12 - Voidable transactions and Directors’ Liability in Insolvency

Question 1

What is the liability of directors of an insolvent company?

Answer 1

They may be held to be personally liable to compensate the company and its creditors if found guilty of one of:
- Fraudulent trading (s 213 / 246Z 1986)
- Wrongful trading ( s 214 / 246Z 1986)

Liquidators and administrators have the power to bring proceedings for compensation against directors personally for this.

Question 2

Why were the provisions on fraudulent trading enacted?

Answer 2

To prevent abuse of limited liability by those running companies.

They address concerns that directors might:
- Continue trading while the company is in financial difficulty, incurring further debts.
- Cause increased losses to creditors.

Under the Insolvency Act 1986 (IA 1986), the court has powers to impose:
- Criminal sanctions on directors and other liable persons.
- Civil sanctions for fraudulent trading.

Despite these provisions, claims for fraudulent trading are rare due to the high evidential burden of proving intent to defraud creditors.

Question 3

Who can a claim for fraudulent trading be made by?

Answer 3

A claim can be made by:
- A liquidator (under s 213 IA 1986)
- An administrator (under s 246ZA IA 1986)
- Making an application to court.

The provisions of s 246ZA are aligned with those of s 213 but are adapted for administration.

Question 4

What is a claim for fraudulent trading, and when can it be made?

Answer 4

A fraudulent trading claim arises when a person is knowingly involved in carrying on a business:
- With intent to defraud creditors, or
- For a fraudulent purpose (s 213/246ZA IA 1986).

Example: Banks may be liable due to their employees’ knowledge of such (Morris v State Bank of India). ‘Any person’ is a wide definition.

Civil liability under these sections requires the guilty party to contribute to the funds available for unsecured creditors.

A corresponding criminal claim exists under s 993 CA 2006 for fraudulent trading, punishable by:
- Imprisonment (up to 10 years), and/or
- Fines.

Question 5

What constitutes actual dishonesty in fraudulent trading claims?

Answer 5

Actual dishonesty must be proved, assessed by:
- Subjective test: Dishonesty is judged based on what the person knew or believed.
- Blind-eye knowledge: Requires suspicion of facts combined with deliberate avoidance of confirmation.

Definition of fraud (Re Patrick and Lyon Ltd): Real dishonesty involving moral blame as judged by current notions of fair trading among commercial men at the present day.

Two-stage test (Ivey v Genting Casinos):
- Determine the subjective state of knowledge of the accused.
- Assess whether their conduct was objectively dishonest by the standards of ordinary, decent people.

Fraud against even one creditor is sufficient to bring a claim. It is not necessary to show all creditors have been defrauded.

Question 6

What remedies are available when a person is found to be liable for fraudulent trading?

Answer 6

Civil remedies under s 213/246ZA IA 1986 include:
- Contribution to the company’s assets, compensating creditors for their loss, that the court thinks proper.
- No punitive elements in the contribution amount. The contribution should only reflect and compensate for the loss caused to the creditors.
- Recovered sums held on trust for the general body of unsecured creditors, not for defrauded creditors.

Additional consequences for directors:
- Likely disqualification order under s 10 CDDA 1986.
- Criminal penalties under s 993 CA 2006:
- Imprisonment (up to 10 years), and/or
- Fines.

Question 7

What is the difference between fraudulent trading and wrongful trading?

Answer 7

Fraudulent trading (s 213/246ZA IA 1986):
- Requires proof of intent to defraud or fraudulent purpose.
- High evidential standard makes claims rare.

Wrongful trading (s 214/246ZB IA 1986):
- Easier to prove and more commonly pursued.
- Focuses on directors continuing trading while aware of insolvency risk, even without fraudulent intent.

Question 8

Provide a summary of fraudulent trading.

