Guide

Avoid wrongful trading as a company director

How directors can avoid personal liability for wrongful trading under section 214 of the Insolvency Act 1986. Covers the legal test, the "every step" defence, and what to do when your company faces insolvency.

UK-wide

Wrongful trading is a civil offence under section 214 of the Insolvency Act 1986. If your company goes into insolvent liquidation or administration, you can be held personally liable for the company's debts if you knew, or ought to have known, that there was no reasonable prospect of avoiding insolvency and you continued trading.

This guide explains how to recognise when wrongful trading might apply and the steps you must take to protect yourself and minimise losses to creditors.

When does the wrongful trading test apply?

The wrongful trading provisions bite when three conditions are met:

  1. The company has entered insolvent liquidation or administration
  2. At some point before insolvency, you knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation/administration
  3. You were a director at that time (including shadow directors)

The liquidator or administrator brings the claim against you. The proceeds are for the benefit of creditors.

The dual standard of knowledge

Section 214(4) applies a dual test - whichever is higher:

  • Objective standard: What a reasonably diligent person carrying out your role should have known
  • Subjective standard: What you actually knew given your skills and experience

This means experienced or qualified directors are held to a higher standard. If you are a qualified accountant, you cannot claim ignorance of financial warning signs.

The "every step" defence

You escape liability if you can prove that from the moment you knew (or should have known) insolvency was inevitable, you took every step with a view to minimising the potential loss to the company's creditors.

What constitutes "every step"

  • Seek professional advice from a licensed insolvency practitioner immediately
  • Call a board meeting to formally assess the company's position
  • Prepare up-to-date financial information
  • Consider all rescue options (moratorium, CVA, administration)
  • If no rescue is possible, cease trading and enter liquidation/administration
  • Do NOT continue trading if it worsens creditor position
  • Do NOT incur further credit
  • Do NOT dispose of assets improperly

Consequences of wrongful trading

If the court finds you liable, it can declare that you must make a contribution to the company's assets of such amount as the court thinks proper.

Typical awards range from £10,000 to £500,000 or more, depending on:

  • The extent of losses caused by continued trading
  • Your culpability
  • Whether you acted honestly

Wrongful trading is not a criminal offence, unlike fraudulent trading under section 213.

Recognising warning signs

Directors must monitor the company's financial position. Key warning signs that should prompt you to seek advice:

  • Creditors pressing for payment
  • Inability to pay wages or HMRC on time
  • Bounced cheques or cancelled direct debits
  • Suppliers demanding cash on delivery
  • County court judgments or statutory demands
  • Bank refusing to extend overdraft
  • Management accounts showing sustained losses
  • Cash flow forecast showing shortfall

  1. Monitor your company's solvency continuously

    Review cash flow and management accounts monthly. Apply both the cash flow test (can you pay debts as they fall due?) and balance sheet test (do assets exceed liabilities?).

  2. Seek advice from an insolvency practitioner at the first sign of trouble

    Do not wait until the situation is critical. Many IPs offer free initial consultations. Early advice gives you more options.

  3. Document all board discussions and decisions

    Keep written records of meetings, advice received, options considered, and reasons for decisions. This evidence is essential if your conduct is questioned later.

  4. Stop trading if continuing would increase creditor losses

    If there is no realistic prospect of rescue, you must stop. Continuing to trade when you cannot pay debts may be wrongful trading.

  5. Do not prefer connected creditors

    Paying family members, other directors, or associated companies ahead of other creditors can be challenged and recovered. These preferential payments also indicate awareness of insolvency.

  6. Do not dispose of assets at undervalue

    Selling assets for less than market value to defeat creditors can be set aside by the liquidator. Directors may face personal liability.

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