Out-Law / Your Daily Need-To-Know

Wrongful trading FAQ

Out-Law Guide | 09 Jul 2007 | 3:33 pm | 3 min. read

This guide is based on UK law as at 1st February 2010, unless otherwise stated. It is part of a series on Financial difficulty and insolvency . Resigning will not, by itself, remove liability. In...

This guide is based on UK law as at 1st February 2010, unless otherwise stated. It is part of a series on Financial difficulty and insolvency.

What if I resigned from the company. Will I still be liable?

Resigning will not, by itself, remove liability. In some circumstances, directors will be liable for all debts incurred up to their resignation.

Directors who resigned knowing insolvent liquidation was inevitable will, in principle, only be “safe” if they can show they acted on that knowledge – i.e. took steps to protect their interests and those of creditors. They must have tried to persuade the other directors to follow what they believed to be the right course, perhaps using the threat of resignation as a negotiating tool. They must have expressed their views at a board meeting, preferably after producing a reasoned paper for the board, and made sure the minutes accurately recorded their views. In other words, the resignation must be capable of being seen as a response to a refusal to listen – the last resort of a responsible director.

A director who resigns in an attempt to avoid any future liability but continues to be involved with the management of the company as a shadow director may still be liable.

What standards will I be judged by?

In the first instance, a director is judged by the standards of the “reasonable” director. This means they will be deemed to have the general knowledge, skill and experience that can be reasonably expected of a person carrying out the functions of a director. The mere fact that their own knowledge, skill and experience were inadequate for their role cannot be relied on as a defence. On top of that basic standard, a director will also be judged against the general knowledge, skills and experience they in fact possess. Judgments about the extent of these standards will be made case by case, taking into account both objective and subjective criteria. Directors with professional qualifications (e.g. accountants) may find that their professional body takes disciplinary action or at least seeks explanations of a director’s conduct, particularly in relation to the signing off of previous years’ accounts and the concept of a “going concern”.

How are shadow directors defined?

The key point is that shadow directors can be liable for wrongful trading and be ordered to contribute to the assets of an insolvent company. A holding or parent company can be classed as a shadow director in certain circumstances; so can private equity houses and banks.

Liability arises when the shadow director’s influence extends to the whole board. For example, a dominant investor can be a shadow director if the whole board, and not just the investor’s representative on the board, was acting on its directions.

Are non-executives liable?

As their involvement may be critical when a company runs into difficulties, non-executive directors may find that they are as much at risk under the wrongful trading provisions as executive directors. This will depend on the circumstances of each case, but getting good advice early is key.

What will the court do?

Once liability is established, the court can order a director to “make such contribution (if any) to the company’s assets as it thinks proper”. It has complete discretion over the amount. In each case, it is likely to assess the difference between the actual net deficiency to creditors and what it would have been on the date when liquidation first appeared inevitable.

The court should also take account of the level of culpability of a particular director and recognise that other factors may have caused the deterioration in the net deficiency.

If it makes a declaration under the wrongful trading provisions, the court may also make an order to disqualify the director from being in any way concerned in the management of a company for a minimum period of two years.

What can I do to protect myself?

The answer is found in our guide to Financial difficulties and insolvency: An introduction, under the heading Actions that minimise the risks of liability. In summary, it is to act responsibly and with integrity. Take an active role in monitoring the company’s financial performance and never be afraid to raise concerns about solvency. Make sure what you say, and what you are told in response, are recorded. If fellow directors refuse to accept that the company is wrongfully trading, take no part in incurring further indebtedness.

Insist that any advice you and the board take is noted. It may be vital in disproving allegations by a liquidator and show that you and your fellow directors had reasonable grounds to believe insolvency could be avoided.