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Business Law and Practice > Corporate Insolvency > Flashcards

Corporate Insolvency Flashcards

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1
Q

What is insolvency?

A

When a company is unable to pay its debts.

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2
Q

What are examples of a company facing financial difficulty that directors must recognise?

A
  1. Company has many unpaid creditors who are putting pressure on the company to pay the amounts owed to them
  2. Company’s overdraft facility it fully drawn and bank is refusing further credit
  3. Has loans and other liabilities that exceed the value of its assets
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2
Q

What are the four tests for a when a company is deemed unable to pay its debts?

A
  1. Cash flow test: unable to pay its debts as they fall due
  2. Balance sheet test: has liabilities that are greater than its assets
  3. Does not comply with a statutory demand for a debt over £750
  4. Has failed to pay a creditor to satisfy enforcement of a judgment debt
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3
Q

What are the options for a company facing financial difficulties?

A
  1. Do nothing
  2. Do a deal
  3. Appoint an administrator
  4. Request the appointment of a receiver
  5. Place the company into liquidation
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4
Q

Why must directors ensure that they take urgent and advice and action when a company is in financial difficulty?

A

Because directors may be personally liable under provisions of IA 1986 where the company is insolvent if they do not take the correct steps and in breach of their duties under CA 2006.

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5
Q

When can directors be held personally liable to compensate the company and its creditors during an insolvency procedure?

A

If found guilty of either:
- fraudulent trading
- wrongful trading

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6
Q

Who can make a claim for fraudulent trading against a director?

A

A liquidator ot administrator

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7
Q

What are the components of fraudulent trading?

A

A claim for fraudulent trading can be brought against:
- any person
- who is knowingly part to the carrying on of any business of the company
- with intent to defraud creditors or for any fraudulent purpose

any person includes banks

There is both civil and criminal liability for fraudulent trading.

Civil liability means liability to contribute to the funds available to the general body of unsecured creditors if directors are found liable for fraudulent trading.

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8
Q

What needs to be proven for a claim of fraudulent trading?

A

Actual dishonesty.

Ivey test. (subjective)

Means this is difficult to prove - more often claims for wrongful trading are brought.

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9
Q

What remedies are available for fraudulent trading?

A

Person can be ordered to make such contribution to the company’s assets as the court thinks proper.

If director will likely also make a disqualification order.

Contribution should only reflect and compensate loss - not be punitive.

Sums recovered are for unsecured creditors generally not the defrauded creditor specifically.

Criminal = imprisonment of up to 10 years and/or fines.

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10
Q

Against whom a claim for fraudulent trading can be brought?

A

Any person who is knowingly party to the carrying on of any business of the company with an intent to defraud creditors.

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11
Q

What kind of claim is a claim for wrongful trading?

A

Civil only.

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12
Q

Who can bring a claim for wrongful trading?

A

A liquidator or administrator.

Can also assign wrongful trading claims to a third party as a way of raising funds for the insolvent estate and thereby avoid the risk of litigation.

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13
Q

What duty do directors have when they become aware or ought to be aware that an insolvent liquidation is reasonably inevitable?

A

Duty to take every step possible to minimise the potential losses to the company’s creditors.

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14
Q

What happens if director’s fail to take every step possible to minimise the potential losses to the company’s creditors?

A

If they fail the court can order the directors to contribute to the insolvent estate by way of compensation for the losses that the general body of creditors have suffered as a result of the directors’ conduct.

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15
Q

What is the effect of ‘wrongful trading’?

A

It imposes personal liability on directors for unpaid debts for failing to make the right judgement about the company’s financial prospects and then failing to take steps to minimise losses to the creditors.

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16
Q

Against whom can a claim for wrongful trading be brought?

A

May be brought against any person who was at the relevant time a director. Includes shadow, de facto and non-executive directors (as well as executive directors).

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17
Q

What are the two limbs of liability for wrongful trading?

A

First limb: Requirements for liability - deals with directors making a proper assessment of the company’s prospects and ability to avoid an insolvency.

Second limb: Every step defence: won’t be liable if they took every step to minimise potential loss to company’s creditors

Need to prove continued trading

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18
Q

What are the requirements for liability for wrongful trading?

A

Court must be satisfied that the company has gone into insolvent liquidation or administration and:

  1. at some time 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 that the company would avoid going into insolvent liquidation.
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19
Q

What needs to be proven for continued trading?

A
  1. The director in question allowed the company to continue to trade during the period in which they knew or ought to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation or administration; and
  2. the continued trading made the company’s position worse.

