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Corporate Insolvency – Investigating directors and challenging past transactions | Business Law – SQE1 & SQE2 Exam

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Corporate Insolvency – Investigating directors and challenging past transactions
Introduction
• Statutory provisions below apply when a company is in:
o Liquidation; or
o Administration
• … but not when it is in
o Administrative receivership; or
o Other receivership
• … except proceedings re: transactions defrauding creditors – s 423, can be brought
whether or not company in insolvent procedure
• Administrators + liquidators both have power to look back to a specific period before
formal insolvency procedure begins + to bring proceedings for court order (at court’s
discretion) to restore company’s position to what it would have been had it not
entered into the transaction
o Unwinding of transaction = voidable transactions
o Seek compensation to restore in monetary terms
• Also As + Ls have power to bring proceedings against directors personally:
o Both = fraudulent trading
o Both = wrongful trading
o L only = misfeasance
Fraudulent trading – s 213 + s 246ZA IA 1986
Claims
• Claims by liquidator / administrator on behalf of unsecured creditors suffering loss
• … Against any person (s 213(2) – liquidator’s claim; s 246ZA(2) – administrator’s
claim) who is knowingly party to the carrying on of any business of the company
with intent to defraud creditors or for any fraudulent purpose (s 213(1); s 246ZA(1))
o Claims may be assigned to a 3rd party to raise funds without risk of litigation
• Actual dishonesty must be proved => very high standard of proof, and therefore
wrongful trading claims much more common
o Defence – dishonesty assessed on a subjective basis => honestly held belief
need not be realistic
Sanction
1. May be ordered to make such contribution to the company’s assets as the court
thinks proper – must not be punitive; compensate for losses only
2. May make disqualification order under s 10 CDDA 1986
3. Criminal sanctions may be imposed under s 993 CA 2006 to punish fraudulent
trading, whether or not the company is being wound up => imprisonment + fine
© Liam Porritt 2020 2
Wrongful trading – s 214; s 246ZB IA 1986
• Claims by liquidator / administrator on behalf of unsecured creditors suffering loss
• … Against any person who was at the relevant time a director (s 214(1); s 246ZB(1))
(including shadow directors (s 214(7); s 246ZB(7)) as defined in s 251 CA 2006, de
facto or non-executive directors), where court satisfied (s 214(2); s 246ZB(2)):
i) Company has entered insolvent liquidation / administration, i.e. when
assets insufficient for payment of debts + other liabilities + the expenses
of winding up (s 214(6)) / administration (s 246ZB(6)) => BALANCE SHEET
METHOD
AND
ii) At some time:
a. before the commencement of the winding up or insolvent
administration
b. The director know or ought to have concluded that
c. There was no reasonable prospect that the company would avoid
going into insolvent liquidation / administration =>
i. Apply reasonably diligent person test (see below) (s 214(4);
s246ZB(4))
ii. APPLY to facts – the following might be warning signals that
the directors ought to have concluded that there was no
reasonable prospect (circumstances depending!):
1. Liabilities > assets
2. Proceedings vs company for unpaid sums
3. Increasing creditor pressure – recalled overdraft /
refusals from suppliers to make deliveries until
invoices settled
4. Failure to meet sales / cash flow targets
5. Collapse of customer / supplier
6. Change in market
‘Every step’ defence – s 214(3); s 246ZB(3) IA 1986
• Director may escape liability where satisfies court that after he knew or ought to
have concluded that there was no reasonable prospect of the company avoiding
insolvent administration /liquidation, he took every step with a view to minimising
the potential loss of the company’s creditors
o Apply reasonably diligent person test = just say standard again
o Consider steps already taken
o + Steps they should take moving forward:
§ Voicing concerns at regular BMs, especially whether appropriate to
incur new credit / liabilities
§ Seeking independent financial + legal advice => advice on continued
trading
§ Suggesting reductions in overheads / liabilities
§ Ensuring adequate financial information available to creditors
§ No further credit
© Liam Porritt 2020 3
Reasonably diligent person test (s 214(4); s 246ZB(4))
• Court applies the reasonably diligent person test (s 214(4); s 246ZB(4)) to determine
whether:
o S 214(2) / s 246ZB(2) liability => when director ought to have concluded no
reasonable prospect of avoiding liquidation /administration
o S 214(3) / s 246ZB(3) defence => whether director took every step
• Facts which director ought to have known + conclusions drawn + steps taken = those
of reasonably diligent person with the higher of:
o General knowledge, skill + experience reasonably expected of a person
carrying out the functions carried out by the director (objective); and
o Actual knowledge, skill and experience of that particular director (subjective)
