Directors Beware! Increased Risk of Breach of Duty and Wrongful Trading
Directors Beware! Increased Risk of Breach of Duty and Wrongful Trading
Over the past 15 years or so, one of the most commonly recurring themes in my practice has been advising both insolvency practitioners and directors on the prospects of legal proceedings being pursued for breach of director duties and/or wrongful trading. Very often the two claims are put together for the purposes of an actual or threatened claim, and very often sitting behind the scenes as well is a possible investigation and/or claim that one or more directors should be disqualified. I believe that the likelihood of such claims succeeding, and therefore being pursued in the first place, is on the rise as a result of recent cases before the courts and forthcoming changes in legislation.
Over my career as an insolvency lawyer, the law relating to these particular areas has not changed vastly. Sure enough the Companies Act 2006 codified directors’ duties substantially, and there are current legislative changes in motion which will very probably increase the burden of expectation on directors, chiefly in terms of raising the bar on regulatory compliance and the possibility of compensation being awarded through disqualification proceedings, but these are for another time, another blog. For now at least, successful wrongful trading and misfeasance claims remain relatively rare, when compared with claims for unpaid directors’ loan accounts, unlawful preferences, undervalues, dividends and other, more obvious claims, more easily susceptible to clear proof and the sort of certainty demanded by stakeholders such as ATE insurers. That may be about to change, however.
What concerns me today are two very recent cases in the Companies Court which, arguably, are already setting the bar of defensible conduct considerably higher for directors acting in companies which become insolvent. The two judgments in question are in Re Micra Contracts Ltd and Re Robin Hood Centre Plc. They share a number of common features: both were decided by Registrars (Barber and Jones respectively), both in July 2015, both resulted in findings against active and less active directors, and both were for relatively modest sums in compensation (under £100,000 each), which itself rather puts paid to the commonly held assumption that a smaller claim for breach of duty and/or wrongful trading will not be cost effective and/or will not be of interest to legal Counsel and funders.
Re Micra was a misfeasance claim (s.212 Insolvency Act 1986). On the day the directors consulted insolvency practitioners they also instigated or allowed to be instigated connected party transactions which resulted in £72,000 being paid out to a connected creditor, alongside £500,000 to unconnected creditors, one of which subsequently employed one of the directors. In effect, they tried to carry out an informal liquidation process of their own, and they argued in court that they had in effect just applied the same set offs which would have applied had they happened post-liquidation and that the company had therefore not suffered any loss. The court accepted that in view of the benefit to the director(s) and the fiduciary nature of the duty to act in the best interests of the company, the burden of proof lay against the directors to show that they honestly believed these actions were in the company’s interests. On the facts, the directors had failed to discharge that subjective burden in respect of the payment to the connected company, which had not followed the normal dealings between the parties and was not in the ordinary course of the company’s business. It was also found that, objectively, no intelligent and honest man would have acted as the directors did in their position.
Re Robin Hood Centre was primarily a wrongful trading claim (s.214 Insolvency Act 1986). A misfeasance claim was tagged to this but did not go beyond the allegation that it was the directors’ failure to conclude that the company was insolvent at some point prior to its eventual liquidation and to act on this, which produced the loss to the company, so there was no need to award compensation for breach of duty separately if wrongful trading was established. In a mammoth 309 paragraph judgment the court effectively picked apart every decision the directors had made over a number of years prior to insolvency, relying heavily on the evidence of professional advisors who had been called in to assist, before holding that the directors knew, or ought to have known, that insolvent liquidation was inevitable. On the facts, the directors’ defence that, having reached this point of knowledge or deemed knowledge they took every step to minimise the loss to creditors, also failed, in large measure on the basis that at no point did they have a viable plan to deal with ongoing liabilities to HMRC and to their landlord, despite the professional advice they had sought (the professional advisors seemingly not having been provided with full facts and data upon which to advise).
Facts aside, however, the practical points of interest to be distilled from these two cases are:
1. All directors can expect to feel the full force of the law if they don’t take steps to defend themselves.
In Micra two out of three directors declined to give evidence, relying instead on the third who had been responsible for most of the offending decisions. That director’s evidence had (according to Counsel’s report of the case) been largely drafted in legalese rather than representing a true and frank account of the facts, so there was no proper explanation of the recharges until live evidence given at trial. Both of these features went against all three directors, who were ordered to pay the liquidators’ costs in full. In Robin Hood Centre, the second (non-executive) director was equally happy to defend the claim against him on the basis that both directors’ “defences stood or fell together”. He was found jointly and severally liable for all of the loss; the Registrar concluded, “he was or ought to have been party to the decisions which led to that award”. It follows from this that any director who disagrees with the board’s decision to enter into certain transactions and/or to continue trading beyond a certain point should take steps to ensure that his views are recorded, ideally in safely held board minutes and/or a letter of resignation from the board, and that in the event of an investigation or claim directors should consider whether it is appropriate for them to retain separate solicitors and Counsel.
