This snapshot taken on 09/07/2011, shows web content selected for preservation by The National Archives. External links, forms and search boxes may not work in archived websites.

CIVIL RECOVERIES FOLLOWING THE MISCONDUCT OF DIRECTORS

PART 4

February 2010

CIVIL RECOVERIES FOLLOWING THE MISCONDUCT OF DIRECTORS

31.4B.66 Civil recoveries against a director of an insolvent company

Where a director has been involved in asset related misconduct - for example, the misappropriation of assets - it may be possible to take a civil recovery action against him/her – whether or not he/she has been found guilty in a prosecution or made subject to a disqualification order.  The types of misconduct that may lead to such a recovery order are detailed in this Part of the chapter, as follows:

Other circumstances where a director may be personally liable are when he/she has unlimited liability, when he/she has an outstanding loan account (paragraph 31.4B.73) or when he/she has received excessive remuneration (paragraph 31.4B.88).

 

31.4B.67 Position of civil recoveries

  Unlike other forms of antecedent recoveries (see, for example, preferences and transactions at undervalue – see Chapter 31.4A), civil recoveries against directors do not seek necessarily to restore a position to what it would have been had a transaction not taken place; rather they seek to have the director (or other liable office-holder) pay compensation for the loss to the company caused by his/her action or inaction.  It is not intended that the payment should be punitive (that is, to punish the director) [note 1].

 

31.4B.68 Fraudulent trading

If it appears that any business of the company has been carried on with intent to defraud creditors of the company or of any other person, or for any fraudulent purpose, the court may, on application of the liquidator, declare that any persons (not just company officers) who were knowingly parties to the carrying on of the business in the manner mentioned above are liable to make such contributions to the company’s assets as the court thinks fit [note 2].

For a successful action under the provisions relating to fraudulent trading it is necessary to demonstrate that there was an intent to defraud [note 3].

Information regarding fraudulent trading of the criminal type can be found in Chapter 38 of the Enforcement Investigation Guide (http://intranet/Enforcement/EnforcementTopLevel/EIGuide/Volume2/Chapter38.htm).

 

31.4B.69 Wrongful trading

Where a director, former director or shadow director [note 4],  knew or ought to have concluded  that there was no reasonable prospect that the company would avoid insolvent liquidation, and took the decision to carry on trading, the court, on application of the liquidator, may declare that the director is liable to make such contribution to the company’s assets as the court thinks proper [note 5] [note 6].  

Simply allowing the company to continue to trade when it is insolvent would not put a director in contravention of these provisions.  It must be shown that he/she ought to have known, or concluded, that there was no reasonable prospect of avoiding insolvent liquidation [note 7].

Information regarding wrongful trading as a matter of unfit conduct can be found in Chapter 38 of the Enforcement Investigation Guide (http://intranet/Enforcement/EnforcementTopLevel/EIGuide/Volume2/Chapter38.htm).

 

31.4B.70 Wrongful trading – order declaring director liable

The court will not make an order declaring a director liable to make a contribution to the company’s assets if it is satisfied that the director took every step with a view to minimising the potential loss to the company’s creditors as he/she ought to have taken [note 8].  In reaching this conclusion, the court will take into account the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as that director [note 9] and the actual knowledge, skill and experience of the director [note 10].

The court must be satisfied that that the company’s position was worse as at the date of liquidation than it was when there was knowledge of insolvency to make an order [note 11].  It is possible that not all the directors could be found liable as each individual‘s role will be individually assessed by the court. [note 12].

 

31.4B.71 Misfeasance – general

Where a person entrusted with a position (in this case, a company director) carries out an act causing a loss or damage (or fails to carry out an act thereby causing loss or damage), even if the act is a legal act, then this is termed a misfeasance.

Where during the course of a winding up, it appears that a person who is or has been an officer of the company or a person concerned in the formation, promotion or management of the company 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, section 212 will apply [note 13]. 

 

31.4B.72 Misfeasance – court action

The court may, on the application of the official receiver or the liquidator, or of any creditor or contributory, examine the conduct of such a person and compel him/her -

  • 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 [note 14], or
  • to contribute such sum to the company's assets by way of compensation in respect of the misfeasance or breach of fiduciary duty as the court thinks just [note 15].

An action for misfeasance is in the name of the company against the person(s) liable and is brought by the liquidator.  The action must demonstrate a breach of duty and a loss [note 16] [note 17].

A creditor has standing to bring an action for misfeasance but the court can only make an order in favour of the company and not in favour of the person bringing the action.  This is termed a “class action” [note 18].

 

31.4B.73 Examples of misfeasance

Examples of behaviour (the commission or omission of which could be classed as misfeasance) are :

  • The director has received monies or other consideration from the company (other than the proper remuneration for services provided) which has resulted in a material loss to the company [note 19].
  • The director has authorised payments or other dispositions of property to himself/herself (or to connected persons – see paragraph 31.4B.30) which has resulted in a loss to the company [note 20].
  • The director has been responsible for the non-disclosure to the company of any contracts, dealings or other transactions in which use was made of the company's assets or property (including goodwill) and which has resulted in a material loss to the company [note 21].
  • The director has been responsible for any material loss to the company occasioned by the sale, assignment, transfer or property other than in the normal course of business [note 22].

