Liquidating the Company Flashcards
Re London and Paris Banking Corp (1874) LR 19 Eq 444
Thus, if a creditor presents a petition in order to pressurise the company into paying a debt, the amount of which is genuinely disputed as being excessive, the court may dismiss the petition with costs (Re London and Paris Banking Corp (1874)
First, if the debt is bona fide disputed and the defence is a substantial one, the court will not wind up the company. The court has dismissed a petition for winding up where the creditor claimed a sum for goods sold to the company and the company contended that no price had been agreed upon and the sum demanded by the creditor was unreasonable. See London and Paris Banking Corporation (1874) LR 19 Eq 444. Again, a petition for winding up by a creditor who claimed pauyment of an agreed sum for work done for the company when the company contended that the work had not been properly was not allowed. See Re.
Measures Bros Ltd v Measures [1910] 1 Ch 336
The winding up order terminates the management powers of the company’s directors (Measures Bros Ltd v Measures (1910)1 Ch 336). Their powers are transferred to the liquidator, together with their fiduciary duties, and so a liquidator must act in good faith,
Facts
Entered into an agreement with the C company (of which he was a director) (1.) to hold office for seven years at a fixed salary, and (5.) COVed that so long as he should continue to hold office, and for seven years after ceasing to hold such office, he would not, either solely or jointly with, or as manager or agent for, any other person or persons or company directly or indirectly carry on or be engaged or interested in any business that would compete with that carried on by the company. In April, 1909, a receiver and manager was appointed in a debenture-holder’s action, and a compulsory winding-up order was made against the company. The receiver and manager having given notice to the D that his services would no longer be required, and having ceased to pay his salary, the D commenced to carry on business on his own account.
Held
the plaintiff company could not have specific performance of clause 5 without performing, and they could not now perform, clause 1 in favour of the defendant, and consequently that he was no longer bound by his restrictive covenant and that the company were not entitled to an injunction.
Silkstone and Haigh Moore Coal Co v Edey [1900] 1 Ch 167
powers are transferred to the liquidator, together with their fiduciary duties, and so a liquidator must act in good faith, avoid a conflict of interests and not make a secret profit
Where a liquidator sold the undertaking of the company nominally to a new company, but really to himself, and the sale was set aside on the ground of concealment, and the property ordered to be reconveyed to the old company:
Stead, Hazel & Co v Cooper [1933] 1 KB 840
Stead, Hazel & Co v Cooper 1933,liquidator has no personal contract liabilityThe liquidator acts in the name of the company and will not, therefore, be liable on contracts entered into on behalf of the company.
Coutts & Co v Stock [2000] 1 BCLC 183
Coutts & Co v Stock [1999] EWHC 191 (Ch), [2000] 1 WLR 906 is a UK insolvency law case, concerning voidable transactions.
Facts
Coutts & Co gave Mr Stock’s company a £200,000 overdraft. Mr Stock gave a personal guarantee for it. Then came a winding up petition, as the account was £500 in credit. But by the time the petition was advertised, the account was overdrawn by £121,875 and £190,000 by the time the petition was granted. The bank honoured cheques in favour of third parties, most of which were three companies controlled by Mr Stock. Coutts & Co wanted to enforce the guarantee. Mr Stock argued the Insolvency Act 1986’s section 127[a] prevented the bank from debiting the account, and so the bank could not recover from him.
Judgment
The Bank was held to be entitled to the full sum claimed, as it was a debt owed by the Debtor.[1]
Lightman J noted that “[t]he authorities are in disarray and the state of the law is uncertain, if not confused.”[2] He then proceeded to identify “the principles which would be expected to operate in a case where Section 127 applies”:[3]
The invalidation of dispositions of a company's assets after the date of presentation of a winding up petition is part of the statutory scheme designed to prevent the directors of a company, when liquidation is imminent, from disposing of the company's assets to the prejudice of its creditors and to preserve those assets for the benefit of the general body of creditors. The retrospective invalidation effected by Section 127 does not change what happened between the date of the petition and the date of the winding up order The invalidation is limited to dispositions of property: it does not invalidate a company's assumption of liabilities, and it has no impact on the company's use, consumption or exhaustion of its assets. Presentation of the winding up petition has no impact on the powers of the directors of the company, the authority of the company's agents or the powers of disposition of the company. If the acts of the bank of honouring cheques drawn on a company's overdrawn account constitute payments by the bank (by way of loan to the company) of its own monies to the party in whose favour the cheques are drawn, the transaction is outside Section 127, for there is no disposition of the company's property. The acts of the bank in honouring cheques drawn on a company's overdrawn account constitute (i) loans of the sums in question by the bank to the company and (ii) payment by the bank as agent of the company of the sums loaned as monies of the company to the party in whose favour the cheques are drawn. The first act is not a disposition of the company's money and is therefore outside Section 127; but the second act does constitute a disposition to the payee by the company within Section 127 and is recoverable by the liquidator from the payee
Re J Leslie Engineers Co Ltd [1976] 1 WLR 292
In re J Leslie Engineers Co Ltd: 1976
The director of a company between presentation of a petition to wind up and the making of the order paid over pounds 1050 to a creditor for work done. Of this sum, pounds 800 was paid by way of a cheque drawn on the personal account of the director and his wife, which was in fact overdrawn at the time. The director caused the Company to pay pounds 800 into the joint account to reimburse them for the sum paid to the creditor.
