First instance judgment
In a detailed and comprehensive judgment Registrar Jones reviewed the existing authorities and law relating to wrongful trading. He held that there were three principle conditions to a finding of wrongful trading: [4]
- the company must have gone into liquidation with insufficient assets to meets the claims of its creditors and the costs of winding-up (the "insolvency condition")
- at some time before the commencement of winding-up the directors knew or ought to have concluded that there was no prospect of avoiding insolvent liquidation (the "knowledge condition")
- the director (which includes a "shadow director") failed to take "every step" to minimise loss to the company's creditors (the "minimising loss defence").
Burden of proof
The court held that the burden of proof was on the liquidator to establish (a) the insolvency condition and (b) the knowledge condition. But having established that, the burden of proof then switched to the directors to establish the minimising loss defence, if applicable. The court rejected academic sources which suggested that the burden of proof was also on the liquidators to disprove the defence, and followed the High Court decision of Ms Lesley Anderson QC in Re Idessa (UK) Ltd [2011] EWHC 804(Ch) , [2012] BCC 315 at [113].
The court also followed Re Idessa in holding that "every step" was a stricter test than "every reasonable step", which Parliament had impliedly rejected.
Date of knowledge
The court further held that the liquidators only need prove that the directors knew insolvent litigation was unavoidable prior to the commencement of winding-up. It was not necessary to prove that they had this knowledge on any particular date (following Re Continental Assurance Co of London plc [2001] BPIR 733). However the directors did have a right to know the case that they had to meet, and so the liquidators would not be able to claim a different date period at trial to the one identified in pleadings and evidence in support.
Applying the tests
The liquidators had to establishing insolvency on the balance of probabilities. It was sufficient to show that there was insufficiency of assets and that the company would inevitably run out of assets under the "Eurosail test" ( BNY Corporate Trustees Services Ltd v Eurosail-UK 2007-3BL plc [2013] UKSC 28). Accordingly, it was not necessary for the company to actually be insolvent at the time - merely that future insolvency was inevitable.
However there was no general prohibition on companies trading whilst they were insolvent if they legitimately believed that they could trade at a profit and thereby minimise loss to creditors. The law must leave room for cases where directors genuinely thought they could trade out of their difficulties, even if they turned out to be wrong.
The court also confirmed that it must be careful not to approach the knowledge condition with the benefit of hindsight. Directors would often be faced with decisions to which there was no obvious right or wrong answer. But the policy behind section 214 of the Insolvency Act 1986 was against "conduct ranging from the irresponsible to the unreasonable". This might be positive conduct, but it might also be directors wilfully shutting their eyes.
Standard of conduct
The conduct of the directors was to be tested against the general level of knowledge, skill and experience reasonably expected of a director.
Minimising loss defence
What would constitute taking "every step" to minimise loss to creditors would depend upon the facts of each case. But the court identified a number of factors to be considered: [5]
- whether the directors ensured that the accounting records were kept up to date, particularly budget and cash-flow forecasts
- preparing business plans and business reviews which included steps to minimise losses (ie. cutting costs)
- keeping creditors informed and seeking agreements to address debt and supply
- regular monitoring of trade and financial positions, both informally and at board meetings
- asking and assessing if losses were being minimised
- ensuring adequate capitalisation
- obtaining professional legal and financial advice
- considering alternative insolvency and restructuring remedies
Application
The court held that its jurisdiction in relation to an application under section 214 was not fettered. The compensation to be awarded was designed to recoup losses to the company caused by the wrongful trading. The maximum award would therefore normally be the amount by which the company's assets had been depleted in consequence of the wrongful trading. However although the law did not impose a specific test for causation, there must be more than a "but for" nexus between the wrongful trading and the depletion. Allowance must be given for losses that were not caused by the directors' actions. [6]
The assessment should be based upon bridging the gap between what the position would have been if the company had been put into a hypothetical liquidation at the last point when it was reasonable to do so, against the actual position. Where there were two or more defendants who are shared culpability, that award would be joint and several.
