Wrongful Trading - What you need to know

The inquiry into the collapse of Carillion and the press coverage of the role of directors in its downfall has shunted the issue of wrongful trading into the media spotlight. Along with well-reported difficulties in some academy trusts It highlights the need for trustees of academy trusts to be aware of their duties and the law on wrongful trading, including protecting themselves against the potential risk of personal liability.

Where a company (such as an academy trust) is in financial difficulties, the offence of wrongful trading may arise where a director allows a company to continue to trade where they knew (or ought to have concluded) that there was no reasonable prospect that the company would avoid insolvent liquidation.  Liability can arise if it is shown that the company is worse off on a net basis as a result of the continuation of trading.  If so, the liquidator or administrator can seek a court declaration that the director ‘contributes to the company’s assets.’  This is a (rare) exception to the general position that a trustee does not have personal liability for the debts of an academy trust.

A possible defence is that directors took every step they should have taken to minimise the potential loss to the company’s creditors. It is important to note this emphasis on the outcome for the academy trust’s creditors: this is in contrast to the ‘default’ operating position of considering primarily the trust’s beneficiaries (i.e. the pupils attending its academies). Being required to cease “trading” is particularly problematic given the likely consequences for pupils, as well as staff and the local community.

Trustees should ensure there is regular monitoring and reporting of the academy trust’s financial position, so that risks of insolvency can be identified as early as possible. Immediately they become aware the trust is in financial difficulty, trustees should seek professional advice from their accountants or auditors; keep a record of this advice and of any decisions made as a consequence; as well as being very mindful of their reporting obligations to the ESFA.   

In many cases the ESFA will already be involved and may have directed the trust to work with an “expert in school financial health and efficiency” or ultimately have issued a “Financial Notice to Improve”, requiring specified actions to be completed within a given timeframe.  Potential solutions may include additional grant funding; restructuring to release capital and/or reduce outgoings; or the transfer of one or more academies to another trust.  In our experience, trustees can face pressure from the DfE to continue trading in order to keep schools open, even if this may potentially place the trustees at risk of liabilities for wrongful trading.

Reassuringly, in practice the risk of personal liability for wrongful trading is generally most unlikely to arise, given the amount of work and expense that a liquidator or administrator would be required to undertake to demonstrate both the existence of wrongful trading and also that this has led to creditors losing more than they would otherwise have done. Instances of trustees being held personally liable in a charity context are extremely rare – but as ever, it is better to be safe than sorry.

Guidance is available for charities (including academy trusts) on financial management, including Charity Commission Guidance CC12, which includes a number of questions and recommendations for charities to consider when facing the risk of insolvency. Managing financial difficulties insolvency in charities.

The law and practice referred to in this article has been paraphrased or summarised. It might not be up-to-date with changes in the law and we do not guarantee the accuracy of any information provided at the time of reading. It should not be construed or relied upon as legal advice in relation to a specific set of circumstances.

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