Anatomy of a threatened financial recovery claim against a director of an insolvent company
This is article 1 of 2 in which our Insolvency Litigation Solicitors look at how a financial recovery claim – for misfeasance, breach of statutory duty and fiduciary duty – intimated against a Director by a Liquidator or Administrator (‘Claims’) might typically proceed and what the well-advised Director can and should do. Take a look at the second article in this series – ‘Settling by Mediation’.
Context
Claims are pursued against Directors of small, medium and large failed SME businesses, not just against Directors of big, failed companies. The majority of Claims are most commonly pursued against Directors of small, failed limited companies. Claims may threaten the family home, personal savings and the financial future of the Director and his family. They bring with them enormous angst and worry.
What types of claim?
Claims seeking financial recovery against the Director personally are intimated/made by Liquidators against the Director(s) of the failed limited company when the Director may already be at his/her lowest financial and emotional ebb – alleging one or more of:
- Misfeasance claims (section 212 of the Insolvency Act 1986 (‘the IA86’)) – i.e. most typically allegations of misapplication or misuse of company assets or property.
- Breach of statutory or fiduciary duty, arising (for example) out of one of more of the matters above and below, typically in the 2 years leading up to the date of liquidation.
- Trading Misfeasance – the very recent decision in Wright and Others v Chappell [2024] EWHC 1417 arose out of the failure of BHS and the Judgment established a new insolvency offence, ‘Trading Misfeasance’. The offence is committed when a Director fails to consider the interest of creditors when a company is insolvent or bordering on insolvency but instead carries on trying to trade out of trouble only for the company to then fall into liquidation/insolvency. A financial liability of £100m was awarded against the unsuccessful Directors in the BHS case.
Specific examples of director misconduct
- Entering into Transaction(s) at an Undervalue (section 238 of the IA86).
- Entering into Preferences (section 239 of the IA86).
- Declaring and/or paying illegal or improper Dividends.
- Removing or disposing of company assets before or at liquidation.
- Maintaining an overdrawn Directors Loan Account (‘DLA’) at liquidation.
- Wrongful Trading (section 214 of the IA86).
- Fraudulent trading (section 213 of the IA86).
- Trading to the detriment of creditors generally or to the detriment of the Crown (i.e. Tax debt).
- Claims brought under section 423 of the IA86 – typically, transactions at an Undervalue where the Court is satisfied that the transaction was intended to put assets beyond the reach of creditors.
- A myriad of other insolvency related Claims.
Remember – the wider picture
A parallel Director Disqualification Investigation (‘DDI’) and/or a Criminal law investigation may also be ongoing against the Director, arising out of the same subject matter. These possibilities need to be considered/investigated and factored into the advice given.
What should the well-advised director do?
It never ceases to amaze us that so many Directors dive into a liquidation process without checking there is any water in the pool i.e. without the Director first taking legal advice about the personal liability and exposure position of the Director.
Remember: The Licensed Insolvency Practitioner (‘LIP’) who is brought in typically advises the company, not the Directors. Directors personally need help more than ever at this crucial time, in the period before liquidation.
Which liquidator?
Relying on your Accountant or others to recommend a proposed Liquidator is often enough. Most reputable LIPs (and most are) will explore and explain likely problematic issues before liquidation, with the Director.
Some potentially problematic issues may not, however, be evident at this point to the Director. Good insolvency legal advice may well identify such issues and allow them to be addressed at this very early point.
A ‘heads up’ and realistic discussion with the proposed Liquidator often allows the Director to at least know what he/she is getting into. If you know, the Director can risk assess and make decisions. Legal advice should be obtained by the Director, now.
But….
So many Directors who come through our door post liquidation have dived blind into the liquidation pool, only to find there is no water. In other words, the chosen Liquidator has decided, often years after the event of liquidation (and once the Director is back on his/her financial feet) to bring a financial recovery claim against the Director. The Liquidator often has 6 or more years to bring a Claim.
We can help
Not all LIPs are the same. We have decades of experience of working with many trusted and different LIPs across the UK, in firms large and small. Choosing the most appropriate Liquidator or Administrator for the particular case is vitally important. We can help.
Time limits
In the broadest terms, the Liquidator typically has 6 years from the date of liquidation to bring Claims. That period can often however be much longer, if for example a breach of trust is alleged/proved against the Director.
What are a Liquidator’s objectives in claiming financially against a director?
To recover funds (for creditors). That may feel a little ‘empty’ to the Director when (as we see far too often) Claims are first intimated against the Director by the Liquidator in years 4, 5 or 6 of the liquidation process and where creditors have long since written off their debts, reclaimed their VAT and moved on. There may of course be good reason why Claims have not been brought earlier in the liquidation process.
