Company Directors' Liability and Creditor Protection 9780367210519, 9781032515113, 9780429266232

Table of contents :
Cover
Half Title
Series
Title
Copyright
Contents
Preface
Table of cases
Table of legislation
Part A Introduction
Chapter 1 Background
Unpaid Debts and Creditors
Directors
The Format, Approach and Purpose of the Book
Chapter 2 Directors
Introduction
General
De Jure Directors
De Facto Directors
Shadow Directors
Distinguishing Between De Facto and Shadow Directors
Executive and Non-Executive Directors
Responsibilities and Obligations
Conclusion
Chapter 3 Creditors
Introduction
Who Is a Creditor?
Contingent Debts
Prospective Debts
Future Debts
Kinds of Creditors
Consensual Creditors
Involuntary Creditors
Creditor Protection
Contractual Protection
Pre-Contract Checks
Security
Monitoring
Imposing Higher Interests
Conclusion
Chapter 4 Claimants and Actions
Introduction
Claimants
Proceedings
Misfeasance
Conclusion
Part B Fraudulent Trading
Chapter 5 Background and Aim
Introduction
Background
Aim
Conclusion
Chapter 6 Fraudulent Trading: The Provision and its Scope
Introduction and Background
The Elements: An Introduction
The Applicant
Applications
Persons Who May Be Liable
Directors and Company Officers
Employees
Outsiders (Accessories)
Criminal Proceedings
Conditions for Liability
Party to the Carrying on of Business
Knowingly
What Constitutes Fraudulent Trading?
Loss
The Order
Relief From Liability
The Destination of Proceeds
Conclusion
Chapter 7 Intent to Defraud and Fraudulent Purpose
Introduction
Creditors
Intent to Defraud
Dishonesty
The Issues
What Actions Can Constitute Fraud?
‘Fraudulent Purpose’
Conclusion
Part C Wrongful Trading
Chapter 8 Wrongful Trading: Background, Aims and Rationale
Introduction
Background
Aims
Rationale
Conclusion
Chapter 9 An Exposition of the Wrongful Trading Provision and its Scope
Introduction
The Applicant
Claims
The Elements Required for Liability
Insolvent Liquidation
Directors
Knowledge
No Reasonable Prospect of Avoiding Insolvent Liquidation
The Point of Liability
What Should Directors Be Doing?
Judicial Considerations
The Types of Companies Involved in Actions
Loss
The Order
Introduction
Judicial Discretion
Compensation in the Order
Payment of Existing Debts With New Money
Concurrent and Additional Liability
Division of Liability
Other Matters Contained in Orders
The Effects of an Order
Compensation Orders Under the Company Directors ’Disqualification Act 1986
The Public Factor
Conclusion
Chapter 10 The Wrongful Trading Defence
Introduction
The Substance of the Defence
What Constitutes ‘Every Step’?
Introduction
Professional Advice
Resignation
Placing the Company Into a Formal Insolvency Regime
Cessation of Business
Miscellaneous Options
Inability to Take Steps to Minimise Losses
Conclusion
Chapter 11 Relief from Liability
Introduction
Relief Under the Companies Act 2006?
Is Relief Under the Companies Act Necessary?
Conclusion
Part D The Obligation to Consider the Interests of Creditors
Chapter 12 The Development of the Obligation
Introduction
The Evolution of the Obligation
The Genesis
The UK Developments of the Last Century: The Early Days
Judicial Opinion in the UK in the 1990s and Early 2000s
Section 172(3) of the Companies Act 2006: The Statutory Aid
Cases Post Companies Act 2006
The Supreme Court in Sequana
Conclusion
Chapter 13 The Nature of and Rationale for the Obligation
Introduction
The Nature of the Obligation
The Foundation of the Obligation
The Traditional Foundation
The Disconnect?
The Case Law and Other Explanations
The Judicial Foundations
Conclusion
Chapter 14 When Does the Obligation Arise?
Introduction
Background
The Importance of the Trigger
Insolvency
The Obligation and Pre-Insolvency Circumstances
Context
The Judicial Formulations
The Supreme Court in Sequana
The Knowledge of the Directors
Reflections
Conclusion
Chapter 15 Complying with the Obligation
Introduction
Context
The Content of the Duty
Insolvency
When Insolvent Liquidation or Administration Is Probable
Circumstances Short of Insolvency
Summary
The Nature of the Consideration to Be Given to Creditor Interests
Balancing
Paramountcy of Creditor Interests
Factors and Issues in Considering Creditor Interests
Creditors v Creditors
Conclusion
Chapter 16 Commencing Proceedings and Determining Liability
Introduction
Who Can Commence Proceedings?
Respondents to Proceedings
The Relationship to Wrongful Trading
Limitation of Actions
Disadvantages With Proceedings
Granting Judicial Relief
Security for Costs
Enforcement
Proceeds of Judgment
Determining Liability
Conclusion
Chapter 17 Relief from Liability
Introduction
Ratification
Judicial Relief
Conclusion
Part E Diminution of Company Funds
Chapter 18 Unlawful Distributions
Introduction
Starting Points
Distributions and the Legislative Framework
Introduction
In General
Public Companies
Dividends
Liability for Unlawful Distributions
Member Liability
Director Liability
Auditor Liability
Relief From Liability
Conclusion
Index

Citation preview

C O MPA N Y D IR E C TO R S ’ LI ABI LI TY AN D C R E D ITO R P R O TECTI ON

CONTEMPORARY COMMERCIAL LAW The Law and Autonomous Vehicles Matthew Channon, Lucy McCormick and Kyriaki Noussia FIDIC Yellow Book A Commentary Ben Beaumont The Contract of Carriage Multimodal Transport and Unimodal Regulation Paula Bäckdén FIDIC Red Book A Commentary Ben Beaumont Blockchain Technology and the Law Opportunities and Risks Muharem Kianieff

Reinsurance and the Law of Aggregation Event, Occurrence, Catastrophe, Cause Oliver D. William Comparative Analysis of Interim Measures Interim Remedies (England& Wales) v Preservation Measures (China) Vivek Jain, Thomas Macey-Dare QC and Shengnan Jia Knock-for-Knock Indemnities and the Law Contractual Limitation and Delictual Liability Edited by Kristoffer Svendsen, Endre Stavang & Greg Gordon

Third Party Protection in Shipping Carlo Corcione

Managing International Trade Risk Customs, Revenue and VAT Compliance Mark Rowbotham

Multi-sided Music Platforms and the Law Copyright, Law and Policy in Africa Chijioke Ifeoma Okorie

Company Directors’ Liability and Creditor Protection Andrew Keay

For more information about this series, please visit: www.routledge.com/ Contemporary-Commercial-Law/book-series/CCL

COMPANY DI R E CTO R S ’ LIA B I L I T Y AND C RE D ITO R PR OT E C T I O N ANDR EW KEAY

Designed cover image: Getty First published 2023 by Informa Law from Routledge 4 Park Square, Milton Park, Abingdon, Oxon OX14 4RN and by Informa Law from Routledge 605 Third Avenue, New York, NY 10158 Informa Law from Routledge is an imprint of the Taylor & Francis Group, an informa business © 2023 Andrew Keay The right of Andrew Keay to be identified as author of this work has been asserted in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library ISBN: 978-0-367-21051-9 (hbk) ISBN: 978-1-032-51511-3 (pbk) ISBN: 978-0-429-26623-2 (ebk) DOI: 10.4324/9780429266232 Typeset in Times New Roman by Apex CoVantage, LLC

CONTENTS

Preface Table of cases Table of legislation

xi xiii xxvii PART A INTRODUCTION

CHAPTER 1 BACKGROUND Unpaid Debts and Creditors Directors The Format, Approach and Purpose of the Book

3 3 3 5

CHAPTER 2 DIRECTORS Introduction General De Jure Directors De Facto Directors Shadow Directors Distinguishing Between De Facto and Shadow Directors Executive and Non-Executive Directors Responsibilities and Obligations Conclusion

7 7 7 8 8 11 12 13 14 17

CHAPTER 3 CREDITORS Introduction Who Is a Creditor? Contingent Debts Prospective Debts Future Debts Kinds of Creditors Consensual Creditors Involuntary Creditors Creditor Protection Contractual Protection Pre-Contract Checks

18 18 18 19 19 19 19 20 23 23 23 24 v

CONTENTS

Security Monitoring Imposing Higher Interests Conclusion

25 25 26 26

CHAPTER 4 CLAIMANTS AND ACTIONS Introduction Claimants Proceedings Misfeasance Conclusion PART B

27 27 27 28 28 30

FRAUDULENT TRADING

CHAPTER 5 BACKGROUND AND AIM Introduction Background Aim Conclusion FRAUDULENT TRADING: THE PROVISION AND ITS SCOPE Introduction and Background The Elements: An Introduction The Applicant Applications Persons Who May Be Liable Directors and Company Officers Employees Outsiders (Accessories) Criminal Proceedings Conditions for Liability Party to the Carrying on of Business Knowingly What Constitutes Fraudulent Trading? Loss The Order Relief From Liability The Destination of Proceeds Conclusion

33 33 33 35 36

CHAPTER 6

CHAPTER 7

INTENT TO DEFRAUD AND FRAUDULENT PURPOSE

Introduction Creditors vi

37 37 38 39 40 44 44 46 46 53 55 55 59 61 63 64 67 67 68 69 69 69

CONTENTS

Intent to Defraud Dishonesty The Issues What Actions Can Constitute Fraud? ‘Fraudulent Purpose’ Conclusion

70 70 72 83 84 85

PART C WRONGFUL TRADING CHAPTER 8 WRONGFUL TRADING: BACKGROUND, AIMS AND RATIONALE Introduction Background Aims Rationale Conclusion CHAPTER 9 AN EXPOSITION OF THE WRONGFUL TRADING PROVISION AND ITS SCOPE Introduction The Applicant Claims The Elements Required for Liability Insolvent Liquidation Directors Knowledge No Reasonable Prospect of Avoiding Insolvent Liquidation The Point of Liability What Should Directors Be Doing? Judicial Considerations The Types of Companies Involved in Actions Loss The Order Introduction Judicial Discretion Compensation in the Order Payment of Existing Debts With New Money Concurrent and Additional Liability Division of Liability Other Matters Contained in Orders The Effects of an Order Compensation Orders Under the Company Directors’ Disqualification Act 1986 The Public Factor Conclusion vii

89 89 90 95 96 98 99 99 99 100 105 105 106 108 115 116 123 124 129 130 136 136 137 139 140 142 143 144 145 148 149 150

CONTENTS

CHAPTER 10 THE WRONGFUL TRADING DEFENCE Introduction The Substance of the Defence What Constitutes ‘Every Step’? Introduction Professional Advice Resignation Placing the Company Into a Formal Insolvency Regime Cessation of Business Miscellaneous Options Inability to Take Steps to Minimise Losses Conclusion

151 151 151 153 153 155 158 160 162 163 167 167

CHAPTER 11 RELIEF FROM LIABILITY Introduction Relief Under the Companies Act 2006? Is Relief Under the Companies Act Necessary? Conclusion

168 168 168 175 175

PART D THE OBLIGATION TO CONSIDER THE INTERESTS OF CREDITORS CHAPTER 12 THE DEVELOPMENT OF THE OBLIGATION Introduction The Evolution of the Obligation The Genesis The UK Developments of the Last Century: The Early Days Judicial Opinion in the UK in the 1990s and Early 2000s Section 172(3) of the Companies Act 2006: The Statutory Aid Cases Post Companies Act 2006 The Supreme Court in Sequana Conclusion

179 179 181 181 182 186 192 194 197 198

CHAPTER 13 THE NATURE OF AND RATIONALE FOR THE OBLIGATION Introduction The Nature of the Obligation The Foundation of the Obligation The Traditional Foundation The Disconnect? The Case Law and Other Explanations The Judicial Foundations Conclusion

200 200 200 203 203 206 207 208 214

CHAPTER 14 WHEN DOES THE OBLIGATION ARISE? Introduction

215 215

viii

CONTENTS

Background The Importance of the Trigger Insolvency The Obligation and Pre-Insolvency Circumstances Context The Judicial Formulations The Supreme Court in Sequana The Knowledge of the Directors Reflections Conclusion CHAPTER 15 COMPLYING WITH THE OBLIGATION Introduction Context The Content of the Duty Insolvency When Insolvent Liquidation or Administration Is Probable Circumstances Short of Insolvency Summary The Nature of the Consideration to Be Given to Creditor Interests Balancing Paramountcy of Creditor Interests Factors and Issues in Considering Creditor Interests Creditors v Creditors Conclusion CHAPTER 16

COMMENCING PROCEEDINGS AND DETERMINING LIABILITY

Introduction Who Can Commence Proceedings? Respondents to Proceedings The Relationship to Wrongful Trading Limitation of Actions Disadvantages With Proceedings Granting Judicial Relief Security for Costs Enforcement Proceeds of Judgment Determining Liability Conclusion CHAPTER 17 RELIEF FROM LIABILITY Introduction Ratification Judicial Relief Conclusion ix

216 218 219 226 226 228 230 233 234 236 237 237 238 239 240 242 243 245 245 246 250 252 256 270 271 271 271 273 275 276 279 279 279 281 281 281 284 285 285 285 286 288

CONTENTS

PART E

DIMINUTION OF COMPANY FUNDS

CHAPTER 18 UNLAWFUL DISTRIBUTIONS Introduction Starting Points Distributions and the Legislative Framework Introduction In General Public Companies Dividends Liability for Unlawful Distributions Member Liability Director Liability Auditor Liability Relief From Liability Conclusion

291 291 291 294 294 296 301 302 303 303 306 311 311 314

Index

315

x

P R E FA C E

Companies are managed by directors who, as a result, are the ones who determine in what direction companies go and what they do. This means that they play very important roles and they need to discharge significant functions. As a consequence of this the law imposes many obligations on directors. Some of these are to protect the shareholders, and a number of these are designed to ensure that the directors act appropriately and do not engage in self-dealing. Besides these obligations, the law also provides that directors have obligations which are effectively constructed to protect creditors of the company, and it is with these obligations that the book is concerned. This book endeavours to focus on four primary obligations. These are the obligations not to engage in fraudulent trading, to avoid engaging in wrongful trading, to consider the interests of creditors during periods of a company’s financial distress, and to refrain from making unlawful distributions from company funds. If these obligations did not exist, then directors could act in such a way that creditors could lose out when companies are unable to pay the debts which they owe. The obligations provide potentially important protections for creditors. Their breach, when a company falls into insolvent administration or liquidation, may well lead to an administrator or liquidator commencing proceedings against miscreant directors. The obligations considered in the book have been the subject of a complex and detailed case law, and this is examined in this book along with the statutory provisions that establish the obligations of the directors. The book is an analytical exposition of the law as it has developed in relation to the obligations. It is divided into five parts to reflect the four obligations referred to in the previous paragraph together with an introductory part. I would like to thank Informa plc, publisher of Lloyds Maritime and Commercial Law Quarterly, for allowing me to use parts of my article ‘Financially Distressed Companies, Restructuring and Creditors: What is a Director to do?’ [2019] Lloyds Maritime and Commercial Law Quarterly 297–317. I thank Guy Loft and Amelia Bashford from Routledge for liaising with me and providing me with guidance during the writing and publishing processes. I would also like to thank Marie Roberts for managing the preparation of the book for publication I have stated the law as it was available to me as at 1 November 2022. Andrew Keay

xi

TA B L E O F C A SE S

ASIC v Healey [2011] FCA 717 ........................................................................... 1.7, 9.89 A Company (No 001418 of 1988), Re [1991] BCLC 197 ............. 6.24, 6.25, 6.113–6.115, 7.6, 7.23, 7.29 A Company (No 00314 of 1989), Re [1991] BCLC 154 .............................................16.6 A Company No 005009 of 1987, Re [1988] BCLC 570; (1988) 4 BCC 424 .........................................................................................2.17, 9.32, 12.42 A Debtor, Re [1927] 1 Ch 410 ....................................................................................9.180 A Debtor (No.17 of 1966), Re [1967] Ch 590, [1967] 1 All ER 668 .........................9.25 Abbey Forwarding Ltd v Hone [2010] EWHC 2029 (Ch) ..........................................6.23 Abou-Ramah v Abacha [2006] EWCA Civ 1492; [2007] Bus L R 220; [2007] 1 Lloyd’s Rep 115 ............................................................................ 7.15, 7.44 Agriplant Services Ltd, Re [1997] BCC 84 ..................................................................6.63 Aktieselskabet Dansk Skibsfinansiering v Brothers [2001] 2 BCLC 324.......................................................................................................7.27, 7.31, 7.32, 7.37, 7.43 Aidiniantz v The Sherlock Holmes International Society Ltd [2015] EWHC 2882 (Ch); [2015] BPIR 1329 ................................................................16.39 Allsopp, Re [1914] 1 Ch 1, 11 ......................................................................................11.5 Alpha Sim Communications Ltd v CAZ Distribution Services Limited [2014] EWHC 207 (Ch) ...........................................................................................7.9 Aluminium Industrie Vaassen BV v Romalpa Aluminium Ltd [1976] 2 All ER 552 (CA) .................................................................................................3.20 Androvin v Figliomeni (1996) 14 ACLC 1461 ..........................................................10.62 Anglo-Austrian Printing & Publishing Co, Re [1985] 2 Ch 891 ................6.22, 9.7, 16.9 Anglo-French Co-operative Society, Re (1882) 21 Ch D 492 ...................................9.180 Armstrong v Strain [1952] 1 KB 232, 246 ...................................................................7.39 Ashburton Oil NL v Alpha Minerals NL (1971) 123 CLR 614 ....................................1.6 Atkinson v Kingsley [2020] EWHC 2913 (Ch) ........................................................18.86 Augustus Barnett & Son Ltd, Re (1986) 2 BCC 98, 904 ........................6.49, 6.51, 6.23, 6.65, 7.26, 7.30, 7.51 Australian Innovation Ltd v Paul Andrew Petrovsky (1996) 14 ACLC 1357, 1361 .............................................................................................14.5 Automatic Self-Cleansing Filter Syndicate Co Ltd v Cunninghame [1906] 2 Ch 34 .........................................................................................................1.6 Avacade Ltd, Re [2021] EWHC 1501 (Ch) ................................................ 15.112, 15.119 Aveling Barford Ltd v Perion Ltd [1989] BCLC 626 ........................18.10, 18.13, 18.16, 18.55, 18.67

xiii

TA BLE OF CASES

B. Johnson & Co (Builders) Ltd, Re [1955] Ch 634 ...................................................4.11 B. J. Crabtree (Insulation) Ltd v G.P.T. Communications Systems (1990) 59 Build L R 43 ...................................................................................................16.42 BCCI; Banque Arabe Internationale D’Investissement SA v Morris, Re [2002] BCC 407 .............................................................................6.1, 6.41, 6.44, 6.45, 6.49, 6.50 BCCI; Morris v State Bank of India, Re [2004] 2 BCLC 236; [2004] EWHC 528 (Ch); [2004] 2 BCLC 279, 297; [2004] BCC 404, affirmed on appeal in [2005] EWCA Civ 693; [2005] 2 BCLC 328, [2005] BPIR 1067 ............................................................... 5.12, 6.7, 6.9, 6.35, 6.46, 6.51–6.56, 6.61–6.64, 6.91–6.95, 6.100, 6.101, 6.103, 6.115, 6.117, 6.120, 6.122, 7.2, 7.6, 7.14, 9.38 BHS Group Ltd, Re. See Wright and Rowley v Chappell— BM Electrical Solutions Ltd, Re [2020] EWHC 2749 (Ch); [2021] 1 BCLC 638 ............................................................................................... 18.8, 18.12 BNY Corporate Trustee Services Ltd v Eurosail-UK 2007–3BL Plc [2013] UKSC 28; [2013] 1 WLR 1408 (SC); [2013] 3 All ER 271; [2013] BCC 397; [2013] 1 BCLC 613............................................9.24, 9.25, 14.28, 14.30, 14.31 BTI 2014 LLC v Sequana S.A. [2016] EWHC 1686; [2017] 1 BCLC 453; [2017] EWHC 211 (Ch) .................................................................. 12.54, 18.65 BTI 2014 LLC v Sequana S.A. [2019] EWCA Civ 112; [2019] EWCA Civ 119; [2019] 2 All ER 784; [2019] BCC 631; [2019] 1 BCLC 347; [2019] BPIR 562, on appeal to the Supreme Court [2022] UKSC 25 ................................... 8.27, 8.29, 9.93, 11.9, 12.1, 12.40, 12.43, 12.52, 12.54, 12.59, 12.60, 12.64–12.68, 12.70, 12.71, 12.75, 13.4, 13.6, 13.9, 13.12, 13.27, 13.33, 13.43–13.45, 13.48, 13.51, 14.4, 14.11, 14.12, 14.16, 14.20, 14.21, 14.23, 14.24, 14.32, 14.34, 14.37–14.39, 14.45, 14.46, 14.48–14.50, 14.54, 14.57, 14.58–14.61, 14.63, 14.64, 14.68, 14.71–14.76, 14.78, 14.79, 14.85, 14.88, 14.89, 15.2, 15.4, 15.8, 15.11, 15.20–15.25, 15.29, 15.30, 15.32, 15.35, 15.38, 15.44, 15.48, 15.49, 15.55, 15.64, 15.71, 15.72, 15.102, 15.103, 15.110, 15.121, 16.19–16.24, 16.54, 17.8, 18.40, 18.41, 18.64, 18.65, 18.71 Bairstow v Queen Moat Houses plc [2000] BCC 1025; [2000] 1 BCLC 549, affirmed by the Court of Appeal [2001] EWCA Civ 712; [2001] 2 BCLC 531; [2002] BCC 91 ............... 11.5, 11.15, 11.18, 11.19, 11.24, 17.7, 17.10, 18.7, 18.8, 18.10, 18.13, 18.16, 18.32, 18.60, 18.67–18.70, 18.75–18.77, 18.79, 18.81, 18.82, 18.86–18.88 Ball v Hughes [2017] EWHC 3228 (Ch) ....................................................................13.24 Bangla Television Ltd (in liq.), Re [2009] EWHC 1632; [2010] BCC 143 ..........................................................................................9.66, 9.123, 15.81 Bank of Credit and Commerce International (Overseas) Ltd v Akindele [2001] Ch 437.......................................................................................18.55 Bank of India v Morris. See BCCI; Morris v State Bank of India, Re— Barlow Clowes International Ltd (in Liquidation) v Eurotrust International Ltd [2005] UKPC 37; [2006] 1 WLR 1476............................. 7.36, 7.43, 7.44, 7.46

xiv

TA BLE OF CASES

Barnes v Addy (1874) LR 9 Ch App 244 ...................................................................16.17 Bath Glass Ltd, Re [1988] BCLC 329 ............................................................ 9.174, 10.18 Bell Group Ltd (in liq) v Westpac Banking Corporation (No 9) [2008] WASC 239 ........................................................................14.45, 15.16, 15.17, 15.19, 15.28, 15.35, 15.42, 15.56, 15.59, 15.66, 16.16 Belmont Finance Corp Ltd v Williams Furniture Ltd (No.2) [1980] 1 All ER 393 ....................................................................18.10, 18.55, 18.67, 18.68, 18.76 Berg Sons & Co Ltd v Adams [1992] BCC 661 ........................................................13.39 Bernasconi v Nicholas Bennett & Co [2000] BCC 921; [2000] BPIR 8 .............................................................................................. 5.6, 6.108, 6.110, 7.7, 7.14, 7.24 Bilta (UK) Ltd v Natwest Markets plc [2020] EWHC 546 (Ch) ..................... 6.46, 6.61, 6.64, 6.103, 7.7, 7.12, 7.14, 7.33 Bilta (UK) Ltd (In Liquidation) v Nazir [2012] EWHC 2163 (Ch), affirmed on appeal [2013] EWCA Civ 968, [2014] Ch 52 ................................12.52 Bilta (UK) Ltd v Nazir (In Liquidation) (No. 2) [2015] 2 WLR 1168; [2015] UKSC 23, [2016] AC 1 ....................................6.58–6.60, 12.6, 12.40, 12.58, 13.11, 13.29, 13.44, 14.19, 14.63–14.65, 14.67, 15.118, 17.3 Bilta (UK) Ltd (In liquidation) v SVS Securities plc [2022] EWHC 723 (Ch) .....................................................................................................6.46 Biscoe v Milner [2021] EWHC 763 (Ch) ...............................................6.23, 6.36, 6.126, 9.33, 9.120, 9.122 Bluebrook Ltd, Re [2009] EWHC 2114 (Ch); [2010] 1 BCLC 338. ............ 15.85, 15.91 Bluecrest Mercantile BV v Vietnam Shipbuilding Group [2013] EWHC 1146 (Comm)...........................................................................................10.43 Borden (UK) Ltd v Scottish Timber Products Ltd [1981] Ch 25 ................................3.11 Bowe Watts Clargo Ltd, Re [2017] EWHC 7879 (Ch) ..............................................14.23 Brady v Brady (1988) 3 BCC 535 .............................................. 8.30, 12.6, 14.20, 14.53, 14.86, 15.12, 15.13 Brian D. Pierson (Contractors) Ltd, Re [1999] BCC 26; [2001] BCLC 275 .............................................................. 9.7, 9.37, 9.39, 9.53, 9.71, 9.80, 9.95, 9.100, 9.111, 9.112, 9.114, 9.121, 9.139, 9.152, 9.166, 9.178, 9.186, 10.7, 10.9, 10.18, 10.23, 10.50, 11.15, 11.16, 15.33, 15.79, 15.80, 15.83, 15.101 Bright Future Software Ltd, Re [2020] EWHC 1674 (Ch); [2021] 2 BCLC 536 ..........................................................................9.58, 9.65, 10.19 Broadside Colours and Chemicals Ltd, Re [2011] EWHC 1034 (Ch) ......................16.30 Brocks Mount ltd v Beasant (unreported), 2 April 2003 (Ch D) ................. 11.24, 17.10 Bronia Buchanan Associates Ltd (in liq), Re [2021] EWHC 2740 (Ch); [2022] BCC 229 ...........................................................................................18.6 Brooks v Armstrong [2015] EWHC 2289 (Ch), [2015] BCC 661; [2016] BPIR 272; [2016] EWHC 2893 (Ch), [2017] BCC 99 ........8.23, 9.41, 9.50, 9.60, 9.67, 9.72, 9.97, 9.100, 9.118, 9.124, 9.130, 9.140, 9.143, 9.157, 9.164, 10.3, 10.4, 10.8, 10.20, 10.40, 10.54, 10.56, 11.29, 11.32 Burnden Holdings (UK) Ltd v Fielding [2016] EWCA Civ 557; [2018] UKSC 14, [2018] AC 257; [2019] EWHC 1566 (Ch); [2020] BPIR 1 ................................................................... 16.27, 16.31, 16.33, 18.34, 18.78, 18.79, 18.90, 18.91

xv

TA BLE OF CASES

Business Computers v Anglo-African Leasing [1977] 1 WLR 578, 580 ....................3.11 Byblos Bank SAL v Al-Khudhairy (1986) 2 BCC 99,549 (CA) .................................9.25 C. & E. Commrs v Hedon Alpha Ltd [1981] QB 818 ................................... 11.12, 11.13 C.T.Bowring & Co (Insurance) Ltd v Corsi & Partners Ltd [1994] BCC 713 (CA)......................................................................................................16.38 C S Holidays Ltd; Secretary of State for Trade and Industry v Gash, Re [1997] BCC 172; [1997] 1 WLR 407 .............................................................9.65 Caley Oils Ltd (In Administration) v Wood [2018] CSOH 42 .......12.54, 15.101, 15.108 Canadian Land Reclaiming and Colonizing Co; Coventry & Dixon’s Case, Re (1880) 14 Ch D 660 (CA)............................................................... 2.9, 2.16, 4.11 Cannane v Cannane (1998) 192 CLR 557 ....................................................................7.34 Capital For Enterprise Fund A LP and another v Bibby Financial Services Ltd [2015] EWHC 2593 (Ch) ..............................................................................15.92 Capitol Films Ltd (in administration), Re [2010] EWHC 2240 (Ch); [2011] 2 BCLC 359 .........................................................................................................15.14 Carman v Cronos Group SA [2005] EWHC 2403 (Ch); [2006] BCC 451 ....... 6.28, 6.29 Cave v Robinson Jarvis & Rolf [2002] UKHL 18 .....................................................16.32 Cavendish-Bentinck v Fenn (1887) 12 App Cas 652 ......................................... 4.11, 4.13 Chancery plc, Re [1991] BCC 171, 172 .....................................................................10.38 Chandler v DPP [1964] AC 763 ......................................................................................8.5 Charterbridge Corp Ltd v Lloyds Bank Ltd (‘Charterbridge’) [1970] Ch 62 ..........12.38, 12.39, 12.41, 12.42, 16.47–16.49 Cheyne Finance plc (No 2), Re [2007] EWHC 2402 (Ch); [2008] 1 BCLC 741............................................................................................................. 14.28, 14.31 Chohan v Saggar [1992] BCC 750..............................................................................18.65 Ciban Management Corp v Citco (BVI) Ltd [2020] UKPC21; [2021] AC 122; [2020] BCC 964 ...........................................................................................18.85 Citron v Fairchild Camera and Instrument Corp 1988 WL 53322 (Del Ch) ............16.50 City Equitable Fire Insurance Co Ltd, Re [1925] Ch 407 ............................... 4.11, 18.76 Cityspan Ltd, Re [2007] EWHC 751 (Ch); [2007] 2 BCLC 522; [2008] BCC 60 ................................................................................................... 14.23, 15.101 Clydebank Football Club Ltd v Stedman 2002 SLT 109 ...........................................18.21 Cobden Investments Ltd v RWM Langport [2008] EWHC 2810 (Ch) ......... 12.38, 12.50 Colin Gwyer and Associates Ltd v London Wharf (Limehouse) Ltd [2002] EWHC 2748 (Ch); [2003] BCC 885; [2003] 2 BCLC 153 ...... 12.36, 12.37, 12.40, 12.43, 14.16, 14.23, 14.51, 14.53, 15.13, 15.26, 15.62, 15.65, 15.106, 16.47, 16.52, 16.53 Commissioners of Inland Revenue v McEntaggart [2004] EWHC 3431 (Ch); [2007] BCC 260 ............................................................................... 11.1, 11.14 Commissioners of Inland Revenue v Richmond [2003] EWHC 999 (Ch) ..............18.68 Continental Assurance Co of London plc, Re [2001] BPIR 733 ............. 9.13–9.15, 9.30, 9.31, 9.45, 9.55, 9.59, 9.70, 9.72, 9.73, 9.78, 9.80, 9.85, 9.90, 9.108, 9.110, 9.112, 9.118, 9.119, 9.121, 9.124–9.126, 9.135, 9.145, 9.146, 9.156, 9.162, 9.166, 9.167, 10.9, 10.10, 10.18, 10.58, 15.75, 15.80–15.83, 15.107 Cook v Deeks [1916] 1 AC 554 ..................................................................................13.35 Corporate Affairs Commission (NSW) v Drysdale (1978) 141 CLR 236 .....................2.9 Cosy Seal Insulation Limited (in Administration), Re [2016] EWHC 1255 (Ch) .................................................................................................. 15.101, 17.8

xvi

TA BLE OF CASES

County Marine Insurance Co, Re (1870–71) 6 LR Ch App 104 ...............................18.76 Cowell v Taylor (1885) 31 Ch D 34 (CA) .................................................................16.40 Cox and Hodges, Re (1982) 75 Cr App R 291 (CCA) ..................................................7.6 CU Fittings Ltd, Re [1989] BCLC 556.........................................................................9.91 Cyona Distributors Ltd, Re [1967] Ch 889, 902; [1967] 1 All ER 281 (CA) ............................................................................................................ 6.10, 6.115 DKG Contractors Ltd, Re [1990] BCC 903 ............................ 6.22, 8.22, 9.7, 9.40, 9.63, 9.71, 9.89, 9.104, 9.111, 9.160, 9.163, 9.164, 9.166, 10.18, 10.49, 11.20, 12.6, 17.3 DPP v Schildkamp [1971] AC 1 ...................................................................................6.69 Daystreet15 Limited, Re [2020] EWHC 1140 (Ch) ........................................... 6.86, 7.11 Deep Ocean, Re [2021] EWHC 138 (Ch)...................................................................15.87 Dempster v HMRC [2008] EWHC 63 (Ch); [2008] STC 2079 ..................................6.23 Deputy Commissioner of Taxation v Austin (1998) 16 ACLC 1555...........................2.14 Deputy Commissioner of Taxation v Solomon (2003) 199 ALR 325 .........................2.12 Dickinson v NAL Realisations (Staffordshire) Ltd [2017] EWHC 28 (Ch); [2017] BPIR 611; [2018] BCC 506; [2018 1 BCLC 623; [2019] EWCA Civ 2146 ............................................................................ 11.5, 14.14 D’Jan of London Ltd, Re [1993] BCC 646 ......................................... 11.17, 11.19, 18.75 Dollar Land Holdings Ltd, Re [1994] BCLC 404 ............................................ 3.6, 15.113 Douglas Construction Services Ltd, Re [1988] BCLC 397 .......................................10.18 Dovey and the Metropolitan Bank (of England and Wales) Ltd v John Cory [1901] AC 477 .....................................................................18.76, 18.79, 18.80 Dryburgh v Scotts Media Tax Ltd [2011] CSOH 147.........................15.33, 15.61, 16.51 Duckwari plc; Duckwari plc v Offerventure Ltd (No. 2), Re [1998] Ch 253; [1999] BCC 11 .........................................................................................18.6 Duomatic Ltd, Re [1969] 2 Ch 365; [1969] 2 WLR 114; [1969] 1 All ER 161 ........................................................................................................18.85 E-Clear (UK) Plc (InLiquidation) v Elias Elia [2013] EWCA Civ 1114 ......................................................................................................14.7, 15.3, 16.7 Edwards v A-G [2004] NSWCA 272 ........................................................................15.116 El Ajou v Dollar Land Holdings plc [1994] BCC 143; [1994] 2 All ER .............................................................................................6.56, 6.57, 18.55 Elsworth Ethanol Co Ltd v Hartley [2014] EWHC 99 (IPEC)....................................2.11 Equitable Life Assurance Society v Bowley [2003] EWHC 2263 (Comm); [2004] 1 BCLC 180 ...............................................................................................2.28 Equiticorp Finance Ltd (in liq) v BNZ (1993) 11 ACLC 952 ........................ 14.8, 14.16, 14.47, 14.86, 15.68, 15.69 Equiticorp International Plc, Re [1989] 1 WLR 1010; (1989) 5 BCC 59.................10.35 Esal (Commodities) Ltd; London and Overseas (Sugar) Co Ltd v Punjab National Bank, Re [1993] BCLC 872, affirmed on appeal: [1997] 1 BCLC 705 (CA) ...................................................................................... 6.10, 6.118 Esko Group Ltd (in liq) v Eskdale [2019] NZHC 1664; [2020] NZCCLR 4 .............18.8 Evans v Coventry (1856) 25 LH Ch 489 ....................................................................18.66 Exchange Banking Company (Flitcroft’s Case), Re (1882) 21 Ch D 519 (CA) .................................................................... 12.19, 18.7, 18.68, 18.76 Extrasure Travel Insurances Ltd v Scattergood [2003] 1 BCLC 598 ........... 12.42, 15.61, 16.49–16.51

xvii

TA BLE OF CASES

Facia Footwear Ltd (in administration) v Hinchliffe [1998] 1 BCLC 218...................................................................9.102, 12.6, 12.29, 12.30, 14.53, 15.3, 15.34, 15.47, 15.54, 15.58, 15.63, 16.7 Farmizer (Products) Ltd, Re [1997] 1 BCLC 589 (CA); [1997] BCC 655 (CA) ............................................................................ 6.31, 6.114, 8.16, 9.8, 9.9, 9.151, 9.171, 10.39 First Subsea Ltd v Balltec [2017] EWCA Civ 186, [2018] Ch 25 ............................16.30 Foss v Harbottle (1843) 2 Hare 461; 67 ER 189 ............................................. 13.35, 16.3 Frederick Inns Ltd, Re [1991] ILRM 582 (Irish HC), affirmed at [1994] ILRM 387 (Irish SC); [1993] IESC 1 ................................12.6, 14.22, 15.50 Freeman v Pope (1870) LR 5 Ch 538...........................................................................7.34 Fulham Football Club Ltd v Cabra Estates plc [1994] 1 BCLC 363 ........................12.21 GHLM Trading Ltd v Maroo [2012] EWHC 61 (Ch); [2012] 2 BCLC 369...............................................................12.57, 13.24, 13.37, 14.51, 15.26, 15.91, 15.95, 15.98, 15.101, 15.105, 18.6 Galladin Pty Ltd v Aimnorth Pty Ltd (in liq) (1993) 11 ACSR 23 .............................12.6 Gallagher v Jones [1994] Ch 107; [1994] 2 WLR 160 ..............................................18.27 Gemma v Davies [2008] EWHC 546 (Ch); [2008] BCC 812 .....................................2.14 Gerald Cooper Chemicals Ltd, Re [1978] 2 All E R 49; [1978] Ch 262............................................................6.10, 6.35, 6.47–6.49, 6.81, 6.85, 6.86, 6.90, 6.106, 6.107, 7.16, 7.19, 7.23, 7.51 Global Corporate Ltd v Hale [2018] EWCA Civ 2618; [2019] BCC 431 .......................................................................................18.12, 18.33, 18.52, 18.66, 18.74, 18.75 Global Print Strategies Ltd, Re (unreported), High Court, 24 November 2004 .................................................................................................9.42 Goldfarb v Alibhai (unreported, 11 December 2017, Business and Property Courts) .....................................................................................................6.24 Greener v E Kahn & Co Ltd [1906] 2 KB 374..........................................................16.40 Group Seven Ltd v Nasir (Notable Services LLP) [2019] EWCA Civ 614; [2020] Ch 129......................................................................................6.99, 7.14, 7.46 Grove v Flavel (1986) 4 ACLC 654, 11 ACLR 161 .............................12.6, 14.42, 14.55 Guiness plc v Saunders [1988] 1 WLR 863, affirmed on appeal [1990] 2 WLR 32 .............................................................................................................9.180 Gwembe Valley Development Co Ltd v Koshy [2003] EWCA Civ 1048, [2004] 1 BCLC 131 ......................................................................13.10, 16.26, 16.30 Gwyer v London Wharf (Limehouse) Ltd. See Colin Gwyer and Associates Ltd v London Wharf (Limehouse) Ltd— HL Bolton (Engineering) Co Ltd v T J Graham & Sons Ltd [1957] 1 QB 159 ........6.56 HLC Environmental Projects Ltd, Re [2013] EWHC 2876 (Ch); [2014] BCC 337 .......................................................12.57, 13.9, 13.24, 13.28, 13.37, 14.23, 14.49, 14.74, 15.14, 15.26, 15.98, 15.101, 16.50, 16.52, 16.53, 17.8 Halt Garage (1964) Ltd, Re [1982] 3 All ER 1016................... 18.8, 18.23, 18.51, 18.67 Hardie v Hanson [1960] HCA 8, (1960) 105 CLR 451 ...........................6.79, 7.19, 7.22, 7.24, 7.28, 7.32, 7.37 Hart Investments Ltd v Larchpark Ltd [2007] EWHC 291 (TCC); [2007] BCC 541 ...................................................................................................16.38

xviii

TA BLE OF CASES

Hawkes Hill Publishing Co Ltd (in liq.), Re [2007] EWHC 3073 (Ch); [2007] BCC 937; [2007] BPIR 1305 ............................. 9.58, 9.59, 9.65, 9.70, 9.95, 9.97, 9.101, 10.18, 10.19, 15.34, 15.81, 15.82 Hefferon Kearns Ltd (No 2), Re (1993) 3 IR 191 ......................................... 10.46, 15.75 Hill’s Waterfall Estate Co, Re [1896] 1 Ch 947 ...........................................................4.13 Hilton International Ltd (in liq) v Hilton [1989] NZLR 442 ........................... 12.6, 14.55 Hitco 2000 Ltd, Re [1995] 2 BCLC 63 ............................................................ 9.89, 15.83 Home & Colonial Insurance Co., Re [1930] 1 Ch 102 .................................... 4.13, 16.37 Hooker Investments Pty Ltd v Email Ltd (1986) 10 ACLR 443.................................12.6 Horsley & Weight Ltd, Re [1982] 1 Ch 442; [1982] 3 All ER 1045 (CA) ...................................................................................... 2.33, 12.6, 12.12, 12.17, 13.35, 14.53, 17.3 Howard Holdings Inc, Re [1998] BCC 549 ........................................................ 6.26, 9.34 Hydrodan (Corby) Ltd, Re [1994] BCC 161; [1994] 2 BCLC 180 .........2.10, 2.22, 9.33 IT Human Resources plc v Land [2014] EWHC 3812 (Ch)......................................16.32 Idessa (UK) Ltd, Re [2011] EWHC 804 (Ch); [2011] BPIR 957; [2012] BCC 315 ...........................................................9.24, 9.28, 9.57, 9.131, 9.134, 9.161, 9.164, 9.166, 10.4, 10.24, 10.57, 10.59, 13.24, 15.34, 15.50, 15.62, 15.63, 15.79, 15.83, 17.8, 18.6 Implement Consulting Ltd, Re [2019] EWHC 2855 (Ch); [2020] 2 BCLC 537 .....................................................................................18.17, 18.23, 18.57, 18.58, 18.61, 18.62 Inland Revenue Commissioners v Hashmi [2002] 2 BCLC 489 .................................7.34 Inland Revenue Commissioners v Richmond [2003] EWHC 999 (Ch); [2003] 2 BCLC 442.............................................................18.10, 18.86, 18.88 Inn Spirit Ltd v Burns [2002] EWHC 1731 (Ch); [2002] 2 BCLC 780.........................................................................................................................18.90 Instant Access Properties Ltd, Re [2018] EWHC 756 (Ch) ......................2.15, 2.18, 2.24 Instant Access Properties Ltd v Rosser [2018] EWHC 756 (Ch); [2018] BCC 751 .....................................................................2.16, 2.21, 16.12–16.14 Instrumentation Electrical Services Ltd, Re (1988) 4 BCC 301 .................... 10.35, 10.53 International Championship Management Ltd, Re [2006] EWHC 768 (Ch) ..............9.32 International Vending Machines Ltd, Re (1961) 80 WN (NSW) 465 .......................16.37 It’s A Wrap (UK) Ltd v Gula [2006] EWCA Civ 544; [2006] BCC 626............................................................................. 18.7, 18.55, 18.57, 18.59, 18.60 Ivey v Genting Casinos (UK) Ltd [2017] UKSC 67, [2018] AC 391, [2018] 3 WLR 1212 (Sp Ct)............................................ 7.10, 7.14, 7.41, 7.46, 7.47 Ivy Technology v Martin (2019) EWHC 2510 .............................................................6.23 JSC BTA Bank v Ablyazov [2018] EWCA Civ 1176; [2019] BCC 96; [2018] BPIR 898 ....................................................................................................7.34 J Franklin & Son Ltd, Re [1937] 2 All ER 32 ................................................... 11.5, 17.7 J.J. Harrison (Properties) Ltd v Harrison [2002] BCLC 162 (CA); [2002] BCC 719 ............................................................................13.10, 16.26, 16.30 Jackson v Casey [2019] EWHC 1657 (Ch) ...........................................9.75, 9.134, 9.160 Jeffree v NCSC (1989) 7 ACLC 556 ........................................12.20, 12.21, 13.3, 15.114 Jenkins v Harbour View Courts Ltd [1966] 1 NZLR 1 .............................................18.16

xix

TA BLE OF CASES

Jetivia SA v Bilta (UK) Ltd [2015] UKSC 23; [2016] AC 1; [2015] 2 WLR 1168; [2015] 2 All ER 1083; [2015] 1 BCLC 443 .................................6.27 John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113 .........................................1.6 Johnson v Arden [2018] EWHC 1624 (Ch); [2019] 2 BCLC 215, [2019] BPIR 901 approved of on appeal in Johnson v Beighton ([2019] EWHC 895 (Ch), (2019) BCC 979 .............. 9.48, 9.76, 10.25, 10.31, 10.33 Johnson v Beighton. See Johnson v Arden— Joint Liquidators of CS Properties (Sales) Ltd [2018] CSOH 24 .................. 13.24, 15.77 Jones v Gunn [1997] 3 IR 1; [1997] 2 ILRM 245 .......................................................12.6 Kalls Enterprises Pty Ltd v Baloglow [2007] NSWCA 191; (2007) 25 ACLC 1094 ........................................................................................... 12.6, 14.56 Kaytech International plc, Re [1999] 2 BCLC 351 (CA) ................. 2.9, 2.13, 2.14, 2.22 Keary Developments Ltd v Tarmac Constructions Ltd [1995] 3 All ER 534 ............... 16.41 Keeping Kids Company, Re [2021] EWHC 175 ..........................................................2.14 Kenna & Brown Pty Ltd v Kenna (1999) 32 ACSR 430 ..........................................11.21 Kingston Cotton Mill Co (No.2), Re [1896] 1 Ch 331 .................................. 18.75, 18.76 Kinsela v Russell Kinsela Pty Ltd (‘Kinsela’) (1986) 4 ACLC 215, (1986) 10 ACLR 395 ...................................12.6, 12.14, 12.15, 12.23, 12.28, 12.30, 13.15, 13.42, 13.44, 13.46–13.48, 14.10, 14.11, 14.17, 14.18, 14.20, 14.55, 14.86, 15.15, 15.44, 15.68, 15.76, 17.3 Kirby Coaches Ltd, Re [1991] BCLC 414, 416 .........................11.23, 11.24, 17.9, 17.10 Knight v Frost [1999] BCC 819 ..................................................................................15.98 Kudos Business Solutions Ltd (in liq.), Re [2011] EWHC 1436 (Ch); [2012] 2 BCLC 65 .................................................... 9.58, 9.63, 9.133, 9.149, 9.161, 9.163, 9.164, 15.27, 15.34, 15.78 L. Todd (Swanscombe) Ltd, Re [1990] BCC 125; [1990] BCLC 454...................................................................................................... 6.5, 6.104, 6.119 LRH Services Ltd (in liquidation) v Trew [2018] EWHC 600 (Ch) ..................................................................................................14.8, 18.82, 18.88 Lands Allotment Co, Re [1894] 1 Ch 616 .................... 13.10, 16.26, 18.10, 18.68, 18.76 Lee, Behrens and Co Ltd, Re [1932] 2 Ch 46............................................................18.10 Langreen Ltd, Re (unreported), 21 October 2011 (ChD) ................................ 9.70, 9.161, 15.80, 15.81, 15.82 Leeds Estate, Building and Investment Co v Shepherd (1887) 36 Ch D 787 ..........18.80 Lennard’s Carrying Co Ltd v Asiatic Petroleum Co Ltd [1915] AC 707, 713................................................................................................................. 6.56, 6.57 Lewis v Doran [2005] NSWCA 243; (2005) 219 ALR 555 ......................................14.28 Li Shu Chung, Re (unreported, 2 November 2021 (Ch D) ........................................16.40 Linton v Telnet Pty Ltd (1999) 30 ACSR 465 ....................................14.53, 14.55, 15.33 Liquidator of CSB 123 Limited) v Stanbury [2021] EWHC 2506 (Ch) ..................18.77 Liquidator of Marini Ltd v Dickensen [2004] BCC 172; [2003] EWHC 334 (Ch) .............................................................................. 9.85, 9.121, 9.124, 9.135, 17.12, 18.68, 18.82, 18.86 Liquidator of West Mercia Safetywear Ltd v Dodd (1988) 4 BCC 30 .................................... 7.50, 12.6, 12.13, 12.22, 12.28, 12.35, 12.36, 12.52, 12.59, 13.10, 13.24, 13.34, 13.35, 13.43, 13.44, 14.7, 14.11, 14.19, 14.86, 15.11, 15.12, 15.100–15.102, 15.108, 17.3, 18.88

xx

TA BLE OF CASES

Lo-Line Electric Motors Ltd, Re [1988] Ch 477, 486 ...............................................9.174 London Joint City & Midland Bank v Herbert Dickinson Ltd [1922] WN 13.........13.40 Lonrho Ltd v Shell Petroleum Co. Ltd [1980] 1 WLR 627 ............................ 12.6, 12.12 Loquitur Ltd, Inland Revenue Commissioners v Richmond, Re [2003] EWHC 999 (Ch); [2003] 2 BCLC 442 .............................11.24, 17.10, 18.41, 18.76 MDA Investment Management Ltd, Re [2003] EWHC 227 (Ch); [2004] BPIR 75; [2004] EWHC 42 (Ch); [2005] BCC 783, 838 ......... 11.19, 11.24, 14.53, 15.3, 15.27, 17.10 Madoff Securities International Ltd (in liq) v Raven [2013] EWHC 3147 (Comm).................................................................................12.38, 12.50, 18.16 Madsen-Ries v Cooper [2020] NZSC 100 ........................................................ 11.9, 15.72 Maidstone Buildings Ltd, Re [1971] 1 WLR 1085 .......................... 5.3, 6.43, 6.48, 6.49, 6.82, 7.51, 8.8 Main Realisations Limited [2017] EWHC 3878 (Ch) ................... 9.58, 9.75, 9.98, 9.134 Manifest Shipping Company Ltd v Uni-Polaris Company Ltd [2003] 1 AC 46...................................................................................................................6.97 Marini Ltd, Re [2003] EWHC 334 (Ch); [2004] BCC 172 .........11.5, 15.81, 15.83, 17.7 Micra Contracts Ltd, Re [2016] BCC 153 ...................................................... 13.37, 15.98 Midland Bank v Wyatt [1997] 1 BCLC 242.................................................................7.34 Millgate Financial Corporation Ltd. v BCED Holdings Ltd 2003 CanLII 39497 (Ont SC) .........................................................................................13.3 Morphitis v Bernasconi [2003] EWCA Civ 289; [2003] Ch 552; [2003] BCC 540 ....................................................6.10, 6.85–6.87, 6.89, 6.90, 6.106, 6.107, 6.111, 6.112, 6.115, 6.116, 6.128, 9.147 Morris v Bank of India [2005] EWCA Civ 693; [2005] 2 BCLC 328; [2005] BPIR 1067 ..................................................................................................6.42 Manolete Partners Plc v Hayward and Barrett Holdings Ltd [2021] EWHC 1481 (Ch) ...................................................................................................4.12 Meridian Global Funds Management Asia Ltd v Securities Commission [1995] BCC 942; [1995] 2 AC 500 (PC) .................................... 6.35, 6.56, 6.58, 6.59, 6.63 Morris v Bank of America National Trust [2001] 1 BCLC 771; [2000] BCC 1076; [2000] BPIR 83 (CA) .........................................................................6.23 Morris v State Bank of India. See BCCI; Morris v State Bank of India, Re— Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical Services Ltd [1983] Ch 258 ....................................... 12.3, 12.13, 14.7, 14.86, 15.68 Mumtaz Properties Ltd, Re [2011] EWCA Civ 610; [2012] 2 BCLC 109...............................................................................................2.10, 2.11, 2.14, 2.20 Murray-Watson Ltd, Re (unreported) 6 April 1977, Ch D ................................. 6.86, 6.90 NRMA v Parker (1986) 4 ACLC 609 .............................................................................1.6 National Crime Agency v GTG Management Ltd [2020] EWHC 963 (Ch).................7.4 National Livestock Insurance Co, Re (1858) 26 Beav 153; 53 ER 855 .....................9.25 National Trustees Co of Australasia v General Finance Co of Australasia [1905] AC 373 .......................................................................................... 11.24, 17.10 National Westminster Bank Plc v Jones [2000] BPIR 1092 ......................................18.65 Natwest Markets Plc, Mercuria Energy Europe Trading Ltd v Bilta (UK) Ltd (In Liquidation) [2021] EWCA Civ 680 ..........................................6.46, 6.103, 7.47

xxi

TA BLE OF CASES

New World Alliance Pty Ltd, Re (1994) 122 ALR 531 .............. 13.3, 13.6, 13.35, 14.51 Nicholson v Fielding (Unreported), Ch D, 15 September 2017 ................................10.63 Nicholson v Permakraft (NZ) Ltd (1985) 3 ACLC 453 (NZCA) ..........2.43, 12.6, 12.30, 13.32, 14.3, 14.5, 14.13, 14.33, 14.52, 14.53, 14.55, 14.86, 15.28, 15.33, 15.77, 15.115 Noble Vintners Ltd, Re [2019] EWHC 2806 (Ch); [2020] BCC 198 .......................9.183 Norman v Theodore Goddard [1992] BCC 14 ...........................................................18.75 Northampton Borough Council v Anthony Michael Cardoza [2019] EWHC 26 (Ch); (related litigation– [2017] EWHC 2014 (Ch)) ...................................15.109 Northampton Coal Co v Midland Waggon Co (1878) 7 Ch D 500...........................16.41 Oasis Merchandising Services Ltd, Re [1995] BCC 911, affirmed on appeal [1997] 1 All ER 1009, [1997] BCC 282, (CA) .....................6.30, 6.118, 6.128, 9.5, 9.142, 9.173, 9.177, 9.187 Official Receiver v Doshi [2001] 2 BCLC 235 .................. 6.21, 9.17, 9.74, 9.148, 9.178 Official Receiver v Stern [2001] EWCA Civ 1787; [2002] 1 BCLC 119 ......................................................................................................12.6, 14.19, 17.3 Overnight Ltd (In Liquidation); Goldfarb v Higgins, Re [2009] EWHC 601 (Ch); [2010] EWHC 613 (Ch); [2010] BCC 787; [2010] 2 BCLC 186 ............6.13, 6.31, 6.121, 6.122 Oxford Pharmaceuticals Ltd, Re [2009] EWHC 1753 (Ch), [2010] BCC 838 .........15.14 PFTZM Ltd, Re [1995] BCC 280 .................................................................................2.25 Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd [1971] 2 All ER 1028 ............................................................................................6.43 Pantiles Investments Ltd (in liquidation), Re [2019] EWHC 1298 (Ch); [2019] BCC 1003; [2019] 2 BCLC 295...........................................6.22, 6.88, 16.31 Pantone 485 Ltd, Re [2001] EWHC 705 (Ch); [2002] 1 BCLC 266......... 12.6, 12.35, 14.8, 14.16, 14.23, 15.13, 15.14, 15.72, 15.91, 15.95 Paragon Finance plc v D B Thackerar [1999] 1 All ER 400 .....................................16.30 Parkin Elevator Co., Re (1916) 41 DLR 123 ...............................................................3.18 Paton, as liquidator of Ricky Martin (Racing) Limited v Kelly Martin, Elizabeth Martin, Richard John Martin [2016] SC AIR 57 ..................... 9.27, 9.145 Patrick & Lyon Ltd, Re [1933] Ch 786 .................................................. 5.4, 6.6, 7.1, 7.6, 7.17–7.19, 8.8 Paycheck Services 3 Ltd, Re [2008] EWHC 2200 (Ch); [2008] 2 BCLC 613; [2009] BCC 37; [2009] EWCA Civ 625; [2010] BCC 104; [2010] UKSC 51; [2010] 1 WLR 2793; [2011] BCC 1; [2011] 1 BCLC 141 (See Also Revenue and Customs Commissioners v Holland; Paycheck Services 3 Ltd, Re) ....................... 18.33, 18.68, 18.76, 18.77, 18.82, 18.88, 18.89 Peoples’ Department Stores Inc v Wise (1998) 23 CBR (4th) 200 ...........................13.33 Peoples’ Department Stores Inc v Wise [2004] SCC 68; (2004) 244 DLR (4th) 564; [2004] 3 SCR 461. .................................................................... 13.3, 13.27 Percival v Wright [1902] 2 Ch 421 ...............................................................................12.3 Peskin v Anderson [2000] BCC 1110, [2000] 2 BCLC 1, affirmed by the Court of Appeal, [2001] BCC 874 ........................................................................12.3 Phoenix Contracts (Leicester) Ltd (sub nom: Shepherd v Phoenix Contracts (Leicester) Ltd, Re [2010] EWHC 2375 (Ch) ....................................................15.43

xxii

TA BLE OF CASES

Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447; [1985] BCLC 385; (1985) 1 BCC 99; (1985) 1 BCC 99539 ......18.7, 18.13, 18.32, 18.55, 18.75 Primlake Ltd v Matthews Associates [2006] EWHC 1227 (Ch); [2007] 1 BCLC 686 ............................................................................................... 2.16, 16.12 Prod. Res. Grp. LLC v NCT Crp Inc. 863 A. 2d 772 (Del. Ch. 2004).....................15.42 Produce Marketing Consortium Ltd, Re (1989) 5 BCC 399 ..... 11.9, 11.10, 11.15, 11.20 Produce Marketing Consortium Ltd (in liq.) (No.2), Re (1989) 5 BCC 569; (1989) BCLC 520 ......................................... 6.21, 8.22, 9.6, 9.51, 9.58, 9.92, 9.100, 9.114, 9.119, 9.128, 9.130, 9.139, 9.140, 9.151, 9.152, 9.160, 9.166, 9.168, 9.172, 9.173, 10.1, 10.44, 11.9, 15.83 Progress Property Company Ltd v Moorgath Group Ltd [2010] UKSC 55; [2011] 1 WLR 1; [2011] 2 BCLC 332; [2011] BCC 196 .............. 18.7, 18.9, 18.11, 18.16, 18.18, 18.19, 18.21, 18.52 Pure Spirit Co v Fowler (1890) 25 QBD 235 ............................................................16.41 Purpoint Ltd, Re [1991] BCC 121; [1991] BCLC 491 .................... 6.22, 8.22, 8.26, 9.7, 9.71, 9.105, 9.111, 9.125, 9.132, 9.133, 9.142, 9.149, 9.154, 9.161, 9.163, 9.177, 10.18, 10.59, 15.83 Queensway Systems Ltd v Walker [2006] EWHC 2496 (Ch); [2007] 2 BCLC 577 ........................................................................ 18.12, 18.8, 18.83, 18.90 R R R R

v v v v

R R R R

v v v v

R R R R R R R R R R R R R R R

v v v v v v v v v v v v v v v

Berrada (1990) 91 Cr App R 131 (CCA) ..............................................................7.35 Gibson [1999] 2 Cr App R (S) 52 .........................................................................6.71 Ghosh [1982] QB 1053 (CCA) ..............................................................................7.14 Grantham [1984] 2 QB 675; [1984] 2 WLR 815; [1984] BCLC 270 (CCA)................................................... 6.72, 6.74, 6.104, 6.105, 7.2, 7.6, 7.23, 7.23, 7.25, 7.29, 7.32, 7.34, 7.37, 7.48 Inman [1967] 1 QB 140 (CCA); [1966] 3 All ER 414............................... 6.81, 7.53 Kemp [1988] QB 645 (CCA) ....................................................................... 6.72, 7.53 Lockwood (1986) 2 BCC 99,333 (CCA) .................................. 6.72, 6.85, 6.107, 7.6 Mackey [2012] EWCA Crim 2205; [2013] 1 Cr App R(S) 100...........................................................................................................................6.71 Miles [1992] Crim L R 657 ................................................................6.35, 6.44, 6.66 Mohammed Ali [2019] EWCA Crim 1263 .................................................. 6.70, 6.71 Peters [2019] EWCA Crim 1484............................................................................6.73 Pickerden [2018] EWCA Crim 1153 .....................................................................6.72 Rollafson [1969] 1 WLR 815 .................................................................................6.69 Say [2021] EWCA Crim 520 .................................................................................6.72 Sinclair [1968] 1 WLR 1246 ........................................................................ 7.25, 7.26 Smith [1996] 2 BCLC 109 (CCA) ......................................................5.12, 6.80, 6.81 Smith [1997] 2 Cr App R (S) 167 .........................................................................6.72 Smith and Palk [1997] 2 Cr App R (S) 167 ..........................................................6.70 Terry [1984] AC 374, 380–381 ................................................................................7.5 Waite (2003) WL 21162167 (CCA) .................................................6.43, 6.72, 6.104 Wallace Duncan Smith [1996] 2 CrApp R 1 ...........................................................6.9 Ward [2001] Cr App R (S) 14 ................................................................................6.72 Wax 1957 (4) SA 399 .............................................................................................7.16

xxiii

TA BLE OF CASES

Ralls Builders Ltd, No 2, Re [2016] EWHC 1812 (Ch); [2016] BCC 581............................................................................................................. 9.138, 9.150 Ralls Builders Ltd, Re [2016] EWHC 243 (Ch), [2016] BCC 293...............................................8.23, 8.28, 9.45, 9.47, 9.48, 9.54, 9.58, 9.60, 9.65, 9.76, 9.96, 9.115, 9.116, 9.118, 9.120, 9.127–9.129, 9.133, 9.138, 9.139, 9.142, 9.143, 9.155, 9.158, 9.159, 9.162, 9.184, 9.189, 10.3, 10.7, 10.14–10.16, 10.18, 10.19, 10.54, 10.59, 11.29, 11.30 Rance’s Case (1870) LR 6 Ch App 104......................................................................18.80 Regal (Hastings) v Gulliver (1942), [1967] 2 AC 134n ...............................................18.6 Regentcrest plc v Cohen [2001] BCC 494; [2002] 2 BCLC 80 ................... 12.42, 15.61, 16.49, 16.51 Revenue and Customs Commissioners v Holland; Paycheck Services 3 Ltd, Re [2010] UKSC 51; [2011] BCC 1 .........................................2.11, 2.15, 2.18, 2.24 Ridge Securities Ltd v IRC [1964] 1 All ER 275; [1964] 1 WLR 479 ......................18.8 Ring v Sutton (1980) 5 ACLR 546 ..................................................................... 12.6, 14.8 Roberts v Frohlich [2011] EWHC (Ch) 257, [2012] BCC 407, [2011] 2 BCLC 625 ..................... 9.53, 9.56, 9.76, 9.78, 9.111, 12.42, 13.23, 13.24, 14.23, 15.14, 15.26, 15.33, 15.61, 15.63, 15.79, 15.80, 16.49, 16.51 Royal Brunei Airlines Sdn Bhd v Tan [1995] 2 AC 378 .........................6.100, 7.8, 7.14, 7.41, 7.42, 7.46, 7.48 Rubin v Gunner [2004] EWHC 316 (Ch), [2004] BCC 684, [2004] 2 BCLC 110............................................9.52, 9.54, 9.74, 9.101, 9.111, 9.148, 15.81 SSF Realisations Ltd v Loch Fyne Oysters Ltd, Re [2020] EWHC 3521 (Ch); [2021] BCC 354 ................................................................ 18.61, 18.77, 18.82, 18.86 Salomon v A Salomon and Co Ltd [1897] AC 22............................. 2.4, 2.42, 8.14, 18.8 Saltri III Limited v MD Mezzanine SA Sicar and Ors [2012] EWHC 3025 (Comm); [2013] 2 BCLC 217 ....................................................................15.71 Sands v Clitheroe [2006] BPIR 1000 ............................................................................7.34 Sarflax Ltd, Re [1979] 1 Ch 592; [1979] 1 All ER 529 ...........................6.81, 6.85, 7.50 Sasea Finance Ltd v KPMG [2002] BCC 574............................................................13.35 Satyam Enterprises Ltd v Burton [2021] EWCA Civ 287; [2021] BCC 640............................................................................................................. 18.13, 18.85 Scott v Commissioners of Police for the Metropolis [1975] AC 819 ...........................7.7 Secretary of State for Business, Energy and Industrial Strategy v Selby [2021] EWHC 3261 (Ch) .......................................................................................2.23 Secretary of State for Business Innovation and Skills; Re UKLI Ltd [2013] EWHC 680 (Ch) .......................................................................................16.13 Secretary of State for Trade and Industry v Becker [2003] 1 BCLC 555......... 2.10, 2.19 Secretary of State for Trade and Industry v Creegan [2002] 1 BCLC 99, 101 (CA)...........................................................................................................12.6 Secretary of State for Trade and Industry v Deverell [2001] Ch 340; [2000] 2 WLR 907; [2000] 2 BCLC 133 (CA) ....................................................2.19 Secretary of State for Trade and Industry v Gash [1997] 2 BCLC 341 ....................9.101 Secretary of State for Trade and Industry v Gill [2004] EWHC 933 (Ch) ...............10.11 Secretary of State for Trade and Industry v Goldberg [2004] 1 BCLC 597 .............15.33 Secretary of State for Trade and Industry v Hollier [2006] EWHC 1804 (Ch); [2007] BCC 11. Secretary of State for Trade and Industry v Taylor [1997] 1 WLR 407; [1997] BCC 172 .................................................................. 9.101, 10.30, 10.51, 12.6

xxiv

TA BLE OF CASES

Secretary of State for Trade and Industry v Tjolle [1998] BCC 282; [1998] 1 BCLC 333 (CA) ................................................................... 2.10, 2.11, 2.14 Segenhoe Ltd v Akins (1990) 8 ACLC 263................................................................18.84 Selangor United Rubber Estates Ltd v Cradock (No.3) [1968] 1 WLR 1555 ..........18.76 Sequana. See BTI 2014 LLC v Sequana S.A.— Sevenoaks Stationers (Retail) Ltd, Re [1991] 1 Ch 164 (CA)...................................9.174 Sharpe, Masonic and General Life Assurance Company v Sharpe, Re [1892] 1 Ch 154 .............................................................................................18.76 Sheldon v RHM Outhwaite (Underwriting Agencies) Ltd [1996] AC 102 ...............16.32 Sherborne Associates Ltd, Re [1995] BCC 40, 54 ................ 6.33, 9.12, 9.16, 9.43, 9.70, 9.71, 9.90, 9.95, 9.100, 9.101, 15.33 Shuttleworth v Cox Bros and Co (Maidenhead) Ltd [1927] 2 KB 9 ........................16.50 Simmons Box (Diamonds) Ltd, Re [2000] BCC 275; [2001] 1 BCLC 176 (CA) ..................................................................................................... 4.10, 9.118 Singla v Hedman [2010] EWHC 902 (Ch), [2010] BCC 684 ...................................15.80 Sir Lindsay Parkinson & Co Ltd v Triplan Ltd [1973] 2 All ER 273; [1973] 1 QB 60 ........................................................................................ 16.39, 16.42 Smith and Fawcett Ltd, Re [1942] Ch 304 .................................................................12.38 Smithton Ltd (formerly Hobart Capital Markets Ltd) v Naggar [2014] EWCA Civ 939, [2015] 1 WLR 189, [2014] BCC 482 ............. 2.9–2.11, 2.14, 2.20 Sojourner v Robb [2006] 3 NZLR 808 .....................................................................15.119 South Pacific Shipping Ltd, Re (2004) 9 NZCLC 263 ................................................9.94 Spies v The Queen [2000] HCA 43, (2000); 201 CLR 603; (2000) 173 ALR 529 ........................................................................12.11, 13.3, 14.51, 14.51 Standish v Royal Bank of Scotland [2018] EWHC 1829 (Ch); [2019] EWHC 3116 (Ch) .....................................................................................16.14 Stanford International Bank Ltd (in liquidation) v HSBC Bank plc [2021] EWCA Civ 535; [2021] 1 BCLC 711 ............................................. 6.98, 7.39 Stanford Services Ltd, Re [1987] BCLC 607 .............................................................9.174 Starglade Properties Ltd v Nash [2010] EWCA Civ 1314 ...........................................7.45 Stocznia Gdanska SA v Latreefers Inc (No2) [2001] 2 BCLC 116 (CA) ...................9.34 Stone & Rolls Ltd v Moore Stephen [2009] UKHL 39 ..................................... 6.58, 6.59 Stonegate Securities Ltd v Gregory [1980] 1 Ch 576 ...................................... 3.6, 15.113 Strand Wood Co, Re [1904] 2 Ch 1 (CA) ..................................................................16.40 Sunlight Incandescent Gas Lamp Co. Re (1900) 16 TLR 535 ..................................16.37 Supply of Ready Mixed Concrete (No2), Re [1995] 1 AC 456 ..................................6.35 Sutherland dec’d, Re [1963] AC 235, [1961] 3 WLR 1062 ..........................................3.5 Sycotex Pty Ltd v Baseler (1994) 51 FCR 425; (1994) 122 ALR 531 .......................13.6 Sydlow Pty Ltd v Melwren Pty Ltd (1993) 13 ACSR 144 ........................................15.65 TMG Brokers Ltd v Staines [2021] EWHC 2033; [2021] EWHC 2033 ............18.6, 18.90 TMG Brokers Ltd, Re [2021] EWHC 1006 (Ch) ........................................... 18.67, 18.85 Tan Hung Yeoh v PP......................................................................................................6.82 Tea Corp Ltd, Re [1904] 1 Ch 12 ...............................................................................15.85 Termite Resources NL (in liq) v Meadows, in the matter of Termite Resources NL (in liq) (No 2) [2019] FCA 35 ....................................................15.56 Tesco Supermarkets Ltd v Nattrass [1972] AC 153 .....................................................6.56 Three Rivers DC v Bank of England (No. 3) [2003] 2 AC 1 .....................................6.23 Toone v Robbins [2018] EWHC 569 ................................................................ 18.6, 18.90 Tradestar Limited v Kevin Goldfarb [2018] EWHC 3595 (Ch) .....................6.109–6.111

xxv

TA BLE OF CASES

Trevor v Whitworth (1887) 12 App Cas 409 ..............................................................18.14 Tudor Furnishers Ltd v Montague & Co [1950] Ch 113 ...........................................16.41 Twinsectra Ltd v Yardley [2002] UKHL 12; [2002] 2 AC 164 ........................ 6.95, 6.96, 7.41–7.44, 7.48 UKLI Ltd, Re [2013] EWHC 680 (Ch); [2015] BCC 755 ................................ 2.13, 2.14 Ultraframe UK Ltd v Fielding & Ors [2005] EWHC 1638 (Ch); [2006] FSR 17 ...............................................2.16, 15.18, 15.27, 16.12, 16.13, 18.85 Vining Sparks UK Limited, Re [2019] EWHC 2885 (Ch) ............................... 6.86, 7.16 Virgin Active Holdings Limited, Re [2021] EWHC 1246 .........................................15.87 Viviendi SA v Richards [2013] EWHC 3006 (Ch); [2013] BCC 771..................................................................................................16.13, 16.14, 16.30 Wagner v White [2018] EWHC 2882 (Ch); (15 November 2017), (Ch D) .................................................................................................................15.117 Walker v Allen, High Court, 18 March 2004 ...............................................................9.94 Walker v Wimborne (1976) 137 CLR 1; (1976) 3 ACLR 529 ............ 12.9–12.12, 12.72, 14.7, 14.16, 14.86, 15.16, 15.94 Webb v Whiffin (1872) LR 5 HL 711 .........................................................................6.127 Welfab Engineers Ltd, Re [1990] BCC 600 ...............................................................15.65 Welham v DPP [1961] AC 103 ....................................................................7.5, 7.29, 7.32 Wessely v White [2018] EWHC 1499 (Ch) ................................................................15.88 Westmid Packing Service Ltd, Re [1998] 2 All ER 124 ................................................2.4 Westpac Banking Corporation v Bell Group Ltd (in liq.) (No. 3) [2012] WASCA 157 ...................................................................... 15.17, 15.71, 15.76, 15.94 Westpac Banking Corporation v Bell Group Ltd (in liq.) (No. 9) [2008] WASC 239 ............................................................................................................16.50 White and Osmond (Parkstone) Ltd, Re, (unreported) 30 June 1960..........................7.20 William C. Leitch Bros Ltd, Re [1932] 2 Ch 71 .........................6.25, 6.104, 6.114, 7.16, 7.18, 7.27, 7.28 William C. Leitch Bros Ltd (No. 2), Re [1933] Ch 261 ............................................6.127 William Hockley Ltd, Re [1962] 1 WLR 555 .................................................. 3.5, 15.119 Williams v Central Bank of Nigeria [2014] UKSC 10; [2014] AC 1189 .................16.31 Wingate v SRA [2018] EWCA Civ 366, [2018] 1 WLR 3969......................................7.8 Winkworth v Edward Baron Development Co Ltd [1986] 1 WLR 1512; [1987] 1 All ER 114............... 12.6, 12.16, 12.18, 12.58, 13.3, 13.21, 14.55, 15.114 Winter v IRC [1961] 3 All ER 855 ...........................................................................15.119 Woodgate v Davis (2002) 42 ACSR 28 ........................................................................8.26 World Expo Park v EFG (1995) 129 ALR 685 ..............................................................7.5 Wright v Frisina (1983) 1 ACLC 716 .........................................................................14.55 Wright and Rowley v Chappell; BHS Group Ltd, Re [2021] EWHC 3501 (Ch); [2022] 2 BCLC 145, allowed appeal BHS Group Ltd, Re [2022] EWHC 2205 (Ch) ............................................................ 9.72, 9.76, 9.117 Yan v Mainzeal Property and Construction Ltd [2021] NZCA 99 ............................9.159 Yukong Lines Ltd of Korea v Rendsburg Investments Corporation of Liberia (No2) [1998] BCC 870 ........................................ 12.27, 12.28, 14.29, 16.13

xxvi

TA B L E O F L E G I S L AT I ON (Primary and secondary)

Bankruptcy Act 1966 (Cth) s. 121................................................7.34 Betting and Gaming Duties Act 1972— s. 2(2) ............................................. 11.12 Civil Procedure Rules (‘CPR’) 1998, SI 1998/3132 ................................9.14 Pt. 7 .......................................4.12, 16.43 r. 12.13(2) ......................................16.39 r. 25.12 ................................16.37, 16.39 r. 25.13(1)(a) ..................................16.39 r. 25.13(2) ......................................16.39 r. 25.13(2)(c) .......................16.39, 16.40 Companies (Tables A–F) Regulations 1985, SI 1985/805 ..........................1.6 Table A, art. 70 ..................................1.6 Companies Act 1907 ..........................18.76 s. 32............................. 11.4, 11.7, 18.76 Companies Act 1928— s. 75.............................................5.2, 5.3 Companies Act (consolidated) 1929 ......6.6 s. 275..................................................5.3 Companies Act 1948 ...................6.40, 6.69 s. 332................................ 5.3, 5.4, 6.10, 6.35, 6.69, 6.72, 8.8 s. 333..............................................13.10 s. 333(1) .........................................13.10 Companies Act 1981— s. 96..................................................6.69 Companies Act 1985 ..............................1.6 s. 270.............................................. 11.11 s. 458........................5.5, 5.6, 6.43, 6.44 ss 459–461 .......................................16.6 s. 653................................................6.29 s. 727....................................11.7, 11.15, 11.17, 11.19, 11.20

Sch. 24 .............................................6.70 Companies Act 1990— s. 340(2) .............................................9.3 Companies Act 1993— s. 135.........................................9.3, 11.9 Companies Act 2006 ...............1.6, 1.8, 1.9, 2.3, 2.5, 2.33, 2.34, 2.44, 4.4, 4.13, 6.70, 11.4, 12.3, 12.44, 12.55, 13.6, 18.13, 18.26, 18.27, 18.48, 18.49, 18.51, 18.53, 18.58, 18.66, 18.67, 18.73, 18.92 Pt. II, Chs. 1, 2 .......................15.7, 16.5 Pt. 23 ..................................15.84, 18.31, 18.32, 18.40–18.42, 18.65, 18.66 Pt. 26 ..............................................15.84 Pt. 26A ...........................................15.87 s. 82..................................................2.35 s. 154(1), (2) ......................................2.3 s. 170(1) ...................................4.2, 12.7, 13.21, 16.3 s. 170(4) ...........................................13.5 ss. 171–177 ................................1.8, 9.7, 9.191, 11.8, 13.10, 18.67 s. 171..............................................18.67 s. 172........................ 12.51, 13.6, 13.10, 14.4, 17.8 s. 172(1) ...............................8.30, 10.41, 12.3, 12.5, 12.38, 12.46, 12.49–12.51, 13.6, 13.9, 13.49, 14.2, 14.6, 14.8, 14.15, 15.4–15.8, 15.43, 15.55, 17.8, 18.67 s. 172(1)(a)–(f).................................15.8

xxvii

TA BLE OF LEGISLATION

s. 172(3) ....................... 1.8, 9.23, 9.155, 10.55, 12.32, 12.34, 12.40, 12.44, 12.51–12.57, 12.66, 12.74, 13.6, 13.9, 13.10, 13.10, 13.33, 13.50, 14.4, 14.6, 14.9, 14.15, 15.3–15.7, 15.31, 15.33, 15.46, 15.63, 15.72, 15.79, 15.83, 15.98, 15.101, 15.104, 15.106, 16.12, 16.13, 16.48, 16.50, 17.1–17.3, 17.8, 17.11, 17.13, 18.41, 18.71, 18.92 s. 174..................................10.41, 13.10, 14.81, 16.13, 18.67 s. 178(2) .........................................13.10 s. 250..................................................2.3 s. 251(1) ...........................................2.17 s. 251(2) ...........................................2.17 ss. 260ff .............................................4.4 s. 260(3) .............................................4.4 s. 265(3) .............................................4.4 s. 266................................................16.5 ss. 395–397 ....................................18.49 s. 396...................................18.30, 18.43 s. 414..............................................18.49 ss. 580, 641 ......................................2.34 ss. 678, 679, 713, 719, 721 ............... 2.33 s. 727...................................18.89, 18.90 s. 741(1) ...........................................2.13 s. 761................................................2.35 s. 829(1) .........................................18.23 s. 829(2) .........................................18.24 s. 830......................... 2.34, 18.46, 18.73 s. 830(1) .........................................18.25 s. 830(2) ..............................18.25, 18.37 s. 830(3) .........................................18.26 s. 831...................................18.45, 18.47 s. 831(1), (2), (3) ...........................18.43 s. 831(4) .........................................18.44 s. 831(4)(c).....................................18.46 s. 831(5) .........................................18.45 ss. 832, 835 ....................................18.26 s. 836(1) .............................18.26, 18.30, 18.32, 18.33 s. 836(2) .........................................18.31 s. 836(2)(b) ....................................18.35 s. 836(3), (4) ..................................18.31 s. 837–839......................................18.31 s. 837..............................................18.32

837(2)–(4) ..................................18.32 838(2) .........................................18.33 838(3)–(6) ..................................18.49 839(1) .........................................18.33 839(2) .........................................18.35 839(3)–(5), (7) ...........................18.50 840..............................................18.36 841–844......................................18.37 845–846......................................18.38 847(2) .............................18.56, 18.57, 18.60 s. 847(3) .........................................18.57 s. 849..............................................18.39 s. 851(1) .........................................18.40 s. 993.............................. 2.32, 5.6, 5.12, 6.1, 6.4, 6.44, 6.66, 6.67, 6.70, 6.74–6.76, 6.125, 7.5, 7.35, 7.52, 7.53, 9.186 s. 993(2) ...........................................6.67 s. 994.....................................15.43, 16.6 s. 1028(1) .........................................6.29 s. 1032(1) .........................................6.29 s. 1121 .............................................. 11.7 s. 1121(2)(a) ..................................... 11.7 s. 1157 .......................... 6.126, 8.7, 11.1, 11.4, 11.5, 11.7, 11.10–11.12, 11.15, 11.17, 11.19, 11.21–11.23, 11.25–11.29, 11.32, 16.37, 17.7, 17.8, 17.9, 17.11, 18.62, 18.76, 18.77, 18.81, 18.86, 18.87, 18.89, 18.90 s. 1157(2) ....................................... 11.25 s. 1173 .....................................11.7, 17.7 Sch. 16 .............................................6.70 Companies Act 2006 (Consequential Amendments, Transitional Provisions and Savings) Order 2009, SI 2009/1941— Sch. 2, para. 1..................................6.70 Companies Act 2014— s. 610..................................................9.3 Companies (Model Articles) Regulations 2008, SI 2008/3229 ........................1.6 regs. 2, 4 ............................................1.6 Sch. 1, art. 5 ......................................1.6 Sch. 3, art. 5 ......................................1.6 Companies (Tables A–F) Regulations (as amended by SI 2007/2541 and SI 2007/2826—

xxviii

s. s. s. s. s. s. s. s. s. s.

TA BLE OF LEGISLATION

regs. 102, 104 ................................18.51 Companies (Model Articles) Regulations 2008, SI 2008/3229 reg. 30(1)–(4) .................................18.51 reg. 70(1)–(3) .................................18.51 Company Directors’ Disqualification Act 1986 ..............................4.3, 9.182 s. 4(1), (3) ......................................6.125 s. 6.......................................9.174, 9.183 s. 10.....................................6.178, 9.182 s. 10(1) ...........................................6.125 s. 10(2) ................................6.125, 9.186 s. 15A..................................9.181, 9.184 s. 15B .............................................9.183 s. 22(5) .............................................2.17 Company Law Enforcement Act 2001— s. 7......................................................9.4 Corporate Insolvency and Governance Act 2020 ............................8.17, 17.13 s. 12.......................................8.17, 17.13 s. 12(1) .............................................8.17 Sch. ZA1 .................................8.18, 8.20 Corporate Insolvency and Governance Act 2020 (Coronavirus) (Extension of the Relevant Period) Regulations 2021, SI 2021/375— reg. 2 ................................................8.20 Corporate Insolvency and Governance Act 2020 (Coronavirus) (Suspension of Liability for Wrongful Trading and Extension of the Relevant Period) Regulations 2020, SI 2020/1349— reg. 2 ................................................8.19 reg. 2(4) ...........................................8.19 Corporations Act (Australia) 2001 (Cth) ........................................... 11.21 s. 588G ..................................8.26, 10.62 s. 588R ...............................................9.3 s. 1318............................................ 11.21 Criminal Justice Act 1991— s. 8(1) ...............................................7.35 s. 17..................................................6.70 Enterprise Act 2002............3.15, 9.2, 9.174 Finance Act 2020— s. 98..................................................3.17 s. 99 ..............................................3.17

Forgery Act 1913— s. 4....................................................7.29 Fraud Act 2006— s. 9....................................................6.76 s. 10(1) .............................................6.70 Insolvency Act 1985 ................... 8.11, 8.15 s. 15................................................. 8.12 Insolvency Act 1986 ...............1.8, 1.9, 2.3, 2.36, 2.44, 4.5, 5.7, 5.9, 9.18, 9.175, 10.53, 12.66, 13.7, 13.38, 18.15, 18.77 Pt. 12 ................................................4.12 s. 112 .........................................6.12, 9.5 s. 122(1)(g) ......................................6.16 s. 123(1)(e).....................................14.27 s. 123(2) ..............................14.27, 14.31 s. 124(1) ..............................10.35, 10.53 s. 124A.............................................6.81 s. 127................................................6.28 s. 168(5) ........................ 6.12, 9.5, 16.10 s. 175................................................3.14 s. 176A.............................................16.9 s. 176ZA.........................................9.176 s. 176ZB.................... 6.22, 9.165, 9.175 s. 176ZB(2) ....................................9.175 s. 212...............................2.36, 4.9–4.13, 6.22, 9.7, 9.163–9.165, 9.179, 12.9, 13.10, 15.100, 16.8, 16.43, 18.68, 18.77, 18.86, 18.88, 18.89 s. 212(1) .........................................13.10 s. 213.................................. 4.6, 5.5, 5.8, 5.9, 5.12, 6.1–6.4, 6.6, 6.10, 6.13–6.16, 6.18, 6.19, 6.21–6.23, 6.28, 6.30, 6.31, 6.33, 6.35, 6.36, 6.41, 6.45, 6.46, 6.49, 6.61, 6.64, 6.66–6.68, 6.81, 6.82, 6.84–6.86, 6.89, 6.106, 6.108–6.111, 6.114, 6.115, 6.119, 6.121, 6.125, 6.128, 6.129, 7.1, 7.7, 7.12, 7.13, 7.21, 7.26, 7.28, 7.30, 7.35, 7.36, 7.50, 7.52, 7.53, 9.6, 9.139, 9.142, 9.147, 9.158, 9.175, 11.21 s. 213(1) ..................................6.41, 6.80 s. 213(2) ..................................6.45, 6.49

xxix

TA BLE OF LEGISLATION

s. 214...........................4.6, 5.5, 5.8, 6.4, 6.21, 6.26, 6.31, 6.33, 6.118, 6.128, 8.1, 8.3–8.7, 8.14, 8.15, 8.21, 8.22, 8.24–8.26, 8.28– 8.31, 8.34, 9.1, 9.2, 9.5–9.8, 9.11, 9.12, 9.17, 9.20, 9.29, 9.30, 9.32, 9.34, 9.36, 9.40, 9.62, 9.67, 9.73, 9.107, 9.110, 9.122, 9.126, 9.136, 9.140, 9.142, 9.151, 9.156, 9.163, 9.164, 9.169, 9.171, 9.173, 9.175, 9.178–9.180, 9.182, 9.186, 9.187, 9.188, 9.191, 10.1, 10.8, 10.15, 10.18, 10.47, 10.62, 11.1, 11.9, 11.10, 11.12, 11.14, 11.15, 11.21–11.23, 11.25, 11.27–11.29, 11.32, 12.47, 15.23, 15.78, 18.42 s. 214(1) ..................... 8.4, 9.115, 9.125, 9.128, 9.147 s. 214(2) ...................................8.4, 9.10, 9.68, 9.79 s. 214(2)(a).......................................9.24 s. 214(2)(b) ................... 9.35, 9.74, 9.85 s. 214(3) ...................................8.4, 8.25, 9.16, 9.108, 9.127–9.129, 9.158, 9.191, 10.2, 10.3, 10.9, 10.12, 10.14–10.16, 10.59, 11.2 s. 214(4) ....................... 9.36, 9.39, 9.43, 9.44, 9.55, 9.100, 9.103, 10.3, 10.5, 16.18–16.24 s. 214(5) ................................9.39, 9.103 s. 214(6) ....................................8.4, 9.24 s. 214(7) ...........................................9.32 s. 214(8) ....................................6.21, 9.6 s. 215....................... 6.123, 6.124, 9.169 s. 215(1) ..................................6.34, 9.22 s. 215(2) ..............................6.123, 9.169 s. 215(2)(a), (b)...................6.123, 9.169 s. 215(4) ..............................6.123, 9.170 s. 216............................. 2.37, 6.89, 6.90 ss. 235, 236 ......................................9.13 s. 238....................2.37, 6.32, 7.5, 14.67 s. 239.............................. 2.36, 6.32, 7.5, 7.50, 9.155, 9.156, 9.158, 13.8, 14.35, 14.67, 15.99, 15.101, 15.103, 15.110

xxx

s. s. s. s. s. s.

239(2) .........................................14.35 240..............................................15.99 240(1) .........................................14.35 240(2) .........................................14.67 245............................... 1.8, 6.32, 7.17 246ZA........................... 4.6, 5.9, 6.10, 6.15, 6.18, 6.31, 6.124 s. 246ZB.................................4.6, 6.124, 6.128, 8.1–8.3, 8.15, 9.2, 9.3, 9.20, 9.24, 16.18, 16.22, 189.42 s. 246ZB(2) ....................................6.128 s. 246ZB(2)(a), (6)(a) ......................9.24 s. 246ZC.........................................6.124 s. 246ZD(2)(b) ...................................9.5 s. 251............................... 2.3, 2.17, 9.32 s. 386................................................3.14 s. 423.............................. 1.8, 2.36, 7.34, 7.50, 13.48, 18.30, 18.64, 18.65 Sch. B1...........................................10.37 Sch. B1, para. 75 .............................4.14 Sch. 6 ...............................................3.14 Insolvency Act 1986 (HMRC Debts: Priority on Insolvency) Regulations 2020, SI 2020/983 ......................9.174 reg. 2 ................................................3.17 Insolvency, Restructuring and Dissolution Act 2018— s. 239................................................9.29 Insolvency Rules 2016— Pt. 12 ............................. 4.12, 6.18, 9.20 rr. 6.44–6.48 ...................................9.176 rr. 7.111–116 ..................................9.176 r. 14.1(5) ...................................3.3, 9.26 r. 14.1(6) ...................................3.3, 9.25 Late Payment of Commercial Debts (Interest) Act 1998 .............2.38 Limitation Act 1980 ...........................16.25 s. 9....................................................6.31 s. 9(1) .................................................9.8 s. 21................................................16.28 s. 21(1) ................................16.29–16.31 s. 21(1)(a)............................16.30, 16.31 s. 21(1)(b) ......................................16.30 s. 21(3) ...............................16.28–16.30, 16.32

TA BLE OF LEGISLATION

s. 32.....................................16.32, 16.34 s. 32(1)(b) ......................................16.32 s. 32(2) ...........................................16.32 Limited Liability Partnerships (Application of Companies Act 2006) Regulations 2009, SI 2009/1804 ................................6.75 reg. 47 ..............................................6.75 Limited Liability Partnerships Regulations 2001, SI 2001/1090 ................................6.14 reg. 5 ................................................6.14 Sch. 3 ...............................................6.14 Magistrates’ Courts Act 1980— s. 32..................................................6.70 Model Articles....................................18.51 arts. 34, 76 .....................................18.51

Small Business, Enterprise and Employment Act 2015— s. 110 ..............................................9.181 s. 117 ...........................................5.9, 8.2 s. 119 ...................................6.128, 9.175 s. 120................................................6.17 Small Business, Enterprise and Employment Act 2015 (Commencement No.2 and Transitional Provisions) Regulations2015, SI 2015/1689— reg. 2(j) ...............................6.128, 9.175 Social Security Act 1975.................... 11.12 s. 448.............................................. 11.12 Theft Act ..............................................7.14 Trustee Act 1925 ................................18.62 s. 61.......................................11.4, 18.62

xxxi

PA RT A

INTRODUCTION

CHAPTER 1

Background

Unpaid Debts and Creditors 1.1 A fact of life is that some creditors will, unfortunately, not get paid by a company which owes them money. This is often a common occurrence. Nonpayment might lead to a prolonged argument about what is owed, and creditors may take a variety of steps to ensure that they do in fact get paid eventually. This might involve simply instituting proceedings against the company on the basis of a breach of contract, or it may entail the creditors presenting a winding-up petition against the company in order to try and force the company to pay. This book does not seek to address these matters. What it seeks to do is to address those proceedings that might be taken against directors, usually by liquidators or administrators, where creditors have not been paid and the company has entered some formal insolvency procedure because it is unable to pay its debts. Where such a procedure has been instigated the company will not be able to pay all creditors in full (save in a very exceptional case), so that is why a liquidator or administrator might consider taking action against directors if the liquidator or administrator believes that the directors have in fact breached a duty or responsibility to the company before the entry into liquidation or administration. 1.2 The law that permits actions to be brought against directors is designed to protect creditors in various ways. We will return to consider creditors in some detail in Chapter 3. Directors 1.3 Whether a creditor is paid or not is likely to be a matter that falls, ultimately, to the directors of the debtor company, and this is especially so in small companies. In larger companies managers at below board level are likely to make decisions about the payment of creditors, especially when the creditors are not owed huge sums. Directors in larger companies might have to make decisions when asked by managers, and they will certainly have to do so when there are questions about paying large and/or critical creditors. It might in fact be necessary for directors to negotiate with creditors. 1.4 The directors of a company are members of a board, and the board is said to be the heart of a company. This is because a board manages the affairs DOI: 10.4324/9780429266232-2

3

BACKGROU N D

of the company. In large companies it is impossible for the shareholders to do so, as there are often many of them, and too many for them to meet together on a regular basis and to discuss strategy and the direction of the company. While in small companies the shareholders might be so few that they could practically direct the life of the company, they must, under the law, have at least one director, and often all of the shareholders are also directors. These types of companies are often known as owner-managed companies in that the shareholders are seen as the owners of the company (although technically in law they are not) and they conduct the management process. 1.5 Unlike the practice in many other countries around the world, such as Germany, which involves companies having two boards, a management board and a supervisory board, UK companies only have one board. It is a management board but companies other than small ones will have as members of the board persons known as non-executive directors who have, as one of their functions, the role of supervisors of the work of the executives and managers; they do this on behalf of the shareholders. 1.6 Usually, the company’s articles of association will vest the directors, elected by the shareholders at a general meeting, with very broad general management powers, many of which are then delegated to company managers and officers. Examples of broad power are found in art 70 of Table A of the Companies (Tables A–F) Regulations 19851 (for companies incorporated under the Companies Act 1985) and reg 2 and Sch 1, art 5 (private companies) and reg 4 and Sch 3, art 5 (public companies) of the Companies (Model Articles) Regulations 20082 (for companies incorporated since the enactment of the Companies Act 2006) (‘the Act’). The foregoing regulations will apply to a company where it has not excluded the relevant regulations which apply to it. Even where companies have excluded these regulations, which they are entitled to do, they usually adopt an article that will award the directors broad powers to ensure that directors are not hamstrung in the management of the company. The wide-ranging powers that are normally given to the directors by the articles can only be exercised by the directors, and the only action that the shareholders might be able to take is to pass a special resolution to amend the articles; the shareholders cannot interfere in the exercise of the management power except in very limited circumstances.3 1.7 According to one judge: ‘A director is an essential component of corporate governance. Each director is placed at the apex of the structure of direction and management of a company.’4 So, directors are important, and holding the post of a director brings with it a considerable number of obligations and responsibilities. These are set out in hard law, like the Act and case law and, for some

1 SI 1985/805. 2 SI 2008/3229. 3 John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113, 134; NRMA v Parker (1986) 4 ACLC 609, 613–614. See, Automatic Self-Cleansing Filter Syndicate Co Ltd v Cunninghame [1906] 2 Ch 34, 44; Ashburton Oil NL v Alpha Minerals NL (1971) 123 CLR 614. 4 ASIC v Healey [2011] FCA 717, [14] per Middleton J.

4

BACKGROU N D

directors, in soft law, such as the UK Corporate Governance Code 20185 or the Wates Corporate Governance Principles for Large Private Companies.6 We will not address many of these responsibilities in this book. Rather, we will focus on those obligations and responsibilities that relate directly to the losses that creditors might sustain if they are not paid by a director’s company. The fact is that many things that a director or a board does could lead to a company’s collapse and losses to creditors. 1.8 It is not intended to deal with the general duties imposed on directors under the Act,7 the duties of loyalty (fiduciary) and care. These are very important, but they have been discussed in detail elsewhere.8 While the book deals with directors’ responsibilities in relation to losses that creditors might sustain from dealing with the directors’ company, the book does not address the adjustment provisions contained in the Insolvency Act 1986. Thus, no consideration is given to directors making preference payments to creditors,9 entering into transactions at an undervalue, engaging in defrauding creditors (as envisaged by s 423 of the Insolvency Act 1986) or creating charges that are invalid under s 245 of the Insolvency Act 1986.10 1.9 Some responsibilities of directors are relatively minor and procedural, while others are more onerous and serious as far as consequences are concerned if the directors fail to meet the responsibilities. While directors’ responsibilities are set out under different legislative instruments, the responsibilities which are of concern in this book are found in the Act and the Insolvency Act 1986. Some obligations of directors are mentioned in Chapter 2. 1.10 The imposition of responsibilities on directors is done, inter alia, to make directors accountable for what they do or do not do.11 The Format, Approach and Purpose of the Book 1.11 Including this part, Part A, which is introductory in nature, the book consists of five parts. Part A introduces the book and its aims and scope. It will 5 www.frc.org.uk/getattachment/88bd8c45-50ea-4841-95b0-d2f4f48069a2/2018-UK-CorporateGovernance-Code-FINAL.PDF, accessed 31 March 2020. 6 Published by the Financial Reporting Council in December 2018. See: www.frc.org.uk/ getattachment/31dfb844-6d4b-4093-9bfe-19cee2c29cda/Wates-Corporate-Governance-Principlesfor-LPC-Dec-2018.pdf, accessed 31 March 2020. 7 Sections 171–177. 8 For instance, see Simon Mortimore (ed), Company Directors: Duties, Liabilities and Remedies (3rd ed, OUP, 2017); Andrew Keay, Directors’ Duties (4th ed, LexisNexis, 2020). 9 Although the book does consider in later chapters whether an action might succeed under s 172(3) of the Act against directors if preference-like transactions are entered into when a company is insolvent or is in the vicinity of insolvency. 10 For in depth consideration of the relevant provisions, see, for example, John Armour and Howard Bennett, Vulnerable Transactions in Corporate Insolvency (Hart Publishing, 2003); Rebecca Parry et al., Transactional Avoidance in Insolvencies (3rd ed, OUP, 2018); Andrew Keay, McPherson and Keay’s The Law of Company Liquidation (5th ed, Sweet and Maxwell, 2021), Chapter 11. 11 For a detailed discussion of the accountability of directors, see A Keay, Board Accountability and Corporate Governance (Routledge, 2015); A Keay, P Walton and J Curl QC, Corporate Governance in Insolvency Law: Accountability and Transparency (Edward Elgar, 2022).

5

BACKGROU N D

place directors in context and deal with matters such as who are directors and creditors and the obligations of directors, as well as the likely claimants in actions brought against directors. Fraudulent trading is discussed in Part B, wrongful trading in Part C and the obligation of directors to take into account the interests of creditors is addressed in Part D. Part E then considers situations where directors might be liable for the diminution of the funds of their companies. It deals with the distribution of company funds, and in particular the payment of dividends to shareholders. While the focus of the book is on the UK, reference is made, in places, to legislation and common law operating in other common law jurisdictions, particularly Ireland, Australia and New Zealand. 1.12 The work endeavours to provide a critical doctrinal study of the law that presently exists in the UK in relation to the areas mentioned in the previous paragraph. This involves an analytical examination of the relevant legislative provisions and case law, and it will incorporate engagement with some of the literature written by practitioners and academics where relevant to the exposition of the law. The book generally eschews making normative arguments, although in places it does highlight some of the shortcomings of the law.

6

CHAPTER 2

Directors

Introduction 2.1 It is necessary as a starting point to consider the two main groups with which this book is concerned, namely directors and creditors. This will be done in this chapter and the next. Far more emphasis will be placed on directors as we are focusing on their responsibilities, but we must not lose sight, in general terms, of those to whom these responsibilities are owed, albeit indirectly. General 2.2 It is not intended to indulge in an examination of the roles and work of directors, save in limited terms, as standard company law texts provide discussions of these matters, but it is appropriate that we say something about who are directors. Principally, we are concerned about noting who they are in legal terms and not delving into how they operate in practical terms. 2.3 All companies are required by law to have at least one director,1 with public companies required to have two.2 The latter type of company will usually have far more than two. The Companies Act 2006 (‘the Act’) provides in s 250, and the Insolvency Act 1986 does so in s 251, that a director includes anyone occupying the position of director ‘by whatever name called.’ This means that a person can be a director even if he or she does not have that title. So, it is not necessarily critical before a person is to be regarded as a director for the purposes of company law that he or she is called ‘a director’; what is critical is whether a person occupies the position of director. Unfortunately, there is no legislative interpretation of ‘occupying the position of a director.’ 2.4 In becoming directors, persons should realise the important duties that they owe, the extensive powers they wield and the substantial obligations and responsibilities with which they must comply.3 A critical point is that notwithstanding the extent of a director’s obligations, a director is not usually personally liable for the liabilities of his or her company because of the fact that a director’s company 1 Companies Act 2006, s 154(1). 2 Companies Act 2006, s 154(2). 3 Re Westmid Packing Service Ltd [1998] 2 All ER 124, 130–131.

DOI: 10.4324/9780429266232-3

7

DIR ECTORS

is a separate legal entity.4 However, as we will see in this book, directors might be held liable for company liabilities in certain circumstances. 2.5 In practice directors can be divided into either executive directors or nonexecutive directors, although one does not find these designations mentioned in the Act. The former types of directors are employed full time by the company, and in some companies they might be appointed to specific posts, such as finance director or sales director. In contrast the non-executive directors are not engaged on a full-time basis. They are appointed to provide expertise and experience for the board and are usually paid annual retainers and expenses for giving their advice and attending board meetings. While non-executive directors are not required to engage in as much and as detailed work as executives, the Act does not distinguish between executive and non-executive directors when imposing duties and obligations on directors, although more will usually be expected of executive directors because of the nature of their full-time role. Effectively, there are three main kinds of directors: • De jure • De facto • Shadow 2.6 Before briefly discussing these different kinds of directors, it should be pointed out that there are other kinds of directors. First, companies might have nominee directors, who are de jure directors owing their appointment due to some third person, often a member or members of the company who hold a strong position in relation to company affairs. Secondly, an alternate director is a person who only acts temporarily on behalf of a director who has nominated the alternate to act for him or her on the board when the director is absent, perhaps because of illness or other pressing commitments. The articles of association must, and often they will, permit the nomination of an alternate. De Jure Directors 2.7 These directors are those who have been formally appointed by their consent, and according to the company’s articles. Such appointments will appear on the company records held by Companies House, and these records can be searched in order to check whether a person is actually appointed as a director. 2.8 All of the obligations that are discussed in this book apply to de jure directors. De Facto Directors 2.9 There is no legislative provision that defines the term, ‘de facto director,’ but it has been used for a long time5 and covers a person who is held out as a 4 Salomon v Salomon and Co Ltd [1897] AC 22. 5 Re Kaytech International plc [1999] 2 BCLC 351 (CA).

8

DIR ECTORS

director by the company, claims to be one and acts as a director while never being appointed according to law. A de facto director assumes the functions and status of a director. The person might not be appointed legally as a as a de jure director as a result of some defect in the appointment,6 but more often than not it covers someone who is not appointed but is involved in directorial roles. If a person had assumed responsibility to act as a director, then the court would have to determine in what capacity the person was acting.7 As one would expect, usually the name of a person alleged to be a de facto director is not to be found on the company’s records held at Companies House. A de facto director is a person who assumes the functions and status of a director.8 2.10 A person will only be held to be a de facto director if it can be established that he or she carried out director-like functions that could only be discharged by a director.9 There is not one decisive test that establishes that a person is or is not a de facto director. Courts have to take into account all relevant factors, including: • whether there was a holding out of the person as a director;10 • whether the person used the title;11 • whether the person had proper information on which to base decisions;12 and • whether the person had to make major decisions.13 2.11 But none of these factors are necessarily decisive on their own,14 for the case law plainly states that there is no one decisive test for determining if someone is a de facto director.15 Courts have to take into account all relevant factors.16 In Elsworth Ethanol Co Ltd v Hartley17 HH Judge Hacon (sitting as a High Court judge) said that a court was permitted to consider all relevant factors in arriving at a decision in the person’s position. This included whether the person acted as an equal of one or more of the directors.

6 This occurred in Re Canadian Land Reclaiming and Colonizing Co (1880) 14 Ch D 660. Also, see Corporate Affairs Commission (NSW) v Drysdale (1978) 141 CLR 236. 7 Smithton Ltd (formerly Hobart Capital Markets Ltd) v Naggar [2014] EWCA Civ 939, [2015] 1 WLR 189, [2014] BCC 482, [36]. 8 Re Kaytech International plc [1999] 2 BCLC 351 (CA). 9 Re Hydrodan (Corby) Ltd [1994] BCC 161, [1994] 2 BCLC 180; Secretary of State for Trade and Industry v Becker [2003] 1 BCLC 555. 10 Secretary of State for Trade and Industry v Tjolle [1998] 1 BCLC 333 (CA); Re Mumtaz Properties Ltd [2011] EWCA Civ 610, [2012] 2 BCLC 109. 11 Ibid; Smithton Ltd (formerly Hobart Capital Markets Ltd) v Naggar [2014] EWCA Civ 939, [2015] 1 WLR 189, [2014] BCC 482. 12 Secretary of State for Trade and Industry v Tjolle [1998] 1 BCLC 333 (CA). 13 Ibid. 14 Ibid. 15 Revenue and Customs Commissioners v Holland; Re Paycheck Services 3 Ltd [2010] UKSC 51, [2011] BCC 1; Re Mumtaz Properties Ltd [2011] EWCA Civ 610, [2012] 2 BCLC 109; Smithton Ltd (formerly Hobart Capital Markets Ltd) v Naggar [2014] EWCA Civ 939, [2015] 1 WLR 189, [2014] BCC 482, [33]. 16 Re Mumtaz Properties Ltd [2011] EWCA Civ 610, [2012] 2 BCLC 109. 17 [2014] EWHC 99 (IPEC).

9

DIR ECTORS

2.12 In the Australian case of Deputy Commissioner of Taxation v Solomon18 two persons who had resigned as directors of a company were held to be de facto directors because they were involved in the main activity of the company, performed top-level management functions, acted for the company in important matters and outsiders perceived that they were directors. Specifically, one of the persons had daily contact with directors, had the right to approve an asset sale and was actively involved in the preparation of projections of cash flow. The other person was involved in negotiations with directors and third parties in relation to possible capital injections into the company, sought professional advice for the company and also was actively involved in the preparation of projections of cash flow. 2.13 Persons does not have to believe that they are directors before they are held to be de facto directors,19 but they must presume to act as if they were directors.20 Also, a person does not have to be actually referred to as a director, for according to s 741(1) of the Act a director includes anyone occupying the position of director ‘by whatever name called.’ Consequently, the law is concerned with the substantive nature of what the person does in the life of the company, rather than to how he or she is referred. 2.14 The critical matter seems to be that for a person to be classified as a de facto, he or she has to have been part of the corporate governance structure.21 To be successful in alleging someone has acted as a de facto director a claimant must demonstrate that the person assumed the status and functions of a company director and exercised ‘real influence’ in the corporate governance of the company.22 It is likely that the nature of the functions or powers which are exercised and the extent of their exercise will be of great importance;23 that is, the person performs, and the acts subject to complaint, must be such as could only be undertaken by a director, not ones which could properly be performed by a manager or other employee below board level.24 The role of a de facto director need not extend over the whole range of a company’s activities,25 provided it covers that area of the company’s affairs about which a claim is concerned.26 2.15 The fact is that whether a person is a de facto director or not will depend upon the specific facts of each case, and there is no clear legal test to help one decide whether a person is or is not a de facto.27 18 (2003) 199 ALR 325. 19 Re Kaytech International Plc [1999] 2 BCLC 351. 20 Re UKLI Ltd [2013] EWHC 680 (Ch), [2015] BCC 755, [41]. 21 Secretary of State for Trade and Industry v Tjolle [1998] BCC 282, [1998] 1 BCLC 333, 344; Re Mumtaz Properties Ltd [2011] EWCA Civ 610, [2012] 2 BCLC 109; Re UKLI Ltd [2013] EWHC 680 (Ch), [2015] BCC 755, [41]; Re Keeping Kids Company [2021] EWHC 175, [167]. 22 Re Kaytech International Plc [1999] 2 BCLC 351, 423; Gemma v Davies [2008] EWHC 546 (Ch), [2008] BCC 812, [40]; Re UKLI Ltd [2013] EWHC 680 (Ch), [2015] BCC 755, [41]. 23 Deputy Commissioner of Taxation v Austin (1998) 16 ACLC 1555, 1559. 24 Re UKLI Ltd [2013] EWHC 680 (Ch); [2015] BCC 755, [41]. 25 Smithton Ltd (formerly Hobart Capital Markets Ltd) v Naggar [2014] EWCA Civ 939, [2015] 1 WLR 189, [2014] BCC 482, [32]. 26 Re UKLI Ltd [2013] EWHC 680 (Ch), [2015] BCC 755, [41]. 27 Revenue and Customs Commissioners v Holland; Re Paycheck Services 3 Ltd [2010] UKSC 51, [2011] BCC 1; Re Instant Access Properties Ltd [2018] EWHC 756, [217].