Held: The payment of pounds 800 from the Company to the joint account was a disposition of the Company’s property and accordingly void, but the payment out of the joint account to the creditor was not a disposition of the Company’s property and therefore was not void. The creditor therefore was not liable in respect of that sum to the Company. The invalidating provisions in section 227 do not spell out the appropriate remedy of the company when the disposition is avoided: ‘Now, it must be remembered that the invalidation of a disposition of the company’s property and the recovery of the property disposed of, are two logically distinct matters. Section 227 says nothing about recovery; it merely avoids dispositions . . What is the appropriate remedy in respect of the invalidated disposition is a matter not regulated by the statute and that has to be determined by the general law.’
Section 227 did not mean that the company had some special remedy which enabled it to proceed with a claim in circumstances where, had the disposition been invalid on some other ground than the section, no such remedy would have lain.
Oliver J
[1976] 1 WLR 292
Companies Act 1948 227
England and Wales
Cited by:
Cited – Akers and Others v Samba Financial Group SC 1-Feb-2017
Saad Investments was a Cayman Islands company in liquidation. The liquidator brought an action here, but the defendant sought a stay saying that another forum was clearly more appropriate. Shares in Saudi banks were said to be held in trust for the . .
Re Produce Marketing Consortium Ltd [1989] BCLC 520
Re Produce Marketing Consortium Ltd (No 2) [1989] 5 BCC 569 was the first UK company law or UK insolvency law case under the wrongful trading provision of s 214 Insolvency Act 1986.
Facts
Eric Peter David and Ronald William Murphy ran Produce Marketing Consortium Ltd, importing lemons, grapefruit and oranges from Cyprus (previously, more Spain). It got shipped to Portsmouth. They were the only employees by the end (except David’s wife who did clerical work for £70 per month). PMC was incorporated in 1964 as an amalgamation of three smaller businesses. David was director from the start, and owned half the shares. As other directors left and died, Murphy became the other director in 1974. He had no accountancy qualifications, but was an experienced bookkeeper. The company earned profit through a 3.5% commission on the gross sale price of the fruit which was imported through its agency. But the business was dropping because they lost business of a large Spanish exporter. They made losses of £14K, £25K and £21K in 1981, 1982 and 1983, and a profit of £43 in 1984, by which time there was a bank overdraft of £91K. The report for that year was that,
“At the balance sheet date, the company was insolvent but the directors are confident that if the company continues to trade, it will be able to meet its liabilities.”
The auditor said the company’s continuation depended on the bank’s continued facilities. Banco Exterior SA took a secured debenture on 18 October 1983 on all property and assets, present and future, including good will, book debts and uncalled capital (but fixed assets were only £5000). They also took a personal guarantee from David for £30K. The draft accounts for 1984-6 were produced by auditors six months late in January 1987. They showed a £55K loss and £29K loss, with liabilities over assets reaching £175K. Auditors warned of insolvent trading, if the bank did not give more credit. The bank did oblige in March, but less than before. The overdraft decreased, but debt to its most important Cypriot shipper increased to £175K. The company was put in creditors’ voluntary liquidation on 2 October 1987, with debts of £317,694, half owed to one Cypriot shipping firm, as a trade creditor that brought them fruit. In 1988 the liquidator asked David and Murphy why there was trading while insolvent. David replied that they knew liquidation was inevitable in February with the accounts, and trading was continued because there was perishable fruit in cold store. The liquidator sought them to contribute £107,946 each, plus costs the court saw fit. The liquidator argued that the right measure to contribute was the reduction in net assets caused by the wrongful trading.
Miss Mary Arden QC was acting for the liquidator.
Judgment
vte
Wrongful trading cases
Knox J held that £75K should be contributed by both (not each). David should pay the first £50K and above that they would be jointly liable. They should have concluded in July 1986 there was no reasonable prospect of avoiding this, and though they did not have the accounts till January 1987 they had an intimate knowledge of the business and must have known turnover was well down on previous years. s 214(4) was applied, so it did not matter that they may not have actually known about the accounts. They ought to have known the results for the financial year 1985-6. The two had not taken steps they should have under s 214(3). After February 1987, trading was not limited to realising the fruit in cold store. Overall, s 214 was compensatory, not penal, and the right amount to contribute was the amount caused to be depleted by the directors’ conduct. The key parts of Knox J’s decision were as follows.
This was a new provision in the Insolvency Act 1985, s 15. It contrasts with s 213 of the Insolvency Act 1986 in relation to fraudulent trading, which is derived from s 630 of the Companies Act 1985, itself derived (with some amendments) from s 332 of the Companies Act 1948, in turn derived from the Companies Act 1929, s 275 . Under these latter successive enactments the intent to defraud had to be established in relation to the particular person sought to be charged, and although in Re William C Leitch Bros Ltd [1932] 2 Ch 71, Maugham J. held (at p 77) that if a company continued to carry on business and to incur debts at a time when there was to the knowledge of the directors no reasonable prospect of the creditors ever receiving payment of those debts, it was, in general, a proper inference that the company was carrying on business with intent to defraud, there were authorities which exonerated from liability under the fraudulent trading legislation persons who honestly hoped that creditors would be paid off one day, albeit that this was not a reasonable expectation by any objective standard. Thus I was referred to an unreported decision of Buckley J in Re White & Osmond (Parkstone) Ltd (30 June 1960) , in the course of which he said:
“In my judgment, there is nothing wrong in the fact that directors incur credit at a time when, to their knowledge, the company is not able to meet all its liabilities as they fall due. What is manifestly wrong is if directors allow a company to incur credit at a time when the business is being carried on in such circumstances that it is clear the company will never be able to satisfy its creditors. However, there is nothing to say that directors who genuinely believe that the clouds will roll away and the sunshine of prosperity will shine upon them again and disperse the fog of their depression are not entitled to incur credit to help them to get over the bad time.”
