We Need A Presumption Of Insolvency For Company Records Failure – Don’t We?

The answer to the question We Need A Presumption Of Insolvency For Company Records Failure – Don’t We? is yes we do and therefore this would appear to need a change in the law to bring the UK more into line with Australian insolvency law.

This discussion is sparked following a review of the case of Hayes (liquidator), in the matter of Container Freight Services Pty Ltd (in liq) v Sinadinos [2024] FCA 885 (“Hayes”), flying in from the Federal Court of Australia on 9 August 2024.

It highlights a difference between the law in England and Wales from that of Australia when companies have not kept the requisite records and a presumption of insolvency arises when recovery proceedings are issued by a liquidator (Section 588E of the Corporations Act 2001).

Statutory Presumption Of Insolvency In Australia

In Australia when a company enters into a voidable transaction a failure to keep company records can trigger the presumption of insolvency. In the UK an absence of records does not trigger such a presumption. A liquidator in Australia will no doubt be assisted by this presumption.

The reason it is submitted by the writer that we may need a change in the law to adopt such a presumption is because at the moment the consequence of a failure to keep company records under Section 386 of the Companies Act 2006 is largely confined to the offence prescribed in Section 387 of the Companies Act 2006 and director disqualification proceedings. However, the argument could be made that the potential consequence of the Section 387 offence is insufficient relative to the harm that may be caused.

What Happened To Company Records In Hayes?

In the Hayes case, a liquidator challenged certain transactions entered into by the company directors.

A key issue on the insolvent trading claim was the point of insolvency which the liquidator was unable to address due to an absence of records. 

The Court noted the following:

Both defendants admitted in their public examinations that the Company’s physical books and records were thrown into a skip bin because they had nowhere to put them when the Company vacated its leased premises. At the same time both admitted in their public examinations that the Company had only ever retained limited physical records. Mr Sinadinos admitted that these were limited to run sheets or paperwork from customers or “stuff like that”, and no receipts for business expenses were kept. Ms Kalantzis admitted that the only paper records that had been retained by the Company before they were thrown into the skip were drivers’ run sheets and proof of delivery dockets.

The books and records of the Company that might have been maintained electronically on its Xero file did not extend beyond the documents identified at [81] above.

For the foregoing reasons, I am satisfied that the Company failed to maintain the books and records that would be expected to be maintained for a company in the position of the Company, for the whole of the period between the Incorporation Date and the Winding Up Date, and it thereby failed to keep or retain financial records as required by s 286 of the Corporations Act, and is therefore deemed to be insolvent pursuant to s 588E(4) of the Corporations Act for the whole of that period.

What Is The Purpose Of Company Records?

Company records are not just necessary to assist directors whilst they are trading; they are fundamental to enable a liquidator’s review once a company has gone into insolvent liquidation.

In the case of Re Firedart Ltd; Official Receiver v Fairall [1994] 2 BCLC 340 the judge explained this as follows:

Mr Ritchie, in his able submissions for the applicant, emphasised the failure to keep accounting records on the basis that, as this case shows, they are important both while a company is a going concern and in the event of liquidation. I accept that submission which accords with a passage I wrote in another context:

‘It is essential that officers of a company should ensure that a company maintains proper accounting records so that business decisions are made on reliable information and so that in the event of insolvency the administration of the winding up may be facilitated.’

(Buckley on the Companies Acts, Special Bulletin on the Companies Act 1989, p 10).

Potential Harm From Failure To Keep Company Records

The potential harm arising from a failure to keep company records is that an absence of company accounting records can severely hamper the winding up of a company and make it more costly for creditors. 

It can fetter a liquidator seeking to investigate and identify all routes to making asset recoveries. 

It may adversely affect a liquidator from being able to investigate particular transactions entered into by company directors which may conflict with the interests of the company, being in their favour with the effect resulting in reduced returns to creditors. Such extra costs might involve higher liquidation investigation costs or claims not being discovered in some cases at all.

Why should a director who fails to keep proper company books and records be able to have any advantage over a liquidator (who notably enters office as a stranger) in adversarial proceedings, when transactions favourable to the director but seemingly at the expense of the company are challenged? Why should such a director be able to suggest it is the liquidator who has to prove their case?

This appears completely contrary to the dictum in Toone & Anor v Robbins & Anor [2018] EWHC 569 (Ch) in which Mr Justice Norrice as he then was, said directors cannot be heard to say:

“We have received company money: but our record keeping is so bad that the basis upon which we received it is unclear. So by reason of our defaults we ask you to assume in our favour that we took the money lawfully”.

As a result, the burden is on the director to demonstrate that notwithstanding the absence of records, the transaction was a proper one.

The provision of proper and complete company records would of course in the alternative release the liquidator from the straitjacket of being that stranger.

Current State Of Insolvency Presumptions

In Australia, if company records have not been properly maintained the liquidator can look to potentially rely upon the statutory presumption of insolvency in certain recovery proceedings due to the records failure.

In the UK although there is an insolvency presumption in Section 240 (2) of the Insolvency Act 1986 in some scenarios (transactions at an undervalue and preference payments), this is not triggered by company records.

Advantages Of A Change In The Law

The advantages of having a change in the UK law to match the position in Section 588E of the Corporations Act 2001 would be:

• Added incentive for directors to keep company books and records.
• Additional options for a liquidator in pursuing recovery claims when being unable to prove the point of insolvency due to records keeping failures.
• Cheaper recovery proceedings for liquidators as applicants bringing recovery claims.
• Such an approach would codify and extend the adverse inferences that may be deduced from such director misconduct.
• Pursuit of wrongful trading claims in the UK is troublesome (see our article on how did wrongful trading go wrong) but being able to pinpoint the date of insolvency by reference to inadequate record keeping may give it a welcome boost.

Disadvantages Of A Change In The Law

The disadvantages of having a change in the UK law would be:

• Instead of focusing on proving the insolvency point as a necessary ingredient of recovery proceedings claims, attention might move disproportionately onto consideration of whether the records keeping had failed.
• A respondent in adversarial proceedings may have to prove their conduct was proper rather than adherence to the cardinal principle that it is the role of the applicant.
• The introduction of further statutory hypotheses such as presumptions may encourage unfairness in legal proceedings that may lead to risks of miscarriages of justice.

Conclusion On Changing The UK Law To Add A Statutory Presumption Of Insolvency For Company Records Failure

The matter of whether or not a change in the law should be made to add a statutory presumption of insolvency for directors who fail to keep company records is not an easy question. 

Statutory presumptions already exist in certain instances in the UK when antecedent transactions are challenged by a liquidator. However, statutory presumptions could facilitate the creation of facts that may leave a respondent vulnerable to unfairness at trial. 

Weighing up the arguments the writer’s view is that by the finest of whiskers, they appear to favour of a change in the law with more merit than doing nothing and leaving matters as they presently prevail. 

The key rationale for this suggestion is that insolvency recovery proceedings are plagued by the potential inequality of the liquidator entering office as a stranger. It is unrealistic for a liquidator to be able to investigate the point of insolvency without access to a proper set of records.

A director occupies a fiduciary position and as a result, cannot in such circumstances take advantage of their misconduct by failing to keep proper company accounting records without accepting the consequences that go beyond what might amount in many instances to a mere slap on the wrist. 

The general notion ‘he who claims must prove’ is an important safeguard in adversarial legal proceedings generally but once it can be shown a director has not kept relevant records the burden to prove solvency must slide seamlessly back to their door.