10) Corporate Insolvency II Flashcards
Liability of directors of an insolvent company
Directors can be personally liable if found guilty of:
* Misfeasance (s212 IA 1986)
* Fraudulent Trading (ss213/246ZA IA 1986)
* Wrongful trading (ss 214 / 246ZB IA 1986)
Misfeasance Act
s 212 IA 1986
Fraudulent Trading
ss 213
ss 245ZA IA 1986
Wrongful trading
ss 214 / 246ZB IA 1986
Who can bring proceedings against directors personally
Liquidators and administrators
Liquidators can only do this for misfeasance
ss 171 - 178 CA 2006
Directors owe duties to the company.
Breach of ss 171 - 178 CA 2006
Actionable by the company.
Shareholders may bring a claim for unfair prejudice
= just and equitable winding up
= derivative claim
Typically on winding up
- Liquidator who brings the actions against directors
- Under s212 IA 1986
Section 212
- Does not create any new liability or rights
- Summary procedure to enable the company (acting via its liquidators) to pursue claims against directors who have breached duties.
If liability is established
Court may order that person compensate the company in respect of money or property misapplied.
What is misfeasance?
Misfeasance is the act of performing a legal action in an improper or illegal way?
Who may bring a claim for misfeasance?
- Liquidator
- Official receiver
- Creditor or contributory
s212(3) IA 1986
Mullarkey v Broad 2008
Burden of proof is on the claimants to establish misfeasance on the part of the director or defendant
Burden of proof misfeasance
- On the claimant to est misfeasance
- Not up to director to justify their contact
Mullarkey v Broad 2008
Who can a misfeasance claim be brought against?
- Any person who has been an officer int he company
- Any others who acted in promotion, formation or management of the company
- A liquidator or administrative receiver.
S212(1)
Re Centralcrest Engineering Co Ltd 2000
- Inland Revenue brought proceedings against liquidator s212
- Allowed trading for 27 months
- £73,230 owed to IR
- Court held 2 elements for misfeasance
- Liquidator liable for £120,826
Two elements of misfeasance
Re Centralcrest Engineering Co Ltd 2000
1) Allowing the company to trade without sanction of the court or liquidation committee
2) Allowing the company to trade, when apparent assets should have been realised.
What amounts to misfeasance?
- Misapplication of any money or assets of the company
- Breach of statutory provisions
- Undervalued or preferenced transactions
- Breach of duty to exercise care, skill and diligence = negligence
s 174 CA 2006
Misfeasance:
Breach of duty to exercise reasonable care, skill and diligence
= s 174 CA 2006
s 238 CA 2006
Misfeasance:
Directors responsible for transactions at an undervalue
s 239 CA 2006
Misfeasance:
Directors responsible for transactions at an preference
Breach of statutory provision or duty = misfeasance
- Unlawful loans (s197)
- A director entering into a contract with own company and failing to notify the board (s177)
- Failing to seek prior GM approval where a director entered a substantial property transaction (s190)
- Director failing to act within their powers (s171)
s197 CA 2006
Misfeasance = breach of statutory duty
Unlawful loans to a director
s177 CA 2006
Misfeasance = breach of statutory duty
- Director entering into a contract with his own company and failing to notify the board.
s190 CA 2006
Misfeasance = breach of statutory duty
- Failing to seek prior GM approval where director has entered into a substantial property transaction.
s 171 CA 2006
Misfeasance = breach of statutory duty
A director failing to act within their powers
Remedies
Order for repayment, restoration, or contribution to the company’s assets as it thinks just
Directors relief
s 1157 - relief
Where court is satisfied that the director acted honestly and reasonably, having regard to all the circumstances of the case.
Finding misfeasance is a relevant factor when a court considers…..
A disqualification order for unfitness.
Company Directors’ Disqualification Act 1986
Ratification
- Ratification by shareholders can usually absolve directors from personal liability for breach of duty.
s 239 CA 2006
Ratification by the shareholders
Ratification when company is solvent precludes misfeasance proceedings.
s 239 CA 2006
When a company is facing insolvency, case law has established
Duties of directors shift toward the company’s creditors and away from the members as a whole.
It is not possible for shareholders to ratify directors’ breaches when….
The company’s fortunes have declines
No reasonable prospect of insolvent liquidation or administration.
s239(7) CA
s239(7) CA
Ratification procedure does not prejudice any rule of law which provides shareholder ratification is of no effect.
Provisions on fraudulent and wrongful trading in IA 1986
Aims to prevent directors incurring further debts when company is in financial difficulty with no reasonabl prospect fo turn around.
Claim for fraudulent trading can be brought under….
ss213 / 246ZA IA 1986
Claim for fraudulent trading can be brought against….
