BLP - Voidable transactions and directors’ liability in insolvency

What is the liability of directors of an insolvent company?

Directors may be held personally liable to compensate the company and its creditors if found guilty of:

- Fraudulent trading

- Wrongful trading

What is fraudulent trading?

Where a business is carried on with intent to defraud creditors of the company

Who can bring a claim for fraudulent trading and for wrongful trading?

a liquidator or administrator of the company

Who can be subject to a fraudulent trading claim?

- Any person (usually directors, or banks)

- Who is knowingly party to carrying on business of the company

- With intent to defraud creditors or for any fraudulent purpose

Is fradulent trading a criminal offence or a tort?

Both

What is required to prove fraudulent trading?

1. Demonstrate director was actually dishonest, based on subjective state of knowledge

2. And show conduct was dishonest, applying objective standards of ordinary, decent people

Defrauding even one of the company's creditors will be sufficient

What are the remedies for fraudulent trading?

1. Court can order contribution to company's assets as it thinks proper

- should only compensate for loss caused to creditors

- recovered sums held on trust for unsecured creditors generally

2. Court likely to make disqualification order under CDDA 1986 - cannot be a director again

3. Criminal sanctions under s 993 CA 2006 (up to 10 years imprisonment and/or fines)

Why are claims for fraudulent trading rare?

a very high standard of proof is required for a successful claim in fraudulent trading

What is wrongful trading?

- liability for directors who fail to take every step possible to minimise the potential losses to the company's creditors when the company is about to go into insolvency

- civil, not criminal offence, unlike fraudulent trading

What is the purpose of wrongful trading provisions?

- To ensure directors take steps to minimise potential losses to creditors when insolvent liquidation/administration is inevitable

- courts can order directors to compensate for losses suffered by creditors due to their conduct

- introduced because fraudulent trading was too difficult to prove

Who can wrongful trading claims be brought against?

- Can be brought against any person who was a director at the relevant time, including shadow directors, de facto directors, and non-executive directors

- narrower scope than fraudulent trading

What are the requirements for wrongful trading liability? (Limb 1) (what insolvency test applies?)

1. Company has gone into insolvent liquidation or administration (balance sheet test applied)

2. At some point before this (the 'point of no return'), the director knew or ought to have concluded there was no reasonable prospect of avoiding insolvency

(no liability if this limb is not satisfied)

What are the requirements for wrongful trading liability? (Limb 2)

3. Director allowed company to continue trading after the 'point of no return'

4. Continued trading made the company's position worse

(no liability if the company has not reached the point of no return)

Does wrongful trading require evidence of intent or dishonesty?

No

Is wrongful trading a civil wrong or criminal offence?

just a civil wrong, not a criminal offence (unlike fraudulent trading)

What is the 'every step' defence in wrongful trading?

Directors can escape liability if they can prove they took every step to minimise potential loss to creditors after the 'point of no return'

What are examples of evidence for the every step defence?

- Voicing concerns at board meetings

- Seeking independent financial and legal advice

- Ensuring up-to-date financial information is available

- Suggesting reductions in overheads/liabilities

- Not incurring further credit

- Taking advice on insolvency procedures or negotiating with creditors

How is the 'reasonably diligent person' test applied in wrongful trading cases?

1. what a director ought to have known, concluded, or done, in relation to concluding whether there was no reasonable prospect of avoiding insolvency

2. also used in relation to whether D then took every step to minimise potential losses to creditors

What standard is applied when the court uses the 'reasonably diligent person' test? (objective/subjective)

- there is a minimum objective standard expected of all directors

- and then there may be a higher subjective level expected of an especially qualified director

What advice should be given to directors to minimise wrongful trading risk?

- Hold frequent board meetings and keep detailed minutes

- Seek professional advice promptly

- Maintain up-to-date financial information and act on it

- Resigning may not escape liability and could be an act of wrongful trading itself

What are the remedies for wrongful trading?

