Chapter 10: Corporate Insolvency II

Question 1

1.1 Liability of directors of an insolvent company

Answer 1

When a company becomes insolvent, the directors need to be extremely careful in how they act,
since they may be held to be personally liable to compensate the company and its creditors if
found guilty of one of the following:
* Misfeasance (s 212 IA 1986)
* Fraudulent trading (ss 213/246ZA IA 1986)
* Wrongful trading (ss 214/246ZB IA 1986)

Liquidators and administrators have the power to bring proceedings for compensation against the directors personally (for fraudulent trading and wrongful trading) and in the case of liquidators only, for misfeasance).

Question 2

1.2 Misfeasance – s 212 IA 1986

Answer 2

As you know, directors of a company owe duties to the company under ss 171–178 CA 2006. Breach of any such duties is generally actionable by the company, although shareholders may be able to bring a claim for unfair prejudice, just and equitable winding up or a derivative claim on
behalf of the company.

Question 3

Liquidator brings action against directors for misfeasance

Answer 3

On a winding up, typically it will be the liquidator, not the company, who will bring an action against the directors under s 212 IA 1986 for any breaches of duty committed by them.
Section 212 does not create any new liability or rights but simply provides a summary procedure to enable the company (acting by its liquidators) to pursue claims against directors who have breached their duties. Where a person’s liability is established, the court may order that person to compensate the company in respect of money or property misapplied as a result of the misfeasance.

Question 4

1.3 Who may bring a claim? against directors for misfeasance

Answer 4

Under s 212(3) IA 1986 claim may be brought by:
* A liquidator (but note, not an administrator);
* The Official Receiver; or
* Any creditor or contributory.
The burden of proof is on the claimants to establish misfeasance on the part of the director or
other defendant, it is not for the defendant to justify their conduct (Mullarkey v Broad [2008] 1
BCLC 638).

Question 5

1.4 Against whom may a claim be brought?

Answer 5

Under s 212(1) a claim in misfeasance may be brought against:

(a) Any person who is or has been an officer of the company (including present or former
directors, managers or secretaries of the company);
(b) Any others who acted in the promotion, formation or management of the company; and
(c) A liquidator or administrative receiver (a claim for misfeasance can also be brought against
an administrator under Schedule B1 to the IA 1986).

Question 6

Key case: Re Centralcrest Engineering Co Ltd [2000] BCC 727

Answer 6

The Inland Revenue brought proceedings against a liquidator under s 212. The liquidator had
allowed the company to continue to trade for 27 months after it had gone into compulsory liquidation, resulting in £73,230 being owed to the IR. The court held that there were two elements to the misfeasance:

firstly, allowing the company to trade without the sanction of the court or
liquidation committee and secondly allowing the company to trade when it was apparent that the assets should have been realised. The liquidator was held liable to compensate the company for
losses of £120,826 incurred during the trading period.

Question 7

1.5 What amounts to misfeasance?

Answer 7

Misfeasance covers the whole spectrum of directors’ duties and therefore includes:
(a) Misapplication of any money or assets of the company;
(b) Breach of a statutory provision or a duty, for example:
- Unlawful loans to a director (s 197 CA 2006);
- A director entering into a contract with his own company and failing to notify the board (s
177 CA 2006);
- Failing to seek prior general meeting approval where a director has entered into a
substantial property transaction (s 190 CA 2006); and
- A director failing to act within their powers (s 171 CA 2006);
(c) Directors responsible for transactions at an undervalue as provided in s 238 or preferences as
provided in s 239 may thereby commit a misfeasance; and
(d) Breach of the duty to exercise reasonable care, skill and diligence, ie negligence (s 174 CA
2006)

Question 8

1.6 Remedies

Answer 8

The court will examine the conduct of the director/other person against whom the claim formisfeasance has been brought and make an order for repayment, restoration or contribution to the company’s assets as it thinks just. The director may claim relief under s 1157 (where the court is satisfied that the director acted honestly and reasonably and, having regard to all the circumstances of the case, ought fairly to be excused).

A finding of misfeasance is also a relevant factor to which a court shall have regard when considering whether to make a disqualification order against a director for unfitness under s 6 Company Directors’ Disqualification Act 1986 (CDDA 1986).

Question 9

1.7 Ratification can absolve directors from personal liability

Answer 9

Ratification by the shareholders under s 239 CA 2006 can usually absolve the directors from personal liability for breach of duty. Ratification at a time when the company is solvent should therefore preclude misfeasance proceedings.