Buckley J also referred to another decision of Maugham J in Re Patrick and Lyon Ltd [1933] Ch 786, where (at p 790) he expressed the opinion, regarding s 275 of the Companies Act 1929:
“that the words ‘defraud’ and ‘fraudulent purpose,’ where they appear, in the section in question, are words which connote actual dishonesty involving, according to current notions of fair trading among commercial men, real moral blame.”
The Insolvency Act 1986 now has two separate provisions: s 213 dealing with fraudulent trading – to which the passages which I have quoted from the judgments of Maugham J and Buckley J no doubt are still applicable – and s 214 which deals with what the side-note calls “wrongful trading”. It is evident that Parliament intended to widen the scope of the legislation under which directors who trade on when the company is insolvent may, in appropriate circumstances, be required to make a contribution to the assets of the company which, in practical terms, means its creditors.
Two steps in particular were taken in the legislative enlargement of the court's jurisdiction. First, the requirement for an intent to defraud and fraudulent purpose was not retained as an essential, and with it goes the need for what Maugham J. called “actual dishonesty involving real moral blame”.
I pause here to observe that at no stage before me has it been suggested that either Mr David or Mr Murphy fell into this category.
The second enlargement is that the test to be applied by the court has become one under which the director in question is to be judged by the standards of what can be expected of a person fulfilling his functions, and showing reasonable diligence in doing so. I accept Mr. Teverson's submission in this connection, that the requirement to have regard to the functions to be carried out by the director in question, in relation to the company in question, involves having regard to the particular company and its business. It follows that the general knowledge, skill and experience postulated will be much less extensive in a small company in a modest way of business, with simple accounting procedures and equipment, than it will be in a large company with sophisticated procedures.
Nevertheless, certain minimum standards are to be assumed to be attained. Notably there is an obligation laid on companies to cause accounting records to be kept which are such as to disclose with reasonable accuracy at any time the financial position of the company at that time (Companies Act 1985, s 221(1) and (2)(a)).[1] In addition directors are required to prepare a profit and loss account for each financial year and a balance sheet as at the end of it ( Companies Act 1985, s 227(1) and (3)).[2] Directors are also required, in respect of each financial year, to lay before the company in general meeting copies of the accounts of the company for that year and to deliver to the registrar of companies a copy of those accounts, in the case of a private company, within ten months after the end of the relevant accounting reference period (Companies Act 1985, s 241(1) and (3), and s 242(1) and (2)(a)).[3]
As I have already mentioned, Mr. Halls gave evidence that the accounting records of PMC were adequate for the purposes of its business. The preparation of accounts was woefully late, more especially in relation to those dealing with the year ending 30 September 1985, which should have been laid and delivered by the end of July 1986.
The knowledge to be imputed in testing whether or not directors knew or ought to have concluded that there was no reasonable prospect of the company avoiding insolvent liquidation is not limited to the documentary material actually available at the given time. This appears from s 214(4) which includes a reference to facts which a director of a company ought not only to know but those which he ought to ascertain, a word which does not appear in s 214(2)(b) . In my judgment this indicates that there is to be included by way of factual information not only what was actually there but what, given reasonable diligence and an appropriate level of general knowledge, skill and experience, was ascertainable. This leads me to the conclusion in this case that I should assume, for the purposes of applying the test in s 214(2) , that the financial results for the year ending 30 September 1985 were known at the end of July 1986 at least to the extent of the size of the deficiency of assets over liabilities.
Mr. David and Mr. Murphy, although they did not have the accounts in their hands until January 1987, did, I find, know that the previous trading year had been a very bad one. They had a close and intimate knowledge of the business and they had a shrewd idea whether the turnover was up of down. In fact it was badly down in that year to £526,459 and although I have no doubt that they did not know in July 1986 that it was that precise figure, I have no doubt that they had a good rough idea of what it was and in particular that it was well down on the previous year. A major drop in turnover meant almost as night follows day that there was a substantial loss incurred, as indeed there was. That, in turn, meant again, as surely as night following day, a substantial increase in the deficit of assets over liabilities.
That deals with their actual knowledge but, in addition, I have to have regard to what they have to be treated as having known or ascertained, and that includes the actual deficit of assets over liabilities of £132,870. This was £80,000 over Mr. David's personal guarantee. It was a deficit that, for an indefinite period in the future, could not be made good, even if the optimistic prognostications of level of turnover entertained by Mr. David and Mr. Murphy were achieved. They later estimated, when they visited the bank on 16 February 1987, a turnover of £1.6m. If one assumes half as much again, at £2.4m, the gross income of the company would only have risen to £84,000 and the overheads were accepted as being not less than £65,000. That gives a notional profit of £19,000 per annum. If one takes the figure of £1.6m, overheads of £65,000 would not have been covered.
Mr. Teverson was not able to advance any particular calculation as constituting a basis for concluding that there was a prospect of insolvent liquidation being avoided. He is not to be criticised for that for, in my judgement, there was none available. Once the loss in the year ending 30 September 1985 was incurred PMC was in irreversible decline, assuming (as I must) that the directors had no plans for altering the company's business and proposed to go on drawing the level of reasonable remuneration that they were currently receiving.
