What is the Difference Between Fraudulent and Wrongful Trading?

Fraudulent or wrongful trading can have serious repercussions for a limited company director. Fraudulent trading is a criminal act, while wrongful trading is a civil offence. 

Both wrongful trading and fraudulent trading are offences under the Insolvency Act 1986 and the Companies Act 2006 and directors must be particularly vigilant to both acts if their company is at risk of becoming insolvent. Trading while knowingly insolvent may lead to accusations of wrongful trading, or the more serious charge of fraudulent trading if you are thought to have deliberately attempted to deny creditors what they are owed.

If you fear that your company has reached a state of insolvency, you must tread very carefully in order to ensure you do not inadvertently commit an act which could constitute wrongful trading. Insolvency is when you are unable to pay bills as they fall due, or when the total of company liabilities exceeds the total value of assets held.

It is incumbent on a director to be aware of their company’s financial position at all times, and putting forward a defence that you were unaware of the insolvent situation will carry little weight. Failing to realise that a company is in financial difficulties may be regarded as negligent, irresponsible, or proof of ‘unfit conduct’ of directors, which will add to the seriousness of the situation.

What is fraudulent trading?

If creditors have taken legal action against your company, and you are facing voluntary or compulsory liquidation, your conduct as a director will come under scrutiny during the liquidation process. Allegations of fraudulent trading are extremely serious and ramifications include a prison sentence, director disqualification and/or financial penalties.

The Insolvency Practitioner dealing with the liquidation is obliged to send a report to the Secretary of State on the conduct of directors leading up to the company’s insolvency. If fraudulent trading is suspected, as opposed to wrongful trading, it means that directors have been considered to act to deliberately avoid payment of company liabilities.

Continuing in business, whether that means accepting lines of credit from suppliers, or taking payment on credit from customers knowing that the orders will be unfulfilled, and attempting to maximise the amount of money coming in prior to liquidation, is a serious offence.

Selling company assets at a price less than market value during the time leading up to liquidation could also be viewed with suspicion by the investigating Insolvency Practitioner.

The intention to defraud creditors in this way has to be proven, however, and the Insolvency Service will carry out a thorough investigation in an attempt to reach the truth.

What is wrongful trading?

A judgment of wrongful trading carries with it potential disqualification as a director for up to 15 years, plus other financial fines and penalties. Being held personally liable for company debts is also a possibility. Although not considered a criminal offence, wrongful trading is a civil offence which is taken very seriously by the courts.

Directors have an obligation to inform company shareholders when an insolvent position has been reached, and to seek the guidance of a licensed Insolvency Practitioner.

Although directors may have carried on trading with good intentions in order to ultimately guide the company out of trouble, they have a duty to put creditors’ interests first when insolvency strikes and to limit creditors’ exposure to additional debt. In many cases this will mean the company should cease trading immediately, however, there are certain exceptions to this such as if the company is midway through a lucrative contract which will bring in more money to the business than it will cost to complete. The rules surrounding this are complex and fraught with complications therefore professional insolvency advice should be taken as a matter of urgency.

Acts of misfeasance can leave you liable for company debts followings its liquidation. If it is found that you have shown preference to one or two creditors over others, you may face questions as to your motives. The interests of creditors as a whole should be at the forefront of director actions, rather than individual creditors.

Begbies Traynor is the largest UK business recovery practice with with an extensive UK office network. Contact a member of our expert team to discuss your business situation.