Henry Shinners explores the consequences of 'wrongful trading' for professional practices.
The UK economy has just emerged from the worst recession in living memory and we are far from out of the woods. Growth is at best slow, public borrowing is extremely high, and, while earlier fears of a double-dip recession have subsided, inflation is running at double the rate the Bank of England is mandated to achieve. The effects of the spending cuts flowing out of the Government's Spending Review have yet to be felt in the wider economy and the availability of credit remains restricted.
It's a pretty gloomy economic picture, yet a combination of record low interest rates and a long period during which HM Revenue & Customs has been extremely supportive of businesses seeking to defer repayment of tax arrears has meant that, to date, there have been fewer business failures than one would have expected during such economic turmoil. Nevertheless, a significant number of UK businesses (including some professional practices) are in poor financial health and many of those may, unwittingly or otherwise, be trading while insolvent.
Impact on LLPs
So, what is trading while insolvent (or 'wrongful trading' to give it its formal title) and does it apply or matter in a professional practices context? In a traditional partnership, where partners have unlimited personal liability for all of the debts of the business, there are no increased financial consequences for the partners personally if they should continue to trade an insolvent business beyond the point that they should. However, in an LLP, where the members will consider themselves to have limited liability, greater care is needed if a nasty surprise is to be avoided.
It's important to remember that LLPs are analogous to limited companies in that an LLP is a body corporate, with a separate legal identity, and its members have limited liability. The corporate (rather than personal) provisions of the insolvency legislation are broadly applied to LLPs in the same way that they are to companies. As with companies, there are certain circumstances in which the corporate veil can be pierced, and a key risk for the members of a financially distressed LLP is that they could be held personally liable for debts of the LLP if they are found to have been trading wrongfully.
Procedure
Wrongful trading is a civil action brought by a liquidator, who will consider whether the LLP's members continued to trade the business beyond the point that they knew, or ought to have known, that there was no reasonable prospect of avoiding insolvent liquidation and whether, in doing so, they worsened the position for creditors. Upon a successful application by a liquidator, the court may make any declaration it sees fit, but ordinarily it would be that the members should personally make a contribution to the LLP's assets. The quantum would be such as to restore the position for creditors to what it would have been if the LLP had not continued trading beyond that point of no return.
Unfortunately, for members of LLPs who may find themselves in these circumstances, the defences against a claim for wrongful trading are limited. It is not sufficient to say, for example, that one was acting honestly or in the best interests of the partnership – the interests of creditors take priority when a business is insolvent or at risk of insolvency. In practice, the best way for members of a potentially insolvent LLP to minimise the risk of a wrongful trading claim and personal liability is to take professional advice as early as possible from an insolvency practitioner. He or she will be able to guide the members through the steps that should be taken to minimise the potential loss to creditors and the options available to the members generally.
Adjustment of withdrawals
Finally, no discussion of personal liability for members of an LLP would be complete without reference to the 'adjustment of withdrawals' or 'clawback' provisions of the Insolvency Act 1986, which are unique to LLPs and apply to members of an insolvent LLP who withdrew for their own benefit property of the LLP during the period of two years ending with the commencement of a liquidation. For these purposes, property includes share of profits, payment of interest on a loan to the LLP or any other withdrawal of property.
In common with the wrongful trading remedies available to a liquidator, the 'knew or ought to have known' insolvency test will apply and the court can make any order it thinks fit, which, in a proven case, is likely to be an order that the members repay any withdrawals for their personal benefit in the period.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