Question 10

Prospect of Insolvency

Answer 10

However, when a company is facing the prospect of insolvency, case law has established that the duties of directors shift towards the company’s creditors and away from the members as a whole. This is because in these circumstances, it is the creditors rather than the shareholders of the company who stand to lose if the directors breach their duties

Question 11

Not possible for the shareholders to ratify what amounts to a breach of
directors’ duties

Answer 11

Consequently, it is not possible for the shareholders to ratify what amounts to a breach of directors’ duties at a time when the company’s fortunes have declined to such an extent that there is a reasonable prospect that the company will go into an insolvent liquidation or administration.

This is recognised in s 239(7) CA 2006 which provides that the ratification procedure does not prejudice any rule of law which provides that shareholder ratification is of no
effect.

Question 12

1.8 Summary

Answer 12

• Misfeasance is a summary procedure under s 212 IA 1986 to enable the company (usually
  acting by its liquidators) to pursue claims against directors who have breached their duties. Claims may also be brought against the liquidator in certain circumstances.
• Any breach of directors’ duties in the context of insolvency may amount to misfeasance.
• The court has a broad discretion with regard to remedies and may make an order for repayment, restoration or contribution to the company’s assets as it thinks just.
• A finding of misfeasance is also a relevant factor to which a court shall have regard when considering whether to make a disqualification order against a director for unfitness under s 6 Company Directors Disqualification Act 1986.
• Ratification is not available for a breach of directors’ duty at a time when the company’s fortunes have declined to such an extent that there is a reasonable prospect that the company will go into an insolvent liquidation or administration.

Question 13

2 Fraudulent trading

2.1 Liability of directors of an insolvent company

Answer 13

The provisions on fraudulent and wrongful trading in IA 1986 were enacted to prevent reckless and
negligent conduct on the part of those running companies. The concern is that directors may continue to incur further debts at a time when the company is in financial difficulty with no reasonable prospect of turning the company’s prospects around, with the result that losses to creditors are increased.

Question 14

2.2 Fraudulent trading

Answer 14

A claim for fraudulent trading under ss 213/246ZA IA 1986 can be brought against:
* any person who is knowingly party to the carrying on of any business of the company (s 213(2) and s 246ZA(2))
* with intent to defraud creditors or for any fraudulent purpose (s 213(1) and s 246ZA(1)).

Question 15

Civil liability

Answer 15

Sections 213 (in liquidation) and 246Z (in administration) IA 1986 impose a civil liability to contribute to the funds available to the general body of unsecured creditors suffering loss caused by the carrying on of the company’s business with intent to defraud.

There is also a corresponding criminal claim for fraudulent trading under s 993 CA 2006. The claim may be brought by a liquidator under s 213 or an administrator under s 246ZA, although court approval is required.

Question 16

2.3 Actual dishonesty

Answer 16

Actual dishonesty must be proven for a claim for fraudulent trading to succeed. Dishonesty is assessed on a subjective not objective basis ie what the particular person knew or
believed. Knowledge includes blind-eye knowledge, which requires a suspicion of the relevant
facts together with a deliberate decision to avoid confirming that they did exist (Morris v State
Bank of India [2005] 2 BCLC 328).

The meaning of fraud for the purposes of s 213 has been defined as requiring “real dishonesty
involving, according to current notions of fair trading among commercial men at the present day,
real moral blame.” (Re Patrick and Lyon Ltd [1933] Ch 786).

Question 17

Re Gerald Cooper Chemicals Ltd [1978] Ch 262

Answer 17

It is not necessary to show that all of the company’s creditors have been defrauded. In Re Gerald Cooper Chemicals Ltd [1978] Ch 262 it was held that accepting advance payment for the supply of goods from one creditor where the directors knew that there was no prospect of the goods being supplied amounted to fraudulent trading, despite only one creditor having been defrauded.

Question 18

Remedies

Answer 18

A person found to be liable under ss 213/246ZA can be ordered to make such contribution to the company’s assets as the court thinks proper. The court does not have the power to include a punitive element in the amount of any contribution to be made.

The contribution should only
reflect and compensate for the loss caused to the creditors (Morphitis v Bernasconi [2003] 2 BCLC 53). Any sums recovered are held on trust for the unsecured creditors generally and not for the defrauded creditor (Re Esal (Commodities) Ltd [1997] 1 BCLC 705).

Question 19

Section 213/246ZA & Criminal Sanctions

Answer 19

Where the court makes an order against a person under ss 213/246ZA, and that person is also a director, the court is likely also to make a disqualification order under s 10 CDDA 1986. In addition, criminal sanctions can be imposed by the court under s 993 CA 2006, to punish a person knowingly party to fraudulent trading, whether or not the company is being wound up.
The penalties are imprisonment (of up to 10 years on indictment) and/or fines

Question 20

2.5 Fraudulent trading vs wrongful trading

Fraudulent Claims are very rare

Answer 20

In practice, a very high standard of proof is required for a successful claim in fraudulent trading,
which is likely to be extremely difficult for a liquidator or an administrator to establish.