It was stated by Mr. David that the persons and companies with whom PMC did business were in the main long established trading partners. In fact that could not be said of Ramona which was, by July 1986, a very important creditor. But even if one disregards that aspect, it would not be right to assume that even old established trading partners will wait indefinitely to have their debts paid. Nor, in my judgment, do the facts that the bank was throughout willing to continue its facilities and that Mr. Tough, although expressing the grave warnings that he did when the accounts for the years ending 30 September 1985 and 1986 were available to him, was willing to accompany Mr. David and Mr. Murphy to the bank in February 1987 to see if further facilities would be granted, detract from the conclusion I have reached that Mr. David and Mr. Murphy ought to have concluded at the end of July 1986 that there was no reasonable prospect that PMC would avoid going into insolvent liquidation. The bank was secured by Mr. David's guarantee, if not to any significant extent by the other securities which it took, and Mr. Tough's attitude was never more than one of doubt and caution.
The next question which arises is whether there is a case under s 214(3) for saying that after the end of July 1986 the respondents took every step with a view to minimising the potential loss to the creditors of PMC as, assuming them to have known that there was no reasonable prospect of PMC avoiding insolvent liquidation, they ought to have taken. This clearly has to be answered “No”, since they went on trading for another year.
Mr. Teverson gallantly attempted to establish that – assuming that the first time when the respondents ought to have concluded that there was no such reasonable prospect was February 1987 when they actually signed the preceding two years' accounts – their decision to trade on so as to realise the fruit in cold store to the best advantage satisfied the requirement of s 214(3) . I would not have accepted that submission in any event because the continued trading was far from limited to the realisation of the fruit in cold store, and Ramona were not told, as they should have been, what the true financial picture was so as to be given the opportunity of deciding for themselves what to do. But this is academic because that submission, even if correct in relation to February 1987, quite plainly was untenable in relation to the end of July 1986.
I am therefore driven to the conclusion that the court's discretion arises under s 214(1) . Upon the nature of that discretion there were conflicting submissions made to me. Mr. Teverson submitted that the court's discretion is entirely at large, and he pointed to no less than three sets of words indicating the existence of a wide discretion: the court may declare that that person is to be liable to make such contribution ( if any ) to the company's assets as the court thinks proper . He also submitted that the provision is both compensatory and penal in character. He referred me to Re William C Leitch Bros Ltd at pp. 79–80, where Maugham J said of s 275 of the Companies Act 1929:
“I am inclined to the view that s 275 is in the nature of a punitive provision, and that where the Court makes such a declaration in relation to ‘all or any of the debts or other liabilities of the company,’ it is in the discretion of the Court to make an order without limiting the order to the amount of the debts of those creditors proved to have been defrauded by the acts of the director in question, though no doubt the order would in general be so limited.”
However, Mr. Teverson also submitted that the amount which the court concluded had been lost as a result of the wrongful trading should provide a ceiling for the figure which the court declared should be contributed to the company's assets, which is of course the exact opposite of what Maugham J. said in that regard. He also relied upon the provisions of s 214(3) which prevent the exercise of the discretion under subsection (1) in any case where, to put it briefly, the director has done everything possible to minimise loss to creditors, and suggested that it would be inequitable for a director who has just failed to escape scot-free under the provision because he had only done nearly but not quite everything to that end, to be treated on a par with a director who had done nothing to minimise loss to creditors.
Miss Arden, for the liquidator, submitted that s 214 of the Insolvency Act 1986 gave a purely civil remedy, unlike the predecessors of s 213 of that Act, such as s 275 of the Companies Act 1929 and s 332 of the Companies Act 1948 which combined the civil and criminal. More significantly, for my purpose, she submitted that s 214 was compensatory rather than penal. What is ordered to be contributed goes to increase the company's assets for the benefit of the general body of creditors. On that basis she submitted that the proper measure was the reduction in the net assets which could be identified as caused by the wrongful activities of the persons ordered to contribute. This jurisdiction, it was submitted, is an enhanced version of the right which any company would have to sue its directors for breach of duty; enhanced in the sense that the standard of knowledge, skill and experience required is made objective.
On this analysis, once the circumstances required for the exercise of discretion under s 214(1) are shown to exist, she submitted that the situation was analogous to that obtaining where a tort such as negligence was shown to have been committed, in that quantum was a matter of causation and not culpability. The discretion given to the court was to enable allowance to be made for questions of causation and also to avoid unjust results such as unwarranted windfalls for creditors. Thus in Liquidator of West Mercia Safetywear Ltd v Dodd (1988) 4 BCC 30, at p 33, Dillon LJ said of s 333 of the Companies Act 1948:
“The section in question, however, s 333 of the Companies Act 1948, provides that the court may order the delinquent director to repay or restore the money, with interest at such rate as the court thinks fit, or to contribute such sum to the assets of the company by way of compensation in respect of the misapplication as the court thinks fit. The court has a discretion over the matter of relief, and it is permissible for the delinquent director to submit that the wind should be tempered because, for instance, full repayment would produce a windfall to third parties, or, alternatively, because it would involve money going round in a circle or passing through the hands of someone else whose position is equally tainted.”
