Insolvency and voidable transactions Flashcards
Cash flow test
A company is unable to meet its debts as they fall due
Balance sheet test
the company has liabilities that are greater than its assets
4 situations where a company is insolvent
- is unable to pay its debts as they fall due known as the cash flow test;
- has liabilities that are greater than its assets known as the balance sheet test;
- does not comply with a statutory demand for a debt of over £750, this provides evidence that the company is cash flow insolvent; or
- has failed to pay a creditor to satisfy enforcement of a judgment debt
Who does the directors owe duties towards when the company is in financial difficulty?
Creditors
Standstill agreement
a company may ask creditors to enter into a Standstill Agreement whereby the creditors agree not to enforce their rights or remedies for a specified period to give the company time to negotiate an arrangement with them to resolve the company’s financial issues.
Pre-insolvency moratorium
A ‘moratorium’ is a period during which creditors are unable to take action to exercise their usual rights and remedies, thereby creating a breathing space for the company to attempt to resolve the situation.
The company can do this wile it figures out its next steps
The actions restricted by the moratorium include:
- no creditor can enforce its security against the company’s assets;
- there is a stay of legal proceedings against the company and a bar on bringing new proceedings against it;
- no winding up procedures can be commenced in respect of the company (unless commenced by the directors) and no shareholder resolution can be passed to wind up the company (unless approved by the directors); and
- no administration procedure can be commenced in respect of the company (other than by the directors).
Procedure for obtaining a pre-insolvency moratorium
A company can obtain a pre-insolvency moratorium by filing documents at court including:
- A statement that the company is, or is likely to become, unable to pay its debts as they fall due.
- A statement from a licensed insolvency practitioner (usually an accountant), known as a Monitor for these purposes, stating that in their view, it is likely that a moratorium will result in the rescue of the company as a going concern. The Monitor has a supervisory function during the pre-insolvency moratorium.
How long does a pre-insolvency moratorium last?
- The pre-insolvency moratorium lasts for 20 business days but can be extended by the directors for a further 20 business days. Further extensions are possible with the consent of a requisite majority of creditors and/or court order. The maximum period is one year subject to a court order to extend further.
- The moratorium will terminate automatically if the company enters liquidation or administration, or at the point that a CVA is approved, or a court sanctions a restructuring plan or a scheme of arrangement.
Does a company have to pay
- debts incurred before the moratorium
- debts incurred during the moratorium
Pre-moratorium debts
- The company does not have to pay pre-moratorium debts whilst the pre-insolvency moratorium subsists
- These are debts which have fallen due before or during the moratorium by reason of an obligation incurred before the moratorium
However the statutory repayment holiday does not apply to the following pre-moratorium debts which must still be paid:
- The Monitor’s remuneration or expenses;
- Goods and services supplied during the moratorium;
- Rent in respect of a period during the moratorium;
- Wages or salary or redundancy payments; and
- Loans under a contract involving financial services.
Moratorium debts
- All moratorium debts must be paid. These are debts that fall due during or after the moratorium by reason of an obligation incurred during the moratorium.
2 formal arrangements to help a company in financial difficulties
- Company Voluntary Arrangement
- Restructuring plan
2 informal arrangements to help a company in financial difficulties
- negotiate with creditors
- pre-insolvency moratorium
What is a CVA?
Company Voluntary Arrangement
- the creditors agree to part payment of the debts owed to them and/or to a new extended timetable for repayment.
- The CVA proposal once approved needs to be reported to the court (but no need for court approval)
- The CVA is supervised and implemented by a Supervisor who is an Insolvency Practitioner. During the CVA the company’s directors remain in office and will continue to run the company’s affairs subject to the terms of the CVA.
How to set up a CVA?
CVA proposal will be approved if:
- at least 75% in value (i.e, value of debts owed) of those voting on the CVA proposal (excluding secured creditors) vote in favour;
- If the above majority is obtained, the decision of those creditors will be invalid if those voting against the CVA proposal include more than half of the total value of creditors unconnected to the company (e.g. not a related company, shareholder or director of the company proposing the CVA); and
- a simple majority of shareholders/members vote in favour.
