Claims Against Directors

What is wrongful trading?

If you are a director of a company and are worried that your company is, or is likely to become, insolvent, you must consider whether to stop trading straightaway. If during the course of an insolvent winding up or administration of a company, it appears that a director knew or ought to have known that there was no reasonable prospect of avoiding liquidation or administration, then the director can be ordered by the court to make a contribution to the company’s assets. Also, any director found to be liable for wrongful trading may face director disqualification proceedings.

The court will not make an order for wrongful trading if, knowing there was no reasonable prospect that the company would avoid going into insolvent liquidation or administration, the director took every step possible to try and minimise any potential losses to the company’s creditors.

Any liquidator or administrator seeking an order from the court in respect of wrongful trading does not have to prove dishonesty on the part of a director. However, they will need to produce evidence to the court not only of the wrongful trading itself but also that it resulted in a loss to the creditors that would not otherwise have occurred.

Avoiding the risks of wrongful trading

There are a variety of ways in which directors can avoid being liable for wrongful trading, both in terms of their ongoing conduct as a director of a company facing financial difficulty and in seeking independent professional advice from a solicitor and (when relevant) a licensed insolvency practitioner on their company’s procedure and the best options going forwards.

Given the above, we would recommend that you contact us as soon as possible to improve your prospects of avoiding the risk of a wrongful trading claim being brought against you should your company enter a formal insolvency process.

What is fraudulent trading?

If in the course of a winding up or administration of a company, it becomes clear that a person (including directors) has been involved in any attempt to try to defraud creditors, then a liquidator or administrator can seek an order from the court that the relevant person makes a contribution towards the company’s assets. As well to the civil courts being able to make orders, fraudulent trading is also a criminal offence under the Companies Act 2006 and directors who are guilty of fraudulent trading can face disqualification as a director.

Proving fraudulent trading

The liquidator or administrator has to provide evidence to the court that a director or other relevant person has acted deliberately to avoid payment of company liabilities. The burden of proof that the liquidator or administrator has to satisfy is high, and, as a result, fraudulent trading claims are less common than other types of claims against directors.

What is misfeasance?

The definition of misfeasance is contained in the Insolvency Act 1986. Misfeasance encompasses the misapplication and/or retention of property (including money) belonging to a company, becoming accountable for property belonging to the company and breach of fiduciary duty relating to the company.

Breach of duty is an essential element in bringing a misfeasance claim. An action for misfeasance is only capable of being brought where an officer of a company breaches a duty that he/she owes in their capacity as an officer. As an indication, the following examples have been found to be a breach of duty for the purpose of proving misfeasance:

• A director causing a company not to pay VAT;
• Directors making secret profits;
• Directors purchasing a property that was then sold onto a company; and
• Directors granting preferences to creditors.

Who can be sued for misfeasance?

Where a company has gone into liquidation, then a misfeasance claim can be brought under section 212 of the Insolvency Act 1986 against an officer or former officer of the company in liquidation (which definition can include, as well as a director who is or was registered at Companies House, a de facto or shadow director).  It is worth noting that such a claim can also be brought against a person who has been involved in the promotion, formation or management of the company.

Who can bring a misfeasance claim?

Where a company is in liquidation, a misfeasance claim can be brought by a liquidator of the company, a creditor of the company, a contributory to the company’s capital (as long as leave from the court is obtained) or the Official Receiver. An administrator cannot bring a misfeasance claim where a company is in liquidation, but administrators can take action in the insolvent company’s name.

Court Remedies

If the court finds that a person has been misfeasant or has breached their duty (fiduciary or otherwise) to the company, the court may order him/her to:

• Repay, restore or account for any misappropriated money or property to the company with interest; or
• Compensate the company for any misfeasance or breach of duty by contributing to the insolvent company’s assets.

What is a TuV?

An administrator or a liquidator of a company can apply to the court to set aside any TuV.

A TuV is where:

• An insolvent company made a gift or otherwise entered into a transaction where the company received no consideration;
• An insolvent company entered into a transaction where the consideration payable is significantly less than the true value of the transaction;
• The relevant transaction was entered into two years before the onset of insolvency (i.e. entering into administration or liquidation); and
• The company was unable to pay its debts at the time the transaction was entered into or became unable to pay its debts as a result of the transaction.

Defending a TuV Claim

The court will not make an order to set aside a TuV if it is satisfied that both:

• The company entered into the transaction in good faith and for the purpose of carrying on its business; and
• At the time it did so, there were reasonable grounds for believing that the transaction would benefit the company.

