Some Thoughts on Wrongful Trading, Companies House “Technicalities” and the Need for a Credit Line for the Auditors

First of all, I want to welcome my readers to a new year on this blog. (I am aware that it is a new year elsewhere too of course.)

After a woefully disappointing football result today at New Broomfield, I decided to take refuge in the blog and to get it kick started for 2012.

It appears that I am suffering from the occupational hazard of bloggers, which is to have an assortment of half-finished pieces lying about, but not enough time to finish them. The world will therefore have to wait for my analysis of the Offensive Behaviour at Football etc Act, for example, which is figuratively lying on my desktop in a number of pieces whilst I look for the glue to put it all together.

My thoughts on the NFL playoffs might be complete by the time the Super Bowl starts (which is clearly a bit too late.)

So, to start the year, I thought I would cheat by using something written for another purpose, this saving me some effort. Needless to say though, I have added a few bits in, at the top and tail of the piece.

So – here we go with the first blog of 2012!

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Introduction

I had occasion a while ago to prepare a brief note (well brief by my standards) about “Wrongful Trading” and in particular the procedure under s214 of the Insolvency Act where, in a liquidation, the liquidator can ask the court for an order that directors responsible for “wrongful trading” should be found personally liable to make redress to the liquidator.

This is separate from any issues regarding fraud, which are covered in s213 and which I did not mention in my note, or issues about fitness in the future to be a company director, in terms of the Company Directors Disqualification Act 1986.

Why post this now?

Firstly, in the slumping economy this is an issue for more and more businesses. (I should add, for the avoidance of doubt, that nothing in this post should be taken as being provision of legal advice and any reader who faces the issues described should seek their own independent legal advice.)

Secondly, with reference to the football focus (at times) on this blog, I was having a discussion with a friend who was asking if, for example, Hearts or Rangers might experience  adverse results due to these provisions.

Thirdly, it was previously disclosed that Bryan Jackson, eminence grise of Insolvency Practitioners in Scotland, had advised the Directors of Rangers, prior to the Whyte takeover, on this very issue.

The fact that the club continued to trade would suggest that his advice reassured the Directors at the time, although all but Dave King have now left the Board.

 

A Brief Aside Regarding Company Law Technicalities

As a side note, the “cautious observer” on the Rangers Tax Case Blog spotted that Companies House do not appear to have received notification of the resignations of Messrs Greig and McClelland from the Board earlier this year. The Companies Act requires the company to notify Companies House of such changes within 14 days, otherwise an offence is committed by the company and the remaining directors.

Despite Rangers announcing this to the PLUS Stock Exchange, it appears that (a) Rangers have failed to notify Companies House, as required; (b) the notifications have been lost in the post; or (c) Companies House has erred by not recording the matter correctly. I can offer no comment on that issue, other than to say that I am sure that any lapse on the part of Rangers, should there have been such, has been entirely the result of an oversight or administrative error.

On a continued side note, the Companies House print out for Rangers as of 5 minutes ago includes the line “Next Accounts Due: 31/12/2011 OVERDUE”. As has been pointed out, the accounts might well have been delivered prior to the deadline, as it is unlikely that Companies House is able to log instantaneously the fact that accounts have been received.

In any event, the failure toi provide accounts to Companies House by the deadline now passed would be a further criminal offence committed by the company and its directors, if indeed they have not been lodged timeously.

In addition, it is a criminal offence for a company and its officers to fail to hold an Annual General Meeting within certain time limits. Rangers’ time limit passed on 31st December. No meeting had been held.

These are all “technical” matters. However they are vital in connection with the Company’s obligations as regards corporate governance and also in relation to continued presence on the PLUS Exchange.

It remains, I think, unlikely that any formal prosecutions regarding these matters will be raised, although that depends on how quickly the alleged breaches are remedied.

