on any debt the company owes the director, and it can order that the director's own loans to the company are repaid only after every other creditor. A director ordered to contribute can also be disqualified, as explained below.

Wrongful trading is also one of several claims a liquidator can bring against directors after reviewing the run-up to the insolvency.

• Misfeasance. A claim under section 212 for breach of duty or misapplied company money, which the liquidator, the Official Receiver or a creditor can bring.
• Preferences. Payments the company chose to make to put a creditor ahead of the rest, which can be reversed if made in the six months before insolvency, or two years for a connected person such as a director or their family (sections 239 and 240).
• Transactions at an undervalue. Assets given away or sold for significantly less than they were worth in the two years before insolvency (sections 238 and 240).
• An overdrawn director's loan account. Money a director owes the company is an asset the liquidator must collect, as our guide to an overdrawn director's loan account in insolvency explains.

What is the difference between wrongful trading and fraudulent trading?

The difference between wrongful trading and fraudulent trading is intent: wrongful trading needs no dishonesty, only a failure to act once insolvent liquidation was unavoidable, while fraudulent trading requires business carried on with intent to defraud creditors or for any fraudulent purpose.

Fraudulent trading exists twice over. Section 213 of the Insolvency Act 1986, or section 246ZA in an administration, is a civil claim the liquidator or administrator brings against anyone who was knowingly a party to the fraud, which can include people outside the company. Section 993 of the Companies Act 2006 makes the same conduct a criminal offence, whether or not the company is ever wound up, with a maximum sentence of ten years in prison.

Ordering goods on credit, or taking customers' deposits, when you know they will never be paid for or delivered is the kind of conduct that can cross that line.

Can wrongful trading lead to director disqualification?

Wrongful trading can lead to director disqualification in two ways: the court hearing the claim can disqualify the director for up to 15 years under section 10 of the Company Directors Disqualification Act 1986, or the Insolvency Service can seek a ban for unfit conduct.

Most disqualification applications are made under section 6 of that Act. They need no wrongful trading claim. GOV.UK lists "continuing to trade to the detriment of creditors when a company is insolvent" among its examples of unfit conduct, and a section 6 ban runs for a minimum of 2 years and a maximum of 15. The Insolvency Service must usually apply within three years of the insolvency, and many directors instead give a disqualification undertaking, which has the same effect without a court hearing.

A disqualified director can also face a compensation order under section 15A, requiring them to compensate creditors who lost out because of misconduct after 1 October 2015. Our guide to how director disqualification works covers the investigation and what a ban means in practice.

Was wrongful trading suspended during the Covid-19 pandemic?

Wrongful trading liability was partly suspended during the Covid-19 pandemic, from 1 March to 30 September 2020 and again from 26 November 2020 to 30 June 2021, and the full rules have applied to all trading since 1 July 2021.

The suspension never switched the law off. Section 12 of the Corporate Insolvency and Governance Act 2020, and the regulations that brought it back in November 2020, told the court to assume a director was not responsible for any worsening of the company's finances during those periods when working out a contribution. It did not touch fraudulent trading, misfeasance, director disqualification or directors' duties to creditors, and some financial businesses were excluded altogether.

For anyone looking back at that period, the dates are these.

• 1 March 2020 to 30 September 2020. The first suspension, under section 12 of the 2020 Act.
• 1 October 2020 to 25 November 2020. No suspension; the normal rules applied.
• 26 November 2020 to 30 June 2021. The second suspension, set to end on 30 April 2021 and then extended to 30 June 2021.
• From 1 July 2021. No suspension. Claims about trading in the earlier windows can still be brought, but the court must assume the director was not responsible for any worsening of the company's position during them.

How can a director avoid wrongful trading once insolvency is likely?

A director keeps clear of wrongful trading, once insolvency is likely, by taking advice early from a licensed insolvency practitioner, minuting each board decision with the figures behind it, stopping credit the company may not repay, and treating all creditors alike.

That does not mean closing the doors today. It means trading on only while there is a reasonable prospect of avoiding insolvent liquidation, in a way that does not shift losses onto creditors, and being able to prove it later.

If the business can be saved, a company voluntary arrangement or administration can protect it while creditors are dealt with. If it cannot, a creditors' voluntary liquidation stops the losses growing and puts a licensed practitioner in charge. Our guide to the options for an insolvent company compares the routes.

Why speak to NTF about wrongful trading?

NTF Corporate Solutions is a specialist corporate insolvency practice whose advice to directors on wrongful trading comes from two named practitioners, James Kaye and Nick Morgan, licensed by the Institute of Chartered Accountants in England and Wales.

Call before the decision to carry on or stop has been made, because advice taken then becomes part of the record that protects you. Bring the figures. We will go through them with you, tell you plainly whether the company has a reasonable prospect of avoiding insolvent liquidation, and set out the steps to take from today. As part of the NTF group, we have helped company directors since 2009, and the first conversation is free, confidential and without obligation.