Answer 8

• Claims for fraudulent trading may be brought by a liquidator or an administrator.
• The claim can be brought against any person who is knowingly party to the carrying on of any business of the company with intent to defraud creditors or for any fraudulent purpose, including directors and banks.
• Actual dishonesty must be proven on a subjective basis.
• A person found to be liable can be ordered to make such contribution to the company’s assets as the court thinks proper. There is no punitive element to the remedy however – the contribution should only reflect and compensate for the loss caused to the creditors.
• The court is likely also to make a disqualification order under s 10 CDDA 1986 where a director has been found liable for fraudulent trading
• There is also a criminal claim for fraudulent trading under s 993 CA 2006. The remedies for this are up to 10 years’ imprisonment or fines.

Question 9

What is the purpose of a claim for wrongful trading?

Answer 9

Wrongful trading was introduced to address negligence in carrying on a business rather than fraud, following criticism of fraudulent trading’s ineffectiveness due to the high threshold for proving it.

A claim for wrongful trading is:
- A civil claim brought by a liquidator (under s 214 IA 1986) or an administrator (under s 246ZB IA 1986).
- There are no criminal provisions for wrongful trading, unlike fraudulent trading, which is both civil and criminal.

Wrongful trading poses a significant risk to directors of companies nearing insolvency, making it critical for lawyers to advise on mitigating such risks.

Question 10

What is the purpose of wrongful trading provisions under s 214 and s 246ZB?

Answer 10

The purpose is to ensure directors act responsibly when aware (or ought to be aware) that insolvency (by liquidation or administration) is inevitable.

Directors are under a duty to take every possible step to minimise the potential losses to the company creditors.

Courts can order directors to compensate the insolvent estate for losses caused by their conduct, increasing funds for unsecured creditors.

Key features:
- Imposes personal liability on directors, overriding the principle of limited liability.
- No requirement to prove intent or dishonesty, making wrongful trading easier to establish than fraudulent trading.
- It focuses on directors failing to make correct judgments about the company’s financial prospects and not minimising creditor losses.

Question 11

Who may bring a claim for wrongful trading?

Answer 11

Claims may be brought by:
- Liquidators under s 214(1)
- Administrators under s 246ZB(1)

Administrators and liquidators may assign claims to third parties under the SBEEA 2015, raising funds for the insolvent estate and avoiding litigation risks.

Question 12

Against whom can a claim for wrongful trading be brought?

Answer 12

Claims can be brought against any person who was a director at the relevant time, including:
- Shadow directors (s 251 CA 2006)
- De facto directors
- Non-executive and executive directors

This claim can only be brought against any person who was knowingly party to the carrying on of the company’s business with intent to defraud creditors.

Question 13

What are the requirements for liability under limb one of s 214(2) / s 246ZB(2)?

Answer 13

For a director to be liable for wrongful trading, there are two limbs to satisfy. First, the directors must make a proper assessment of the company’s prospects and ability to avoid an insolvency.

Liability arises if:

The court must be satisfied that the company has gone into insolvent liquidation or administration and -

1. At some point before the commencement of the winding up or insolvent administration (‘point of no return’),
2. The director knew or ought to have concluded that
3. There was no reasonable prospect of avoiding insolvency (liquidation/administration).

Note: A company goes into insolvent liquidation at a time when its assets are insufficient for the payment of its debts and other liabilities at the expenses of winding up or administration.

Question 14

How is insolvency judged for wrongful trading, and when must directors consider limb two?

Answer 14

Insolvency is judged solely on the balance sheet test (s 123 IA 1986), where assets are insufficient to cover debts and expenses.

Directors need to consider limb two only if they know or ought reasonably to know that the company cannot avoid liquidation or administration.

If directors reasonably assess that the company has a chance of avoiding insolvency, limb one is not satisfied, and no further action is required.

However, if they conclude or ought to conclude there is no reasonable prospect of avoiding insolvency, they must proceed to limb two, taking every possible step to minimise losses to creditors.

Question 15

How does continued trading affect wrongful trading liability?

Answer 15

Liability arises if a director in question:
- Allows the company to continue to trade after knowing or ought to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation or administration.
- The continued trading worsens the company’s financial position.

If the company has not reached the ‘point of no return’, wrongful trading liability does not apply, and there is no need to consider further defences.

Question 16

What is the ‘every step’ defence under limb 2 of s 214(3) and s 246ZB(3)?

Answer 16

Directors may escape liability if they can satisfy the court that, after knowing insolvency was unavoidable, they took every step with a view to minimise the potential losses to creditors.

