Continued trading while insolvent is not necessarily wrongful trading

Continued trading while insolvent is not necessarily wrongful trading

When a company director faces the possibility that their business is in financial difficulty, it is important to understand how the law might assess his or her conduct and actions in those circumstances. Should the company continue trading where there is a possibility that the business may enter an insolvent liquidation or administration? At that stage, the decisions made by a company director may affect not only the survival and future of the company, but also the director’s own financial and reputational position.

The Insolvency Act

In the UK, under section 214 of the Insolvency Act 1986 (IA 1986), company directors may be required to make a contribution to the company’s assets in respect of its losses upon it entering insolvent liquidation or administration. However, two recent cases have demonstrated the court’s flexibility in assessing and determining liability (if any) under that section.

In the 2016 case of Grant v Ralls1the court declined to make an order under section 214 IA 1986, requiring the company’s directors to make a contribution to the company’s assets in respect of its losses. In those particular circumstances, it was “entirely plausible that [the company’s continued trading] did not cause loss to the Company overall, or worsen the position of the creditors as a whole”. In that case, the company’s bank and certain historic creditors were paid at the expense of new creditors; a result that Mr. Justice Snowden described as “the real sin of the Directors”, albeit one that, because of “a shortcoming in the structure of section 214”, he felt unable to remedy (leaving that task to Parliament).

The unreported case of Nicholson v Fielding

A year later, in the case of Nicholson v Fielding2, the court returned to section 214 IA 1986. The case concerned an allegation of wrongful trading in the immediate aftermath of the financial crisis in 2008. As in Grant v Ralls, the court refused to make an order under section 214 IA 1986. However, in contrast to Grant v Ralls, the company’s continued trading had caused loss to the company’s creditors overall.

When a business continues trading

Mainland Car Deliveries Limited (Mainland) was incorporated on 10 July 2006, and its principal business was transporting new and used cars on behalf of manufacturers and hirers, including Ford Motors. Some three years later Mainland entered administration (with officeholders of BDO being appointed as administrators). On 25 June 2010, it moved into creditors’ voluntary liquidation (with officeholders of Haslers being appointed as liquidators). A section 214 IA 1986 application was issued on 17 June 2016, shortly before the expiry of the relevant limitation period. The liquidators’ application sought a declaration that the directors of Mainland at the relevant time (the respondents; Messrs Fielding, McWilliams and Tait) knew or ought to have concluded from 31 October 2008 that there was no reasonable prospect that Mainland would avoid entering into insolvent liquidation.

The Deputy Registrar noted that Mainland was balance sheet insolvent from around July 2008, and that its balance sheet deficiency had increased by some amount between then and 31 October 2008 (although the precise quantum of such increase was unclear from the evidence), but nevertheless refused to make a declaration under section 214 IA 1986.

Taking into account wider economic and behavioural factors

Following a careful examination of the directors’ conduct over that period, including Mainland’s ongoing correspondence with HMRC (requesting and then renegotiating time to pay arrangements), he said that:

“The question of wrongful trading cannot be addressed by looking at [Mainland’s] business in an economic vacuum. It was operating in a market directly affected by the global financial shock, not only in the cost of financing but in its core business”.

He went on to note that sales for transporting new cars in the market as whole during 2008 fell by 15.1% compared to the year before, and that hauliers are rarely able to secure long-term contracts. He summarised by saying that Mainland’s eventual collapse had occurred against a “background of an uncertain financial world, oscillating fuel prices, and an industry entering a significant downturn of uncertain duration”, and that during that time “the directors were doing their best to take account of those, and they cannot be criticised for not predicting their full effect”.

Directors’ efforts to save a business may help to excuse them from liability

Helpfully, the transcript cites Lewison J in Re Hawkes Hill Publishing Co Ltd3, who said that the relevant question is “not whether the directors knew or ought to have known that the company was insolvent. The question is whether they knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation”. In the present case the Deputy Registrar felt able to conclude that in the unprecedented financial maelstrom of 2008, and given the directors’ various efforts to reduce costs and secure new business (all of which is documented in the transcript), it was credible for them to believe, at least for a time, that Mainland could trade out of its insolvency.

This case may be encouraging for company directors whose companies become subject to unexpected, macroeconomic turbulence. Clearly, the foreseeability of such turbulence, and the appropriateness of the directors’ response to those changing circumstances, will determine their liability, if any, in each case.

A positive outcome for responsive company directors

Some key points emerging from this case are outlined below.

  • It is not uncommon for companies, from time to time, and because of factors that may be entirely beyond their control and/or that are unforeseeable, to swing in and out of cash flow and/or balance sheet insolvency. Losses to creditors may increase over a period of continued trading in those circumstances. This will not necessarily make the directors liable to wrongful trading upon a subsequent administration or liquidation.
  • What is important is the directors’ response to such crises, and the credibility of their assessment as to whether there is a reasonable prospect the company can avoid an insolvent outcome.
  • That assessment must be supported by a considered and robust analysis, with all necessary information and professional advice taken where appropriate, carried out on a rolling basis, and carefully recorded.
  • Directors must not be complacent about their responsibilities during difficult times, and/or during a broader economic crisis.

One final point of interest emerging from this case was the Deputy Registrar’s (obiter) comments concerning the finance director, Mr Tait. He said that Mr Tait was “no more than the numbers man”…and “had no real say [in strategic matters]”. Therefore, had he been required to apportion liability between the directors for a failure to foresee insolvent liquidation, then that failure would have lain more heavily with the other directors who actually ran the business.

This is a reminder that directors will be assessed under section 214 IA 1986 on both a subjective and objective basis, and with regard to their duties and responsibilities.

1Grant v Ralls EWHC 243 (Ch)

2Nicholson v Fielding – 15 September 2017

3Re Hawkes Hill Publishing Co Ltd [2007] BCC 937