In my judgment the jurisdiction under s 214 is primarily compensatory rather than penal. Prima facie the appropriate amount that a director is declared to be liable to contribute is the amount by which the company's assets can be discerned to have been depleted by the director's conduct which caused the discretion under s 214(1) to arise. But Parliament has indeed chosen very wide words of discretion and it would be undesirable to seek to spell out limits on that discretion, more especially since this is, so far as counsel were aware, the first case to come to judgment under this section. The fact that there was no fraudulent intent is not of itself a reason for fixing the amount at a nominal or low figure, for that would amount to frustrating what I discern as Parliament's intention in adding s 214 to s 213 in the Insolvency Act 1986 , but I am not persuaded that it is right to ignore that fact totally.
I take into account the following factors in addition to those set out above, which give rise to the existence of the court's discretion under s 214(1):
This was a case of failure to appreciate what should have been clear, rather than a deliberate course of wrongdoing.
There were occasions when positive untruths were stated which cannot just be treated as unwarranted optimism. Mr. David in particular is given to a flowing turn of phrase. He referred to PMC's continuing to trade as “the ship of state sailing on”. That, in itself, is not to be held against him, although it is doubtless a symptom of his inability to see the realities of the current trading position. But when, as happened more than once, a statement of fact was made which was positively untrue, that is to be held against him.
The most solemn warning given by the auditor in early February 1987 was effectively ignored. I do not regard Mr. Tough's attendance at the bank on 10 February as indicating even tacitly that if the bank agreed to extend facilities it would be proper to carry on trading.
Mr. David has given a guarantee to the bank with a limit of £50,000. The bank will have a charge over anything which Mr. David or Mr. Murphy contributes pursuant to my order. Pro tanto that will relieve Mr. David from his guarantee liability.
The affairs of PMC were conducted during the last seven months of trading in a way which reduced the indebtedness to the bank, to which Mr. David had given a guarantee, at the expense of trade creditors and in particular Ramona. The bank is, if not fully, at least substantially secured. If this jurisdiction is to be exercised, as in my judgment it should be in this case, it needs to be exercised in a way which will benefit unsecured creditors.
The evidence regarding the disappearance of debtors from the statement of affairs is not entirely clear and there remains in my mind an element of speculation on the extent to which it is right to fix on £22,000 as the amount to be treated as having been overstated in September 1986.
Taking all these circumstances into account I propose to declare that Mr. David and Mr. Murphy are liable to make a contribution to the assets of PMC of £75,000.
As between the two of them it seems to me right that Mr. David should indemnify Mr. Murphy as to £50,000 and that above that figure they should be jointly liable. As against the liquidator they should be jointly and severally liable for the whole £75,000. I take this view regarding the indemnity to be given by Mr. David partly because Mr. David was Mr. Murphy's senior in every sense – age, standing in the company and personality – but principally because of the existence of Mr. David's guarantee to the bank. Naturally Mr. Teverson was not in a position to make submissions to me how matters should be dealt with as between his two clients, and I should be sorry to see the costs, which must already run the risk of eroding the benefits which the section is intended to confer on creditors, further increased.
Brooks v Armstrong [2015] EWHC 2289 (Ch)
Brooks v Armstrong [2016] EWHC 2289 (Ch), [2016] All ER (D) 117 (Nov) is a UK insolvency law case on wrongful trading under section 214 of the Insolvency Act 1986.[1][2]
The original decision by Registrar Jones was widely reported ([2015] EWHC 2893 (Ch), [2015] BCC 661, [2015] All ER (D) 45 (Aug)) in relation to the extensive guidance and consideration given to the issues. That decision was then partly overturned on appeal by David Foxton QC sitting as a Deputy High Court judge. The liquidators have now applied for further permission to appeal to the Court of Appeal.[3]
Facts
From July 1998 Robin Hood Centre plc (“the company”) engaged in the business of a Robin Hood themed tourist attraction in Nottinghamshire. The company went into creditors’ voluntary liquidation on 6 February 2009. The liquidators brought proceedings against the directors of the company for misfeasance and wrongful trading.
Although the company accounts showed a surplus of assets for the 12 years prior to liquidation, the liquidators argued that the companies were in fact balance-sheet insolvent during the relevant period due to mis-stating of depreciation on the company accounts.
First instance judgment
In a detailed and comprehensive judgment Registrar Jones reviewed the existing authorities and law relating to wrongful trading. He held that there were three principle conditions to a finding of wrongful trading:[4]
the company must have gone into liquidation with insufficient assets to meets the claims of its creditors and the costs of winding-up (the "insolvency condition") at some time before the commencement of winding-up the directors knew or ought to have concluded that there was no prospect of avoiding insolvent liquidation (the "knowledge condition") the director (which includes a "shadow director") failed to take "every step" to minimise loss to the company's creditors (the "minimising loss defence").
Burden of proof
The court held that the burden of proof was on the liquidator to establish (a) the insolvency condition and (b) the knowledge condition. But having established that, the burden of proof then switched to the directors to establish the minimising loss defence, if applicable. The court rejected academic sources which suggested that the burden of proof was also on the liquidators to disprove the defence, and followed the High Court decision of Ms Lesley Anderson QC in Re Idessa (UK) Ltd [2011] EWHC 804 (Ch), [2012] BCC 315 at [113].
The court also followed Re Idessa in holding that “every step” was a stricter test than “every reasonable step”, which Parliament had impliedly rejected.
