Liability of Directors - Wrongful Trading

Question 1

Which came first, fraudulent or wrongful trading?

Answer 1

Fraudulent trading, significantly

Question 2

Why has wrongful trading overtaken fraudulent trading?

Answer 2

Requirement for proof of dishonest intent to establish liability for fraudulent trading has meant that proceedings for fraudulent trading are rare

Question 3

Why was wrongful trading introduced?

Answer 3

To establish liability for directors who carry on business negligently rather than fraudulently

Question 4

Who can bring a claim for wrongful trading against a director?

Answer 4

Liquidator under s 214

Administrator under s 246ZB IA 1986

Question 5

Are there any criminal provisions for wrongful trading?

Answer 5

There are no criminal provisions for wrongful trading, in contrast to fraudulent trading which is both a civil and a criminal wrong

Question 6

What is the purpose of wrongful trading?

Answer 6

Ensure that when directors become aware (or ought to become aware) that an insolvent liquidation is inevitable, they are under a duty to take every step possible to minimise the potential losses to the company’s creditors.

Question 7

What happens if Directors fail to become aware of their duty to minimise potential losses to creditors?

Answer 7

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

Question 8

What kind of liability does wrongful trading impose on Directors?

Answer 8

Personal

Question 9

Why is the personal liability wrongful trading orders on Directors important?

Answer 9

Marks a very important exception to the principle of limited liability

Question 10

Why is wrongful trading easier to show than fraudulent trading?

Answer 10

No requirement to show intent or dishonesty, it is easier for a liquidator or administrator to prove wrongful trading than it is fraudulent trading

Question 11

Who can bring a claim for wrongful trading?

Answer 11

• Liquidators under s 214(1)

- Administrators under 246ZB(1)

Question 12

Who can a wrongful trading claim be brought against?

Answer 12

Any person who was at the relevant time a director

Question 13

Case for shadow directors being included as directors for the purpose of wrongful trading?

Answer 13

Re Hydrodam (Corby) Ltd [1994]

Question 14

Re Hydrodam (Corby) Ltd [1994].

Answer 14

Case that shows shadow/de facto directors count for the purpose of wrongful trading

Question 15

What are the requirements for liability under s214(2) / 246ZB(2)?

Answer 15

1) At some time before the commencement of the winding up or insolvent administration (the ‘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 (or insolvent administration).

Question 16

When does a company go into insolvent liquidation/administration?

Answer 16

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 
s 214(6) / 246ZB(6)

Question 17

s214(6)?

Answer 17

INSOLVENT LIQUIDATION = Time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of winding up or administration

Question 18

Which test is insolvent liquidation based solely on?

Answer 18

Balance sheet test

Question 19

Re Continental Assurance Co of London plc [2001]

Answer 19

It must be proven that the director in question allowed the company to continue to trade during the period in which they knew that there was no reasonable prospect that the company would avoid going into insolvent liquidation and that the continued trading made the company’s position worse

Question 20

When will a director be liable for wrongful trading?

Answer 20

After ‘the point of no return’

Question 21

Which section describes the ‘every step defence’?

Answer 21

s214(3) and 246ZB(3)

Question 22

What is the every step defence?

Answer 22

After they first knew or ought to have concluded that there was no reasonable prospect of the company avoiding an insolvent administration or liquidation (from the ‘point of no return’), they took every step with a view to minimising the potential loss to the company’s creditors

Question 23

Evidence for the every step defence?

Answer 23

• 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; and
• Consulting a lawyer and/or an insolvency practitioner for advice on continued trading and the different insolvency procedures.

Question 24

Which case established that the burden of proof for every step is on the Directors?

Answer 24

Brooks v Armstrong [2015]

Question 25

What case does the court apply for the ‘every step’ defence4?

Answer 25

‘Reasonably Diligent Person’ Test

Question 26

Which section shows the ‘reasonably diligent person test’?

Answer 26

s 214(4) / 246ZB(4)

Question 27

What does the reasonably diligent person test establish?

Answer 27

• A liquidator or administrator has established that a director ought to have concluded that there was no reasonable prospect of avoiding an insolvent liquidation = s 214(2)
• Whether the director then took every step to minimise the potential loss to the company’s creditors (the s 214(3) defence

Question 28

What are the facts a director ought to have known or ascertained, the conclusions which they ought to have reached and the steps which they ought to have taken?

Answer 28

Those which would have been known or ascertained, or reached or taken, by a reasonably diligent person having both:

• General knowledge -(an objective test)
• Actual knowledge, (a subjective test).

The court then applies the higher of the two standards.

Question 29

Advice to directors?

Answer 29

• Hold board meetings regularly
• Write up minutes of each meeting so there is a written record on which the directors can later rely to justify why decisions were taken
• It is quite common for lawyers advising a company in financial difficulties to take an active role in helping directors to prepare minutes and to ensure that board meetings consider all the relevant issues

Question 30

Can a director escape liability just by resigning?

Answer 30

No
Without previously taking every step to minimise the potential loss to the company’s creditors, since a claim for wrongful trading can be brought against any person who was a director at the relevant time - Re Purpoint Ltd [1991]

Question 31

Re Purpoint Ltd [1991]

Answer 31

A director cannot escape liability by resigning without taking every step to minimise the potential loss to the company’s creditors - a claim for wrongful trading can be brought against any person who was a director at the time

Question 32

What is the best course of action?

Answer 32

The best course of action for a company is to seek professional advice as soon as possible - Re Continental Assurance Co of London plc [2001]

Question 33

Re Continental Assurance Co of London plc [2001]

Answer 33

The best course of action for a company is to seek professional advice as soon as possible

Question 34

Does the absence of warnings from advisors absolve directors of liability?

Answer 34

No - Re Brian D Pierson (Contractors) Ltd [2001]

Question 35

Re Brian D Pierson (Contractors) Ltd [2001]?

Answer 35

Absence of warnings from advisors does not absolve directors of liability

Question 36

Which section involves remedies for directors wrongfully trading>

Answer 36

s214(1)

Question 37

What sort of discretion does the court have to determine the extent of a directors liability?

Answer 37

Wide - contribution will ordinarily be based on the additional depletion of the company’s assets caused by the directors’ conduct from when directors ought to have seen the ‘point of no return’

Question 38

Is a court order against a director compensatory or penal?

Answer 38

Compensatory, joint and several THE COURT CAN APPORTION LIABILITY

Question 39

How is the apportionment of liability based?

Answer 39

On culpability

Question 40

Case for relief under s1157 NOT being available under wrongful trading proceedings?

Answer 40

Re Produce Marketing Consortium Ltd [1989]

Question 41

Re Produce Marketing Consortium Ltd [1989]

Answer 41

No relief under s1157 with wrongful trading proceedings