The Need To Fund Insolvency Proceedings And Investigations

It is ironic that insolvency proceedings such as liquidation all too often sprout when all the readily available assets have been deployed trying to put off the day of destiny, leaving nothing to fund much needed detailed investigations to uncover the causes of demise and recover the fruits of any wrongdoing discovered.

Often directors do not make adequate provision for payment of placing a company into voluntary liquidation and end up instead paying that part of the liquidator’s bill themselves. They need not do so as it is a legitimate liability of the company under Rule 6.7 of the Insolvency (England and Wales) Rules 2016 for it to discharge the costs of the statement of affairs in a voluntary liquidation and in convening a decision procedure of creditors so they can vote on the appointment a liquidator.

This general problem of expecting an insolvent business to fund cases was highlighted by Tony Butcher’s comments to the House of Commons Business, Innovation and Skills Committee, reported in 2013:

Effectively, we have to recognise that the very nature of the Insolvency Service is that it is going to be unable to recover its costs, because it is dealing with insolvent businesses

Once all the assets are lost through trading none will remain to fund investigations and recovery of contested assets and claims. This is the dichotomy between enforcement of the insolvency corrective provisions designed to deter and root out misconduct and the ability to fund that work.

Absence Of Funds For Detailed Investigations

Insolvency necessarily means creditors are likely to suffer a loss and not get all of their money. Often they do not receive any of it.

This highlights the importance of a liquidator’s investigations. Creditors are entitled to know why they have suffered a loss.

In many instances, if they were aware the company was insolvent they likely would have ceased trading with it or taken security to protect them from losses. The least the insolvency regime can do is provide creditors with a detailed explanation.

However, that certainly does not come cheap. Detailed explanations will usually require detailed investigations. Detailed investigations unsurprisingly need money to fund them. Yet the funding available (leaving aside director disqualification and criminal proceedings) from the government for that is largely it seems nowhere to be seen.

Whilst a liquidator has a duty under Statement of Insolvency Practice Number 2 (“SIP 2”) to do an investigation that is proportionate to the facts of the case, SIP 2 itself recognises the problem of funding those investigations:

There may be circumstances where there are clearly insufficient funds to carry out a detailed investigation or to take action for the recovery of assets, and an office holder should consider whether it is appropriate to seek funding from creditors or others.

Plainly an absence of funds will hamper the ability of the liquidator to undertake detailed investigations. 

Lack Of Funding Risking An Abuse Of Process

This all could lead to an abuse of the insolvency regime.

A director instead of ceasing to trade when insolvent liquidation is coming around the corner, could deliberately continue to trade on until all value in the company had been extinguished, leaving nothing to fund the investigations. 

Why Are Insolvency Investigations Important?

Investigations are important not simply to explain to creditors why they may be facing a write off but also to obtain discovery of the truth of why the company has failed. This might uncover wrongdoing on the part of the directors. An absence of a detailed investigation due to a lack of funding could enable a rogue director to conceal their misfeasance and breaches of duty without even taking positive steps to do so.

However, there is a further dilemma. Suppose wrongdoing is discovered and there are good claims against the directors for example who could be sued to compensate the company for damage they caused. How are such claims themselves to be brought and funded?

So many companies that go into creditors voluntary liquidation (the most common type of corporate insolvency procedure) have few or no assets available at the date of liquidation. Aside from the basic SIP 2 investigation that must be undertaken, funding is likely to be needed from other sources to plug the gap. But where could this come from?

Alternative Sources Of Funding A Liquidator’s Investigations

Creditor funding can be requested but it is perhaps hopelessly unrealistic on a wide scale for creditors to be expected to fund investigations and legal proceedings. The common perception of creditors is that they risk throwing good money after bad. 

Litigation funding is a growing market with more funders entering the market but such funding is often expensive and targeted towards the running of claims rather than the liquidator’s investigations. Such claims are carefully targeted and many are not snapped up. Even when funding claims the returns provided to the litigation funder may materially reduce what could be left for creditors.

The liquidator could personally fund the investigations and any resulting litigation but there is no obligation for them to do so and it is perhaps unrealistic for this to be a solution to what is a widespread problem.

Government Funding Solution Needed For Insolvency Proceedings

The solution seems reasonably clear.

The government needs to be creative and step in to bridge the gap thereby enabling the detailed investigations to be paid for and for the claims to be brought so that the law can be properly deployed.

There is no sign this is remotely likely to happen and in fact the reverse is the case. It can be inferred that the government has not exactly flooded the coffers of the Insolvency Service, instead perhaps seemingly preferring it to be self funding where possible, even though this has been recognised as impractical as highlighted in the report dated 29 January 2013 by the House of Commons Business, Innovation and Skills Committee “The Insolvency Service Sixth Report of Session 2012–13“:

In 2009, our predecessor Committee raised concerns about the robustness of future funding arrangements for the Insolvency Service.

…

Funding for the Official Receiver Service relies on a fee-generated income model. It is clear from the evidence we received that this model is unreliable in the current economic climate. We recommend that the Insolvency Service work together with the Department for Business, Innovation and Skills to look at alternative funding models that are sustainable and not wholly reliant on unpredictable levels of casework and asset values.

Conclusion On The Need For A Funding Re-Think For Insolvency Proceedings

Without liquidation cases having sufficient funding it seems many options to recover money for creditors utilising the Insolvency Act 1986’s civil recovery claims of antecedent transactions, misfeasance and wrongful trading will continue to be lost. Wrongful trading has long been an action rarely brought – see our article on this point: How Did Wrongful Trading Go Wrong?.

What is the point of having such provisions in the legislation to arrest wrongdoing if they are not enforced?