Corporate Insolvency – Directors Liability
Investigating Directors – to determine Director’s Personal liability.
Insolvency Act = built to protect creditors, particularly unsecured (as secured have their own protections)
Liquidator will look at period before insolvency to consider if: it can challenge transactions + if it can take
action against directors (who have contributed to financial problems of company.
EXAM = Company G is experiencing difficult trading conditions; provide advice to the directors of
Company G on their potential liabilities.
Fraudulent trading
S.213 = Winding Up
S.246ZA IA 1986 = Administration
Who can bring a claim + Against who?
The Liquidator (S.213) or Administrator (S.246ZA)
S.213(2) + S.246ZA(2) = Can seek a Court order against that any person who is knowingly party to the
carrying on of any business, must make contributions to the company’ assets.
Requirements: Dishonesty (also Directors Defence)
S.213(1) + S.246ZA(1) = If, in the course of winding up, it appears that any business of the company has
been carried on with intent to defraud creditors or for any fraudulent purpose by the Directors
S.213(1) = Must prove actual Dishonesty (subjective test).
A very high standard of proof is required = extremely difficult for a liquidator or an administrator to establish.
It is for this reason that claims for fraudulent trading are rare and claims for wrongful trading are more often
brought against directors.
Dishonesty is assessed on a subjective not objective basis i.e. what the particular person knew or believed.
Defence = Therefore, if the directors genuinely believed, however unrealistically, that ‘things would get better’
and the company would trade out of its difficulties, this would provide an effective defence – the “sunshine
defence”.
Purpose – Sanctions:
S.213 IA = If person found liable = Imposes a civil liability on Directors, who are ordered to contribute to the
funds available (companies’ assets), as the court thinks proper, to the general body of unsecured creditors
suffering loss, caused by the carrying on of the company’s business, with intent to defraud.
The court does not have the power to include a punitive element in the amount of any contribution to be
made.
The contribution should only reflect and compensate for the loss cause to the creditors.
S.993 CA 2006 = There are criminal sanctions – imprisonment up to 10 years and/ or fines.
S.10 CDDA = Disqualification of director up to 15 years + S.4 (fraud in a winding up)
Wrongful Trading
S.214 (Liquidation) + S.246ZB IA (Administration)
S. 214 and 246ZB = When directors become aware (or ought to become aware), that an insolvent
liquidation or administration is inevitable, they are under a duty to do everything possible to minimise the
potential losses to the company’s creditors.
No requirement to show intent or dishonesty – unlike fraudulent trading.
Who can bring a claim + Against who?
S.214(2)(a) + S.246ZB(2)(a) = Claim can be brought if Company goes into insolvent liquidation or
administration.
Liquidators = S.214(1) Or Administrators = S.246ZB(1) – make an application to the court.
S.214(7) IA = Claim against any person who was at the relevant time a director. This includes shadow
directors under S.251 CA 2006.
, Requirements to prove Liability
S.214(2)(b) + S.246ZB(2)(b) = At some point before the commencement of the winding up or insolvent
administration (‘the point of no return’)
1. STEP 1: The director (de facto, de jure and shadow – S.251 CA) = knew or ought to have concluded that
2. STEP 2: There was no reasonable prospect that the company would avoid going into insolvent liquidation
administration, and
S.214(6) = Insolvent liquidation for purposes of wrongful trading means, if the company were to go into
liquidation at a time when its assets were insufficient for the payment of its debts, other liabilities, and the
expenses of winding up
Insolvency is judged on the ‘balance sheet test’ (the value of Companies assets is less than the amount of
its liabilities): S.123(2) IA 1986
Not the cash-flow test (company is unable to pay its debts as they fall due): S.123(1)(e)
Exam = Determine what clients concerns are. If they are concerned with cash-flow test, then need more
information as to whether Company could be insolvent on the balance sheet test.
S.246ZB(6) = Insolvent Administration means if the Company were to enter administration at a time when its
assets were insufficient for the payment of its debts, other liabilities, and the expenses of administration
Warning Signs include
Companies accounts showing liabilities exceeding assets
Creditor pressure
Proceedings brought against company for unpaid sums
Failure to meet sales forecasts and targets.
Change in market
3. STEP 3: S.214(2)(c) + S.246ZB (2)(c) = That person was a director at the time of going into insolvent
liquidation or administration
4. STEP 4: S.214(3) + S.246ZB(3) = Director did not take every reasonable step to minimise loss to creditors.
(E.g. contact auditors, raise concerns with other Directors).
Defence = This could constitute a defence. Director could argue they took, from that time, ‘every step’
with a view to minimising potential loss to the companies’ creditors (see below).
A director cannot avoid liability by simply resigning, without previously taking every step to minimise
potential losses to creditors.
A director who disagrees with other directors should seek to persuade them. before resigning.
Reasonably Diligent Director
Reasonably diligent’ director test is used.
Court applies test in considering whether Director ought to have known (S.214(2)(b) + the steps that they
ought to have taken (S.214(3).
To establish that a director ought to have concluded that there was no reasonable prospect of avoiding
insolvent liquidation or administration.
Reasonably diligent person having both: S.214(4)(a)-(b) IA
The facts which a director ought to have known + conclusion which he ought to have reached, + steps he ought
to have taken are those which would have been taken by a reasonably diligent person having both:
a) Objective = The general knowledge, skill and experience that may reasonably be expected of a director
carrying out the same functions as are carried out by the director in question (usual director behaviour) –
E.g. that of a managing director.
b) Subjective = The actual knowledge, skill, and experience of that particular director – consider professional
background of the director
The court applies the higher of the two standards!