Note in practice, it is only the approval of the CVA proposal by creditors which matters. If the creditors vote in favour of the CVA proposal but the members vote against, the creditors’ vote will always prevail.
Effects of a CVA
A CVA is binding on all unsecured creditors, including those who did not vote or voted against it. However, secured or preferential creditors are not bound unless they unanimously consent to the CVA
1 advantage and 1 disadvantage of a CVA
From the company’s perspective, CVAs are advantageous as the directors remain in control of the company, and the company can continue to trade subject to the terms of the CVA proposal with the hope of the company surviving as a going concern. However, the major disadvantage is that a CVA cannot bind secured or preferential creditors without their consent.
Can creditors challenge a CV? If so what is the time limit for doing so? How to do it?
A creditor can challenge a CVA within 28 days of the CVA’s approval by creditors being reported to the court on the grounds of ‘unfair prejudice’ that is the CVA treats one creditor unfairly compared to another or material irregularity relating to the procedure which the company has followed in seeking approval of the CVA
Restructuring plan - what is it? who does it bind? how to you set it up? do you need court approval? when can you enter a restructuring plan?
the purpose of the Restructuring Plan (Plan) is to compromise a company’s creditors and shareholders and restructure its liabilities so that a company can return to solvency.
The Plan, however, can only be used by companies which have or are likely to encounter financial difficulty.
A Plan requires court approval which is called a ‘sanction’. Creditors and members must be divided into classes and each class which votes on the Plan must be asked to approve it. The votes needed by the class meetings for approval are similar to those under a CVA, so that the Plan must be approved by at least 75% on value of those voting in each class.
The Plan only becomes binding if the court sanctions it. If the court sanctions the Plan, it binds all creditors including secured creditors.
What is a cross-class cram down in a restructuring plan?
A cramdown of shareholders means forcing shareholders to accept a debt for equity swap in which creditors are able to hold new shares in the company in place of their debt claims.
The court can sanction a plan which brings about a “cross-class cram down” if:
- the dissenting class would not be any worse off than they would be in the event of the cross-class cram down not being approved; and
- the restructuring plan has been approved by at least one class of creditors or members who would receive payment or have a genuine economic interest in the company in the event of the cross-class cram down not being approved.
Who does the administrator owe duties to?
the court
Statutory objectives of administration
administrators must perform their functions with the objective of achieving one of the three objectives. These objectives are in a specific order and are:
(a) First, to rescue the company as a going concern, or if that is not reasonably achievable,
(b) Secondly, to achieve a better result for the company’s creditors as a whole than would be likely if the company were wound up…, or if that is not reasonably achievable, and
(c) Thirdly, to realise the company’s property in order to make a distribution to one or more secure or preferential creditors.
Appointment of administrator - list 2 procedures
court procedure
out of court procedure
Appointing an administrator through a court procedure
- test
- who can apply
- what will the court consider
- procedure
- advantage
The court may appoint an administrator where the company is or is likely to become unable to pay its debts on the application of: the company, the directors, a creditor, the supervisor of a CVA or a liquidator.
The court when deciding to make an administration order must consider that the appointment is reasonably likely to achieve the purpose of the administration
An interim moratorium temporarily freezing creditor action comes into effect on the application to court and until the administration order is made and lasts until either, until the administration order is made, or the court dismisses the application.
If the court makes an administration order, the pending winding up proceedings are automatically dismissed.
Procedure: apply to court -> interim period including interim moratorium -> hearing and order
Appointing an administrator through an out of court procedure
- list 2 ways to do it
- procedure
2 out of court procedures
- Directors of the company appoint
- Qualifying floating charge holder appoints
A QFC means a floating charge which (i)together with any other security that the holder of the floating charge holds relates to the whole or substantially the whole of the company’s property and (ii) the document that creates it provides that either Sch B1 para 14 IA 1986 applies to the charge or that the holder has the power to appoint an administrator or an administrative receiver.
If there is an appointment under Para 22 by the directors, they must file a notice of intention to appoint (‘NOI’) at court and, not less than 10 business days later file a notice of appointment at court. The administrators’ appointment takes effect when the second notice is filed at court.
