How to avoid the trap of wrongful trading

What is wrongful trading?

Wrongful trading describes a situation where directors are continuing to trade beyond the point where they knew, or ought to have known, that insolvent liquidation could not be avoided. It also inevitably makes a precarious financial situation worse. However, if you look for the warning signs and seek advice as early as possible it can be avoided or resolved without long-term consequences.

What are the implications of wrongful trading?

When a company eventually goes into insolvent liquidation, the Court has the power to enforce the directors to contribute to the company’s assets for the additional losses incurred. The Court’s first job is judging whether the directors should have known that avoiding insolvent liquidation was not possible. And/or that they did not take appropriate steps to minimise the potential loss to creditors.

The Court must also consider whether the steps taken by the director were the same as those that would have been reached or taken by a reasonably diligent person having the general knowledge, skill and experience expected of a person carrying out the same functions as that director.

If the Court is satisfied that the directors took every possible step to minimise the potential loss to creditors, then it will not make a declaration. Directors are at risk of being accused of wrongful trading when they cannot provide evidence that they acted in good faith when making decisions that then turned out to be wrong. If found guilty, directors can face disqualification and may be liable to make a payment to the company at a level that the Court thinks fit.

Spotting the warning signs

If, for example, you’re in severe debt and you know that your future orders don’t look solid but you still considering opening up a new line of credit, then it’s time to get some advice. You need to have a credible plan to meet your ongoing costs and deal with your old liabilities, so you’re not worsening your position and increasing your debt burden.

However, if every month you’re continuing to make that burden worse, that’s unsustainable. For example, if you’re taking deposits on projects you can’t complete, managing cash-flow by spending one customer’s deposit on other customer’s project or wasting money because you don’t have a clear plan, then these are all signs you’re in danger of wrongful trading. At this point it’s time to pause and seek advice before you expose your creditors to even bigger losses.

Click here for more advice on spotting the key signs that you might need professional advice.

Now’s the time to act…

So, once you’ve realised you’re in a difficult position, what are the next steps?

1. Seek advice early

This is the most important step. Be open to dialogue from an independent perspective and seek advice from your accountant or go straight to an Insolvency Practitioner. Your accountant or IP will help you put together a plan on how to turn things around and then help you to monitor it closely.

2. Get a handle on your financial position

People get in a muddle with their numbers. Make sure you have up-to-date information on your assets and your liabilities. Do some projection work on what’s going to happen for the next month, three months, six months and a year. Break it down with some level of certainty. You need good financial information and cash flow projections.

3. Look at practical cost savings

Think about where you can save money to alleviate the immediate pressure.

4. Start documenting your decisions

Keep details of what you’re doing and why you made certain decisions. Then, if things do go wrong and you need to explain your decision-making process, you can. You’ll be able to say that, at that time, it was a reasonable call and explain why.

5. Communicate with creditors

Early discussion with your creditors can pre-empt a lot of problems. Communicate in an upfront way, early on, that you’re working on the issues and you will get back to them. Although, be careful not to make promises you can’t keep.

How we can help…

We offer a free consultation. If you come to us with what you do know and what the challenges are, we can put together a road map or a plan. You may be referred to us by your accountant and they will often have done a bit of work first, which is a good starting point. Alternatively, you can also come direct to us, without going via your accountant.

We will then go through what your position is, what the projections are and what the risks are. Then we’ll come up with a plan. It could be as little as telling you to sit down with your accountant and see how you go. If you don’t have an accountant, we can introduce you to someone.

If the situation is more severe, we may need to act on it and, at the other end of the spectrum, we may say you shouldn’t really be carrying on. The key point is to reach out to us to start this ball rolling, before the situation becomes more serious.

Book your free consultation now

So, if you’re concerned about your financial situation, contact us today for a free consultation. You can arrange a time and a date that works for you and meet with a qualified insolvency practitioner. There’s also no need to travel, as we can run the meeting over Zoom or Microsoft Teams if you prefer. We’ll ask about the background circumstances and current financial position before giving you a no-obligation competitive quote.