Directors' Liabilities and Voidable Transactions

Question 1

Voidable Transactions

Answer 1

A Trustee has the power to challenge voidable transactions and will do this with the aim of increasing the assets available to creditors. In doing so, the Trustee will have to balance the costs and risks of litigation with the chances of success in making recoveries for the bankruptcy estate. The principles for voidable transactions for individuals are similar to corporate insolvencies but sometimes involve different time periods and different sections of IA86.

The voidable transactions that are the focus of this topic are:

Transactions at an undervalue (s 339 IA86)

Preferences (s 340 IA86)

Transactions defrauding creditors (s 423 IA86)

If the requirements for each of these voidable transactions are met, the court has the power to make such order as it thinks to restore the position to what it would have been but for the transaction or preference.

Question 2

Transaction at an Undervalue (‘TUV’) s 339 IA86

Answer 2

What is a TUV

A Trustee can bring a claim for TUV if the transaction is either:

• a gift; or
• in consideration of marriage or the formation of a civil partnership; or

for a consideration the value of which in money or money’s worth is significantly less than the consideration provided by the bankrupt

Relevant time

The transaction must take place within 5 years preceding the day of the presentation of the bankruptcy petition

Is insolvency required

It must be proved that the individual was insolvent but only if the transaction took place between 2-5 years from the day of the presentation of the petition.

Presumption available

Insolvency of the bankrupt is presumed (subject to rebuttal) where a transaction at an undervalue is entered into with an ‘associate’ of the bankrupt (see s 435 IA86 for the definition of associate).

Question 3

Preferences s 340 IA86

Answer 3

What is a preference

A Trustee can bring a claim for a preference if:

• that person is a creditor (or a surety or guarantor of their debts or liabilities); and

the individual does anything or suffers anything to be done which has the effect of putting that person in a better position than they otherwise would have been in the event of the individual being made bankrupt.

Relevant time

Within 6 months preceding the day of the presentation of the petition if to an unconnected person; or within 2 years preceding the day of the presentation of the petition if to an associate.

Is insolvency required

It must be proved that the individual was insolvent at the time of the preference or became insolvent as a result of it.

Other requirements/

It must be shown that the individual was influenced by the desire to prefer the creditor. There is a rebuttable presumption that the bankrupt individual was influenced by the desire to prefer the creditor where the preference is to an associate

Question 4

Transactions Defrauding Creditors (TDC) s 423 IA86

Answer 4

• The same provisions apply to TDCs for individuals as they do for companies. The detail is in the Voidable Transactions element in corporate insolvency. The key points are summarised below.
• In addition to the list of persons that can bring a claim for TDC mentioned in the corporate insolvency element, the Trustee or Official Receiver can also bring a claim.
• To bring a claim for TDC it must be shown that the transaction was a transaction at an undervalue with an intent to defraud creditors and there is therefore a high evidential burden.
• There is no relevant time for bringing a TDC claim and therefore a Trustee is most likely to bring a TDC claim when they are outside the time limits for a transaction at an undervalue claim.
• There is also no need to prove that the debtor is or was insolvent.

Question 5

Liability of directors for fraudulent trading

Answer 5

The provisions on fraudulent trading were enacted to prevent the abuse of limited liability by those running companies.

The concern is that directors may continue to trade and incur further debts at a time when the company is in financial difficulty, with the result that losses to creditors are increased. Therefore, the IA86 gives the court power to impose both criminal and civil sanctions on directors (and other persons, see below) if they are found guilty of fraudulent trading. However, claims for fraudulent trading are rare due to the evidential requirements in proving an intent to defraud creditors (see below).

A claim for fraudulent trading may be made by a liquidator (s 213 IA86) or an administrator (s 246ZA IA86) by making an application to court. The provisions in s 246ZA reflect those in s 213 IA86 with the necessary changes for administration and liquidation, respectively.

Question 6

Fraudulent trading

Answer 6

A claim for fraudulent trading under s 213 / 246ZA IA 1986 can be brought against:

• any person (s 213(2) and s 246ZA(2))
• who is knowingly party to the carrying on of any business of the company
• with intent to defraud creditors or for any fraudulent purpose (s 213(1) and s 246ZA(1)).

Although claims for fraudulent trading are usually brought against directors, ‘any person’ is a wide definition and includes banks, who may also be liable for fraudulent trading by virtue of their employees’ knowledge (Morris v State Bank of India[2005] 2 BCLC 328).

Sections 213 (in liquidation) and 246ZA (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.

Question 7

Actual dishonesty

Answer 7

Actual dishonesty must be proven for a claim for fraudulent trading to succeed. Examples of the meaning of dishonesty and fraud are set out below.

