The Difference Between Fraudulent Trading and Wrongful TradingSeptember 2, 2020
The COVID-19 pandemic has turned the world upside down. After two consecutive quarters of economic decline, the UK has now technically entered its first recession since 2009 - and it’s the deepest on record.
While the Government has offered a variety of stimulus packages to jump-start an economic recovery, many businesses face dire prospects. It’s at times like this that it’s especially important to be wary of fraudulent and wrongful trading and to understand the crucial difference between them.
In this article, we’re going to explain the difference between fraudulent trading and wrongful trading.
What is wrongful trading?
Wrongful trading occurs when a company continues to trade while insolvent, even when managers are aware that the company is going out of business. This is a civil offence under section 214 of the Insolvency Act 1986.
Directors must be found to have acted responsibly in the time preceding the company’s insolvency and to have put the creditor’s interests first to avoid accusations of wrongful trading.
What constitutes wrongful trading?
According to the Insolvency Act of 1986, wrongful trading occurs when company directors have continued to trade when they ‘knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation’.
Further, it is considered wrongful trading if the director did not take ‘every step with a view to minimising the potential loss to the company’s creditors’.
Some of the actions which may be considered as evidence of wrongful trading include:
- Failing to publish annual returns at the Companies House.
- Not filing annual or audited accounts at Companies House.
- Incorrect usage of the PAYE scheme, including not paying PAYE and NIC when due and building up arrears.
- Incorrect use of the VAT scheme.
- Accepting deposits from customers when you know the product or service will not be delivered.
- Taking salaries that exceed that which the company can afford.
- Repaying a director that has made a loan to the company while other creditors were not repaid.
- Accepting additional credit when there is ‘no reasonable prospect’ of paying the creditor on time.
- Continuing to trade while insolvent.
It’s worth noting that there is a six year limitation period, after which you won’t be charged. Wrongful trading will only apply in terminal insolvency - that is, when the business is no longer viable and formal insolvency proceedings, such as liquidation or administration, have been actioned.
Even with these limitations, you should always seek to act in the preferential creditors’ interests. If you are aware that you have participated in wrongful trading but your company has avoided insolvency, you should keep a record of any details - they may help protect you in the future.
How is a director accused of wrongful trading?
During the process of winding up a company, the liquidator or administrator will determine whether wrongful trading has occurred. They will carry out a thorough investigation of the director’s conduct during the liquidation process.
What is the punishment for wrongful trading?
If found guilty of wrongful trading, the company director may be held personally liable for company debts from the point at which it became insolvent, and be forced to make such contributions as the court sees fit. You may also face disqualification as a director for up to 15 years.
What is fraudulent trading?
Unlike wrongful trading, fraudulent trading is a criminal offence and brings much greater consequences for those involved.
The actions which constitute fraudulent trading are largely the same - the difference is intent. Directors who participate in fraudulent trading have a clear intent to defraud and deceive both their customers and creditors.
A typical example of behaviour that might be viewed with suspicion by the investigating insolvency service is selling the company’s assets “undervalue” - that is, less than the market value - in the run up to a liquidation. Disposing of company assets in this way to avoid liquidation and repaying creditors is an act of misfeasance.
It is much more difficult to secure a verdict of fraudulent trading because of what’s known as the ‘burden of proof’ - it’s usually exceptionally hard to prove that the business of the company has been carried on with the intent to defraud.
A liquidator may report their findings of wrongful trading long before they make an accusation of fraudulent activity. Evidence will usually be weighed heavily in the court before such an order is even considered.
What is the punishment for fraudulent trading?
As you would expect, the punishments for fraudulent trading are much more severe.
According to the Companies Act 2006, Section 993, every person ‘knowingly a party to the carrying on of the business in that manner’ can be held accountable.
Compared to wrongful trading, you may be held personally responsible for a greater proportion of the company’s debts and receive a larger fine, as well as a longer disqualification from being a company director. You may also face up to 10 years imprisonment.
How to avoid wrongful trading or fraudulent trading accusations.
If your company is insolvent, or is in a precarious financial position, you should seek help from a licensed insolvency practitioner immediately.
If you act early enough, you may be able to secure a Company Voluntary Arrangement (CVA). This allows you to stay in charge of the company while receiving protection from your creditors as you attempt to negotiate a settlement with your creditors.
Most creditors, particularly unsecured creditors, will have a strong desire to accept a proportion of what they are owed and allow you to continue trading, as it means that they are guaranteed to receive something. This may not be the case if the company goes bust.
Pursuing a CVA will also buy you time to turn your business around by shedding excess staff, refocusing marketing, and cutting costs.
If you are struggling with tax debts, you may also be able to negotiate a Time to Pay agreement with HMRC.
If found to be guilty of trading with a fraudulent purpose, the punishments can be severe. However, wrongful trading can also cause considerable damage to your reputation.
In light of the coronavirus pandemic, the Government has introduced temporary measures to support businesses who are under financial pressure. This included amendments made to the insolvency law to provide breathing space for companies and temporarily suspending wrongful trading provisions from 1 March 2020 for a period of 3 months. Nevertheless, company directors must remain mindful of their fiduciary duty to creditors and should seek advice at the earliest possible time.