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Business Law and Practice (V) > Voidable transactions and directors' liability in insolvency > Flashcards

Voidable transactions and directors' liability in insolvency Flashcards

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1
Q

What 2 types of trading can directors be held personally liable to compensate creditors/company for if they are found guilty of?

A
  • Fraudulent trading
  • Wrongful trading
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2
Q

In the event of wrongful or fraudulent trading, will liquidators have the power to bring proceedings for compensation against the company?

A

No - against directors personally

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3
Q

What do the provisions of fraudulent trading seek to prevent?

A

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

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4
Q

Who can make a claim for fraudulent trading and how?

A

Liquidator or administrator on application to court

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5
Q

Can a claim for fraudulent trading only be brought against directors?

A

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

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6
Q

What are the 2 requirements to bring a claim of fraudulent trading against ‘any person’?

A
  1. Person is knowingly party to the carrying on of any business of the company
  2. With intent to defraud creditors/for any fraudulent purpose
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7
Q

What must be proven to show intent to defraud?

A

Actual dishonesty

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8
Q

On what basis is actual dishonesty assessed and what does is mean for ‘blind-eye knowledge’ to be included?

A
  • 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
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9
Q

What is the two stage test for proving actual dishonesty?

A

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

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10
Q

Is it necessary to show that all company creditors have been defrauded?

A

No - provided at least one creditor has been defrauded it is enough to bring a claim

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11
Q

What can a person be ordered to do should they be found liable for fraudulent trading?

A

Make such contribution to the company’s assets as the court thinks proper

No punitive element; reflects and compensates loss

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12
Q

Are recovered sums held for the defrauded creditor?

A

No - for unsecured creditors generally

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13
Q

What other sanctions may be imposed on somone found liable of fraudulent trading?

A
  • Disqualification order if they are a director
  • Criminal sanctions (whether or not company being wound up)

Can be imprisonment of up to 10 years

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14
Q

Is fraudulent trading used as much as wrongful trading?

A

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)

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15
Q

What duty does the rules on wrongful trading impose on director in the event of insolvency?

A

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

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16
Q

Is there requirement to show intent/dishonesty for wrongful trading (as with fraudulent trading)?

A

No - easier to prove

Also no criminal sanctions

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17
Q

What does wrongful trading a) impose on directors and b) mark an exception to?

A

a) Personal liability
b) Exception to principle of limited liability (those who run a company can be liable for its unpaid debts)

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18
Q

Who can bring a claim for wrongful trading and against who?

A
  • 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

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19
Q

How broad is the scope of ‘director’ re who a claim can be brought against?

A

Includes shadow, de-facto, non-executive, and executive directors who were a director at the relevant time

Broad!

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20
Q

What are the two limbs (requirements) that must be satisfied for a director to be liable for wrongful trading?

A
  1. The point of no return
  2. Every step defence
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21
Q

How does limb one work?

The point of no return

A

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

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22
Q

When is a company insolvent for the purposes of wrongful trading?

A

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

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23
Q

When will limb one not be satisfied?

2 ways

A
  1. If directors assess on reasonable grounds that they consider the company has reasonable prospects of avoiding insolvency
  2. 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

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24
Q

How does limb two work?

The every step defence

I.e. to escape liability, what must the director show and when?

A

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
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25
Q

What does ‘taking every step’ look like?

Examples

A
  • 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
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26
Q

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

A

The reasonably diligent person test

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27
Q

How does the reasonably diligent person test work?

A

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

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28
Q

What should directors do to minimise the risk of a wrongful trading claim?

A
  1. Hold frequent BMs to review company’s financial position (and record minutes so director can rely on to prove limbs later on)
  2. Take professional advice ASAP (lawyers, insolvency practicioners, accountants)
  3. Make sure they have up to date financial information about state of company’s finances
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29
Q

Will resignation mean a director escapes liability?

A

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

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30
Q

What can the court order if a director is found to be liable for wrongful trading?

A

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

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31
Q

What will contribution figure usually be based on?

A

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

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32
Q

How are contributions from each director apportioned?

A

Joint and severally or based on culpability

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33
Q

When is relief under s1157 - where director has acted honestly and reasonably and director ought fairly to be excused - available for wrongful trading?

A

It is not

34
Q

What are voidable transactions?

A

Transactions that took place in the specified period prior to insolvency of a company which the liquidator/administrator has the power to challenge

35
Q

What is the aim of the challenge, and why are provisions often described as ‘clawback’?

A
  • Aim is to restore company to position it would be in had transaction not taken place (increase funds available)
  • Clawback = can result in order reversing transactions/providing financial restitution to be paid
36
Q

Where directors are targets for fraudulent and wrongful trading, who are the targets of voidable transactions?

A

The counterparty to the transaction with insolvent company

37
Q

What are connected persons and associates?

A
  • Connected persons = directors, associates of directors/company
  • Associates = spouses, business partners, employees, relatives, certain Ts, related company etc.
38
Q

What date is the onset of insolvency?

