Six insolvency traps to avoidby
As small businesses consider insolvency to escape Covid loans, Lisa Thomas explains six actions which can land directors and shadow directors in deep trouble.
When a UK Limited company enters liquidation or administration, the appointed Insolvency Practitioner (IP) has a statutory duty to investigate what caused the company’s demise and whether the directors committed any misconduct.
The IPs findings are reported to the Insolvency Services who can take the following action against the directors concerned:
- Disqualify from being a director
- Issue a penalty
- Pursue civil proceedings
- Pursue criminal charges leading to imprisonment.
The IP also has the power to bring proceedings against the directors (including shadow directors) personally.
1. Wrongful trading
This is where the directors ought to have liquidated the company but instead continued trading, and the company’s position worsened during the period. This offence is least likely to be brought about, especially as a stand-alone claim, because it is difficult and expensive to prove (Insolvency Act 1986 s 214).
Directors need to be able to show they took every step to minimising the losses, so good record keeping of the financial figures and the rationale for decisions to continue, are both essential.
Case law (Ralls Builders Ltd  EWHC 243 (Ch)) determined that IPs must prove the actual deficiency got worse. If upheld, the court can order the directors to make any contribution to the company’s assets as it sees fit.
Wrongful trading claims were suspended during the Covid pandemic between March 2020 and July 2021, but not in full as claims could still be brought about during that time. However, any accounting losses during the ‘suspension period’ must be taken out of the equation. In my opinion, this provided false comfort to directors, because the was no suspension of the easier claims to pursue (see below).
2. Fraudulent trading
This type of claim is also rare. It is defined as directors carrying on the business with the intent to defraud creditors or any other person - most commonly defrauding HMRC (Insolvency Act 1986, s 213).
Any guilty person can be held liable to make contributions to the company’s assets.
3. Transactions at an undervalue
This claim is triggered where assets are transferred for free, or sold at less than market value, at a time when the company was insolvent (Insolvency Act 1986, s 238).
The court shall make such order as it thinks fit for restoring the position to what it would have been if the company had not entered into that transaction. The best defence a director can have is to prove the transfer was at market value by obtaining a professional valuation of the assets at the time of the transfer.
The IP can challenge transactions that occurred up to two years prior to ‘the onset of insolvency’.
4. Illegal preferences
This is where one or more creditors were preferred for payment over others, at a time when the company was insolvent, (Insolvency Act 1986 s 239). This is the most common type of claim I see.
The IP can challenge transactions that occurred up to six months prior to ‘the onset of insolvency’ for unconnected parties, and up to two years prior for connected parties. The IP can pursue the creditor or the directors to restore the position to what it would have been had the preference not been made. In practice the IP will pursue the amount of the preference made.
One defence is that the company was influenced by desire to make the payment, which can be hard to prove against an unconnected party. However, ‘desire’ is automatically presumed in the case against connected parties making it harder for directors to defend any such claim brought against them.
The most common creditor preferences are when directors pay themselves, a family member, or a creditor for whom they have provided a personal guarantee.
This is where a company officer has misapplied, retained, or become accountable for any money or property of the company, or been guilty of any misfeasance or breaches of duties (Insolvency Act 1986, s 212).
In the past, the most common type of misfeasance claims I would see would be illegal dividends drawn by shareholders and, to some extent, unprotected customer deposits. Going forward I expect the misuse of Covid funds will form misfeasance claims (see below).
The court can order the party to repay, restore or account for the money or property with interest, or to pay compensation.
6. Misuse of Covid funds
The IP will investigate fraud incurred with the following covid support schemes:
- SSP refunds
- Local authority grants
- Eat Out to Help Out grants
- CJRS for furlough pay
- Bounce Back Loans (BBLs)
The IP report any such fraud identified to the Insolvency Services and to HMRC. The IP can also pursue the directors for misfeasance.
With a BBL the IP will investigate whether the company genuinely met the criteria to apply for the loan and what the funds were used for. The BBL terms stipulated the loan must provide an ‘economic benefit to the company and not be used for personal use’. If the directors spent the funds personally, resulting in an overdrawn director’s loan account we can also pursue repayment.
With furlough scheme fraud HMRC can charge a 100% tax penalty and 100% interest.
The IP will rarely bring a claim all the way to court as claims are often negotiated and settled out of court. If a director is in any doubt as to their position, they should seek independent legal advice.
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I am a licensed Insolvency Practitioner with over 19 years experience at www.nevilleco.co.uk and can be contacted on 01752 786800 or [email protected] for further advice. I have produced various advisory videos which can be...