Court Orders that may be made

 If a TuV claim is successful, there are a number of orders the court may make. In particular, the court may:

• Require any property transferred as part of the transaction be re-vested in the company;
• Require proceeds of sale from a property to be re-vested in the company;
• Release or discharge any security given by the company;
• Require any person who received a benefit from the insolvent company to pay such sums to the administrator or liquidator of the company;
• Require a person whose obligations to the insolvent company were released or discharged to provide new or revived obligations;
• Require security to be provided relating to the discharge of any obligation; or
• Provide that a person whose property is ordered to be vested in the company or on whom obligations are imposed to be allowed to prove a claim against the insolvent company.

What is a preference?

A company gives a preference to a person if each of the following applies:

• The person is one of the company’s creditors or a surety or a guarantor for any of the company’s debts or other liabilities;
• The company does something which has the effect of putting that person into a position which is better than the position the person would be in in the event of the company going into insolvent liquidation;
• The company was influenced in deciding to give the preference by a desire to prefer the party. This is a subjective test, not an objective one. It is necessary to establish that the company positively wished to put the party in a better position. ;
• The preference was made at least six months before the onset of the company’s insolvency (this time limit is increased to 2 years if the preference is made to a connected person (e.g. a director, a shadow director or a person who has control over the company’s decision-makers)); and
• The company was unable to pay its debts at the time of the transaction or became unable to pay its debts as a result of the transaction.

Examples of preferences include:

• Paying an unsecured creditor ahead of others;
• Granting security to a previously unsecured creditor;
• Allowing a supplier to change its terms and conditions to include a retention of title clause; and
• Repaying a director’s loan account or reducing a company debt guaranteed by one of the directors.

Court Orders that may be made

Where a preference is established, the court may make any order it thinks fit for restoring the position to one where the company had never given the preference. In particular, the court may:

• Require any property transferred as part of the transaction be re-vested in the company;
• Require proceeds of sale from a property to be re-vested in the company;
• Release or discharge any security given by the company;
• Require any person who received a benefit from the insolvent company to pay such sums to the administrator or liquidator of the company;
• Require a person whose obligations to the insolvent company were released or discharged to provide new or revived obligations;
• Require security to be provided relating to the discharge of any obligation; or
• Provide that a person whose property is ordered to be vested in the company or on whom obligations are imposed be allowed to prove a claim against the insolvent company.

What is an unlawful dividend?

An unlawful dividend is a distribution to shareholders that either contravenes common law or Part 23 of the Companies Act 2006. A distribution may contravene common law if it is made out of capital. A distribution may contravene Part 23 of the CA 2006 if a dividend is declared in excess of the company’s distributable profits or if a dividend is justified by a public company’s interim accounts which have not been filed.

If a distribution is in excess of distributable profits, the distribution is unlawful to the extent of the deficiency in the available profits, not in its entirety.

Examples of unlawful dividends include where::

• Interim accounts are not prepared, and the last annual accounts show insufficient distributable reserves;
• A parent company declares and pays a distribution when the requisite profits have not been received and recorded by way of proper dividends from its subsidiaries, even when subsidiaries had sufficient profits to pass onto the parent company;
• A public limited company fails to file interim accounts that have been prepared in respect of an interim dividend with the registrar of companies;
• A subsidiary carries out a capital reduction and prepares interim accounts which show a positive reserve and distributes dividends to the parent company, only for it to transpire that not all of the legal procedures relating to the capital reduction were carried out, and therefore the capital reduction is invalid; or
• A parent company receives a dividend from its subsidiary and then makes a distribution to its shareholders. The dividend, however, causes an impairment in the subsidiary’s value which is not reflected in the parent company’s accounts and the loss arising wipes out some of the distributable reserves in the parent, meaning there are insufficient reserves to cover the dividend paid.

Liability of shareholders and directors

A shareholder who knows or has reasonable grounds to believe that distribution (or part of it) contravenes the rules on distribution of dividends is liable to repay the dividend. However, where it cannot be shown that a shareholder knew or had reasonable grounds to believe the dividend payment was unlawful, the shareholder will not be liable to repay, and the directors who recommended the unlawful distribution may be liable to the company instead.

A director who authorises the payment of an unlawful distribution may be in breach of statutory and common law duties (e.g. duty to exercise reasonable care, skill and diligence) and may be personally liable to repay the company even if they are not a shareholder.