10

DIR ECTORS

2.16 If a person is regarded as a de facto director then he or she owes the same duties and responsibilities that are owed by a de jure director.28 Shadow Directors 2.17 While the definition in s 251(1) of the Act only encompasses de jure and de facto directors, there is another type of director recognised by the law, and that is the shadow director. This kind of director is recognised in s 251(2) of the Act, s 251 of the Insolvency Act 1986 and s 22(5) of the Company Directors’ Disqualification Act 1986. Section 251(2) of the Act provides that a shadow director means ‘a person in accordance with whose directions or instructions the directors of the company are accustomed to act.’ The sub-section then states that persons are not deemed to be shadow directors just because the directors act on their advice, in situations where the advice is given in a person’s professional capacity. Ordinarily, this will exclude as shadow directors people such as lawyers, accountants and auditors. But, while professional advisers are not considered to be shadow directors, they might act in such a way that they cross the line and move from advising to instructing. A company can be a shadow director.29 2.18 As with trying to determine who are de facto directors, it is difficult to ascertain, in many cases, who is a shadow director. Again, with de facto directors there is no clear legal test to help one decide whether a person is or is not a shadow.30 2.19 In determining whether a person is a shadow director, courts will look at the communications between the alleged shadow and the board, and ascertain, from an objective perspective, whether those communications might be able to be regarded as directions or instructions. In this regard the outcome of the communication is the important element on which to focus.31 There is no need to establish the fact that the giver of instructions expected them to be followed.32 If the board is able to be characterised as subservient to a particular person, that indicates shadow directorship, but it is not necessary to establish subservience before one can deem a person to be a shadow director.33 It is necessary to establish that the directors acted on more than one occasion on the instructions or directions of a person for him or her to be regarded as a shadow, but there is no need to prove that the directors either constantly took instructions during

28 Re Canadian Land Reclaiming and Colonizing Co (1880) 14 Ch D 660, 670 (CA); Ultraframe UK Ltd v Fielding [2005] EWHC 1638 (Ch), [2006] FSR 17, [1257]; Primlake Ltd v Matthews Associates [2006] EWHC 1227 (Ch, [2007] 1 BCLC 686, [284]; Instant Access Properties Ltd v Rosser [2018] EWHC 756 (Ch), [254]. 29 Re a Company No 005009 of 1987 (1988) 4 BCC 424. 30 Revenue and Customs Commissioners v Holland; Re Paycheck Services 3 Ltd [2010] UKSC 51, [2011] BCC 1; Re Instant Access Properties Ltd [2018] EWHC 756, [217]. 31 Secretary of State for Trade and Industry v Deverell [2001] Ch 340, [2000] 2 WLR 907, [2000] 2 BCLC 133 (CA). 32 Ibid. 33 Ibid.

11

DIR ECTORS

the life of the company or even for a significant period of time from the person alleged to be a shadow.34 2.20 Just as with de facto directors, it is not a requirement before a person is deemed to be a shadow director that the person exercises influence over the whole field of activities of the company.35 2.21 While a shareholder always could be held to be a shadow, the fact that a particular shareholder is an influential shareholder would not make him or her a shadow director necessarily.36 Distinguishing Between De Facto and Shadow Directors 2.22 At one time it was thought that it was necessary to distinguish between a person who was acting as a de facto director and a person who was acting as a shadow director. This was because, it was said, the terms did not overlap.37 In Re Kaytech International plc38 Robert Walker LJ (as he then was) tentatively said that the two different designations were not necessarily mutually exclusive.39 His Lordship said: the two concepts do have at least this much in common, that an individual who was not a de jure director is alleged to have exercised real influence (otherwise than as a professional adviser) in the corporate governance of a company. Sometimes that influence may be concealed or sometimes it may be open. Sometimes it may be something of a mixture, as the facts of the present case show.40

2.23 Recently in Secretary of State for Business, Energy and Industrial Strategy v Selby41 ICC Judge Prentis recognised that the same person may at times be a shadow director and at times a de facto director. 2.24 The Supreme Court in Revenue and Customs Commissioners v Holland; Re Paycheck Services 3 Ltd42 acknowledged that the tests for de facto and shadow directors do overlap and are not mutually exclusive. Thus, the hard distinctions between the two kinds of directors appear to have been blurred.43 2.25 Nevertheless, while there are clear overlaps between the two designations, there are distinctions to be made between the two types of directors. For instance, de facto directors claim, and purport, to act for the company as directors and are held out as such by the company even though they have never 34 Secretary of State for Trade and Industry v Becker [2003] 1 BCLC 555. 35 Re Mumtaz Properties Ltd [2011] EWCA Civ 610, [2012] 2 BCLC 109, [35]; Smithton Ltd (formerly Hobart Capital Markets Ltd) v Naggar [2014] EWCA Civ 939, [2015] 1 WLR 189, [2014] BCC 482, [32]. 36 Instant Access Properties Ltd v Rosser [2018] EWHC 756 (Ch), [227]. 37 Re Hydrodan (Corby) Ltd [1994] BCC 161, 163. 38 [1999] 2 BCLC 351. Also, see Secretary of State for Trade and Industry v Hollier [2006] EWHC 1804 (Ch), [2007] BCC 11. 39 [1999] 2 BCLC 351. 40 Ibid, 423. 41 [2021] EWHC 3261 (Ch), [18]. 42 [2010] UKSC 51, [2011] BCC 1. 43 Re Instant Access Properties Ltd [2018] EWHC 756 (Ch), [217].

12

DIR ECTORS

been appointed properly. In contrast, shadows do not make a claim to act for the company as directors; on the contrary they usually maintain that they are not directors. Shadows tend to act behind the scenes (although this is not necessarily required for a person to be regarded as a shadow director) and hide behind the de jure directors of the company, perhaps ‘pulling the strings,’44 while the activity of de facto directors may well be more obvious. Executive and Non-Executive Directors 2.26 As discussed in Chapter 1, directors can be classified as either executive directors or non-executive directors. The companies’ legislation does not (and never has) recognise this distinction, but it is in practice and in soft law instruments, such as the UK Corporate Governance Code 2018. In legislation and in common law rules dealing with directors the same approach is employed in relation to both executives and non-executives, although in determining what directors should have done in any given case the courts will have cognisance of the role a director played. 2.27 The primary distinction between the two kinds of directors is that executive directors are employed full time by the company in order to lead the management of the company while non-executives are not employed by the company. The former will often have service contracts and be granted significant management powers. In some companies executive directors might be appointed to specific posts, such as finance director or sales director, and they are given specific tasks related to the day-to-day conduct of the company’s business. 2.28 Small companies often have no non-executive directors at all. In larger companies they are often appointed to provide expertise and experience for the board and to act on behalf of the shareholders as monitors of the executives. Commonly non-executive directors are executive directors elsewhere or are former executive directors of other companies. While non-executives will be involved in all board discussions and decisions, including formulating strategy, companies are entitled to look to non-executives to supervise the executives.45 2.29 While executives must give their full endeavours to their company, a nonexecutive’s responsibilities are transitory, as they are not engaged on a full-time basis and are not commissioned with the task of overseeing the daily operations of the company. They will attend board meetings and, in larger companies, act as a member of board committees. 2.30 While, as mentioned, there is no legislative distinction made between executive and non-executive directors, the courts in more recent times have acknowledged the different roles that are played by individual directors and will refer to the two terms in judgments.

44 Re PFTZM Ltd [1995] BCC 280, 292 per HHJ Paul Baker QC. 45 Equitable Life Assurance Society v Bowley [2003] EWHC 2263 (Comm), [2004] 1 BCLC 180, [41].

13

DIR ECTORS

Responsibilities and Obligations 2.31 As mentioned earlier, directors owe what can be called, in the broad sense, obligations or responsibilities to creditors. Most of these can be listed and little else needs to be said about them, as they are either clear-cut or uninteresting, or both. Many of these only provide very indirect obligations to creditors. They flow from the idea that while companies are formed for the benefit of the shareholders, this is done subject to safeguards for the benefit of creditors.46 Most of the substantive obligations and responsibilities placed on directors are designed to prevent the expropriation of creditor wealth and to protect creditors’ legitimate expectations when providing credit to a company. 2.32 This book is primarily concerned with the responsibilities that are owed by directors under the civil law, although in Part B there is some discussion of the criminal proceedings that can be taken pursuant to s 993 of the Act where directors (and others) have engaged in fraudulent trading.47 2.33 Directors are liable under several provisions if they engage in certain activity, and this could well affect creditors. The ensuing discussion does not purport to be exhaustive but mentions some instances of directors’ obligations to creditors. We must note initially that the share capital provisions of the Act ‘protect[s] corporate creditors from the abuse of limited liability by shareholders,’48 and so there are limits placed on a company’s dealings in its corporate share capital. First, companies are not permitted to give financial assistance in the purchase of their shares.49 Furthermore, directors of private companies, for whom the proscriptions on giving financial assistance are relaxed, are obliged to publicise any resolution that provides for the payment from capital for the purchase of the company’s own shares,50 and creditors may object.51 Likewise, the law obliges directors not to repay any paid-up capital to the shareholders except by means of an authorised reduction of capital, and this might be regarded as an indirect duty owed by directors to creditors.52 Directors are to ensure that they do not engage in making an unlawful reduction of capital, and, as Buckley LJ stated in Re Horsley & Weight Ltd,53 this might be regarded as an indirect duty to creditors, although his Lordship preferred to see this as a duty to the company.54 2.34 Any reduction of company capital will, of course, impact on the company’s ability to repay creditors in the event of insolvency. The principle is that companies should maintain their capital as a fund from which the creditors 46 Company Law Review, Modernising Company Law: The Strategic Framework (DTI, 1999), para 5.1.4. 47 For a discussion of responsibilities under the criminal law, see G Scanlan, ‘The Criminal Liabilities of Directors to the Creditors of the Company’ (2003) 24 Co Law 234. 48 John Armour, ‘Share Capital and Creditor Protection: Efficient Rules for a Modern Company Law’ (2000) 63 MLR 355, 355. 49 Companies Act 2006, ss 678, 679. 50 Ibid, ss 713, 719. 51 Ibid, s 721. 52 Re Horsley & Weight Ltd [1982] 1 Ch 442, 454, [1982] 3 All ER 1045, 1055 (CA). 53 Ibid. 54 Ibid, 454, 1055.

14

DIR ECTORS

can claim what they are owed. So, before reducing capital it is necessary for a company to secure the approval of the court.55 Secondly, and allied to what has just been discussed, the Act prohibits the payment of dividends to shareholders from capital – they must only be paid out of profits.56 This is a responsibility that is discussed in detail in Chapter 18. Thirdly, when raising capital, a company is not entitled to issue shares at a discount in relation to their par value.57 2.35 Fourthly, another obligation, although not relating to share capital, is that under s 82 of the Act directors have an obligation to ensure that the company’s name is displayed on documents and communications. Fifthly, directors of public companies must ensure that their company does not breach s 761 of the Act by doing business or exercising borrowing powers where the registrar of companies has not issued a certificate. 2.36 Sixthly, there are indirect obligations to creditors which involve directors ensuring that company property is not disposed of in certain situations. During the life of the company, directors should not enter into transactions that might be classified as transactions defrauding creditors under s 423 of the Insolvency Act 1986.58 This usually involves putting assets out of the reach of creditors. Directors might be regarded as having an obligation to the general body of their company’s creditors, when their company is insolvent, not to prefer one or more creditors by paying them and not paying others, on the basis that any distribution of funds should be according to the statutory scheme set out in the Insolvency Act 1986. Directors are also under an obligation not to enter into a transfer if that would lead to the insolvency of the company; it is regarded as a preference.59 If a director does pay a preference, then he or she might be held liable for a breach of duty or trust covered by s 212 of the Insolvency Act (the misfeasance section). Usually, in practice a director will only be the subject of an action if the person who was the recipient of the preference is impecunious, cannot be traced or the conditions attached to a preference action under s 239 of the Insolvency Act cannot be fulfilled.60 Of course, the company might not end up in administration or liquidation, or such payments might not be deemed to constitute preferences. The fact of the matter is that until a company enters administration or liquidation and an administrator or liquidator successfully claims in court that a preference was given, it is not possible to say that the directors had an obligation and that the obligation was not honoured. Therefore, it is highly debatable whether one can say that this is a responsibility owed to creditors. One can say that directors should be careful in paying only one or 55 Companies Act 2006, s 641. 56 Ibid, s 830. 57 Ibid, s 580. 58 For more detailed discussion of this field, see G Miller, ‘Transactions Prejudicing Creditors’ [1998] The Conveyancer and Property Lawyer 362; Rebecca Parry et al., Transaction Avoidance in Insolvencies (3rd ed, OUP, 2018), Ch 10; Andrew Keay, McPherson and Keay’s Law of Company Liquidation (5th ed, Sweet and Maxwell, 2021), Ch 11. 59 See Insolvency Act 1986, s 239. 60 See, Andrew Keay, ‘Financially Distressed Companies, Preferential Payments and the Director’s Duty to Take Account of Creditors’ Interests’ (2020) 136 Law Quarterly Review 52.

15

DIR ECTORS

some of their company’s accounts when their company is insolvent and likely to enter liquidation.61 2.37 If a company is insolvent, directors are not to engage in transactions which are able to be classified as transactions at an undervalue. The same applies if the transaction will lead to the insolvency of the company. Transactions at an undervalue are explained in s 238 of the Insolvency Act. They are transactions that have left the company short of funds or property because the company has either made gifts to others or received consideration of a value that is significantly less than that which was given by the company. Again, action will only be taken against directors where the company enters administration or liquidation. Finally, mention should be made of the fact that directors of a company that has gone into insolvent liquidation are not permitted, because of s 216 of the Insolvency Act 1986, to re-use the company’s name, save in limited circumstances.62 This proscription is designed to protect creditors. 2.38 There are, of course, obligations that companies have to their creditors, but we are concerned in this book with the personal responsibilities of the directors of companies and not their responsibilities when acting for the company. For instance, under the Late Payment of Commercial Debts (Interest) Act 1998, companies must not, as must not any recipient of goods or services, delay the payment of the supplier. The directors have the responsibility to ensure timely payment, but this responsibility is merely humanising the responsibility of the company. 2.39 Having set out some of the important obligations that directors have to creditors, we now note the responsibilities that are at the heart of this book. These were identified in Chapter 1. Two are set in negative terms, and they are that directors have the responsibility not to engage either in fraudulent trading or wrongful trading. Directors also have the positive obligation, at certain times in the life of their company, to have consideration for the interests of creditors of their company in discharging their functions. 2.40 Directors are obliged not to distribute company funds by, for example, paying dividends to shareholders if the payments are not to be made out of profits. Part E discusses this obligation. 2.41 If directors fail to adhere to their obligations mentioned in the last two paragraphs, they may well be subject to legal proceedings brought against them by an administrator of liquidator if their company is insolvent and enters one or other of these insolvency regimes, and a court may order the directors to pay sums to the administrator or liquidator to make up for the losses, ultimately sustained by creditors.

61 Ibid. 62 This means that at the time of entering liquidation, the company’s assets are insufficient for the payment of its debts and other liabilities and the expense of winding up: s 216(7). For a concise discussion of this, see T Carter, ‘The Phoenix Syndrome – The Personal Liability of Directors’ (2006) 19 Insolvency Intelligence 38.

16

DIR ECTORS

2.42 It is generally against company law principles for directors to be liable personally to creditors of their companies. The classic case of Salomon v Salomon and Co Ltd63 of course laid down the inveterate principle that a company was a separate entity at law and, hence, that the company’s directors and shareholders were not liable for the debts of the company. There has been, generally speaking, a reluctance on the part of judges to impose personal liability on directors, as it tends to undermine the doctrine of separate legal entity, namely the company entity is separate from its directors and shareholders. The consequence of this doctrine is, of course, that the directors (and the members) are not liable for the debts and liabilities of the company. Creditors will contract with the company and not the directors, but there are social and economic reasons why, in certain cases, directors are made responsible by the legislature or the courts for what they do on behalf of their companies. The problem with permitting directors to get off scot-free if their company is unable to discharge wholly or in part its liabilities, is that directors might act cavalierly, or even improperly, in managing the affairs of the company. The doctrines of limited liability and separate legal personality, are often ‘easily manipulated.’64 As Cooke J of the New Zealand Court of Appeal stated in Nicholson v Permakraft (NZ) Ltd:65 It [limited liability] is a privilege healthy as tending to the expansion of opportunities and commerce, but it is open to abuse. Irresponsible structural engineering – involving the creating, dissolving and transforming of incorporated companies to the prejudice of creditors – is a mischief to which the courts should be alive.66

Conclusion 2.43 This chapter has focused on directors who are those persons required to be responsible in managing their companies in a way that provides some form of protection for creditors in times of financial difficulty. 2.44 The chapter has identified the different kinds of directors that exist in UK law and practice, namely directors appointed according to law (de jure), de facto directors and shadow directors, and it notes that in practice directors tend to be either executive or non-executive directors. The chapter has also identified many of the responsibilities and obligations that are imposed on directors and contained in the Companies Act 2006 and the Insolvency Act 1986 and noted that they exist to provide safeguards for creditors.

63 [1897] AC 22. 64 Harry Glasbeek, ‘More Direct Director Responsibility: Much Ado About . . . What?’ [1985] Canadian Business Law Journal 416, 422. 65 (1985) 3 ACLC 453. 66 Ibid, 459.

17

CHAPTER 3

Creditors

Introduction 3.1 The book is concerned about the responsibilities that directors have to creditors. It is necessary to be more specific about whom we are talking when we refer to creditors. The term ‘creditor’ encompasses a broad group, and there are many different kinds of creditors. This chapter seeks to examine the nature of a creditor and identify the various types of creditors and what rights they enjoy. The discussion is necessarily brief and introductory, as the book’s focus is not on defining creditors but examining the responsibilities that directors owe to such persons. Who Is a Creditor? 3.2 Essentially, and in broad terms, a creditor is someone who is owed a debt by a debtor,1 or someone who is owed money by another.2 Who is a creditor will often depend on the circumstances in which one is asking the question. Of course, the term might be given a specialist meaning in appropriate circumstances, especially in legislation. 3.3 As indicated earlier, a creditor is owed a debt. ‘Debt’ is a broad term. It can be regarded as wider than what is generally regarded as a debt, namely money owed for money lent, goods supplied or services rendered. According to r 14.1(5) of the Insolvency Rules 2016, which defines ‘debt’ for the purposes of the liquidation and administration of companies, it is a term which includes any debt or liability that is present or future, whether it is certain or contingent or whether its amount is fixed or liquidated or is able to be ascertained by fixed rules or as a matter of opinion. Further, it would include liabilities involving the liability to pay money or money’s worth, including any liability under an enactment, any liability for breach of trust, any liability in contract, tort or bailment, and any liability arising out of any obligation to make restitution.3 3.4 There are three particular kinds of debts that are worth mentioning.

1 See E A Martin (ed), ‘Creditor’ in The Oxford Dictionary of Law (OUP, 2003), 127. 2 Hardy Ivamy, Mozley & Whiteley’s Law Dictionary (Butterworths, 1990), 119. 3 Insolvency Rules 2016, r 14.1(6).

18

DOI: 10.4324/9780429266232-4

CR EDITORS

Contingent Debts 3.5 In Re William Hockley Ltd4 Pennycuick J said that a ‘contingent creditor’ is taken to be ‘a person towards whom, under an existing obligation, the company [debtor] may or will become subject to a present liability on the happening of some future event or at some future date.’5 This is broadly in accord with the statement of Lord Reid on the subject in In re Sutherland dec’d,6 that a contingent liability was ‘a liability which, by reason of something done by the person bound, would necessarily arise or come into being upon an event or events which might or might not happen.’7 A prime example of contingent liability is the liability of a surety as a result of the failure of the principal debtor to pay what is owed. Prospective Debts 3.6 A person or company who owes a prospective debt has been described as one who is indebted in a sum of money not immediately payable,8 and one who is owed a debt which will certainly become due in the future, either on some determined date or some date which will be determined by reference to future events.9 The nature of a prospective creditor presumes that that there is an existing obligation. An example of a prospective creditor is a person who has a claim, which is unable to be disputed, for unliquidated damages which remains to be quantified and will lead to a debt for more than a nominal amount.10 Future Debts 3.7 These are similar to contingent debts in that both future and contingent creditors will look to the future before the debts owed become payable. However, while contingent creditors are not certain that a debt will be payable, future creditors are. There seems little, if any, difference between prospective and future debts. Kinds of Creditors 3.8 Any company might have all or any of the following types of creditors: secured creditors, suppliers with a retention of title clause in supply contracts,

4 [1962] 1 WLR 555. 5 Ibid, 558. 6 [1963] AC 235, [1961] 3 WLR 1062. 7 Ibid, 249, 1069. 8 R Wright and R Buchanan, Palmer’s Company Precedents, Part 2: Winding Up Forms and Practice (17th ed, Stevens and Sons Ltd, 1960), 41. 9 Stonegate Securities Ltd v Gregory [1980] 1 Ch 576, 579. 10 Re Dollar Land Holdings Ltd [1994] BCLC 404.

19

CR EDITORS

trade creditors, suppliers under long-term contracts, lessors, holders of unexpired intellectual property licences, employees, HMRC, tort victims with claims, and customers who have paid deposits for goods or services to be supplied by the company. Some of these creditors will be able to protect themselves through contract and other self-help options, but others cannot do so and are often at the mercy of a company debtor. Consensual Creditors 3.9 These are creditors who have voluntarily extended credit to a company pursuant to some form of agreement. The category can be divided into secured and unsecured creditors. Secured Creditors 3.10 These creditors often enjoy the best possible situation if a company debtor does not pay what it is owed, as such creditors (of companies) are granted proprietary rights over a company’s asset(s), enabling them to exert some action over the asset(s) if necessary. This will usually be where the company fails to meet its repayment schedule or the company enters some form of insolvency regime, such as liquidation. For the most part, secured creditors are not going to be overly concerned about the responsibilities that are examined in this book. They will monitor the company and, more specifically, the assets over which they have security, to ensure that the assets will realise funds that will adequately cover what is owed. Unsecured Creditors 3.11 This category contains the vast majority of creditors. These creditors have been said to ‘receive a raw deal,’11 a view contained in several judicial observations.12 Such creditors have to rely primarily on their contract with the debtor. 3.12 There are various kinds of creditors who fall into this category. They range from moneylenders to trade creditors who supply goods or services to consumers who have paid a deposit to a company in exchange for a promise of a delivery of goods or services. Also included is HMRC, owed various taxes, and the employees of companies, who are owed arrears of wages and other benefits relating to their employment. Moneylenders is a group that encompasses debenture (bond) holders. Some might lend on a secured basis, but many do not. Trade creditors will usually supply goods or services on credit, with the arrangement involving a contractual deferment of a price obligation,13 and this is known as sales credit. The suppliers will usually render an invoice with the requirement that it be paid within a specified period, often 30 days. Some suppliers might require cash on

11 Borden (UK) Ltd v Scottish Timber Products Ltd [1981] Ch 25, 42 (per Templeman LJ). 12 Such as in Business Computers v Anglo-African Leasing [1977] 1 WLR 578, 580. 13 V Finch, Corporate Insolvency Law (CUP, 2002), 61, n 4.

20

CR EDITORS

delivery of the goods or services. This is a particular mode of operation where the recipient of the goods or the services is of questionable solvency. 3.13 It is this broad group of creditors which is mainly going to be concerned about the kind of responsibilities that are studied in this book. They have no company assets which they can grab, unless they have supplied goods subject to contracts which contain what are known as ‘retention of title clauses.’ There are a number of different kinds of unsecured creditors which we can identify, and they are discussed in brief next. PREFERENTIAL CREDITORS14

3.14 When a company enters administration or liquidation, unsecured creditors are treated equally and rateably when it comes to paying them out. This principle is known as pari passu. But there are some unsecured creditors who are given, by insolvency legislation, special treatment and a priority right when creditors are paid. Sections 175 and 386 with Schedule 6 of the Insolvency Act 1986 detail the present categories of preferential debts for corporate insolvencies. The type of creditors covered is discussed next. REVENUE AUTHORITIES

3.15 At one time in the UK the revenue authorities, principally HMRC, was a privileged creditor, as it came within the type of creditors mentioned in the previous paragraph. But in the Enterprise Act 2002 provision was made for the abolition of the priority which HMRC held. Since losing preferential status in insolvency regimes, such as liquidation, HMRC had to rethink its position as far as corporate debtors were concerned. When HMRC had full preferential status it was in a strong position. It could, except where it was aware that a company was hopelessly insolvent, wait and see what the company was going to do, or it could, if it was felt appropriate, seek a winding-up order against the company without regard for the company’s future, and whether the company had a chance of rehabilitating itself if it was suffering financial difficulties. When it lost its preferential position HMRC was cast in the same position as all other unsecured creditors and, arguably, had to monitor companies more closely and carefully. 3.16 Other countries around the world, such as Austria, Australia and Germany, have taken the same action as the UK did in 2002 and abolished the priority of revenue authorities. Revenue authorities in other countries, such as Ireland, France, Spain, Italy and South Africa have decided that it is appropriate to retain a priority position in insolvencies. 3.17 The position in the UK has recently changed again. The Finance Act 2020 provided, in ss 98 and 99, for the return of priority for some debts owed to HMRC. From 1 December 2020 any amounts owed to HMRC in respect of

14 For a detailed discussion, including the history of the provision for these creditors, see A Keay and P Walton, ‘The Preferential Debts’ Regime in Liquidation Law: In the Public Interest?’ (1999) 3 Company Financial and Insolvency Law Review 84.

21

CR EDITORS

VAT and any ‘relevant deduction,’15 which includes any deductions retained by the company in respect of PAYE income tax and employee National Insurance Contributions had preference status.16 EMPLOYEES

3.18 The justification for granting priority status to the wage claims of employees has been stated to be that: [S]alaries and wages are generally needed for, and generally expended in, the support and maintenance of the persons earning them, their wives and families and others dependent on them, and so may well be given priority, for a short period, over debts due to other creditors in the ordinary course of business and generally more nearly related to the profit and loss account of the creditor than his sustenance or that of those dependent upon him.17

3.19 The employee has for a long time attracted the sympathy of the legislature. The employee is seen as being in a weak bargaining position compared to other creditors and investors. The employee priority is to ‘ease the financial hardship caused to a relatively poor and defenceless section of the community by the insolvency of their employer.’18 Employees, when negotiating the terms of their employment contract do not usually insist upon a provision to protect them should the employer become insolvent; they usually do not even turn their minds to the insolvency of their employer. The reason given for priority to such creditors is the effect of an employer’s insolvency on the employee is likely to be more serious than the effect on other creditors. Wages are likely to be the only source of income for an employee whilst other creditors are likely to have other sources of income. RETENTION OF TITLE CREDITORS

3.20 Some creditors, mainly suppliers of goods, will provide, as a term of the supply contract, that they retain title to the goods until they are paid for. This means that if a debtor enters some insolvency regime, the supplier is able to demand the return of the goods from the insolvency officeholder, as the supplier still has title to the goods.19 Retention of title creditors are not secured creditors, although they might be said to enjoy quasi-security rights. SPECIAL RELATIONSHIP CREDITORS

3.21 What is envisaged here are those creditors who have a company as one of their main or only customers. Some creditors might even have more than half 15 This is explained in reg 2 of the Insolvency Act 1986 (HMRC Debts: Priority on Insolvency) Regulations 2020 (SI 2020/983). 16 For a discussion, see Andrew Keay, McPherson and Keay’s Law of Company Liquidation (5th ed, Sweet and Maxwell, 2021), Ch. 13. 17 Re Parkin Elevator Co. (1916) 41 DLR 123, 125 (per Meredith CJCP). 18 Insolvency Law Review Committee, Insolvency Law and Practice (commonly known as ‘the Cork Report’ after its chairman, Sir Kenneth Cork), Cmnd 858, HMSO (1982), para 1428. 19 The classic case that accepted these kinds of terms in English law was Aluminium Industrie Vaassen BV v Romalpa Aluminium Ltd [1976] 2 All ER 552 (CA).

22

CR EDITORS

of their business with one company, and others might focus their whole business on supplying the company. Examples are suppliers of large companies, for instance those who supply components to the multinational car makers.20 This kind of relationship might be lucrative, but these suppliers are in a potentially vulnerable position. If their main customer fails to pay on time or, even worse, clearly falls into a financial malaise, the supplier could well collapse, as it is so reliant on the one company. Clearly, there are dangers in not having a diversified customer base. CUSTOMERS

3.22 When thinking about risk one immediately focuses on those who have delivered supplies or lent money to a company. Customers of companies are not usually considered in such a context. However, it is not unusual for customers to pay to companies a deposit for goods or services that they have ordered, or even, in some areas such as in the travel and mail order sectors, the full price. Until those goods or services are delivered, the customer is a creditor of the supplier. In a sense customers are involuntary creditors, because unless they provide the required payment, they do not get the goods or services. Involuntary Creditors 3.23 This covers those who have not agreed to become creditors of the debtor but are creditors because of some action or inaction of the debtor. The prime candidate for this category is the person who is a victim of a tort committed by the debtor. To be able to have a claim against the tortfeasor/debtor, the creditor will have to obtain a judgment against the tortfeasor/debtor. Such creditors are particularly vulnerable, as they never have any opportunity of protecting themselves or the chance to negotiate with the debtor company. Creditor Protection 3.24 In granting credit to companies creditors are able to avail themselves of a number of protection measures, in order to ensure that they do not lose out from an extension of credit, or, if they do lose, they limit how much they lose. Contractual Protection 3.25 Consensual creditors might seek to safeguard their position by including certain terms in their contract with the company. These terms are as varied as the ingenuity of man. But some are frequently used and are referred to here. One that has been referred to already in this chapter is the retention of title clause. 20 This was the case with those who supplied goods and services to Carillion. Anecdotal evidence suggests that many businesses associated with Carillion in some form or other either suffered large losses or entered insolvency regimes.

23

CR EDITORS

Such a clause might enable a creditor to recover its goods or goods made with the materials that it supplied to the company, if the company collapses, on the basis that the creditor retained title in the goods/materials until the debt was paid. 3.26 A second protection, and one that is favoured by banks, is to require one or more of the directors of the company to provide a personal guarantee, whereby the director(s) covenants that if the company fails to pay the creditor, he or she will meet the obligations. This is a method that allows for dispensing with the separate entity rule. Sometimes guarantees are taken to support the giving of security by the company. Guarantees tend to be used only for small companies. 3.27 A third protection is where the contract states that the company is to disclose certain kinds of information to the creditor (over and above what the law requires). 3.28 Fourthly, a creditor might require that the contract includes certain terms that place constraints on the company, known as restrictive covenants. Examples are: the company is not to change the nature of its business; the company is not to dispose of certain assets; or the company is limited in relation to the dividends that it can declare. Perhaps one of the most popular is the ‘negative pledge clause,’ which provides that the company will not create security over some or all of the company’s assets that are not subject to security already. 3.29 A final protection is where the contract provides that the creditor is given governance rights in relation to the company. Examples might be where a creditor obtains the right to nominate a director to the company’s board. 3.30 Many creditors, particularly small trade creditors do not possess sufficient financial clout to be able to employ some or any of the previously mentioned protections. Many small suppliers and tradespeople are likely either not to even contemplate protection, or if they do the measures which they could take to protect themselves. 3.31 The great majority of trade creditors, as well as other kinds of creditors, find it difficult to document transactions, and so often they end up providing goods and services on ‘open account’ terms without entering into a formal written contract containing agreed terms.21 One reason for this, besides the time factor, is the fact that the preparation of formal and widely drawn contracts involves significant costs.22 Pre-Contract Checks 3.32 Before entering into a contract to extend credit, the creditor might undertake certain checks in relation to the company to ascertain things like the capacity of the company to repay. Often those who are likely to end up 21 S Schwarcz, ‘Rethinking a Corporation’s Obligations to Creditors’ (1996) 17 Cardozo Law Review 647, 652. 22 L Butler and H Ribstein, ‘Opting Out of Fiduciary Duties: A Response to the Anti-Contractarians’ (1990) 65 Washington Law Review 1, 28; D Harvey, ‘Bondholders’ Rights and the Case for a Fiduciary Duty’ (1991) 65 St John’s Law Review 1023, 1037; M Whincop, ‘Painting the Corporate Cathedral: The Protection of Entitlements in Corporate Law’ (1999) 19 OJLS 19, 28.

24

CR EDITORS

being substantial creditors of a company will ask their solicitors to undertake a search of the company at Companies House. This will disclose many of the key features of the company, although it will not, alone, determine whether the company is a good credit risk. Other checks that might be undertaken are making inquiries with credit reference agencies, enabling them to find out about a company’s past credit history. Less formal action might include contacting present or former creditors of the company, if known. 3.33 Unfortunately, for many suppliers of goods and services, there is not sufficient time for them to undertake inquiries before they have to decide whether or not to supply the company with credit. Companies often need goods and services immediately, and if the supplier wants time in which to investigate the company in any depth, it is likely that the company will take its business elsewhere. Security 3.34 Perhaps regarded as the most coveted form of protection, security (collateral) enables a creditor to depend not on the personal covenants of the company, which will most often require the need to go to court to enforce them if default occurs and, of course, will not be particularly fruitful if the company is insolvent, but to depend on certain company property. That is, if the company fails to pay the creditor, the latter can realise the property over which it has security and pay itself back from the proceeds of the realisation. In this type of situation the creditor is granted a proprietary right against the company. A classic way of creating security in relation to corporate debtors is through the charge. Some charges are fixed and others are floating, and still others are hybrid, that is a combination of fixed and floating. A fixed charge is taken over ascertainable property that is permanent or semi-permanent. The traditional view is that debtors are unable to deal in any way with property that is subject to a fixed charge. In contrast, a floating charge is a charge that is not fixed on any property; it hovers over property and fixes (the technical term being ‘crystallises’) on the happening of certain events, such as non-payment by the debtor and other events identified in the loan agreement. Floating charges are usually taken over circulating-type assets, such as stock in trade and book debts.23 3.35 One of the main advantages of taking security is that under the AngloAmerican models of law, the creditor retains its rights and can realise the secured property even after the commencement of some formal insolvency regime, such as liquidation. Monitoring 3.36 During the period when they are owed money by a company, a creditor can engage in monitoring the company and its financial position. Creditors 23 For further discussion, see Andrew Keay and Peter Walton, Insolvency Law: Corporate and Personal (5th ed, LexisNexis, 2020), 58–60.

25

CR EDITORS

often do this informally, but this is generally not sustained and its effectiveness is very problematic. Formal and substantial monitoring can be time-consuming and costly, and even then it might not be sufficient to keep the creditor well informed.24 The problem is that many creditors will not have the resources to carry out necessary monitoring. If a creditor decides that it will need to monitor a company, then it will have to build a cost factor into the price of the credit which it extends to the debtor, because obtaining information and monitoring the affairs of a company are costly undertakings,25 particularly if professional advice is sought. This might make the price of the goods or services uncompetitive. Imposing Higher Interests 3.37 If a creditor is concerned about the company as a credit risk, it can demand that the company pays a higher rate of interest on credit extended. While this might compensate a creditor, it does not protect the creditor from a company failing and being unable to repay the debt owed. Conclusion 3.38 ‘Creditors’ is a very broad term and may include a wide range of people giving some form of credit. The group may consist of lenders who have been granted security (fixed, floating or both) (chiefly, banks), those holding long-term debt (holding publicly issued bonds or debentures), trade creditors, employees and those with tort claims, and it might, in some circumstances, include customers, such as those who have paid deposits for goods and/or services to be supplied in the future. This book will from time to time consider specific kinds of creditors, but generally when a reference is made to creditors the whole range of creditors that a company might have is in view.

24 See the comments in Brian Cheffins, Company Law: Theory, Structure and Operation (Clarendon Press, 1997), 524. 25 R Posner, ‘The Rights of Affiliated Corporations’ (1976) 43 University of Chicago Law Review 499, 508.

26

CHAPTER 4

Claimants and Actions

Introduction 4.1 Thus far we have considered the parties who are the main focus of the book, namely directors and creditors. In this chapter we consider who may bring claims against directors where they have not acted properly and what kind of actions can be initiated. When dealing with each of the obligations which are discussed in this book in Parts B–E, more specific details will be provided in relation to who can bring proceedings and what types of proceedings might be instigated. Claimants 4.2 Directors do not owe duties to creditors during the life of their company; duties are owed to the company.1 Also, the responsibilities which directors have, and which are discussed in this book, are not ones that are specifically owed to the creditors. Creditors are not able to bring proceedings against directors if directors fail to meet the obligations that are analysed in this book. 4.3 Unlike in some countries, such as Australia, there is no corporate regulator in the UK which is empowered to take action against directors who fail to meet those responsibilities owed by directors and discussed in this book. It should be added that the Secretary of State for Business Energy and Industrial Strategy might, through the Insolvency Service, seek the disqualification of a director under the Company Directors’ Disqualification Act 1985, for not complying with certain specified obligations. 4.4 Shareholders might seek to make claims against directors using the derivative action process found in the Companies Act 2006,2 where directors have failed in their responsibilities. Section 260(3)3 provides that a claim may be brought in relation to a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director. 1 Companies Act 2006, s 170(1). 2 Ibid, ss 260ff. 3 For England and Wales and Northern Ireland. Section 265(3) is the equivalent provision applying in Scotland.

DOI: 10.4324/9780429266232-5

27

CLAIM ANTS AND ACTIONS

Shareholders bring an action on this basis on behalf of the company and any relief granted by a court goes to the company. Shareholders are not going to countenance bringing a derivative action in relation to any of the responsibilities discussed in this book, as it is not going to benefit them unless they are also creditors of the company. 4.5 An action relating to a director’s failure to meet the responsibilities examined in this book will be brought by an administrator or liquidator who are appointed when a company enters either administration or liquidation. In fact, a couple of responsibilities that are considered in the book, not to engage in fraudulent trading and wrongful trading can only be enforced, according to the Insolvency Act 1986 (‘the Act’) itself, by an administrator or liquidator. The actions considered in the book will only occur where a company has become insolvent and has entered administration or liquidation, although the actions brought may relate back to a point of time when the company was not insolvent. For instance, the responsibility of a director to take into account the interests of creditors, and discussed in Part D, can arise prior to the actual insolvency of the director’s company. Proceedings 4.6 The Act provides that an administrator, under s 246ZA, and a liquidator, under s 213 may bring an action against directors if they breach their obligation not to engage in fraudulent trading (discussed in Part B). Likewise, the Act provides an administrator, under s 246ZB, and a liquidator, under s 214, may bring an action against directors if they breach their obligation not to engage in wrongful trading (discussed in Part C). Administrators and liquidators are not empowered specifically to enforce breaches of the other responsibilities discussed in the book, but they can and do so when they act on behalf of the company and bring proceedings in its name. 4.7 Part D examines the duty of directors to take into account the interests of the creditors of their company in certain circumstances and if they fail to do so, it is an administrator or liquidator who will instigate proceedings against the directors once the company enters either administration or liquidation. If the company does not enter administration or liquidation, it will usually mean that any breach by the directors has been made good. If directors fail to meet their obligation only to make distributions of company funds out of profits (discussed in Part E), again it will be an administrator or liquidator that will initiate proceedings against the miscreant directors. These proceedings might be in lieu of or in addition to proceedings brought against any shareholders who received the distributions. 4.8 In any particular situation a liquidator or administrator may bring proceedings claiming alternative causes of action. Misfeasance 4.9 With actions mentioned in 4.7, liquidators will usually include the claims in what is known as a misfeasance summons.4 Section 212 of the Act permits a 4 For a broader discussion of misfeasance actions, see Andrew Keay, McPherson and Keay’s The Law of Company Liquidation (5th ed, Sweet and Maxwell, 2021), [16.005] – [16.028].

28

CLAIM ANTS AND ACTIONS

liquidator, amongst others, to institute this type of proceeding against directors where it is alleged that they have misapplied or retained, or become accountable for, any money or other property of the company, or been guilty of any misfeasance or breach of any fiduciary or other duty in relation to the company which the liquidator is winding up. Breaches of the responsibilities considered in Parts D and E fall within s 212. 4.10 For a misfeasance action to succeed under s 212, it must be founded on some action in relation to which the company could have initiated proceedings prior to winding up, namely a breach of any fiduciary or other duty owed to the company;5 so, under s 212 an applicant must ‘establish actionable wrongdoing by the respondent independently of s 212.’6 4.11 Section 212, in accordance with its legislative precursors, does not provide liquidators with a cause of action. As Lord Evershed MR observed,7 there is no such distinct wrongful act known to the law as misfeasance; it is merely procedural in effect.8 It provides a summary mode of bringing proceedings.9 A misfeasance action will usually plead that directors have breached one or more of their duties. Section 212 is designed to facilitate recovery of assets improperly dealt with, and to enable the liquidator to obtain compensation for misconduct which had caused loss to the company.10 4.12 There are a number of practical advantages to a liquidator in pursuing misfeasance proceedings under s 212, which the liquidator does in his or her own name, rather than taking proceedings in the normal manner under Part 7 of the Civil Procedure Rules (‘CPR’) and in the name of the company. First, unlike an insolvent company a liquidator is not susceptible to an application for security for costs, potentially a serious obstacle to the conduct of claims. Secondly, the procedure under Part 12 of the Insolvency 2016 Rules by which a misfeasance claim under s 212 is pursued, is generally quicker in terms of the listing of an initial return date at which directions are given and the cost of issuing proceedings is less than proceeding under Part 7 of the CPR.11 Thirdly, and related to the first factor, an after the event costs insurer is, generally speaking, likely to consider a claim pursued by a liquidator to be a better commercial prospect than one pursued by an insolvent company in liquidation potentially susceptible to a security for costs order. 4.13 As intimated, the existence of s 212 does not displace the right of the company to bring action in the ordinary way, and it created no new rights or 5 For a recent instance of a misfeasance action, see Re Simmons Box (Diamonds) Ltd [2000] BCC 275, which involved directors failing to act carefully. 6 Fidelis Oditah, ‘Misfeasance Proceedings Against Company Directors’ [1992] LMCLQ 207, 208. 7 Re B. Johnson & Co (Builders) Ltd [1955] Ch 634, 648. 8 Cavendish-Bentinck v Fenn (1887) 12 App Cas 652, 669; City Equitable Fire Insurance Co, Re [1925] Ch 407, 527; Re B. Johnson & Co (Builders) Ltd [1955] Ch 634, 647–648. 9 Re Canadian Land Co; Coventry & Dixon’s Case (1880) 14 Ch D 660, 670. 10 Re B. Johnson & Co. (Builders) Ltd [1955] Ch 634. 11 If a claim that would fall under s 212 if brought by a liquidator is assigned then the assignee is not able to bring proceedings under Part 12 of the Insolvency Act 1986 but has to proceed under Part 7 of the CPR: Manolete Partners Plc v Hayward and Barrett Holdings Ltd [2021] EWHC 1481 (Ch), [51]–[52].

29

CLAIM ANTS AND ACTIONS

liabilities but was simply intended to provide a summary mode of enforcing rights which, apart from the section, could have been enforced by the company12 prior to liquidation, or which came into existence by virtue of special statutory provisions which apply in winding up.13 As Lord Macnaghten in Cavendish Bentinck v Fenn14 stated in relation to a precursor of s 212, it ‘creates no new offence, and . . . it gives no new rights, but only provides a summary and efficient remedy in respect of rights which apart from that section might have been vindicated either at law or in equity.’ 4.14 The process is not available in administration, even though para 75 of Sch B1 to the Insolvency Act 1986 does deal with misfeasance. However, the provision may only be used against administrators who have allegedly acted improperly. Conclusion 4.15 The chapter has been concerned with examining who will bring proceedings to enforce wrongful actions engaged in by directors and has focused on liquidators and administrators who are the persons who most often bring proceedings, and in fact they are the only people who can take action for some directorial breaches as the law grants them that right. After considering who can bring proceedings the chapter discussed in some depth the misfeasance action that can be brought by liquidators, this being a frequent way that liquidators will proceed against directors.

12 Rights personal to a creditor or contributory in an individual capacity could not be enforced: Re Hill’s Waterfall Estate Co [1896] 1 Ch 947; B Parker and M Buckley, Buckley on the Companies Act (14th ed, Butterworths, 1981), 375–376. 13 Home & Colonial Insurance Co, Re [1930] 1 Ch 102, 132, per Maugham J. This embraces items such as voidable preferences, dispositions after the commencement of winding up, etc. 14 (1887) 12 App Cas 652.

30

PART B

FRAUDULENT TRADING

CHAPTER 5

Background and Aim

Introduction 5.1 This chapter begins consideration of the legislation and case law that has imposed certain responsibilities on company directors as far as creditors are concerned. Specifically, in this chapter we will examine the advent, development and raison d’ệtre for the provision dealing with what is commonly known as ‘fraudulent trading.’ Following that, the chapter identifies the aim of the provision. The ensuing chapters discuss aspects of the fraudulent trading provision and its use by administrators and liquidators in bringing proceedings against directors. Background 5.2 For many years company legislation has made it an offence to carry on the business of a company with intent to defraud creditors. Also, the legislation has provided that a civil remedy is available where such activity can be proved. The first provision that was enacted to deal with what has been loosely referred to as ‘fraudulent trading’ was s 75 of the Companies Act 1928. There had been dissatisfaction in the first quarter of the twentieth century at the ease with which the protection of limited liability could be abused by those who managed companies, and in 1926 the Greene Committee on Company Law Reform1 had its attention directed particularly to the case, said to be encountered principally in private companies, ‘where the person in control of the company holds a floating charge and, while knowing that the company is on the verge of liquidation, “fills up” his security by means of goods obtained on credit and then appoints a receiver.’2 The Committee’s recommendation, which with one small addition was originally embodied in s 75 of the Companies Act 1928, was that a new section should be inserted providing that where, in the course of winding up a company, it appeared that any business of the company had been carried on with intent to defraud creditors of the company, the court should have power, on application by the liquidator or any creditor or contributory, to

1 Report of the Company Law Amendment Committee, Cmnd 2697, HMSO, London, 1926. 2 Ibid, [61].

DOI: 10.4324/9780429266232-7

33

BACKGROU N D AND AIM

declare that the directors responsible should be subjected to unlimited personal liability in respect of the debts or other liabilities of the company; and, further, that the court should be empowered to charge such liability upon any debt or obligation due from the company to the director, or upon any charge on any of the company’s assets held by or vested in him or her or in any person on the director’s behalf. 5.3 Section 75, shortly after its enactment, became s 275 in the consolidated Companies Act 1929. The original section and its successors have been referred to as ‘the most important incursion[s] into the principle of the separate personality of a company.’3 The section imposed both criminal and civil liability, and in both civil and criminal proceedings the elements of the section had to be established beyond reasonable doubt.4 Proceedings could be initiated by the official receiver, the liquidator, creditors or contributories. Section 275 of the 1929 Act became s 332 of the Companies Act 1948, which, as a result of the recommendations of the Cohen Committee in 1945,5 expanded the pool of possible respondents to include those who had been parties to fraudulent trading. 5.4 The Report of the Insolvency Law Review Committee, Insolvency Law and Practice (commonly known as, and similarly referred to here, ‘the Cork Report’)6 was of the opinion that the fraudulent trading provision as set out in s 332 of the 1948 Act possessed significant inadequacies in dealing with irresponsible trading, such as the fact that the criminal burden of proof applied to civil actions and, also, applicants were required to establish actual dishonesty and real moral blame on the part of respondents.7 5.5 Consequently, the Cork Committee recommended that the provision be amended and that only criminal liability should apply in relation to fraudulent trading, with a new provision being introduced to allow for civil actions. The legislature took up these proposals, partly, and enacted s 214 of the Insolvency Act 1986, which covered civil action for wrongful trading, and fraudulent trading was left to be covered by two provisions, namely s 213 of the Insolvency Act and s 458 of the Companies Act 1985. 5.6 The fact that civil liability was retained for fraudulent trading as well as criminal liability meant that the recommendations of the Cork Committee were not wholly implemented. But, unlike previous provisions, criminal liability was to be determined by a different provision, and this was s 458 of the Companies Act 1985 (now s 993 of the Companies Act 2006). The two provisions, the one dealing with civil liability and the other dealing with criminal sanctions are essentially the same provision.8 The main differences are as to the question of

3 4 5 6 7 8

R Williams, ‘Fraudulent Trading’ (1986) 4 Company & Securities Law Journal 14. Re Maidstone Buildings Ltd [1971] 1 WLR 1085, 1094. Cmnd 6659, [149]. Cmnd 858, HMSO (1982). Re Patrick and Lyon Ltd [1933] Ch 786. Bernasconi v Nicholas Bennett & Co [2000] BCC 921, 924.

34

BACKGROU N D AND AIM

proof, the order of the court and the fact that with s 993 there is no need for the company to be in liquidation. 5.7 While the pre-1986 decisions related to a provision that could lead to both civil and criminal consequences, the courts in post-1986 decisions have not uttered any caveats about relying upon, and employing, the older cases, and they certainly have not refused to hear argument based upon them. This seems reasonable given the fact that the provisions are very similar. 5.8 When ss 213 and 214 of the Insolvency Act 1986 were enacted, the latter was introduced to deal more with trading activity that was not fraudulent per se, but closer to negligent or irresponsible trading. Some of the discussion in this part overlaps with issues that are relevant to wrongful trading, which is discussed in Part C of the book. 5.9 Until recently an administrator was not empowered to bring fraudulent trading proceedings as s 213, and its precursors only covered liquidators. Now an administrator has power, under s 246ZA, to institute an action for fraudulent trading.9 The provision is in the same terms as s 213. For ease of exposition the book will refer, for the most part, to s 213 and to liquidators, but readers must be aware that what is said will usually apply equally to administration. There is no indication anywhere in the case law that s 246ZA will be interpreted any differently than s 213. 5.10 At one stage the civil fraudulent trading provision was little used and led one commentator to say that the section was virtually obsolete,10 but in the first decade of the twenty-first century, in particular, there was a renaissance and there were several important cases successfully brought by liquidators, and in the past decade there have been several cases, indicating that the action is not redundant. 5.11 Many Commonwealth jurisdictions, as well as Ireland, have enacted legislation akin to the UK’s legislation, and so some case law from these jurisdictions can be helpful in examining the UK’s provisions. Aim 5.12 The paramount aim of s 213 is to compensate those who have lost out due to the actions of persons, who are identified in the section, engaging in fraudulent trading,11 while the aim of s 993 is to punish by imposing penalties where the action is considered criminal. Also, the provisions are designed to prevent insolvent trading to the detriment of those who are induced to do business with the relevant company.12

9 This right came about through the enactment of s 117 of the Small Business, Enterprise and Employment Act 2015, which provided for a new section in the Act. 10 Vanessa Finch, Corporate Insolvency Law: Perspectives and Principles (CUP, 2002), 511. 11 Bank of India v Morris [2005] EWCA Civ 693, [111]. 12 R v Smith [1996] 2 BCLC 109, 122(CCA).

35

BACKGROU N D AND AIM

Conclusion 5.13 The chapter has sought to provide an explanation of how the law developed to proscribe fraudulent trading and how it has been extended to enable administrators as well as liquidators take action against directors and others who engage in fraudulent trading.

36

CHAPTER 6

Fraudulent Trading The Provision and Its Scope

Introduction and Background 6.1 As indicated in the last chapter, two provisions address fraudulent trading. They are the civil provision, s 213 of the Insolvency Act 1986 (‘the Act’) and the criminal provision, s 993 of the Companies Act 2006. They are essentially identical, with the primary differences being procedural. The standard of proof for a s 213 action is the same as for any civil proceeding, namely the balance of probabilities, while the standard for the criminal proceeding remains beyond reasonable doubt. The claimant in a civil claim is the liquidator, while criminal proceedings must be initiated by the Crown. It has been stated that decisions on s 993 are relevant to a consideration of s 213,1 so in Part B no distinction is made between the cases on the basis of the provision under which they were decided. The main focus of this part is, however, on s 213, although, of course, many of things said here will be relevant to s 993, and occasionally reference will be made to the provision, either in the text or in footnotes. Also, there are a couple of sections of the chapter that include brief discussions of aspects of s 993. 6.2 This chapter involves an examination of the central elements of s 213, together with a discussion of the effect of its application. However, discussion of one of the main elements, and perhaps the most difficult element, of the provision, namely the need to establish intent to defraud or acting for any fraudulent purpose, is postponed, for the most part, to Chapter 7. 6.3 What s 213 provides is that if, in the course of carrying on a business, a company has done so either with intent to defraud the creditors or the creditors of anyone else or for any fraudulent purpose, a court may, on the application of the liquidator, declare that any persons who were knowingly parties to the carrying on of the business in such a manner are liable to make contributions (if any) to the company’s assets as the court thinks proper. 6.4 At the outset we should note that at one time it was generally thought that s 213 would not be invoked very often, given the advent of the action of wrongful trading in s 214 of the Act, but that is not the case. While s 214 has a lower threshold of proof, and the elements of the section appear prima

1 Re BCCI; Banque Arabe Internationale D’Investissement SA v Morris [2002] BCC 407, 413.

DOI: 10.4324/9780429266232-8

37

FR AU DU LENT TR A DI NG

facie easier to establish, s 213 is far from being a dead letter, and there have been several fraudulent trading actions in recent times. There have also been, and continue to be, a respectable number of prosecutions under s 993 of the Companies Act, which is not, of course, affected by the presence of s 214 on the statute books. 6.5 Finally, in relation to interpretation, as mentioned earlier, while there have been some changes in the present fraudulent trading provisions compared with previous ones, it is clear that the cases decided under previous provisions are relevant to proceedings taken under the present provisions,2 although some of the cases have not been followed and some have even been overruled in light of the reform of the provisions. 6.6 Furthermore, we should note that the interpretation of parts of s 213 has vexed courts and led the judge in one of the first reported cases dealing with the first fraudulent trading provision, Re Patrick & Lyon Ltd,3 to say that the provision (in the 1929 Act) was ‘a very remarkable section and one which is by no means easy to construe.’4 The Elements: An Introduction 6.7 According to the decision in Re BCCI; Morris v Bank of India,5 there are three elements that constitute the action: • the business of the company in liquidation has been carried on with intent to defraud creditors or for any other fraudulent purpose; • the respondent participated in the carrying of business; and • the respondent did so knowingly. 6.8 As mentioned earlier, we will examine the first of these elements in a separate chapter, namely Chapter 7, as it has been an element that has been controversial and warrants its own chapter. The other elements are examined next. 6.9 In a case in which the criminal version of fraudulent trading was considered, R v Wallace Duncan Smith,6 the Court of Appeal actually set out four elements, which are roughly equivalent to what the court in Re BCCI; Morris v Bank of India propounded. They were: (1) the respondents were knowingly parties to the carrying on of the business; (2) there were creditors entitled to be paid; (3) the respondents intended that creditors should be defrauded in that they intentionally carried on its business to the prejudice of the rights of those creditors; and (4) the respondents were acting dishonestly.

2 3 4 5 6

Re L. Todd (Swanscombe) Ltd [1990] BCC 125. [1933] Ch 786. Ibid., 789–790. [2004] 2 BCLC 236, [11]. [1996] 2 Cr App R 1.

38

FR AU DU LENT TR A DI NG

The Applicant 6.10 While individual creditors were able, under previous legislation, such as s 332 of the Companies Act 1948, to initiate applications for compensation on their own account, and it appears that a number of claims were initiated by persons other than liquidators,7 this cannot be done now,8 as only liquidators are entitled to apply for an order under s 213;9 applications are collective in that a liquidator is seeking compensation for the general body of creditors. Hence, courts are unable to direct that, as a consequence of fraudulent trading, a specific creditor be compensated for losses sustained.10 6.11 Arguably, the position that we have now in the UK is more equitable than was the former situation, as in the past one creditor who brought proceedings might be able to get paid following a fraudulent trading application, but as a result, the respondent might be placed in an impecunious state and, therefore, be unable to pay other creditors who either were slow in initiating proceedings or failed to do so. 6.12 Although creditors are not entitled to bring proceedings, they are not completely eliminated from the equation, as it is submitted that in some circumstances creditors could apply to the courts for a review of the decision of the liquidator if he or she chooses not to proceed with a fraudulent trading action. This could be done pursuant to s 168(5) of the Act for compulsory liquidations, and under s 112 for voluntary liquidations. But, of course, absent those situations where the threat of creditors to seek a court review may cause a liquidator to think again, creditors will have to expend time and money on court proceedings, and it might be thought that it is not worth doing so. 6.13 In the context of s 213, ‘liquidator’ does not include a provisional liquidator, so the latter is not entitled to initiate proceedings.11 Any proceedings will have to wait until the provisional liquidator or someone else is appointed as liquidator. 6.14 A liquidator of a limited liability partnership is empowered to bring proceedings under s 213 by virtue of the Limited Liability Partnerships Regulations 2001.12 6.15 Now, as we have noted previously, administrators are able to bring proceedings, but they are brought pursuant to s 246ZA of the Act. This broadens 7 For example, In re Gerald Cooper Chemicals Ltd [1978] Ch 262; Re Cyona Distributors Ltd [1967] Ch 889, 902, [1967] 1 All ER 281, 284 (CA). 8 In common with previous UK legislation, other jurisdictions permit a wider category of applicants who can bring proceedings against directors, including creditors and members, such as creditors and members as well as liquidators. 9 Administrators may bring proceedings under s 246ZA, a provision equivalent to s 213 and applying to administrators. 10 Re Esal (Commodities) Ltd; London and Overseas (Sugar) Co Ltd v Punjab National Bank [1993] BCLC 872 and affirmed on appeal: [1997] 1 BCLC 705 (CA); Morphitis v Bernasconi [2003] EWCA Civ 289, [2003] Ch 552, [2003] BCC 540. 11 Re Overnight Ltd; Goldfarb v Higgins [2009] EWHC 601 (Ch), [2010] BCC 787, [2010] 2 BCLC 186. 12 SI 2001/1090 reg 5 and Sch 3.

39

FR AU DU LENT TR A DI NG

the options available to administrators in bringing legal proceedings and means that a company would not have to be converted from an administration to a liquidation merely to allow for proceedings under s 213 to be taken, as was the case before the advent of s 246ZA. Applications 6.16 Fraudulent trading actions in civil law may only be initiated when the company in relation to whose affairs the actions are being brought, is in liquidation (or administration). A reason for the limitation might be that it is envisaged that companies not in liquidation would be solvent and action could be taken against the company itself.13 However, the fact that the company is solvent might be due to the success of its fraudulent activity.14 Also, it should be noted that s 213 does not require the company to be in insolvent liquidation, so the provision could be invoked in relation to a company that has been wound up on a ground other than an inability to pay debts, such as the just and equitable ground.15 6.17 At one time liquidators were required, before taking action, to secure approval from either the liquidation committee or the court, but that is no longer the case. The requirement of obtaining approval was abolished by s 120 of the Small Business, Enterprise and Employment Act 2015, although liquidators might take the view that it is prudent to obtain sanction in some cases, particularly where the case could involve a lot of expenditure, or the chances of success are not high. 6.18 Proceedings that are brought under s 213 or s 246ZA are covered by Part 12 of the Insolvency Rules 2016. Liquidators and administrators who decide to commence proceedings against directors would ordinarily complete and file a Form 1AA with supporting witness statements. 6.19 The application is made in the insolvency proceedings commenced, either liquidation or administration. It should seek a declaration under s 213 that the respondent has engaged in fraudulent trading and that the respondent is liable to make such contribution to the assets of the company as the court thinks fit. 6.20 On the filing of an initiating form (and supporting witness statements) the court will fix a return date, and this will usually involve a short appointment, at which the court will give directions either as to witness statement evidence in response and any further evidence to be filed by the applicant (if so advised) in reply or, in a more complex case where pleadings are appropriate (where the applicant will often have provided draft points of claim), an order that the draft points of claim stand as points of claim followed by points of defence and points of reply.16 The matter will usually then come back to court for a further case management hearing to deal with disclosure, inspection, evidence and trial arrangements. 13 14 15 16

R Williams, ‘Fraudulent Trading’ (1986) 4 Company & Securities Law Journal 14, 17. Ibid. Insolvency Act 1986, s 122(1)(g). Often the parties will have previously agreed directions.

40

FR AU DU LENT TR A DI NG

6.21 The section which addresses wrongful trading, s 214, contains a provision, s 214(8), that states that s 214 is without prejudice to s 213, so there is nothing to prevent a liquidator, in the appropriate case, from mounting proceedings which claim relief under s 213 and, in the alternative, under s 214. The liquidator in Re Produce Marketing Consortium Ltd17 commenced his action relying on both ss 213 and 214, and while the s 213 claim was dropped (clearly because the directors were not guilty of intending to defraud creditors),18 the judge did not comment adversely on the liquidator bringing proceedings under both of the sections. It was held in Official Receiver v Doshi19 in relation to an application under s 214, that such an application may be consolidated with disqualification proceedings, and there is no reason to think that it is otherwise where fraudulent trading is involved. 6.22 It is likely that in some situations liquidators may choose to couple a claim under s 213 with other claims, such as a claim under s 212 (misfeasance proceedings), as occurred, for example, in Re Pantiles Investments Ltd (in liquidation),20 arguing that directors have breached their duties.21 If a liquidator were to launch proceedings under both ss 213 and 212, the respondent’s liability, if the liquidator succeeded, will be regarded as concurrent,22 except where the conduct leading to liability under each heading was different, and in such a case the court might order cumulative awards.23 The difficulty that might arise where there is a concurrent award is that any award pursuant to s 213 is to be distributed amongst the general body of unsecured creditors,24 while any award for causes of action brought under a s 212 summons goes to the company,25 as the action for breach of duty is the company’s and not the liquidator’s, and this might enable a holder of a floating charge over company property to have priority in payment out of this latter award. 6.23 Claiming under s 213 involves an allegation of dishonesty, and so dishonesty must be pleaded in an application (and also put to the respondent in cross-examination).26 The application should plead fraud clearly and with particularity,27 that is, the actual conduct that constitutes an intent to defraud must be set out clearly.28

17 (1989) 5 BCC 569. 18 Ibid., 594. 19 [2001] 2 BCLC 235. 20 [2019] EWHC 1298 (Ch), [2019] BCC 1003, [2019] 2 BCLC 295. 21 Often liquidators will rely on a breach of the director’s duty to take into account the interests of creditors when the company was insolvent or close to it. 22 Re DKG Contractors Ltd [1990] BCC 903. 23 Re Purpoint Ltd [1991] BCC 121, [1991] BCLC 491. 24 Insolvency Act 1986, s 176ZB. 25 Re Anglo-Austrian Printing & Publishing Co [1985] 2 Ch 891. 26 Dempster v HMRC [2008] EWHC 63 (Ch), [2008] STC 2079, Abbey Forwarding Ltd v Hone [2010] EWHC 2029 (Ch). See Three Rivers DC v Bank of England (No. 3) [2003] 2 AC 1, [55], [160]. 27 Re Augustus Barnett (1986) 2 BCC 98,904, 98,908. 28 Morris v Bank of America National Trust [2001] 1 BCLC 771 [2000] BCC 1076, [2000] BPIR 83 (CA) (an appeal relating to a strike out application). See Ivy Technology v Martin (2019) EWHC 2510, [12]; Biscoe v Milner [2021] EWHC 763 (Ch), [174].

41

FR AU DU LENT TR A DI NG

6.24 The pleadings should include an averment that creditors of the company have sustained loss and what action caused the loss,29 but unlike with wrongful trading, where it is critical that the liquidator pleads a date from which the wrongful trading is alleged to have commenced, courts have still held a respondent to be liable even if no date as to when the fraudulent trading occurred is stated, or where several alternate dates are alleged.30 6.25 The application should plead that the respondent is responsible for a definite sum and not be liable in general terms.31 6.26 As a claim under s 214 can be made where a company is being wound up as an unregistered company,32 it is contended that a claim for fraudulent trading could also be made in the same circumstances where it is appropriate to do so. 6.27 The Supreme Court made it perfectly plain, in Jetivia SA v Bilta (UK) Ltd,33 that the provision has extra-territorial effect in that it can be applied to individuals and companies that reside outside of the UK, so the respondents might not in be in the country. 6.28 According to the decision in Carman v Cronos Group SA,34 proceedings are not able to succeed under s 213 in relation to conduct that occurred between the date of the presentation of a winding-up petition and the making of a winding-up order, as a company cannot be regarded as carrying on business when any transaction in the course of that business which amounts to a disposition of property is deemed to be void under s 127 of the Act, unless the court orders to the contrary. 6.29 It was held in Carman v Cronos Group SA35 that liability under s 213 may be imposed in relation to actions that occurred when the company had been dissolved but is later reinstated to the register. This was on the basis that s 653 of the Companies Act 1985 stated that a dissolved company, when reinstated, was deemed to have continued in existence as if it had not been struck off the register.36 This provision is effectively now found in ss 1028(1) and 1032(1) of the Companies Act 2006, and thus the Carman decision would still apply. 6.30 Funding an action is always a challenge for a liquidator or administrator when considering any action. One option is to get a litigation funder to bankroll proceedings. Another is to have the creditors indemnify the liquidator. A further option is to assign an action to an outsider for some consideration. At 29 Goldfarb v Alibhai(unreported, 11 December 2017, Business and Property Courts, Registrar Barber). 30 Re a Company No 001418 of 1988 [1991] BCLC 197. 31 Re William C Leitch Bros Ltd [1932] 2 Ch 71, 77–79; Re a Company No 001418 of 1988 [1991] BCLC 197, 203. 32 Re Howard Holdings Inc [1998] BCC 549. 33 [2015] UKSC 23, [2016] AC 1, [2015] 2 WLR 1168, [2015] 2 All ER 1083, [2015] 1 BCLC 443, [13], [107], [110], [213]. 34 [2005] EWHC 2403 (Ch), [2006] BCC 451, [37]. 35 Ibid., [24]. 36 Ibid.

42

FR AU DU LENT TR A DI NG

one time a liquidator was unable to assign an action under s 213 because it was an action given to him or her personally in the position of liquidator,37 but now things are different, as s 246ZD(2)(a) permits assignment of s 213 cases. This broadens the scope of what a liquidator can do to obtain some benefit from an action under s 213. 6.31 There is no law specifically on what the limitation period is for the commencement of an action under s 213, but it has been held in relation to s 214 that the application can be categorised as a claim in respect of a sum of money within s 9 of the Limitation Act 1980, and hence a six-year limitation period, from the date of the accrual of the cause of action, applies.38 It is submitted that the view could be applied to s 213, as proceedings are of the same ilk as those under s 214. As a fraudulent action is personal to the liquidator any limitation period would commence to run from the time of the resolution to wind up in voluntary liquidations, or from the date of the court order in compulsory liquidations,39 as they would be the respective points when the cause of action accrued. With s 246ZA and administrations the limitation period would run from the time when the administration commenced. 6.32 Unlike with actions under ss 238, 239 and 245 of the Act, for instance, liquidators are not limited in how far they go back in the life of the company to identify periods of fraudulent trading, but in practice the period subject to inquiry will usually be the couple of years prior to the advent of winding up. 6.33 It is somewhat uncertain as to whether a claim pursuant to s 213 would survive the death of a person allegedly liable under s 213, but who died before the initiation of proceedings. May it be continued against a director’s estate in the event of the alleged wrongdoer’s death? In a wrongful trading case, Re Sherborne Associates Ltd,40 it was said that as far as s 214 there was reason to suppose that Parliament had intended that such a claim should not be defeated by death,41 but in that case the judge issued the caveat that if the director had lived, he or she might have been able to provide a credible explanation for what had been done or not been done, and consequently a judge should have in mind the fact that the director might have been able to rebut the liquidator’s claims had he or she lived.42 It might be submitted that the comments of the judge in Re Sherborne Associates Ltd43 are even more pertinent with respect to a s 213 action, as in this kind of action an intent to defraud has to be established and a director should be given the opportunity to challenge any allegations of fraud made against him or her and to be able to give evidence that he or she had no intent to defraud. However, this might 37 Re Oasis Merchandising Services Ltd [1995] BCC 911. 38 Re Farmizer (Products) Ltd [1997] 1 BCLC 589, 598, CA. 39 Re Overnight Ltd (In Liquidation) [2009] EWHC 601 (Ch), [2010] BCC 787, [2010] 2 BCLC 186, [36]. 40 [1995] BCC 40. 41 Ibid., 46. 42 Ibid., 47. 43 Ibid.

43

FR AU DU LENT TR A DI NG

be said to be unfair for the creditors, particularly if there is clear objective evidence of an intent to defraud. 6.34 Finally, the liquidator may give evidence at the hearing of an application in addition to calling other witnesses.44 Persons Who May Be Liable Directors and Company Officers 6.35 Unlike both the wrongful trading provision, discussed in the next part, which states that only directors are liable, and the fraudulent trading provision that pre-dated the version found in s 332 of the Companies Act 1948, which limited liability to directors past and present, any persons who are knowingly parties to the fraudulent trading can be the subject of proceedings under s 213. While it is probable, certainly based on history, that the most likely respondents to an action will be the directors and other officers of the company,45 with the executive directors likely to be subject to action the most often, persons who are not involved in conducting the business of the company may be liable.46 6.36 Besides de jure directors being liable for a breach of s 213, de facto directors may also be held liable.47 The same goes for shadow directors, as the respondent does not have to be a director. 6.37 What if directors are not involved in the actions that can be said to constitute the fraudulent trading? Are they liable? Much will depend on the facts. The simple answer would be that if directors were not knowingly parties to the carrying on of business that was intended to defraud creditors, they would not be liable. But things will often be more complicated than that. Why did the directors not know about the fraudulent trading? If they were deliberately kept out of the loop, possibly because other directors thought that they were too ethical to support the conduct, then they are probably not going to be liable. This is unless there was evidence existing that should have put the directors on notice concerning the questionable activity and they turned a blind eye to it. In the latter case a court might hold that they should be held liable, as they did have certain knowledge and suspicions. We will consider

44 Insolvency Act 1986, s 215(1). 45 There is every indication that the persons who can be said to be the ‘directing mind’ of the company are liable, more often than not, to be the subject of proceedings. See R v Miles [1992] Crim L R 657. Also, see Re Supply of Ready Mixed Concrete (No2) [1995] 1 AC 456; Meridian Global Funds Management Asia Ltd v Securities Commission [1995] BCC 942. 46 For example, see Re Gerald Cooper Chemicals Ltd [1978] Ch 262 where a creditor was held liable. See S Griffin, Personal Liability and Disqualification of Company Directors (Hart Publishing, 1999), 45–46. For a more recent case, see, Morris v Bank of India [2004] BCC 404 and affirmed on appeal in [2005] EWCA Civ 693, [2005] 2 BCLC 328, [2005] BPIR 1067, where a third-party bank was held liable under s 213. 47 Biscoe v Milner [2021] EWHC 763 (Ch).

44

FR AU DU LENT TR A DI NG

what blind-eye knowledge is later when we discuss the possible liability of those outside of the company. 6.38 What if directors were not deliberately kept out of the loop by miscreant directors but simply failed to see what was going on as they were passive? That is, they did not attend board meetings or ask obvious questions about company actions. Nowadays, and for some time, the law has not smiled on directors who fail to engage with their companies’ affairs. Gone are the days when directors could stay away from board meetings in the hope that they could then claim that they had nothing to do with decisions which might later be subject to challenge, either by a new majority shareholder or a liquidator. 6.39 While this book focuses on directors and their responsibilities, it is appropriate here to discuss in brief the liability of others. Much more could be said, but it would be going too far outside the scope of the book if we did. 6.40 It will be recalled that at one time directors were the only ones who could be subject to liability for fraudulent trading and that in 1947 the Companies Act replaced the reference to directors as being the people who could be held liable for fraudulent trading with the word ‘persons.’ This was done to implement the recommendations of the Cohen Committee48 in June 1945, which had said that: ‘We think that the subsections should be extended so as to apply not only to directors but also to other persons who were knowingly parties to the frauds.’49 6.41 The scope of s 213 is such that the range of possible respondents is broad and the respondent does not, necessarily, have to be someone who performed a managerial or controlling role in the company.50 This has been criticised on the basis that originally the reference to ‘any person’ in s 213(1) was aimed at those who were involved in some way in the management of, or had control over, the company that was in liquidation.51 Nevertheless, the courts have visited liability on some who were not involved in management or control, as the following discussion suggests. 6.42 In determining whether proceedings can be brought against a particular person, each case must be judged on its own facts and requires a consideration of all the circumstances surrounding the transaction.52 6.43 In Re Maidstone Buildings Ltd53 the court held that the secretary of a company was not liable for failing to advise the directors that the company was insolvent and there should be a cessation of business, yet this decision must be doubted given the enhanced role of the secretary and the fact that such officers can bind the company to contracts that deal with administrative matters.54 This

48 Report of the Committee on Company Law Amendment, the Cohen Committee, June 1945 (Cmd. 6659). 49 Ibid., [149]. 50 Re BCCI; Banque Arabe Internationale d’Investissement v Morris [2002] BCC 407, 411. 51 David Foxton QC, ‘Accessory Liability and Section 213 Insolvency Act’ [2018] JBL 324, 336. 52 Morris v Bank of India [2005] EWCA Civ 693, [2005] 2 BCLC 328, [2005] BPIR 1067, [112]. 53 [1971] 1 WLR 1085. 54 Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd [1971] 2 All ER 1028.

45

FR AU DU LENT TR A DI NG

later reading of the law seems to be consistent with the fact that in a criminal prosecution under s 458 of the Companies Act 1985, R v Waite,55 a company secretary was successfully prosecuted. Employees 6.44 Section 213(2) can cover employees, but only certain ones. Whether an employee will be liable will very much depend on the facts. Neuberger J (as he then was) said in Re BCCI; Banque Arabe Internationale d’Investissement v Morris56 that an employee of the company who was merely carrying out orders does not fall within the section but somebody who ‘orchestrates, organises or can seize of the business concerned does fall within the section.’57 Thus, a company salesman who acted under orders of management was held in R v Miles58 not to be liable under s 458 of the Companies Act 1985, the precursor of s 993. Outsiders (Accessories) 6.45 The terms of s 213 allow for persons who are not part of the insolvent company or involved in directing or managing the company to be held liable if they are knowingly parties to the carrying of business with intent to defraud creditors. Such persons are usually referred to in the cases and literature as ‘outsiders’ or ‘accessories.’ In Re BCCI, Banque Arabe Internationale d’Investissement v Morris59 Neuberger J made the point that: ‘If anything it [the wording of s 213(2)] is a more natural reference to people who are not employed by the company at all, but who are third parties to the company.’60 Later his Lordship warned about interpreting s 213(2) so as include such a wide range of people who might be held liable so as to risk stultifying normal business transactions, but he then said that that: is not a good reason for preventing a liquidator from pursuing a person who actively and dishonestly assisted, and/or benefited from, the company in adopting a dishonest course of conduct, which predictably led to lenders to, or shareholders of, the company being defrauded.61

6.46 The Court of Appeal certainly appeared to accept the reasoning of Neuberger J in Bank of India v Morris62 that s 213 was to be construed widely and that outsiders could be held liable for breach of s 213. Snowden J (as he then was) in

55 56 57 58 59 60 61 62

(2003) WL 21162167 (CCA). [2002] BCC 407. Ibid., 414. [1992] Crim L R 657. [2002] BCC 407. Ibid., 411. Ibid., 412. [2005] EWCA Civ 693, [2005] 2 BCLC 328, [2005] BPIR 1067, e.g. see [112].

46

FR AU DU LENT TR A DI NG

Bilta (UK) Ltd v Natwest Markets plc63 adopted that view.64 His Lordship was of the view that in light of the Court of Appeal’s judgment in Bank of India v Morris65 he could not, in finding outsiders liable under s 213, entertain the criticisms of David Foxton QC (as he then was) against allowing outsiders to be liable.66 6.47 Creditors of an insolvent company that is in liquidation have been held liable on occasion. In Re Gerald Cooper Chemicals67 a creditor was held liable, where he was aware that his debt was satisfied as a result of a fraud committed in relation to a customer of the company. Templeman J (as he then was) said that: In my judgment a creditor is party to the carrying on of a business with intent to defraud creditors if he accepts money which he knows full well has in fact been procured by carrying on the business with intent to defraud creditors for the very purpose of making the payment.68

6.48 Stephen Griffin has asserted that in light of the later decision in Re Maidstone Buildings Ltd,69 a person could only be found liable if participating in the company’s trading activities in a significant manner,70 and so he criticised the decision in Re Gerald Cooper Chemicals Ltd,71 where the court held a creditor liable, and he did so on the basis that the creditor was only acting in a passive way.72 6.49 More recently, the decision in Re Gerald Cooper Chemicals Ltd has attracted further criticism.73 Certainly in Re Maidstone Buildings Ltd the judge said that a person, to be liable, had to act in a positive way.74 Thus, could it be said that an outsider, unlike a director of the insolvent company, such as a creditor, should not be liable if acting passively? The problem is that the decision of Templeman J in Re Gerald Cooper Chemicals Ltd does not appear to be an outlier. For instance, in Re Augustus Barnett & Son Ltd75 Hoffmann J (as he then was) said that the relevant words in s 213(2) may be wide enough to 63 [2020] EWHC 546 (Ch), [187]. 64 A retrial of the case was ordered by the Court of Appeal (Natwest Markets Plc v Bilta (UK) Ltd (In Liquidation) [2021] EWCA Civ 680), as it ruled that the 19-month delay between trial and judgment being delivered meant that it could not be assumed that the judgment was prepared ‘with a full recollection of the relevant evidence.’ In Bilta (UK) Ltd (in liquidation) v SVS Securities plc [2022] EWHC 723 (Ch), Marcus Smith J held that a wide reading was defensible (at [79]) and was not persuaded that the approach in the judgments of Neuberger and Snowden JJ was wrong. 65 [2005] EWCA Civ 693, [2005] 2 BCLC 328, [2005] BPIR 1067, e.g. see [112]. 66 ‘Accessory liability and section 213 Insolvency Act’ [2018] JBL 324. Snowden J’s decision was reversed on appeal (Natwest Markets Plc v Bilta (UK) Ltd (In Liquidation) [2021] EWCA Civ 680) (see n 64 above), but the Court of Appeal did not overrule Snowden J on this point. 67 [1978] Ch 262. 68 Ibid., 268. 69 [1971] 1 WLR 1085. 70 Stephen Griffin, Personal Liability and Disqualification of Company Directors (Hart Publishing, 1999), 45–46. 71 [1978] Ch 262. 72 Stephen Griffin, Personal Liability and Disqualification of Company Directors (Hart Publishing, 1999), 45. 73 David Foxton QC, ‘Accessory Liability and Section 213 Insolvency Act’ [2018] JBL 324, 335. 74 [1971] 1 WLR 1085, 1093. 75 (1986) 2 BCC 98,904.

47

FR AU DU LENT TR A DI NG

encompass people outside of the insolvent company who could not be said to have carried on or even assisted the carrying on of the company’s business, but who nevertheless in some way participated in the fraudulent acts, and thus are liable. Neuberger J in Re BCCI, Banque Arabe Internationale d’Investissement v Morris76 agreed with the comments of both Templeman and Hoffmann JJ.77 6.50 More often than not the outsider whom a liquidator seeks to attack is a company that has had some dealings with the insolvent company. In Banque Arabe Internationale D’Investissement SA v Morris78 the court said that a company or other entity that was involved in, and assisted and benefited from, the action that was fraudulent, and did so knowingly, could be held liable.79 6.51 Outsider respondents need not know all of the precise details of any fraudulent action perpetrated by the company or how the fraud was to be carried out, before they are held liable, provided that they knew, either from their own observations of what was being done or from what they were told, that the company was intending to carry out a fraud on creditors.80 In Re Augustus Barnett & Sons Ltd,81 Hoffmann J said, while not having to decide the point, that outsiders who were not carrying on, or assisting in the carrying on, of the business of the company, but who participated some way in the fraudulent acts may be respondents.82 6.52 Taking action against an outsider company can be more difficult for a liquidator as the company, obviously, is not a human person but a legal person and requires humans to act for it. A company could be held liable even if none of its board members had knowledge of the fraudulent trading activity, as that would defeat the policy behind the provision,83 provided that someone of authority (that was authority granted by the board) had the requisite knowledge. Hence, an outsider company employee’s knowledge of fraudulent trading may be attributed to his or her employer company.84 Persons involved in outsider companies will not be liable on the basis that they are acting for a company that has participated in the fraudulent trading unless they hold some role that involves managing or controlling the affairs of the outsider company.85 6.53 In Bank of India v Morris86 the Court of Appeal indicated that an outsider company can be held liable where the person who had the requisite knowledge was a manager at below board level if the company involved was

76 [2002] BCC 407. 77 Ibid., 413. 78 [2002] BCC 407. 79 Ibid., 412, 414. 80 Re BCCI; Morris v State Bank of India [2004] BCC 404, [13]. 81 (1986) 2 BCC 98,904, 98,907. 82 Ibid. 83 Bank of India v Morris [2005] EWCA (Civ) 693, [2005] 2 BCLC 328, [2005] BPIR 1067, [108], [129]. 84 Ibid. 85 Ibid. 86 [2005] EWCA (Civ) 693, [2005] 2 BCLC 328, [2005] BPIR 1067.

48

FR AU DU LENT TR A DI NG

a large company.87 In this case the knowledge of the general manager of the outsider company, the Bank of India, a bank that was facilitating the company in liquidation in relation to part of its operations, was attributable to the bank. The bank was, therefore, held liable. 6.54 Therefore, just going back to the point that to make an outsider company liable it would normally be necessary to attribute the knowledge of someone connected with the outsider company to the company itself, the Court of Appeal stated in Bank of India v Morris: In most companies of any size there will be a chain of command and delegation of authority and it is likely that the transactions with the fraudulent company will be dealt with at a level in the company below that of the board. It would in practice defeat the effectiveness of [Section 213] if liability were limited to those cases in which the board of directors was actually a direct privy to the fraud of the company with whom the transactions were entered into.88

6.55 The Court said that the question that must be asked is: who had authority in the outsider company to deal with the company in liquidation in respect of the relevant transaction(s)?89 6.56 Thus, it is only the knowledge of persons who can be said to be the directing mind of the company which can be attributed to the company and make the company liable.90 However, ascertaining who is the directing mind and will of the company and what was their knowledge is never an easy task.91 The Court of Appeal in Bank of India v Morris92 said that the articles of association of the company, its contractual relations and the ways in which its powers are actually exercised are all relevant to locating who is the company’s directing mind and will as far as ascertaining the relevant acts for which it is going to be made liable.93 The company has, under this approach, attributed to it the mind and will of the natural person(s) who manages and controls its actions.94 6.57 According to Viscount Haldane in Lennard’s Carrying Co Ltd v Asiatic Petroleum Co Ltd,95 the directing mind and will might be a person who is under the direction of the shareholders in general meetings, the board or someone who has, pursuant to the articles, an authority co-ordinate with the board.96 Hoffman LJ (as he then was) said in El Ajou v Dollar Land Holdings plc97 that ‘a person

87 Ibid., [112]. 88 Ibid. 89 Ibid. 90 Ibid., [95]. 91 For example, see Lennard’s Carrying Co Ltd v Asiatic Petroleum Co Ltd [1915] AC 707, 713; HL Bolton (Engineering) Co Ltd v T J Graham & Sons Ltd [1957] 1 QB 159, 172–173; Tesco Supermarkets Ltd v Nattrass [1972] AC 153, 170; El Ajou v Dollar Land Holdings plc [1994] BCC 143, 150 and 158; Meridian Global Funds Management Ltd v Securities Commission [1995] 2 AC 500 (PC). 92 [2005] EWCA (Civ) 693, [2005] 2 BCLC 328, [2005] BPIR 1067. 93 Ibid., [95]. 94 El Ajou v Dollar Land Holdings plc [1994] BCC 143, 150. 95 [1915] AC 707. 96 Ibid., 713. 97 [1994] BCC 143.

49

FR AU DU LENT TR A DI NG

held out by the company as having plenary authority or in whose exercise of such authority the company acquiesces, may be treated as its directing mind.’98 6.58 Then, in the Privy Council in Meridian Global Funds Management Asia Ltd v Securities Commission,99 said to be the locus classicus in this area of the law,100 Lord Hoffmann, stated that whose mind was attributed to the company was to be found in the company’s constitution, and regard must be had to any statutory provision involved and the context and policy of that provision. His comments were approved of by the House of Lords in Stone & Rolls Ltd v Moore Stephen101 and subsequently by the Supreme Court in Bilta (UK) Ltd v Nazir.102 In the latter case Lord Neuberger (on behalf of the majority) specifically indicated that any statutory context was critical.103 6.59 In Meridian Global Lord Hoffmann discerned that the attribution of the state of mind of a person to a company may also be appropriate where the person is the directing mind and will of the company for the purpose of performing the particular function in question, without necessarily being the company’s directing mind and will for other purposes.104 His Lordship said that it is incumbent to ask: ‘whose act or knowledge or state of mind is for the purpose of the relevant rule to count as the act, knowledge of the state of mind of the company?’105 Later Lord Phillips in Stone & Rolls Ltd v Moore Stephen106 appeared to approve of the approach adopted by Lord Hoffmann.107 6.60 In Bilta (UK) Limited v Nazir (No.2)108 Lord Sumption said that: The question what persons are to be so far identified with a company that their state of mind will be attributed to it does not admit of a single answer. . . . The primary rule of attribution is that a company must necessarily have attributed to it the state of mind of its directing organ under its constitution, i.e. the board of directors acting as such or for some purposes the general body of shareholders.109

6.61 However, Lord Sumption explained (and what had been acknowledged by Lord Hoffmann in Meridian) that the state of mind of someone other than the board might be attributed to a respondent company.110 Snowden J in Bilta (UK) Ltd v Natwest Markets plc111 noted that this approach had been employed

98 Ibid., 159. 99 [1995] 2 AC 500. 100 Stone & Rolls Ltd v Moore Stephen [2009] UKHL 39, [221]. 101 Ibid. 102 [2015] UKSC 23. 103 Ibid., [19], [20]. 104 [1995] 2 AC 500, 507. 105 Ibid. This was quoted with approval by Lord Neuberger in Bilta (UK) Ltd v Nazir [2015] UKSC 23, [20]. 106 [2009] UKHL 39. 107 Ibid., [28], [41]. 108 [2015] UKSC 23, [2016] AC 1. 109 Ibid., [67]. 110 Ibid., [68]. 111 [2020] EWHC 546 (Ch).

50

FR AU DU LENT TR A DI NG

by the Court of Appeal in Bank of India v Morris112 in the context of s 213.113 In Bilta a subsidiary of a bank external to the companies whose liquidators were making the claim under s 213 was alleged to have participated in the commission of missing trader intra-community VAT fraud. The fraud was alleged to have been undertaken by the directors of their companies, who participated in chains of transactions for the purchase of European Union carbon credits from other EU member states, not attracting VAT, and their sale to UK counterparties, attracting VAT. Snowden J said that the traders employed by the subsidiary were the ones who were given the authority to conduct the relevant trades of the EU carbon credits on behalf of the subsidiary.114 6.62 The Court of Appeal in Bank of India v Morris115 stated that if knowledge were not attributed to an outsider company, then in many cases, such as the one before the Court, the purpose of imposing liability upon such a company to pay compensation would be shorn of any power.116 The section, according to the Court, and if it was appropriate, allows for the knowledge of the fraud of a company employee or agent to be attributed to the company even though the person with actual knowledge of the fraud had acted dishonestly, in breach of the person’s duty to principal or employer, and in a situation where the person would not have passed on his or her knowledge to his or her agent or employer.117 The Court opined that the agent or employee’s importance or seniority in the hierarchy of the company is important, such that the more senior a person is, the easier it is to attribute the person’s knowledge and intention. If a person is given freedom to act in relation to the particular transaction(s) that is said to constitute fraudulent trading, then the more it is that person’s transaction, and the more he or she is effectively given room to proceed with it by the board, the easier it is to attribute knowledge.118 6.63 In small companies, especially when they are owner managed, it is much easier to establish a directing mind. A good example is Re Agriplant Services Ltd,119 where the judge was content to equate the state of mind of the director who essentially ran the company with the state of mind of the company.120 In general terms, whether attribution occurs will depend on the terms of the legislation that are under examination, as indicated by Lord Hoffmann in Meridian Global Funds Management Asia Ltd v Securities Commission,121 and whether it

112 113 114 115 116 117 118 119 120 121

[2005] EWCA (Civ) 693, [2005] 2 BCLC 328, [2005] BPIR 1067. Bilta (UK) Ltd v Natwest Markets plc [2020] EWHC 546 (Ch), [221]. Ibid., [222]. [2005] EWCA (Civ) 693, [2005] 2 BCLC 328, [2005] BPIR 1067. Ibid., [112]. Ibid., [116]. Ibid., [130]. [1997] BCC 842. Ibid., 851. [1995] 2 AC 500.

51

FR AU DU LENT TR A DI NG

is appropriate to attribute knowledge to the company notwithstanding the fact that the employee has acted dishonestly.122 6.64 Of course, for fraudulent trading to be proven against an outsider company the person whose knowledge is to be attributed to the outsider must have acted dishonestly.123 The Court of Appeal in Bank of India v Morris124 stated that there will be some situations where one cannot attribute an individual’s knowledge of fraud to a company.125 It is certainly not possible to argue that there should not be attribution merely, because the participation in a fraud by employees of an outsider company has caused potential harm to their company in that it has opened up the company to potential liability to fraudulent trading.126 The Court of Appeal concluded that ‘knowledge of fraud may be attributed to a company even though such attribution may expose it to the risk of liability under section 213,’127 and in this case there was attribution. It is submitted that if there was no attribution permitted in the kind of situations just adverted to, outsider companies would rarely be, if ever, liable under s 213. It should be noted that whether or not the knowledge of an employee will be attributed to a company will very much depend on the facts of each case, and where a company acts in good faith and has set up an appropriate and rigorous system of supervision it is likely that the company will not be held liable.128 6.65 Holding companies may be held liable where they clearly participate in the fraudulent trading, such as actively directing the activities of the subsidiary, particularly where there was some active encouragement on the part of the holding company for the subsidiary to conduct its business in a fraudulent manner.129 But, in proving a case against a holding company a liquidator would have to provide clear evidence of the participation. It is not sufficient for the liquidator merely to point to the parent–subsidiary relationship and ask the court to infer participation, because the companies are separate legal entities and are to be treated accordingly.130 6.66 Where a criminal prosecution is involved, the situation for an individual who is an outsider might be different. In R v Miles131 Pennycuick V-C said that persons who participate in the kind of conduct envisaged by s 213 can be held liable under the criminal equivalent of one of the section’s forerunners, but the judge criticised the summing up of the judge at the trial when the summing up

122 Bank of India v Morris [2005] EWCA (Civ) 693, [2005] 2 BCLC 328, [2005] BPIR 1067, [116]. 123 Bilta (UK) Ltd v Natwest Markets plc [2020] EWHC 546 (Ch), [225]. 124 [2005] EWCA (Civ) 693, [2005] 2 BCLC 328, [2005] BPIR 1067. 125 Ibid., [114]. 126 Ibid. 127 Ibid. 128 Ibid., [129]. See A Cloherty, ‘Knowledge, Attribution and Fraudulent Trading’ (2006) 122 Law Quarterly Review 25, 30–31. 129 Stephen Griffin, Personal Liability and Disqualification of Company Directors (Hart Publishing, 1999), 46–47, n 4. 130 Re Augustus Barnett & Son Ltd (1986) 2 BCC 98,904. 131 [1992] Crim LR 657.

52

FR AU DU LENT TR A DI NG

suggested the defendant could be liable if he concurred in the wrongful actions.132 Thus, a person will not be convicted under s 993 if he or she does not hold some role that involves managing or controlling the affairs of the company,133 and thus outsiders are not going to be subject to prosecution. Criminal Proceedings 6.67 Section 993 of the Companies Act 2006 provides the same first subsection as s 213. Section 993(2) then states, in contrast to s 213, that the provision applies whether or not the company is in liquidation. The third sub-section includes the criminal penalties that may be imposed on a person found liable. If a person is charged under indictment, the penalty can be severe. 6.68 Where criminal proceedings for fraudulent trading are brought, there are no requirements that are additional to a s 213 action that have to be proved for securing a criminal conviction, but naturally, a different burden of proof will apply. 6.69 As a result of the decision of the House of Lords in DPP v Schildkamp,134 when addressing fraudulent trading as regulated by s 332 of the Companies Act 1948, a prosecution could not be initiated in relation to a company that was a going concern unless a liquidation had commenced.135 This decision was overturned with the enactment of s 96 of the Companies Act 1981, which permitted prosecutions to be brought whether or not the company has been or is in the course of being wound up. The change may have been due to the fact that it was felt that the situation under the 1948 statute reduced the effectiveness of the provision.136 6.70 Putting the offence of fraudulent trading in context, while a charge on this ground is certainly regarded as serious, it is less serious than a specific charge of theft for fraud for an equivalent amount.137 It is uncertain what the maximum penalty is, as s 10(1) of the Fraud Act 2006 amended Sch 24 of the Companies Act 1985 and introduced a new maximum sentence of 10 years and/ or an unlimited fine, but the section was repealed.138 To complicate matters, Sch 24 was repealed by the Companies Act 2006. It is possible that the maximum sentence for offences under s 993 might be thought to have reverted to seven years, which was the penalty under Sch 24; however, the decision in R v Mohammed Ali139 states that the penalty is 10 years.140 Naturally, in a criminal action mounted under s 993, if the prosecution is successful the court will order that 132 Ibid., 658. 133 Ibid. 134 [1971] AC 1. 135 Also, see R v Rollafson [1969] 1 WLR 815. 136 Certainly, the view espoused by R Williams in ‘Fraudulent Trading’ (1986) 4 Company & Securities Law Journal 14, 17. 137 R v Smith and Palk [1997] 2 Cr App R (S) 167. 138 It was repealed by Companies Act 2006 (Consequential Amendments, Transitional Provisions and Savings) Order 2009/1941, Sch 2 para 1. 139 [2019] EWCA Crim 1263. 140 Ibid., [28].

53

FR AU DU LENT TR A DI NG

the respondent be penalised by way of a criminal sanction. Schedule 24 of the Act, repealed by Sch 16 of the Companies Act 2006, set out the parameters for any penalty. The penalty was substantial, being up to seven years imprisonment or a fine, or both, if the proceedings were on indictment, and where proceedings were brought summarily the sanction was six months imprisonment or the statutory maximum fine, or both. The statutory maximum fine in England and Wales is, at present, £5,000 according to s 32 of the Magistrates’ Courts Act 1980 as amended by s 17 of the Criminal Justice Act 1991. 6.71 There are no sentencing guidelines specifically for the offence of fraudulent trading, but the Court of Appeal has expressly set out guidance in guideline judgments, such as the case of R v Mackey.141 Also, courts have reference to the guidelines issued by the Sentencing Council with effect from 1 October 2014 on ‘Fraud, Bribery and Money Laundering Offences.’142 The Court of Appeal laid down guidelines on what are appropriate sentences to be imposed on respondents convicted under the precursor of s 993, s 458 of the Companies Act 1985.143 6.72 Terms of imprisonment have ranged from 12 months in R v Lockwood,144 15 months in R v Grantham,145 18 months in R v Smith146 (reduced from three years), two years in R v Say,147 three years in R v Ward148 (reduced from four years), and one respondent in R v Waite149 was sentenced to five years imprisonment. In R v Pickerden150 the respondent was sentenced to one of the longest sentences, namely six years nine months. In R v Kemp151 lesser penalties were imposed on the respondent who was fined £500 on one count, and on a second count he was subject to a term of imprisonment for three months, a two-year suspension and a fine of £3,000. 6.73 In R v Peters152 the defendant was charged with a number of offences, eventually pleading guilty to three charges of fraudulent trading for which he was sentenced by HH Judge Jeremy Jenkins at Cardiff Crown Court to three years and nine months’ imprisonment and ordered to pay £75,000 compensation. 6.74 A claim for fraudulent trading under s 993 can succeed even if it is not possible to establish that anyone has suffered a loss.153

141 [2012] EWCA Crim 2205, [2013] 1 Cr App R(S) 100. See R v Mohammed Ali [2019] EWCA Crim 1263, [31]. 142 R v Mohammed Ali [2019] EWCA Crim 1263, [35]. 143 R v Gibson [1999] 2 Cr App R (S) 52. 144 (1986) 2 BCC 99,333. 145 [1984] 1 QB 675) (under s 332 of the Companies Act 1948). 146 [1997] 2 Cr App R (S) 167. 147 [2021] EWCA Crim 520. The term was to be served concurrently with a six-year sentence for fraud by abuse of position. An appeal against the sentence was dismissed. 148 [2001] Cr App R (S) 14. 149 (2003) WL 21162167. 150 [2018] EWCA Crim 1153. 151 [1988] QB 645. 152 [2019] EWCA Crim 1484. 153 R v Grantham [1984] QB 675, 683–684.

54

FR AU DU LENT TR A DI NG

6.75 A prosecution may be brought under s 993 in relation to businesses conducted by limited liability partnerships by virtue of the Limited Liability Partnerships (Application of Companies Act 2006) Regulations 2009.154 6.76 The Fraud Act 2006 in s 9 provides for an offence that is parallel to s 993. It provides an offence where a business is carried on with intent to defraud creditors of any person, or for any other fraudulent purpose. Conditions for Liability 6.77 One of the conditions for liability, and perhaps the most important, is that the business of the company in liquidation has been carried on with intent to defraud creditors or for any other fraudulent purpose. This will be dealt with in detail in the next chapter. Party to the Carrying on of Business 6.78 After setting out what fraudulent liability entails, namely carrying on business with intent to defraud creditors or for any other fraudulent purpose, s 213(2) then states who may be liable in civil actions and for what they can be liable. First, that the persons who are able to be proceeded against are those who are knowingly parties to the carrying on of a business of a company with intent to defraud creditors or for a fraudulent purpose. Secondly, such persons are liable to make such contributions to the company as the court thinks proper. 6.79 The provision appears to be quite broad, in that it provides that it covers ‘any business of the company [that] has been carried out.’ This is broader than merely stating ‘the business of the company.’155 6.80 The provision is designed essentially to safeguard the interests of creditors. In R v Smith,156 a case decided under the criminal provision, Rose LJ, in delivering the judgment of the court, said that ‘creditor’ is to be given its ordinary meaning and covers someone to whom money is owed; it is not material whether the debt can be sued for. The provision applies where the intention is to defraud future creditors of the company.157 While creditors are to be the primary ones protected, the fact is that the words ‘carrying on a business for any fraudulent purpose’ and ‘creditors of any other person’ in s 213(1), give the provision a greater ambit, and it has been asserted that it is likely that this is to protect persons other than those regarded as classic creditors. 6.81 Customers of a company may in fact be regarded as creditors of the company for the purposes of s 213158 on the basis that they are prospective or

154 SI 2009/1804, reg 47. 155 Hardie v Hanson [1960] HCA 8, (1960) 105 CLR 451. 156 [1996] 2 BCLC 109, 122 (CCA). 157 Ibid. 158 R v Inman [1967] 1 QB 140 (CCA); [1966] 3 All ER 414; Re Sarflax Ltd [1979] 1 Ch 592; R v Smith [1996] 2 BCLC 109.

55

FR AU DU LENT TR A DI NG

contingent creditors, although this does not include all customers.159 However, it is more than likely that the Secretary of State for Business Energy and Industrial Strategy would seek to invoke s 124A of the Act to present a petition to wind up companies that were engaging in fraudulent activity that affected consumers, on the basis that it would be in the public interest to do so.160 6.82 In examining the condition that is the subject of this part, we must note that the respondent must be involved in the carrying on of business, that is he or she was ‘party to the carrying on of business.’ According to Re Maidstone Buildings Ltd161 this means nothing more than participating, taking part or concurring in the business of the company. The alleged breach of s 213 must involve some positive steps. As was noted earlier, someone is not a party to carrying on a business if he or she takes no positive steps at all.162 This approach might well exclude those who might know about the fraudulent conduct but who do not get involved,163 for in Re Maidstone Buildings Ltd the company secretary, knowing the company was insolvent, refrained from advising the directors to cease trading, and he was not held liable. This is the position in Singapore, where the court in the case of Tan Hung Yeoh v PP said that the phrase ‘knowingly a party to the carrying on of the business’ involved someone participating, concurring or taking some positive step in relation to the fraudulent transaction(s) the subject of the proceedings. 6.83 The problem for a party, as we will see shortly, in doing nothing when one is aware of the fraudulent trading, may, in certain cases, mean that one is liable for turning a blind eye to what was going on. 6.84 The chapter raised earlier the issue of whether a court today might be more ready to hold directors liable for inertia given the fact that the jurisprudence on directors’ duties clearly indicates that judges will not brook any argument that a director should not be liable merely because he or she was compliant or failed to inquire. In many of the wrongful trading cases, courts have indicated that directors were not liable because they sought to address their company’s situation, and in other cases directors have been criticised for doing nothing. Courts might well adopt a similar position with respect to s 213 cases. One would think that it would be very difficult for directors, save where they registered unequivocal dissent to the action that the company has taken, to argue that they were not a party to the carrying on of business. 6.85 ‘Carrying on business’ within s 213 is interpreted broadly. For fraudulent trading to have been committed, it is not necessary for the liquidator to prove that there has been a course of conduct, as a single transaction or act is able to

159 In re Gerald Cooper Chemicals Ltd [1978] Ch 262. 160 These petitions are known as ‘public interest petitions.’ See, Andrew Keay, ‘Public Interest Petitions’ (1999) 20 Company Lawyer 296; Vanessa Finch, ‘Public Interest Liquidation: PIL or Placebo?’ [2002] Insolvency Lawyer 157. 161 [1971] 1 WLR 1085. 162 Ibid., 1093. 163 Ibid., 1094.

56

FR AU DU LENT TR A DI NG

constitute the basis for action under s 213.164 Hence, where a company is doing nothing except for collecting and distributing its assets, it can be regarded as carrying on business within s 213, because carrying on trade is not required.165 In Re Sarflax Ltd166 a company had agreed to sell goods to buyers who were in Italy. The buyers asserted that the goods supplied were unsatisfactory and they rescinded the contract. Litigation commenced in England and was not followed through, but litigation initiated in Italy was prosecuted and judgment was secured against the company after the company had ceased trading and entered voluntary liquidation. The liquidator sought a declaration that the business of Sarflax had been carried on with intent to defraud creditors. This application was based on the fact that before the advent of liquidation the company had distributed its assets to some of its creditors (including Sarflax’s parent company). The judge held that the company was carrying on business as there was a continuous course of active conduct. 6.86 Fraudulent trading can occur when business is being carried on to defraud just one creditor,167 but one cannot say that whenever a fraud on a creditor is perpetrated while carrying on business it is inevitable that a breach of s 213 occurs; critically s 213 only applies where the business has been carried on with intent to defraud.168 In this context, intent to defraud in the carrying on of business must be distinguished from misrepresentations and deception in general.169 A useful illustration was given in Re Murray-Watson Ltd170 by Oliver J when he said that a car dealer was not carrying on business to defraud creditors merely because every time that he sold a car he told lies about it. Such a fraud was a fraud on the customer, but the dealer did not intend to defraud a creditor.171 The dealer could be sued for misrepresentation by each individual customer, but the dealer was not carrying on fraudulent trading within s 213. Thus, the mere existence of a fraud did not mean that there had been a breach of s 213.172 In this case Oliver J said that: [The section] is aimed at the carrying on of a business . . . and not at the execution of individual transactions in the course of carrying on that business. I do not think that the words ‘carried on’ can be treated as synonymous with ‘carried out’, nor can I read the words ‘any business’ as synonymous with ‘any transaction or dealing’. The director of a company dealing in second-hand motor cars who wilfully misrepresents the age and capabilities of a vehicle is, no doubt, a fraudulent rascal, but I do not think he can be said to be carrying on the company’s business for a fraudulent purpose, although no doubt he carries out a particular business transaction in a fraudulent manner.173 164 Re Gerald Cooper Chemicals Ltd [1978] Ch 262; R v Lockwood (1986) 2 BCC 99,333, 99,341 (CCA); Morphitis v Bernasconi [2003] EWCA Civ 289, [2003] Ch 552, [2003] BCC 540. 165 Re Sarflax Ltd [1979] 1 Ch 592, [1979] 1 All ER 529. 166 Ibid. 167 Morphitis v Bernasconi [2003] EWCA Civ 289, [2003] Ch 552, [2003] BCC 540, [46]; Re Vining Sparks UK Limited [2019] EWHC 2885 (Ch). 168 Morphitis v Bernasconi [2003] EWCA Civ 289, [2003] Ch 552, [2003] BCC 540, [46]–[47]. 169 Ibid., [43]. 170 unreported, 6 April 1977, Ch D. 171 Re Gerald Cooper Chemicals Ltd [1978] Ch 262, 267. 172 Re Daystreet15 Ltd [2020] EWHC 1140 (Ch), [14]. 173 Quoted by ICC Judge Mullen in Re Daystreet15 Limited [2020] EWHC 1140, [14].

57

FR AU DU LENT TR A DI NG

6.87 This statement was approved of in Morphitis v Bernasconi by Chadwick LJ. 6.88 An instance of where there was intent to defraud is the decision of Re Pantiles Investments Ltd (in liquidation),174 in which the company had been established at the outset to conceal assets from a third party’s creditors. In this case the conduct of the business as a whole involved fraudulent trading. 6.89 The Court of Appeal in Morphitis v Bernasconi175 made the point that Parliament had not sought to hold liable a person for fraudulent trading merely when any creditor had been defrauded in the course of carrying on business. The very business itself must be being conducted with the aim of defrauding creditors. The facts in Morphitis are worth recounting. T Ltd carried on business from leasehold premises owned by R. T Ltd was struggling mainly, so the respondents (the directors of the company at the time) thought, because of the high cost of renting the company’s business premises. After seeking legal advice, the following plan was formulated. A new company was incorporated, with a similar style name to T Ltd, and it purchased the goodwill of T Ltd and operated the business once carried on by T Ltd. The respondents resigned as directors of T Ltd and became directors of the new company. The intention was to place T Ltd into liquidation, at which time the leases from R could be disclaimed as onerous property. However, so that the respondents did not fall foul of s 216 of the Act (improper re-use of a company name), T Ltd had to continue to operate for 12 months after the resignation of the respondents as directors of T Ltd. To ensure that this occurred the solicitors of T Ltd were instructed to stall R’s solicitors and prevent R from taking legal proceedings that might lead to a winding-up order being made against T Ltd. The strategy implemented was for T Ltd’s solicitors (acting also as the respondents’ solicitors) to justify late payments and to seek extensions of time to pay. In response to threats by R to commence proceedings, T Ltd promised payment. T Ltd’s solicitors did their job and T Ltd was not wound up for more than the requisite 12-month period. When it was wound up, it was as a result of a petition presented by R. The liquidator subsequently initiated proceedings under s 213, but the Court of Appeal found that there was no fraudulent trading. 6.90 The decision in Morphitis has been criticised on the basis that the Court of Appeal did not treat the expression ‘intent to defraud’ as a composite whole and defined ‘intent’ in isolation.176 The Court regarded the directors’ intention as being to avoid liability under s 216, and not to defraud R, the landlord, yet it has been argued that it would be equally acceptable to categorise the intent as being to permit the company to divest itself of onerous property, or minimise payments to R and seeking to delay the initiation of proceedings.177 Would that

174 [2019] EWHC 1298 (Ch), [2019] BCC 1003, [2019] 2 BCLC 295. 175 [2003] EWCA Civ 289, [2003] Ch 552, [2003] BCC 540, [46]. 176 A Savirimuthu, ‘Morphitis in the Court of Appeal: Some Reflections’ (2005) 26 Company Lawyer 245, 247. 177 Ibid., 247–248.

