The High Court has considered how ‘loss’ caused by wrongful trading should be calculated[1] and, in so doing, provided guidance for those considering bringing claims under section 214 Insolvency Act 1986.

Wrongful trading

Section 214 Insolvency Act 1986 allows the court to order that directors of companies in insolvent liquidation contribute to a company’s assets, where the company has experienced loss as a result of ‘wrongful trading’[2]. Wrongful trading occurs when directors continue to trade a company at a time where they were aware or ought to have concluded that there was no reasonable prospect of the company avoiding insolvent liquidation or insolvent administration[3].

Directors escape liability by establishing that, whilst trading, they took every step with a view to minimising the potential loss to the company’s creditors[4]. This is sometimes known as the ‘Minimising Loss Defence’[5]. Directors may also escape being ordered to make a contribution where the wrongful trading has caused no loss to the company.

Background

Ralls Builders Limited (in Liquidation) is a construction company which started to make losses over the winter of 2009/2010. The company’s bank refused to extend further lending in July 2010, and so the directors engaged an insolvency specialist to help implement a turnaround plan. It quickly became apparent that the company was in severe financial difficulty, but the directors continued to trade throughout the summer and early autumn of 2010 in the hope that investment could be secured from an apparently wealthy individual known to one of the directors. The investment never materialised, and the company was placed into administration on 13 October 2010. It entered creditors’ voluntary liquidation on 3 December 2010.

Claim and defence

The Liquidators brought a claim against the directors under section 214 and alleged that:

  • The directors knew or ought to have known in either July or August 2010 that the company could not avoid insolvent liquidation
  • The company suffered further loss as a result of continuing to wrongfully trade beyond July or August 2010
  • As a result of wrongful trading, the amount owed to unsecured creditors increased even though the secured creditor was paid in full
  • There was no reasonable prospect of the investor fulfilling his promises and this should have been apparent to the directors in either July or August 2010.

The Liquidators therefore claimed that the wrongful trading caused a loss of either £988,000 or £600,000 depending on when the wrongful trading began.

The Directors defended the claim on the bases that:

  • There was no wrongful trading because it could not have been known that the company could not avoid insolvent liquidation until October 2010, when administrators were appointed over the company
  • In any case, every step was taken to avoid loss to the company because continuing to trade allowed key projects to complete, limiting losses which could be claimed in the administration or liquidation
  • It was reasonable to expect the investor would fulfil his promises, allowing creditors to be repaid in full
  • The bank supported the company’s actions and the insolvency specialist had not advised that the company should cease trading in July or August 2010
  • Even if there had been wrongful trading, the company had suffered no loss as a result.

 

Decision

The Judge concluded that the directors had wrongfully traded during the period from the end of August 2010 to the appointment of administrators on 13 October 2010. The directors ought to have been clear by the end of August that the investment would not occur, and the directors had been advised on 2 August and 6 August that the company should stop trading if the investment was not forthcoming after ‘a limited period’. The Judge found that there had been no attempt to minimise loss to the body of creditors as a whole, so the Minimising Loss Defence was not available to the directors.

Calculating loss

Importantly, when considering how the ‘loss’ to the company should be calculated, the Judge held that:

  • Where an attempt has been made to keep proper accounting records, loss should be calculated by the increase in the net deficiency of the company during the wrongful trading period (Re Purpoint[6] and Re Continental Assurance[7] distinguished)
  • Where no attempt has been made to keep proper accounting records, loss may be calculated by the increase in trade creditors of the company during the wrongful trading period
  • Loss caused by the liquidation itself should not be included in the calculation
  • The costs of the liquidation itself should not be included in the calculation.

Applying these principles to the case before him, the Judge decided that the wrongful trading may have caused a £45,000 increase to the net deficiency of the company, but could also have caused a £132,833 reduction to the net deficiency of the company. Accordingly, he could not order a contribution under section 214 Insolvency Act 1986 where it was not clear that the wrongful trading caused loss to the company.

Issues yet to be determined

The Liquidators also claimed for the increase of the costs of the liquidation specifically attributable to the period of wrongful trading. The Judge said that this point had not yet been properly evidenced and he invited proposals about how the issue should be dealt with. He also said ramifications for the directors under the Company Directors Disqualification Act 1986 would be considered at any subsequent hearing.

Comment

This case provides a useful pointer in relation to how the courts will approach the issue of ‘loss’ in such insolvency matters. It will be interesting to see if the Liquidators are ultimately successful in recovering costs and expenses caused by the wrongful trading.

If the directors are ordered to contribute to the costs and expenses attributable to their wrongful conduct, then insolvency practitioners may be more likely to pursue claims even where loss to the company itself is not completely clear.

This post was edited by Ashley Fredericks. For more information, email blogs@gateleyplc.com.

 

[1] Stephen Paul Grant and James Richard Tickell (Joint Liquidators of Ralls Builders Limited) v William Ralph Ralls, Nicholas Lee Ralls and Gary Christopher Hailstones [2016] EWHC 243 (Ch)

[2] Section 214(1) Insolvency Act 1986

[3] Section 214(2)(b) Insolvency Act 1986, as amended by s117(3)(a) Small Business Enterprise and Employment Act 2015

[4] Section 214(3) Insolvency Act 1986

[5] Philip Anthony Brooks and Julie Elizabeth Willetts (Joint Liquidators of Robin Hood Centre Plc) v Kieron Armstrong and Ian Walker [2015] EWHC 2289 (Ch)

[6] Re Purpoint [1991] BCC 121

[7] Re Continental Assurance [2006] BPIR 862

 

 


Leave a Reply

Your email address will not be published. Required fields are marked *

three − one =

This blog is intended only as a synopsis of certain recent developments. If any matter referred to in this blog is sought to be relied upon, further advice should be obtained.