Fraudulent Trading: The Widening Pool Of Persons Liable
All business organisations, particularly those who may be struggling to stay afloat, need to understand the implications of wrongful or fraudulent trading. Importantly, where fraudulent trading is found to have taken place, liability is not restricted to directors and company officers only.
So, how does fraudulent trading differ from wrongful trading; and who is responsible for creditors’ financial losses? Not just the company’s officers, as a case1 illustrates.
Wrongful trading – This is when, in simple terms, a company continues to trade while knowing (or should have known) that it was insolvent and fails to protect creditors from potential loss. Wrongful trading (governed by s214 Insolvency Act) can be inadvertent and is a civil wrong, not a criminal offence.
Even so, the directors found liable for wrongful trading can be held personally liable and risk disqualification from directorships.
Fraudulent trading – This is more serious and amounts to wrongdoing that tips over into criminal conduct. An offence of fraudulent trading is committed where the directors of an insolvent company intend to trade in a way that will deceive or defraud creditors and or customers.
Under s423 Insolvency Act 1986, an offence is committed where the purpose is to transfer money away from, for instance HMRC - and into the directors’ hands. Note that the maximum sentence in the most serious cases of tax fraud is now 14 years’ imprisonment.
What happened in this case?
Five companies became insolvent owing “enormous” amounts of VAT to HM Revenue & Customs. Each had been involved in a missing trader intra-community (MTIC) VAT fraud.
The companies’ fraudulent conduct was undeniable, however, the court had to consider whether anyone else could also be held liable. Under the s213 of the 1986 Act, “any persons who were knowingly parties to the carrying on of the business [in a fraudulent manner] are to be liable …”.
The effect of this provision is to ‘pierce the corporate veil’ to make culpable company directors personally liable for a company’s debts.
The claimant companies brought proceedings against a finance company for dishonest assistance to the directors. In addition, the companies’ liquidators alleged that the finance company participated in the companies’ fraudulent trading in breach of s213. The finance company had suspicions about the companies’ activities but continued work for them anyway.
On a detailed review of the law, the court found that the scope of s213 has been widened – a move necessary to protect others from fraud. Liability is not limited to ‘persons exercising management or control over the company in question’
The court observed that as the legislation defines ‘director’ to include a shadow director, it must have been intended to widen the net beyond those in active control of the business, whether or not they are formally directors.
In essence, the purpose of s213 is about compensating the victims of fraudulent trading, rather than protecting directors and others who are parties to the fraud from liability.
How this is applied in a given case will, however, depend upon the particular circumstances. As Lord Justice Lewison states: ‘Whether an "outsider" can be said to be party to the carrying on by a company of a fraudulent business may well be a question of fact and degree which requires careful analysis.’
Key takeaways
There are several lessons to take from this ruling:
· Businesses are reminded to exercise caution when continuing to trade during the course of its winding up to avoid a claim for wrongful or fraudulent trading
· Liability under s213 is not limited to the directors and company officers of a company found to have been trading fraudulently
· Third parties (‘outsiders’) who are knowingly involved in giving dishonest assistance to an insolvent company involved in fraudulent trading – or otherwise helping them in their wrongdoing - can also be held liable
Directors who are diligent in complying with their statutory duties and take reasonable steps to protect the company’s creditors from losses should have little to be concerned about. If in doubt about the implications of your own business’ future trading, take specialist advice from specialist lawyers.
1Tradition Financial Services Ltd v Bilta (UK) Ltd [2023] EWCA Civ,
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