- Court can order directors to contribute to company assets, usually based on additional depletion of assets from the 'point of no return'

- Orders are compensatory, not penal

- but, court has discretion to apportion the amount to be paid by each director, based on their respective culpability

- Disqualification orders may also be made under CDDA 1986, to stop Ds from becoming directors again

Is relief available under s 1157 CA 2006 for wrongful trading?

- court may ordinarily relieve a director from liability in proceedings for negligence, breach of duty or breach of trust, on such terms as it thinks fit, if satisfied that they acted honestly and reasonably

- however, NO relief is available for wrongful trading

What is a claim for misfeasance?

- liquidator can bring a claim against a director for breach of any of their duties as a director

Who can bring a claim for misfeasance?

- a liquidator (but not an administrator)

- the Official Receiver

- any creditor

Who can a claim for misfeasance be brought against?

- current and former directors (inc. de facto directors)

- company secretaries (and former secretaries)

- liquidators or administrative receivers

What is the penalty for misfeasance?

may be ordered to compensate the company in respect of money or property misapplied as a result of the misfeasance.

Who bears the burden of proof for misfeasance?

Burden on the claimants to establish misfeasance on the part of the director or other defendant.

Is ratification of the director's breach of duty by the shareholders a defence to misfeasance?

- not possible if the company's fortunes have declined to such an extent that there is a reasonable prospect that the company will go into an insolvent liquidation or administration.

What are voidable transactions?

Transactions that took place within specified statutory periods prior to the insolvency of a company

- which can be challenged by a liquidator or administrator so they can clawback the money as if the transaction never happened

What are examples of voidable transactions?

- Transactions at an undervalue

- Transactions defrauding creditors

- Preferences

- Avoidance of Floating Charges

Which questions will a liquidator/administrator challenging voidable transactions need to ask?

- Did the transaction involve a 'connected person' or 'associate'?

- Did the transaction take place within the 'relevant time'?

- Was the company insolvent at the time of the transaction or did it become insolvent as a result of the transaction?

- Is there a presumption available which shifts the burden of proof from the liquidator/administrator to the other party?

What is the definition of insolvency, when assessing voidable transactions?

- insolvency = inability to pay debts, under either the cash flow or balance sheet basis (unlike for wrongful trading)

Who are connected persons? (1/3)

- directors (including shadow directors)

- associates of directors

- associates of the company

Who are associates of a director? (2/3)

spouses, business partners, employees, relatives including brother, sister, uncle, aunt, niece, nephew (widely defined)

Who are associates of a company? (3/3)

a company which is controlled by the same director

What are transactions at an undervalue (TUV)?

- a gift, or a transaction at significantly less than market value

What are the conditions for TUV?

a. Must occur within 2 years before the onset of insolvency (regardless of connected person or not)

b. Company was insolvent at the time or became insolvent as a result of the transaction

Can granting a security/paying a dividend be classed as TUV?

- caselaw has been uncertain

- but current position is that paying a dividend and granting a security can be TUVs

What is the definition of the onset of administration when assessing transactions at an undervalue?

date of filing of application (court procedure)

or notice of intention to appoint

or appointment (out-of-court procedure)

What is the definition of the onset of liquidation when assessing transactions at an undervalue?

date of resolution for members'/creditors' voluntary winding up/date of presentation of petition

What defence is available for transactions at an undervalue?

- Company acted in good faith, and had reasonable grounds for believing the transaction would benefit the company

e.g., company grants new security to stave of threat of bank to begin winding up proceedings if the security is not granted

What sanctions will the court impose for transactions at an undervalue?

- discretion to make such order as it thinks fit to restore the position as if the company had not entered into the transaction

eg making the other party pay the remaining value to make the price full market value

What is the effect of a transaction at an undervalue if the good has subsequently been sold?

- any court order should not affect a subsequent purchaser of the good transferred at an undervalue (eg they can keep the good)

- as long as they were acting 'in good faith and for value'

When will there be a rebuttable presumption that an acquisition of a good that is subject to TUV by a subsequent purchaser was not in good faith?