Date of knowledge
The court further held that the liquidators only need prove that the directors knew insolvent litigation was unavoidable prior to the commencement of winding-up. It was not necessary to prove that they had this knowledge on any particular date (following Re Continental Assurance Co of London plc [2001] BPIR 733). However the directors did have a right to know the case that they had to meet, and so the liquidators would not be able to claim a different date period at trial to the one identified in pleadings and evidence in support.
Applying the tests
The liquidators had to establishing insolvency on the balance of probabilities. It was sufficient to show that there was insufficiency of assets and that the company would inevitably run out of assets under the “Eurosail test” (BNY Corporate Trustees Services Ltd v Eurosail-UK 2007-3BL plc [2013] UKSC 28). Accordingly, it was not necessary for the company to actually be insolvent at the time - merely that future insolvency was inevitable.
However there was no general prohibition on companies trading whilst they were insolvent if they legitimately believed that they could trade at a profit and thereby minimise loss to creditors. The law must leave room for cases where directors genuinely thought they could trade out of their difficulties, even if they turned out to be wrong.
The court also confirmed that it must be careful not to approach the knowledge condition with the benefit of hindsight. Directors would often be faced with decisions to which there was no obvious right or wrong answer. But the policy behind section 214 of the Insolvency Act 1986 was against “conduct ranging from the irresponsible to the unreasonable”. This might be positive conduct, but it might also be directors wilfully shutting their eyes.
Standard of conduct
The conduct of the directors was to be tested against the general level of knowledge, skill and experience reasonably expected of a director.
Minimising loss defence
What would constitute taking “every step” to minimise loss to creditors would depend upon the facts of each case. But the court identified a number of factors to be considered:[5]
whether the directors ensured that the accounting records were kept up to date, particularly budget and cash-flow forecasts preparing business plans and business reviews which included steps to minimise losses (ie. cutting costs) keeping creditors informed and seeking agreements to address debt and supply regular monitoring of trade and financial positions, both informally and at board meetings asking and assessing if losses were being minimised ensuring adequate capitalisation obtaining professional legal and financial advice considering alternative insolvency and restructuring remedies
Application
The court held that its jurisdiction in relation to an application under section 214 was not fettered. The compensation to be awarded was designed to recoup losses to the company caused by the wrongful trading. The maximum award would therefore normally be the amount by which the company’s assets had been depleted in consequence of the wrongful trading. However although the law did not impose a specific test for causation, there must be more than a “but for” nexus between the wrongful trading and the depletion. Allowance must be given for losses that were not caused by the directors’ actions.[6]
The assessment should be based upon bridging the gap between what the position would have been if the company had been put into a hypothetical liquidation at the last point when it was reasonable to do so, against the actual position. Where there were two or more defendants who are shared culpability, that award would be joint and several.
The court held on the facts of the case, there were no grounds for making any separate award for misfeasance.[7]
Commentary
Most commentators responded positively to the decision, noting the clarity with which it set out the relevant constituent elements of liability, and provided important clarification of the issues relating to burden of proof.[8]
Appeal
Upon appeal the decision was reversed in part by David Foxton QC, sitting as a Deputy High Court judge.[3]
He held that notwithstanding the missing financial information, it was nevertheless possible for the court to perform “increase in net deficiency” calculations. In this case the liquidators had been able to do so, although Registrar Jones had felt their calculations were deficient. In this case the facts were distinguishable from Re Purpoint and Re Kudos Business Solutions as the directors had not failed to keep records, but simply that certain records had not been collected by the liquidators (the liquidators argued that the directors had breached their duty to produce the company’s papers and were responsible for their absence, but no finding of fact was made in that regard).
Foxton QC held that the tribunal below had applied the correct test when assessing Mr Armstrong’s conduct, and that it was entitled to take into account those matters in assessing the director’s knowledge as at October 2006.
He noted that challenges to the company’s supposed profitability were not raised at trial, and there was no certainty that if changes had had to be made to the VAT scheme that this would have precluded the company from continuing to operate profitably.
The court was satisfied that there was no inconsistency between finding that the assets of the company would have fetched little (or possibly nothing) upon a sale in liquidation, but that the assets could still continue to generate positive cash flow within the business as a going concern. It was noteworthy that the negative effects of asset depreciation had already occurred by 31 January 2007, and this was not worsened through continued use.
The honesty of the directors was one of a number of factors which the Registrar referred to, and he was entitled to consider those as part of his balancing exercise when assessing compensation.
The deputy judge was persuaded that the Registrar had erred in trying to apply an analysis which had not in fact been advanced by either litigant, and which had not been the subject of counsels’ submissions at trial. The parties would have been entitled to raise legitimate objections to this approach, either on the basis that there was not sufficient evidence on key issues, or alternatively, if that analysis was followed through to a proper conclusion then there would arguably have been no compensation payable.
BNY Corporate Trustee Services Ltd v Eurosail-UK 2007-3BL plc [2013] UKSC 28.