If the company has granted a QFC then the process is different. When the directors file the NOI at court, they must also send the NOI to the holder of the QFC. The QFC then has 5 business days to appoint its own choice of administrator. If the QFC does not do this, the directors can file the notice of appointment in the usual way and the directors’ choice of administrator is appointed.
If a QFC holder wishes to appoint an administrator out of court, it must first enforce its security in accordance with the terms of the QFC and the appointment will take effect when it has filed a notice of appointment at court.
Where there is more than one holder of a QFC, a holder of a QFC which ranks below another QFC in priority (normally determined by a priority agreement entered into by the QFC holders), it must first give two business days’ notice to the holders of a QFC which have priority and can only proceed with the appointment if the higher ranking QFC holders consent to the appointment.
Administrator’s role
- can directors still act
- administrator’s powers
- time limit to complete the administration
The administrator is an officer of the court and has a duty to act in the interests of all the creditors to achieve the purposes of the administration. When an administrator is in office, The directors are unable to exercise any of their management powers without the consent of the administrator, but the directors remain in office. Employees also remain employed by the company .
An administrator’s powers include the power to carry on the business of the company, take possession and sell the property of the company, (only with the consent of the fixed charge holder or the court if the property is subject to a fixed charge), borrow money and execute documents in the company’s name.
Once appointed, the administrator has up to eight weeks to produce a report setting out proposals for the conduct of the administration. If their proposals are achieved, the company will exit administration. There is a 12-month fixed time limit for the completion of administrations, although it is possible to obtain extensions.
Administrative moratorium
- what is it?
- what are its benefits?
One key benefit of administration is that during administration, the company has the benefit of a full moratorium. During this time, all business documents and the company’s website must state that the company is in administration.
during the moratorium (except with consent of the court or the administrator):
1.No order or resolution to wind up the company can be made or passed;
2.No administrative receiver of the company can be appointed;
3.No steps can be taken to enforce any security over the company’s property or to repossess goods subject to security, hire purchase and retention of title;
4.No legal proceedings, execution or other process can be commenced or continued against the company or its property, and
5.A landlord cannot forfeit a lease of the company’s premises.
Administrators powers
Administrators have wide powers under IA 1986 to ‘do all such things as may be necessary for the management of the affairs, business and property of the company’
Includes:
- Removal and appointment of directors
- Disposal of property subject to fixed and floating charges
Receivership - what is it?
We have seen that administration is a collective procedure; in contrast, receivership is an enforcement procedure which is conducted in the interests of a secured creditor.
3 types of receiverships
- Administrative receiver
- Fixed charge receiver
- Court-appointed receiver
Administrative receivership - what is it?
Administrative receivership is now a rare procedure and is prohibited in most cases. When applicable, a secured creditor with fixed and floating charges over all of the company’s assets may appoint an AR. The AR will take control of the secured assets, sell them and use the proceeds to repay the debt owed to the secured creditor.
Fixed charge receiver - what is it? how does it work?
Fixed charge receivers are appointed by the holders of a fixed charge pursuant to the terms of the relevant security document. They are appointed to enforce the security, manage and sell the secured assets (most commonly, land and buildings) and out of the sale proceeds, repay the debt that is owing to their appointor, often a bank. They owe their duties primarily and exclusively to the appointor
A fixed charge receiver becomes the receiver and manager only of the assets secured by the security document and is only entitled to deal with those and not any other assets of the company.
A fixed charge receiver cannot be appointed while a pre-insolvency moratorium subsists or if the company is in administration.
court-appointed receiver
Court-appointed receivers are relatively rare at the moment. They are appointed by the court and their powers and duties are set out in the court order.
Liquidation - what is it?
Liquidation is the process by which a company’s business is wound up and its assets transferred to creditors and (if there is a surplus of assets over liabilities) to its members.
The company will then be removed from the register of companies and dissolved.
What is the liquidator’s function?
The liquidator’s function is to realise the company’s assets for cash, determine the identity of the company’s creditors and the amount owed to each of them and then pay a dividend to the creditors on a proportionate basis relative to the size of their determined claims
Types of liquidations
- Compulsory liquidation
- Voluntary liquidation
a) Members’ Voluntary Liquidation
b) Creditors’ Voluntary Liquidation
What happens after liquidation?