As regards the accounts not being audited, which seems to be the problem, I came across an article written by Paul Rogerson in the Herald in December 2004 after the rights issue in connection with Rangers resulted in Sir David Murray’s companies, which underwrote the issue, having to take almost 98% of the shares. Only 4,500 individual shareholders and fans, to the tune of an average spend of £248 each, took advantage of the rights issue to subscribe to shares.

It is a very interesting piece for a number of reasons, but I mention it specifically for the following. The article refers to RAngers having established a new credit facility to the tune of £37 million with the Bank of Scotland. This was done by Rangers, according to Sir David Murray, at the insistence of the auditors, Grant Thornton.

The article stated “Murray has stressed, however, that the new facility was put in place because the club had to satisfy auditors Grant Thornton that it had sufficient funds for its rights issue business plan under a “worst-case scenario”.

“That could perhaps involve a swift exit from European competition, or even the unlikely event of failing to qualify for Europe at all.”

Today, as far as has been made public, Rangers do not have a credit facility with any bank. This season the worst case scenario came to pass. If, seven years ago, Grant Thornton were insistent on the club having a facility available to cover such an event, is it not likely that similar considerations apply today. Might the absence of a facility be the reason for delay in the audited accounts being prepared, rather than, on its own, Rangers’ present tax issues?

Anyway, on with the originally scheduled article:-

 

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Wrongful Trading

 

Insolvency Act 1986

214.— Wrongful trading.

(1) Subject to subsection (3) below, if in the course of the winding up of a company it appears that subsection (2) of this section applies in relation to a person who is or has been a director of the company, the court, on the application of the liquidator, may declare that that person is to be liable to make such contribution (if any) to the company’s assets as the court thinks proper.

(2) This subsection applies in relation to a person if—

(a) the company has gone into insolvent liquidation,

(b) at some time before the commencement of the winding up of the company, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation, and

(c) that person was a director of the company at that time;

but the court shall not make a declaration under this section in any case where the time mentioned in paragraph (b) above was before 28th April 1986.

(3) The court shall not make a declaration under this section with respect to any person if it is satisfied that after the condition specified in subsection (2)(b) was first satisfied in relation to him that person took every step with a view to minimising the potential loss to the company’s creditors as (assuming him to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation) he ought to have taken.

(4) For the purposes of subsections (2) and (3), the facts which a director of a company ought to know or ascertain, the conclusions which he ought to reach and the steps which he ought to take are those which would be known or ascertained, or reached or taken, by a reasonably diligent person having both—

(a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company, and

(b) the general knowledge, skill and experience that that director has.

(5) The reference in subsection (4) to the functions carried out in relation to a company by a director of the company includes any functions which he does not carry out but which have been entrusted to him.

(6) For the purposes of this section a company goes into insolvent liquidation if it goes into liquidation at a time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of the winding up.

(7) In this section “director” includes a shadow director.

(8) This section is without prejudice to section 213.

 

 

This section lays out the principal rules about “wrongful trading”. S213, mentioned in ss8, refers to “fraudulent trading”. That is an entirely different matter. Therefore this note only addresses “wrongful trading”.

 

As can be seen from the section, the necessary ingredients for a finding that a person has been engaged in wrongful trading are as follows:-

  • the company has gone into liquidation at a time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of the winding up;
  • at some time before the commencement of the winding up of the company, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation; and
  • that person was a director of the company at that time.

In those circumstances the liquidator can ask the court dealing with a winding up to make an order that any director found to have been at fault for “wrongful trading” should make a personal contribution to the debts of the company.

 

There are surprisingly few reported court decisions on precisely what constitutes wrongful trading.

The case of Liquidator of Marini Ltd v Dickenson in 2003 gives some useful guidance as to how the courts interpret this.

In this case a menswear retailer experienced a sudden drop in turnover and profit. The directors viewed this as a short term problem. They had bought their autumn stock, and expected things to pick up over the Christmas and New Year period. This did not happen.