- Any person knowingly carrying out business of the company
s213(1) and s246ZA(1) - Intend to defraud creditors or for any fraudulent purpose s213(2) and s246ZA(2)
Civil liability to contribute to …
s213 (when in liquidation)
s246Z (when in administration)
to general body of unsecured creditors who suffered loss caused by carrying out the company’s business with intent to defraud
s993 CA 2006
Criminal claim for fraudulent trading
What must be proved for a fraudulent claim to succeed
Actual dishonesty must be proven for fraudulent claim.
How is dishonesty assessed…
- Subjective not objective basis
- Knowledge includes blind eye knowledge.
Blind eye knowledge
Requires suspicion of relevant facts.
Deliberate decision to avoid confirming they did exist
Morris v State Bank of India 2005
Morris v State Bank of India 2005
Blind eye knowledge
Requires suspicion of relevant facts.
Deliberate decision to avoid confirming they did exist
Meaning of fraud
s213
“Real dishonesty involving, according to current notions of fair trading among commercial men at the present day, real moral blame”
Re Patrick and Lyon Ltd 1933
Re Patrick and Lyon Ltd 1933
Meaning of fraud:
“Real dishonesty involving, according to current notions of fair trading among commercial men at the present day, real moral blame”
It is not necessary for all creditors to have been defrauded
Re Gerald Cooper Chemicals Ltd 1978
…only one creditor is enough to establish
Re Gerald Cooper Chemicals Ltd 1978
Advance payment for supply of foods from one creditor.
Directors knew that there was no prospect of of payment
= fraudulent trading
Re Gerald Cooper Chemicals Ltd 1978
It is not necessary for all creditors to have been defrauded
… only one creditor is enough to establish
Remedies for fraudulent trading
- Court can order a contribution
- Cannot include punitive element
- Contribution must reflect loss of creditors
Morphitis v Bernasconi 2003
Remedy contribution for fraudulent loss should reflect and compensate for the loss caused by creditors…. not punitive
Re Esal (commodities) Ltd 1997
Any sums recovered are held in trust for the unsecured creditors generally and not for the defrauded credito.
When a court makes an order against a director under ss213 / 246ZA
Then the court is also likely to make a disqualification order under
s 10 CDDA 1986
s 993 CA 2006
Criminal sanctions can be imposed the court
Punish a person knowing party to fraud
Up to 10 years in prison or fines
Criminal sanctions for knowingly fraudulent trading
s 993 CA 2006
* Up to 10 years in prison
* Fines
Fraudulent vs wrongful trading
- Usuually wrongful trading.
Wrongful trading, difference to negligently
For negligently carrying out business… if not fraudulently
Wrongful trading
s 214 or s246ZB IA 1986
* No criminal provisions for wrongful trading - but there is civil
Duty of ss214 and s246ZB…
Directors under a duty to take every step possible to minimize the potential losses to the company’s creditors
Under ss214 and s246ZB …
compensation
Courts can order directors to contribute to insolvent estate by why of compensation for losses by body of creditors.
Wrongful trading liability
Imposes personal liability on directors.
= exception to the principle of limited liability.
Proof of wrongful trading
No need to show intent or dishonesty
Who can bring a claim for wrongful traiding
- Liquidators s214(1)
- Administrators 246ZB(1)
SBEEA 2015
Wrongful trading claims can be assigned to a third party as a way of raising funds for insolvent estate. ]
Avoiding risk of litigation.
Against whom may a claim for “wrongful trading” be brought?
Any person who was a director at the time
- includes de facto, shadow and non-executive directors.
Re Hydrodam (Corby) Ltd 1994
Shadow, de facto and non executive directors can be
Requirements for liability
Wrongful Trading
ss214(2) and 246ZB(2)
- Before the insolvent liquidation
- Director knew or ought to have concluded
- No reasonable prospect that the company would avoid going into going into liquidation / administration
A company goes into insolvent liquidation at a time when….
Assets are insufficient for the payment of its debts and other liabilities and the expenses of winding up and adminstration.
ss214(6) and 246ZB(6)
Insolvency for wrongful trading purposes is judged…
Judged solely on the
* Balance sheet test
* Not the cash flow test
Continued trading
- Must be proven that the director allowed company to trade
- Knew or ought to have know there was no reasonable prospect to avoid liquidation /administration
- Cont’d trading made position worse
Re Continental Assurance Co of London plc 2001
Re Continental Assurance Co of London plc 2001
- Continued trading
- Knew or ought to have known there was no reasonable prospect to avoid insolvency.
- Cont’d trading worsened situation
If the company has not reached a point of no return
Wrongful trading cannot arise.
No need to consider “every step” defence.
Re Produce Marketing Consortium Ltd 1989
- s 214 IA 1986
- Two directors each liable for £75k
- Directors ought to have realised, on the latest date the accounts ought to have been delivered.
- Irrelevant they had not seen the accoutns.