Examples of steps include:
- Raising concerns in board meetings.
- Seeking independent financial/legal advice.
- Ensuring up-to-date financial information is available.
- Proposing overhead/liability reductions.
- Avoiding further or increased credit.
- Taking advice on insolvency procedures or creditor negotiations.

Question 17

What is the ‘reasonably diligent person’ test under s 214(4) and s 246ZB(4)?

Answer 17

This test assesses if directors:
- Knew or ought to have known that there was no reasonable proespect of avoiding an insolvent liquidation or administration (Limb 1).
- Whether the directors then took every reasonable step to minimise the potential loss to the company’s creditors (Limb 2).

Under the test, the facts which a director ought to have known or ascertained, the conclusions which he ought to have reached, the steps which he ought to have taken, are those which would have been known or ascertained, or reached or taken, by a reasonably diligent person having both:
- An objective test: knowledge, skill, and experience reasonably expected of a director in the same role.
- A subjective test: the director’s actual knowledge, skill, and experience.

The court then applies the higher standard of the two.

Question 18

What advice should directors follow to minimise the risk of wrongful trading liability?

Answer 18

Actions to reduce risks include:
- Hold regular board meetings to review the company’s financial position, with detailed minutes documenting decisions and evidence supporting the company’s ability to avoid insolvency.
- Take professional advice from lawyers, insolvency practitioners, or accountants promptly.
- Ensure up-to-date financial information is available and acted upon at board meetings.

Directors cannot escape liability by resigning; resignation may itself be wrongful if done irresponsibly.
Resignation is only advisable if a director is repeatedly outvoted on decisions and cannot influence change.

Question 19

What remedies are available for wrongful trading under s 214(1) and s 246ZB(1)?

Answer 19

The court can order directors to contribute to the company’s assets of the company as the court thinks fit. The contribution will increase the assets of the company available for distribution to the general body of unsecured creditors.

Key aspects:
- Contribution Order: The court can order directors to contribute to the company’s assets to increase funds for unsecured creditors.
- Extent of Liability: Determined by the additional asset depletion caused from the ‘point of no return’. Liability is compensatory, not penal.
- Joint and Several Liability: Directors may be held jointly and severally liable, with discretion to apportion liability based on culpability.
- Disqualification Order: The court may disqualify directors under s 10 CDDA 1986.

Question 20

Why is relief under s 1157 CA 2006 unavailable for wrongful trading?

Answer 20

• While s 1157 allows the court to excuse directors from liability in negligence, breach of duty, or breach of trust if they acted honestly and reasonably, this does not apply to wrongful trading.
• Case example: Re Produce Marketing Consortium Ltd [1989], confirming that s 1157 relief cannot be used in wrongful trading cases.

Question 21

Provide a summary of wrongful trading.

Answer 21

• Claims for wrongful trading may be brought by a liquidator under s 214 IA 1986 or an administrator under s 246ZB IA 1986.
• The claim can be brought against any person who was at the relevant time a director.
• The court must be satisfied that at some time before the commencement of the winding up or insolvent administration, the director knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation (or insolvent administration); limb one.
• A director may be able to escape liability if they can satisfy the court that, after they first knew or ought to have concluded that there was no reasonable prospect of the company avoiding an insolvent administration or liquidation, they took “every step with a view to minimising the potential loss to the company’s creditors” (s 214(3) / 246ZB(3); limb two
• The court applies the reasonably diligent person test under s 214(4) / 246ZB(4) to what the director ought to have known.
• A person found to be liable under s 214 / 246ZB can be ordered to make such contribution to the company’s assets as the court thinks proper and may also be disqualified under s 10 CDDA 1986.

Question 22

What are voidable transactions, and what is the aim of them during insolvency proceedings?

Answer 22

• Voidable transactions are those challenged by a liquidator or administrator under the IA 1986 within specified statutory periods before a company’s insolvency.
• Their purpose is to restore the company to its position had the transaction not occurred, increasing funds available in the insolvent estate for creditors.
• These provisions, often called ‘clawback’, can reverse transactions or provide financial restitution to be paid into the insolvent estate.
• It is the counterparty to the transaction with the insolvent company (and sometimes its successor in title) that is the target of the clawback provisions, rather than the directors responsible for causing their company to enter into the transaction.