 

31.4B.74 Debts owed to the company by a company officer

Where the company officer owes money to the company under a contract, this should be pursued through the normal channels for debt recovery (see Chapter 31.1) rather than as a matter of misfeasance [note 23].

 

31.4B.75 Restriction on re-use of company name

When a company goes into insolvent liquidation, the Act [note 24] places restrictions (subject to certain exceptions) on the re-use of a prohibited company name or names, for a period of five years, by the directors or shadow directors of the company who held office at any time in the period of 12 months ending with the day that the company went into liquidation [note 25].

A name of a company becomes a prohibited name if [note 26]:

  • it is a name by which the liquidating company was known at any time in that period of 12 months, or
  • it is a name so similar to a name by which the company was known as to suggest an association with that company.

If a person acts in contravention of Section 216 he/she is liable to imprisonment or a fine, or both [note 27].

The restrictions consist of prohibitions upon his/her being:-

  • a director of any other company that is known by a prohibited name, or
  • in any way, whether directly or indirectly, concerned or taking in the promotion, formation or management of any such company, or
  • in any way, whether directly or indirectly, concerned or taking in the carrying on of a business carried on (otherwise than by a company) under a prohibited name.

 

31.4B.76 Exceptions to restrictions on re-use of company name

A director may apply for leave of the court to act as a director of a company with a prohibited name [note 28] [note 29].

There are three excepted circumstances where a director may act without leave of the court and without committing an offence and attracting personal liabilities [note 30]:

  • Where a company (the successor company) acquires the whole, or substantially the whole, of the business of an insolvent company, under arrangements made by an insolvency practitioner acting as its liquidator, administrator or administrative receiver, or as supervisor of a voluntary arrangement, and gives notice to the insolvent company's creditors following the procedure detailed in the Rules [note 31].
  • If the director applies for leave of the court [note 32] not later than seven business days from the date on which the company went into liquidation, he/she may act until the day falling six weeks after the day the company went into liquidation, or until the day on which the court disposes of the leave application, whichever happens first [note 33].
  • Leave of the court is not required where the company is known by a prohibited name if [note 34]:
    • It has been known by that name for the whole of the period of 12 months ending on the day before the liquidating company went into liquidation, and
    • has not at any time in those 12 months been dormant within the meaning of section 252(5) of the Companies Act 1985 (whilst this section is no longer in force, the wording of the section continues to exist for the purpose of the relevant Rule).

This exception allows a former director to continue to act in the affairs of an established company even though it is known by a name that would otherwise be prohibited, provided that it has been using that name for at least one year before his/her other company went into liquidation.

 

31.4B.77 Personal liability following use of a prohibited name

A person is personally responsible for all the relevant debts (see paragraph 31.4B.78) of a company if at any time [note 35]:

a) in contravention of section 216, he/she is involved in the management of the company, or

b) as a person who is involved in the management of the company, he/she acts or is willing to act on the instructions given (without leave of the court) by a person whom he/she knows at that time to be in contravention in relation to the company of section 216.

 

31.4B.78 Relevant debts

The relevant debts of a company are [note 36] -

  • in relation to a person who is personally responsible (see (a) at paragraph 31.4B.77), such debts and other liabilities of the company as are incurred at a time when that person was involved in the management of the company, and
  • in relation to a person who is responsible (see (b) at paragraph 31.4B.77), such debts and other liabilities of the company as are incurred at a time when that person was acting or was willing to act on instructions given as mentioned above.

The person is liable for the debts of the successor company, not for the debts of the original company in liquidation.

Where only part of the successor business was conducted under a prohibited name, the person will be liable only for those debts incurred under the prohibited name [note 37].

 

31.4B.79 Liability for relevant debts

Where a person is personally responsible for the relevant debts of the company, he/she is jointly and severally liable in respect of those debts with the company and any other person who is so liable [note 38].

Liability under this section is automatic; there is no need for a court order declaring the director liable. Neither does the director have to have been convicted under section 216. A creditor may then pursue the director personally for settlement of his/her debt.

 

31.4B.80 Bringing a prohibited names contravention to the attention of creditors

A director’s previous directorships are a matter of public record, as are the names of the companies of which he/she was previously a director. If a director was previously a director of a company with a similar name which has had a winding-up order made against it, the official receiver may consider it appropriate to include the information in the report to creditors so that creditors might become aware that they may have individual rights against the director(s) concerned due to the operation of section 217. See also Chapter 18 Part 1 - Reports to creditors and contributories.

Under no circumstances should the official receiver actively encourage creditors to take proceedings, or attempt to provide legal advice.  Official receivers should explain that they are unable to offer any legal advice and creditors should be advised to take their own independent legal advice if that is considered to be necessary.

