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Insolvency Liability Of Directors And Voidable Transactions Notes

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Insolvency - Liability of directors

Fraudulent trading - s.213 Insolvency Act 1986

Purpose

Liable where there is an intent to defraud

Who may bring a claim?

The liquidator with sanction from the creditors or the court- s.213(2) IA 1986

Against whom can a claim be brought?

Against any person who is knowingly party to the carrying on of any business of the company with intent to defraud creditors or for any fraudulent purpose - s.213(1) IA 1986

Requirements for liability

You must prove actual dishonesty

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High standard of proof and very difficult for liquidator to establish

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Therefore wrongful trading claims are preferred against directors

Defence

Dishonesty is based subjectively (upon what the particular person knew or believed) not objectively

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Therefore even if directors were unrealistically believing the company could be saved, they would have this (sunshine) defence

Sanction

Civil

Can be ordered to make a contribution ot the company's assets, to the amount as the court thinks proper - s.213 IA 1986

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It should reflect and compensate for the loss caused to the creditors by the continuing of the company's trading

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Court may also make a disqualification order against a director under s.10 CDDA 1986

Criminal

Imprisonment of up to 10 years and / or fines can be imposed on a person knowingly party to fraudulent trading, whether or not the company is being wound up - s.993 CA 1986

Wrongful trading - s.214 IA 1986

Purpose

Where a director becomes aware that insolvent liquidation is inevitable, they do everything possible to minimise the potential losses to creditors

Who may bring a claim?

The liquidator with sanction from the creditors or the court- s.214(1) IA 1986

Against whom can a claim be brought?

Against a person who was, at the relevant time, a director, shadow director or non-executive director

Requirements for liability

Requirements

1) At some time prior to the winding up (the point of no return);

2) The director knew or ought to have concluded that;

3) There was no reasonable prospect that the company would avoid going into insolvent liquidation

Evidence where directors should have concluded no reasonable prospect

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Defence

Company accounts showing liabilities greater than assets Proceedings against company for unpaid sums Creditor pressure - Bank calling in or refusing to extent loans Failure to meet sales or cash flow targets / forecasts Collapse of a major customer or supplier Major change in the market

Requirements

Director can escape liability if after they first ought to have concluded there was no reasonable prospect of avoiding insolvent liquidation they took every step with a view to minimising the potential loss of the company's creditors

Evidence that is supportive of establishing the every step defence

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Voicing concerns at board meetings Seeking independent financial advice Suggesting reduction in overheads / liabilities Not incurring further credit Consulting an insolvency practitioner for advice

Insolvent liquidation is where a company's assets are insufficient for the payment of its liability and the expenses of winding up - s.214(6) IA 1986. It is judged on the 'balance sheet test' rather than the 'cash flow test' - s.123 IA 1986

Reasonably diligent person test - s.214(4) IA 1986

What is the test applied to?

1) Determines whether a director ought to have concluded that insolvent liquidation was unavoidable; and - s.214(2)

2) Whether the director then took every step to minimise the potential loss to the company's creditors - s.214(3)

Test

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The court will apply the higher of the two standards

1) The objective standard - The general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by the director in question - s.214(4)(a) IA 1986

2) The subjective test - The actual knowledge and experience of that particular director - s.214(4)(b) IA 1986

Evidence used when deciding which test to apply

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If a director is also a chartered accountant, using the subjective standard, a higher standard may be applied to her If a director has no skill as a director, the objective standard as the base minimum expected of a director, will be applied

Escaping liability by resigning

As liability is incurred when someone is a director at the relevant time, a director cannot escape liability by simply resigning - s.214(2) IA 1986

Sanction

Civil

Can be ordered to make a contribution to the company's assets, to the amount as the court thinks proper / fit

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It will reflect the additional depletion of the company's assets caused by the directors' conduct from the date he ought to have concluded insolvent liquidation could not be avoided

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The order will be made against the directors on a joint and several basis but the court can apportion culpability between the directors

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Court may also make a disqualification order against a director under s.10 CDDA 1986

Liability of directors for misfeasance - s.212 IA 1986

Purpose

Allows a breach of duty by the directors to be actionable, as well as by the company, by the liquidator.

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This does not create any new liability or rights, but provide a summary procedure available in liquidation for enforcing rights

Who may bring a claim? s.212(3) IA 1986

1) A liquidator; 2) An Official Receiver; 3) Any creditor or contributory

Against whom can a claim be brought?

1) Any person who is or has been an officer of the company; 2) Any person who acted in the promotion, formation or management of the company; and 3) A liquidator or administrative receiver

Requirements for liability

Requirements

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Any breach of director's duties including:

1) Misapplication of any money or assets of the company

2) Breach of statutory provision of a duty including a) Unlawful loans to a director b) Failure to disclose an arrangement between director and company c) Failure to get approval for a SPT d) A director failing to act within his powers

3) Directors responsible for transactions at an undervalue or preferences

4) Breach of duty of skill and care (negligence)

Shareholder ratification

When the company is solvent

Shareholders can effectively absolve the director from liability by ratifying the breach of duty at a general meeting

When the company is insolvent or on the brink of insolvency

The effectiveness of shareholder ratification is diminished and therefore they will struggle to ratify the breach of duty

Relief

Relief will only be given where the wrong has been done to the company and does not apply where claims against the director are brought by one of the creditors - s.1157 CA 2006

Sanction

Civil

Can be ordered to make a contribution to the company's assets, make an order for repayment or restoration of assets to the amount as the court thinks proper / fit

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Court may also make a disqualification order against a director under s.10 CDDA 1986

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