Wrongful Trading and Employee Impact

1. Meaning of Wrongful Trading

Wrongful trading arises when the management of a financially distressed company continues to carry on its business when the directors or partners knew, or ought to have known, that there was no reasonable prospect of avoiding insolvency proceedings, and they failed to exercise due diligence to minimise the potential loss to creditors.

In India, the principal statutory provision is Section 66(2) of the Insolvency and Bankruptcy Code, 2016 (IBC). It permits the Adjudicating Authority, on an application by the Resolution Professional during CIRP, to require a director or partner to contribute to the assets of the corporate debtor when the statutory conditions are established.

Wrongful trading is therefore different from an ordinary business failure. A company becoming insolvent does not, by itself, establish wrongful trading. The conduct of the persons responsible for the company's management and their knowledge of the financial circumstances are important.

2. Wrongful Trading vs Fraudulent Trading

Section 66 contains two distinct concepts.

Fraudulent trading – Section 66(1)

This concerns carrying on the company's business:

• with intent to defraud creditors; or
• for a fraudulent purpose.

It can apply to persons who were knowingly parties to such conduct.

Wrongful trading – Section 66(2)

This focuses on directors or partners who:

1. knew or ought to have known that there was no reasonable prospect of avoiding insolvency proceedings; and
2. failed to exercise due diligence to minimise potential loss to creditors. 

Thus, fraudulent trading primarily focuses on fraudulent intent, whereas wrongful trading focuses on continuing the business despite the absence of a reasonable prospect of avoiding insolvency and failure to take appropriate steps to minimise creditor losses.

3. Why Employees Are Affected

Employees can be significantly affected when a company continues trading improperly during severe financial distress.

Potential consequences include:

• unpaid wages;
• delayed salaries;
• unpaid bonuses;
• non-payment of statutory employment-related dues;
• loss of employment;
• loss of employee benefits;
• failure to make appropriate contributions or payments;
• deterioration of working conditions;
• sudden closure of the undertaking.

For example, management might continue accepting customer orders despite knowing that the company has insufficient funds to meet existing liabilities. Employees may continue working and accumulating salary claims while the company's financial position deteriorates.

This creates an important employee-impact issue: the longer an insolvent business continues without an appropriate restructuring or insolvency strategy, the greater the potential accumulation of unpaid employee-related liabilities.

4. Employee Wages as an Indicator of Financial Distress

Failure to pay employees can sometimes be an important factual indicator of financial distress.

However, non-payment of wages alone does not automatically prove wrongful trading. The surrounding circumstances must be examined.

Relevant questions may include:

• How long have wages remained unpaid?
• Did management know about the company's financial condition?
• Were other creditors being paid while employees were not?
• Were directors taking payments for themselves?
• Were assets being transferred away?
• Was management taking reasonable steps to restructure the business?
• Was there a realistic possibility of avoiding insolvency?

The factual circumstances and evidence remain crucial.

5. Directors' Duty to Minimise Loss

Section 66(2) focuses on whether the director or partner exercised due diligence to minimise the potential loss to creditors.

Possible examples of responsible conduct may include:

• obtaining professional insolvency advice;
• reviewing the company's financial position;
• stopping unnecessary expenditure;
• negotiating with creditors;
• restructuring operations;
• protecting company assets;
• avoiding preferential or suspicious payments;
• considering an appropriate insolvency process;
• preserving value for creditors and stakeholders.

Employees can benefit indirectly from such steps because preservation of company assets increases the pool potentially available for satisfying legitimate claims.

6. Directors Paying Themselves While Employees Remain Unpaid

A particularly relevant situation is where directors continue receiving money from a financially distressed company while employees remain unpaid.

In K. N. Narayanan Namboodiripad v. K. Parameswaran Nair, the NCLT discussed circumstances relevant to wrongful trading, including a director paying his own salary while employee salaries remained unpaid. It also identified other potentially relevant circumstances such as repayment of director loans while other creditors remained unpaid and purchasing goods on credit when there was no reasonable means of payment.

This does not mean every director payment is automatically wrongful. The nature of the payment, the company's financial position, the services rendered, authorisation, timing and surrounding circumstances must be examined.

7. Employee Claims and Insolvency

When insolvency proceedings commence, employees may become creditors of the corporate debtor for unpaid employment-related amounts.

The treatment of employee and workmen claims depends on the applicable provisions of the IBC and the nature and period of the claim.

This makes wrongful trading significant from an employee perspective because management decisions taken before insolvency can affect the amount of assets ultimately available for distribution.

8. Wrongful Trading and Preferential Transactions

Wrongful trading should not be confused with preferential transactions.

A preferential transaction generally concerns giving an advantage to a particular creditor or related party in circumstances covered by the IBC.

Wrongful trading under Section 66(2), by contrast, examines whether directors knew or ought to have known that insolvency could not reasonably be avoided and whether they failed to exercise due diligence to minimise creditor losses.

The distinction is important because different statutory provisions have different requirements and consequences. Recent appellate decisions have expressly emphasised that fraudulent, preferential and wrongful transactions should not simply be treated as interchangeable concepts.

9. Important Case Laws

1. K. N. Narayanan Namboodiripad v. K. Parameswaran Nair (2022)

The NCLT examined Section 66(2) and the concept of wrongful trading.

The tribunal identified circumstances that may indicate wrongful conduct, including:

• payment of director loans while other creditors remained unpaid;
• payment of a director's own salary while employees were not paid;
• purchasing goods on credit despite having no reasonable means to pay;
• improper accounting;
• falsification of records;
• transfer or sale of assets below reasonable commercial value. 

Employee impact

The case is particularly relevant because it expressly identifies payment to directors while employee salaries remain unpaid as a circumstance requiring examination.