Who gets paid from a financial recovery?
Like it or not, the Liquidator’s fees and expenses (to include legal costs) are often a first deduction from any Director recovery in Claims. The Liquidator and his Solicitor are quite often gambling with their own time costs, in trying to achieve a successful recovery from the Director(s), if there is no money in the liquidation pot to pursue a Claim.
The Insolvency and Litigation Team here at NDP regularly represent both claiming Liquidators and in other cases targeted Directors in Claims. In a case where there are no funds, the Liquidators and their Lawyers may thus be incentivised to succeed in financially recovering against the Director (whatever the merit of the alleged case). The Liquidator wants in most cases an early financial recovery. The financial consequences for the Director of not engaging early with the Liquidator or allowing Court proceedings to be issued can be financially ruinous for the Director.
What should the well-advised director do?
Any claiming Liquidator will have done their homework. They will have researched the Director’s likely ability to pay a successful Claim involving an assessment of the Director’s personal wealth. That might involve as a starting point assessing the value of the Director’s interest in his home or other obvious assets, such as shareholdings in other companies.
What is the claim process? Pre-action protocol letter of claim (‘the letter’)
The Liquidator or his/her Solicitors will send the Letter to the Director setting out the Liquidator’s Claims. The well-advised Director will engage with this claim process, get specialist insolvency legal advice early and in most cases, should respond to the Claims made in the Letter through experienced Solicitors. The Claim is simply not going to go away. The Director has up to 3 months to response to the Letter. The Director should use that time wisely in evidence gathering and other tasks.
Insurance – litigating with little or no risk to the liquidator
Director Claims don’t just happen. The Liquidator and his Solicitor have a couple of head starts on the targeted Director. The Liquidator may have been collecting evidence and preparing the Claim for months. The Liquidator can often threaten litigation (against a Director) knowing he can get insurance to pay his costs liability, if he commences but then loses litigation against the Director. The Liquidator can often thus litigate without personal risk of an adverse costs award.
Does the director have an insurance policy that responds to the claims?
If so, use it. Check Household and Motor Insurance Policies. Is there a Directors and Officers Insurance Policy in place? If so, contact the Insurer immediately. Failure to do so early in the process may invalidate the insurance position. We can assist in that process.
Responding insurance cover is in most cases however not a luxury available to the Director who if he/she wants to defend litigation Claims, may financially be risking everything. The commercial imperative on the Director to settle is often great. Much as it might stick in the throat.
Assignment of claims – litigation funders
The Liquidator has another advantage/head start because the Liquidator can look to sell the Claims against the Director, to one of a number of insolvency litigation finance companies. They buy or fund insolvency Claims, working with the Liquidator of the failed company. They have deep pockets and are formidable opponents as a result.
BUT
The Assignee/buyer of the Claims faces the same practical realities as the Liquidator i.e. if the Director has a good Defence to a Claim from the Liquidator, then he is also likely to be able to deploy that Defence against the litigation funder.
Update: manolete partners plc v freed and ors [2024] ewhc 2242 (ch)
This case confirmed that on the facts of this case, Manolete (as purchaser from the Liquidator of the Claims against the Directors) were not restricted in the amount of its recovery to the deficit in the liquidation estate. It was entitled to Judgment for the full amount of its Claims against the Director(s).
Comments
- This decision surely emphasises the need for Directors to engage with the claiming Liquidator at an early point. Chances are that there is a better and cheaper deal to be done with the Liquidator, rather than with the Assignee of the Claim. The message remains to engage early with the Liquidator.
- This ties into the need to settle using Alternative Dispute Resolution, using options such as Mediation.
So the director has no tools in his armoury?
Yes- the Director does. These include:
- Legal arguments on the merits of the Claims – but will a claiming Liquidator even listen? Going to the trouble and expense of putting forward response arguments often however results in a lower settlement number being reached, than might otherwise be the case. Spend a modest sum in legal costs to achieve a better settlement.
- Part 36 Offers. Beyond the scope of this article but a powerful weapon for the Director.
- Security for Costs application by the Director (but not usually effective against a Litigation Funder).
- Practical arguments – see below.
Our messages
- Even where the targeted Director has grave reservations about the legal merits of the Claims against him/her, stand back and look at the wider picture. If you are going to fight the Liquidator’s Claim, do so with eyes wide open as to the true cost and the true levels of risk, angst, distraction, time away from family and business life, over what may be an extended period of time in litigation.
- Consider settling Claims early, perhaps ignoring what may be the dubious merits of the Claim (but always looking to reflect the merits or lack of them in the amount of the proposed settlement). From the Director’s perspective, a negotiated settlement (especially an early one) avoids/limits risk, cost, wasted energy, angst and distraction from family and business life.
