There are two aspects of wrongful trading and misfeasance that are of interest (i) board directors (and those advising the board) must be aware of the duties that the directors are subject to in performing their role as directors and the liability that attaches to breach of those duties and (ii) companies may be affected by the wrongful trading/misfeasance of customers/suppliers which impacts on trading.

This article highlights recent examples of how the court has considered these duties in the context of applications by liquidators or administrators of insolvent companies where allegations against directors of misfeasance (under section 212 of the Insolvency Act 1986) and wrongful trading (sections 214/246ZB of the Insolvency Act 1986) have been made.

Wrongful trading

Directors of a company can be held liable to make a contribution to the assets of that company if the company enters insolvent liquidation or administration, and the directors continued to trade the company and incur further credit after the point at which they ‘knew or ought to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation or administration’.

A liquidator must plead a specific date (or dates) and has a high threshold to establish this: ‘hindsight’ is far from sufficient. Directors have open to them the defence that they took every step to minimise potential loss to creditors under sections 214(3) or 246ZB of the Insolvency Act 1986. This is itself a high threshold.

In Ralls Builders Limited (in liquidation) [2016] EWHC 243 (Ch), the court held that the directors ought to have concluded six weeks prior to ceasing trading that the company could not have avoided insolvent liquidation. However, the court held that in this case it was possible that no overall increase in credit was caused. The liquidators contended that this did not permit new credit to be taken. The court held that the effect on creditors overall was the starting point, but not the only point to consider. The court decided that the test for use of the sections 214/246ZB(3) defence is not only that the steps taken were intended to reduce the net deficiency to creditors, but that risk of loss to ‘new’ creditors had to be minimised. In the unreported 2017 case of Nicholson -v- Fielding, it was held that the sections 214/246ZB(3) defence would not have succeeded as the evidence suggested that the steps taken to minimise the losses were at the expense of HMRC. The court would not have expunged liability using sections 214/246ZB(3) in either case.

The cases illustrate the importance, to both the company itself and its directors, of the need to get professional advice (from accountants and/or solicitors) so that directors can get a greater understanding of their duties and (possibly) more objective insight.

Misfeasance – directors’ remuneration and dividends

Directors can be held to be misfeasant under section 212 of the Insolvency Act 1986 if they have misapplied monies or property or breached any fiduciary or other duties they have in relation to the company.

There is always the risk of conflict, or duties being breached, in advising on the remuneration of directors or persons connected to them: the court considered this in two cases in 2017. The intention behind payments in these cases appears to be relevant.

In PV Solar Solutions Limited (in liquidation) [2017] EWHC 3228 (Ch), the directors were aware in 2011-2012 that conditions within the trading sector of the company (installation of solar panels) were soon to deteriorate. The directors withdrew £750,800 in three tranches at times when the company was at least potentially insolvent, utilising an EFRBS scheme marketed as an effective form of tax avoidance. The company’s solvency position was at least uncertain upon the first withdrawal, and worse on the second and third withdrawals. The court ruled that the respondent directors were guilty of misfeasance and ordered repayment of the monies withdrawn.

In Global Corporate Ltd -v- Hale [2017] EWHC 2277, the director undertook substantial work for the company and received modest payments described as ‘dividend payments’. These payments were argued to be unlawful, as there were no distributable reserves to make dividend payments. Unusually, the court held that payments here were not dividends, ruling that no decisions were made on what the payments entailed until established whether there were distributable reserves. In previous years, payments had been re-classified as salary. In such companies, it is more standard for payments to be classed as directors’ loans and then converted as required upon final accounts being prepared.

A number of factors assisted the defendant in Hale, and extreme caution should be placed on trying to rely on it to justify dividend payments.

Putting assets out of the reach of creditors

Marex Financial Ltd -v- Sevilleja Garcia [2017] EWHC 918 (Comm) potentially widens the scope for recovery that a judgment creditor has against an individual who procures non-payment of a debt by a corporate judgment debtor.

The claimant alleged that the defendant (the controller of two companies subject to a judgment in favour of the claimant, who had ‘asset stripped’ the companies after the claimant obtained judgment, before the claimant was able to obtain a freezing order) may be held liable in tort for inducement in procuring that the companies would not be able to satisfy the claimant’s judgment debt.

The court held that the claimant ‘had the better argument for the existence’ of this tort. Further, Marex held that the rule against reflective loss (i.e. that only the companies could sue, and not a third party, such as the claimant) does not apply ‘where the claimant sues for a defendant’s knowingly inducing and procuring a third party to act in wrongful violation of the claimant’s rights’.

It must be emphasised that Marex primarily considered jurisdiction issues, but the findings suggest that a judgment claimant may now have a direct action against an individual procuring the judgment debtor’s breach of the judgment.

The cases highlight the importance of directors knowing their duties and the remedies available where breach of duty can be established.