2. Ramesh Kumar Suneja v. Arun Chadha, Liquidator of Pawan Buildwell Pvt. Ltd. (2023)

The NCLAT considered issues involving transactions and Section 66 of the IBC.

The case demonstrates the importance of examining transactions undertaken before insolvency and distinguishing between different types of transactions governed by the IBC.

Employee impact

The case is useful for understanding how transactions undertaken before insolvency can affect the assets available to satisfy creditor claims, including employment-related claims.

3. Rakshit Dhirajlal Doshi v. Chirag Shah, Liquidator of Doshion Water Umbrella Pvt. Ltd. (2026)

The NCLAT considered whether managerial remuneration drawn by suspended management constituted fraudulent or wrongful trading under Section 66.

The appellate tribunal stressed that mere suspicion or presumption of fraud is insufficient and that fraudulent trading requires cogent evidence establishing the necessary intent. It ultimately found that the remuneration in question could not be treated as fraudulent or wrongful trading on the evidence before it.

Employee impact

The case demonstrates an important limitation: the mere fact that employees or other creditors remain unpaid does not automatically make every payment to management wrongful. Evidence concerning the legitimacy, timing and circumstances of the payment is essential.

4. Nitin Ramchandra Jadhav v. Vijendra Kumar Jain (2026)

The NCLAT examined Section 66 and reproduced the statutory test for fraudulent and wrongful trading.

The decision reinforces that Section 66(1) and Section 66(2) address distinct situations and that wrongful trading under Section 66(2) concerns directors or partners who knew or ought to have known that insolvency proceedings could not reasonably be avoided and failed to exercise due diligence to minimise creditor losses.

Employee impact

Where employees have accumulated unpaid wages during a period in which management continued operating without appropriate measures, the company's increasing liabilities can form part of the broader factual context examined by the insolvency authorities.

5. Rana Sarkar v. Bimal Agarwal (2025)

The NCLAT discussed the distinction between Section 66(1) fraudulent trading and Section 66(2) wrongful trading.

The decision explained that Section 66(1) concerns business carried on with fraudulent intent, whereas Section 66(2) concerns the failure of directors or partners to take due diligence where insolvency could not reasonably have been avoided.

Employee impact

The distinction matters for employees because not every business failure or unpaid salary situation establishes fraudulent conduct. The legal test depends upon the particular statutory provision and evidence.

6. Suniel Dhhandhania v. Vichitra Narayan Pathak, RP of Golden (2026)

The NCLAT again considered Section 66 and the statutory requirements for fraudulent and wrongful trading.

The case illustrates that liability under Section 66 depends upon satisfying the specific statutory requirements rather than simply showing that a company subsequently entered insolvency proceedings.

Employee impact

For employees, this reinforces the importance of establishing the actual conduct and financial circumstances of management rather than relying solely on the fact that wages or other dues remained unpaid.

7. Orix Leasing and Financial Services v. Palak S. Desai, Liquidator of JSK (2026)

The NCLAT reiterated the distinction between Section 66(1) and Section 66(2).

The tribunal explained that fraudulent trading involves knowingly carrying on business with an intention to defraud creditors, whereas wrongful trading under Section 66(2) concerns the director's knowledge regarding the lack of a reasonable prospect of avoiding insolvency and failure to exercise due diligence to minimise creditor losses.

Employee impact

The case is relevant where employee claims form part of the creditor pool because the statutory objective of minimising creditor losses can encompass preservation of the company's assets for legitimate claims.

8. Dinesh Keshawrao Atkare v. Palak Swapnil Desai (2026)

The NCLAT considered whether Section 66 could apply even where the allegations concerned a particular transaction.

The tribunal observed that fraudulent trading does not necessarily require a series of independent transactions; the relevant question is whether the business was carried on with the statutory fraudulent purpose.

Employee impact

This is relevant where a particular asset-related transaction has substantially reduced the company's asset base and consequently affected the recovery prospects of employees and other creditors.

10. Practical Employee Impact

Wrongful trading can affect employees at several stages:

11. Relationship Between Wrongful Trading and Employee Protection

The underlying purpose of Section 66 is not specifically an employee-protection provision. It is primarily concerned with protecting the interests of creditors and preventing persons responsible for the company's management from worsening creditor losses through conduct covered by the provision.

Nevertheless, employees can benefit from the operation of Section 66 because employees may themselves have outstanding claims against an insolvent company.

If a director is ordered to contribute money to the corporate debtor's assets, the restored assets can potentially increase the pool available for distribution according to the applicable insolvency framework.

12. Important Limitation

It is important to distinguish wrongful trading from ordinary commercial failure.

A company may become insolvent because of:

• market conditions;
• loss of customers;
• unexpected expenses;
• economic downturn;
• supply-chain problems;
• unsuccessful expansion;
• legitimate business risk.

These circumstances do not by themselves establish wrongful trading.

The critical questions under Section 66(2) concern the director's knowledge or constructive knowledge regarding the lack of a reasonable prospect of avoiding insolvency and whether the director exercised the required due diligence to minimise creditor losses.

Conclusion

Wrongful trading is an important insolvency-law concept because management may face personal contribution liability where the statutory conditions of Section 66(2) of the IBC are established.

For employees, its importance arises primarily from the potential effect of management conduct on the company's ability to pay wages and other employment-related claims. Continued trading during severe financial distress, diversion or depletion of assets, improper payments to management, and failure to take reasonable steps to minimise losses can become relevant evidence.

At the same time, insolvency, unpaid wages, or a payment to a director does not automatically establish wrongful trading. Courts and tribunals examine the statutory requirements, the director's knowledge, the company's financial circumstances, the steps taken to minimise losses, and the evidence concerning the particular transactions.