Funding Gap For Liquidation Investigations

Funding Gap For Liquidation Investigations

The funding gap for Liquidation investigations is the absence of assets to fund a review of the conduct of the Directors to consider if claims exist that could create more assets from which creditors might stand to benefit. The status quo is a potential Gordian knot, being a system whereby Liquidation investigations (save for the mandatory investigations) are in part reliant on funding from residual company assets or creditors.

There is perhaps something strangely ironic that cases devoid of any assets at all may even warrant more detailed investigations than those with assets, yet such absence will likely fetter the same.

Whilst there is an obligation on the Liquidator to investigate the company’s failure which will necessarily consider the conduct of the Directors, how can an investigation necessarily be guaranteed to be sufficiently thorough if there is no funding for it?

We have a system potentially open to abuse by Directors aware that a company drained of all its assets may not be in a position to fully investigate their conduct.

Why Is There A Need For Insolvency Investigations?

There is a need for insolvency investigations because insolvencies such as Liquidation are the result of an insolvent entity being unable to pay its debts when they fall due. Creditors go unpaid and suffer loss. As a result, they are entitled to know why they have suffered such a loss and if there is anything that can be done to remedy any Director misconduct that might have caused the same. 

However, a Limited liability company starts from the position that the company is a separate legal person from the individuals that control or own it. The liabilities of a company do not transfer onto Directors. Nevertheless, Directors who are in breach of duty can be required to compensate a company for losses they cause by virtue of Section 212 of the Insolvency Act 1986.

In many cases of Director misconduct in a Liquidation where there are no disclosed assets, the principal assets will be the legal consequences and claims flowing from that Director’s misconduct itself. It is unrealistic to expect that Director misconduct will be voluntarily disclosed by the Directors themselves (regardless of the duty to disclose it) so it is axiomatic it has to be investigated to be discovered. The problem is whether discovery will ever be made given Directors control the primary source of information that is the gateway to that discovery. Resistance to the disclosure of information will cause investigation costs to rise and therefore create a funding issue.

Even if there are no legal claims brought to recover money for creditors it is important any material misconduct is unearthed so that it can be used to bring Director Disqualification Proceedings and strip such a person for a period of time of the ability to trade using limited companies. It is important that misconduct is not permitted to run unchecked to deter others.

Statutory Duty To Investigate

A Liquidator has a statutory duty to realise the assets. The requirement to investigate is a duty not in any doubt and clearly to be inferred from the asset realisation duty.

It has been held that such a duty extends to:

Given there is a duty on these liquidators to get the money in, there was a duty to investigate what money could be got in. 

A & J Fabrications Ltd v Grant Thornton [1998] 2 BCLC 227

Regulatory Duty To Investigate

Statement of Insolvency Practice Number 2 requires the Liquidator to investigate. However, that does not mean an in-depth forensic investigation has to be undertaken in every case. 

The regulatory requirement appears to recognise the impact of funding and how it might hamper investigations:

In every case, an office holder should make an initial assessment as to whether there could be any matters that might lead to recoveries for the estate and what further investigations may be appropriate. 

An office holder should determine the extent of the investigations in the circumstances of each case, taking account of the public interest, potential recoveries, the funds likely to be available, either from within the estate and/or from other sources, to fund an investigation, and the costs involved.

Need For Funding Liquidation Investigations

The root of the problem is the so-called ‘nil asset’ cases, where there are no assets but substantial debts. These need to be investigated to uncover the basis for the discrepancy. 

Ordinarily, it ought to be anticipated that a case with substantial debts will be one which at one time had material assets against which some of the credit historically obtained was secured. However, a shortage of investigation funds can mean a less extensive investigation and consequently, the risk of serious wrongdoing going undetected. 

The arguable reluctant use of Wrongful Trading as a legal action due to its inherent difficulties means there might often not be much incentive for Directors to take insolvency advice at an early stage (as perhaps they should) and instead, they might continue to trade on until all the assets have been exhausted. This means that often there is nothing in the Liquidation to fund investigations. Indeed often Directors will personally have to pay for a Creditors Voluntary Liquidation themselves. 

It, therefore, follows that the investigation funding gap falls on the creditors to fill. However, the problem is insolvency is a class action meaning whatever is recovered is for the creditors as a whole after the costs and expenses of the insolvent estate have been discharged. 

Creditors inevitably will be wary about the risk of throwing good money after bad in the pursuit of investigations they might never benefit from. Investigations do not mean legal proceedings will be brought as their outcome is uncertain. Even if funding is found for an investigation and a claim is discovered there is the supplemental problem of funding the civil action.

The current status quo means the extent of investigations and issuance of recovery proceedings in cases where there are no disclosed assets is very much dependent upon the Insolvency Practitioner’s willingness to invest time and often money at their own personal risk. It would be perhaps unsurprising if indeed it is the case that few Insolvency Practitioners will go far above and beyond the legal and regulatory requirements in a case where there appear to be no assets to fund any of their investigation work and no creditors are willing to do so. 

What Is The Solution To The Funding Gap?

There is no easy solution but there are some small ways which could go a long way to improve upon the current position.

Any solution suggesting government funding is unrealistic. The government has attempted to make its own Insolvency Service self-funding; it is not likely to fund the private sector. 

However, a potential way to address disincentives to conduct more in-depth investigations might be alleviated if the risk and delays involved in bringing recovery proceedings were not so great when Directors seem to have unfairly rewarded themselves at the expense of creditors. 

The starting point is to remove the obstacles to an investigation that drives funding requirements. Before you can begin to investigate anything an information gathering phase is needed. It is perhaps ironic this can sometimes be as time consuming and even as expensive as the review of the information itself.

One of the biggest issues for any Liquidation investigation is accessing the books, records and bookkeeping files of a company. It is perhaps alarming that it can potentially be costly to assemble such documents that are plainly needed by any Liquidator looking to fully investigate and unpick a company’s financial affairs. The problem can be exacerbated by lengthy delays in looking to compel the production of such information through Court proceedings arising from applications under Section 234 of the Insolvency Act 1986 and Section 236 of the Insolvency Act 1986.

It ought to be taken into account that insolvency arises all too often from decisions taken by the Directors which have not worked out favourably for the company and therefore its creditors. Directors have a duty to help clear up the mess left behind, regardless of whether or not blame can be lodged at their specific door.

A Liquidator comes to the affairs of an insolvent company as a stranger and needs assistance from the Directors. If that is not provided then there should be swift and robust consequences.

This position could be improved if the requirement for Directors to keep proper books and records was readily and robustly penalised. Such barriers to the Liquidator’s ability to investigate could be removed enabling the process to be more cost effective and quicker.

Investigations need momentum. When they stop and start they risk dwindling.

In addition, changes to the costs regime in relation to adverse costs, when a Liquidator sues a Director who appears to have rewarded themselves at the expense of creditors and obstructed the information gathering phase of investigations, could focus not so much on winners and losers but instead on who has caused the litigation costs to escalate.