The court held on the facts of the case, there were no grounds for making any separate award for misfeasance. [7]
Most commentators responded positively to the decision, noting the clarity with which it set out the relevant constituent elements of liability, and provided important clarification of the issues relating to burden of proof. [8]
Appeal
Upon appeal the decision was reversed in part by David Foxton QC, sitting as a Deputy High Court judge. [3]
He held that notwithstanding the missing financial information, it was nevertheless possible for the court to perform "increase in net deficiency" calculations. In this case the liquidators had been able to do so, although Registrar Jones had felt their calculations were deficient. In this case the facts were distinguishable from Re Purpoint and Re Kudos Business Solutions as the directors had not failed to keep records, but simply that certain records had not been collected by the liquidators (the liquidators argued that the directors had breached their duty to produce the company’s papers and were responsible for their absence, but no finding of fact was made in that regard).
Foxton QC held that the tribunal below had applied the correct test when assessing Mr Armstrong's conduct, and that it was entitled to take into account those matters in assessing the director's knowledge as at October 2006.
He noted that challenges to the company's supposed profitability were not raised at trial, and there was no certainty that if changes had had to be made to the VAT scheme that this would have precluded the company from continuing to operate profitably.
The court was satisfied that there was no inconsistency between finding that the assets of the company would have fetched little (or possibly nothing) upon a sale in liquidation, but that the assets could still continue to generate positive cash flow within the business as a going concern. It was noteworthy that the negative effects of asset depreciation had already occurred by 31 January 2007, and this was not worsened through continued use.
The honesty of the directors was one of a number of factors which the Registrar referred to, and he was entitled to consider those as part of his balancing exercise when assessing compensation.
The deputy judge was persuaded that the Registrar had erred in trying to apply an analysis which had not in fact been advanced by either litigant, and which had not been the subject of counsels' submissions at trial. The parties would have been entitled to raise legitimate objections to this approach, either on the basis that there was not sufficient evidence on key issues, or alternatively, if that analysis was followed through to a proper conclusion then there would arguably have been no compensation payable.
Liquidation is the process in accounting by which a company is brought to an end in Canada, United Kingdom, United States, Ireland, Australia, New Zealand, Italy, and many other countries. The assets and property of the company are redistributed. Liquidation is also sometimes referred to as winding-up or dissolution, although dissolution technically refers to the last stage of liquidation. The process of liquidation also arises when customs, an authority or agency in a country responsible for collecting and safeguarding customs duties, determines the final computation or ascertainment of the duties or drawback accruing on an entry.
A number of legal systems make provision for companies trading while insolvent to be unlawful in certain circumstances, and provide for directors to become personally liable for a company's debts if they have acted improperly. In most legal systems, the liability in respect of unlawful transactions only extends for a certain period of time prior to the company going into liquidation.
Wrongful trading is a type of civil wrong found in UK insolvency law, under Section 214 Insolvency Act 1986. It was introduced to enable contributions to be obtained for the benefit of creditors from those responsible for mismanagement of the insolvent company. Under Australian insolvency law the equivalent concept is called "insolvent trading".
In company law, fraudulent trading is doing business with intent to defraud creditors.
In law, a liquidator is the officer appointed when a company goes into winding-up or liquidation who has responsibility for collecting in all of the assets under such circumstances of the company and settling all claims against the company before putting the company into dissolution. Liquidator is a person officially appointed to 'liquidate' a company or firm. Their duty is to ascertain and settle the liabilities of a company or a firm. If there are any surplus, then those are distributed to the contributories.
United Kingdom insolvency law regulates companies in the United Kingdom which are unable to repay their debts. While UK bankruptcy law concerns the rules for natural persons, the term insolvency is generally used for companies formed under the Companies Act 2006. "Insolvency" means being unable to pay debts. Since the Cork Report of 1982, the modern policy of UK insolvency law has been to attempt to rescue a company that is in difficulty, to minimise losses and fairly distribute the burdens between the community, employees, creditors and other stakeholders that result from enterprise failure. If a company cannot be saved it is "liquidated", so that the assets are sold off to repay creditors according to their priority. The main sources of law include the Insolvency Act 1986, the Insolvency Rules 1986, the Company Directors Disqualification Act 1986, the Employment Rights Act 1996 Part XII, the Insolvency Regulation (EC) 1346/2000 and case law. Numerous other Acts, statutory instruments and cases relating to labour, banking, property and conflicts of laws also shape the subject.
Re Continental Assurance Co of London plc [2007] 2 BCLC 287 is a UK insolvency law case on wrongful trading under section 214 of the Insolvency Act 1986.
Re Produce Marketing Consortium Ltd [1989] 5 BCC 569 was the first UK company law or UK insolvency law case under the wrongful trading provision of s 214 Insolvency Act 1986.