BNY Corporate Trustees Services Ltd v Eurosail-UK 2007-3BL plc [2013] UKSC 28 (often referred to as simply the Eurosail case) was a decision of the Supreme Court of the United Kingdom in relation to the proper interpretation of section 123(2) of the Insolvency Act 1986[1] (the so-called “balance-sheet test”) as it had been applied in commercial bond documentation. The analysis and reasoning in the case are now commonly referred to as the Eurosail test.[2]
The ruling related to the insolvency of a special purpose company which had issued asset-backed securities as part of a securitisation. However, the collapse of Lehman Brothers meant that certain tranches of the securities were exposed because Lehman Brothers would not be able to meet its obligations under derivative contracts which had been entered into. Although strictly speaking the Court was expressing an opinion on the proper interpretation of an event of default in the bond documentation, the ruling is treated as an authoritative interpretation on section 123(2).[3]
The Supreme Court also rejected the “point of no return” test suggested by the Court of Appeal,[4] and also ruled on the limited efficacy of the post-enforcement call option (“PECO”).[5]
Facts
The company, Eurosail-UK 2007-3BL plc, was a single purpose entity which was formed to acquire various mortgage loans as part of a securitisation in 2007.
The transaction was complex, and the documentation was described as “forbiddingly voluminous”.[6] The benefit of various mortgage loans were assigned to the company, which then issued various tranches of bonds to investors (then, as normally happens in a securitisation, the proceeds of those bonds was then paid over to the original lenders under the mortgage loans as the purchase price for the loans). The payments under the various tranches of notes were intended to be protected by certain swap transactions which had been entered into the company with Lehman Brothers. But after the notes were issued, Lehman Brothers went into bankruptcy meaning that the company could not expect to receive payment under those swaps. The financial effect of this on the company was that although it could continue to meet its obligations for the time being, it would almost inevitably become unable to do so at a future point (because the company was a single purpose company there was no prospect of it trading out of its financial difficulties). The essential question for the court was whether this inevitable future shortfall means that the company could be treated as insolvent today, or whether it was necessary to wait until either it ran out of funds, or at least came close to doing so.[3]
If it was decided that because the financial track the company was inevitably on meant it should be treated as insolvent now, then this would trigger an event of default under the bond documentation, which would result in an acceleration of the payment of all of the tranches on the notes. On the other hand, if the company was allowed to continue for several more years, the various tranches of the notes which matured sooner would be paid in full, and those tranches of the notes which were due to be repaid later would bear the entire loss caused by the inability of Lehman Brothers to make payments under the swaps.[7]
Essentially the dispute was between the different tranches of noteholders as to how the loss for the collapse of Lehman should be shared between them. The note trustee was not represented at trial, and took a neutral position.
A subsidiary issue which arose in the trial related to the post enforcement call option (PECO). This was a mechanism designated to ensure that the company remained “bankruptcy remote”.[8] Essentially if there was a default under any tranche of the notes, each investor had a put option which would allow it to force a related company (Eurosail Options Ltd, referred to as “OptionCo”) to buy the notes at face value. Theoretically this would mean that the investors would never take a loss, and OptionCo would then release the company from its obligations to avoid a bankruptcy. The subsidiary question was whether this protection should affect the conclusion whether the company was insolvent or not.[5]
Decision:
At first instance and in the Court of Appeal it was held that the company was not insolvent, and the Court of Appeal had applied the “point of no return” test in relation to determination of balance sheet solvency. The Supreme Court upheld those decisions, but for different reasons.
Lord Walker
Lord Walker, with whom all the other judges agreed, gave the main judgment on the insolvency test under English law.
The crux of the decision was how to apply the test in section 123(2) in order to determine whether a company was balance-sheet insolvent. That section provides:
A company is also deemed unable to pay its debts if it is proved to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities.[1]
The key here was the prospective liabilities. Various tranches of the notes were due for payment at various future dates, the latest of which were 2045 (or thirty years after the date that the case was being heard in the Supreme Court).
Lord Walker restated the basic proposition, that “whether or not the test of balance-sheet solvency is satisfied must depend on the available evidence as to the circumstances of the particular case”. He noted that given the specific (ie. non-trading) nature of the company, it was permissible to use its present assets as a guide to the company’s ability to meet its long-term liabilities. The insufficiency of assets which caused concern was the inability of Lehman Brothers as swap counterparty to make payments under the swaps. However, Lord Walker noted that there may be no payment due at all under the swap contracts depending upon the movements in currency exchange rates over the periods.
However, he also found that there existed “three imponderable factors”,[9] namely:
the effect of potential currency movements; the effect of potential interest rate movements; and the state the UK economy and housing market.
He noted that these factors needed to be considered in light of a period of more than 30 years until the final redemption of the notes in 2045. This meant that trying to evaluate balance-sheet insolvency in the context of those contingencies was “a matter of speculation rather than calculation and prediction on any scientific basis”.[10] He further noted (but did not enumerate it as a fourth imponderable factor) that the company has a claim in the estate of Lehman Brothers which has a current market value. Accordingly the courts should proceed with the greatest caution before deciding that a company is balance sheet insolvent. On the evidence before the court, he concluded that the company’s ability to pay all of its debts (whether present or future) could not be finally determined until much closer to the date for redemption. Accordingly, the company was not balance-sheet insolvent under the test in section 123(2).
He also held that the “point of no return”, adopted by the Court of Appeal, should be rejected. He stated that the phrase “should not pass into common usage as a paraphrase of the effect of section 123(2)”.[11]
Lord Hope gave a short concurring judgment in which he agreed with Lord Walker and then went on to consider the PECO. Technically speaking the additional protection afforded by the PECO became irrelevant because of the decision that the company was not insolvent. But Lord Hope noted that “A PECO is widely used in securitisation transactions of the kind that was entered into in this case, and we have been told that the question is of some importance to the securitisation market more generally. So it is appropriate that we should give our reasons”,[12] and therefore he expressed his opinion on the issue.
