A further nail in the coffin for wrongful trading claims?
Reported Court decisions on wrongful trading cases are few and far between. The last case of note was Re Langreen Limited in 2011 where our director Andy Taylor acted for the managing director and co-ordinated the successful pre-trial defence of the proceedings.
On 31 July 2015 Mr Registrar Jones handed down a 66 page judgement in respect of wrongful trading proceedings against the two directors of Robin Hood Centre Plc which, as the name suggests, operated a visitor attraction in Nottingham for many years before going into liquidation in 2009. The liquidators embarked on the proceedings hoping to persuade the Court to order the directors to make a contribution to the company’s assets of around £400,000. They may have won the case, but the judgement shows that it was a close run thing, and ultimately the Court ordered the directors to pay only £35,000 which one suspects was a fraction of the legal costs of bringing the proceedings and was less than the liquidators’ time costs of £38,135, such that the proceedings will have had no discernible benefit for the creditors.
Why was this? Well, the answer ultimately lies in the Registrar’s new approach to assessing the compensation that the directors should pay. This approach is likely to cause consternation amongst liquidators looking to take wrongful trading proceedings in the future, because of the need to establish a connection between the wrongful trading and the loss to be compensated.
The judgment covers many of the fundamentals of wrongful trading proceedings and will be the subject of much legal commentary. This article highlights four of the main points.
The Knowledge Condition v the Minimising Loss Defence
The Registrar came up with the phrase “the Knowledge Condition” to describe the test under section 214(2) Insolvency Act, namely that the Liquidator has to prove that at some time before liquidation the director knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into liquidation.
In assessing this test, the Registrar noted that the onus of proof is on the liquidator. Section 214 does not require proof of insolvency at the date of the Knowledge Condition. There is no duty upon a director not to trade whilst insolvent or to ensure that the company does not trade at a loss. Section 214 requires knowledge that there is no reasonable prospect of avoiding future liquidation where there will be insufficient assets to pay creditors. Thus it is the balance sheet test of insolvency that is relevant, applying the test established by the Supreme Court in BNY Corporate Trustee Services Limited v Eurosail.
If the liquidator establishes the Knowledge Condition to the Court’s satisfaction, then the Court has to consider the Minimising Loss Defence. This is the phrase that the Registrar used to describe the defence available to the director set out in section 214(3) Insolvency Act. This states that the Court will not order compensation if the director took “every step” with a view to minimising the loss to the company’s creditors.
The Registrar took issue with the comments made in Sealy & Milman and said that the onus of proof for establishing the Minimising Loss Defence is on the director. At first blush, this would appear to strengthen a liquidator’s hand in making the wrongful trading claim, especially as the Registrar pointed out that the phrase “every step” was deliberate and Parliament had rejected the phrase “every reasonable step”. However, the Registrar then went on to say that the term “every step” has to be interpreted in the context of “the Reasonable Diligent Director Test” set out in section 214(4) so that, in essence, the Court is only concerned with the steps that a reasonably diligent director would have taken.
Specifying the date when the Knowledge Condition is satisfied
The Registrar described this as the “Ambit of the Claim”. The liquidators pleaded five alternative dates between 31 January 2005 and 3 May 2007 when they alleged the Knowledge Condition was satisfied. The issue arose as to whether, as the evidence unfolded, the Court could decide another date or whether the liquidators could plead further dates. The Registrar said that it was not strictly necessary to specify a starting date but the basic principle is that the director must know the case he has to meet, and case law establishes that the liquidator will not be able to claim a different date or period at trial to the one capable of being identified from the application and evidence.
