Aziz Rahman explains the difference between wrongful and fraudulent trading and outlines what those in business need to know to avoid being accused of either.

It sometimes seems as if the terms wrongful trading and fraudulent trading are used to describe any business that finds itself in trouble. But there is a vast difference between the two - and those in business must understand how to make sure they do not face allegations involving either offence.
Wrongful trading is where a company director knows, or should have realised, that the firm was going into liquidation but continues trading. Fraudulent trading is where a company director knows or should have realised that the firm was going into liquidation but continues trading with the intention of defrauding creditors.
It is this intention to defraud creditors that distinguishes fraudulent trading from wrongful trading – and why fraudulent trading carries heavier penalties, as it is always a criminal act.
Wrongful
Section 214 of the Insolvency Act 1986, allows a court to order a director of a company in liquidation to contribute personally to the assets in the liquidation if they are found guilty of wrongful trading. If an insolvency practitioner (IP) pursues a wrongful trading action against a company director, it can be settled without a court hearing; saving the IP time and resources.
But if the case is going to be contested, a defence team can find much to challenge in the IP’s claims. A central part of the case will be exactly what a director knew about the company’s situation at the time of the alleged trading.
A defence team needs to not only argue that its client believed he was trading honestly and legally – it must find evidence to back up this claim. This evidence has to prove the director believed he was trading legally, that any reasonable director would have believed he was trading legally - and that he actually was. This puts the onus on the IP, who then has to set about challenging the claims being put forward by the defence. The defence’s use of evidence can, therefore, be of dual use: it can deter an IP from making wrongful trading allegations but can also be used to challenge any action that is brought.
Factors
If a company can be seen to be insolvent on its balance sheet, fails to pay its debts or is not paying its tax liabilities, a director should have known the company was insolvent. He is, therefore, liable under S214 of the Insolvency Act.
These are all factors that IP’s and creditors use to attempt to prove the exact time when directors knew or should have known that the company was insolvent. Financial projections, company assessment of accounts and trading practices will all be looked at by IP’s as they search for proof of a careless approach to trading.
Fraudulent
Fraudulent trading can carry up to 10 years imprisonment under the Companies Act 2006. This is because the intention to defraud makes it a much more serious matter. In all the wrangling regarding the collapse of BHS, it seems that few people have any clear idea whether the matter is one of fraudulent trading, wrongful trading or neither.
But while fraudulent trading carries more severe penalties than wrongful trading, it is similar in that defending any allegation depends on the compiling, interpreting and using of evidence to counter allegations made by the other side. Insightful analysis of company accounts, business plans, expenditure and tax and creditor payments can help a defence argue that those being accused are decent, honest business figures. As with wrongful trading, it is up to the prosecution to challenge the evidence and assertions put forward by the defence.
Advice
It must be said that such defences are prepared in response to a company or individual being the subject of allegations or investigations. In many cases, such problems could be avoided if those in business seek legal advice the moment they suspect something may be wrong.
At Rahman Ravelli, we routinely carry out internal investigations for clients who wish to make sure they are trading legally. Such investigations can flag up problems before they become issues that could end up in court. It is also worth noting that legal advice can be invaluable in not only identifying problems but in recognising how they can be best dealt with.
Issues such as when to place a company into administration – where a company is managed by a court-appointed administrator – or when to report problems to bodies such as HM Revenue and Customs, the Serious Fraud Office or the National Crime Agency have to be timed correctly.
By conducting such activities at the right time and handling any resulting negotiations carefully, a defence team can give a huge boost to a director’s chances of being believed when they seek to prove they traded honestly and legally.