Being a company director brings with it significant legal responsibilities, and a failure to face up to or comply with those responsibilities can lead to serious consequences. In particular, the risks for directors increase when a company is performing poorly.

This article focuses on two of the main risks that may affect directors personally: so called “wrongful trading” and “fraudulent trading”.

Fraudulent trading

Fraudulent trading occurs when a director allows a company to continue to carry on business or trade with the intention of defrauding the company’s creditors.

If found guilty of fraudulent trading a director may face:

• A court order against the individual director to contribute personally to the assets of the company for the purposes of satisfying creditors;
• a disqualification order prohibiting him from being appointed a director of any company for a given period;
• a fine; and
• prosecution and potential imprisonment for up to 7 years.

An honest director should not find himself guilty of fraudulent trading, as it is not enough to show that the company continued to run up debts when the directors knew that it was insolvent. There has to be “actual dishonesty, involving, ..., real moral blame”. Directors of any company which is nearing a state of insolvency should however ensure that they act with heightened prudence.

Wrongful trading

When a company is insolvent or approaching insolvency the directors owe new duties to the company’s creditors in addition to the company itself.

Wrongful trading occurs when:

• a director allows a company to continue to trade when he knew, or ought to have concluded that the company was insolvent or that there was no reasonable prospect of the company avoiding going into insolvent liquidation; and
• the company then does go into insolvent liquidation.

There is no requirement to show intent, dishonesty or fraud in order to establish liability for wrongful trading.

The consequences if liability for wrongful trading is established are:

• a court order against the individual director to contribute personally to the assets of the company for the purposes of satisfying creditors; and
• the risk that a disqualification order will be made against the director.

A director has a defence to a charge of wrongful trading if, once he knew (or ought in the circumstances to have concluded) that there was no reasonable prospect that the company would avoid going into insolvent liquidation, he is able to demonstrate that he took every step with a view to minimising the potential loss to the company's creditors as he ought to have taken.

Practical advice

There are a number of steps that a director can and should take in order to minimize the risk of personal liability.

• Directors should make contact with the company’s external advisers to seek advice as soon as they are aware that the company is in financial difficulties. A record of any advice sought and provided should be kept by the board;
• Directors should keep up to date with the company’s latest financial information at all times and be aware of its implications for the company. Directors should seek to be as pro-active as possible by speaking with the company’s funders at an early stage, producing accurate cash flow projections and monitoring projected compliance with financial covenants to avoid breaches;
• Regular Board Meetings should be held to ensure that the decisions taken and the thinking behind them are fully recorded;
• Each director should seek to form his own view on the company’s status taking into account the available legal and financial advice and information, prior to board meetings being held and options discussed;
• If there is no reasonable prospect that the company will avoid going into insolvent liquidation, the directors should take every step with a view to minimising the potential loss to the company's creditors. Directors in these circumstances may also wish to seek specific legal advice on their own positions;
• Directors should bear in mind that resigning will not solve the problem and is unlikely to have an impact on a directors’ potential liabilities. Again individual advice may be sought by individual directors if they have formed a different view to the rest of the board on the company’s solvency;
• If a director believes that there is no reasonable prospect of the company avoiding insolvency then he should immediately bring this to the attention of the Board and the company should take independent advice as a matter of urgency. In these circumstances, almost without exception, the company should not incur new liabilities unless and until it has been appropriately advised otherwise;
• Directors should be careful to avoid making decisions to pay certain creditors in preference to others;
• Directors should avoid taking customer deposits when they know they are going to be unable to fulfil all or part of an order;
• Directors should avoid issuing cheques or incurring credit on behalf of the company where they know there is little chance of payment.