Question 21

2.6 Summary

Answer 21

• Claims for fraudulent trading may be brought by a liquidator under s 213 IA 1986 or an administrator under s 246ZA IA 1986.
• The claim can be brought against any person who is knowingly party to the carrying on of any business of the company with intent to defraud creditors or for any fraudulent purpose.
• Actual dishonesty must be proven on a subjective basis.
• A person found to be liable under ss 213/246ZA can be ordered to make such contribution to the company’s assets as the court thinks proper. There is no punitive element to the remedy however – the contribution should only reflect and compensate for the loss caused to the
  creditors.
• The court is likely also to make a disqualification order under s 10 CDDA 1986.
• There is also a criminal claim for fraudulent trading under s 993 CA 2006. The remedies for this
  are up to 10 years’ imprisonment or fines.

Question 22

3. Wrongful trading

3.1 The claim for wrongful trading

Answer 22

Liability for fraudulent trading existed long before liability for wrongful trading was introduced. However, the requirement for proof of dishonest intent to establish liability for fraudulent trading has meant that proceedings for fraudulent trading are rarely brought.

Following criticism of the ineffectiveness of the fraudulent trading provisions, the concept of
wrongful trading was introduced in order to establish liability fordirectors who carry on business negligently rather than fraudulently.

Question 23

Civil Claim for Wrongful Trading

Answer 23

A civil claim for wrongful trading can be brought against a director by a liquidator under s 214 or an administrator under s 246ZB IA 1986. There are no criminal provisions for wrongful trading, in contrast to fraudulent trading which is both a civil and a criminal wrong.

Wrongful trading is now the major risk run by the directors of a company trading on the brink of
insolvency. Directors must take the risk of liability for wrongful trading seriously and it is an important part of a lawyer’s job to advise on the risk and how to mitigate it.

Question 24

3.2 Wrongful trading – purpose

Answer 24

The purpose of ss 214 and 246ZB is to ensure that when directors become aware (or ought to
become aware) that an insolvent liquidation (or insolvent administration, as the case may be) is
inevitable, they are under a duty to take every step possible to minimise the potential losses to the company’s creditors.

Question 25

Under s 214 and 246ZB

Answer 25

Order the directors to contribute to
the insolvent estate by way of compensation for the losses that the general body of creditors have
suffered as a result of the directors’ conduct, and thereby, increase the funds available for distribution to unsecured creditors in the insolvency

Question 26

Wrongful trading and personal liability as a crucial exemption

Answer 26

Wrongful trading liability therefore imposes personal liability on directors and marks a very important exception to the principle of limited liability under which those who run a company cannot be liable for its unpaid debts.

Question 27

3.3 Who may bring a claim? - ss 214(1)/246ZB(1)

Answer 27

A claim for wrongful trading may be brought by:
* Liquidators under s 214(1); and
* Administrators under 246ZB(1).
Administrators and liquidators can also now (under the SBEEA 2015) assign wrongful trading claims to a third party as a way of raising funds for the insolvent estate and thereby, avoid the risk of litigation.

Question 28

3.4 Against whom may a claim be brought?

Answer 28

A claim may be brought against any person who was at the relevant time a director. This includes shadow directors as defined in s 251 CA 2006, de facto and non-executive directors. Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180, ChD. Contrast this with fraudulent trading where a claim can be brought against any person who has the intention to commit a fraud.

Question 29

3.5 Requirements for liability – ss 214(2)/246ZB(2)

Answer 29

For a director to be liable for wrongful trading, the court must be satisfied that the company has
gone into insolvent liquidation or insolvent administration and:

(a) At some time before the commencement of the winding up or insolvent administration (for
convenience, that time is referred to as the ‘point of no return’)
(b) The director knew or ought to have concluded that
(c) There was no reasonable prospect that the company would avoid going into insolvent liquidation (or insolvent administration).

Question 30

Timing of Insolvency

Answer 30

Note that a company goes into insolvent liquidation (or as the case may be, an insolvent administration) at a time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of winding up or administration (ss 214(6)/246ZB(6)).
Insolvency for wrongful trading purposes is therefore judged solely on the ‘balance sheet test’ and not on the ‘cash flow test’ (see s 123).

Question 31

3.6 Continued trading

Director in question allowed the company to go insolvent

+

Continued trading made the position of the company worse

Answer 31

It must be proven that the director in question allowed the company to continue to trade during the period in 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 and that the continued trading made the company’s position worse (Re Continental Assurance Co of London
plc [2001] BPIR 733)

Question 32

Company has not reached point of no return

Answer 32

Note however, if the company has not reached the point of no return, then wrongful trading liability cannot arise and there is no need to consider the ‘every step’ defence which we consider below.