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.

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).

It is not necessary to show that all of the company’s creditors have been defrauded. Provided at least one creditor has been defrauded, this will be enough to bring a claim.

Question 8

Remedies

Answer 8

A person found to be liable under s 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.

Any sums recovered are held on trust for the unsecured creditors generally and not for the defrauded creditor.

Where the court makes an order against a person under s 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 9

The claim for wrongful trading

Answer 9

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 for directors who carry on business negligently rather than fraudulently.

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 10

Wrongful trading – purpose

Answer 10

The purpose of s 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.

If they fail to do this, the court can, under s 214 and 246ZB, 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.

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.

Since there is no requirement to show intent or dishonesty, it is easier for a liquidator or administrator to prove wrongful trading than it is fraudulent trading.

Question 11

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

Answer 11

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 12

Against whom may a claim be brought?

Answer 12

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

Contrast this with fraudulent trading where a claim can be brought against any person who has the intention to commit a fraud (so not only directors).

Question 13

Requirements for liability – s 214(2) / 246ZB(2)

Answer 13

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

1. 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’)
2. the director knew or ought to have concluded that
3. there was no reasonable prospect that the company would avoid going into insolvent liquidation (or insolvent administration).

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 (s 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 14

Continued trading

Answer 14

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.

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 15

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

Answer 15

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.

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 16

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

Answer 16

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 s 214(2) / 246ZB(2) liability), and
• whether the director then took every step to minimise the potential loss to the company’s creditors (the s 214(3) / 246ZB(3) defence).

Under that test, the facts which a director ought to have known or ascertained, the conclusions which he ought to have reached and the steps which he ought to have taken, are those which would have been known or ascertained, or reached or taken, by a reasonably diligent person having both:

• 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 17

Advice to directors

Answer 17

• To minimise the risk of a wrongful trading claim, directors should:
• hold regular board meetings to review the company’s financial position and write up minutes of each meeting so there is a written record on which the directors can later rely to justify decisions that were taken. 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; and
• consider whether it is appropriate to incur new credit and liabilities.
• 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.

The best course of action for a company is to seek professional advice as soon as possible. However, it is important to note that case law suggests that the absence of warnings from advisers does not relieve directors of the responsibility to review the company’s position critically.

Question 18

Remedies – s 214(1) / 246ZB(1)

Answer 18

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.

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’).

An order by the court for a director to contribute to the company’s assets under s 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.

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

Question 19

No relief under s 1157

Answer 19

Under s 1157 CA 2006, the court may ordinarily relieve a director from liability in proceedings for negligence, breach of duty or breach of trust, on such terms as it thinks fit, if satisfied that he/she acted honestly and reasonably,and having regard to all the circumstances of the case, the director ought fairly to be excused. However, that relief is not available in wrongful trading proceedings (Re Produce Marketing Consortium Ltd [1989] BCLC 513, ChD).

Question 20

Voidable transactions

Answer 20

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.

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.

These provisions are often described as ‘antecedent’ or ‘clawback’ or 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.

All references below are to IA 1986 unless stated otherwise.

Question 21

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

Answer 21

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 ‘an office-holder’ which means:

• a liquidator, or
• an administrator.

Question 22

TUV: What is a transaction at an undervalue?

Answer 22

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 £100,000 but only received £50,000 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 23

TUV: Granting security / payment of a dividend

Answer 23

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).

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.

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 24

TUV: When and how can the transaction be avoided?

Answer 24

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

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.

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.

It is proved 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 25

TUV: Defence

Answer 25

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:

the company entered into the transaction in good faith and for the purpose of carrying on its business; and

at the time there were reasonable grounds for believing that the transaction would benefit the company.

This defence is often relied on in practice and can save many transactions which would otherwise be open to challenge.

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 26

TUV: Sanctions

Answer 26

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).

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)).

However, under s 241(2A) there is a rebuttable presumption that an acquisition by a subsequent purchaser was not in good faith where the subsequent purchaser either:

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

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 27

Transactions defrauding creditors (TDC) - s 423 IA 1986

Answer 27

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:

there has been a transaction at an undervalue; and

the intention or purpose of the transaction was to put assets beyond the reach of creditors of the company or otherwise prejudice their interests, this transaction may be avoided under s 423(3). This even includes future creditors who were unknown at the time of the transaction.

Insolvency practitioners may prefer to bring claims under s 238 (TUV) than under s 423. 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 28

TDC: Who may claim and sanctions

Answer 28

An application to the court to set aside the transaction can be made by any of the following (s 424):

a liquidator or an administrator;

a supervisor of a voluntary arrangement; or

a victim of the transaction in question.

