Meaning
The legal provision that imposes personal liability on directors if they continue to trade when there is no reasonable prospect of avoiding insolvent liquidation. This action under section 214 holds directors financially accountable for any increase in the debts of the company after the point they realized the company was insolvent. The court can order the directors to make a personal contribution to the assets of the company to compensate the unpaid creditors.
This protects the market from directors who act recklessly at the expense of suppliers.
Liability Threshold
Insolvency practitioners must establish that the directors knew or ought to have concluded that the company could not avoid liquidation. Under section 214, the standard of knowledge expected is that of a reasonably diligent person carrying out those director duties. If a director possesses special professional qualifications, the court applies a higher subjective standard of scrutiny.
This dual test ensures that directors cannot hide behind ignorance of their financial position.
Defence Provision
Directors can avoid liability if they can prove they took every possible step to minimize the loss to creditors.
Financial Remedy
Courts determine the size of the personal contribution based on the financial deterioration of the company during the wrongful trading period. It calculates this by measuring the difference between the net assets at the date wrongful trading began and the assets available at the date of liquidation. These funds are distributed among the unsecured creditors who suffered losses during the period of irresponsible trading.
This remedy provides a powerful incentive for directors to cease trading and seek professional advice as soon as insolvency becomes inevitable.