Question 33

Key case: Re Produce Marketing Consortium Ltd [1989] BCLC 513, ChD

Answer 33

This was the first reported case under s 214 IA 1986. The court held the two directors of the company each liable to contribute £75,000 to the company’s assets. It was held that the time at which the directors ought to have realised that there was no reasonable prospect of the company avoiding insolvent liquidation was the latest possible date on which the annual accounts for that year ought to have been delivered.

The fact that the directors had not seen the accounts was irrelevant since s 214(4) required them to be judged not only on the facts actually known to them but on the facts that they should have known had the accounts been delivered in accordance with the Companies Act

Question 34

Key case: Re Produce Marketing Consortium Ltd [1989] BCLC 513, ChD Judgement

Answer 34

It follows that the general knowledge, skill and experience postulated will be much less extensive in a small company in a modest way of business, with simple accounting procedures and equipment, than it will be in a large company with sophisticated procedures.

Nevertheless, certain minimum standards are to be assumed to be attained. Notably there is an obligation laid on companies to cause accounting records to be kept which are such as to disclose with
reasonable accuracy at any time the financial position of the company at that time

Question 35

3.7 The ‘every step’ defence - ss 214(3)/246ZB(3)

Answer 35

Assuming the company has reached the point of no return, a director may be able to escape liability if they can satisfy the court that, after they first knew or ought to have concluded that there was no reasonable prospect of the company avoiding an insolvent administration or liquidation (ie from the ‘point of no return’ onwards), they took every step with a view to minimising the potential loss to the company’s creditors.

Question 36

Evidence that can help establish the ‘every step’ defense

Answer 36

Examples of evidence that may be supportive of establishing the every step defence include:
* Voicing concerns at regular board meetings;
* Seeking independent financial and legal advice;
* Ensuring adequate, up-to-date financial information is available;
* Suggesting reductions in overheads/liabilities;
* Not incurring further credit; and
* Consulting a lawyer and/or an insolvency practitioner for advice on continued trading and the
different insolvency procedures.

Question 37

Key case: Brooks v Armstrong [2015] EWHC 2289 Key case: Brooks v Armstrong [2015] EWHC 2289

Answer 37

The court in this case stressed that the burden of proof is on the directors to establish that they
took every step to minimise loss to the creditors once they were aware that there was no reasonable prospect of the company avoiding insolvent liquidation.

It was noted that the meaning of ‘every step’ will depend on the facts in each case but the following factors should be kept under review by directors:

Question 38

Accounting Records are kept up to date

Answer 38

Ensuring accounting records are kept up to date with a budget and cash flow forecast;

preparing a business review and a plan dealing with future trading including steps that can be
taken (for example cost cutting) to minimise loss;

keeping creditors informed and reaching agreements to deal with debt and supply where possible; regularly monitoring the trading and
financial position together with the business plan both informally and at board meetings;

asking if loss is being minimised;

ensuring adequate capitalisation; obtaining professional advice (legal and financial); and considering alternative insolvency remedies. Ensuring accounting records are kept up to date with a budget and cash flow forecast;

preparing a business review and a plan dealing with future trading including steps that can be
taken (for example cost cutting) to minimise loss;

keeping creditors informed and reaching agreements to deal with debt and supply where possible; regularly monitoring the trading and
financial position together with the business plan both informally and at board meetings;

asking if loss is being minimised; ensuring adequate capitalisation; obtaining professional advice (legal and financial); and considering alternative insolvency remedies.

Question 39

3.8 The ‘reasonably diligent person’ test – ss 214(4)/246ZB(4)

Answer 39

The court applies the ‘reasonably diligent person’ test in order to determine whether:

• A liquidator or administrator has established that a director ought to have concluded that there was no reasonable prospect of avoiding an insolvent liquidation or administration (the ss
  214(2)/246ZB(2) liability), and
• Whether the director then took every step to minimise the potential loss to the company’s
  creditors (the ss 214(3)/246ZB(3) defence).

Question 40

Definition of a reasonably diligent person

Answer 40

• The general knowledge, skill and experience that may reasonably be expected of a person
  carrying out the same functions as are carried out by the director in question (an objective
  test); and
• The actual knowledge, skill and experience of that particular director (a subjective test). The court then applies the higher of the two standards.

Question 41

3.9 Advice to directors: Writing up minutes of the meeting

Answer 41

Directors should hold board meetings regularly to review the company’s financial position and
consider whether, in any particular case, it is appropriate to incur new credit and liabilities. They should write up minutes of each meeting so there is a written record on which the directors can later rely to justify why decisions were taken when they were.

