Corporate Fraud and Corporate Insolvency

Question 1

Corporate Insolvency

Definition, Key legislation, Tests for Insolvency

Answer 1

Corporate Insolvency
- Definition: A company is insolvent when it can’t pay its debts and liabilities as they fall due.

Key legislation:
- Insolvency Act 1986
- Insolvency Rules 2016

Tests for Insolvency
- Cash flow test - Courts need proof a company can’t pay debts as they fall due
- Balance sheet test - Courts need proof liabilities exceed assets

Question 2

Insolvency Procedures

Answer 2

Insolvency Procedures
1. Liquidation - Brings a company to an end by selling assets and distributing to creditors
- Compulsory liquidation
- Court-ordered
- Begins with a petition; judge decides if winding up is appropriate
- Voluntary liquidation
- Initiated by shareholders
- Used when the company decides to dissolve itself
2. Administration
- Aims to rescue the company or achieve a better result for creditors than liquidation
3. Company Voluntary Arrangement (CVA)
- Agreement with creditors to pay debts over time, aiming to avoid liquidation
4. Receivership
- Allows secured creditors to recover debts using specific asset secured by a charge

Question 3

Distribution of Assets in Insolvency

Answer 3

Distribution of assets in insolvency
Order of priority
1. Fixed charge creditors
2. Expenses of the liquidation (e.g. liquidator fees)
3. Preferential creditors (e.g. employees, pensions)
4. Unsecured creditors (e.g. trade creditors)
5. Interest on debts and deferred creditors
6. Shareholders (if any surplus remains)

Question 4

Director Liability & Corporate Fraud

Answer 4

Director Liability & Corporate Fraud
Misfeasance (s.212 Insolvency Act 1986)
- Directors may be ordered to repay or contribute if they misuse company funds or act improperly
- Example: Leasing a car for personal use or unaccounted petty cash
- Key case: Whalley v Doney - Director redirected company sale proceeds to another business he owned

Fraudulent Trading (S.213 Insolvency Act 1986)
- Business operated with intent to defraud creditors
- Example: Taking credit knowing it can’t be repaid
- Rare and requires proof of intent and moral blame
- Key Case: Morphitis v Bernasconi - High threshold of proof; mere creditor loss is not enough

Wrongful Trading (S.214 Insolvency Act 1986)
- Director continues trading when they knew or ought to have known the company couldn’t avoid insolvency
- Key Requirement: Must prove that the director didn’t take every step to minimise losses to creditors
- Examples of “every step” defence:
- Voicing concerns at meetings
- Seeking financial advice
- Cutting costs
- Avoiding new credit
- Consulting insolvency professionals