58

FR AU DU LENT TR A DI NG

not constitute an intent to defraud creditors? One might ask whether the situation covered in Morphitis is the type of single transaction situation envisaged by the court in Re Gerald Cooper Chemicals Ltd,178 or is it like the illustration given in Re Murray-Watson Ltd? Arguably, it is like the former, as the only creditor affected by what the directors in Morphitis did was the landlord of the premises leased by the company, and the business was being carried on in order to effect a fraud. Knowingly 6.91 Once it has been established that the company’s business has been carried on with intent to defraud or for a fraudulent purpose, and the respondent was a party to the carrying on of the business, the courts may only impose liability on the respondent provided he or she was knowingly a party to the carrying on of business. It has been held that the liquidator is required to demonstrate dishonesty on the part of the respondent,179 and if a person is found to have knowingly participated, then he or she is acting dishonestly.180 6.92 Knowledge means, in the context of s 213, that there must have been an actual realisation on the part of the respondent that the company that went into liquidation was engaging, or likely to engage, in fraudulent trading.181 According to Patten J in Re BCCI; Morris v Bank of India182 failure to recognise the truth of what was going on is not enough, however obvious that might seem to be in hindsight.183 6.93 The knowledge also has to be contemporaneous with the allegedly improper assistance that the respondent had given.184 Notwithstanding all of this, to be knowingly parties to the fraud, people do not have to know every detail of the fraud or how it is to be perpetrated.185 6.94 What about where there are a series of transactions? The Court of Appeal in Bank of India v Morris186 said that it was appropriate to look at a respondent’s conduct as a whole in determining his or her state of mind. However, it would appear, from what the Court went on to say, that a court must evaluate a person’s state of mind in relation to each transaction.187 That is, the respondent’s state of mind for each transaction must be considered separately; it is not possible

178 [1978] Ch 262. 179 Bank of India v Morris [2005] EWCA Civ 693, [2005] 2 BCLC 328, [2005] BPIR 1067, [8]. 180 Re BCCI; Morris v Bank of India [2004] 2 BCLC 236, 244. 181 Ibid., [13]. 182 Ibid. 183 Ibid. 184 Ibid. 185 Morris v Bank of India [2004] EWHC 528 (Ch), [13], [2004] 2 BCLC 279, 297; [2004] BCC 404, 419. 186 Re BCCI; Morris v Bank of India [2005] EWCA Civ 693, [2005] 2 BCLC 328, [2005] BPIR 1067, [71]. 187 Ibid.

59

FR AU DU LENT TR A DI NG

to say that just because the respondent had a guilty mind at the time of one of the transactions, he or she had a guilty mind when another was entered into.188 6.95 It would appear that the way that a transaction is structured can go some way to indicating whether or not there was knowledge of fraud.189 Therefore, the fact that a transaction or a set of transactions are artificial or have never been heard of previously, in the context of the particular trade being carried on, is likely to contribute to a finding of knowing participation in the fraud.190 This is consistent with what Lord Hoffman said in Twinsectra Ltd v Yardley191 when dealing with an alleged assistance of a breach of trust that necessitated the proving of dishonesty. His Lordship said that he would not suggest that one cannot be dishonest without a full appreciation of the legal analysis of the transaction. In addressing the kind of action before him he said that a person may dishonestly assist in the commission of a breach of trust without any idea of what a trust means.192 6.96 Provided that liquidators can demonstrate that the respondents had ‘blindeye’ knowledge, namely deliberately shutting their eyes to the obvious, in that it was obvious to the respondents that fraud was involved, they could succeed in establishing that the respondents were knowingly parties to fraud.193 Blind-eye knowledge involves a suspicion on the part of a person, and that is well-grounded, that a fraud exists and a deliberate decision to avoid confirming that it exists.194 6.97 In Manifest Shipping Company Ltd v Uni-Polaris Company Ltd195 Lord Scott put it this way: ‘In summary, blind-eye knowledge requires, in my opinion, a suspicion that the relevant facts do exist and a deliberate decision to avoid confirming that they exist.’196 But clearly the way that suspicion is interpreted is important. Lord Scott went on to sound a warning that: Suspicion is a word that can be used to describe a state-of-mind that may, at one extreme, be no more than a vague feeling of unease and, at the other extreme, reflect a firm belief in the existence of the relevant facts. In my opinion, in order for there to be blind-eye knowledge, the suspicion must be firmly grounded and targeted on specific facts. The deliberate decision must be a decision to avoid obtaining confirmation of facts in whose existence the individual has good reason to believe. To allow blind-eye knowledge to be constituted by a decision not to enquire into an untargeted or speculative suspicion would be to allow negligence, albeit gross, to be the basis of a finding of privity.197

188 Ibid. 189 Morris v Bank of India [2004] 2 BCLC 236. 190 Bank of India v Morris [2005] EWCA (Civ) 693; [2005] 2 BCLC 328; [2005] BPIR 1067, [34]–[43]. 191 [2002] UKHL 12; [2002] 2 AC 164. 192 Ibid., [24]. 193 Ibid. 194 Ibid. 195 [2003] 1 AC 469. 196 Ibid., [116]. 197 Ibid.

60

FR AU DU LENT TR A DI NG

6.98 Thus, for blind-eye knowledge to have occurred there must have been targeted suspicion.198 6.99 It has been held in Group Seven Ltd v Notable Services LLP199 that where a court is able to impute blind-eye knowledge, a person is treated for the purposes of establishing liability for dishonest assistance as if he or she had actual knowledge of the relevant facts, and one would think that the same could be applied to fraudulent trading.200 6.100 In the Privy Council decision of Royal Brunei Airlines Snd Bhd v Tan,201 a case involving a claim that a person had dishonestly assisted in a breach of a trust, Lord Nicholls, on behalf of the Judicial Committee, indicated that it was dishonest for a person ‘deliberately to close his eyes and ears, or deliberately not to ask questions, lest he learn something he would rather not know, and then proceed regardless.’202 In like fashion, it was said in a fraudulent trading case that if a person declines to ask questions because he or she knows that the answers would be likely to disclose the fact that a fraud exists, then that person cannot defend a fraudulent trading claim.203 6.101 It was accepted in Re BCCI; Morris v Bank of India204 that it is necessary to distinguish between a person who has a conscious appreciation of the true nature of the business that is occurring and someone who fails, even negligently, to appreciate the fraud. Only the former is liable. 6.102 Therefore, directors who are not intimately involved in the actions of the company that constitute fraudulent conduct, and who had suspicions but did nothing about them, are not usually going to be able to extricate themselves from liability. 6.103 In determining whether a person had suspicion about the conduct of the company the courts must be careful to avoid reliance on hindsight. Snowden J in Bilta (UK) Ltd v Natwest Markets plc205 said that if a person fails to recognise the truth of what was occurring, namely the dishonesty, that will not mean he or she is liable, and that is the case even if in hindsight the conduct of the company was obvious. As noted earlier, the relevant knowledge must be contemporaneous with any transactions that were entered into with the company.206 What Constitutes Fraudulent Trading? 6.104 The fact that a company continues to engage in trading while it is insolvent does not constitute fraudulent trading. Having said that, there are 198 Stanford International Bank Ltd (in liquidation) v HSBC Bank plc [2021] EWCA Civ 535, [2021] 1 BCLC 711, [19]. 199 [2019] EWCA Civ 614, [2020] Ch 129. 200 Ibid., [61]. 201 [1995] 2 AC 378. 202 Ibid., 389. 203 Re BCCI; Morris v Bank of India [2004] 2 BCLC 236, [13]. 204 Ibid., [13]. 205 [2020] EWHC 546 (Ch), [240]. While the Court of Appeal (Natwest Markets Plc, Mercuria Energy Europe Trading Ltd v Bilta (UK) Ltd [2021] EWCA Civ 680) allowed in part an appeal, it did not rule that Snowden J was wrong on this matter. 206 See Morris v State Bank of India [2004] BCC 404, 419.

61

FR AU DU LENT TR A DI NG

some cases that suggest that directors might be liable where they, on behalf of the company, obtain credit when they know that there is good reason that funds will not be available to pay the debt when the debt becomes payable.207 This can include the failure to pay trade creditors and not remitting moneys, deducted from employees’ salary, to the revenue authorities, or the failure to pay VAT when receiving money for goods sold,208 and continuing to incur liabilities when the company is clearly insolvent and with no chance of being able to discharge them as the company is obviously heading for administration or liquidation.209 6.105 Fraudulent trading can be made out even if it is not possible to establish that anyone has suffered a loss.210 The critical issue is the intent to defraud or have a fraudulent purpose. 6.106 As mentioned earlier, not every fraud or fraudulent misrepresentation made by a company can constitute fraudulent trading within s 213 as the provision is aimed at carrying on business and not the execution of individual transactions.211 For instance, if a retailer made misrepresentations to customers, he would not be committing fraudulent trading even though he is perpetrating a fraud on the customers, and provided that he did nothing to prevent them from bringing an action and to recover their losses.212 Chadwick LJ explained in Morphitis,213 it was not intended that the powers under s 213 were able to be exercised at any time a creditor was defrauded by a company in the course of the carrying on of business. That is, if a fraud is committed in the course of carrying on a legitimate business this is not fraudulent trading; what is involved in this kind of situation is a fraudulent-type transaction. The actual business carried on must in fact be a fraud for fraudulent trading to have been perpetrated. It has been submitted that on occasions the two different scenarios just identified have been elided and thus the distinction is not always recognised.214 Foxton J, when writing before his elevation to the bench, provides a good example of what is not likely to be fraudulent trading, namely where a company officer tells a creditor that the company has sent the creditor a cheque when it has not.215 He makes the point that this might constitute the tort of deceit, but it is not fraudulent trading. The question is whether it could constitute fraudulent trading if the company officer follows that approach with most or all creditors. Might that not consist of carrying on the essence of the business in a fraudulent manner? It becomes a norm of the company’s business. 6.107 Clearly, in some circumstances it is not going to be easy to distinguish between the two kinds of activity identified earlier. It is also clear that, 207 R v Grantham [1984] 2 QB 675, 682–683; R v Waite (2003) WL 21162167, [5] (CCA). 208 Re L Todd (Swanscombe) Ltd [1990] BCLC 454. 209 Re William C. Leitch Bros Ltd [1932] 2 Ch 71, 77. 210 R v Grantham [1984] QB 675, 683–684. 211 Morphitis v Bernasconi [2003] EWCA Civ 289, [2003] Ch 552, [2003] BCC 540, [43], [46]. 212 Re Gerald Cooper Chemicals Ltd [1978] Ch 262, 267. 213 [2003] EWCA Civ 289, [2003] BCC 540, [46]. 214 David Foxton QC, ‘Accessory Liability and Section 213 Insolvency Act’ [2018] JBL 324, 328–329. 215 Ibid., 332.

62

FR AU DU LENT TR A DI NG

as indicated, engaging in a single act, provided that it is done in the course of carrying on business, can fall within the section in certain cases.216 6.108 Finally, in obiter comments in Bernasconi v Nicholas Bennett & Co217 Laddie J said that ‘closing a company down by methods which seriously, unfairly and impermissibly disadvantage creditors does not per se offend against’ s 213. Loss 6.109 The first thing to make plain is that s 213 is not concerned with losses that the company has suffered but with losses that a creditor or creditors of the company have suffered as a result of the alleged fraudulent trading.218 6.110 To succeed in a claim the liquidator must establish causation. Causation in the context of s 213 does not involve a simple ‘but for test,’ as it is not sufficient alone to demonstrate that a wrongful act of a defendant caused the damage which is the subject of the claim. According to Laddie J in Bernasconi v Nicholas Bennett & Co:219 ‘Initiation of a train of events which results in loss to the claimant does not, per se, make the initiator liable for those losses.’220 6.111 Fancourt J in Tradestar Limited v Kevin Goldfarb221 explained that s 213 is not concerned with losses recoverable in claims by victims against those responsible for frauds, nor with the extent of loss that might be recoverable on conventional principles of causation and quantum in such a claim, except to the extent that any such claim that could be brought adversely affects the position of the creditors of the company.222 There must be some nexus between, on the one hand, the loss which has been caused to the company’s creditors generally by the carrying on of the business in the manner which gives rise to the exercise of the power and, on the other hand, the contribution which those knowingly party to the carrying on of the business in that manner should be ordered to make to the assets in which the company’s creditors will share, in the liquidation.223 That is, the liquidator has to establish a nexus between the loss caused to creditors because of the fraudulent trading and the contribution that is being sought from the person allegedly involved in the fraudulent trading.224 6.112 Chadwick LJ provided the following example in Morphitis v Bernasconi225 as an obvious case for contribution, namely: [W]here the carrying on of the business with fraudulent intent has led to the misapplication, or misappropriation, of the company’s assets. In such a case the appropriate 216 Re Gerald Cooper Chemicals Ltd [1978] Ch 262; R v Lockwood; Morphitis v Bernasconi [2003] EWCA Civ 289, [2003] BCC 540. 217 [2000] BCC 921, [2000] BPIR 8, [16]. 218 Tradestar Limited v Kevin Goldfarb [2018] EWHC 3595 (Ch), [19]. 219 [2000] BPIR 8, [2000] BCC 921. 220 Tradestar Limited v Kevin Goldfarb [2018] EWHC 3595 (Ch), [15]. 221 Ibid. 222 Ibid., [22]. 223 Morphitis v Bernasconi [2003] EWCA Civ 289, [2003] Ch 552, [2003] BCC 540, [55]. Also, see Tradestar Limited v Kevin Goldfarb [2018 EWHC 3595 (Ch), [20]. 224 Morphitis ibid., [53]. 225 Ibid.

63

FR AU DU LENT TR A DI NG

order might be that those knowingly party to such misapplication or misappropriation contribute an amount equal to the value of the assets misapplied or misappropriated. Another obvious case would be where the carrying on of business with fraudulent intent has led to claims against the company by those defrauded, In such a case the appropriate order might be that those knowingly party to the conduct which has given rise to those claims in the liquidation contribute an amount equal to the amount by which the existence of those claims would otherwise diminish the assets available for distribution to creditors generally; that is to say an amount equal to that amount which has to be applied out of the assets available for distribution to satisfy those claims.226

6.113 If the requisite nexus can be established, then the sum that is to be ordered to be paid is limited to the amount of the debts of the creditors proved to have been defrauded by the fraudulent trading.227 The Order 6.114 In civil actions under s 213, if the liquidator’s case is proved the court may make a declaration that the respondent was a person who was knowingly a party to the carrying on of business with intent to defraud or to effect a fraudulent purpose, and if it does it may then specify the sum that is to be paid by the respondent by way of contribution.228 It is clear that s 213 proceedings are for the recovery of a sum of money which the court declares the delinquent respondent liable to contribute to the assets of the company.229 Thus, the declaration should specify responsibility for a definite sum and not be in general terms as, for example, to creditors whose debts were incurred after commencement of the fraudulent trading.230 6.115 As to the substance of the declaration, the court has a broad discretion. UK courts will be principally concerned about awarding a sum to the liquidator to compensate the creditors for the wrongful action of the respondent. The paramount purpose behind s 213 is to provide for compensation.231 But besides an order for compensation, courts have been, in the past, willing to include a punitive element in the order.232 Re Cyona Distributors Ltd233 was decided pursuant to the 1948 statute, and the position it espoused was followed in Re a Company (No 001418)234 where the court ordered a punitive amount of £25,000 in addition to a compensatory sum of £131,420. Notwithstanding the fact that s 213 is wider 226 Ibid. 227 Re a Company No 001418 of 1988 [1991] BCLC 197, 203. 228 Ibid., 202. 229 Re Farmizer (Products) Ltd [1997] BCC 655, 662 (CA). The case was dealing with s 214 claim, but the Court of Appeal did refer to s 213. 230 Re William C Leitch Bros Ltd [1932] 2 Ch 71, 77–79; Re a Company No 001418 of 1988 [1991] BCLC 197, 203. 231 Bank of India v Morris [2005] EWCA Civ 693, [2005] 2 BCLC 328, [2005] BPIR 1067, [111]. 232 Re Cyona Distributors Ltd [1967] Ch 889, [1967] 1 All E R 281 (CA); Re A Company (No 001418 of 1988) [1991] BCLC 197, 202. 233 Cyona ibid. 234 Re A Company (No 001418 of 1988) [1991] BCLC 197.

64

FR AU DU LENT TR A DI NG

than its precursors, and there is case law to the effect that a punitive award as well as a compensatory award may be delivered if it is appropriate, in Morphitis v Bernasconi235 the Court of Appeal said, in obiter, that there was no power in s 213 which permitted a court to include any punitive element in the amount of any contribution ordered. The Court added that the power to punish a guilty party was preserved in the criminal form of fraudulent trading.236 6.116 The Court of Appeal opined that the contribution to the assets was to be shared amongst the creditors and should reflect the loss which has been caused to the creditors by the carrying on of the business in the way that gives rise to the exercise of the power.237 6.117 Even though it appears that a court cannot penalise the respondent, contribution orders can be high. For example, in Bank of India v Morris238 Patten J ordered the respondent to pay the liquidators £82,302,941, a sum that included interest and costs.239 6.118 Any court award must be in favour of the liquidator and for the whole body of creditors, and not an individual creditor,240 something that is also applicable to s 214.241 The award is to be held by a liquidator for the purpose of making a distribution to the unsecured creditors242 and is, therefore, not available for a secured creditor holding a charge over company assets. This is discussed a little later in detail under ‘The Destination of the Proceeds.’ 6.119 It is not always easy for a court to decide what is an appropriate order of compensation. This is highlighted by the case of Re L. Todd (Swanscombe) Ltd. In that case the liquidator of T Ltd applied for a declaration under the immediate predecessor of s 213, for a declaration that a former director of the company, M, was liable for fraudulent trading. Specifically, it was argued that M was knowingly a party to the carrying on of business with intent to defraud creditors. Prior to winding up it seems that M received substantial amounts of cash in relation to transactions involving the sale of company goods, but these transactions were not entered in the books of the company and VAT was not paid. Her Majesty’s Customs and Excise discovered these facts when investigating the company. The precise amount of VAT, interest and penalties due to Customs was not proved before the court. The court did end up making a declaration that M was liable for fraudulent trading and that he was liable for debts, namely the VAT, interest and penalties, to the tune of slightly in excess of £70,000.

235 [2003] EWCA Civ 289, [2003] BCC 540, [55]. 236 Ibid. 237 Ibid. 238 [2004] BCC 404, [1]. 239 This still palled into insignificance when compared with the deficiency of BCCI at the time of its collapse – in the region of US$10 billion (Bank of India v Morris ([2005] EWCA Civ 693, [2005] 2 BCLC 328, [2005] BPIR 1067, [3]). 240 Re Esal (Commodities) Ltd [1997] 1 BCLC 705 (CA). 241 Re Oasis Merchandising Services Ltd [1995] BCC 911, 918. 242 Ibid. and affirmed on appeal [1997] 1 All ER 1009, [1997] BCC 282, (CA).

65

FR AU DU LENT TR A DI NG

6.120 It has been accepted that any order of contribution, while essentially compensatory, could only ever be a reasonable approximation of the damage either caused or contributed to by the respondent.243 6.121 The court is entitled to determine that several persons should be held jointly and severally liable for the loss caused. As the word ‘contributions’ was used in the section the court is not required to order that the contribution is the same for each of the respondents; the court has a wide discretion when it comes to ordering what each respondent should contribute.244 The court held that in relation to the issue of contribution the approach utilised in cases dealing with wrongful trading should apply to s 213, as it would be surprising if different approaches were used in relation to identical wording contained in adjacent provisions of the Act. 6.122 A judge who finds that the respondent is liable may include an element of interest in the contribution ordered.245 However, if the liquidator unreasonably delays the institution of proceedings then the liquidator might not be granted an order that would cover the payment of all interest that is claimed to be owed.246 If there is good reason for delaying the institution of proceedings then a court will not penalise the liquidator on interest.247 In Re Overnight Ltd (in liq)248 the court came to the conclusion that the liquidator had not in fact unreasonably delayed the initiation of proceedings. Here, the liquidator had waited to issue proceedings until the time when there were assets available from which recovery could be made. 6.123 Where a court makes a declaration against the respondent to an application, it is, at its discretion, empowered to make further directions to give effect to its declaration.249 In particular, it may provide, under s 215, for the liability of the respondent under the declaration to be a charge on any debt or obligation due from the company to the respondent, or on any mortgage or charge or any interest in a mortgage or charge on assets of the company held by or vested in the respondent, or any person on behalf of the respondent, or any person claiming as assignee from or through the respondent.250 The court may, from time to time make such further or other order as may be necessary for enforcing any charge imposed under s 215.251 Section 215(4) provides that in the case of a court declaration against a person that is liable for fraudulent trading, the court may direct that the whole or any part of a debt owed by the company to the guilty person is to rank after all other debts owed and interest payable in those debts. 243 Re BCCI; Morris v State Bank of India [2004] EWHC 528 (Ch), [2004] 2 BCLC 279, [2004] BCC 404, [122]. 244 Re Overnight Ltd (in liq) [2010] EWHC 613 (Ch), [2010] BCC 787, [2010] 2 BCLC 186, [30]–[32]. 245 Re BCCI; Morris v State Bank of India [2004] EWHC 528 (Ch), [2004] 2 BCLC 279, [2004] BCC 404, [134]. 246 See Re Overnight Ltd (in liq) [2010] EWHC 613 (Ch), [2010] BCC 787, [2010] 2 BCLC 186. 247 Ibid. 248 Ibid. 249 Insolvency Act 1986, s 215(2). 250 Ibid., s 215(2)(a). 251 Ibid., s 215(2)(b).

66

FR AU DU LENT TR A DI NG

6.124 According to s 246ZC, s 215 applies to applications made by an administrator under either s 246ZA or s 246ZB claiming that respondents are liable for wrongful trading or fraudulent trading respectively, and as if references to a liquidator were references to an administrator. 6.125 Besides imposing a criminal penalty under s 993 or ordering compensation under s 213, a court may disqualify the respondent from acting as a director or taking part in the management of a company,252 with the maximum period of disqualification being 15 years.253 Relief From Liability 6.126 Section 1157 of the Companies Act 2006, which has several forebears, empowers a court to relieve officers of a company, and this includes directors, from liability arising out of their negligence, breach of duty or breach of trust on the basis that they had acted honestly and reasonably, and as a consequence of their actions, ought fairly to be excused from liability. It is submitted that directors, or other officers of the company, could not avail themselves of the provision for if they have been found guilty of fraudulent trading they must have been regarded as being dishonest, which means that they could not be said to have acted honestly as required by s 1157.254 The Destination of Proceeds 6.127 A critical issue for liquidators who recover sums of money pursuant to s 213 is to know how they are to distribute the funds, assuming that the expenses and costs of winding up will not gobble up all that is recovered. In Re William Leitch Bros Ltd (No. 2)255 the defrauded creditors argued that the amount recovered should be carried to a separate account to be applied in discharging their claims alone; but Eve J rejected this contention and held instead that it formed part of the general assets of the company available for division among all unsecured creditors.256 The judge based this conclusion in part upon the problem of establishing any other way of applying the funds, coupled with the absence of any machinery in the section itself, and in part upon the analogy provided by Webb v Whiffin.257 6.128 However, it would seem that, notwithstanding the view of Eve J, any award ordered to be paid is not available to a chargeholder who has a charge over the present and future assets of the company. This is because the liquidator, in taking proceedings under s 213, is proceeding in his or her own capacity and not on the company’s behalf. This is the same situation as liquidators taking action 252 253 254 255 256 257

Company Directors Disqualification Act 1986, ss 4(1) and 10(1). Ibid., ss 4(3), 10(2). Biscoe v Milner [2021] EWHC 763 (Ch), [276]. [1933] Ch 261. Ibid., 266. (1872) LR 5 HL 711.

67

FR AU DU LENT TR A DI NG

under the wrongful trading ground, and the courts have made it plain that any funds recovered are to be distributed amongst the unsecured creditors alone,258 and this has been affirmed by the Court of Appeal.259 Since then the legislature entrenched this view in statute. Section 119 of the Small Business, Enterprise and Employment Act 2015 introduced s 176ZB of the Act,260 and this new provision in the Act, put in force from 1 October 2015, made it clear in subs (2) that the proceeds of a claim under s 213 (as well as claims, inter alia, under s 214) are not to be treated as part of the company’s net property, namely the amount of its property, which would be available for satisfaction of claims of holders of debentures secured by, or holders of, any floating charge created by the company. Conclusion 6.129 This has been a wide-ranging chapter. It has provided an analysis of s 213 of the Act and how it is applied. It has explained the elements of the section and identified who may apply for relief under s 213. The chapter has also considered the applications that can be made and what they might entail as well as examining the ones against whom such applications can be made. Although this book is primarily concerned with actions against directors, applications may be made not only against directors but also against others who may be involved in some way in the fraudulent trading, and this may include persons who are outside of the company. 6.130 The chapter then analysed the conditions that have to be established for a successful claim. The applicant has to establish that the company’s business has been carried on with intent to defraud or for a fraudulent purpose and the respondent was a party to the carrying on of the business, and the courts may only impose liability on the respondent provided he or she was knowingly a party to the carrying on of business. This was followed by a consideration of what orders might be made. Orders can only be compensatory; they cannot be penal. Finally, consideration was given to whether defendants can be relieved from liability, and it discussed the fact that the proceeds of any successful claim go to the unsecured creditors and cannot be taken by floating chargeholders.

258 Re Oasis Merchandising Services Ltd [1995] BCC 911. 259 [1997] 1 All ER 1009; [1997] BCC 282. Also, see Morphitis v Bernasconi [2003] EWCA Civ 289, [2003] Ch 552, [2003] BCC 540. 260 Section 176ZB came into force through the passing of reg 2(j) of the Small Business, Enterprise and Employment Act 2015 (Commencement No.2 and Transitional Provisions) Regulations, 2015/1689.

68

CHAPTER 7

Intent to Defraud and Fraudulent Purpose

Introduction 7.1 The primary element of the fraudulent trading provision is that the respondent must be proved to have carried on business with intent to defraud creditors or for any fraudulent purpose, that is, the intention to defraud or acting for any fraudulent purpose must accompany the carrying on of the business. The main issue that has dogged the provision, ever since its advent, has been certainty over the meaning of ‘intent to defraud,’ and ‘fraudulent purpose,’ and what actually has to be proved by a liquidator in order to establish that the respondent has engaged in one or the other. These phrases have never been defined statutorily. In one of the first reported cases dealing with the first fraudulent trading provision, Re Patrick & Lyon Ltd,1 Maugham J said that the words ‘defraud’ and ‘fraudulent purpose’ are words that connote actual dishonesty that encompass real moral blame.2 Ascertaining a meaning of these words is far from easy, as ‘there has been a lack of consistency over the years in the judicial approach to formulating a test for fraudulent conduct’3 in relation to s 213 of the Insolvency Act 1986 (‘the Act’). This chapter traces the way that the courts have interpreted the expressions, focusing on the most recent case law, and seeks to ascertain what the present tests are for establishing ‘an intent to defraud.’ 7.2 It has been suggested in fact that the greatest obstacle to the use of fraudulent trading proceedings is the requirement of fraud or dishonesty.4 The onus of proving an intent to defraud, which involves dishonesty,5 can be extremely hard to discharge,6 and one important reason why wrongful trading was introduced. Creditors 7.3 Before dealing with the main focus of this chapter, namely the meaning of ‘intent to defraud,’ a few words need to be said about the victims of the defrauding of the respondents. 1 2 3 4 5 6

[1933] Ch 786. Ibid., 790. Ian F Fletcher, The Law of Insolvency (3rd ed, Sweet and Maxwell, 2002), para 27.015. Fidelis Oditah, ‘Wrongful Trading’ [1990] LMCLQ 205, 206. R v Grantham [1984] QB 675, [1984] 2 WLR 815, [1984] BCLC 270 (CCA). Bank of India v Morris [2005] EWCA (Civ) 693, [2005] 2 BCLC 328, [2005] BPIR 1067, [101].

DOI: 10.4324/9780429266232-9

69

I NTENT TO DEFR AU D AND FR AU DU LENT PU R POSE

7.4 The civil and criminal provisions state that for liability for fraudulent trading the respondent/defendant must have intended to defraud the company’s creditors or the creditors of any other person. Much was said about creditors in Chapter 2, and that discussion will not be rehearsed. The main point to make here is that besides present creditors the fraudulent trading provisions include future creditors of the company.7 That is, an applicant could establish, in order to succeed, that the business of the company was carried on with intent to defraud future creditors of the company as well as present creditors. Intent to Defraud 7.5 The first matter to consider in relation to this expression is the interpretation which is to be given to the meaning of ‘fraud’ in the context of the section. This has been the main issue facing courts over the years and, as is generally well known, fraud is difficult to define for it has different meanings in different contexts,8 although in R v Terry9 the House of Lords did indicate that in some cases, such as the House of Lords decision in Welham v DPP,10 judicial comments have been made with an intention to cover fraud generally. It is submitted that one of the causes of the problem that faces the courts is that judges, in summing up to juries in fraudulent trading prosecutions, have had to try and explain for the jury what fraud involves in the context of s 993 of the Companies Act 2006 and its forebears, and these difficulties have been transferred to civil cases. Although focusing on Australian provisions in insolvency law that enable liquidators to avoid pre-liquidation transactions, such as preferences and uncommercial transactions,11 what Pincus JA of the Queensland Court of Appeal had to say in World Expo Park v EFG12 is most apposite. His Honour said that fraud is: A legal curiosity that after 400 years of judicial exposition of the statutes which have reproduced part or all of the substance [of bankruptcy and insolvency fraud provisions] there remains room for argument as to the nature of the fraud which must be proved, under such provision in order to set aside a transaction.13

Dishonesty 7.6 First, we must note that for a person to be liable for fraud he or she must be proved to have engaged in dishonesty,14 a concept that is associated 7 National Crime Agency v GTG Management Ltd [2020] EWHC 963 (Ch), [31]. 8 John Farrar, ‘Fraudulent Trading’ [1980] JBL 336, 339. 9 [1984] AC 374, 380–381. 10 [1961] AC 103. 11 The UK provisions covering these kinds of transactions are Insolvency Act 1986, ss 239 and 238 respectively. 12 (1995) 129 ALR 685. 13 Ibid., 708. 14 Re Cox and Hodges (1982) 75 Cr App R 291 (CCA); R v Grantham [1984] QB 675, [1984] 2 WLR 815, [1984] BCLC 270 (CCA); Bank of India v Morris in [2005] EWCA Civ 693, [2005] 2 BCLC 328, [2005] BPIR 1067, [8].

70

I NTENT TO DEFR AU D AND FR AU DU LENT PU R POSE

with fraud. Fraud is said to connote dishonesty involving, according to current notions of fair trading among commercial men, real moral blame.15 Where s 993 is concerned, the notion does not appear to be different from the concept of dishonesty in general criminal cases.16 7.7 In Bernasconi v Nicholas Bennett & Co17 the judge said that the claimant must show actual dishonesty on the part of the respondent,18 and it was the dishonesty factor which distinguished s 213 from an action for wrongful trading.19 All of this is consistent with the general view that dishonesty is an essential element of fraud.20 7.8 Honesty is a basic moral quality which is expected of all members of society. It involves being truthful about important matters and respecting the property rights of others.’21 Acting dishonestly means simply not acting as an honest person would in the circumstances. In Royal Brunei Airlines Sdn Bhd v Tan Lord Nicholls said that: Honesty has a connotation of subjectivity . . . it is a description of a type of conduct assessed in the light of what a person actually knew at the time, as distinct from what a reasonable person would have known or appreciated. Further, honesty and its counterpart dishonesty are mostly concerned with advertent conduct, not inadvertent conduct. . . . Thus for the most part dishonesty is to be equated with conscious impropriety. However, these subjective characteristics of honesty do not mean that individuals are free to set their own standards of honesty in particular circumstances. The standard of what constitutes honest conduct is not subjective. Honesty is not an optional scale, with higher or lower values according to the moral standards of each individual. If a person knowingly appropriates another’s property, he will not escape a finding of dishonesty simply because he sees nothing wrong in such behaviour.22

7.9 These comments were applied by David Donaldson QC (sitting as a deputy judge of the High Court) in Alpha Sim Communications Ltd v CAZ Distribution Services Limited23 in relation to a claim of fraudulent trading. 7.10 Lord Hughes in the later Supreme Court decision of Ivey v Genting Casinos (UK) Ltd,24 said: [T]he fact-finding tribunal must first ascertain (subjectively) the actual state of the individual’s knowledge or belief as to the facts. The reasonableness or otherwise of his belief is a matter of evidence (often in practice determinative) going to whether he held the belief, but it is not an additional requirement that his belief must be

15 Re Patrick & Lyon Ltd [1933] Ch 786, 790; Grantham ibid.; Re a Company No 001418 of 1988 [1991] BCLC 197. 16 R v Lockwood (1986) 2 BCC 99,333, 99,340 (CCA). 17 [2000] BPIR 8, [2000] BCC 921. 18 Ibid., [14]; Bilta (UK) Ltd v Natwest Markets plc [2020] EWHC 546 (Ch), [176]. 19 Bernasconi v Nicholas Bennett & Co [2000] BPIR 8, [2000] BCC 921, [16]. 20 Scott v Commissioners of Police for the Metropolis [1975] AC 819. 21 Wingate v SRA [2018] EWCA Civ 366, [2018] 1 WLR 3969, [93]. 22 Ibid. 23 [2014] EWHC 207 (Ch), [59]. 24 [2017] UKSC 67, [2018] AC 391, [2018] 3 WLR 1212.

71

I NTENT TO DEFR AU D AND FR AU DU LENT PU R POSE

reasonable; the question is whether it is genuinely held. When once his actual state of mind as to knowledge or belief as to facts is established, the question whether his conduct was honest or dishonest is to be determined by the fact-finder by applying the (objective) standards of ordinary decent people. There is no requirement that the defendant must appreciate that what he has done is, by those standards, dishonest.25

7.11 While his Lordship was not dealing with fraudulent trading in the case before him, in Re Daystreet15 Limited26 the previous quotation was referred to in the context of fraudulent trading as an explanation of dishonesty.27 7.12 A plea of ignorance on the part of the respondent may not be sufficient to defend a case successfully under s 213, for in Bilta (UK) Ltd v Natwest Markets plc,28 Snowden J said that: ‘It is clear, however, that a finding of dishonesty can be made where an assister does not actually know all the relevant facts.’29 The Issues 7.13 There are two primary issues that need to be resolved when considering the meaning of fraud in the context of s 213. First, can a court only consider what a respondent says about his or her state of mind, namely applying a subjective test, or can any objective considerations be taken into account in determining whether the respondent was dishonest? Allied to this is whether a court is able to infer what respondents’ state of mind were from their actions and the circumstances surrounding the alleged fraudulent trading? Secondly, what standard of honesty is to be applied? Is it that of the respondent, according to his or her evidence, namely what he or she regarded as honest conduct, or is it some other standard? Undoubtedly the two issues are related, but for analytical and expositional purposes it is better to separate them. The State of Mind 7.14 The test for intent to defraud is a subjective and not an objective test,30 namely what a court has to consider is the state of the mind of the respondent at the time of the alleged fraudulent trading; that is the decisive issue.31 The liquidator must establish that there was either an intent to defraud or a reckless indifference whether or not the creditors were defrauded.32 The upshot is that if it was established that the respondent had knowledge of fraud then it follows that

25 Ibid., [74]. 26 [2020] EWHC 1140 (Ch). 27 Ibid., [15]. 28 [2020] EWHC 546 (Ch). 29 Ibid., [229]. 30 Bernasconi v Nicholas Bennett & Co [2000] BPIR 8, [2000] BCC 921, [14]. 31 R v Ghosh [1982] QB 1053 (CCA), a case dealing with the Theft Act. 32 Bernasconi v Nicholas Bennett & Co [2000] BPIR 8, [2000] BCC 921, [14]; Bilta (UK) Ltd v Natwest Markets plc [2020] EWHC 546 (Ch), [176].

72

I NTENT TO DEFR AU D AND FR AU DU LENT PU R POSE

the respondent was acting dishonestly.33 The mind of the defendant is assessed in the light of what the person actually knew at the time, as distinct from what a reasonable person would have known or appreciated.34 The defendant’s actual state of knowledge and belief as to relevant facts forms a crucial part of the test.35 Knowledge of a fact may be imputed to a person if he or she turns a blind eye to it, that is deliberately abstaining from inquiry as to the facts in order to avoid certain knowledge of what the person already suspects to be the case.36 In fact, according to the Court of Appeal in Group Seven Ltd v Nasir37 a person’s beliefs may include suspicions which he or she harbours and a person’s suspicions which fall short of constituting blind-eye knowledge are not necessarily irrelevant when evaluating whether the person’s behaviour was dishonest.38 7.15 The test for intent to defraud is subjective in that the defendant must know of the elements of the transaction which make it dishonest.39 While the test is subjective, and not objective, in this regard in that the state of the mind of the respondent is the critical factor, we have case law right from the time of the first fraudulent trading provision that indicates that objective considerations are not irrelevant. The issue is, however, in what circumstances may objective factors be taken into account by a court, and to what extent may these factors be used? 7.16 An examination of the meaning of ‘carrying on business with intent to defraud’ and what objective factors are relevant, if at all, must commence with two judgments of Maugham J in the 1930s which were, it has been suggested, inconsistent. In the first of the cases, Re William C. Leitch Bros Ltd,40 the judge gave ‘intent to defraud’ a wide meaning41 and, in effect, indicated that courts could infer the requisite state of mind. His Lordship said: If a company continues to carry on business and to incur debts at a time when there is, to the knowledge of the directors, no reasonable prospect of the creditors ever receiving payment of those debts, it is, in general, a proper inference that the company is carrying on business with intent to defraud.42

7.17 The case in question fell directly within the mischief which the section was designed to suppress, for it was one in which the governing director of the company had, at a time when the company was, to his knowledge, unable 33 Re BCCI; Morris v State Bank of India [2004] EWHC 528 (Ch), [2004] 2 BCLC 279, [2004] BCC 404. 34 Royal Brunei Airlines Sdn Bhd v Tan [1995] 2 AC 378, 389; Ivey v Genting Casinos (UK) Ltd [2017] UKSC 67, [2018] AC 391, [2018] 3 WLR 1212, [60]. 35 Group Seven Ltd v Nasir [2019] EWCA Civ 614, [2020] Ch 129, [58]. 36 Ibid., [59]. For more discussion of what blind-eye knowledge entails, see [6.96]–[6.97]. 37 [2019] EWCA Civ 614, [2020] Ch 129. 38 Ibid., [61]. 39 Abou-Ramah v Abacha [2006] EWCA Civ 1492, [2007] Bus L R 220; [2007] 1 Lloyd’s Rep 115, [59]. 40 [1932] 2 Ch 71. 41 In recent times it has been said that the test of intention to defraud is extremely wide: Re Vining Sparks UK Limited [2019 EWHC 2885 (Ch). 42 [1932] 2 Ch 71, 77. See also R v Wax 1957 (4) SA 399 and Re Gerald Cooper Chemicals [1978] 2 All E R 49.

73

I NTENT TO DEFR AU D AND FR AU DU LENT PU R POSE

to pay its debts, ordered goods on credit which thereupon became subject to a floating charge in favour of the director.43 His Lordship’s statement suggested that where the relevant conduct of the director could be regarded ‘as dishonest per se, the inference will be that the conduct was dishonest and thus constitutes on the part of the director intent to defraud.’44 The suggestion from the case is that intent to defraud could be inferred even if the respondent states that he or she had no such intent. In view of this, the proposition laid down by Maugham J may have been rather more widely framed than was strictly necessary for the decision of the case, and it may not be without significance that in the subsequent case of Re Patrick & Lyon Ltd45 the same judge declined to make a declaration of personal liability against a director who had deliberately delayed in despatching notices of intention to wind up voluntarily with the object of protecting his charge from invalidity under the precursor of s 245 of the Act (a provision that permits, in certain circumstances, the invalidation of floating charges in a liquidation or administration). 7.18 It is often said that the judge in Re Patrick & Lyon Ltd favoured a narrower approach than that which he articulated in Leitch. While in Patrick & Lyon the judge clearly found for the defendant, and did not consider whether intent could be inferred, his Lordship did not say anything that indicated a retraction of what he had said in the earlier case. The judge simply did not think that the defendant was deliberately intending to defraud. 7.19 Certainly, in Patrick & Lyon, the facts, as far as they are reported, do not disclose the same questionable activities on the part of the defendant when compared with the defendant in the earlier case, and might be explained accordingly. However, in Hardie v Hanson,46 the Australian High Court expressed grave doubts as to the validity of the proposition of Maugham J in Leitch, quoted earlier, being regarded as a rule of substantive law, and thought it was, at most, a proposition of evidence of proof which was only ‘in general’ true.47 The Australian court seemed disposed to regard it as essential that a party charged under the section should be shown to have intended to benefit or protect himself or herself at the expense of the company’s creditors,48 and this, in the opinion of one of the judges, Kitto J, was not established by proving simply that he had ‘acted with blameworthy irresponsibility, knowing that he was gambling in effect with his creditors’ money as well as his own, and with much more of their money than of his own.’49

43 The director was declared personally liable for £6,000, the amount of the debts incurred, which was charged on a debenture held by him. 44 Gary Scanlan, ‘The Criminal Liabilities of Directors to the Creditors of the Company’ (2003) 24 Co Law 234 at 239. 45 [1933] Ch 786. 46 (1960) 105 CLR 451. 47 Ibid., 460 per Dixon CJ, and Kitto J agreed (at 464). 48 Ibid., 461–462, 464, 467. Compare the decision in Re Gerald Cooper Chemicals Ltd [1978] Ch 262. 49 Ibid., 464.

74

I NTENT TO DEFR AU D AND FR AU DU LENT PU R POSE

7.20 In the unreported decision of Re White and Osmond (Parkstone) Ltd,50 Buckley J appears to have sought to reconcile any perceived divergence in the two decisions of Maugham J. Buckley J said: In my judgment there is nothing wrong in the fact that directors incur credit at a time when, to their knowledge, the company is not able to meet all its liabilities as they fall due. What is manifestly wrong is if directors allow a company to incur credit at a time when the business is being carried on in such circumstances that it is clear that the company will never be able to satisfy its creditors. However, there is nothing to say that directors who genuinely believe that the clouds will roll away and the sunshine of prosperity will shine upon them again and disperse the fog of their depression are not entitled to incur credit to help them to get over the bad time.51

7.21 Therefore, Buckley J seems to accept that the requisite state of mind could be inferred. Nevertheless, his Lordship drew a distinction between inferring intent in the case where the respondent knows that the company will never be able to pay debts that are incurred, as opposed to the case where debts are incurred when it is known that the company cannot satisfy debts as they fall due, but in the latter case the person has a genuine belief that the debts may well be satisfied in due course. According to the judge, only in the former case was the respondent liable under the forebear of s 213. Consequently, this approach does not lead to liability for a person who is possessed by unfounded optimism. There appears to be little in the case law that is against the first of the two positions proposed by Buckley J. It is in relation to the latter that there is some divergence. 7.22 At about the time of Buckley J’s judgment, the Australian High Court in Hardie v Hanson,52 and discussed earlier, rejected the idea that a person is liable if he or she incurs debts without any reasonable prospect of being able to pay. The Court said that personal dishonesty needed to be established. One of the judges, Menzies J, said: [E]ven if the chances of payment of all creditors in full were so remote that it belonged to the realms of hope rather than belief, it seems to me that the fault, grievous though it may be, falls short of fraud unless it is coupled with something else, such as misrepresentation of the position or an intention to use goods on credit for the purposes of dishonest gain, which gives it a fraudulent character.53

7.23 However, the Court of Appeal in R v Grantham54 (and followed by the court hearing a civil claim in Re a Company (No 001418 of 1988))55 took a more robust approach, and it indicated that a person may be liable, having the required state of mind, if, when obtaining credit, it was known that there was no reason for thinking that the debt would be able to be paid when it became

50 51 52 53 54 55

30 June 1960. Quoted in Paul Davies et al., Palmer’s Corporate Insolvency Law (Sweet and Maxwell), 1249. (1960) 105 CLR 451. Ibid., 467. [1984] QB 675, [1984] 2 WLR 815, [1984] BCLC 270 (CCA). [1991] BCLC 197.

75

I NTENT TO DEFR AU D AND FR AU DU LENT PU R POSE

due or shortly afterwards. A similar position was taken in Re Gerald Cooper Chemicals Ltd.56 In this case Templeman J court said that a company was being carried on with an intent to defraud if it accepted payments for goods when it was known to the directors that the company could not supply the goods, and the directors knew that the company was insolvent.57 The judge also stated that the word ‘intent’ is employed in the sense that a person must be taken to intend the ‘natural or foreseen consequences of his act,’58 clearly accepting the fact that intent can be inferred. This view received the implicit imprimatur of the Court of Appeal (Criminal Division) in R v Grantham,59 when it approved of the following, taken from the summing up in the trial: A man intends to defraud a creditor either if he intends that the creditor shall never be paid or alternatively if he intends to obtain credit or carry on obtaining credit when the rights and interests of the creditor are being prejudiced in a way which the defendant himself has generally regarded as dishonest . . . a trader can intend to defraud if he obtains credit when there is a substantial risk of the creditor not getting his money or not getting the whole of his money and the defendant knows that is the position and knows he is stepping beyond the bounds of what ordinary decent people engaged in business would regard as honest.60

7.24 In these decisions the courts were, in effect, inferring intent to defraud, based on something close to recklessness. Laddie J seemed to accept this view in Bernasconi v Nicholas Bennett & Co,61 as he said that to be liable the respondent had to evince an intent or, as an alternative, a reckless indifference as to whether creditors were defrauded.62 All of this suggests a more severe approach than that taken in the Australian case of Hardie. 7.25 In Grantham the Court referred to an earlier decision of the Court of Appeal (Criminal Division), R v Sinclair,63 a case involving a prosecution for fraudulently using a company’s assets for purposes other than those of the company, and where the Court of Appeal upheld the statement of the trial judge that: To prove fraud it must be established that the conduct was deliberately dishonest. In the circumstances of this case what sort of test should be applied as to whether the conduct was dishonest? It is fraud if it is proved that there was the taking of a risk which there was no right to take which would cause detriment or prejudice to another.64

7.26 On the basis of this case, it might be argued that a respondent has committed a breach of s 213 if he or she incurred debts in such a way that there was a significant risk that there would be no repayment, even if there was no 56 57 58 59 60 61 62 63 64

[1978] Ch 262, 268. Ibid., 267–268. Ibid, 267. [1984] QB 675, [1984] 2 WLR 815, [1984] BCLC 270 (CCA). [1984] QB 675, 681. [2000] BPIR 8; [2000] BCC 921. Ibid, [14]. [1968] 1 WLR 1246. Ibid., 1250.

76

I NTENT TO DEFR AU D AND FR AU DU LENT PU R POSE

subjective intent to defraud. The use of the phrase ‘the taking of a risk which there was no right to take’ in Sinclair suggests recklessness. This is to be contrasted with a situation like that found in Re Augustus Barnett & Sons Ltd65 where the respondents were held not liable. When they incurred liabilities, the directors believed that their company would be supported by the company’s holding company, and this belief was reasonable, because inter alia the holding company had provided large subsidies in the past. In terms of the test in Sinclair, there was no taking of a risk that there was no right to take. There was a degree of reasonableness in the decision made. 7.27 In the Hong Kong case of Aktieselskabet Dansk Skibsfinansiering v Brothers66 Lord Hoffmann, when sitting as a member of the Court of Final Appeal and delivering a judgment that was agreed to by the other four members of the Court, did not express his views in the same terms as the judges in the decisions just considered. His Lordship emphasised other factors and agreed with the High Court of Australia that the statement in Leitch, which was quoted earlier, was a not a helpful generalisation,67 and he went on to accept the view of the trial judge in the case on appeal before him that whether a person was or was not dishonest was dependent on an assessment of all of the facts. But his Lordship did think that there was adequate evidence in Leitch, namely the defendant ordering goods greatly in excess of the company’s usual requirements so that the value would reduce the extent of the defendant’s guarantee to the bank which had a charge over the assets of the company, to permit Maugham J to find that fraudulent trading had occurred. 7.28 Lord Hoffmann indicated that for a person to be liable under the Hong Kong equivalent of s 213, where he or she ordered goods or services from a creditor, an applicant had to establish that the respondent was seeking to gain a personal advantage and was deceiving the creditor.68 This might be seen as consistent with Leitch where emphasis was placed on the fact that the defendant in that case deliberately went on trading in the name of the company in order, as he hoped, to safeguard his own position, and without any regard to the interests of the creditors. It is also reminiscent of the views expressed by the Australian judges in Hardie. 7.29 The corollary of the view of Lord Hoffmann might be that directors who order goods for their company are not going to be liable necessarily for fraudulent trading merely because there is a risk that the supplier is not going to get paid. The directors must be gaining a personal benefit from the ordering of the goods for liability to be imposed. Certainly, Lord Radcliffe in Welham v DPP69 (a case involving consideration of s 4 of the Forgery Act 1913 and one of the leading cases on the issue of fraud) said that fraud invariably is associated

65 66 67 68 69

(1986) 2 BCC 98,904. [2001] 2 BCLC 324. Ibid., 331. Ibid. [1961] AC 103.

77

I NTENT TO DEFR AU D AND FR AU DU LENT PU R POSE

with the obtaining of an advantage for the perpetrator, but his Lordship indicated that the effect on the party who is the object of an alleged fraud is the critical element,70 a point accepted in Grantham71 and Re a Company No 001418 of 1988.72 The court in Grantham73 actually stated that fraudulent trading can be made out even if it is not possible to establish that anyone has suffered a loss. 7.30 A matter with which Lord Hoffmann was deeply concerned was the fact that he felt that precedent was being used in fraudulent trading cases improperly. His Lordship stated that while precedent can be used to establish principles in relation to dishonesty, each case must be assessed on its own facts.74 The position of the judge is that one cannot say, by way of generalisation, that anyone who incurs debts, for example, at a time when there is no likelihood of being able to pay, is necessarily liable for a breach of s 213.75 This concern is consistent with what his Lordship said in the earlier case of Re Augustus Barnett & Sons Ltd,76 where he said that it is not permissible to translate the actual facts pleaded in a fraudulent trading action into generalities and then draw inferences from the generalities instead of from the facts themselves. 7.31 In Aktieselskabet Dansk Skibsfinansiering77 Lord Hoffmann expressed the need for caution when employing statements about objective considerations. He said that courts must be careful in invoking the concept of the hypothetical decent honest man and what that person would have done in the circumstances, as there might be a temptation to treat the respondent’s shortcomings as a failure to comply with this necessary objective standard of conduct. Lord Hoffmann went on to say that dishonesty depended on an assessment of all the facts and stated that it was much safer to focus on the respondent before the court and to ask whether that person had been dishonest. 7.32 The previous analysis seems to suggest some difference in the view of Lord Hoffmann and that of the Court of Appeal in Grantham, although his Lordship did not take issue with anything said in Grantham when he referred to it in his judgment, and in fact he was of the opinion that the defendants in Grantham should have been found liable. It will be recalled that Lord Hoffmann in Aktieselskabet Dansk Skibsfinansiering emphasised the fact that for the respondent to be liable he or she must have benefited personally from the alleged fraud, a point also taken in the Hardie case, while in Grantham, and other decisions, including the important case of Welham, injury to the creditors was regarded as the essential requirement for liability. Lord Hoffmann and the Australian High Court in Hardie seem to be of the view that inferences can only be made where the respondent actually benefits personally from the allegedly fraudulent 70 71 72 73 74 75 76 77

Ibid., 123. [1984] QB 675, 683–684. [1991] BCLC 197, 198. [1984] QB 675, 683–684. [2001] 2 BCLC 324, 331–332. Ibid. (1986) 2 BCC 98,904, 98,909. [2001] 2 BCLC 324.

78

I NTENT TO DEFR AU D AND FR AU DU LENT PU R POSE

trading, hence, it follows that if a respondent is able to claim without challenge that he or she had no intent to defraud, and the respondent did not benefit from the incurring of debts on behalf of the company, he or she should not be held liable. Also of note is the fact that both the Australian High Court in Hardie and Lord Hoffmann in Aktieselskabet Dansk Skibsfinansiering expressed concern about making the right to infer intent a rule of law; rather, the focus should be on the facts of each case. 7.33 In a recent case, Bilta (UK) Ltd v Natwest Markets plc,78 Snowden J said that a court is entitled to infer a state of mind in some circumstances. His Lordship opined that in determining whether a respondent was dishonest ‘the court can take into account, as a matter of common sense, any relevant “inherent improbabilities” as to the defendant’s behaviour.’79 7.34 A similar approach to that advocated in Grantham has been implemented in a cognate field, namely where a person is alleged to have put assets beyond the reach of his, her or its creditors, which involves a breach of s 423 of the Act. The Australian High Court in Cannane v Cannane,80 a case dealing with the Australian equivalent of s 423, s 121 of the Bankruptcy Act 1966 (Cth), involved three of the five judges saying that intent to defraud could be established by inference, and whether a court was able to infer depended on all the circumstances.81 This approach has been utilised for many years in England, and certainly as far back as Freeman v Pope82 where Lord Hatherley LC permitted inferences to be drawn in evaluating whether there had been an intent to defraud in relation to a precursor of s 423. There is case law dealing with s 423 to the effect that engaging in risky or a hazardous activity might be a factor which might well justify the court making an inference that the debtor’s intention was to put assets beyond the reach of creditors.83 In recent times, in giving the leading judgment of the Court of Appeal in the s 423 case of Inland Revenue Commissioners v Hashmi,84 Arden LJ indicated that judges may draw inferences. The Report of the Insolvency Law Review Committee, Insolvency Law and Practice85 supported allowing courts to infer purpose where this would be the natural and probable consequences of the debtor’s actions.86 In the most recent Court of Appeal decision to address s 423, JSC BTA Bank v Ablyazov,87 the Court seemed to be suggested that a court is able, in certain circumstances, to make inferences.88 7.35 When it comes to consideration of the phrase, ‘intent to defraud’ in a prosecution under s 993, it should be seen in light of s 8(1) of the Criminal Justice 78 79 80 81 82 83 84 85 86 87 88

[2020] EWHC 546 (Ch). Ibid., [239]. (1998) 192 CLR 557. Ibid., 566–567 and 591–593. (1870) LR 5 Ch 538. Midland Bank v Wyatt [1997] 1 BCLC 242; Sands v Clitheroe [2006] BPIR 1000. [2002] 2 BCLC 489. Cmnd 858, HMSO (1982), and known as the Cork Report. [2002] 2 BCLC 489, [1283]. JSC BTA Bank v Ablyazov [2018] EWCA Civ 1176, [2019] BCC 96, [2018] BPIR 898. Ibid., [15], [25].

79

I NTENT TO DEFR AU D AND FR AU DU LENT PU R POSE

Act 1987, which provides that a court is not bound to infer that the defendant intended or foresaw a result of his or her actions. It must decide whether the defendant did intend or foresaw the result by reference to all of the evidence, drawing such inferences from the evidence as appears fit and proper. Arguably this is no different than the position that the courts have taken under s 213. All of this is not surprising, for there are a number of criminal cases in which it has been stated that courts may draw inferences concerning the state of mind of a director.89 If the courts are willing to infer in criminal cases, it seems logical to say that the courts should, in certain circumstances, do so in civil cases where the ramifications of liability for directors is not going to involve the registering of a criminal conviction. 7.36 Added to all of the above is the fact that unless there is some external evidence in which the person expresses what they know or think about any transactions, it will be necessary to draw inferences in most cases for an applicant to succeed.90 That is, if inferences are not permitted then s 213 will have little potency. 7.37 In sum, the preponderance of authority, including notably Grantham, seems to hold to the view that a court may infer that the respondent had an intent to defraud either where the respondent, when incurring a debt, was aware that there was no good reason for thinking that the debt could be satisfied, or where the respondent knew that there was a risk that the creditor may not get paid. Lord Hoffmann, primarily in Aktieselskabet Dansk Skibsfinansiering, and the Australian High Court in Hardie, seem to require the respondent to receive a personal gain from a transaction before they would acquiesce to the making of any inference. While his Lordship’s view, in particular, is of strong persuasive force, it is not binding on a High Court judge, and one would think that the Grantham approach would prevail. 7.38 Also, given the case law it can be argued strongly that where it is appropriate, a judge may infer an intention to defraud. 7.39 One final point on this issue is that it is not possible to combine two innocent minds to establish dishonesty, that is, it is not permissible to add an innocent state of mind to an innocent state of mind and end up with a dishonest state of mind.91 The Standard of Honesty 7.40 The issue to which we now turn is whether respondents are entitled to say that they are not liable because they believed that what they did was not fraudulent, or is some other standard relevant?

89 R v Berrada (1990) 91 Cr App R 131 (CCA). 90 Barlow Clowes International Ltd (in Liquidation) v Eurotrust International Ltd [2005] UKPC 37; [2006] 1 WLR 1476, [26]. 91 Armstrong v Strain [1952] 1 KB 232, 246; Stanford International Bank Ltd (in liquidation) v HSBC Bank plc [2021] EWCA Civ 535, [2021] 1 BCLC 711, [17].

80

I NTENT TO DEFR AU D AND FR AU DU LENT PU R POSE

7.41 Two critical cases that have addressed the concept of dishonesty in a civil setting are Royal Brunei Airlines Snd Bhd v Tan92 and Twinsectra Ltd v Yardley.93 They did so in the context of a claim that the respondents were involved in dishonestly assisting a breach of trust. It is not intended to undertake an exposition of these two cases, but what they have to say about dishonesty is on point. In Twinsectra, Lord Hutton (with whom three of the other Law Lords agreed) said that there were three tests that could be applied to determining whether someone acted dishonestly or not. The first two tests were the standard subjective and objective tests. His Lordship applied the third test,94 which he called ‘the combined test.’ This is a: standard which combines an objective test and a subjective test, and which requires that before there can be a finding of dishonesty it must be established that the defendant’s conduct was dishonest by the ordinary standards of reasonable and honest people and that he himself realised that by those standards his conduct was dishonest.95

7.42 In a similar manner, Lord Nicholls said in Royal Brunei Airlines (and this was approved of by a majority of the House of Lords in Twinsectra) that: Honesty has a connotation of subjectivity, as distinct from the objectivity of negligence. Honesty, indeed, does have a strong subjective element in that it is a description of a type of conduct assessed in the light of what a person actually knew at the time, as distinct from what a reasonable person would have known or appreciated. Further, honesty and its counterpart dishonesty are mostly concerned with advertent conduct, not inadvertent conduct. Carelessness is not dishonesty. Thus for the most part dishonesty is to be equated with conscious impropriety. However, these subjective characteristics of honesty do not mean that individuals are free to set their own standards of honesty in particular circumstances. The standard of what constitutes honest conduct is not subjective. Honesty is not an optional scale, with higher or lower values according to the moral standards of each individual. If a person knowingly appropriates another’s property, he will not escape a finding of dishonesty simply because he sees nothing wrong in such behaviour.96

7.43 Lord Hoffmann, who as we saw earlier sounded warnings in Aktieselskabet Dansk Skibsfinansiering v Brothers97 about employing objective considerations when fraudulent trading was in issue, accepted the statement of the trial judge that the further a person moves away from objective standards of honesty, the more likely he or she is dishonest.98 His Lordship seemed to agree that while respondents are not liable unless they knew that they were acting dishonestly, 92 [1995] 2 AC 378. 93 [2002] UKHL 12, [2002] 2 AC 164. It is interesting that in this case, involving the issue of whether the respondent was liable for being an accessory to a breach of trust, Lord Millett, who dissented, favoured a totally objective test. 94 In the Supreme Court in Ivey v Genting Casinos (UK) Ltd [2017] UKSC 67, [2018] AC 391, [2018] 3 WLR 1212, [56] it was said that this approach was a compromise rule. 95 Ibid., [27]. 96 [1995] 2 AC 378, 389. 97 [2001] 2 BCLC 324. 98 Ibid., 330.

81

I NTENT TO DEFR AU D AND FR AU DU LENT PU R POSE

the standard of honesty is not that of the respondent; it is the ordinary standards of reasonable and honest people.99 It is notable also that Lord Hoffmann sat as a member of the House of Lords in the appeal in Twinsectra. Furthermore, when a member of the Judicial Committee of the Privy Council in Barlow Clowes International Ltd (in Liquidation) v Eurotrust International Ltd100 Lord Hoffmann said that: Although a dishonest state of mind is a subjective mental state, the standard by which the law determines whether it is dishonest is objective. If by ordinary standards a defendant’s mental state would be characterised as dishonest, it is irrelevant that the defendant judges by different standards. The Court of Appeal held this to be a correct state of the law and their Lordships agree.101

7.44 In Abou-Ramah v Abacha,102 another case dealing with dishonest assistance of a breach of trust, Arden LJ (as she then was) was firmly of the view that the Privy Council in Barlow Clowes clarified the situation and interpreted Twinsectra in such a way that a court does not require the defendant to be conscious of his or her wrongdoing for liability to attach. Arden LJ was of the opinion that it was sufficient for liability to be imposed if the defendant was aware of the elements of the transaction which made it dishonest according to normally accepted standards of behaviour.103 7.45 The Court of Appeal in Starglade Properties Ltd v Nash,104 yet another dishonest assistance decision, confirmed that the relevant standard was the ordinary standard of honest behaviour. Sir Terence Etherton C said that the subjective understanding of the person concerned as to whether his or her conduct is dishonest is irrelevant.105 7.46 The Supreme Court in Ivey v Genting Casinos (UK) Ltd,106 dealing with a claim of cheating in a gambling context, accepted that the test of dishonesty as set out by Lord Nicholls in Royal Brunei Airlines Sdn Bhd v Tan and by Lord Hoffmann in Barlow Clowes International Ltd v Eurotrust International Ltd was correct.107 Lord Hughes (with whose judgment all the judges agreed) said that: When dishonesty is in question the fact-finding tribunal must first ascertain (subjectively) the actual state of the individual’s knowledge or belief as to the facts. The reasonableness or otherwise of his belief is a matter of evidence (often in practice determinative) going to whether he held the belief, but it is not an additional requirement that his belief must be reasonable; the question is whether it is genuinely held. When once his actual state of mind as to knowledge or belief as to facts is established, the question whether his conduct was honest or dishonest is to be

99 Ibid., 333. 100 [2005] UKPC 37, [2006] 1 WLR 1476. 101 Ibid., [10]. 102 [2006] EWCA Civ 1492, [2007] Bus L R 220, [2007] 1 Lloyd’s Rep 115. 103 Ibid., [59], [65]. 104 [2010] EWCA Civ 1314. 105 Ibid., [32]. 106 [2017] UKSC 67, [2018] AC 391, [2018] 3 WLR 1212. 107 Ibid., [74].

82

I NTENT TO DEFR AU D AND FR AU DU LENT PU R POSE

determined by the fact-finder by applying the (objective) standards of ordinary decent people. There is no requirement that the defendant must appreciate that what he has done is, by those standards, dishonest.108

7.47 The Court of Appeal in Natwest Markets Plc, Mercuria Energy Europe Trading Ltd v Bilta (UK) Ltd109 explained that the decision in Ivey v Genting Casinos establishes that where dishonesty is at issue the court must ascertain, first, the defendant’s actual state of knowledge or belief as to the facts and, secondly, whether, in the light of that state of mind, conduct of the defendant was honest or dishonest applying the objective standards of ordinary decent people.110 7.48 The position of the Court of Appeal in Grantham is also consistent with the approaches adopted in Royal Brunei and Twinsectra. 7.49 Therefore, it seems that the case law holds that the combined approach, as Lord Hutton put it, is to be followed in relation to fraudulent trading, as this maintains the subjectivity of the respondent’s state of mind and does not invoke the hypothetical reasonable person, but it ensures that the ordinary standards of reasonable and honest people are not excluded, so that respondents cannot impose their own standards. What Actions Can Constitute Fraud? 7.50 Initially, it is worthwhile setting out some actions that are and are not regarded as fraud for the purposes of s 213. First, the payment of preferences, that is entering into transactions that can be classified as giving preferential payment to creditors and which are within the scope of s 239 of the Act, will not generally be deemed to be fraud,111 the reason being that a debtor is entitled to pay its creditors in whatever order it sees fit.112 It is not until administration or liquidation eventuates that that action may be impugned, and that is done retrospectively. When a preference is given, it might well be that the officers had no way of expecting the company to enter liquidation or administration. It is well recognised that the giving of a preference is not illegal, for when it occurred the provisions in the Act that deem transactions to be preferences did not apply.113 But if a company were to pay uncommercial sums to a party with the intention

108 Ibid., [74]. Although Ivey involved a criminal issue, the test has been employed in civil law, such as in relation to dishonest accessory liability: Group Seven Ltd v Notable Services LLP [2019] EWCA Civ 614, [2020] Ch 129. 109 [2021] EWCA Civ 680. 110 Ibid., [130]. 111 Re Sarflax Ltd [1979] 1 All ER 529. 112 Ibid., 535, 545. 113 Notwithstanding this, directors could be attacked for the payment of preferences on the basis of engaging in misfeasance, but such proceedings are usually only taken where there is a flaw in a preference action against the recipients of the preferences, and proceedings are only likely to succeed where the directors knew clearly that the company was insolvent at the time. For an example, see Liquidator of West Mercia Safetywear Ltd v Dodd (1988) 4 BCC 30. Also, see Andrew Keay, ‘Financially Distressed Companies, Preferential Payments and the Director’s Duty to Take Account of Creditors’ Interests’ (2020) 136 Law Quarterly Review 52.

83

I NTENT TO DEFR AU D AND FR AU DU LENT PU R POSE

of ensuring that property were put out of the reach of creditors, then this could be regarded as fraudulent trading, and possibly a breach of s 423 of the Act. 7.51 As we saw in Chapter 6, inaction cannot constitute fraudulent trading, as some positive action must have been taken.114 Hence, if an officer of, or adviser to, the company, such as the company secretary, neglects to inform the directors that the company is insolvent, and what the consequences are in continuing to trade, that person is not liable, as there is no positive conduct. While, for the most part, a respondent is not liable except where he or she has committed a positive act, a respondent who is a third party as far as the company in liquidation is concerned may be held liable notwithstanding the fact that there was neither a positive act on the part of the third party nor involvement in the carrying on of business if the third party is knowingly a party to a fraudulent act.115 For instance, a creditor who receives a payment from the company at a time when he or she knew that the payment was made possible because a controller of the company was carrying on business with an intent to defraud may be held liable.116 This is likely to occur quite infrequently, save where a creditor is connected to the directors or the company in some way, as creditors will not be aware of how and why payments have been made. 7.52 As indicated in the previous chapter, a single transaction or act may be the basis for a successful action under either s 993 or s 213.117 So, if a director were to get a trade supplier to provide goods with the intention of deceiving the supplier, in that the director had no intention of paying for them, this would appear to constitute an intent to defraud.118 ‘Fraudulent Purpose’ 7.53 When addressing the expression, ‘fraudulent purpose,’ the first thing to ask is whether it should be read ejusdem generis with ‘intent to defraud creditors.’ The court in R v Kemp119 thought not. This conclusion is supported by the fact that in R v Inman120 it was said that there were two offences covered by the provision (now s 993), namely carrying on business with intent to defraud creditors and carrying on business for any fraudulent purpose. The expression should not be seen in any way to be restricting the application of s 213. On the contrary, the expression is extremely wide.121 7.54 A person is not liable on the basis of fraudulent purpose merely because he or she nominated a person as a director who committed fraudulent trading, or because he or she had the opportunity of influencing the conduct of the affairs 114 115 116 117 118 119 120 121

Re Maidstone Buildings Ltd [1971] 1 WLR 1085. Re Augustus Barnett & Sons Ltd (1986) 2 BCC 98,904, 98,907. Re Gerald Cooper Chemicals Ltd [1978] 2 All ER 49. Ibid. Ibid. [1988] 1 QB 645, 654 (CCA). [1967] 1 QB 140. [1988] 1 QB 645, 654–655 (CCA).

84

I NTENT TO DEFR AU D AND FR AU DU LENT PU R POSE

of the company. Company officers will not, necessarily, be liable for trading while the company is insolvent. As indicated earlier in the chapter, it may well depend on whether the directors have been reckless in incurring debts. If there is no recklessness, and there is no intent to defraud involved, a liquidator might well prefer to proceed against directors under the wrongful trading provision. Conclusion 7.55 The chapter has examined the most important and often the most difficult condition for an applicant to prove, that is that the respondent carried on business with intent to defraud creditors or for any fraudulent purpose. 7.56 It has been stated that: [I]n the absence of reasonably clear indications that the requisite intent to defraud was present at the time of the conduct in question, there remains a degree of uncertainty whether civil or criminal proceedings for fraudulent trading will prove to be successful in any given case.122

7.57 With respect, this appears to be true, for we do not have a clear articulation of the relevant principles in one or two recent cases. To ascertain what the present position is requires a substantial study of the cases, and even then there is a lack of certainty. 7.58 It is submitted that we have general acceptance, as noted in this chapter, that while the test for fraud is a subjective one, the courts do not take into account the respondent’s standard of honesty, but those of ordinary people. Whether, and if so when, courts can infer intent to defraud with respect to a respondent is not without some doubt, but it is submitted that courts can do so either where respondents incur debts at a time when they know that their company will clearly not be able to make repayment, or where there is considerable risk in not being able to repay the creditor(s) when the debts are due or shortly thereafter.

122 Ian F Fletcher, The Law of Insolvency (2nd ed, Sweet & Maxwell, 1990), 196.

85

PART C

WRONGFUL TRADING

CHAPTER 8

Wrongful Trading Background, Aims and Rationale

Introduction 8.1 This part of the book deals with an action that might be taken by liquidators and administrators against directors of a company who engage in what is known as ‘wrongful trading’ before the company entered insolvent liquidation or insolvent administration. The action is instigated by liquidators and administrators in order to obtain some contribution from the directors towards the payment that is made to the creditors, who, of course, in an insolvent liquidation or an insolvent administration are not going to get back all of what they were owed by the company. This action is initiated either by liquidators pursuant to s 214 of the Insolvency Act 1986 (‘the Act’) or by administrators under s 246ZB. 8.2 Section 246ZB, giving administrators the power to initiate a wrongful trading action, came late in the day. Until it was introduced in 2015 by s 117 of the Small Business Enterprise and Employment Act 2015 only liquidators could commence wrongful trading proceedings. This enactment meant that an administration would not have to be converted to a liquidation merely to permit the commencement of a wrongful trading action. 8.3 As the law has developed in response to actions brought by liquidators, and it is liquidators by far who are the initiators of wrongful trading actions, in this chapter reference will be made to actions commenced by liquidators. Adopting this approach will also be conducive to more concise and fluid exposition. What is said in relation to wrongful trading and the provisions in s 214 as they apply to liquidation applies equally to actions commenced in administrations; ss 214 and 246ZB are effectively in the same terms. 8.4 Section 214 provides, in effect, that the liquidator of a company that is in insolvent liquidation (effectively the situation where a company’s assets are not sufficient to pay its debts at the time of liquidation)1 may commence proceedings against the company’s directors, and in these proceedings the liquidator may seek an order that the directors make such contribution to the company’s assets as the court thinks proper.2 Directors may only be liable where at some time before

1 Section 214(6). 2 Section 214(1).

DOI: 10.4324/9780429266232-11

89

W RONGFU L TR A DI NG

the commencement of the winding up of the company, they knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation.3 Courts are not to make an order against directors if satisfied that, after the directors first knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation, the directors took every step with a view to minimising the potential loss to the company’s creditors as they ought to have taken.4 8.5 It is worth pointing out that s 214 does not use the words ‘wrongful trading’; it is a description that is only employed in a marginal note in the Act, but the cases and the literature have adopted the term to describe directors who knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation. There is clear authority that a marginal note is not to be used as an aid to interpretation of legislation.5 8.6 It has been suggested that the trading that offends against s 214 is, perhaps, better referred to as ‘irresponsible’ or ‘illicit.’6 However, it might be argued that even these descriptions would be slanting the provision in a way that is not appropriate and should be eschewed. ‘Wrongful’ tends to connote the idea of a substantial amount of blameworthiness and to a lesser degree so does ‘irresponsible’ or ‘illicit,’ and yet the provision, while accepting that to be liable there must be some degree of unreasonableness and even culpability, it does not require directors to have engaged in heinous activity before they can be held liable. Perhaps ‘unreasonable trading’ or even ‘irrational trading’ would be better descriptors. 8.7 This chapter is effectively an introduction to wrongful trading. It explains the background, aims and rationale of the provision. Chapter 9 then explains and analyses the elements and scope of s 214, and Chapter 10 discusses the sole defence that is available to respondents to proceedings. In the course of achieving the goals of Chapters 9 and 10 there is some assessment of the provision, but this is not really part of the major aim of the book. Finally, in this part, Chapter 11 considers whether courts may relieve directors of liability and in this respect considers whether relief is possible pursuant to s 1157 of the Companies Act 2006. Background 8.8 The advent of wrongful trading was due primarily to the perceived inadequacies of the fraudulent trading provision. The Report of the Insolvency Law Review Committee, Insolvency Law and Practice (commonly known as, and similarly referred to here, ‘the Cork Report’)7 was of the opinion that the 3 Section 214(2). 4 Section 214(3). 5 Chandler v DPP [1964] AC 763. 6 The latter term was employed in Andrew Keay and Michael Murray, ‘Making Company Directors Liable: A Comparative Analysis of Wrongful Trading in the United Kingdom and Insolvent Trading in Australia’ (2005) 14 International Insolvency Review 27. 7 Cmnd 858, HMSO (1982). The Committee was chaired by Sir Kenneth Cork.

90

W RONGFU L TR A DI NG

fraudulent trading provision, which was, at the time that the Committee was considering the state of insolvency law and practice in the UK, set out in s 332 of the Companies Act 1948, possessed significant inadequacies in dealing with irresponsible trading,8 such as the application of the criminal burden of proof to civil actions and, also, applicants being required to establish actual dishonesty and real moral blame on the part of the defendant.9 Courts were hesitant to find defendants liable, given the nature of the provision and particularly the need to find defendants had acted dishonestly in that they had an intent to defraud. For instance, in Re Maidstone Building Provisions Ltd10 the judge, who held the defendant not guilty of fraudulent trading, emphasised the fact that the provision was a penal one.11 8.9 The Cork Committee was concerned that unsecured creditors were not protected adequately, and it took the view that compensation ought to be available to those persons who experience loss due to unreasonable behaviour as well as fraudulent action.12 It was concerned that the existing fraudulent trading provision had failed in curbing directors running up losses when their companies were in deep financial difficulty.13 Directors who were not intending to defraud but had failed to act responsibly in their trading were essentially exempt from liability. Also, at this time there was no developed jurisprudence in relation to the duties of directors to consider the interests of creditors when their company was insolvent, a matter discussed later in Part D of the book. What the nature of these duties and when they arose was, at this point (and for some time thereafter), unclear. 8.10 As a consequence of the foregoing, the Cork Committee recommended that a new provision be introduced to provide a right to bring civil actions for unreasonable trading and where only the civil burden of proof would apply.14 Hitherto, and as indicated earlier, directors were only liable if they were proved to have had an intent to defraud creditors. The Committee wanted to see legislation provide that a director, otherwise honest but who sees insolvency coming and does nothing to arrest it, should lose the benefits of limited liability along with those directors who are fraudulent.15 To this end the Committee advocated an objective test to determine liability.16 It proposed liability if the directors incurred liabilities when their company was insolvent and where the company did not have a reasonable prospect of satisfying the debts. What the Committee envisaged was legislation that encouraged company directors to satisfy themselves concerning the company’s ability to discharge commitments. The Committee

8 Ibid., [1776]–[1780]. 9 See, Re Patrick and Lyon Ltd [1933] Ch 786. 10 [1971] 1 WLR 1085. 11 Ibid., 1095. 12 Cmnd 858, HMSO (1982), [1777]. 13 Ibid., [1776]–[1778]. 14 Ibid., [1777]. 15 Adrian Walters, ‘Enforcing Wrongful Trading – Substantive Problems and Practical Incentives’ in B A K Rider (ed), The Corporate Dimension (Jordans, 1998), 146. 16 Cmnd 858, HMSO (1982), [1782–1783].

91

W RONGFU L TR A DI NG

recommended that criminal liability should continue to apply only in relation to fraudulent trading. 8.11 While the Government stated in a 1984 White Paper entitled ‘A Revised Framework for Insolvency Law’17 that it agreed that there had to be a tighter rein on directors’ activities in order to prevent irresponsible trading where insolvent companies were concerned, it declined to take up many of the recommendations of the Cork Report relating to wrongful trading. This view had not changed by the time that the Insolvency Bill was introduced in late 1984 (later to become the Insolvency Act 1985). The reason that the Government gave for this attitude was that the Cork Report’s approach imposed too severe a responsibility on directors for their companies’ liabilities. 8.12 The wrongful trading provision, first finding life as s 15 of the Insolvency Act 1985, provided a concept that was more limited than that recommended by the Cork Committee, and it reflected legislative caution against watering down the law of limited company liability. The provision focused on the making of directors liable for creditor losses when the former failed to take appropriate steps where the avoidance of insolvent liquidation was not a reasonable prospect. 8.13 Professor Len Sealy recorded that one reason that was given for the decision not to adhere to the Cork Report proposal in relation to the enactment of a new provision that curbed the actions of irresponsible, as opposed to fraudulent, directors was that it was not envisaged that the conduct covered should be restricted to the incurring of liabilities when insolvent.18 Sealy noted that it was suggested that the provision might well encompass the situation where there is a loss of company assets in order to pay excessive directors’ fees.19 Also, the Government decided, contrary to the Cork Report’s recommendations, to retain a civil liability, as well as a criminal provision, dealing with fraudulent trading. 8.14 Provisions like s 214 are, in effect, exceptions to the fundamental principle of corporate law that a company is liable for its debts, and it alone. This fundamental rule is based, of course, on the inveterate principle emanating from Salomon v Salomon & Co Ltd20 that a company is a legal entity which is separate from its members and controllers and consequently it, and not its directors (or shareholders), is liable inter alia for its contracts and debts generally. Section 214 involves, in essence, a kind of piercing of the corporate veil in that the directors can be liable for those sums that are owed by the company to creditors. 8.15 The section that we have now, s 214, was enacted as part of the Act. It has not been amended, although in 2015, as mentioned earlier, a new provision, s 246ZB, was inserted in the Act to permit administrators to bring wrongful trading proceedings against directors. As discussed in Part B of the book, this action also occurred in relation to fraudulent trading. 17 Cmnd 9175. 18 L S Sealy, ‘Personal Liability of Directors and Officers for Debts of Insolvent Corporations: A Jurisdictional Perspective (England)’ in Jacob Ziegel (ed), Current Developments in International and Comparative Corporate Insolvency Law (Clarendon Press, 1994), 491. 19 Ibid. 20 [1897] AC 22.

92

W RONGFU L TR A DI NG

8.16 An interesting observation is that apart from Re Farmizer (Products) Ltd,21 which dealt with quite narrow issues, there is no appellate court that has provided a broad-ranging judgment on wrongful trading, although there have been some appeals to High Court judges from decisions of registrars. As we will see in the next chapter we are, therefore, reliant upon the decisions of single judges. Generally speaking, these decisions are consistent, although there do appear to be some differences that have not, hitherto, been considered either judicially or in the academic and practitioner literature. 8.17 One matter that might impact on possible future wrongful trading actions, and should be mentioned at this point, is that the Corporate Insolvency and Governance Act 2020, which partly was enacted in reaction to the COVID-19 pandemic which commenced in early 2020, was said to suspend liability for wrongful trading for a period, namely from 1 March 2020 until 30 September 2020. It did not actually do what the heading (‘Suspension of liability for wrongful trading’) to s 12 suggests. What the Corporate Insolvency and Governance Act actually provided in s 12(1) was that a court, in determining what contribution a director should make for wrongful trading, is to assume that a director is not responsible for the worsening of a company’s financial position or that of the company’s creditors during this period.22 The provision, therefore, does not prevent liability; it merely, potentially, circumscribes liability in that a director cannot be required to make a contribution in respect of the worsening of a company’s financial position or that of the company’s creditors during the relevant period. 8.18 The so-called suspension did not apply if the company concerned was excluded from being eligible by any of the paragraphs of Sch ZA1 to the Act. The exclusions cover a broad range of companies. Examples of such companies are banks and insurers. 8.19 In November 2020 the Government decided to introduce a further suspension of liability for the period from 26 November 2020 until 30 April 2021. This was provided for by reg 2 of the Corporate Insolvency and Governance Act 2020 (Coronavirus) (Suspension of Liability for Wrongful Trading and Extension of the Relevant Period) Regulations 2020.23 Like earlier provisions, reg 2 provided that suspension did not apply if the company concerned was excluded from being eligible by any of the paragraphs of Sch ZA1.24 This suspension probably gave directors some solace. However, there might be some concern that there is a period of about two months (30 September to 26 November 2020) where the suspension does not apply and it is possible that if a company experienced distress issues during the period up to 30 September 2020, but it is only at some point between 30 September and 25 November that the directors can be said to be guilty of wrongful trading, namely if in this period the directors knew or

21 22 23 24

Ibid. See s 12 of the Corporate Insolvency and Governance Act 2020. SI 2020/1349. Regulation 2(4).

93

W RONGFU L TR A DI NG

ought to have known that the company could not avoid insolvent liquidation, the directors could be liable and subject to a contribution order. 8.20 On 21 March 2021 the Government in reg 2 of The Corporate Insolvency and Governance Act 2020 (Coronavirus) (Extension of the Relevant Period) Regulations 202125 further extended the suspension of liability for wrongful trading to 30 June 2021. Unlike the early regulations there was no inclusion of a provision that said that suspension did not apply if the company concerned was excluded from being eligible by any of the paragraphs of Sch ZA1. 8.21 The purpose of the Government’s action was to remove the deterrent of personal liability in order that directors did not have to take into account possible liability when deciding whether or not a company, whose business has been impacted by the effects of the pandemic, should continue trading. Absent the suspension provision, concern on the part of directors over s 214 might have caused companies entering insolvency proceedings unnecessarily, therefore ending the companies’ lives prematurely. 8.22 Shortly after the enactment of the Act, a number of academics and practitioners regarded wrongful trading as a significant weapon in the arsenal of liquidators. Academics and practitioners alike saw s 214 as having a bright future in providing much needed protection for creditors.26 In the early days of the provision, Professor Dan Prentice said that it was ‘unquestionably one of the most important developments in company law this century.’27 Dr Fidelis Oditah said that s 214 was a ‘welcome additional weapon in the fight against abuse of the privilege of limited liability by directors of trading companies.’28 This optimism might be seen as justified in light of the fact that liquidators won early cases.29 However, since these statements were made, other commentators have been more circumspect and less optimistic about the potential, and impact, of the wrongful trading provision. It is not putting it too highly to say that s 214 has not lived up to its early promise. For example, one commentator stated that: [D]espite the provision’s potential to significantly displace the director’s protective shield of limited liability, section 214 has, in reality, failed to fulfil its objective of achieving an efficient means by which the wrongful trading activities of directors can be successfully penalised.30

8.23 Recent developments support the contention that the provision has been a disappointment, with liquidators failing to obtain awards of contributions from courts in some costly actions.31 25 SI 2021/375. 26 Ibid. 27 ‘Creditor’s Interests and Director’s Duties’ (1990) 10 OJLS 265, 277. 28 ‘Wrongful Trading’ [1990] LMCLQ 205, 222. 29 Re Produce Marketing Consortium Ltd (1989) 5 BCC 569; Re DKG Contractors Ltd [1990] BCC 903; Re Purpoint Ltd ([1991] BCC 121, [1991] BCLC 491. 30 Stephen Griffin, Personal Liability and Disqualification of Company Directors (Hart Publishing, 1999), 96. 31 For example, Brooks v Armstrong [2015] EWHC 2289 (Ch), [2015] BCC 661; Re Ralls Builders Ltd [2016] EWHC 243 (Ch), [2016] BCC 293.

94

W RONGFU L TR A DI NG

8.24 Nevertheless, the provision does have its place in the armoury of a liquidator or administrator, and while it is argued by many that s 214 should be amended, the terms of the provision must not be ignored by directors and may well give some liquidators, in some situations, the opportunity to recover funds for the creditors of insolvent companies. Aims 8.25 Patently, s 214 can be characterised as a regulation that is intended to control corporate activities. The objective of a regulation is to affect the demeanour of someone so as to precipitate a particular outcome.32 In this regard, the wrongful trading provision was introduced in order to require directors to take some action to arrest their companies’ slide into insolvency; the intention is that directors are forced to engage in more rigorous monitoring of their companies’ health, take account of the creditors’ position and not allow the descent of their companies into insolvency to persist without trying to prevent it. Section 214(3) requires directors to take ‘every step with a view to minimising the potential loss to the company’s creditors as (assuming him to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation) he ought to have taken.’ 8.26 The section was designed not to penalise directors for taking a company into a state of insolvency, but to address the situation where directors can see that their company is in difficulty, perhaps insolvent, and they do nothing to protect creditors’ interests. Effectively, it is a stick approach to induce the raising of directorial standards. In more practical terms the purpose of s 214 was to ‘recoup the loss to the company in order to benefit the creditors as a whole.’33 A similar rationale was given for the Australian counterpart of s 21434 by Barrett J in the New South Wales Supreme Court case of Woodgate v Davis,35 when he said: Section 588G and related provisions serve an important social purpose. They are intended to engender in directors of companies experiencing financial stress a proper sense of attentiveness and responsible conduct directed towards the avoidance of any increase in the company’s debt burden. The provisions are based on a concern for the welfare of creditors exposed to the operation of the principle of limited liability at a time when the prospect of that principle resulting in loss to creditors has become real.36

8.27 Wrongful trading is not intended to deal with mismanagement per se. It is also not included to make directors liable where their company is insolvent, but there is ‘light at the end of the tunnel.’37 It provides directors ‘the necessary 32 Karen Yeung, ‘Private Enforcement of Competition Law’ in C McCrudden (ed), Regulation and Deregulation (Clarendon Press, 1999), 40. 33 Re Purpoint Ltd [1991] BCLC 491, 499 per Vinelott J. 34 Corporations Act 2001, s 588G. It is referred to as ‘insolvent trading.’ 35 (2002) 42 ACSR 286. 36 Ibid., 294. 37 BTI 2014 LLC v Sequana S.A [2022] UKSC 25, [174] per Lord Briggs JSC.

95

W RONGFU L TR A DI NG

space to continue running the business if that is appropriate to enable them to pursue the possibilities of a rescue.’38 The provision is designed to address the situation where directors can see that their company is in significant difficulty and they do nothing to protect creditors’ interests. The provision is an attempt not to have creditors compensated through laws proscribing wrongful trading, but to try to ensure that wrongful trading does not occur in the first place so that such compensation is unnecessary. The provision can be seen as an attempt to ‘align the interests of managers of firms [although it is not limited to the managers alone] on the verge of insolvency with the interests of the firm’s creditors.’39 If wrongful trading occurred then it would not only hurt the creditors, but the directors as well. Therefore, it should benefit both creditors and directors if wrongful trading is avoided. 8.28 If s 214 fails to persuade directors to minimise the loss of creditors, then the provision aims to bestow a financial remedy in effect to restore the financial position of the company to what it would have been had wrongful trading not occurred.40 It is arguable whether it does so, given the way that s 214 has been interpreted. Rationale 8.29 Lord Briggs JSC said in BTI 2014 LLC v Sequana S.A.41 that s 214 was a central plank in the statutory scheme of creditor protection, thus it is designed to seek to protect creditors. 8.30 Regulating directors through the use of s 214 was an attempt to stop directors from externalising the cost of their companies’ debts and placing all of the risks of further trading on the creditors. For if a company is heading for insolvent liquidation, the creditors of the company are effectively the ones who have a residual claim (the claim of those whose wealth directly rises or falls with changes in the value of the company)42 over the company’s assets.43 The only people likely to suffer from the company trading on in the same manner would be the creditors. Thus, the directors should be taking actions to minimise the losses of the creditors. The provision covering wrongful trading requires the directors’ allegiance to shift from the shareholders to the creditors (assuming that the directors are to run the company for the benefit of the shareholders

38 Ibid., [321], per Lady Arden JSC. 39 Rizwan Mokal, ‘On Fairness and Efficiency’ (2003) 66 MLR 452, 461. 40 Re Ralls Builders Ltd [2016] EWHC 243 (Ch), [2016] BCC 293, [244]. 41 [2022] UKSC 25, [123]. 42 D Baird, ‘The Initiation Problem in Bankruptcy’ (1991) 11 International Review of Law and Economics 223, 228–229; S Gilson and M Vetsuypens, ‘Creditor Control in Financially Distressed Firms: Empirical Evidence’ (1994) 72 Washington University Law Quarterly 1005, 1006. This seems to be what was being said in Brady v Brady (1988) 3 BCC 535. 43 S Schwarcz, ‘Rethinking a Corporation’s Obligations to Creditors’ (1996) 17 Cardozo Law Review 647, 668.

96

W RONGFU L TR A DI NG

according to the shareholder primacy principle,44 or the enlightened shareholder value approach contained in s 172(1) of the Companies Act 200645 when the company is solvent). 8.31 Many argue that directors can be expected, when their companies are in difficulty, to embrace actions which involve more risk,46 because the shareholders, given the concept of limited liability, have little to lose where their company is in financial distress. If the risk-taking pays off, then the shareholders will see their wealth maximised, but if it does not, then they have lost nothing more; it is the creditors who will bear the cost of further losses. Many would argue that corporate regulations are introduced because of market failure,47 and s 214 might be seen as a response to the fact that market forces have failed to discipline directors and, thereby, prevent creditors losing out. The wrongful trading provision is an attempt to stop directors from abusing the privilege of limited liability by making them liable if they do so.48 The issues raised here are discussed further in Part D in the context of an obligation that directors have to consider creditors’ interests when their company is insolvent or close to it. 8.32 As we will see in the following chapters, while wrongful trading has been with us for more than 35 years, the corpus of reported cases is not large. The reason for this could be legionary. There could have, and probably have, been a lot of demands made by liquidators and administrators against directors and these directors have agreed to meet these demands or come to some compromise. Another explanation is that a lot of proceedings have been issued but a good portion of them have been settled, thereby obviating the need for a trial. However, many believe that the paucity of the number of reported cases is due to the fact that establishing a good claim against directors is difficult and so liquidators and administrators have been put off taking action. Certainly, as 44 This is the prevailing approach in Anglo-American corporate governance, namely that the directors’ primary duty is to the shareholders of their companies. There is a vast literature on the subject. For a discussion, see J Armour, S Deakin, and S Konzelmann, ‘Shareholder Primacy and the Trajectory of UK Corporate Governance’ (2003) 41 British Journal of Industrial Relations 531; Andrew Keay, ‘Shareholder Primacy in Corporate Law: Can It Survive? Should It Survive?’ (2010) 7 European Company and Financial Law Review 369. 45 For example, see Andrew Keay, The Enlightened Shareholder Value Principle and Corporate Governance (Routledge, 2013), Chapter 4; Andrew Keay, ‘Enlightened Shareholder Value, the Reform of the Duties of Company Directors and the Corporate Objective’ [2006] Lloyds Maritime and Commercial Law Quarterly 335; A Alcock, ‘An Accidental Change to Directors’ Duties?’ (2009) 30 Company Lawyer 362; J Yap, ‘Considering the Enlightened Shareholders Value Principle’ (2010) 31 Company Lawyer 36; N Grier, ‘Enlightened Shareholder Value: Did Directors Deliver?’ [2014] Juridical Review 95. 46 B Adler, ‘A Re-Examination of Near-Bankruptcy Investment Incentives’ (1995) 62 University of Chicago Law Review 575, 590–598; R Barondes, ‘Fiduciary Duties of Officers and Directors of Distressed Corporations’ (1998) 7 George Mason Law Review 45, 46 and 49; K Daigle and M Maloney, ‘Residual Claims in Bankruptcy: An Agency Theory Explanation’ (1994) 37 Journal of Law and Economics 157. See Company Law Review Steering Group, Modern Company Law for a Competitive Economy: Final Report, Vol 1 (DTI, 2001), [3.15]. 47 For example, see Ian M Ramsay, ‘Models of Corporate Regulation: The Mandatory/Enabling Debate’ in C Rickett and R Grantham (eds), Corporate Personality in the 20th Century (Hart Publishing, 1998), 219. 48 Cork Report, [1805].

97

W RONGFU L TR A DI NG

we will see in the next chapter, there are complications and difficult hurdles for liquidators and administrators to surmount. 8.33 Another frequently mentioned reason for a lack of case law is the fact that liquidators and administrators have difficulty in funding actions. Wrongful trading actions can be complex and demanding, and this can make them costly. 8.34 Whatever the reason for the small corpus of case law we have, it might be argued that s 214 has not had a great impact on the way that directors operate when their companies are in difficulty. That is a policy issue which, although very important and needing to be considered, is not within the scope of this book. Conclusion 8.35 This chapter has sought to introduce the wrongful trading provisions which enable liquidators and administrators to bring proceedings against directors of a company in insolvency liquidation or administration seeking that they be ordered to make a contribution to the company’s assets. While the wrongful trading provision’s enactment was due to the work of the Cork Report, the provision does not reflect exactly what the report recommended. 8.36 The aim of the provision is to ensure that directors seek to minimise the losses of their company’s creditors when their company is in serious financial trouble and to attempt to prevent directors from externalising the cost of their companies’ debts and placing all of the risks of further trading on the creditors. The provision is, therefore, clearly designed to protect creditors.

98

CHAPTER 9

An Exposition of the Wrongful Trading Provision and Its Scope

Introduction 9.1 This chapter focuses on the contents of the wrongful trading provision, s 214 of the Insolvency Act 1986 (‘the Act’). It provides an analytical exposition of the law that has been decided in relation to the section, and it endeavours to ascertain the scope of the provision. Specifically, the chapter considers who can bring proceedings, who can be sued, the nature of the proceedings, the elements that must be established for liability, what loss must be established and the nature and effect of the orders that can be made. It also briefly considers compensation orders that may be ordered when the Secretary of State for Business Energy and Industrial Strategy obtains a disqualification order against a director who has engaged in wrongful trading. The Applicant 9.2 Until 2015 only liquidators were permitted to institute wrongful trading proceedings. This is still the case as far as s 214 of the Act is concerned, but now administrators are also entitled to bring proceedings. This is permitted by s 246ZB, which is in virtually the same terms as s 214. The Insolvency Law Review Committee in its report, entitled Insolvency Law and Practice (‘the Cork Report’),1 actually advocated that administrators and administrative receivers, as well as liquidators, be given the right to take proceedings.2 It is submitted that giving the right to administrative receivers would be rather redundant in light of the fact that administrative receivership was phased out by the provisions of the Enterprise Act 2002 whereby only floating charges created before 15 September 2002 can be the basis for appointing an administrative receiver. 9.3 While s 246ZB has expanded the number of potential applicants for relief from wrongful trading, other common-law jurisdictions that have a similar provision generally permit a greater range of persons to commence proceedings. In Ireland action can be taken by a receiver, examiner, creditor and a contributory,

1 Cmnd 858, HMSO (1982). 2 Ibid., [1792].

DOI: 10.4324/9780429266232-12

99

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

in addition to a liquidator.3 Creditors and members as well as liquidators are permitted to take action according to both the New Zealand4 and the Singaporean5 provisions. There may be some limit on when proceedings can be brought by some applicants. In Australia creditors are entitled, in certain circumstances, to bring proceedings.6 9.4 In both Ireland and Australia, a government agency is entitled to initiate proceedings against directors for the equivalent of wrongful trading. In Ireland action may be taken by the Director of Corporate Enforcement (an office created by s 7 of the Company Law Enforcement Act 2001), and in Australia action is able to be initiated by the Australian Securities and Investment Commission. 9.5 While creditors are not entitled to bring proceedings in the UK, they are not completely eliminated from the equation as it is submitted that in some circumstances creditors could apply to the courts for a review of the decision of the liquidator if he or she chooses not to proceed with a wrongful trading action. This application could be made pursuant to s 168(5) of the Act for compulsory liquidations, and under s 112 for voluntary liquidations. But, of course, absent those situations where the threat of creditors to seek a court review may cause a liquidator to think again, creditors will have to expend time and money on court proceedings, and it might be thought that it is not worth doing so. Creditors could also seek to get a liquidator to assign his or her right to proceed under s 214, probably for some financial compensation or a slice of any subsequent proceeds from a legal action. While liquidators were not permitted to assign their right to bring proceedings under s 214, at one time, because they were actions given by statute to them personally in their position as liquidator,7 liquidators now may do so.8 Administrators may also do so. If an assignment is effected, then the assignee is entitled to institute proceedings. Claims 9.6 Section 214(8) provides that the section is without prejudice to s 213 (the fraudulent trading provision), so there is nothing to prevent a liquidator, in the appropriate case, from mounting proceedings which claim relief under s 214 and, in the alternative, under s 213. The liquidator in Re Produce Marketing Consortium Ltd 9 commenced his action relying on both ss 213 and 214, and while the s 213 claim was dropped (clearly because the directors were not guilty

3 Companies Act 2014, s 610. 4 Companies Act 1993, s 135. 5 Companies Act 1990, s 340(2). 6 Corporations Act 2001 (Cth), s 588R. 7 Re Oasis Merchandising Services Ltd [1995] BCC 911, affirmed on appeal [1997] 1 All ER 1009, [1997] BCC 282, CA. 8 Insolvency Act 1986, s 246ZD(2)(b). 9 (1989) 5 BCC 569.

100

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

of intending to defraud creditors),10 the judge did not comment adversely on the liquidator bringing proceedings under both sections. 9.7 It is likely that in some situations liquidators may choose to couple a claim under s 214 with other claims, such as a claim under s 212 (misfeasance proceedings), as occurred, for example, in Re Brian D. Pierson (Contractors) Ltd,11 arguing that directors have breached their duties as well as engaging in wrongful trading.12 Claims for breach of duty would now rely on one or more of ss 171–177 of the Companies Act 2006. If a liquidator were to launch proceedings under both ss 214 and 212, the respondent’s liability, if the liquidator succeeded, would be regarded as concurrent,13 except where the conduct leading to liability under each heading was different, and in such a case the court might order cumulative awards.14 The difficulty that might arise where there is a concurrent award is that any award pursuant to s 214 is to be distributed amongst the general body of unsecured creditors, while any award for causes of action brought under a s 212 summons goes to the company,15 as the action for breach of duty is the company’s and not the liquidator’s. This might enable a holder of a floating charge over company property to have priority in payment out of this latter award. The issue of priority in relation to an award under s 214 is discussed later in the chapter under ‘The Order.’ 9.8 Claims under s 214 are regarded as claims for the recovery of sums of money,16 so the limitation period is six years from the date of the accrual of the cause of action,17 and runs from the date when the company entered insolvent liquidation,18 namely either the date of the resolution to wind up for voluntary liquidation or the date of the winding-up order for compulsory liquidation. It is at either of these points when the cause of action accrues, that is when the liquidator is appointed (the action under s 214 being the liquidator’s action and not the company’s). The court in Re Farmizer (Products) Ltd19 rejected the idea that the commencement of the limitation period was the time when it appeared to the liquidator that s 214(2) applied.20 9.9 While the limitation period might seem not to be a problem, a liquidator must be careful to ensure work is done on any possible claims as early as possible. Of course, this often will not be able to be done until there has been significant investigative work completed in relation to the company’s affairs in

10 Ibid., 594. 11 [1999] BCC 26, [2001] BCLC 275. 12 Often liquidators will rely on a breach of the director’s obligation to take into account the interests of creditors when the company was insolvent or close to it. See Part D. 13 Re DKG Contractors Ltd [1990] BCC 903. 14 Re Purpoint Ltd [1991] BCC 121, [1991] BCLC 491. 15 Re Anglo-Austrian Printing & Publishing Co [1985] 2 Ch 891. 16 Re Farmizer (Products) Ltd [1997] BCC 655, 662 (CA). 17 Limitation Act 1980, s 9(1). 18 Re Farmizer (Products) Ltd [1997] BCC 655 (CA). 19 Ibid. 20 Ibid., 661.

101

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

the time before winding up commenced. In any event, unreasonable delay in initiating proceedings by a liquidator could see the proceedings being struck out.21 9.10 It will be recalled that the provision that provides for wrongful trading neither includes the words ‘wrongful trading’ within it (the term was used by the Cork Report) nor sets out the kind of conduct which will constitute wrongful trading.22 This suggests that the section is very wide and can catch all sorts of activity or inactivity which involved directors’ misconduct in the affairs of their companies. However, the kind of conduct which will mean that directors fall foul of the section is restricted by s 214(2). The sub-section provides inter alia that a director will only be liable if he or she knew or ought to have concluded that there was no reasonable prospect of the company avoiding going into insolvent liquidation. 9.11 Stephen Griffin has said that the type of conduct caught by s 214 includes the paying of over-generous dividends, selling company assets at an undervalue and the payment of excessive remuneration to directors, as well as the incurring of liabilities when the directors knew or ought to have known that the company was likely not to be able to satisfy those liabilities and existing liabilities.23 As the word ‘trading’ is not expressly mentioned in s 214, there is no reason why activity short of actual trading cannot be the subject of an action, such as selling assets with a view to winding up the company or failing to collect debts owed. 9.12 A claim pursuant to s 214 may be continued against a director’s estate in the event of his or her death as there was reason, according to the court in Re Sherborne Associates Ltd,24 to suppose that Parliament had intended that such a claim should not be defeated by death, but in Re Sherborne Associates Ltd25 the judge issued the caveat that if the director had lived, he or she might have been able to provide a credible explanation for what had been done or not been done, and consequently a judge should have in mind the fact that the director might have been able to rebut the liquidator’s claims had he or she lived.26 Does this, therefore, mean that a claim against the estate would not be permitted in some cases? 9.13 One practical issue that is worth raising is that it might be worthwhile for liquidators, assuming that they have not sought a private examination of the directors under s 236 of the Act, to seek to arrange, before initiation of proceedings, a conference with the directors against whom they are contemplating making a claim. This would enable the liquidators and their advisers to assess the directors. Park J made the point in Re Continental Assurance Co of London plc27 that if the liquidators had seen the directors they would 21 Ibid. 22 See the criticism of the fact that the section does not set out what activity is proscribed in Louis Doyle, ‘Anomalies in the Wrongful Trading Provisions’ (1992) 13 Company Lawyer 96. 23 Personal Liability and Disqualification of Company Directors (Hart Publishing, 1999), 64. 24 [1995] BCC 40, 46. 25 Ibid. 26 Ibid., 47. 27 [2001] BPIR 733.

102

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

have discovered that the directors were not irresponsible or roguish, and that might have affected their decision to take proceedings.28 Another way forward might be to apply to examine the directors under s 236, but that can be costly and could not be recommended, except where a claim is likely to be very high, if the sole reason for examination is to assess the nature of the likely respondents. Certainly, an examination should not be initiated until the liquidators find that the directors are not willing to cooperate in answering questions and addressing requests for information, as they are obliged to do under s 235. Liquidators also have to think seriously before issuing proceedings against a number of respondents. In Re Continental Assurance the trial lasted for 72 days, and much of this was due to the fact that the applicants’ case had to be put to all of the respondents and each of the respondents had to be cross-examined thoroughly.29 9.14 Although there are no guidelines on how liquidators should act prior to initiating proceedings, Park J in Re Continental Assurance was clearly unimpressed with the way that the liquidators and their solicitors had conducted themselves. For instance, proceedings were commenced just before the elapse of the limitation period and the liquidators’ solicitors had not been in contact with the directors for in excess of five years before issuing process. Furthermore, the solicitors did not acknowledge the fact that the directors had answered, in some detail, the allegations of the liquidators quite early in the liquidation process. As Professor Adrian Walters has said: The message seems to be that although insolvency litigation is not the subject of a pre-action protocol, the liquidator and his legal team will be expected to conduct the pre-action phase of wrongful trading proceedings in accordance with the spirit of the Civil Procedure Rules.30

9.15 In assessing whether to bring proceedings a liquidator would do well to consider the following issues:31 • How strong is the evidence against the directors? Case law such as Re Continental Assurance has made it clear that judges are not going to be impressed unless the evidence demonstrates some degree of irresponsibility. • Is the loss due to wrongful trading worth chasing? • Are directors clearly culpable? • Are the directors people of some substance, or are they likely to be impecunious? • How do the largest creditors view proceedings? Are they supportive?

28 Ibid., 764. 29 Ibid., 765. 30 ‘Wrongful Trading: Two Recent Cases’ [2001] Insolvency Lawyer 211, 214. 31 These are based on those stated in Roy Goode, Principles of Corporate Insolvency Law (2nd ed, Sweet and Maxwell, 1997), 477.

103

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

9.16 The burden of making out a case is, as one would expect, on the liquidator.32 If the liquidator is able to establish that there was no reasonable prospect of avoiding insolvent liquidation, then the burden of proof is transferred to the director, who must make out a defence pursuant to s 214(3), a matter discussed in Chapter 10. 9.17 An application under s 214 may be consolidated with disqualification proceedings.33 9.18 At one time liquidators were required by the Act, before taking action, to secure approval from either the liquidation committee or the court. Now approval is not required, although it might be prudent for a liquidator to bring consideration of a prospective action before the liquidation committee, if there is one, and before the creditors if there is not one, and this is especially where the chances are estimated to be marginal and/or the costs are likely to be high. 9.19 Unlike with many actions that can be initiated by a liquidator, there is no limit on the time when the wrongful trading took place, although in most cases it will be the period immediately before the commencement of winding up. 9.20 Proceedings that are brought under s 214 and s 246ZB are covered by Part 12 of the Insolvency Rules 2016. Liquidators and administrators who decide to commence proceedings against directors would ordinarily complete and file a Form 1AA with supporting witness statements. 9.21 On the filing of an initiating form the court will fix a return date and this will usually involve a short appointment, at which the court will give directions either as to witness statement evidence in response and any further witness statements to be filed on behalf of the applicant (if so advised) in reply or, in a more complex case where pleadings are appropriate (where the applicant will often have provided draft points of claim), an order that the draft points of claim stand as points of claim followed by points of defence and points of reply.34 The matter will usually then come back to court for a further case management to deal with disclosure, inspection, evidence and trial arrangements. 9.22 According to s 215(1), the liquidator may give evidence at the hearing of an application. 9.23 A final point to note is that a liquidator (or an administrator) may consider instituting proceedings against directors for wrongful trading and for a breach of their obligation to consider the interests of creditors, as provided for by s 172(3) of the Companies Act 2006. The relationship between these two actions is discussed in Chapter 16.35

32 33 34 35

Re Sherborne Associates Ltd [1995] BCC 40. Official Receiver v Doshi [2001] 2 BCLC 235. Often the parties will have previously agreed directions. See [16.18]–[16.24].

104

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

The Elements Required for Liability Insolvent Liquidation 9.24 The first point to note is that the company must have entered insolvent liquidation.36 This is something that the liquidator must establish.37 According to s 214(6) insolvent liquidation means that the company, at the time of winding up, was in a position where its debts and liabilities together with the expenses of winding up exceeded its assets.38 Therefore, a balance sheet test is employed rather than a cash flow test.39 Perhaps we can say that it applies a mechanistic balance sheet test which has been subject to some criticism by the recent case law.40 While the majority of liquidations do involve insolvent companies, if a company was not insolvent within the meaning of s 214(6) no proceedings can be brought. 9.25 As balance sheet insolvency is the test, in determining whether the assets are outweighed by the liabilities a court is able to take into account contingent and prospective liabilities, although the Supreme Court in BNY Corporate Trustee Services Ltd v Eurosail-UK 2007–3BL Plc41 said that they should be discounted.42 And this, together with the fact that contingent and prospective assets are not taken into account,43 potentially makes things easier for a liquidator in establishing insolvency. Only the assets owned by the company at the time at which the company entered liquidation are able to be taken into account; this will include the uncalled capital of the company44 but not assets which are expected to be received or funds out on loan.45 ‘Liabilities’ is broader than ‘debts’46 and is defined for the purposes of winding up in r 14.1(6) of the Insolvency Rules 2016 to mean: a liability to pay money or money’s worth, including any liability under an enactment, any liability for breach of trust, any liability in contract, tort or bailment, and any liability arising out of an obligation to make restitution.

