In some cases, the insolvency of a company is just the beginning of the end. Many are surprised to learn that the Liquidator is pursuing them personally for losses caused to the company or its creditors. While limited liability is generally understood by directors, it is not always understood is that English law has long held that it is not absolute. There are many avenues for pursuing directors where there is evidence of abuse of the company vehicle or misconduct causing the company or creditors loss. Directors can be made to make good these losses personally. Further, many of these avenues exist in a summary procedure under the Insolvency Act 1986 (‘the Act’) without long drawn-out litigation required.
What powers to Liquidators have?
Liquidators have a duty to investigate the affairs of the company, collect and realise the company’s assets for the benefit of creditors. These duties are supported by wide-ranging powers under ss234-236 of the Act to take possession of the company’s books and records, interview directors and call upon the company’s professional advisors, such as lawyers or accountants. Directors can be compelled to give information or records they hold regarding the company as can third parties, such as banks.
Therefore, most corporate skeletons are certainly capable of being discovered by a diligent, or motivated Liquidator.
This article will look at the common claims made by liquidators: misfeasance, transfers at an undervalue and preference claims.
What is a misfeasance claim?
This is, basically, director misconduct.
Misfeasance, also breach of duty, claims are brought under s212 of the Act. This provides that if a Director:
“has misapplied or retained, or become accountable for, any money or other property of the company, or been guilty of any misfeasance or breach of any fiduciary or other duty in relation to the company….”
Then the court may examine that conduct and compel the director:
“(a)to repay, restore or account for the money or property or any part of it, with interest at such rate as the court thinks just, or
(b)to contribute such sum to the company’s assets by way of compensation in respect of the misfeasance or breach of fiduciary or other duty as the court thinks just.”
Section 212 covers wrongful retention or diversion of the company’s property but also loss caused to the company for any other breach of duty. This is a wide net and can see directors be investigated for breaching their general duties under ss171-177 Companies Act 2006 as well as those duties imposed by equity. Claims under s212 include acting negligently. Importantly, this section is procedural, it does not create new claims or rights, it simply provides an avenue for bringing them through the Insolvency procedure.
What kinds of things fall into misfeasance or s212?
Common examples include making payments to a spouse or third party with no role in the company or paying for personal expenses with the company’s money. This may be seen as a perk of running a company, however, when the company becomes insolvent, its easy pickings for the Liquidator. Some of these payments will simply never be justified as “wholly and necessary incurred” expenses for the business, such as remodelling one’s garden, paying for school fees or paying off the mortgage.
Likewise, if a director creates a liability by a transaction or act, through exercising a power he did not have under the company’s constitution, he may be liable to compensate the company as the court considers just.
What is a transaction at an undervalue?
This is a transaction which is unfavourable to the company.
A transaction at an undervalue is where the company, under s238(4):
“(a) … makes a gift… or otherwise enters into a transaction… on terms that provide for the company to receive no consideration, or
(b) the company enters into a transaction… for a consideration the value of which, in money or money’s worth, is significantly less than the value, in money or money’s worth, of the consideration provided by the company.”
Classically, this is the company transferring £100 to company B for nothing in return (s238(4)(a)) or for £50 (s238(4)(b)).
Directors may have a defence if they can satisfy the court that the company (a) made the transaction in good faith and for carrying out its business and (b) at the time, there was good reason to believe that the transaction would benefit the company (see s238(5)).
There is considerable overlap between s238 and misfeasance. For example, payments to a spouse that has nothing to do with the company would fall foul of both s212 and s238(4)(a).
Liquidators will usually put the offending transaction under both sections unless s238 cannot apply. Transactions at an undervalue can only be challenged if they took place 6 months before the petition to wind up is presented OR if the transaction is made in favour of a “connected” person (such as the director’s spouse or another company of the director), the period is 2 years before (see ss240(1)-(3)).
What kinds of transactions are “at an undervalue”?
The ones that seem to come up often are: random payments to family members or the director; transfers of vehicles or company property for nothing, the company providing its services or staff for nothing. A good example is found in Receiver v Nadeem [2023] EWHC 2735 (Ch).
The trickier ones are which, with hindsight, look suspect but, at the time, did not seem controversial. These include: paying a spouse a large salary relative to the work, paying for golf club membership as a “networking opportunity,” buying stock from a group company at inflated prices or paying excessive management charges. Trickier still, are dividends. It seems that unless directors or a connected company benefits, dividends may not fall within ss238 or 239: Johnson (Liquidator of Strobe 2 Ltd) v Arden [2018] EWHC 1624 (Ch).