Note: if company has not reached the point of no return, then wrongful trading liability cannot arise and no need to consider second limb.

20
Q

What is the ‘every step’ defence?

A

Assuming that a company has reached point of no return - a director will have no liability for wrongful trading 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.

  • assessed by reasonably diligent person test

Examples of evidence to support this:
- Voicing concerns at board meetings
- Seeking independent financial and legal advice
- ensuring adequate, up-to-date financial information is available
- suggesting reductions in overheads and costs
- not incurring further credit with someone who is not an existing creditor or increasing credit owed to an existing creditor;
- taking advice on steps such as initiating appropriate insolvency procedures or negotiating with creditors to restructure its liabilities

21
Q

When will the court apply the reasonably diligent person test (wrongful trading)?

A

To determine whether:

  • a liquidator or administrator has established that a director ought to have concluded that there was no reasonable prospect of avoiding an insolvent liquidation or administration; and
  • whether the director then took every step to minimise the potential loss to the company’s creditors
22
Q

What is the reasonably diligent person test (wrongful trading)?

A

Under the test: the facts which a director ought to have known or ascertained, the conclusions which he ought to have reached and 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:

  • the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by the director in question (objective); and
  • the actual knowledge, skill and experience of that particular director (subjective)

Court applies the higher of the two standards.

23
Q

What advice should lawyers give to directors to minimise the risks of wrongful trading?

A
  • Hold frequent board meetings to review company’s financial position and write up minutes of each meeting so there is a record on which directors’ can later rely on.
  • Take professional advice as soon as possible
  • Make sure they have up to date information about the state of the company’s finances and this info is considered and acted upon at board meetings.
24
Q

What remedies are available for wrongful trading?

A

Court can order that director to make such contribution to the assets of the company as the court thinks fit.

Contribution will increase the assets of the company available for distribution to the general body of unsecured creditors.

Will be based on depletion from date of no return.

Compensatory and not penal.

May also order disqualification order.

25
Q

Can directors claim relief from wrongful trading under s1157 CA 2006?

A

No.

26
Q

What is the point of no return?

A

he time before the commencement of the winding up or insolvent administration at which 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).

27
Q

What are voidable transactions?

A

Transactions which a liquidator and an administrator have the ability to challenge and that have taken place within specified statutory periods prior to the insolvency of a company.

Aim of such a challenge is to restore the company to the same position it would have been in had the transaction not taken place and thereby increase the funds available in the insolvent estate for the benefit of creditors.

28
Q

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

A
  1. Did the transaction involve a connected person or associate?
  2. Did the transaction take place within the relevant time?
  3. Was the company insolvent at the time of the transaction or did it become insolvent as a result of the transaction?
  4. Is there a presumption available which shifts the burden of proof from the liquidator/administrator to the other party?
29
Q

What is a connected person (voidable transactions)?

A

Connected persons with the company are directors, associates of directors and associates of the company.

30
Q

Who are associates (voidable transactions)?

A

Associates of a director/company: include spouses, business partners, employees, relatives including brother, sister, uncle, aunt, niece, nephew etc., certain trustees, a company which is controlled by the director and a company which is itself associated with the company in question where both are mutually controlled by some other company or person.

31
Q

What is the ‘onset of insolvency’?

A

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

Liquidation: date of commencement of winding up (date of resolution for members’ or creditors’ voluntary winding up or date of presentation of petition for compulsory winding up)

32
Q

What is a transaction at an undervalue?

A

Either:

  • A gift; or
  • A transaction for a consideration the value of which in money or money’s worth is significantly less in value than the consideration provided by the company.

Sometimes can include granting of a security or payment of a dividend: law is uncertain in this area.

in Hill where security was granted for no consideration to put assets beyond the reach of HMRC was found to be a TUV.

33
Q

How and when can a transaction at an undervalue be avoided?

A

Court may set aside if:

  1. Company made a gift or otherwise entered into a transaction for consideration, the value of which in money or money’s worth is significantly less in value than the consideration provided by the company
  2. Took place within the relevant time - in the two years ending with the onset of insolvency.
  3. It is proved by the applicant that the company was insolvent at the time of the transaction or became so as a result of it. Where a transaction takes place with a connected person insolvency is presumed unless connected person proves otherwise.
34
Q

What is the defence for transaction of goods at an undervalue?