36 Section 214(2)(a). If proceedings are brought by administrators under s 246ZB then the administrators must establish that the company entered insolvent administration (s 246ZB(2)(a)). 37 Re Idessa (UK) Ltd [2011] EWHC 804 (Ch), [2012] BCC 315, [113]. 38 This is the same test used for determining insolvent administration in s 246ZB proceedings: s 246ZB(6)(a). 39 For a discussion of these tests, see Kristin van Zwieten (ed), Goode’s Principles of Corporate Insolvency Law (5th ed, Sweet & Maxwell, 2019), 136–179, Andrew Keay, McPherson and Keay’s Law of Company Liquidation (5th ed, Sweet and Maxwell, 2021), [3–025]–[3–039]. 40 The leading case on balance sheet insolvency is the decision of the Supreme Court in BNY Corporate Trustee Services Ltd v Eurosail-UK 2007–3BL Plc [2013] UKSC 28, [2013] 1 WLR 1408, [2013] 3 All ER 271, [2013] BCC 397, [2013] 1 BCLC 613. 41 Ibid. 42 Ibid., [137]. 43 Byblos Bank SAL v Al-Khudhairy (1986) 2 BCC 99,549, CA. 44 Re National Livestock Insurance Co (1858) 26 Beav 153, 53 ER 855. 45 Byblos Bank SAL v Al-Khudairy (1986) 2 BCC 99,549, 99,562–99,563. 46 Re A Debtor (No.17 of 1966) [1967] Ch 590, [1967] 1 All ER 668.

105

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

9.26 According to r 14.1(5), it is immaterial whether the liability is present or future, whether it is certain or contingent, or whether its amount is fixed or liquidated, or is capable of being ascertained by fixed rules or as a matter of opinion. 9.27 Assets, in determining insolvency in this context, are valued, as one would expect, on a break-up basis.47 Directors 9.28 Besides the fact that the company must be in insolvent liquidation the two primary elements for liability of a person are that: (1) At some time prior to the commencement of winding up the person knew or ought to have concluded that there was no reasonable prospect of the company avoiding going into insolvent liquidation; and (2) he or she was at that time a director of the company. These are factors that the liquidator must establish.48 9.29 We will deal with the second point first. Unlike fraudulent trading, which may apply to a broad range of persons, s 214 only applies to directors. It is interesting to note that some jurisdictions are broader than the UK section in that they impose liability on an officer of the company, and not just directors. For instance, the equivalent Singaporean legislation49 provides that any person involved with the company may be liable if that person knew that the company was trading wrongfully, and any officer can be liable if he or she ought to have known that the company was trading wrongfully. In this context ‘officer’ will include a director, a secretary, receiver and manager or a liquidator in a voluntary liquidation, although a director must be an executive director. The Cork Committee had advocated any person that was party to the carrying on of the company’s business when it was wrongful could be held liable if he or she knew or ought to have known that the trading was wrongful,50 but this was one of a number of recommendations not taken up by the Government. 9.30 It must be noted at this point that the focus of s 214 is on individual directors and their conduct, not on the joint conduct of a board of directors as a whole.51 If an application is made against more than one respondent, then, according to Park J in Re Continental Assurance Co of London plc,52 the starting point should not be one of joint and several liability. The reason for his Lordship’s opinion was that s 214: concentrates individually on each director who is a respondent to an application by a liquidator. . . . [T]he initial duty of the court where it finds that liability exists on the part of two or more respondents is to determine in the case of each respondent how much he individually ought to contribute.53

47 Paton, as liquidator of Ricky Martin (Racing) Limited v Kelly Martin, Elizabeth Martin, Richard John Martin [2016] SC AIR 57, [56]. 48 Re Idessa (UK) Ltd [2011] EWHC 804 (Ch), [2012] BCC 315, [113]. 49 Insolvency, Restructuring and Dissolution Act 2018, s 239. 50 Cork Report, [1787]. 51 Re Continental Assurance Co of London plc [2001] BPIR 733, 846. 52 Ibid. 53 Ibid., 846–847.

106

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

9.31 If it is found that liability exists on the part of two or more directors, the court is to determine in the case of each respondent how much each individual ought to contribute.54 9.32 ‘Director’ is defined in s 214(7) to include a shadow director. Persons who give advice in a professional capacity or business relationship are not, according to s 251, included within the definition of ‘shadow director,’ even though the directors may act on his or her advice. Notwithstanding this exclusion of professionals, investigating accountants put into a company by influential creditors, and accountants involved in an informal corporate rescue, must be especially careful that they are not seen as running the company and, therefore, being regarded as shadow directors. Such persons must be seen as advising the board and permitting it to make its own independent decision after assessing their advice. It has been held that companies can be regarded as shadow directors for the purposes of s 214.55 9.33 There is authority for the proposition that liability may extend to de facto directors as well as de jure directors.56 As Millett J stated in Re Hydrodan (Corby) Ltd:57 Liability cannot sensibly depend on the validity of the defendant’s appointment. Those who assume to act as directors and who thereby exercise the powers and discharge the functions of a director, whether validly appointed or not, must accept the responsibilities which are attached to the office.58

9.34 A claim may be initiated against foreign directors of a foreign company being wound up in England or Wales, but in assessing the claims courts must have regard for the relevant foreign law under which the directors were acting and the obligations imposed on directors as far as minimising losses to the company’s creditors under that law.59 Where the foreign law does not impose obligations that are similar to s 214, the English court will decide that it is not appropriate to make an order under s 214.60 However, Chadwick J (as he then was) did go on to say in Re Howard Holdings Inc.61 that he found it difficult: to envisage any developed system of corporate law which does not impose some obligations on those charged with responsibility off [sic] the management of a company’s affairs to pay regard to the question whether or not it is, from time to time, solvent and, if insolvent, to consider what should be done about it.62 54 Ibid, 847. 55 Re a Company No 005009 of 1987 (1988) 4 BCC 424. It was held in Re International Championship Management Ltd [2006] EWHC 768 (Ch) that an insolvency practitioner who advised directors before their company entered liquidation could not be under a common liability with the directors in relation to proceedings brought against the directors. 56 Re Hydrodan (Corby) Ltd [1994] BCC 161, 162; Biscoe v Milner [2021] EWHC 763 (Ch). 57 Ibid. 58 Ibid. 59 Re Howard Holdings Inc. [1998] BCC 549, 552; Stocznia Gdanska SA v Latreefers Inc (No2) [2001] 2 BCLC 116, 142 (CA). 60 Re Howard Holdings Inc. [1998] BCC 549, 554. 61 Ibid. 62 Ibid., 555.

107

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

Knowledge 9.35 The primary condition for wrongful trading, found in s 214(2)(b), is that at some time prior to the commencement of winding up the person knew or ought to have concluded that there was no reasonable prospect of the company avoiding going into insolvent liquidation. Thus, a liquidator may argue that this condition is fulfilled if a director had either actual or deemed knowledge that insolvent liquidation was likely to occur. 9.36 Section 214 has ditched the concept of dishonesty that proved so troublesome in relation to claims for fraudulent trading, and has introduced an objective standard, along with a subjective test, such that s 214(4) includes both objective and subjective tests. The sub-section sets out the approach that a court must take in assessing a claim and provides that the facts that a director ought to know or ascertain, the conclusions which ought to be reached and the steps which the director ought to take are those that a reasonably diligent person would take or have taken. Thus, the objective element of the provision is marked by the reference to the reasonably diligent person. This concept is used to refer to one who has the general knowledge, skill and experience that may reasonably be expected of a person who carries out the same functions as are carried out by the respondent director, and in addition, that person has the general knowledge, skill and experience that the respondent director possesses. 9.37 The subjective element introduces the general knowledge, skill and experience of the director, namely something that is specific to the respondent director. But this does not serve to reduce the standard of knowing or ascertaining; rather, it heightens it if the director is experienced. Therefore, if a director is not very experienced or has qualities that do not match that of the reasonable person, he or she is not able to take advantage of that fact and be protected from liability; ignorance is not an excuse.63 Directors are not able to excuse themselves from liability by arguing that they left all management functions to others without question; there are minimum responsibilities that must be met, and there is no such thing as exonerating a ‘sleeping director.’64 All directors have responsibility, and there is no place for a defence of passivity, as there once was. 9.38 It should be noted that if a director is involved in what the Cork Committee called, ‘wilful blindness,’65 and what has been referred to in the fraudulent trading cases as ‘blind eye knowledge,’66 that is resolutely shutting one’s eyes to the obvious or refraining from asking obvious questions in case he or she discovers the truth, the director will be regarded as having the requisite knowledge. 9.39 If a person is designated as the ‘sales director,’ ‘marketing director’ or ‘finance director’ then special skills must be expected of that person.67 This 63 Re Brian D. Pierson (Contractors) Ltd [1999] BCC 26, 55, [2001] BCLC 275, 309. 64 Ibid. 65 Cork Report, [1788]. 66 For example, see Bank of India v Morris [2005] EWCA (Civ) 693, [2005] 2 BCLC 328, [2005] BPIR 1067. 67 Re Brian D. Pierson (Contractors) Ltd [1999] BCC 26, 55, [2001] BCLC 275, 309.

108

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

follows, in any event, from s 214(5), which provides that the reference to functions carried out by directors in s 214(4) includes functions that were entrusted to them but which they failed to fulfil. 9.40 All of this means that a director will be judged by two tests and the director has to attain the higher of the standards set by the tests. Therefore, if a director were to meet the standard of a reasonable person carrying out his or her functions in relation to the company, but a court took the view that the director did not act in such a way as one would expect with someone with his or her knowledge, skill and experience (an experienced and well-qualified director, for example), the director could be held liable under s 214; that is, the director would meet the objective standard but not the subjective. In the reverse situation, where a director does act consistently with his or her knowledge, skill and experience (perhaps a poorly qualified director with little experience), but the director cannot be said to have acted in line with how the reasonable person would have acted, the director again will be liable, not being able to hide behind a lack of expertise. The director may well fulfil the subjective test, but not the objective. He or she must fulfil both tests to avoid liability. This prevents highly experienced directors extricating themselves from liability where they might act as reasonable directors but fail to live up to the standard that one would expect of such directors with their experience. Likewise, the tests mean that very inexperienced directors are not able to duck liability merely because they did what persons of their (lack of) experience would have done, if their conduct falls below that expected of a reasonable director. For instance, in Re DKG Contractors Ltd68 one of the directors said that he did not know about companies and had no idea what was involved in being a director. But this did not save him.69 9.41 If a director had experience in a different field from what the company was engaged in doing, then it is likely that he or she would not be expected to have greater knowledge than that of a reasonable director.70 9.42 Obviously, the concern of the legislature is that neither inexperienced nor incompetent directors are to be protected because of the mere fact that they are inexperienced or incompetent, and those who are experienced are not able to say that while they did not live up to their standards, they did what the reasonable person would have done. In New Zealand, in Re Global Print Strategies Ltd71 the court emphasised the fact that there ‘must be some element of subjectivity in determining whether what a director has failed to do constitutes reckless trading [equivalent to wrongful trading]’ as well as an objective element.72 The New Zealand court also indicated that higher standards would be expected of professional directors.

68 69 70 71 72

[1990] BCC 903. Ibid., 912. Brooks v Armstrong [2015] EWHC 2289 (Ch), [2015] BCC 661, [2016] BPIR 272, [173]. unreported, High Court, 24 November 2004, Salmon J. Ibid., [39].

109

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

9.43 Although not saying this exactly, in Re Sherborne Associates Ltd73 the judge did indicate that two of the directors against whom proceedings had been brought, being non-executives, were entitled to rely on the third director who was sued, a highly experienced chairman, because he had greater involvement with the company and the accounts.74 The judge went on to accept that where a director relies on another director, the latter’s views or conclusions are matters to be taken into account in making the assessment required by s 214(4). However, it must be added that the courts are not ready to absolve directors merely because they left everything to other directors, as the courts have indicated, as noted earlier, that there is no room for passive directors who abdicate their responsibilities. It will very much depend on the facts as to whether reliance on another director will absolve a director from liability. 9.44 The objective test laid down in s 214(4) was something new as far as directors and their duties were concerned. The following aptly summarises the position as far as the objective test is concerned: The court is thus required to arrive at a conclusion as to the appropriate conduct and acumen of a hypothetical person assuming him to have possessed in combination the levels of general knowledge, skill and experience which the director in question subjectively did possess and which objectively he ought to have possessed in view of the position held.75

9.45 It is likely that liquidators will rely more often on establishing that the directors ought to have concluded that the company was heading for insolvent liquidation, as was the liquidators’ submission in Re Continental Assurance Co of London plc,76 rather than proving that the directors actually knew that that was the company’s fate, the latter being, obviously, more difficult to establish. Indeed, this is borne out by the fact that Snowden J (as he then was) in Re Ralls Builders Ltd77 was of the opinion that whether the directors ought to have concluded that the company was heading for insolvent liquidation was the real issue in a wrongful trading case.78 9.46 It needs to be emphasised that the liquidator is not required to prove that a director participated in irresponsible conduct. All that he or she has to do is to establish that the director knew or ought to have concluded that there was no reasonable prospect of the company not going into insolvent liquidation. Of course, a director’s actions or inactions in light of the knowledge or deemed knowledge might constitute irresponsibility.

73 74 75 76 77 78

[1995] BCC 40. Ibid., [55]. P Davies et al. (eds), Palmer’s Corporate Insolvency Law (Vol 1, Sweet and Maxwell), 1256. Re Continental Assurance Co of London plc [2001] BPIR 733, 766. [2016] EWHC 243 (Ch), [2016] BCC 293. Ibid., [191].

110

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

9.47 The mere fact that the directors might expect that continued trading might be profitable for the company does not mean that the directors ought not to have concluded that the company could avoid insolvent liquidation.79 9.48 In bringing proceedings a liquidator must specify a date from which he or she maintains the director should have realised that insolvent liquidation was inevitable.80 The word ‘inevitable’ has been used in several cases as shorthand for the statutory language of ‘no reasonable prospect of avoiding’ for something which the company had no reasonable prospect of avoiding.81 9.49 The key issue is clearly: at what time did the director know or should have concluded that there was no reasonable prospect of the company avoiding insolvent liquidation? The point of time when liability fixes has been referred to as ‘the moment of truth.’82 Professor Harry Rajak explains this as the point ‘when the reasonably diligent person would have said, “Oh dear (or words to that effect), while yesterday I thought that we could pull through, today I see that that is highly unlikely.’83 Professor Sir Roy Goode stated that this is the time, ‘when the writing is on the wall.’84 9.50 Importantly the case law suggests that directors will generally be allowed time to investigate what to do when they know or ought to have known that there is no reasonable prospect of avoiding insolvent liquidation rather than to be criticised for acting too quickly.85 9.51 The fact that directors might be able to get a bank to extend more credit should not be seen as a ‘green light’ and an indication that everything is all right, for as Cooke and Hicks have stated: ‘it is far easier to persuade a bank to support trading than it may be to persuade a court that there was a reasonable prospect of avoiding insolvent liquidation.’86 In Re Produce Marketing Consortium87 the judge did not regard the fact that the company’s bank had continued to make finance available as relevant to his decision, although that was primarily due, probably, to the fact that the bank was not made aware of the company’s financial problems. 9.52 In some situations, the likely provision of funds might be sufficient for directors to have confidence that insolvent liquidation can be avoided, but circumstances might be such, as they were in Rubin v Gunner,88 where eventually the respondent director’s reliance on that becomes inappropriate. 79 Ibid., [186]. 80 Ibid. 81 See, Re Ralls Builders Ltd ([2016] EWHC 243 (Ch), [2016] BCC 293), and at first instance in Johnson v Arden ([2018] EWHC 1624 (Ch), [2019] 2 BCLC 215, [2019] BPIR 901) and approved of on appeal in Johnson v Beighton ([2019] EWHC 895 (Ch), (2019) BCC 979). 82 H Boschma and L Lennarts, ‘Wrongful Trading in a Comparative Perspective’ in J Wouters and H Schneider (eds), Current Issues of Cross-Border Establishment of Companies in the European Union (Maklu, 1995), 205. 83 ‘Wrongful Trading’ (1989) New Law Journal 1458, 1459. 84 Roy Goode, Principles of Corporate Insolvency Law (2nd ed, Sweet and Maxwell, 1997), 204. 85 For example, see Brooks v Armstrong [2016] EWHC 2893 (Ch), [2017] BCC 99, [40]. 86 ‘Wrongful Trading – Predicting Insolvency’ [1993] JBL 338, 340. 87 (1989) 5 BCC 569. 88 [2004] EWHC 316 (Ch), [2004] BCC 684, [2004] 2 BCLC 110.

111

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

9.53 Clearly, a director is not going to be able to rely solely on a feeling that things would get better. In Roberts v Frohlich89 Norris J was critical of the fact that the directors proceeded to trade on with wilful blind optimism.90 Directors cannot work solely on the basis that they hope that ‘something might turn up.’91 The directors in Re Brian D. Pierson (Contractors) Ltd92 seemed to have adopted a similar stance and continuing business as usual.93 According to the judgment in that case, the male director who was the real force behind the company had given no proper thought to whether that was a realistic possibility in all of the circumstances of avoiding insolvent liquidation.94 9.54 Directors would have to be able to point to something that indicated, to the reasonable person in their position that the company’s state would either improve, or at least not deteriorate. Of course, a court might well feel that the views of directors are not reasonable. For instance, in Rubin v Gunner95 the judge described the notion that the company, later to be liquidated, would receive sufficient funds to bail it out of its problems from the flotation of a new company in a very short period of time as ‘fantastic.’96 In Re Ralls Builders Ltd97 Snowden J talked about the fact that ‘at no relevant time was there any realistic basis for concluding that the company could, by trading alone, eliminate the huge hole of about £1.4 million in its balance sheet,’98 which meant that there was no reasonable prospect of the company avoiding insolvent liquidation. 9.55 Notwithstanding the fact that s 214(4) provides that directors can be liable if they ought to have known that the company was destined for insolvent liquidation, there are suggestions that some courts have been more concerned with the belief actually held by the directors. For instance, in Re Continental Assurance Co of London plc99 Park J said, in considering the fact that the figures of the company presented at a board meeting were worrying, he was of the opinion that the directors were not expecting figures which showed a bad financial situation, and this fact appears to have been weighted by his Lordship in the favour of the directors. This was notwithstanding expert evidence from one of the liquidator’s witnesses that indicated that the figures suggested a worse financial position,100 and the fact that the directors did not expect it might suggest that they were not on top of things.

89 [2011] EWHC (Ch) 257, [2012] BCC 407, [6], [110]. 90 Ibid., [112]. 91 Ibid. 92 Re Brian D. Pierson (Contractors) Ltd [1999] BCC 26, [2001] BCLC 275. 93 Ibid., 54; 308. 94 Ibid. 95 Ibid. 96 Ibid. 97 [2016] EWHC 243 (Ch), [2016] BCC 293. 98 Ibid., [187]. 99 [2001] BPIR 733. 100 Ibid., 753.

112

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

9.56 In Roberts v Frohlich101 Norris J was of the opinion that the following meant that the directors ought to have concluded that their company could not avoid insolvent liquidation: the company was both balance sheet and cash flow insolvent; there were significant immediate liabilities and further contingent liabilities in respect of work done but not certified; the company’s bank was adopting a highly restrictive approach to funding; there was no hope of a fixed price or capped contract being offered by the firm that was doing critical work for the company; a deal with a third party that would have seen the infusion of funding had collapsed; attempts to interest a co-venturer to become involved had collapsed.102 9.57 In Re Idessa (UK) Ltd103 Lesley Anderson QC (sitting as a deputy High Court judge) felt that the fact that external investment had dried up was a significant factor in finding the directors liable for wrongful trading.104 9.58 In determining whether a director knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation, courts are not restricted to a consideration of the material available to the director during the period of the alleged wrongful trading; reference may be had to material that was able to be accessed by a person exercising reasonable diligence and an appropriate level of general knowledge.105 Also, in determining whether the directors ought to have concluded that there was no reasonable prospect of the company avoiding insolvent liquidation, it is not dependent ‘on a snapshot’ of the company’s financial position at any given time; it depends on rational expectations of what the future might hold. But directors are not clairvoyants, and the fact that they fail to see what eventually comes to pass does not mean, necessarily, that they are guilty of wrongful trading.106 Indeed, it is in cases where the directors have been held to have had no rational basis for believing that the event that they hoped would provide a way out for the company would come about, where they have been held liable.107 Deputy Registrar Prentis (as he then was) said in Re Main Realisations Limited108 that: ‘The most effective way of ascertaining the rationality of a director’s averred belief may be to test it against what inured.’109 As mentioned, in Re Ralls Builders Ltd110 Snowden J referred to what was realistic in considering whether the company could extricate itself from its financial malaise.111

101 [2011] EWHC (Ch) 257, [2012] BCC 407, [6], [110]. 102 Ibid., [111]. 103 [2011] EWHC 804 (Ch), [2012] BCC 315. 104 Ibid., [119]. 105 Re Produce Marketing Consortium Ltd (1989) 5 BCC 569, 595. 106 Re Hawkes Hill Publishing Co Ltd (in liq) [2007] BCC 937, [2007] BPIR 1305, [41]. 107 For example, see Re Kudos Business Solutions Ltd (in liq) [2011] EWHC 1436 (Ch), [2012] 2 BCLC 65, [61]; Re Ralls Builders Ltd [2016] EWHC 243 (Ch), [2016] BCC 293, [174], [216]; Re Bright Future Software Ltd [2020] EWHC 1674 (Ch), [2021] 2 BCLC 536, [324]. 108 [2017] EWHC 3878 (Ch). 109 Ibid., [40]. 110 [2016] EWHC 243 (Ch). 111 Ibid., [187].

113

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

9.59 Courts might well decide not to find that a director knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation notwithstanding the existence of factors that might seem to point to liability. The decision in Re Continental Assurance Co of London plc might be seen as a prime example. Another is Re Hawkes Hill Publishing Co Ltd (in liq).112 In this latter case a private company was established with a capital of £100 and D and P as directors (the latter being a de facto director). The company was incorporated to conduct the business of publishing a free bi-monthly golfing magazine, and profitability would depend on the level of advertising revenue that it could generate. D and P expected the company to make a loss at first but hoped that when the magazine was established and had a track record it would achieve profitability. As the magazine was bi-monthly with advertising revenues not arriving for some time after publication but production costs had to be paid up front, the company soon experienced cash-flow difficulties. To assist cash flow D and P arranged for the company to enter into factoring arrangements, but after a while these had to be ended. Lewison J (as he then was) formed the opinion that the following did not lead to the conclusion that the directors ought to have concluded that the company would not be able to avoid insolvent liquidation: • The company never made a profit during its short life; • P and D had been compelled to make loans to the company in order to keep it going; • Following the termination of the factoring agreement the company’s financial position was uncertain; • The company’s sales team was ineffective and not cost efficient; • It was proving difficult to persuade golf clubs to take up advertising in the magazine; • The company could not afford to pay P any wages; and • The directors did not keep as full financial records as they could have done.113 9.60 The range of things that might be relevant in determining whether directors had the required knowledge for liability is broad. This is evident in several cases, with the matters that the court took into account in Brooks v Armstrong114 being a good example. In that case it was relevant that the directors adopted a policy of discrimination as to who got paid.115 9.61 If a liquidator can establish the fact that directors knew or ought to have known that there was no reasonable prospect of the company avoiding insolvent liquidation, the directors’ liability will be based on the losses incurred by the company after this time.

112 [2007] BCC 937, [2007] BPIR 1305. 113 Ibid., [43]. 114 [2015] EWHC 2289 (Ch), [2015] BCC 661. 115 Ibid., [303]. This was also something that concerned Snowden J in Re Ralls Builders Ltd [2016] EWHC 243 (Ch), [2016] BCC 293.

114

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

9.62 It is interesting that it has been asserted that even though s 214 enables a liquidator to establish deemed knowledge that there was no reasonable prospect of avoiding insolvent liquidation and that a director failed to meet an objective test, it has been said that practitioners have found that in practice a wrongful trading action is almost as difficult to prove as fraud.116 9.63 It is not possible to catalogue the circumstances that might lead a court to say that the directors knew or ought to have concluded that the company had no reasonable prospect of avoiding insolvent liquidation. The cases are of limited assistance. The loss of a major customer or contract on the one hand or the withdrawal of credit by a primary supplier, as was the case in Re DKG Contractors Ltd,117 on the other, might suffice. Directors are not able to rely merely on a speculative hope that it all might work out in the end;118 there must be a rational expectation.119 In Re Kudos Business Solutions Ltd120 where the company had entered into contracts which the director knew, or ought to have known, it was not capable of fulfilling, the director was held to be engaging in wrongful trading. Directors must be able to refer to some good reason for any hope that they had that the company would be able to overcome any parlous position in which the company found itself.121 No Reasonable Prospect of Avoiding Insolvent Liquidation 9.64 The phrase ‘reasonable prospect’ is clearly elusive.122 It is difficult for directors, in many situations, leaving aside those cases where their company is clearly hopelessly insolvent and cannot possibly recover, or the slide into insolvency appears to be inexorable, to gaze into the future and determine whether insolvent liquidation is to be the company’s lot. Much is likely to turn on what the directors are doing, what are the company’s prospects as far as its business goes, what is the general commercial milieu as far as it affects the company and its business, and whether funds are likely to be received in the short term. Certainly, temporary cash-flow problems should not be seen as meaning, necessarily, that the company is heading for insolvent liquidation,123 but obviously continual problems in this regard must be seen as a warning sign. 9.65 It has been suggested by one commentator that ‘the question whether directors ought reasonably to conclude that their company has no reasonable prospect of avoiding insolvent liquidation so as to avoid liability . . . can only be answered by identifying the cause of the particular insolvency.’124 This is an 116 A McGee and C Williams, A Company Director’s Liability for Wrongful Trading (Certified Accountants Educational Trust, 1992), 10. 117 [1990] BCC 903. 118 Re Kudos Business Solutions Ltd (in liq) [2011] EWHC 1436 (Ch), [2012] 2 BCLC 65, [59]. 119 Ibid., [61]. 120 Ibid. 121 Ibid., [59], [61]. 122 Fidelis Oditah, ‘Wrongful Trading’ [1990] LMCLQ 205, 208. 123 Ibid. 124 Ibid., 210.

115

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

adroit comment, although the company does not necessarily have to be insolvent at the point when wrongful trading actually commences, but clearly one would expect the company would not be far from it if the liquidator is to succeed. On this point, it has been made clear that liability is not imposed on the directors necessarily where they knew or ought to have known that the company was insolvent;125 it is only where the directors knew or ought to have concluded that the company could not avoid entering insolvent liquidation that they can be liable.126 Chadwick J had this to say in Re C S Holidays Ltd; Secretary of State for Trade and Industry v Gash:127 The companies legislation does not impose on directors a statutory duty to ensure that their company does not trade while insolvent; nor does that legislation impose an obligation to ensure that the company does not trade at a loss. Those propositions need only to be stated to be recognised as self-evident. Directors may properly take the view that it is in the interests of the company and of its creditors that, although insolvent, the company should continue to trade out of its difficulties. They may properly take the view that it is in the interests of the company and its creditors that some loss-making trade should be accepted in anticipation of future profitability. They are not to be criticised if they give effect to such view.128

9.66 Having said this, if a company is hopelessly insolvent at the point from which a company is alleged to be engaging in wrongful trading, then that is likely to lead a court to find that the directors are liable.129 9.67 In line with the earlier reasoning, the liquidator does not have to prove solvency or insolvency at the date on which he or she submits the director had the knowledge which s 214 requires.130 The Point of Liability 9.68 The liquidator will need to decide on a point of time from which it is alleged the director knew or ought to have concluded that there was no reasonable prospect of the company avoiding going into insolvent liquidation, for s 214(2) (b) specifies that ‘at some time’ before the commencement of the winding up the respondent must have known or ought to have known that insolvent liquidation could not be avoided. Liquidators will have to weigh up a number of factors in determining from which time they allege wrongful trading commenced.131

125 Re Hawkes Hill Publishing Co Ltd (in liq) [2007] BCC 937, [2007] BPIR 1305, [28]; Re Ralls Builders Ltd [2016] EWHC 243 (Ch), [2016] BCC 293, [168], Re Bright Future Software Ltd [2020] EWHC 1674 (Ch), [2021] 2 BCLC 536, [318]. 126 Re Hawkes Hill Publishing Co Ltd (in liq) [2007] BCC 937, [2007] BPIR 1305, [28]. 127 [1997] BCC 172, [1997] 1 WLR 407. 128 Ibid., 178, 414. 129 See, Re Bangla Television Ltd (in liq.) [2009] EWHC 1632, [2010] BCC 143, [51]. 130 Brooks v Armstrong [2015] EWHC 2289 (Ch), [2015] BCC 661, [180]. 131 In this regard, see A Hicks, ‘Advising on Wrongful Trading: Part 1’ (1993) 14 Company Lawyer 16, 17.

116

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

On many occasions, it is submitted that identifying the point might well be a difficult task.132 9.69 In much of the literature133 it has been assumed that a liquidator will need to decide on an exact point of time at which it is alleged the director knew or ought to have concluded that there was no reasonable prospect of the company avoiding going into insolvent liquidation and the liquidator must stick to that date. 9.70 It has been held in Re Sherborne Associates Ltd134 and Re Continental Assurance Co of London plc135 that a liquidator is not entitled, where the case presented is not made out in relation to the dates pleaded in the claim, to argue for wrongful trading in respect of other dates once the evidence has been heard, as this would be unfair on the respondent(s).136 In Re Hawkes Hill Publishing Co Ltd (in liq)137 Lewison J refused to permit the liquidator on the first day of the trial to amend the date which he had identified in the pleadings as the time of the commencement of wrongful trading as it was too late.138 9.71 This restrictive approach evident in these cases has not been applied in all cases. There is evidence of a more liberal approach in some judgments.139 Some courts have either permitted a liquidator to argue at trial for different points of time than the one originally pleaded, or they have elected to impose their own starting points for wrongful trading, certainly where the company’s affairs are in a total shambles,140 often not an infrequent state of affairs with insolvent companies. The following are instances of a more liberal approach. First,141 in Re DKG Contractors Ltd142 John Weeks QC (sitting as a deputy Judge of the High Court) (as he then was) held the respondents liable in relation to wrongful trading from 31 (sic) April 1988 even though it appears the date pleaded by the liquidator was the end of July 1988.143 Secondly, in Re Purpoint Ltd144 Vinelott J, who ended up standing over the s 214 application seemed to regard liability under s 214 stemming from 1 January 1987, while the indication from the judgment is that the date pleaded by the liquidator was probably 28 May 1987.145 Thirdly, in Re Brian D. Pierson (Contractors) Ltd146 Hazel Williamson QC (sitting as a deputy High Court judge), while not disagreeing with the viewpoint expressed 132 M Simmons, ‘Wrongful Trading’ (2001) 14 Insolvency Intelligence 12, 13. 133 For instance, see ibid. 134 [1995] BCC 40. 135 [2001] BPIR 733. 136 Re Sherborne Associates Ltd [1995] BCC 40, 42; Re Continental Assurance Co of London plc [2001] BPIR 733, 766–767; Re Langreen Ltd (unreported, 21 October 2011, ChD, Registrar Derrett). 137 [2007] BCC 937, [2007] BPIR 1305. 138 Ibid., [37]. 139 The distinction between restrictive and liberal approaches was first drawn in Andrew Keay, ‘Wrongful Trading and the Point of Liability’ (2006) 19 Insolvency Intelligence 132. 140 Re Purpoint Ltd [1991] BCC 121, 128, [1991] BCLC 491, 498–499. 141 Parts of the following discussion is based on Andrew Keay, ‘Wrongful Trading and the Point of Liability’ (2006) 19 Insolvency Intelligence 132. 142 [1990] BCC 903. 143 Ibid., 912. 144 [1991] BCC 121, [1991] BCLC 491. 145 Ibid., 128, 498–499. 146 [1999] BCC 26, 49–50, [2001] BCLC 275, 302–303.

117

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

in Re Sherborne Associates Ltd147 and referred to in the previous paragraph, and in fact mentioning that case in her judgment, seemed to suggest that she would not be averse to a liquidator being able to point to events that establish liability around about the date that has been pleaded. The deputy judge thought that it would ‘be unduly technical to hold that Mr Barker [counsel for the liquidators] was limited by his pleading to 13 June 1994 with absolute rigidity.’148 9.72 Fourthly, perhaps Registrar Jones (as he then was) in Brooks v Armstrong149 and Johnson J in Re BHS Group Ltd150 provided the most liberal approach. In the former case the registrar said that a starting date for when the wrongful trading is alleged to have commenced does not always have to be specified, although he indicated that it would usually be useful, and he added that the claim will not necessarily be lost if a specific date is not made out.151 However, the registrar gave a warning that the directors must know as a matter of fairness the case they have to meet and case law establishes that the liquidators will not be able to claim a different date or period at trial to the one capable of being identified from the application and evidence in support.152 In this case the liquidators provided in their evidence and points of claim that the knowledge requirement was satisfied in relation to five different dates ranging from 31 January 2005 to 3 May 2007. The registrar considered the position of the company and the knowledge of the directors at each of the five dates identified by the liquidators. In Re BHS Group Ltd153 Johnson J said that earlier cases were not laying down any rule that a claim must always be pleaded by reference to a specific date or dates.154 He went on to say that he did not think that judges like Park J in Re Continental Assurance Co of London plc155 were laying down any rule that a claim must necessarily fail if a specified date is pleaded, and that date is not established at trial. His Lordship felt that the position was more flexible.156 He took the view that the court had latitude in deciding what the date or dates constituted the point(s) of liability.157 Johnson J said that: ‘Essentially the question is one for the trial judge, and ultimately depends upon what is fair to the parties.’158 This seems to have occurred in several of the decisions referred to earlier. In Re BHS Group the judge felt that it was unfair to the respondents in the case before him that the point of liability was left at large.159

147 148 149 150 151 152 153 154 155 156 157 158 159

[1995] BCC 40. Ibid., 49. [2015] EWHC 2289 (Ch), [2015] BCC 661. [2022] EWHC 2205 (Ch). Ibid., [13]. Ibid., [14]. [2022] EWHC 2205 (Ch). Ibid., [99]. [2001] BPIR 733. [2022] EWHC 2205 (Ch), [99]. Ibid., [99]–[101]. Ibid., [101]. Ibid., [102], [104].

118

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

9.73 Fifthly, even in Re Continental Assurance which might be seen, in some lights, as providing difficulties for liquidators to bring successful wrongful trading claims, and where Park J said that he was not prepared to consider evidence or submissions that argued for a date later than the one pleaded, because the case was so complex, he said that his judgment should not be seen as: authority for the proposition that in all cases under s 214 the liquidator must always specify his starting date, and must lose the whole case if he cannot satisfy the court that his case is made out by reference to that particular date. Cases vary in detail and complexity.160

9.74 Sixthly, in Official Receiver v Doshi161 Hart J held that the respondent was engaging in wrongful trading from November 1992, and the fact that the liquidator had alleged that the trading had commenced in February 1992, did not seem to matter as far as the liquidator’s case was concerned.162 The same goes for Rubin v Gunner.163 In that case, in the ‘Details of Claim’ it was pleaded that wrongful trading began in about June 1998, in counsel’s skeleton argument it was stated that the respondent had the knowledge mentioned in s 214(2)(b) from about April 1998 and in counsel’s concluding oral submissions before the court the period when wrongful trading commenced was said to be May 1998.164 Notwithstanding all of this, Etherton J found that wrongful trading began from 15 October 1998 and held the director liable accordingly from that date. 9.75 Finally, in Re Main Realisations Limited165 Deputy Registrar Prentis (as he then was) acceded to an application at the commencement of the trial by counsel for the liquidators to amend the application to add a further date on which wrongful trading was alleged to have commenced. This appears to be a liberal approach, but the registrar indicated that he did this only because the new date was already given in the pleadings as the date from which the consequent loss to the company was calculated.166 Again, in Jackson v Casey,167 ICC Judge Prentis (as the former deputy registrar had become) permitted the liquidator to change the dates at the outset of the trial.168 9.76 An approach that a liquidator might consider adopting is to plead alternative dates from which wrongful trading commenced. This was the strategy in Roberts v Frohlich,169 Re Ralls Builders Ltd,170 Johnson v Arden171 and Wright

160 161 162 163 164 165 166 167 168 169 170 171

Ibid., 899. [2001] 2 BCLC 235. Ibid., 281. [2004] EWHC 316 (Ch), [2004] BCC 684, [2004] 2 BCLC 110. Ibid., [54]. [2017] EWHC 3878 (Ch). Ibid., [23]. [2019] EWHC 1657 (Ch). Ibid., [183]. [2011] EWHC (Ch) 257, [2012] BCC 407, [6], [110]. [2016] EWHC 243 (Ch), [2016] BCC 293, [132]. [2018] EWHC 1624 (Ch), [2019] 2 BCLC 215, [2019] BPIR 901, [50].

119

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

and Rowley v Chappell; Re BHS Group Ltd172 and the respective judges did not criticise the liquidator for doing so. In fact in the first case the judge, Norris J, did not hold that wrongful trading had commenced on either of the dates pleaded, although the date on which he settled was only two weeks from the second of the dates pleaded and the liquidator had pleaded that wrongful trading had commenced around 1 September 2004.173 This case demonstrates that liquidators will be allowed to ‘hedge their bets’ a little by pleading that wrongful trading commenced ‘around’ or ‘on or about’ a particular date. Surely, though, liquidators who specify alternate dates will have to specify in their application or supporting evidence reasons why alternate dates might constitute dates from when wrongful trading commenced. 9.77 What liquidators must be careful of doing is not to nominate a date or dates in the life of the company when a court might well take the view that at these times it would have been too early for the directors to take more drastic or defensive measures,174 such as initiating an administration because it would be too early to rationally expect that the company could not avoid insolvent liquidation. 9.78 As mentioned, it needs to be acknowledged by a court that identifying the point of liability from which wrongful trading commenced might well be a difficult task and that means that it should, certainly in appropriate cases, justify some leeway being shown,175 provided the respondent is not ambushed or prejudiced in some way. This can be demonstrated from a study of several of the reported cases, such as Re Continental Assurance Co of London plc,176 where it is clearly a very vexed issue as to when the wrongful trading commenced, if at all. Although one should note that Park J in that case regarded the complexity of the case as a reason for not permitting the liquidator to revise his submissions concerning the commencement of alleged wrongful trading.177 In Roberts v Frohlich178 the applicant, as mentioned earlier, pleaded that the date was ‘around 1 September 2004,’ and the judge found there was a successful claim even though he found wrongful trading commenced on 14 September 2004.179 9.79 There is nothing in the provision itself that suggests that a liquidator is obliged to nominate a date and prove it. The section only provides (in s 214(2) (b)) that ‘at some time before the commencement of winding up . . .’ the respondent must have known or ought to have concluded that insolvent liquidation was unavoidable. Therefore, provided the evidence demonstrates that wrongful trading commenced before the company entered winding up, then it might be arguable that the provision is satisfied, and it should not matter if the exact date,

172 [2021] EWHC 3501 (Ch), [12]. An appeal in relation to the pleadings in this case succeeded (Re BHS Group Ltd [2022] EWHC 2205 (Ch)), but the appeal judge did not take issue with this approach. 173 Ibid., [113]. 174 [2015] EWHC 2289 (Ch), [2015] BCC 661, [242]. 175 M Simmons, ‘Wrongful Trading’ (2001) 14 Insolvency Intelligence 12, 13. 176 [2001] BPIR 733. 177 Ibid., 899. 178 [2011] EWHC (Ch) 257, [2012] BCC 407, [6], [110]. 179 Ibid., [113].

120

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

if any, pleaded is not correct. Of course, if no specific time were pleaded then the respondent might justifiably seek further and better particulars of the claim, and a court might well accede to an application requiring particulars if the liquidator declined to give such particulars. Certainly, where a liquidator gives no details of when he or she regarded wrongful trading commencing then a court is going to look unfavourably on the application. 9.80 Given the difficulty of establishing exactly when, if at all, a director has engaged in wrongful trading, as made manifest in a number of cases,180 it might seem fair, as mentioned earlier, that a liquidator should not be confined rigidly to any date or period that is pleaded, assuming that a court can find that the director did engage in wrongful trading before the commencement of winding up. Certainly, Hazel Williamson QC in Re Brian D. Pierson (Contractors) Ltd181 seemed to be of such a view. In her judgment she stated: In my judgment it would be unduly technical to hold that Mr Barker was limited by his pleading to 13 June 1994 with absolute rigidity, such that the case would stand or fall according to whether the directors could be expected to have taken stock of the situation before 13 June 1994.182

9.81 The deputy judge felt that the liquidator should be allowed to make out his case in relation to the period shortly after the date pleaded. In that case the deputy judge stated that while the date pleaded was 13 June 1994, the case had been argued on the basis that that the relevant time was really the period between 13 June 1994 and 31 July 1994.183 9.82 The riposte to the argument that no specific date should have to be pleaded is probably that directors should know the exact case that is being made out against them so that they can prepare a proper defence. Also, directors might say that that they cannot be expected to defend themselves in relation to a claim covering any date before the commencement of winding up, as the period could be very long. 9.83 Thus, it would seem that if a liquidator makes every effort to ascertain and plead a specific time he or she may not be out of court if the time chosen is not correct and in the course of the trial another date becomes apparent as the time when wrongful trading commenced. This should not, of course, be seen as an excuse for sloppy accounting and factual analysis by both the liquidator and his or her lawyers and for vague pleading. 9.84 It does seem fair that liquidators should not have to rely on an exact date. Rather, they should be permitted to plead that the respondent engaged in wrongful trading within a period that is reasonable in length. If this were permitted then the directors would at least know the relevant time on which the liquidator was focusing, and one would expect a court to require from a liquidator

180 181 182 183

Such as Re Continental Assurance Co of London plc [2001] BPIR 733. [1999] BCC 26, [2001] BCLC 275. Ibid, 50, 303. Ibid, 49, 302.

121

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

a proper basis for reliance on the period alleged, including relating the period relied upon to the claim for loss by reference to the deficiency in the company’s assets. Of course, it might be found in any given case that the period pleaded is unreasonably long. A court would have to consider each case on its merits and determine whether the period is overly long or inappropriate. A respondent might be advised to seek to strike out a claim that includes an unreasonable period, with the likely result being that, if all things are equal, and the court agreed with the respondent’s contention, the court would allow the liquidator to amend points of claim to include what is considered a reasonable period. Naturally, that would normally have effects as far as costs are concerned. 9.85 It might be fair to say that while liquidators might not be required to nominate an exact day from which wrongful trading started to occur, they should not be permitted to have ‘a second bite of the cherry’ during the trial. If the liquidator nominated period X as the time in which the respondent knew or ought to have concluded that insolvent winding up was unavoidable, and a court found that in fact while the respondent had the requisite knowledge at the time pleaded, he or she actually had started to engage in wrongful trading earlier, at point Y, it is submitted that it would be fair to say that the liquidator has proven his or her case (if the director had relevant knowledge prior to the date or period relied upon it can be safely assumed that that knowledge was possessed at the later point in time), but any contribution order could only be based on wrongful trading occurring from point X, or close to that point. The case law has provided that liquidators are required to show that there was a net deficiency in company assets when comparing the company’s position as at the time when wrongful trading is alleged to have commenced (and trading should have stopped) and the position when trading actually ceased184 (or the company entered into liquidation), so any calculation would have to be based on the company’s position at X. Alternatively, if a court found that the respondent did not know or could not have concluded that insolvent winding up was unavoidable at point X, but had the requisite knowledge at point Z, a time subsequent to X, while technically s 214(2)(b) might be fulfilled in that ‘at some time’ prior to winding up the respondent had knowledge, it is perhaps arguable that it would be unfair to hold him or her liable, as the defence was not concentrating on point Z. This could well depend on the facts of the case and, given what Park J said in Re Continental Assurance Co of London plc,185 the complexity of the issues before the court. 9.86 What date will be chosen? It has been suggested that the point from which liability commences is likely to be a crisis point in the life of the company when directors have to acknowledge the inevitable.186 However, when talking

184 Re Continental Assurance Co of London plc [2001] BPIR 733, 821, 844; The Liquidator of Marini Ltd v Dickensen [2004] BCC 172, [2003] EWHC 334 (Ch), [68]. 185 [2001] BPIR 733. 186 T Cooke and A Hicks, ‘Wrongful Trading – Predicting Insolvency’ [1993] Journal of Business Law 338, 339.

122

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

about principles rather than a particular case, it is impossible to specify the date based on any particular criteria. 9.87 It is likely that the further back that a liquidator seeks to push the point of liability, the greater the difficulty of establishing that fact. A liquidator will have to balance the weight of evidence as against the quantum of a possible contribution order. It might be wise for a liquidator to be conservative and nominate a date from which the directors clearly knew or ought to have concluded insolvent liability was inevitable. What Should Directors Be Doing? 9.88 It has been submitted that the drafting of the provision is so broad that it is able to render liability for ‘incompetence, ignorance and indifference’ as well as conscious wrongdoing,187 so directors must be careful how they act. 9.89 Critically, directors must keep on top of the financial position of their companies, and, in accordance with what the law now requires of directors, they must be able to understand company accounts.188 If they are not able to do so, then they must employ someone who can advise them appropriately.189 Even conscientious and competent directors can be placed in difficult positions when they become aware that their company’s finances are not too healthy. They must not be cavalier, but they must not be overly cautious, because the latter could see them do something that would not benefit creditors. For example, the immediate cessation of business could well be the worst thing for all concerned. The directors also might be in breach of their duties to shareholders. 9.90 Rarely, where directors have made an effort to understand the position of their company, and particularly where they have sought the advice of appropriate professionals, will they be held liable where they decided to continue doing business.190 Indeed, in Re Continental Assurance Co of London plc191 Park J said that the typical case in which directors have been held to be liable, the directors have: [C]losed their eyes to the reality of the company’s position, and carried on trading long after it should have been obvious to them that the company was insolvent and that there was no way out for it. In those cases the directors had been irresponsible,

187 L S Sealy, ‘Personal Liability of Directors and Officers for Debts of Insolvent Corporations: A Jurisdictional Perspective (England)’ in J Ziegel (ed), Current Developments in International and Comparative Corporate Insolvency Law (Clarendon Press, 1994), 491. 188 See the comments in Re DKG Contractors Ltd [1990] BCC 903 and referred to in D Milman, ‘Strategies for Regulating Managerial Performance in the “Twilight Zone” – Familiar Dilemmas: New Considerations’ [2004] Journal of Business Law 493, 497. Also, see (in relation to a claim for breach of a director’s duty of care) the comments of Middleton J in ASIC v Healey [2011] FCA 717 on the question of directors having knowledge of accounts. 189 Re Hitco 2000 Ltd [1995] 2 BCLC 63. 190 See Re Sherborne Associates [1995] BCC 40; Re Continental Assurance Co of London plc [2001] BPIR 733. 191 [2001] BPIR 733.

123

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

and had not made any genuine attempt to grapple with the company’s real position.192

9.91 Admittedly, what is required of the directors is some ‘crystal ball gazing’ as to the future of the company, and this, in many cases, might be difficult to do. That is why the seeking of professional advice can be really important. It has been judicially recognised that ‘directors immersed in the day to day task of trying to keep their business afloat cannot be expected to have wholly dispassionate minds.’193 But the same judge also acknowledged that ‘there comes a point at which an honest businessman recognises that he is only gambling at the expense of his creditors on the possibility that something may turn up.’194 Therefore, directors have to engage in a careful balancing act. 9.92 Importantly, it would seem most advisable for directors to record details of all of their decisions and what information they have sought and considered, as well as, perhaps, the reasons for their decisions, so that if they have to account for what they have done they are able to do so in a rational way. Also, they should obtain all available information about the company, and that should include not only what is available to them but what ought to be available195 and that which they could have been reasonably obtained,196 such as documents or information concerning the financial state of the company. For instance, the directors are deemed to know what is to be found in the company’s accounting records. It should be noted that the knowledge that is imputed to directors is not limited to any documents that are available at the relevant time.197 9.93 While it is probably self-evident, we should note that directors are to treat the interests of creditors as paramount.198 9.94 In New Zealand the courts seem to have distinguished between those actions which involve legitimate business risks and those which are illegitimate.199 The latter can constitute reckless trading (equivalent to wrongful trading) and could be marked by a significant departure from orthodox business practice and extensive risks for creditors.200 Judicial Considerations 9.95 Obviously when hearing a wrongful trading case, the courts are hearing it retrospectively and the courts must acknowledge that fact, and also the fact that the director respondent did not have the benefit of hindsight when making 192 Ibid., 769. 193 Re CU Fittings Ltd [1989] BCLC 556 at 559 per Hoffmann J. 194 Ibid. 195 P Fidler, ‘Wrongful trading after Continental Assurance’ (2001) 17 I L & P 212, 215. 196 Re Produce Marketing Consortium Ltd (1989) 5 BCC 569, 595. 197 Ibid. 198 BTI 2014 LLC v Sequana S.A. [2022] UKSC 25, [121] per Lord Briggs JSC. 199 Re South Pacific Shipping Ltd (2004) 9 NZCLC 263,570; Walker v Allen, High Court, 18 March 2004, France J. 200 Re South Pacific Shipping Ltd (2004) 9 NZCLC 263, 570.

124

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

decisions. It has been judicially recognised that there is always the danger of the courts taking the view, because of hindsight, that it can be assumed that what in fact occurred was always bound to happen and was apparent, and courts must be wary of making such an assumption.201 In Re Hawkes Hill Publishing Co Ltd,202 a wrongful trading case, Lewison J said that: ‘I must take care to avoid being influenced by hindsight.’203 Later his Lordship said that: Of course it is easy with hindsight to conclude that mistakes were made. An insolvent liquidation will almost always result from one or more mistakes. But picking over the bones of a dead company in a courtroom is not always fair to those who struggled to keep going in the reasonable (but ultimately misplaced) hope that things would get better.204

9.96 In like manner, in a more recent case Snowden J in Re Ralls Builders Ltd205 said that he had to caution himself against the use of hindsight in making his decision.206 9.97 The courts have indicated that they cannot expect directors to be clairvoyants207 and the courts should remember that ‘there is a real difference between the court analysing events in the court room and the directors having to reach decisions on the ground, at the time and under the pressures their office brings.’208 9.98 Any examination of the decisions of the directors must be undertaken whilst having consideration for the context of the decisions and the material available to them, and the exact circumstances that existed at the relevant time. Clearly the market in which a company is trading or the type of industry in which the company is engaged is an important consideration. For instance, in Re Main Realisations Limited209 the court took into account the fact that the period in which wrongful trading was alleged to have occurred, the transport industry, being the industry in which the company operated, was suffering hardship in the wake of the Global Financial Crisis of 2008.210 9.99 It is submitted that judicial decisions manifest the fact that the courts have appreciated the fact that they are examining what happened ex post and they have not used hindsight to the detriment of respondents. Indeed, courts have tended, for the most part, to give respondents the benefit of any doubts.

201 Re Sherborne Associates Ltd [1995] BCC 40, 54; Re Brian D. Pierson (Contractors) Ltd [1999] BCC 26, 50, [2001] BCLC 275, 303. 202 [2007] BCC 937, [2007] BPIR 1305. Also, see Sherborne, ibid, 54. 203 [2007] BCC 937, [2007] BPIR 1305, [38]. 204 Ibid., [47]. 205 [2016] EWHC 243 (Ch). 206 Ibid., [216]. 207 [2007] BCC 937, [2007] BPIR 1305, [41]; Brooks v Armstrong [2015] EWHC 2289 (Ch), [2015] BCC 661, [180(d)]. 208 Brooks, ibid., [180] per Registrar Jones. 209 [2017] EWHC 3878 (Ch). 210 Ibid., [98].

125

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

9.100 Clearly courts are to have regard for the kind of company managed by the directors, as well as the type of business in which it is involved.211 Consequently, the courts will expect less general knowledge, skill and experience of a director of a small company which has modest systems, simple accounting processes and equipment, and which is involved in a modest amount of business, than a person whose company has well-developed systems and practices and is conducting a large-scale business.212 It has been contended that s 214(4) should ‘give scope for the courts to make some allowances in the case of non-executive and part-time directors.’213 But, that does not mean that non-executives will be able to escape liability.214 Also, courts will assume that certain minimum standards should be attained to cause accounting records to be maintained properly.215 Probably more might be expected of some directors, with particular knowledge and/or experience in specialist fields, such as accounting or law. 9.101 As indicated earlier, the courts will not hold directors liable merely because their company was insolvent at the time when they are alleged to have engaged in wrongful trading.216 In Rubin v Gunner217 the court absolved the respondents from liability, despite the company being insolvent, because it was satisfied that the respondents had a genuine and reasonable belief that liquidation could be avoided because of the fact that sufficient funding was going to be forthcoming.218 In a director disqualification case, Secretary of State for Trade and Industry v Gash,219 Chadwick J said that directors are entitled, even when their company is insolvent, to continue to trade in order to try and trade out of its difficulties, on the basis that it is in the interests of the creditors to do so.220 This might be done where the directors take the view that it is in the interests of creditors that some loss-making activity should be accepted in anticipation of the company enjoying profitability in the future. Of course, this might, as the judge acknowledged, lead to personal liability on one or more of the bases discussed in this book. 9.102 Clearly directors are not stopped from taking some risks. For instance, in Facia Footwear Ltd (in administration) v Hinchliffe,221 a case involving a claim that directors had failed to take into account creditors’ interests, Sir Richard 211 Re Produce Marketing Consortium Ltd (1989) 5 BCC 569, 594; Re Sherborne Associates Ltd [1995] BCC 40, 54; Re Brian D. Pierson (Contractors) Ltd [1999] BCC 26, 55, [2001] BCLC 275. 212 Produce Marketing, ibid., 594–595. 213 L S Sealy and D Milman, Annotated Guide to the Insolvency Legislation (second revised 7th ed, Sweet and Maxwell, 2004), 277. 214 For instance, see Brooks v Armstrong [2015] EWHC 2289 (Ch), [2015] BCC 661 where both directors, the executive director and the non-executive director, sued were held jointly and severally liable (at [308]). 215 Re Produce Marketing Consortium Ltd (1989) 5 BCC 569, 595. 216 Re Sherborne Associates Ltd [1995] BCC 40; Re Hawkes Hill Publishing Co Ltd (in liq) [2007] BCC 937, [2007] BPIR 1305, [28]. 217 [2004] EWHC 316 (Ch), [2004] BCC 684, [2004] 2 BCLC 110. 218 Ibid., [79]. 219 [1997] 2 BCLC 341. 220 See Secretary of State for Trade and Industry v Taylor [1997] 1 WLR 407. 221 [1998] 1 BCLC 218.

126

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

Scott V-C acknowledged that in continuing trading the directors were taking a risk, but his Lordship went on to say that ‘the boundary between an acceptable risk that an entrepreneur may properly take and an unacceptable risk . . . is not always, perhaps not usually, clear cut.’222 9.103 Section 214(5) assists courts in the interpretation of s 214(4). It provides that the reference in the latter sub-section to the functions carried out in relation to the company by the director includes any function that the director does not carry out but was entrusted to him or her. This, therefore, makes directors responsible for omitting to do that which they should have done. 9.104 In determining whether there was no reasonable prospect of a company avoiding insolvent liquidation, courts will take into account a broad range of factors which may be presented to them through evidence. This may include evidence concerning pressure from creditors who were owed debts, the withdrawal of support from banks, the loss of contracts, the fact that fresh contracts cannot be obtained, the failure to pay Crown debts223 and the loss of a major supplier.224 9.105 The courts do not appear to impose liability readily and, as mentioned earlier, often give directors the benefit of any doubts. For instance, in Re Purpoint Ltd225 it was stated that even if it might be said that a reasonably prudent director would not have permitted the company to commence trading at the time when it in fact did, because the company was poorly set up, it is probably too harsh to conclude that the director ought to have known that the company was doomed to fall into insolvent liquidation.226 9.106 As adverted to earlier, courts appear to look favourably on respondents when they sought and obtained advice from professionals, provided that they are the right kind of professionals and with the right kind of experience and expertise. 9.107 In most cases where directors have been found liable, they have been found to have acted irresponsibly. Arguably, though, given the legislation, liability should not be linked, necessarily, to irresponsibility. The issue is: did the director know or ought to have concluded that there was no reasonable prospect of the company avoiding insolvent liquidation? A director could have been responsible in taking advice, monitoring the company and undertaking checks and still the director might fall foul of s 214, as he or she ought to have concluded that there was no reasonable prospect of the company avoiding insolvent liquidation. It is not totally about what directors actually did, but it is about what they knew or ought to have concluded. Directors might be conscientious, but then they might totally miss the fact that their company is doomed. 9.108 It is respectfully contended that Park J in Re Continental Assurance missed the point when he noted that the directors did not ignore the fact as to

222 Ibid., 228. 223 Stephen Griffin, Personal Liability and Disqualification of Company Directors (Hart Publishing, 1999), 66. 224 For example, Re DKG Contractors Ltd [1990] BCC 903. 225 [1991] BCC 121, [1991] BCLC 491. 226 Ibid., 127, 498.

127

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

whether the company should continue to trade,227 for that is not the essential issue. The issue is: should they have concluded that there was no reasonable prospect of the company avoiding insolvent liquidation? Admittedly, the fact that, as Park J said, the directors ‘reduced the scale of trading to minimal and cautious levels’228 as the financial position became more bleak, should be an issue to be taken into account. However, this should only be in respect of whether the defence mentioned in s 214(3) can be made out. It should go towards determining whether the directors took every step to minimise the potential loss to creditors and not to whether they knew or ought to have concluded that there was no reasonable prospect of the company avoiding insolvent liquidation. Indeed, counsel for the liquidators in Re Continental Assurance argued that while the directors tried their best, they got things wrong, and it was their fault that they got things wrong.229 Park J felt that that was an ‘austere attitude’230 and he had sympathy with the view put forward by counsel for the directors that the liquidators relied on hindsight and they failed to appreciate the realities of being a director.231 His Lordship noted that the directors questioned figures that were presented to them, but while that is a laudable course of action to take and perhaps a contributing factor to a defence of taking ‘every step,’ it is surely not directly relevant to the issue of whether they could not have concluded that their company could not avoid liquidation. The asking of questions by directors, while likely to be an important thing to do, is not alone the critical issue. The critical issue is what answers were given, if any, and what did they do in response and ultimately whether they should have been in a position to know or conclude that liquidation was not able to be avoided, if they had not been in a position beforehand. Equally, of course, the answers might, or could, not have taken them any further in knowing where the company was heading because, as his Lordship noted, the answers given might have been incorrect.232 9.109 It is submitted that it might not be possible to take issue with the conclusion that Park J drew, namely that the directors were not liable for wrongful trading, but it is contended that some of the factors that he took into account were erroneous. His Lordship seemed to be looking for some clear wrongdoing on the part of the directors, and found none, and that meant that they were not liable. The provision does not require the establishing of any wrongdoing, certainly in the sense of blameworthiness. 9.110 The concern with the approach in Re Continental Assurance is that it appears to circumscribe the scope of s 214, by indicating that lack of blameworthiness is an issue that is critical in determining liability. It is submitted that if anything it should only go to the issue of the amount of contribution ordered to be paid. 227 228 229 230 231 232

Ibid. Ibid. Ibid., 770. Ibid. Ibid. Ibid., 812.

128

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

The Types of Companies Involved in Actions 9.111 Returning briefly to the cases where an order in favour of a liquidator has been made, to date, the cases have involved exclusively small closely held companies (owner-managed), such as Re DKG Contractors Ltd,233 Re Purpoint Ltd,234 Re Brian D. Pierson (Contractors) Ltd,235 Rubin v Gunner236 and Roberts v Frohlich.237 9.112 There is not a single instance of the directors of a larger company in the UK being held liable. In the only reported case involving a public company, Re Continental Assurance of London plc,238 the liquidators failed. Why is it that it is only the directors of small private companies that appear to be the subject of proceedings? Dr Rizwaan Mokal states that ‘companies large enough to have professional non-executive directors are highly unlikely to engage in wrongful trading.’239 Perhaps the directors of larger companies are more ready to seek professional advice, and to act on it, rather than directors of closely held companies who may be fiercely independent and intolerant of such advice, partially on the basis that they opine that the professionals do not know the business as well as they, the directors do, who might rely on ‘gut feeling’ founded on experience240 on many occasions. Another reason might be that information about the company’s financial position might be more readily available in large companies. A substantial reason is likely to be that the directors of a large company are not so wedded to the company and its mission as those who start small businesses, who often put their heart and soul into ventures and find it hard to admit that they might not be able to achieve success,241 often leading to what can only be described as ‘wishful thinking.’ An example is the male respondent in Re Brian D. Pierson (Contractors) Ltd.242 9.113 Whereas directors of large companies have to ensure as much as possible they do not damage their reputation for the future as they will ordinarily want to go and be involved in, and even manage, other companies. And as Professor Ron Daniels has stated in relation to the executive directors of larger companies: [I]n light of their imminent re-entry into the job market, managers may reason that the best strategy to adopt in a distress situation is one of honesty and integrity. Rather than using wrongdoing as a way of gambling the company back to success, the managers may decide to avoid unscrupulously any hint of wrongdoing out of a

233 [1990] BCC 903. 234 [1991] BCC 121; [1991] BCLC 491. 235 [1999] BCC 26, 55, [2001] BCLC 275. 236 [2004] BCC 684; [2004] EWHC 316 (Ch). 237 [2011] EWHC 257 (Ch), [2011] 2 BCLC 625; [2012] BCC 407. 238 [2001] BPIR 733. 239 Corporate Insolvency: Theory and Application (OUP, 2005), 283 n 97. 240 Re Brian D. Pierson (Contractors) Ltd [1999] BCC 26, 50, [2001] BCLC 275, 303. 241 Rizwaan Mokal, ‘An Agency Cost Analysis of the Wrongful Trading Provisions: Redistribution, Perverse Incentives and the Creditors’ Bargain’ (2000) 59 CLJ 335, 353–354. 242 [1999] BCC 26, 55, [2001] BCLC 275.

129

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

concern for inflicting irrevocable damage to their reputational capital in the managerial market.243

9.114 There are three other possible reasons. First, it could be that the directors of small companies do not always separate their personal affairs from their business affairs, again a criticism made of the male respondent in Re Brian D. Pierson (Contractors) Ltd.244 Secondly, directors of owner-managed companies often have strong views about how their businesses should be conducted and, as mentioned earlier, they are not always ready to take advice;245 they believe that they know the industry in which they work and can make the best decisions. Thirdly, directors of public companies are able to benefit, very often, from the advice of in-house professionals, such as corporate counsel. As Knox J stated in Re Produce Marketing Consortium Ltd,246 the general knowledge, skill and experience will be much less extensive in a small company in undertaking a modest business, with simple accounting procedures and equipment, than it will be in a large company with sophisticated procedures.247 Loss 9.115 Section 214(1) provides that a court may declare that a person who is found guilty of wrongful trading is to be liable to make such contribution (if any) to the company’s assets as the court thinks proper. This, therefore, presumes that a loss must be demonstrated on the part of the company from the time of the commencement of the alleged wrongful trading until the date of liquidation.248 9.116 Snowden J in Re Ralls Builders Ltd249 said that the function of this sub-section is to restore the financial position of the company to what it would have been had the wrongful trading not occurred. Therefore, a court, in deciding whether a director is to be required to make a contribution must discern whether the company has suffered loss caused by the alleged wrongful trading.250 9.117 It has been held that there was no requirement that the quantum of loss must be pleaded if the amount is clearly addressed by expert evidence before trial and the respondents knew exactly the case they had to meet.251 9.118 Although not deciding the issue, it was assumed in some of the earlier case law, such as Re Simmon Box (Diamonds) Ltd,252 that it may not be necessary to prove a causal link between the wrongful trading established, and any 243 ‘Must Boards Go Overboard?’ (1994–5) 24 Canadian Business Law Journal 229, 241. 244 [1999] BCC 26, 39, [2001] BCLC 275, 290. 245 For an instance, see Re Brian D. Pierson (Contractors) Ltd [1999] BCC 26, [2001] BCLC 275. 246 (1989) 5 BCC 569. 247 Ibid., 594–595. 248 See, Re Ralls Builders Ltd [2016] EWHC 243 (Ch), [2016] BCC 293, [252]. 249 Ibid. 250 Ibid., [242]. 251 Wright and Rowley v Chappell; Re BHS Group Ltd [2021] EWHC 3501 (Ch), [2022] 2 BCLC 145. An appeal from this decision was allowed (Re BHS Group Ltd [2022] EWHC 2205 (Ch)), but the judge does not seem to have taken issue with the approach at first instance on this matter. 252 [2000] BCC 275; [2001] 1 BCLC 176, CA.

130

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

particular loss, but later case law has made it plain that a liquidator must prove a link between the wrongful trading and any loss sustained, and it must be more than a ‘but for’ nexus.253 Therefore, it is necessary that compensation should be linked to the liabilities that result from the wrongful trading attributed to the directors.254 9.119 In Re Continental Assurance of London plc255 Park J said that it was necessary to establish more than a mere nexus between an incorrect decision to carry on trading and a particular loss sustained by the company;256 there had to be some sufficient connection between the wrongfulness of the directors’ conduct on the one hand, with the company’s increase in net deficiency on the other.257 Park J said that the required connection will often be obvious, such as where a director turns a blind eye to inherent loss-making.258 This general view is in accord with the argument of counsel for the liquidator in Re Produce Marketing Consortium Ltd.259 9.120 In Re Ralls Builders Ltd260 Snowden J went a little further than the comments of the judges in earlier cases and said that there had to be some causal connection between the amount of any contribution and the continuation of trading.261 This was something which Meade J agreed with in Biscoe v Milner.262 9.121 Not all losses suffered by a company after the directors wrongly decide to continue trading can necessarily be claimed by a liquidator.263 The law will limit liability to those consequences which are attributable to the wrongful action(s).264 For instance, a company’s losses could have been due to circumstances not related to the actions or inactions of the directors and involve circumstances beyond their control. In Re Brian D. Pierson (Contractors) Ltd265 the court accepted that some losses were due to bad weather conditions which inhibited the company’s business, and the construction and maintenance of golf courses.266 9.122 Nevertheless, Meade J made it plain in Biscoe v Milner267 that any suggestion that s 214 only hit where the failures of the respondent were the sole cause of loss was wrong.268 Thus, if a director’s wrongful trading was one 253 Re Continental Assurance Co of London plc [2001] BPIR 733, 844–845; Brooks v Armstrong [2016] EWHC 2893 (Ch), [2015] BCC 661, [287]; Re Ralls Builders Ltd No 2 [2016] EWHC 1812 (Ch), [2016] BCC 581, [31]. 254 Re Continental Assurance, ibid. 255 Ibid. 256 Ibid., 844. 257 Ibid. 258 Ibid. 259 Ibid., 864. 260 [2016] EWHC 243 (Ch), [2016] BCC 293. 261 Ibid., [242]. 262 [2021] EWHC 763 (Ch), [264]. 263 Ibid.; The Liquidator of Marini Ltd v Dickensen [2003] EWHC 334 (Ch), [2004] BCC 172, [68]. 264 Re Continental Assurance Co of London plc [2001] BPIR 733, 845. 265 [1999] BCC 26, 55, [2001] BCLC 275. 266 Ibid., 56; 310. 267 [2021] EWHC 763 (Ch). 268 Ibid., [265].

131

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

cause of loss sustained by the company that would be sufficient for an applicant to succeed. 9.123 A transfer of assets at an undervalue could constitute a loss requiring a contribution by the directors.269 In Re Bangla Television Ltd (in liq)270 the directors had effected a transfer at an undervalue, and the judge held that the value of the property transferred represented an increase in the net deficiency of the company’s assets. 9.124 As mentioned earlier, a number of cases have held that liquidators are required to show that there was a net deficiency in company assets when comparing the company’s position at the time when wrongful trading is alleged to have commenced (and trading should have stopped)271 and the position when trading actually ceased.272 That is, the net deficiency is the loss to the company caused by the wrongful trading. The increase in the net deficiency on the date when there was a commencement of wrongful trading (this often being regarded as the point of hypothetical insolvent liquidation) to, usually, the date of the compulsory winding-up order or resolution to wind up will normally reflect the loss to the company, being a result of the liquidation having been delayed.273 9.125 There are a significant number of cases that say that the loss will normally be represented by the amount the assets have been depleted.274 While this is not spelled out clearly in the legislation it might be said that this is consistent with the fact that s 214(1) refers to the fact that a director might be required to make a contribution to ‘the company’s assets.’ 9.126 In Re Continental Assurance Co of London plc275 Park J summarised it this way: I believe that the starting point for liability under section 214 is any element of loss to the company from its trading on instead of going into liquidation at the earlier date. The continued trading – albeit wrongful – has to make the company’s position worse, so that it has less money available to pay creditors, rather than to leave the company’s position at the same level. It must make the company’s position worse before it becomes appropriate for the court to order the directors to make a contribution.276

9.127 The point that is made by several cases is that it is the loss to the company, and not loss to the creditors that is critical. It appears to be no good liquidators pointing to the fact that creditors have lost out because of the conduct 269 Re Bangla Television Ltd (in liq) [2009] EWHC 1632 (Ch). 270 Ibid. 271 This point is often known as the hypothetical liquidation point. For instance, see Brooks v Armstrong [2016] EWHC 2893 (Ch); [2015] BCC 661, [287]. 272 Re Continental Assurance Co of London plc [2001] BPIR 733, 821, 844; The Liquidator of Marini Ltd v Dickensen [2003] EWHC 334 (Ch), [2004] BCC 172, [68]. 273 Re Continental Assurance ibid., 821; Brooks v Armstrong [2016] EWHC 2893 (Ch); [2015] BCC 661, [287]. 274 Re Purpoint Ltd [1991] BCC 121, 128; Re Continental Assurance ibid; Brooks v Armstrong [2016] EWHC 2893 (Ch), [2015] BCC 661, [287]. 275 Re Continental Assurance Co ibid., 821–822. 276 Ibid.

132

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

of the directors, for the issue is: has the company suffered a net deficit? This was plainly the approach of Snowden J in Re Ralls Builders Ltd.277 Certainly, the legislation does not refer to losses of creditors, and it does not make any link between a contribution to be paid by errant directors and the losses of creditors. Nevertheless, in some cases the court has considered the position of the creditors. Also, of some note is the fact that s 214(3) refers to loss to creditors, albeit obliquely. In this sub-section respondents can only defend themselves successfully if they can establish that they took every step with a view to minimising the potential loss to the company’s creditors and this suggests that directors should be liable to contribute to the assets of the company to the extent that new liabilities were taken on after the date when wrongful trading commenced, and they were not paid. Nothing is said in s 214(3) about the loss to the company, although often the two will be same. 9.128 Given the way that s 214(1) is drafted one might think that s 214(3) should state that every step has to be taken to minimise losses to the company, although s 214(3) does refer to ‘potential’ loss to the creditors and this loss will come about if the company has experienced loss, as the loss will represent what is owed to the creditors. Certainly, the focus of the Cork Report was on creditors who suffered loss from a company assuming liabilities which they had no reasonable prospect of paying. The Report stated that: ‘In future, we propose that a company should be trading wrongfully if, being insolvent or unable to pay its debts as they fall due, it incurs liabilities to other persons without a reasonable prospect of meeting them in full’278 Also, in Re Produce Marketing Consortium Ltd279 Knox J said that the section is about compensating creditors for something happening which ought not to have happened, and so the ultimate focus was on the creditors.280 In Re Ralls Builders Ltd281 Snowden J brought both net deficiency and loss to creditors together when he said: [A]nd to require a director who wishes to take advantage of the defence offered by that subsection [s 214(3)] to demonstrate not only that continued trading was intended to reduce the net deficiency of the company, but also that it was designed appropriately so as to minimise the risk of loss to individual creditors.282

9.129 His Lordship went on to say that if this were not the case, ‘a director could make out the defence under s 214(3) by claiming that he or she traded on with a view to reducing the overall deficiency for creditors as a general body, irrespective of how he or she achieved that result as between creditors.’283

277 278 279 280 281 282 283

[2016] EWHC 243 (Ch); [2016] BCC 293. Cmnd 858, HMSO (1982), [1781]. (1989) BCLC 520. Re Produce Marketing Consortium Ltd (1989) BCLC 520, 555 (not in the BCC report). [2016] EWHC 243 (Ch), [2016] BCC 293. Ibid., [245]. Ibid.

133

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

9.130 There might be cases where it is difficult for the courts to ascertain the net deficit precisely.284 It is often going to be a difficult task for the liquidator in constructing a case, and sometimes difficult for a judge in coming to a fair assessment. In fact, the whole assessment of compensation can be demanding. As Registrar Jones said in Brooks v Armstrong:285 ‘Whilst the award of compensation is objective, it cannot be wholly scientific because there will be many potential variables and a precise exercise will be disproportionate even if, which is unlikely, it is possible.’286 9.131 This has meant that on occasion judges have had to be pragmatic. In Re Idessa UK Ltd287 Lesley Anderson QC (sitting as a deputy judge of the High Court) said that the court could, in the absence of sufficiently detailed financial information that would enable the court to determine the increase of the net deficiency, determine the increase in the net deficiency between the alleged date when wrongful trading commenced and the actual date of the liquidation, calculate the actual net deficiency between the two dates and then pro-rata the net deficiency if the date when the wrongful trading did actually commence was between the two dates.288 The deputy judge made it plain that such a rough and ready approach only ought to be adopted if no other approach is available, and she said that the court should be cautious to employ it where there is no good explanation as to why a deficiency account has not been produced.289 9.132 In Re Purpoint Ltd290 proper accounting records had not been kept and Vinelott J adopted a pragmatic solution to quantify the loss to the company caused by continuation of trading. His Lordship said that: The difficulty is that it is impossible, because of Mr Meredith’s [the respondent director] total failure to ensure that proper records were kept and that proper cash flow calculations and net worth calculations were made, to ascertain the precise extent of the company’s net liabilities at the end of 1986 or the extent to which the net liabilities were increased by the continuance of the company’s trading after the end of 1986.291

9.133 To ascertain if there was a loss the judge aggregated the debts owed to creditors which were incurred after the commencement of wrongful trading and unpaid when the company ceased trading.292 He was willing to do this even though the figures could not be determined at the time of trial.293 The judge said that given these circumstances he stood over the application so that these figures

284 This was acknowledged by Knox J in the first case to come to judgment under the provision, Re Produce Marketing Consortium Ltd (1989) 5 BCC 569, 589. 285 [2016] EWHC 2893 (Ch); [2015] BCC 661. 286 Ibid., [302]. 287 [2011] EWHC 804 (Ch), [2012] BCC 315. 288 Ibid., [131]. 289 Ibid. 290 [1991] BCC 121, 128. 291 Ibid. 292 Ibid. 293 Ibid.

134

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

could be calculated.294 Interestingly, the judge did not mention net deficit at all in any part of his judgment. Clearly his Lordship was more concerned with the net liabilities of the company. Faced with a similar problem, namely poor recordkeeping, Sarah Asplin QC (sitting as a deputy High Court judge) (as she then was) in Re Kudos Business Solutions Limited295 adopted the same approach.296 As with Vinelott J, the deputy judge did not consider net deficiency. In Re Ralls Builders Ltd297 there had been far better records kept, and so Snowden J did not adopt the approach evident in the latter two cases. 9.134 The pragmatic approach of the court might be contrasted with that of the court in Re Main Realisations Limited.298 In this case Deputy Registrar Prentis, who had decided that the liquidators’ claim failed, said that even if the liquidators had been able to establish that wrongful trading had occurred, he would not have made any award, as there was not a deficiency account provided by the liquidators and he had been given no explanation for why one had not been prepared.299 As the registrar had already decided that the claim failed he might well have felt that it was not necessary to explain why the rough and ready approach referred to in Re Idessa UK Ltd300 could not be employed.301 However, he did say that he was not provided with any explanation as to why no deficiency account had been produced,302 and so we can probably assume that that falls within the caveat emitted by Lesley Anderson QC that the rough approach should only be adopted cautiously where there is no good explanation for the absence of a net deficit calculation. 9.135 In The Liquidator of Marini Ltd v Dickensen303 Judge Seymour QC (sitting as a High Court judge) agreed304 with Park J in Re Continental Assurance Co of London plc305 that in determining loss the appropriate test was not whether new debt was incurred after the date on which it was decided that the respondent knew or ought to have concluded that the company could not avoid insolvent liquidation, but whether the company was in a worse position at the date of liquidation than it would have been if trading had ceased at the time when it should, allegedly, have done. 9.136 What we have is a clear thread through the case law that a liquidator has to demonstrate that the company experienced a net deficit when looking at the company’s position at the date of the commencement of wrongful trading and

294 Ibid. 295 [2011] EWHC 1436 (Ch). 296 Ibid., [62]. 297 [2016] EWHC 243 (Ch), [2016] BCC 293, [277]. 298 [2017] EWHC 3878 (Ch). 299 Ibid., [112]. 300 [2011] EWHC 804 (Ch), [2012] BCC 315. 301 The deputy registrar in Jackson v Casey [2019] EWHC 1657 (Ch), [189] was implicitly critical of a rough and ready approach. 302 Ibid. 303 [2003] EWHC 334 (Ch), [2004] BCC 172, [74]. 304 Ibid., [68]. 305 [2001] BPIR 733.

135

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

the date when trading ended or the company entered liquidation or administration. However, there have been occasions where the courts have not insisted on this approach, and a different method has been adopted in determining if there was loss within s 214. It is submitted that this can be done because the provision gives the court an unfettered discretion when making an order. 9.137 While it might be contended that the net deficit interpretation is so ingrained in our law that it must be followed, it might be argued that blind adherence to the net deficit approach is wrong. Other approaches in relation to loss can and should, in appropriate situations, be embraced legitimately by a court. One such case would be where the company has paid off its creditors using funds obtained as a result of incurring new debts after the point where the directors knew or ought to have known that there was no reasonable prospect that the company could avoid insolvent liquidation. In this type of situation the net deficit might not have increased between the date of commencing wrongful trading and liquidation/administration, but the company has only been able to continue to trade because it has taken on new debt when the directors knew or ought to have known that the new creditors would not get paid as the directors knew or ought to have known that the company was bound for insolvent liquidation. 9.138 Finally, it has been suggested that in calculating the net deficiency, the court will not take into account the costs of the liquidation.306 Snowden J in Re Ralls Builders Ltd307 said something similar, and his Lordship added that the directors should not be responsible for losses that the company would have incurred in any event as a result of the company entering a formal insolvency procedure, including the costs of the procedure.308 His Lordship came to the conclusion in this case that it was entirely plausible that continued activity after the commencement of wrongful trading did not cause loss to the company overall or worsen the position of the creditors as a whole, and thus he did not make any award against the directors concerned.309 The Order Introduction 9.139 The provision states that if satisfied that the respondent engaged in wrongful trading, the court, as with claims under s 213 for fraudulent trading, may declare that the respondent is liable to make such contribution to the company’s

306 Adrian Walters, ‘Wrongful Trading: Two Recent Cases’ [2001] Insolvency Lawyer 211, 212. 307 [2016] EWHC 243 (Ch), [2016] BCC 293. 308 Ibid., [242], [282]. In Re Ralls Builders Ltd No 2 [2016] EWHC 1812 (Ch), [2016] BCC 581, [21], it was held that the liquidators were not able to claim a contribution under s 214 in respect of the costs incurred in the liquidation of investigating and preparing such a claim or of their own involvement in the conduct of that claim whether or not the court made an award against the directors under s 214. 309 Re Ralls Builders Ltd [2016] EWHC 243 (Ch), [2016] BCC 293, [279]–[280].

136

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

assets as is thought proper; it is a matter left to the court’s discretion310 so that it appears that it is able to award any sum that it thinks is appropriate. The court may in fact, as we have seen in the last section, refrain from ordering any contribution.311 In Re Ralls Builders Ltd312 Snowden J plainly stated that it does not necessarily follow that directors should be required to make a contribution to the company’s assets if they ought to have concluded that there was no reasonable prospect of the company avoiding insolvent liquidation.313 Judicial Discretion 9.140 The court’s discretion under s 214 is unfettered314 (subject to acting judicially and to achieving the purpose of the power) and the aim is to compensate creditors and not to penalise the directors found liable.315 As to the discretion of the court, Registrar Jones in Brooks v Armstrong said that: Whilst compensation reflects the amount of the company’s loss, namely the increase in debt, the fundamental problem of an absence of assets of any significant value due to the adverse consequences of liquidation should not be ignored when exercising the discretion.316

9.141 In that case the registrar thought that it was relevant in the exercise of his discretion that the true position was that the directors continued to trade because if they did not there would be nothing left, and this gave the company a chance to remain in business and did procure some benefit by the mitigation of some debts.317 9.142 Any award is to benefit the creditors as a whole, that is it is paid out on a pari passu basis.318 There is no jurisdiction to provide direct payment to a specific class of creditors or an individual creditor. This is consistent with the position under s 213 and with respect to claims under both s 213 and s 214, the objective of which is to assist the liquidator to recoup the loss to the company in order to benefit all of the creditors of the company.319 Also, the purpose of s 214 is not to provide differential redress for individual creditors, depending upon an assessment of the extent of their loss caused by the period of wrongful trading.320 9.143 Those whose debts are incurred after the date of wrongful trading have no stronger claim than those creditors who existed at the time of the 310 Re Produce Marketing Consortium Ltd (1989) 5 BCC 569, 597; Re Brian D. Pierson (Contractors) Ltd [1999] BCC 26, 49, [2001] BCLC 275, 302. 311 As was the case in Re Ralls Builders Ltd [2016] EWHC 243 (Ch), [2016] BCC 293. 312 Ibid. 313 Ibid., [219]. 314 Re Produce Marketing Consortium Ltd (in liq.) (No.2) (1989) 5 BCC 569, 597. 315 Brooks v Armstrong [2016] EWHC 2893 (Ch), [2015] BCC 661, [287]. 316 Ibid., [304]. 317 Ibid. 318 Re Ralls Builders Ltd [2016] EWHC 243 (Ch), [2016] BCC 293, [236]. 319 Re Purpoint Ltd [1991] BCC 121, 129, [1991] BCLC 491, 499; Re Oasis Merchandising Services Ltd [1995] BCC 911, 918. 320 Ibid.

137

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

commencement of wrongful trading. All creditors at the date of liquidation will suffer from the company’s loss to the extent that the assets of the company have been depleted and/or creditors increased by the decisions and actions of the directors.321 Snowden J in Re Ralls Builders Ltd322 said: a creditor whose debt was incurred after the relevant date cannot claim to recover 100 per cent of his loss in priority to a creditor whose debt was incurred prior to that date and who may only have been marginally disadvantaged (or not disadvantaged at all) by the continuation of trading.323

9.144 How loss is determined was discussed in the previous section of the chapter. What loss has been incurred is likely to affect the final order made. 9.145 Where there are two or more respondents to a claim, a judge is entitled to order the respondents to pay different amounts, depending on their position, knowledge and experience.324 9.146 Notwithstanding the fact that the court has a discretion, in Re Continental Assurance Co of London plc325 Park J noted that while there is a major element of discretion, it is not entirely at large.326 His Lordship appeared to accept that a judge had to determine what is the maximum amount that could be ordered, and then he or she could exercise discretion to reduce that amount. The maximum amount would appear to be the net deficiency in the company’s assets. 9.147 In relation to s 213, it was noted earlier that the Court of Appeal in Morphitis v Bernasconi,327 when dealing with the same wording as in s 214(1), said that the contribution to the assets is to be shared amongst the creditors and should reflect the loss which has been caused to the creditors by the carrying on of the business in the way that gives rise to the exercise of the power,328 and this appears to limit the discretion of judges, certainly when it comes to ascertaining loss. 9.148 Determining what order of contribution should be made is often a difficult matter and might require the judge to hear further argument and evidence, as was the case in Official Receiver v Doshi.329 In Rubin v Gunner330 the court, after making the required declaration, ordered an account in order to ascertain what contribution should in fact be ordered.331 9.149 In the situation where, as is not infrequently the case, there is a lack of accounts, a court may order the directors to be liable to make a contribution 321 Brooks v Armstrong [2016] EWHC 2893 (Ch), [2015] BCC 661, [287]. 322 [2016] EWHC 243 (Ch), [2016] BCC 293. 323 Ibid., [236]. 324 Re Continental Assurance Co of London plc [2001] BPIR 733, 847, Paton, as liquidator of Ricky Martin (Racing) Limited v Kelly Martin, Elizabeth Martin, Richard John Martin [2016] SC AIR 57. 325 Re Continental Assurance Co of London plc [2001] BPIR 733. 326 Ibid., 821. 327 [2003] EWCA Civ 289, [2003] BCC 540. 328 Ibid., [55]. 329 [2001] 2 BCLC 235, 289. 330 [2004] EWHC 316 (Ch), [2004] BCC 684, [2004] 2 BCLC 110. 331 Ibid., [125].

138

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

to the company’s assets equal to the loss caused by the continuation of trading after the date from which wrongful trading commenced quantified in terms of the aggregate of its debts incurred after that date.332 9.150 What a court will not do, according to Re Ralls Builders Ltd No 2,333 is to include in an order a contribution in respect of the costs incurred in the liquidation of investigating and preparing such a claim or of the liquidator’s own involvement in the conduct of that claim.334 Compensation in the Order 9.151 In making an order, is a court limited merely to ordering compensation for the loss sustained, or may it make an order that is penal? In Re Produce Marketing Consortium335 Knox J, said that the jurisdiction under s 214 is ‘primarily compensatory’336 (author’s emphasis). This is consistent with the fact that the Court of Appeal in Re Farmizer (Products) Ltd337 said that the basis of the claim under the provision is that it is to compensate for loss caused to the creditors of the company through wrongful trading.338 9.152 While in Re Produce Marketing Consortium Ltd339 Knox J accepted that the contributions should be the amount by which the company’s assets can be regarded as being depleted by the wrongful trading of the directors, the judge seemed to leave open the possibility of being able to take into account the fact that a director was culpable, with the result that courts may treat directors who have been reckless more harshly than those who have acted honestly, and perhaps naively.340 This position was favoured by the judge in Re Brian D. Pierson.341 It has been asserted, on the basis that the courts have a broad discretion, that the courts may take into account the fact that a director was culpable when considering the wrongful trading.342 So, perhaps the making of untruths by directors may be taken into account, as might the ignoring of warnings from the company’s auditors. Other factors that might be taken into account in determining the amount of the contribution are: the fact that the company’s position was worsened by issues outside of the directors’ control or reasonable anticipation; the directors received no warnings from advisers; the attitude of the directors to advice; and whether a director relied on the experience and dominance of other directors.343 332 Re Purpoint Ltd [1991] BCC 121, 129, [1991] BCLC 491, Re Kudos Business Solutions Ltd (in liq) [2011] EWHC 1436 (Ch), [2012] 2 BCLC 65, [62]. 333 [2016] EWHC 1812 (Ch), [2016] BCC 581. 334 Ibid., [21]. 335 Re Produce Marketing Consortium Ltd (in liq.) (No.2) (1989) 5 BCC 569. 336 Ibid., 597. 337 [1997] BCC 655. 338 Ibid., 662. 339 Re Produce Marketing Consortium Ltd (in liq.) (No.2) (1989) 5 BCC 569. 340 Ibid., 597–598. 341 [1999] BCC 26, 55, [2001] BCLC 275, 310. 342 Stephen Griffin, Personal Liability and Disqualification of Company Directors (Hart Publishing, 1999), 83. 343 Re Brian D. Pierson (Contractors) Ltd [2001] BCLC 275, 310–311.

139

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

9.153 Therefore, while no actions of the directors will, it appears, lead to penal awards, if directors have acted honestly, the award might be reduced. 9.154 We have noted already that creditors whose debts are incurred after the point when the directors are said to have begun to engage in wrongful trading have no better claim than the pre–wrongful trading creditors as both classes of creditors suffer to the extent that assets are depleted by the wrongful trading.344 The criticism of the present system of compensation has been that the persons who have been the real victims of the wrongful trading, namely those who became creditors subsequent to the time when wrongful trading commenced, do not receive all or a greater part of the compensation, for some of it will go to persons who had become creditors prior to the advent of wrongful trading.345 Payment of Existing Debts With New Money 9.155 The case law has taken the view that if directors rack up new debt during a period of wrongful trading and use the money to pay off old debt, then liquidators have to rely on taking proceedings under the preference provision, s 239 of the Act to recoup the money paid out.346 And, if there is no desire to prefer on the part of the company in paying off old debt (and where it would fall foul of s 239 of the Act), then provided the net deficit of the company does not increase during the wrongful trading period there can be no effective remedy unless the liquidators could claim that the directors had failed to take account of the interests of the creditors and were in breach of s 172(3) of the Companies Act 2006. This duty is discussed later and specifically the issue of whether the duty could be employed in the kind of situation envisaged here. 9.156 Clearly Park J in Re Continental Assurance Co of London plc347 was not concerned that some creditors might have been ‘preferred’ to others during the wrongful trading period in that they were paid out from new money.348 According to the judge, that was a matter for s 239 and the law on preferences. His Lordship said that: ‘it would be anomalous for a liquidator nevertheless to be able to rectify an “innocent” preference by proceeding instead against the directors under s 214.’349 9.157 In Brooks v Armstrong,350 Registrar Jones noted that the directors wrongly discriminated between creditors, as to who got paid, but there was no dishonesty or intent to commit a wrongdoing and, therefore, he made no award.351

344 345 346 347 348 349 350 351

Re Purpoint Ltd [1991] BCC 121, 129, [1991] BCLC 491, 499. A Hicks, ‘Advising on Wrongful Trading: Part 1’ (1993) 14 Company Lawyer 16, 17. Re Ralls Builders Ltd [2016] EWHC 243 (Ch), [2016] BCC 293, [251]. Re Continental Assurance Co of London plc [2001] BPIR 733, 864. Ibid. Ibid., 865. [2016] EWHC 2893 (Ch), [2015] BCC 661. Ibid., [303].

140

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

9.158 In Re Ralls Builders Ltd,352 Snowden J said that the directors ought not to be entitled to an outright defence under s 214(3) (a matter discussed in the next chapter) because of the manner in which they chose to continue trading led to some of the existing creditors being paid at the expense of new creditors who ended up not being paid. The judge said that: Irrespective of whether or not that amounted to a breach of duty to the company, a preference under s.239, or fraudulent trading under s.213, that is not, in my judgment, a regime which the directors ought to have allowed to operate after the time at which they ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation.353

9.159 Nevertheless, the judge opined that he could not make an award against the directors, on the terms of s 214, because there was no increase in the net deficit. The end result in Re Ralls Builders Ltd has been criticised by several commentators.354 Snowden J said that if the result was unjust it was a problem with the structure of s 214 and any perceived shortcomings in the provision was, of course, a matter for Parliament.355 Whilst it is outside of the scope of this present work to consider what should be done about the law, if anything, it is submitted that the present state of affairs does appear to be potentially unjust and certainly not in accord with the recommendations of the Cork Report. The structure of s 214 is faulty and not fit for purpose. The fact is that those persons who become creditors after the commencement of wrongful trading and whose credit is used to pay off earlier creditors, will usually be the ones to lose out. Gabriel Moss QC put it most adroitly when he said that: ‘The approach in Produce Marketing and Ralls Builders provides directors with the perverse incentive of continuing to trade as long as they are careful to “rob Peter to pay Paul” and to make sure that the net deficit remains constant.’356 9.160 The idea that the court must focus on the net deficit and not the loss to creditors seems to find its genesis in Re Produce Marketing Consortium Ltd,357 and it has generally been followed without question in the subsequent case law. In the relatively early decision of Re DKG Contractors Ltd,358 John Weeks QC (sitting as a deputy Judge of the High Court) said that the directors who were held to have engaged in wrongful trading were to make a contribution equal to the amount of the trade debts incurred by the company on or after the date from which the directors knew or ought to have concluded that the company could not

352 [2016] EWHC 243 (Ch), [2016] BCC 293. 353 Ibid., [246]. 354 For example, Gabriel Moss QC, ‘No Compensation for Wrongful Trading – Where Did it All Go Wrong?’ (2017) 30 Insolvency Intelligence 49. 355 Re Ralls Builders Ltd [2016] EWHC 243 (Ch), [2016] BCC 293, [279]. 356 ‘No Compensation for Wrongful Trading – Where Did it All Go Wrong?’ (2017) 30 Insolvency Intelligence 49, 51. This supports the approach taken in New Zealand, see Yan v Mainzeal Property and Construction Ltd [2021] NZCA 99, [269]. 357 (1989) 5 BCC 569. 358 [1990] BCC 903.

141

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

reasonably avoid insolvency liquidation.359 Yet, this comment does not appear to have attracted any support or judicial remark in subsequent cases. However, interestingly, in Jackson v Casey360 ICC Judge Prentis said that: ‘a net deficiency approach to quantification of loss could never have been appropriate; and no other has been proposed.’361 This suggests that an approach different from ascertaining the net deficiency was in fact possible in making out a case for an award. 9.161 It will be recalled that in cases such as Re Purpoint Ltd,362 Re Langreen Limited,363 Re Idessa UK Ltd364 and Re Kudos Business Solutions Limited365 the respective courts did not make an order based on net deficit; they employed a different way of constructing an order. The courts ordered a contribution to the company’s assets equal to the loss caused by the continuation of trading after the date from which wrongful trading commenced quantified in terms of the aggregate of its debts incurred after that date. Admittedly this approach was adopted because of the poor record keeping of the companies and the courts had to be pragmatic, but it does demonstrate that the idea that an award can only be made where there is a net deficit is not, perhaps, as ingrained as one might think. 9.162 The point might be made that the way that the law has been interpreted in the most publicised cases, such as Re Continental Assurance Co of London plc366 and Re Ralls Builders Ltd,367 does seem to mean that it will restrict the number of actions initiated by liquidators because liquidators might be extremely fearful of a court, while finding that the directors knew or ought to have concluded that the company could not avoid insolvent liquidation, and no defence was available to the directors, holding that there was no increase in the net deficit and, therefore, there would be no award.368 Concurrent and Additional Liability 9.163 Where a claim is made pursuant to both s 212 (perhaps for a breach of the obligation to consider creditors’ interests) and s 214, not an unusual occurrence, there is no injustice in ordering payments under both provisions provided that the liquidator does not recover more than was required to satisfy the liabilities of the company and the expenses of the liquidation;369 that is, there is no double counting. Thus, any liability under s 212 is to go to satisfying 359 Ibid., 912. 360 [2019] EWHC 1657 (Ch). 361 Ibid., [231]. 362 [1991] BCC 121, 128, [1991] BCLC 491. 363 Unreported, Ch D, 21 October 2011. 364 [2011] EWHC 804 (Ch), [2012] BCC 315. 365 [2011] EWHC 1436 (Ch), [2012] 2 BCLC 6. 366 Re Continental Assurance Co of London plc [2001] BPIR 733, 864. 367 [2016] EWHC 243 (Ch), [2016] BCC 293. 368 In his criticism of the present state of affairs Gabriel Moss QC said that: ‘The present position on quantum hugely reduces the value of the wrongful trading remedy’ (‘No Compensation for Wrongful Trading – Where Did it All Go Wrong?’ (2017) 30 Insolvency Intelligence 49, 53). 369 Re Purpoint Ltd [1991] BCC 121, 128, [1991] BCLC 491, 499, Re Kudos Business Solutions Limited [2011] EWHC 1436 (Ch), [2012] 2 BCLC 65, [63].

142

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

the liability under s 214,370 and vice versa.371 Professor Sir Roy Goode points out that ‘to the extent that recovery for an unconnected loss under section 212 reduces the net deficiency below the amount of the loss caused by the director’s breach of section 214 his liability under that section will abate.’372 Of course, liability under a cause of action falling within a s 212 proceeding and relating to events occurring before the commencement of wrongful trading under s 214 might well mean that there is a contribution additional to that ordered to be paid by the directors under s 214. 9.164 In Re Idessa (UK) Ltd373 Lesley Anderson QC set out how one should go about determining the relief where there is concurrency of relief between claims under ss 212 and 214. They are as follows. First, it is necessary to ascertain the total amount of the misfeasance claim. Secondly, the court has to consider whether the loss caused by the misfeasance claim is the same as, or part, of the loss represented by the claim for wrongful trading. Thirdly, in undertaking the foregoing, breaches of duty prior to the day when wrongful trading commenced are not able to form part of the claim under s 214 and, in principle, the applicant is entitled to recover under the claim for breaches of duty as well as under s 214. Fourthly, in respect of breaches of duty (and claimed under s 212) which occurred after the commencement of wrongful trading, the underlying facts and matters which support the breaches of duty claim also underpin the wrongful trading claim; then there is duplication and thus the correct approach is that recoveries under the s 212 claim after the commencement of wrongful trading will reduce pro tanto the quantum of the claim under s 214, as the net deficiency experienced by the company is reduced.374 Fifthly, recoveries in respect of those unconnected breaches of duty under s 212 prior to wrongful trading remain relevant because insofar as they reduce the net deficiency below the amount of the respondents’ liability under s 214, that liability will reduce accordingly. Sixthly, once one has determined the misfeasance liabilities prior to and after the date of commencement of wrongful trading one must assess how the net deficit is affected by payment of the misfeasance claim as at the date when wrongful trading commenced, and as at the date of the actual insolvency.375 Division of Liability 9.165 The division of the contribution made by directors can be important to creditors, as any money paid because of an order under s 212 is regarded as a company asset, and a secured creditor with a charge will usually be entitled 370 Re DKG Contractors Ltd [1990] BCC 903, 912; Re Kudos Business Solutions Limited [2011] EWHC 1436 (Ch), [2012] 2 BCLC 65, [63]; Re Idessa (UK) Ltd [2011] EWHC 804 (Ch), [2012] BCC 315, [125]. 371 The case in Brooks v Armstrong [2015] EWHC 2289 (Ch), [2015] BCC 661, [309]. 372 Roy Goode, Principles of Corporate Insolvency Law (2nd ed, Sweet and Maxwell, 1997), 462. 373 [2011] EWHC 804 (Ch), [2012] BCC 315, [128]. 374 See Re DKG Contractors Ltd [1990] BCC 903. 375 Re Idessa (UK) Ltd [2011] EWHC 804 (Ch), [2012] BCC 315, [128].

143

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

to payment before anything goes to the general creditors, whereas money paid under an order made for wrongful trading is not the company’s asset376 and will be distributed among all creditors. 9.166 Where more than one director is subject to proceedings, the court has a discretion whether to hold that the directors are to be jointly and severally liable on the one hand or severally liable on the other.377 The courts in Re Produce Marketing378 and Re DKG Contractors Ltd379 made orders encompassing the first alternative. In the former case the judge felt that one director should be liable for more than the other as he had more experience and was senior.380 In Re Continental Assurance of London plc381 the judge did not hold the directors liable, but he said that if he had held them liable it would not have been appropriate to embrace the first alternative; he saw several liability as the starting point and then a court could exercise its discretion and make the director jointly and severally liable if it chose to do so.382 Park J’s reason for this view was that the provision’s focus is on ‘an individual director and his conduct, not on the joint conduct of a board of directors as a whole,’383 hence he would have ordered several liability in the case before him if he felt that the directors were indeed liable.384 9.167 Where more than one director is involved in an action, a judge can order the various respondents to pay different amounts, depending on their position, knowledge and experience.385 Other Matters Contained in Orders 9.168 A judge may include in the contribution awarded against a respondent an amount covering interest in order to compensate the creditors for the time that has elapsed.386 9.169 Where a court makes a declaration against the respondent to a s 214 application, it is according to s 215(2), at its discretion, empowered to make further directions to give effect to its declaration. In particular it may provide for the liability of the respondent under the declaration to be a charge on any debt or obligation due from the company to the respondent, or on any mortgagee or charge or any interest in a mortgage or charge on assets of the company held by

376 Insolvency Act 1986, s 176ZB. 377 Re Brian D. Pierson (Contractors) Ltd [1999] BCC 26, 57, [2001] BCLC 275, 311; Re Continental Assurance Co of London plc [2001] BPIR 733, 847; Re Idessa (UK) Ltd [2011] EWHC 804 (Ch), [2012] BCC 315, [129]. 378 Re Produce Marketing Consortium Ltd (in liq.) (No.2) (1989) 5 BCC 569, 598. 379 [1990] BCC 903, 912. 380 Re Produce Marketing Consortium Ltd (in liq.) (No.2) (1989) 5 BCC 569, 598. 381 [2001] BPIR 733. 382 Ibid., 846, 847. 383 Ibid., 846. 384 Ibid., 847. 385 Ibid. 386 Re Produce Marketing Consortium Ltd (1989) BCLC 520, 554 (this is not in the BCC report).

144

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

or vested in the respondent, or any person on behalf of the respondent, or any person claiming as assignee from or through the respondent.387 Also, the court may, from time to time, make such further or other order as may be necessary for enforcing any charge imposed under s 215.388 9.170 Section 215(4) provides that in the case of a court declaration against a person that is liable for wrongful trading, the court may direct that the whole or any part of a debt owed by the company to the guilty person is to rank after all other debts owed and interest payable on those debts. The Effects of an Order 9.171 Even though s 214 is an action for the recovery of a sum of money which a court declares a respondent liable to contribute and if a director is liable the court must make an order for a sum of money,389 liquidators are entitled to accept property other than money from directors when the latter seek to satisfy any award against them.390 9.172 Perhaps one of the major issues facing a liquidator who is granted an award of funds as a result of litigation is to know to whom the funds should be distributed. One of the primary questions is whether a holder of a charge over company assets is given any priority in relation to the funds recovered. While in the judgment in Re Produce Marketing Consortium Ltd391 Knox J stated that the chargeholder would have a charge over anything that the respondents paid under his order,392 his Lordship did indicate that he disagreed with this state of affairs and that if ‘this jurisdiction is to be exercised, as in my judgment it should be in this case, it needs to be exercised in a way which will benefit unsecured creditors.’393 9.173 Subsequently, the Court of Appeal in Re Oasis Merchandising Services Ltd394 stated that the discretion given to courts under s 214 is to be exercised in order to benefit unsecured creditors.395 The Court indicated that any award would not constitute property of the company; a liquidator is taking proceedings under s 214 on behalf of the creditors and contributories of the company, so any money recovered will be paid to them and not paid out first to creditors who hold charges. This accords with the thinking of the Cork Committee and overturns the decision in Produce Marketing.396 As a consequence, chargeholders will merely rank with all other creditors in relation to any pay out, and only in so far as they are not secured. 387 388 389 390 391 392 393 394 395 396

Section 215(2)(a). See Re Farmizer (Products) Ltd [1997] BCC 655, 662 (CA). Section 215(2)(b). [1997] BCC 655, 662 (CA). Re Farmizer (Products) Ltd [1997] BCC 655, 662 (CA). (1989) 5 BCC 569. Ibid., 598. Ibid. [1998] Ch 170. Ibid., 185. (1989) 5 BCC 569.

145

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

9.174 Professor Rebecca Parry has pointed out that it could be argued that a chargeholder would be prejudiced by wrongful trading just as much as any other creditor, as demonstrated by many disqualification cases where companies have traded on while insolvent, doing so at the expense of the Crown.397 This has often involved companies using unremitted deductions of tax from employees’ wages to enable them to continue to do business, a practice that has been condemned by the courts,398 and it might lead to the making of a director’s disqualification order under s 6 of the Company Directors’ Disqualification Act 1986.399 The thrust of Parry’s observation was that the Crown had preferential status and would be able to recover from company funds what was owed before the chargeholder. Of course, while the Crown lost its broad preferential right, taken away by the Enterprise Act 2002 (from 15 September 2003), from 1 December 2020 the Crown has had reinstated to it a partial preferential right.400 The chargeholder is only prejudiced if the funds of the company are reduced below what the chargeholder is owed, and the chargeholder, if holding a charge over the whole, or substantially the whole, of the company’s assets, is able to protect itself as it is entitled to appoint either an administrative receiver (if the charge pre-dates 15 September 2003) or an administrator. In contrast, unsecured creditors cannot appoint either of these office holders extra-judicially, although they could apply for an administration order from the court. 9.175 In any event this is all rather academic, as the legislature introduced in 2015, through s 119 of the Small Business, Enterprise and Employment Act 2015, s 176ZB of the Act401 and this new provision in the Act, put in force from 1 October 2015, made it clear in subs (2) that the proceeds of a claim under s 214 (as well as claims, inter alia, under s 213), including assignments of claims to others, are not to be treated as part of the company’s net property, namely the amount of its property which would be available for satisfaction of claims of holders of debentures secured by, or holders of, any floating charge created by the company. 9.176 A disadvantage that follows from the view that a floating chargeholder receives no priority in relation to any order made is that the chargeholder will not be inclined to assist in funding a wrongful trading action, and this removes a significant potential source for funding. However, now and ever since its introduction, s 176ZA provides that the expenses of litigation may be paid out of assets covered by floating charges if it is approved of by the security holder or the court.402 397 ‘The Destination of Proceeds of Insolvency Litigation’ (2002) 23 Company Lawyer 49, 55. 398 Re Stanford Services Ltd [1987] BCLC 607; In re Lo-Line Electric Motors Ltd [1988] Ch 477, 486. 399 Re Bath Glass Ltd ([1988] BCLC 329, 333; Re Sevenoaks Stationers (Retail) Ltd [1991] 1 Ch 164, 183–184 (CA). 400 See, The Insolvency Act 1986 (HMRC Debts: Priority on Insolvency) Regulations 2020. 401 Section 176ZB came into force through the passing of reg 2(j) of the Small Business, Enterprise and Employment Act 2015 (Commencement No.2 and Transitional Provisions) Regulations, SI 2015/1689. 402 See Insolvency Rules 2016, rr 6.44–48 and 7.111–116.

