Judgement clarifies law of wrongful trading

In a judgement on 11 February 2016, between the joint liquidators of Ralls Builders Limited and the former directors, Mr Justice Snowden reviewed the law of wrongful trading and previous, apparently contradictory, decisions.

The Law:

Section 214(1) of the Insolvency Act 1986 gives the court the power to order a former director of an insolvent company be “liable to make such contribution (if any) to the company’s assets as the court thinks proper”. To enforce this power the court must be satisfied that “at some time before the commencement of the winding up of the company, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation”.

Section 214(3) states that a declaration under 214(1) should not be made if the director, upon concluding an insolvent liquidation unavoidable, “took every step with a view to minimising the potential loss to the company’s creditors as … he ought to have taken”.

The Judgement:

Mr Justice Snowden first observed that “it is important to note that the fact that a company is insolvent (on a balance sheet or cash-flow basis) and carries on trading does not mean that a director – even one with knowledge of that fact – will be liable for wrongful trading if the company fails to survive” going on to state that insolvency by either measure can be a short term problem but not necessarily terminal for a company.

On the subjective nature of the “no reasonable prospect that the company would avoid going into insolvent liquidation” he stated that the court does not approach the question with the “benefit of 20:20 hindsight” citing Mr Justice Lewison’s judgement in Hawkes Hill that this “is not always fair to those who struggled to keep going in the reasonable (but ultimately misplaced) hope that things would get better”. He went on to emphasise that the court would “place some weight upon the evidence as to whether the directors took professional advice, and if so, what that advice was”.

When reading into the purpose of 214(1) Mr Justice Snowden referred to the fact that any contribution would be distributed equally amongst unsecured creditors, indicating that it was in place to protect the interests of “creditors as a whole” rather than on an individual basis. He went on to say that to determine that a contribution is appropriate it is paramount to “ascertain whether the company suffered loss which was caused by the continuation of trading” after a director should have concluded insolvent liquidation is inevitable.

On 214(3)’s wording, “every step” was singled out to show the intention that the law be a “high hurdle for directors to surmount” and that any continued trading be “designed appropriately so as to minimise the risk of loss to individual creditors” not just reduce the company’s deficiency. Consequently, paying existing creditors at the expense of new ones as a result of continued trading, whilst not harming the overall position, “prevents them from being able to rely upon section 214(3)”.

However, due to his reading of 214(1), Mr Justice Snowden reiterated that not 214(3) not being applicable did not justify a contribution to be made to the assets of the company. Highlighting that whilst this may be seen as a shortcoming any change “ would be for Parliament” to make.

If you are a director of a company in financial distress and would like to know more of your duties leading up to a possible insolvency or are a creditor unhappy with the conduct of former directors, we encourage you to contact us and speak with one of our experienced Practitioners who will be more than happy to provide guidance and advice. An initial consultation is provided free of charge.