I attended a swanky business dinner in the mid-1990s addressed by a well-known Irish CEO. In his speech, the CEO admitted that his now-thriving company was insolvent in the 1980s. Some of us raised a metaphorical eyebrow at this disclosure as we felt the CEO was confessing publicly to an illegal act – reckless trading. The CEO was none other than Seán FitzPatrick, and he was talking about Anglo Irish Bank.

In current economic conditions, reckless trading is an issue for many directors whose businesses are financially stressed. If directors continue to trade when it is no longer reasonable to expect an upturn in the company's fortunes, they are trading recklessly. By way of a simple example, after the bookshop Hughes and Hughes went into receivership, it was accused by a customer of reckless trading for selling book tokens when management must have known the company would not be able to honour the tokens. However, this might not amount to reckless trading in court.

Directors generally operate through limited liability companies. This is very beneficial. It means directors' personal wealth is safe from creditors. There are, however, some exceptions. A director can be held personally responsible (without limitation of liability) for all or part of the debts of the company, where he or she is found to be knowingly a party to the carrying on of the business in a reckless manner.

Almost all cases of reckless trading are taken by liquidators of insolvent firms. That is because, when reckless trading becomes an issue, the company is likely to be in liquidation (partly as a consequence of the reckless trading). Liquidators have a statutory obligation to take restriction proceedings against directors, unless they have been relieved of that obligation by the Office of the Director of Corporate Enforcement (ODCE). The ODCE will relieve liquidators of the obligation to take restriction proceedings if it is satisfied that the company's directors acted responsibly and honestly in conducting the affairs of the company.

Reckless trading involves company directors building up company debts, not honestly believing the company will be able to repay them. In practice, however, there is a lack of clarity on what exactly constitutes reckless trading. Sloppy business practices do not amount to reckless trading, because this will not necessarily cause loss or damage to others.

Proving reckless trading is not easy. The director has to be shown to have knowingly engaged in it. Recklessness has to be determined objectively. The prosecution must demonstrate that the director must have known the actions taken entailed serious risk of loss or damage to others. The director must be shown to have ignored the risk and put selfish efforts to keep the company alive ahead of the interests of the creditors.

Notwithstanding the legal difficulties in prosecuting reckless trading, successful actions have been taken by liquidators. Damages of €2.2m were obtained against two directors of Doherty Advertising, who were also restricted from acting as company directors for five years. A director of PSK Construction was held personally liable for €1.6m of the company's debts, and he and a fellow director were disqualified from acting as company directors for seven and five years respectively.

The Stokes twins, who ran the Residence private members' club, described by Judge Peter Kelly as "delinquent directors", are being investigated by the ODCE; they may be prosecuted for reckless trading and held personally liable for the debts of the club.

There are simple ways to avoid a charge of reckless trading. Keeping proper records to demonstrate that all reasonable steps were taken in running the business properly is essential. Directors should also keep personal records of their actions. Ultimately, however, acting responsibly and honestly is the best defence against allegations of reckless trading.

Niamh Brennan is Michael MacCormac Professor of Management at UCD and is Academic Director of the Centre for Corporate Governance at UCD