Question 23

What questions will a liquidator or administrator seeking to challenge a voidable transaction need to ask?

Answer 23

• Did the transaction involve a ‘connected person’ or ‘associate’?
• Did the transaction occur within the ‘relevant time’?
• Was the company insolvent at the time, or did it become insolvent due to the transaction?
• Is there a presumption that shifts the burden of proof to the counterparty?

Question 24

How are ‘connected persons’ and ‘associates’ defined under the IA 1986?

Answer 24

Connected persons (s.249): Include directors (and shadow directors), their associates, and associates of the company.

Associates of a Director or Company (s.435): Broadly defined to include:
- Spouses, business partners, employees, and close relatives (e.g., siblings, uncles, nieces).
- Trustees linked to the director or company.
- Companies controlled by the director or associated through mutual control by another entity.

Question 25

How is the ‘onset of insolvency’ defined under ss.240(3) and 245(5) IA 1986?

Answer 25

Administration:
- Date of filing the application (court procedure).
- Date of filing notice of intention to appoint or (if none) the date of appointment (out-of-court procedure).

Liquidation - Date of commencement of winding up, which is:
- The date of the resolution for members’ or creditors’ voluntary winding up.
- The date of the petition’s presentation for compulsory winding up (s.129).

Question 26

How is insolvency defined for transactions at an undervalue under s 238 IA 1986?

Answer 26

s238 provisions concern loss of value from a company, whether through gifts or a transaction where there has been a singificant inequality in the value of the consideration which the company received compared to the value of the asset it gave away, to the company’s detriment at a time when it is ‘insolvent’.

Insolvency refers to the inability to pay debts (s.123), assessed on:
- The cash flow test: Inability to meet debts as they fall due.
- The balance sheet test: Liabilities exceeding assets.

This definition is broader than insolvency for wrongful trading, which uses only the balance sheet test.

Claims under s.238 can be brought by a liquidator or administrator (‘office-holder) to address undervalued transactions that harm the company’s estate.

Question 27

What is a transaction at an undervalue under IA 1986?

Answer 27

• A gift, or
• A transaction where the consideration received by the company in money or money’s worth is significantly less than what the company gave away.

Example: Selling an asset worth £100,000 for £50,000.

The transaction involves an inequality of exchange adverse to the company under the transaction. Granting security or payment of a dividend may also amount to a TUV in certain circumstances.

Question 28

Can granting security or paying a dividend be a transaction at an undervalue?

Answer 28

Granting security:
- Initially thought not to deplete assets (Re MC Bacon Ltd [1990]).
- Hill v Spread Trustee Co Ltd [2006]: Security granted for no or inadequate consideration can be challenged as a TUV.
- Main purpose in Hill: To put assets beyond HMRC’s reach.

Paying dividends:
- Previously uncertain.
- BTI 2014 LLC v Sequana SA [2019]: Suggests a lawful dividend can still be challenged as a TUV.

Question 29

When and how can the TUV be avoided?

Answer 29

The company made a gift or received consideration significantly less than it gave.
- This must be significantly less in value than the consideration provided by the company.

The transaction occurred within the relevant time:
- Two years before the onset of insolvency (s 240(1)(a)) is the relevant time. This is regardless of whether the transaction took place with a connected person or not.
- Insolvency begins with the administration or liquidation process (s 240(3)).

The company was insolvent at the time or became insolvent due to the transaction:
- For connected persons, insolvency is presumed unless they prove solvency (s 240(2)).

Question 30

What defence can be used to avoid a transaction at an undervalue (TUV) claim?

Answer 30

Even if all of the requirements are met, the transaction will not be set aside if:
- The company entered the transaction in good faith for the purpose of carrying on its business.
- There were reasonable grounds to believe the transaction would benefit the company.
This defence is often relied on in practice.

Common defence:
Example: Granting security to prevent a bank from terminating facilities and initiating winding-up proceedings, where directors reasonably believe the company can recover from financial difficulties.

