Guide to common issues facing directors of (potentially) insolvent companies

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1 Guide to common issues facing directors of (potentially) insolvent companies Fraudulent Trading Wrongful Trading Transactions at an Undervalue Preference Good Practice Tips

2 Fraudulent trading 213 Insolvency Act 1986 provides the statutory definition of Fraudulent Trading. Essentially, this is where anyone who is knowingly a party (directors, officers, employees, etc) in carrying on trading with the intention of defrauding creditors (or others) or for any other fraudulent purpose. This section applies not just to Directors, but anyone who is knowingly a party to the fraud and can extend to those outside of the company too. Essentially Fraudulent Trading is deliberate dishonesty. As this is a criminal breach (as opposed to a civil breach) the burden of proof is beyond reasonable doubt. The fraud can be a single transaction or a series of transactions. Typical examples include (please note the list is not exhaustive): Knowingly moving assets out of the company and continuing to trade Fraudulent invoicing Forgery of signatures Carousel fraud Taking deposits from customers knowing the orders will not be fulfilled Unsubstantiated director loan accounts Taking on credit knowing that it will not be paid No. There are both criminal and civil consequences to those found guilty of Fraudulent Trading. Criminal consequences: Unlimited fine this is intended to be punitive Imprisonment up to 7 years Civil consequences Unlimited personal contribution towards the assets of the company as a court thinks proper (i.e.being made to pay for the problem they have let happen). This contribution can be punitive instead of just being compensatory. Disqualification from acting as a Director under Company Directors Disqualification Act 1986 for up to 15 years. page. 01

3 Wrongful trading 214 Insolvency Act 1986 provides the statutory definition of Wrongful Trading. Essentially, this is where the Directors knowingly carry on trading whilst the company is insolvent and applies when a company enters insolvent liquidation. Directors can be: Those who are registered at Companies House Those who have the job title but are not registered as such at Companies House Shadow Directors i.e. people who issue directions or instructions to the company which the Directors are accustomed to following Essentially Wrongful Trading is negligence on the part of the Directors. It can even encompass elements of incompetence where finance is not the area of the Director s own personal expertise. Every Director is expected to act with a reasonable level of skill, knowledge and experience. Every Director must act as would a reasonably prudent and diligent director (this is known as the objective test ). For those Directors who have additional skills, knowledge, qualifications or experience they are expected to act with the objective level of skill mentioned above, but also with additional standards in line with their additional skills, etc. Yes the Director must show that they took every step to minimise potential loss. If it can be shown on a balance of probabilities (the civil burden of proof) that a Director is guilty of Wrongful Trading, then they may face one or more of the following consequences: Unlimited personal compensatory contribution towards the assets of the company as a court thinks proper (i.e. being made to pay for the problem they have let happen) Disqualification from acting as a Director under Company Directors Disqualification Act 1986 for up to 15 years. page. 02

4 Transactions at an undervalue 238 Insolvency Act 1986 provides the statutory definition of a Transaction at an Undervalue. Essentially, this is where a Director sells assets for significantly less than they are worth or even made a gift of the asset to another person or organisation. Directors can be: Those who are registered at Companies House Those who have the job title but are not registered as such at Companies House Shadow Directors i.e. people who issue directions or instructions to the company which the Directors are accustomed to following The gift or sale of the asset (for less than it is worth) must have been within the relevant time period (i.e. in the 2 years immediately preceding insolvent liquidation or administration). The company must have been insolvent at the time the transaction took place or was made insolvent as a direct result of the transaction. Yes the Director must show all three of the following: 1. The transaction was in good faith 2. It was for the purpose of carrying on the business 3. There were reasonable grounds for believing that the transaction would benefit the company The transaction can be reversed, i.e. to return the company to the position it would have been in had the transaction never taken place thus the recipient of the asset (either by purchase or gift) will lose what they have bought / been given. The alternative is to take an action against the Directors for Misfeasance where: Personal compensatory contribution towards the assets of the company as a court thinks proper (i.e. being made to pay for the problem they have let happen) The other potential consequence is that the Director may face disqualification from acting as a Director under Company Directors Disqualification Act 1986 for up to 15 years. page. 03

5 Preference 239 Insolvency Act 1986 provides the statutory definition of a Preference. Essentially, this is where a Director puts one creditor or guarantor into a better position than all other creditors. This applies to the Company acting by its employees or its Directors (i.e. those who are making the preference occur). Directors can be: Those who are registered at Companies House Those who have the job title but are not registered as such at Companies House Shadow Directors i.e. people who issue directions or instructions to the company which the Directors are accustomed to following The payment must have taken place in the 6 months immediately prior to insolvent liquidation or administration if the recipient is an unconnected party, otherwise in the previous 2 years if to a connected party. In relation to preferences, connected parties are: A person related by law or blood to the Directors or shareholders (husbands, wives, civil partners, ex-husbands, ex-wives, ex-civil partners, brothers, sisters, step/half brothers, step/half sisters, parents, adoptive parents, children, adoptive children, aunt, uncle, niece, nephew, lineal ancestor, lineal descendent) A company controlled by a Director or their connected person The Company must have been influenced by the desire to put one creditor into a better position than the others. The desire is automatically presumed if the preference is made to a connected person. The company must be insolvent at the time of the preference or have been made insolvent by it. A common occurence is where the Directors re-pay a bank overdraft and they have given personal guarantees to the bank. Thus the Directors have been placed into a better position because the bank will not call upon their personal guarantees. No. The preference can be reversed, i.e. to return the company to the position it would have been in had the preference never taken place thus the recipient of the payment will have to put the money back. The alternative is to take an action against the Directors for Misfeasance where: Personal compensatory contribution towards the assets of the company as a court thinks proper (i.e. being made to pay for the problem they have let happen) The other potential consequence is that the Director may face disqualification from acting as a Director under Company Directors Disqualification Act 1986 for up to 15 years. page. 04

6 Good Practice Tips Directors must consider ensuring the following occur in order to help them, the company and its creditors: Do not incur further credit. Do not pay monies into overdrawn bank accounts especially if there are personal guarantees covering that bank account. Ensure that all assets are insured and that premiums are up to date. Do not take customer deposits unless the order can be fulfilled. Pay customer deposits into a separately identifiable client monies account. Do not sell assets other than those during the normal course of trade (i.e. selling stock is fine) unless you get a formal professional valuation of the asset and it is sold for market value. If an asset is to be sold (following professional valuations) you may still have to seek shareholder approval under Substantial Property Transactions ( 190 Companies Act 2006). If the property exceeds the lesser of - 10% of the company s net assets and is more than 5, ,000 then shareholder approval must be sought via an ordinary resolution. If not so approved, the transaction can be voidable. Do not dissipate the assets (making payments out of a positive bank balance can even be considered as dissipating a cash asset.) Try to reduce all overheads pay particular attention to the levels of directors remuneration. Hold regular board meetings and keep formal minutes. Decisions taken by the board need to be justified and the minutes are considered as prima facie evidence that will explain the Director s thought processes. This can sometimes protect you in the future. Do not consider resignation as an option anyone holding office as Director in the last 3 years are treated as current if an insolvency occurs. Hold all member meetings in accordance with statute. Do not continue to supply customers where there is already a dispute over an existing book debt. If you owe hauliers money, try to avoid using them again so that they cannot exercise a lien over any goods they hold in transit. Do not use the company s credit cards. Seek and take all professional advice this is particularly important if you have been told by your accountant / solicitor / insolvency practitioner that the company is insolvent and then you choose to ignore the advice this can leave the Directors open to possible Wrongful Trading actions against them. page. 05

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