Dissolution
- Following liquidation, the company’s life is generally brought to an end automatically by dissolution. In the case of a compulsory liquidation, this will be three months after notice by the liquidator to the Registrar of Companies that the winding up of the company has been completed.
- In the case of voluntary liquidation, dissolution will occur three months from the filing by the liquidator of the final accounts and return. On dissolution, the company ceases to exist as a legal person.
Compulsory liquidation
- is it a court or out of court procedure?
- how do you commence it?
- who can apply?
Compulsory liquidation is a court-based process for placing a company into liquidation.
To begin the process, an applicant presents a winding up petition to the court under which the applicant requests the court to make a winding up order against the company on a number of statutory grounds.
Compulsory liquidation - who can apply to the court for the issue of a winding up petition?
- a creditor;
- the company (acting by the shareholders; this would happen where there are insufficient assets in the company to fund a voluntary liquidation);
- the directors (by board resolution); again, this would happen where there are insufficient assets to fund a voluntary liquidation;
- an administrator;
- an administrative receiver;
- the supervisor of a CVA; and
- the Secretary of State for Business, Energy & Industrial Strategy (on public policy grounds).
Compulsory liquidation - key grounds
The key grounds on which the court can order a company to be wound up, are set out in s 122(1) IA 1986 and include: (1) the company is unable to pay its debts; and (2) it is just and equitable for the company to be wound up.
(1) Inability to pay debts
- Failure by the company to comply with a creditor’s statutory demand. A statutory demand is a written demand in a prescribed form requiring the company to pay a specific debt. The statutory demand can only be used if the debt exceeds £750 and is not disputed on substantial grounds. The company has 21 days in which to pay the debt, failing which the creditor has the right to petition the court to wind up the company.
- The creditor sues the company, obtains judgment and fails in an attempt to execute the judgment debt.
- Proof to the satisfaction of the court that the company is unable to pay its debts as they fall due (the “cash-flow test”).
- Proof to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities (the “balance sheet test”)
Compulsory liquidation - consequences of a winding up order
- an automatic stay will be granted on commencing or continuing with proceedings against the company;
- all employees will be automatically dismissed, and
- the directors lose their powers and they are automatically dismissed from office
Members’ voluntary winding up
- what is it
- what companies can do it
- procedure
- This method of voluntary winding up may only be used for companies which are solvent.
- The directors are required to swear a declaration of solvency stating that they have made a full enquiry into the company’s affairs and they have formed the opinion that the company will be able to pay its creditors in full, together with interest at the official rate, within a period not exceeding 12 months from the commencement of the winding up (s 89(1) IA 1986). The declaration must also contain a statement of the company’s assets and liabilities as at the latest practicable date before making the declaration.
- Any director making a declaration of solvency who does not have reasonable grounds for their opinion is liable to a fine or imprisonment (s 89(4) IA 1986). If the debts are not actually paid in full within the specified period it will be presumed that the director did not have reasonable grounds for his opinion.
- The members must then pass a special resolution to place the company into MVL and an ordinary resolution to appoint a liquidator. The winding up commences when the special resolution is passed (s 84(1) and s 86 IA 1986).
- On a MVL, if the liquidator considers that the company will be unable to pay its debts, they must change the members’ winding up into a creditors’ voluntary liquidation.
Creditors’ voluntary winding up
- It is a form of insolvent liquidation commenced by resolution of the shareholders, but under the effective control of the creditors who can choose the liquidator
- Where a directors’ declaration of solvency has not been made, the liquidation will be a creditors’ voluntary liquidation.
- The procedure is for the shareholders to pass a special resolution to place the company into a CVL and an ordinary resolution to appoint a nominated liquidator.
- Within 14 days of the special resolution being passed the directors of the company must ask the company’s creditors to either approve the nominated liquidator or put forward their own choice of liquidator. Where the creditors’ choice of liquidator differs from that of the company’s shareholders, the creditors’ nomination will take precedence.
Role of the liquidator
As noted above, the appointment of a liquidator terminates the management powers of the company’s directors, and these powers are transferred to the liquidator together with their fiduciary duties, meaning that liquidators must act in good faith, avoid conflicts of interest and not make a secret profit.