Question 31

What sanctions can the court impose for a transaction at an undervalue?

Answer 31

The court has discretion under s 238(3) to make orders as it see’s fit restoring the position as if the transaction had not occurred.

Common orders (s 241(1)):
- Counterparty pays the value lost (e.g., £50,000 if an asset worth £100,000 was sold for £50,000).

Protection for subsequent purchasers:
- Any subsequent purchaser acting in good faith and for value is not prejudiced (s 241(2)).
- However, there’s a presumption of bad faith (s 241(2A)) if the purchaser:
(a) Had notice of the TUV and proceedings.
(b) Was connected with or an associate of the company or counterparty who was party to the TUV.
- In such circucmstances, the burden shifts to the purchaser to prove good faith.

Question 32

What are transactions defrauding creditors (TDC) under s 423 IA 1986?

Answer 32

Definition: Claims under s 423 involve:
- A transaction at an undervalue.
- The intention to put assets beyond creditors’ reach or to prejudice their interests, including future creditors who are unknown at the time of the transaction..

Key points:
- TDC claims can arise even if the company is solvent.
- Unlike TUV claims, s 423 requires proof of the intent to harm creditors.
- Liquidators/administrators often prefer TUV claims where possible (assuming the claim satisfies the criteria e.g., ‘relevant time’ and insolvency). This is because under s 238 there is no requirement to prove that the purpose of the transaction was to put the assets beyond the reach of the creditors or otherwise prejudice them.

Question 33

Who can make a claim for transactions defrauding creditors, and what sanctions may apply?

Answer 33

An application to the court to set aside the transaction:
Who can claim?
- Liquidator or administrator.
- Supervisor of a voluntary arrangement.
- A victim of the transaction in question.

Sanctions:
- The court can make orders as it thinks fit to restore the position as if the transaction had not occurred (s 423(2)).
- Orders include reversing the transaction or providing restitution (s 425(1)).

Advantages of TDC claims:
- No time limit – claims can be brought for any past transaction.
- However, recent transactions are easier to challenge as intent is easier to prove.

Question 34

What are preferences by a company under s 239 IA 1986?

Answer 34

Purpose: Prevent creditors from gaining an improper advantage over others when the company is insolvent.

Who can bring a claim? - A liquidator or administrator.

Definition of preference: The company puts a creditor (or surety/guarantor of its debts) in a better position than they would have been in during insolvency.

Examples:
- Paying an unsecured creditor ahead of others.
- Granting security to an unsecured creditor.

Not a preference: Paying a secured creditor before an unsecured one.

Question 35

Under what conditions can a preference be avoided?

Answer 35

1. If it was given within the relevant time:
   Within 6 months of the onset of insolvency, being the commencement of the relevant insolvency procedure.
   The relevant time is extended to 2 years for preferences to connected persons.
2. Insolvency: The company was insolvent (cash flow or balance sheet basis) at the time of the transaction or became insolvent because of it.
3. Desire to prefer: The company must have been influenced by a desire to improve the creditor’s position ( this is a subjective test under s 239(5)). The company must have positively wished to put the party in a better position.

No presumption of insolvency for preferences involving connected persons unlike TUV.

Question 36

How does the presumption of desire to prefer apply to connected persons in s 239 IA 1986?

Answer 36

• A rebuttable presumption applies that the company was influenced by a desire to prefer the creditor (s 239(6)).
• Burden of proof shifts to the connected person or associate to prove that the company was not influenced by this desire. This means that the preferred person must prove that the company was not influenced by a desire to prefer them.
• Definitions of connected persons and associates are found in s 249 and s 435 IA 1986.

Question 37

What is the defence against a preference claim under s 239 IA 1986?

Answer 37

Defence is an absence of the desire to prefer (s 239(5)).

Re MC Bacon Ltd [1990]:
- Security granted to a bank was not a preference as directors were influenced by commercial pressure to avoid calling in the overdraft, not a desire to prefer the bank.
- Key distinction: Desire to prefer (subjective) vs. intention to prefer (objective).
- Genuine commercial pressure negates any desire to prefer.

