Comment from the Insolvency Litigation Specialists. Wrongful Trading and Fraudulent Trading: When is it Wrong to Trade? A 2015 Decision.
At NPD, as insolvency litigation specialists, we believe this article, which looks at the likely effect on directors of insolvent companies of a recent legal decision regarding a case of wrongful trading and fraudulent trading, will be of great interest to parties facing or involved in this type of insolvency litigation. This is because, on the face of it, the decision makes it easier for liquidators to instigate insolvency litigation proceedings and attack directors for trading on too long, in the period before liquidation or administration.
The Background to this Insolvency Litigation Decision
This article relates to the 2015 decision of Registrar Jones in Brooks and Willetts (Joint Liquidators of Robin Hood Centre Plc) v Armstrong and Walker (2015), which has sent a loud and clear warning shot across the bows of directors, potentially making it easier for liquidators of insolvent companies to successfully bring insolvency claims against the directors by alleging wrongful trading under section 214 of the Insolvency Act 1986.
In the case of Robin Hood Centre, the company had run a themed tourist attraction. The liquidators claimed that the directors of Robin Hood had wrongfully traded in the knowledge that there was no reasonable prospect of the company avoiding insolvent liquidation (and therefore facing insolvency litigation and likely insolvency claims) following certain events, which included:
- The production of the year-end accounts for 2005 and 2006;
- The receipt of professional advice in October 2006 about a large VAT liability, in respect of which the directors had sought a Review from HMRC;
- The year-end accounts for January 2007, which showed a loss and that did not include the VAT liability or take account of an increase in rent, expected from a pending rent review;
- A letter from H M Revenue and Customs in May 2007 stating that the VAT liability had been confirmed on review.
What Were the Insolvency Litigation Issues?
The company entered insolvent liquidation on 6 February 2009. The key insolvency litigation issues before the Court were:
- The burden of proof in respect of wrongful trading under the Insolvency Act 1986 section 214.
- Whether Director 1 (D1) should be judged by a higher standard than a “reasonable director” given his particular business experience.
- The interpretation of company financial statements for the purpose of knowledge.
- Whether the directors had wrongfully traded.
- Whether the directors had taken every step with a view to minimising the potential loss to creditors so as to establish the statutory defence under section 214 (3) of The Insolvency Act 1986.
- The calculation of compensation.
What Were the Main Legal Issues Held?
- Once it had been established that a director knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation (and therefore possibly face insolvency litigation proceedings), the onus was on the director to establish that he had taken every step to minimise the potential loss. Idessa (UK) Ltd (In Liquidation) Re  EWHC 804 (Ch),  B.C.C. 315 was applied.
The liquidators had to prove that the directors had knowledge of the company’s position at some time before the start of the winding-up, rather than on a particular date. A starting date did not always have to be specified and their case would not necessarily fail if a specific date was not made out, but the director had to know the case to be met.
- Although D1 had greater experience as a director, it was in a different retail field and did not lead to a higher standard by which he should be judged in the present case.
- Although the company’s financial statements were not available until the next financial year, the directors ought to have used the information they contained to assess the extent to which the company was commercially solvent. Depreciation and a debt write-off should have been excluded, as they did not help an understanding of whether the company was profitable.
- Very significantly, the Court found there was no duty not to trade while insolvent, or at a loss; a company could legitimately trade at a loss because the directors anticipated generating profit to the benefit of existing creditors. Section 214 did not require proof of insolvency at the date of knowledge. Knowledge should not be approached with hindsight, and the fact that a decision proved to be wrong did not necessarily amount to a failure to act as a reasonable director.
In the instant case, following the VAT advice, the directors had been entitled to investigate what to do rather than be criticised for acting too precipitously. However, acting reasonably and with the general knowledge, skill and experience reasonably expected, the Court concluded that the directors knew or ought to have known by January 20018 that the company could not afford, and therefore make, a time-to-pay arrangement with Revenue and Customs and that the company had no reasonable prospect of avoiding insolvent liquidation.
- Applying the reasonably diligent direct test in section 214(4), the adverse consequences of liquidation when balanced against the potential benefits of trading meant that he directors had taken the right course by continuing to trade from February 2007. However, circumstances changed with receipt of the May 2007 letter.
Further, it was or ought to have been foreseeable that the company would be unable to make the next rent payment. Whether the directors had minimised the loss had to be judged by reference to the body of creditors as a whole. The directors had ensured that the trade creditors were paid, but not the VAT and rent liabilities, so that the liabilities to the creditors as a class were increasing: the requirement ‘to take every step’ needed the directors to aim to minimise loss for all creditors.
- The discretion to order compensation under section 214 was unfettered. It was designed to recoup loss, not to be penal. To establish the maximum liability the loss would normally be represented by the amount that the assets had been depleted and/or the debts to the creditors increased. There had to be more than a “but for” nexus between the wrongful trading and the loss.
Compensation based on the difference between a hypothetical liquidation on 3 May 2007 and the actual liquidation should take account of the facts that continued trading had not caused the VAT liability but had increased interest and penalties; increased the debt to the landlord, but it could prove for all future rent subject to a discount; benefitted trade creditors and reduced the bank overdraft; not been for dishonest reasons.
NDP’S View of This Insolvency Litigation Decision
On the face of it, this case makes it easier for liquidators to attack directors (and probably instigate insolvency liquidation proceedings) for trading on for too long, in the period before liquidation or administration.
Directors clearly have to tread a fine line when making decision about whether to trade on when the storm clouds begin to gather. The team at NDP, as insolvency litigation specialists, are well placed to advise on such issues.
If you are faced with an insolvency claim relating to insolvency litigation involving wrongful or fraudulent trading, call us now on (0121) 200 7040 for a FREE initial discussion on the phone or over a coffee with our experienced insolvency litigation solicitors, or contact us online.