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 court may make such order as it thinks fit to restore the position to what it would have been but for the transaction in question (s 423(2)). A non-exhaustive list of orders is set out in s 425(1).

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

Question 29

Preferences by a company – s 239 IA 1986

Answer 29

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:

that person is a creditor of the company (or a surety or guarantor of any of the company’s debts or liabilities); and

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 he/she would otherwise have been in.

An example of a preference would be paying an unsecured creditor in priority to other creditors or granting security to an unsecured creditor.

Question 30

When can a preference be avoided?

Answer 30

The preference is voidable if:

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 to2 years for preferences to connected persons and associates (s 240(1)(a)). (See sections 249 and 435 for definitions of ‘connected persons’ and ‘associates’);

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)); and

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).

Note in relation to 2 above, that unlike 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 31

Preferences: Connected persons

Answer 31

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 32

Preferences: Defence

Answer 32

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

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 33

Preferences: Sanctions

Answer 33

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 34

Avoidance of certain floating charges - s 245 IA 1986

Answer 34

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.

A high-profile example of a contentious floating charge was seen in the liquidation of BHS, where its liquidators were seeking to challenge a floating charge under s 245 held by Phillip Green’s Arcadia Group. A settlement agreement was reached and the legal proceedings by the liquidator were discontinued, apparently with no judgment as to the validity of the floating charge.

Question 35

When can floating charges be avoided?

Answer 35

For the floating charge to be invalid:

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 2 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’).

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 36

When are new floating charges valid?

Answer 36

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)).

The effect of s 245(2) is that if a floating charge is granted to secure the repayment of a new loan made on or after the creation of the charge, then it will be valid.

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 37

Overdrafts

Answer 37

The position regarding the grant of a floating charge to secure an existing overdraft is fairly complex due to case law and the effect of s245(2) in these cases is reduced.

In Re Yeovil Glove Co. Ltd [1965] CH 148, the company granted a floating charge to its bank to secure an existing unsecured overdraft, as a condition of the bank not calling in the overdraft, at a time when it was insolvent. The company went into liquidation a few month later. The liquidator challenged the validity of the floating charge as it related to past unsecured indebtedness. The court held that the floating charge was valid because (1) each time the company used its overdraft facility after the creation of the floating charge, this was deemed to be ‘new money’ advanced by the bank (2) The rule in Devaynes v Noble [1816] 1 Mer. 572provides that payments into a bank account discharges the earliest advances made by the bank first. As the company had paid more than £67,000 into the account since the grant of the floating charge, it could be said that the pre-charge debt of £67,000 had been paid off and that the existing overdraft balance at the time of appointment of the officeholder was ‘new’ debt.

Question 38

Avoidance of floating charges

Answer 38

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 s 238 and 239.

Question 39

House of Lords Select Committees

Answer 39

The Lords’ select committees concentrate on broader more thematic scrutiny, based on six main areas:
* Europe
* Science and technology
* Economics
* Communications
* The UK constitution
* International relations

Question 40

What are select committees?

Answer 40

Select committees are a key mechanism by which Parliament holds the government to account. They consist of MPs, Lords, or, in the case of ‘Joint Committees’, both. Most select committees are established under Standing Orders (parliamentary rules), meaning that they are permanent entities although their membership will change with a change of parliament. Select committees are appointed by the House to perform a variety of tasks on the House’s behalf,
including scrutinising the work of all government departments and examining expenditure, procedures, and domestic administration of the House. Committees determine the subjects into which they will inquire, and they have extensive powers to gather evidence, both written and oral.
Their findings and recommendations are submitted to the House and published as reports. The modern system of select committees was established relatively recently, in 1979. It has equivalents in many other parliaments across the globe.

Question 41

Why does Parliament need select committees?

Answer 41

In separate materials you have seen how various mechanisms such as debates, parliamentary questions (PQs) and Prime Minister’s Questions (PMQs) are used to hold the government to account in the House of Commons. Select committees provide Parliament with a way of increasing its capacity to scrutinise the government away from the Commons chamber. Select committees are cross-party (including MPs and/or Lords from both sides of the House). There is not enough sitting time for MPs to scrutinise fully, and for the government to provide answers on, every important policy or piece of legislation. The Lords, who have comparatively more time, are able to focus expertise on key political areas.

Question 42

Select committee membership

Answer 42

The Institute for Government considers that the identity of the select committee Chair ‘determines its impact more than any other factor’ (White H., Select Committees Under Scrutiny, Institute for Government, 2015). Party whips play no part in Select Committee appointments.