146

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

9.177 One issue that might be worth raising is whether those who became creditors during the period of wrongful trading warrant being paid the funds recovered as they have been, arguably, most wronged by the directors’ actions. But, as mentioned earlier, the courts have held that they cannot make orders in favour of particular creditors, as the objective is to assist the liquidator to recoup the loss to the company so as to benefit all of the creditors of the company.403 In Re Purpoint Ltd404 Vinelott J said that those who became creditors before the commencement of wrongful trading are equally prejudiced by the loss of funds. This view can be justified on the basis that earlier creditors would receive more on a distribution in the liquidation if the directors had not engaged in wrongful trading, because for liability for wrongful trading to exist the company must have incurred losses which involved taking on more debt and prejudicing the creditors. 9.178 If a person is found to have been involved in wrongful trading and is liable to make a contribution to the assets of the company then the court may, on application or of its own volition, and pursuant to s 10 of the Company Directors’ Disqualification Act 1986, make a disqualification order thereby disqualifying the person from acting as a director or taking part in the management of a company.405 As mentioned earlier, it is possible for an application under s 214 to be consolidated with disqualification proceedings.406 9.179 What if an order is made under both s 212 and s 214 and the director against whom the order is made is unable to satisfy the amount involved? This is a relevant issue because of the fact that those with charges over company property are going to be entitled to be paid first out of funds recovered under the former provision, but not under the latter. It has been stated that the court has a discretion in making an order and it is for it to consider what effects justice in the matter.407 However, when the court makes an order it will not know whether the director is able to pay the sum ordered to be paid. But it has been suggested, adroitly, that: [T]he most appropriate solution would seem to be to respect the debenture holder’s rights as regards assets recovered in a proprietary claim and to divide the total sum awarded in respect of the director’s personal liability between the two heads of claim in the proportion which each bears to the total.408

9.180 The point should be made that directors held liable are not able to set-off any payment which they are owed by the company against the amount awarded by the court. The reasons for this are as follows: First, there is an absence of 403 Re Purpoint Ltd [1991] BCC 121, 129, [1991] BCLC 491, 499; Re Oasis Merchandising Services Ltd [1995] BCC 911, 918. 404 [1991] BCC 121, 129, [1991] BCLC 491. 405 The maximum period of disqualification is 15 years: s 10(3). See Re Brian D. Pierson (Contractors) Ltd [1999] BCC 26, 55, [2001] BCLC 275 for a case where the respondents were found to have been guilty of wrongful trading and were disqualified from acting as directors as a result. 406 Official Receiver v Doshi [2001] 2 BCLC 235. 407 Kristin van Zwieten, Goode on Principles of Corporate Insolvency Law (5th ed., Sweet and Maxwell, 2019), 780. 408 Ibid.

147

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

mutual dealings, as the debt owed by the company involves a dealing between the director and the company, and the wrongful trading issue is between the director and the liquidator.409 This reasoning has also applied in relation to the recovery of preferences paid to company creditors.410 Secondly, s 214 creates ‘a liability to contribute to the general assets of the company; and, since they do not give a right of set-off, the statutory ability to contribute extends to the whole amount ordered to be paid.’411 Thirdly, on policy grounds it would be wrong, for, as Oditah has stated: ‘it is not right that a director . . . guilty of wrongful . . . trading should have his liability to contribute converted into a debt so as to provide him with a right of set-off.’412 Compensation Orders Under the Company Directors’ Disqualification Act 1986 9.181 Section 15A of the Company Directors’ Disqualification Act 1986413 provides that a court, whilst ordering the disqualification of a director of an insolvent company (or within two years of any such disqualification), may also order that the disqualified person is to compensate creditors for the loss that his or her conduct caused, provided it led to loss suffered by one or more creditors. The order may be made in favour of specific creditors who have suffered loss or more generally in favour of all creditors. The overall effect of the court exercising this discretion is both to protect the public from unfit directors but also to compensate those creditors who have suffered loss due to the unfit conduct of those directors. 9.182 One ground for disqualifying a director is engaging in wrongful trading.414 A claim could be made by the Secretary of State, in accordance with the Company Directors’ Disqualification Act 1986 (‘the CDDA’), rather than the liquidator bringing proceedings under s 214, for a disqualification order based on wrongful trading, and a compensation order may ensue if the director is disqualified. 9.183 Section 15B of the CDDA contains a discretion extending both to the amount of any compensation order and for whose benefit it is payable.415 In considering the amount to be awarded in a compensation order s 15B requires the court to have regard to the amount of the loss, the nature of the conduct and whether the person had made any other financial recompense.416 409 Guiness plc v Saunders [1988] 1 WLR 863 and affirmed on appeal [1990] 2 WLR 324. 410 Re A Debtor [1927] 1 Ch 410, 419. 411 Fidelis Oditah, ‘Wrongful Trading’ [1990] LMCLQ 205, 222 and referring to Re Anglo-French Co-operative Society (1882) 21 Ch D 492. 412 Oditah, ibid. 413 It was inserted by s 110 of the Small Business Enterprise and Employment Act 2015 and came into force on 1 October 2015. 414 Company Directors’ Disqualification Act 1986, s 10. 415 Re Noble Vintners Ltd [2019] EWHC 2806 (Ch) [2020] BCC 198, [41]. In this case the director had been disqualified under s 6 of the Company Directors’ Disqualification Act 1986. 416 Ibid., [42].

148

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

9.184 The employment of s 15A of the CDDA might be a way of getting around the problem evident in cases like Re Ralls Builders Ltd,417 where the liquidator could not establish any net deficit even though the directors had been guilty of wrongful trading. This is because under s 15A the Secretary of State only has to establish loss to one or more creditors and not loss to the company. So, one would think, given facts similar to Ralls Builders, the Secretary of State might, assuming a disqualification order were made, be able to get a compensation order as some who became creditors subsequent to the point when the directors engaged in wrongful trading suffered losses. Of course, the Secretary of State might reason that directors’ conduct did not warrant a disqualification application and so no compensation could be ordered. 9.185 The disadvantage of an application by the Secretary of State for liquidators in these circumstances is that they would have to rely on the Secretary of State taking action and they also would not earn fees in getting up and running an action. It might also be problematic for creditors in that they could not force the Secretary of State to take disqualification proceedings and seek a compensation order, while they might be able to bring pressure to bear on a liquidator to take wrongful trading proceedings. Of course, if the Secretary of State was minded to bring disqualification proceedings and also seek a compensation order it might certainly be fruitful for creditors. The Public Factor 9.186 While the main thrust of s 214 is to compensate creditors of companies in insolvent liquidation, it also plays a public role. If a person is guilty of wrongful trading there is no criminal sanction to be imposed. If it is thought that what a person has done is fraudulent then proceedings may be initiated under s 993 of the Companies Act 2006. Nevertheless, the fact that wrongful trading does not lead to criminal liability should not be seen as an indication that s 214 has no public role to play. On the contrary, it is intended to play a public as well as a private role. If wrongful trading is found to have occurred, the court is at liberty, of its own volition, as discussed earlier, to disqualify the director from being involved in the management of companies for a period of up to 15 years.418 This has occurred in a number of cases, with Re Brian D. Pierson (Contractors) Ltd419 being one prime example. 9.187 Clearly, s 214 has both a private law and a public law function. Robert Walker J in Re Oasis Merchandising Services Ltd420 adverted to the public element in s 214 proceedings, which involves an attempt to prescribe a minimum standard of conduct of directors in managing the affairs of companies.421 The

417 418 419 420 421

Re Ralls Builders Ltd [2016] EWHC 243 (Ch), [2016] BCC 293. CDDA, s 10(2). [1999] BCC 26, 55, [2001] BCLC 275. Re Oasis Merchandising Services Ltd [1995] BCC 911. Ibid., 918.

149

AN EX POSITION OF THE W RONGFU L TR A DI NG PROVISION A N D ITS SCOPE

public function is marked by the fact that it is linked to disqualification, the latter being an attempt to protect the public from reckless and/or dishonest directors. Conclusion 9.188 The chapter has set out and explained the conditions that are needed to bring a successful action under s 214 for wrongful trading. It has identified and addressed the threads that can be seen running though the existing case law. There is no doubt that most wrongful trading actions will be complicated in several ways. Three are worth mentioning. First, establishing either actual or deemed knowledge on the part of the respondent directors that there was no reasonable prospect of their company avoiding insolvent liquidation. Secondly, establishing the point in time from when the directors had this knowledge. Thirdly, proving that the company experienced a net deficit between the point when wrongful trading commenced and when the company either stopped trading or entered liquidation/administration. 9.189 As stated in Chapter 8, when wrongful trading was first enacted there was a good deal of optimism that it would be a significant weapon in the arsenal of liquidators. While there were early successes for liquidators, as time went on there were fewer successes and even in cases where wrongful trading was established, liquidators, such as those in Re Ralls Builders Ltd,422 were not favoured with an award, as there was not a net deficit. In this and other cases creditors have lost out not only from a depletion of company assets but from long and expensive litigation. 9.190 Wrongful trading cases can be quite complex and difficult to run, as they often involve a lot of documentary evidence, evidence given by witnesses many years after the relevant occurred and the need to consider accounting records and practices. 9.191 While directors might be able to argue successfully that they did not engage in wrongful trading within s 214 or that they can employ the defence in s 214(3) and discussed in the next chapter, a liquidator might be able to rely on other grounds for succeeding against directors. Often these are breaches of directors’ duties set out in ss 171–177 of the Companies Act 2006. In particular, the liquidator might claim that the directors failed to take into account the interests of creditors when the company was insolvent or bordering insolvency. This matter is discussed in Part D of the book.

422 [2016] EWHC 243 (Ch), [2016] BCC 293.

150

CHAPTER 10

The Wrongful Trading Defence

Introduction 10.1 In the previous chapter we examined the scope of the wrongful trading provision and focused on what conditions must be satisfied to hold a director liable. We now turn to consider when directors might be able to defend successfully any action brought against them and where the liquidator is able to satisfy the elements of a claim under s 214 of the Insolvency Act 1986 (‘the Act’). Naturally, the director need only establish the defence in s 214 once the liquidator’s case has been made out.1 But it should be noted that prima facie the liquidator is not required to prove that a director participated in irresponsible conduct, for all that he or she has to do is to establish that the director knew or ought to have concluded that there was no reasonable prospect of the company not going into insolvent liquidation. Once that has been established then the burden is thrown on the respondents to extricate themselves by making out the defence provided. 10.2 The chapter explores what is entailed in establishing the defence and what issues result from it for directors and liquidators alike; particular emphasis is placed on ascertaining the meaning of ‘every step’ in s 214(3), an essential part of the defence. This sub-section is explained in the first part of the chapter. The Substance of the Defence 10.3 The solitary defence to a wrongful trading action is found in s 214(3), which provides that a director is not liable for wrongful trading where the court is satisfied that after becoming or ought to have become aware that the company was bound for insolvent liquidation, the director took ‘every step with a view to minimising the potential loss to the company’s creditors as (assuming him to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation) he ought to have taken.’ If the court comes to the conclusion that directors took every step etc. then they are not going to be liable even if their efforts fail to keep their company from experiencing insolvent

1 For example, see, Re Produce Marketing Consortium Ltd (1989) 5 BCC 569, 596.

DOI: 10.4324/9780429266232-13

151

THE W RONGFU L TR A DI NG DEFENCE

liquidation and the losses of creditors are not in fact minimised.2 The requirement for the directors is to take ‘every step’ to minimise loss to creditors and applying the test in s 214(4) (see [10.05]) this involves the directors aiming to minimise loss for all of the creditors and if the directors have the aim of minimising the loss for some they are not going to be able to satisfy the defence.3 10.4 Once liquidators have made out a case, respondents have a positive burden placed on them of establishing the elements of the defence, on the balance of probabilities.4 In Brooks v Armstrong5 Registrar Jones (as he then was) explained that if Parliament had intended the burden of proof to be upon the applicant/liquidator, it would have expressly provided in the legislation that a declaration could not be made by a court unless the applicant was able to satisfy the court that every step had not been taken. Also, it was more logical to place such an onus upon the respondents in circumstances where they have been trading, knowing there was no reasonable prospect of avoiding insolvent liquidation, as they will be aware of the company’s situation.6 The critical issue is, as we shall see, what ‘every step’ entails? 10.5 In determining whether the defence is made out or not, that is did the director take every step, the court is required by s 214(4) to consider if the director took the steps which a reasonably diligent person who has the general knowledge, skill and experience that may reasonably be expected of a person who carries out the same functions as are carried out by the respondent director, and the general knowledge, skill and experience that the respondent director has, would have taken.7 This is the same factor that applies in deciding whether or not directors fall within the condition for liability, that is did they have the requisite knowledge (actual or deemed) that there was no reasonable prospect of the company avoiding insolvent liquidation. 10.6 Again, as with consideration of the requisite knowledge, in considering steps to be taken directors are not able to rely on their inexperience as a defence. Nor is the experienced director who is above average in terms of expertise and experience able to argue that he or she did what the reasonable person would have done and so should be excused from liability. In this case, where the standard expected of a reasonable person would be less than for a person with the director’s experience and skill then the higher standard will be used to judge the director. 10.7 As noted earlier, if directors can demonstrate that they took every step, they avoid liability even if they do not actually succeed in minimising the potential loss to the creditors.8 2 Re Ralls Builders Ltd [2016] EWHC 243 (Ch), [2016] BCC 293, [244]. 3 Brooks v Armstrong [2015] EWHC 2289 (Ch), [2015] BCC 661, [276]. 4 Re Idessa (UK) Ltd [2011] EWHC 804 (Ch), [2012] BCC 315, [113], [120]; Brooks, ibid., [7]. While the latter decision was partly reversed on appeal, this view was not criticised: [2016] EWHC 2893 (Ch), [2017] BCC 99. 5 Brooks, ibid. 6 Ibid., [7]. 7 This was effectively affirmed by Registrar Jones in ibid., [10]. 8 Re Brian D. Pierson (Contractors) Ltd [1999] BCC 26, 54, [2001] BCLC 275, 309; Re Ralls Builders Ltd [2016] EWHC 243 (Ch), [2016] BCC 293, [244].

152

THE W RONGFU L TR A DI NG DEFENCE

10.8 The difficulty with the defence is that there is nothing in s 214 which tells us what is actually required for a director to be found not liable. The provision does not state the steps that should be taken by a director. Of course, what is to be done is heavily dependent on the particular situation facing directors.9 What might be entirely appropriate in one case might be totally inappropriate in another. It is possible to say that what directors must not do if they have the requisite knowledge for wrongful trading is: nothing. The ‘head in the sand’ approach is unforgivable in the context of s 214. 10.9 In Re Continental Assurance Co of London Ltd10 Park J found for the directors and said that their actions were to be contrasted with those of directors who ‘closed their eyes to the reality of the company’s position, and carried on trading long after it should have been obvious to them that the company was insolvent and that there was no way out for it.’11 To escape liability the directors must be seen to be engaging in some action in light of the company’s financial problems, something that Park J thought the directors in Re Continental Assurance were doing. Thus, even if a director determines that the company should continue to trade a director must do something fresh, as it is likely that the company will not avoid insolvent liquidation if a director does nothing. The judgment of Hazel Williamson QC (sitting as a deputy judge of the High Court) in Re Brian D. Pierson (Contractors) Ltd12 is consistent with that view. The deputy judge said that s 214(3): ‘is intended to apply to cases where, for example, directors take specific steps with a view to preserving or realising assets or claims for the benefit of creditors, even if they fail to achieve that result.’13 What Constitutes ‘Every Step’? Introduction 10.10 Initially, we should acknowledge the fact that when faced with a company that is insolvent or rapidly heading that way, directors find themselves, very often, in the sort of dilemma explained by Park J in Re Continental Assurance of London plc:14 An overall point which needs to be kept in mind throughout is that, whenever a company is in financial trouble and the directors have a difficult decision to make whether to close down and go into liquidation, or whether instead to trade on and hope to turn the corner, they can be in a real and unenviable dilemma. On the one hand, if they decide to trade on but things do not work out and the company, later rather than sooner, goes into liquidation, they may find themselves in the situation of the respondents in this case – being sued for wrongful trading. On the other hand,

9 10 11 12 13 14

Brooks v Armstrong [2015] EWHC 2289 (Ch), [2015] BCC 661, [259]. [2001] BPIR 733. Ibid., 769. [1999] BCC 26, [2001] BCLC 275. Ibid., 54; 309. [2001] BPIR 733.

153

THE W RONGFU L TR A DI NG DEFENCE

if the directors decide to close down immediately and cause the company to go into early liquidation . . . they are at risk of being criticised on other grounds. A decision to close down will almost certainly mean that the ensuing liquidation will be an insolvent one. . . . They [the creditors] will complain bitterly that the directors shut down too soon; they will say that the directors ought to have had more courage and kept going. If they had done, so the complaining creditors will say, the company probably would have survived and all of its debts would have been paid. Ceasing to trade and liquidating too soon can be stigmatised as the cowards’ way out.15

10.11 Blackburn J, when giving judgment in a disqualification case, Secretary of State for Trade and Industry v Gill,16 agreed with these sentiments. 10.12 The provision does not enumerate actions that may constitute the step(s) which a director ought to take, and therein lies the problem for directors and their advisers. Guidelines have not been developed in the cases as to what directors should do, and although one can obtain some assistance from judgments, overall there is little in the way of judicial statements on the defence and the scope of ‘every step.’ The following discussion represents an attempt to ascertain what has been said by judges in order that it may inform us, to some degree, about the scope of s 214(3). 10.13 One thing is clear, in terms of general principle, is that the director: [W]ill ordinarily be required to establish that his participation in the company’s affairs was, as from the date upon which he realised that there was no reasonable prospect of the company avoiding liquidation, both active and geared to the protection of the interests of corporate creditors.17

10.14 Snowden J said in Re Ralls Builders Ltd18 that s 214(3) requires directors seeking to avail themselves of the defence contained in it: ‘to demonstrate not only that continued trading was intended to reduce the net deficiency of the company, but also that it was designed appropriately so as to minimise the risk of loss to individual creditors.’19 10.15 The use of the words ‘every step’ might be said to be too strong, for if one wanted to be strict, the defence is, except in rare cases, almost impossible to establish. As Professor Sir Roy Goode once said, in relation to the words ‘every step,’ this may mean no more than, given the reference in s 214 to the reasonably diligent person, requiring the taking of ‘every reasonable step.’20 With respect, this is the only way that the expression is able to be interpreted. Nevertheless, after saying that it has been said that establishing that directors have taken every

15 Ibid., 817. 16 [2004] EWHC 933 (Ch), [154]. 17 Stephen Griffin, Personal Liability and Disqualification of Company Directors (Hart, 1999), 74–75. 18 Re Ralls Builders Ltd [2016] EWHC 243 (Ch), [2016] BCC 293. 19 Ibid., [245]. 20 Principles of Corporate Insolvency Law (2nd ed, Sweet and Maxwell, 1997), 471.

154

THE W RONGFU L TR A DI NG DEFENCE

step constitutes a high hurdle to get over, and that was something intended by the legislature.21 Snowden J in Re Ralls Builders Ltd22 explained that: it is right to construe section 214(3) strictly and to require a director who wishes to take advantage of the defence . . . to demonstrate not only that continued trading was intended to reduce the net deficiency of the company, but also that it was designed appropriately so as to minimise the risk of loss to individual creditors. Otherwise a director could make out the defence . . . by claiming that he traded on with a view to reducing the overall deficiency for creditors as a general body, irrespective of how he achieved that result as between creditors.23

10.16 We established, in the previous chapter, that a contribution will only be payable where there has been a loss to the company from the time of the commencement of wrongful trading until the commencement of liquidation (or administration), and the emphasis is very much on the fate of the company and not what creditors have actually lost. Thus, the focus is not on individual creditor losses. However, when it comes to determining whether directors have made out the defence in s 214(3), they ought not be entitled to an outright defence if their decision to continue trading means that some of the existing unsecured creditors are paid at the expense of new creditors who end up not being paid.24 10.17 While ‘every step’ might seem to provide a difficult hurdle to negotiate, the courts have not been overly strict in deciding whether every step was taken, and importantly for directors a determination of whether a director took every step is not to be considered in light of later developments that could not be reasonably foreseen by directors; thus courts will not employ hindsight, just as they will not when determining whether directors ought to have concluded that their company had no reasonable prospect of avoiding insolvent liquidation. Professional Advice 10.18 Where the directors’ own knowledge, skill and experience are inadequate for addressing the issues which they encounter as far as financial stress, they should seek appropriate professional advice.25 This is important as the courts appear to manifest sympathy for any director who seeks professional advice, and in their judgments courts have placed some weight on the directors doing so.26 This was the case, for example, in two disqualification cases, Re Bath Glass Ltd27 and Re Douglas Construction Services Ltd.28 Furthermore, in Re Continental Assurance Co of London plc,29 Park J placed a lot of emphasis on the fact 21 22 23 24 25 26 27 28 29

Re Ralls Builders Ltd [2016] EWHC 243 (Ch), [2016] BCC 293, [245]. Ibid. Ibid. Ibid., [246]. Re DKG Contractors Ltd [1990] BCC 903. Re Ralls Builders Ltd [2016] EWHC 243 (Ch), [2016] BCC 293, [176], [206], [210]. [1988] BCLC 329. [1988] BCLC 397. [2001] BPIR 733, 814.

155

THE W RONGFU L TR A DI NG DEFENCE

that the directors did seek and listen to professional advice at critical points.30 It is likely that in many situations, if advice sought is not heeded then directors are likely to find it more difficult to defend s 214 actions. In Re Brian Pierson (Contractors) Ltd,31 one of the directors who was subject to proceedings (and found liable) had ignored indications, although not warnings, from professional advisers concerning the financial malaise of the company. In the earlier case of Re Purpoint Ltd32 the respondent was found liable when professional advice was not taken into account. Notwithstanding being given professional advice concerning the parlous state of the company’s affairs, the director in this case did not cease trading for six months and did not place the company in liquidation for nearly a year.33 10.19 In Re Hawkes Hill Publishing Co Ltd (in liq)34 Lewison J (as he then was) thought that it was an important point for the directors that when the directors sought advice from the accountant who prepared the company’s accounts he did not advise that the company’s position was hopeless.35 In fact, in that case the accountant had said that the company had a promising future.36 In like fashion in Re Ralls Builders Ltd,37 the fact that an insolvency practitioner whom the directors had consulted gave advice to the effect that the directors were not, at one of the points at which wrongful trading was alleged to have commenced, trading wrongfully was fatal to the liquidators’ case that the directors ought to have concluded that there was no reasonable prospect of the company avoiding an insolvent liquidation.38 10.20 What if a director takes professional advice, follows that advice as best as he or she could and, notwithstanding that, the company enters insolvent liquidation? Can the director be held liable? It is submitted that the answer is yes, for following the advice of a professional adviser is not guaranteed to provide a defence for a director, but it should go some way to doing so.39 Clearly, directors stand a much better chance of successfully defending an action if they do seek and follow advice from an appropriate person than if they do not. Although in Brooks v Armstrong40 Registrar Jones said that the directors could not rely upon

30 For other cases where courts have indicated that they will also take into account the fact that the directors have taken appropriate professional advice, see, for instance, Re Hawkes Hill Publishing Co Ltd [2007] BCC 937, [2007] BPIR 1305, [45]; Re Ralls Builders Ltd [2016] EWHC 243 (Ch), [2016] BCC 293, [176], [206]. 31 [1999] BCC 26, [2001] BCLC 275. 32 [1991] BCC 121, [1991] BCLC 491. 33 Ibid., 125, 495. 34 [2007] BCC 937, [2007] BPIR 1305. 35 Ibid., [45]. 36 Ibid. 37 Re Ralls Builders Ltd [2016] EWHC 243 (Ch), [2016] BCC 293; Re Bright Future Software Ltd [2020] EWHC 1674 (Ch), [325]. 38 Ralls Builders ibid., [206]. 39 See Fidelis Oditah, ‘Wrongful Trading’ [1990] LMCLQ 205, 208 where the commentator argued that if a director acts on the informed advice of an auditor a strong case should be able to be mounted against the director being held liable. 40 [2015] EWHC 2289 (Ch), [2015] BCC 661.

156

THE W RONGFU L TR A DI NG DEFENCE

the fact that none of the professionals consulted advised the company to enter administration or liquidation, two of the options the registrar said were available in order for the directors to meet the every step requirement. He went on to say that the fact that there was no advice concerning administration or liquidations as possible options did not relieve the respondents of their ability. They had the obligation to take every step when reaching their decisions based upon the financial position which was or ought to have been known to them.41 While this might be regarded as inconsistent with the comments in other cases, in Brooks v Armstrong the directors do not appear to have sought advice squarely on the issue of wrongful trading and the obligation that they had to minimise creditor losses. And in fact, one adviser whom the directors consulted did not have knowledge of all of the company’s liabilities when giving advice.42 10.21 In seeking advice directors must take care to determine to whom they should speak and the adviser’s experience and qualifications. Not every professional person’s advice is likely to be seen by a court to mean that the directors had acted properly in taking the relevant advice. For example, it is likely that the advice of a solicitor alone might not be sufficient as the advice of someone with accounting qualifications, and possibly an insolvency specialism, would be appropriate. Further, the advice of a generalist solicitor might well be inappropriate, as the advice of someone with corporate insolvency experience is needed. 10.22 Are directors likely to be able to protect themselves if they seek and act on the advice of a qualified insolvency practitioner? One respondent to a survey conducted by Andrew Hicks suggested that if directors take advice from an insolvency practitioner that should be regarded as an absolute defence to an allegation of wrongful trading.43 It is possible to identify three concerns with this view. First, the process might be just regarded as paying lip service to a requirement and provide the directors with immunity from liability. Secondly, the directors might not take the advice of the practitioner, so nothing has been gained. Thirdly, there is no guarantee that a practitioner will provide appropriate advice. One might ask whether the creditors’ position should depend, effectively, on the advice given by just one practitioner? 10.23 What is the case where a director seeks advice but there are no professional warnings about the state of the company’s finances? In Re Brian D. Pierson (Contractors) Ltd44 the deputy judge said that she did not find that the absence of warnings from any adviser altered her view that the directors ought to have reviewed the company’s position critically.45 10.24 It is probably the case that if the directors, in light of advice, can demonstrate that when they were aware of financial difficulties they adopted a frugal approach to business, as well as adopting that approach in relation to their

41 42 43 44 45

Ibid., [280]. Ibid., [281]. Andrew Hicks, ‘Wrongful Trading – Has it Been a Failure?’ (1993) 8 I L & P 134, 136. [1999] BCC 26, [2001] BCLC 275. Ibid., 54, 308.

157

THE W RONGFU L TR A DI NG DEFENCE

own salary entitlements,46 this might well impress a court.47 Likewise, courts might be impressed by directors who pay money into the company from their own funds in order to keep it trading, although if the situation suggested that pouring in new money would not turn things around then even this action might not be regarded favourably. 10.25 One would think that the courts should be wary that on occasions directors might seek professional advice merely as ‘window dressing,’ which was the argument put by the liquidators in Johnson v Arden.48 That is, the directors want to give the impression they were concerned about complying with their obligations as directors, and so obtained advice, but had no intention of following such advice, unless it was consistent with what they wished to do. 10.26 It is likely that while directors are entitled to rely on professional advisers, they must not do so blindly accepting all that they are told and failing, where appropriate, to ask reasonable questions. Also, it is submitted that directors cannot simply instruct a professional and think that they can ‘wash their hands’ of the wrongful trading matter totally. Of course, any decisions made are those of the directors, or else directors could effectively pass on responsibility to the advisers. Directors have a duty to exercise discretion, and they cannot turn over that discretion to others. 10.27 It is contended that to ensure that they are not liable, directors must: carefully think about what kind of advice they need and whose advice they should seek; consider the adviser’s qualifications and experience and ensure that they are appropriate for the advice needed; inform the adviser of all necessary facts; read and weigh up the advice given by the adviser; and return to the adviser with questions about any uncertainty which the directors have concerning the advice. 10.28 In sum, we can probably say that directors are entitled to rely on the advice of professionals who are appropriately qualified and independent, where the advice is within the expertise of the adviser and where the director has provided the adviser with the correct information and context and the directors have assessed the advice as far as their expertise and knowledge permits. Resignation 10.29 If a director believes that insolvent liquidation cannot be avoided, resignation might be considered, but it should be seen, in most cases, as the last straw, for if directors do resign they lose the opportunity to influence what is decided at board meetings, to obtain confidential information, and the directors can no longer influence the direction of the company’s affairs. Also, if directors who have resigned are later held to be liable for wrongful trading, their liability could be greater because of what has been done post-resignation. If the 46 D Milman, ‘Strategies for Regulating Managerial Performance in the “Twilight Zone” – Familiar Dilemmas: New Considerations’ [2004] JBL 493, 505. 47 Re Idessa (UK) Ltd [2011] EWHC 804 (Ch), [2012] BCC 315. 48 [2018] EWHC 1624 (Ch), [2019] 2 BCLC 215, [2019] BPIR 901, [52.5].

158

THE W RONGFU L TR A DI NG DEFENCE

directors stayed in the company, they might have been able to influence the way the company went, and this might have reduced liabilities. Moreover, it might be said that resigning is ‘designed to protect the interests and integrity of the individual director, rather than seeking to confer any benefit on the company in respect of minimising the potential loss of its creditors.’49 10.30 Although resignation has never been regarded as a fool-proof way of extricating oneself from liability for wrongful trading, one would think that it is often going to be in the directors’ favour in later proceedings, particularly where they have found that their advice or recommendations have not been heeded, and perhaps not even considered. In fact, in Secretary of State for Trade and Industry v Taylor50 Chadwick J (as he then was) said, while hearing a disqualification application, that in such a situation it was prudent for a director to resign.51 It must be said that what his Lordship went on to say makes it clear that just because a director does not resign does not necessarily mean that he or she will be held liable. 10.31 Resignation may be the only action that directors can take if they have made proposals to the board for the arrest of a company’s demise, and the board has refused to implement them or any other efficacious alternatives52 and the directors believe that the company is heading for insolvent liquidation. Obviously, a court will have to weigh up the reason behind the resignation and what other options might have been available to the directors. Yet, resignation may lead a liquidator to refrain from taking action against a director or at least in respect of losses incurred following resignation, as was the case in Johnson v Arden.53 10.32 If directors are of the view that the company is heading for insolvent liquidation, but they are alone in this view, then the directors face an uphill battle. So, resignation might be the most appropriate action for the directors to take. This action should only be taken after the directors have expressed their concern at a board meeting or in some other formal way, and they have ensured that what they have to say is minuted or recorded in some fashion, indicating their dissent, and thus it can be perused by a liquidator if the company does fall into liquidation. It is submitted that it would be wise for directors, before resigning, to ensure that there is evidence to which the directors are able to point indicating that they have considered the ramifications for the company of their resignation. 10.33 The resignation of directors might be problematic for the remaining directors, as liquidators might feel that this bolsters their case against the latter directors as the resigning directors have got out because they could see the likelihood of the company engaging in wrongful trading.54 49 Stephen Griffin, Personal Liability and Disqualification of Company Directors (Hart, 1999), 77. 50 [1997] 1 WLR 407, 414. 51 Ibid., 412. 52 Griffin has submitted that resignation, in the majority of cases, will probably be viewed as an indication of the fact that the director has failed to take every step: Personal Liability and Disqualification of Company Directors (Hart, 1999), 76. 53 [2018] EWHC 1624 (Ch), [2019] 2 BCLC 215, [2019] BPIR 901. 54 An argument to this effect was run in Johnson v Arden ibid., [52.7].

159

THE W RONGFU L TR A DI NG DEFENCE

Placing the Company Into a Formal Insolvency Regime 10.34 It might be thought that liquidation is the step that should be taken by the directors. While liquidation might minimise further company losses, it might not be the most beneficial action as far as the creditors are concerned. For instance, in liquidation if assets are sold off piecemeal, in what is often referred to as a ‘fire sale,’ the liquidator will recover less than if the assets were sold off strategically, or as part of a sale of the business as a whole. Nevertheless, there might well be cases where liquidation is appropriate and possibly the only step that can be taken. 10.35 In owner-managed companies where there is only one director, then instituting liquidation will be simple. The shareholder/director can pass a resolution at a members’ meeting. It might be more of a problem where there are two or more directors, especially if there are disagreements concerning the way forward. Section 124(1) of the Act states that the directors of a company are able to present a petition for the company’s winding up. It has been held that the reference to directors means all of the directors and not one or a majority of them, so unless there is a proper resolution of the board of directors, all of the directors must agree to the presentation of the petition.55 If a proper resolution for the winding up of the company is passed by the board (and this can usually be achieved with a majority approving the resolution) then it is in order for a petition to be presented even if a minority of directors dissent from the resolution, as once a resolution has been duly passed all directors are bound by it.56 10.36 If liquidation is thought to be the appropriate step to take, it may be necessary, in some cases, such as where there are extensive differences between directors and concern that some directors might act in such a way as to add to the company’s problems, to seek the appointment of a provisional liquidator after lodging a petition for winding up.57 10.37 Perhaps one of the safest courses of action is to place the company into administration, and this can be done now quite swiftly under Sch B1 of the Act, and it is a relatively costless exercise, compared with previous times, because no court involvement is necessary. In Australia, voluntary administration, the equivalent of administration in the UK, has been used regularly by directors to prevent insolvent trading, the equivalent of wrongful trading. In fact, in Australia, where it is a defence to the equivalent of wrongful trading that one took all reasonable steps to prevent the incurring of further debts (when the company was insolvent), the legislation goes on to say that steps taken by a director to place his or her company in administration can be taken into account in deciding whether an adequate defence had been made out.

55 Re Instrumentation Electrical Services Ltd (1988) 4 BCC 301. 56 Re Equiticorp International Plc [1989] 1 WLR 1010, (1989) 5 BCC 599. 57 For a detailed discussion of which, see Andrew Keay, McPherson and Keay’s The Law of Company Liquidation (5th ed, Sweet and Maxwell, 2021), Ch 6.

160

THE W RONGFU L TR A DI NG DEFENCE

10.38 Directors might, quite properly, now regard administration more favourably as an escape route from possible wrongful trading. It appears that this might have been done in Re Chancery plc,58 one of the few instances we have in case law of the directors of a public company getting close to engaging in wrongful trading. 10.39 Before administration could be initiated extra-judicially, then, because of the time and cost involved in obtaining an administration order, directors might have been discouraged from seeking administration where they were concerned about the issue of wrongful trading. In favour of directors taking their companies into administration now is the fact that the administration process can be initiated more cheaply and quickly. It is interesting to note that in Re Farmizer (Products) Ltd,59 the liquidator was only seeking contribution up until the time when the company entered administration, so at least that step might restrict the liability of a director. By way of caution, we must note that appointing an administrator will not necessarily save a director from liability, as administrators may now bring wrongful trading actions. 10.40 In Brooks v Armstrong60 Registrar Jones identified placing the company in administration or liquidation as options that were available to the directors.61 10.41 The danger with placing the company in some form of formal insolvency regime is that the company may not be ‘finished’ or even in need of rescue, and so its placement in administration or liquidation may be premature; the company might have been able to carry on and the directors might have felt that there was a fair chance of survival, but the fear of personal liability could cause them to embrace what might be perceived as the safe alternative. If directors did place their company in an insolvency regime, then in some situations, and it is suggested that they would have to be fairly extreme, directors might be subject to liability for wrongful trading, as the action might not be regarded as minimising creditor losses. Liability would, it is submitted, only be imposed in cases where the directors panicked or totally misread the situation and the company clearly could have returned to profitable trading if appropriate action had been taken but entering an insolvency regime meant that that was never going to be possible. Query whether action could also be brought against the directors in such a situation on the basis that they breached either their duty under s 172(1) of the Companies Act 2006 to promote the success of the company or their duty under s 174 to exercise care and skill. 10.42 The drawback with liquidation is that the company’s business or its individual assets will, as indicated earlier, usually be realised on a fire sale basis, which will often leave the creditors with little or nothing. Even with administration, which more commonly will not involve a rescue of the company, the business and the assets will have to be sold and they will not realise market value. 58 59 60 61

[1991] BCC 171, 172. Re Farmizer (Products) Ltd [1997] BCC 655, 662 (CA). [2015] EWHC 2289 (Ch), [2015] BCC 661. Ibid., [278]. The registrar’s comments suggested that there might have been other options.

161

THE W RONGFU L TR A DI NG DEFENCE

10.43 It should be said at this point that it is generally far safer for directors to place the company in administration rather than to embark on some form of rescue process. For instance, the process of seeking to put in place some arrangement with creditors, such as a company voluntary arrangement or an informal scheme is fraught with danger in the sense that they could take a while to finalise and during this period any one of the creditors could obtain a winding-up order (or even an administration order) against the company and the liquidator (administrator) could conceivably bring wrongful trading proceedings at some later date.62 Cessation of Business 10.44 The termination of business may in some circumstances be the most sensible and proper action for directors to take. For the most part it will mean that there will be no further debts, and it may reduce the amount owed to creditors. Too often companies trade on for too long. This is particularly the situation with owner-managed companies set up by an entrepreneurial director-owner who identifies with the company and its business and will do all that he or she can to ensure that the company remains in business.63 The company may be fulfilling the owner’s dream, or the owner may be passionately convinced that the company must succeed eventually. Clearly, the directors in Re Produce Marketing Consortium Ltd64 should have stopped trading given the state of the company’s affairs. They continued on trading because of some feeling of obligation to a trader for whom the company was acting.65 The fulfilment of the perceived obligation was rather misguided, as the continued trading was deleterious for the general body of creditors. 10.45 If the directors decide to cease trading, it would usually be proper to instigate some formal insolvency regime, such as administration or liquidation. The reason for instigating an insolvency regime is to prevent the dismembering of the company, as both administration and liquidation usher in a moratorium on claims. 10.46 However, ceasing business could in fact be the worst thing, especially in the short term, as it may be detrimental for all concerned, particularly the creditors, a point made in Re Hefferon Kearns Ltd (No 2)66 by Lynch J when discussing the equivalent Irish provision. This is especially the case where the company can make gains in the short term, such as completing contracts and obtaining rewards for doing this, and this might rescue the company from its

62 A judge might grant a stay against proceedings, as the judge did in Bluecrest Mercantile BV v Vietnam Shipbuilding Group [2013] EWHC 1146 (Comm), where there was a proposed scheme of arrangement and there was a reasonable prospect of success of the scheme being sanctioned. 63 R Mokal, ‘An Agency Cost Analysis of the Wrongful Trading Provisions: Redistribution, Perverse Incentives and the Creditors’ Bargain’ (2000) 59 CLJ 335, 354. 64 Re Produce Marketing Consortium Ltd (1989) 5 BCC 569. 65 Ibid., 596. 66 (1993) 3 IR 191.

162

THE W RONGFU L TR A DI NG DEFENCE

parlous state or at least provide more for creditors on a subsequent administration or liquidation. 10.47 Therefore, just because directors continue to trade does not necessarily mean that they have not taken every step. As Vanessa Finch has said: If directors reasonably believe that creditors may fare worse in a premature forced sale of assets, and that this combined with the cost of liquidation proceedings may well be disastrous from unsecured creditors’ point of view, the directors’ duty under section 214 may well include a duty to attempt a company rescue or to stay at the helm.67

10.48 What the commentator says is undoubtedly true, but the comment was made well before administration become far easier to implement, and now an administrator might oversee a rescue of the company. Miscellaneous Options 10.49 It might well be that one of the steps which the directors should have taken was the obtaining of information, and what they should have obtained will often vary according to whether or not there were warning signs, such as pressure from creditors, indicating a particular need to monitor the solvency of the company.68 Obtaining information might be only one of the steps to be taken, as when there are warning signs, it is likely to require the directors to take other steps. 10.50 Again, one of the steps that directors should take is to ensure that the management accounts provide a reasonably accurate picture of the company’s financial position.69 10.51 If directors feel that resignation is not the most appropriate action to take, but they are alone in the opinion that they hold about the company, the directors should, amongst other things, ensure that their concern(s) is minuted in board meetings, and the director should call for action such as the seeking of professional advice, the compilation of up-to-date accounts and projections of profits and losses, and to ensure that these requests are minuted. In some situations, it might be prudent for the directors themselves to obtain information concerning the company’s state and other records, rather than relying on others who might be either of the opinion that the directors are ‘over the top’ with their concerns or have secrets to keep. If a director protests against continued trading and does what he or she can to bring about the cessation of trading, it is more likely that no liability will attach to him or her.70

67 V Finch, ‘Directors’ Duties: Insolvency and the Unsecured Creditor’ in A Clarke (ed), Current Issues in Insolvency Law (Stevens, 1991), 96. 68 Re DKG Contractors Ltd [1990] BCC 903. 69 Re Brian Pierson (Contractors) Ltd [1999] BCC 26, [2001] BCLC 275. 70 Secretary of State for Trade and Industry v Taylor [1997] 1 WLR 407, 415, [1997] BCC 172, 178 – dealing with an application for a director’s disqualification.

163

THE W RONGFU L TR A DI NG DEFENCE

10.52 The Institute of Directors in its guidelines has suggested that a director whose concerns are not being recognised might consider gaining the support of shareholders, although one wonders if most shareholders would be overly concerned, as they are not going to be liable, and it might be better for them if the company carries on trading with the hope of pulling itself out of its malaise. If the attempt succeeds the shareholders might in fact benefit, and if it fails then they are not liable for any losses, provided their shares are fully paid-up. The other recommendation of the Institute is for a director to talk to the auditors.71 These suggestions might be appropriate in larger companies but have no relevance for small private companies, and particularly the situation where the company is owner-managed. 10.53 While the Act permits the directors to petition for the winding up of their company,72 a single director may not do so,73 and nor can he or she petition for an administration order, unless the director is also a creditor, so these options are not available. Furthermore, if directors disagree with the board, they would not be wise to publicise their concerns, as this could escalate the company’s demise,74 and it could constitute a breach of duty. Creditors might pull their support and the company’s customers might become jittery. 10.54 It might be thought that engaging with the major creditors is an appropriate step to take. It may be, but the directors must ensure that if they do so they do not neglect other creditors and make arrangements which will only benefit the major creditors, as the directors’ responsibility is to work to minimise the losses of all creditors. In Brooks v Armstrong75 the directors put in place a plan that was designed to discriminate against two major creditors, the company’s landlord and HMRC, and benefit trade creditors. The directors paid trade creditors but completely ignored the two major creditors. In fact, the directors permitted the debts of the two major creditors to increase, and this provided the working capital the company required to enable trading.76 This, according to the court, was not an appropriate way for the directors to act.77 Also, in Re Ralls Builders Ltd78 Snowden J held that the directors’ failure to take steps that ought to have been taken to protect the interests of new creditors (those holding debt incurred after the point when the directors had to take every step to minimise loss) meant that they were prevented from relying on the defence.79 10.55 What other steps could, or should, directors take to safeguard themselves? One or more of the following may be prudent:

71 ‘IOD Guidelines for Directors’ 1991, paras 339–345 and referred to in A Hicks, ‘Advising on Wrongful Trading: Part 2’ (1993) 14 Company Lawyer 55, 58. 72 Section 124(1). 73 Re Instrumentation Electrical Services Ltd (1988) 4 BCC 301. 74 See ibid. 75 Brooks v Armstrong [2016] EWHC 2893 (Ch); [2015] BCC 661. 76 Ibid., [275]. 77 Ibid., [282]. 78 Re Ralls Builders Ltd [2016] EWHC 243 (Ch), [2016] BCC 293. 79 Ibid., [246].

164

THE W RONGFU L TR A DI NG DEFENCE

• calling a creditors’ meeting in order to advise them of the state of the company; • convening regular board meetings to review the position of the company and ensure that discussions and processes are clearly documented, including an indication that creditor interests are taken into account in the decisions made;80 • assessing the reasons for the company’s financial woes and addressing them in some positive way(s); • regularly assessing and monitoring the financial position of the company, including getting up-to-date reports about the company’s cash flow and its overall position; and • ensuring that the company’s accounts are properly kept up to date. 10.56 In Brooks v Armstrong,81 Registrar Jones included in his judgment the following statement as guidance on the factors that probably should be considered by directors and kept under review both generally and when considering specific financial decisions, assuming the business remains sustainable: Ensuring accounting records are kept up to date with a budget and cash-flow forecast; preparing a business review and a plan dealing with future trading including steps that can be taken (for example cost cutting) to minimise loss; keeping creditors informed and reaching agreements to deal with debt and supply where possible; regularly monitoring the trading and financial position together with the business plan both informally and at board meetings; asking if loss is being minimised; ensuring adequate capitalisation; obtaining professional advice (legal and financial); and considering alternative insolvency remedies.82

10.57 In Re Idessa (UK) Ltd83 Lesley Anderson QC found that the directors had not taken every step. She said that: all of the evidence points to the fact that the respondents [the directors] continued to use (and as I have found in several instances abuse) the company’s money in much the same way as they had done previously. The respondents continued to pay themselves the same salaries and continued to incur the same type of expenses as before. There was no “tightening” of the corporate belt or any evidence that they or their employees were encouraged to implement cost savings or do anything differently. In short, there is no evidence that the respondents gave any thought at all to the company’s creditors or to the impact on them of continuing to trade. There is no material at all from which I can infer that they had in place any strategy to enable the company to repay the sums owed to creditors (or for that matter, its investors).84

10.58 A possible option is for the directors to operate more cautiously and, in some cases, for the company to reduce the volume of its trading activities. In Re 80 This would also be aimed at heading off any potential liability under s 172(3) of the Companies Act 2006, discussed in later chapters. 81 Brooks v Armstrong [2016] EWHC 2893 (Ch), [2015] BCC 661. 82 Ibid., [259]. 83 [2011] EWHC 804 (Ch), [2012] BCC 315. 84 Ibid., [120].

165

THE W RONGFU L TR A DI NG DEFENCE

Continental Assurance Co of London Ltd,85 Park J was impressed with the fact that the directors ‘reduced the scale of trading to minimal and cautious levels,’ and eventually ceased trading when they were advised that their company was insolvent.86 But, conservative action, such as restricting trading to a cash basis, might not be sufficient, as overheads and recurrent expenses will continue to mount up.87 Directors should also consider the salary and fees being paid to themselves. If they are excessive, in the circumstances, then that might lead a court to the view that the directors did not take every step that they could have taken; curtailing spending on remuneration is a fairly easy and straightforward step that could be taken by directors. 10.59 On the issue of directorial remuneration, in Re Purpoint Ltd88 the court was critical of one of the directors for the excessive remuneration that he received.89 Clearly excessive remuneration is likely to tell against directors if they allow this, but what about the continuation of the payment of normal remuneration? We noted in 10.57 the comment of Lesley Anderson QC in Re Idessa (UK) Ltd,90 that there was no belt tightening and there was a continuation of the outlay of heavy expenses, including remuneration, and that told against the directors. The deputy judge was perhaps suggesting that the directors could have taken a pay cut. However, in Re Ralls Builders Ltd91 Snowden J said that the directors should not be deprived of the s 214(3) defence merely because they also continued to draw reasonable salaries to which they were entitled for work actually done during the alleged period of wrongful trading.92 Clearly there were other expenses besides directorial salaries with which Lesley Anderson QC was concerned, and she may well have not commented on these salaries if the other expenses had been considered by the directors and subsequently reduced. We cannot draw from the cases the proposition that the directors must take reduced remuneration, provided that their salary was, in all of the circumstances, reasonable. Of course, it might be argued that where a company is in dire straits it is reasonable for the directors to put in place some remuneration reduction. 10.60 Directors should also take into account the fact that it is probable that a court is more likely to hold a director not liable if he or she pursues orthodox business practices and takes measures to evaluate the effect of actions on creditors. A maverick approach can always work, but the risks are probably higher for the directors. 10.61 Of course, it is prudent for a director to ensure that he or she keeps a detailed record of all that he or she has done to minimise the losses of creditors once the avoidance of insolvent liquidation does not seem a reasonable prospect. 85 86 87 88 89 90 91 92

[2001] BPIR 733. Ibid., 769. Fidelis Oditah, ‘Wrongful Trading’ [1990] LMCLQ 205, 214. [1991] BCC 121, 128, [1991] BCLC 491. Ibid., 125, 495. [2011] EWHC 804 (Ch), [2012] BCC 315. [2016] EWHC 243 (Ch). Ibid., [248].

166

THE W RONGFU L TR A DI NG DEFENCE

Inability to Take Steps to Minimise Losses 10.62 The provision fails to cater for the position where a director is unable to take every step to minimise potential loss to creditors. For example, what if a director is ill or overseas? In the Australian case of Androvin v Figliomeni,93 a director was held not liable under the Australian equivalent of s 214,94 because the breach of the provision occurred while he was overseas. The director had indicated to the other directors, before his departure, that he would not be in a position to act as a director or accept any responsibilities during his absence. As a result, there had been a fundamental change in the working operations of the company. 10.63 It is very likely that British directors would not, in similar circumstances, be saved from liability, because directors might be thought to be irresponsible if they were to absent themselves from the country for a long period of time, and even then, in today’s world, communications enable contact to be maintained. It was an important point in Nicholson v Fielding95 that while one of the directors had been away overseas, he had been kept up to date with the company’s affairs.96 It was also noted in that case that not a single important decision was taken without the director’s knowledge and consent.97 10.64 As far as illness goes, it would very much depend on the nature and length of the illness. Conclusion 10.65 The chapter has explained the only defence there is for a director who has engaged in wrongful trading. The defence is that the director must satisfy the court that after becoming or ought to have become aware that the company was bound for insolvent liquidation, the director took every step with a view to minimising the potential loss to the company’s creditors as he or she ought to have taken. 10.66 The defence has been analysed, and it has been asserted that it is difficult to know the meaning of ‘every step.’ The previous discussion has considered a number of actions that directors might take in order to fulfil the requirement in the section. Every step could involve one or more of the following: taking professional advice, resignation, ceasing business and placing the company into a formal insolvency regime. Obviously, the company’s circumstances might very well determine what every step means.

93 94 95 96 97

(1996) 14 ACLC 1461. Corporations Act 2001, s 588G. Unreported, Ch D, 15 September 2017. Ibid., [44]. Ibid.

167

CHAPTER 11

Relief From Liability

Introduction 11.1 The previous chapter was concerned with the analysis of the defence which respondents to wrongful trading claims may embrace in combatting a claim. This defence is specifically provided for in s 214 of the Insolvency Act 1986. This chapter considers an issue that is not included in s 214. It is: is a respondent who is found liable for wrongful trading able to secure judicial exculpation in relation to that liability? This consideration is something that might be considered by a court and is usually additional to dealing with whether a respondent has a defence.1 11.2 In any given case a respondent will often endeavour, first, to take issue with the evidence and submissions which the applicant puts to the court and argue that the applicant has not made out a case that the respondent has engaged in wrongful trading. Secondly, a respondent will argue that even if a case can be made out by the applicant, the respondent has a defence, the one contained in s 214(3), and examined in Chapter 10, namely that the director took every step with a view to minimising the potential loss to the company’s creditors. Section 214(3) is exhaustive of the defences available to a director so a director can go nowhere else. Directors are not able to avail themselves of general defences.2 Thirdly, the respondent may say that even if an applicant succeeds on the claim and the respondent’s defence is rejected by the court, the respondent should be relieved from liability. 11.3 The chapter explains the basis for any relief to which a respondent may be entitled, and then it seeks to analyse the law in the context of a wrongful trading claim. Relief Under the Companies Act 2006? 11.4 For many years, courts have been empowered by the Companies Act 2006 (‘the Act’) to exculpate directors from liability in certain situations. The 1 In Comrs of Inland Revenue v McEntaggart [2004] EWHC 3431 (Ch), [2007] BCC 260, [45] the judge described a precursor of s 1157 of the Companies Act 2006 and the subject of this chapter as providing a defence. 2 Fidelis Oditah, ‘Wrongful Trading’ [1990] LMCLQ 205, 214.

168

DOI: 10.4324/9780429266232-14

R ELIEF FROM LI A BILITY

existing provision that enables the courts to do this is s 1157.3 The provision can be traced all the way back to s 32 of the Companies Act 1907, and it is in fact based on sections that enabled trustees to be relieved from liability by courts.4 11.5 Section 1157 permits a court to excuse an officer, and this term includes directors, from liability arising out of his or her negligence, breach of duty or breach of trust if three elements are fulfilled. They are that: the officer (director) acted honestly; the officer acted reasonably; and a consequence of the officer’s actions so he or she ought fairly to be excused from liability. The third element is a matter of judicial discretion, for s 1157 states that ‘the court may relieve,’ while the first two elements are regarded as conditions which trigger the exercise of the discretion.5 The officer has the burden of establishing that the first two elements are satisfied.6 Both of these elements must be established to the court’s satisfaction before a court is to consider whether relief should be ordered.7 However, an officer might be able to satisfy the two limbs but fail to be excused as the court, as a matter of discretion, does not think that he or she ought to be fairly excused.8 11.6 The conduct for which relief may be given is broad,9 and it permits, according to Newey LJ in Dickinson v NAL Realisations (Staffordshire) Ltd,10 a judge to grant relief ‘from liability without distinguishing between different species’11 of liability, thus relief can be awarded whether the claim is personal or proprietary. 11.7 The term ‘officer’ is defined in s 1173 of the Act in a non-exhaustive manner. It provides that the term includes a director, manager or secretary, and thus directors are clearly covered. In the context of offences ‘officer’ is defined in s 1121, and as part of that definition s 1121(2)(a) includes directors within the term. Of course, directors have been generally regarded as officers of the company. For example, in relation to s 1157’s precursors, such as s 727 of the Companies Act 1985, courts have quite happily applied the provision to directors, primarily in relation to breaches of their general duties. Also, when the original forebear of s 1157 was enacted,12 it was directed only at directors.

3 For a detailed discussion of the provision, see Andrew Keay, Directors’ Duties (4th ed, LexisNexis, 2020), Ch 17. 4 The latest provision is Trustee Act 1925, s 61 but it was in operation before that. 5 Bairstow v Queen Moat Houses plc [2000] 1 BCLC 549, 561 and affirmed by the Court of Appeal at [2001] EWCA Civ 712, [2001] 2 BCLC 531, [2002] BCC 91, [58]; Re Marini Ltd [2003] EWHC 334 (Ch), [2004] BCC 172, [57]. 6 Bairstow v Queen Moat Houses plc [2001] EWCA Civ 712, [2001] 2 BCLC 531, [2002] BCC 91, [58]. 7 Ibid., [63]. 8 Re J Franklin & Son Ltd [1937] 2 All ER 32; Bairstow v Queen Moat Houses plc [2000] 1 BCLC 549, 561. 9 Dickinson v NAL Realisations (Staffordshire) Ltd [2019] EWCA Civ 2146, [43]. This was the case under the provisions that dealt with trustees: Re Allsopp [1914] 1 Ch 1, 11. 10 Dickinson, ibid. 11 Ibid., [44]. 12 Companies Act 1907, s 32.

169

R ELIEF FROM LI A BILITY

11.8 The provision has been employed in the past by directors who have been found liable for breaching their duties as provided for under common law and equity. It is broad, for it is obviously not limited to excusing directors who breach their general duties.13 It has also been judicially accepted that the provision applies to the general duties of directors as codified in ss 171–177 of the Act. 11.9 Does wrongful trading fall within the failings of officers set out in s 1157, namely ‘negligence, breach of duty or breach of trust’? As Knox J stated in Re Produce Marketing Consortium Ltd,14 s 214 does not impose a duty in a literal sense,15 but, it is submitted, it does lay down an obligation akin to a duty, namely directors are not to engage in wrongful trading. The Supreme Court of New Zealand in Madsen-Ries v Cooper16 regarded reckless trading under s 135 of the Companies Act 1993, the New Zealand equivalent of wrongful trading, as a duty.17 Nevertheless, in BTI 2014 LLC v Sequana S.A.18 Lord Hodge DPSC said that in his view s 214 did not impose a duty but enables directors to avoid the liability which it imposes if they act in the way the section specifies.19 The comment of his Lordship was entirely obiter, and no other justice passed comment on the matter. 11.10 Even if Lord Hodge is correct and s 214 does not provide for a duty, it does not mean, necessarily, that s 1157 cannot be invoked. After what Knox J had to say, and while he did not have to come to a decision on this issue, he did state in Re Produce Marketing Consortium Ltd that: It is correct in the sense that there is no duty in terms imposed. On the other hand I feel that there is considerable force in Mr. Teverson’s [counsel for the respondents] submission that a duty in fact exists at the back in the shape of a director’s obligations in relation to which sec. 214 imposes a sanction for not having discharged it in a way which the law requires.20

11.11 Furthermore, there are instances in the UK where directors’ applications for relief under s 1157 have been entertained when directors have been in breach of statutory provisions which do not involve a breach of duty, and an example is s 270 of the Companies Act 1985 (equivalent to s 836 of the Act) which dealt with directors improperly distributing dividends. 11.12 The Court of Appeal said in C. & E. Commrs v Hedon Alpha Ltd,21 a case dealing with whether directors could employ a precursor of s 1157 when subject to claims under s 2(2) of the Betting and Gaming Duties Act 1972, that the provision is not able to be pleaded in relation to a claim by a third party,22 13 14 15 16 17 18 19 20 21 22

Andrew Keay, Directors’ Duties (4th ed, LexisNexis, 2020), 594. (1989) 5 BCC 399. Ibid., 404. [2020] NZSC 100. Ibid., [75]. [2022] UKSC 25. Ibid., [230]. (1989) 5 BCC 399, 404. [1981] QB 818. Ibid., 826.

170

R ELIEF FROM LI A BILITY

as the claim must be by the company for the relief to apply. However, the Court of Appeal did extend the right to seek relief in relation to proceedings brought by the company’s liquidator against directors and, of course, s 214 proceedings are brought by liquidators.23 Nevertheless, the Court of Appeal might have had in mind liquidators acting as the representative of companies, that is, bringing proceedings in the name of the company and enforcing a company right. Section 214 is the liquidator’s right and not that of the company, and actions must be brought in the name of the liquidator. Given this, it might be argued that the relief is not available, and that might be supported by the fact that the Court of Appeal judgment suggested that the relief is not available in relation to proceedings brought under non-Companies Act legislation.24 In the Court of Appeal Stephenson LJ said: If Parliament had wished to provide a director, whom it exceptionally makes liable to discharge a company liability, with the protection of section 448 [s 1157] or some other protection, it would, in my judgment, have done so by express words, either by subjecting the statutory liability to the right to claim relief under section 448 or, as in the Social Security Act 1975, by subjecting it to some other restriction.25

11.13 Later, Griffiths LJ in the same case said that it would not be fair if directors could avail themselves of relief but others involved in the bookmaking industry could not.26 He went on to say that: ‘It would be odd indeed if such limitation, confined essentially only to one category of person, was to be found in a wholly unrelated Act to which no reference was made.’27 Yet the provisions of the Insolvency Act 1986 dealing with corporate insolvency are arguably related to the Act. Also, s 214 cannot be applied to anyone who is not a director; therefore, directors would not get special treatment and acquire an advantage over other members of the community if s 1157 applied. 11.14 Subsequent to the Court of Appeal decision, in Comrs of Inland Revenue v McEntaggart,28 Patten J said that s 1157 applies only where the essential nature of the proceedings is to enforce at the suit of, or for the benefit of, the company the duties which the director owes to the company.29 Arguably, s 214 does that, even though the proceedings are brought by liquidators acting in their own capacity. 11.15 It has been held by some cases that a person cannot be excused for wrongful trading under s 727 of the Companies Act 1985 and hence s 1157.30 The reason given for this was that it is incompatible with the objective nature of the test found in s 214, namely that the action of the director could not be 23 Ibid. 24 Ibid. 25 Ibid., 824. 26 Ibid., 827. 27 Ibid. 28 [2004] EWHC 3431 (Ch), [2007] BCC 260. 29 Ibid., [46]. 30 For instance, see Re Produce Marketing Consortium Ltd (1989) 5 BCC 399; Re Brian D. Pierson (Contractors) Ltd [1999] BCC 26, 55, [2001] BCLC 275.

171

R ELIEF FROM LI A BILITY

said to be reasonable.31 In this regard, in Re Produce Marketing Consortium Ltd32 Knox J said that: Now there again it seems to me virtually impossible for the courts to indulge in the exercise required by sec. 727 of looking at all the circumstances of the case and checking that the director in question has acted honestly and reasonably and deciding whether on those grounds he ought fairly to be excused and at the same time applying the different test which is involved in imputing to him some general knowledge, skill and experience which he may well not in fact have had.33

11.16 The decision of Knox J was followed in Re Brian D. Pierson (Contractors) Ltd.34 11.17 Notwithstanding all of this, in Re D’Jan of London Ltd,35 a case involving a breach of duty claim against a director by a liquidator, where Hoffmann LJ held that the test in s 214(4) was to be used in determining whether a director had breached his or her duty of care and skill, his Lordship said that a director found liable could be relieved from liability under s 727. The judge said that: ‘For the purposes of s 727 [s 1157] I think that he [the defendant] acted reasonably.’36 In this case, the respondent director signed an insurance form which had been completed by his insurance broker, and the director signed without first checking whether the contents of it were in fact accurate, and subsequently the insurance company repudiated liability in relation to an event covered by the insurance on the basis of the wrong answers provided on the insurance form by the director. The director’s company entered liquidation, and the liquidator brought proceedings against the director for breach of duty; it was based on the director’s alleged negligence. Hoffmann LJ acknowledged that it might ‘seem odd that a person found to have been guilty of negligence, which involves failing to take reasonable care, can ever satisfy a court that he acted reasonably.’37 But, as his Lordship noted, s 727 contemplated that a director may do so and ‘it follows that conduct may be reasonable for the purposes of sec. 727 despite amounting to lack of reasonable care at common law.’38 11.18 In Bairstow v Queen Moat Houses plc39 Nelson J, when determining whether directors were liable for paying unlawful dividends, said that: [E]ven if under the rules of negligence a director ought to have known of the facts which rendered the payments unlawful, the court may nevertheless relieve him from liability if considering his personal situation it was reasonable that he did not in fact know. It is a matter of discretion for the court on the individual facts of the

31 32 33 34 35 36 37 38 39

Ibid. See the comments of Nelson J in Bairstow v Queens Moat Houses plc [2000] BCC 1025. (1989) 5 BCC 399. Ibid., 404. [1999] BCC 26, 55, [2001] BCLC 275. [1993] BCC 646. Ibid., 649. Ibid., 648. Ibid., 649. [2000] BCC 1025.

172

R ELIEF FROM LI A BILITY

case as to whether the director should escape the normal consequences of his breach of duty and be excused liability for his negligence.40

11.19 The Court of Appeal subsequently reversed his Lordship’s decision to excuse the directors under s 72741 on the basis that the judge had found the former directors were guilty of dishonestly preparing false accounts in order to deceive the market, so it was not open to him to find that they had acted honestly. However, the Court did not impugn the judge’s comment that was quoted earlier and his general reasoning. It is submitted that what Nelson J said could be applied to wrongful trading, and so one could argue that s 1157 is able to operate. Subsequently, in Re MDA Investment Management Ltd42 Park J said that the reasonableness of a director’s conduct must be assessed objectively, and the issue of subjectivity is only relevant when assessing the honesty of a director. The judge made it clear that in Re D’Jan of London Hoffmann LJ did not intend to provide for a purely subjective test. 11.20 In Re DKG Contractors Ltd,43 decided after Re Produce Marketing Consortium Ltd, the judge said that the directors had not acted reasonably in that they failed to obtain, as they should have, some professional advice before trading in the way that they had, and they had not taken up what advice they were offered.44 The judge decided not to relieve the directors of liability under s 727,45 but he did not espouse the view that s 727 was not available in wrongful trading cases. 11.21 It would appear that respondents to insolvent trading actions in Australia are able to be relieved from liability under the Corporations Act 2001 equivalent to s 1157, s 1318,46 but it is perhaps critical that the Australian provision does not refer to the need to act reasonably; it limits itself to providing that the respondent must have acted honestly, and of course s 214, unlike s 213, is not concerned with honesty. 11.22 Another factor that seems to have been overlooked is that, as was discussed in Chapter 9, while s 214 undoubtedly includes an objective approach, it also embraces the subjective. Furthermore, s 1157 ‘is not entirely free of subjective factors,’47 in that it requires consideration of the respondent’s state of mind in examining the issue of honesty. Thus, s 214 in fact involves both subjective and objective elements, as does s 1157, and on that basis perhaps ss 214 and 1157 are not as incompatible, as has been suggested in several judgments. 11.23 If s 1157 is available to directors in relation to s 214 liability, a director is not required to plead before trial that he or she seeks relief under s 1157.48 40 41 42 43 44 45 46 47 48

Ibid., 1034. [2001] 2 BCLC 531. [2005] BCC 783, 838. [1990] BCC 903. Ibid., 912. Ibid., 913. Kenna & Brown Pty Ltd v Kenna (1999) 32 ACSR 430. R Bradgate and G Howells, ‘No Excuse for Wrongful Trading’ [1990] JBL 249, 251 n11. Re Kirby Coaches Ltd [1991] BCLC 414, 416.

173

R ELIEF FROM LI A BILITY

This means that directors are not under any obligation to disclose beforehand the facts that they will support a submission that they ought to be excused. Normally, directors will seek relief through counsel at trial who will raise it if the court decides to find the directors liable. 11.24 Directors have the burden of persuading a court that they are entitled to relief.49 The nature of the burden is different when it comes to establishing reasonableness and fairness compared with honesty. Hoffmann J stated in Re Kirby Coaches Ltd50 that directors are assumed to have acted honestly unless evidence indicates that that is not the case, while directors have to establish that they acted reasonably and ought fairly to be excused.51 The courts have to consider the specific facts provided by the evidence and determine if the director has acted reasonably or not.52 11.25 If directors are able to rely on s 1157 then subs (2) is of potential interest, as it allows directors who have reason to apprehend that a claim will or might be made against them under s 214, to apply to the court for relief without having to wait for the initiation of a claim by the liquidator. This is a process that is similar to what the Cork Report recommended should apply in relation to a claim under any wrongful trading provision that was brought into effect;53 such a provision was not included within s 214. 11.26 As with cases that deal with whether directors are in breach of their duties, the facts of each case are going to be critical in determining whether directors found liable for wrongful trading cases are able to avail themselves of the benefit of s 1157. 11.27 Even if relief were possible under s 1157, it is likely that it would be employed in relatively few situations, for, as discussed in Chapter 9, the courts have tended to impose liability on directors only when they are irresponsible, and in such cases the courts are not likely to excuse them from liability on the basis that the directors ought not to be excused. The possibility of the (uncommon) use of s 1157 does allow judges to find directors liable under s 214 in cases short of irresponsibility, yet they can excuse them under s 1157. This approach maintains the integrity of s 214 but permits courts to excuse those directors whose conduct is not completely irresponsible. 11.28 Robert Bradgate and Geraint Howells, writing in 1990, gave the following instance of where the precursor of s 1157 might apply in relation to the context of wrongful trading.54 Assume that the directors of a company, which has no reasonable prospect of avoiding insolvency, decide to keep trading to 49 National Trustees Co of Australasia v General Finance Co of Australasia [1905] AC 373; Bairstow v Queens Moat Houses plc [2000] 1 BCLC 549, 572 and affirmed on appeal ([2001] EWCA Civ 712, [2001] 2 BCLC 531, [58]); Re Loquitur Ltd, Inland Revenue Commissioners v Richmond [2003] EWHC 999 (Ch), [2003] 2 BCLC 442; Brocks Mount ltd v Beasant (unreported, 2 April 2003, Sonia Proudman QC (sitting as a deputy High Court judge) (as she then was), Ch D). 50 [1991] BCLC 414. 51 Ibid., 415. 52 Re MDA Investment Management Ltd [2004] EWHC 42 (Ch), [2005] BCC 783, [25]. 53 Cmnd 858, HMSO (1982), [1788]–[1792]. 54 ‘No Excuse for Wrongful Trading’ [1990] JBL 249, 253.

174

R ELIEF FROM LI A BILITY

permit their company to complete a contract that is vital for the other party to the contract in order to permit the latter to fulfil a valuable export contract. Whilst the directors are in breach of s 214, they might be regarded as acting reasonably. Is Relief Under the Companies Act Necessary? 11.29 It is questionable whether s 1157, in any event, needs to be relied on by a director where a court is of the opinion that the director should be excused from liability. The reason is that a respondent can argue that a judge can achieve the same result if he or she were to reduce or make no order for contribution against a director under s 214, as Snowden J did in Re Ralls Builders Ltd.55 This is possible, as a judge has a discretion as to whether he or she thinks any contribution should be made and how much it should be.56 The court could use this approach in circumstances where the respondent was found to be liable but where there were mitigating circumstances, such as where the respondent was ill or there was some other reason why the court felt that it was not fair and reasonable to make an order of contribution that reflected the loss sustained by the company due to the wrongful trading. According to some cases, the court may, for instance, take into account the honesty of the directors.57 In Re Ralls Builders Ltd Snowden J plainly stated that it does not necessarily follow that directors should be required to make a contribution to the company’s assets if they ought to have concluded that there was no reasonable prospect of the company avoiding insolvent liquidation.58 11.30 After saying that, it is probably not going to be common for a court to make no contribution order on the basis of the directors’ honesty or other behaviour. It is to be remembered that in Re Ralls Builders Ltd Snowden J declined to make an order against the directors because the company’s net deficit did not increase materially during the period in which the directors engaged in wrongful trading and not because of the respondents and what they did or did not do. In fact, in that case the judge was critical of the directors discriminating against creditors in paying out creditors what they were owed. Conclusion 11.31 The chapter has considered whether a respondent who is found liable for wrongful trading is able to secure judicial exculpation in relation to that liability. This consideration is something that might be considered by a court and is usually additional to dealing with whether a respondent has a defence. 11.32 There is no provision under s 214 for exculpation, but there may be provision under s 1157 of the Companies Act 2006. The chapter examined the 55 56 57 58

[2016] EWHC 243 (Ch), [2016] BCC 293. Ibid. Brooks v Armstrong [2015] EWHC 2289 (Ch), [2015] BCC 661, [303]. [2016] EWHC 243 (Ch), [2016] BCC 293, [219].

175

R ELIEF FROM LI A BILITY

cases where directors have sought exculpation, and while there are cases which cast aspersions on whether s 1157 may be relied on, it is submitted that there is still room to argue that s 1157 can be used by a director. It is questionable, however, whether in fact it is necessary for a director to invoke this provision, as a respondent can argue that a judge is able to achieve the same result if he or she were to reduce or make no order for contribution against a director under s 214, as occurred in Ralls Builders.

176

PA RT D

THE OBLIGATION TO CONSIDER THE INTERESTS OF CREDITORS

CHAPTER 12

The Development of the Obligation

Introduction 12.1 Thus far we have considered two responsibilities/obligations that are imposed on directors as a result of statute. We now turn to a responsibility that has been developed, not by the legislature, but by the courts, and they have done this over the past 45 years or so. This is an obligation imposed on directors to consider the interests of their companies’ creditors in certain circumstances. There has been a substantial corpus of case law addressing this obligation, and there has been a significant amount of debate as to whether it should exist.1 Notwithstanding the misgiving of some and the trenchant criticism of others, the obligation has become a well-used weapon in the armouries of liquidators, with it being recognised as part of UK law in 2022 by the Supreme Court in BTI 2014 LLC v Sequana SA (‘Sequana’).2 12.2 What this chapter seeks to do is to provide an exposition and analysis of the genesis of the obligation and how the law relating to it has developed. The following chapters examine specific aspects of, and issues with, the obligation. This chapter specifically charts the developments that have taken place since the obligation was first raised in 1976. The focus is on the law in the UK, but the law is similar in many common law jurisdictions, such as Ireland, Australia and New Zealand, and some of the decisions in these jurisdictions are considered, particularly where they have contributed to the development of the jurisprudence in the area. 12.3 It is trite law that in UK company law, directors of companies owe duties of loyalty to their companies.3 The primary duty has been that the directors must act in the best interests of their companies. What is meant by this is a vexed question. However, it is fair to say that it has been traditionally interpreted as meaning that the duties are owed to present and future shareholders, and not, 1 For instance, see, The Honourable Justice Kenneth Hayne, ‘Directors’ Duties and a Company’s Creditors’ (2014) 38 Melbourne University Law Review 795; Peter Watts, ‘Why as a Matter of Englishlaw Principle Directors Do Not Owe a Obligation of Loyalty to Creditors Upon Insolvency’ [2021] JBL 103. 2 [2022] UKSC 25. 3 Percival v Wright [1902] 2 Ch 421; Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical Services Ltd [1983] Ch 258.

DOI: 10.4324/9780429266232-16

179

THE DEV ELOPMENT OF THE OBLIGATION

absent exceptional circumstances, to any individual shareholders.4 This was affirmed by the enactment of s 172(1) of the Companies Act 2006 (‘the Act’),5 now arguably the prime loyalty obligation, which provides that directors have a duty to promote the success of their company for the benefit of the shareholders. 12.4 The approach of focusing on the shareholders and maximising profits for shareholders is generally described in modern times as the shareholder primacy or shareholder value theory,6 and regarded probably as the pre-eminent position in Anglo-American corporate law when it comes to the purpose of the company. Whether in fact UK case law actually supports shareholder primacy is a moot point and not within the scope of this book.7 The principle is frequently justified on the basis that the shareholders ‘own’ the company and are, as a consequence, entitled to have it managed for their benefit.8 However, there is significant commentary to the effect that the company is not to be regarded, just as the shareholders, but as an enterprise and that this includes others besides shareholders, such as creditors in certain cases.9 12.5 Section 172(1) of the Act arguably employs a shareholder primacy approach, although it is referred to as providing for enlightened shareholder value,10 because the ultimate beneficiary of the exercise of the obligation contained in this provision is the shareholders. It is referred to as ‘enlightened’ because the directors must consider the interests of certain stakeholders when exercising their duty. 12.6 While directors do not have any obligation under statute to ensure that their company does not trade while insolvent or at a loss11 (although this might 4 Percival, ibid.; Multinational Gas, ibid. [1983] Ch 258 (CA); Peskin v Anderson [2000] BCC 1110, [2000] 2 BCLC 1 (and affirmed on appeal by the Court of Appeal, [2001] BCC 874). Also, see the comments of the UK’s Jenkins Committee, Cmnd 1749 (1962), [89]. 5 All sections referred to in the chapter will be provisions of the Companies Act 2006 unless the contrary is indicated. 6 For instance, see J Macey, ‘An Economic Analysis of the Various Rationales for Making Shareholders the Exclusive Beneficiaries of Corporate Fiduciary Duties’ (1991) 21 Stetson Law Review 23; S Bainbridge, ‘In Defense of the Shareholder Maximization Norm: A Reply to Professor Green’ (1993) 50 Washington and Lee Law Review 1423; D Smith, ‘The Shareholder Primacy Norm’ (1998) 23 Journal of Corporation Law 277; Andrew Keay, ‘Shareholder Primacy in Corporate Law: Can It Survive? Should It Survive?’ (2010) 7 European Company and Financial Law Review 369. 7 See Andrew Keay, ‘Moving Towards to Stakeholderism? Enlightened Shareholder Value, Constituency Statutes and More: Much Ado About Little?’ (2011) 22 European Business Law Review 1. 8 The view was made more (in)famous by the comments of the Noble laureate economist, Milton Friedman, ‘The Social Responsibility of Business is to Increase its Profits’ New York Times, September 13, 1970, Section 6 (Magazine). See, for instance, M van der Weide, ‘Against Fiduciary Duties to Corporate Stakeholders’ (1996) 21 Delaware Journal of Corporate Law 27; Lyn Stout, ‘Bad and Not-so-Bad Arguments for Shareholder Primacy’ (2002) 75 Southern California Law Review 1189, 1190–1191. 9 J Heydon, ‘Directors’ Duties and the Company’s Interests’ in P Finn (ed), Equity and Commercial Relationships (Law Book Co, 1987), 134–135; R Grantham, ‘The Judicial Extension of Directors’ Duties to Creditors’ [1991] Journal of Business Law 1, 6; D Wishart, ‘Models and Theories of Directors’ Duties to Creditors’ (1991) 14 New Zealand Universities Law Review 323, 338–339. 10 See Andrew Keay, The Enlightened Shareholder Value Principle and Corporate Governance (Routledge, 2013). 11 Secretary of State for Trade and Industry v Taylor [1997] 1 WLR 407, 415, [1997] BCC 172, 178.

180

THE DEV ELOPMENT OF THE OBLIGATION

later lead to a director’s disqualification order being made),12 in the UK,13 parts of the Commonwealth14 and Ireland15 courts have held that as part of directors’ duties to their companies, directors must, in discharging their duties to their companies, where varying degrees of financial difficulty exist, take into account the interests of the creditors of their companies. The obligation does not exist at all times, and the circumstances that will precipitate the advent of the obligation are discussed in Chapter 14. In a situation where creditors’ interests intrude, the shareholders cannot ratify any breach by directors,16 as they can when creditors’ interests are not to be taken into account, for they are not the only group which is interested in the company’s funds. Hence, the directors cannot be sure, just because they have secured the ratification of their actions by the shareholders, that they are not going to be held liable. 12.7 In the ensuing discussion in this chapter and following chapters the discussion will refer to an ‘obligation to creditors’ or simply ‘the obligation.’ Sometimes, and in a loose sense, this has been referred to as a duty to creditors. This description is not strictly correct, as directors only owe duties to their companies,17 and as mentioned earlier, the obligation considered here is a duty to the company to take account of the interests of creditors. The Evolution of the Obligation The Genesis 12.8 The obligation owes its genesis in modern times to several decisions delivered in Australasia, although in the United States some courts had found that, for many years, directors were liable to act in favour of creditors at certain times pursuant to the trust fund doctrine.18 12 Secretary of State for Trade and Industry v Creegan [2002] 1 BCLC 99, 101 (CA). 13 For example, see Lonrho Ltd v Shell Petroleum Co. Ltd [1980] 1 WLR 627; Re Horsley & Weight Ltd [1982] 3 All ER 1045; Winkworth v Edward Baron Development Ltd [1986] 1 WLR 1512; [1987] 1 All ER 114; Brady v Brady (1988) 3 BCC 535; Liquidator of West Mercia Safetywear v Dodd (1988) 4 BCC 30; Facia Footwear Ltd (in administration) v Hinchliffe [1998] 1 BCLC 218; Re Pantone 485 Ltd [2002] 1 BCLC 266. 14 Most notably Australia (Ring v Sutton (1980) 5 ACLR 546; Hooker Investments Pty Ltd v Email Ltd (1986) 10 ACLR 443; Grove v Flavel (1986) 4 ACLC 654, 11 ACLR 161; Kinsela (1986) 4 ACLC 215, (1986) 10 ACLR 395; Galladin Pty Ltd v Aimnorth Pty Ltd (in liq) (1993) 11 ACSR 23; Kalls Enterprises Pty Ltd v Baloglow [2007] NSWCA 191; (2007) 25 ACLC 1094) and New Zealand (Nicholson v Permakraft (NZ) Ltd (1985) 3 ACLC 453; Hilton International Ltd (in liq) v Hilton [1989] NZLR 442). 15 Re Frederick Inns Ltd [1991] ILRM 582 (Irish HC) and affirmed at [1994] ILRM 387 (Irish SC); Jones v Gunn [1997] 3 IR 1, [1997] 2 ILRM 245. 16 For instance, see Re Horsley & Weight Ltd [1982] 3 All ER 1045; Kinsela (1986) 4 ACLC 215, (1986) 10 ACLR 395; Re DKG Contractors Ltd [1990] BCC 903; Liquidator of West Mercia Safetywear Ltd v Dodd (1988) 4 BCC 30; Official Receiver v Stern [2001] EWCA Civ 1787, [2002] 1 BCLC 119; Bilta (UK) Ltd v Nazir [2015] UKSC 23, [2016] AC 1. 17 Companies Act 2006, s 170(1). 18 For a discussion of the doctrine, see E Hunt, ‘The Trust Fund Theory and Some Substitutes for it’ (1902) 12 Yale L J 63; J Norton, ‘Relationship of Shareholders to Corporate Creditors Upon Dissolution: Nature and Implications of the “Trust Fund” Doctrine of Corporate Assets’ (1975) 30

181

THE DEV ELOPMENT OF THE OBLIGATION

12.9 The starting point for any consideration of an obligation to consider the interests of creditors is the judgment of the High Court of Australia in Walker v Wimborne.19 In that case a liquidator had brought misfeasance proceedings, under the equivalent of s 212 of the Insolvency Act 1986, against several directors of the company being liquidated, Asiatic Electric Co Pty Ltd (‘A’). The claim was based on the fact that the directors had moved funds from A to other companies in which they held directorships. The relevant companies, including A, were treated by the directors as a group. The directors were accustomed to moving funds between companies, and when this was done no security was usually taken and no interest charged or paid. At the time of the movement of funds that was the subject of the action, A was insolvent. A later entered liquidation. 12.10 In his leading judgment, Mason J (with Barwick CJ concurring) said: In this respect it should be emphasised that the directors of a company in discharging their obligation to the company must take into account the interests of its shareholders and its creditors. Any failure by the directors to take into account the interests of creditors will have adverse consequences for the company as well as for them.20

12.11 His Honour went on to say that the transactions attacked by the liquidator were entered into pursuant to a course of conduct that involved a total disregard for the interests of A and its creditors.21 The judge said that for there to be a misfeasance there had to be a breach of duty, and in his view the actions of the directors constituted a breach of duty. His Honour was clearly accepting that directors had a positive obligation towards creditors. The comments of Mason J were obiter, but it might be argued that what he said: ‘has taken on an authoritative status over the years.’22 The UK Developments of the Last Century: The Early Days 12.12 It was not for some years that the approach propounded in Walker v Wimborne was followed in the UK. There were some statements made in the occasional case that indicated that the judges might favour this approach, but no direct application of the principle. For instance, in Lonrho Ltd v Shell Petroleum Co. Ltd23 Lord Diplock said, without any further elaboration, that the best interests of the company are not exclusively those of the shareholders, ‘but may

Business Lawyer 106; A Shaffer, ‘Corporate Fiduciary – Insolvent: The Fiduciary Relationship Your Corporate Law Professor (Should Have) Warned You About’ (2000) 8 American Bankruptcy Law Institute Review 479, 543–550. 19 (1976) 137 CLR 1, (1976) 3 ACLR 529. 20 Ibid., 6–7, 531. 21 Ibid., 7, 532. 22 J McConvill, ‘Directors’ Duties to Creditors in Australian After Spies v The Queen’ (2002) 20 Company and Securities Law Journal 4, 12 and referring to R Tomasic, J Jackson, and R Woellner, Corporations Law: Principles, Policy and Process (Butterworths, 1996), 413–418. 23 [1980] 1 WLR 627 (HL).

182

THE DEV ELOPMENT OF THE OBLIGATION

include those of its creditors.’24 Re Horsley & Weight Ltd25 involved a claim by the liquidator of a company that the granting of a pension to a former director constituted a breach of duty, allowing for misfeasance proceedings to be brought. The liquidator failed in his claim, but Templeman LJ said that: If the company had been doubtfully insolvent at the date of the grant [of the pension] to the knowledge of the directors, the grant would have been both a misfeasance and a fraud on the creditors for which the directors would remain liable.26

12.13 Subsequently, in Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical Services Ltd27 a differently constituted Court of Appeal rejected the argument that the directors owed an obligation to take into account creditors’ interests after the directors made a bad decision and this led to the company becoming insolvent. Later, in Liquidator of West Mercia Safetywear Ltd v Dodd (‘West Mercia’)28 Dillon LJ said that the reason for the decision in Multinational Gas (his Lordship had been a member of the Court in the earlier case) was the fact that the subject company was amply solvent, and the decision of the directors was made in good faith. The Court in Multinational Gas was really only saying that directors owed no direct duty to creditors that was enforceable by creditors, as it went on to state that likewise there was no duty to individual shareholders, and ‘it could hardly be suggested that their [shareholders] interests need not be taken into account by directors.’29 12.14 A very influential decision, as far as the UK, Ireland and most Commonwealth jurisdictions are concerned, in the development of the responsibility is the Australian case of Kinsela v Russell Kinsela Pty Ltd (‘Kinsela’).30 This was a decision given by the Court of Appeal in New South Wales. In that case the liquidator of a company, RK, which carried on business as a funeral director, brought proceedings to have a lease over premises granted by RK to directors of the company, set aside. The lease had been granted three months before the commencement of winding up, and at a time when the company’s financial position was precarious. The company had sustained a significant loss during the previous year, had suffered less severe losses for several years and the accounts some six months before the lease was entered into showed that the company’s liabilities exceeded its assets by nearly A$200,000. Also, of importance, was the fact that the company had committed itself to performing services in relation to pre-paid funerals. The lease involved the directors being given a term of three years at a below-market rental, there was no escalator clause to cover inflation

24 Ibid., 634. 25 [1982] 1 Ch 442. 26 Ibid., 455. 27 [1983] Ch 258. 28 (1988) 4 BCC 30. 29 Christopher Riley, ‘Directors’ Duties and the Interests of Creditors’ (1989) 10 Company Lawyer 87, 91, n36. 30 (1986) 4 ACLC 215, (1986) 10 ACLR 395.

183

THE DEV ELOPMENT OF THE OBLIGATION

and the directors were entitled, during the life of the lease, to purchase part of the premises for a sum which was well below true value. 12.15 The Court found that the intention of the directors was to put the assets of RK beyond the reach of its creditors and to preserve what had been a family business for many years.31 In delivering the leading judgment (with which the other members of the Court concurred), Street CJ said that when a company is insolvent, the creditors’ interests intrude.32 His Honour went on to point out that in such a situation the shareholders are not entitled to ratify what would constitute a breach of obligation.33 As will be discussed in Chapter 14, his Honour refrained from formulating a test as to the degree of financial instability that was needed before directors were obliged to consider creditor interests, because the facts of the case did not require him to do so; as the company was clearly in a state of insolvency at the time of the relevant transactions, the obligation arose. 12.16 The first major statement that indicated that the UK courts would embrace any obligation to creditors was given in the House of Lords in the case of Winkworth v Edward Baron Development Co Ltd.34 Here X and his wife, Y, were the directors and shareholders of a company, Z, having used company money to purchase their shares. Z bought a property that X and Y occupied as their home. As a consequence of this and other payments, the company was overdrawn on its bank account. The company’s bank was given an undertaking by X that the deeds of the property purchased by Z would be held to the order of the bank. Y was unaware of this, as she did not take an active part in the company. X and Y sold their former marital home and paid part of the proceeds into Z’s bank account. Then X, without the knowledge of Y, initiated the mortgage of Z’s property to W in order to raise funds to discharge the indebtedness on the overdraft. Z subsequently became insolvent and went into liquidation. W commenced an action for possession against Z, as it has defaulted on its mortgage payments. Y opposed these proceedings on the basis that the payment of the funds from the former marital home gave her an equitable interest in the property. 12.17 Ultimately the House of Lords held that Y did not have an equitable interest. Much of what was said in the judgment is not relevant for our purposes. What is crucial, however, was the fact that Lord Templeman emitted a dictum which caused a significant amount of academic response, some of it highly critical. The dictum in fact constituted a development of what he had said in Re Horsley & Weight Ltd.35 12.18 His Lordship said rather boldly, without, discussing any previous cases that either directly or indirectly addressed the issue of directors’ duties to creditors, that: [A] company owes a duty to its creditors, present and future. The company is not bound to pay off every debt as soon as it is incurred and the company is not obliged

31 32 33 34 35

Ibid., 219, 399. Ibid., 221, 401. Ibid., 223, 404. [1986] 1 WLR 1512, [1987] 1 All ER 114. [1982] 1 Ch 442.

184

THE DEV ELOPMENT OF THE OBLIGATION

to avoid all ventures which involve an element of risk, but the company owes a obligation to its creditors to keep its property inviolate and available for the repayment of its debts. . . . A duty is owed by the directors to the company and to the creditors of the company to ensure that the affairs of the company are properly administered and that its property is not dissipated or exploited for the benefit of the directors themselves to the prejudice of the creditors.36

12.19 It has been suggested37 that Lord Templeman might have been merely restating the capital maintenance doctrine set out in In re Exchange Banking Company (Flitcroft’s Case),38 namely that the capital of a company cannot be reduced save as provided for in statute, not even with the sanction of a members’ meeting, as ‘there is a statement that the capital shall be applied for the purposes of the business, and on the faith of that statement, which is sometimes said to be an implied contract with creditors, people dealing with the company give it credit.’39 But most have taken the comment of his Lordship to have been advocating a direct duty to creditors and that the recipients of this duty included future creditors. Perhaps the primary reason for taking this approach is that rather than saying that the directors owed a duty to the company, and this included the creditors, his Lordship said that there was a duty owed to the company and to creditors. 12.20 Certainly, it appears that the latter view mentioned earlier was the one taken by the Full Court of the Western Australian Supreme Court in Jeffree v NCSC.40 At a time when arbitration proceedings were extant against a company, W, the controlling director, J, established a new company and sold the assets of W to the new company for value but not including anything for goodwill. When the person who initiated the arbitration proceedings succeeded, there were no assets held by W. Subsequently, the then Australian corporate regulator brought criminal proceedings against J on the basis that he had breached his directorial duties (at the time in Australia both civil and criminal proceedings could be brought against directors for breach of their duties). All three members of the Court agreed with the views expressed by Lord Templeman. 12.21 The dictum of Lord Templeman, which appeared to advocate a direct duty to creditors and that the recipients of this duty included future creditors, was met with some robust academic criticism.41 Apart from one dictum in a Court of Appeal decision, the decision in Jeffree v NCSC and the decision of a couple of Canadian judges at first instance, the view that his Lordship expressed seems to have met with little support. Although, in Fulham Football Club Ltd v 36 [1986] 1 WLR 1512, 1516, [1987] 1 All ER 114, 118. 37 John Farrar, ‘The Responsibility of Directors and Shareholders for a Company’s Debts’ (1989) 4 Canterbury Law Review 12, 14; I Trethowan, ‘Directors’ Personal Liability to Creditors for Company Debts’ (1992) 20 Australian Business Law Review 41, 46. 38 (1882) 21 Ch D 519. 39 Ibid., 533 per Jessel MR. 40 (1989) 7 ACLC 556. 41 Notably by Professor Len Sealy (‘Directors’ Duties – An Unnecessary Gloss’ [1988] CLJ 175). Professor Bob Baxt referred to the decision as ‘remarkable’ (‘A Senior Australian Court Gives the “Thumbs Up” to the Winkworth Principle’ (1989) 7 Companies and Securities Law Journal 344).

185

THE DEV ELOPMENT OF THE OBLIGATION

Cabra Estates plc,42 the Court of Appeal said, not dealing with an insolvency scenario, that the duties of directors are to the company, and ‘the company is more than just the sum total of its members. Creditors, both present and potential, are interested.’43 12.22 The Court of Appeal, in West Mercia,44 the case that became for many years the leading case in England on the issue under discussion,45 certainly until 2019, and cited and applied on many occasions, provided a more significant study of the area, and the usefulness of the obligation became evident as a result. In this case, D was the director of two companies, X and Y. X was the parent company of Y. At the relevant time both companies were in financial difficulty. X had a large overdraft that D had guaranteed, and it also had a charge over its book debts. One debt owed to X was £30,000, and this was owed by Y. A few days before there was a meeting of the members of Y, which was going to consider a motion that Y wind up, D transferred the sum of £4,000 that had been paid to Y by one of its debtors to X’s overdrawn bank account. On liquidation of Y, the liquidator sought from the bank repayment to Y of the £4,000. The bank refused and so the liquidator sought both a declaration that D was guilty of misfeasance and breach of obligation in relation to the transfer of the money to X, and repayment of the £4,000. 12.23 At first instance, in the county court, the liquidator failed. He then appealed to the Court of Appeal. Dillon LJ, who gave the leading judgment with which the other members of the Court (Croom-Johnson LJ and Caulfield J) concurred, found that the payment constituted a fraudulent preference (under the Bankruptcy Act 1914). As far as the claim that there had been a breach of duty, his Lordship approved of what Street CJ said in Kinsela,46 particularly in relation to the directors having an obligation to consider creditor interests when a company is in financial difficulty, and came to the view that there was a breach of duty on the part of D. 12.24 The decision in this case also made it plain that if a company is subject to circumstances that meant that creditor interests have to be taken into account by directors, shareholders cannot ratify any breach of duty on the part of the directors where the company is insolvent or even in financial difficulty. Judicial Opinion in the UK in the 1990s and Early 2000s 12.25 We now turn to see what decisions have been delivered in more recent times. In reported cases those arguing for the obligation had mixed success in the period on which this section focuses.

42 [1994] 1 BCLC 363. 43 Ibid., 379. 44 (1988) 4 BCC 30. 45 Professor Paul Davies has said that the case provides the clearest recognition of the obligation in English law: Gower’s Principles of Company Law (6th ed, Sweet and Maxwell, 1997), 603. 46 (1986) 4 ACLC 215, (1986) 10 ACLR 395.

186

THE DEV ELOPMENT OF THE OBLIGATION

12.26 The fact is that there were relatively few cases in the 1990s, but there was a growth in claims for breach of the obligation in the early 2000s and this has continued to the present day. This means that not all cases will be considered in this chapter. Many of the decisions cannot be said to have taken the jurisprudence concerning the obligation any further, provided helpful interpretation of it or provided guidance on the scope of the obligation. 12.27 The first case to consider is that of Yukong Lines Ltd of Korea v Rendsburg Investments Corporation.47 Here the plaintiff was a shipping company (YL Ltd) which bought proceedings against two companies, R and L, and an individual, Y, for relief in relation to the repudiation of a charterparty by R. The charterparty involved the charter of a vessel for three years. The document was signed on behalf of R by Y, as a director of M, a broking company acting for R. A short time before the vessel was to be delivered by YL Ltd to R, Y wrote to YL Ltd advising it that R was unable to perform the charterparty because of matters beyond its control. YL Ltd issued proceedings against R. Subsequently, YL Ltd added L and Y as defendants on the basis that they were undisclosed principals of R in relation to the charterparty. It was discovered that on the day that the charterparty was repudiated a large sum was transferred from R’s bank account to L. For our purposes, YL Ltd claimed damages from Y on the basis that he directed, at all material times, the affairs of R and L for himself and his family and the companies were his alter ego and that the transfer of assets from R to L was to put those assets beyond the reach of creditors. Leaving aside the arguments concerning the need to lift the corporate veil of R, we can focus on the claim made by YL Ltd that it was injured by a conspiracy between R, L and Y. This conspiracy, according to the submission of YL Ltd, involved a breach of Y’s fiduciary obligation to R. 12.28 Toulson J accepted that Y was a shadow director of R and that he owed a duty to R, and that the transfer of the funds from R to L was a clear breach of that obligation.48 His Lordship relied on West Mercia. Toulson J denied that Y owed YL Ltd a direct fiduciary obligation, but his Lordship did accept, following a reference to West Mercia (which also included a reference to Kinsela),49 that where a director of an insolvent company acts in breach of a duty to the company by causing assets of the company to be transferred in disregard of the interests of its creditors, the director is answerable.50 12.29 We now come to the case of Facia Footwear Ltd (in administration) v Hinchliffe.51 FF Ltd was a company whose sole shareholder was X. X and Y were its directors. The company was party to certain arrangements with the F group of companies. The group had been assembled by X and Y. In June 1996 an administration order was made against FF Ltd. A few months later the administrators of

47 48 49 50 51

[1998] BCC 870. Ibid., 884. (1986) 4 ACLC 215, (1986) 10 ACLR 395. [1998] BCC 870, 885. [1998] 1 BCLC 218.

187

THE DEV ELOPMENT OF THE OBLIGATION

FF Ltd commenced proceedings against X and Y for reimbursement of moneys alleged to have been paid improperly to third parties. The administrators alleged that because of the financial difficulties affecting the F group (including FF Ltd), X and Y had no realistic expectation that the payments, which had benefitted the F group, could ever be repaid. X and Y argued that these payments had to be made or else the F group would have had to cease trading and that would have led to FF Ltd’s demise. Also, X and Y argued that they believed that the F group had a reasonable chance of surviving. The administrators sought summary judgment from the court. 12.30 Sir Richard Scott V-C denied the application but recognised that the administrators might succeed at a full hearing of the issues. His Lordship, importantly for our purposes, did find that because of the parlous state of the finances of F group, X and Y had to have regard for the interests of creditors.52 The judge acknowledged that the Australian case of Kinsela,53 the New Zealand case of Nicholson v Permakraft (NZ) Ltd54 and the English case of West Mercia could be cited in support of the argument that the directors did owe a duty to take into account creditors’ interests. 12.31 Apart from the last two cases discussed there were no other reported cases in which liquidators were relying on the obligation to consider creditors’ interests. Since the turn of the century there have been far more cases brought by liquidators in which the obligation has been the basis of the action or one of the causes of action on which there has been reliance,55 and this is notwithstanding the fact that there have not been, generally speaking, more liquidations in the 2000s compared with the 1980s and 1990s. 12.32 The growth in cases is possibly due to five factors. First, liquidators had success in the early days of the 2000s and that could have encouraged other liquidators to proceed. Secondly, notwithstanding the introduction in April 2016 of the ‘Jackson reforms’ (reforms based upon Lord Justice Jackson’s recommendations),56 funding has become easier to obtain.57 Thirdly, principles developed concerning the obligation as more and more cases were decided and the greater treatment of the law and what directors should be doing may have given liquidators (and their funders) more confidence to proceed. Some of these principles are discussed in the next few paragraphs of this section of the chapter. 52 Ibid., 228. 53 (1986) 4 ACLC 215, (1986) 10 ACLR 395. 54 (1985) 3 ACLC 453. 55 See A Keay, J Loughrey, T McNulty, F Okanigbuan and A Stewart, ‘Business Judgment and Director Accountability: A Study of Case-Law Over Time’ (2020) 20 Journal of Corporate Law Studies 359. 56 Contained in Review of Civil Litigation Costs: Final Report (TSO, 2009) and found in the Legal Aid, Sentencing and Punishment of Offenders Act 2012. For discussion of it and the potential effect on insolvency practitioners, see the reports prepared by P Walton for R3: ‘The Likely Effect of the Jackson Reforms on Insolvency Litigation – an Empirical Investigation’ April 2014, www.r3.org.uk/media/ documents/policy/JA.C.kson_Campaign/JA.C.kson_Reforms_Insolvency_Litigation_April_2014. pdf, accessed 9 July 2018; ‘Insolvency Litigation and the Jackson Reforms: An Update’, April 2016. 57 A Keay, J Loughrey, T McNulty, F Okanigbuan and A Stewart, ‘Business Judgment and Director Accountability: A Study of Case-Law Over Time’ (2020) 20 Journal of Corporate Law Studies 359.

188

THE DEV ELOPMENT OF THE OBLIGATION

Fourthly, the codification (preservation) of the obligation in s 172(3) of the Act may have provided greater publicity to the obligation and also given liquidators more confidence to bring actions on the basis that there was no longer merely judicial acceptance of the obligation but also legislative acceptance. Fifthly, it is likely that with the advent of the neutral citation system of reporting58 we are aware of more cases than was previously the case when we were often dependent on cases being reported in the authorised reports and/or the specialist company case reports. 12.33 The relative high employment of the claims for breach of the obligation is perhaps a little surprising given the fact that there still remained several uncertainties in relation to what has to be established in bringing proceedings under this cause of action.59 12.34 The following discussion does not purport to deal with all cases that have been reported since 2000. It merely seeks to mention those cases which can be identified as providing some commentary that has contributed to the development of the obligation in the UK and up until the enactment of s 172(3) of the Act. More cases are referred to and discussed in Chapters 14 and 15 when the book considers the two main issues that exist with the obligation, namely when is it triggered and what must directors do to avoid a breach? 12.35 The first case to mention is Re Pantone 485 Ltd60 where the applicant liquidator failed before the High Court in a claim that the directors of the company in liquidation had disposed of company property without taking into account the interests of one of the creditors, an unsecured creditor entitled to priority in a distribution of the company’s assets. While Richard Field QC (sitting as a deputy High Court judge) acknowledged that when a company was insolvent the directors had to have regard for the creditors’ interests,61 the judge’s problem with the claim was that directors had a duty to make decisions, when their company was insolvent, while having regard for all general creditors, and not one, or a section, of the creditors. It was on this basis that the judge distinguished the case of West Mercia.62 This decision, therefore, made it clear that the interests of all the creditors were relevant in relation to what the directors were to do. 12.36 Arguably, the next case which provided a further development in the obligation was the decision of Leslie Kosmin QC (sitting as a deputy judge of the High Court) in Gwyer v London Wharf (Limehouse) Ltd.63 The deputy judge affirmed the principles laid down in West Mercia64 and said that the directors of 58 Neutral citations were introduced in the UK in 2001 for judgments from all divisions of the High Court and are independent of any law reports series. Many of these cases are publicly available on the website for the British and Irish Legal Information Institute (BAILII). Even more are available through specialist databases, such as Westlaw UK and Lexis Library. 59 See, Andrew Keay, ‘Directors’ Duties and Creditors’ Interests’ (2014) 130 Law Quarterly Review 443. 60 [2001] EWHC 705 (Ch), [2002] 1 BCLC 266. 61 Ibid., [73]. 62 (1988) 4 BCC 30. 63 [2003] 2 BCLC 153, [2002] EWHC 2748. 64 (1988) 4 BCC 30.

189

THE DEV ELOPMENT OF THE OBLIGATION

an insolvent company breached their duty to their company by not considering the interests of the creditors of the company when agreeing to a compromise over a legal action.65 But, more importantly, the decision in Gwyer v London Wharf (Limehouse) Ltd set out for the first time the test that should be applied in determining whether the directors were liable or not for breach of the obligation. 12.37 The judge applied the ‘Charterbridge Corporation test’ to the obligation to consider creditors. He said that: In relation to an insolvent company, the directors when considering the company’s interests must have regard to the interests of the creditors. If they fail to do so, and therefore ignore the relevant question, the Charterbridge Corporation test can be applied with the modification that in considering the interests of the company the honest and intelligent director must have been capable of believing that the decision was for the benefit of the creditors. In my view the Charterbridge Corporation test is of general application.66

12.38 Charterbridge Corp Ltd v Lloyds Bank Ltd (‘Charterbridge’)67 was a case where the judge had to consider, in the course of his deliberations, the duty of directors to act in good faith in the best interests of their company, in circumstances where the company was solvent. The duty considered was the classic duty of loyalty developed by the courts and which applied in the UK until 2007 when the duty in s 172(1) of the Act came into force. This provision demands that directors do that which they consider in good faith will promote the success of the company for the benefit of the members.68 The duty requiring directors to act in good faith in the best interests of the company as a whole has been held to be the precursor of s 172(1).69 Re Smith and Fawcett Ltd70 had earlier provided that this duty was subjective, as directors were obliged to act ‘bona fide in what they consider – not what a court may consider – is in the interests of the company.’71 The test for determining whether directors acted properly was: did they believe that what they did was in the best interests of the company? If the answer was yes, then the directors had acted properly. 12.39 The judge in Charterbridge, Pennycuick J, said that where the director against whom proceedings have been initiated had actually failed to consider whether the action that was the subject of complaint would be in the interests of the company, objective considerations would come into play and the court had to ask whether an intelligent and honest person in the position of a director of

65 [2002] EWHC 2748, [2003] 2 BCLC 153, [81]. 66 Colin Gwyer and Associates Ltd v London Wharf (Limehouse) Ltd [2002] EWHC 2748 (Ch), [2003] BCC 885, [87]. 67 [1970] Ch 62. 68 For a detailed discussion of s 172(1) and the duty, see Andrew Keay, Directors’ Duties (4th ed, LexisNexis, 2020), Chapter 6. 69 For example, see Cobden Investments Ltd v RWM Langport [2008] EWHC 2810 (Ch), [52]; Madoff Securities International Ltd (in liq) v Raven [2013] EWHC 3147 (Comm), [260]. 70 [1942] Ch 304. 71 Re Smith and Fawcett Ltd [1942] Ch 304, 306 per Lord Greene MR.

190

THE DEV ELOPMENT OF THE OBLIGATION

the company involved, could, in the whole of the circumstances, have reasonably believed that the action was for the benefit of the company.72 12.40 As mentioned, Leslie Kosmin QC applied this approach in Gwyer v London Wharf (Limehouse) Ltd to directors who were subject to the obligation to consider the interests of creditors (now preserved in s 172(3)).73 The deputy judge accepted that directors who argued that they acted in good faith in carrying out the decision(s) complained of by a liquidator, and who gave evidence that supported the contention, failed to consider creditor interests when they made relevant decisions, then in order to ascertain whether they were liable the court should ask whether an intelligent and honest person in the position of the directors, could, in the whole of the circumstances, have reasonably believed that the action that was impugned was for the benefit of the creditors. If the answer was ‘no’ then the directors were liable for breach of the obligation to take account of the interests of the creditors. 12.41 In Charterbridge, Pennycuick J said that when directors state that they believed in good faith that what they did was in the best interests of the company, the court is not obliged to believe them. In other words, while a claimant has to establish that the respondent directors did not act in good faith, this does not mean that directors’ assertions that they acted in good faith were unassailable. The court is not going to accept unquestioningly bald statements by directors that they acted in good faith if the evidence does not support that fact. 12.42 The position taken in Charterbridge was affirmed by Harman J in Re A Company74 when he said: ‘It is, in my judgment, vital to remember that actions of boards of directors cannot simply be justified by invoking the incantation “a decision taken bona fide in the interests of the company.”’75 Also, the fact is that it is going to be more difficult for courts to accept a director’s claim to have acted in good faith where he or she has benefitted personally from the impugned action or for some purpose other than advancing the welfare of the company and its interests.76 12.43 Leslie Kosmin QC clearly applied this approach in Gwyer v London Wharf (Limehouse) Ltd77 to where there was an alleged breach of the obligation to consider creditor interests.78 The upshot of the judgment is that if the directors assert that they acted in good faith and the court could find nothing that controverted that assertion, then there was no breach. If, however, there was evidence that the directors had not taken into account the interests of creditors 72 Charterbridge [1970] Ch 62, 74. 73 Bilta (UK) Ltd (in liquidation) v Nazir [2015] UKSC 23; [2016] AC 1, [104], [123]–[124]; Sequana [2022] UKSC 25, [13], [69], [73], [99], [209], [252], [342]. 74 [1988] BCLC 570. 75 Ibid., 577. 76 Regentcrest plc v Cohen [2001] BCC 494, [2002] 2 BCLC 80; Extrasure Travel Insurances Ltd v Scattergood [2003] 1 BCLC 598; Roberts v Frohlich [2011] EWHC 257 (Ch), [2012] BCC 407, [2011] 2 BCLC 625. 77 [2003] 2 BCLC 153, [2002] EWHC 2748. 78 The approach was accepted by the Court of Appeal in BTI 2014 LLC v Sequana SA [2019] EWCA Civ 112, [2019] 2 All ER 784, [2019] BCC 631, [2019] 1 BCLC 347, [2019] BPIR 562, [147].

191

THE DEV ELOPMENT OF THE OBLIGATION

then what the court would do is to determine whether the honest and intelligent director would have believed that the decision was for the benefit of the creditors. Section 172(3) of the Companies Act 2006: The Statutory Aid 12.44 In 2006 Parliament passed the Companies Act 2006. This was a result of significant study of the UK’s company law by a specialised group and substantial debate in the two Houses of Parliament. 12.45 In the late 1990s the UK government’s Department of Trade and Industry commissioned a review that would formulate proposals for the reform of UK company law.79 This review was to be the most wide-ranging since the middle of the nineteenth century and was established to formulate a framework of company law which ‘facilitates enterprise and promotes transparency and fair-dealing.’80 The review that was commissioned was to be overseen by a Steering Group that became known as the Company Law Review Steering Group (‘CLRSG’).81 The CLRSG was constituted by company law experts, jurists, academics, businesspersons and others.82 12.46 One of the major recommendations of the CLRSG was that the general duties of directors should be codified. In this regard the CLRSG recommended that the codified duties would be based on the existing general duties in equity and at common law, but it did recommend some changes to the duties. The duty that caused the most debate is now found in s 172(1) of the Act. This obligation was, as we have seen, to provide for something called ‘an enlightened shareholder value approach’ (‘ESV’).83 12.47 The CLRSG formulated the view that in legislation-regulating companies there should be a statement of principles concerning duties of directors. The CLRSG rejected (provisionally), at one stage and in earlier position papers, the idea of including, in this statement of principles a requirement that directors must have regard for creditor interests.84 One of the primary reasons for this view was that a statement of principles including mention of placing a responsibility on directors to creditors might ‘cut across section 214 of the Insolvency Act 1986’ (the wrongful trading provision).85 Nevertheless, by the time that the 79 Company Law Review, Modern Company Law For a Competitive Economy (DTI, 1998), 1. For a more detailed discussion of the considerations undertaken in relation to this review, see Andrew Keay, The Enlightened Shareholder Value Principle and Corporate Governance (Routledge, 2013), Ch 3. 80 Company Law Review, Modern Company Law for a Competitive Economy (DTI, 1998), Foreword. 81 There has been in recent times some criticism of the constitution of the CLRSG by members of it. See D Collison et al., ‘Shareholder Primacy in UK Corporate Law: An Exploration of the Rationale and Evidence,’ Research Report 125, Certified Accountants Educational Trust, London, 2011, 30. 82 Modernising Company Law, Cm 5553-I, Vol 1 (DTI, 2002), para 7. For more discussion about the CLRSG and its views, see Andrew Keay, The Enlightened Shareholder Value Principle and Corporate Governance (Routledge, 2013), Ch 3. 83 For more and detailed discussion about ESV, see Keay, ibid. 84 Modern Company Law for a Competitive Economy: Developing the Framework (DTI, 2000), para 3.73. 85 Ibid., para 3.72.

