When drafting disqualification affidavits the Secretary of State is keen to avoid what is known as “the statutory trap”, an ideological cage which ensnares all those who make an allegation which mirrors a legislative provision and thereby demands that certain specific criteria are met before success can be achieved. As a result, what you will be familiar with as Wrongful Trading, defined by Section 214 of the Insolvency Act 1986, is translated into any number of generic formats chiselled from the stoic “Trading with Knowledge of Insolvency at risk and to the detriment of creditors generally”. Break that down and, as with any genus of allegation, it is possible to draw out the key components worth further consideration:
- Knowledge: showing that the defendant knew or (more often) ought to have known that a set of circumstances raised the spectre of insolvency. Done by reference to “badges” of insolvency such as the approval of insolvent accounts, unpaid writs and judgements, bounced cheques, bad debts, loss of market... anything which shows an inability to pay debts when due or a deficiency of assets and definitely a case of strength in depth.
- Risk: demonstrating that as a consequence of continued trading creditor monies were subject to an unreasonable level of jeopardy. This involves overcoming defences based upon “future” events such as possession of a strong order book, active attempts to market and sell the business, potential investment by a third party and similar promises of a turnaround, beyond the belief that the sun will shine tomorrow.
- Detriment: the transmutation of that risk into a tangible and material loss to third parties. After all, no protector of the public interest is sufficiently sadistic to attempt to disqualify a director for causing detriment solely to his own retirement plan, there has to be an innocent caught in the crossfire.
The stronger and more sustainable allegations of unfitness take a clear indicator, such as advice from the company’s own accountant that it is trading insolvently, supported by an accumulation of further evidence supporting that insolvent preposition, and then address and eliminate the possible defences. The Court will tend to take a dim view of any failure on the part of the director to modify behaviour in light of knowledge of insolvency as there is a recognition that directorial duties change at that point, with the necessary emphasis being on the minimisation of creditor losses. Although care must always be taken to look at the facts available to the director at that time studiously avoiding the application of beneficial hindsight.
The point at which a company is insolvent is often the subject of great conjecture, but for the purpose of preparing an adverse conduct return it is perfectly acceptable to make reference to a number of key dates as the subsequent investigation should be able to track the accumulation of evidence to a point of irrefutability. It is possible for the Secretary of State to make a multi-layered allegation which is based upon an initial event – say a judgement being obtained against the company – at which point the director(s) ought to have known that the company was insolvent, followed by a series of other occurrences – say approval of insolvent accounts, incurrence of a bad debt, loss of a key salesman – and culminating in the service of a winding up petition, by which point the knowledge of insolvency is readily demonstrable. If the increase in liabilities can similarly be tracked over this period then the question is not whether there is misconduct, but rather the seriousness of that misconduct, taking into account aggravating and mitigating factors such as the level of director’s remuneration thereafter, or the extent to which belts were tightened.
Yet, there is always the lurking possibility of a defence, hidden in the depths of the contemporaneous mind-set of the director. Not often visible to the naked eye but always vulnerable to attack from the question “why?” - What reason might exist which could justify the continuation of this insolvent business, other than pure, unfettered optimism? Seasonality! Possibly, in the short term, but for a more deadly strike from the hip you could be confronted with prospects of a sale of the business – with promised proceeds which would generate a far greater return for creditors than even the most frugal insolvency proceedings. If so then this prospect must be investigated to determine whether it was genuine and, if so, the point at which it faded to nought. The Court has been known to take the view that a decision to continue trading notwithstanding strong indicators of insolvency was “brave” rather than inappropriate, due to the specific circumstances of the case, measures taken by the directors, a clear strategy and a potential improved return to creditors. Ultimately, no amount of chiselling will lead to an outcome being set in stone.
No matter what the individual facts of the case though, don’t forget to keep in mind the four M’s – Misconduct, Motive, Materiality and Mitigation – the essential guiding mantra for your thought process.
In future articles I shall take a look at other areas with a high level of relevance to the most commonly presented allegations of unfitness, exploring what makes a transaction detrimental to creditors, Crown debt as an issue of unfitness in its own right and the involvement, in a company, of an individual subject to an existing restriction.
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