In these unprecedented last few months, the insolvency industry has faced some dramatic changes in a very short space of time.
Following various conversations with insolvency practitioners and insolvency lawyers, we appear to be in a period of limbo whereby directors (and creditors) are holding the position, pending further developments in the state of both the economy and COVID-19. This now appears likely to last through until the autumn, given (a) the extension of the furlough scheme until October 2020 and (b) the stay on all corporate statutory demands/winding up petitions until 1 October 2020 at the earliest.
In light of the current climate, the next 3-4 months present an opportunity for insolvency practitioners to review existing and even historic cases in order to progress them to closure. When reviewing each case, the case handler should consider any potential actions that can be seen based on the documentation held.
We have set out below a brief synopsis some of the most common actions to look out for.
Transactions at an undervalue (section 238 of the Insolvency Act 1986)
A company enters into a transaction with a person at an undervalue if
- the company makes a gift to that person or otherwise enters into a transaction with that person on terms that provide for the company to receive no consideration, or
- the company enters into a transaction with that person 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.
Where the company has at a relevant time entered into a transaction with any person at an undervalue, the office-holder may apply to the court for an order under this section. The ‘relevant time’ is within two years of the onset of insolvency. If the payment is made to a person who is connected to the company, there is a presumption that the company was insolvent at the time.
The court shall not make an order under this section in respect of a transaction at an undervalue if it is satisfied
- that the company which entered into the transaction did so in good faith and for the purpose of carrying on its business, and
- that at the time it did so there were reasonable grounds for believing that the transaction would benefit the company.
Accordingly, the key point here is whether or not the Company received a benefit as a result of the payment(s) made. If there is no ascertainable benefit for the Company, with no commercial benefit made at the relevant time, it is very likely to be deemed as at transaction at an undervalue.
What to look out for
The simple position on transactions at an undervalue is to question all payments made out of a company’s bank account where either (a) it is not clear from the face of the transaction what it is, or (b) there is no explanation for the payment made. Large round sum payments should set off a red flag and be investigated further.
Explanations should be sought as to why certain payments have been made during the relevant period. In the event that you do receive a valid explanation, you should consider whether such payments constitute transactions at an undervalue or preference payments.
Preference Payments (section 239 of the Insolvency Act 1986)
A company gives a preference to a person if
- that person is one of the company’s creditors or a surety or guarantor for any of the company’s debts or other liabilities, and
- the company does anything or suffers anything to be done which (in either case) has the effect of putting that person into a position which, in the event of the company going into insolvent liquidation, will be better than the position he would have been in if that thing had not been done.
Where a company has at a relevant time given a preference to any person, the office-holder may apply to the court for an order under this section. The ‘relevant time’ is within two years of the onset of insolvency if the payment is made to a person who is connected to the company, otherwise 6 months for unconnected parties.
The court shall not make an order under this section in respect of a preference given to any person unless the company which gave the preference was influenced in deciding to give it by a desire to produce a more favourable outcome in relation to that person. Where a company which has given a preference to a person connected with the company (otherwise than by reason only of being its employee) at the time the preference was given is presumed, unless the contrary is shown, to have been influenced in deciding to give it by such a desire.
The policy behind preference payments is quite simple – payments of debts to certain parties, at a time when other parties debts remains unpaid, offends the pari passu principle. Accordingly, you are required to show that (a) the company was insolvent (cash flow or balance sheet) and (b) other creditors were outstanding as at the time of the payments made to a certain creditor.
What to look out for
Common examples in practice are:
- Payment of debts due to family members.
- Payment of debts due to connected companies.
- Payment of debts due to business associates.
- Payment of debts which are personally guaranteed
- Offsetting of a director’s loan account.
Misfeasance/Director’s Duties (sections 212 Insolvency Act 1986 and 171-177 Companies Act 2006)
Section 212 applies to a director who 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. The section allows the court to make an order that the director
- repays, restores or accounts for the money or property or any part of it, with interest at such rate as the court thinks just, or
- contributes 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.
There are many overlaps with between misfeasance claims and preference/undervalue claims. In a typical scenario it is likely that if a director has authorised a payment to connected party by way of preference/undervalue, a concurrent claim for misfeasance can be brought against the director.
In relation to the specific duties owed under the CA 2006, these include the following duties:
- To act within the powers available.
- To act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. When a company is insolvent or of borderline insolvency, the interests of the creditors become paramount.
- To exercise independent judgment.
- To exercise reasonable care, skill and diligence. This means the care, skill and diligence that would be exercised by a reasonably diligent person with (a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and (b) the general knowledge, skill and experience that the director has.
- To avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company.
- Not to accept a benefit from a third party conferred by reason of (a) his being a director, or (b) his doing (or not doing) anything as director.
To succeed in any such action, you have to show that as a result of the director’s breach of duty, the company suffered loss which was caused by the breach.
Recent case law has also indicated that directors will have an ongoing duty to the company, even after an insolvency event.
What to look out for
There is a very wide scope of actions that a director may have undertaken/failed to undertake, so it is important to consider and investigate all actions in the round. Some common examples:
- Director’s granting payments at an undervalue/preferences.
- Director’s making secret profits/transfer of clients.
- Transfer of assets away from the company.
- Director causing a company not to pay VAT/other tax.
- Write off of debts/director’s loan accounts.
Void Dispositions (section 127 Insolvency Act 1986)
In a winding up by the court, any disposition of the company’s property, and any transfer of shares, or alteration in the status of the company’s members, made after the commencement of the winding up is, unless the court otherwise orders, void.
Investigations of all payments and transfers of any company property, after the date of the presentation of a winding up petition, should be investigated.
Director’s Loan Account
Investigations of the Company’s books and records should be carried out to ascertain the position of the director’s loan account. This can be a simple task by referring to the latest accounts; however, where accounts have not been filed in a recent period prior to insolvency, further investigations and analysis may be required in order to reconstitute the director’s loan account.
Investigations of the company’s books and records should be carried out to ascertain whether there are any book debts to recover.
There are many points and factors to consider when reviewing your cases in relation to the potential claims that exist, and the above list is not exhaustive. We are very happy to discuss any potential claims with you in the first instance, so if you believe that there may be actions available in any of your cases, please do contact us.
The contents of this article are intended for general information purposes only and shall not be deemed to be, or constitute legal advice. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of this article.