Wrongful trading: what it is and when directors face personal liability

The legal test under Section 214

Section 214 of the Insolvency Act 1986 imposes liability on a director who knew, or ought to have concluded, that there was no reasonable prospect of the company avoiding insolvent liquidation, and who failed to take every step with a view to minimising the potential loss to creditors. The court applies both a subjective test (what this director actually knew) and an objective test (what a reasonably diligent person with that director's function would have known).

The objective element means that lack of financial expertise is not a complete defence. A director who should have understood the company's financial position — even if they delegated accounts to a co-director or accountant — is still expected to meet the standard of a reasonably diligent person in that role.

When does wrongful trading begin?

There is no bright-line date. The question is when a director knew or ought to have concluded that insolvent liquidation was inevitable. Warning signs the courts consider include persistent overdrawn bank accounts, creditor pressure and county court judgments, inability to pay HMRC on time, loss-making trading periods, and a deficit on the balance sheet after realistic asset valuations.

Directors who receive formal advice — from an accountant, insolvency practitioner, or solicitor — that the company is approaching insolvency should treat that date as the likely starting point from which their conduct will be scrutinised. Meeting minutes and board papers from that period will be central to any later claim.

The defence: taking every step to minimise loss

A director avoids liability if they can show they took every step a reasonably diligent person would have taken to minimise potential creditor losses once insolvent liquidation became apparent. In practice, this means promptly appointing an insolvency practitioner, ceasing to take on new credit, preserving assets, keeping accurate records, and cooperating fully with the process.

Continuing to trade with a genuine and reasonable belief that rescue is achievable is not wrongful trading — the key word is "reasonable". That belief must be grounded in something concrete: a credible refinancing in progress, a signed heads of terms, a formal forbearance agreement with creditors. Directors who continue trading on hope alone rather than documented evidence are in a more exposed position.

How borrowing interacts with wrongful trading risk

Taking on new debt — including refinancing existing debt — when a company may already be heading toward insolvent liquidation is a decision directors must approach carefully. New borrowing increases the pool of creditor losses if the company subsequently fails. A lender who advances funds to a company in distress will have its own rights, but the director who authorised the borrowing remains exposed to a wrongful trading claim for the loss flowing from that decision.

If your company is in financial difficulty and you are considering taking on additional borrowing to trade through a difficult period, obtain a written assessment from an insolvency practitioner first. That assessment provides contemporaneous evidence of the basis for your belief that rescue was achievable — which is the best protection against a later wrongful trading claim.