Corporate Insolvency - Voidable Transactions and Directors Flashcards
In what two situations may directors be personally liable to contribute to assets of the company on insolvency?
If they are found guilty of either:
- fraudulent trading
- wrongful trading
What consequences could a director face if they are found guilty of fraudulent trading?
Could face both criminal and civil sanctions
Who can a claim for fraudulent trading be brought against?
- 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
What must be proved for fraudulent trading claims?
Actual dishonesty
What is the test for actual dishonesty in relation to fraudulent trading claims?
- 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
Do all creditors need to be defrauded to bring a claim for fraudulent trading?
No - just need to show that one creditor has been defrauded.
What remedies are available for a claim of fraudulent trading?
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)
Why is fraudulent trading claim less likely to be brought than wrongful trading claim?
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
Who can bring a wrongful trading claim and against whom?
Claim can either be brought by liquidator or administrator against a director (including de jury, de facto and shadow directors, executives and non-executives)
What type of liability attaches to a claim for wrongful trading?
Civil only not criminal
What duty are directors under that is the basis for wrongful trading claims?
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
Is there a requirement to show dishonesty on the part of directors for wrongful trading claim?
No
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?
They can assign the claim to a third party in return for funds
What is limb one of the test that the court must be satisfied of for a wrongful trading claim?
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
When is a company in insolvent liquidation for the purposes of wrongful trading test?
Purely on the basis of the balance sheet test ie liabilities must be more than assets
If the directors believe the company has a reasonable prospect of avoiding insolvency, will limb one of the test for wrongful trading be satisfied?
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
What must be proved in relation to wrongful trading and continued trading?
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
What is the second limb of the wrongful trading test (every step defence)?
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
What would be evidence in support of the defence that director took every reasonable step to minimise potential loss to company’s creditors?
- 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
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?
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
What should directors do to minimise the risk of a claim for wrongful trading being brought against them?
- 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
What effect might resigning as a director have on wrongful trading claim?
- 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
What remedies can the court order for claim of wrongful trading?
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
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?
No - no such relief available for wrongful trading
What transactions by a company are potentially voidable on liquidation or administration?
- transaction at an undervalue
- transactions at an undervalue defrauding creditors
- preferences
- avoidance of floating charges
Who brings a challenge in relation to voidable transactions by a company?
Liquidators or administrators
What is the aim of challenging voidable transactions?
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
Who are connected persons in relation to voidable transactions?
Directors - including shadow directors, associates of directors and associates of the company
Who are associates in relation to voidable transactions?
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.
When is the onset of insolvency in relation to voidable transactions?
- 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
When will there be a transaction by a company at an undervalue?
- 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
When is a company insolvent for the purposes of voidable transactions?
- 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
When will the granting of security be a transaction at undervalue?
Where it is for consideration significantly less than the value of the charge
When must the company have made the transaction at undervalue for it to be challengeable?
Must be made within 2 years before the onset of insolvency
For transaction at undervalue must the company be insolvent at the time transaction was made?
Yes - unless company becomes insolvent as a result of the transaction
What presumption exists when a transaction for undervalue is entered into with a connected person?
Insolvency is presumed unless the connected person proves the company was solvent at the relevant time
What defences exist for transaction at undervalue?
- 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
What sanctions are available to the court in relation to transactions at undervalue?
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
What should any court order in relation to a transaction at undervalue not do?
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
When does a rebuttable presumption that an acquisition by a subsequent purchaser was not in good faith in relation to a transaction at undervalue?
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
When will there be a transaction at undervalue defrauding creditors?
- 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.
Does a company have to be insolvent for a claim to be brought for a transaction at undervalue defrauding creditors?
No - company can also be solvent
Who may bring a claim in relation to transaction at undervalue defrauding creditors?
- a liquidator or an administrator
- a supervisor of a voluntary arrangement
- a victim of the transaction in question
What order may a court make in relation to transaction at undervalue defrauding creditors?
Any order it thinks fit to restore the company to the position it would have been in had it not been for the transaction
What is the time limit for bringing a transaction at undervalue defrauding creditors?
There is no time limit - can be made any time in the past
What is the purpose of s 239 provision making preferences by a company voidable?
Purpose is to prevent a creditor obtaining improper advantage over other creditors of a company at a time when that company is insolvent
Who can bring a claim against preferences by a company?
Either a liquidator or administrator
When will a company give a preference?
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
What is the time limit for a preference being voidable?
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
Must the company be insolvent at the time the preference is given?
Yes either on the cash flow or balance sheet basis at time of transaction or become insolvent as a result of it
What else must be proved in relation to preference aside from time limit, and insolvency of company (relates to state of mind)?
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
What presumption arises if the preference was given to a connected person or associate?
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.
What defence is available for preferences by a company?
Company can argue that there was an absence of desire to prefer such as when done through desire to continue trading
What sanctions are available to the court in relation to preferences by a company?
Court has discretion to make order to restore the position as if the company had not given the preference
When can a challenge to avoid floating charge be brought?
- 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
Are court proceedings necessary to avoid a floating charge?
Not always - certain floating charges are avoided automatically but proceedings may be needed where the floating charge holder disputes the avoidance
When will a floating charge created within the relevant period be nonetheless valid?
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
What is the effect of a floating charge being avoided?
Only the charge and not the debt itself is avoided
Does the company need to be insolvent at the time the floating charge is granted?
Yes, if unconnected person.
No, if a connected person.