Investigating Directors – to determine Director’s Personal liability.
Insolvency Act = built to protect creditors, particularly unsecured (as secured have their own protections)
Liquidator will look at period before insolvency to consider if: it can challenge transactions + if it can take
action against directors (who have contributed to financial problems of company.
EXAM = Company G is experiencing difficult trading conditions; provide advice to the directors of
Company G on their potential liabilities.
Fraudulent trading
S.213 = Winding Up
S.246ZA IA 1986 = Administration
Who can bring a claim + Against who?
The Liquidator (S.213) or Administrator (S.246ZA)
S.213(2) + S.246ZA(2) = Can seek a Court order against that any person who is knowingly party to the
carrying on of any business, must make contributions to the company’ assets.
Requirements: Dishonesty (also Directors Defence)
S.213(1) + S.246ZA(1) = If, in the course of winding up, it appears that any business of the company has
been carried on with intent to defraud creditors or for any fraudulent purpose by the Directors
S.213(1) = Must prove actual Dishonesty (subjective test).
A very high standard of proof is required = extremely difficult for a liquidator or an administrator to establish.
It is for this reason that claims for fraudulent trading are rare and claims for wrongful trading are more often
brought against directors.
Dishonesty is assessed on a subjective not objective basis i.e. what the particular person knew or believed.
Defence = Therefore, if the directors genuinely believed, however unrealistically, that ‘things would get better’
and the company would trade out of its difficulties, this would provide an effective defence – the “sunshine
defence”.
Purpose – Sanctions:
S.213 IA = If person found liable = Imposes a civil liability on Directors, who are ordered to contribute to the
funds available (companies’ assets), as the court thinks proper, to the general body of unsecured creditors
suffering loss, caused by the carrying on of the company’s business, with intent to defraud.
The court does not have the power to include a punitive element in the amount of any contribution to be
made.
The contribution should only reflect and compensate for the loss cause to the creditors.
S.993 CA 2006 = There are criminal sanctions – imprisonment up to 10 years and/ or fines.
S.10 CDDA = Disqualification of director up to 15 years + S.4 (fraud in a winding up)
Wrongful Trading
S.214 (Liquidation) + S.246ZB IA (Administration)
S. 214 and 246ZB = When directors become aware (or ought to become aware), that an insolvent
liquidation or administration is inevitable, they are under a duty to do everything possible to minimise the
potential losses to the company’s creditors.
No requirement to show intent or dishonesty – unlike fraudulent trading.
Who can bring a claim + Against who?
S.214(2)(a) + S.246ZB(2)(a) = Claim can be brought if Company goes into insolvent liquidation or
administration.
Liquidators = S.214(1) Or Administrators = S.246ZB(1) – make an application to the court.
S.214(7) IA = Claim against any person who was at the relevant time a director. This includes shadow
directors under S.251 CA 2006.
, Requirements to prove Liability
S.214(2)(b) + S.246ZB(2)(b) = At some point before the commencement of the winding up or insolvent
administration (‘the point of no return’)
1. STEP 1: The director (de facto, de jure and shadow – S.251 CA) = knew or ought to have concluded that
2. STEP 2: There was no reasonable prospect that the company would avoid going into insolvent liquidation
administration, and
S.214(6) = Insolvent liquidation for purposes of wrongful trading means, if the company were to go into
liquidation at a time when its assets were insufficient for the payment of its debts, other liabilities, and the
expenses of winding up
Insolvency is judged on the ‘balance sheet test’ (the value of Companies assets is less than the amount of
its liabilities): S.123(2) IA 1986
Not the cash-flow test (company is unable to pay its debts as they fall due): S.123(1)(e)
Exam = Determine what clients concerns are. If they are concerned with cash-flow test, then need more
information as to whether Company could be insolvent on the balance sheet test.
S.246ZB(6) = Insolvent Administration means if the Company were to enter administration at a time when its
assets were insufficient for the payment of its debts, other liabilities, and the expenses of administration
Warning Signs include
Companies accounts showing liabilities exceeding assets
Creditor pressure
Proceedings brought against company for unpaid sums
Failure to meet sales forecasts and targets.
Change in market
3. STEP 3: S.214(2)(c) + S.246ZB (2)(c) = That person was a director at the time of going into insolvent
liquidation or administration
4. STEP 4: S.214(3) + S.246ZB(3) = Director did not take every reasonable step to minimise loss to creditors.
(E.g. contact auditors, raise concerns with other Directors).
Defence = This could constitute a defence. Director could argue they took, from that time, ‘every step’
with a view to minimising potential loss to the companies’ creditors (see below).
A director cannot avoid liability by simply resigning, without previously taking every step to minimise
potential losses to creditors.
A director who disagrees with other directors should seek to persuade them. before resigning.
Reasonably Diligent Director
Reasonably diligent’ director test is used.
Court applies test in considering whether Director ought to have known (S.214(2)(b) + the steps that they
ought to have taken (S.214(3).
To establish that a director ought to have concluded that there was no reasonable prospect of avoiding
insolvent liquidation or administration.
Reasonably diligent person having both: S.214(4)(a)-(b) IA
The facts which a director ought to have known + conclusion which he ought to have reached, + steps he ought
to have taken are those which would have been taken by a reasonably diligent person having both:
a) Objective = The general knowledge, skill and experience that may reasonably be expected of a director
carrying out the same functions as are carried out by the director in question (usual director behaviour) –
E.g. that of a managing director.
b) Subjective = The actual knowledge, skill, and experience of that particular director – consider professional
background of the director
The court applies the higher of the two standards!