192

THE DEV ELOPMENT OF THE OBLIGATION

CLRSG published its Final Report on 26 July 2001, the majority of the Group had changed its mind,86 certainly in relation to the situation where insolvency threatens a company. The CLRSG said, inter alia, that: In providing a high level statement of directors’ duties, it is important to draw to directors’ attention that different factors may need to be taken into consideration where the company is insolvent or threatened by insolvency. To do so would risk misleading directors by omitting an important part of the overall picture.87

12.48 The CLRSG went on to observe, adroitly, it is submitted, that as a company’s situation becomes more desperate financially: [T]he normal synergy between the interests of members, who seek the preservation and enhancement of the assets, and of creditors, whose interests are protected by that process [insolvency], progressively disappears. As the margin of assets reduces, so the incentive on directors to avoid risky strategies which endanger the assets of members also reduces; the worse the situation gets, the less members have to lose and the more one-sided the case becomes for supporting risky, perhaps desperate, strategies.88

12.49 The CLRSG’s recommendations were effectively embraced by the UK Government in two White Papers and the Company Law Reform Bill 2005. Eventually the recommendations were accepted, in the main, by Parliament after some rigorous debate and they became part of the Companies Act 2006. ESV was encapsulated in s 172(1). 12.50 It is not within the scope of the book to engage in any discussion of s 172(1)89 save to say that the provision has been interpreted by the courts in the same manner as they interpreted the precursor duty, the duty to act in the best interests of the company as a whole.90 12.51 In s 172 the legislature also included a provision that addressed the CLRSG’s concern about creditor interests. This provision is s 172(3) and it provides: ‘The obligation imposed by this section [s 172(1)] 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.’ 12.52 Section 172(3) is statutory recognition or preservation of the principle91 that the interests of creditors are within the scope of the duties of directors, at least where the company is or may become insolvent, and it is a recognition of

86 Modern Company Law for a Competitive Economy: Final Report Vol 1 (DTI, 2001), para 3.13. 87 Ibid., para 3.12. 88 Ibid., para 3.15. 89 For an examination of s 172(1), see Andrew Keay, The Enlightened Shareholder Value Principle and Corporate Governance (Routledge, 2013), Ch 4; Andrew Keay, Directors’ Duties (4th ed, LexisNexis, 2020), Ch 6. 90 See Cobden Investments Ltd v RWM Langport Ltd [2008] EWHC 2810 (Ch), [52]; Madoff Securities International Ltd (in liq) v Raven [2013] EWHC 3147 (Comm), [260]. 91 See Sequana [2022] UKSC 25,

193

THE DEV ELOPMENT OF THE OBLIGATION

the case law, including the then leading case of West Mercia.92 The obligation that has been developed is regarded as a rule of law within the terms of s 172(3). 12.53 Section 172(3) recognises the common law development of an obligation of directors to consider the interests of the creditors of the company in certain circumstances. The provision does not state when creditors’ interests intrude into the judgment and decision-making of directors, and it does not say what considering or acting in the interests of creditors entails. Both matters are left to the common law. The circumstances which will lead to directors having to consider creditor interests is discussed in detail in Chapter 14 and involves situations where the company is in some form of financial difficulty.93 What directors should be doing to meet the requirement that they consider or act in the interests of creditors is examined in Chapter 15. Cases Post Companies Act 2006 12.54 There is, as Rose J noted in Bti 2014 Llc v Sequana SA,94 a long line of cases which have been based on a claim under s 172(3),95 either alone or in conjunction with other causes of action. In Caley Oils Ltd (In Administration) v Wood96 it was stated by Lord Clark that: ‘There is no doubt therefore that section 172(3) preserves the common law position and makes no alterations to it. . . . It is clear that section 172(3) preserves the common law position.’ This comment is representative of those made in a host of cases since the enactment of the Act, and most notably by the Supreme Court in Sequana.97 The legislature has, in s 172(3), authorised the courts to develop the obligation.98 12.55 The case law that has been handed down since the enactment of s 172(3) is as important to a consideration of the obligation as the case law that preceded the provision’s introduction in the Act, for while the case law delivered prior to the Act’s enactment was what was in the minds of the policy-makers, decisions delivered after the enactment have developed the obligation further and given us greater insight into the scope and application of the obligation. 12.56 Generally, the approach prior to s 172(3) coming into being has been retained in the post-2006 cases with some attempt to try and make the obligation clearer. This section of the chapter examines those cases that were decided following the enactment of s 172(3). Not all cases are considered. Many important cases are discussed later in Chapters 14 and 15, where the book endeavours to explain the scope and application of the obligation. It is not suggested that the

92 Bilta (UK) Ltd (In Liquidation) v Nazir [2012] EWHC 2163 (Ch), [37] and affirmed on appeal at [2013] EWCA Civ 968, [2014] Ch 52, [22]. 93 This has been considered in Andrew Keay, ‘Formulating a Framework for Directors’ Duties to Creditors: An Entity Maximisation Approach’ (2005) 64 Cambridge Law Journal 614. 94 [2016] EWHC 1686, [2017] 1 BCLC 453. 95 Ibid., [465]. 96 [2018] CSOH 42, [43]. 97 [2022] UKSC 25, [13], [69], [73], [99], [209], [252], [342]. 98 Ibid., [237], [253].

194

THE DEV ELOPMENT OF THE OBLIGATION

cases discussed in the following paragraphs are necessarily more important than others; the cases considered are merely those that appear to have moved along the interpretation of the obligation and are marked by some significant holdings. 12.57 In Re HLC Environmental Projects Ltd,99 a case where he was faced with an insolvent company whose directors were subject to s 172(3) and who paid only some of its creditors, John Randall QC (sitting as a deputy judge of the High Court) said that the respondent director had breached his duty in choosing which creditors to pay and which to leave exposed to a real risk of not being paid.100 The deputy judge was critical of the respondent director’s decision to choose which creditors to pay and which to leave exposed to a risk of non-payment at a time when the director had to take into account the company’s creditors.101 The foregoing suggested that creditors must be treated as a class. This had been indicated a little earlier by Newey J (as he then was) in GHLM Trading Ltd v Maroo,102 when said that where a company is insolvent then the director’s duty involves having regard for the interests of the creditors as a class. His Lordship said that: ‘If a director acts to advance the interests of a particular creditor, without believing the action to be in the interests of creditors as a class, it seems to me that he will commit a breach of duty.’103 12.58 While the obligation was not considered in any great detail in the judgment, in Bilta (UK) Ltd v Nazir,104 two Justices of the Supreme Court acknowledged the existence and importance of the obligation, and this was the first time that it had been mentioned at this judicial level since the dictum of Lord Templeman in 1986 in Winkworth v Edward Baron Development Co Ltd.105 The joint judgment of Lords Toulson and Hodge in the decision in Bilta (UK) Ltd v Nazir is also of importance in that their Lordships said, in obiter, that in the context of considering duties owed by directors when their company is insolvent, the directors have a duty to take account of the interests of the prospective creditors of their company.106 12.59 The Court of Appeal had its first opportunity to consider the obligation since West Mercia in 2019 in BTI 2014 LLC v Sequana SA.107 12.60 It is worthwhile setting out the facts in BTI 2014 LLC v Sequana SA, as the case will be referred to on many occasions in the following chapters and also the case went on appeal to the Supreme Court. X, a wholly owned subsidiary

99 [2013] EWHC 2876 (Ch), [106]. 100 Whilst it might be argued that all of the creditors paid were associated with the director making the payment or the payments benefitted the director either directly or indirectly, the deputy judge did not make any distinction between paying creditors that benefitted the director and paying creditors that did not provide any benefit. 101 [2013] EWHC 2876 (Ch), [2014] BCC 337, [106]. 102 [2012] EWHC 61, [2012] 2 BCLC 369. 103 Ibid., [168]. 104 [2015] UKSC 23, [2016] AC 1. 105 [1986] 1 WLR 1512, [1987] 1 All ER 114. 106 [2015] UKSC 23, [2016] AC 1, [123]. 107 [2019] EWCA Civ 112, [2019] 2 All ER 784, [2019] BCC 631, [2019] 1 BCLC 347, [2019] BPIR 562.

195

THE DEV ELOPMENT OF THE OBLIGATION

of Y, acquired two businesses. Under the terms of the business acquisition, X assumed the liabilities of the seller, Z, including certain environmental liabilities, and Y agreed to indemnify Z if X failed to meet those liabilities. Y established W as the holding company of X. The following year, W was demerged from Y and later merged with another company, changing its name to A. The businesses acquired by Y had been responsible for extensive pollution, and subsequently claims were notified against X and Z. Under an agreement made between X, Y and Z, it was agreed that liabilities of the parties related to the pollution would be shared up to a total of $75m as to 45% by Z and as to 55% by X and Y. A was acquired by S. In 2001, X was sold by A. As part of the sale, A indirectly indemnified X against all liabilities relating to the pollution. X assigned to A its rights against third parties, including rights under insurance policies that had been taken out by Y. Through a subsidiary, A purchased a guaranteed investment contract, to provide funds to pay for all aspects of the liability for the pollution. 12.61 Following the sale of X, A ceased to be a trading company. The proceeds of sale of its businesses and other receipts were lent, over the years, to S. S and the directors of A explored ways of reducing the debt owed to S. At that time A’s only significant obligations were its contingent indemnity liabilities. A provision of €62.8m was made against its contingent liabilities in A’s interim accounts, and it represented the difference between the amount recoverable under insurance that it had taken out in relation to any liability relating to the pollution and the directors’ best estimate of the liability. To the extent that the S debt exceeded the provision, it represented net assets in the accounts that were, on the face of the accounts, surplus to A’s requirements. The net assets shown in the interim accounts amounted to €517m. S and the directors of A decided that a dividend of €443m should be paid to S. In order to achieve this, the board of A resolved to make a capital reduction. The board of A resolved to pay a dividend by way of set-off against the S debt, reducing the debt to €142.5m. Following these steps, A’s paid-up share capital was €1m and its distributable reserves, as shown in its final accounts were €137m. Subsequently, the insurance policy was deemed sufficient to cover the best estimate of the liability for the pollution and, therefore, it was not necessary to include a provision in the accounts for the liability. An audit gave the accounts an unqualified certificate that they gave a true and fair view. 12.62 The final accounts showed distributable reserves of €137m, and A’s board resolved to pay an interim dividend of €135,181,358 by way of set-off against the S debt, reducing it to about €3.1m. The dividend was paid in contemplation of the sale by S of A. At the time of the sale of A, S was no longer exposed to the risk that its debt to A would be called to fund indemnity payments. Later, A, acting through its new board, challenged both dividends and in each case on three grounds, one of which was they were paid in breach of the duty of the directors of A to have regard to the interests of its creditors. Claims were brought against the former directors of A who authorised the payment of the dividends and against S as a constructive trustee. B purchased the claims from A. At first instance Rose J (as she was then) dismissed the claim for breach 196

THE DEV ELOPMENT OF THE OBLIGATION

of duty but found against S on another ground. S appealed against the judgment given against it and B appealed against the dismissal of the rejection of the claim for breach of duty, arguing that directors had a duty to take into account creditors’ interests when there was a real, as opposed to a remote, risk of insolvency. 12.63 What is important for the purposes of this book is that the Court of Appeal and then the Supreme Court dismissed B’s appeal against the decision of Rose J that there had been no breach of duty. More will be said about aspects of the judgment in Chapters 14 and 15, because it is more appropriate to discuss it in those chapters. Suffice to say at this point is that the Court of Appeal accepted that the obligation applied where a company was insolvent, and it could arise where a company’s financial circumstances were dire and short of insolvency. B appealed to the Supreme Court against this element of the judgment of the Court of Appeal. Thus, finally the Supreme Court got to hear a claim that was centred on the obligation. The Supreme Court in Sequana 12.64 Many references are made in the following chapters to the judgment of the Supreme Court in Sequana,108 thus it is not intended here to discuss and analyse the judgment in detail. Rather, aspects of the judgment will be analysed in later chapters in the light of the main issues that have to be addressed in relation to the obligation and its application. What we need to say here is that the Supreme Court dismissed the appeal that there had been a breach of duty. 12.65 Like the Court of Appeal, all the judges roundly rejected the argument that the obligation was triggered when there was a real, as opposed to a remote, risk of insolvency. While dismissing the appeal the Supreme Court did not agree with the Court of Appeal’s view as to when the obligation arises. This is discussed in Chapter 14. The Court made a number of comments relating to the obligation, but members of the Court felt that many of them should be seen as provisional, as there was no need for the Court to provide a final decision.109 Many of the comments of the Court are, therefore, obiter. 12.66 Whilst the respondents to the appeal actually argued inter alia that the obligation did not exist in English law, the judges unanimously said that it did,110 and it had a sound legal basis.111 Lord Briggs JSC said that undoubtedly the obligation’s existence rather than its denial was more consistent with both company law, as reflected in the Act, and with insolvency law as largely codified in the Insolvency Act 1986.112 It was accepted that the obligation is a rule of law within s 172(3).113 The need for the obligation was explained in Sequana by Lord Hodge DPSC when he said that: 108 109 110 111 112 113

[2022] UKSC 25. For instance, see ibid., [4], [78]. Ibid., [76], [111], [138], [247], [248]. Ibid., [76], [138], [228]. Ibid., [151]. Ibid., [69].

197

THE DEV ELOPMENT OF THE OBLIGATION

I am not persuaded that the existing law without the directors’ fiduciary duty to the company to have proper regard to the interests of its creditors covers the field adequately where there is a significant conflict between the interests of the shareholders and the interests of the company’s creditors when it is insolvent or bordering on insolvency.114

12.67 His Lordship had said earlier in his judgment that if the Court rejected the obligation’s existence: it would be going against the recognition by Parliament of the existence of the common law duty to creditors and its expectation that the courts will develop the law in this area. It would also be creating incoherence between our company law and our law of corporate insolvency and would place directors in a position in which their duties and their personal interest were in conflict.115

12.68 Lady Arden JSC said that there was a need for the obligation even when one takes into account the many provisions providing for the avoidance of transactions occurring before administration or liquidation and establishing liability in insolvency.116 12.69 It was in relation to the two most important issues concerning the obligation, namely when does it arise and what does it require directors to do, that the Supreme Court judgment is most illuminating, and that is discussed in Chapters 14 and 15. 12.70 The Supreme Court, echoing comments made by other judges, some in other jurisdictions, made it clear that the obligation was developing117 and needed fleshing out,118 so the Supreme Court judgment is far from the end of the story. Lord Hodge in Sequana said that the scope of liability pursuant to the obligation is to be determined in the future in a case in which the matter is relevant to the outcome of the appeal.119 This was not something that was at issue in the appeal. Thus, many of the comments of the judges which are referred to in this book are, as noted, only obiter. However, as they are the views of Supreme Court judges, they will be regarded as highly persuasive in succeeding cases. 12.71 One interesting thing to note is that while some of the views of the Supreme Court judges accord with the views of appellate court judges in other jurisdictions, other views do not, and we wait to see if the Sequana judgment affects how judges elsewhere will see the obligation. Conclusion 12.72 The chapter has explained how the obligation to consider the interests of creditors in time of financial strife developed from the decision of Walker v 114 115 116 117 118 119

Ibid., [242]. Ibid., [232]. Ibid., [258]. Ibid., [15]. Ibid., [250]. Ibid., [239].

198

THE DEV ELOPMENT OF THE OBLIGATION

Wimborne120 in 1976 to the present day. The obligation developed by way of judicial exposition in courts in the UK and many other common law jurisdictions. The case law in these jurisdictions has built on earlier case law to enable the obligation to become clearer. Although, it must be stated that there remains some uncertainty concerning the application of the obligation, a matter which is examined in Chapters 14 and 15. 12.73 An examination of the case law demonstrates that while most courts have resisted the view that directors owe an independent obligation to creditors of their companies, they have confirmed that directors do owe a duty to their companies to take into account the interests of creditors when companies are in some form of financial difficulty. A significant jurisprudence has developed in the UK, several Commonwealth jurisdictions, Hong Kong and Ireland. 12.74 While liquidators and administrators who wish to proceed against directors for breach of duty, namely failing to consider creditor interests, will continue to have to rely on this case law they now have together with s 172(3) of the Act which provides statutory recognition of the obligation. 12.75 A critically important development is the judgment of the Supreme Court in Sequana. This decision unequivocally accepted that the obligation does exist in UK law. Besides that, the judges gave opinions in relation to many aspects of the obligation and, whilst obiter, these comments are going to be regarded as highly persuasive in future UK decisions. Thus, it will act as the guide for both directors in deciding how to act and officeholders who will need to determine whether directors have breached the obligation and should be subject to proceedings.

120 (1976) 137 CLR 1, (1976) 3 ACLR 529.

199

CHAPTER 13

The Nature of and Rationale for the Obligation

Introduction 13.1 The previous chapter explained how the obligation to take into account the interests of creditors developed from 1976. There were parts of the chapter which mentioned aspects of the nature of the obligation. This chapter explores that matter further and also endeavours to trace the foundations of the obligation, which provides some indication of the reason for its existence. It is submitted that a consideration of these two matters is essential to understand the obligation and how it might be applied in practice. 13.2 The chapter begins with a consideration of the nature of the obligation and then proceeds to examine its foundations. The Nature of the Obligation 13.3 There has been some debate over the years as to whether the obligation meant that directors owed an independent duty to creditors when the obligation was said to arise,1 that is a direct duty to creditors, or whether in discharging their duty to act in the best interests of the company and owed to the company required directors to consider the interests of creditors. As mentioned in Chapter 12, there were a couple of cases, Winkworth v Edward Baron Development Co Ltd2 in the UK and Jeffree v NCSC in Western Australia,3 that supported the view of one or two commentators that it was the former.4 Yet, over time, that view has become discredited, expressly in Australia5 and implicitly elsewhere.6 13.4 The only time that the issue of whether the obligation constituted a direct duty to creditors since Winkworth was discussed in the Supreme Court decision

1 See Chapter 14. 2 [1986] 1 WLR 1512, [1987] 1 All ER 114. 3 (1989) 7 ACLC 556. 4 For a discussion of the issue, see Andrew Keay, Company Directors’ Responsibilities to Creditors (Routledge, 2007), Ch 15. 5 Re New World Alliance Pty Ltd ((1994) 122 ALR 531; Spies v The Queen [2000] HCA 43, (2000) 201 CLR 603, (2000) 173 ALR 529. 6 Millgate Financial Corporation Ltd. v BCED Holdings Ltd 2003 CanLII 39497 (Ont SC); Peoples’ Department Stores v Wise ([2004] SCC 68, (2004) 244 DLR (4th) 564.

200

DOI: 10.4324/9780429266232-17

THE NATU R E OF AND R ATIONA LE FOR THE OBLIGATION

in BTI 2014 LLC v Sequana SA (‘Sequana’).7 The judges unanimously rejected the notion that the obligation involved a new or free-standing duty to creditors.8 Lord Reed PSC said that the effect of the obligation is: to preserve the directors’ duty to act in the interests of the company, but to modify the sense of the latter expression so that, where the rule applies, the interests of the company are no longer regarded as solely those of its shareholders but are understood as including those of its creditors as a whole.9

13.5 Perhaps the final point to make on this matter is that directors owe their duties to their company according to s 170(1) and so they could not owe them to creditors. Thus, there is no shift in directors’ duties, but how directors are to discharge their duties. 13.6 In some case law it has been said that the duty might better be explained as an imperfect obligation,10 as creditors are unable to enforce a breach of the so-called duty. Proceedings must be brought by the company, or more likely by the company’s liquidator or administrator. Certainly, the description of the responsibility as being an imperfect obligation might represent a fair description prior to the Companies Act 2006 (‘the Act’) when the obligation to creditors might have been seen as an aspect of the duty to act in good faith in the best interests of the company. The same might also be said since the enactment of s 172 of the Act as s 172(3) provides that ‘the duty imposed by this section [s 172(1)] has effect subject to any enactment or rule of law.’ Thus, as the Supreme Court has said, the obligation is a qualification11 or modification12 of the duty in s 172(1). 13.7 Unlike most protections given to creditors, but like the wrongful trading provision in the Insolvency Act 1986, the duty imposes personal liability on the directors of the company. The benefit of this is, of course, if the company ends up in insolvent liquidation there is a chance that some money can be recouped from taking proceedings against the directors. While the imposition of the obligation places directors under the threat of legal proceedings in the future, it does permit them to exercise their discretion, if their company is financially distressed, to make decisions that favour, or at least do not prejudice, the creditors, without being open to the charge of not acting in the best interests of the members. 13.8 Perhaps the most controversial aspect of the duty is its ex post nature. At the time of entering into credit arrangements the directors are not subject to the obligation unless the company is already in financial strife. They only become subject to it at some time after the contracts have been finalised. It is fair to say that while creditors might have considered, and even raised the issue

7 [2022] UKSC 25. 8 Ibid., [11], [25], [77], [205], [250], [261]–[277], [334], [426]. 9 Ibid., [79]. 10 See Re New World Alliance Pty Ltd; Sycotex Pty Ltd v Baseler (1994) 51 FCR 425, 444–445, (1994) 122 ALR 531, 550; J Heydon, ‘Directors’ Duties and the Company’s Interests’ in P D Finn (ed), Equity and Commercial Relationships (Law Book Co, 1987), 131. 11 Sequana [2022] UKSC 25, [225], [258], [265]. 12 Ibid., [74], [96], [252].

201

THE NATU R E OF AND R ATIONA LE FOR THE OBLIGATION

of management responsibilities, during the course of negotiations, few creditors will have required any terms in the credit contract, such as the inclusion of a negative pledge, to address what management does or does not do. It might be thought to be unfair for directors to be held liable for actions that are not covered by the credit contract,13 and that their conduct could be reviewed by a court at some point down the track. Suffice it to say at present, the law does not refrain, in other respects, from imposing responsibility ex post. For example, the power to adjust preferential transfers, under s 239 of the Insolvency Act 1986, when a company is in administration or liquidation, is one of a number of powers that invokes such a strategy. 13.9 In 2013 John Randall QC (sitting as a deputy judge of the High Court) in Re HLC Environmental Projects Ltd14 seemed to assume that the obligation is fiduciary in nature, and it is respectfully submitted he was right to do so. This can be demonstrated as follows. First, the obligation referred to in s 172(3) provides for a qualification15 or modification16 of the duty in s 172(1), and the latter is clearly a fiduciary duty. 13.10 Secondly,17 s 212 of the Insolvency Act 1986, the provision through which claims under s 172(3) are usually brought, refers to a director being responsible for misfeasance if committing a ‘breach of any fiduciary or other duty.’18 From this it might be argued, perhaps, that the obligation to account for creditors’ interests falls under the words ‘other duty,’ distinguishing it from fiduciary duty. Yet, at the time of the decision in Liquidator of West Mercia Safetywear Ltd v Dodd19 (‘West Mercia’) s 212’s precursor, s 333 of the Companies Act 1948, did not include the words ‘breach of any fiduciary or other duty.’ Rather, it referred only to a ‘breach of trust.’20 The Court of Appeal was willing to accept in West Mercia that the ‘breach of obligation’ fell within s 333 and to make an order. This indicates that the Court regarded the breach of the obligation to take creditors’ interests into account as falling within the category of a ‘breach of trust,’ and breach of trust has been interpreted by the courts as including a breach of a fiduciary duty in a corporate context.21 Furthermore, s 178(2) of the Act provides, in effect, that the duties in s 172 are fiduciary, as the sub-section states that the duties in ss 171–177 are all enforceable, with the exception of the obligation of care found in s 174, in the same way as any

13 Some might argue that it also represents an illegitimate transfer of wealth from shareholders to creditors. 14 [2013] EWHC 2876 (Ch), [2014] BCC 337. 15 Sequana [225], [258], [265]. 16 Ibid., [74], [96], [252]. 17 This paragraph draws on Andrew Keay, ‘Financially Distressed Companies, Preferential Payments and the Director’s Obligation to Take Account of Creditors’ Interests’ (2020) 136 Law Quarterly Review 52, 72. 18 Section 212(1). 19 [1988] 4 BCC 30. 20 Section 333(1). 21 Re Lands Allotment Co [1894] 1 Ch 616; J.J. Harrison (Properties) Ltd v Harrison [2002] BCC 719, Gwembe Valley Development Co Ltd v Koshy [2003] EWCA Civ 1048, [2004] 1 BCLC 131.

202

THE NATU R E OF AND R ATIONA LE FOR THE OBLIGATION

other fiduciary obligation owed to the company. Of course, the obligation under discussion is found in s 172(3). 13.11 Thirdly, Lords Toulson and Hodge JJSC in Bilta (UK) Ltd v Nazir22 confirmed this implicitly when they said that: It is well established that the fiduciary duties of a director of a company which is insolvent or bordering on insolvency differ from the duties of a company which is able to meet its liabilities, because in the case of the former the director’s duty towards the company requires him to have proper regard for the interest of its creditors and prospective creditors.23

13.12 Finally, in Sequana Lord Hodge DPSC said the directors had a fiduciary duty to the company to have proper regard to the interests of its creditors.24 The Foundation of the Obligation 13.13 Generally, there has been little consideration of the foundations of the obligation.25 This part of the chapter considers this issue. The Traditional Foundation 13.14 The traditional foundation for the obligation is found predominantly in the American academic literature. The reason that it is referred to in this chapter as the traditional foundation is simply because it has a degree of longevity and it has been the only foundation/rationale provided by much of the academic literature for the requirement that directors should consider the interests of creditors where the company is insolvent or close to it. 13.15 The traditional foundation is said to be rooted in over-investment theory of finance,26 and it has been heavily influenced by much of the law and economics literature which has relied on this theory. When a company is insolvent or in financial difficulty it is said that the shareholders are no longer the owners of the residual value of the firm, having been, in effect, transplanted by the creditors, whose rights are transformed into equity-like rights.27 Thus, at this

22 [2015] UKSC 23, [2016] AC 1. 23 Ibid., [123]. 24 [2022] UKSC 25, [242]. 25 It is not within the scope of the book to consider the normative question of whether it should exist. Some have questioned whether it should. For instance, see the Honourable Justice Kenneth Hayne, ‘Directors’ Duties and a Company’s Creditors’ (2014) 38 Melbourne University Law Review 795; Peter Watts, ‘Why as a Matter of English-Law Principle Directors Do Not Owe a Duty of Loyalty to Creditors Upon Insolvency’ [2021] JBL 103. 26 Royce de R Barondes, ‘Fiduciary Duties of Officers and Directors of Distressed Corporations’ (1998) 7 George Mason Law Review 45, 46. 27 Steven Schwarcz, ‘Rethinking a Corporation’s Obligations to Creditors’ (1996) 17 Cardozo Law Review 647, 668. See Douglas Baird, ‘The Initiation Problem in Bankruptcy’ (1991) 11 International Journal of Law and Economics 223, 228–229.

203

THE NATU R E OF AND R ATIONA LE FOR THE OBLIGATION

point, the creditors being the residual claimants of the company’s assets28 and the ones who have the valid interests in the company’s assets,29 may be seen as the major stakeholders in the company;30 the company is effectively trading with the creditors’ money, and as a result the directors have an obligation not to sacrifice creditor interests.31 13.16 According to the views of financial economists, directors could be expected, when their companies are in difficulty, to embrace actions which involve more risk;32 this was a position embraced by the Company Law Review Steering Group (‘CLRSG’) when engaging in a comprehensive analysis of UK company law at the end of the 1990s and the first years of this century.33 13.17 The directors might engage in excessive risk-taking34 and, in effect, gamble with the creditors’ funds in the hope of reviving the company35 and gaining benefits for the shareholders in due course. Directors might well incur more debt, and this will dilute the benefits enjoyed by the existing creditors. The shareholders would usually support such an approach taken by the directors even if there was little chance of the company making enough to pay off creditors and produce sufficient funds to enable returns to shareholders, as they have

28 Frank Easterbrook and Daniel Fischel, The Economic Structure of Corporate Law (Harvard University Press, 1991), 60. 29 J William Callison, ‘Why a Fiduciary Duty Shift to Creditors of Insolvent Business Entities is Incorrect’ (2007) 1 Journal of Business and Technology Law 431, 432. 30 Kinsela v Russell Kinsela Pty Ltd (1986) 4 ACLC 215, 221. See Stephen R McDonnell, ‘Geyer v Ingersoll Publications Co: Insolvency Shifts Directors’ Burden From Shareholders to Creditors’ (1994) 19 Delaware Journal of Corporate Law 177, 185; Royce de R Barondes, ‘Fiduciary Duties of Officers and Directors of Distressed Corporations’ (1998) 7 George Mason Law Review 45, 63; Janis Sarra, ‘Taking the Corporation Past the ‘Plimsoll Line’ – Director and Officer Liability When the Corporation Founders’ (2001) 10 International Insolvency Review 229, 234–235; Brian Morgan and Harry Underwood, ‘Directors’ Liability to Creditors on a Corporation’s Insolvency in Light of the Dylex and Peoples Department Stores Litigation’ (2004) 39 Canadian Business Law Journal 336, 338. 31 Sarra, ibid., 235; Morgan and Underwood, ibid., 338. See Marcia T Moffat, ‘Directors’ Dilemma – An Economic Evaluation of Directors’ Liability for Environmental Damages and Unpaid Wages’ (1996) 54 University of Toronto Faculty of Law Review 293, 302. 32 See, Christopher C Nicolls, ‘Liability of Corporate Officers and Directors to Third Parties’ (2001) 35 Canadian Business Law Journal 1, 35; Rima Fawal Hartman, ‘Situation Specific Fiduciary Duties for Corporate Directors: Enforceable Obligations or Toothless Ideals’ (1993) 50 Washington and Lee Law Review 1761, 1771; Royce de R Barondes, ‘Fiduciary Duties of Officers and Directors of Distressed Corporations’ (1998) 7 George Mason Law Review 45, 46; John Armour, ‘The Law and Economics of Corporate Insolvency: A Review’ (2001) ESRC Centre for Business Research, University of Cambridge, Working Paper No 197, 1. 33 Modern Company Law for a Competitive Economy: Final Report, Vol 1 (DTI, 2001), para 3.15. 34 See, Frank Easterbrook and Daniel Fischel, The Economic Structure of Corporate Law (Harvard University Press, 1991), 60; Vladimir Jelisavcic, ‘A Safe Harbour Proposal to Define the Limits of Directors’ Fiduciary Duty to Creditors in the ‘Vicinity of Insolvency’ [1992] Journal of Corporation Law 145, 148; Royce de R Barondes, ‘Fiduciary Duties of Officers and Directors of Distressed Corporations’ (1998) 7 George Mason Law Review 45, 50; Remus D Valsan and Moin A Yahya, ‘Shareholders, Creditors, and Directors’ Fiduciary Duties: A Law and Finance Approach’ (2007) 2 Virginia Law and Business Review 1, 10. 35 Brian Morgan and Harry Underwood, ‘Directors’ Liability to Creditors on a Corporation’s Insolvency in Light of the Dylex and Peoples Department Stores Litigation’ (2004) 39 Canadian Business Law Journal 336, 338.

204

THE NATU R E OF AND R ATIONA LE FOR THE OBLIGATION

nothing to lose;36 they cannot expect dividends or return of capital if nothing is done, so a gamble might be better than nothing. 13.18 Where there are owner-managed companies, then of course the directors are likely to think of their position as shareholders and in a near insolvency or actual insolvency situation they, in their capacity as shareholders, have nothing to lose, as there is little or no equity left in the company.37 Professor Robert Scott puts it this way: As the probabilities of business failure increase, so the debtor’s incentives to engage in high risk or wrongful conduct designed to salvage the sinking enterprise. As long as the debtor’s business prospects remain good, a strong reputational incentive deters misbehaviour. But once the business environment deteriorates, the [company’s manager] is increasingly influenced by a “high-roller” strategy. The poorer the prospects for a profitable conclusion to the venture, the less the entrepreneur has to risk and the more he stands to gain from imprudent or wrongful conduct.38

13.19 The type of action just adverted to is referred to often, particularly in the United States, as ‘betting the farm’39 (or ‘betting the company’)40 approach, that is, risking everything on a venture that one thinks might be successful.41 Because of the concept of separate legal entity the directors are, ordinarily, insulated from liability if their actions fall flat. 13.20 There is empirical evidence to support the fact that betting the farm tends to occur,42 particularly where the directors are also the owners43 in small-medium private companies. The unsecured creditors are protected only by contractual rights, and when companies are financially stressed there are, arguably, cogent arguments that their position warrants some form of extra protection, especially as they face the risk of a company’s behaviour following the entering into of a contract will increase risk of default.44 Unless there is protection then the 36 Laura Lin, ‘Shift of Fiduciary Duty upon Corporate Insolvency: Proper Scope of Directors’ Duty to Creditors’ (1993) 46 Vanderbilt Law Review 1485, 1489; Paul Davies, ‘Directors’ CreditorRegarding Duties in Respect of Trading Decisions Taken in the Vicinity of Insolvency’ (2006) 7 EBOR 301, 306. 37 See, Cory Dean Kandestin, ‘The Duty to Creditors in Near-Insolvent Firms: Eliminating the ‘The Near Insolvency’ Distinction’ (2007) 60 Vanderbilt Law Review 1235. 38 ‘Relational Theory of Secured Financing’ (1986) 86 Journal of Legal Studies 901, 924. 39 See the use of the term, for instance, in Jeffrey S Harrison, R Edward Freeman, and Mônica Cavalcanti Sá de Abreur, ‘Stakeholder Theory as an Ethical Approach to Effective Management’ (2015) 17 Review of Business Management 858, 861. 40 Henry Hu and Jay Westbrook, ‘Abolition of the Corporate Duty to Creditors’ (2007) 107 Columbia Law Review 1321, 1378–1379. 41 MacMillan Dictionary: www.macmillandictionary.com/dictionary/british/bet-the-farm, access ed 27 November 2018. 42 Ronald J Daniels, ‘Must Boards Go Overboard? An Economic Analysis of the Effects of Burgeoning Statutory Liability on the Role of Directors in Corporate Governance’ in Jacob S Ziegel (ed), Current Developments in International and Comparative Corporate Insolvency Law (Clarendon Press, 1994), 549. However, Royce de R Barondes, ‘Fiduciary Duties of Officers and Directors of Distressed Corporations’ (1998) 7 George Mason Law Review 45, 62 challenges this view. 43 Rizwaan Mokal, ‘An Agency Cost Analysis of the Wrongful Trading Provisions: Redistribution, Perverse Incentives and the Creditors’ Bargain’ (2000) 59 CLJ 335, 353–354. 44 Mark E Van der Weide, ‘Against Fiduciary Duties to Corporate Stakeholders’ (1996) 21 Delaware Journal of Corporate Law 27, 43–44; Ramesh Rao, David Sokolow, and Derek White, ‘Fiduciary

205

THE NATU R E OF AND R ATIONA LE FOR THE OBLIGATION

directors have every reason, at this time, to externalise the cost of the company’s debt and to engage in risky ventures that could bring in substantial benefits, but could, if they fail, imperil the company. Allied to this reason is that directors of the company might, in order to sustain the company’s business, offer higher priority to new creditors, thereby weakening the position of existing creditors. 13.21 The traditional foundation has mainly been the subject of consideration in the United States, where there has been sustained debate as to whether directors can be said to owe a (fiduciary) duty to creditors.45 As mentioned earlier, apart from the occasional dictum,46 in Anglo-Commonwealth jurisdictions it has never been an issue that directors owed a duty to creditors; they owe their duties to their company, and this has been codified in s 170(1) of the Act. While there has been a reasonable amount of academic literature in the UK and in the Commonwealth dealing with the obligation, and many references to the traditional foundation have been made, this has been done largely without providing approval or criticism of it,47 and there has been little exploration undertaken to ascertain any other possible foundations for the obligation. 13.22 It should also be said that with small UK private companies the directors who will usually own the company are often obliged to give personal guarantees to lenders, guaranteeing repayment of their company’s borrowings, so there is often not the same incentive to bet the farm as there might be. If any high-risk action of the directors fails, then the directors are the ones who will pick up at least part of the tab on liquidation. Obviously, it will depend on what guarantees were given and what they covered. The Disconnect? 13.23 While it might be possible to read the occasional case, like Roberts v Frohlich48 where the directors were involved in ‘using creditors’ money as the working capital of ODL [the directors’ company] for a project they recognised was “speculative,”’49 as involving betting the farm type behaviour when the company is insolvent or near to insolvency, the vast majority of the cases do not reflect the traditional foundation and do not advert to it. 13.24 The case law shows that there are two broad situations where the UK courts have held that the obligation applies. First, where directors have sought to self-deal, perhaps involving a transfer of company assets or funds to themselves Duty a la Lyonnais: An Economic Perspective on Corporate Governance in a Financially-Distressed Firm’ (1996) 22 Journal of Corporation Law 53, 64. 45 For example, see Royce de R Barondes, ‘Fiduciary Duties of Officers and Directors of Distressed Corporations’ (1998) 7 George Mason Law Review 45; Henry Hu and Jay Westbrook, ‘Abolition of the Corporate Duty to Creditors’ (2007) 107 Columbia Law Review 1321. 46 For example, Winkworth v Edward Baron Development Co Ltd [1986] 1 WLR 1512, 1526, [1987] 1 All ER 114, 118. 47 For example, Andrew Keay, ‘Directors’ Duties to Creditors: Contractarian Concerns Relating to Efficiency and Over-Protection of Creditors’ (2003) 66 MLR 665. 48 [2011] EWHC 257 (Ch), [2012] BCC 407, [2011] 2 BCLC 625, [112] per Norris J. 49 Ibid., [90].

206

THE NATU R E OF AND R ATIONA LE FOR THE OBLIGATION

or associates, such as to repay to themselves a debt that they are owed by the company.50 Secondly, where they have either turned a blind eye to their company’s financial malaise or failed to appreciate the predicament in which their company finds itself.51 13.25 Besides the lack of recognition of the traditional foundation in the case law, the argument has been made by some academics that directors do not engage in excessive risk-taking when their companies are distressed, an argument that is supported by some American empirical evidence.52 Hu and Westbrook take the view that there are disincentives for directors to increase risk-taking in an insolvency type situation. They assert that cultural pressures may press them to take care and their natural inclination to protect salaries and benefits for staff will be accentuated.53 The commentators go on to say that creditors will place pressure on directors to protect creditor interests and directors might accede, as they will need to continue to obtain credit to operate the business.54 13.26 Another matter that is important as far as professional directors are concerned, is that they might well refrain from engaging in risky activity lest the company does enter insolvent liquidation, which could well affect their reputations and mean that it would make it harder to obtain another post. Also, in such a case there is always the spectre of disqualification from acting as a director looming, which would be disastrous for those who are professional directors, as they would lose their livelihoods. With owner-managed companies where the directors have given guarantees, the only instance where directors may engage in excessive risk-taking is where the amount of debt owed is high and surpasses significantly what is owed to the lenders holding guarantees, for in such a case the directors’ personal liability will get no worse if they fail in their gamble with the company’s affairs. The Case Law and Other Explanations 13.27 If the bulk of UK cases do not reflect the traditional foundation, what appears to be the foundation on which decisions are based? What is noteworthy, and it makes our search for the foundation somewhat more difficult, is the fact that the UK courts, like courts in other jurisdictions, have not generally attempted to articulate what they see as the foundation/rationale for the obligation. All of 50 For example, see Liquidator of West Mercia Safetywear Ltd v Dodd [1988] 4 BCC 30; GHLM Trading Ltd v Maroo [2012] EWHC 61 (Ch); Re HLC Environmental Projects Ltd (in liq) [2013] EWHC 2876 (Ch), [2014] BCC 337; Ball v Hughes [2017] EWHC 3228 (Ch); Joint Liquidators of CS Properties (Sales) Ltd [2018] CSOH 24. 51 For example, see Re Idessa (UK) Ltd [2011] EWHC 804 (Ch), [2012] BCC 315. Also, Roberts v Frohlich [2011] EWHC (Ch) 257, [2012] BCC 407, [2011] 2 BCLC 625 may partly fit within this classification. 52 Royce de R Barondes, ‘Fiduciary Duties of Officers and Directors of Distressed Corporations’ (1998) 7 George Mason Law Review 45, 62; Henry Hu and Jay Westbrook, ‘Abolition of the Corporate Duty to Creditors’ (2007) 107 Columbia Law Review 1321, 1378. 53 Hu and Westbrook ibid. 54 Ibid., 1379.

207

THE NATU R E OF AND R ATIONA LE FOR THE OBLIGATION

the cases reported accept, whether they find for the claimant and against directors or not, that the obligation exists. In many cases the discussion of the obligation is very cursory. The exception to all of this is the decision of the Supreme Court of Canada in Peoples Department Stores Inc v Wise55 and that of the UK Supreme Court in Sequana.56 13.28 It is clear that the obligation is a form of creditor protection, that is the courts have taken the view that creditors should be protected to a certain extent when a company is in some sort of financial distress. In Re HLC Environmental Projects Ltd57 John Randall QC (sitting as a deputy judge of the High Court) said that: 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.58

13.29 In the Supreme Court in Bilta (UK) Ltd (in liquidation) v Nazir (No 2),59 Lords Toulson and Hodge JJSC said, in obiter, that: Instead, the protection which the law gives to the creditors of an insolvent company while it remains under the directors’ management is through the medium of the directors’ fiduciary duty to the company, whose interests are not to be treated as synonymous with those of the shareholders but rather as embracing those of the creditors.60

13.30 Certainly, this notion of creditor protection is in accord with what the CLRSG said in 1999 when it stated that duties of directors were subject to an overriding obligation to ensure that creditors are not wrongfully exposed to insolvency.61 13.31 The following considers what have been the foundations identified for protecting the creditors through the obligation. The Judicial Foundations Abusing the Privilege of Limited Liability 13.32 In Nicholson v Permakraft,62 in the New Zealand Court of Appeal, Cooke J expressed the view that the obligation is justified on the basis that it ensures that the privilege of limited liability is not abused.63 This has been trenchantly 55 [2004] 3 SCR 461, 2004 SCC 68, [45]. 56 [2022] UKSC 25. 57 [2013] EWHC 2876 (Ch). 58 Ibid., [89]. 59 [2015] UKSC 23; [2016] AC 1. 60 Ibid., [126]. 61 Company Law Review, Modern Company Law for a Competitive Economy: The Strategic Framework (DTI, 1999), para 5.1.6. 62 (1985) 3 ACLC 453. 63 Ibid., 459.

208

THE NATU R E OF AND R ATIONA LE FOR THE OBLIGATION

rejected ex-judicially by former Australian High Court judge Kenneth Hayne.64 The CLRSG did note that it had been submitted to it that the responsibility of company management not to abuse limited liability had not been given sufficient attention,65 but it did not engage in any further consideration of the matter. It must be remembered that in many director-owned companies the directors have surrendered the right to rely on limited liability, as they will have signed contracts guaranteeing repayment of loans owed by their companies.66 13.33 The comment of Cooke J has been mentioned only occasionally in subsequent cases and no case has actually given approval.67 Sequana68 Lord Briggs JSC was critical of this being regarded as a foundation for the obligation.69 Consequently, we can probably say that this has not been accepted as a foundation for the operation of the rule of law even though it might be in the minds of judges at some point in the hearing of cases involving s 172(3). Fraud on Creditors 13.34 Without the obligation directors can perpetrate a fraud on the creditors. First, in West Mercia70 Dillon LJ seems to suggest that underpinning the obligation is the fact that if directors pay a creditor to the effect that it hurts the other creditors, they are committing a fraud on the creditors. His Lordship said that the directors: ‘had been expressly told not to deal with the company’s bank account, and Mr. Dodd [the defendant director] had, in fraud of the creditors of the company, made the transfer to the Dodd company’s account for his own sole benefit.’71 13.35 This might well be consistent with what was said prior to West Mercia, in dicta in Re Horsely and Weight Ltd,72 by two members of the Court of Appeal, namely that it would be wrong for directors to enter into transactions which the directors ought to know are likely to cause loss to creditors.73 Obviously the fraud in this context is equitable fraud (and not criminal fraud), and it is akin to fraud on the minority, developed inter alia as an exception to the rule in Foss v Harbottle.74 Gummow J in the Australian decision of Re New World Alliance75 confirmed this when he said that: ‘The restriction [the obligation to 64 The Honourable Justice Kenneth Hayne, ‘Directors’ Duties and a Company’s Creditors’ (2014) 38 Melbourne University Law Review 795, 814. 65 Final Report Vol para 3.13. 66 Kristen van Zwieten, ‘Director Liability in Insolvency and Its Vicinity’ (2018) 38 OJLS 382, 389. 67 Although not approving the exact comments of Cooke J, Greenberg J at first instance in the Quebec case of Peoples Department Stores Inc v Wise (1998) 23 CBR (4th) 200, [203], did refer to the principle of limited liability as justifying the obligation. 68 [2022] UKSC 25. 69 Ibid., [145]. 70 [1988] 4 BCC 30. 71 Ibid., 33. 72 [1982] 1 Ch 442. 73 Ibid., 454–455 (Cumming-Bruce and Templeman LJJ). 74 For instance, see Cook v Deeks [1916] 1 AC 554. 75 (1994) 122 ALR 531, 550.

209

THE NATU R E OF AND R ATIONA LE FOR THE OBLIGATION

consider creditor interests] is similar to that found in cases involving fraud on the minority.’ The concept of ‘fraud on creditors’ has not been clearly defined,76 but in Sasea Finance Ltd v KPMG77 Hart J said: The question of what is implied in the notion, in this context, of dishonesty or ‘fraud on creditors’ is not discussed in any of the authorities which were cited to me. It is simply accepted that ‘fraud on the creditors’ constitutes a general exception to the principle that the shareholders can bind the company to a particular transaction.78

13.36 It is plain that the range of transactions that can fall within this notion is broad.79 The notion is also related to the point that creditors have certain legitimate expectations when providing credit. They must rely on the way that directors handle the funds of the company, and they would expect the directors to use the funds in a way that would not be detrimental to the repayment of the money owed to them. If directors did not act appropriately then the directors are engaging in action that the creditors did not agree to,80 and this might be viewed as a form of equitable fraud. 13.37 Another instance where it could be said that directors might be perpetrating a fraud on the creditors is where the directors endeavour to undertake an informal liquidation,81 namely, a distribution of company funds to whomsoever the directors choose and not in accordance with insolvency law. In Re HLC Environmental Projects Ltd82 John Randall QC was critical of the respondent director in choosing which creditors to pay and which to leave exposed to a risk of non-payment at a time when the director had to take into account the company’s creditors.83 In a later case, Re Micra Contracts Ltd,84 Registrar Barber (as she then was) appeared to support the outlawing of the notion of directors carrying out an informal liquidation by paying off selected creditors and ignoring the interests of others.85 This might explain the cases where courts have found in favour of liquidators under the duty and where there have been preference payments made by the directors, that is, payments paying off a debt owed to creditors and giving them benefits over other creditors. The comment of Newey

76 John Armour, ‘Avoidance of Transactions as a “Fraud on Creditors” at Common Law’ in John Armour and Howard Bennett (eds), Vulnerable Transactions in Corporate Insolvency (Hart, 2003), 281. 77 [2002] BCC 574. 78 Ibid., 582. 79 John Armour, ‘Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law’ in John Armour and Howard Bennett (eds), Vulnerable Transactions in Corporate Insolvency (Hart, 2003), 282. 80 David Wishart, ‘Models and Theories of Directors’ Duties to Creditors’ (1991) 14 New Zealand Universities Law Review 323, 354. 81 A term used by Registrar Barber in Re Micra Contracts Ltd [2016] BCC 153, [103]. 82 [2013] EWHC 2876 (Ch), [2014] BCC 337. 83 Ibid., [106]. 84 [2016] BCC 153. 85 Ibid., [103].

210

THE NATU R E OF AND R ATIONA LE FOR THE OBLIGATION

J (as he then was) in GHLM Trading Ltd v Maroo86 also may point to this, certainly as far as some preference-like payments are made. His Lordship said that: Where creditors’ interests are relevant, it will similarly, in my view, be a director’s duty to have regard to the interests of the creditors as a class. If a director acts to advance the interests of a particular creditor, without believing the action to be in the interests of creditors as a class, it seems to me that he will commit a breach of duty.87

13.38 This presupposes that what directors do cannot pre-empt what would happen in a liquidation where funds will be distributed according to the pari passu principle (after payment of any creditors given priority by the Insolvency Act 1986). The pari passu principle requires creditors to be paid equally and rateably. It can be inferred from Newey J’s comment that in benefitting one creditor and not the class as a whole, the director’s action offends pari passu, unless the director was acting in the interests of the creditors as a whole. 13.39 Some time ago, in Berg Sons & Co Ltd v Adams,88 Hobhouse J stated that when a company is insolvent the duty of the directors is to preserve the assets of the company and not to act contrary to the rules of insolvency,89 and, one might infer, not to engage in anything amounting to an informal liquidation of the company. 13.40 An informal liquidation might be seen as a fraud on the creditors because if the company is insolvent (on a balance sheet or cash flow basis) the creditors are entitled to petition to wind up the company and participate in a distribution of the company’s funds, and if the directors act to the detriment of one or more of the creditors then it could be said that they are frustrating ‘the creditors’ inchoate entitlement,’90 namely participating in a distribution of the company’s assets. Furthermore, the courts have made it clear in other contexts that there can be no liquidation save that sanctioned by statute;91 informal liquidations are not permitted. 13.41 The notion of fraud on the creditors is related to some degree to creditor vulnerability. Providing that persons are guilty of a fraud in equity usually means that they have taken advantage of someone who is in a vulnerable position. This is the case with minority shareholders where directors are found liable for a fraud on the minority, and it might be argued that creditors are vulnerable when a company is in severe distress. The Proprietary Interests of Creditors 13.42 Arguably, the foundation for the obligation which has attracted the most support over the years was given by Street CJ in Kinsela v Russell Kinsela Pty Ltd92 (‘Kinsela’). His Honour said that: 86 [2012] EWHC 61, [2012] 2 BCLC 369. 87 Ibid., [168]. 88 [1992] BCC 661. 89 Ibid., 679. 90 John Armour, ‘Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law’ in John Armour and Howard Bennett (eds), Vulnerable Transactions in Corporate Insolvency (Hart, 2003), 318. 91 London Joint City & Midland Bank v Herbert Dickinson Ltd [1922] WN 13, 14. 92 (1986) 4 ACLC 215.

211

THE NATU R E OF AND R ATIONA LE FOR THE OBLIGATION

In a solvent company the proprietary interests of the shareholders entitle them as a general body to be regarded as the company when questions of the duty of directors arise. If, as a general body, they authorise or ratify a particular action of the directors, there can be no challenge to the validity of what the directors have done. But where a company is insolvent the interests of the creditors intrude. They become prospectively entitled, through the mechanism of liquidation, to displace the power of the shareholders and directors to deal with the company’s assets. It is in a practical sense their assets and not the shareholders’ assets that, through the medium of the company, are under the management of the directors pending either liquidation, return to solvency, or the imposition of some alternative administration.93

13.43 This comment has been approved of by many courts, in the UK and in other jurisdictions. It was approved of by Dillon LJ in West Mercia,94 and this reason for the obligation’s existence has generally held sway in the UK, as Lord Briggs in Sequana acknowledged.95 13.44 What Street CJ said has been interpreted as suggesting is that creditors assume a proprietary interest in the company’s assets on insolvency. In dicta in Bilta (UK) Ltd (in liquidation) v Nazir (No 2),96 Lord Sumption JSC said, in citing the previous comment in Kinsela, with approval, that the common law treated the interests of an actually or prospectively insolvent company as synonymous with those of its creditors.97 In BTI 2014 LLC v Sequana S.A.98 David Richards LJ (as he then was) said, when addressing the argument that the test for the triggering of the obligation was when there was a real, but not a remote, risk of insolvency, that it would necessarily be wrong to adopt this as the test. It would be a new test and not anchored to the quasi-proprietary interests of creditors in the assets of an insolvent company,99 as envisaged by what was said in the previous comment in Kinsela. 13.45 Nevertheless, the UK Supreme Court in Sequana said that the notion that the creditors assumed proprietary interests when the company was financially distressed could not be the foundation for the obligation. For instance, Lord Briggs, with whom Lord Hodge DPSC and Lord Kitchin JSC agreed, accepted the comments of several commentators that creditors never have a proprietary interest in the assets of a company, any more than do shareholders.100 Creditors Have Economic Interests 13.46 As we have just seen, a majority of Supreme Court judges in Sequana dismissed the notion of the creditors having a proprietary interest in the company, but some of the reasoning behind it was not rejected. Lord Reed PSC did not

93 Ibid., 221. 94 [1988] 4 BCC 30. 95 Sequana [2022] UKSC 25, [147]. 96 [2015] UKSC 23, [2016] AC 1, [2015] 2 WLR 1168. 97 Sequana [2022] UKSC 25, [123]. 98 [2019] EWCA Civ 119, [2019] 2 All ER 784, [2019] BCC 631, [2019] 1 BCLC 347, [2019] BPIR 562. 99 Ibid., [200]. 100 [2022] UKSC 25, [132].

212

THE NATU R E OF AND R ATIONA LE FOR THE OBLIGATION

disagree with the analysis in Kinsela but rather the language used to explain what happened on a company’s financial distress. His Lordship said that it was not satisfactory to talk about the obligation in terms of the creditors having proprietary interests in company assets.101 He opined that it was clearer to say that the creditors had economic rather than legal interests in the company assets on insolvency,102 and Lord Hodge specifically agreed with this approach.103 Lord Reed said that there was a shift in economic interests when insolvency occurs,104 and the obligation reflects the reality of the economic interests in the company.105 Lord Hodge said that: A company’s creditors always have an economic interest in its continued solvency so that it can pay its debts to them. The relative importance of that economic interest or stakeholding as against the economic interest or stakeholding of the company’s shareholders increases when a company is bordering on insolvency.106

13.47 Lady Arden JSC said that the obligation redressed the situation in which creditors, who had a greater economic interest in the company than shareholders on insolvency had no control over the conduct of its business.107 While not stating it in the same terms as the other judges, Lord Briggs seemed to implicitly agree with what they said when he stated that one could describe creditors as having the main economic stake in the liquidation process which may be triggered by insolvency and, therefore, as ones whose interests must be taken into account when insolvency descends.108 Company Owes Responsibilities to Creditors 13.48 This foundation has only been identified by Lord Briggs in Sequana, although Lords Hodge and Kitchin agreed with his judgment. However, Lord Kitchin gave no reasoned judgment and Lord Hodge, in his separate judgment, did not deal with this justification. As indicated earlier, Lord Hodge seemed to accept the economic interests of creditors as the foundation for the obligation. According to Lord Briggs, it has been argued that the company itself owes responsibilities to its creditors at the point of insolvency so that the directors ‘as the custodians of the conscience of the company are duty bound to the company to see that it performs those obligations.’109 His Lordship felt that this was an old responsibility, and he traced it back to the Lex Paulina, a Roman law. He saw it as being

101 102 103 104 105 106 107 108 109

Ibid., [12]. Ibid., [45]. Also, see [12]. Ibid., [246], [247]. Ibid., [86]. Lady Arden JSC agreed with this (at [256]). Ibid., [96]. Ibid., [246]. Ibid., [263]. Ibid., [147]. Ibid., [129].

213

THE NATU R E OF AND R ATIONA LE FOR THE OBLIGATION

given effect to by s 423 of the Insolvency Act 1986.110 He felt that the long passage of time gave real force to this as a foundation.111 Conclusion 13.49 This chapter has noted that the obligation cannot be seen as providing some kind of stand-alone duty. It is a modification or qualification of the duty of directors under s 172(1), formerly the duty to act in the best interests of the company as a whole. 13.50 The foundation of the obligation to account for the interests of directors has never been clearly or unequivocally set out. It is clear that what has been referred to in the chapter as ‘the traditional foundation’ for the obligation, that is it is designed to prevent directors engaging in betting the farm type actions and indulging in high-risk strategies, cannot be sustained, as the foundation, or at least as the only one, because courts have invoked s 172(3) in cases where the situation envisaged by the traditional foundation does not apply. The vast majority of UK cases have not involved directors engaging in high-risk activity in an attempt to try to resurrect the company and make it profitable again. 13.51 The chapter began the analysis of the foundation with noting that several cases have stated that the obligation is designed to protect creditors. The chapter then explored foundations for the existence of the obligation. The one that has generally held sway, namely that the creditors assume proprietary interests in the company’s assets when the company is distressed, did not attract the approval of the Supreme Court judges in Sequana. All of the judges questioned it, and Lord Briggs clearly dismissed it. Two of the judges, Lords Reed and Hodge, did not take issue with the reasoning in the cases that had accepted this justification, but they did feel that the language was inappropriate. They preferred to say that the foundation was that the creditors assumed economic interests in the company when the company was bordering on insolvency or was insolvent. Lady Arden seemed to indicate some acceptance of this. 13.52 This suggests that the foundation that the creditors have assumed economic interests in the company is the one that has attracted the most support in the Supreme Court and will likely be accepted in the UK. Elsewhere in the world where the obligation applies, either the proprietary interest foundation or some other may be relied on.

110 Ibid., [129]. 111 Ibid., [142].

214

CHAPTER 14

When Does the Obligation Arise?

Introduction 14.1 Thus far the book has considered the development of the obligation of directors to consider the interests of the company’s creditors as part of their duty to their company and the nature and foundation of the obligation. There are two major issues that exist with respect to the obligation, namely ascertaining its application and scope, and this chapter and the next address these matters. 14.2 The first is pertinent to dealing with the fact that while directors do not owe an obligation to consider creditor interests at all times, there are circumstances when they do and these circumstances need to be discovered. What are these circumstances, that is, when does the obligation arise? This is a critical issue, for until the obligation is triggered the directors must fulfil what is demanded of them by s 172(1) of the Companies Act 2006 (‘the Act’), and directors must know when they have to change their focus, namely from promoting the success of the company for the benefit of the members under s 172(1) to taking into account the interests of creditors. As we will see, the cases have not been precise on when this shift is to take place. The chapter identifies and then examines the circumstances that the courts have identified as causing the triggering of the obligation to take into account creditors’ interests. 14.3 There is a need for a legal test which is certain, but as Richardson J said in Nicholson v Permakraft (NZ) Ltd,1 the adoption of any legal test for triggering the obligation involves ‘a difficult amalgam of principle, policy, precedent and pragmatism.’2 When the obligation is triggered is a decision that will have very significant practical consequences for the conduct of business, and it is therefore a decision best taken on an informed basis as to those consequences. In the light of that information, a policy decision can be taken. 14.4 In BTI 2014 LLC v Sequana S.A.3 David Richards LJ (as he then was) made it plain that the way that s 172 of the Act is structured, as well as the

1 (1985) 3 ACLC 453. 2 Ibid., 463. 3 [2019] EWCA Civ 112, [2019] 2 All ER 784, [2019] BCC 631, [2019] 1 BCLC 347, [2019] BPIR 562.

DOI: 10.4324/9780429266232-18

215

W HEN DOES THE OBLIGATION A R ISE?

wording of s 172(3), there is implicit recognition of the fact that a precise statement of the trigger is difficult.4 14.5 In deciding on a trigger care must be taken, for if the obligation is imposed only at one extreme of the financial spectrum, namely insolvency, there is the significant danger that creditors will not be protected, but if the obligation was to apply at the other extreme, namely when the company is solvent, then it would have the effect of unreasonably interfering with the decision-making of directors, hamper the business of the company and would be likely to lead to directors being over-cautious. Therefore, in identifying a point when the obligation arises, there must be a balance. On the one hand the courts must not place unreasonable limitations and burdens on directors and must permit companies to be managed commercially.5 Yet, on the other hand, the courts must ensure that they do not allow directors absolute freedom so that the position of the creditors is ignored.6 Hence, courts have the somewhat difficult task of reconciling the interests of the creditors on the one hand and the interests of shareholders and directors on the other. Background 14.6 It will be recalled that s 172(3) of the Act provides that the obligation imposed by s 172(1) applies except when 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. The provision does not explain what is meant by ‘certain circumstances.’ This has been the task of the courts. 14.7 First, while the dictum of Mason J in Walker v Wimborne7 might be interpreted as suggesting a continuing obligation owed to take creditors’ interests into account, the subsequent authorities make it plain that the obligation does not arise where a company is clearly solvent and thus it is not a continuing obligation. This point was made patent in Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical Services Ltd8 where Dillon LJ said that provided a company is solvent the shareholders are in substance the company, and the directors, therefore, do not owe duties to creditors, or arguably any other constituency of the company. His Lordship amplified his decision when giving his judgment in Liquidator of West Mercia Safetywear Ltd v Dodd (‘West Mercia’).9 More recently, the Court of Appeal in E-Clear (UK) Plc (In Liquidation) v Elias

4 Ibid., [202]. See, Andrew Keay, ‘The Director’s Obligation to Take into Account the Creditors’ Interests: When is it Triggered?’ (2001) 25 Melbourne University Law Review 315; Rosemary Teele Langford and Ian Ramsay, ‘The Contours of the “Creditors’ Interests’ Obligation”’ (2021) 21 JCLS 85. 5 See the comments in Australian Innovation Ltd v Paul Andrew Petrovsky (1996) 14 ACLC 1357, 1361. 6 See the comments in Nicholson v Permakraft (NZ) Ltd (1985) 3 ACLC 453, 459. 7 (1976) 137 CLR 1, (1976) 3 ACLR 529. 8 [1983] Ch 258. 9 (1988) 4 BCC 30.

216

W HEN DOES THE OBLIGATION A R ISE?

Elia10 essentially said that if a company is solvent and not in danger of imminent insolvency then the obligation does not apply.11 14.8 The New South Wales Court of Appeal in Equiticorp Finance Ltd (in liq) v BNZ12 also indicated that where there was no question about the solvency of a company, there was no need to consider the idea of an obligation to consider creditors’ interests13 and more recent cases have taken the same view.14 Although, we should note that in LRH Services Ltd (in liquidation) v Trew15 HH Judge David Cooke (sitting as a High Court judge) said, when considering s 172(1), that: Success of the company for the benefit of members requires it to be able to meet its liabilities to creditors, since if it does not do so it is liable to be wound up, putting an end to its business and, necessarily, its ‘success.’16

14.9 One can see the wisdom of this remark in that if a company does not fulfil its obligations to creditors, then it is not likely that it will survive. It is unlikely, though, that the judge would say that this obligation is of the same nature as that to be found in s 172(3) given the fact that s 172(3) applies to a company which is in dire financial straits. 14.10 Clearly nominating a precise point when the obligation should arise is far from easy. In Kinsela v Russell Kinsela Pty Ltd (‘Kinsela’)17 Street CJ refrained from attempting to provide a general test of the degree of financial instability which must exist before directors are subject to an obligation to consider the interests of creditors.18 His Honour said that: ‘I hesitate to attempt to formulate a general test of the degree of financial instability which would impose upon directors an obligation to consider the interests of creditors.’19 Nevertheless, for the sake of certainty for both directors and others (particularly liquidators who are most often going to bring proceedings for breach) it is necessary to seek to formulate some test. 14.11 Of course, in many cases, such as Kinsela and West Mercia,20 things are pretty straightforward, as the companies involved were clearly insolvent. As David Richards LJ said in BTI 2014 LLC v Sequana S.A.,21 most cases litigated and reported have involved companies that were insolvent when the directors acted in alleged breach of the obligation. Notwithstanding this, directors need to know 10 [2013] EWCA Civ 1114. 11 Ibid., [24]. 12 (1993) 11 ACLC 952. 13 Ibid., 1016. 14 For instance, see Re Pantone 485 Ltd [2002] 1 BCLC 266, 285. Compare the decision of the New South Wales Court of Appeal in Ring v Sutton ((1980) 5 ACLR 546), although that decision has been the subject of significant criticism and has not been followed in Australia. 15 [2018] EWHC 600 (Ch). 16 Ibid., [30]. 17 (1986) 4 ACLC 215. 18 Ibid., 223. 19 Ibid. 20 (1988) 4 BCC 30. 21 [2019] EWCA Civ 119, [2019] 2 All ER 784, [2019] BCC 631, [2019] 1 BCLC 347, [2019] BPIR 562.

217

W HEN DOES THE OBLIGATION A R ISE?

when the obligation is triggered, and if it is to be triggered before insolvency, when is that to be. The previous approach in Kinsela is understandable, but we must arrive at some guidelines to be fair to directors so that they can plan and know when they must exhibit some loyalty to creditors. Also, guidelines must be identified if this development of the law is not to suffer further criticism on the basis that it is imprecise and produces uncertainty. 14.12 As adverted to in the Introduction, in deciding upon a trigger there must be a balance. On the one side the law must not unduly hamper directors and must allow companies to be governed in a commercial manner.22 14.13 But on the other side of the coin, the law must ensure that it does not permit directors to do whatever they like so that the position of the creditors is ignored. Limited liability is a privilege, and it must not be forgotten that it can work to the disadvantage of creditors. As Cooke J stated in Nicholson v Permakraft (NZ) Ltd:23 It [limited liability] is a privilege healthy as tending to the expansion of opportunities and commerce, but it is open to abuse. Irresponsible structural engineering – involving the creating, dissolving and transforming of incorporated companies to the prejudice of creditors – is a mischief to which the courts should be alive.24

14.14 When identifying a trigger, it has been made clear that an obligation to consider creditors’ interests is not to be invoked simply because there is a recognised risk of adverse events that would lead to insolvency.25 Nevertheless, after saying that the directors must always be informed and have regard to the state of the company’s liabilities.26 The Importance of the Trigger 14.15 Directors have to know when they are required to exercise the obligation to consider creditor interests because until it is triggered, they have different responsibilities. It will be recalled that ordinarily directors must, according to s 172(1), promote the success of the company for the benefit of the members. If a company is in financial straits directors have to be able to ascertain the point when the s 172(3) obligation arises. That is, there is a time when the directors’ focus is no longer on s 172(1), but on s 172(3). If this time is not set down clearly directors might not know whether they have passed from being subject to s 172(1) to being subject to s 172(3), and they might well be confronted with making a decision at a time when they are unsure whether they should aim to fulfil the requirements of s 172(1) or the requirements of s 172(3).

22 See the comments of Lord Reed PSC in BTI 2014 LLC v Sequana S.A. [2022] UKSC 25, [87]. 23 (1985) 3 ACLC 453. 24 Ibid., 459. 25 Dickinson v NAL Realisations (Staffordshire) Ltd [2017] EWHC 28 (Ch), [2017] BPIR 611, [2018] BCC 506, [2018 1 BCLC 623, [118]. 26 Ibid.

218

W HEN DOES THE OBLIGATION A R ISE?

Insolvency 14.16 It is almost non-contentious to say that the directors owe the obligation to have regard for the interests of creditors when the company is insolvent.27 This has been the case ever since the genesis of the obligation. While Mason J in the seminal case of Walker v Wimborne28 did not limit the obligation to cases of insolvency or even of financial distress,29 notwithstanding the fact that the case before him did involve directors moving funds from their company, which was insolvent, to other companies, several of the cases in the 1980s introduced insolvency as a requirement,30 and that has clearly been applied in later case law across jurisdictions.31 14.17 In one of the leading cases in the area, Kinsela32 the New South Wales Court of Appeal was faced with a claim against directors who, on behalf of their company, entered into a lease of the company’s premises in favour of themselves for a three-year period with a three year option at a rental which was well below the current market rental. At the time the company was in a financially precarious state. Shortly after the lease was given the company entered liquidation pursuant to a winding-up order, on the basis that it was insolvent. 14.18 Subsequently, the liquidator sought a declaration that the lease was voidable. Street CJ, in delivering the leading judgment, found against the directors of the company because of the fact that the company was clearly insolvent when the lease was executed. His Honour left open the door as to whether the obligation would be extended to encompass other states of financial distress short of insolvency, preferring not to comment on the degree of financial instability required before an obligation was imposed on directors as he was not required to do so given the facts of the case.33 But his Honour did say that: ‘the plainer it is that it is the creditors’ money that is at risk, the lower may be the risk to which the directors, regardless of the unanimous support of all of the shareholders, can justifiably expose the company.’34 14.19 The views of Street CJ have been cited with approval in a number of jurisdictions, including in England and Wales by the Court of Appeal in both

27 For instance, see Re Pantone 485 Ltd [2002] 1 BCLC 266, 285; Gwyer v London Wharf (Limehouse) Ltd [2002] EWHC 2748, [2003] 2 BCLC 153, [74]; BTI 2014 LLC v Sequana S.A. [2019] EWCA Civ 112, [2019] 2 All ER 784, [2019] BCC 631, [2019] 1 BCLC 347, [2019] BPIR 562, [195], [213], 214] and on appeal to the Supreme Court, [2022] UKSC 25, [90], [203]. 28 (1976) 137 CLR 1, (1976) 3 ACLR 529. 29 It has been submitted that one can infer that Mason J was saying that creditors’ interests must be taken into account before the advent of insolvency: R Barrett, ‘Directors’ Duties to Creditors’ (1977) 40 MLR 226, 229. 30 For example, see the comments of Clarke and Cripps JJA of the New South Wales Court of Appeal in Equiticorp Finance Ltd (in liq) v BNZ (1993) 11 ACLC 952, 1016. Their Honours did not appear to favour the obligation arising at any time, other than insolvency. 31 For example, see the UK cases cited at note 27. 32 (1986) 4 ACLC 215, (1986) 10 ACLR 395. 33 Ibid., 223; 404. 34 Ibid.

219

W HEN DOES THE OBLIGATION A R ISE?

West Mercia35 and Official Receiver v Stern36 and by a couple of justices of the Supreme Court, Lords Toulson and Hodge JJSC, in Bilta (UK) Ltd (in liquidation) v Nazir.37 14.20 When insolvency exists it has been said that the notions of corporate ownership and creditors’ rights converge.38 Some judges have said that where insolvency exists the creditors then are the real owners of the company;39 the ownership rights of the shareholders having been expunged, as there is nothing over which they have a claim.40 The Supreme Court in BTI 2014 LLC v Sequana S.A. (‘Sequana’)41 was more circumspect in what it said about this matter and, as discussed in Chapter 13, it rejected the idea that creditors obtain proprietary interests in the company on insolvency. Nevertheless, a clear majority of judges accepted that when insolvency occurs the creditors have economic interests in the company’s assets.42 Lord Reed said that the onset of insolvency means that a shift has occurred,43 and Lord Hodge effectively agreed with this.44 14.21 It is clear that the judges in Sequana must accept that insolvency is a trigger because they identify ‘bordering on insolvency’ (discussed later in the chapter) as a trigger, and naturally insolvency is further down the path as far as a company’s parlous financial state is concerned, so it makes sense that insolvency must be a trigger if bordering insolvency is so regarded. 14.22 The Supreme Court of Ireland in Re Frederick Inns Ltd45 took the view that if companies are insolvent then creditors have the right to petition for their winding up, and if that is the case, the directors should not deal with company property in any way other than for the betterment of the creditors.46 The court said that this is because such companies were no longer the beneficial owners of the assets that they held. 14.23 There is a reasonably large corpus of cases, including Re Pantone 485 Ltd,47 Gwyer v London Wharf (Limehouse) Ltd,48 Re Cityspan Ltd,49 Roberts v

35 (1988) 4 BCC 30, 33. 36 [2001] EWCA Civ 1787, [2002] 1 BCLC 119, [32]. 37 [2015] UKSC 23, [2016] AC 1, [123]. 38 S Schwarcz, ‘Rethinking a Corporation’s Obligations to Creditors’ (1996) 17 Cardozo Law Review 647 at 666. The learned author sees the creditors’ rights being transformed into equity-type rights with the advent of insolvency (at 668). 39 Brady v Brady (1987) 3 BCC 535, 552 (CA); Kinsela (1986) 4 ACLC 215, 221. See Roy Goode, Principles of Corporate Insolvency Law (2nd ed, Sweet and Maxwell, 1997), 455; S McDonnell, ‘Geyer v Ingersoll Publications Co: Insolvency Shifts Directors’ Burden From Shareholders to Creditors’ (1994) 19 Delaware Journal of Corporate Law 177, 185. 40 E Ferran, ‘Creditors’ Interests and ‘Core’ Company Law’ (1999) 20 Company Lawyer 314, 316. 41 [2022] UKSC 25. 42 Ibid., [45], [88], [246], [263]. 43 Ibid., [86]. 44 Ibid., [224]. 45 [1994] ILRM 387, [1993] IESC 1. 46 Ibid. 47 [2002] 1 BCLC 266. 48 [2002] EWHC 2748 (Ch), [2003] 2 BCLC 153. 49 [2007] EWHC 751 (Ch); [2007] 2 BCLC 522; [2008] BCC 60.

220

W HEN DOES THE OBLIGATION A R ISE?

Frohlich,50 Re HLC Environmental Projects Ltd,51 and Re Bowe Watts Clargo Ltd52 at first instance which has accepted unequivocally that the obligation arises when a company is insolvent. David Richards LJ indicated in several parts of his leading judgment in the Court of Appeal in BTI 2014 LLC v Sequana S.A.53 that the obligation is triggered by insolvency.54 On appeal the Supreme Court agreed.55 14.24 The Supreme Court judgment in Sequana is now our most important authoritative statement on the obligation, as mentioned earlier in the book. The appeal eventuated because the Court of Appeal rejected the argument that the obligation is triggered when there is a real and not a remote risk of the company being insolvent. While there were four separate judgments delivered, all judges agreed that the appeal should be dismissed. Again, all judges accepted that the obligation applied if a company was insolvent or insolvent liquidation or administration was probable.56 Lord Briggs JSC added a qualification, namely that insolvency is only a trigger if there was no light at the end of the tunnel for the company. He said this because companies will often go in and out of insolvency and the obligation should only be relevant where a company is irretrievably insolvent.57 While Lord Briggs might accept that insolvency can be a trigger, in his opinion it is only where insolvent liquidation or administration is probable and there is no light at the end of the tunnel for the company that the obligation is definitely triggered. 14.25 If the trigger for the liability of directors to creditors is insolvency, one major problem exists: what definition of insolvency applies? Some have said that insolvency is a broad and ambiguous term,58 while others have focused on the indefinite nature of the concept.59 Accounting details are often critical in assessing whether a company is insolvent or not and, in this regard, David Wishart is concerned that accounting practice is bedevilled by lack of definitions and difficulties with valuations.60 He has stated that: [A]ccounting information is being called on to draw a definite line on which liability hangs yet which in many ways does not yield certain results. In emphasising legal form through the definition of status, consideration of the ambivalence of the

50 [2011] EWHC 257 (Ch); [2012] BCC 407; [2011] 2 BCLC 625, [85]. 51 [2013] EWHC 2876 (Ch), [92]. 52 [2017] EWHC 7879 (Ch). 53 [2019] EWCA Civ 112, [2019] 2 All ER 784, [2019] BCC 631, [2019] 1 BCLC 347, [2019] BPIR 562. 54 Ibid., [195], [213], [214]. 55 [2022] UKSC 25, [90], [203]. 56 Ibid. 57 Ibid., [164], [176]. 58 A Stilson, ‘Reexamining the Fiduciary Paradigm at Corporate Insolvency and Dissolution: Defining Directors’ Duties to Creditors’ (1995) 20 Delaware Journal of Corporate Law 1, 113; R Rao, D Sokolow, and D White, ‘Fiduciary Obligation a la Lyonnais: An Economic Perspective on Corporate Governance in a Financially-Distressed Firm’ (1996) 22 The Journal of Corporation Law 53, 62. 59 Leonard Sealy, ‘Director’s Wider Responsibilities – Problems Conceptual Practical and Procedural’ (1987) 13 Monash University Law Review 164, 179. 60 David Wishart, ‘Models and Theories of Directors’ Duties to Creditors’ (1991) 14 New Zealand Universities Law Review 323, 344.

221

W HEN DOES THE OBLIGATION A R ISE?

position of creditors in insolvent companies is shifted from directors’ duties to accounting requirements.61

14.26 All of these criticisms are fair, certainly in relation to the past, when there was no statutory definition of ‘insolvency.’ But now in the Insolvency Act 1986 there are definitions, albeit ones that need judicial elaboration. 14.27 ‘Insolvency’ can mean different things in different provisions, but generally the state of insolvency is defined in one of two ways in the UK. First, where ‘it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due.’62 Secondly, ‘if it is proved to the satisfaction of the court that value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities.’63 The first definition provides for commercial or, as it is more frequently known, cash flow insolvency. This definition requires one to consider whether a company is able to pay its debts as they fall due, that is, when they are payable under any credit arrangement. It is clear that the test is not without its problems.64 The main difficulties with the cash flow test have been said to be that it is vague in meaning65 and the decision about whether a company, on a particular day, is insolvent, is often a difficult and imprecise one.66 14.28 While these comments continue to hold some water, it is fair to say that in recent years there has been some greater certainty in assessing whether or not a company was insolvent (on the cash flow basis) at a particular point of time, especially given the comments in Re Cheyne Finance plc (No 2),67 although after saying that we must acknowledge that uncertainty still remains. In Re Cheyne Finance Briggs J (as he then was) said that the reference to the payment of debts ‘as they fall due’ imported an element of futurity into deciding whether a company was insolvent, so in deciding the issue it was necessary to consider not just a company’s present liabilities but also its future liabilities. Although, it is not all possible future liabilities that are to be considered, as that could enhance uncertainty.68 The judge said that debts that were payable in the reasonably near future could be factored into a consideration of solvency. This provides for some vagueness, but it may well be that UK courts will apply the 61 Ibid., 345. 62 Insolvency Act 1986, s 123(1)(e). 63 Section 123(2) of the Insolvency Act. 64 For example, see Andrew Keay, ‘The Insolvency Factor in the Avoidance of Antecedent Transactions in Corporate Liquidations’ (1995) 21 Monash University Law Review 305; John Duns, ‘Insolvency’: Problems of Concept, Definitions and Proof’ (2000) 28 Australian Business Law Review 22. 65 David Milman, ‘Test of Commercial Insolvency Rejected’ (1983) 4 Company Lawyer 231, 232; A Stilson, ‘Reexamining the Fiduciary Paradigm at Corporate Insolvency and Dissolution: Defining Directors’ Duties to Creditors’ (1995) 20 Delaware Journal of Corporate Law 1, 113. 66 K Chiah, ‘Voidable Preference’ (1986) 12 New Zealand Universities Law Review 1, 6; Christopher Riley, ‘Directors’ Duties and the Interests of Creditors’ (1989) 10 Company Lawyer 87, 88–89. 67 [2007] EWHC 2402 (Ch), [2008] 1 BCLC 741. 68 For greater discussion of cash flow insolvency, see Kristen van Zwieten (ed), Goode on Principles of Corporate Insolvency Law (5th ed, Sweet and Maxwell, 2019), 149–158; Andrew Keay, McPherson and Keay’s The Law of Company Liquidation (5th ed, Sweet and Maxwell, 2021), [3–025]–[3–039].

222

W HEN DOES THE OBLIGATION A R ISE?

approach taken in the Australian case of Lewis v Doran,69 which said that how far one goes into the future depends on the kind of business conducted by the company and, if known, the company’s future liabilities. Also, in BNY Corporate Trustee Service Ltd v Eurosail-UK 2007–3BL plc,70 a case to which we will come shortly, Lord Walker JSC said that the moment the reasonably near future becomes the future depends upon the facts of each case. 14.29 The second definition of insolvency provides for what is known as balance sheet insolvency.71 In Yukong Lines Ltd of Korea v Rendsburg Investments Corporation72 Toulson J (as he was then) applied the balance sheet test and said that in the case before him there was a clear breach of the obligation because the liability to a creditor was well in excess of the company’s assets.73 14.30 However, like the cash flow test, this definition also has its shortcomings and has caused problems. Until quite recently we did not have any comprehensive authority that addressed the balance sheet test. The general approach to determining whether a company was balance sheet insolvent was merely to see whether the amount on the credit side of the balance sheet outweighed the amount on the debit side. Arguably, this led to a rather mechanistic, and perhaps simplistic, way of approaching insolvency. These concerns were addressed to some extent by the Supreme Court in BNY Corporate Trustee Service Ltd v Eurosail-UK 2007–3BL plc,74 which provided for a more nuanced approach to assessing whether a company was balance sheet insolvent, although arguably uncertainty still exists to some degree. 14.31 In Eurosail the Supreme Court (or House of Lords) had its first opportunity to address the definition of insolvency. Importantly the Court endorsed Briggs J’s judgment in Re Cheyne Finance in relation to the judge’s interpretation of ‘as they fall due.’ Lord Walker opined that the cash flow test and the balance sheet interact and are, therefore, not completely exclusive of each other. His Lordship said that once one goes past the reasonably near future, the cash flow test can no longer be sensibly used and so it is necessary to consider the balance sheet test as it becomes the only sensible test to employ. In addressing what the balance sheet test involved Lord Walker said: Essentially, section 123(2) requires the court to make a judgment whether it has been established that, looking at the company’s assets and making proper allowance for its prospective and contingent liabilities, it cannot reasonably be expected to be able to meet those liabilities. If so, it will be deemed to be insolvent although it is

69 [2005] NSWCA 243; (2005) 219 ALR 555, [103]. 70 [2013] UKSC 28, [2013] 1 WLR 1408 (SC). 71 For greater discussion of balance sheet insolvency, see Kristen van Zwieten (ed), Goode on Principles of Corporate Insolvency Law (5th ed, Sweet and Maxwell, 2019), 158–167; Andrew Keay, McPherson and Keay’s The Law of Company Liquidation (5th ed, Sweet and Maxwell, 2021), [3–035]– [3–039]. Also, for a detailed consideration of the history and context of insolvency, see Peter Walton ‘“Inability to pay debts”: beyond the point of no return?’ [2013] JBL 212. 72 [1998] BCC 870. 73 Ibid., 884. 74 [2013] UKSC 28, [2013] 1 WLR 1408.

223

W HEN DOES THE OBLIGATION A R ISE?

currently able to pay its debts as they fall due. The more distant the liabilities, the harder this will be to establish.75

14.32 Both the Court of Appeal76 and the Supreme Court77 in BTI 2014 LLC v Sequana S.A. appeared to approve, in the context of the obligation, that insolvency involved consideration of either of the tests discussed earlier. 14.33 Leonard Sealy raised, in his attack on the use of insolvency as the trigger for the advent of the obligation, the fact that a company may move in and out of insolvency as its fortunes fluctuate, and that the duties of directors should be evaluated from a broad perspective and not on the basis of technicalities.78 This is a most adroit point, although a riposte to this view is that if a company does move in and out of insolvency, obviously indicating that it is highly unstable from a financial point of view, then it is exactly the type of company whose affairs should be run with consideration for the creditors’ interests; it is likely to collapse without much warning.79 In fact, the point Sealy makes may well be a good reason for having a less definite point at which the obligation is triggered. Ross Grantham has made a similar point when he says that: [I]nsolvency is the most obvious indication that the residual risk is no longer borne by the shareholders. Thus the question posed by the court is not simply whether the company is insolvent, but that given the distribution of risk does it continue to be appropriate to regard the interests of shareholders as exclusively reflecting the corporate interest.80

14.34 In Sequana Lord Briggs JSC observed that companies can go in and out of insolvency and that insolvency should only be a trigger where there was no light at the end of the tunnel for a company.81 Nevertheless, it is submitted that whether there was ‘light at the end of the tunnel’ might be difficult to assess in some companies, and thus this does produce some uncertainty. 14.35 It is not unusual to find that insolvency is a necessary condition in finding directors or others liable. For instance, s 239 of the Insolvency Act 1986 provides that a transaction may only be regarded as a preference, and perhaps adjusted, if either the company was insolvent when the transaction that was impugned as a preference was entered into or the entering into of the transaction caused the company to become insolvent.82 14.36 It is submitted that many of the concerns over the issue of insolvency are illusory. Another important point to note is that insolvency rarely occurs 75 Ibid., [42]. 76 [2019] EWCA Civ 119, [2019] 2 All ER 784, [2019] BCC 631, [2019] 1 BCLC 347, [2019] BPIR 562, [213]. 77 [2022] UKSC 25, [88]. 78 Leonard Sealy, ‘Director’s Wider Responsibilities – Problems Conceptual Practical and Procedural’ (1987) 13 Monash University Law Review 164. 79 See the comments of Cooke J in Nicholson v Permakraft (NZ) Ltd (1985) 3 ACLC 453, 459. 80 Ross Grantham, ‘The Judicial Extension of Directors’ Duties to Creditors’ [1991] JBL 1, 15. 81 [2022] UKSC 25, [164], [176]. 82 See s 239(2) and s 240(1) (‘relevant time’).

224

W HEN DOES THE OBLIGATION A R ISE?

overnight, and there are tell-tale signs of a company’s demise well before the point that technical insolvency occurs. Often the directors of companies, particularly owner-managed ones, are just too proud or overly optimistic to recognise that the company is in trouble.83 14.37 David Richards LJ in BTI 2014 LLC v Sequana S.A.84 made the following astute observation: ‘The precise moment at which a company becomes insolvent is often difficult to pinpoint. Insolvency may occur suddenly but equally the descent into insolvency may be more gradual.’85 14.38 Lord Reed stated in Sequana that argument was not heard as to what insolvent meant in the context of the obligation, but his Lordship expressed a provisional view that insolvency for the purposes of the obligation meant cash flow or balance sheet insolvency and temporary commercial insolvency should be excluded.86 This would, according to Lady Arden JSC, mean in the context of these tests that the directors should have regard to liabilities which they can foresee will arise in the reasonably near future.87 Lady Arden opined that the cash flow and balance sheet tests should be the starting point, but they should be ‘applied with the degree of flexibility appropriate to the rationale and context of the obligation.’88 14.39 According to her Ladyship,89 and in agreement with Lord Reed, the obligation should not apply to where a company is temporarily insolvent. Her Ladyship said that she agreed with Lord Briggs in this respect,90 but Lord Briggs did not quite say that temporary insolvency could not be the trigger for the obligation. He said that if there was an onset of temporary insolvency the creditors’ interests would not be paramount,91 although it might be argued from other parts of his Lordship’s judgment that he was against temporary insolvency acting as a trigger. In his judgment the judge, it will be recalled, referred to the fact that insolvency where there is light at the end of the tunnel would not precipitate the obligation arising.92 14.40 The upshot of the Supreme Court judgments is that while insolvency is a trigger, it is not if the insolvency is merely temporary. This begs the question: when does temporary insolvency get converted into permanent insolvency? Also, how do the directors determine this? Thus, uncertainty still exists.

83 See, for instance, Rizwaan Mokal, ‘An Agency Cost Analysis of the Wrongful Trading Provisions: Redistribution, Perverse Incentives and the Creditors’ Bargain’ (2000) 59 CLJ 335, 354. 84 [2019] EWCA Civ 112, [2019] 2 All ER 784, [2019] BCC 631, [2019] 1 BCLC 347, [2019] BPIR 562. 85 Ibid., [218]. 86 [2022] UKSC 25, [88]. 87 Ibid., [308]. 88 Ibid., [307]. 89 Ibid., [309]. 90 Ibid. 91 Ibid., [173]. 92 Ibid., [164].

225

W HEN DOES THE OBLIGATION A R ISE?

The Obligation and Pre-Insolvency Circumstances Context 14.41 The previous part of the chapter provided that if a company is insolvent the directors must take account of the interests of creditors. But is there an earlier point at which a director’s obligation shifts and consideration of creditors’ interests is mandatory under s 172(3)? 14.42 At the outset one can say that Mason J did not expressly limit the taking of the interests of creditors into account to the time when the company is insolvent, a point affirmed by Jacob J in his leading judgment in Grove v Flavel.93 One commentator has asserted that: In fact, Mason J seems to infer that creditors’ interests must be taken into account even before insolvency, since those interests ‘may be prejudiced by the movement of funds between companies in the event that the companies become insolvent.’ This suggests that the theoretical possibility of future insolvency is sufficient to require directors to give continuing attention to creditors’ interests.94

14.43 Some subsequent cases have given indications that an obligation to take into account creditors’ interests arises before the company enters an insolvent state. This part of the chapter addresses this matter. 14.44 It needs to be noted, initially, that there is a problem in the case law because the courts in the UK and around the Commonwealth have sought to make distinctions between what seem to be various marginal states of financial difficulty. It has been said that ‘it is extraordinarily difficult to slice the world into categories of solvency, insolvency, and the vicinity of insolvency.’95 Other commentators have made the point that: ‘the question of whether a company is, or is not, solvent requires detailed accounting analysis and is not one that directors can easily judge when making commercial decisions.’96 Although, if they take professional advice, which one would think that they should if there are signs of financial malaise, they might be able to make a determination. 14.45 In Bell Group Ltd (in liq) v Westpac Banking Corporation (No 9)97 Owen J acknowledged that there was some substance in the view that it is impractical for directors, while they are involved in the course of day-to-day activities, to form views as to whether the company’s financial position has got to the point of indicating doubtful solvency.98 But his Honour did say that businesspersons make decisions in light of their company’s finance every day, and these can involve

93 (1986) 11 ACLR 161. 94 R Barrett, ‘Directors’ Duties to Creditors’ (1977) 40 MLR 226, 229. 95 R Barondes et al., ‘Twilight in the Zone of Insolvency: Fiduciary Obligation and Creditors of Troubled Companies – History & Background’ (2007) 1 Journal of Business & Technology Law 229, 239. 96 Anil Hargovan and Jason Harris, ‘For Whom the Bell Tolls: Directors’ Duties to Creditor After Bell’ (2013) 35 Sydney Law Review 433, 437. 97 [2008] WASC 239. 98 Ibid., [4447].

226

W HEN DOES THE OBLIGATION A R ISE?

consideration of legal concepts, and he did not think that determining their company’s financial state short of insolvency was impossible.99 Indeed, in Sequana Lord Briggs said that: ‘directors who keep themselves properly informed about their company’s affairs ought to be aware of commercial insolvency . . . broadly when it occurs, even if balance sheet insolvency may be more insidious.’100 Lady Arden said that directors must keep themselves informed and this included being informed about financial matters.101 14.46 There has been a variety of formulations in many cases as to when the obligation should arise prior to insolvency, and this led David Richards LJ to make the point in BTI 2014 LLC v Sequana S.A.102 that there was English authority which was clearly based on the proposition that the obligation is triggered by anything short of actual insolvency. However, his Lordship noted that in all the cases where reference had been made to circumstances short of actual insolvency triggering the obligation, the company was actually insolvent. Nevertheless, the judge also noted that on many occasions judges, many of them with considerable company law experience, assumed that something less than actual insolvency would trigger the obligation and his Lordship felt that that very fact carried weight.103 Later in his judgment David Richards LJ said that he concluded that the obligation may be triggered when a company’s circumstances fall short of actual, established insolvency.104 Consideration of what his Lordship thought were those circumstances is discussed later. 14.47 The point at which the obligation arises is going to revolve around the solvency of the company. As Clark and Cripps JJA in the New South Wales Court of Appeal in Equiticorp Finance Ltd (in liq) v BNZ105 said: [T]he question whether directors are required to consider the interests of creditors in determining whether particular action is or is not for the benefit of the company depends upon the state of solvency of the company at the time of the contemplated action.106

14.48 What those situations short of insolvency are that will trigger the obligation, and how one should describe them, has precipitated some uncertainty. Given the authoritative comments in the recent decision of the Supreme Court in Sequana,107 a detailed consideration of the formulae that have been mentioned by the cases for determining at what point prior to insolvency the obligation is triggered is not warranted, but it is perhaps appropriate to provide a summary, as it provides useful context. 99 Ibid., [4448]-[4449]. 100 [2022] UKSC 25, [201]. 101 Ibid., [304]. 102 [2019] EWCA Civ 112, [2019] 2 All ER 784, [2019] BCC 631, [2019] 1 BCLC 347, [2019] BPIR 562. 103 Ibid., [195]. 104 Ibid., [216]. 105 (1993) 11 ACLC 952. 106 Ibid., 1007. 107 [2022] UKSC 25.

227

W HEN DOES THE OBLIGATION A R ISE?

The Judicial Formulations 14.49 Before explaining what the courts have said about the trigger preinsolvency, it is notable that in Re HLC Environmental Projects Ltd108 John Randall QC said, after referring to many of the formulae mentioned in the cases, some of which are set out next, that they add up to the same thing, something that Lord Reed PSC noted in Sequana.109 The former opined that: I do not detect any difference in principle behind these varying verbal formulations. It is clear that established, definite insolvency before the transaction or dealing in question is not a pre-requisite for a duty to consider the interests of creditors to arise.110

14.50 The same view was espoused by David Richards LJ in BTI 2014 LLC v Sequana S.A.111 The judge went on to observe that judges had shied away from a single form of words and they had chosen instead to employ a variety of expressions.112 His Lordship declined to give his imprimatur to any of the existing formulae and was critical of many of them. 14.51 A majority of the High Court of Australia in Spies v R113 approved of the comments of Gummow J in Re New World Alliance Ltd114 when his Honour said that if a company is nearing insolvency directors have an obligation to take into account the interests of creditors. Something similar was said in Gwyer v London Wharf (Limehouse) Ltd,115 where Leslie Kosmin QC said that the obligation arose where the company was on the verge of insolvency, for that is probably the same as near insolvency.116 14.52 While insolvency may suffer from imprecision, prescribing the triggering of the obligation when the company is near to insolvency suffers even more from that problem,117 for it is impossible in many situations to say from what point a company is nearing insolvency, except where one is viewing the company’s dealings ex post. 14.53 Several cases, including the Court of Appeal in Brady v Brady,118 have held that directors may be subject to the obligation when a company’s solvency

108 [2013] EWHC 2876 (Ch), [2014] BCC 337. 109 [2022] UKSC 25, [88]. 110 [2013] EWHC 2876 (Ch), [2014] BCC 337, [94], [95]. 111 [2019] EWCA Civ 119, [2019] 2 All ER 784, [2019] BCC 631, [2019] 1 BCLC 347, [2019] BPIR 562, [213]. 112 Ibid., [216]. 113 [2000] HCA 43, (2000) 201 CLR 603, (2000) 173 ALR 529. 114 (1994) 122 ALR 531. 115 [2002] EWHC 2748; [2003] 2 BCLC 153, [74]). 116 Also, see GHLM Trading Ltd v Maroo [2012] EWHC 61 (Ch), [2012] 2 BCLC 368, [173]. 117 See the comments of Richardson J in Nicholson v Permakraft (NZ) Ltd (1985) 3 ACLC 453, 463. It has been suggested that ‘in the vicinity of insolvency’ may, like ‘obscenity,’ be difficult to define, but a reasonable director can be expected to know it when he or she sees it (R Rao, D Sokolow, and D White, ‘Fiduciary Obligation a la Lyonnais: An Economic Perspective on Corporate Governance in a Financially-Distressed Firm’ (1996) 22 The Journal of Corporation Law 53, 64 (n78). 118 Brady v Brady (1988) 3 BCC 535, 552.

228

W HEN DOES THE OBLIGATION A R ISE?

is doubtful.119 Other cases have not sought to identify with any precision how close to insolvency the company must be before the obligation arises. They have been content to say that the company must be in a dangerous financial position,120 financially unstable,121 or in financial difficulties.122 These phrases can mean a number of things and can be regarded as indefinite. 14.54 In Sequana Lord Reed said that all of the formulae that have been employed provided a sense of imminence of insolvency.123 14.55 Moving further away from the point of insolvency than near insolvency or vicinity of insolvency, some cases have supported, either expressly or implicitly, the fact that directors have an obligation to creditors once there is a risk of insolvency.124 In Nicholson v Permakraft125 Cooke J indicated that directors might be under a responsibility to creditors where the company was risking becoming insolvent. The judge said that directors owed an obligation where a ‘contemplated payment or other course of action would jeopardise solvency,’126 and similar language was used by Giles JA in the New South Wales Court of Appeal case of Linton v Telnet Pty Ltd.127 14.56 Some years latter Giles JA said in his judgment in Kalls Enterprises Pty Ltd v Baloglow128 that: It is sufficient for present purposes that, in accord with the reason for regard to the interests of creditors, the company need not be insolvent at the time and the directors must consider their interests if there is a real and not remote risk that they will be prejudiced by the dealing in question.129

14.57 Relying on a risk of insolvency has never been embraced wholeheartedly by any UK authority and in BTI 2014 LLC v Sequana S.A.130 David Richards LJ rejected the idea of risk of insolvency being a trigger. In the case before him his Lordship explicitly rejected the argument, based on the previous quote from Giles JA, that the obligation was triggered where there was a real as opposed to a remote risk of insolvency.131 David Richards LJ said that he would not be 119 For instance, see Nicholson v Permakraft (NZ) Ltd (1985) 3 ACLC 453, 459, 463, 464 (NZCA); Gwyer v London Wharf (Limehouse) Ltd [2003] 2 BCLC 153; [2002] EWHC 2748, [74]. Also, see the comments of Templeman LJ in Re Horsley & Weight Ltd [1982] 1 Ch 442, 455. 120 Facia Footwear Ltd (in administration) v Hinchliffe [1998] 1 BCLC 218. 121 Linton v Telnet Pty Ltd (1999) 30 ACSR 465. 122 Re MDA Investment Management Ltd [2003] EWHC 227 (Ch), [2004] BPIR 75, [70]. 123 [2022] UKSC 25, [88]. 124 For example, see Wright v Frisina (1983) 1 ACLC 716; Grove v Flavel (1986) 11 ACLR 161, 170; Kinsela v Russell Kinsela Pty Ltd (1986) 4 ACLC 215, 223 (agreeing with Cooke J in Nicholson v Permakraft (NZ) Ltd (1985) 3 ACLC 453); Winkworth v Edward Baron Development Ltd [1986] 1 WLR 1512; Hilton International Ltd (in liq) v Hilton [1989] NZLR 442. 125 Nicholson, ibid. 126 Ibid., 459. 127 (1999) 30 ACSR 465, 478. 128 [2007] NSWCA 191; (2007) 25 ACLC 1094. 129 Ibid., [162]. 130 [2019] EWCA Civ 119, [2019] 2 All ER 784, [2019] BCC 631, [2019] 1 BCLC 347, [2019] BPIR 562. 131 Ibid., [214], [215].

229

W HEN DOES THE OBLIGATION A R ISE?

willing to sanction the notion of risk of insolvency, however it was described. He felt that saying that the trigger was where there was a real as opposed to a remote risk of insolvency would provide for a much lower threshold for the application of the obligation than saying the obligation arose when the company was on the verge of insolvency or likely to become insolvent.132 14.58 David Richards LJ said that if risk of insolvency was the trigger, then it would ‘have a chilling effect on entrepreneurial activity.’133 This view is supported by academic opinion. One commentator has said in relation to an obligation requiring directors to consider creditors that it: [E]xposes directors to liability for breach of fiduciary obligation to creditors without clearly defining the point at which this new obligation springs forth. This poorly defined, potentially large personal liability could chill directors’ exercise of their business judgment when confronted with difficult choices. Directors may feel constrained to make overly-conservative decisions when they are unsure whether their corporation is in the ‘vicinity of insolvency.’134 (footnote omitted)

14.59 The party in BTI 2014 LLC v Sequana S.A.135 that was arguing that the trigger was a risk that there was a real and not remote risk of insolvency, appealed the Court of Appeal decision to reject this as the trigger for the obligation. However, the appeal was dismissed by the Supreme Court, and it also unequivocally rejected the risk of insolvency as the test for the trigger. 14.60 In the Court of Appeal in BTI 2014 LLC v Sequana S.A.136 David Richards LJ said that the descriptions considered in this section convey something less than insolvency, but he felt that they were too vague to serve as a useful test for determining when the obligation arose.137 The judge cautiously espoused the view that the obligation could be triggered before insolvency. He held that the obligation arose when the directors knew or should have known that the company was or was likely to become insolvent. However, on appeal the Supreme Court disagreed with this as the trigger. We will now examine what the Supreme Court had to say. The Supreme Court in Sequana 14.61 It has already been noted that the judges of the Supreme Court recognised insolvency as a trigger for the obligation. They also accepted that the obligation may be triggered before that time, although just as the Court of Appeal had done,

132 Ibid., [214]. 133 Ibid., [200]. 134 Vladimir Jelisavcic, ‘A Safe Harbour Proposal to Define the Limits of Directors’ Fiduciary Obligation to Creditors in the ‘Vicinity of Insolvency’ [1992] Journal of Corporation Law 145, 159. 135 [2019] EWCA Civ 119, [2019] 2 All ER 784, [2019] BCC 631, [2019] 1 BCLC 347, [2019] BPIR 562. 136 Ibid. 137 Ibid., [213].

230

W HEN DOES THE OBLIGATION A R ISE?

the Supreme Court rejected the test for the obligation as being whether there was a real but not remote risk of insolvency.138 14.62 The judges’ comments in this case on the actual subject of the trigger were obiter, as it was not necessary to decide exactly when the obligation is triggered.139 However, naturally the comments of the judges on the subject are going to be regarded as highly persuasive in any future cases. For his part Lord Reed, after rejecting David Richards LJ’s test for the trigger, opined that likelihood of insolvency may objectively exist before the interests of shareholders and creditors are in practice liable to diverge, which is the point where the interests of the creditors warrant separate consideration.140 Lord Briggs said that the test argued for in the case by the appellant was too remote from the event which changes a creditor’s prospective entitlement into an actual one.141 He went on to say that: ‘When real risk is distinguished from probability . . . insolvency itself is by definition unlikely, and insolvent liquidation may only be a remote possibility.’142 14.63 It still remains a little uncertain as to when the obligation arises in light of the Sequana decision. In several places, besides identifying insolvency or probable insolvent liquidation or administration as the test, all of the judges, except Lord Briggs (with whom Lord Kitchin agreed), refer to the trigger as possibly being when a company is bordering on insolvency,143 something recognised earlier by Lords Toulson and Hodge in Bilta (UK) Ltd (in liquidation) v Nazir.144 However, Lord Briggs did not refer to the obligation being triggered when a company is bordering on insolvency. He said that: I would prefer a formulation in which either imminent insolvency (ie an insolvency which directors know or ought to know is just round the corner and going to happen) or the probability of an insolvent liquidation (or administration) about which the directors know or ought to know, are sufficient triggers for the engagement of the creditor duty.145

14.64 Although Lord Hodge said that for the reasons given by Lord Briggs the appeal should be dismissed, he did say that this was subject to the comments in his judgment.146 In his judgment he did acknowledge that if a company was bordering on insolvency, then the obligation could be triggered,147 which was consistent with his judgment in Bilta (UK) Ltd (in liquidation) v Nazir. 14.65 It is not clear what bordering insolvency entails. It might be argued that it means close to insolvency. Is this the same as imminent insolvency? If so, 138 139 140 141 142 143 144 145 146 147

[2022] UKSC 25, [14], [83], [111], [193], [250], [306]. For instance, see the comment of Lord Briggs, ibid., [199]. [2022] UKSC 25, [89]. Ibid., [193]. Ibid. Ibid., [12], [88], [207], [246], [247], [279]. Ibid., [123]–[124]. Ibid., [203]. Ibid., [207]. Ibid., [207], [246].

231

W HEN DOES THE OBLIGATION A R ISE?

there would be no differences between the judges. As no member of the Court referred to any disagreement on this score, and the judges appear to have read one another’s judgments, it does seem to suggest that imminent insolvency and bordering on insolvency are the same, certainly in the eyes of the judges. However, Lord Reed said in his judgment, as did the other judges, that the creditors’ interests are to be balanced with the interests of the shareholders until a point where the creditors’ interests require separate consideration by the directors. His Lordship said that: ‘the interests of creditors acquire a discrete significance from those of shareholders, and require separate consideration, once the company’s insolvency is imminent, or its insolvent liquidation or administration becomes probable.’148 This might well suggest that there is a point before imminent insolvency when the obligation is triggered and when the directors must consider both the creditors’ and shareholders’ interests. Did his Lordship think that that was when the company was bordering on insolvency? If so, there might be a case for drawing a distinction between bordering on insolvency and imminent insolvency, with the former being further away from insolvency. A company could be close to or bordering insolvency and yet insolvency might not be imminent. 14.66 It might be argued that the view of the members of the Court, even those mentioning ‘bordering on insolvency,’ was that the trigger should be at a later stage and further down the track towards insolvency than the test espoused by the Court of Appeal, any earlier UK single judge decision or by judges in any other jurisdiction, although ‘bordering on insolvency’ might not be far from the ‘near to insolvency’ or verging on insolvency’ formulae identified in some cases. 14.67 Interestingly, Lady Arden said in her judgment that she agreed that the obligation arises when the company is insolvent or bordering on insolvency, or an insolvent liquidation or administration is probable, and she added that the test is also engaged when the directors plan to enter into a transaction which would place the company into any of those aforementioned positions.149 This seems to suggest that her Ladyship preferred a trigger point that was further away from insolvency than the trigger other judges adopted, as planning to enter into a transaction which would place the company into insolvency or probable insolvent liquidation would be a step further away from insolvency. It is reminiscent of what is stated in s 240(2) of the Insolvency Act 1986, which provides that an officeholder, in order to establish that a transaction fell within either s 238 (transaction at an undervalue) or s 239 (preference) must prove that the company was insolvent or became insolvent in consequence of the transaction. 14.68 The concern that might be expressed in relation to the trigger being only insolvency or where insolvent liquidation is probable is that sounded by David Richards LJ, in his leading judgment in BTI 2014 LLC v Sequana S.A.:150

148 Ibid., [96]. 149 Ibid., [279]. 150 [2019] EWCA Civ 119, [2019] 2 All ER 784, [2019] BCC 631, [2019] 1 BCLC 347, [2019] BPIR 562.

232

W HEN DOES THE OBLIGATION A R ISE?

actual insolvency will be established within a very short time and that may well describe many situations in which the duty is triggered, but it does not or may not cover the situation where, although the company may be able to pay its debts as they fall due for some time, perhaps a considerable time, to come, insolvency is nonetheless likely to occur and decisions taken now may prejudice creditors when the likely insolvency occurs.151

14.69 Overall, the Supreme Court adopted a conservative position that requires the trigger to be either insolvency or very close to it and this appears to tend to favour directors and not insolvency officeholders. The Knowledge of the Directors 14.70 Does it have to be established that directors knew or ought to have known that the company was insolvent or bordering on insolvency or that an insolvent liquidation or administration is probable before they can be said to be subject to the obligation? 14.71 In Sequana152 Lord Briggs (with whom Lord Kitchin concurred) and Lord Hodge, providing therefore the majority view, considered that the obligation would arise if the directors knew or ought to know that the company was insolvent or bordering on insolvency or that an insolvent liquidation or administration was probable. Whereas Lord Reed153 was less certain than Lord Briggs and Lord Hodge that it was essential that the directors ‘know or ought to know’ that the company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable, and felt that it was unnecessary and inappropriate to express a concluded view on the issue without hearing argument on the matter. 14.72 Likewise, Lady Arden said that she would leave open the matter to another day.154 However, she did say that directors ought to be aware of the company’s financial position and that if they assert that they were not aware of the company’s financial straits the onus should be on them to show that they reasonably ought to be excused, for whatever reason.155 14.73 The fact that the test includes directors being subject to the obligation if they should know that the company is or is likely to become insolvent as well as directors being aware of insolvency is wise. If a claimant had to establish that the directors were aware, when considering a course of action, the company was insolvent, bordering on insolvency or insolvent liquidation or administration was probable, it would be leaving the creditors too exposed. Such a requirement could too easily favour indigent directors who have not sought to apprise themselves of the state of the company’s affairs and, consequently, did not know that the company was insolvent or likely to become insolvent. Company law has for

151 152 153 154 155

Ibid., [219]. [2022] UKSC 25. Ibid., [90]. Ibid., [281]. Ibid., [280]. For further discussion of exculpation of directors who are held liable, see Chapter 17.

