When is it wrong to trade?

When a company enters liquidation, its liquidator can apply to the Court for a financial contribution from any director who has allowed the company to wrongfully trade (as per section 214 of the Insolvency Act 1986).

In order to succeed, the Court must be satisfied that the director in question knew or ought to have concluded, before the commencement of the winding up process, that there was no reasonable prospect that the company would avoid going into insolvent liquidation.

A recent case provides useful guidance on how the wrongful trading test should be applied.

In what is being widely regarded as a helpful decision for liquidators, the Court confirmed that, once it has been established that a director knew or ought to have concluded that there was no reasonable prospect of the company avoiding insolvent liquidation, the burden of proof shifts to the director to demonstrate to the Court that he took every step with a view to minimising the potential loss to creditors.

The Court also emphasised that the question as to whether a director has taken such steps must be judged by reference to the body of creditors as a whole because it is they as a class who are protected by section 214 and not just individual creditors.

On the facts, the Court identified two fundamental problems for the directors in their attempt to apply the so-called Minimising Loss Defence:

(1) The directors had allowed a period of approximately 18 months to pass without getting close to a sale of the business; and

(2) The company was only able to continue trading because the directors had chosen to adopt a policy of discriminating against specific creditors, namely the company’s landlord and HMRC. In this respect, while the directors in question had ensured that trade creditors were being paid in full, the same could not be said for the company’s VAT and rent liabilities, which meant that the company’s liabilities to the creditors as a whole continued to increase.

This decision is a useful reminder of how section 214 is applied in practice by the Court. In particular, it confirms that respondent directors who seek to rely upon the so-called Minimising Loss Defence will be required to produce evidence to the Court that every step they took was taken with a view to minimising the potential loss to creditors as a whole.

[1] Philip Anthony Brooks and Julie Elizabeth Willetts (Joint Liquidators of Robin Hood Centre Plc) v Keiron Armstrong and Ian Walker [2015] EWHC 2289 (Ch)

Source: www.gateleyplc.com