Commons select committees
* Most committee Chairs are elected by their fellow MPs
* Minimum 11 members, selected by internal party election
* Membership reflects the party-political balance of the House

Lords select committees
* Chairs appointed by the House on the proposal of the Committee of Selection
* Members usually proposed by Committee of Selection, and voted on by the House
* No fixed number of members
* No rule on political balance

Scrutiny of government
Select committee reports (which not infrequently criticise the government’s policies and actions – or inaction) cannot simply be ignored. The government is committed to replying to every select
committee report within 60 days of its publication.
Select committees can influence the direction of government by:
* Writing reports for the House
* Attracting media attention to a political issue – this is increasingly important
* Encouraging ministers to engage properly with an issue, knowing that they will be called to give evidence to a select committee meeting

Question 43

Joint select committees

Answer 43

There are four joint select committees (with members from both Houses):
* The Joint Committee on Human Rights which considers human rights issues in the UK.
* The Joint Committee for National Security Strategy which scrutinises the structures for
governmental decision-making on national security, particularly the role of the National
Security Council and the National Security Adviser.
* The Joint Committee on Statutory Instruments is appointed to consider statutory instruments made in exercise of powers granted by Act of Parliament. Instruments not laid before Parliament are included within the Committee’s remit.
* The Joint Committee on Consolidation Bills considers Bills which bring together a number of existing Acts of Parliament on the same subject into one Act without amending the law, although they occasionally contain minor corrections and improvements.

Question 44

Select committee powers to call evidence

Answer 44

House of Commons select committees are given powers by the House to ‘send for persons, papers and records’, meaning they have the power to summon and examine witnesses.

If any witness who has been summoned to appear before a select committee refuses to attend, the fact is reported to the House and an order made for his attendance at the bar to be admonished by the Speaker (Erskine May’s Parliamentary Practice (24th Edn, 2011) p 820).

Remember that civil servants, Ministers, MPs and Lords cannot be summonsed in this way.

The institution of Parliament

Power to summons witnesses

Usually, witnesses attend willingly. If they do not, the Select Committee may issue a summons. If that is ignored, then a warrant may be issued. If a Select Committee has issued a summons to a witness to attend, or produce papers, and the witness has not responded, it is for the House to act (or not) on the basis of a Report made to it by the committee. The House may order the Serjeant at Arms as Warrant Officer of the
House to serve a Warrant on the witness. In serving the Warrant, the Serjeant or his appointee may call on the full assistance of the civil authorities, including the police.
(House of Commons Information Office ‘Disciplinary and Penal Powers of the House’ September 2010)

Who gives evidence to select committees?
The principal role of select committees is to scrutinise government. Ministers and civil servants will frequently appear before departmental select committees.
On occasion, in the event of a crisis or issue which is in some way linked to a failure of
government oversight, senior company employees may be asked to give evidence.
For example, in 2018 Mark Zuckerberg, Facebook CEO, was asked to give evidence to an ‘international grand committee’ of parliamentary select committees as part of the UK Department of Culture Media and Sport’s ongoing investigation into online disinformation, ‘fake news’ and links to interference in the Brexit referendum. Mr Zuckerberg declined several invitations to attend, sending company employees in his place.

Question 45

Different process for secondary legislation

Answer 45

Secondary legislation is made under powers granted to the relevant Secretary of State in primary legislation, often known as the ‘parent act’. Secondary legislation usually takes the form of Statutory Instruments (SIs).

Not all secondary legislation is put to Parliament for consideration. This depends on the procedure mandated by the primary legislation.

Affirmative resolution procedure
SIs must be debated and approved by both Houses of Parliament. SIs must be debated and approved by both Houses of Parliament.

Negative resolution procedure
An SI does not need active approval by Parliament. It will automatically become law unless either House passes a motion to reject it (usually within 40 days).

JCSI
Before being put before Parliament, the Joint Committee on Statutory Instruments scrutinises the government’s secondary legislation to make sure it is clear and within the powers granted by the primary legislation.

Question 46

Bills starting in the Commons

Answer 46

Most proposed primary legislation can start either in the Commons or the Lords but will need the approval of both Houses. (The only exception to this is if the Parliament Act procedure is used, in which case it is possible to bypass the Lords.)
For bills introduced by the government, the decision whether to start in the Commons or the Lords is made by the PBLC with a view to ensuring a balanced programme of legislation in each House. By convention, bills on constitutional matters start in the Commons.

