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The risks for a director of company liquidation are varied, ranging from reputation, future earning potential through to litigation.

What Are Risks For A Director Of Company Liquidation From Insolvency Practitioner Claims?

Risks For A Director Of Company Liquidation from Insolvency Practitioner claims is litigation capable of being brought by an Insolvency Practitioner to improve the potential returns to creditors.

What are the Different Types of Insolvency Practitioner Claims?

Insolvency Practitioner claims include the following:

There are transactions that arise by virtue of the insolvency. These are the Insolvency Practitioner Claims known as Antecedent Transactions such as Transactions at an: Undervalue and Preference which are transactions entered into prior to the insolvency that can be set aside by an Insolvency Practitioner in certain insolvency proceedings.

What is a Transaction at an Undervalue? Risks For A Director Of Company Liquidation

Transactions at an Undervalue are Insolvency Practitioner Claims that involve transactions within 2 years of the relevant insolvent date (in the case of bankruptcy that period can extend to 5 years) which appear to be for less than their money’s worth. Such transactions can be set aside by the officeholder of the insolvent estate for the benefit of creditors.

Typically such transactions will involve transfers of money or property to connected and or associated parties. The applicable statutory provisions are Section 238 of the Insolvency Act 1986 and Section 339 of the Insolvency Act 1986.

These are transactions within 2 years of the relevant insolvent date (in the case of bankruptcy that period can extend to 5 years) which appear to be for less than their money’s worth. Such transactions can be set aside by the officeholder of the insolvent estate for the benefit of creditors.

Typically such transactions will involve transfers of money or property to connected and or associated parties. The applicable statutory provisions are Section 238 of the Insolvency Act 1986 and Section 339 of the Insolvency Act 1986.

What is a Preference? Risks For A Director Of Company Liquidation

Preferences are Insolvency Practitioner Claims that involve transactions within 2 years of the relevant insolvent date which appear to have put someone in a better position than which they ought to have been and influenced by a desire to prefer them.

Such transactions can be set aside by the officeholder of the insolvent estate for the benefit of creditors if certain insolvency and other criteria are met. Typically such transactions will involve transfers of money or property to connected and or associated parties.

The applicable statutory provisions are Sections 239 of the Insolvency Act 1986 or Section 340 of the Insolvency Act 1986.

What is are Transactions Defrauding Creditors? Risks For A Director Of Company Liquidation

Transactions Defrauding Creditors are Insolvency Practitioner Claims that involve transactions that have no limitation period. These are transactions undertaken to put assets beyond the reach of creditors at an undervalue.

Such transactions can be set aside by the officeholder of the insolvent estate for the benefit of creditors if certain insolvency and other criteria are met. The applicable statutory provision is Section 423 of the Insolvency Act 1986.

What is Misfeasance? Risks For A Director Of Company Liquidation

Misfeasance and Breach of Duty or breach of trust can arise because Directors owe fiduciary duties to their companies. The duty is that amongst other things of loyalty, not to secretly profit and to act in good faith in the best interests of the company.

What happens if you are in breach of duty or trust?

If a director has misapplied or retained any property of the company then on an application to court as to that fact a director can be compelled to repay, restore or account for the money or property of the company and thereby contribute via payment of compensation towards the assets of the company for the loss and or damage caused.

The availability of a remedy to address misfesasance is set out in Section 212 of the Insolvency Act 1986. A claim under this section can be brought by a company in liquidation through its liquidator.

This can commonly arise where Directors personally have benefitted at the expense of their companies. In a misfeasance claim whereit is proved that a director is himself the recipient of a benefit from the company, the evidential burden is then on him to prove that the payment was proper as was set out in the case of Hellard & Anor (Liquidators of HLC Environmental Projects Ltd) v Carvalho [2013] EWHC 2876 (Ch).

“The underlying principle is that directors are not free to take action which puts at real (as opposed to remote) risk the creditors’ prospects of being paid, without first having considered their interests rather than those of the company and its shareholders. If, on the other hand, a company is going to be able to pay its creditors in any event, ex hypothesi there need be no such constraint on the directors. Exactly when the risk to creditors’ interests becomes real for these purposes will ultimately have to be judged on a case by case basis. Different verbal formulations may fit more comfortably with different factual circumstances.”