It is quite common for lawyers
advising a company in financial difficulties to take an active role in helping directors to prepare
minutes and to ensure that board meetings consider all the relevant issues

Question 42

3.9 Advice to directors: Cannot simply escape liability

Answer 42

A director cannot escape liability by simply resigning without previously taking every step with a view to minimising the potential loss to the company’s creditors, since a claim for wrongful trading can be brought against any person who was a director at the relevant time (Re Purpoint Ltd [1991] BCLC 491).

Question 43

3.9 Advice to directors: Seek professional advice

Answer 43

The best course of action for a company is to seek professional advice as soon as possible (Re
Continental Assurance Co of London plc [2001] BPIR 733). However, it is important to note that the absence of warnings from advisers does not relieve directors of the responsibility to review the company’s position critically (Re Brian D Pierson (Contractors) Ltd [2001] 1 BCLC).

Question 44

3.10 Remedies – ss 214(1)/246ZB(1)

Making contributions to the assets of the company

Answer 44

If a director is found to be liable for wrongful trading, the court can order that director to make such contribution to the assets of the company as the court thinks fit.

The contribution will increase the assets of the company available for distribution to the general body of unsecured creditors.

Question 45

Wide discretion to determine the extent of director’s liability

Answer 45

The court has a wide discretion to determine the extent of the directors’ liability. The contribution
will ordinarily be based on the additional depletion of the company’s assets caused by the
directors’ conduct from the date that the directors ought to have concluded that the company
could not have avoided an insolvent administration or liquidation (ie from the ‘point of no return’)

Question 46

Compensatory & not Penal in Nature

Answer 46

An order by the court for a director to contribute to the company’s assets under ss 214/246ZB is compensatory and not penal in nature. An order to contribute may be made against the directors on a joint and several basis. However, the court has a discretion to apportion liability between
directors based on their culpability by ordering the more culpable directors to pay more than the less culpable ones.

Court can make disqualification order towards directors: Where the court makes a contribution order against a director under ss 214/246ZB, the court also has a discretion to make a disqualification order against them under s 10 CDDA 1986.

Question 47

3.11 No relief under s 1157

Answer 47

Relief maybe offered in other cases of general negligence and breach of duty. However, that relief is not available in wrongful trading
proceedings (Re Produce Marketing Consortium Ltd [1989] BCLC 513, ChD). The risk of an action for wrongful trading can be of concern to directors, particularly in a difficult
economic climate.

It is for this reason that the government suspended the wrongful trading provisions for an initial period from 1 March 2020 - 30 September 2020 to allow company directors to attempt to keep their businesses going during the coronavirus pandemic without risk of personal liability.

Question 48

3.12 Summary

Answer 48

• Claims for wrongful trading may be brought by a liquidator under s 214 IA 1986 or an administrator under s 246ZB IA 1986. The claim can be brought against any person who was at the relevant time a director.
• The court must be satisfied that at some time before the commencement of the winding up or
  insolvent administration, the director knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation (or insolvent administration).
• A director may be able to escape liability if they can satisfy the court that they took ‘everymstep with a view to minimising the potential loss to the company’s creditors’ (ss
  214(3)/246ZB(3).
• The court applies the reasonably diligent person test under ss 214(4)/246ZB(4).
• A person found to be liable under ss 214/246ZB can be ordered to make such contribution to
  the company’s assets as the court thinks proper and may also be disqualified under s 10 CDDA
  1986.

Question 49

4 Voidable transactions

Answer 49

This section considers the following transactions which may potentially be avoided by liquidators
or administrators:
* Transactions at an undervalue
* Transactions defrauding creditors
* Preferences
* Avoidance of Floating Charges.

Question 50

4.1 Introduction

Answer 50

The IA 1986 gives both a liquidator and an administrator the ability to challenge certain transactions that have taken place within specified statutory periods prior to the insolvency of a company. These are known as ‘voidable’ or ‘antecedent’ transactions.

Question 51

Aim of the Challenge

Answer 51

The aim of a challenge is to restore the company to the same position it would have been in had the transaction not taken place and thereby, increase the funds available in the insolvent estate for the benefit of creditors.

Question 52

Clawback Provisions

Answer 52

These provisions are often described as ‘clawback’ provisions which can result in an order reversing transactions or more usually, providing for financial restitution to be paid, in order to increase the assets of the insolvent company for the benefit of creditors.

It is the beneficiary of the transaction with the insolvent company that is the target of the proceedings, rather than the directors of the company responsible for entering into the transaction.