The principal functions of a liquidator in a winding up by the court are:
- To secure and realise the assets of the company then distribute to the company’s creditors (s 143 IA 1986); and
- To take into their custody or under their control all the property of the company (s 144 IA 1986).
Statutory order of priority on insolvency when paying creditors back
1.Liquidator’s fees and expenses of preserving and realising assets subject to fixed charges.
2.Amount due to fixed charge creditor out of the proceeds of selling assets subject to the fixed charge.
3.Liquidator’s other remuneration, costs and expenses.
4.Preferential creditors (the first tier and then the secondary tier).
- The first tier consists of (i) employee claims for unpaid remuneration due in the four months before the ‘relevant date’ (generally the date of the winding up resolution or petition) but subject to a maximum of £800 per employee plus accrued holiday pay, and (ii) for certain contributions owing to an occupational pension scheme.
- The secondary tier consists of Crown debts: PAYE, HMRC, VAT
5.Creation of the prescribed part fund (if available) for unsecured creditors.
6.Amount due to creditors with floating charges.
7.Unsecured/trade creditors (including payment of the prescribed part).
- All the unsecured creditors rank and abate equally. This is known as the “pari passu” rule.
8.Interest owed to unsecured creditors.
9.Shareholders.
List personal insolvency procedures
- Bankruptcy
- Individual voluntary arrangements
Individual voluntary arrangement
- what is it
- It is an arrangement under which a debtor makes a proposal for a compromise of their liabilities with their creditors
- If approved by the requisite percentage of creditors (see below), the IVA binds the debtor and all of their creditors to the terms of the IVA.
- A licensed insolvency practitioner must be appointed as Supervisor of the IVA. The Supervisor supervises the debtor’s implementation and compliance with the terms of the IVA.
- 14 day interim moratorium available
- In order for the proposal to become binding, it must be approved by creditors holding at least 75% (by value) of the total debt owed to the creditors voting on the proposal but if that approval is given, it will not be effective if more than half the of the total value of creditors who are not associates of the debtor vote against it.
Effect of an IVA
- An IVA cannot bind a secured creditor or a preferential creditor without that creditor’s consent.
- The Nominee becomes the Supervisor of the IVA and is responsible for its implementation
- The Supervisor can apply to court for directions and must report to the court periodically. If the debtor fails to comply with the terms of the IVA, the supervisor can usually has the right under the terms of the IVA to petition for the debtor’s bankruptcy.
Bankruptcy
- what is it
- 2 types of petitions
- petition grounds and requirements
Bankruptcy is a collective insolvency procedure enabling an orderly collection, sale and distribution of an insolvent individuals’ assets for the benefit of all the bankrupt’s creditors.
Creditors’ Petition
- A ground for the petition is that the debtor is unable/has no reasonable prospect to pay its petition debts.
- The debt must be for a liquidated sum exceeding £5,000
Debtor’s Petition
- The only ground for this petition is that the debtor is unable to pay its debts.
- The petition must be accompanied by a statement of affairs setting out the debtors’ assets and liabilities.
What is the debtor’s inability to pay its debts evidenced by?
- a statutory demand that has neither been satisfied within three weeks from service of that demand, nor set aside by the court; or
- an unsatisfied execution of a judgment or of another legal process
Trustees in a bankruptcy
- who is it
- what do they do
- Upon the making of a bankruptcy order, the Official Receiver will become the first trustee in bankruptcy (the ‘Trustee’) unless the court orders otherwise.
- The bankrupt’s estate (comprising all assets and rights of the bankrupt) vests in the Trustee immediately and automatically by operation of law upon the making of the bankruptcy order.
- The Trustee will sell the assets of the estate and must distribute the money in the estate in accordance with a statutory order of priority for bankruptcies.
Bankruptcy - order of priority of payments
1.secured creditors (but limited to the value of the security itself and ranking with ordinary unsecured creditors for any amount not recovered under the security);
2.expenses of the bankruptcy including the Trustee’s remuneration;
3.two tiers of preferential creditors (identical to the ones on a corporate winding up);
4.ordinary unsecured creditors;
5.statutory interest;
6.debts of a spouse (must be provable but they are postponed to other creditors); and
7.finally, any surplus is payable to the bankrupt.