Question 47

First and Second readings

Answer 47

The First Reading is a formality – there is no debate on the bill at this stage. The Second Reading is a debate on the main principles of the bill, held in the chamber.
* A Government minister will open the debate by setting out the case for the bill and explaining its provisions.
* The Opposition will respond, and then other members are free to discuss it. The Government will close the debate by responding to the points made. No amendments can be made to the
text of the bill at this stage, although members may give an idea of the changes they will be proposing at later stages.
* At the end of the debate the House will vote on the bill. If the vote is lost by the Government, the bill cannot proceed any further, though it is rare for a Government bill to be defeated at this stage.

Question 48

Committee stage

Answer 48

This stage involves a detailed consideration of the bill. In the Commons, this can be done in the chamber, or by a specially convened committee of MPs called a Public Bill Committee. In the Lords, the detailed reading may also be done in the chamber, or outside it. Any peer can participate in this.
A Public Bill Committee in the Commons can:
* Take oral and written evidence about the subject matter of the bill
* Propose amendments
* Propose wholly new clauses
Amendments will need the approval of the PBLC before going on to the next stage.

Question 49

Report stage and third reading

Answer 49

n both Houses, the report stage takes place in the chamber. Only amendments proposed at committee stage are discussed.
In the Commons, the third reading takes place immediately after the Report. No amendments can be made at this stage. In the Lords, third readings take place later, and amendments can be tabled.

Question 50

Final stages

Answer 50

Both Houses must agree on the text of a bill before it can become an Act. This means that, if the bill is amended in the second House, it must return to the first House for those amendments to be considered. The first House can reject the amendments, make changes to them or suggest alternatives. A bill may move backwards and forwards between the two Houses before agreement is reached, so this stage is sometimes called ‘ping pong’.
The time taken to go through all these stages depends on the length of the bill, how controversial it is and whether it needs to be passed particularly quickly. An emergency bill may be passed in a matter of days, whereas a larger bill may be introduced at the beginning of the session and only passed at the end a year later.

Question 51

Royal assent

Answer 51

n order for a bill to become law after it has passed both Houses after third reading, Royal Assent is also required. The monarch can give royal assent in person, but this has not happened since 1854. The King’s agreement to give his assent to a bill is a formality. By convention, the monarch
does not refuse assent, though he is legally entitled to. When Royal Assent has been given, an announcement is made in both Houses – by the Lord Speaker in the Lords and the Speaker in the Commons.
The legislation may then come into force immediately, or after a period of time specified in the legislation, or on a later date following a ‘commencement order’ by the minister. A commencement order is designed to bring into force the whole or part of an Act of Parliament at a date later than the date of the Royal Assent. If there is no commencement order or other provision, the Act will come into force at the beginning of the day on which it receives Royal Assent.

Question 52

Private Members’ Bills (PMBs)

Answer 52

These are proposals for primary legislation introduced by MPs and Lords who are not government Ministers.
Like public bills, Private Members’ bills can be introduced in either House and must go through the same set stages. However, as less time is allocated to these bills, it is less likely in practice that they will proceed through all the stages.
In the Commons, Private Members’ bills have precedence over government business on thirteen Fridays in each parliamentary session.
Private members’ bills have on occasion made very significant changes to the law. Examples include:
* The Murder (Abolition of the Death Penalty) Act 1965 was introduced as a PMB by Sydney Silverman MP.
* The Abortion Act 1967 was introduced as a PMB by David Steel MP but was then backed by the government.
* The Sustainable Communities Act 2007 introduced legislation intended to help reverse the trend of community decline, also called ‘Ghost Town Britain’.

Question 53

Parliament Acts 1911 and 1949

Answer 53

In certain situations, it is possible for a public bill to be passed on the basis of a procedure first
introduced in the Parliament Act 1911.
This initially allowed a bill being sponsored by the government to be sent for Royal Assent without
the approval of the House of Lords, if the Lords refused to consent to it for a period of two years.
This time period was further reduced to one year through the Parliament Act 1949.
The reason for this procedure being introduced in 1911 was because of the collapse of a longstanding convention, under which the House of Lords did not block financial legislation (‘money
bills’). This happened following a radical budget introduced by Lloyd George in 1909, which was strongly rejected by the Lords. After two years of constitutional crisis the Liberal government of the day decided to legislate in order to formally reduce the delaying powers of the House of Lords.
Use of the Parliament Act procedure has been quite sparing over time. It has only been called upon seven times in total, the last being in 2004 with the Hunting Act. This use of the procedure was particularly notable as it led to a challenge to the legality of the Hunting Act itself in the case
of R (Jackson) v Attorney-General (2005).