When a company falls into financial strife, life can become desperate. Trying to save your business and the jobs of your employees can lead to you taking actions that, without proper thought and knowledge, can result in you been prosecuted for wrongful trading. And deliberate actions to defraud creditors can result in charges of fraudulent trading.
If you have been accused of wrongful or fraudulent trading, it is crucial to seek legal advice immediately, as both offences carry severe penalties, including disqualification from acting as a company director, fines, personal liability for debts, and in the case of fraudulent trading, a custodial sentence.
What is wrongful trading?
Wrongful trading is a statutory offence under section 214 and section 246ZB of the Insolvency Act 1986. These sections state that once a director knows, or ought to know that there is no way to avoid the company falling into insolvent liquidation or administration, they have a duty to take each of the steps a reasonably diligent person would in order to minimise potential loss to the company’s creditors.
If found guilty of wrongful trading, you will lose your rights to limited liability, meaning you could become personally liable to the company’s creditors for money owned.
To be liable under section 214, it must be proven that the company is worse off by continuing to trade. Therefore, the question of when to cease trading is a vital one. A director who cannot (or will not) rely on the defences available under section 214(3) or 246ZB(3) of the Insolvency Act 1986, namely that during any continuing period of trading they are taking every step with a view to minimising the potential loss to the company’s creditors, cessation of trading should be seriously considered.
You may experience a tension between different types of creditors regarding ceasing trading. A financial creditor may put pressure on you to continue to trade whilst rescue negotiations are taking place. They may even be prepared to fund continued trading. In accepting funding offers, you should have careful regard to the following risks:
• If your company does fall into liquidation, liabilities which are incurred in reliance on the promised funding might remain unpaid; and
• If conditions are placed on the use of the funds, whether this could come back to haunt you at a later date.
It is highly advisable that as soon as you realise that insolvency can or will become a reality, you seek professional advice. Most business owners do not have a full understanding of the complex laws around wrongful trading and could well find themselves inadvertently taking actions which could be challenged by the liquidators/administrators.
What is fraudulent trading?
Sections 213 and section 246ZB of the Insolvency Act 1986 cover fraudulent trading. Fraudulent trading occurs when a director deliberately takes actions for the purpose of defrauding creditors.
Fraudulent trading is also a criminal offence under section 993 of the Companies Act 2006.
For fraudulent trading to occur, there must be a deliberate intent to act dishonestly. The standard for intent is high – in Re Patrick and Lyon ltd (1933), this involved proving “actual dishonesty, involving, according to current notions of fair trading among commercial men, real moral blame”.
Unlike wrongful trading, people other than company directors can be found guilty of fraudulent trading. The offence extends to anyone knowingly party to carrying on the business with intent to defraud.
A cause of action for fraudulent trading can only accrue from the moment a winding-up order is made.
Fraudulent trading and public companies
Directors of public companies must keep in mind the provisions of the Market Abuse Regulation (MAR), Listing Rules(LR), AIM Rules for Companies (AIM Rules), Prospectus Rules (PR), the Financial Services and Markets Act 2000 (FSMA) (as applicable) and the Financial Services Act 2012 (FS Act), in particular the provisions on misleading the market.
You can choose to delay disclosure of inside information provided that immediate disclosure is likely to prejudice its legitimate interests, the market is not likely to be misled, and the company is able to ensure the confidentiality of that information. However, you should not deliberately fail to disclose details of financial difficulties. Where a company fails to make the necessary disclosures under MAR, the Financial Conduct Authority (FCA) may suspend the trading of its securities and impose sanctions.
It is also crucial to be aware of making misleading statements or impressions under the FS Act. Under section 89 of the FS Act it is a criminal offence for a person to either:
• Make a knowingly false or misleading statement or is reckless as to whether it is false or misleading.
• Dishonestly conceal any material facts, whether in connection with a statement made or otherwise.
An offence is only committed if the statements or impressions induce another to enter into or refrain from entering into a contract or exercise or refrain from exercising any rights conferred by a relevant investment.
This article barely scrapes the surface of the law surrounding wrongful and fraudulent trading. This is why obtaining professional advice is so vital to ensure your interests are protected. You may, inadvertently, carry out an action which you believe is in the best interests of your company, but is instead detrimental to your creditors.
To find out more about wrongful or fraudulent trading, please contact me on 020 3870 3187.