“Wrongful Trading vs Fraudulent Trading: What are they?”

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In Brooks and another v Armstrong [1]joint liquidators applied for orders against directors of the insolvent company the Company under section of the Insolvency Act the Act the wrongful trading provision and for remedies to be awarded against delinquent directors under section of the Act. The Company had been run as a themed tourist attraction. The liquidators maintained that the directors had wrongfully traded in the knowledge that there fraudulent trading insolvency act liquidation no reasonable prospect of the Company avoiding insolvent liquidation following certain events, namely: The first issue before the High Court concerned the burden of proof in respect of wrongful trading.

The Court held that once it had been established that a director knew or ought to have concluded that there was no reasonable prospect of the Company avoiding insolvent liquidation, the onus was on the defendant director to show that he or she had taken every step to minimise the potential loss to creditors.

It was not for the liquidator to establish that the director had not taken the necessary steps. The Court also ruled that the liquidators merely had to prove knowledge at some time before the start of the winding-up rather than at a particular date. The Court stated that there was no duty on the directors not to trade while insolvent, or at a loss and that a company could legitimately trade at a loss where the directors anticipated profit to accrue to the benefit of the creditors. The fact that the directors turned out to be wrong did not fraudulent trading insolvency act liquidation denote fraudulent trading insolvency act liquidation failure to act as reasonable director would have done.

However, on the facts of this case, the directors ought to have recognised by January that the Company had no reasonable prospect of avoiding insolvent liquidation. Whether the directors had minimised the loss to creditors had to be judged by reference to the body of creditors as a whole.

In this case, the directors had ensured that trade creditors were paid but not the VAT and rent liabilities; accordingly, the directors had not taken every step needed with the aim of minimising loss to all creditors. On the compensation payable under sectionthe Court stated that objective was to recoup loss, not to be penal. Relevant considerations in the instant case were that the continued trading had not actually caused the VAT liability but had increased interest and penalties; it had increased the debt to the landlord; it had benefited trade creditors and reduced the overdraft and it had not been done dishonestly.

The case is a useful statement of the current judicial position in respect of fraudulent trading insolvency act liquidation trading. In this context it is worth noting the changes introduced to the law by the Small Business, Enterprise and Employment Act These make it possible for office-holders to assign wrongful trading actions and also make it possible for administrators — not just liquidators — to bring wrongful trading actions. Skip to content Like most websites, our website uses cookies.

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The following legal case illustrates the impact on directors of fraudulent trading - with fraudulent trading defined by Section of The Insolvency Act The High Court has ruled that directors who made representations that a company would meet its rental obligations on certain of its leases of property, when they had no intention of making payments after a certain date, were involved in fraudulent trading for the purposes of the Insolvency Act They were required to make a monetary contribution to the company's assets in its liquidation, as were solicitors involved in the scheme that resulted in non-payment of the rent see Morphites v Bernasconi [] 10 Current Law Section of the Insolvency Act provides that if, in the case of a company's winding-up, it appears that any company business has been carried on with intent to defraud its creditors or creditors of any other person, or for any fraudulent purpose, then the court may, on the liquidator's application, declare that any people who knowingly carried on the business in that way are to be liable to make such contributions if any to the company's assets as the court thinks proper.

The company was established as part of a road haulage franchise. It acquired some onerous leases through a former managing director, who was removed. The company's directors, with its solicitors devised a scheme under which the shares in the company were sold to the father-in-law of one of the directors, and the goodwill was acquired by a new company that continued to trade under another name.

The directors gave assurances to the landlord that the rent under the leases would continue to be paid. It wasn't, and the company went into liquidation. The liquidator asked the court for a declaration as to the director's liability to make a contribution to the funds of the company in liquidation. The court gave the declaration of liability. The directors had been closely involved in operating the business under the scheme, and the representation to the landlord about future payment of rent had been demonstrably false.

The case is a warning to directors not to represent to creditors that they will be paid the debts owed to them. In proving fraudulent trading, the dishonest element can be shown by the fact that the directors had no reason to think that funds would be available to make the payments. They do not have to intend or actually know that the payments will not be made see R v Grantham [] 3 All ER Fraudulent trading claims are not limited to directors, as wrongful trading claims under s of the Insolvency Act are.

In this case, a claim was also brought against the solicitors who had advised on the scheme. In terms of the loss arising, this in fact extinguished the director's liability in a payment sense. A cautionary tale for all corporate advisers - including of course accountants, at least where the non-payment of the debt is likely to arise from the advice given.

The decision The court gave the declaration of liability. Comment The case is a warning to directors not to represent to creditors that they will be paid the debts owed to them.