Despite this the directors continued on, thinking that matters would change for the better. This did not happen, and in the April (the problem first having arisen the previous September) they decided to take advice. One adviser recommended liquidation. The directors decided to struggle on a bit further in the hope of turning the corner. This failed and they put the company into liquidation in the July.

The liquidator asked the court for an order that the directors be found liable for wrongful trading. He argued that in the September the directors should have realised liquidation was inevitable and they should have wound the company up then.

The judge dismissed the wrongful trading claim.

He stated “it must be demonstrated that, as a result of continuation of trading after the point in time at which it is said that the person against whom a remedy is sought under section 214 knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvency liquidation, the company was at the date of the actual liquidation in a worse position than it would have been in had trading ceased at the time contended it should have done.

The judge used the “net deficiency test”. This test compares the net deficiency in the company’s assets at the date when the liquidator claims the directors ought to have stopped trading with that on the date on which trading did in fact cease.

It is not enough for a liquidator to say that a particular loss would not have been suffered by the company, should the company continue to trade.

In this case the judge, applying the net deficiency test, failed to find any evidence that the net deficiency in the company’s assets increased from September 1998 through to July 1999.

The Judge also considered whether the directors knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation. He did not criticise the decision to trade on from September to Christmas.

However he said that, by the time sales up to Christmas had not produced any improvement, the directors ought to have appreciated that there was no reasonable prospect of avoiding insolvency unless radical measures were taken. But even at that stage, he said that the evidence did not indicate that insolvent liquidation was anything like inevitable.

Having noted this, the Judge concluded that the fatal issue for the liquidator was that the net deficit had not been shown to have increased. On this basis, he concluded that the wrongful trading claim had failed.

 

Conclusions

 

The importance of this case is to show that the measure of wrongful trading is whether the company was at the date of the actual liquidation in a worse position than it would have been in had trading ceased at the time contended it should have done.

Even where, as in this case, there was advice in April to wind up, the directors were not liable for continuing on till the July.

This decision is of importance as it shows a reasoned, pragmatic approach to how directors should run their business in the face of an adverse financial climate and reiterates the net deficit test of Re Continental Assurance as the test for wrongful trading. It further illustrates the difficulties faced by a liquidator attempting to bring an action of wrongful trading under s.214.

The case of Marini seems to  show that the court is reluctant to readily impose the remedy of personal liability on directors. This is particularly the case where directors have taken advice from professional advisers.

 

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What Does This mean for Hearts and Rangers?

The whole point of the legislation is to protect creditors. The Act is designed to stop companies increasing their debts at a time when the new debt will not be able to be repaid. If company directors proceed to incur new debt KNOWING that it will not be repaid, then that may very well be fraudulent. As I mentioned in the note, that is not what I am looking at and there is no suggestion that that applies to either of the teams mentioned.

The cases make it clear that there has to be something unusual for the court to determine that the directors should be found culpable for wrongful trading. In addition, in the particular circumstances of both teams, the principal creditor is the owner, or the owner’s companies. Accordingly the main effects of either of these teams continuing to trade when “insolvent” (which is not the case just now I am sure) would probably be felt by the owners themselves. In the event of either company entering liquidation, it is unlikely that the liquidator would insist on taking action against the owner for the purpose of raising additional funds to pay off the owner!

The question boils down to that of the “net deficiency”. Bearing in mind the documented financial issues of both teams, this could impact on their abilities to purchase new players in the transfer window. If there is a danger of either team becoming insolvent, would it be appropriate for them to incur liability for a transfer fee (as most substantial fees are paid up by instalments).

Here is where the expert adviser comes into his own. As long as a company which suspects it may be in such a position takes advice and receives guidance that it can continue, even if there are prospects of failure, that would act to protect the directors from personal liability. As in the Marini case indeed, even where one advise recommended liquidation, the directors were not penalised for failing to follow that advice.