Bankrupt’s duties and what If they fail to comply with them?
“The bankrupt shall-
(a) give to a trustee such information as to his affairs;
(b) attend on the trustee at such times, and
(c) do all such other things,
as the trustee may for the purposes of carrying out his functions reasonably require.”
It is a criminal offence for the bankrupt to fail to comply with their obligations
When is bankruptcy discharged?
Generally, a bankrupt is automatically discharged from bankruptcy after a maximum period of one year. Discharge means that the bankrupt is released from most of the bankruptcy debts and the personal restrictions eg acting as a director, obtaining credit etc mentioned above.
A person is discharged upon the received files a notice stating that the person’s bankruptcy does not require further investigation
Bankruptcy Restriction Orders
The Secretary of State, or the Official Receiver acting on the Secretary of State’s direction, may apply to the court for a Bankruptcy Restriction Order (“BRO”) if the court considers it appropriate having regard to the conduct of the bankrupt (before or after the bankruptcy order).
A BRO will operate for a period of between two and 15 years. For the duration of the order, the bankrupt is unable to act as a director or obtain credit of more than £500 without disclosing that they are subject to a BRO.
Breach of a BRO is a criminal offence punishable by fine and/or imprisonment.
What is the liability of directors is found guilty of fraudulent or wrongful trading?
may be held to be personally liable to compensate the company and its creditors
Who can bring proceedings against directors for wrongful or fraudulent trading?
Liquidators and administrators have the power to bring proceedings for compensation against the directors personally
Fraudulent trading - test
A claim for fraudulent trading under s 213 / 246ZA IA 1986 can be brought against:
- any person (s 213(2) and s 246ZA(2))
- who is knowingly party to the carrying on of any business of the company
- with intent to defraud creditors or for any fraudulent purpose (s 213(1) and s 246ZA(1)).
Actual dishonesty:
- Actual dishonesty must be proven for a claim for fraudulent trading to succeed.
- Dishonesty is assessed on a subjective not objective basis ie what the particular person knew or believed. Knowledge includes blind-eye knowledge, which requires a suspicion of the relevant facts together with a deliberate decision to avoid confirming that they did exist.
- More recently, the court has formulated a two stage test. First, the liquidator needs to demonstrate the director’s subjective state of knowledge and then second, show that the director’s conduct was dishonest applying the objective standards of ordinary decent people
- It is not necessary to show that all of the company’s creditors have been defrauded. Provided at least one creditor has been defrauded, this will be enough to bring a claim.
Fraudulent trading - who can apply to court?
Liquidators
Administrators
Fraudulent trading - consequences
Criminal liability - up to 10 years imprisonment and/or fines
Civil liability - to contribute to the funds available to the general body of unsecured creditors suffering loss caused by the carrying on of the company’s business with intent to defraud.
Fraudulent trading - remedies
can be ordered to make such contribution to the company’s assets as the court thinks proper. The court does not have the power to include a punitive element in the amount of any contribution to be made. The contribution should only reflect and compensate for the loss caused to the creditors.
Any sums recovered are held on trust for the unsecured creditors generally and not for the defrauded creditor.
Wrongful trading - what is it about?
Wrongful trading is about the directors failing to make the right judgements about the company’s financial prospects and then failing to take steps to minimise losses to the creditors.
The purpose of s 214 and 246ZB is to ensure that when directors become aware (or ought to become aware) that an insolvent liquidation (or insolvent administration, as the case may be) is inevitable, they are under a duty to take every step possible to minimise the potential losses to the company’s creditors.
If they fail to do this, the court can, under s 214 and 246ZB, 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, and thereby, increase the funds available for distribution to unsecured creditors in the insolvency.
Who can bring a claim for wrongful trading?
- Liquidator
- Administrator
- Administrators and liquidators can also now (under the SBEEA 2015) 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.
Against whom may a claim for wrongful trading be brought?
A claim may be brought against any person who was at the relevant time a director.
This includes shadow directors as defined in s 251 CA 2006, de facto and non-executive directors as well as executive directors.