What is Wrongful Trading? Risks For A Director Of Company Liquidation

What is Wrongful Trading? Wrongful Trading is trading whilst insolvent without having reasonable prospect of avoiding insolvent liquidation. However, a Director is not necessarily liable for such loss caused if he or she took every step to minimise the loss.

Two things need to happen therefore for a Director to be liable to creditors upon a company going into insolvent liquidation in such circumstances: 1) there needs to be a loss to creditors after the date at which the wrongful trading commenced and 2) the loss suffered by creditors was not minimised.

In most cases the company in question is already insolvent at the point when the foreseability of insolvency is deemed inevitable but it need not be.

A company that is not insolvent can still inevitably go into liquidation. An example would be a change of market conditions that leads to a company having no future.

With that in mind it is not inconceivable that a solvent company could be the focus subsequently of a wrongful trading claim by a liquidator but it would be the exception rather than the rule.

Wrongful Trading or Insolvent Trading: Which is the Unlawful Act?

The short answer is Wrongful Trading is the unlawful act as set out in Section 214 of the Insolvency Act 1986. Insolvent Trading or trading whilst insolvent would be part of the evidence of an act of Wrongful Trading, however it is not necessarily an unlawful act. It depends upon the facts of the case.

So what is the difference between the two? There is no statutory recognition afforded to Insolvent Trading. Whilst undesirable in many instances it is not necessarily unlawful.

Wrongful Trading is an action that can only be undertaken by a person occupying the position of Director of a limited company.

That position of “Director” can be determined in a number of ways, being official (recognised at Companies House and in a company’s statutory register), de facto or shadow as set out in the Companies Act.

Wrongful trading is the act by Directors of a period of trading in which debts and liabilities are incurred and typically increase, whilst having no reasonable prospect of a company avoiding insolvent liquidation.

It is the action by Directors of accepting credit when it is highly unlikely that the same would be discharged due to the financial position of a company.

Wrongful Trading only applies to company Directors, whereas Insolvent Trading can be undertaken by individuals such as sole traders.

The Solvency Test

There are two tests for solvency defined in Section 123 of the Insolvency Act 1986, being:

1) are your assets exceeded by your liabilities; and

2) are you failing to discharge your debts as and when they fall due. If you satisfy either criteria then you are technically insolvent in accordance with the definition of the same in the legislation.

Are you insolvent? Check out the Oliver Elliot Solvency Calculator to find out.

What is Wrongful Trading Risk?

What is the risk? Well if you are accused by a liquidator of a company of Wrongful Trading then as Director you could be personally liable for the damage the company suffered during a period of Wrongful Trading – so do not do it!! If in any doubt take professional advice at the earliest possible opportunity.

Often such advice can be obtained without charge for an initial consultation with a Licensed Insolvency Practitioner.

What is Wrongful Trading Covid-19 Suspension?

Suspension of Wrongful Trading: Wrong Trade-off? The Government announced the suspension of the Wrongful Trading provisions with the following message on its website in a press release on 28 March 2020 – Regulations temporarily suspended to fast-track supplies of PPE to NHS staff and protect companies hit by COVID-19:

…temporarily suspending wrongful trading provisions retrospectively from 1 March 2020 for three months for company directors so they can keep their businesses going without the threat of personal liability

There appears little doubt that whether you support or dissent from the Government’s approach to tackling the Coronavirus that economic shockwaves are being felt. Just look at the High Street; the emptiness and absence of activity is there for all to witness when seeking to fill their shopping bag of essentials. Press reports are replete with suggestions that a substantial number of businesses will close which risks extending to a material proportion of the UK’s economy.

To address that position it appears the Government considers that suspension of Section 214 of the Insolvency Act 1986 (“Wrongful Trading”) will assist. Business Secretary Alok Sharma said:

Today’s measures will also reduce the burden on business, giving bosses much-needed breathing space to keep their workers employed and their companies going.

However, how will suspension of Wrongful Trading provide a breathing space? It sounds positive and a useful suspension to deploy but on closer inspection can it work as it appears to have been publicly promoted?

We are right to speculate about it because the Government was quick to make its seemingly opaque plans public but it seems arguably rather short on the specifics.

In short, it appears to be an unfashionable claim to bring. It is considered expensive, difficult, risky and very time-consuming. Insolvency literature is replete with reference to it and whilst the consequential publicly reported court cases do ascertain considerable prominence, they do not appear as voluminous or as routine as claims for antecedent transactions, misfeasance and unlawful dividends.

