Get the details right: Buying the right to recover outstanding debts
Jennifer Adams considers a little known section of the Insolvency Act 1985 which allows creditors to 'buy' the right to recover company debts from directors personally.
As many readers commented after the publication of the previous article, taking a client to court takes time and money. Even if you win and a CCJ is granted there is still no guarantee that the debt will be paid.
Depending upon the amount outstanding you might not think it is worth the bother particularly if the company has been placed into liquidation.
Position of directors under liquidation
Whatever the reason put forward for incorporation many businesses do so either to save tax or because the directors believe that if a company fails the word 'limited' means just that – that their liability to debts will be limited or hopefully nil.
Many directors have no idea of their responsibilities under the Companies Act 2006 and will have never heard of either The Insolvency Act 1986 (IAA 1986) or The Small Business, Enterprise and Employment Act 2015 (SBEEA 2015) both of which give extensive powers against a director on behalf of creditors.
Directors of companies which become, or are likely to become, insolvent are under a duty to maximise the return for that company’s creditors. If they are aware of any impending liabilities then they cannot deliberately take action that would cause the company's debts to increase or go unpaid (taking drawings as soon as the income hits the company bank account is a favourite).
In addition, directors are not supposed to show favouritism towards particular suppliers or creditors – even if that creditor is HMRC. Although everyone knows who usually comes first.
All directors are aware that they have to pay taxes but many directors of small companies with a tax bill that cannot be paid apply for voluntary liquidation in the belief that by doing so the company will not have to pay the outstanding tax bill.
If there are any other unsecured creditors then they will be caught up in the process and either not be paid or paid in proportion with other such creditors, if there are any assets or cash available. Since the passing of the Enterprise Act 2002 HMRC has ranked pari passu with other unsecured creditors.
A creditor can issue a compulsory liquidation petition on a debt of as little as £750; the debtor having failed to pay this debt either after a formal payment demand or if a County Court Judgment (CCJ) has been awarded.
Typical liquidation costs whether compulsory or voluntary are approx £3,000+, to include all court costs and disbursements.
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By placing a company into liquidation the liquidator is charged with collecting any monies outstanding and satisfying debts from inter alia the sale of any assets that may be available.
Invariably there are no or little assets and in this type of situation consideration of s 213, 214 and s238, 239 IAA 1986 might be a way of getting some money back.
Fraudulent or wrongful trading
When a company goes into liquidation (or administration) the court has the power, on the application of the liquidator (or administrator under the SBEEA 2015), to declare that a person who is, or was, a director of the Company be liable for a contribution to the company’s assets (s 213/214 or s 246 (z) IAA 1986 (inserted by s117 SBEEA 2015) if the company is in administration).
The liquidator will only do this if he can prove that the directors were either trading fraudulently or wrongfully. Note that it is the liquidator/administrator who has this power and not the creditor although the liquidators/administrator's remit is to work on the creditors behalf.
Obviously he will only take such action if he believes it is financially worthwhile for him to do so and thinks that he will get the directors to pay.
- Fraudulent trading
A successful charge for fraudulent trading requires a high standard of proof that the directors conducted the business with dishonest intent to defraud creditors. Should such trading be proved then not only will the directors be personally liable but criminal proceedings could result.
As an aside under the Limitation Act 1980 a claim against a director within six years of the breach is usually out of time but in the case of fraudulent trading there is no time limit. It should be noted that a director who is appointed the role of finance director or managing director will be held to a higher standard than other directors.
- Wrongful trading
Of the two it is the charge of wrongful trading that is more likely to succeed. Wrongful trading applies where a director knows or ought to have known that the company was heading for insolvency and did not take the necessary steps to minimise the potential loss to creditors (s214 IA 1986).
The court will require proof that at the date that the company went into liquidation it was in a worse position than it would have been if it has ceased to trade at an earlier date.
Who gets what?
As previously noted a liquidator will only take action against a director if they feel that the creditors will get something in the end. Before making his decision he will consult with the creditors.
There is a hierarchy of who gets what if any monies are recovered as laid down in the IA1986 namely:
- Liquidator fees and expenses
- Secured creditors with a fixed charge
- Preferential creditors
- Secured creditors with a floating charge
- Unsecured creditors
- Connected unsecured creditors
Although HMRC ranks beside other unsecured creditors they are invariably the creditor with the largest amount owed to them and as such their voice possibly counts as louder.
Apparently they will only take up a case if the liability is above £10,000. The DMB will have already spent time and money in other enforcement action and the company will have either not paid at all or made unacceptable proposals for settling the debt. HMRC will already know whether it is worthwhile going further via use of its connect computer system used to ascertain a director's financial position.
BDO’s 10 way HMRC knows if you are a tax cheat report detailing the methods HMRC use makes for interesting reading.
Other creditors - 'Buying the right'
The liquidator is always paid first but if he believes that it is pointless proceeding any further then there is the facility for creditors to buy the debt process. The technical term is 'assigning the rights of action'.
Liquidators now have the right to assign the right to any party that is willing to purchase the debts that the liquidator has failed to collect. Practically this means that the buyer pays to stand in the shoes of the liquidator.
It is then up to the purchaser to prove to the court that the directors were guilty of fraudulent or wrongful trading. The purchaser offers a price for the right and the amount is set at a figure that will at least cover the liquidator's legal costs of drawing up the transfer agreement. This amount is added to any future claim submitted to the Court.
Does it work?
The same comments about time, costs etc apply. Many directors are unaware not only of the process but that the right to purchase is available to the creditor.
They think that going into liquidation is the end of the process and they breathe a sigh of relief – the above text shows that this may not be entirely correct.
Jennifer Adams is Consulting Editor of AccountingWEB and is a professional business author specialising in corporate governance and taxation. She runs her own accounting and consultancy business with offices based in Surrey and Dorset.