- if buyer had notice of the transaction at an undervalue or preference and of the relevant proceedings and went ahead with the purchase

- or if buyer was connected with or was an associate of either the company or the party which transacted at an undervalue with the company.

In such circumstances the burden of proof shifts to the subsequent purchaser to show good faith.

What is the presumption when a transaction at an undervalue is to a connected person?

- presumption that company was insolvent when transaction is to a connected person

- no need to for administrator to prove this, burden of proof will shift

What are transactions defrauding creditors?

- Transaction at an undervalue with intention to defraud creditors (one step further than regular TUV)

- No need for company to be insolvent for this to be found

What are the requirements for a transaction defrauding creditors?

1. there has been a transaction at an undervalue

AND

2. the intention or purpose of the transaction was to put assets beyond the reach of creditors of the company or otherwise prejudice their interests

- (includes the reach of future creditors who were unknown at the time of the transaction.)

Who can claim for transaction to defraud creditors?

- a liquidator or an administrator;

- a supervisor of a voluntary arrangement; or

- a victim of the transaction in question.

When must a claim for transaction to defraud creditors be brought?

- no 'relevant time' or period within which the transaction must have taken place (one benefit over TUV)

- but the more recent the transaction, the more likely it is that the applicant will be able to succeed

What orders can a judge make in response to transaction to defraud creditors?

court may make such order as it thinks fit to restore the position to what it would have been but for the transaction in question

What are preferences?

- Company puts a creditor in a better position than they would be in liquidation

What are the requirements for a preference?

- Must be influenced by a desire to prefer the creditor (subjective test)

- Must occur within 6 months before insolvency (or 2 years for connected persons)

- Company must be insolvent at the time or become insolvent as a result (cash flow or balance sheet)

Who can bring a claim for preference?

liquidator or administrator

What is the assumption if a preference is given to a connected person or associate?

- there is a rebuttable presumption that the company was influenced by the desire to prefer the creditor

- preferred person must then prove that the company was not influenced by a desire to prefer them.

What is the defence for preferences?

Absence of any desire to prefer

- eg if there is genuine commercial pressure, this can negate desire to prefer

- but still a preference if there is a mix of desire to prefer and commercial pressure, as that would be the requisite desire was still there

What sanctions can be applied for a preference?

- Court has discretion to restore the position as if the transaction had not occurred

- e.g., can order repayment of money or property to the liquidator/administrator

What is the avoidance of floating charges?

- Prevents creditor obtaining floating charge to secure existing debt without giving new consideration

- Applies in liquidation or administration

- Automatically makes certain floating charges invalid without need for administrator/liquidator to bring legal proceedings

When will floating charges be automatically invalid? (3 requirements)

1. Created within 12 months preceding insolvency (or 2 years for connected persons)

2. Company was insolvent at time of creation or became insolvent as a result (unless connected person, in which case company can be solvent)

3. No new money or fresh consideration provided

When will a new floating charge be valid?

- even if a floating charge is to a connected person or the company is insolvent, a floating charge will be valid if fresh consideration is provided in exchange for the charge

What will the new floating charge cover?

- there is existing debt, then a floating charge given without fresh consideration, and then fresh consideration is given afterwards

- the floating charge will only cover the amount of fresh consideration given, instead of the whole amount of the debt

Explanation of why new floating charges without consideration are invalid, to aid understanding:

- If the rules about invalidity of a new floating charge without consideration, did not apply, an unsecured creditor could improve its position in the order of priority

- However, if an existing unsecured creditor provides further credit to the company then that creditor is rightly entitled to have the protection of a valid floating charge.

What is the position regarding floating charges securing overdrafts?

a floating charge given to a bank to prevent them calling in an overdraft can be valid even if created just before insolvency

- Each use of overdraft after creation of charge deemed 'new money' advanced by the bank

- Payments into account applied to oldest advances

What is the effect of a floating charge being void?

the creditor can still claim the money they're owed, but they lose the special priority of the floating charge

Should a director in a company facing insolvency seek further lines of credit?

No, this would not be in the best interests of future creditors