Separating assets, which for example, belong to the customer or a third party, may not be a transaction at an under value but a trust: Re Lewis’s of Leicester Ltd [1995] B.C.C. 514.
Directors may have good reasons for these transactions at the time. Here, lucid evidence is important but more important is some objective evidence, especially in writing from the time, which may show why the transaction was made in good faith, in its business and was considered to benefit the company. For this reason, directors (even sole directors) should keep good records and use things like Sage to document transactions.
An issue that often comes up is that when all the boxes of files and computers are handed over to the Liquidator, as they should be, directors complain that they do not have “the files” to make good their defences. Further, Liquidators can, and perhaps do, search for and collate selective entries from Sage or the accounts and paint a picture showing the company’s money being spent on very questionable things. When, in fact, the whole picture may paint a different story.
What is a preference?
This is preferential treatment of a creditor or guarantor.
A preference under s239(4)(b) is where a creditor or guarantor benefits from a transaction by being put in a better position in the event of insolvency than they otherwise would be but for the transaction. However, the company must have some desire to put the creditor in a better position and that desire must have influenced the making of the preference.
Like a transfer at an undervalue, preferences are reversable if they took place 6 months before the petition to wind up is presented OR if the preference is made in favour of a “connected” person, the period is 2 years before (see ss240(1)-(3)).
Sadly, a transaction undertaken pursuant to a court order is not itself a defence (see s239(7)). So settling a debt owed to a former wife in compliance with a Family Court order would not escape s239 of itself.
What kinds of transactions are preferences?
Common ones which catch the attention of Liquidators are paying off loans for which a director has given a personal guarantee. It is always hard to explain why the £10k overdraft with a PG was paid off but the £7k owed to the supplier was overlooked. Settling of loans to group companies is almost always challenged as are loans repaid to directors or family.
The more difficult ones are suppliers which are essential to the “new Co” or the director’s invariably similar new venture. The argument is that, paying off suppliers which are required for the next company is a clear preference as they are being put in a better position for a calculated reason. The desire and influence are made out.
Claims that group companies were being repaid transfers made “in error” will fail unless the sums clearly match: see Asertis Ltd v Heathcote. Likewise, giving security for an existing debt or returning goods which have not been paid for is likely a preference. In contrast, transfers of assets held under trust are not preferences: Re Branston & Gothard Ltd [1999] B.P.I.R. 466.
A recent example which proved difficult was where a company, within 2 years of the petition, paid off a large debt owed to a group company before the debt, which formed the basis of the petition, arose. The directors argued, at that time they were paying debts as they fell due. However, Liquidators will often set out specific facts to show why either the preference then caused the insolvency or, at that time, the company was in fact unable to pay its debts as they fell due (see s240(2)).
In borderline cases, the question will always be whether the directors were influenced by a desire to put the creditor into a better position or, in fact, despite the creditor being put in a better position, the director was influenced by something else. Examples may be paying off a particular creditor because he refused to deliver further supplies or a landlord threatening forfeiture. In such cases, the director could be influenced by averting a threat rather a desire to put the creditor in a better position.
Conclusions
The end of the company is merely the end of the beginning. Liquidators have various routes to personal liability against directors and have the advantage of possessing the company’s books, records and information. Further, they have the advantage of selecting the offending transactions which can raise a debate over what the “full picture” of all the transactions, going back before the 2 years shows. Nevertheless, directors should bear in mind that the wide-ranging powers of Liquidators, including the power to pursue third parties and directors alike, means that where their conduct is questioned, they should get advice early as opposed to giving off-the cuff replies or whatever comes to their mind immediately. They should also think long and hard about retaining copies of essential company records, especially electronic records as they may need them to answer the very questions they are then asked. Finally, it is worth pointing out that, in addition to all the above, Liquidators may also refer the conduct to the Insolvency Service for disqualification proceedings.
Whilst every effort has been taken to ensure that the law in this article is correct, it is intended to give a general overview of the law for educational and/or informational purposes. It is not intended to be a substitute for specific legal advice and should not be relied upon for this purpose.
This article represents the opinion of the author and does not necessarily reflect the view of any other member of St Philips Chambers.
