Author: Azizur Rahman
3 February 2015
4 min read
A look at the differences – and the similarities – between wrongful and fraudulent trading and the challenges they pose for directors and insolvency practitioners when accusations are made.
It is one of those distinctions that people often fail to make. Yet the difference between wrongful and fraudulent trading is both large and important.
Putting it simply, if a company director knows, or should have realised, that the firm was going into liquidation but carries on trading then he is guilty of wrongful trading. If, however, that company director carries on trading with the intention of defrauding creditors then it is fraudulent trading. Penalties for fraudulent trading are far more severe as it is always a criminal act. But for both wrongful and fraudulent trading, the all-important factor is the finding and utilising of evidence – whether you are the accuser or accused.
Under Section 214 of the Insolvency Act 1986, a director of a company in liquidation can be ordered by the court to contribute personally to the assets in the liquidation if they are found to have been guilty of wrongful trading. If an insolvency practitioner (IP) decides to pursue a wrongful trading action against a company director, it is possible for a settlement to be reached short of a court hearing. This can mean that reported court cases of wrongful trading are often few and far between, even though results have been obtained by the IP.
This is a procedure that IP’s can see obvious benefits in as it gives them the possibility of an outcome without the time and effort of a full court hearing. But for anyone looking to contest such an allegation, a wrongful trading case does provide plenty of opportunities to argue a defence. Especially if the defendant seeks legal representation with expertise in this particular field.
Much of a defence case will rest on effective challenging of the claims made by the IP. Even the IP would have to admit that it is difficult to prove what someone knew at the time the alleged trading was being committed. It is a matter involving the defendant’s state of mind - if he says that he believed he was trading legally or honestly believed the company could trade its way out of difficulty then the IP needs to be able to challenge that. As a firm with experience in dealing with these types of cases, we believe the best approach is to not merely claim that a company director believed they were trading legally – we look to find and use evidence that proves that this is the case. Similarly, the IP needs to find the evidence that can counter this.
Finding and using such evidence can be valuable for two reasons. The first, and most obvious, is that it provides the director with a solid defence should the case go to a court hearing. But secondly, such evidence has value as a deterrent for the defence. If an IP is considering bringing a wrongful trading action, they will be less keen to do so if confronted with defence team evidence; especially if they are weighing up whether they have the funds to pursue the action. For that reason, the IP has to be able to produce as much evidence as possible to support their allegations.
One important point to note about the evidence in such cases – and one that cannot be emphasised enough – is that the issue at stake is not only what the director knew, it is also what they should have known if they were a reasonable director. So, for example, a director may claim he did not know the company was insolvent because he possessed no information that showed that. But the court could still find him guilty of wrongful trading as he failed to act as a reasonable director would.
A company can be classed as insolvent if it is shown to be so on the balance sheet or if it cannot meet its debts as they arise. The last balance sheet showing the company is insolvent, failure to make PAYE or corporation tax remittances on time over a number of months or non-payment of VAT due are all considered indicators that the directors should have known a company was in trouble, thus making them liable under S214 of the Insolvency Act. Such indicators are likely to be brought up both by IP’s and creditors as they seek to determine a definite point in time when the directors knew or should have known that the company was insolvent. Financial projections and evidence to support them will be scanned intently by IP’s looking to establish a pattern of action that led to wrongful trading, as will the company’s assessment of its accounts over time. Over-optimistic projections will be used by IP’s as proof that a director was not reasonable while insufficient analysis of the accounts will also be used to indicate a cavalier approach to trading.
An IP may be unsuccessful in their action for wrongful trading but they can still report the events to the DTI with a view to having the director disqualified. As with wrongful trading, the outcome of the case will depend on the strength of the evidence that each side can produce.
As fraudulent trading is defined as when directors carry on trading in order to defraud creditors, the penalties are more severe than they are for a S214 wrongful trading; which is not necessarily an unlawful act. Fraudulent trading can carry up to 10 years imprisonment under the Companies Act 1996; making it a much more serious allegation than wrongful trading. But, just as with wrongful trading, the emphasis on evidence to support either the prosecutor or defendant’s case remains strong.
Anyone facing such an accusation needs to be able to refer to accounts, expenditure, business plans and their track record of VAT, PAYE, National Insurance and creditor payments to be able to build up a picture of them acting reasonably at all times during their time at the helm of the company. If they cannot do that then the IP’s task becomes much simpler. If, however, a director is able to seek legal expertise in order to present a strong case using some or all the above evidence then the challenge facing the prosecutor is how to rebut the defence arguments and find ways of interpreting this evidence – and any other evidence they may have obtained – to indicate that the director has failed to act reasonably.
The defence can argue mitigating factors such as the size of the amounts involved, the period over which the fraud was carried out, whether there have been voluntary repayments and if any personal issues exist such as illness or family problems. However, such factors may also give scope to the prosecution to call for the stiffest possible penalty.
Ideally, the best approach is to avoid becoming embroiled in business problems that lead to either wrongful or fraudulent trading allegations. But if it is too late for that, a director has to find and make the very best use of all the evidence available.
Aziz Rahman is Senior Partner at Rahman Ravelli and its founder. His ability to coordinate national, international and multi-agency defences has led to success in some of the most significant corporate crime cases of this century and top rankings in international legal guides. He is recognised worldwide as one of the most capable legal experts regarding top-level, high-value commercial and financial disputes.