With that in mind, it is perhaps remarkable that the Government has sought to focus on it given the extent of its reach relative to other more widely litigated liquidator claims. It appears to me to be a public relations proposition given many Directors may be aware of the existence of wrongful trading but perhaps not so aware of the number of such claims issued.

What is Wrong with Wrongful Trading?

Wrongful Trading is not the same as obtaining credit by deception but a Director has a duty to creditors whilst promoting the company’s success. Section 172(3) of the Companies Act 2006 spells this out:

The duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company.

Section 172(3) of the Companies Act 2006

Obtaining credit by deception takes many forms such as Fraudulent Trading which is set out in Section 213 of the Insolvency Act 1986. But this is not Wrongful Trading.A distinction is that Wrongful Trading requires no finding of dishonesty but a reasonable Director in compliance with their Director Duties will not usually engage in such wrongful acts as Wrongful Trading.The general issue at large as to what is the ‘wrong’ or what is wrong with Wrongful Trading, was notably promulgated by the late Gabriel Moss QC in Insolvency Intelligence in 2017 in his article “No compensation for wrongful trading – where did it all go wrong?

… directors should be deterred from causing debtor companies to take on liabilities which they have no reasonable prospect of paying. If that occurs, then subject to the statutory criteria for liability, compensation should be available for creditors whose debts have been wrongfully incurred

What is Fraudulent Trading? Risks For A Director Of Company Liquidation

Fraudulent Trading is the intention of defrauding creditors. It is the action by a director of a company of carrying out its business with the discrete intention of defrauding its creditors.

If found to have acted in such a manner a director will be liable to contribute to the assets of the company as the court thinks fit as set out in Section 213 of the Insolvency Act 1986.

Fraudulent Trading also arises if trading is undertaken for a fraudulent purpose.

This is more serious than Wrongful Trading because generally there is an element of dishonesty shown.

Wrongful trading is a less serious and more common offence, which can lead to a custodial sentence, director disqualification and financial penalties.

Directors involved in a Creditors Voluntary Liquidation or a compulsory liquidation process are always questioned by the liquidator as he or she must conduct an investigation and send a report to the Secretary of State on director conduct leading up to the company’s insolvency.

If fraudulent trading is suspected, directors have acted deliberately to avoid payment of company liabilities by continuing to trade, accepting supplier credit or taking payment on credit from customers knowing that orders will be unfulfilled prior to liquidation. Selling company assets for “undervalue” or lower than their market value prior to the liquidation is also considered suspect by the liquidator.

What is an Unlawful Dividend? Risks For A Director Of Company Liquidation

Unlawful and illegal dividends by Directors are dividends that are declared at a point when the company does not have sufficient distributable reserves. The consequences of this for an insolvent company is that the Director will be unable to ratify the breach of duty and liable to repay the dividends back to the company.

A dividend must be declared with reference to relevant accounts. This is a mandatory requirement in the Companies Act 2006. A dividend cannot be an after thought i.e. something that is processed after the year end for accounting purposes to justify a Director’s receipt of company money. You must declare the dividend first and then you can draw it, not backdate it into the accounts after the year end to justify monies a Director has extracted during the year.

The perils of backdating dividends should not be underestimated.

Profits made by a limited company are distributed to shareholders through the declaration of dividends. Quite often, for example in the case of owner managed businesses, the directors and shareholders of the company are the same. In such businesses, directors might take a minimum salary and pay the rest of their remuneration by way of dividend.

For some time, this has been a tax-efficient means for directors to be remunerated. However, before a company is able to pay a dividend, two main criteria must be met: sufficient distributable reserves (profits) and the reference to the ‘relevant accounts’ referred to above.

If the two main criteria are met, the company then needs to comply with certain formalities before the dividend is paid.

If companies fail to comply with the above requirements, the dividend will be unlawful.

Sometimes unlawful dividends are paid to shareholders when the directors incorrectly determine what available profits the company may have. This could be due to a mixture of poor record keeping and inaccurate accounts.

Dividends may also be paid when the company is insolvent or it may become insolvent as a result of that payment. In the event of the company’s insolvency, recovery claims inevitably will be brought by the insolvency officeholder against the shareholders and the directors.

There are other Risks For A Director Of Company Liquidation from Insolvency Practitioner Claims but the above covers the most common ones.

Disclaimer: This page Risks For A Director Of Company Liquidation is not legal advice and no liability is accepted for any reliance placed upon the same.