Contrast this with fraudulent trading where a claim can be brought against a wider scope of persons than just the directors
Wrongful trading - test
For a director to be liable for wrongful trading, there are two limbs to satisfy.
Limb one:
The 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 (for convenience, that time is referred to as the ‘point of no return’) and
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 (or insolvent administration).
Note: that a company goes into insolvent liquidation (or as the case may be, an insolvent administration) at a time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of winding up or administration
It must, therefore, be proven 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.
Limb 2:
Assuming the company has reached the point of no return, 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 (ie from the ‘point of no return’ onwards), they took every step with a view to minimising the potential loss to the company’s creditors.
Examples of evidence that may be supportive of establishing the every step defence include:
- Voicing concerns at regular board meetings;
- seeking independent financial and legal advice;
- ensuring adequate, up-to-date financial information is available;
- suggesting reductions in overheads/liabilities;
- not incurring further credit with someone who is not an existing creditor or increasing credit owed to an existing creditor; and
- Taking advice on steps such as initiating appropriate insolvency procedures or negotiating with creditors to restructure its liabilities.
The court applies the ‘reasonably diligent person’ test in order 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 (the s 214(2) / 246ZB(2) liability which is relevant for limb one), and
- whether the director then took every step to minimise the potential loss to the company’s creditors (the s 214(3) / 246ZB(3) defence which is relevant to limb two).
Under that 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 (an objective test); and
the actual knowledge, skill and experience of that particular director (a subjective test). The court then applies the higher of the two standards.
Consequences for the director for wrongful trading
Civil sanctions - YES
Criminal sanctions - NO
Disqualification order against the director
Note directors cannot escape liability by simply resigning. It might be an act of wrongful trading to resign
Wrongful trading - remedies
If a director is found to be liable for wrongful trading, the court can order that director to make such contribution to the 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.
The contribution will ordinarily be based on the additional depletion of the company’s assets caused by the directors’ conduct from the date that the directors ought to have concluded that the company could not have avoided an insolvent administration or liquidation (ie from the ‘point of no return’).
Is relief by court for the director available?
NO
Under s 1157 CA 2006, the court may ordinarily relieve a director from liability in proceedings for negligence, breach of duty or breach of trust, on such terms as it thinks fit, if satisfied that he/she acted honestly and reasonably,and having regard to all the circumstances of the case, the director ought fairly to be excused. However, that relief is not available in wrongful trading proceedings
List voidable transactions
- transaction at an undervalue
- avoidance of floating charges
- transactions defrauding creditors
- preferences
Who can challenge a voidable transaction?
The IA 1986 gives both a liquidator and an administrator the ability to challenge certain transactions that have taken place within specified statutory periods prior to the insolvency of a company. These are known as ‘voidable’ transactions.
What is the aim of challenging voidable transactions?
The aim of 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.
Definitons of connected persons and associates for the purpose of challenging voidable transactions
Connected persons’ with the company (s.249) – are directors (including shadow directors), associates of directors and associates of the company.
‘Associates’ of director/company (s.435) – include spouses, business partners, employees, relatives including brother, sister, uncle, aunt, niece, nephew, etc. (widely defined in s.435(8)), 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.
Define onset of insolvency for the purpose of challenging 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
Transaction at an undervalue
- requirements summary
- who can bring a claim
- which transactions are encompassed
- presumption
- defence
- sanctions
Requirements:
- 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)
liquidator or administrator can bring a claim
What is a transaction at an undervalue?
- Gift
- 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
- Note: granting of security for no consideration (or for consideration significantly less than the value of the charge can be challenged as a transaction at an undervalue
Presumption:
- Where a transaction at an undervalue is entered into with a person connected with the company, insolvency is presumed unless the connected person proves otherwise. This means that the connected person must prove the company was solvent at the relevant time.
Defence:
Even if all of the requirements set out above are satisfied, no order will be made to set aside the transaction if the court is satisfied that:
- the company entered into the transaction in good faith and for the purpose of carrying on its business; and
- at the time there were reasonable grounds for believing that the transaction would benefit the company.