Resignation
• Resignation will not permit a director to escape liability, as s 214(2) + s 246ZB(2)
refer to a person who was a director at the relevant time => must take every step
with a view to minimising potential loss of creditors before resignation
o Where director disagrees with behaviour of other directors, should seek to
persuade them to his PoV before resigning = resignation as the last option
Sanctions
• May be ordered to make such contribution to the assets of the company as the court
thinks fit (s 214(1); s 246ZB(1))
o Compensatory, not penal
o Wide discretion for court, based on depletion of assets caused by directors’
conduct from date directors ought to have concluded that company could
not reasonably avoid administration / insolvency
o May be joint and several / apportioned as court sees fit
o S 1157 relief in proceedings where director acted honestly and reasonably
does not apply to wrongful trading proceedings
• May make disqualification order under s 10 CDDA 1986
© Liam Porritt 2020 4
Liability for misfeasance – s 212 IA 1986
• Summary procedure enabling company acting by liquidator, Official Receiver or
creditor / contributory (s 212(3)) for breach of duty by (s 212(1)):
o Current / former officer of company (directors, managers, secretaries);
o Others who acted in the promotion, formation or management of the
company; and
o Liquidator / administrative receiver
§ Claim against administrator possible under Sch B1 IA 1986
• Misfeasance = covers all directors’ duties:
o Misapplication of money / assets
o Breach of statutory duty
§ Unlawful loans
§ S 170-177 CA 2006
• Acting outside powers (s 171)
• Reasonable care, skill and diligence (s 174)
• Failure to notify where interested (s 177)
§ Failing to seek prior GM approval for substantial property transaction
(s 190 CA)
o Transactions at an undervalue (s 238) + preferences (s 239)
• Shareholder ratification is of no effect at a time when the company’s fortunes have
declined to such an extent that there is a reasonable prospect that the company
will go into an insolvent liquidation / administration (s 239(7) CA 2006)
Sanctions
• Order as court thinks fit for repayment, restoration or contribution
• Misfeasance is a relevant factor when court considers disqualification order against a
director for unfitness under s 6 CDDA 1986
Disqualification of directors
• Grounds relating to insolvency:
o Fraud in a winding up (s 4 CDDA)
o Unfit conduct of directors of insolvent companies (s 6 CDDA) = court
considers:
§ Misfeasance (s 212)
§ Transaction at undervalue (s 238)
§ Preference (s 239)
§ Transaction defrauding creditors (s 432)
o Fraudulent and wrongful trading, for up to 15 years (s 10 CDDA)
© Liam Porritt 2020 5
Voidable transactions by a company
• Liquidator / administrator has ability to challenge certain transactions that have
taken place within specified statutory periods prior to the insolvency of the company
= ‘voidable’ / ‘antecedent’ transactions
• ‘Clawback’ provisions may result in claims against the beneficiary of the transaction
for:
o An order reversing the transaction
o An order to make financial restitution
• Claims may not be made against bona fide purchasers for value without notice who
were not a party to the original transaction (s 241(2) + s 241(2A) IA 1986)
Litigation expenses
• Major factor in deciding whether to pursue a challenge against a beneficiary of a
transaction = costs of legal challenge, given costs + adverse costs order will diminish
assets for distribution
• Recovery of liquidator’s costs + expenses, including the bringing or defending of
litigation, whether successful or not, out of company’s assets in statutory order =
after fixed charge costs + payments to fixed charge holders
© Liam Porritt 2020 6
Challenging voidable transactions
Questions for challenges to voidable transactions (except defrauding creditors under s 423):
1. Did the transaction involve a connected person or associate?
a) Connected person (s 249) –
I. (Shadow) directors + associates of directors (s 249(a)); and
II. Associates of the company (s 249(b))
b) Associates (of director / company) (s 435) –
I. Spouse / CP (s 435(2)(a))
II. Relative / spouse’s relative, broadly defined under s 435(8) (s
435(2)(b))
III. Business partner (s 435(3))
IV. Employer / employee (s 435(4))
V. Certain trustees (s 435(5))
VI. Company controlled by the same person as the person who has
control of the insolvent company
VII. Company controlled by director/company (s 435(7))
2. Did the transaction take place within the relevant time?
o Calculated backwards from the onset of insolvency (s 240(3) for s 238/39 + s
245(5) for s 245)=>
a. Administration – date of filing application (court procedure) or
notice of intention to appoint or (if none) appointment (o-o-c
procedure)
b. Liquidation – date of commencement of winding up (date of
resolution for members’ or creditors’ voluntary winding up or date
of presentation of petition for compulsory winding up (s 129))
3. Was the company insolvent at the time of the transaction or did it become insolvent
as a result of the transaction?