A
  1. the company entered into the transaction in good faith and for the purpose of carrying on its business; and
  2. at the time there were reasonable grounds for believing that the transaction would benefit the company
35
Q

What sanctions are available for a transaction at an undervalue?

A

The court has a discretion to make such order as it thinks fit to restore the position as if the company had not entered into the transaction.

Common order is for the counterparty to pay the amount of the undervalue the company sustained under the transaction.

Court order should not prejudice a subsequent purchaser from the party which transacted at and undervalue or received preference from the company, provided they were acting in good faith for value.

36
Q

What are the requirements for a claim of transaction defrauding creditors?

A
  1. there has been a transaction at an undervalue; and
  2. the intention or purpose of the transaction was to put assets beyond the reach of creditors of the company or otherwise prejudice their interests.

Even includes future creditors who were unknown at the time of the transaction.

Can be brought in respect of a transaction that took place at any time in the past whereas TUVs only concern transactions entered into within two years of the onset of insolvency.

37
Q

Who can bring a claim for a transaction defrauding creditors?

A

Do not necessarily relate to insolvency, these claims may also be brought by a victim of the transaction in question where the company is solvent.

  1. liquidators or administrator
  2. supervisor of a voluntary arrangement
  3. victim of the transaction in question

Liquidators and administrators will often prefer to bring claims under s 238, transactions at an undervalue because there is no requirement to prove that the purpose of the transaction was to put the assets beyond the reach of creditors or otherwise prejudice them.

38
Q

When does a company give preference to a person?

A

If:

  1. that person is a creditor of the company (or a surety or guarantor of any of the company’s debts or liabilities); and
  2. the company does anything or allows anything to be done which has the effect of putting that person in a better position in the event of the company going into insolvent liquidation than they would otherwise have been in.

e.g. paying an unsecured creditor in priority to other creditors or granting security to an unsecured creditor.

39
Q

When can a preference be avoided?

A

Preference is voidable if:

  1. it was given within the relevant time - in the 6 months ending with the ‘onset of insolvency’ being the commencement of the relevant insolvency procedure. Relevant time is extended to 2 years for preferences to connected persons and associates
  2. it is proved that the company was insolvent (on either a cashflow or balance sheet basis) at the time of the transaction or became so as a result of it; and
  3. It is proved that the company was ‘influenced by a desire to prefer the creditor’. Subjective test. Company must have positively wished to put the party in a better position.
40
Q

What is the presumption if a preference is given to a connected person or associate?

A

There is a rebuttable presumption that the company was influenced by the desire to prefer the creditor.

Means that the preferred person must prove that the company was not influenced by a desire to prefer them.

41
Q

What defence is available for preference?

A

An absence of the desire to prefer.

42
Q

What sanctions are available for preferences?

A

Court has a discretion to make an order to restore the position as if the company has not given the preference.

e.g. pay back money received from the company

43
Q

When can floating charges be avoided?

A
  1. floating charge must have been created within the ‘relevant time’ - 12 months ending with the onset of insolvency. Extended to 2 years in the case of a floating charge granted to a connected person.
  2. unless granted to connected person, must be proved that the company was insolvent (on either cash-flow or balance sheet basis) at the time of the floating charge’s creation or became insolvent in consequence of the transaction under which the charge was created.
44
Q

When are new floating charges valid?

A

A floating charge will be valid to the extent that ‘new money’ or other fresh consideration is provided to the company in return for the grant of the floating charge on or after its creation.

45
Q

What happens if a floating charge is void?

A

Only the security will be void and not the debt itself.

46
Q

What are the voidable transactions?

A
  1. Avoidance of floating charges
    - floating charge created for no new consideration
    - within 12 months prior to inset of insolvency/ within 2 years if connected person
    - company insolvent at time/ as a result (no need to prove insolvency with a connected person)
  2. Transactions at an undervalue:
    - transaction for an undervalue within 2 years prior to onset of insolvency
    - company insolvent at time/ as a result (presumed with connected person)
  3. Transactions defrauding creditors:
    - transaction for an undervalue
    - intention to defraud creditors
    - no need for company to be insolvent
    - no time limit before insolvency to consider
  4. Preferences:
    - Company puts creditor in better position and influenced by desire to prefer
    - Within 6 months prior to onset of insolvency / 2 years if connected person and presumption of preference
    - Company insolvent at time/as a result
47
Q

How do you calculate how much a creditor will receive during winding up? (unsecured)

A

Divide total assets by total liabilities. Multiply that amount per pound by the amount the creditor is owed.

Business Law and Practice (12 decks)

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