Legal and Financial Implications of Wrongful Trading Claims

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Legal and Financial Implications of Wrongful
Trading Claims
As businesses face financial difficulties,
company directors must manage their companies
with diligence and care. One of the most serious
risks they encounter during insolvency is the
possibility of a wrongful trading claim. Wrongful
trading occurs when directors continue to trade,
knowing theres no reasonable prospect of
avoiding insolvency. The implications of such
claims can be devastating, both legally and
financially, for those involved. In this article,
we explore the legal framework surrounding
wrongful trading and discuss the financial
implications for directors.
When might wrongful trading claims arise?
Wrongful trading claims typically arise when a
company has entered liquidation, and the
appointed liquidator reviews the conduct of its
directors in the lead-up to insolvency. If the
liquidator finds evidence that directors failed
to take appropriate action to cease trading or
mitigate losses to creditors, they may pursue a
claim. Directors need to be aware that even if
they were acting in good faith or under a lot of
pressure, they could still be held liable if they
didnt fulfil their legal obligations.
Legal consequences of wrongful trading
The legal and financial implications of wrongful
trading claims can be substantial for directors,
affecting their liability, insurance protections
and even their careers. Some of the most
significant risks include Personal liability
for directors One of the most serious legal
implications of wrongful trading is personal
liability. If a director is found guilty of
wrongful trading, they may be ordered to
contribute to the companys assets, which could
then be distributed to creditors. This can
involve substantial sums, and directors may have
to use their personal assets to make these
contributions. Unlike corporate debt, which is
usually limited to the assets of the business,
wrongful trading claims hold directors personally
responsible. In extreme cases, this could lead to
directors facing personal bankruptcy if unable to
meet the courts demands. Disqualification from
directorship Directors found guilty of wrongful
trading may also face disqualification under the
Company Directors Disqualification Act 1986. A
director can be banned from acting as a director
or being involved in the management of a company
for up to 15 years, depending on the severity of
their conduct. That can have long-lasting career
implications, particularly for individuals who
rely on directorship roles in multiple
businesses. Legal costs and defences
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Defending a wrongful trading claim can be a
costly and time-consuming process. Directors will
need to present a strong defence, which often
requires detailed financial evidence showing that
they acted responsibly. The burden of proof lies
with the liquidator, but if the directors
actions are deemed negligent, they can still be
held liable. Furthermore, even if directors can
successfully defend themselves, they may still be
responsible for their legal costs, which can be
significant.
Financial implications of wrongful trading
The financial consequences of wrongful trading
can be far-reaching for directors, impacting
their personal finances, insurance coverage and
assets. Key risks include Personal financial
risk The financial implications of wrongful
trading claims are severe. If a director is found
liable, they may be required to personally
contribute to the companys debts. This can be
financially crippling, especially if the debts
are substantial. The court will assess how much
the director must pay, but this amount will often
reflect the increased losses to creditors caused
by the directors decision to continue
trading. Director and Officer Liability
Insurance (DO Insurance) To mitigate potential
losses from wrongful trading claims, many
directors invest in Directors and Officers (DO)
liability insurance. However, while DO insurance
provides some protection, it may not cover
wrongful trading claims in all circumstances.
Policies typically have exclusions, and its
important that directors fully understand what
their policy covers. In some cases, DO insurance
may only cover the legal costs of defending a
claim rather than the financial liabilities
associated with wrongful trading. Risk to
personal assets When a director is found
personally liable, their assets may be at risk.
This includes property, savings, investments and
other key assets. The directors financial future
can be severely impacted, particularly if their
assets are not protected. In the UK, there are
limited options for shielding personal assets
from these types of claims, making it important
for directors to carefully consider the risks
before continuing to trade while insolvent.
Steps directors should take to avoid wrongful
trading claims
To reduce the risk of wrongful trading claims,
directors can take proactive steps to safeguard
their position and demonstrate responsible
management, including Seeking professional
advice early One of the best ways to avoid
wrongful trading claims is to seek professional
insolvency advice at the earliest sign of
financial distress. Engaging with an insolvency
practitioner can help directors understand their
legal obligations and take appropriate action to
reduce creditor losses. Early intervention may
allow the company to enter a formal restructuring
process, such as administration or a Company
Voluntary Arrangement (CVA), which can preserve
business value and protect the directors from
personal liability. Keeping detailed
records Directors should also keep detailed
records of all financial decisions and the
rationale behind them, particularly when the
business is struggling. These records can serve
as valuable evidence in the event of a wrongful
trading claim, showing that directors took
reasonable steps to act in the companys best
interests. Implementing financial
controls Strong financial controls can help
directors make informed decisions about the
viability of their business. Regularly reviewing
cash flow, forecasting future financial
performance and acting swiftly when issues arise
can prevent directors from inadvertently
breaching their duties.
Safeguarding against the risks of wrongful trading
The legal and financial implications of wrongful
trading claims are profound. Directors can face
personal liability, disqualification and severe
reputational damage if found guilty. Given the
potentially devastating financial consequences,
directors must act responsibly and get expert
insolvency advice if they suspect their company
may be approaching insolvency. By taking
proactive steps to protect both the company and
creditors, directors can avoid the risks
associated with wrongful trading claims. Need
expert insolvency advice? If youre concerned
about the risks of wrongful trading and need
expert guidance, were here to help. At Leading
Insolvency Practice, our team of insolvency
specialists can offer practical advice to protect
you and your business. Call us on 0800 246 1845
or email us at mail_at_leading.uk.com to schedule a
confidential consultation. Dont wait until its
too late get the professional support you need
today.
By Viv1 November 19th, 2024 Legal Updates
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