The perils of insolvent trading

A director can be ordered by the court to make payments to the liquidator if it is proved that "wrongful trading" has occurred.
Liability for wrongful trading arises if all of the following tests are satisfied:

• the company has gone into insolvent dissolution
• at some point before the dissolution the director knew -- or should have known -- that there was no reasonable prospect of avoiding dissolution due to the company's insolvency
• after reaching the point above, the director then failed to take every step possible to minimise the loss to creditors.

This normally means that the director has continued to trade and incur further losses for some time after he/she realised - or should have realised - that the company would not be able to pay all its liabilities.

The law applies an objective test in considering:

• when a director should have recognised the inevitability of the impending dissolution and
• whether the director has taken every step to minimise the loss to creditors.

A director is expected to have the "knowledge, skill and experience" appropriate to the responsibility of holding office as a director. The standard will vary according to the size and nature of the business. The court will also take account of any special skills that a director has.

No one should ever hold office as a director if they do not intend to carry out the role. Inactivity in relation to the company is no defence to wrongful trading; indeed it is prima facie evidence of neglect leading to culpability.

When a business is in difficulty, the directors may wish to consider various survival strategies other than attempting to trade out of trouble. Whatever is decided, the basis of the decision should be fully documented for future reference in case the plan does not work and a subsequently appointed liquidator takes action against the directors.

Professional advice should be sought to protect the directors' own positions and that of the creditors. There is no such thing as the ordinary course of business, when a company is insolvent.

Directors may enter into transactions in all innocence, which, with the benefit of hindsight, are capable of being challenged by a liquidator. This is perhaps the greatest challenge for the innocent director who does not take professional advice.