When a company goes insolvent, an insolvency practitioner’s duty is to maximise recoveries for creditors. Inevitably, this results in a spotlight being shone on the running of the company in the months leading up to its insolvency, and therefore on the actions of the directors.
There are a number of avenues open to insolvency practitioners (or others) to recover losses for creditors from directors of insolvent companies. We summarise the main causes of actions below.
These claims are not mutually exclusive and can be pursued simultaneously[1]. For example, in the well-known case of Wright v Chappell[2], liquidators pursued multiple claims against three directors of British Home Stores including for wrongful trading and misfeasance, and breach of their duties to creditors, with two directors ordered (jointly and severally) to pay compensation of £110 million.
Although each case very much turns on its own facts, this case is a cautionary tale for directors, highlighting the importance of directors adopting a carefully considered and comprehensive approach when taking advice from their financial advisers.
Misfeasance and Breach of Duty
If, in the course of winding up a company, it appears that a present or former director has:
- misapplied or retained, or become accountable for, any money or other property of the company; or
- been guilty of any misfeasance or breach of any fiduciary or other duty,
a liquidator, creditor, contributory to the company’s capital or Official Receiver can apply for an order that the director repay, restore or account for the money or property (with interest), or contribute such sum to the company’s assets by way of compensation as the Court thinks just.
Importantly, as soon as a director knows or ought to know that a company is insolvent or borderline insolvent, the ordinary director’s duty to act in the company’s interests shifts to include the interests of the company’s creditors (prioritising creditors’ interests where necessary). This is known as the “creditor duty” and a director can be pursued in misfeasance for breaching this duty.
The applicant would need to show a loss to the insolvent company caused by the relevant breach of duty and the Court has discretion in relation to the relief ordered.
There is a defence available to directors if they can prove that:
- they acted honestly and reasonably; and
- the circumstances of the case mean it is fair to excuse them from the liability.
Alternatively, the director may be excused from liability if they can prove that the shareholders of the company ratified the relevant action.
Wrongful Trading
An insolvency practitioner can seek a Court declaration that a director contributes to the company’s assets if it can be shown that:
- The director knew or ought to have concluded at some point before the commencement of the liquidation or administration of the company that there was no reasonable prospect that the company would avoid going into insolvent liquidation or administration, yet the director continued trading; and
- The company is worse off as a result of the continuation of trading.
The Court will not make an order if it can be shown that the director took every step with a view to minimising the potential loss to the company’s creditors as the director ought to have taken.
Fraudulent Trading
If, in the course of winding up a company, it appears that any business of the company has been carried on with the intent to defraud creditors, or for any other fraudulent purpose, an insolvency practitioner can see a court declaration that anyone who was knowingly party to the fraudulent business contribute to the company’s assets.
The insolvency practitioner must demonstrate that the director acted with dishonesty. It is, therefore, a higher burden of proof than that required to prove wrongful trading.
Fraudulent trading is also a criminal offence, and a person held liable for either fraudulent or wrongful trading may be disqualified from acting as a director of any company for a period of 2 to 15 years.
Restriction on Re-use of Company Names
Where a company enters into insolvent liquidation, its directors (or former directors in the 12 months preceding insolvency) cannot be a director or shadow director of another company or business with the same or a similar name for a period of five years.
This is a strict liability civil and criminal offence, so, if the conditions are met, the Court does not have any discretion to excuse or limit the director’s liability. The principal remedy would be for the directors / former directors to be held personally liable for the debts of the new company, although imprisonment and/or fines are possible. This rule is designed to protect creditors from what is colloquially known as ‘phoenixing’, though as the rule is contained in a little-known provision of the Insolvency Act and is nevertheless a strict liability offence with no discretion granted to the Court, it can undoubtedly lead to potential unfairness where there is no malicious intent or managerial impropriety by the relevant individuals.
There are three exceptions to the applicability of this rule:
- Where the insolvent company’s business is sold to another entity, and the director gives notice to all creditors of the insolvent company before they in contravention of the above.
- The director applies for the Court’s permission within seven business days of the insolvent company’s liquidation (this exception applies for a maximum of 6 weeks).
- The second company with the prohibited name has been known by that name for at least 12 months before the insolvent company goes into liquidation (this was successfully raised as a defence in the recent case of Maxima Creditor Resolutions Ltd v Fealy [3]).
Concluding Comments
In short, there are a myriad of potential claims that can be brought by insolvency practitioners against an insolvent company’s former directors. To protect themselves, directors should ensure that they have up to date financial information for the company at all times, maintain comprehensive minutes of all board meetings (particularly when it is evident that the company is in financial difficulties) and seek advice as soon as they suspect that the company is in financial difficulties.
Fladgate regularly acts for both insolvency practitioners and directors of companies. If you would like to discuss the contents of this article in more detail, please do get in touch with its co-authors, Nadia Osborne, Partner, and Romy Cross, Associate.
[1] Though for completeness, it should be noted that a Court will not make multiple awards of compensation in respect of the same underlying liability.
[2] [2024] EWHC 1417 (Ch)
[3] [2024] EWHC 2694 (Ch)
