Voidable transactions and directors' liability in insolvency Flashcards
What 2 types of trading can directors be held personally liable to compensate creditors/company for if they are found guilty of?
- Fraudulent trading
- Wrongful trading
In the event of wrongful or fraudulent trading, will liquidators have the power to bring proceedings for compensation against the company?
No - against directors personally
What do the provisions of fraudulent trading seek to prevent?
The abuse of limited liability by directors who will continue to trade/incur futher debts when company in financial difficulty so losses to creditors are increased
Are RARE due to evidential requirements in proving intent to defraud
Who can make a claim for fraudulent trading and how?
Liquidator or administrator on application to court
Can a claim for fraudulent trading only be brought against directors?
Can be brought against ‘any person’ - includes (and usually is) directors, but extends to banks who may be liable by virtue of employee’s knowledge
What are the 2 requirements to bring a claim of fraudulent trading against ‘any person’?
- Person is knowingly party to the carrying on of any business of the company
- With intent to defraud creditors/for any fraudulent purpose
What must be proven to show intent to defraud?
Actual dishonesty
On what basis is actual dishonesty assessed and what does is mean for ‘blind-eye knowledge’ to be included?
- Assessed on a subjective basis i.e. what person knew/believed
- Inc blind-eye knowledge: suspicion of relevant facts + deliberate decision to avoid confirming that they exist
What is the two stage test for proving actual dishonesty?
Liquidator must:
1. Demonstrate director’s subjective state of knowledge; and
2. Show director’s conduct was dishonest applying the objective standard of ordinary decent people
Is it necessary to show that all company creditors have been defrauded?
No - provided at least one creditor has been defrauded it is enough to bring a claim
What can a person be ordered to do should they be found liable for fraudulent trading?
Make such contribution to the company’s assets as the court thinks proper
No punitive element; reflects and compensates loss
Are recovered sums held for the defrauded creditor?
No - for unsecured creditors generally
What other sanctions may be imposed on somone found liable of fraudulent trading?
- Disqualification order if they are a director
- Criminal sanctions (whether or not company being wound up)
Can be imprisonment of up to 10 years
Is fraudulent trading used as much as wrongful trading?
Wrongful trading used more often than fraudulent trading (which is rare because of very high standard of proof required for successful claim in fraudulent trading)
What duty does the rules on wrongful trading impose on director in the event of insolvency?
The duty to take every step possible to minimise potential losses to creditors when they (ought to) become aware that insolvent liquidation/administration is inevitable
Is there requirement to show intent/dishonesty for wrongful trading (as with fraudulent trading)?
No - easier to prove
Also no criminal sanctions
What does wrongful trading a) impose on directors and b) mark an exception to?
a) Personal liability
b) Exception to principle of limited liability (those who run a company can be liable for its unpaid debts)
Who can bring a claim for wrongful trading and against who?
- Liquidators and administrators can bring a claim for wrongful trading
- Against directors
Can also assign wrongful trading claims to a third party as a way of raising funds and avoiding litigation
How broad is the scope of ‘director’ re who a claim can be brought against?
Includes shadow, de-facto, non-executive, and executive directors who were a director at the relevant time
Broad!
What are the two limbs (requirements) that must be satisfied for a director to be liable for wrongful trading?
- The point of no return
- Every step defence
How does limb one work?
The point of no return
Court must be satisfied that company has gone into insolvent liquidation/administration and at some point beforehand the director knew or should have known there was no reasponable prospect of avoiding it
Point of no return = the time that this would happen
I.e. must be proven that:
1. Director in question allowed company to continue to trade during period in which they knew/ought to have known there was no reasonable prospect company would avoid going into insolvent liquidation/administration
2. Continued trading made the company’s position worse
When is a company insolvent for the purposes of wrongful trading?
When assets are insufficient for payment of debts/liabilities/expenses of winding up etc.; the balance sheet test only
Narrower definition than voidable transactions which inc cash flow test
When will limb one not be satisfied?
2 ways
- If directors assess on reasonable grounds that they consider the company has reasonable prospects of avoiding insolvency
- If company has not reached point of no return
It is only if directors know/ought reasonably to know they cannot avoid liquidation/administration can it be satisfied
How does limb two work?
The every step defence
I.e. to escape liability, what must the director show and when?
Director can escape iability if they satisfy the company that:
- After they first knew/ought to have concluded there was no reasonable prospect of company avoiding insolvent administration/liquidation (point of no return)
- They took every step with a view to minimising the potential loss to company’s creditors
What does ‘taking every step’ look like?
Examples
- Voicing concerns at board meetings
- Seeking independent financial and legal advice
- Ensuring adequate, up to date financial information
- Suggesting reduction in overheads/liabilities
- Not incurring further credit w someone who is not an existing creditor/increasing credit owed to existing creditor
- Taking advice on steps like initiating appropriate insolvency procedures/negotiating with creditors to restructure
What test is applied to both limbs?
I.e. when determining whether:
1. A liquidator/administrator has established a director ought to have concluded that there was no reasonable prospect of avoiding…
2. Whether director then took every step to minimise potential loss to creditors
The reasonably diligent person test
How does the reasonably diligent person test work?
The facts/conclusions/steps which director ought to have ascertained/reached/taken are those which would have been by a reasonably diligent person having both:
- General knowledge, skill and experience reasonably expected of person carrying out same functions as director (objective); and
- The actual knowledge, skill and experience of that particular director (subjective)
Court then applies higher of two standards
What should directors do to minimise the risk of a wrongful trading claim?
- Hold frequent BMs to review company’s financial position (and record minutes so director can rely on to prove limbs later on)
- Take professional advice ASAP (lawyers, insolvency practicioners, accountants)
- Make sure they have up to date financial information about state of company’s finances
Will resignation mean a director escapes liability?
No - resigning itself may be an act of wrongful trading
Should only resign if constantly out voted by other directors and unable to persuade change of course
What can the court order if a director is found to be liable for wrongful trading?
Such contribution to assets of the company as court thinks fit to increase assets for distribution to general body of unsecured creditors
* Can also make disqaulification order
What will contribution figure usually be based on?
The additional depletion of company’s assets caused by director’s conduct from point of no return
I.e. when directors should have concluded company could not avoid
How are contributions from each director apportioned?
Joint and severally or based on culpability