A
  1. Administration
    1a. Court procedure = date of filing application or NOI to appoint
    1b. Out-of-court procedure = date of appointment
  2. Liquidation = date of commencement of winding up
    2a. MVL/CVL = date of resolution for winding up
    2b. Compulsory = date of presentation of petition
39
Q

What are the voidable transactions?

A
  1. Transactions at an undervalue (TUV)
  2. Transactions defrauding creditors (TDC)
  3. Preferences
  4. Avoidance of floating charges
40
Q

What is the test for insolvency for voidable transactions?

A

Cash flow or balance sheet

41
Q

What is a transaction at an undervalue?

A
  1. A gift
  2. Transaction for consideration which is significantly less in value than consideration provided by company (in money or money’s worth)
  3. Granting of security/payment of dividend in some situations (law uncertain for both)

i.e. inequality of exchange adverse to company

E.g. company sells asset worth £100k for £50k

42
Q

Fo a TUV be avoided, what 3 things must be proved?

A
  1. Company made gift/transaction for consideration the value of which in money(‘s worth) is significantly less than consideration provided by company
  2. It took place in the relevant time
  3. It is proved (by applicant) that company was insolvent at the time of the transaction/became so as a result
43
Q

What is the relevant time for a TUV?

A

Two years ending with onset of insolvency

44
Q

When is insolvency presumed for a TUV?

A

Where TUV entered into with a person connected to company

Unless person proves otherwise; that company solvent at relevant time

45
Q

What is the defence to a TUV?

Even if all requirements satisfied

2 conditions - made in + what for

A

If court is satisfied that:

  1. Company entered into transaction in good faith and for purpose of carrying on business; and
  2. At the time there were reasonable grounds for believing that transaction would benefit company

E.g. a company grants new security to stave off a genuine threat made by an unsecured bank to terminate facilities and begin winding up proceedings if the security is not granted, in circumstances where the directors consider on reasonable grounds that the company can turn around its financial difficulties and thereby avoid entering into an insolvency procedure.

46
Q

What sanctions can the court impose generally for a TUV, and what is the most common?

A
  • An order as it thinks fit to restore position as if company had not entered into transaction
  • Most common: counterparty to pay amount of undervalue the company sustained under transaction

(e.g. 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)

47
Q

When will a court not prejudce a subsequent purchaser from the counterparty of a TUV?

Also applies to preferences

A

Will not prejudice the subsequent purchaser provided they were acting in good faith and for value

48
Q

When will there be a rebuttable presumption that susbequent purchaser was not acting in good faith?

2 circumstances

A

Where subsequent purchaser either:

  1. Had notice of relevant surrounding circumstances/proceedings
  2. Was connected with/was an associate of company or the party which transacted at undervalue

Burden shifts to subsequent purchaser to show good faith

49
Q

For transactions defrauding creditors (TDC), does the company have to be solvent or insolvent?

A

Does not matter - TDC claims don’t necessarily relate to insolvency

50
Q

What are the 2 requirements for a TDC claim?

A
  1. There has been a transaction at an undervalue
  2. The intention/purpose of transaction was to put assets beyond reach of creditors or otherwise prejudice their interests
51
Q

What can ‘creditors’ in ‘beyond reach of creditors’ mean in TDC?

A

Future creditors who were unknown at time of transaction

52
Q

What is easier for a liquidator/administrator to bring out of a TUV and TDC?

A

A TUV - this does not require liquidator/administrator to prove that purpose of transaction was to put assets beyond reach of creditors

53
Q

Who can make an application to set aside TDC?

A
  • Liquidator/administrator
  • Supervisor of voluntary arrangement
  • Victim of transaction in question
54
Q

What is the relevant period for a TDC?

A

No relevant period - but likely to be easier to show necessary intent for more recent transaction

Advantage over TUV - TDC claims can be brought re transaction from anytime in past

55
Q

What order would a court make for a TDC?

A

An order as it thinks fit to restore position to what it would have been but for transaction in question

56
Q

What is the purpose of provisions for preferences by a company?

A

To prevent creditor obtaining improper advantage over creditors of company at time when company insolvent

57
Q

Who can bring a claim for preferences by a company?

A

Liquidator/administrator

58
Q

When does a company give a preference?

A

The company does/allows to be done anything which has effect of putting a person, who is a creditor of the company (surety/guarantor) in a better position in event of company going into insolvent liquidation than they otherwise would have been

E.g. paying an unsecured creditor in priority to other creditors or granting security to an unsecured creditor

59
Q

When can a preference be avoided?

3 conditions

When, what was company, influenced by…

A
  1. If given within relevant time
  2. If proved company was insolvent at the time of transaction or became so as a result
  3. It is proved that company was influenced by desire to prefer the creditor
60
Q

What is the relevant time for a preference and when/how long will it be extended?

A

6 months ending with the ‘onset of insolvency’
* Extended to 2 years for preferences to connected persons and associates

61
Q

What presumption operates re insolvency where preference is given to a person connected to company?

As with TUV

A

None!

62
Q

What is the test for proving that company was influenced by desire to prefer creditor?