What defence can directors invoke to wrongful trading
The “every step” defence
ss214(3)
ss246ZB(3)
The “every step” defence
After the “point of no return” the directors took every step with a view to minimising the potential loss to the company’s creditors
Examples of the “every step” defence evidence
- Voicing concerns at regular board meetings.
- Independent and legal advice
- Ensuring adequate, up-to-date financial advice
- Suggesting reductions in overhead / liabilities
- Not incurring further credit
- Consulting a lawyer and/or insolvency practitioner for advice
Brooks v Armstrong 2014
- Burden of proof is on the directors to establish they took every step to minimise loss
- Meaning of every step, depends on the facts
Brooks v Armstrong 2015
Directors should keep an eye on the following factors
Accounting, budget and cash flow forecast, business review, future trading, creditors kept informed, agreements to deal with debt, monitor trading, financial position, business plan, minimising loss, professional advice,
The reasonably diligent person test
ss214(4) and s246ZB(4)
- Director ought to have concluded past “the point of no return”
- Director then took every step to minimise the potential loss.
ss214(2) and s246ZB(2)
Should a reasonable director ought to have concluded they were past “the point of no return”
ss214(3) and s246ZB(3)
Director then took every step to minimise potential loss to creditors.
Under reasonably diligent person test
- General knowledge, skill and experience (Objective test)
- Particular knowledge of a director (Subjective test)
Applies the higher of the two standards.
Advice to director
Hold board meeting
Review financial position
Minutes
Director cannot escape liability by resigning
Without previously taking every step with a view to minimise potential loss
Re Purpoint Ltd 1991
Best course of action
For a company to seek professional advice as soon as possible
**Re Continental Assurance Co of London
Re Continental Assurance Co of London
Best course of action is for a company to seek professional advice as soon as possible
Re Brian D Pierson Contractors Ltd
Absence of warnings from advisors does not relieve directors of responsibility to review company position critically
Remedies for wrongful trading
s214(1) - 246ZB(1)
- Cout can order contribution to assets of the company as court thinks fit.
- Wide discretion to determine extent of liability.
Directors contribution amount
Will be based on additional depletion caused by directors’ conduct from the date that directors ought to have identified “point of no return”
Court order for a director to contribute to company’s assets
Compensatory and not penal in nature
An order to contribute against directors may be….
On a joint and several basis.
Court has discretion to apportion liability between directors.
Where a court makes a contribution order
Court also has discretion to make a disqualification order under s10 CDD 1986
Contribution order
ss214/246ZB
s 1157 - wrongful trading
Relief is not available in wrongful trading proceedings
Re Produce Marketing Consortium Ltd
Re Produce Marketing Consortium Ltd
Relief under s1157 CA not available
Voidable transactions
At under value
Transactions defrauding creditors
Preferences
Defrauding floating charges
Aim of challenging voidable transactions
Restore the company to the same position it would have been in had transaction not take place, increasing funds available
Clawback
Reversing transaction / financial rerstitution
s238 IA
Transactions at an undervalue
s423 IA
Transactions defrauding creditors
s239 (IA
Prefeerneces
s245 IA
Avoidance of floating charges
Questions to ask when seeking to challenge a voidable transaction?
- DId the transaction involve a connected person or associate?
- “Relevant time”
- Insolvent at the time, or as a result of
- Presumption, shiftin burden of proof?
TUV
s238
Loss of value from a company - gifts or significant inequality in consideration
Insolvency in wrongful trading
Balance sheet insolvency only
Insolvency in voidable transaction
Balance sheet
Cash flow
A claim may be brought for TUV
Under s238(1)
* Either a liquidator
* An administrator
Re MC Bacon Ltd
Granting of security by a company cannot amount to a transaction at an undervalue
Security does not deplete assets or diminsh value
Hill V Spread Trustee Company Ltd
Granting of security for no consideration (undervalue) can be challenged.
- purpose in this case was to avoid HMRC
Can a dividen lawfully paid amount to a transaction at undervalue
Arguable yes
BTI 2014 LLC v Sequana*
What comparison is needed to est undervalue?
Gave Away
vs
Received
TUV avoiding transaction
1) Undervalue
2) At relevant time = 2 years preceding
3) Insolvent at the time or because of
238(2)
TUV - relevant time
Two years preceding onset of isolvency
240(2)
Company was insolvent at the time or beacasue of trasnaction
Presumed if connected person, unless can be proved otherwise.
TUV defence
- Good faith
- Purpose of business
- Reasonable grounds to believe benefit.
YUV Sanctions
Discretion to make order to restore position prior to TUV
238(3)
241(2)
TUV order, should not prejudice subsequent purchaser from party that transacted
If good faith and value
Under 241(2A)
Rebuttable presumption that an acquisition by a subsequent purchaser was not in good faith where
* Had notice of cirucmstances
* COnnectd with associate
BUrden shifts
TDC
Transactions defrauding creditors
s423 IA 1986
s423 solvent?
Does not have to be insolvent to bring this claim.