2. In certain circumstances the burden of evidence will fall on the directors, not the liquidators.
This may well seem somewhat unfair, and I personally would have some sympathy for that view. Typically all of the company’s books and records will have been surrendered to the office holders, perhaps many years before any sort of claim is mooted. Emails and other records which were under the directors’ control may likewise have been surrendered, or otherwise deleted or destroyed by them, thinking that the matter has been dealt with. However, it seems from the Robin Hood Centre case particularly that the credible view expressed in leading academic texts such as Sealy & Milman to the effect that the burden of establishing whether the directors’ actions from a relevant point amount to taking every step to minimise loss to creditors should lie against the liquidators may simply be discarded in court, in favour of a literal reading of the relevant sections. Although the Registrar ostensibly drew from a 2011 case (Re Idessa) in holding that the burden of proof lay upon the directors and further that the liquidators did not need to pin wrongful trading to a specific date in order to succeed, unless and until this decision is appealed or overruled, liquidators will seize upon it as justification for putting a relatively sparse case in correspondence and placing the onus on the directors to provide evidence that they considered and acted appropriately at every stage. The moral of this part of the story is that, no matter how reassured a director may be with the noises they hear back from an office holder on first appointment, they need to ensure also that their war chest is suitably stocked with evidence of their decision making processes, both when the company is in the ‘Twilight Zone’ and when they take steps after having concluded that the company is or may be insolvent. It may be beneficial for the directors to engage solicitors at this stage (in their personal capacities, not under a retainer with the company) to help them compile their evidence and to bounce decisions off, as an insurance policy against possible future action. As a rule of thumb, the need to ensure that the rationale for all decisions is suitably evidenced is greatly heightened where the director will obtain a direct or indirect personal benefit from that decision, but even if the only beneficiaries are certain creditors rather than others, there does need to be a contemporaneous record to explain the decision objectively.
3. DIY insolvency may lead to a DIY disaster
The directors of Micra may well have thought they were doing the right thing by getting in the cash and distributing it to creditors before shutting up shop. They may even have thought that tidying up the intercompany account would save the eventual liquidator a lot of time, effort and cost. The directors of Robin Hood Centre may have felt that by exploring a veritable patchwork of options, with different professional advisors all having a certain window on the company’s affairs, for resolving their trading difficulties they were doing all they could to protect creditors, and through this themselves. However, both sets of directors lost sight, it seems, of the bigger picture, and of the need to measure every single step they took against the yardstick of whether it fitted into an overall scheme which benefited all creditors equally, or at least in accordance with the order of priorities which would have prevailed had a liquidator been appointed earlier. The result was that the steps they took did not achieve their desired effect. Had they taken and followed early, professional advice from a reputable insolvency practitioner accountant, and provided that IP with all relevant information and kept in touch with them at every stage, and/or if they had engaged solicitors to advise them in their personal capacities, they might well have avoided these liabilities. Whilst the judgments themselves may have been relatively modest, by the time their own legal costs, adverse legal costs, and all of the productive time they will have lost during the proceedings have been taken into account, they will I imagine rue the cost of failing to take these relatively simple steps at the relevant time.
Reading the two cases together, one is left with the distinct impression that as the economy recovers we are moving into an era where creditors and office holders will be far less forgiving on directors in the event of an insolvent liquidation where the eventual deficiency to creditors turns out to have deepened as a result of decisions taken in the months and years beforehand. We might say that whereas, when economic conditions generally were responsible for most insolvencies, directors would once be given the benefit of the doubt, today and in the future it falls to the directors actively to show why they are not in some way culpable for the loss to creditors.
Combined with the forthcoming statutory changes (about which more anon), I think directors of companies would be well advised to start paying the closest possible attention to whether their commercial decisions are sustainable for the relevant company and ensuring that their rationale for key decisions is carefully recorded and copies of those records retained somewhere that they will be able to access them reliably, potentially in many years’ time. There will undoubtedly be a use for professional advice in this process. As for insolvency practitioners taking appointments, I also think they may need to start looking at even relatively modest potential claims against directors more closely than they perhaps would have hitherto, for fear that creditors and/or regulators may call them to account for having rejected a possible claim as unviable. It must be remembered in this respect that CFA uplifts and ATE insurance premiums remain recoverable between the parties in insolvency litigation, and that there are funders in the marketplace today who will support such litigation where this might once have been unavailable.
Finally, I should add for completeness that nothing in the above mentioned cases changes the basic principle that when advancing a claim against a director, the liquidator must set out the case the director has to meet. If, for example, in a wrongful trading case the liquidator fails to identify at least one date by which he says, on substantial grounds, that the director ought to have concluded that insolvent liquidation was unavoidable and/or fails to demonstrate that there is a substantial loss attributable to the director’s failure, by reference to a calculation of net deficiency outcome based on that earlier notional liquidation date, the director would be entitled to retort that there is no case for him to answer. This is so notwithstanding that the burden of proving the ‘every step’ defence may have shifted back onto the director, because defences do not even come into play unless a prima facie claim has been made out. As and when wrongful trading and other claims which are currently ‘liquidator only’ claims become more freely assignable, thanks to changing legislation which of course will potentially also make these claims more likely to be pursued (e.g. by aggrieved creditor directly), any prospective assignee would do well to factor this sort of consideration in, and if necessary take his own legal advice at this stage, when bidding to purchase the rights of action from a liquidator.
If you have any queries or concerns about claims against directors having read this blog, please do not hesitate to contact the author, Mike Pavitt, by telephone or email.