Corporate Insolvency - Voidable Transactions and Directors

Question 1

In what two situations may directors be personally liable to contribute to assets of the company on insolvency?

Answer 1

If they are found guilty of either:

• fraudulent trading
• wrongful trading

Question 2

What consequences could a director face if they are found guilty of fraudulent trading?

Answer 2

Could face both criminal and civil sanctions

Question 3

Who can a claim for fraudulent trading be brought against?

Answer 3

• any person (broader than just directors, eg includes banks potentially)
• who is knowingly party to the carrying on of any business of the company
• with intent to defraud creditors or for any fraudulent purpose

Question 4

What must be proved for fraudulent trading claims?

Answer 4

Actual dishonesty

Question 5

What is the test for actual dishonesty in relation to fraudulent trading claims?

Answer 5

• liquidator needs to demonstrate director’s subjective state of knowledge
• then liquidator needs to show that the director’s conduct was dishonest applying the objective standards of ordinary decent people

Question 6

Do all creditors need to be defrauded to bring a claim for fraudulent trading?

Answer 6

No - just need to show that one creditor has been defrauded.

Question 7

What remedies are available for a claim of fraudulent trading?

Answer 7

Court can make order for any such contribution to company’s assets that it sees fit

Court cannot be punitive in ordering contribution but should instead look to compensate for loss caused to creditors

Any directors involved are likely to face a disqualification order. Criminal sanctions may also be faced (up to 10 years imprisonment and fines)

Question 8

Why is fraudulent trading claim less likely to be brought than wrongful trading claim?

Answer 8

The standard of proof for a successful claim is much higher meaning it is harder to bring a successful fraudulent trading claim compared to wrongful trading

Question 9

Who can bring a wrongful trading claim and against whom?

Answer 9

Claim can either be brought by liquidator or administrator against a director (including de jury, de facto and shadow directors, executives and non-executives)

Question 10

What type of liability attaches to a claim for wrongful trading?

Answer 10

Civil only not criminal

Question 11

What duty are directors under that is the basis for wrongful trading claims?

Answer 11

When directors become reasonably aware that an insolvent liquidation is reasonably inevitable, they are under a duty to take every step possible to minimise the potential losses to the company’s creditors

Question 12

Is there a requirement to show dishonesty on the part of directors for wrongful trading claim?

Answer 12

No

Question 13

How can administrators and liquidators use wrongful trading claims to increase funds for an insolvent estate without bringing about the claim by way of litigation?

Answer 13

They can assign the claim to a third party in return for funds

Question 14

What is limb one of the test that the court must be satisfied of for a wrongful trading claim?

Answer 14

1) the company must have gone into insolvent liquidation or administration AND

2) At some time before the commencement of the winding up or insolvent administration (for convenience, that time is referred to as the ‘point of no return’) AND

3) The director knew or ought to have concluded that

4) there was no reasonable prospect that the company would avoid going into insolvent liquidation or administration

Question 15

When is a company in insolvent liquidation for the purposes of wrongful trading test?

Answer 15

Purely on the basis of the balance sheet test ie liabilities must be more than assets

Question 16

If the directors believe the company has a reasonable prospect of avoiding insolvency, will limb one of the test for wrongful trading be satisfied?

Answer 16

No - provided that belief is reasonably held

Test only satisfied if directors have concluded or ought reasonably to be concluded that there is no reasonable prospect of avoiding insolvency

Question 17

What must be proved in relation to wrongful trading and continued trading?

Answer 17

It must be proved that 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

That the continued trading made the company’s position worse

Question 18

What is the second limb of the wrongful trading test (every step defence)?

Answer 18

Director will face no liability for wrongful trading where 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 (reasonable) step with a view to minimising the potential loss of the company’s creditors

Question 19

What would be evidence in support of the defence that director took every reasonable step to minimise potential loss to company’s creditors?

