Fraudulent Trading: Definition, Law & Director Liability

Definition

Fraudulent trading describes the conduct of carrying on a company's business with the intent to defraud creditors or for any other fraudulent purpose. Under Section 213 of the Insolvency Act 1986, a liquidator may apply to the court for a declaration that any person who was knowingly party to such conduct must make a contribution to the company's assets. Section 993 of the Companies Act 2006 creates the parallel criminal offence, applicable whether or not the company is in liquidation.

The concept sits at the intersection of insolvency law and corporate governance, because it defines the outer boundary of conduct for which those controlling a company face personal consequence. Where most director duties operate as standards of care or loyalty, fraudulent trading represents the point at which commercial failure becomes personal culpability, and the distinction between the two turns entirely on the presence or absence of dishonest intent.

How Fraudulent Trading Works

The mechanism turns on a single factual question, established in Re William C Leitch Bros Ltd [1932]: did the person carry on or participate in the company's business knowing that creditors would be defrauded? The test requires actual dishonesty rather than mere negligence or poor judgement. A director who incurs credit knowing the company has no reasonable prospect of repayment, and who conceals that knowledge from creditors, satisfies the threshold.

The civil route under s.213 can only be pursued by a liquidator after formal insolvency proceedings have commenced, meaning the company must first enter liquidation. The criminal route under s.993 carries no such restriction and can be prosecuted while the company continues to trade, which gives the Insolvency Service and Crown Prosecution Service a broader enforcement window when evidence of fraud emerges before formal insolvency.

In practice, investigators look for patterns of behaviour that reveal deliberate concealment rather than unfortunate commercial decline. Accumulating trade debts while diverting assets, issuing false accounts to maintain credit lines, or continuing to accept customer deposits after the directors know the company cannot fulfil its obligations all represent the kind of sustained dishonesty that transforms insolvency into fraud and produces consequences reaching well beyond the company itself.

Real-World Example

Consider a construction firm whose directors continued accepting advance payments on contracts for six months after concluding the business was insolvent. Internal communications later revealed the directors knew subcontractors could not be paid, yet they instructed sales staff to pursue new deposits. On liquidation, the appointed liquidator brought a s.213 claim, and the court declared both directors personally liable for the full value of deposits received during the period of knowing insolvency, totalling approximately £2.4 million.

In parallel, the Insolvency Service referred the matter for criminal prosecution, resulting in disqualification orders and custodial sentences. The case illustrates how the line between trading while insolvent (potentially wrongful trading) and fraudulent trading is drawn at the point where concealment and dishonest intent become provable. The directors did not simply misjudge the company's prospects. They actively concealed the financial position from creditors while extracting value, and that concealment converted what might have been negligence into fraud.

Key Considerations and Limitations

Fraudulent trading is a powerful creditor protection, but its high evidential threshold means it is invoked far less frequently than wrongful trading in practice. The requirement to prove actual dishonesty places a significant burden on liquidators, because documentary evidence of knowledge and intent is essential. Companies that keep poor records may paradoxically be harder to prosecute, since the very absence of documentation that suggests fraud also removes the paper trail needed to prove it.

Liquidators must also weigh the cost of litigation against likely recoveries. Contribution orders are only valuable if the respondent has personal assets to satisfy them, and directors who operate through complex group structures or who have dissipated assets before proceedings commence may render a successful claim economically worthless. This creates a practical gap between the statute's deterrent power and its enforcement reality.

Finance professionals reviewing board oversight structures should recognise that the most effective protection against fraudulent trading claims is contemporaneous documentation of decision-making, particularly around continued trading decisions taken near the point of insolvency. Board minutes that record the information available, the alternatives considered, and the reasoning behind each decision create a defensible record that distinguishes legitimate commercial risk-taking from the kind of concealment that triggers personal liability.

Fraudulent Trading vs Wrongful Trading

The distinction between these two provisions resolves a question that arises naturally from the limitations described above. If fraudulent trading is so difficult to prove, what alternative does the law provide? Wrongful trading under s.214 of the Insolvency Act 1986 fills that gap by removing the requirement for dishonesty entirely, imposing liability where a director knew or ought to have concluded that insolvent liquidation was unavoidable, yet failed to take every step to minimise creditor losses. The practical implication is that liquidators typically pursue wrongful trading as the primary claim because of its lower burden and objective test, reserving fraudulent trading for cases where dishonesty is clearly documented.

The two provisions operate as complementary tools within the same legislative framework. Wrongful trading catches the director who was negligent or unreasonably optimistic about the company's prospects, while fraudulent trading catches the director who knew the position was hopeless and deliberately concealed it to extract further value. In practice, a liquidator will often plead both claims in the alternative, allowing the court to find liability under whichever provision the evidence supports.

Conclusion

Fraudulent trading represents the most severe personal consequence available under UK insolvency and company law for those who abuse the corporate form. Its combination of unlimited civil contribution orders and custodial criminal sentences reflects the seriousness with which Parliament views deliberate creditor fraud, and its scope extends to anyone knowingly involved in the conduct rather than directors alone.

For finance professionals and board members, the practical lesson is that the boundary between legitimate commercial risk and personal liability runs through documentation and intent. Directors who maintain clear, contemporaneous records of their decision-making, who take professional advice when the company's financial position deteriorates, and who act transparently with creditors throughout create a defensible position even when the company ultimately fails. Those who conceal, divert, and continue extracting value in the knowledge that creditors will suffer cross a line from which neither limited liability nor the corporate veil offers protection.

References

1. Insolvency Act 1986, s.213, s.214. UK Public General Acts.
2. Companies Act 2006, s.993. UK Public General Acts.
3. Re William C Leitch Bros Ltd [1932] 2 Ch 71.
4. Morphitis v Bernasconi [2003] EWCA Civ 289.