Exam (elaborations)
LPC NOTES ON INSOLVENCY -DISTINCTION GRADE
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LPC NOTES ON INSOLVENCY -DISTINCTION GRADELPC NOTES ON INSOLVENCY -DISTINCTION GRADE
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LPC NOTES[INSOLVENCY]
(2019-2020)
, INSOLVENCY
Wrongful trading (s 214 of the IA 1986)
may be brought by a liquidator only after the company has gone insolvent.
If at some time before the winding up the director knew, or ought to have known, that there
was no reasonable prospect that the company would avoid insolvent liquidation, the director
may be found guilty of wrongful trading and have to make a contribution to the company’s
assets.
directors must therefore show some level of financial understanding and diligence, and take
advice if their company is in financial difficulties.
When looking at whether a director knew, or ought to have known, that the company could not
avoid insolvent liquidation, both subjective and objective tests are applied (IA 1986, s 214(4)).
That is:
(a) What did this particular director know?
(b) And what would a reasonable director have known in the circumstances?
Matters such as the size of the business, the director’s function (eg, a finance director is
expected to have a greater degree of competence on accountancy matters than other directors),
etc are looked at.
In practice, the liquidator seeks overwhelming evidence of insolvency about which any director
should have been aware. This might be evidence showing:
(a) insolvency on a balance sheet basis;
(b) creditor pressure;
(c) late filing of accounts;
(d) any qualification on the accounts by the auditors;
(e) the practice of paying the creditors only when they issue proceedings or statutory
demands; or
(f ) numerous judgments against the company.
Section 214(3) of the IA 1986 provides a defence.
This is that the director took every step with a view to minimising a potential loss to the
company’s creditors after he became aware that the company had no prospects of avoiding
insolvent liquidation.
Example - taking professional advice, both legal and accountancy, minimising further goods
taken on credit, rigorous collection of debts, and drawing up management accounts (possibly
daily) to establish the financial position of the company.
It does not usually include resigning.
If wrongful trading is established then a director may be ordered to make a personal
contribution for the loss that he has caused by his actions - compensatory rather than punitive.
Precautions that a director may wish to take to protect himself from an accusation of wrongful
trading include:
(a) keeping an accurate record of his own activities, including board meetings;
(b) being satisfied that the financial records kept are sufficient;
(c) seeking professional advice at the earliest sign of financial problems in the company;
(d) raising with the board financial concerns when these start to become evident; and
(e) possibly resigning (but he might be liable whether or not he remained on the board).
,Fraudulent trading (s 213 of the IA 1986)
not limited to directors but also applies to any persons knowingly party to such action (see IA
1986, s 213(2)).
fraudulent trading claim may only be brought by a liquidator of the company.
must be shown that the business of the company was carried on with intent to defraud creditors
- directors must have known that creditors would not be paid.
In practice, fraudulent trading actions are rare due to the difficulty of establishing intent, and are
only used against persons engaged in criminal conduct (see R v Nigel Garvey [2001].
If fraudulent trading is established, the directors may be made liable to make such personal
contribution to the company’s assets as a court thinks proper.
Bank of India v Christopher Morris [2005] held that s 213 of the IA 1986 attracted only civil
liability and was not a penal provision.
Thus, there was a liability under s 213 to pay ‘compensation’ in cases where the company which
traded fraudulently was being wound up.
The Court pointed out that criminal punishment for fraudulent trading was dealt with
separately, in what is now s 993 of the CA 2006.
Misfeasance (s 212 of the IA 1986)
any breach of any fiduciary or other duty of directors.
If misfeasance is established then, under s 212(3) of the 1986 Act, directors may be ordered to
repay any money or personally contribute to the assets of the company to compensate for
their misfeasance.
ED Games Ltd v Cipolletta [2009] the court upheld the liquidator’s claim under s 212 of the IA
1986 seeking a contribution to the company’s losses from a director of the company, which
owed £900,000 including a substantial VAT payment.
Whalley (Liquidator of MDA Investment Management Ltd) v Doney [2003] - the sole director of
an insolvent company was found liable for misfeasance under s 212 of the IA 1986.
He had sold the business just prior to liquidation, and part of the proceeds were channelled to
another of his companies. INSOLVENCY
Corporate Insolvency
WHEN IS A COMPANY INSOLVENT AND HOW IS THIS PROVED?
The test for insolvency is contained in the Insolvency Act 1986 (IA 1986), ss 122 and 123, and is
based on the company’s ability to pay its debts (IA 1986, s 122(1)(f )).
A company is deemed unable to pay its debts if:
(a) a creditor owed more than £750 has served a formal written demand on the company (a
‘statutory demand’), waited three weeks and has not been paid or come to an arrangement
with the company (IA 1986, s 123(1)(a));
(b) a creditor has obtained judgment against the company and attempted to execute the
judgment (by sending court officials to recover assets or cash from the company), and the
debt is still unsatisfied in full or in part (IA 1986, s 123(1)(b));
(c) it can be proved to the court that the company cannot pay its debts as they fall due -
‘cash flow test’ ) (IA 1986, s 123(1)(e));
, (d) it can be proved to the court that the company’s assets are less than its liabilities -
‘balance sheet test’ (IA 1986, s 123(2)).
What are the insolvent company’s options?
(a) to take steps to put the company into liquidation themselves;
(b) to talk to their creditors, to see if they will wait for payment or come to a compromise;
(c) to enter into a formal arrangement with their creditors, called a company voluntary
arrangement (CVA). This may be an arrangement to pay the creditors less, or for them to
wait longer to be paid. A CVA may allow the company to avoid liquidation;
(d) to appoint an administrator to take over the running of the company and, possibly, to
return it to solvent trading or sell it as a going concern.
What are the unpaid creditor’s options?
Unsecured creditor
(a) serve a statutory demand (IA 1986, s 123(1)(a)), wait three weeks and then present a
petition to the court to put the company into liquidation;
(b) sue the company, obtain judgment, attempt to execute the judgment (IA 1986, s 123
(1)(b)) and then present a petition to the court to put the company into liquidation;
(c) suggest a CVA;
(d) apply to court to put the company into administration.
Generally prefer (c) or (d), as it is likely to receive little or nothing if the company goes
into liquidation.
However, issue of statutory demand or commencement of court action may encourage
the debtor company to find the money to pay that particular creditor, rather than
another, if it possibly can, which may solve the problem for that creditor.
Secured creditor
As well as the options listed above, the secured creditor may have the following
additional options, depending on the type of security it has:
(a) to appoint an administrator out of court;
(b) to appoint an LPA receiver;
(c) if security created before 15 September 2003, appoint administrative receiver.
WHAT IS LIQUIDATION?
The basic steps are:
(a) liquidation proceedings are commenced;
(b) a liquidator is appointed;
(c) the liquidator collects the company’s assets and may review past transactions;
(d) the liquidator distributes the assets in the statutory order to the creditors; and
(e) the company is dissolved.
There are three types of liquidation:
(a) compulsory liquidation (CL) – commenced against an insolvent company by a third party;
(b) creditors’ voluntary liquidation (CVL) – commenced by an insolvent company, usually in
response to creditor pressure; and
(c) members’ voluntary liquidation (MVL) – commenced by a solvent company that wishes
to cease trading.
Compulsory liquidation
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