Lord Hope expressed the view that the Supreme Court agreed “with the Chancellor and the Court of Appeal that it has no effect on the way the liability of the Issuer to the Noteholders for the purposes of the default provision”.[12] In the courts below the view had been expressed that “[u]nless and until the option holder releases the Issuer from all further liability, which it is under no obligation to do, the liability of the Issuer is unaffected.” Accordingly, even though there might be a commercial expectation that the PECO would operate to secure the release of company from its obligations under the notes,[13] for the purpose of applying the insolvent test one should not make that assumption. In this case the liability under the notes would remain the same - it is simply that exercising the PECO would mean that the liability of the company was transferred to the OptionCo.
Some market commentators predicted that this would lead to originators reverting to traditional limited recourse language, particularly as the tax advantages related to PECOs no longer subsisted.[14]
Other points
The Supreme Court cited with approval the decision of Briggs J in Re Cheyne Finance plc [2008] EWHC 2402 (Ch), [2008] BCC 182, in relation to the “element of futurity” inherent in the insolvency test.[15]
All of the barristers who appeared in the case for every party (Gabriel Moss QC, Robin Dicker QC, Richard Fisher, Jeremy Goldring and David Allison) all belonged the same set of chambers.[16]
Reception
Commentary on the decision has been largely positive.
Most commentators broadly concurred that the decision “has clarified that the test in section 123(2) requires the exercise of judgement. Creditors wishing to rely on the balance-sheet test in winding up proceedings will find it harder to successfully establish the subjective threshold of the test.”[17]
It has been referred to as a “profound and far-reaching” decision, noting in particular that “the contention that a PECO structure gives effective limited recourse is now discredited.”[18] UK based issuers who operate these structures will not be able to rely on the PECO to effectively discount the value of their liabilities to noteholders back to the level of their assets, at least until the conclusion of the transaction. Conversely, it was noted that “[p]ractitioners had been looking to this case to give some guidance on the issue of balance sheet insolvency. Lord Neuberger in the Court of Appeal went some way towards doing this with the adoption of the point of no return test… The Supreme Court decision, however, takes us back to where we were at the outset … with a petitioner needing to satisfy a court that a company is balance sheet insolvent and that exercise being heavily fact specific.”[18]
However, other commentators note that “there are [still] unanswered questions”, noting that the case involved “a ‘closed business’ [which] differs greatly from the majority of businesses and the balance-sheet test itself is very dependent on the specific circumstances of the case.”[7]
Sample examination question
In 1996, Helen, then aged 24, qualified as a chartered accountant. In 1997 she
formed Pear Ltd and its wholly-owned subsidiary, Sub Ltd. Helen holds all the shares
in Pear except one, which is held by a nominee for her. Pear Ltd holds all the shares
in Sub Ltd, except one, which is similarly held by a nominee for Pear Ltd. Helen is the
only director of both companies and neither company has filed any accounts with
the Registrar for the last three years. Other than her shares in Pear Ltd, Helen has
virtually no assets.
Since 1997 Pear Ltd has made telephone answering machines and has flourished so
that it now has assets of over £1 million and employs 40 people. Sub Ltd however,
is mainly engaged in supplying Pear Ltd with components and is not run primarily
with a view to making a profit on its own, although for the first two years, 1998 and
1999, Sub Ltd made profits of £8,000 and £3,000 respectively. However in 2000 it
made a loss of £38,000; in 2001 a loss of £23,000 and in 2002 a loss of £11,000.
In September 2001 Big Bank plc was pressing for a reduction of Sub Ltd’s overdraft
of £40,000. Helen then paid £20,000 of her own money into the account, taking in
return a debenture from Sub Ltd for £20,000 and a floating charge to secure both
that £20,000 and an earlier loan by her to the company of £15,000.
On 2 April 2003 a creditor presented a petition for the winding up of Sub Ltd and a
winding up order was made on 14 May 2003. The assets of Sub Ltd fall short of its
liabilities by £60,000.
Advise Helen as to her potential liabilities, if any, and her position generally.
Advice on answering this question
You will need to address the following issues.
u Section 245 IA 1986, whereby the liquidator of an insolvent company can avoid
floating charges (see Chapter 7 of this guide).
u Whether or not Helen is liable for wrongful trading – see IA 1985, s.214. Particular
reference should be made to Re Produce Marketing Consortium (No.2).
u You will need to discuss Salomon v Salomon [1897] AC 22 and Adams v Cape Industries
plc [1990] 2 WLR 657 (see Chapters 3 and 4) in order to explain that a parent
company (Pear Ltd) is not liable for the debts of its subsidiary (Sub Ltd). However,
if Pear Ltd is a shadow director of Sub Ltd (see Chapter 14 of this guide and
particularly Secretary of State for Trade and Industry v Deverall [2001] Ch 340), the
assets of Pear Ltd may be liquidated to meet the claims against Sub Ltd.
u Whether Helen can be disqualified as a director under the Company Directors
Disqualification Act 1986 (see Chapter 14). Particular reference should be made
to the degree of culpability required before the court will disqualify a director. In
Re Lo-Line Electric Motors Ltd [1988] Ch 477 Sir Nicholas Browne-Wilkinson V-C said
that while ordinary commercial misjudgment is not in itself sufficient to establish
unfitness, conduct which displays ‘a lack of commercial probity’ or conduct which
is grossly negligent or displays ‘total incompetence’ would be sufficient to justify
disqualification.