233

W HEN DOES THE OBLIGATION A R ISE?

many years been moving to require directors to find out about the company’s affairs and not to turn a blind eye or shirk their duties. 14.74 The Sequana approach chimes with the approach taken earlier in Re HLC Environmental Projects Ltd156 by John Randall QC. In his judgment he rejected the submission that the obligation is only triggered if the director was aware that the company fulfilled the conditions for the application of the subsection. The test propounded by the majority in Sequana on knowledge is not dependent totally on subjective considerations, and this is consistent with the test for wrongful trading discussed earlier, namely the director is liable if he or she knew or ‘ought to have concluded’ that there was no reasonable prospect of the company avoiding insolvency liquidation. 14.75 Given what the majority said in Sequana, perhaps some of the arguments in future cases will revolve around whether directors ought to have known that insolvency was likely. One can see counsel for directors arguing that it was not possible for the directors to know insolvency was likely given all the circumstances. And in some situations, there may well be some merit in that submission. Reflections 14.76 Determining what the trigger should be for the obligation is not an easy task, attested to by the fact that courts in the UK and in the Commonwealth have arrived at different formulae to try and address the trigger question. Thus, one must be careful in being critical of the Supreme Court’s pronouncements. However, what might be of some concern to some is that the formula set out by the Supreme Court in Sequana appears to place the point at which the obligation is triggered at a time that is very close to insolvency, and this is far more restrictive than many of the formulations put forward in earlier cases and even that set by David Richards LJ in the Court of Appeal.157 This might conceivably make it more difficult for liquidators to establish cases against directors. On the other hand, directors might take some comfort from the court’s test, feeling that it does not place unfair constraints on them in managing the company’s business. 14.77 The Supreme Court’s decision, like that of the earlier judgment of the Court of Appeal, does mean, for the UK at least, that we can probably put aside all of the various descriptions of the trigger that have been espoused by a variety of courts all around the Commonwealth and concentration can be on whether the directors knew or should have known that the company was insolvent, bordering on insolvency or insolvent liquidation or administration was probable when the directors engaged in the impugned conduct. 14.78 Of course, the trigger advocated by the Supreme Court in Sequana158 falls short of providing all concerned with a precise trigger. In particular, and 156 [2013] EWHC 2876 (Ch). 157 [2019] EWCA Civ 119, [2019] 1 BCLC 347, [2019] BPIR 562. 158 [2022] UKSC 25.

234

W HEN DOES THE OBLIGATION A R ISE?

as mentioned earlier, what bordering on insolvency means still leaves room for uncertainty. Nevertheless, in this area of law it is difficult to see how a trigger pre-insolvency could be formulated more precisely. 14.79 Therefore, the position is, notwithstanding the judgment in Sequana, because of some of the different comments made by the judges, the trigger remains imprecise and still uncertain, and perhaps that could only be expected. 14.80 While the Supreme Court has provided some clarification one wonders if directors are still left wondering what it all means in relation to their decisionmaking. It also does not help officeholders too much, as they have the difficult task of identifying what was the thrust of the judgment and what ‘bordering on insolvency’ means. 14.81 What directors must take note of is that they are to stay informed concerning the company’s financial position. Yet, that is something which they are required to do as part of their duty to take care, as found in s 174 of the Act. In particular, directors should be aware of circumstances that might mean that creditors will not be paid, or on time at least. 14.82 Unfortunately, for all concerned we do not have total certainty as to the precise timing of the triggering of the obligation. Different formulations were put forward by judges of the Supreme Court. As we have seen these were ‘imminent insolvency’ or the probability of an insolvent liquidation (or administration) or ‘bordering on insolvency.’ 14.83 We may be able to say that if a company is not bordering on insolvency, insolvency is not imminent or insolvent liquidation is not probable then the obligation is not triggered. 14.84 It is probable that any claimant is going to be a little more (or a lot more) circumspect when determining whether to take legal proceedings if all that can be established is that directors did not take into account creditors’ interests when the company was in some form of financial difficulty that was short of insolvency. Having said that, it might be argued that if the cases post 2006 and where directors were held liable were heard now liability still would be imposed on the directors. This is primarily because in these cases the companies concerned were insolvent. 14.85 It is clear from some of the comments of the judges in Sequana that they do not want to restrict the entrepreneurial spirit of directors and they feel that if a trigger were imposed some distance from insolvency directors’ risk-taking would be curtailed unfairly. Undoubtedly, companies need, at times, to take risks to prosper.159 One can even say that without risks being taken we would not enjoy some of the things that we do enjoy in society today.160

159 W Allen, ‘Ambiguity in Corporation Law’ (1997) 22 Delaware Journal of Corporate Law 894, 896. 160 Leonard Sealy, ‘Director’s Wider Responsibilities – Problems Conceptual Practical and Procedural’ (1987) 13 Monash University Law Review 164, 181. Also, see F Easterbrook and D Fischel, The Economic Structure of Company Law (Harvard University Press, 1991), 41–44.

235

W HEN DOES THE OBLIGATION A R ISE?

Conclusion 14.86 Perhaps the first thing to conclude is that authority unequivocally favours the view that an obligation to take into account the interests of creditors does not arise where a company is clearly solvent.161 Equally clear from the authorities is the fact that if a company is insolvent then the directors must take into account the interests of the creditors. 14.87 While the point at which the trigger arises before insolvency has not been clear, there has been a significant amount of judicial opinion that supports the view that the obligation may be triggered before a company actually becomes technically insolvent. The problem has been that because of the existence of a variety of descriptions of the point when the obligation does arise pre-insolvency, there has been uncertainty. 14.88 While there remains some uncertainty in respect of what it might mean for any given case, the Supreme Court in Sequana has given us what will be highly persuasive for a court hearing any future cases. The Court said that the obligation arises when the company is insolvent, bordering on insolvency, insolvency is imminent or insolvent liquidation or administration is probable, although Lord Briggs did place qualifications on these triggers. The trigger has been moved closer to the point of insolvency than it was before. This might, therefore, encourage greater risk-taking by directors. 14.89 Thus, while the Supreme Court has provided some certainty, the application of this test is heavily dependent on the facts,162 and clearly there remains concerns about what ‘bordering on insolvency’ and ‘imminent insolvency’ in particular mean in practice. Determining when the obligation is triggered is clearly not a matter of exact science.

161 For example, see Multinational Gas and Petrochemical Co v Mutlinational Gas and Petrochemical Services Ltd [1983] Ch 258; Nicholson v Permakraft (NZ) Ltd (1985) 3 ACLC 453; Brady v Brady (1988) 3 BCC 535; Kinsela (1986) 4 ACLC 215; West Mercia (1988) 4 BCC 30; Equiticorp Finance Ltd (in liq) v BNZ (1993) 11 ACLC 952. In the last case the New South Wales Court of Appeal said that Mason J’s comments in Walker v Wimborne (1976) 137 CLR 1, (1976) 3 ACLR 529 were made in the context of an insolvent company (at 1016). 162 Sequana [2022] UKSC 25, [238].

236

CHAPTER 15

Complying With the Obligation

Introduction 15.1 Thus far we have considered that a duty to act for the interests of creditors exists in UK law, but only in certain circumstances. In analysing whether directors have breached the obligation it was necessary first to determine whether the directors were in fact required to consider creditors’ interests – had the obligation been triggered? Did the circumstances referred to in s 172(3) of the Companies Act 2006 (‘the Act’) exist? This was undertaken in the last chapter. Once one ascertains what the trigger for the obligation is, the next question to ask is whether the directors have complied with the obligation and fulfilled their duty to the company, that is, did they consider the creditors’ interests? This means that we must know what complying with the obligation entails. 15.2 Both the issue of when the obligation arises and what directors are to do to comply with the obligation have been clouded in a significant amount of uncertainty. We saw in the last chapter that there has been some degree of certainty introduced by the decision in BTI 2014 LLC v Sequana S.A. (‘Sequana’)1 in determining when the obligation is triggered. Can we say the same for the second issue: what are directors to do in order to comply? The chapter addresses this issue. It asks: how are the directors to behave and to discharge the obligation to consider creditor interests? The chapter examines, in essence, what the content of the obligation should be. In this regard particular consideration is given to how directors are to have regard to the interests of creditors as a whole, a matter on which relatively little has been said. 15.3 The issue that is considered in the chapter is of inestimable importance in two major respects. First, directors need to know how they might discharge the obligation provided for in s 172(3) so as to avoid possible liability. Secondly, those who might seek to claim against directors pursuant to s 172(3), and this will usually be liquidators2 (and occasionally administrators), need to know when they are entitled to take action against directors for what they have done or not done. 1 [2002] UKSC 25. 2 See, Re MDA Investment Management Ltd [2003] EWHC 227 (Ch), [2005] BCC 783, [70]. In fact, nearly all cases thus far have involved liquidators as claimants and it is difficult to see any other claimants, save for administrators (e.g. see, Facia Footwear Ltd (in administration) v Hinchliffe

DOI: 10.4324/9780429266232-19

237

COMPLYI NG WITH THE OBLIGATION

Context 15.4 Section 172(3) of the Act provides that the duty imposed by s 172(1), the duty to promote the success of the company for the benefit of the members of the company, is subject to any enactment or rule of law requiring directors, in certain circumstances, to take into account the interests of creditors. This means that in certain cases s 172(3) modifies3 or qualifies4 the duty set out in s 172(1) because it makes the latter subject to the former. Section 172 overall clearly seeks to achieve a reasonable balance between reducing the risk that creditors will not get paid and promoting the success of the company for the benefit of its members. 15.5 Section 172(3) means that directors will not be in breach of s 172 if they have taken into account creditor interests. Indeed, if they do not take into account creditor interests, they could well be in breach and, possibly, liable. 15.6 All of this means that directors need to know when there is a shift in the nature of their duty, from the responsibility imposed on them by s 172(1) to fulfilling the obligation contained in s 172(3). One problem is that it is unlikely that the move from being subject to s 172(1) to being subject to s 172(3) is going to be seamless. Companies do not always spiral downhill financially and keep going that way. They might well move in and out of states of financial difficulty depending on a myriad of circumstances, such as payments by their debtors or the failure of their own debtors to make payments. 15.7 Potentially, the obligation in s 172(3) provides some unwelcome uncertainty for both directors and those, likely most often to be either liquidators or administrators, who are contemplating whether to proceed against directors. Directors might well be confronted with making a decision at a board meeting at a time when they are unsure whether they should aim to fulfil s 172(1) or s 172(3). If there is doubt, it is submitted that it is probably prudent for directors to make decisions that take account of creditors’ interests. Admittedly this could, conceivably, cause shareholders to instigate derivative action proceedings, under either Chapter 15 or Chapter 26 of Part 11 of the Act, but it is unlikely for a number of reasons. 15.8 The reasons are as follows. First, shareholders need to seek and obtain the permission of the court to prosecute such an action, the granting of leave is not granted readily and the need to follow this process might deter a shareholder from taking action, particularly given the fact that permission is far from certain.7 [1998] 1 BCLC 218; E-Clear (UK) Plc (In Liquidation) v Elias Elia [2013] EWCA Civ 1114) bringing proceedings. Creditors themselves have no locus standi to bring proceedings as the obligation is not owed to them. 3 Sequana [2022] UKSC 25, [225], [258], [265]. 4 Ibid., [74], [96], [252]. 5 This covers England and Wales and Northern Ireland. 6 This covers Scotland. 7 See Andrew Keay and Joan Loughrey, ‘An Assessment of the Present State of Statutory Derivative Proceedings’ in Joan Loughrey (ed), Directors’ Duties and Shareholder Litigation in the Wake of the Financial Crisis (Edward Elgar, 2013), Ch 7.

238

COMPLYI NG WITH THE OBLIGATION

Secondly, shareholders will have to take into account the costs and the time in making an application for leave. Monetary and time costs that shareholders could incur could be substantial in seeking leave and then bringing a derivative action if leave is granted. Thirdly, it is likely, save in small companies, that shareholders will not be aware of the action taken by the directors, at least for some time, and when they do become aware the company might well be in administration or liquidation, or the company will have recovered, possibly justifying the action of the directors. Fourthly, directors who do consider creditors’ interests might still be said to be complying with s 172(1) because while the sub-section requires directors to have regard to several factors set out in s 172(1)(a)–(f), which does not include a reference to creditors, the provision states that the factors in paragraphs (a)–(f) are not exhaustive of the directors’ consideration.8 The legislation permits directors to have regard to other factors, which could embrace consideration of creditors’ interests as long as this can be seen as promoting the success of the company for the ultimate benefit of the members. In any event it could be said to be wise and proper that directors take creditors’ interests into consideration when there are some doubts over the financial position and future of the company.9 15.9 For the purposes of the discussion in this chapter, the chapter assumes that the obligation of the directors has triggered and thus what the directors are to do is the focus of the chapter. The Content of the Duty 15.10 A requirement that directors are ‘to act in the interests of the creditors’ verges on the facile, as it does not tell us exactly how directors should act or how far directors have to go in fulfilling the requirement to consider the interests of creditors. The fact of the matter is that most cases do not address this issue. They simply say that directors should act in the interests of creditors, or creditors’ interests should be taken into account or considered. They then find that the directors either did consider creditor interests or they did not. 15.11 It is somewhat unfortunate that the leading English judgment on this topic, certainly until the decisions of the Court of Appeal in BTI 2014 LLC v Sequana S.A.,10 and the appeal in the same matter to the Supreme Court,11 Liquidator of West Mercia Safetywear Ltd v Dodd (‘West Mercia’),12 a decision of the Court of Appeal, was relatively brief and did not provide any major assistance. Its prime benefit was making it plain that the obligation applied in England and Wales. However, this state of affairs is not peculiar to West Mercia, 8 See Lady Arden’s comment in Sequana [2022] UKSC 25, [252], but cf the comment of Lord Briggs at [229]. 9 Andrew Keay, ‘Directors’ Duties and Creditors’ Interests’ (2014) 130 Law Quarterly Review 443, 448. 10 [2019] EWCA Civ 112, [2019] 2 All ER 784, [2019] BCC 631, [2019] 1 BCLC 347, [2019] BPIR 562. 11 [2022] UKSC 25. 12 (1988) 4 BCC 30, 33.

239

COMPLYI NG WITH THE OBLIGATION

as most judgments here and in the Commonwealth have not provided very much guidance as to what directors should be doing. 15.12 Besides West Mercia all the cases, until recently, that are on point were either single judge or Irish or Commonwealth decisions.13 Historically, most of the cases appear to distinguish between where a company is insolvent and where a company is in financial difficulties short of insolvency, a matter on which we focused in the last chapter. Insolvency 15.13 As observed in the last chapter, there are numerous cases which state that the duty to act in the interests of creditors applies to directors when the company is insolvent. But amongst these cases there appears to be some divergence concerning how the directors are to approach the interests of the creditors. It is possible to identify three approaches from the case law. First, in Re Pantone 485 Ltd14 Richard Field QC (sitting as a deputy judge of the High Court) suggested that directors are required to have an exclusive focus on creditors’ interests.15 Earlier in obiter in the Court of Appeal in Brady v Brady16 Nourse LJ did say that where the company is insolvent the interests of the company are in reality the interests of existing creditors alone. It might be thought that such an approach wrongly ‘ignores the need for directors, depending on the circumstances, to consider the interests of other stakeholders including shareholders and employees.’17 In a position where a company is in financial straits any consideration of a restructuring is likely to have to consider the interests of some stakeholders or it might be doomed ab initio. 15.14 The second approach comes from a large corpus of first instance English decisions, such as Re Pantone 485 Ltd,18 Colin Gwyer v London Wharf (Limehouse) Ltd,19 Re Capitol Films Ltd (in administration),20 Re Oxford Pharmaceuticals Ltd,21 Roberts v Frohlich22 and Re HLC Environmental Projects Ltd,23 where it has been stated that when a company is insolvent the creditors’ interests are paramount. What paramount entails is discussed later. 15.15 What some other courts require directors to do seems close to, if not synonymous with, the idea of paramountcy. In Kinsela v Russell Kinsela Pty

13 There was a dictum from Nourse LJ in Brady v Brady (1987) 3 BCC 535, 552, and which is discussed later. 14 [2002] 1 BCLC 266. 15 Ibid., [67]–[68], [72]. 16 (1987) 3 BCC 535, 552. 17 Rosemary Teele Langford and Ian Ramsay, ‘The Contours of the “Creditors’ Interests’ Duty”’ (2021) 21 JCLS 85, 105. 18 [2002] 1 BCLC 266, [69]. 19 [2002] EWHC 2748 (Ch), [2003] 2 BCLC 153, [74]. 20 [2010] EWHC 2240 (Ch), [2011] 2 BCLC 359, [49]. 21 [2009] EWHC 1753 (Ch), [2010] BCC 838, [92]. 22 [2011] EWHC 257 (Ch), [2012] BCC 407, [2011] 2 BCLC 625, [85]. 23 [2013] EWHC 2876 (Ch), [92].

240

COMPLYI NG WITH THE OBLIGATION

Ltd,24 Street CJ said that if the company is insolvent the interests of the creditors intrude and the creditors become prospectively entitled to displace the power of the shareholders and directors to deal with the company’s assets.25 The general thrust of the sentiments expressed by Street CJ, while not using the word ‘paramount,’ are not far from it as they appear to envisage the creditors supplanting the shareholders. 15.16 A third line of cases appears to be represented by some Australian decisions as well as an English decision. In the seminal decision of Walker v Wimborne,26 Mason J said that the directors of an insolvent company in discharging their duty to the company must take account of the interest of its shareholders and its creditors. Nevertheless, his Honour did not say that the interests of creditors supplanted, or became paramount with respect to, those of shareholders. Owen J at first instance in Bell Group Ltd (in liq) v Westpac Banking Corporation (No 9) (‘Bell Group’)27 referred to comments of Mason J, but not to the comments of any English court. His Honour said that: ‘I do not read any of these statements [which were set out in the Australian cases] as demanding that the interests of creditors be treated as paramount. They emphasise the importance of treating the position of creditors with due deference.’28 15.17 Notwithstanding this, Owen J did accept that on occasion, depending on the circumstances of the company, it was necessary that the creditors’ interests should be seen as paramount.29 On appeal, Drummond AJA agreed with his Honour’s comments,30 and this despite the fact that in other parts of his Honour’s judgment it would seem that he favoured an approach close to paramountcy. In his judgment Owen J got close to saying that, when considering what courts had to do in assessing creditors’ interests, directors had to engage in a balancing exercise where the risk to creditors could be included as one of several considerations to be taken by management. He opined that the greater the risk to creditors, the more directors should take the interests of creditors into consideration.31 Consideration is given to the issue of balancing later in the chapter. 15.18 In Ultraframe (UK) Ltd v Fielding32 Lewison J (as he then was) took a similar approach to that adopted by the Australian cases. His Lordship said that whether a company is insolvent or short of that, if it is in financial difficulties and creditors are at risk the duties which the directors owe to the company are extended so as to encompass the interests of the company’s creditors as a whole, as well as those of the shareholders.33

24 25 26 27 28 29 30 31 32 33

(1986) 4 ACLC 215, (1986) 10 ACLR 395. Ibid., 221, 401. (1976) 137 CLR 1, 7. [2008] WASC 239, [4436]. Ibid., [4438]–[4439]. Ibid., [4440]. Westpac Banking Corporation v Bell Group Ltd (in liq) (No 3) [2012] WASCA 157, [2046]. Bell Group [2008] WASC 239, [1436]–[1439]. [2005] EWHC 1638 (Ch). Ibid., [1304].

241

COMPLYI NG WITH THE OBLIGATION

15.19 A fourth approach is for directors to engage in balancing the interests of the creditors and the shareholders in the way they run the company when s 172(3) applies. As mentioned, the issue of balancing has been countenanced in Australia as manifested by the judgment of Owen J in Bell Group.34 The Supreme Court in Sequana mentioned the need for balancing certainly when the obligation arises prior to insolvency and even during periods of insolvency. As indicated earlier, we will return to the balancing issue shortly. 15.20 Finally, it would seem that judges in Sequana took the view that the more parlous the state of the company’s finances and the closer it gets to insolvent liquidation or administration, greater weight should be given to the interests of creditors.35 When Insolvent Liquidation or Administration Is Probable 15.21 While not without some uncertainty, it seems that, overall, the Supreme Court in Sequana accepted the fact that it was only when insolvent liquidation or administration is probable that the creditors’ interests become paramount. Lord Reed said that the interests of creditors acquire a discrete significance from those of shareholders, and require separate consideration, once the company’s insolvency is imminent or its insolvent liquidation or administration becomes probable.36 Nevertheless, earlier in his judgment his Lordship said that it is not possible to say that the interests of the shareholders vanish whenever a company becomes insolvent.37 He went on to say that it is only where an insolvent liquidation or administration is unavoidable that the shareholders can be said to have no remaining interest in the company.38 15.22 Lord Briggs was, arguably, more forthright on this issue. He said that practical common-sense pointed strongly against a duty to treat creditors’ interests as paramount at the onset of insolvency, for it might only be temporary insolvency. His Lordship said that it is when an insolvent liquidation or administration is inevitable the directors must treat the interests of the creditors as paramount.39 As we saw earlier, Lord Reed in part of his judgment seemed to agree with this. 15.23 Lord Briggs rejected insolvency, either balance sheet or cash flow, of itself as advancing the status of creditors beyond being contingent main stakeholders, and this remained until liquidation eventuates rather than insolvency. His Lordship went on to say that if there is ‘light at the end of the tunnel,’ the contingency may never occur. The reason for the existence of the obligation did not go so far as to render creditors’ interests necessarily paramount upon insolvency.40 The judge said that if the creditors’ interests became paramount 34 35 36 37 38 39 40

[2008] WASC 239. [2022] UKSC 25, [11], [81]. Ibid., [96]. Ibid., [50]. Ibid., [50]. Ibid., [173]. Ibid., [175]. Also, see [190].

242

COMPLYI NG WITH THE OBLIGATION

when insolvency occurs rather than inevitable liquidation, that would appear to run contrary to the statutory insolvency scheme, and indeed to make s 214 largely redundant.41 Thus in his Lordship’s view creditors’ interests would not become paramount at the point of insolvency unless insolvent liquidation or administration was inevitable. 15.24 Although Lord Hodge appeared to agree with much of this, he did say that it was where a company was irretrievably insolvent that the interests of creditors become a paramount consideration in the directors’ decision-making.42 It is not clear whether ‘irretrievably insolvent’ is the same as insolvent liquidation or administration being inevitable, which is what Lord Briggs relied on. Lady Arden thought that it was hard to see creditor interests becoming paramount before irreversible insolvency,43 which seems to connote insolvent liquidation or administration being inevitable. Circumstances Short of Insolvency 15.25 As noted in Chapter 14, there is case law to the effect that the obligation under s 172(3) might arise at some point before insolvency or the probability of insolvent liquidation or administration occurs. When the obligation arises in such circumstances, in what manner are the directors to discharge their obligation? Again, there has been some divergence in the case law that addresses this matter, but Sequana has probably settled things for the UK. 15.26 On one side are some cases that emit the view that the interests of creditors have to be regarded as paramount, even where the company is short of being insolvent. This is well-illustrated by the decision in Colin Gwyer v London Wharf (Limehouse) Ltd.44 The deputy judge did not, when stating the obligations of directors, distinguish between insolvency and cases where the company is of doubtful solvency or on the verge of insolvency. According to the deputy judge in all these instances the creditors’ interests were to be seen as paramount.45 Several first instance decisions, including Roberts v Frohlich,46 GHLM Trading Ltd v Maroo,47 and Re HLC Environmental Projects Ltd,48 approved specifically of what Leslie Kosmin QC had said when it comes to companies which are not necessarily insolvent. 15.27 Nevertheless, there are cases which support the view that while directors must consider creditors’ interests when the company is in financial difficulties short of insolvency, they are not obliged to see creditors’ interests as paramount, 41 Ibid., [172]. 42 Ibid., [247]. 43 Ibid., [290]. 44 [2002] EWHC 2748 (Ch), [2003] 2 BCLC 153, [74]. 45 [2002] EWHC 2748 (Ch), [2003] 2 BCLC 153, [74]. 46 [2011] EWHC 257 (Ch), [2011] 2 BCLC 625, [85]. 47 [2012] EWHC 61, [2012] 2 BCLC 369, [165]. In fact, Newey J specifically stated that where a company was doubtfully solvent or on the verge of insolvency then the interests of the company were to be identified with those of the creditors (at [162]). 48 [2013] EWHC 2876 (Ch), [92].

243

COMPLYI NG WITH THE OBLIGATION

and shareholder interests may have to be given greater consideration than has been suggested by some other courts. In Re MDA Investment Management Ltd49 Park J indicated that when a company is in financial difficulties, although not insolvent, the directors’ duties owed to the company are extended so as to include the interests of the company’s creditors as a whole, in addition to those of the shareholders. This statement appeared to be cited with approval in Re Kudos Business Solutions Ltd.50 Lewison J in Ultraframe (UK) Ltd v Fielding51 took the same approach and said that when a company is in financial difficulties the duties which the directors owe to the company are extended so as to encompass the interests of the company’s creditors as a whole, as well as those of the shareholders.52 15.28 As one might expect given what he had said about companies that are insolvent, in Bell Group53 Owen J said that where the financial situation of a company is short of insolvency the shareholders retain their interest, as the creditors’ interests do not supplant those of the shareholders.54 In the New Zealand Court of Appeal in Nicholson v Permakraft (NZ) Ltd55 a case where the company was said to be nearing insolvency56 at the time of the alleged breach, Cooke J said that he did not think that the interests of the shareholders should be put aside.57 15.29 There is no absolute consistency among the Supreme Court judges in Sequana when it comes to the significance of creditor interests when the obligation is triggered before insolvency. As mentioned earlier, Lord Reed said the interests of creditors acquire a discrete significance from those of shareholders and require separate consideration once the company’s insolvency is imminent, as well as when insolvent liquidation or administration becomes probable.58 Thus, this suggests paramountcy can apply prior to insolvency. However, Lord Briggs (with whom Lords Hodge and Kitchin agreed) said that practical common sense points strongly against a duty to treat creditors’ interests as paramount when insolvency is imminent.59 According to Lord Briggs imminent insolvency is when directors know or ought to know that insolvency is ‘just round the corner and going to happen.’60 15.30 Lord Briggs had said earlier in his judgment that ‘creditors are not to be treated as having the main economic stake in the company at least while a company is solvent or, if insolvent, while there is still light at the end of the

49 50 51 52 53 54 55 56 57 58 59 60

[2004] 1 BCLC 217, 245, [2004] BPIR 75, 102. [2011] EWHC 1436 (Ch); [2012] 2 BCLC 65, [43]. [2005] EWHC 1638 (Ch). Ibid., [1304]. Bell Group Ltd (in liq) v Westpac Banking Corporation (No 9) [2008] WASC 239, [4436]. [2008] WASC 239, [4436]. (1985) 3 ACLC 453. Ibid., 459. Ibid., 460. Sequana [2022] UKSC 25, [96]. Ibid., [173]. Ibid., [203].

244

COMPLYI NG WITH THE OBLIGATION

tunnel.’61 If the creditors had the main economic interest, then it is likely we can say that their interests should be seen as paramount. 15.31 Therefore, unlike where a company is insolvent or even where insolvent liquidation is inevitable, it seems that creditors’ interests are not to be seen as paramount, at least prior to insolvency eventuating. Nevertheless, the employment of a paramountcy approach, regardless of the company’s financial difficulties, can be advantageous. First, for creditors it would be attractive, for obvious reasons, but it might be attractive both to directors and officeholders who are determining whether to make a claim against directors. The reason is that it would produce a consistent approach and the depth of the company’s financial straits would not be at all relevant. If paramountcy of creditor interests were to apply at any time the company’s directors are subject to s 172(3), directors would avoid having to engage in consideration of the exact state of their company’s affairs. Importantly, if that was the position one might think that it would be a less demanding exercise compared with undertaking the balancing of the interests of shareholders and creditors, which, as we will see shortly, can be regarded as problematic. Summary 15.32 While there has been a fair degree of uncertainty as to how creditors’ interests should be viewed on the triggering of the obligation, the predominant position that has been articulated by the Supreme Court in Sequana is that short of insolvency, where the company is bordering on insolvency, the interests of the creditors and the shareholders must both be considered. Even when insolvency occurs the interests of creditors may not be paramount. It will only be if the state of insolvency is not temporary that paramountcy would apply. It is not until there is the probability of a company’s insolvent liquidation or administration that the interests of creditors definitely become paramount. The Nature of the Consideration to Be Given to Creditor Interests 15.33 No matter how directors are to act when they are subject to s 172(3), the decision-making of directors is largely going to be evaluated some significant time after the event, and that means that some caution needs to be exercised by courts in assessing their actions. The courts in dealing with many cases, such as actions brought for wrongful trading,62 assessments of a director’s conduct when hearing an application under the Company Directors’ Disqualification Act 1986,63 and claims for a breach of a director’s duty of care,64 have recognised the

61 Ibid., [164]. 62 For example, see Re Sherborne Associates Ltd [1995] BCC 40, 54; Re Brian D. Pierson (Contractors) Ltd [1999] BCC 26, 50, [2001] BCLC 275, 303. 63 Secretary of State for Trade and Industry v Goldberg [2004] 1 BCLC 597, 613. 64 Dryburgh v Scotts Media Tax Ltd [2011] CSOH 147, [114].

245

COMPLYI NG WITH THE OBLIGATION

problem that hindsight brings. It has been indicated many times that hindsight is a wonderful thing.65 The courts have acknowledged that they must take care that they do not apply too severe a standard on directors as the courts have the benefit of hindsight.66 15.34 In Facia Footwear Ltd (in administration) v Hinchliffe67 Sir Richard Scott V-C cautioned that it must not be forgotten that the defendants/directors acted without the benefit of hindsight at the time they allegedly breached the obligation. Similarly, Sarah Asplin QC (sitting as a deputy judge of the High Court) (as she was then) in Re Kudos Business Solutions Ltd68 said: ‘Directors are not required to be clairvoyants.’69 In her judgment in Re Idessa (UK) Ltd70 Lesley Anderson QC (sitting as a deputy judge of the High Court) said that: ‘particular care should be taken not to invoke hindsight and proper regard must be had to the difficult choices which often confront directors when deciding whether to continue to trade and on what basis.’71 Balancing 15.35 Given the Supreme Court decision in Sequana it would seem that creditors’ interests must be considered along with those of the shareholders where a company is short of insolvency, namely bordering on insolvency. Also, Lord Briggs in Sequana and the Australian decision of Bell Group indicate that even where a company is insolvent, directors might still need to consider the interests of both shareholders and creditors. Whether courts need to consider both shareholder and creditor interests when insolvency occurs will very much depend on the company’s exact financial situation. Lord Briggs would say that even where a company is insolvent if there was ‘light at the end of the tunnel’ then shareholders’ interests must still also be considered. 15.36 If a company is not insolvent, then perhaps it is fair to say that creditor interests should not be preeminent, as the point has not been reached where the creditors are not able to be paid in full. In fact, they might be paid in full, and there is more chance of them receiving all their money where the company has not fallen into an insolvent position. 15.37 The question that comes to mind where directors are to consider the interests of the creditors and the shareholders is: how are they to discharge this requirement? A number of judges in different jurisdictions have referred to the

65 See Linton v Telnet Pty Ltd (1999) 30 ACSR 465. 66 See the comment of Cooke J in Nicholson v Permakraft (NZ) Ltd (1985) 3 ACLC 453, 462. Also, see Roberts v Frohlich [2011] EWHC 257 (Ch), [2012] BCC 407, [2011] 2 BCLC 625, [108]. 67 [1998] 1 BCLC 218, 228. 68 [2011] EWHC 1436 (Ch), [2012] 2 BCLC 65. 69 Ibid., [61]. Also, see the comments of Lewison J (as he then was) in Re Hawkes Hill Publishing Co Ltd [2007] EWHC 3073 (Ch), [41]. 70 [2011] EWHC 804 (Ch), [2012] BCC 315. 71 Ibid., [113].

246

COMPLYI NG WITH THE OBLIGATION

need for directors to engage in balancing the interests of shareholders and creditors when the obligation is triggered. 15.38 The most important statements for our purposes are those made in Sequana. Lord Reed said that where the company is insolvent or bordering on insolvency but is not faced with an inevitable insolvent liquidation or administration, the directors’ fiduciary duty to act in the company’s interests has to reflect the fact that both the shareholders and the creditors have an interest in the company’s affairs. In those circumstances, the directors should have regard to the interests of the company’s general body of creditors, as well as to the interests of the general body of shareholders, and act accordingly. He then acknowledged the need for balancing,72 as did Lord Hodge.73 Lord Briggs (with whom Lord Kitchin concurred) said that there was nothing inconsistent with the fiduciary nature of the directors’ duty and the balancing of potentially competing interests.74 However, none of their Lordships stated, and they probably felt that it was not warranted given the case before them, how the balancing was to be undertaken, although Lord Reed did say that the balancing is to reflect the respective weights of the shareholders and creditors’ interests in the light of the gravity of the company’s financial difficulties.75 15.39 ‘Balancing’ involves, according to the Cambridge Dictionary: ‘to give several things equal amounts of importance, time, or money so that a situation is successful.’76 Some commentators have expressed it as ‘assessing, weighing and addressing the competing claims of those who have a stake in the actions of the organization.’77 Even though, prima facie, it might sound attractive, as it suggests rational and careful thinking is to be engaged in, there are a number of problems with a balancing approach.78 First, not only do shareholders and creditors have divergent interests, those within the shareholder and creditor groups themselves are likely to have diverging interests. Secondly, the process of balancing can mean that there is no enforceable accountability. In purporting to balance, directors can escape any enforceable accountability. Directors could justify any decision which they make based on the fact that they engaged in balancing interests, and this could disguise their ineptitude or opportunism. 15.40 Thirdly, is the notion of balancing really understood? What does balancing actually entail? Does it mean embracing compromise or taking such action that enables the interests of the shareholders and the creditors to coincide?79 The former might not be acceptable to many and might leave some disenchanted, and 72 Sequana [2022] UKSC [81], [96]. 73 Ibid., [238]. 74 Ibid., [176], [177]. 75 Ibid., [96]. 76 https://dictionary.cambridge.org/dictionary/english/balancing, accessed 31 October 2022. 77 S Reynolds, F Schultz, and D Hekman, ‘Stakeholder Theory and Managerial Decision-Making: Constraints and Implications of Balancing Stakeholder Interests’ (2006) 64 Journal of Business Ethics 285 at 286. 78 For criticism of a balancing approach, see Andrew Keay, ‘Directors’ Duties and Creditors’ Interests’ (2014) Law Quarterly Review 460. 79 B Shenfield, Company Board (George Allen and Unwin Ltd, 1971), 149.

247

COMPLYI NG WITH THE OBLIGATION

the latter does not, for the most part, appear to be possible. Fourthly, related to the last point and perhaps the primary concern is that it is difficult for directors to know what is the basis on which they are to balance interests. It is not possible to provide directors with any specific guidance in conducting a balance, and how the various interests are to inform their decision-making.80 There are no standards devised for assigning relative weight to the interests of the shareholders and creditors involved and no criteria for solving problems. The upshot is that directors are presented with a standardless discretion.81 15.41 ‘Balancing’ has been advocated by many who argue for stakeholder theory in company law and corporate governance, but these scholars have failed to arrive at firm assistance for directors, and the difficulty with balancing has been pointed out in the context of corporate governance.82 Barrett has noted the difficulty with balancing, namely there will be insoluble problems of reconciling conflicting interests of shareholders and creditors if a duty to creditors applied other than where insolvency exists.83 15.42 The problem for directors is that when a company is in a financially parlous state the interests of shareholders and creditors can be ‘starkly divergent,’84 and thus it seems unlikely that a balance can be secured. 15.43 There has been some judicial support for balancing in respect of a consideration of s 172(1),85 although in the context of a s 994 petition claiming relief for unfair prejudice, and so it is of marginal assistance. However, again in this decision there was no indication from the court what balancing actually means for directors when they are concerned with running the company’s business. 15.44 Nevertheless, it can be said, as a general rule, based on what Lord Reed said in Sequana, that the more parlous the state of the company, the more the interests of the creditors will predominate, and greater weight should therefore be given to their interests as against those of the shareholders. That is most clearly the position where an insolvent liquidation or administration is inevitable, and the shareholders consequently cease to retain any valuable interest in the company. Lady Arden made a similar point when she said that where the financial position

80 A Sundram and A Inkpen, ‘The Corporate Objective Revisited’ (2004) 15 Organization Science 350, 353; M Jensen, ‘Value Maximisation, Stakeholder Theory, and the Corporate Objective Function’ (2001) 7 European Financial Management 297, 305. 81 Lawrence Mitchell, ‘A Theoretical and Practical Framework for Enforcing Corporate Constituency Statutes’ (1992) 70 Texas Law Review 579, 589. 82 W Leung, ‘The Inadequacy of Shareholder Primacy: A Proposed Corporate Regime that Recognizes Non-Shareholder Interests’ (1997) 30 Columbia Journal of Law and Social Problems 589; E Sternberg, ‘The Defects of Stakeholder Theory’ (1997) 5 Corporate Governance 3, 6; A Sundram and A Inkpen, ‘The Corporate Objective Revisited’ (2004) 15 Organization Science 350, 353; Andrew Keay, ‘Ascertaining the Corporate Objective: An Entity Maximisation and Sustainability Model’ (2008) 71 MLR 663, 677–678. 83 ‘Directors’ Duties to Creditors’ (1977) 40 MLR 226, 231. 84 Prod. Res. Grp. LLC v NCT Crp Inc. 863 A. 2d 772 (Del. Ch. 2004) at 790 and referred to in A Hargovan and J Harris, ‘For Whom the Bell Tolls: Directors’ Duties to Creditors After Bell’ (2013) 35 Sydney Law Review 433, 437. 85 Re Phoenix Contracts (Leicester) Ltd (sub nom: Shepherd v Phoenix Contracts (Leicester) Ltd [2010] EWHC 2375 (Ch), [103].

248

COMPLYI NG WITH THE OBLIGATION

of the company deteriorates, the shareholders’ interests decrease in importance, and those of creditors increase in importance.86 The Supreme Court seemed to approve of the notion of a sliding scale which has bordering insolvency at one end, where the interests of both shareholders and creditors are relevant, and inevitable insolvent liquidation or administration at the other, where creditors’ interests predominate. This is not new. In Kinsela v Russell Kinsela Pty Ltd87 Street CJ said that: ‘Moreover, the plainer it is that it is the creditors’ money that is at risk, the lower may be the risk to which the directors, regardless of the unanimous support of all the shareholders, can justifiably expose the company.’88 15.45 Therefore, the state of the company will be a factor to be considered in the act of balancing. Probably because as the company’s solvency deteriorates, the interests of creditors must be apportioned more weight where they conflict with shareholders’ interests. By the time an insolvent liquidation or administration is inevitable, the interests of creditors will have become paramount. 15.46 In balancing one would think that directors need to endeavour to effect a reasonable balance between excessive risk and excessive caution. If the directors were only concerned for shareholder benefits, they might be inclined to indulge in excessive risk, while if they were focusing on benefitting the creditors solely, directors might engage in excessively cautious activity, thereby perhaps leaving potential value unrealised or even eschewing a possible viable restructuring. The result is that if directors are subject to s 172(3) they are not to react by acting too cautiously, which might mean that the company fails to take up good opportunities, but they must ensure that they evaluate their operating strategy in light of creditors’ interests. 15.47 Hence, ‘the directors must undertake a balance so that creditors are protected and at the same time the company’s ability to innovate and take some appropriate risks is not totally or unreasonably proscribed.’89 This is consistent with comments in Facia Footwear Ltd (in administration) v Hinchliffe,90 a case in which the claim was made that the directors had failed to take into account creditors’ interests. Sir Richard Scott V-C acknowledged that in continuing trading the directors were taking a risk, but his Lordship went on to say that ‘the boundary between an acceptable risk that an entrepreneur may properly take and an unacceptable risk . . . is not always, perhaps not usually, clear cut.’91 15.48 In balancing we might say that directors are to consider creditors’ interests at all material times and not to harm their interests.92 Thus, according to Lord Hodge, directors are not ‘to take any step which would materially and adversely prejudice the interests of creditors, or to omit to take a step which 86 Sequana [2022] UKSC 25, [303]. 87 (1986) 4 ACLC 215 (1986) 10 ACLR 395. 88 (1986) 4 ACLC 215, 223. 89 Andrew Keay, Company Directors’ Responsibilities to Creditors (Routledge-Cavendish, 2007), 245–246. 90 [1998] 1 BCLC 218. 91 Ibid., 228. 92 Sequana [2022] UKSC 25, [288].

249

COMPLYI NG WITH THE OBLIGATION

could reasonably be taken by them, and which would prevent or reduce such prejudice.’93 Paramountcy of Creditor Interests 15.49 The Supreme Court in Sequana said, as we have seen, that when an insolvent liquidation or insolvent administration is inevitable, then the directors must treat the interests of creditors as paramount. This section of the chapter endeavours to analyse what is meant by paramountcy in the context of the obligation. 15.50 ‘Paramount’ means something that is more important than anything else,94 so we can conclude that the creditors’ interests are to be seen as pre-eminent or predominant, although, perhaps, not exclusive. Thus, this would suggest that directors must put the interests of creditors before any other concern or interest, including those of the shareholders, although the latter’s interests would not be ignored. While not mentioning the paramountcy of creditors’ interests when a company is insolvent, Lesley Anderson QC in Re Idessa (UK) Ltd95 said that the interests of the creditors overrode those of the shareholders, and there probably is little difference between this and saying the interests of the creditors are paramount. The Irish Supreme Court in Re Frederick Inns Ltd96 also seemed to require paramountcy when it said that: [b]ecause of the insolvency of the companies the shareholders no longer had any interest. The only parties with an interest were the creditors. The payments made could not have been lawful because they were made in total disregard of their interests.97 (writer’s emphasis)

15.51 If creditors’ interests are to be paramount, the directors have to concentrate on the interests of the creditors. The consequence is that the company’s affairs are to be administered in such a way as to ensure that actions will enhance the wealth of creditors, that is, the creditors will be repaid more of the funds that are owed to them. 15.52 There are obvious attractions to the courts applying a paramountcy approach where the company is insolvent, certainly where insolvency is irreversible. First, when the company is insolvent the creditors are clearly the only residual owners of company property, as all of it is distributed to the creditors on a winding up. Secondly, this kind of approach is easier for the directors to apply than say the balancing approach because it offers more certainty to directors about

93 Ibid. 94 J Pearsall, New Oxford Dictionary of English (OUP, 2001), 1346. 95 [2011] EWHC 804 (Ch), [2012] BCC 315, [54]. 96 [1993] IESC 1, [47]. 97 There is a divergence of opinion in the courts in the United States as to whether duties are still owed to shareholders. See R Millner, ‘What Does it Mean for Directors of Financially Troubled Corporations to Have Fiduciary Duties to Creditors?’ (2000) 9 Journal of Bankruptcy Law and Practice 201, 217.

250

COMPLYI NG WITH THE OBLIGATION

what is meant by balancing interests, as their focus is almost fully on what will benefit the creditors, not that ascertaining what is in the interests of creditors is itself an easy task, a matter taken up shortly. Thirdly, it assists possible claimants such as liquidators in determining whether directors have complied with the obligation that is imposed on them.98 15.53 If creditors’ interests are paramount, then the directors have to concentrate on the interests of the creditors although not perhaps to the complete exclusion of other stakeholders. The first thought of the directors is to be when considering a course of action: how will this affect the creditors? Perhaps we can say that everything that the directors do must provide an advantage for creditors, either directly or indirectly. The consequence is that the company’s affairs are to be administered in such a way as to ensure that actions will enhance the wealth of creditors. 15.54 As the writer has stated previously: Paramountcy cannot simply entail directors refraining from disposing of assets improperly or diverting property to insiders in the company, which are obviously actions detrimental to the creditors (and arguably to the shareholders save where all of the insiders constitute the entire shareholding body), but it extends to all of the duties that are owed, and functions undertaken, by directors. There will be very obvious breaches of duty, such as where directors decide to enter into a transaction that could not possibly benefit the creditors as occurred in Colin Gwyer, but many other actions or inactions of directors are not going to be as clear-cut as that.99 (footnotes omitted)

15.55 Clearly, in the light of Sequana, directors are not required to see creditors’ interests as paramount in as broad a range of situations as earlier case law indicated, and not necessarily even in insolvency. This may cause problems, as highlighted by what David Richards LJ (as he then was) said in Sequana in the Court of Appeal:100 The reconciliation of the duty under section 172(1) and the creditors’ interests duty [the obligation] will, unless creditors’ interests are paramount, present difficulties. Take the case of a company which is solvent and has cash resources available to meet a liability due to mature in two years’ time. The interests of creditors would be served by retaining the cash until the liability matures, investing it in the meantime in risk-free assets. The company has an opportunity to invest the funds in a business venture that carries significant risks and rewards. It would not be a foolhardy investment but, if the real risk of failure occurs, it is the creditors who will lose.101

98 Rosemary Teele Langford and Ian Ramsay, ‘The Contours of the “Creditors’ Interests’ Duty”’ (2021) 21 JCLS 85, 107. 99 Andrew Keay, ‘Directors’ Duties and Creditors’ Interests’ (2014) Law Quarterly Review 443, 458. See, Facia Footwear Ltd (in administration) v Hinchliffe [1998] 1 BCLC 218, 228. 100 [2019] EWCA Civ 112, [2019] 2 All ER 784, [2019] BCC 631, [2019] 1 BCLC 347, [2019] BPIR 562. 101 Ibid., [199].

251

COMPLYI NG WITH THE OBLIGATION

Factors and Issues in Considering Creditor Interests 15.56 Clearly what directors should do in complying with the obligation will vary according to context and circumstances. What is appropriate for the directors to do or not to do will depend on many factors, some of which are likely to be: the financial state of the company; the kind of company that is involved;102 the type of business in which the company was involved;103 the number of creditors the company has; the types of creditors the company has and the amount owed to each creditor; whether the company is part of a corporate group; and the potential impact of any contemplated transactions being considered by the directors on the creditors.104 15.57 One would think that directors will have to assess the fairness and appropriateness of all investment opportunities when they are subject to the obligation. Directors: ‘would have to eschew wild risk-taking to the extent that they do not engage in what might be referred to as “bet the firm” options.’105 15.58 Directors may have a difficult task in determining whether any risk attached to a proposed course of action is permissible. As noted earlier, Sir Richard Scott V-C acknowledged in Facia Footwear Ltd (in administration) v Hinchliffe106 that: ‘the boundary between an acceptable risk that an entrepreneur may properly take and an unacceptable risk . . . is not always, perhaps not usually, clear cut.’107 15.59 In assessing what the directors have done, courts need to accept that the circumstances that dictate what directors are to do will wax and wane.108 Certainly in acting in the interests of creditors directors need to refrain: from excessive risk taking, from entering into transactions for which full value is not received and from improper diversion of assets (particularly to directors or members). It also means prioritising the ability of creditors to recover the sums due to them. This would include diligently assessing the company’s financial position, ascertaining the company’s financial problems and seeking professional advice. Directors should demonstrate that they have given good faith consideration to the potential effect of their action on creditors. Where they do this, the creditors’ interests duty would not be breached just because creditors do not receive full payment.109 (footnotes omitted)

102 Andrew Keay, ‘Directors’ Duties and Creditors’ Interests’ (2014) Law Quarterly Review 443, 458. 103 See, Bell Group [2008] WASC 239, [4393]. 104 R Austin and I Ramsay, Ford, Austin and Ramsay’s Principles of Corporations Law (16th ed, LexisNexis), [8.100.12] and referred to in Termite Resources NL (in liq) v Meadows, in the matter of Termite Resources NL (in liq) (No 2) [2019] FCA 354, [208]. 105 Andrew Keay, ‘Directors’ Duties and Creditors’ Interests’ (2014) Law Quarterly Review 443, 461. 106 [1998] 1 BCLC 218. 107 Ibid., 228. 108 Bell Group [2008] WASC 239, [4440]. 109 Rosemary Teele Langford and Ian Ramsay, ‘The Contours of the “Creditors’ Interests’ Duty”’ (2021) 21 JCLS 85, 106.

252

COMPLYI NG WITH THE OBLIGATION

15.60 Before committing the company to a particular transaction, when s 172(3) applies, directors should satisfy themselves that it is appropriate to enter the transaction having regard to the effect it will have on the company’s financial position, the value to be derived from it, the benefits that will accrue to the company’s business and any potential prejudice to creditors’ interests generally that may ensue. 15.61 The courts110 have made it clear when dealing with a solvent company that while it does not rule out a conclusion that directors were acting in good faith in what they have done, it might be harder for the directors to maintain good faith when the company has incurred a substantial detriment. The same is likely to apply when a company is insolvent or in financial difficulties and the creditors have sustained a significant loss.111 It is even more likely to be the case where the directors have benefitted personally from what they have done. 15.62 According to Leslie Kosmin QC in Colin Gwyer v London Wharf (Limehouse) Ltd,112 directors must, in the process of taking into account the interests of creditors, consider the impact of any decision on the ability of the creditors to recover the sums due to them from the company.113 15.63 The required reaction of directors to the existence of a state of affairs that would attract the operation of s 172(3) could be varied, as discussed already. In some cases it could be reducing expenditure and ‘tightening the corporate belt,’ as Lesley Anderson QC said should have happened in Re Idessa (UK) Ltd.114 In others it might involve not commencing a project unless it was adequately funded,115 or seeking refinancing that could support either a continuation of profitable trading of the company or the successful reorganisation of the company’s affairs, as the termination of trading followed by the disposal of the assets of the companies on a forced sale basis could lead to heavy losses for the creditors.116 15.64 Clearly if the obligation is triggered, directors can still consider restructuring.117 Lord Hodge in Sequana118 said that a reasonable decision by directors to attempt to rescue a company’s business in the interests of both its members and its creditors would not in his view involve a breach of the common law

110 Regentcrest plc v Cohen [2002] 2 BCLC 80, 105; Extrasure Travel Insurances Ltd v Scattergood [2003] 1 BCLC 598. 111 Roberts v Frohlich [2011] EWHC 257 (Ch), [2012] BCC 407, [2011] 2 BCLC 625. Also see, Dryburgh v Scotts Media Tax Ltd [2011] CSOH 147, [94]. 112 [2002] EWHC 2748, [2003] 2 BCLC 153. 113 [2002] EWHC 2748 (Ch), [2003] 2 BCLC 153, [81]. This view was also voiced by Lesley Anderson QC (sitting as a deputy High Court judge) in Re Idessa (UK) Ltd (sub nom Burke v Morrison) [2011] EWHC 804 (Ch), [2012] BCC 315, [120]. 114 [2011] EWHC 804 (Ch), [2012] BCC 315, [92], [112]. 115 For example, see Roberts v Frohlich [2011] EWHC 257 (Ch), [2012] BCC 407, [2011] 2 BCLC 625. 116 Facia Footwear Ltd (in administration) v Hinchliffe [1998] 1 BCLC 218, 228. 117 For a detailed analysis of restructuring in the context of the application of the obligation, see Andrew Keay, ‘Financially Distressed Companies, Restructuring and Creditors: What is a Director to Do?’ [2019] Lloyds Maritime and Commercial Law Quarterly 297. 118 [2022] UKSC 25.

253

COMPLYI NG WITH THE OBLIGATION

duty.119 The issue of liability in a restructuring revolves around a tension between wanting to ensure, on the one hand, that companies survive if possible, and this will benefit all involved, and ensuring, on the other hand, that creditors are protected to a certain or reasonable degree, and attempts at restructuring do not reduce company funds substantially. 15.65 It might be that the creditors’ only chance of being paid in full lies in a continuation of trading, but obviously it will be necessary for directors to weigh up the likely success of a restructuring, assuming that one was needed and given the state of the company’s financial affairs, and the information and advice available to them. In doing this the benefit for the creditors must be in the minds of the directors and not the continuing viability of the business,120 or the interests of others, such as the employees.121 Yet in other cases a company may be so insolvent that the directors cannot reasonably expect the company to survive and that it is appropriate to put the company into administration or liquidation, as the directors in Colin Gwyer v London Wharf (Limehouse) Ltd122 perhaps should have done in the circumstances which confronted them. 15.66 In Bell Group123 Owen J said if a company is insolvent then the directors should cease trading, although this is something that has not been required thus far in the UK. His Honour felt that whether the same should occur if the company was nearly insolvent or of doubtful solvency might depend on how ‘near’ insolvency or how ‘doubtful’ solvency is,124 but that clearly suggests that in some cases the cessation of trading was required even where the company was short of insolvency. Taking this action has some attractions for directors, as it is likely to safeguard them, but the argument against it is that it might lead to the premature end for companies that have potential to recover. Whether it is in fact appropriate or not to end trading or place the company in administration or liquidation is likely to depend heavily on the depth of the insolvency and, in the light of market conditions and financing as well as the prospects of the company. 15.67 The fact is that when a company is in financial difficulty, the shareholders’ interests may well dictate that the company should take on greater risks,125 the reason being that the shareholders will have little to lose if action involving significant risk is not successful, and yet, if it is successful then besides perhaps saving the company it could benefit the shareholders substantially. If the directors’ action does not work, then it is the creditors who lose, and to a greater extent than if the action was not entered into. This might cause directors to be concerned about what they should be doing, but they should be comforted by 119 Ibid., [238]. 120 Sydlow Pty Ltd v Melwren Pty Ltd (1993) 13 ACSR 144. 121 But see the decision of Hoffmann J in Re Welfab Engineers Ltd [1990] BCC 600. 122 Colin Gwyer v London Wharf (Limehouse) Ltd [2002] EWHC 2748, [2003] 2 BCLC 153, [80]. 123 Bell Group Ltd (in liq) v Westpac Banking Corporation (No 9) [2008] WASC 239, [838]. 124 [2008] WASC 239, [838]. 125 R Scott, ‘A Relational Theory of Default Rules for Commercial Contracts’ (1990) 19 Journal of Legal Studies 597, 624; B Adler, ‘A Re-Examination of Near-Bankruptcy Investment Incentives’ (1995) 62 University of Chicago Law Review 575, 590–598; Royce de R Barondes, ‘Fiduciary Duties of Officers and Directors of Distressed Corporations’ (1998) 7 George Mason Law Review 45, 46, 49.

254

COMPLYI NG WITH THE OBLIGATION

the fact that, provided they act in good faith and endeavour to take creditors’ interests into account, it is likely that a court would deem it unreasonable to find them liable. When analysing the case law where directors have been held liable one finds that in many of the cases directors have clearly failed to act in good faith; they have ‘engaged in excessive risk-taking or entered into transactions of an improper nature, or, at least, transactions of highly questionable merit.’126 15.68 There is a time to take high risks127 (where the success rate is low), such as marketing a new untried product, there are times to take calculated risks and there are times when few or no risks should be taken. The degree of the risk permitted will depend on the actual level of financial difficulty. If the company is financially embarrassed the shareholders and directors may have nothing to lose by embracing a high-risk strategy;128 the taking of significant risks could be highly profitable and ‘make the company.’ But if the gamble does fail then the ones ‘picking up the tab’ are the creditors. The directors do not have the right to gamble with the creditors’ money. This does not mean that directors must sit on their hands or refrain from seeking to take the company forward; their only obligation is to refrain from taking action that cannot be calculated overall to be in the interests of the creditors. The degree of financial instability and the degree of risk are interrelated,129 and the latter must be determined by the former. As Clark and Cripps JJA in the New South Wales Court of Appeal in Equiticorp Finance Ltd (in liq) v BNZ130 said: [T]he question whether directors are required to consider the interests of creditors in determining whether particular action is or is not for the benefit of the company depends upon the state of solvency of the company at the time of the contemplated action.131

15.69 Hence, the more obvious it is that the creditors’ interests are at risk, the lower must be the risk to which directors should expose the company.132 So, providing that a director must, in certain cases, have concern for the interests of creditors does not mean that risk-taking is to be totally proscribed. This includes ensuring that they have current financial information, including indications as to who their creditors are and when debts are due and owing. It is often going to be helpful for the directors to have financial forecasts in making their decisions. They should ensure that any concerns that they have in relation to the

126 Andrew Keay, ‘Directors’ Duties and Creditors’ Interests’ (2014) Law Quarterly Review 443, 460. 127 For instance, in Mutlinational Gas and Petrochemical Co v Mutlinational Gas and Petrochemical Services Ltd [1983] Ch 258. In that case it was acceptable, as the company was plainly solvent. 128 Ironically directors might in such circumstances, absent any duty to take creditors’ interests into account, not be liable in taking such action even though the action is close to reckless because the shareholders would not complain. 129 See Kinsela v Russell Kinsela Pty Ltd (1986) 4 ACLC 215 at 223; Equiticorp Finance Ltd (in liq) v BNZ (1993) 11 ACLC 952 at 1017. 130 (1993) 11 ACLC 952. 131 Ibid., 1007. 132 Ibid.

255

COMPLYI NG WITH THE OBLIGATION

actions to be taken by their company are minuted and that there is an appropriate paper trail, which might include e-mails demonstrating concern and suggesting alternative actions. Of course, any e-mails or letters sent by directors within the company and/or to third parties should be carefully framed in the light of the company’s difficult position. What would they look like to someone sometime later reviewing the company’s actions? It is particularly important for the board to minute its decisions and to give reasons for those decisions. The reasons might clearly state that the board took notice of the interests of creditors and any other relevant matters when making its decisions. 15.70 If the board is considering the restructuring of the company in the light of financial woes, then it is probably sensible to take advice from an insolvency practitioner concerning the possible options available to them and the likely consequences of each option. This demonstrates care and responsibility. As we saw when considering wrongful trading earlier in the book, the courts tend to be impressed by directors who have secured appropriate professional advice and assistance, and they have acted upon it. Creditors v Creditors General Issues 15.71 We have already noted that it is likely that the shareholders and the creditors will have divergent interests when a company is bordering on insolvency or is insolvent. But that is not the only divergence issue, and it applies whether or not the creditors’ interests are to be regarded as paramount. Most companies are likely to have different kinds of creditors133 whose interests may well conflict.134 It is not unlikely that the creditors will have different views as to corporate risk and what they would like to see the company do, and of course, they will be treated differently by the law, particularly on winding up.135 This all means that what might be viewed as acting in the interests of one group of creditors will not be in the interests of others. Elsewhere the writer has asked: ‘do directors have to turn their mind to the various rights of creditors on a liquidation of the company?’136 The answer that was given was to expect the directors to be conversant with all of the rules and principles of insolvency law and how they should deal with company affairs in light of it might be rather unreasonable, 133 For an example of a case where there were conflicting interests amongst the creditors, see Saltri III Limited v MD Mezzanine SA Sicar and Ors [2012] EWHC 3025 (Comm), [2013] 2 BCLC 217. The case dealt with a forced restructuring of the German Stabilus group of companies that was in financial trouble and involved disputes between senior lenders and mezzanine lenders. Decisions concerning conflicts of interest of creditors had to be addressed by a security trustee, and it was held to have breached its duty. Unlike directors who owe fiduciary duties to their company, the security trustee did not owe fiduciary duties in this case. 134 Sequana [2022] UKSC 25, [48]. 135 This issue is dealt with in greater depth in Andrew Keay, Company Directors’ Responsibilities to Creditors (Routledge-Cavendish, 2007), 235–241. 136 Andrew Keay, ‘Directors’ Duties and Creditors’ Interests’ (2014) Law Quarterly Review 443, 462.

256

COMPLYI NG WITH THE OBLIGATION

and Drummond AJA in Westpac Banking Corporation v Bell Group Ltd (in liq) (No 3)137 said that the pari passu principle cannot provide any justification for any form of equal treatment of creditors prior to winding up even where a company is in an insolvency situation.138 Yet directors could and perhaps should seek legal advice, as they must realise that if the company does implode then creditors will be affected and probably to different degrees. 15.72 There is some certainty in the fact that the courts have said that creditors should be treated as a class, and no creditor within the class should be favoured over others. In Re Pantone 485 Ltd139 the directors of a company in liquidation had disposed of company property without taking into account the interests of one of the creditors, an unsecured creditor entitled to priority in a distribution of the company’s assets on a winding up, and when the company subsequently entered liquidation, the liquidator brought proceedings against them for breach of duty. While the Court acknowledged that when a company was insolvent the directors had to have regard for the creditors’ interests,140 the claim failed. This was because, according to the Court, the directors had a duty to make decisions, when their company was insolvent, while having regard for all the general creditors, and not one, or a section, of the creditors. More recently the Supreme Court of New Zealand in Madsen-Ries v Cooper141 indicated that directors must consider the interests of all the company’s creditors when they are subject to the duty to consider creditor interests.142 According to Sequana, creditors’ interests are those of the general body of creditors, that is the creditors as a whole,143 not specific creditors with specific interests such as subordinated or contingent creditors.144 Therefore, if a court ascertains that directors have, when being required to consider the interests of creditors, that what they have done has advantaged one or more creditors within a class, they will have breached the obligation under s 172(3). 15.73 One matter that the cases do not address is where the directors’ company is insolvent and it has creditors of another class, besides the general creditors. This is especially the case where the company has secured creditors. In such circumstances and where the company’s assets are sufficient only to discharge the debts of the secured creditors, the view might be taken that the directors should ignore the interests of the unsecured creditors’ interests as their money has gone, just as is the case with the shareholders’ money; any further activity would entail the use of the funds of the secured creditors, and thus the trading would be at their risk. Given such a situation it could be argued that in order to

137 138 462. 139 140 141 142 143 144

[2012] WASCA 157, [2610]. Andrew Keay, ‘Directors’ Duties and Creditors’ Interests’ (2014) Law Quarterly Review 443, [2002] 1 BCLC 266. Ibid., [73]. [2020] NZSC 100. Ibid., [116]. [2022] UKSC 25, [48]. Ibid., [256].

257

COMPLYI NG WITH THE OBLIGATION

take account of the interests of the secured creditors the directors should place the company into administration or liquidation.145 15.74 If the company were to trade on and risk the loss of further funds it might suit junior and unsecured creditors who would hope that the company is restored to some measure of health, but for the reason mentioned earlier, secure creditors would not usually be in favour of such a strategy. The difficulty for the directors is determining the exact financial position of the company and whose interests are at risk by a particular strategy at a specific point of time. It might not be easy to ascertain whether company assets would exceed the value of secured debt, and especially if the directors have to act quickly to take advantage of an opportunity. While it might take time it is important that the directors are as well informed as they can be, and if they need to take advice or wait for a financial report then prudence suggests that they should do so. Importantly the court in Sequana focused on the need for directors being well informed. 15.75 It is not uncommon for the position of a company or its future to be unclear. This means that directors are faced with a dilemma when faced with financial difficulties. Do they place the company in administration or liquidation, the effect of which is, for the most part, to terminate the incurring of more debt, or do directors continue on and embrace the idea of restructuring their company with the hope of corporate rescue? In this regard unease is often emitted that in many cases directors might be so concerned about liability that they take their company into administration or liquidation prematurely.146 It is not always clear whether ending a company’s business and placing it in administration or liquidation is in the best interests of the creditors; it certainly might not be in the best interests of the shareholders. However, continuing the company’s business and seeking a restructuring could exacerbate the plight of creditors, because at the very least the company is likely to have incurred professional costs associated with possible restructuring and these costs can be, as Carillion showed, very high.147 15.76 Does taking into account the impact on creditors mean noting what the impact will be or doing something about it in order to ameliorate the position of the creditors? Surely it must be the latter. This was certainly implicit, if not explicit, in what Drummond AJA said in the appeal court in Westpac Banking Corporation v Bell Group Ltd (in liq) (No 3)148 when he stated that it is not sufficient for the directors merely to think about the interests of the creditors.149

145 Andrew Keay, ‘Directors’ Duties and Creditors’ Interests’ (2014) Law Quarterly Review 443, 463. 146 See the comments of Lynch J in the Irish case of Re Hefferon Kearns Ltd (No2) (1993) 3 IR 191 and those of Park J in the wrongful trading case of Re Continental Assurance of London plc [2001] BPIR 733, [281]. 147 For instance, what was expended in some attempts to restructure Carillion just before its fall into liquidation: “Carillion paid out £6.4 mill to advisors before £10 mill taxpayer bailout” www. parliament.uk/business/committees/committees-a-z/commons-select/work-and-pensions-committee/ news-parliament-2017/carillion-advisors-comment-17-19/ (12 March 2018), accessed 14 March 2018. 148 [2012] WASCA 157. 149 Ibid., [2041].

258

COMPLYI NG WITH THE OBLIGATION

His Honour pointed to the fact that in Kinsela v Russell Kinsela Pty Ltd150 Street CJ, of the Court of Appeal in New South Wales, said that directors have a duty to not prejudice the interests of creditors.151 Thus Drummond AJA said that: the duty will not ordinarily be satisfied by directors who consider the impact that entry into a particular transaction by the company will have on its creditors but proceed with the transaction even though it causes significant prejudice to those creditors.152

15.77 In Joint Liquidators of CS Properties (Sales) Ltd153 Lord Bannatyne adopted the statements in a leading book on directors that the interests of creditors are prejudiced if anything occurs that will or may compromise the company’s ability to pay its debts when they are due.154 The text approved of by the judge went on to say that before undertaking any action the directors should have regard to the value to be derived from the action and any potential prejudice to the creditors’ interests generally.155 The Wrongful Trading Case Law 15.78 The point has been made in this book that the cases that have considered the obligation have not provided us with much assistance in determining how directors are to act other than they must consider both creditor and shareholder interests at some points and only the creditors’ interests at other points. To assist in obtaining some guidance the wrongful trading jurisprudence, which was considered earlier in the book, might be studied. While s 214 provides for a different trigger to the obligation to consider creditors and requires directors to act differently, the section and the obligation have similar aims, and wrongful trading cases are often likely to involve issues that overlap with those that apply to the obligation. In some cases, it is likely that directors would be held liable under either s 214 or the obligation when they adopt strategies which indicate a lack of concern for the creditors’ interests.156 15.79 Therefore, just as directors are probably going to be liable for wrongful trading if they do not mitigate their behaviour when they know or should know that their company is heading for insolvent liquidation or administration, they are likely to be liable under s 172(3) if they continue to act in much the same way as they did before the obligation was triggered.157 In Roberts v Frohlich158

150 (1986) 4 ACLC 215, (1986) 10 ACLR 395. 151 [2009] WASCA 223, [2041]. 152 Ibid., [2042]. 153 [2018] CSOH 24. Also, see Nicholson v Permakraft (NZ) Ltd (1985) 3 ACLC 453. 154 S Mortimore (ed), Company Directors: Duties, Liabilities, and Remedies (3rd ed, OUP, 2017), [12.63]. 155 Ibid., [12.97]. 156 An example is Re Kudos Business Solutions Ltd [2011] EWHC 1436 (Ch), [2012] 2 BCLC 65, [50] where the directors’ actions demonstrated a cavalier attitude. 157 See Re Idessa (UK) Ltd [2011] EWHC 804 (Ch), [2011] BPIR 957, [2012] BCC 315, [120]. Also, see Re Brian D Pierson (Contractors) Ltd [1999] BCC 26, 54. 158 [2011] EWHC 257 (Ch), [2012] BCC 407, [2011] 2 BCLC 625, [97].

259

COMPLYI NG WITH THE OBLIGATION

Norris J was critical of the defendant director for not terminating the performance of unperformed parts of existing contracts at a time when it was clear that to continue them was going to be costly. 15.80 As was demonstrated in Chapter 8 there are a number of wrongful trading cases where the courts have been critical of directors who were not prepared to acknowledge that their company was in a hazardous position and demonstrating wilfully blind optimism159 and taking the view that everything would be fine in the end;160 holding a speculative hope that the action that they took might lead to things falling into place;161 burying their head in the sand;162 and shutting their eyes to the reality of the company’s position.163 On the other hand, courts have exculpated directors when they have acted, in the opinion of the court, responsibly and endeavoured to ascertain the problems which the business is experiencing, consulting in relation to the company’s financial problems and carefully assessing financial accounts.164 15.81 The wrongful trading cases indicate inter alia that directors should: have an understanding of basic accounting principles,165 make sure they have an understanding and appreciation of the company’s finances, be in a position by which they are able to discuss and ask questions concerning the company’s accounts,166 have carefully reviewed the company’s circumstances167 and have rational expectations as to the future when trading on.168 Where directors argue that they relied on assurances of financing or other support that they secured from other parties, whether courts will excuse directors will depend on the strength of the assurances or support.169 The judges have tended to be critical of directors who have placed too much on promised support, especially where that reliance is misplaced.170 15.82 As the courts have emphasised that directors should not be required to embrace some form of insolvency regime, such as administration, prematurely,171 there is clearly room for directors to be able to try and find a way out of the

159 Roberts v Frohlich [2011] EWHC 257 (Ch), [2012] BCC 407, [2011] 2 BCLC 625, [112]; Re Brian D Pierson (Contractors) Ltd [1999] BCC 26, 54. 160 Brian D Pierson, ibid. 161 Singla v Hedman [2010] EWHC 902 (Ch), [2010] BCC 684, [106], [107]. 162 Re Continental Assurance of London plc [2001] BPIR 733, [24]. 163 Ibid., [31], [106]; Re Langreen Ltd (in liq) (unreported, but available on Lawtel) 21 October 2011, Ch D, Registrar Derrett, [144]. 164 For example, see Re Continental Assurance of London plc [2001] BPIR 733 and especially at [24], [37], [109]. There was evidence in this case that one directors’ meeting lasted for six hours (at 59]). 165 Ibid., and especially, [258]. 166 Ibid. 167 Re Bangla Television Ltd (in liq) [2009] EWHC 1632 (Ch), [2010] BCC 143, [51]; Re Marini Ltd [2003] EWHC 334 (Ch), [2004] BCC 172, [20]. 168 Re Hawkes Hill Publishing Co Ltd [2007] BCC 937, [28]; Re Langreen Ltd (in liq) (unreported, but available on Lawtel) 21 October 2011, Ch D, Registrar Derrett, [56]. 169 Rubin v Gunner [2004] EWHC 316 (Ch), [2004] BCC 684, [87]. 170 Andrew Keay, ‘Directors’ Duties and Creditors’ Interests’ (2014) Law Quarterly Review 443, 465. 171 Re Continental Assurance of London plc [2001] BPIR 733, [281]; Re Langreen Ltd (in liq) (unreported, but available on Lawtel) 21 October 2011, Ch D, Registrar Derrett, [66].

260

COMPLYI NG WITH THE OBLIGATION

company’s malaise. The courts have acknowledged directors often are faced with a difficult dilemma, namely whether to continue to trade on and risk later proceedings being brought against them or to cease trading and be criticised for taking such action prematurely.172 15.83 Some wrongful trading cases suggest that if directors act sensibly, and even engage in making sacrifices such as ‘belt tightening’173 by foregoing salaries and economising on running costs,174 and seek, and act on, appropriate professional advice,175 they are likely to escape liability, and the same action might well suffice to safeguard them from liability under s 172(3). The Scheme of Arrangement Jurisprudence176 15.84 The law that has grown up in relation to schemes of arrangement under Part 26 of the Act are of further assistance to directors. Where arrangements are proposed there are likely to be multiple groups of creditors with different interests and expectations, and these may well conflict. 15.85 In Re Bluebrook Ltd177 a scheme of arrangement was proposed which restructured a group of companies in the interests of the senior lenders and left the mezzanine lenders in one company in the group without any benefit. The mezzanine lenders opposed the application to court for approval of the scheme. One of the grounds was that the directors had breached their duty in failing to promote the interests of the mezzanine lenders. Counsel for the mezzanine lenders argued that directors of an insolvent company do not owe duties only to particular sections of the creditors.178 The judge accepted that but rejected the claim on the basis that the mezzanine lenders were ‘out of the money’ in that they had no economic interest in the company.179 15.86 The judge in this case, Mann J, said that if a company is insolvent then a consideration of whether to preserve the business as a going concern must be guided by the interests of the creditors and not by consideration of the interests of some third party who had no claim.180 His Lordship said that the directors: entered into arrangements with the section of secured creditors with priority over subordinated creditors who, on the facts as known to them, would not have any 172 Particularly, see the judgments of Park J in Re Continental Assurance of London plc [2001] BPIR 733 and especially, [281], and Lewison J in Re Hawkes Hill Publishing Co Ltd [2007] BCC 937. 173 Re Idessa (UK) Ltd [2011] EWHC 804 (Ch), [2012] BCC 315, [92], [112]. 174 Re Marini Ltd [2003] EWHC 334 (Ch), [2004] BCC 172, [20]. 175 Re Produce Marketing Consortium Ltd (1989) 5 BCC 569; Re Continental Assurance of London plc [2001] BPIR 733. Compare the cases of Re Purpoint Ltd [1991] BCC 121 and Re Brian D Pierson (Contractors) Ltd [1999] BCC 26 where professional advice was not heeded, and the respective courts appeared to see that as a negative point in relation to the defendant directors. Also, see the directors’ disqualification case of Re Hitco 2000 Ltd [1995] 2 BCLC 63. 176 This part of the chapter draws on Andrew Keay, ‘Financially Distressed Companies, Restructuring and Creditors: What is a Director to Do?’ [2019] Lloyds Maritime and Commercial Law Quarterly 297. 177 [2009] EWHC 2114 (Ch), [2010] 1 BCLC 338. 178 Ibid., [67]. 179 Ibid., [25], [80] and referring to Re Tea Corp Ltd [1904] 1 Ch 12. 180 Ibid., [67].

261

COMPLYI NG WITH THE OBLIGATION

interest in the assets because of their subordination. That is entirely different from the situation where directors advance the cause of one creditor at the expense of other creditors who thereby lose a benefit they would otherwise have.181

15.87 This approach has been endorsed in relation to consideration of arrangements that have been proposed under Part 26A of the Companies Act 2006 and which deal with companies in financial difficulty.182 15.88 Applying what his Lordship said in our context, directors are to take into account the commercial realities of the company, and they do not have to consider the interests of those creditors who are ‘out of the money,’ namely someone who has no possibility of recovering money owed, even in a liquidation. Of course, it might not be possible in some cases for directors to know which creditors’ money is effectively at stake and, therefore, who is in the money, so that is always something of which they must be wary. Sometimes the value of a creditor’s interest might be difficult to ascertain. His Honour Judge Mathews (sitting as a High Court judge) in Wessely v White183 said that in dealing with s 172(3) a subjective test applies to what directors have done and as to whether there has been a breach of duty where ‘no material interest has been overlooked.’184 If a creditor is out of the money, then he or she does not hold a material interest and, it follows, can be overlooked. 15.89 If a company is insolvent and it has, besides general unsecured creditors, creditors of another class, such as one or more secured creditors, it might be argued that if the company’s funds/assets do not cover the debts owed to the secured creditors the directors are not required to take into account the unsecured creditors’ interests as their money has gone, just like the shareholders’ funds. That is, they are out of the money, and any trading would involve using the funds of the secured creditors, and it would be at their risk. In such a position it might be thought appropriate that, in order to protect the interests of the secured creditors, the directors should take the company into administration or liquidation. 15.90 To trade on and risk further funds might suit junior and unsecured creditors who have the hope that the company might be turned around, but it would not usually be favoured by secured creditors. Of course, it is not always possible for the directors to ascertain easily at a given moment whether the company has funds/assets that exceed the liabilities owed to the secured creditors. But one would think that if there is concern over the financial position of the company it would be prudent of the directors to discover the exact situation so that they could take into account the interests of the appropriate group(s) of creditors from a strong position of knowledge.

181 Ibid. 182 See Re Virgin Active Holdings Limited [2021] EWHC 1246; Re Deep Ocean [2021] EWHC 138 (Ch). 183 [2018] EWHC 1499 (Ch). 184 Ibid., [40].

262

COMPLYI NG WITH THE OBLIGATION

15.91 While it would seem that directors might ignore the interests of creditors where they are not in the money and by some way, Re Bluebrook Ltd185 clearly provides that the directors must ensure that they do not discriminate between creditors within a particular class. This is a sentiment that has been stated in the cases involving the director’s obligation to creditors. In Re Pantone 485 Ltd,186 the deputy judge said that a director is not in breach if he or she acts consistently with the interests of the general creditors but inconsistently with the interests of a creditor or a section of creditors with special rights in a liquidation,187 hence it follows that if directors favour one creditor or a section of creditors to the prejudice of the general creditors as a whole, then they are in breach. This approach was followed by Newey J (as he then was) in GHLM Trading Ltd v Maroo,188 when he said that where a company is insolvent then the director’s duty involves having regard for the interests of the creditors as a class. His Lordship said that: ‘If a director acts to advance the interests of a particular creditor, without believing the action to be in the interests of creditors as a class, it seems to me that he will commit a breach of duty.’189 15.92 His Honour Judge Pelling QC (sitting as High Court judge) said in Capital For Enterprise Fund A LP and another v Bibby Financial Services Ltd that: However the emphasis of that duty is on the obligation to manage the affairs of the company having regard to the interest of creditors as a class. It does not entitle a director, much less a director acting alone and without board approval, to operate in a manner that prefers the interest of one creditor over those of another and much less in a manner that defeats the interest of creditors generally.190 (emphasis in the original)

15.93 Conversely, then, we might conclude that a director can advance the interests of a specific creditor provided that he or she believes that it will be in the interests of creditors as a class. If one or more creditors benefit from a restructuring at the expense of others, then it suggests that there is a breach, except where they were out of the money. 15.94 In the Western Australian Court of Appeal in Westpac Banking Corporation v Bell Group Ltd (in liq) (No 3),191 the majority view of the Court suggested that every creditor’s interest needs to be taken into account and that view, some commentators suggested, is unworkable.192 But surely it is not unworkable to take every creditors’ interest into account; directors might, after doing so, then decide to ignore the importance of some interests and restructure in a way that some lose out, as that is the only reasonable way forward. In such a situation 185 [2009] EWHC 2114 (Ch); [2010] 1 BCLC 338. 186 [2002] 1 BCLC 266. 187 Ibid., [73]. 188 [2012] EWHC 61, [2012] 2 BCLC 369. 189 Ibid., [168]. 190 [2015] EWHC 2593 (Ch), [89]. 191 [2012] WASCA 157 at [2610]. 192 R Maslen-Stannage, ‘Directors’ Duties to Creditors: Walker v Wimborne Revisited’” (2013) 31 Company and Securities Law Journal 76, 81.

263

COMPLYI NG WITH THE OBLIGATION

it would be advisable for the directors to make it clear in some way that they have considered the interests of all of the creditors before taking the action that is later impugned. Creditors as a Class and Preference-like Payments 15.95 As just discussed in the previous part of the chapter, the courts have clearly provided that directors must consider the interests of creditors as a class and must not favour one or more creditors.193 In GHLM Trading Ltd v Maroo194 Newey J said that: Where creditors’ interests are relevant, it will similarly, in my view, be a director’s duty to have regard to the interests of the creditors as a class. If a director acts to advance the interests of a particular creditor, without believing the action to be in the interests of creditors as a class, it seems to me that he will commit a breach of duty.195

15.96 Some argue that in the situation where a company is insolvent the interests of the company can be considered as the interests of the creditors, as a class.196 15.97 Thus, if directors made a payment to one creditor at a time when they have to consider creditor interests (either solely or along with the shareholders) would such action, involving the payment of a preference-like payment, constitute a breach of the obligation and be able to be challenged in a subsequent administration or liquidation?197 It might be argued that payments made by directors to a creditor would give an advantage to the recipient of the payment compared with the general body of creditors, as the rest of the creditors received nothing and so the requirement that creditors are to be treated as a class would be contravened. 15.98 It is submitted that it could be inferred from the quotation from Newey J’s judgment in GHLM Trading Ltd v Maroo,198 and found in 15.95, that in paying one creditor and not all of the creditors in the class the director is in breach of the obligation, as the payment is not advancing the class199 and, therefore, a claim could be brought for breach of the s 172(3) obligation.

193 For example, see Re Pantone 485 Ltd [2002] 1 BCLC 266, [73]; GHLM Trading Ltd v Maroo [2012] EWHC 61, [2012] 2 BCLC 369, [168]. 194 Maroo, ibid. 195 Ibid. 196 Andrew Keay, ‘Directors’ Duties and Creditors’ Interests’ (2014) Law Quarterly Review 443, 469. 197 This issue is discussed in detail in Andrew Keay, ‘Financially Distressed Companies, Preferential Payments and the Director’s Duty to Take Account of Creditors’ Interests’ (2020) 136 Law Quarterly Review 52. 198 [2012] EWHC 61, [2012] 2 BCLC 369. 199 It should be noted that it might be inferred from the statement of Hart J in Knight v Frost [1999] BCC 819 that ‘It is through the mechanism of liquidation that the creditors are protected’ (at 834) that he would not agree with the line taken in cases such as Re HLC Environmental Projects Ltd [2013] EWHC 2876 (Ch), [2014] BCC 337 and Re Micra Contracts Ltd [2016] BCC 153. Although it must be noted that Hart J was dealing with a derivative action brought by shareholders rather than action brought by a liquidator.

264

COMPLYI NG WITH THE OBLIGATION

15.99 Of course, in the circumstances, the relevant officeholder might be able to claim under s 239 of the Insolvency Act 1986 that the payment was a preference. To succeed the officeholder would have to establish all the elements of a preference as provided for in s 239 and associated provisions, such as s 240.200 However, there might be reasons that cause an officeholder to want to pursue a claim under a breach of the obligation in addition to or in place of a claim under the preference provisions.201 15.100 The starting point is West Mercia,202 a case that was discussed in Chapter 12, and particularly at 12.22. In this case a liquidator proceeded against a director after he paid off a creditor and where it was not worth suing the creditor as it was in liquidation. The proceedings were brought under the misfeasance provision, a precursor of s 212 of the Insolvency Act, and claimed that the director had breached the obligation to take account of the interests of the company’s creditors. The Court of Appeal found in favour of the liquidator, as it held that the granting of the preference was a breach of duty. 15.101 There have been several cases subsequent to West Mercia where courts have made orders against directors where they have breached the obligation by making preference-like payments and the claims have succeeded, whether or not the requirements of s 239 were able to be fulfilled.203 A prime instance is Re HLC Environmental Projects Ltd204 where John Randall QC (sitting as a deputy judge of the High Court) said, when confronted with a case where an insolvent company whose directors were subject to s 172(3) only paid some of its creditors, that the respondent director had breached his duty in choosing which creditors to pay and which to leave exposed to a real risk of not being paid.205 15.102 Importantly, as Lord Reed PSC explained in BTI 2014 LLC v Sequana S.A.,206 the relief that the Court of Appeal in West Mercia awarded against the director was not to repay the preference, as that would have placed the company in a better position than if no breach had occurred. The director was ordered to repay the amount which he had misapplied, and it was also ordered that the debt 200 For a discussion of the conditions for preferences and issues relating to them, see Andrew Keay, ‘Preferences in Liquidation Law: A Time for a Change’ (1998) 2 Company and Financial Law Review 198; A Walters, ‘Preferences’ in J Armour and H Bennett (eds), Vulnerable Transactions in Corporate Insolvency (Hart Publishing, 2003); R Parry et al., Transaction Avoidance in Insolvencies (2nd ed, OUP, 2011); Andrew Keay, McPherson’s Law of Company Liquidation (5th ed, Sweet and Maxwell, 2021), [11–055]–[11–081]. 201 See, for example, [12.22]–[12.23]. 202 (1988) 4 BCC 30. 203 For example, see Re Brian D Pierson (Contractors) Ltd [1999] BCC 26; Re Cityspan Ltd 2007] EWHC 751 (Ch), [2008] BCC 60, [2007] 2 BCLC 522; GHLM Trading Ltd v Maroo [2012] EWHC 61 (Ch), [2012] 2 BCLC 369; Re HLC Environmental Projects Ltd [2013] EWHC 2876 (Ch), [2014] BCC 337; Re Cosy Seal Insulation Limited (in Administration) [2016] EWHC 1255 (Ch); Caley Oils Ltd v Wood [2018] CSOH 42. 204 [2013] EWHC 2876 (Ch), [106]. 205 Whilst it might be argued that all of the creditors paid were associated with the director making the payment or the payments benefitted the director either directly or indirectly, the deputy judge did not make any distinction between paying creditors that benefitted the director and paying creditors that did not provide any benefit. 206 [2002] UKSC 25.

265

COMPLYI NG WITH THE OBLIGATION

which had been discharged by the payment was to be included in the amount of the company’s liabilities for the purpose of calculating the distribution in the company’s winding up, and so if there were funds available to creditors the director would be paid the dividend attributable to that debt. Lord Reed said that: The overall effect was to produce a similar result for the unsecured creditors as would have obtained if the preferential payment had not been made or if it had been set aside as a preference, with the director being treated in the same way as if he had personally paid the debt and been subrogated to the creditor’s right against the company.207

15.103 Lord Reed took the view that the relief granted to the liquidator in West Mercia was correct. His Lordship also posed the question whether the existence of s 239 was incompatible with the obligation.208 His answer was emphatically ‘no,’209 a view with which Lady Arden agreed.210 15.104 If a payment prefers a creditor and the directors were subject to the obligation under s 172(3) it would not advance the interests of the class of creditors, something that is necessary for the avoidance of a breach of the obligation. The directors must consider the interests of the creditors as a whole when making decisions such as whom to repay. 15.105 Thus, it is submitted that it is possible to say that directors can advance the interests of a specific creditor, but this can only be done where they consider that it will be in the interests of creditors as a class. The matter of ‘a class’ was clearly a very critical matter in the judgment of Newey J in GHLM Trading Ltd v Maroo.211 His Lordship stated in two places in his judgment that directors must have concern for creditors as a class when the company is insolvent.212 15.106 It has been contended that administrators and liquidators are able to initiate proceedings, for breach of the obligation under s 172(3), against directors giving preference payments to creditors, because the interest of creditors for the purpose of the obligation is in ensuring that the terms of the contract between they and the company are fulfilled by the company and so the directors should not undertake actions that result in the company not honouring the terms of the contract.213 Directors subject to the obligation who pay a preference to one creditor will cause a detriment to the creditors in general, as there will be fewer funds available for distribution. This view is in line with what was said in Colin Gwyer v London Wharf (Limehouse) Ltd214 where the deputy judge said that in considering the interests of creditors, directors must take into account the impact 207 Ibid., [104]. 208 Ibid., [108]. 209 Ibid., [109]. 210 Ibid., [327]. 211 [2012] EWHC 61; [2012] 2 BCLC 369. 212 Ibid., [168], [173]. 213 Rosemary Teele Langford and Ian Ramsay, ‘The Contours of the “Creditors’ Interests’ Duty”’ (2021) 21 JCLS 85, 99. 214 Colin Gwyer v London Wharf (Limehouse) Ltd [2002] EWHC 2748 (Ch), [2003] 2 BCLC 153, [74].

266

COMPLYI NG WITH THE OBLIGATION

of their decision on the ability of the creditors to recover the sums due to them from the company.215 It stands to reason that any payment by the directors of a creditor is likely to prejudice the class of creditors. 15.107 Nevertheless, it has been said that the company will not have suffered any loss when a preference payment is made to creditors, as the company’s net position is unchanged after the payment.216 The loss, if any, has been suffered by the general body of creditors. The company has merely discharged a debt. Thus, an administrator or liquidator, acting on behalf of the company, has no valid claim. 15.108 Notwithstanding this, there have been a number of cases, including West Mercia, where this has not been identified as a problem. In fact in Caley Oils Ltd v Wood217 the judge did not think that it was necessary for the claimant to establish any loss to the company.218 Funds available to the company to meet the claims of the general body of creditors were depleted by the payment.219 Lord Clark said that: the payment was made, on insolvency, by the company to the director himself and that he caused the misapplication of the funds . . . a loss was suffered in the sense that funds left the Company when insolvent, to the benefit of the defender, against the interests of its creditors, and hence on an improper basis.220

15.109 In fact it has been opined that the payment of a preference can mean that the company has in fact experienced a loss. This is explained in Northampton Borough Council v Anthony Michael Cardoza221 by HH Judge Simon Barker QC (sitting as a High Court judge) when referring to a decision of Newey J in an earlier hearing in related litigation.222 Judge Barker said that he did not understand: Newey J to have meant that in all cases where the balance of assets net of liabilities remains unchanged by reversing a preference the company is unlikely to have suffered a loss. For example, the net assets figure may remain the same after restoration and a compensating adjustment to reinstate a liability to a director but the distribution of assets, notional or actual, to those entitled to receive them (creditors and contributories) may be very materially different. For example, restoration of cash to an otherwise illiquid but solvent (at net book values) balance sheet may have a significant effect on the company’s ability to pay creditors and continue trading. Further, the sense in which the word ‘loss’ is used may include assets which ought to, but do not, form part of the trust estate because they have been misapplied, for example by disbursement without authority. The remedy available to redress this ‘loss’ is restoration, which may be by compensation to restore the value of the assets to the trust estate.223

215 216 217 218 219 220 221 222 223

Ibid., [81]. For instance, see Re Continental Assurance of London plc [2001] BPIR 733, [448]. [2018] CSOH 42. Ibid., [58]. Ibid. Ibid. Northampton Borough Council v Anthony Michael Cardoza [2019] EWHC 26 (Ch). [2017] EWHC 2014 (Ch). [2019] EWHC 26 (Ch), [188].

267

COMPLYI NG WITH THE OBLIGATION

15.110 When discussing s 239 of the Insolvency Act and its relationship with the obligation to consider creditor interests in Sequana, Lord Reed did not suggest that a claim could not succeed because the company had not suffered any loss as a result of a preference payment, although his Lordship did say that consideration of how the obligation related to statutory provisions like s 239 had to wait until another day.224 15.111 Even if, as submitted here, administrators and liquidators are, in granting preference payments, able to bring proceedings against directors for a breach of the obligation in some cases, directors might be able to argue, legitimately, on occasion that it was necessary to make the payment in order to ensure the company’s business continues, and if this happened then the creditors could well be paid more. It is to be remembered that the directors do not have to be necessarily correct in their evaluation of the impact of the payment provided that they honestly consider in good faith that in making the payment they are doing so to benefit the creditors’ interests. A court might, as we have noted earlier, disbelieve the directors in their assertion that they did consider the payment best for creditors in the light of the circumstances surrounding the payment. Thus, the nature and amount of the payment, the situation of the company and its expectations, and to whom payment is made could be of critical importance.225 15.112 Directors may not, subject to issues of security or priority, treat some creditors more favourably than others, but they may do so if they have good reason.226 For instance, unless a debt owed to a creditor is paid then the latter will not supply any more goods and these goods are critical for the continuation of the business. The directors would, in such a situation, have to consider whether the payment was justified and whether continuation of the business would potentially bring benefits to the creditors as a whole. Future Creditors 15.113 When under an obligation to take into account creditors, does this include future creditors? There are two other kinds of creditors that might be relevant to our consideration. First, prospective creditors, who are those owed sums that are not immediately payable, but they will certainly become due in the future, either on some determined date or some date which will be determined by reference to future events.227 15.114 Lord Templeman in Winkworth v Edward Baron Development Co Ltd.228 His Lordship plainly said in dicta that: ‘[A] company owes a duty to its

224 [2022] EWHC 25, [92]. 225 Andrew Keay, ‘Directors’ Duties and Creditors’ Interests’ (2014) Law Quarterly Review 443, 470. 226 Re Avacade Ltd [2021] EWHC 1501 (Ch), [84]. 227 Stonegate Securities Ltd v Gregory [1980] 1 Ch 576, 579. An example of a prospective creditor is a person who has a claim which is unable to be disputed for unliquidated damages which remains to be quantified and will lead to a debt for more than a nominal amount (Re Dollar Land Holdings Ltd [1994] BCLC 404). 228 [1986] 1 WLR 1512, [1987] 1 All ER 114.

268

COMPLYI NG WITH THE OBLIGATION

creditors, present and future.’229 Lord Templeman’s approach was approved of in the Western Australian case of Jeffree v NCSC,230 and Wallace J specifically recognised the fact that a duty was owed to present and future creditors.231 15.115 In Nicholson v Permakraft (NZ) Ltd,232 Cooke J stated that it was proper that directors considered the payment of debts owed to current and continuing trade creditors, but it would be much more difficult to ‘make out a duty to future new creditors,’ on the basis that future creditors have to take a company as they find it when they decide to do business with it.233 Nevertheless one reading of what Cooke J was in fact saying was that creditors who were not in any relationship with the company at the time when the obligation is triggered were not to be taken into account, and future creditors whose debts simply had not become due and payable at the time of the triggering of the duty had interests that should be considered. 15.116 In the New South Wales Court of Appeal case of Edwards A-G.234 Young CJ in Eq appeared to say that future creditors are not covered by the obligation, but he said that a court might extend it so that directors of a company in a precarious financial position might not only owe an obligation to the shareholders and creditors but also to likely future creditors. 15.117 There has been substantial criticism of any view calling for consideration of the interests of future creditors.235 However, as noted elsewhere in this book, the obligation is still developing and there may well be some interest in the courts to including the need to consider future creditors within the obligation. Although not developing the point, in Wagner v White236 Deputy Registrar Garwood seemed to accept that future creditors’ interests were of importance. 15.118 In the UK Supreme Court decision of Bilta (UK) Ltd (in liquidation) v Nazir,237 Lords Toulson and Hodge JJSC stated, in the context of considering duties owed by directors when their company is insolvent, that the directors do have a duty to take account of the interests of the prospective creditors of their company.238 15.119 The second type of future creditors to be considered are contingent creditors. they are, according to Re William Hockley Ltd,239 those ‘towards whom, under an existing obligation, the company may or will become subject to a present liability on the happening of some future event or at some future date.’240 229 Ibid., 1516, 118. 230 (1989) 7 ACLC 556. 231 Ibid., 560. 232 (1985) 3 ACLC 453. 233 Ibid., 459. 234 [2004] NSWCA 272, [153]. 235 For example, see L S Sealy ‘Directors’ Duties – An Unnecessary Gloss’ [1988] CLJ 175; J Farrar, ‘The Responsibility of Directors and Shareholders for a Company’s Debts’ (1989) 4 Canterbury Law Review 12. 236 15 November 2017, Ch D, [107]. 237 [2015] UKSC 23; [2016] AC 1. 238 Ibid., [123]. 239 [1962] 1 WLR 555. See Winter v IRC [1961] 3 All ER 855, 864. 240 [1962] 1 WLR 555, 558.

269

COMPLYI NG WITH THE OBLIGATION

As far as these kinds of future creditors, there has been little authority that has considered whether contingent creditors should be considered by directors, but in the New Zealand decision of Sojourner v Robb241 the High Court said that directors do have to consider contingent creditors, especially if a contemplated course of conduct would endanger the company’s solvency. In the English case of Re Avacade Ltd,242 a case in which the application being considered was for the disqualification of a director, HH Judge Halliwell (sitting as a High Court judge) accepted that a duty was owed to contingent creditors.243 Conclusion 15.120 This chapter has dealt with one of the most important issues that relate to the obligation to consider creditor interests, namely how do directors, when the obligation applies, comply with the obligation to ensure that they are not to be held liable? 15.121 The discussion considered what directors are to do during different stages of a company’s life and where the obligation arises. The Supreme Court in Sequana provided that when a company is insolvent the interests of creditors may be paramount, depending on whether the insolvency is temporary or not. Where the insolvent administration or liquidation of a company is inevitable the creditors’ interests are definitely paramount. In the case where the obligation arises before insolvency, that is, when the company is bordering on insolvency, the directors must consider the interests of both the shareholders and the creditors. In this latter situation, while it might be difficult, the case law seems to suggest that directors must balance the interests of shareholders and creditors in making their decisions. 15.122 The chapter examined what factors directors should take into account when considering the interests of creditors, and particular focus was given to the jurisprudence in relation to wrongful trading actions and applications for the approval of schemes of arrangement in an attempt to try and gauge what courts might require directors to do when considering the interests of creditors. 15.123 The chapter discussed what directors should consider when dealing with the diverging interests of creditors and emphasised that creditors must be treated the same when they are in the same class.

241 [2006] 3 NZLR 808. 242 [2021] EWHC 1501 (Ch). 243 Ibid., [85].

270

CHAPTER 16

Commencing Proceedings and Determining Liability

Introduction 16.1 This chapter addresses two broad issues. First, matters relative to the commencement of proceedings where there has been a breach of the obligation and, in particular, who may commence proceedings, limitation of actions and what sort of proceedings should be initiated. 16.2 The second issue is, how is liability of directors determined by a court? The book has considered what directors should do in fulfilling their duty, but it has not focused on what the courts consider in determining whether a director is in fact liable for breach of the obligation. This obviously follows on from some of the discussion in the last chapter, but it is more concerned with what happens at trials. Who Can Commence Proceedings? 16.3 The duty considered in this part is one that is owed to the company, and thus the company is the correct claimant against the directors for breach, according to the rule in Foss v Harbottle,1 and now made clear in this context by s 170(1) of the Companies Act 2006 (‘the Act’). As directors are highly unlikely to sanction the initiation of proceedings against themselves, or one of their number, creditors will usually have to wait until a liquidator or administrator is appointed in relation to the affairs of the company and hope that he or she will bring proceedings, technically on behalf of the company, but in reality on behalf of the creditors. 16.4 The problem with the duty being owed to the company is that, short of instituting winding-up or administration proceedings, creditors can do nothing to arrest any action taken by directors that prejudices the repayment of the debts that they are owed, unless they have some rights pursuant to covenants in the contract under which they extended credit. Of course, secured creditors with charges might be able to take action if the debenture terms are breached or the company is insolvent. 16.5 A shareholder could conceivably seek to bring proceedings against errant directors by way of derivative proceedings if the company did not do so and

1 (1843) 2 Hare 461.

DOI: 10.4324/9780429266232-20

271

COMMENCI NG PROCEEDI NGS AND DETER MI NI NG LI A BILITY

the company had not entered either liquidation of administration. This is very unlikely. First, the shareholders are not usually going to be too concerned that the directors have breached their obligation to consider the interests of the creditors unless, in rare circumstances one would think, that would chime with the shareholder’s interests or meet some particular aim that the shareholders have. Of course, a shareholder could also be a creditor, and thus he or she might be motivated to initiate proceedings because of that. Secondly, derivative proceedings may only be continued in England and Wales and Northern Ireland,2 and only initiated in Scotland,3 if a court grants permission. Case law manifests the fact that permission is not easy to come by.4 16.6 While derivative proceedings are brought on the part of the company, shareholders may also take proceedings on their own behalf under s 994 of the Act (where the shareholders’ interests have been unfairly prejudiced) to right obvious wrongs.5 A shareholder probably cannot bring an action under s 994 where directors have breached their obligation to act in the interests of the creditors, unless it affects the rights of members, as the provision requires the action complained of to be unfairly prejudicial to the interests of the members, including at least the petitioner’s interests. Could an action be brought where a member was also a creditor? It is permissible in Australia, as a member is able to bring proceedings in a capacity other than as a member. But in the UK a member who launches a s 994 petition must establish conduct that is unfairly prejudicial to the member’s interests as a member, and not in relation to non-member interests,6 so the answer to the question posed is probably ‘no.’ 16.7 Nearly all proceedings that are commenced against directors for breach of the obligation are commenced by liquidators. A few cases have involved proceedings commenced by administrators.7 16.8 Proceedings would usually be commenced by a liquidator pursuant to s 212 of the Insolvency Act 1986 (‘the Insolvency Act’) and commonly known as ‘misfeasance proceedings,’ where a company is in liquidation. Misfeasance proceedings were considered briefly in Chapter 4.

2 Companies Act 2006, Part 11, Chapters 1 and 2. 3 Ibid., s 266. 4 See, Andrew Keay and Joan Loughrey, ‘Derivative Proceedings in a Brave New World for Company Management and Shareholders’ [2010] JBL 151; Andrew Keay ‘Assessing and Rethinking the Statutory Scheme for Derivative Actions Under the Companies Act 2006’ (2016) 16 Journal of Corporate Law Studies 39. 5 The distinction between corporate and shareholders’ personal rights is a vexed issue. See, for example, David Sugarman, ‘Reconceptualising Company Law – Reflections on the Law Commission’s Consultation Paper on Shareholder Remedies’ in Barry Rider (ed) The Corporate Dimension (Jordans, 1986), 206; Hans Hirt, ‘In What Circumstances Should Breaches of Directors’ Duties Give Rise to a Remedy under ss 459–461 of the Companies Act 1985?’ (2003) 24 Company Lawyer 100. 6 Re A Company (No 00314 of 1989) [1991] BCLC 154, 160. 7 For example, see Facia Footwear Ltd (in administration) v Hinchliffe [1998] 1 BCLC 218; E-Clear (UK) Plc (In Liquidation) v Elias Elia [2013] EWCA Civ 1114.

272

COMMENCI NG PROCEEDI NGS AND DETER MI NI NG LI A BILITY

16.9 It might be added that creditors themselves would also have a right to bring misfeasance proceedings against the directors, pursuant to s 212(3),8 where the company is in liquidation. Creditors might be reluctant to do so, given the costs involved and the fact that all creditors would benefit from any award. Creditors might prefer to wait for the liquidator to commence proceedings. Of course, if proceedings are brought by a liquidator and they are successful, the unsecured creditors might not benefit at all, as a secured creditor with a floating charge over company assets might be entitled to the total sum recovered9 less, perhaps, part of it which would go towards ‘the prescribed part’ under s 176A of the Insolvency Act. 16.10 If the liquidator declines to initiate proceedings against directors, creditors have the option of taking actions themselves, as mentioned earlier, or challenging the decision of the liquidator not to take action, under s 168(5) of the Insolvency Act.10 The other possibility is for a creditor to seek the assignment of the liquidator’s cause of action against the directors. Before making an assignment, a liquidator will probably want some consideration being paid. 16.11 A matter of concern for anyone intending to initiate proceedings is funding. This is often of particular concern for a liquidator or administrator. It is not intended to discuss the issue in the context of this work, but obviously it is an issue which may well require some consideration.11 Respondents to Proceedings 16.12 Naturally, the sole respondents to most proceedings will be the directors who are alleged to have breached their duty under s 172(3). Proceedings can be taken against de facto directors, on the basis that they owe the same duties as de jure directors,12 and are subject to the duty.13 16.13 Unlike de facto directors, who are not mentioned in either the Act or the Insolvency Act, shadow directors are. It is clear from the cases that the duty of care dealt with in s 174 of the Act, will apply to shadows, but it is not clear that they are subject to fiduciary duties, and s 172(3) deals with a modification of a fiduciary duty. There is conflicting case law as to whether shadows are liable for breaches of fiduciary duties. In Yukong Line Ltd of Korea v Rendsburg Investments Corp of Liberia (No2)14 Toulson J (as he then was) was strongly of the view that fiduciary duties did apply to shadow directors. Later, in Ultraframe 8 A shareholder could also do so under this provision if he or she obtains the leave of the court (s 212(5)), but it is extremely unlikely that that would occur. 9 Re Anglo-Austrian Printing & Publishing Union [1895] 2 Ch 891. 10 See Andrew Keay, ‘The Supervision and Control of Liquidators’ [2000] Conveyancer and Property Lawyer 295. 11 For funding for liquidators, see Andrew Keay, McPherson and Keay’s The Law of Company Liquidation (5th ed, Sweet and Maxwell, 2021), [9–072]–[9–075]. 12 Instant Access Properties Ltd (in liq.) v Rosser [2018] EWHC 756 (Ch), [2018] BCC 751. 13 See, for instance, see Ultraframe UK Ltd v Fielding [2005] EWHC 1638 (Ch), [2006] FSR 17, [1257]; Primlake Ltd v Matthews Associates [2006] EWHC 1227 (Ch), [2007] 1 BCLC 686, [284]. 14 [1998] BCC 870.

273

COMMENCI NG PROCEEDI NGS AND DETER MI NI NG LI A BILITY

(UK) Ltd v Fielding,15 Lewison J (as he then was) was not so persuaded. More recently the judgments in Secretary of State for Business Innovation and Skills; Re UKLI Ltd16 and Viviendi SA v Richards17 took the view that shadows are liable. In the latter Newey J (as he then was) concluded that there were several reasons for taking the view that shadow directors do commonly owe fiduciary duties to at least some degree.18 In another recent decision, however, Morgan J in Instant Access Properties Ltd (in liq.) v Rosser19 said that he, like Lewison J, did not think that an attempt to define the duties of a typical shadow director was helpful.20 16.14 In the most recent case to consider this issue, Standish v Royal Bank of Scotland, Trower J acknowledged that shadow directors could be liable for breach of their fiduciary duties, but he agreed with Newey J in Viviendi and Morgan J in Instant Access and placed an important limitation on the ambit of liability; shadow directors can only be said to owe fiduciary duties in relation to that part of the company affairs in which they gave instructions or directions. Therefore, there continues to be some uncertainty over the issue of whether shadows are able to be held liable for failing to take account of the interests of creditors. Liability would seem to depend upon whether they gave instructions in matters that affected creditor interests. 16.15 In some cases, it might be appropriate to join as respondents third parties who have either benefitted from the breaches or assisted in the actions constituting the breaches. This might be done where there is concern that the directors might be impecunious or unable to pay the full amount of the claim, and there are third parties who might be liable and might be good for any claim. The remedies that might be awarded against the third parties will often reflect the remedies that are awarded against the directors who are in breach. 16.16 Any liability for which third parties are liable is based on the wrong done by directors in breach of their duty. The third party will be someone who has been involved either in the wrong or is related to the director as a wrongdoer in some way. In many cases the third party is a company established by the miscreant director or a company that is associated with the director in some way. Sometimes there may not be any association. An example of the latter is the Australian case of Bell Group Ltd (in liq) v Westpac Banking Corporation (No 9)21 where the liquidator of Bell took action against banks which had dealt with the company. 16.17 Most often, claimants who bring proceedings against a third party where there is a breach of duty will rely on the old case of Barnes v Addy22 (and 15 16 17 18 19 20 21 22

[2005] EWHC 1638 (Ch), [1284]. [2013] EWHC 680 (Ch), [48]. [2013] EWHC 3006 (Ch). Ibid., [142]. [2018] EWHC 756 (Ch); [2018] BCC 751, [259]. Ibid. [2008] WASC 239. (1874) LR 9 Ch App 244.