Question 53

Voidable or antecedent transactions

Answer 53

The IA 1986 gives both a liquidator and an administrator the ability to challenge certain transactions that have taken place within specified statutory periods prior to the insolvency of a company. These are known as ‘voidable’ or antecedent’ transactions

Question 54

4.2 Different types of voidable transactions

Answer 54

In this element we will look at four different voidable transactions which may be challenged by either a liquidator or an administrator under the relevant provisions of IA 1986:

(a) Transactions at an undervalue – s 238
(b) Transactions defrauding creditors – s 423
(c) Preferences – s 239
(d) Avoidance of floating charges – s 245

Question 55

4.3 Questions to ask

Answer 55

A liquidator or administrator seeking to challenge any voidable transaction (except for a transaction defrauding creditors under s 423) will need to ask the following questions in each
case:

(a) Did the transaction involve a ‘connected person’ or ‘associate’?
(b) Did the transaction take place within the ‘relevant time’?
(c) Was the company insolvent at the time of the transaction or did it become insolvent as a
result of the transaction?
(d) Is there a presumption available which shifts the burden of proof from the liquidator/administrator to the other party?

Question 56

4.4 Transactions by a company at an undervalue (TUV) – s 238 IA 1986

Answer 56

The provisions under s 238 concern loss of value from a company, whether through gifts or a significant inequality in consideration, to the company’s detriment at a time when it is ‘insolvent’.

Insolvency means ‘inability to pay debts’ under s 123 ie the company is insolvent on either the cash flow or balance sheet basis. Note that “insolvency” has a wider definition for voidable transaction purposes than it has for wrongful trading purposes (in the latter case, ‘insolvency’ is restricted to balance sheet insolvency
only).

A claim may be brought under s 238(1) by:
* A liquidator; or
* An administrator

Question 57

4.5 TUV: Granting security/payment of a dividend (Transactions at an undervalue)

Answer 57

It was generally thought that the granting of security by a company cannot amount to a transaction at an undervalue on the basis that the security does not itself deplete the assets of the company or diminish their value (Re MC Bacon Ltd [1990] BCLC 324).

Question 58

Hill v Spread Trustee Company Limited [2006] EWCA Civ 542

Answer 58

However, in Hill v Spread Trustee Company Limited [2006] EWCA Civ 542, it was found that the granting of security for no consideration (or for consideration significantly less than the value of the charge) can be challenged as a transaction at an undervalue. In Hill, the main purpose for the granting of security was to put assets beyond the reach of HMRC. The law is somewhat uncertain
on this point because of the difference in view between the MC Bacon and Hill cases.

Question 59

Whether a dividend, lawfully paid, could amount to a transaction at an undervalue

Answer 59

Similar uncertainty existed around whether a dividend, lawfully paid, could amount to a transaction at an undervalue. The case of BTI 2014 LLC v Sequana SA & others [2019] EWCA Civ 112 now suggests that a dividend can be attacked as a transaction at an undervalue.

Question 60

4.6 TUV: What is a transaction at an undervalue?

Answer 60

A transaction at an undervalue is either:
* A gift; or
* A transaction for a consideration the value of which, in money or money’s worth, is significantly less in value than the consideration provided by the company. This involves a comparison in monetary terms between what the company gave away and what it received under the transaction. The comparison to be made is aimed at establishing if there has been an inequality of exchange adverse to the company under the transaction. A simple example would be where a company sells an asset worth £10,000 but only receives £5,000 in payment.
In some situations, the granting of security or payment of a dividend may be held to amount to a
transaction at an undervalue.

Question 61

4.7 TUV: When and how can the transaction be avoided?

Answer 61

The court may set aside a transaction as a transaction at an undervalue if:

(a) The company made a gift or otherwise entered into a transaction for a consideration, the value of which in money or money’s worth is significantly less in value than the consideration provided by the company.

(b) It took place within the ‘relevant time’ (s 238(2)) - in the two years preceding the onset of insolvency (s 240(1)(a)), which is the commencement of the relevant insolvency procedure (administration or liquidation) (s 240(3)). Note that the relevant time is two years regardless of whether the transaction took place with a connected person or not.

(c) It is proven by the applicant that the company was insolvent at the time of the transaction or became so as a result of it (s 240(2)). Where a transaction at an undervalue is entered into with a person connected with the company, insolvency is presumed unless the connected
person proves otherwise (s 240(2)).

Sections 249 and 435 set out the definitions of ‘connected persons’ and ‘associates’ respectively.

Question 62

4.8 TUV: Defence

Answer 62

Even if all of the requirements set out above are satisfied, no order will be made to set aside the
transaction if the court is satisfied that:
(a) The company entered into the transaction in good faith and for the purpose of carrying on
its business; and
(b) At the time there were reasonable grounds for believing that the transaction would benefit
the company.