Answer 19

• 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 credit with someone who is not an existing creditor or not increasing credit owed to an existing creditor
• taking legal and financial advice on steps the company should be taking such as initiating appropriate insolvency procedures or negotiating with creditors to restructure its liabilities

Question 20

What test will the court apply in determining 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 reasonable step to minimise the potential loss to the company’s creditors?

Answer 20

They apply the reasonable person test so the facts which a director ought to have known or ascertained, the conclusions 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 (subjective) and
• the actual knowledge, skill and experience of that particular director (subjective test)

Court then applies the higher of the two standards

Question 21

What should directors do to minimise the risk of a claim for wrongful trading being brought against them?

Answer 21

• hold frequent board meetings to review the company’s financial position and write up minutes of each meeting so there is a written record on which directors can later rely on to justify their decisions
• take professional advice as soon as possible
• make sure they have up to date financial information about the state of the company’s finances and that this information is considered at the board meetings and acted upon

Question 22

What effect might resigning as a director have on wrongful trading claim?

Answer 22

• resigning in itself will not mean the director escapes liability for wrongful trading claim
• director should only consider resigning if they are constantly outvoted by other directors and are therefore not able to change the course for the company

Question 23

What remedies can the court order for claim of wrongful trading?

Answer 23

Court can order any such contribution by a director as it thinks fit.

Contribution will normally be based upon depletion to assets of company from time directors should have stopped trading

Can be joint and several liability but court has discretion here to reflect varying culpability

May also make disqualification order against director

Question 24

Is the relief under s 1157 for directors facing liability in proceedings for negligence, breach of duty or breach of trust, if court is satisfied that director acted honestly and reasonably and having regard to all the circumstances of the case ought fairly to be excused, available to wrongful trading?

Answer 24

No - no such relief available for wrongful trading

Question 25

What transactions by a company are potentially voidable on liquidation or administration?

Answer 25

• transaction at an undervalue
• transactions at an undervalue defrauding creditors
• preferences
• avoidance of floating charges

Question 26

Who brings a challenge in relation to voidable transactions by a company?

Answer 26

Liquidators or administrators

Question 27

What is the aim of challenging voidable transactions?

Answer 27

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

Question 28

Who are connected persons in relation to voidable transactions?

Answer 28

Directors - including shadow directors, associates of directors and associates of the company

Question 29

Who are associates in relation to voidable transactions?

Answer 29

Spouses, business partners, employees, relatives including siblings, aunt, uncle, nieces and nephews, certain trustees, a company which is controlled by a director and a company which is itself associated with the company in question, where both are mutually controlled by the same other company or person

If they are an associate then they will be a connected person.

Question 30

When is the onset of insolvency in relation to voidable transactions?

Answer 30

• 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

Question 31

When will there be a transaction by a company at an undervalue?

Answer 31

• gift

OR

• transaction for a consideration significantly less in value than the consideration provided by the company

OR

• perhaps granting of security or payment of dividend

AND

Company must be insolvent at the time

Question 32

When is a company insolvent for the purposes of voidable transactions?

Answer 32

• either on cash flow test - unable to pay its debts as they fall due
• or on balance sheet test - company’s assets are less than their liabilities

Question 33

When will the granting of security be a transaction at undervalue?

Answer 33

Where it is for consideration significantly less than the value of the charge

Question 34

When must the company have made the transaction at undervalue for it to be challengeable?

Answer 34

Must be made within 2 years before the onset of insolvency

Question 35

For transaction at undervalue must the company be insolvent at the time transaction was made?

Answer 35

Yes - unless company becomes insolvent as a result of the transaction

Question 36

What presumption exists when a transaction for undervalue is entered into with a connected person?

Answer 36

Insolvency is presumed unless the connected person proves the company was solvent at the relevant time

Question 37

What defences exist for transaction at undervalue?

Answer 37

• company entered into the transaction in good faith for the purpose of carrying on its business
• at the time there were reasonable grounds for believing that the transaction would benefit the company

Question 38

What sanctions are available to the court in relation to transactions at undervalue?

Answer 38

The court has discretion to make such order as it thinks fit to restore the company to the position it would have been in had it not entered into the transaction

Question 39

What should any court order in relation to a transaction at undervalue not do?