274

COMMENCI NG PROCEEDI NGS AND DETER MI NI NG LI A BILITY

cases applying it), which provides, in effect, that an action might be brought successfully against a third party where either the third party knowingly assisted in the breach of duty or received benefits from the breach for his or her own use. Consideration of the liability of third parties is outside the scope of the book.23 The Relationship to Wrongful Trading 16.18 An administrator or liquidator might seek to claim in proceedings that directors breached the obligation the subject of this part of the book, and also they engaged in wrongful trading. Consequently, this section considers how the obligation and wrongful trading relate. Earlier in the book wrongful trading under s 214 (s 246ZB) of the Insolvency Act was discussed in detail, so we will not consider the elements of claims for wrongful trading here. 16.19 In Sequana some of the judges referred to wrongful trading, although Lord Reed said, as mentioned in the last section of the chapter, consideration of how the obligation related to statutory provisions had to wait until another day.24 His Lordship said that the existence of s 214 was not incompatible with the obligation,25 a view in which Lady Arden expressly concurred.26 Lord Reed also noted that s 214 differs from the obligation in important respects.27 First, the points in time at which the obligation and s 214 arise differ considerably. The obligation applies before the time when s 214 might become relevant, namely when a reasonably diligent and competent director would know that there was no reasonable prospect of avoiding insolvency proceedings.28 16.20 Secondly, s 214 applies only where the directors know or ought to know that there was no reasonable prospect of avoiding insolvent liquidation or administration, whereas with the obligation to creditors it is not necessary to establish that the directors had such knowledge.29 16.21 Thirdly, what the directors are to do when the obligation applies compared with when directors are subject to s 214 differs.30 The latter is far more specific. The obligation requires directors to act in a way which they consider in good faith will be in the interests of the creditors as a whole, and this is less stringent than s 214, which requires the directors to take reasonable care to minimise the potential loss to creditors.31

23 For discussion of the liability of third parties, see Andrew Stafford QC and Stuart Ritchie QC, Fiduciary Duties (2nd ed, Jordan Publishing, 2015), 333–370; Andrew Keay, Directors’ Duties (4th ed, LexisNexis, 2020), 550–564. 24 [2022] UKSC 25, [92]. 25 Ibid., [99]. 26 Ibid., [326]. 27 Ibid., [94]. 28 Ibid. 29 Ibid. 30 Ibid. 31 Ibid., [98].

275

COMMENCI NG PROCEEDI NGS AND DETER MI NI NG LI A BILITY

16.22 Fourthly, the remedies differ.32 Fifthly, the range of persons who can bring proceedings for a breach of the obligation is greater than with a claim under s 214.33 A latter claim may only be brought by the liquidator (or by an administrator under s 246ZB). 16.23 Sixthly, the range of persons against whom a claim under the obligation can be initiated is greater than with a s 214 claim.34 The latter may only be instituted against the directors, whereas a claim for breach of the obligation may be commenced against third persons, as mentioned earlier. Seventhly, a finding of liability under the obligation will produce different results from a finding of wrongful trading.35 16.24 Given the approach of the Supreme Court judges in Sequana, the obligation and s 214 overlap where the insolvent liquidation or administration of the company is inevitable. Nevertheless, one would think that officeholders could claim a breach of s 214 and a breach of the obligation in the alternative; they might be able to prove one or the other. Limitation of Actions 16.25 The issue of limitation can be of considerable importance, and this is particularly so where actions are sought to be instituted by liquidators and administrators of insolvent companies and where the directors who committed breaches have been in control of a company for a substantial period following the breaches and before liquidation or administration. As mentioned earlier, the most frequent applicant in proceedings for breach is the liquidator. Directors who might have been in breach might fail to assist the liquidator who comes to a company with little or no knowledge of its affairs, and so it could take a liquidator some time to discover whether breaches have occurred and even longer to gather evidence to support a claim. The limitation position for breaches of duties of directors is a complex matter. This is partly because there is no mention of breaches of duty in the Limitation Act 1980.36 16.26 As discussed in Chapter 13, the obligation considered in this book is a modification of a fiduciary duty. Generally, where there are breaches of directors’ fiduciary duties the director can be regarded in the same way as a trustee.37 That is, the directors are treated as if they were trustees of the funds and other

32 Ibid., [94], [122]. Also, who benefits from the remedies can differ. 33 Ibid., [94]. 34 Ibid. 35 Ibid., [98]. 36 For a discussion of limitation periods for actions in relation to fiduciaries in general, see J Mather, ‘Fiduciaries and the Law of Limitation’ [2008] JBL 344, and in relation to directors and employees, see Andrew Stafford QC and Stuart Ritchie QC, Fiduciary Duties: Directors and Employees (2nd ed, Jordan Publishing, 2015), 505–528. 37 Re Lands Allotment Company [1894] 1 Ch 616, 631−632, 638−639 and 643; J J Harrison v Harrison [2002] BCLC 162, 173 (CA); Gwembe Valley Development Co Ltd v Koshy [2003] EWCA Civ 1048, [2004] 1 BCLC 131, [83].

276

COMMENCI NG PROCEEDI NGS AND DETER MI NI NG LI A BILITY

property of the company that were in their control and that were the subject of any misapplication.38 16.27 In giving the leading judgment in the Supreme Court decision in Burnden Holdings (UK) Ltd v Fielding,39 Lord Briggs explained why directors are treated as trustees for the purposes of the Limitation Act. He said that: It is common ground (and clear beyond argument) that, as directors of an English company who are assumed to have participated in a misappropriation of an asset of the company, the defendants are to be regarded for all purposes connected with section 21 as trustees. This is because they are entrusted with the stewardship of the company’s property and owe fiduciary duties to the company in respect of that stewardship.40

16.28 In this case the Court provided that a director is the trustee of the assets of the company. Thus, the starting point is to ascertain whether a claim is to be regarded as one that constitutes a breach of trust. Section 21 of the Limitation Act addresses claims by beneficiaries against trustees and is applied to claims by companies against directors where there is a breach of fiduciary duty. Section 21 provides for a limitation period of six years unless another provision in the legislation applies or there is a provision in some other legislation which applies a different period. Section 21(3) provides that subject to the preceding provisions of the section, an action by a beneficiary to recover trust property or in respect of any breach of trust, not being an action for which a period of limitation is prescribed by any other provision of this Act, shall not be brought after the expiration of six years from the date on which the right of action accrued. ‘Beneficiary’ in the context of this book would be the company or its representative. 16.29 Section 21(1) constitutes an exception to the approach found in s 21(3). Section 21(1) of the Limitation Act 1980 provides as follows: No period of limitation prescribed by this Act shall apply to an action by a beneficiary under a trust, being an action – (a) (b)

in respect of any fraud or fraudulent breach of trust to which the trustee was a party or privy; or to recover from the trustee trust property or the proceeds of trust property in the possession of the trustee, or previously received by the trustee and converted to his use.

16.30 If applicants wish to proceed against directors for breaches which occurred outside of the six-year period, they must bring the case within s 21(1). This latter provision operates to remove the six-year period mentioned in s 21(3), in two situations. First, under s 21(1)(a) where the basis of the claim against directors

38 The following discussion draws on Andrew Keay, Directors’ Duties (4th ed, LexisNexis, 2020), 86–92. 39 [2018] UKSC 14, [2018] AC 257. 40 Ibid., [11].

277

COMMENCI NG PROCEEDI NGS AND DETER MI NI NG LI A BILITY

is fraud and the director can be implicated in dishonest conduct,41 and secondly, under s 21(1)(b), where the action seeks to recover trust property or proceeds of trust property held by the director as trustee for the company42 or which the director previously received, and converted to his or her own use, and this continues to apply notwithstanding the fact that the director no longer holds the property.43 16.31 Section 21(1)(a) does not require the ‘trustee’ (in our case, the director) to have carried out the fraud himself or herself, only to have been a party to it.44 The Supreme Court held in Williams v Central Bank of Nigeria45 that s 21(1) (a) will only be available in respect of orthodox trustees. The Supreme Court acknowledged directors as trustees of their company’s property for the purposes of the provision, even though directors are not trustees. More recently the Court of Appeal decision in Burnden Holdings (UK) Ltd v Fielding46 accepted that s 21(1) did apply to claims against directors.47 16.32 An applicant might seek to rely on the terms of s 32 of the Limitation Act if his or her claim cannot fall within s 21(3). Section 32(1)(b) provides that if a fact that is relevant to the cause of action of a claimant has been deliberately concealed from the claimant by the respondent, the six years does not begin to run until the point when the applicant discovers the concealment. Section 32(2) expands the meaning of s 32(1)(b) by providing that the deliberate commission of a breach of duty in circumstances in which it is unlikely to be discovered for some time amounts to deliberate concealment of the facts involved in that breach of duty. The House of Lords said, in Cave v Robinson Jarvis & Rolf,48 that for the purposes of s 32 a deliberate breach of duty requires the defendant to have known that he or she was committing a breach of duty.49 The concealment does not have to have taken place contemporaneously with the wrong complained of; it can occur after the accrual of the cause of action. 16.33 In determining when time starts running against a claimant it is necessary to ascertain the persons who, on behalf of the company, might discover the director’s wrongdoing. According to the Court of Appeal in Burnden Holdings (UK) Ltd v Fielding50 it cannot be the wrongdoers themselves. It could be any director who was not alleged to be a wrongdoer.51 41 Viviendi SA v Richards [2013] EWHC 3006 (Ch), [2013] BCC 771, [187]. The Court of Appeal in Paragon Finance plc v D B Thackerar [1999] 1 All ER 400 said that dishonesty was an essential element. 42 Re Broadside Colours and Chemicals Ltd [2011] EWHC 1034 (Ch). 43 J J Harrison v Harrison [2002] 1 BCLC 162 (CA); Gwembe Valley Development Co Ltd v Koshy [2003] EWCA Civ 1048, [2004] 1 BCLC 131, [111]; First Subsea Ltd v Balltec [2017] EWCA Civ 186, [2018] Ch 25. 44 Re Pantiles Investments Ltd [2019] EWHC 1298 (Ch), [66]. 45 [2014] UKSC 10, [2014] AC 1189. 46 [2016] EWCA Civ 557. 47 Ibid., [31]. 48 [2002] UKHL 18. 49 Sheldon v RHM Outhwaite (Underwriting Agencies) Ltd [1996] AC 102. Also, see IT Human Resources plc v Land [2014] EWHC 3812 (Ch), [134]. 50 [2016] EWCA Civ 557, [49]. 51 Ibid.

278

COMMENCI NG PROCEEDI NGS AND DETER MI NI NG LI A BILITY

16.34 Relying on s 32 might be something that liquidators might well seek to do as liquidators might be blocked in ascertaining the truth concerning the affairs of the company or not have access to the necessary information that would demonstrate the truth. It is submitted that in companies where all of the directors are alleged to be wrongdoers the time would not start running until the liquidator is appointed. Disadvantages With Proceedings 16.35 Undoubtedly there are some disadvantages in pursuing a claim for a breach of duty. But, while we must identify them, we must also accept that there are disadvantages with any claim which is prosecuted in relation to the affairs of an insolvent company. It is submitted that all in all the matters which are identified should not dissuade the commencement of proceedings unless there are other issues that would suggest that proceedings should not be instigated. 16.36 What are the disadvantages with a breach of duty action, and especially compared with other possible actions? Granting Judicial Relief 16.37 A director is able to seek to rely on s 1157 of the Act in order to submit that he or she should be excused from liability. Nevertheless, this must be balanced with the acknowledgement that there have been few cases where a submission under s 1157 or one of its precursors has succeeded. Also, s 1157 has only been invoked in some cases if the director makes good the full amount for which, prima facie, he or she was liable,52 and only if the interests of creditors were unlikely to be affected and the members themselves had acquiesced in the wrongful act. Given this, it is likely that it will only be in rare cases that s 1157 will be invoked, and this is especially so where a breach of duty claim is based primarily on the prejudice to creditors.53 Security for Costs 16.38 With an action for breach of the obligation the liquidator may issue proceedings in the name of the company. It is likely that the respondent will apply for an order for security of costs pursuant to r 25.12 of the Civil Procedure Rules. Security of costs exists ‘to prevent the injustice which would result if a plaintiff who was in effect immune from orders for costs were free to litigate at the defendant’s expense even if unsuccessful.’54 52 See Re Sunlight Incandescent Gas Lamp Co. (1900) 16 TLR 535; Re Home & Colonial Insurance Co. [1930] 1 Ch 102. 53 In any case it is for the party in default to show that he or she is entitled to relief: Re International Vending Machines Ltd (1961) 80 WN (NSW) 465, 474–475. 54 C.T. Bowring & Co (Insurance) Ltd v Corsi & Partners Ltd [1994] BCC 713 CA, 724 per Millett LJ. For a list of the principles involved, see Hart Investments Ltd v Larchpark Ltd [2007] EWHC 291 (TCC), [2007] BCC 541, [8]–[11].

279

COMMENCI NG PROCEEDI NGS AND DETER MI NI NG LI A BILITY

16.39 An application pursuant to r 25.12 involves an applicant satisfying the court of two matters.55 First, it is just to make an order, given all of the circumstances.56 Secondly, one or more of the conditions set out in r 25.13(2) apply. There is no exhaustive list of circumstances that a court might take into account where this condition is relied on.57 The condition that a director will rely upon in r 12.13(2) is that found in r 25.13(2)(c), and it provides that the claimant is a company or other body (whether incorporated inside or outside Great Britain) and there is reason to believe that it will be unable to pay the defendant’s costs if ordered to do so. 16.40 If the liquidator chooses to bring proceedings in his or her own name, then normally an order for security for costs will not be ordered;58 r 25.13(2) (c) cannot be relied on, as that paragraph only covers companies and so there must be reliance on another paragraph. 16.41 The traditional view has been that a company in insolvent liquidation is presumed to be insolvent unless evidence is given to the contrary.59 However, to say that there is a presumption that security will be ordered against a company in liquidation is, it is submitted, putting it too highly, for the fact that a company is in insolvent liquidation will be only a factor, albeit a significant one, in favour of ordering security, but the court will act in the light of all the relevant circumstances.60 It has been said that it is regarded as prima facie evidence that a company is unable to pay costs unless contrary evidence is adduced.61 16.42 In the Court of Appeal in Sir Lindsay Parkinson & Co Ltd v Triplan Ltd62 Lord Denning MR said that the court has a complete discretion in ordering security even where it is made plain that if the company were found liable and ordered to pay costs it would not be able to pay those costs.63 Later, the Court of Appeal in B.J. Crabtree (Insulation) Ltd v G.P.T. Communications Systems64 underlined that the discretion of the court was to be kept flexible and not to be limited by applying strict rules. 16.43 One way to circumvent a security for costs application is for a liquidator to pursue a claim as misfeasance proceedings under s 212 of the 55 Sir Lindsay Parkinson & Co Ltd v Triplan Ltd [1973] 2 All ER 273. 56 Civil Procedure Rules, r 25.13(1)(a). 57 Aidiniantz v The Sherlock Holmes International Society Ltd [2015] EWHC 2882 (Ch), [2015] BPIR 1329. 58 Cowell v Taylor (1885) 31 Ch D 34, CA; Re Strand Wood Co [1904] 2 Ch 1 CA; Re Li Shu Chung (unreported, 2 November 2021, Ch D, Flaux J). In the rather peculiar case of Greener v E Kahn & Co Ltd [1906] 2 KB 374, 376 the Court of Appeal did require security of costs from the trustee of a deed of assignment of the property of insolvent person, but here the trustee was an undischarged bankrupt and insolvent. 59 Northampton Coal Co v Midland Waggon Co (1878) 7 Ch D 500; Pure Spirit Co v Fowler (1890) 25 QBD 235; Tudor Furnishers Ltd v Montague & Co [1950] Ch 113. 60 Keary Developments Ltd v Tarmac Constructions Ltd [1995] 3 All ER 534. 61 Pure Spirit Co v Fowler (1890) 25 QBD 235. 62 [1973] 1 QB 609. 63 Ibid., 626. 64 (1990) 59 Build L R 43.

280

COMMENCI NG PROCEEDI NGS AND DETER MI NI NG LI A BILITY

Insolvency Act, as mentioned earlier, which the liquidator does in his or her own name, rather than taking proceedings in the normal manner under Part 7 of the Civil Procedure Rules and in the name of the company. This was discussed in Chapter 4. Enforcement 16.44 Of course, even if a liquidator or administrator obtains an order from the court based on a breach of duty, the problem facing the liquidator/administrator is that the order has to be enforced and at the end of the day the director(s) may be impecunious, rendering the proceedings tantamount to useless. However, this point must be put into perspective, for it applies equally to any claim against a director personally. Proceeds of Judgment 16.45 Probably the biggest drawback with pursuing a claim for breach of duty is the fact that the fruits of a successful claim will be available to any secured creditor who has a floating charge over all present and future company property and has not had their claim satisfied by realising property subject to the charge, because, unlike property and money recovered in proceedings based on provisions that grant liquidators the right to take action personally qua liquidators, such as wrongful trading claims, anything recovered is regarded as company property. Determining Liability 16.46 Obviously, if the directors take into account the interests of creditors when they are required to do so, they are not liable. The duty is assessed subjectively in that the court will consider whether the directors believed they were, in good faith, considering the interests of the creditors. Thus, for applicants to succeed they must establish that the directors did not hold this belief. Prima facie, that makes the applicant’s task a difficult one and appears to give some comfort to directors. Nevertheless, as we will see next, directors are not completely immune from being held liable even if they resolutely assert that they acted in good faith in the interests of the creditors. 16.47 As discussed in Chapter 12, in Colin Gwyer and Associates Ltd v London Wharf (Limehouse) Ltd65 Leslie Kosmin QC (sitting as a deputy judge of the High Court) dealing with a case where directors had failed to consider creditors’ interests when their company was insolvent or close to it, said that the test in Charterbridge Corp Ltd v Lloyds Bank Ltd66 (‘Chaterbridge’) could be applied with the modification that in considering the interests of the company the honest 65 [2002] EWHC 2748 (Ch), [2003] BCC 885. 66 [1970] Ch 62.

281

COMMENCI NG PROCEEDI NGS AND DETER MI NI NG LI A BILITY

and intelligent director must have been capable of believing that the decision was for the benefit of the creditors.67 As explained in Chapter 12, Charterbridge was a case where the judge had to consider, in the course of his deliberations, the duty of directors to act in good faith in the best interests of their company, in circumstances where the company was solvent. 16.48 Pennycuick J in Charterbridge said that where the director against whom proceedings have been initiated had actually failed to consider whether the action that is the subject of complaint would be in the interests of the company, objective considerations may have to be considered and the court had to ask whether an intelligent and honest man in the position of a director of the company involved, could, in the whole of the circumstances, have reasonably believed that the action was for the benefit of the company.68 Where s 172(3) is triggered, if directors failed to consider creditor interests then in order to ascertain whether they are liable the court is to ask whether an intelligent and honest person in the position of the directors, could, in the whole of the circumstances, have reasonably believed that the action that is impugned was for the benefit of the creditors. 16.49 In Charterbridge the court indicated that it is not obliged to believe the directors’ assertions that they acted in the best interests of the company. It is harder for courts to accept directors’ claims to have acted in good faith where they have benefitted personally from the impugned action or for some purpose other than advancing the welfare of the company and its interests.69 16.50 Thus, where a claim is made in relation to a solvent company that directors have breached their duty to act in the best interests of the company courts can come to the conclusion that a director was not acting in good faith when taking a particular action, and this conclusion can be made not only from assessing the evidence of the director, but also from an evaluation of objective matters,70 such as the reasonableness of what the director did or did not do.71 Jonathan Crow (sitting as a deputy judge of the High Court) said in his judgment in Extrasure Travel Insurance Ltd v Scattergood72 that ‘the fact that his [the director’s] alleged belief was unreasonable may provide evidence that it was not in fact honestly held at the time.’73 Jonathan Parker J (as he then was) in Regentscrest plc v Cohen74 accepted the fact that courts are permitted to draw inferences concerning the director’s state of mind from witness statements

67 Colin Gwyer and Associates Ltd v London Wharf (Limehouse) Ltd [2002] EWHC 2748 (Ch), [2003] BCC 885, [87]. 68 Charterbridge Corp Ltd v Lloyds Bank Ltd [1970] Ch 62, 74. 69 Regentcrest plc v Cohen [2001] BCC 494, [2002] 2 BCLC 80; Extrasure Travel Insurances Ltd v Scattergood [2003] 1 BCLC 598; Roberts v Frohlich [2011] EWHC 257 (Ch), [2012] BCC 407, [2011] 2 BCLC 625. 70 This approach has been invoked in the United States: Citron v Fairchild Camera and Instrument Corp 1988 WL 53322 (Del Ch). 71 Shuttleworth v Cox Bros and Co (Maidenhead) Ltd [1927] 2 KB 9, 23–24; Westpac v Bell Group (No 9) [2008] WASC 239, [4598]. 72 [2003] 1 BCLC 598. 73 Ibid., [90]. 74 Regentcrest plc v Cohen [2002] 2 BCLC 80, 105.

282

COMMENCI NG PROCEEDI NGS AND DETER MI NI NG LI A BILITY

and circumstantial evidence. This approach is applied to claims brought under s 172(3) with the modification that if the court does not believe that a director acted in good faith in considering the interests of creditors and he or she did not act reasonably then the director is, prima facie, liable. This approach was approved of by John Randall QC (sitting as a deputy judge of the High Court) in Re HLC Environmental Projects Ltd,75 when dealing with such a claim. The deputy judge said in the situation where a material interest is unreasonably overlooked by directors, such as the interests of a large creditor, in making their decisions, then an objective test should be applied.76 The deputy judge indicated that directors are unable to assert, in a situation where they did not consider the interests of a major creditor, that they did not consider the creditor’s interest because they did not think that the person was a creditor.77 16.51 The courts78 have made it clear when dealing with a solvent company that while it does not rule out a conclusion that directors were acting in good faith in what they have done, it might be harder for the directors to maintain good faith when the company has incurred a substantial detriment. The same is likely to apply when a company is insolvent or in financial difficulties and the creditors have sustained a significant loss.79 It is even more likely to be the case where the directors have benefitted personally from what they have done. 16.52 It is clear from the cases that for a director to be in breach, there is no need to establish that he or she deliberately ignored the interests of the creditors; if it does not occur to the director to take account of a creditor’s interest then that would suffice for a potential breach.80 This suggests that the directors, whatever they are considering doing, such as restructuring, entering new contracts or paying off creditors, they have to be careful to weigh up the creditors’ interests and to determine, as far as they can, what might prejudice those interests. 16.53 In sum, if directors assert that they acted in good faith and considered the interests of creditors, then the directors’ subjective view should be accepted.81 But, if directors failed to consider whether the action that is the subject of the complaint would be in the interests of the company,82 or the court disbelieves directors when they say that they did consider creditor interests, the court has to ask whether an intelligent and honest person in the position of a director of the company involved, could, in the whole of the circumstances, have reasonably

75 [2013] EWHC 2876 (Ch), [92]. 76 Ibid. 77 Ibid., [93]. 78 Regentcrest plc v Cohen [2002] 2 BCLC 80, 105; Extrasure Travel Insurances Ltd v Scattergood [2003] 1 BCLC 598. 79 Roberts v Frohlich [2011] EWHC 257 (Ch), [2012] BCC 407, [2011] 2 BCLC 625. Also see Dryburgh v Scotts Media Tax Ltd [2011] CSOH 147, [94]. 80 Colin Gwyer v London Wharf (Limehouse) Ltd [2002] EWHC 2748 (Ch); [2003] 2 BCLC 153, [78]; Re HLC Environmental Projects Ltd [2013] EWHC 2876 (Ch), [89]. 81 Gwyer, ibid., [83]. Although the court did say that the directors might be held liable for breach of their duty of care if they did make mistakes or acted unreasonably. 82 This might include the situation where the court does not believe the directors when they assert that they did consider the interests of the creditors in good faith.

283

COMMENCI NG PROCEEDI NGS AND DETER MI NI NG LI A BILITY

believed that the transaction was for the benefit of the creditors.83 All of this means that directors may not be liable even if they failed to act in the interests of creditors but they acted in a way that a person in the same position as the directors believed was reasonable. 16.54 Neither the Court of Appeal in BTI 2014 LLC v Sequana S.A.84 nor the Supreme Court on appeal85 had to consider this issue, as the courts held that in the case at hand the duty was not triggered. Conclusion 16.55 The chapter has focused on two primary issues. First, those matters that relate to the initiation of proceedings for a breach of the obligation to consider the interests of creditors. Particular emphasis has been given to who may commence proceedings and what are the rules on limitation of actions that need to be taken into account. Also, the chapter has explained the disadvantages which apply to bringing proceedings for a breach of the obligation. It was submitted that while these disadvantages should be acknowledged they should not, of themselves, cause a prospective claimant to refrain from commencing proceedings. 16.56 The second issue covered in the chapter was what approach courts adopt in determining whether directors are in breach of the obligation. In particular, it was concluded that if directors are shown not to have taken creditor interests into account, then in order to ascertain whether they are liable the court is to ask whether an intelligent and honest person in the position of the directors, could, in the whole of the circumstances, have reasonably believed that the action that is impugned was for the benefit of the creditors. It was also observed that courts may disbelieve directors when they give evidence that they did consider creditor interests and if a court takes this view, then it will determine whether the directors are liable based on the test referred to in the last sentence.

83 The employment of this approach was considered by the deputy judge in Colin Gwyer v London Wharf (Limehouse) Ltd [2002] EWHC 2748 (Ch), [2003] 2 BCLC 153, [73], [88] as he had come to the conclusion that the directors did not consider the interests of the creditors; in fact, they had demonstrated ‘wilful blindness’ (at [83]). 84 [2019] EWCA Civ 119, [2019] 1 BCLC 347, [2019] BPIR 562, [220]. 85 [2022] UKSC 25.

284

CHAPTER 17

Relief From Liability

Introduction 17.1 Thus far this part has focused on the liability of directors and at what point they might be subject to a duty to consider creditor interests and what they might be able to do to comply with this duty and avoid liability. There is no specific defence available to directors. If they wish to contest a claim against them for breach of duty, they will need to argue that the liquidator or administrator has not made out his or her case. This will usually entail arguing that the director was not subject to the duty under s 172(3), as it had not been triggered and/or that the director fulfilled the duty. 17.2 This chapter now considers what relief, if any, is available to directors who are found to be in breach of the obligation in s 172(3). Ratification 17.3 Where a company is clearly solvent and s 172(3) does not apply, the proprietary interests of the shareholders entitle them as a general body to be regarded as the company when questions of the duty of directors arise. If, as a general body, they ratify a particular action of the directors, there can be no challenge to the validity of what the directors have done. But where a company is insolvent or near to it, the interests of the creditors intrude and s 172(3) applies, and the shareholders cannot ratify any breach by directors of the duty contained in the section.1 17.4 Thus, the directors cannot look to the shareholders to get relief from liability.

1 For instance, see Re Horsley & Weight Ltd [1982] 3 All ER 1045; Kinsela v Russell Kinsela Pty Ltd (1986) 4 ACLC 215, (1986) 10 ACLR 395; Re DKG Contractors Ltd [1990] BCC 903; Liquidator of West Mercia Safetywear Ltd v Dodd (1988) 4 BCC 30; Official Receiver v Stern [2001] EWCA Civ 1787, [2002] 1 BCLC 119; Bilta (UK) Ltd (in liquidation) and others v Nazir [2015] UKSC 23, [2016] AC 1.

DOI: 10.4324/9780429266232-21

285

R ELIEF FROM LI A BILITY

Judicial Relief 17.5 If the shareholders cannot relieve the directors from liability, can the courts? The simple answer to this is yes. However, after saying that, the occasions when directors have been relieved from liability have been few. 17.6 Chapter 11 has already dealt with this issue, in the context of wrongful trading, in some depth and thus reference can be made to it. For ease of exposition some points will be repeated, but the following does not purport to be an exhaustive discussion. 17.7 Section 1157 of the Companies Act 2006 permits a court to excuse an officer from liability arising out of his or her negligence, breach of duty or breach of trust if three elements are fulfilled.2 Before mentioning them, it must be stated that a director is an officer for the purposes of this section,3 as courts have readily applied s 1157 and its legislative precursors to directors. The three elements of s 1157 are that: the officer (director) acted honestly; the officer acted reasonably; as a consequence of the officer’s actions he or she ought fairly to be excused from liability. The last and third element is a matter of judicial discretion, for s 1157 states that ‘the court may relieve,’ while the first two elements are regarded as conditions which act as the trigger for the exercise of the discretion.4 The officer has the burden of establishing that the first two elements are satisfied.5 Both of these elements must be established to the court’s satisfaction before a court is to consider whether relief should be ordered.6 However, an officer might be able to satisfy the two limbs but fails to be excused as the court, as a matter of discretion, does not think that he or she ought to be fairly excused.7 17.8 While there might be some uncertainty as to whether ‘wrongful trading’ falls within the wrongdoing covered by s 1157 there is no doubt that a breach of s 172(3) would do so.8 Section 1157 covers ‘negligence, breach of duty or breach of trust.’ It is submitted that s 172(3) refers to a breach of duty as the provision is situated in s 172, one of the provisions covering the general duties of directors, and s 172(3) itself says that the duty (obviously first set out in the section

2 For a detailed discussion of the provision, see Blair Leahy and Andrew Feld, ‘Ratification of Acts of Directors’ in Simon Mortimore QC (ed), Company Directors (3rd ed, OUP, 2017), 512–527; Andrew Keay, Directors’ Duties (4th ed, LexisNexis, 2020), 593–622. 3 ‘Officer’ is defined in s 1173 for the purposes of the Act to include directors. 4 Bairstow v Queen Moat Houses plc [2000] 1 BCLC 549, 561 and affirmed by the Court of Appeal at [2001] EWCA Civ 712, [2001] 2 BCLC 531, [2002] BCC 91, [58]; Re Marini Ltd [2003] EWHC 334 (Ch), [2004] BCC 172, [57]. 5 Bairstow v Queen Moat Houses plc [2001] EWCA Civ 712, [2001] 2 BCLC 531, [2002] BCC 91, [58]. 6 Ibid., [63]. 7 Re J Franklin & Son Ltd [1937] 2 All ER 32; Bairstow v Queen Moat Houses plc [2000] 1 BCLC 549, 561. 8 Indeed, it was claimed, albeit unsuccessfully, in Re Idessa (UK) Ltd [2011] EWHC 804 (Ch), [2012] BCC 315; Re HLC Environmental Projects Ltd [2013] EWHC 2876 (Ch), [2014] BCC 337; Re Cosy Seal Insulation Ltd [2016] EWHC 1255 (Ch). In none of these cases did the respective judges indicate that the provision was not able to apply where there was a breach of s 172(3).

286

R ELIEF FROM LI A BILITY

in s 172(1)) is overtaken when the circumstances in s 172(3) exist. The duty in s 172 is modified when the circumstances discussed in Chapter 14 are fulfilled.9 17.9 A director is not required to plead before trial that he or she seeks relief under s 1157.10 This means that directors are not under any obligation to disclose beforehand the facts that they will argue will support a submission that they ought to be excused. Normally, directors will seek relief through counsel at trial who may raise it if the court decided to find the directors liable. 17.10 Directors have the burden of persuading a court that they are entitled to relief.11 The nature of the burden is different when it comes to establishing reasonableness and fairness compared with honesty. Hoffmann J stated in Re Kirby Coaches Ltd12 that directors are assumed to have acted honestly unless evidence indicates that that is not the case, while directors have to establish that they acted reasonably and ought fairly to be excused.13 The courts have to consider the specific facts provided by the evidence and determine if the director has acted reasonably or not.14 17.11 Unlike with a claim for wrongful trading, where a court can, in its discretion, decide not to award anything to a liquidator or administrator even though the director has engaged in conduct which constitutes wrongful trading, there is no room for a court to do this where a director is found to be in breach of s 172(3), so s 1157 is potentially very important. 17.12 While a director might be able to convince a court that he or she has acted honestly and reasonably, a court is not likely to grant relief ‘in all the circumstances of the case’ if the consequence of the relief is that the director is left, at the expense of creditors, enjoying benefits which he or she would never have received but for the breach of duty. As HH Judge Seymour QC (sitting as a High Court judge) said in Liquidator of Marini Ltd v Dickenson:15 However honestly the director acted, however much it may have appeared at the time of the act complained of that the only person who might be harmed by the act would be the director himself, it just is not fair, as it seems to me, that if it all goes wrong the guilty director benefits and the innocent creditors suffer.16

17.13 Finally, one wonders whether a court might decide to excuse directors where they are in breach but have not acted for their benefit and the action which constituted the breach was a result of, or associated with, the pandemic

9 See BTI 2014 LLC v Sequana S.A. [2022] UKSC 25. 10 Re Kirby Coaches Ltd [1991] BCLC 414, 416. 11 National Trustees Co of Australasia v General Finance Co of Australasia [1905] AC 373; Bairstow v Queens Moat Houses plc [2000] 1 BCLC 549, 572 and affirmed on appeal [2001] EWCA Civ 712, [2001] 2 BCLC 531, [58]; Re Loquitur Ltd, Inland Revenue Commissioners v Richmond [2003] EWHC 999 (Ch), [2003] 2 BCLC 442; Brocks Mount ltd v Beasant (unreported, 2 April 2003, Sonia Proudman QC (sitting as a deputy High Court judge), Ch D). 12 [1991] BCLC 414. 13 Ibid., 415. 14 Re MDA Investment Management Ltd [2004] EWHC 42 (Ch), [25], [2005] BCC 783, 840. 15 [2003] EWHC 334 (Ch), [2004] BCC 172. 16 Ibid., [57].

287

R ELIEF FROM LI A BILITY

of 2020–2022. In Chapter 8 the book mentioned the fact that the Corporate Insolvency and Governance Act 2020 provided that a court, in determining what contribution a director should make for wrongful trading, is to assume that a director is not responsible for the worsening of a company’s financial position or that of the company’s creditors during certain periods in 2020–2022.17 A court might take the view that it would be harsh to not excuse directors from liability under s 172(3) when they would have been excused from making a contribution for engaging in wrongful trading in those periods. Conclusion 17.14 While directors cannot have any breach of the obligation to consider creditor interests ratified by the shareholders so as to relieve them from the breach, directors could be excused by the courts pursuant to s 1157 of the Companies Act.

17 See s 12 of the Corporate Insolvency and Governance Act 2020.

288

PA RT E

DIMINUTION OF COMPANY FUNDS

CHAPTER 18

Unlawful Distributions

Introduction 18.1 The book has thus far considered general concepts that affect directors when their company is in distress or even insolvent. For example, Part D focused on the duty that directors owe to the company to act in the interests of the creditors at certain times, namely where there is extreme financial stress. 18.2 This chapter deals with a more specific issue, and that is the making of distributions by a company to third parties, including to the shareholders and directors. At some points during the life of a company the directors might make payments or transfer assets to third parties, to which reference is made in this chapter by the general term of ‘distributions,’ and they may do this for a variety of reasons, some of which might be regarded as proper and others improper. The making of such payments or transfers can be covered by the obligation discussed in Part D and implementing distributions could constitute a breach of the obligation in that they are made at a time when the directors must act in the interests of the creditors and such distributions do not fulfil such a requirement. Distributions, also, might conceivably contribute to supporting a claim that the directors have engaged in fraudulent or wrongful trading. 18.3 It is obvious that the making of distributions will reduce the funds of a company, and this might mean that it is unable immediately after the making of a distribution or at some point thereafter to fulfil its obligations to existing and/or future creditors. 18.4 The chapter examines those distributions made by directors that may be challenged, ex post, by the company or other applicants, usually a liquidator or administrator on the basis that they are unlawful. Starting Points 18.5 Arguably, there are several points from which we must begin our considerations in this chapter. 18.6 First, there is the basic proposition, widely approved of in English law,1 that if directors of a company dispose of company assets or funds then, 1 For example, see Re Idessa (UK) Ltd [2011] EWHC 804 (Ch), [2011] BPIR 957, [2012] BCC 315, [28]; Toone v Robbins [2018] EWHC 569, [37]; TMG Brokers Ltd v Staines [2021] EWHC 2033, [44].

DOI: 10.4324/9780429266232-23

291

U NLAW FU L DISTR IBUTIONS

because they owe fiduciary duties to their company, this is a transaction which calls for an explanation and the onus is on the directors to explain the reasons for the transaction. This flows from the fact that directors are in a trusteelike position, and they are given considerable power over the property of the company for which they act.2 Furthermore, once it can be demonstrated that a company director has received company money, it is for him or her to show that the payment was proper.3 18.7 Secondly, a company should not drain its capital by, for example, disposing of assets and funds in circumstances where creditors are not able to be paid, because the company’s capital is a kind of guarantee fund from which creditors can expect to be paid;4 creditors lend money or give credit to a company on the faith of the representation that the capital will be applied only for the business of the company.5 Thus, distributions cannot be made from capital.6 A distribution of a company’s assets to a shareholder is a return of capital and unlawful unless, as we will see, it is in accordance with certain statutory provisions.7 18.8 Thirdly, in small private companies where the directors are also the shareholders, of which there are many in the UK, there can be a tendency for some director/shareholders to regard the company as their own property and thus they feel that they can use company funds and property for their own benefit as and when they like. One example of this can be seen in Queensway Systems Ltd v Walker8 where company funds were used to pay for a family holiday and domestic expenses, such as housekeeping and the maintenance of children.9 Another case is Re BM Electrical Solutions Ltd10 where the company had made payments for restaurants, gambling and football season tickets.11 The first thing to say is that that is wrong in the sense that the shareholders do not own the company; they hold shares in the company. The company is a separate legal entity and owns the property held in its name.12 Moreover, case law has held that directors cannot take assets out of the company by way of voluntary

2 Regal (Hastings) v Gulliver (1942) [1967] 2 AC 134n, 159; Re Duckwari plc; Duckwari plc v Offerventure Ltd (No. 2) [1998] Ch 253, 262, [1999] BCC 11, 17. 3 GHLM Trading Ltd v Maroo [2012] EWHC 61, [2012] 2 BCLC 369, [149]. Also, see Re Bronia Buchanan Associates Ltd (in liq) [2021] EWHC 2740 (Ch), [2022] BCC 229. 4 See It’s a Wrap (UK) Ltd v Gula [2006] EWCA Civ 544, [2006] BCC 626, [18]. 5 Re Exchange Banking Co (1882) 21 Ch D 519, CA; Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447, 455, 457, (1985) 1 BCC 99, 539; 99, 541–99, 542, 99, 543; Bairstow v Queen’s Moat Houses plc [2000] BCC 1025, 1030. 6 Ibid. 7 Progress Property Co Ltd v Moorgarth Group Ltd [2010] UKSC 55, [2011] 1 WLR 1, [2011] 2 BCLC 332, [2011] BCC 196, [15], [23]. A reduction may be permitted with court approval. 8 [2006] EWHC 2496 (Ch), [2007] 2 BCLC 577. 9 Ibid., [20]. 10 [2020] EWHC 2749 (Ch), [2021] 1 BCLC 638, [10]. 11 Also, see the New Zealand case of Esko Group Ltd (in liq) v Eskdale [2019] NZHC 1664, [2020] NZCCLR 4 where the directors used company funds for personal use. 12 Salomon v A Salomon & Co Ltd [1897] AC 22. Also, see the comments in Bairstow v Queen’s Moat Houses plc [2001] EWCA Civ 712, [2001] 2 BCLC 531, [44].

292

U NLAW FU L DISTR IBUTIONS

disposition,13 and the dispositions do not have to be fraudulent to be deemed improper.14 As Pennycuick J said in Ridge Securities Ltd v IRC:15 A company can only lawfully deal with its assets in furtherance of its objects. The corporators may take assets out of the company by way of dividend or, with leave of the court, by way of reduction of capital, or in a winding up. They may, of course, acquire them for full consideration. They cannot take assets out of the company by way of voluntary disposition, however described, and, if they attempt to do so, the disposition is ultra vires the company.

18.9 Later, in Progress Property Company Ltd v Moorgath Group Ltd16 in the Supreme Court, Lord Walker said that: A limited company not in liquidation cannot lawfully return capital to its shareholders except by way of a reduction of capital approved by the court. Profits may be distributed to shareholders (normally by way of dividend) but only out of distributable profits computed in accordance with the complicated provisions of the Companies Act 2006 (replacing similar provisions in the Companies Act 1985).17

18.10 What a distribution is was explained by Eve J in Re Lee, Behrens and Co Ltd18 in the following manner: whether [payments] be made under an express or implied power, all such grants involve an expenditure of the company’s money, and that money can only be spent for purposes reasonably incidental to the carrying on of the company’s business, and the validity of such grants is to be tested, as is shown in all the authorities, by the answers to three pertinent questions: (i.) Is the transaction reasonably incidental to the carrying on of the company’s business? (ii.) Is it a bona fide transaction? and (iii.) Is it done for the benefit and to promote the prosperity of the company?19

18.11 The directors are treated as if they were trustees of the company’s funds which are under their control, and if they misapply them they commit a breach of trust.20 In such situations the state of mind of the directors is irrelevant, that is whether they do so knowing the full scope of the law or out of total ignorance.21 While there might not be any repercussions for director/shareholders acting in a way that is consistent with the view that the company is their property when the company is solvent and trading successfully, the actions of directors will be subject to close investigation from a liquidator or administrator if the company 13 Ridge Securities Ltd v IRC [1964] 1 All ER 275, 288, [1964] 1 WLR 479, 495; Re Halt Garage (1964) Ltd [1982] 3 All ER 1016, 1039. 14 Re Halt Garage (1964) Ltd [1982] 3 All ER 1016, 1042. 15 [1964] 1 All ER 275, 288, [1964] 1 WLR 479, 495. 16 [2010] UKSC 55, [2011] 1 WLR 1, [2011] 2 BCLC 332, [2011] BCC 196. 17 Ibid., [1]. 18 [1932] 2 Ch 46. 19 Ibid., 51. 20 Re Lands Allotment Co [1894] 1 Ch 616, 631, 638. This breach is a breach of fiduciary duty: Belmont Finance Corp Ltd v Williams Furniture Ltd [1980] 1 All ER 393, 405; Aveling Barford Ltd v Perion Ltd [1989] BCLC 626, 630; Bairstow v Queen’s Moat Houses plc [2000] BCC 1025, 1031; Inland Revenue Commissioners v Richmond [2003] EWHC 999 (Ch), [2003] 2 BCLC 442, [135]. 21 Progress Property Co Ltd v Moorgarth Group Ltd [2010] UKSC 55, [2011] 1 WLR 1, [2011] 2 BCLC 332, [2011] BCC 196, [28].

293

U NLAW FU L DISTR IBUTIONS

becomes insolvent and enters either liquidation or administration at some point. A liquidator or administrator might decide to take proceedings against the directors for what they did pre-liquidation or pre-administration. Directors can never foresee the future, and they should have the foregoing in mind, lest the company fails at some point. Thus, their actions should be above board at all times and not able to be questioned, let alone subject to successful legal action. 18.12 Besides treating the company as their own personal fiefdom, directors may also make distributions without clearly indicating whether the payments constitute dividends, loans from the company or remuneration.22 This can lead to confusion. Distributions and the Legislative Framework Introduction 18.13 An important part of the Companies Act 2006 (‘the Act’) regulates a company’s distributions in order to ensure capital maintenance. This is Part 23. It reflects a regime that has existed in UK law for many years. The rules contained in Part 23, and which prohibit certain types of distributions, exist in order to protect creditors.23 Distributions that are not permitted under the Act are unlawful as the action is ultra vires and void.24 It is not possible for such distributions to be ratified by the members’ meeting.25 The consequences of a distribution being rendered unlawful are discussed later. 18.14 One of the primary reasons for the law prohibiting distributions is to prevent a return of capital to shareholders at a time when they are behind the creditors in terms of who gets paid and in what order, from the company’s assets. Simply the regime is to stop the shareholders and creditors (in small companies often the same people, of course) colluding in the stripping of company assets with the consequence being that the creditors lose out. In addition, the regime is designed to assist in preventing directors from transferring out of the company money and assets for improper purposes. The creditors have to accept that the company might well lose its funds in carrying on its business, but they can expect the company not to return capital in one form or another to the shareholders.26 18.15 Whilst it is fine for distributions to be made out of profits when a company is solvent, it is another thing when the distributions are made from 22 For instance, see Queensway Systems Ltd v Walker [2006] EWHC 2496 (Ch), [2007] 2 BCLC 577; Global Corporate Ltd v Hale [2018] EWCA Civ 2618, [2019] BCC 431; Re BM Electrical Solutions Ltd [2020] EWHC 2749 (Ch), [2021] 1 BCLC 638. 23 According to the Court of Appeal in Bairstow v Queen’s Moat Houses plc [2001] EWCA Civ 712, [2001] 2 BCLC 531, it is designed also to protect shareholders (at [2], [44]). 24 Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447, (1985) 1 BCC 99539, 99542; Bairstow ibid.; Aveling Barford Ltd v Perion Ltd [1989] BCLC 626, 630. 25 Precision Dippings ibid, 99543; Aveling Barford ibid, 631; Bairstow ibid; Satyam Enterprises Ltd v Burton [2021] EWCA Civ 287, [2021] BCC 640. 26 Trevor v Whitworth (1887) 12 App Cas 409, 415.

294

U NLAW FU L DISTR IBUTIONS

capital and/or the company is insolvent. The capital of the company is regarded as a pool from which creditors should be able to get paid if the company is struggling. Also, if the company is insolvent the company’s assets and funds are spoken for; they belong in a sense to the creditors who will not get paid in full (unless, they have some sort of security or priority status under the Insolvency Act). 18.16 It is possible to envisage distributions being made by companies that are dressed up to look acceptable. However, when the courts are considering whether a distribution is in breach of the legislation, no emphasis will be placed on the form of the distribution; it is a matter of substance,27 and how it is labelled is not critical.28 The statutory code is designed to avoid that difficulty by making it entirely clear on the face of the accounts whether or not a distribution is properly made.29 The task of the court is to assess the true purpose and substance of the distribution, and this entails consideration of all of the facts.30 18.17 In Re Implement Consulting Ltd31 Chief ICC Judge Briggs said that it was not necessary for courts to find that a transaction or arrangement was a sham in order to establish the true nature of the transaction under consideration. According to the judge a court ‘does not have to wear blinkers’ and ignore the purpose behind the transaction, the events leading to the making of the transaction and the carrying into effect of the intention of the directors to pay the shareholders.32 18.18 In the litigation involving Progress Property and Co Ltd at all levels of the court hierarchy, from the High Court to the Supreme Court, the proposition that whenever the company has entered into a transaction with a shareholder which results in a transfer of value not covered by distributable profits, and regardless of the purpose of the transaction, it is able to be impugned, was roundly rejected.33 Lord Walker in the Supreme Court said in Progress Property Co Ltd v Moorgarth Group Ltd,34 in giving the leading judgment, that: A relentlessly objective rule of that sort would be oppressive and unworkable. It would tend to cast doubt on any transaction between a company and a shareholder, even if negotiated at arm’s length and in perfect good faith, whenever the company proved, with hindsight, to have got significantly the worse of the transaction.35 27 Lord Mance said in Progress Property Co Ltd v Moorgarth Group Ltd [2010] UKSC 55, [2011] 1 WLR 1, [2011] 2 BCLC 332, [2011] BCC 196, [42], in approving of what was said by the New Zealand Court of Appeal in Jenkins v Harbour View Courts Ltd [1966] 1 NZLR 1, that this could be regarded as examining for the ‘essence’ of the agreement. 28 Aveling Barford Ltd v Perion Ltd [1989] BCLC 626, 631; Progress Property ibid., [16]; Madoff Securities International Ltd v Raven [2013] EWHC 3147, [204]. 29 Bairstow v Queen’s Moat Houses plc [2000] BCC 1025, 1037. 30 Progress Property Co Ltd v Moorgarth Group Ltd [2010] UKSC 55, [2011] 1 WLR 1, [2011] 2 BCLC 332, [2011] BCC 196, [1], [27]. 31 [2019] EWHC 2855 (Ch), [2020] 2 BCLC 537. 32 Ibid., [61]. 33 For instance, see Progress Property Co Ltd v Moorgarth Group Ltd [2010] UKSC 55, [2011] 1 WLR 1, [2011] 2 BCLC 332, [2011] BCC 196, [24]. 34 Ibid. 35 Ibid.

295

U NLAW FU L DISTR IBUTIONS

18.19 He went on to say that, as mentioned earlier, the court’s assignment is to assess the true purpose and substance of the distribution and in looking at all relevant facts; this might include evaluation of the state of mind of the people involved, that is, the ones who were seeking to make the distribution.36 The judge said that, on occasion, the mindset of people involved are totally irrelevant, for instance, where the distribution is a dividend that is actually paid out of capital, for it is unlawful notwithstanding how well-meaning were the directors who paid it.37 18.20 However, Lord Walker did say that subjective intentions may be relevant in some cases. He said that a distribution disguised as an arm’s length commercial transaction was the paradigm example of a situation where subjective intention was a factor: If a company sells to a shareholder at a low value assets which are difficult to value precisely, but which are potentially very valuable, the transaction may call for close scrutiny, and the company’s financial position, and the actual motives and intentions of the directors, will be highly relevant. There may be questions to be asked as to whether the company was under financial pressure compelling it to sell at an inopportune time, as to what advice was taken, how the market was tested, and how the terms of the deal were negotiated. If the conclusion is that it was a genuine arm’s length transaction then it will stand, even if it may, with hindsight, appear to have been a bad bargain. If it was an improper attempt to extract value by the pretence of an arm’s length sale, it will be held unlawful. But either conclusion will depend on a realistic assessment of all the relevant facts, not simply a retrospective valuation exercise in isolation from all other inquiries.38

18.21 Lord Walker found himself in agreement with a view expressed earlier in the Scottish Court of Session in Clydebank Football Club Ltd v Stedman39 that a mere arithmetical difference between the consideration given for the company’s asset will not of itself mean that there has been a distribution that is unlawful. If the transaction is genuine and put into place as an exchange for value and the difference does not reflect a payment that is manifestly beyond what is a justifiable reward for the asset there is not a ‘dressed up return of capital.’40 In General 18.22 The following discussion in this part will apply generally to all companies. There are some specific provisions which relate only to public companies, and they are discussed in the next part of the chapter.

36 Ibid., [27]. 37 Ibid., [28]. This is the case also with a payment which is on analysis the equivalent of a dividend. 38 Ibid., [29]. 39 2002 SLT 109, [76] per Lord Hamilton. 40 Progress Property Co Ltd v Moorgarth Group Ltd [2010] UKSC 55, [2011] 1 WLR 1, [2011] 2 BCLC 332, [2011] BCC 196, [31].

296

U NLAW FU L DISTR IBUTIONS

18.23 The company legislation defines ‘distribution’ as meaning every description of distribution of a company’s assets to its members, whether in cash or otherwise, save for certain exceptions.41 This is a broad definition. For instance, in Re Implement Consulting Ltd42 it was held that payments made to directors of the company pursuant to Employment Benefit Trust Schemes were unlawful distributions. These schemes involve a company establishing a discretionary trust for the benefit of the company’s employees, and more often than not this will be the directors; money or property will be transferred to the scheme. The most common type of distribution is the dividend payment to shareholders. Another form of distribution that is not infrequent is a payment to directors on the basis that it is classified as remuneration, whereas in reality it is a distribution to the directors, not in relation to their work as directors but in relation to their position as shareholders.43 18.24 After defining ‘distribution,’ the legislation goes on to exclude from its reach certain kinds of distributions,44 such as the issuing of fully or partly paid up bonus shares. 18.25 The general rule is that a company may only make a distribution out of profits.45 According to s 830(2): A company’s profits available for distribution are its accumulated, realised profits, so far as not previously utilised by distribution or capitalisation, less its accumulated, realised losses, so far as not previously written off in a reduction or reorganisation of capital duly made.

18.26 This requirement, which refers to a profit and loss account approach, is, according to s 830(3), subject to specific provisions, namely s 832, which addresses investment companies, and s 835, which deals with distributions out of accumulated revenue profits. The examination of these provisions is outside the scope of the book. Whether there are profits available must be determined by reference to certain accounting records, such as the company’s last annual accounts and to particular items in such accounts.46 Thus a company’s accounts have a critical role in assessing whether a company has profits for distribution for the purposes of the Act. 18.27 Whether a profit has been made or not is largely determined according to the generally accepted accounting principles.47 Only realised profits and losses can be taken into account when determining whether distributions may be paid, and realised profits obviously excludes estimated or even expected profits. The

41 Section 829(1). 42 [2019] EWHC 2855 (Ch), [2020] 2 BCLC 537. 43 Re Halt Garage (1964) Ltd [1982] 3 All ER 1016. In this case Oliver J made the point (at 1038) that there is no presumption that directors’ remuneration is payable only out of divisible profits. 44 Section 829(2). 45 Section 830(1). 46 Section 836(1). 47 Gallagher v Jones [1994] Ch 107, [1994] 2 WLR 160.

297

U NLAW FU L DISTR IBUTIONS

legislation does not define realised profits and losses, leaving it to accounting practice to determine the meaning of these terms. It is generally accepted that: profits shall be treated as realised for the purpose of applying the definition of realised profits in companies legislation only when Profits are regarded as realised for the purposes of distribution when realised in the form of cash or other assets, the ultimate cash realisation of which can be assessed with reasonable certainty.48

18.28 In assessing whether a company has a realised profit, the Institute of Chartered Accountants in England and Wales has said that transactions are not to be considered in isolation.49 ‘A realised profit will arise only where the overall commercial effect on the company is such that the definition of realised profit set out in this guidance is met.’50 18.29 Unrealised losses are not taken into account in determining profits except to the degree to which they are reflected in the accounts, unless public companies are involved, and the losses mean that the net assets of these companies are less than their called-up capital and undistributable reserves. The amount of accumulated realised losses must be subtracted before any distribution may be made and this overcomes the rule at common law that losses made in previous accounting periods do not have to be made good. 18.30 In determining whether a distribution contravenes the Act or not, s 836(1) indicates that reference is to be had to the following items, as stated in the relevant accounts: (a) (b)

profits, losses, assets and liabilities; provisions of the following kinds – (i) where the relevant accounts are Companies Act accounts, provisions of a kind specified for the purposes of this subsection by regulations under section 396; (ii) where the relevant accounts are IAS accounts, provisions of any kind; (c) share capital and reserves (including undistributable reserves).

18.31 For the most part ‘the relevant accounts’ referred to in this provision will be the company’s last accounts (separate from any group accounts),51 properly prepared in conformity with the Act, and circulated to the members as required by s 423 of the Act. However, the relevant accounts can be the interim or initial accounts if the last accounts would mean that the distribution is unlawful.52 Whichever accounts are relied on different stipulations apply,53 and these are contained in ss 837–839. If any applicable requirement fails to be complied with,

48 ICAEW, ‘Guidance on Realised and Distributable Profits Under the Companies Act’ Tech 02/17BL, April 2017, para 3.3, www.icaew.com/search#q=%20Guidance%20on%20realised%20 and%20distributable%20profits%20under%20 . . . %20-%20ICAEW%20www.icaew.com%20&sort= relevancy, accessed 29 January 2021. 49 Ibid., para 3.5. 50 Ibid. 51 Section 836(2). 52 Ibid. 53 Section 836(3).

298

U NLAW FU L DISTR IBUTIONS

the accounts may not be relied on for the purposes of this part of the Act and the distribution is accordingly treated as a contravention of Part 23.54 18.32 Where the last accounts are employed, s 837 applies. The accounts must have been properly prepared in accordance with the Act or have been so prepared subject only to matters that are not material for determining (by reference to the items mentioned in s 836(1)) whether the distribution would contravene Part 23.55 Furthermore, unless the company is exempt from audit and the directors take advantage of that exemption, the auditor must have submitted a report on the accounts,56 and if that report was qualified the auditor must have stated in writing whether in his or her opinion the matters in respect of which the report is qualified are material for determining whether a distribution would contravene Part 23.57 Compliance with this is not regarded merely as a procedural issue which is able to be dispensed with by the members entitled to vote as it and its associated provisions constitute a major protection for creditors, and the requirement of an auditor’s written statement, where the auditor’s report in the relevant accounts has been qualified, is an important part of that protection.58 18.33 Where a company has prepared and circulated accounts prior to the time when it seeks to make a distribution, but these accounts do not permit a distribution to be made, the company may rely on interim accounts.59 Interim accounts may be employed in the situation where the company has improved since its last annual accounts. The interim accounts must be accounts that enable a reasonable judgment to be made as to the amounts of the items mentioned in s 836(1) and quoted earlier.60 ‘Reasonable judgment’ in this context means the making of a reasonable judgment based on facts as reasonably perceived, or that would have been ascertained by reasonable inquiry.61 Specific requirements apply to distributions made by public companies and when based on these accounts. They are discussed next.62 18.34 In Burnden Holdings (UK) Ltd v Fielding63 Zacaroli J said that, while the formal requirements relating to the accounts of public companies, including that they be properly prepared so as to give a true and fair view, do not apply to interim accounts for private companies, it is a relevant factor, when determining ‘whether the accounts do enable a reasonable judgment to be made, to consider whether they do give a true and fair view of, for example, the profit and loss for

54 Section 836(4). 55 Section 837(2). 56 Section 837(3). 57 Section 837(4). 58 Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447, 457, (1985) 1 BCC 99539, 99543; Bairstow v Queen’s Moat Houses plc [2000] BCC 1025, 1037. 59 The directors in Global Corporate Ltd v Hale [2018] EWCA Civ 2618, [2019] BCC 431 sought to do so. 60 Section 839(1). 61 Re Paycheck Services 3 Ltd [2008] EWHC 2200 (Ch), [2009] BCC 37, [2008] 2 BCLC 613, [197]. 62 See s 838(2) and the following sub-sections. 63 [2019] EWHC 1566 (Ch).

299

U NLAW FU L DISTR IBUTIONS

the company for the period in question.’64 The judge went on later to say that in determining whether accounts satisfied the legal requirement that they show a true and fair view, the courts have ‘relied heavily upon the ordinary practices of professional accountants and that compliance with generally accepted accounting principles would be prima facie evidence of satisfaction with the standard (and vice versa).’65 18.35 Besides interim accounts, a company may rely on initial accounts to make a distribution. This is permitted where the distribution is proposed to be declared during the company’s first accounting reference period, or before any accounts have been circulated in respect of that period.66 Just as with interim accounts, there are specific requirements that apply to distributions made by public companies when distributions are based on initial accounts.67 They are discussed later in [18.49] – [18.50]. 18.36 If a company wishes to make successive distributions based on the same accounts, then it must comply with s 840. 18.37 Sections 841–844 deal with accounting matters, and they assist in explaining key parts of the Act, such as elements of s 830(2). The sections include consideration of: what are treated as realised losses and profits;68 determination of profit or loss in respect of assets where records are incomplete;69 and the treatment of development costs.70 18.38 Sections 845–846 address distributions that are made in kind, that is non-cash assets. These can be particularly difficult as far as valuation is concerned. 18.39 There are various other provisions that assist in the regulation of distributions. For instance, s 849 provides that a company must not apply an unrealised profit in paying up debentures or any amounts unpaid on its issued shares. 18.40 Of note is the fact that while Part 23 is, for the most part, a selfcontained code, the requirements and rules contained in it are supplemented by the common law principle that distributions cannot be paid out of capital. This is indicated by s 851(1). Thus, as we will see when considering the consequences of the granting of an unlawful distribution, the common law rules and equitable principles are relevant. The upshot is that a company making a distribution must adhere to both the provisions of Part 23 and the common law rule against making a distribution out of capital.71 18.41 Directors could be liable for a breach of s 172(3) of the Act in making unlawful distributions, and this is the case even if the directors comply with Part

64 65 66 67 68 69 70 71

Ibid., [188]. Ibid., [201]. Section 836(2)(b). See s 839(2) and the following and sub-sections. Section 841. Section 842. Section 844. BTI 2014 LLC v Sequana SA [2022] UKSC 25, [160], [338].

300

U NLAW FU L DISTR IBUTIONS

23, where they are under an obligation to take account of creditors’ interests and the payment is made without considering such interests.72 18.42 Likewise, distributions by directors, whether complying with Part 23 or not, might, one would think, constitute action that could contribute to a court finding that directors engaged in wrongful trading where s 214 (and s 246ZB) of the Insolvency Act applied, namely where the directors knew or ought to have concluded that the company’s insolvent administration or liquidation was inevitable. Public Companies 18.43 Directors of public companies must satisfy two additional elements before making a distribution, namely that they may only distribute: (1) if the amount of the company’s net assets is not less than the aggregate of its called up share capital and undistributable reserves; and (2) if, and to the extent that, the distribution does not reduce the amount of the company’s assets to less than the aggregate.73 In this context a company’s ‘net assets’ are the aggregate of the company’s assets less the aggregate of its liabilities,74 with ‘liabilities’ including: where the relevant accounts are Companies Act accounts, provisions of a kind specified in regulations made under s 396; where the relevant accounts are IAS (International Accounting Standards) accounts, provisions of any kind.75 18.44 Public companies are required to retain assets that will be sufficient to meet the amount of its share capital and undistributable reserves. Consequentially this will reduce the amount of funds that are available to be paid out by way of distribution. The undistributable reserves are: the company’s share premium account; the company’s capital redemption reserve; the amount by which the company’s accumulated, unrealised profits exceed the company’s accumulated, unrealised losses; any other reserve that the company is stopped from disturbing, by any legislation or under its articles.76 18.45 A public company must not include any uncalled share capital as an asset in any accounts relevant for the purposes of s 831.77 18.46 Under s 830 no account has to be taken of unrealised losses. However, under s 831, when determining the extent of any distribution in relation to public companies, unrealised losses must be taken into account, save to the degree that the unrealised losses are covered by unrealised gains.78 18.47 Section 831 applies a balance sheet approach in determining whether the company is sufficiently solvent to make a distribution. 72 73 74 75 76 77 78

Ibid., [160], [161], [342]. Also, see In re Loquitur Ltd [2003] 2 BCLC 442, [240]. Section 831(1). Section 831(2). Section 831(3). Section 831(4). Section 831(5). Section 831(4)(c).

301

U NLAW FU L DISTR IBUTIONS

18.48 It will be remembered that a company may rely on interim or initial accounts in justifying the making of a distribution. There are specific requirements applying where public companies are involved and they seek to employ these accounts. 18.49 With interim accounts the accounts must have been properly prepared, or have been so prepared subject to matters that are not material for determining whether the distribution would contravene the Act.79 In this context ‘properly prepared’ means prepared in accordance with ss 395–397.80 The balance sheet comprised in the accounts must have been signed in accordance with s 414,81 and a copy of the accounts must have been delivered to the registrar of companies.82 18.50 There are similar requirements as far as initial accounts are concerned,83 and also the company’s auditor must have made a report stating whether, in his or her opinion, the accounts have been properly prepared.84 Besides a copy of the accounts being delivered to the registrar a copy of the auditor’s report and of any auditor’s statement must also have been delivered.85 Dividends 18.51 An important element of company law and practice is that shareholders will, if possible, be paid some return on their investment in companies. This income comes in the form of dividends. Thus, from time to time, and in large companies this will often be bi-annually, dividends will be paid to shareholders. Dividends are probably the most frequent type of distribution made by companies. How dividends are paid will depend on the company’s articles, but the Model Articles86 provide that the directors will put before the shareholders a resolution that a dividend be paid to shareholders and the shareholders will decide whether the resolution should be passed or not. If the articles permit, as art 34 of the Model Articles for private companies and art 76 of the Model Articles for public companies do, non-cash dividends may be made. In putting a resolution before the shareholders, the directors must be careful that they do not breach the requirement in the Act concerning the payment of distributions. It means that directors should not pay out dividends when their company is insolvent.87

79 Section 838(3). 80 Section 838(4). 81 Section 838(5). 82 Section 838(6). 83 See s 839(3)(4). 84 Section 839(5). 85 Section 839(7). 86 Companies (Tables A–F) Regulations as amended by SI 2007/2541 and SI 2007/2826, regs 102 and 104. The Companies (Model Articles) Regulations 2008, SI 2008/3229, reg 30(1)-(4) (private companies); reg 70(1)-(3) (public companies). 87 See Re Halt Garage (1964) Ltd [1982] 3 All ER 1016.

302

U NLAW FU L DISTR IBUTIONS

18.52 It needs to be said that while perhaps the most frequent distribution made by companies, traditional dividends are not the only kinds of distributions that are subject to specific rules in the Act.88 As mentioned earlier, in smaller companies which are effectively manager-owned there is a practice of directors being paid for their services, at least partly, by way of dividend.89 The practice is that directors receive payments throughout the financial year and initially they are regarded as dividends, but where the company does not have adequate distributable reserves they are, ex post, re-labelled as salary. Liability for Unlawful Distributions 18.53 What is particularly important in the context of this book is what liability is imposed, especially as far as the directors are concerned, in relation to a distribution that is regarded as unlawful as it is in breach of the Act? Member Liability 18.54 While this book focuses on directors and their potential liability, to be comprehensive we should note that shareholders who receive an unlawful dividend or other distribution may be liable to return the payment or other transfer to the company. This can be important sometimes for directors in small private companies especially as they will usually hold significant shareholdings and will have, themselves, received distributions. They can, therefore, be liable to make returns qua shareholders. 18.55 Liability can be imposed on shareholders both at common law and under statute. At common law shareholders who received an unlawful cash distribution could be liable to repay it on one of two bases, namely either that of money had and received or on the basis that their state of knowledge in receiving trust property, namely company funds,90 was such that it would be unconscionable for shareholders to retain the distribution.91 In this latter situation it would have to be established that the members knew that what was received was traceable to a breach of fiduciary duty.92 If shareholders were liable under this second basis then they would be holding the dividend as constructive trustees for the company.93 88 See Progress Property Co Ltd v Moorgarth Group Ltd [2010] UKSC 55, [2011] 1 WLR 1, [2011] 2 BCLC 332, [2011] BCC 196. 89 For instance, see Global Corporate Ltd v Hale [2018] EWCA Civ 2618. 90 Belmont Finance Corp Ltd v Williams Furniture Ltd [1980] 1 All ER 393, 405. 91 Bank of Credit and Commerce International (Overseas) Ltd v Akindele [2001] Ch 437, 455. 92 El Ajou v Dollar Land Holdings plc [1994] 2 All ER 685, 700. For an example, see Precision Dippings Ltd v Precision Dippings Marketing Ltd (1985) 1 BCC 99539, 99543. For a discussion of ‘knowing receipt’ in the context of directors’ breach of duty, see Andrew Keay, Directors’ Duties (4th ed, LexisNexis, 2020), Ch 15. 93 Belmont Finance Corp Ltd v Williams Furniture Ltd [1980] 1 All ER 393, 405; Aveling Barford Ltd v Perion Ltd [1989] BCLC 626, 630; Precision Dippings ibid.; It’s A Wrap (UK) Ltd v Gula [2006] EWCA Civ 544, [2006] BCC 626, [12].

303

U NLAW FU L DISTR IBUTIONS

18.56 Shareholders may also be liable under statute if at the time of the distribution the member either knows or has reasonable grounds for believing that it is made in breach of the Act.94 18.57 This statutory liability is without prejudice to any obligation that is imposed on shareholders outside of the legislation,95 such as the liability at common law and in equity discussed in 18.55. Liability would mean that the shareholder is liable to repay it to the company, or in the case of a distribution made otherwise than in cash, to pay the company a sum equal to the value of the distribution at that time.96 The liability provided for is strict.97 18.58 For a member to have the required belief for liability it is not necessary that he or she knew that the distribution would breach the Act; it is sufficient if the member knew or had reasonable grounds for believing the relevant facts that constituted the breach.98 This is fact-based knowledge.99 18.59 It’s A Wrap (UK) Ltd v Gula100 provides a helpful explanation as to how the statutory remedy applies. In this case the Court of Appeal said that it was unnecessary for the shareholders to be aware of the statutory provisions and what they provided for, before being held liable. It was sufficient that the shareholders knew the facts that constituted a breach of the legislation. Liability does not turn on whether the shareholders know of the legal rules surrounding distributions. In this case the shareholders knew that the company had no profits, so that was sufficient for there to be a breach. 18.60 There is some uncertainty as to what ‘reasonable grounds for believing’ means. The phrase was considered in It’s a Wrap (UK) Ltd v Gula even though it was not necessary on the facts. Arden LJ referred to the kind of knowledge involved with reasonable grounds for believing as constructive knowledge.101 That would mean that shareholders are liable if the facts were able to be ascertained by proper inquiries, and even if these inquiries were not in fact made. While agreeing with her Ladyship on most matters in this case and that the words ‘reasonable grounds for believing’ do not require proof of actual knowledge, Chadwick LJ disagreed that the kind of knowledge mentioned here could be said to be constructive knowledge. He did so on the basis that the phrase ‘knows or has reasonable grounds for believing’ in s 847(2) does not have the same meaning as ‘knows or ought to know.’102 The judge said that: ‘The knowledge which the legislature has sought to describe . . . is, I think, knowledge which the member has and knowledge which the member “must be taken to have” or, 94 Section 847(2). 95 Section 847(3). 96 Section 847(2). For a case that dealt with this, see It’s a Wrap (UK) Ltd v Gula [2006] EWCA Civ 544, [2006] BCC 626. 97 Re Implement Consulting Ltd [2019] EWHC 2855 (Ch), [2020] 2 BCLC 537, [98]. 98 Ibid., [23], [27], [38]-[39], [43], [49]. 99 Ibid. 100 [2006] EWCA Civ 544, [2006] BCC 626. 101 Ibid., [1]. Nelson J in Bairstow v Queen’s Moat Houses plc [2000] BCC 1025, 1031, had also referred to the second kind of knowledge as constructive knowledge. 102 [2006] EWCA Civ 544, [2006] BCC 626, [52].

304

U NLAW FU L DISTR IBUTIONS

perhaps, “may reasonably be taken to have.”’103 Under this alternative approach a person who is aware of an error in the accounts with the result being that the amount of distributable profits is overstated, but who does not know the exact extent of the overstatement because they have not inquired sufficiently must be taken to know, or have reasonable grounds for knowing, the actual overstatement. 18.61 As the issue was not relevant for deciding the case, the respective judicial statements just referred to are obiter, at best. In any event where public companies are concerned most of the shareholders are unlikely to know about the circumstances associated with a distribution. They rely on the directors to make a decision about whether the company can afford to make the distribution and they are, therefore, unlikely to be liable. It is likely that whichever of the two approaches mentioned earlier is taken, in many cases the result will be the same. This was the case in Re SSF Realisations Ltd v Loch Fyne Oysters Ltd104 where Zacaroli J held that a director was liable whether he applied the approach endorsed by Arden LJ or the one endorsed by Chadwick LJ. As far as shareholders who are also directors are concerned, they are regarded as having actual knowledge of the relevant facts constituting the contravention.105 18.62 Shareholders who are held to have been in receipt of an unlawful distribution in breach of the legislation have no defence that they acted on advice. They are left to suing the person who gave them inaccurate advice, if it possible.106 As a constructive trustee the shareholder would be able to claim that he or she was entitled in appropriate circumstances to relief under s 61 of the Trustee Act 1925, the equivalent (for trustees) in the Trustee Act of s 1157 of the Act (company officers).107 This relief is discussed later. 18.63 Shareholders in small private companies are far more likely to be aware of the facts. Directors who are also shareholders are likely to have grave difficulty in establishing that they did not know or did not have reasonable grounds for believing that the dividends were not paid out of distributable profits. 18.64 Furthermore, members could be held liable and required to repay dividends under s 423 of the Insolvency Act 1986 on the basis that the payment of dividends is, according to the Court of Appeal in BTI 2014 LLC v Sequana,108 capable of constituting a transaction defrauding creditors if the company can be said to have had as its purpose in paying the dividends an intention to put assets beyond the reach of creditors.109 Liability under s 423 is not dependent 103 Ibid., [54]. 104 [2020] EWHC 3521 (Ch), [2021] BCC 354, [125]. 105 Re Implement Consulting Ltd [2019] EWHC 2855 (Ch), [2020] 2 BCLC 537, [81]. 106 Ibid., [12]. 107 Ibid. 108 [2019] EWCA Civ 119, [2019] 1 BCLC 347, [2019] BPIR 562. 109 For detailed discussion of the provision, see Rebecca Parry et al., Transaction Avoidance in Insolvencies (2nd ed, OUP, 2011); John Armour, ‘Transactions Defrauding Creditors’ in J Armour and H Bennett (eds), Vulnerable Transactions in Corporate Insolvency (Hart Publishing, 2003); Andrew Keay, McPherson and Keay’s Law of Company Liquidation (5th ed, Sweet and Maxwell, 2021), [11–112]–[11–130].

305

U NLAW FU L DISTR IBUTIONS

on the knowledge of the third party to whom a debtor company makes a payment or transfer. What has to be established is that the company had, in making the dividends, the purpose of placing company assets beyond the reach of their creditors. The main focus of s 423 is preventing debtors from disposing of assets so as to frustrate their creditors. The overriding objective of the section is to recover assets for the victims of the distribution so as to protect their interests.110 18.65 Liability under s 423 means that the courts would have a broader discretion as to what order they can make, when compared with a breach of Part 23 of the Act, although for the most part the order will be that the dividends be repaid to the company. Also, the discretion granted to the courts allows them to take into account all the circumstances of the different parties involved, in fashioning a just and appropriate remedy,111 and there are some circumstances in which the court can decide that it is not appropriate for there to be any remedy imposed. This would only be in an exceptional case,112 but there might be situations where the shareholders had no knowledge of the company’s finances, and the attitude of the directors might mean that a court would view that as exceptional. If there was a likelihood of this, a liquidator would be more likely to pursue an action against the directors. It is to the liability of directors to which we now turn. Director Liability 18.66 While Part 23 of the Companies Act does not provide specifically that the directors are liable for unlawful distributions, the common law does,113 and other parts of the Act might also be relied on. Probably, where there is an alleged unlawful distribution, most actions are taken against the directors, who might also be, especially in small to medium-sized companies, the members in receipt of the distribution.114 18.67 Before the advent of the Act directors were held liable for making unlawful distributions on the basis of a breach of trust115 or negligence.116 These bases for liability remain.117 Now, liability might also be based on a breach of one of the codified general duties of directors in the Act, namely those contained in ss 171–177, with ss 171, 172(1) and/or 174 being the most likely candidates as they provide appropriate successors to the duties at common law and in equity.118

110 BTI 2014 LLC v Sequana SA [2017] EWHC 211 (Ch), [25]. 111 Ibid., [24]. 112 Chohan v Saggar [1992] BCC 750; National Westminster Bank Plc v Jones [2000] BPIR 1092, 1112–1113; BTI 2014 LLC v Sequana SA [2017] EWHC 211 (Ch), [24]. 113 For example, see Evans v Coventry (1856) 25 LH Ch 489, 501. 114 For example, see Global Corporate Ltd v Hale [2018] EWCA Civ 2618, [2019] BCC 431. 115 Re Halt Garage (1964) Ltd [1982] 3 All ER 1016, 1034. The breach of trust is in the nature of a breach of fiduciary duty: Aveling Barford Ltd v Perion Ltd [1989] BCLC 626, 630. 116 Bairstow v Queen’s Moat Houses plc [2000] BCC 1025. 117 For example, see Belmont Finance Corp Ltd v Williams Furniture Ltd [1980] 1 All ER 393; Bairstow v Queen’s Moat Houses plc [2001] EWCA Civ 712, [2001] 2 BCLC 531. 118 See, Re TMG Brokers Ltd [2021] EWHC 106 (Ch), where the judge held the directors liable for breach of duty where there were unlawful distributions of capital (at [112]).

306

U NLAW FU L DISTR IBUTIONS

18.68 The basis for the notion that the directors are liable for unlawfully distributing company property, and it is long-standing,119 is that the directors are regarded as the trustees of the company’s property and the payment would constitute an unlawful distribution of the company’s assets out of capital.120 If a director is held liable, then the order will be that the director must repay the funds paid out by way of distributions.121 It is usually pleaded that directors who grant unlawful distributions are in breach of duty or breach of trust and action is instituted pursuant to s 212 of the Act (the so-called misfeasance provision).122 Such proceedings were discussed in Chapter 4. 18.69 To be liable for breach of trust a director must be proved to be at fault.123 18.70 Directors will be liable if they had actual knowledge of the fact that there were insufficient profits for a valid distribution or they ought to have known that this state of affairs existed, the latter being based on a reasonably diligent director test.124 18.71 As mentioned earlier in the chapter, where there are unlawful distributions an action could also be brought when the obligation under s 172(3) is triggered, that is, when the company is insolvent, bordering on insolvency or where insolvent administration or liquidation is inevitable,125 something obviously discussed in detail in Part D of the book. 18.72 The prospect of liability should focus the minds of directors and should also help them to resist pressure from shareholders to recommend the declaration of dividends if the company has insufficient profits to satisfy dividends, and also to make other payments, especially to themselves, that are not in the ordinary course of business. 18.73 All of this means that the directors need to satisfy themselves that their company has distributable profits from which distributions can be made. This involves, inter alia, taking into account those matters referred to earlier and enumerated in s 830. Naturally, if a company is insolvent, it will not have distributable profits, so no dividends should be paid out. It is the case that a company might be technically solvent, but still distributions should not be made because the requirements of the Act are not able to be adhered to. 18.74 When considering whether a distribution is unlawful the intention or state of mind of the directors when authorising the distribution is not relevant; 119 See Re Exchange Banking Co (1882) 21 Ch D 519, 534, CA; Re Lands Allotment Co [1894] 1 Ch 616. 120 Re Exchange Banking, ibid.; Belmont Finance Corp Ltd v Williams Furniture Ltd [1980] 1 All ER 393, 405; Bairstow v Queen’s Moat Houses plc [2001] EWCA Civ 712, [2001] 2 BCLC 531, [44], [50], [51]. 121 Re Paycheck Services 3 Ltd [2009] EWCA Civ 625, [2010] BCC 104; Re Paycheck Services 3 Ltd [2010] UKSC 51, [2010] 1 WLR 2793, [2011] BCC 1, [2011] 1 BCLC 141, [48]–[49]. 122 For instance, see The Commissioners of Inland Revenue v Richmond [2003] EWHC 999 (Ch); Re Paycheck Services 3 Ltd [2010] UKSC 51, [2010] 1 WLR 2793, [2011] 1 BCLC 141; Liquidator of Marini Ltd v Dickenson [2003] EWHC 334 (Ch), [2004] BCC 172. 123 Bairstow v Queen’s Moat Houses plc [2000] BCC 1025, 1032. 124 Ibid., 1041. 125 BTI 2014 LLC v Sequana S.A. [2022] UKSC 25, [160], [338]. The fact that the distribution could be a breach of the s 172(3) obligation was also accepted by the Court of Appeal in this case ([2019] EWCA Civ 119, [2019] 1 BCLC 347, [2019] BPIR 562, [220]).

307

U NLAW FU L DISTR IBUTIONS

the focus must be purely on whether the payments when made were lawful distributions of the company’s assets.126 18.75 According to Nelson J in Bairstow v Queens Moat Houses plc127 a director who, in breach of his or her duty, pays an unlawful distribution is liable: (1) (2)

(3) (4)

if he knows that the dividends were unlawful, whether or not that actual knowledge amounts to fraud, or if he knows the facts that established the impropriety of the payments, even though he was unaware that such impropriety rendered the payment unlawful (Re Kingston Cotton Mill Co [1896] 1 Ch 331 at p. 347 and Precision Dippings Ltd ((1985) 1 BCC 99,539) at p. 99,543), if he must be taken in all the circumstances to know all the facts which render the payments unlawful (Precision Dippings Ltd at p. 99,543), if he ought to have known, as a reasonably competent and diligent director, that the payments were unlawful (Norman v Theodore Goddard [1992] BCC 14, Re D’Jan of London Ltd [1993] BCC 646 and s. 214 of the Insolvency Act 1986).128

18.76 In determining whether directors are liable or not, there has been, historically, some uncertainty as to whether liability is decided on the basis that directors are strictly liable, that is if an unlawful distribution occurred the directors are liable without any consideration being given to any fault, involving negligence or dishonesty, on the part of the directors. In the Court of Appeal in Re Paycheck Services 3 Ltd129 counsel for the respondent director identified two lines of authority,130 one supporting the notion of strict liability131 and the other requiring fault for liability to ensue.132 Opposing counsel pointed out that relief under what is now s 1157 of the Act went back only to the Companies Act 1907 (s 32) and so was not available when most of the cases in the line of authority requiring fault were decided, and now relief from liability is available under s 1157 counsel submitted that the court should prefer the view that a director should in principle be strictly answerable to a claim to make good the misapplication of

126 Global Corporate Ltd v Hale [2018] EWCA Civ 2618, [2019] BCC 431, [24]. 127 [2000] BCC 1025. The decision of Nelson J was reversed on appeal, but the Court of Appeal did not take issue with what Nelson J said about the situations when liability occurs. 128 Ibid., 1033. 129 [2009] EWCA Civ 625, [2010] BCC 104. 130 Ibid., [82]. 131 Re Exchange Banking Co (1882) LR 21 Ch D 591; Re Lands Allotment Co [1894] 1 Ch 616, 638; Re Sharpe, Masonic and General Life Assurance Company v Sharpe [1892] 1 Ch 154; Selangor United Rubber Estates Ltd v Cradock (No.3) [1968] 1 WLR 1555, 1575; Belmont Finance Corp v Williams Furniture Ltd (No.2) [1980] 1 All ER 393, 404; Bairstow v Queens Moat Houses Plc [2000] BCC 1,025, 1,030; Re Loquitur Ltd; Inland Revenue Commissioners v Richmond [2003] EWHC 999 (Ch); [2003] 2 BCLC 442, 471 and 472. 132 Re County Marine Insurance Co (1870–71) 6 LR Ch App 104, 118, and 122; Re Kingston Cotton Mill Co (No.2) [1896] 1 Ch 331, 345–348; Dovey v Cory [1901] AC 477; Re City Equitable Fire Insurance Co Ltd [1925] Ch 407, 426.

308

U NLAW FU L DISTR IBUTIONS

funds, subject to possible relief under s 1157.133 Rimer LJ, who gave the leading judgment said that he found this latter submission ‘compelling.’134 18.77 The case went on appeal to the Supreme Court and in his judgment Lord Hope referred to the two strands of authority identified in the submissions of counsel to the Court of Appeal and contained in the judgment of Rimer LJ.135 Lord Hope noted that it was not necessary in the case before the Supreme Court to make a decision on which view was correct, but he said that the better view was that where a distribution was unlawful, the director who causes the payment is strictly liable, subject to a right to claim relief under s 1157,136 or under s 212 of the Insolvency Act 1986.137 We will return to these latter two sections shortly. Lord Walker said in his judgment that he agreed with Rimer LJ and this would include what the latter said about the liability being strict.138 At the end of his judgment, after dealing with some issues but not the issue of strict liability, Lord Clarke expressed his agreement with Lord Walker on ‘all other issues,’139 thus one can assume that he agreed with Lord Walker on the strict liability point. Therefore, while judges in both the Court of Appeal and the Supreme Court addressed the issue of strict liability, they left it open as to what was in fact the correct approach, although they seemed to favour strict liability. 18.78 Given the views expressed by the various judges in the Paycheck litigation, it might seem surprising that, more recently, Zacaroli J held in Burnden Holdings (UK) Ltd v Fielding,140 after a thorough review of the relevant case law, that directors would only be liable if they had known or ought reasonably to have known that the distribution entailed a misapplication of company finds.141 Thus, the judge found that there was not a rule of strict liability.142 The review undertaken by his Lordship led him to believe that the trend of seeing liability of directors for unlawful dividends as strict did not exist in the modern authorities.143 The result of what Zacaroli J said is that directors should only be seen as liable if they know that a distribution is unlawful or that they know the facts that indicate that the distribution is unlawful or directors ought to have known that the distribution was unlawful. Importantly for directors they are permitted to rely on professional advice and judgment, and they are not 133 [2009] EWCA Civ 625, [2010] BCC 104, [83]. 134 Ibid., [84]. 135 Re Paycheck Services 3 Ltd [2010] UKSC 51, [2010] 1 WLR 2793, [2011] 1 BCLC 141, [45]. 136 In Bairstow v Queen’s Moat Houses plc [2000] BCC 1025 Nelson gave relief, under s 1157’s precursor, in relation to some dividends paid, although this order on relief was overturned on appeal (Bairstow v Queen’s Moat Houses plc [2001] EWCA Civ 712, [2001] 2 BCLC 531). 137 Section 212 provides that a court may make such order as it thinks just. 138 Re Paycheck Services 3 Ltd [2010] UKSC 51, [2010] 1 WLR 2793, [2011] 1 BCLC 141, [124]. 139 Ibid., [146]. 140 [2019] EWHC 1566 (Ch); [2020] BPIR 1. 141 Ibid., [139]. Also, see SSF Realisations Ltd v Loch Fyne Oysters Ltd [2020] EWHC 3521 (Ch), [2021] BCC 354. The fault-based approach favoured by Zacaroli J in Burnden was followed in Reynolds (as Liquidator of CSB 123 Limited) v Stanbury [2021] EWHC 2506 (Ch), [504]. 142 There are some earlier authorities (in the nineteenth century) that did suggest strict liability applied. 143 [2019] EWHC 1566 (Ch), [2020] BPIR 1, [154].

309

U NLAW FU L DISTR IBUTIONS

expected to be trained accountants. Therefore, if directors exercise due care in having the accounts prepared properly and these accounts demonstrate the fact that sufficient profits are available for distribution, they will not be liable if, at a later stage, it is established that the profits were not sufficient. The comments by the judge in the case were obiter, but given the extent of analysis undertaken, and the careful comments made by the judge, his view is likely to be persuasive if and when considered in the future. 18.79 Directors were, according to Zacaroli J, entitled to rely on the opinion of others with specialist financial roles within the company and, in particular, the auditors concerning the accuracy of statements that appear in the company’s accounts.144 He believed that this view was supported by the comments of Lord Davey and Lord Halsbury LC in 1901 in Dovey v Cory145 and that the position had not changed since 1901.146 The only change that had occurred since 1901 was, in the opinion of Zacaroli J, the standard expected of directors, and this was highlighted by Nelson J in Bairstow v Queen’s Moat Houses plc.147 18.80 Nevertheless, directors do not have an easy ride, for when a dividend is prima facie not paid out of profit, the burden of proving that it was paid out of profit lies on the directors to excuse themselves.148 18.81 If the company which makes an unlawful distribution has wholly owned subsidiaries which themselves have distributable profits which could lawfully and prudently have been paid to the holding company by way of dividend, that would not save the directors from being liable. It might, however, go towards a consideration of relief under s 1157.149 18.82 A director who is found liable is required to account to the company for the full amount of the distributions and restore them, and not just loss sustained by the company flowing from the unlawful payments.150 The remedy against the director is not for equitable compensation or damages, but for reinstatement of the sum paid out and based on the fact that the director has trustee-like duties. Although, where a distribution is partly justified, according to the decision of HH Judge Seymour QC (sitting as a High Court judge) in Liquidator of Marini Ltd v Dickenson,151 the directors may only be liable for that part of the distribution that is unlawful where there were properly drawn sets of accounts in existence which would permit a partial payment.152 The judge 144 Ibid., [139], [158]. 145 [1901] AC 47. 146 [2019] EWHC 1566 (Ch), [2020] BPIR 1, [158]. 147 [2000] BCC 1025. 148 Rance’s Case (1870) LR 6 Ch App 104, 123; Leeds Estate, Building and Investment Co v Shepherd (1887) 36 Ch D 787, 804; Dovey and the Metropolitan Bank (of England and Wales) Ltd v John Cory [1901] AC 477, 490. 149 Bairstow v Queen’s Moat Houses plc [2001] EWCA Civ 712, [2001] 2 BCLC 531, [36], [54]. 150 Re Paycheck Services 3 Ltd [2009] EWCA Civ 625, [2010] BCC 104, [98]. Members of the Supreme Court agreed on appeal, at [2010] UKSC 51, [2010] 1 WLR 2793, [2011] BCC 1, [2011] 1 BCLC 141. 151 [2003] EWHC 334 (Ch), [2004] BCC 172. 152 Ibid., [43]. Also, see SSF Realisations Ltd v Loch Fyne Oysters Ltd [2020] EWHC 3521 (Ch), [2021] BCC 354, [103], [112].

310

U NLAW FU L DISTR IBUTIONS

relied153 to some extent on comments in the judgment of Nelson J in Bairstow v Queen’s Moat Houses plc154 whose comments, insofar as they touched on the issue, were not disapproved of on appeal.155 Importantly, a director will only be held to be not liable for distributions where they were justified by accounts that were drawn up properly.156 18.83 Directors who are parties to the payment of an unlawful distribution are prima facie jointly and severally liable to repay the amount.157 Auditor Liability 18.84 Where there is an unlawful distribution, the company may have, in the alternative or in addition, to its action against the directors an action against its auditors if they did not act carefully (or acted fraudulently) in the formulation of the company’s accounts and the accounts had not been prepared properly and did not provide a true and fair view of the company’s financial position.158 Relief From Liability 18.85 Is there any relief open to directors who transgress in making distributions that are unlawful? First, we must note that directors cannot rely on the Duomatic principle to validate ultra vires acts, such as an unlawful distribution of capital.159 The principle articulated in the case of Re Duomatic Ltd160 was that a director may have a defence to a claim of breach of duty if the matter was ratified by the unanimous vote of the shareholders.161 18.86 A director who is liable may be able to seek relief under s 1157 of the Act,162 discussed earlier in the book, where the director acted honestly and reasonably, or under s 212 of the Insolvency Act 1986 where the court is willing to exercise its wide discretion as far as the order that it makes.163

153 Ibid., [45]. 154 [2000] BCC 1025, 1039. 155 Bairstow v Queen’s Moat Houses plc [2001] EWCA Civ 712, [2001] 2 BCLC 531. 156 LRH Services Ltd v Trew [2018] EWHC 600 (Ch). 157 Queensway Systems Ltd v Walker [2006] EWHC 2496 (Ch), [2007] 2 BCLC 577. 158 For a decision where an auditor was held liable, see Segenhoe Ltd v Akins (1990) 8 ACLC 263. 159 Ultraframe (UK) Ltd v Fielding & Ors [2005] EWHC 1638 (Ch); Re TMG Brokers Ltd [2021] EWHC 1006 (Ch); Satyam Enterprises Ltd v Burton [2021] EWCA Civ 287, [2021] BCC 640. 160 [1969] 2 Ch 365, [1969] 2 WLR 114, [1969] 1 All ER 161. 161 Ciban Management Corp v Citco (BVI) Ltd [2020] UKPC 21, [2021] AC 122, [2020] BCC 964. 162 In Bairstow v Queen’s Moat Houses plc [2000] BCC 1025 Nelson gave relief, under s 1157’s precursor, in relation to some dividends paid, although this order on relief was overturned on appeal (at [2001] EWCA Civ 712, [2001] 2 BCLC 531). In many cases relief was sought but not granted. For instance, see Inland Revenue Commissioners v Richmond [2003] EWHC 999 (Ch); [2003] 2 BCLC 442; Liquidator of Marini Ltd v Dickenson [2003] EWHC 334 (Ch), [2004] BCC 172. For cases where relief was granted, see Atkinson v Kingsley [2020] EWHC 2913 (Ch); SSF Realisations Ltd v Loch Fyne Oysters Ltd [2020] EWHC 3521 (Ch), [2021] BCC 354, [137]. 163 Section 212 provides that a court may make such order as it thinks just.

311

U NLAW FU L DISTR IBUTIONS

18.87 The judgment of Robert Walker LJ (as he then was) in the decision of Bairstow v Queen’s Moat Houses plc164 seemed to suggest that s 1157 might be employed to relieve directors from liability where, if the right processes had been invoked, the distribution made would not have been unlawful.165 In that case counsel for the directors contended that the subsidiary companies of the company from which the unlawful distribution emanated could have lawfully declared and paid dividends to the parent company, which, had they been declared and paid, would have increased the distributable profits of the parent and meant that there would not have been an unlawful distribution. This did not happen, so, according to the judge, the accounts had to be taken at face value and not as they might have been if some different course had been taken. The circumstances of the subsidiary companies and the fact that a dividend could have been made in favour of the parent company was a matter that could not go to liability, but possibly as to whether the court should give relief.166 18.88 The discretion which the court has in s 212 of the Insolvency Act is not one that relates to liability but merely is a discretion concerning relief.167 This provision does not permit a judge to fix the amount to be paid by a respondent by reference to vague notions of fairness, but enables the court to require the wrongdoer to restore what is just in all the circumstances.168 In the vast majority of cases the directors who have been found liable for making unlawful distributions have failed to gain relief.169 18.89 The previous paragraphs might cause one to ask how s 1157 and s 212 interrelate, if at all? In the Court of Appeal in Re Paycheck Services 3 Ltd170 Ward LJ addressed that and said: It seems to me that s.212 provides the remedy where the officer of the company has misapplied any money but then gives the court a discretion to compel payment of part of the money only if that is what the court thinks just. It is a twofold exercise: (1) establish how much has been misapplied . . . and (2) decide according to the justice of the case whether only a part of it should be repaid. The criterion for the exercise of the latter discretion is the justice of the case depending on all the circumstances of the case. I have no difficulty in considering justice to be a proper, principled guide to the exercise of discretion.

164 [2001] EWCA Civ 712, [2001] 2 BCLC 531. 165 Ibid., [36]. 166 Ibid. 167 See Re Paycheck Services 3 Ltd [2009] EWCA Civ 625, [2010] BCC 104, [110], [129] where Rimer LJ referred to Liquidator of West Mercia Safetywear Ltd v Dodd (1988) 4 BCC 30 as an instance of a case where s 212 was used to provide relief. For a discussion of the relief in s 212, see Inland Revenue Commissioners v Richmond [2003] EWHC 999 (Ch); [2003] 2 BCLC 442. 168 Re Paycheck Services 3 Ltd [2009] EWCA Civ 625, [2010] BCC 104, [129]. 169 For instance, see Bairstow v Queen’s Moat Houses plc [2001] EWCA Civ 712, [2001] 2 BCLC 531; LRH Services Ltd v Trew [2018] EWHC 600 (Ch), [199]. The director in Re Paycheck Services 3 succeeded in obtaining relief at first instance ([2008] EWHC 2200 (Ch), [2009] BCC 37, [2008] 2 BCLC 613). 170 [2009] EWCA Civ 625, [2010] BCC 104.

312

U NLAW FU L DISTR IBUTIONS

Having fixed the amount of the liability under s.212, it seems to me that the court has a further dispensatory power afforded by s.727 [now s 1157 of the Act] provided the officer has acted both honestly and reasonably.171

18.90 Whether s 1157 can ever be employed in relation to a case where directors have received unlawful distributions is not clear-cut. ICC Judge Burton in TMG Brokers Ltd v Staines172 refused to grant relief to the directors who were found to have breached their duties where one of the directors had made unlawful distributions of company capital. The judge, following comments in Toone v Robbins,173 said that s 1157 could not be relied on where money was unlawfully received by directors.174 Yet, there are indications elsewhere that in limited cases directors might be granted relief. In Inn Spirit Ltd v Burns,175 the judge refused to grant summary judgment against directors, as he recognised that the defendants might be able to seek relief under the precursor of s 1157. Although the judge did say that he felt that a court would not be able to grant relief, as it could not say that the directo3rs ought fairly to be excused from liability.176 Also, in Queensway Systems Ltd v Walker177 the deputy judge refused to accede to an application for relief under s 727, but he did not suggest that the application was not available to a director. Furthermore, Zacaroli J said in Burnden Holdings (UK) Ltd v Fielding178 that he would not suggest that the discretion in s 1157 was fettered in such a way that a court could never relieve directors from liability in circumstances where they receive unlawful dividends, even where the company subsequently goes into liquidation so that the retention of the dividend can be said to be at the expense of creditors, but the very fact that a director received a benefit at the expense of creditors was a powerful factor against granting relief.179 He went on to say that: Whether that factor is enough to preclude relief being granted will depend upon matters such as the causal link between the dividend and prejudice to creditors, the length of time between the dividend and the action being commenced and whether the director retains the benefit of the dividend.180

18.91 The judge was of the opinion that what was of particular relevance in deciding whether relief could be afforded, was the extent to which the distribution could lawfully have been made in the circumstances existing at the time it was made.181

171 172 173 174 175 176 177 178 179 180 181

Ibid., [141]–[142]. [2021] EWHC 2033. [2018] EWHC 569. [2021] EWHC 2033, [148]. [2002] EWHC 1731 (Ch), [2002] 2 BCLC 780. Ibid., [30]. [2006] EWHC 2496 (Ch), [2007] 2 BCLC 577. [2019] EWHC 1566 (Ch), [2020] BPIR 1. Ibid., [413]. Ibid. Ibid., [414].

313

U NLAW FU L DISTR IBUTIONS

Conclusion 18.92 The chapter has been concerned with distributions that are made by directors to themselves, shareholders or third parties out of company funds. Distributions are unlawful unless they comply with the companies’ legislation. Distributions are not to be made out of the capital of the company, even to shareholders, unless the provisions of the Companies Act are followed, with the provisions existing to protect creditors. The chapter explained what distributions may be made and who might be liable where unlawful distributions are granted and what relief from liability might be available. The chapter also noted that distributions might also constitute a breach of the obligation of directors to consider the interests of the creditors, if the obligation under s 172(3) has been triggered, and unlawful distributions might also be taken into account when considering a claim for wrongful trading.

314

INDEX

auditor liability for unlawful distributions 18.84 cessation of business in wrongful trading defence 10.44–10.48 claimants and actions claimants 4.2–4.5 misfeasance 4.9–4.14 proceedings 4.6–4.8 commencement of proceedings determining liability and 16.46–16.54 disadvantages with 16.35–16.45 limitations of actions in 16.25–16.34 relationship to wrongful trading 16.18–16.24 respondents to 16.12–16.17 who can initiate 16.3–16.11 Companies Act 2006 obligation to consider interests of creditors cases post 12.54–12.63 relief from liability under 11.4–11.28 Section 172(3) 12.44–12.53 compensation, wrongful trading 9.151–9.154 compliance with obligation to consider interests of creditors balancing in 15.35–15.48 circumstances short of insolvency in 15.25–15.31 content of duty in 15.10–15.32 context of 15.4–15.9 creditors as class and preference-like payments and 15.95–15.119 factors and issues in considering creditor interests in 15.56–15.70 general issues in creditors v creditors and 15.71–15.77 insolvency and 15.13–15.20 nature of consideration to be given in 15.33–15.119

paramountcy of creditor interests in 15.49–15.55 scheme of arrangement jurisprudence and 15.84–15.94 summary on 15.32 when insolvent liquidation or administration is probable 15.21–15.24 wrongful trading case law and 15.78–15.83 conditions for liability, fraudulent trading 6.77–6.103 consensual creditors 3.9 protection of 3.25 contingent debts 3.5 contractual protection 3.25–3.31 creditors company owing responsibilities to 13.48 consensual 3.9 contingent debts and 3.5 customers as 3.22 defined 3.2–3.4 economic interests and obligation to 13.46–13.47 employees as 3.18–3.19 fraud on 13.34–13.41 future debts and 3.7 intent to defraud and fraudulent purpose and 7.3–7.4 involuntary 3.23 kinds of 3.8–3.23 preferential 3.14 proprietary interests of 13.42–13.45 prospective debts and 3.6 protection of 3.24–3.37 retention of title 3.20 revenue authorities 3.15–3.17 secured 3.10 special relationship 3.21

315

I N DEX

unpaid debts and 1.1–1.2 unsecured 3.11–3.13 criminal proceedings, fraudulent trading 6.67–6.76 customers as creditors 3.22 debts contingent 3.5 creditors and unpaid 1.1–1.2 future 3.7 payment of, with existing money in wrongful trading cases 9.155–9.162 prospective 3.6 de facto directors 2.5, 2.9–2.16 distinguished from shadow directors 2.22–2.25 de jure directors 2.5, 2.7–2.8 determination of liability 16.46–16.54 development of obligation to consider interests of creditors cases post Companies Act 2006 12.54–12.63 conclusion on 12.72–12.75 evolution of 12.8–12.72 genesis of 12.8–12.11 introduction to 12.1–12.7 judicial opinion in the UK in the 1990s and early 2000s 12.25–12.43 Section 172(3) of the Companies Act 2006: The Statutory Aid 12.44–12.53 Supreme Court in Sequana and 12.64–12.71 UK developments of the last century in 12.12–12.24 directors 1.3–1.10 de facto 2.5, 2.9–2.16, 2.22–2.25 de jure 2.5, 2.7–2.8 distinguishing between de facto and shadow directors 2.22–2.25 executive and non-executive 2.5, 2.26–2.30 general information on 2.2–2.6 liability for unlawful distributions 18.66–18.83 liability in fraudulent trading 6.35–6.43 number of 2.3 pre-insolvency and knowledge of 14.70–14.75 resignation of 10.29–10.33 responsibilities and obligations of 2.3–2.4, 2.31–2.42 shadow 2.5, 2.17–2.21, 2.22–2.25 wrongful trading provision and 9.28–9.34, 9.88–9.94

316

dishonesty in intent to defraud and fraudulent purpose 7.6–7.12 distributions dividends 18.51–18.52 general provisions related to 18.22–18.42 introduction to 18.13–18.21 public company 18.43–18.50 See also unlawful distributions dividends 18.51–18.52 employees as creditors 3.18–3.19 liability in fraudulent trading 6.44 executive directors 2.5, 2.26–2.30 fraud on creditors 13.34–13.41 fraudulent trading aim of provisions on 5.12 applicant 6.10–6.15 applications 6.16–6.34 background on 5.2–5.11, 6.1–6.6 case elements 6.7–6.9 conditions for liability 6.77–6.103 court order regarding 6.114–6.125 criminal proceedings 6.67–6.76 destination of proceeds 6.127–6.128 directors and company officers liability in 6.35–6.43 employee liability in 6.44 knowing parties to 6.91–6.103 loss due to 6.109–6.113 outsiders (accessories) and 6.45–6.66 party to the carrying on of business 6.78–6.90 persons who may be liable 6.35–6.66 relief from liability 6.126 what constitutes 6.104–6.108 See also intent to defraud and fraudulent purpose future debts 3.7 honesty and intent to defraud and fraudulent purpose 7.40–7.49 insolvency 9.24–9.27 no reasonable prospect of avoiding 9.64–9.67 obligation and pre-insolvency circumstances and 14.41–14.69, 15.13–15.32 as trigger for obligation to consider interests of creditors 14.16–14.40 wrongful trading defence and 10.34–10.43

I N DEX

intent to defraud and fraudulent purpose conclusion on 7.55–7.58 creditors and 7.3–7.4 dishonesty in 7.6–7.12 fraudulent purpose liability 7.53–7.54 introduction to 7.1 issues in 7.13 meaning and components of 7.5–7.49 standard of honesty and 7.40–7.49 state of mind in 7.14–7.39 what actions can constitute fraud and 7.50–7.52 See also fraudulent trading interest rates 3.37 involuntary creditors 3.23 judicial considerations in obligation to consider interests of creditors and pre-insolvency circumstances 14.49–14.60 in wrongful trading cases 9.95–9.110 judicial relief from liability 17.5–17.13 liability, determination of 16.46–16.54 liability, fraudulent trading 7.53–7.54 conditions for 6.77–6.103 relief from 6.126 liability, relief from under Companies Act 2006 11.4–11.28 conclusions on 11.31–11.32, 17.14 fraudulent trading 6.126 introduction to 11.1–11.3, 17.1–17.2 judicial 17.5–17.13 as necessary under the Companies Act 11.29–11.30 ratification 17.3–17.4 unlawful distributions 18.85–18.91 limited liability 13.32–13.33 loss, wrongful trading 9.115–9.138

foundation of 13.13–13.48 fraud on creditors and 13.34–13.41 judicial foundations of 13.32–13.48 limited liability and 13.32–13.33 nature of obligation 13.3–13.12 proprietary interests of creditors and 13.42–13.45 traditional foundation of 13.14–13.22 non-executive directors 2.5, 2.26–2.30 obligation to consider interests of creditors compliance with (See compliance with obligation to consider interests of creditors) development of (see development of obligation to consider interests of creditors) nature of and rationale for (see nature of and rationale for obligation to consider interests of creditors) triggers for (See triggers for obligation to consider interests of creditors) orders fraudulent trading 6.114–6.125 wrongful trading provision 9.139–9.170 outsiders liability in fraudulent trading 6.45–6.66

member liability for unlawful distributions 18.54–18.65 misfeasance 4.9–4.14 monitoring 3.36

pre-contract checks 3.32–3.33 preferential creditors 3.14 proceedings 4.6–4.8 proceeds, fraudulent liability 6.127–6.128 professional advice in wrongful trading defence 10.18–10.28 prospective debts 3.6 protection, creditor 3.24–3.37 contractual 3.25–3.31 imposing higher interests 3.37 monitoring 3.36 pre-contract checks 3.32–3.33 security 3.34–3.35 public factor in wrongful trading provision 9.186–9.187

nature of and rationale for obligation to consider interests of creditors case law and other explanations in foundation of 13.27–13.31 company owes responsibilities to creditors and 13.48 creditors having economic interests and 13.46–13.47 disconnect in 13.23–13.26

ratification 17.3–17.4 relief from liability under Companies Act 2006 11.4–11.28 fraudulent trading 6.126 judicial 17.5–17.13 as necessary under the Companies Act 11.29–11.30 ratification 17.3–17.4 unlawful distributions 18.85–18.91

317

I N DEX

resignation in wrongful trading defence 10.29–10.33 retention of title creditors 3.20 revenue authorities 3.15–3.17 secured creditors 3.10 security 3.34–3.35 Sequana case 12.64–12.71, 14.61–14.69 shadow directors 2.5, 2.17–2.21 distinguished from de facto directors 2.22–2.25 special relationship creditors 3.21 state of mind in intent to defraud and fraudulent purpose 7.14–7.39 triggers for obligation to consider interests of creditors background on 14.6–14.14 context of 14.41–14.48 importance of 14.15 insolvency as 14.16–14.40 judicial formulations in 14.49–14.60 knowledge of directors and 14.70–14.75 pre-insolvency circumstances 14.41–14.69 reflections on 14.76–14.85 Supreme Court in Sequana and 14.61–14.69 unlawful distributions auditor liability for 18.84 director liability for 18.66–18.83 legislative framework for distributions and 18.13–18.52 liability for 18.53–18.84 member liability for 18.54–18.65 relief from liability 18.85–18.91 starting points on 18.5–18.12 unpaid debts and creditors 1.1–1.2 unsecured creditors 3.11–3.13 wrongful trading defence cessation of business in 10.44–10.48 inability to take steps to miminise losses and 10.62–10.64

318

miscellaneous options in 10.49–10.61 placing the company into a formal insolvency regime in 10.34–10.43 professional advice in 10.18–10.28 resignation in 10.29–10.33 substance of 10.3–10.9 what constitutes ’‘every step’? in 10.10–10.17 wrongful trading provision aims of 8.25–8.28 applicant 9.2–9.5 background on 8.8–8.24 claims 9.6–9.23 compensation and 9.151–9.154 compensation orders under Company ‘Directors’ Disqualification Act 1986 9.181–9.185 complying with obligation to consider interests of creditors and 15.78–15.83 concurrent and additional liability under 9.163–9.164 court order regarding 9.139–9.170 directors and 9.28–9.34 division of liability under 9.165–9.167 effects of order regarding 9.171–9.180 elements required for liability 9.24–9.63 insolvent liquidation and 9.24–9.27 judicial considerations 9.95–9.110 judicial discretion and 9.140–9.150 loss in 9.115–9.138 no reasonable prospect of avoiding insolvent liquidation 9.64–9.67 other matters contained in orders 9.168–9.170 payment of existing debts with new money 9.155–9.162 point of liability in 9.68–9.87 public factor and 9.186–9.187 rationale for 8.29–8.34 relationship to commencement of proceedings 16.18–16.24 types of companies involved in actions regarding 9.111–9.114 what directors should be doing regarding 9.88–9.94