 

31.4B.81 Acting while disqualified

A person is personally responsible under the provisions of the Company Directors Disqualification Act 1986 for all the relevant debts (as defined below) of a company if at any time [note 39]:-

a)  in contravention of a disqualification order, or whilst an undischarged bankrupt, without leave of the court he/she is involved in the management of a company, or

b)  as a person who is involved in the management of the company, he/she acts or is willing to act on instructions given without leave of the court by a person whom he/she knows at that time to be the subject of a disqualification order or to be an undischarged bankrupt.

 

31.4B.82 Relevant debts

The relevant debts of a company for these purposes are [note 40] -

  • in relation to a person who is personally responsible (see (a) at paragraph 31.4B.81), such debts and other liabilities of the company as are incurred at a time when that person was involved in the management of the company, and
  • in relation to a person who is responsible (see (b) at paragraph 31.4B.81), such debts and other liabilities of the company as are incurred at a time when that person was acting or willing to act on instructions as referred to above.

 

31.4B.83 Joint and several liability

Where a person is personally responsible under the Company Directors Disqualification Act 1986 for the relevant debts of the company, he/she is jointly and severally liable in respect of those debts with the company and any other person who is so liable [note 41].

Liability under this section is automatic; there is no need for a court order declaring the director liable. Neither does the director have to have been convicted of the offence. A creditor may then pursue the director for settlement of his/her debt.

If a director has been subject to bankruptcy proceedings, or disqualified, this should be included in the report to creditors, so that creditors might become aware that they have individual rights against the director due to the operation of these provisions.

Under no circumstances should the official receiver encourage creditors to take proceedings or attempt to provide legal advice.  Official receivers should explain that they are unable to offer any legal advice and creditors should be advised to take their own independent legal advice if that is considered to be necessary.

 

31.4B.84 Liability when company has purchased its own shares

Where a private company wishes to repurchase its own shares, the company’s directors must make a statutory declaration specifying the amount of permissible capital payment for the shares in question and stating that there will be no grounds on which the company could be found unable to pay its debts and that it will carry on in business for at least a year [note 42].

If the company is wound up within a year of repurchasing shares out of capital, and the aggregate amount of the company's assets is not sufficient for the payment of its debts and liabilities and the expenses of the winding up, any director who signed the statutory declaration may be liable to contribute to the assets of the company.

The directors are jointly and severally liable, with the shareholders whose shares were repurchased, for the amount received as consideration on the repurchase [note 43]. A director may be able to avoid such a liability if he/she can show that he/she had reasonable grounds for forming the opinion set out in the statutory declaration [note 44].

In circumstances where the director is obliged to make a contribution under these provisions, the official receiver may pass the matter to Moon Beever under the arrangement for the collection of book debts (see Chapter 31.1)

 

31.4B.85 Failure to obtain a trading certificate under the Companies Act

A company registered as a public company on its original incorporation must satisfy the Registrar of Companies that it meets the requirements concerning share capital for such a company before it may commence trading [note 45]. The company does this by sending a form [note 46] to the Registrar.  The Form contains a statement of compliance signed by a company officer and states the following information [note 47]:

  • that the nominal value of the company's share capital is not less than the authorised minimum, currently £50,000 [note 48]
  • the amount, or estimated amount, of the company's preliminary expenses
  • any amount or benefit paid or given, or intended to be paid or given, to any promoter of the company, and the consideration for the payment or benefit.

If the Registrar is satisfied, then he/she issues a certificate, sometimes called a trading certificate [note 49].

 

31.4B.86 Trading certificates in private companies re-registering as public

A company re-registering from a private company to a public company does not have to apply for a trading certificate.

 

31.4B.87 Consequences of failing to obtain a trading certificate

If the company does business or exercises any borrowing powers without obtaining a trading certificate (see paragraph 31.4B.85), and then fails to comply with its obligations in that connection within 21 days from being called upon to do so, the directors of the company are jointly and severally liable to indemnify the other party to the transaction in respect of any loss or damage suffered by him/her by reason of the company's failure to comply with those obligations [note 50].

Trading without a trading certificate is also an offence [note 51].

If a company commenced trading either before, or without, the issue of a trading certificate, then an entry to that effect should be included in the report to creditors.

Under no circumstances should the official receiver encourage creditors to take proceedings or attempt to provide legal advice.  Official receivers should explain that they are unable to offer any legal advice and creditors should be advised to take their own independent legal advice if that is considered to be necessary.

 

31.4B.88 Repayment of director's remuneration

It as been held that the power of the company to award remuneration to its directors is properly exercised, remuneration cannot be challenged solely on the basis that it was not to the benefit of the company [note 52]. However, the court did give examples of circumstances where a challenge might be appropriate:-

  • the remuneration is so excessive as to constitute a fraud on creditors;
  • although a director could receive payment simply for holding office, if the remuneration was above the amount which might be reasonably be paid to the director in question, it might be held to be a disguised gift out of capital.

 

 

Back to Part 3 – Avoidance of charges] [On to Part 5 – Avoidance of dispositions of property]