Answer 39

It should not prejudice any subsequent purchaser from the party which transacted at an undervalue with provided they were acting in good faith and for value

Question 40

When does a rebuttable presumption that an acquisition by a subsequent purchaser was not in good faith in relation to a transaction at undervalue?

Answer 40

Where the subsequent purchaser either:

• had notice of the relevant surrounding circumstances (ie the transaction was at an undervalue or preference) and of the relevant proceedings; OR
• was connected with or was an associate of either the company or the party which transacted at an undervalue with (or received a preference from) the company

Question 41

When will there be a transaction at undervalue defrauding creditors?

Answer 41

• there has been a transaction at an undervalue and
• the intention or purpose of the transaction was to put assets beyond the reach of creditors (including future unknown creditors) of the company or otherwise prejudice their interests.

Question 42

Does a company have to be insolvent for a claim to be brought for a transaction at undervalue defrauding creditors?

Answer 42

No - company can also be solvent

Question 43

Who may bring a claim in relation to transaction at undervalue defrauding creditors?

Answer 43

• a liquidator or an administrator
• a supervisor of a voluntary arrangement
• a victim of the transaction in question

Question 44

What order may a court make in relation to transaction at undervalue defrauding creditors?

Answer 44

Any order it thinks fit to restore the company to the position it would have been in had it not been for the transaction

Question 45

What is the time limit for bringing a transaction at undervalue defrauding creditors?

Answer 45

There is no time limit - can be made any time in the past

Question 46

What is the purpose of s 239 provision making preferences by a company voidable?

Answer 46

Purpose is to prevent a creditor obtaining improper advantage over other creditors of a company at a time when that company is insolvent

Question 47

Who can bring a claim against preferences by a company?

Answer 47

Either a liquidator or administrator

Question 48

When will a company give a preference?

Answer 48

Where that person is a creditor of the company

AND

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

Question 49

What is the time limit for a preference being voidable?

Answer 49

If it was given in the six months prior to the ‘onset of insolvency’ or two years if preference given to connected persons or associates

Question 50

Must the company be insolvent at the time the preference is given?

Answer 50

Yes either on the cash flow or balance sheet basis at time of transaction or become insolvent as a result of it

Question 51

What else must be proved in relation to preference aside from time limit, and insolvency of company (relates to state of mind)?

Answer 51

It must be proved that company was influenced by a desire to prefer the creditor (subjective test)

Company through directors must have positively wished to put the party in a better position

Question 52

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

Answer 52

Rebuttable presumption that the company was influenced by desire to prefer the creditor

They must prove that the company was not otherwise influenced by desire to prefer them.

Question 53

What defence is available for preferences by a company?

Answer 53

Company can argue that there was an absence of desire to prefer such as when done through desire to continue trading

Question 54

What sanctions are available to the court in relation to preferences by a company?

Answer 54

Court has discretion to make order to restore the position as if the company had not given the preference

Question 55

When can a challenge to avoid floating charge be brought?

Answer 55

• company is in liquidation or administration
• floating charge created 12 months before onset of insolvency or two years if granted to connected person or associate
• unless floating charge was granted to connected person or associate, the company was insolvent or became insolvent (either on cash flow or balance sheet basis) at time floating charge was granted

Question 56

Are court proceedings necessary to avoid a floating charge?

Answer 56

Not always - certain floating charges are avoided automatically but proceedings may be needed where the floating charge holder disputes the avoidance

Question 57

When will a floating charge created within the relevant period be nonetheless valid?

Answer 57

Where it is in exchange for new money or other fresh consideration

Eg if floating charge is granted to secure the repayment of a new loan made on or after the creation of the charge, then it will be valid

Question 58

What is the effect of a floating charge being avoided?

Answer 58

Only the charge and not the debt itself is avoided

Question 59

Does the company need to be insolvent at the time the floating charge is granted?

Answer 59

Yes, if unconnected person.

No, if a connected person.