In Rangers’ case of course, a substantial adverse finding at the First Tier Tribunal (Tax) might lead to the complications mentioned, but that is something upon which I am sure the Board have taken, and are regularly updating, their legal and accountancy advice.

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5 Comments

Filed under Blogging, Civil Law, Football, Hearts, HMRC v Rangers, Insolvency Act 1986, Offensive Behaviour at Football and Threatening Communications (Scotland) Bill, Rangers, The Company Directors Disqualification Act 1986.

5 responses to “Some Thoughts on Wrongful Trading, Companies House “Technicalities” and the Need for a Credit Line for the Auditors

  1. TheBlackKnight

    ” (2)(b) was first satisfied in relation to him that person took every step with a view to minimising the potential loss to the company’s creditors as (assuming him to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation) he ought to have taken.”

    Excellent as always Paul. Balanced and accurate.

    It is a real shame that the many decent Rangers and Hearts (so called) supporters with the ability to cover such matters do not put as much effort into their research as a neutral observer, such as you, does.

    It certainly leaves an intriguing set of questions in regard to certain claims (in particular Whyte Knight and Rangers):
    1. FTT(T)? – advised that “we will win” despite the “known risks” highlighted by SafferyChampness in the due diligence.
    2. Takeover – Circular to shareholders? -insolvency is clearly referred to several times in the takeover information released to shareholders; “if an insolvency does not occur within 90days of the ruling”
    3. The Bain Papers – the PLCs previous financial director and CEO, both refer to possible insolvency events and the possibility of trading whilst insolvent. Lord Hodge, if I recall correctly, noted a “real risk of insolvency”

    Perhaps the much mooted “warchest” will soon be unearthed and coupled with the (below) “off the radar” wealth of the owner and an outright win at the FTT(T) will allay any fears the decent fans have?

    I am surprised none of these concerned individuals, those involved directly (the ex directors or the company itself) or indirectly (the SFA) have not looked into this.

    Then again……….

    • TBK,

      Thanks as always for the thoughtful comments.

      For a solvent business, as it presently is, those in charge of Rangers spend a lot of time talking about insolvency!

      As regards the Tax Appeal, an interesting question is what Mr Whyte, or Rangers’ counsel, mean by “winning”.

      Lawyers can class as a victory an outcome better than the worst case scenario. In the days of the death penalty, getting a life sentence would be a “win” I suppose!

      Here, where HMRC have claimed a sum which, with interest and penalties, might exceed £50 million, would it not be a “win” to have the bill reduced to “only” £30 million, for example?

      In such an instance, the taxpayer would have “saved” £20 million.

      If the advice received was that Rangers would “win” i.e. have no liability at all, then I would be totally astonished, if only because by the nature of these cases, results 100% either way are rare and an asdviser would be reluctant to pin their colours to such a mast.

  2. TheBlackKnight

    Oh, Sorry Paul, forgot to say I will be looking forward to your piece on the “Offensive Behaviour Act” and in particular, for example, the internet and those who use threatening behaviour or encitement and the likely outcome by any investigations unit………(if you know what I mean 😉 )

  3. Darren

    An interesting piece as always paul thanks. If I have understood you correctly here a director would be immune from any personal liability to their company’s debts provided they can show that they at least sought expert advice at certain critical points. (even if they did not follow it) To a layman like me though I still would have thought it possible that in another case (let’s say hearts purely for example) it can be clearly demonstrated that by continuing to attempt to trade past a certain critical juncture the company has increased its liabilities to certain creditors unneccesarily?

    • Thank you Darren,

      As long as the advice left some room for continuing, then it would be very difficult, as I understand matters, for a court to make such a finding. In the MArini case, my reading is that whilst one adviser said they should wind up in the April, there was other contrary advice.

      It is hard to fault a person where they can show that they have taken professional counsel, especially where the advice received might differ.

      And the cases make clear that it is the total “net deficiency” that matters, rather than individual creditors.

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