- If you are going to settle, do so early and certainly before the commencement of Court proceedings, when costs escalate rapidly in complying with procedural obligations imposed by a Court timetable, the cost of complying with which itself inhibits the prospect of settlement and probably adds to the cost of achieving a settlement.
Negotiating the best financial settlement
In a settlement negotiation with the Liquidator’s Solicitors, the Director can (and often does) deploy powerful, non-legal arguments based on, for example:
- His/her financial (in)ability to pay, which involves a consideration of:
- What assets does the Director have?
- What creditors (other than the claiming Liquidator) does the Director have? Why should the Director favour paying the Liquidator Claimant ahead of the Director’s other creditors?
- The threat of personal bankruptcy for the targeted Director and the impact that may have on the Liquidator’s prospects of a financial recovery.
A worked example
- Assume the Director has one asset of value – his £100,000 equity share in the matrimonial home.
- The Liquidator’s (unproven) Claim against the Director is for the greater sum of £150,000.
- The Director also has other creditors (perhaps Personal Guarantee obligations and credit card debts) of £200,000.
- So £100,000 assets faces £350,000 of Claims and liabilities.
Outcome
The Director is on the face of it at this point insolvent (even before account is taken of the Liquidator’s Claim) – so the Director should use that fact to advantage in negotiating with the Liquidator.
Question
Why would the Director raise and pay £150,000 (or indeed any amount) to pay the claiming Liquidator in the above circumstances?
What to do?
Bankruptcy or an Individual Voluntary Arrangement (‘IVA’) (or the threat of it) may be a real option for the Director and the cheapest way of settling the Liquidator’s Claim and also the Claims of all of the Director’s other creditors. Achieving a financial clear slate ought at least to be considered. The well-advised Director will explain to the Liquidator that (in an appropriate case) in a bankruptcy or IVA the Liquidator may recover much less than the Claim value or even nothing, after the impact of the Director’s own legal costs and the Trustee in Bankruptcy’s costs and expenses.
Every case has to be considered on its own particular facts. The Director may have many reasons why personal bankruptcy is not an option for him/her.
Objective
The Director’s job in a serious negotiation is to give the Liquidator the commercial reason and justification to settle, so that the Liquidator can justify his settlement to the creditors of the company and to the Liquidator’s Professional Regulator, amongst others.
What if matters cannot settle?
The Liquidator can of course start litigation, but:
- The litigation process may take the Liquidator (and the Director) 2 to 3 years, with the liquidation having to remain open for that period.
- The Liquidator is going to have to give evidence at Court (often an unattractive proposition for the Liquidator and also the Director).
- The Director’s available assets may be used up in funding his Defence legal costs – outcome – nothing left for the Liquidator (or the Director), unless the Director wins the case and recovers legal costs.
- The Director can go (or threaten to go) bankrupt or into an Individual Voluntary Arrangement (IVA) at any point in the litigation process. Potentially, a real concern for the Liquidator. In the worked example above, the Director going bankrupt would (within 2 to 3 years of bankruptcy) have to pay a sum to his Trustee in Bankruptcy that equates to the value of his interest in his house (assuming that is the Director’s only asset) – maybe £100,000 (on the above example) depending on valuation of the home. A lot better than paying £200,000 plus the Liquidator’s Claim?
- The Liquidator may receive next to nothing in that scenario and that should be explained to him/her. Liquidators and those advising them do listen to and understand such arguments.
- The Director must however be prepared and able to corroborate his/her financial position in negotiations with the Liquidator. If the Director seeks shelter behind the financial position, he/she had better be prepared to justify it.
Structured settlements
Doing a deal to settle a Liquidator Claim may often involve:
- Agreeing a headline settlement number.
- Payable over time by instalments (deferred consideration).
- With that ‘deferred’ payment element possibly secured by a Legal Charge/Mortgage over the Director’s house (until the settlement sum is paid in full).
- Interest perhaps ceasing to be charged (provided, for example, the settlement payments are met on time).
Settlement terms are usually recorded in a formal Settlement Agreement, that covers all such bases. Getting the terms of that agreement right is vitally important.
Lessons to learn
- Choose your Liquidator carefully. Aim for somebody who knows your business sector and who is prepared to listen to you. We can help. We have worked closely with LIPs who are known to us and trusted by us, for decades.
- Take specialist insolvency law advice in the period before liquidation – go into the process forearmed.
- Be proactive and face down the Liquidator’s Claims head on and early.
- If a Claim is intimated, negotiate hard and early using Solicitors well versed and experienced in such matters and who have the trust and confidence of the opponent. We also regularly represent Liquidators and always prefer to negotiate with Solicitors representing Directors who know what they are doing.
- Avoid issued Court proceedings where possible.