A

Subjective - company must have positively wished to put party in a better position

63
Q

What presumption operates re ‘influenced by desire’ where preference is given to a connected person/associate?

A

Rebuttable presumption that company was influenced by desire to prefer creditor

Burden shifts to the preferred who must prove company was not influenced

64
Q

E

For the defence available for preferences, what must there be an absence/alternate desire of?

something…

A

An absence of the desire to prefer (but rather desire to continue trading and avoid calling in of overdraft [Re MC Bacon])

E.g. where security granted as a result of genuine commercial pressure exerted by lender which negated any desire on debtor’s part to prefer them

65
Q

Will a mixed desire operate as a defence?

E.g. avoid calling in overdraft and positive desire to prefer bank

A

No - necessary desire present even if desire from pressure had been stronger than culpable desire

66
Q

What order can a court make for a preference and what is the most common?

A
  • An order to restore position as if company had not given preference
  • Preferred creditor to pay liquidator/administrator the money it received from company (if unsecured creditor paid ahead of others)
67
Q

For what transactions will orders be made to restore the company to the position it would have been in but for the transaction?

A
  1. TUV
  2. TDC
  3. Preferences
68
Q

What is the purpose of avoidance of certain floating charges?

A

To prevent creditor obtaining floating charge to secure existing debt for no new consideration

69
Q

Is the avoidance of floating charges available outside a liquidation/administration?

A

No

70
Q

How can office-holder challenge floating charges?

A

Happens automatically without the need to challenge via legal proceedings

Proceedings may be necessary if charge holder challenges office-holder

71
Q

What makes a floating charge invalid?

2 conditions

When + what was company

A
  1. Floating charge must have been created in the relevant time
  2. Must be proved company was insolvent at time of charge’s creation or became insolvent as a consequence of the transaction under which charge was granted
72
Q

What is the relevant time period for avoiding floating charges? When will this be extended?

A

12 months preceding onset of insolvency
* Extended to 2 years where floating charge granted to connected person

73
Q

When will there be no requirement to prove insolvency for a floating charge?

A

Where floating charge is granted to a connected person/associate

74
Q

When will new floating charges be valid (and so will actually afford protection to creditor)?

Even if made in relevant time and proved company was insolvent

A

To the extent that new money/other fresh consideration is provided to company in return for grant of floating charge on/after its creation

Instead of granted over existing monies owed

I.e. 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.

75
Q

Example of when floating charge would be invalid

A

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 = floating charge void
* If s245 did not apply, such an unsecured creditor would thereby improve its position in the order of priority if the company later went into an insolvency procedure, which would be unfair on the company’s other unsecured creditors.

If further credit provided, creditor entitled to have proection of valid floating charge

76
Q

What are the rules on granting a floating charge to secure an existing overdraft?

A

Rules are:

1) Each time company uses overdraft facility after creation of floating charge, this is considered new money advanced by bank
2) Payments into a bank account is first applied in discharging the oldest advances made by bank (FIFO) - effect of this = if paid up everything that was owed when charge was granted, the ‘pre-charge debt’ will be paid off and that everything after this is ‘new debt’ (the amount floating charge valid for)

Rules co-exist

Basically: when the company uses the overdraft, this will be the new money - when the company pays back the overdraft it will be the old money (FIFO) -

Re Yeovil Glove Co - company granted a floating charge to its bank to secure an existing unsecured overdraft, as a condition of the bank not calling in the overdraft, at a time when it was insolvent.
The company owed £67,000 under the overdraft at the time the floating charge was created. The company went into liquidation a few months later.
The court held that the floating charge was valid because
1. Each time the company used its overdraft facility after the creation of the floating charge, this was deemed to be ‘new money’ advanced by the bank
2. Payments into a bank account by the company is first applied in discharging the oldest advances made by the bank (FIFO) - as the company had paid more than £67,000 into the account since the grant of the floating charge, it could be said that the pre-charge debt of £67,000 had been paid off and that the existing overdraft balance at the time of appointment of the liquidator was ‘new’ debt.

77
Q

Example of rules in action

A

£15,000 = new money so valid charge over this

78
Q

Where a floating charge is void, is both the security and debt itself void?

A

No - only the security is void; debt not

Floating charge also void if not duly registered with CH

79
Q

What else might a floating charge granted to a creditor be?

A

Voidable as a TUV or preference

80
Q

What presumptions operate for:

  • TUV
  • Preferences
  • Floating charges
A
  • TUV = insolvency presumed if TUV entered into with person connected to the company
  • Preferences = influenced by desire to prefer creditor presumed if preference given to connected person/associate
  • Floating charges = insolvency presumed if floating charge granted to connected person/associate

Insolvency is not presumed for preferences where given to connected person

81
Q

What are the relevant periods for:

  • TUV
  • TDC
  • Preferences
  • Floating charges

And when will they be extended?

A
  • TUV = 2 years
  • TDC = none (but recent better)
  • Preferences = 6 months (2 years if conected person)
  • Floating charges = 12 months (2 years if connected person)

Business Law and Practice (V) (13 decks)

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