Question 63

Company grants new security

Answer 63

One example when the defence may be available is where a company grants new security to stave off a genuine threat made by an unsecured bank to terminate facilities and begin winding up proceedings if the security is not granted, in circumstances where the directors consider on reasonable grounds that the company can turn around its financial difficulties and thereby avoid entering into an insolvency procedure.

Question 64

4.9 TUV: Sanctions

Answer 64

The court has a discretion to make such order as it thinks fit to restore the position as if the company had not entered into the transaction (s 238(3)). Section 241(1) provides a non-exhaustive list of the types of restoration order that the court might make under s 238 (and also under s 239 in relation to voidable preferences; see below).

Question 65

Acting in good faith and for value

Answer 65

Any such order should not prejudice a subsequent purchaser from the party which transacted at an undervalue with (or received a preference from) the company, provided they were acting ‘in
good faith and for value’ (s 241(2)).

Question 66

Rebuttable assumptions of acting in good faith

Answer 66

Purchaser was not in good faith where the subsequent purchaser either:

(a) Had notice of the relevant surrounding circumstances (ie the transaction at an undervalue or
preference) and of the relevant proceedings; or

(b) Was connected with or was an associate of either the company or the party which transacted at an undervalue with (or received a preference from) the company. In such circumstances the burden of proof shifts to the subsequent purchaser to show good faith.

Question 67

4.10 Transactions defrauding creditors (TDC) - s 423 IA 1986

Answer 67

Claims under s 423 do not necessarily relate to insolvency – these claims may also be brought by a victim of the transaction in question where the company is solvent.

The requirements for the claim are:

(a) There has been a transaction at an undervalue and
(b) The intention or purpose of the transaction was to put assets beyond the reach of creditors of the company or otherwise prejudice their interests. ‘Creditors’ in this context includes
future creditors who were unknown at the time of the transaction.

Where these requirements are met, the transaction may be avoided under s 423(3).

Question 68

Insolvency practitioners may prefer to bring claims under s 238 (TUV) than under s 423.

Answer 68

The reason is that, under s 238, it need not be proved that the purpose of the transaction was to put
the assets beyond the reach of creditors or otherwise prejudice them.

Where the challenge is made by an administrator or liquidator, it may therefore be easier to establish the claim under s 238, assuming that the claim satisfies the criteria for challenging an undervalue transaction under the above sections (ie ‘relevant time’ and insolvency)

Question 69

4.11 TDC: Who may claim and sanctions

Answer 69

An application to the court to set aside the transaction can be made by any of the following (s
424):
(a) A liquidator or an administrator;
(b) A supervisor of a voluntary arrangement; or
(c) A victim of the transaction in question.

Question 70

Is there a relevant time period?

Answer 70

There is no ‘relevant time’ or period within which the transaction must have taken place. However, generally speaking, the more recent the transaction, the more likely it is that the applicant will be able to show the necessary intent.

The main advantage of a claim under s 423 is that it does not face the risk of becoming timebarred in the same way as a claim under s 238.

Question 71

4.12 Preferences by a company – s 239 IA 1986

Answer 71

The purpose of s 239 is to prevent a creditor obtaining an improper advantage over other creditors
of a company at a time when that company is insolvent.

A claim may be brought under s 239(1) by:
* A liquidator; or
* An administrator.

A company gives a preference to a person if:
(a) That person is a creditor of the company (or a surety or guarantor of any of the company’s
debts or liabilities); and
(b) The company does anything or allows anything to be done which has the effect of putting that person in a better position in the event of the company going into insolvent liquidation than they would otherwise have been in.

Question 72

4.13 When can a preference be avoided?

Within relevant time

Answer 72

The preference is voidable if:
(a) It was given within the ‘relevant time’ (s 239(2)) - in the 6 months preceding the ‘onset of insolvency’ (s 240(1)(b)), being the commencement of the relevant insolvency procedure (s 240(3)). The relevant time is extended to 2 years for preferences to connected persons and associates (s 240(1)(a)). (See sections 249 and 435 for definitions of ‘connected persons’ and ‘associates’).

Question 73

Proven insolvency & person connected to the company

Answer 73

(b) It is proved that the company was insolvent (on either a cash flow or balance sheet basis) at the time of the transaction or became so as a result of it (s 240(2)). In contrast to transactions at an undervalue, there is no statutory presumption of insolvency where the preference is given to a person who is connected with the company.