If mixed motives existed (e.g., avoiding overdraft and desiring to prefer), the defence fails if the desire to prefer was present.

Question 38

What sanctions can the court impose for preferences under s 239 IA 1986?

Answer 38

• The court can make an order to restore the position as if the company had not given the preference (s 239(3)).
• Section 241(1): Provides a non-exhaustive list of restoration orders, similar to those available for TUVs.
• Example: For an unsecured creditor paid ahead of others, the court may order repayment to the liquidator or administrator.
• Sections 241(2) and 241(2A): Apply equally to preferences and TUVs.

Question 39

How does s 245 IA 1986 regulate floating charges?

Answer 39

• Prevents creditors from securing existing debts with floating charges for no new consideration.
• Applies only in liquidation or administration.
• Floating charges are avoided automatically, without requiring the office-holder to initiate legal proceedings, unless disputes arise.
• However, if there is a dispute between the putative floating charge holder and the liquidator or administrator about the application of s245, legal proceedings may be necessary to determine the dispute.

Example: In the BHS liquidation, liquidators challenged a floating charge under s 245 held by Arcadia Group. The matter was settled without a judgment on its validity.

Question 40

Under what circumstances can a floating charge be avoided under s 245 IA 1986?

Answer 40

The floating charge must have been created within the ‘relevant time’:
- 12 months before the onset of insolvency (commencement of administration or liquidation).
- 2 years if granted to a connected person (s 245(3)(a)).

Unless granted to a connected person, it must be proved that:
- The company was insolvent (cash-flow or balance sheet basis) when the floating charge was created, or
- The company became insolvent due to the transaction under which the charge was created (s 245(4)).

Question 41

When is a new floating charge considered valid under s 245 IA 1986?

Answer 41

A floating charge is valid if ‘new money’ or fresh consideration is provided to the company:
- Includes new loans, goods, or services, or
- Extinguishing existing debts after the charge is created (s 245(2)) in return for the grant of the floating charge on or after its creation.

Example: A charge securing a new loan after its creation is valid.
However, a charge securing existing debt for an insolvent company is void unless further credit or new consideration is provided. E.g., if the company granted a floating charge to an unsecured creditor guaranteeing repayment of debts, this would be void unless new consideration was provided to the company by the creditor.

Question 42

How does the grant of a floating charge to secure an overdraft interact with s 245 IA 1986 and case law?

Answer 42

The effect of s 245(2) on overdrafts is reduced due to case law.

In Re Yeovil Glove Co. Ltd [1965], a floating charge granted to secure a pre-existing overdraft was held valid because:
1. New money: Each overdraft use after the charge creation was considered new money.
2. Rule in Devaynes v Noble (Clayton’s Case): Payments into the account discharged the oldest debt first, meaning the pre-charge debt was repaid, and the existing overdraft was deemed new debt.

Question 43

What are the key points about the avoidance of floating charges under s 245 IA 1986?

Answer 43

• If a floating charge is void under s 245, only the security and the advantage to the floating charge holder in the statutory order of priority is void, not the underlying debt itslef.
• Floating charges are void against liquidators, administrators, and creditors if not registered with Companies House under s 859H CA 2006.
• A floating charge may also be voidable as a transaction at an undervalue (s 238) or a preference (s 239).

Question 44

Provide a summary of voidable transactions.

Answer 44

Transactions at an undervalue s 238:
* Transaction for an undervalue
* Within 2 years prior to onset of insolvency
* Company insolvent at time / as a result (this is presumed with connected persons)

Avoidance of floating charges s 245:
* Floating charge created for no new consideration
* Within 12 months prior to onset of insolvency
* Within 2 years if connected person
* Company insolvent at time / as a result (unless granted to a connected person in which case insolvency is presumed).

Transactions defrauding creditors s 423:
* Transaction for an undervalue
* Intention to defraud creditors
* No need for company to be insolvent
* No time limit before insolvency to consider

Preferences s 239:
* Company puts creditor in better position and influenced by desire to prefer
* Within 2 years prior to onset of insolvency
* 6 months if connected person and presumption of preference
* Company insolvent at time / as a result