Re MC Bacon Ltd [1990] BCLC 324 is a leading UK insolvency law case, concerning transactions at an undervalue and voidable preferences.
Stone & Rolls Ltd v Moore Stephens[2009] UKHL 39 is a leading case relevant for UK company law and the law on fraud and ex turpi causa non oritur actio. The House of Lords decided by a majority of three to two that where the director and sole shareholder of a closely held private company deceived the auditors with fraud carried out on all creditors, subsequently the creditors of the insolvent company would be barred from suing the auditors for negligence from the shoes of the company. The Lords reasoned that where the company was only identifiable with one person, the fraud of that person would be attributable to the company, and the "company" could not rely on its own illegal fraud when bringing a claim for negligence against any auditors. It was the last case to be argued before the House of Lords.
Pre-packaged insolvency is a kind of bankruptcy procedure, where a restructure plan is agreed in advance of a company declaring its insolvency. In the United States pre-packs are often used in a Chapter 11 filing. In the United Kingdom, pre-packs have become popular since the Enterprise Act 2002, which has made administration the dominant insolvency procedure. Such arrangements are also available in Canada under the Companies' Creditors Arrangements Act.
Re Oasis Merchandising Services Ltd [1998] Ch 170 is a UK insolvency law and company law case, concerning wrongful trading.
Re Brian D Pierson (Contractors) Ltd [1999] BCC 26 is a UK insolvency law and company law case, concerning misfeasance and wrongful trading.
Administration in United Kingdom law is the main kind of procedure in UK insolvency law when a company is unable to pay its debts. The management of the company is usually replaced by an insolvency practitioner whose statutory duty is to rescue the company, save the business, or get the best result possible. It is the equivalent of Chapter 11, Title 11, United States Code, although with significant differences. While creditors with a security interest over all a company's assets could control the procedure previously through receivership, the Enterprise Act 2002 made administration the main procedure.
Australian insolvency law regulates the position of companies which are in financial distress and are unable to pay or provide for all of their debts or other obligations, and matters ancillary to and arising from financial distress. The law in this area is principally governed by the Corporations Act 2001. Under Australian law, the term insolvency is usually used with reference to companies, and bankruptcy is used in relation to individuals. Insolvency law in Australia tries to seek an equitable balance between the competing interests of debtors, creditors and the wider community when debtors are unable to meet their financial obligations. The aim of the legislative provisions is to provide:
Provisional liquidation is a process which exists as part of the corporate insolvency laws of a number of common law jurisdictions whereby after the lodging of a petition for the winding-up of a company by the court, but before the court hears and determines the petition, the court may appoint a liquidator on a "provisional" basis. Unlike a conventional liquidator, a provisional liquidator does not assess claims against the company or try to distribute the company's assets to creditors, as the power to realise the assets comes after the court orders a liquidation.
Hong Kong insolvency law regulates the position of companies which are in financial distress and are unable to pay or provide for all of their debts or other obligations, and matters ancillary to and arising from financial distress. The law in this area is now primarily governed by the Companies Ordinance and the Companies Rules. Prior to 2012 Cap 32 was called the Companies Ordinance, but when the Companies Ordinance came into force in 2014, most of the provisions of Cap 32 were repealed except for the provisions relating to insolvency, which were retained and the statute was renamed to reflect its new principal focus.
The Duomatic principle is a principle of English company law relating to the informal approval of actions by a company's shareholders. The principle is named after one of the earlier judicial decisions in which it was recognised: Re Duomatic Ltd [1969] 2 Ch 365, although in that case Buckley J was approving an older statement of the law from the decisions in In re Express Engineering [1920] 1 Ch 466 and Parker and Cooper Ltd v Reading [1926] Ch 975. It origins lie in the obiter dictum comments of Lord Davey in Salomon v Salomon & Co Ltd where he stated that 'the company is bound in a matter intra vires by the unanimous agreement of its members'.
BNY Corporate Trustees Services Ltd v Eurosail-UK 2007-3BL plc[2013] UKSC 28 was a decision of the Supreme Court of the United Kingdom in relation to the proper interpretation of section 123(2) of the Insolvency Act 1986 as it had been applied in commercial bond documentation. The analysis and reasoning in the case are now commonly referred to as the Eurosail test.
Re MC Bacon Ltd [1991] Ch 127 is a UK insolvency law case relating specifically to the recovery the legal costs of the liquidator in relation to an application to set aside a floating charge as an unfair preference.