The Registrar said that the proceedings only identified two other potential dates (apart from the five pleaded dates) being 24 June 2007 (when the company failed to pay rent) and 29 August 2007 (when a rent review liability was triggered). The Registrar said that neither of these dates had been identified as a starting date in the proceedings, and so he said the Court could not allow the liquidator to pursue wrongful trading proceedings by reference to those dates. However, this did not matter because he decided that the Knowledge Condition was satisfied on the fourth and fifth dates pleaded by the liquidator, namely 31 January 2007 and 3 May 2007
In other words, the Registrar reinforced the view that it is very difficult for the liquidator to add in additional dates once the proceedings are at an advanced stage, and almost impossible to do so at trial
The “Every Step” Requirement
The Registrar said that as a matter of guidance the following factors fall to be considered by directors and kept under review:
“Ensuring accounting records are kept up to date with a budget and cash flow forecast; preparing a business review and a plan dealing with future trading including steps that can be taken (for example cost cutting) to minimise loss; keeping creditors informed and reaching agreements to deal with debt and supply where possible; regularly monitoring the trading and financial position together with the business plan both informally and at board meetings; asking if loss is being minimised; ensuring adequate capitalisation; obtaining professional advice (legal and financial); and considering alternative insolvency remedies.”
In relation to 31 January 2007, the Registrar decided that the directors took the right course in trading on. In coming to this conclusion, the Registrar was influenced by the fact that the company was making a small profit which justified keeping things going, even though it would not be enough to pay off liabilities, whilst steps were taken to realise assets to minimise the loss to creditors. The Registrar noted that, by contrast, there would be very little advantage to the creditors if the company were placed in immediate liquidation.
In relation to the period after 3 May 2007, the Registrar took a different view mainly because continued trading was only possible by way of the company not paying HMRC or the landlord and because the company did not come close to achieving a sale of its business.
Calculating the compensation
The liquidators relied upon a deficiency comparison between a hypothetical liquidation on 3 May May 2007 and the actual liquidation in 2009. On this basis they calculated the net deficiency had increased by £388,570 plus the liquidators costs of £38,135. The Registrar rejected this approach to the calculation of compensation as “wrong and wholly unrealistic”.
The Registrar said that the Court’s discretion under section 214 is completely unfettered and the purpose is compensatory, not penal. Whilst acknowledging that current legal authority does not recognise it to be necessary to establish a causal link between wrongful trading and any particular loss, the Registrar said that it is not enough to demonstrate that a loss was merely consequent upon the decision to continue trading. In other words, it is not enough to say that “but for” the continued trading, the loss would not have been incurred. Compensation should be linked to the liabilities that result from the wrongful trading attributed to the directors.
The Registrar looked at the evidence and concluded that continued trading had had no adverse impact on the realisable value of the company’s assets. The position of general creditors and the bank had improved. The rent liability to the landlord had increased by £226,798 but the Registrar concluded that this loss would have been incurred anyway had the company gone into liquidation on 3 May 2007. The liability to HMRC had increased, as to £70,000 in respect of interest and penalties on historic arrears of VAT and £8,500 in respect of unpaid PAYE/NIC for the period of trading. The Registrar said that compensation would be ordered in relation to this, but should be discounted to reflect the fact that general creditors and the bank had benefitted during the same period of trading. On this basis, and whilst emphasising that the award of compensation cannot be entirely scientific, the Registrar came up with a figure of £35,000 for which the two directors had joint and several liability.
The judgement does not deal with the costs of the proceedings which will be a very significant issue.
The compensation is so low that the liquidators (and any adverse costs insurers) will be in difficulty if the directors were advised to make a Part 36 offer early on. Whether they made such an offer is a matter of conjecture, but this demonstrates the advantage to directors of making such an offer, and how seriously liquidators will need to consider such offers in the future.
If the directors are not protected by a Part 36 offer, then they will now be facing a huge costs claim from the liquidators, especially if the proceedings were conducted under a CFA with success uplift and adverse costs insurance. However, they will surely argue that the liquidators lost on four of their five dates, and that the costs claimed are disproportionate to the amount of the compensation. Ultimately, any costs recovery is unlikely to be of benefit to anyone other than the liquidators’ solicitors and any ATE insurers.