o NB insolvency here = inability to pay debts (s 123) = cash flow or balance
sheet insolvent
§ This is distinct from wrongful trading, where insolvency = balance
sheet insolvent
4. Is there a presumption available which shifts the burden of proof from the
liquidator/administrator to the other party?
© Liam Porritt 2020 7
Transactions by a company at an undervalue – s 238 IA 1986
• Application to court only by liquidator / administrator (s 238(1))
Is it a transaction at an undervalue? (s 238(4))
Either:
1. A gift (s 238(4)(a)); or
2. A transaction for consideration the value of which, in money or money’s worth, is
significantly less than the consideration provided by the company (s238(4)(b))
a. In general, this will be clear where there is an exchange
b. Security – there is uncertainty whether the granting of security for value less
than the value of the charge can be challenged as a transaction at an
undervalue; the general rule in Re MC Bacon is that it cannot be so
challenged, but recent case law suggests it may be challenged
c. Dividend – there is uncertainty as to whether a dividend, lawfully paid, can
amount to a transaction at an undervalue; recent case law suggests a
dividend may be so challenged
Time limits
• Transaction took place within the ‘relevant time’ (s 238(2)), i.e. in the 2 years
preceding the onset of insolvency (s 240(1)(a)), which is the commencement of
administration / liquidation (s 240(3))
Insolvency – on cash flow or balance sheet basis (s 123)
• Connected person? – see above
• Where transaction with unconnected person, applicant must prove that the
company was insolvent at the time of the transaction or became so as a result of it (s
240(2))
• Where transaction with connected person, insolvency is presumed unless the
connected person proves otherwise (s 240(2))
Defence
No order to set aside if court satisfied that (s 238(5)):
1. Company entered into the transaction in good faith and for the purpose of carrying
on its business (s 238(5)(a)); and
2. At the time there were reasonable grounds for believing that the transaction would
benefit the company (s 238(5)(b))
E.g. where unsecured creditor is granted new security on demand, so that company can
stave off a genuine threat to terminate facilities and begin winding up proceedings, where
directors consider on reasonable grounds that the company can overcome financial
difficulties
© Liam Porritt 2020 8
Sanction
• Court has discretion to make such order as it thinks fit to restore the position as if
the company had not entered into the transaction (s 238(3))
o Examples of orders under s 241(1) – transfer back property / proceeds of sale
discharge security; monetary payment etc.
• Order should not prejudice bona fide purchasers for value without notice who were
not a party to the original transaction (s 241(2) IA 1986); however…
o NB presumption that acquisition by subsequent purchaser was not in good
faith where subsequent purchaser either (s 241(2A)):
§ Had notice of the relevant surrounding circumstances (i.e. the
transaction at an undervalue / preference) + of the relevant
proceedings; or
§ Was connected with or was an associate of either the company or the
party which transacted at an undervalue with (or received preference
from) the company
ALSO consider defrauding creditors
© Liam Porritt 2020 9
Preferences by company – s 239 IA 1986
• Prevent creditor obtaining improper advantage over other creditors at a time when
the company is insolvent
• Claim by only a liquidator or administrator (s 239(1))
Is a preference given to a person? (s 239(4))
1. Person is a creditor of the company (or a surety or guarantor of any of the
company’s debts / liabilities) (s 239(4)(a)); and
2. The company does anything or suffers (i.e. allows) anything to be done which has
the effect of putting that person in a better position in the event of the company
going into insolvent liquidation than he would otherwise have been in (s 239(4)(b))
Time Limits
• Connected person? – see above
• Given within the ‘relevant time’ (s 239(2))
• Where transaction with a connected person, in the 2 years preceding the onset of
insolvency (s 240(1)(a)), being the commencement of the relevant insolvency period
(s 240(3))
• Where transaction with an unconnected person, in the 6 months preceding the
onset of insolvency (s 240(1)(b))
Insolvency
• Applicant must prove that the company was insolvent (on either a cash flow or
balance sheet basis, s123) at the time of the transaction or became so as a result of
it (s 240(2))
• No statutory presumption of insolvency
‘Influenced by a desire to prefer’
• Where transaction with unconnected person, applicant must prove that the
company was influenced by a desire to prefer the creditor (s 239(5))