Question 74

Company Influenced by a desire to prefer the creditor

Answer 74

(c) It is proved that the company was ‘influenced … by a desire’ to prefer the creditor (s 239(5)). This is a subjective test. The company must have positively wished to put the party in a better position (see Re MC Bacon Ltd).

Question 75

4.14 Preferences: Connected persons

Answer 75

If the preference is given to a connected person or associate, there is a rebuttable presumption
that the company was influenced by the desire to prefer the creditor (s 239(6)). This shifts the burden of proof from the liquidator or administrator to the preferred person to rebut the statutory presumption. Connected persons and associates are defined in s 249 and s 435 IA 1986.

Question 76

4.15 Preferences: Defence

Answer 76

The defence available is an absence of the desire to prefer required by s 239(5).

Question 77

Key case: Re MC Bacon Ltd [1990] BCLC 324

Answer 77

In Re MC Bacon Ltd [1990] BCLC 324, the company granted fixed and floating charges to its bank to secure an existing overdraft, as a condition of the bank not calling in the overdraft, at a time when it was insolvent. It was held that this was not a transaction at an undervalue because it had not diminished the value of the company’s assets. In relation to the claim that this was a
preference, the court said it is not necessary to prove an intention to prefer (which is objective), but a desire to prefer (which is subjective).

On the facts, the security could not be challenged as a preference because the directors, in granting the security, had not been influenced by a desire to prefer the bank, but only by the desire to continue trading and to avoid the calling in of the company’s overdraft (ie the security
was granted as a result of genuine commercial pressure exerted by the lender and the presence of such pressure negated any desire on the debtor’s part to prefer the lender).

Question 78

4.16 Preferences: Sanctions

Answer 78

The court has a discretion to make an order to restore the position as if the company had not given the preference (s 239(3)).
Section 241(1) provides a non-exhaustive list of the types of restoration order that the court may
make. Note that s 241(2) and s 241(2A) apply to both preferences and transactions at an undervalue.

Question 79

4.17 Avoidance of certain floating charges - s 245 IA 1986

Answer 79

The purpose of s 245 is to prevent an unsecured creditor obtaining a floating charge to secure an
existing loan for no new consideration, at the expense of other unsecured creditors.

The section only applies in a liquidation or administration. Unlike transactions at an undervalue
and preferences, s 245 avoids certain floating charges automatically and without the need for the office-holder to challenge the floating charge by bringing legal proceedings (as set out below). However, if there is a dispute between the putative floating charge holder and the office-holder about the application of s 245, legal proceedings may be necessary to determine the dispute.

Question 80

4.18 When can floating charges be avoided?

Answer 80

For the floating charge to be invalid:
(a) The floating charge must have been created within the ‘relevant time’. The relevant time is 12
months preceding the onset of insolvency, ie the commencement of administration or liquidation (s 245(2) and 245(3)(b)).

The relevant time is extended to two years in the case of a floating charge granted to a connected person (s 245(3)(a)). (See s 249 and 435 for definitions of ‘connected persons’ and ‘associates’.)

(b) Unless the floating charge was granted to a ‘connected person’ or an ‘associate’ (in which case there is no insolvency requirement), it must be proved that the company was insolvent (on either a cash-flow or balance sheet basis) at the time of the floating charge’s creation
or became insolvent in consequence of the transaction under which the charge was created
(s 245(4)).

Question 81

4.19 When are new floating charges valid?

Answer 81

Floating charge will be valid: Even if the above requirements are met, a floating charge will be valid to the extent that ‘new money’ or other fresh consideration (which can include goods or services) is provided to the company (or existing debts of the company are extinguished) in return for the grant of the
floating charge on or after its creation (s 245(2)).

Question 82

Example of when a floating charge is void

Answer 82

An example of when a floating charge would be void is where an existing unsecured creditor is granted a floating charge by a company which is insolvent (as defined above) and the charge purports to secure the repayment of existing monies owed to that creditor.

If s 245 did not apply, such an unsecured creditor would thereby improve its position in the order of priority if the company later went into an insolvency procedure, which would be unfair on the company’s other unsecured creditors. However, if (and to the extent that) an existing unsecured creditor provides further credit to the company (or to the extent that any other new credit is given by a new creditor) then that creditor is entitled to have the protection of a valid floating charge.

Question 83

4.20 Avoidance of floating charges

Answer 83

Where a floating charge is void under s 245, only the security (and its advantage to a floating charge creditor in the order of priority) is void and not the debt itself. Remember that a floating charge is also void against a liquidator, administrator and other
creditors if it is not duly registered with Companies House under s 859H CA 2006. Note that a floating charge granted to a creditor may also be voidable as a transaction at an
undervalue or a preference under ss 238 and 239.

Question 84

4.21 Summary

Answer 84

See table