Sanctions:
- 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
- A common order would be for the counterparty to pay the amount of the undervalue the company sustained under the transaction. To continue with the earlier example, if the company sold an asset worth £100,000 for £50,000, the court may order the counterparty to pay another £50,000 to the liquidator or administrator.
transaction defrauding creditors
- does the company need to be insolvent
- requirements
- who can bring a claim
- is there a relevant time
- sanctions
Claims under s 423 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.
Requirements:
- 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 of the company or otherwise prejudice their interests. The reference to creditors even includes future creditors who were unknown at the time of the transaction.
Who can bring a claim?
- a liquidator or an administrator;
- a supervisor of a voluntary arrangement; or
- a victim of the transaction in question.
Note: There is no ‘relevant time’ or period within which the transaction must have taken place.
The court may make such order as it thinks fit to restore the position to what it would have been but for the transaction in question
Preference
- what is it
- who can bring a claim
- test
- presumption
- defence
- sanction
A company gives a preference to a person if:
- that person is a creditor of the company (or a surety or guarantor of any of the company’s debts or liabilities); 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 he/she would otherwise have been in.
- An example of a preference would be paying an unsecured creditor in priority to other creditors or granting security to an unsecured creditor.
A preference is voidable if:
- it was given within the ‘relevant time’ (s 239(2)) - in the 6 months ending with the ‘onset of insolvency’ (s 240(1)(b)), being the commencement of the relevant insolvency procedure (s 240(3)). The relevant time is extended to 2 years for preferences to connected persons (s 240(1)(a)). (See sections 249 and 435 for definitions of ‘connected persons’ and ‘associates’);
- it is proved that the company was insolvent (on either a cash flow or balance sheet basis) at the time of the transaction or became so as a result of it (s 240(2)); and
- It is proved that the company was ‘influenced … by a desire’ to prefer the creditor (s 239(5)). This is a subjective test. The company must have positively wished to put the party in a better position (see Re MC Bacon Ltd).
Presumption:
- If the preference is given to a connected person or associate, there is a rebuttable presumption that the company was influenced by the desire to prefer the creditor
- This means the preferred person must prove that the company was not influenced by a desire to prefer them.
Defence:
- The defence available is an absence of the desire to prefer
- If the company had acted out of mixed desires then the necessary desire would have been present even if the first desire had been stronger than the second.
Sanctions
- The court has a discretion to make an order to restore the position as if the company had not given the preference
- A common court order would in the case of an unsecured creditor paid ahead of others is for the preferred creditor to pay to the liquidator or administrator the money it had received from the company.
Avoidance of floating charges
- purpose of the provision
- do u need to challenge it or is it automatic
- requirements
- when are new floating charges valid
The purpose of s 245 is to prevent a creditor obtaining a floating charge to secure an existing debt for no new consideration.
The section only applies in a liquidation or administration. Unlike transactions at an undervalue and preferences, s 245 avoids certain floating charges automatically and without the need for the office-holder to challenge the floating charge by bringing legal proceedings
Requirements for a loading charge to be invalid:
- The floating charge must have been created within the ‘relevant time’. The relevant time is 12 months preceding the onset of insolvency, ie the commencement of administration or liquidation (s 245(2) and 245(3)(b)).
- The relevant time is extended to 2 years in the case of a floating charge granted to a connected person (s 245(3)(a)). (See s 249 and 435 for definitions of ‘connected persons’ and ‘associates’).
- Unless the floating charge was granted to a ‘connected person’ (in which case there is no insolvency requirement), it must be proved that the company was insolvent (on either a 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
When are new floating charges valid?
- Even if the above requirements are met, a floating charge will be valid to the extent that ‘new money’ or other fresh consideration is provided to the company (or existing debts of the company are extinguished) in return for the grant of the floating charge on or after its creation
- if a 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.
- An example of when a floating charge would be void is where an existing unsecured creditor is granted a floating charge by a company which is insolvent and the charge purports to secure the repayment of existing monies owed to that creditor.
Consequences of a floating charge being void?
Where a floating charge is void under s 245, only the security (and its advantage to a floating charge creditor in the order of priority) is void and not the debt itself.
Floating charges granted at a time when the company is insolvent are void against a liquidator except to the extent that they secure money granted at the same time or after the floating charge is granted.
