11 July 2017

Wrongful Trading

Precisely when should company directors know that, and act as if, they can’t avoid insolvency? That was the point at issue in a High Court case of wrongful trading which should provide useful guidance for future cases.

In Philip Anthony Brooks and Another (Joint Liquidators of Robin Hood Centre PLC (in Liquidation)) v Armstrong and another, the High Court has clarified at what point directors of a company knew, or ought to have concluded, that there was no reasonable prospect that a company would avoid going into insolvent liquidation and at what point (if any) the defence afforded by s.214(3) Insolvency Act 1986 (the “Act”) applies.

Background

Robin Hood Centre PLC (the company) operated a Robin Hood themed tourist attraction that traded until January 2009 and entered creditors’ voluntary liquidation on 6 February 2009.

The joint liquidators (the liquidators) of the company issued court proceedings in the sum of circa £700,000 against the directors, alleging that they were in breach of s.214 IA 1986 and, as such, the directors should be made liable to contribute to the assets of the company. Under section 214(1) of the Act, the court may order a director, who is guilty of wrongful trading, to make such contribution to the company’s assets as the court thinks proper. Under section 214(2), a director must have known, or ought to have concluded, before the date of the company’s actual liquidation that there was no reasonable prospect of the company avoiding insolvent liquidation.

The liquidators identified five key dates, supported by various triggers, in the time leading up to 6 February 2009 at which point(s), they alleged, directors should have, or ought to have, been on notice under section 214 of the Act.

The court was asked to consider (amongst other things):

  1. whether prior to entering into insolvent liquidation on 6 February 2009, the directors knew or ought reasonably to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation – Mr Registrar Jones (the registrar) referred to this as the “Knowledge Condition”; and
  2. once the Knowledge Condition was satisfied, whether the directors took every step with a view to minimising the potential loss to the company’s creditors as they ought to have taken (section 214(3) of the Act– referred to by the registrar as the “Minimising Loss Defence”.

The Registrar ordered that the directors of the company were held to be jointly and severally liable and were to make a contribution of £35,000 in compensation.

The Appeal

The liquidators appealed the registrar’s first instance decision and the directors cross-appealed.

On appeal, the High Court was asked to consider (amongst other things):

  1. at what point in time the Knowledge Condition was satisfied; and
  2. in what circumstances would the Minimising Loss Defence be triggered?

On the first point, the judge provided guidance for establishing the point in time when directors should consider the Knowledge Condition, including:

  1. when considering future trading, the directors did not have to start from the position that the company must clear all of its debts. It was not a case of whether the company will become insolvent but whether the directors knew, or ought to have concluded that there was no reasonable prospect of it avoiding insolvent liquidation;
  2. if the company’s financial statements are not available and/or approved until later in the next financial year, then directors should regularly review the equivalent financial information in the form of monthly management accounts and these should be borne in mind when considering the company’s financial future;
  3. whether there were substantial creditors remaining unpaid or demanding payment; and
  4. n respect of considering options for the company, rational expectations need to be considered and directors need to consider what prospects of success it has in pursuing those options.

On the second, the judge provided guidance on what factors need to be considered by directors and kept under review generally when considering specific financial decisions (assuming that the business remains sustainable):

  1. ensure accounting records are kept up to date with a budget and cash flow forecast
  2. prepare a business review and a plan dealing with the future including steps that can be taken to minimise loss;
  3. keep creditors informed and reaching agreements to deal with debt;
  4. regularly monitor the trading and financial position of the company together with the business plan informally and at board meetings;
  5. ensure loss is being minimised;
  6. ensure adequate capitalisation;
  7. obtain relevant professional advice; and
  8. consider alternative insolvency remedies.

If this guidance is followed, then directors will arguably have a stronger case in establishing the Minimising Loss Defence.

Comment

The court has clarified, contrary to the previously accepted position, that the burden of proof required for the Minimising Loss Defence lies with the director and not the liquidator and helpfully sets out guidance on what factors need to be considered by directors if they seek to rely on the statutory defence under s214(3) of the Act. It also provides helpful guidance on how the court approaches wrongful trading claims.

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About the Author
Sam Payne, Partner, Head of Restructuring & Insolvency Team
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