o Subjective test => company must have positively wished to put the party in a
better position (Re MC Bacon)
• Where transaction with connected person / associate, it is presumed that the
company was influenced by the desire to prefer the creditor (s 239(6), unless the
preferred person can rebut this presumption
© Liam Porritt 2020 10
Defence
• Absence of desire to prefer required by s 239(5) (Re MC Bacon Ltd)
o Not necessary to prove an intention to prefer, but a desire to prefer
o This is not satisfied where the desire is to continue trading (e.g. by avoiding
the company’s overdraft being called in under genuine pressure from
creditor), rather than a desire to prefer the creditor
Sanction
• Court has discretion to make an order to restore the position as if the company had
not given the preference (s 239(3)) – s 241(1) again suggests the types of restoration
order, most likely here to be discharge of security
(As for transactions at an undervalue)
• Order should not prejudice bona fide purchasers for value without notice who were
not a party to the original transaction (s 241(2) IA 1986); however…
o NB presumption that acquisition by subsequent purchaser was not in good
faith where subsequent purchaser either (s 241(2A)):
§ Had notice of the relevant surrounding circumstances (i.e. the
transaction at an undervalue / preference) + of the relevant
proceedings; or
§ Was connected with or was an associate of either the company or the
party which transacted at an undervalue with (or received preference
from) the company
© Liam Porritt 2020 11
Avoidance of certain floating charges – s245 IA 1986
• Applies in liquidation or administration to avoid certain floating charges
automatically (BUT not the debts themselves!) without the need for the officeholder to challenge the floating charge
o Legal proceedings only where dispute between putative floating charge
holder and liquidator / administrator
• Prevent unsecured creditor obtaining floating charge to secure an existing loan for
no new consideration
Time limits
• Connected person? – see above
• Granted within ‘relevant time’ (s 245(2))
• Where floating charge granted to connected person, in 2 years preceding the onset
of insolvency (s 245(3)(a)), being the commencement of the relevant insolvency
period (s 245(5))
• Where floating charge granted to unconnected person, in 12 months preceding the
onset of insolvency (s 245(3)(b))
Insolvency
• Where connected person, no insolvency requirement
• Where unconnected person, must be proved that the company was insolvent (on
cash-flow / balance sheet basis – s 123) at time of the floating charge’s creation or
became insolvent in consequence of the transaction under which the charge was
created (s 245(4))
Valid where fresh consideration for floating charge (s 245(2))
• FC valid to the extent that ‘new money’ / fresh consideration provided to the
company OR company debts extinguished in return for the grant of the floating
charge on or after its creation (s 245(2))
• Where floating charge granted on previously unsecured overdraft, which is being
used by the company at the time of the grant of the FC, the ruling in Re Yeovil Glove
Co Ltd applies:
o Any money advanced by the bank after the grant of the FC is ‘new money’
and therefore payments out of the account after the FC are secured by the FC
o Any money paid into the account discharges the oldest pre-charge
indebtedness first (Re Clayton’s Case), and therefore if the amount of money
paid into the account after FC creation > indebtedness at time of FC, all preFC monies repaid and all new debt is secured by FC
Other points
• NB FC may be voidable as transaction at an undervalue / preference under s 238/9
• NB2 FC is void where not duly registered with CH (s 859H CA 2006)
© Liam Porritt 2020 12
Transactions defrauding creditors – s 423 IA 1986
• Claims do not necessarily relate to insolvency
• Claim by (s 424):
o Liquidator or administrator
o Supervisor of voluntary arrangement
o Victim of transaction
Has there been a transaction defrauding creditors?
• Transaction at an undervalue = same circumstances fulfil s 423(1)
• + must prove intention or purpose of transaction to put assets beyond the reach of
creditors of the company or otherwise prejudice their interests (s 423(3))
o Includes future creditors unknown at time of transaction
Time Limits
• None – therefore, this is circumstance where liquidator / administrator would bring
claim under s 423, rather than s 238 => time limit passed
Sanction
• Court may make such order as it thinks fit to restore the position to what it would
have been but for the transaction in question (s 423(2))
o Non-exhaustive list of orders in s 425(1)

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