This fourth occasional blog piece on disqualification issues looks at transactions which occur in that final period of trading, when the company is clearly insolvent and heading for formal proceedings, and have the effect of removing funds which would otherwise be available for creditors, usually to the benefit of a connected/associated party.
In disqualification terms they can be grouped together as "Transactions to the detriment of creditors" and it is a relatively straightforward allegation to make once knowledge of insolvency has been demonstrated. Essentially, you’ll know these transactions as preferences, or transactions at an undervalue, as defined within sections 239 and 238 of the Insolvency Act 1986 respectively. However, in the world of disqualification proceedings the avoidance of that statutory definition enables the Secretary of State to focus upon the actuality of the transaction in terms of its reasonableness, when set against the backdrop of the company’s financial position, and the impact which it had upon both unpaid creditors and the beneficiary.
We've all heard the "its my company, its my money" attitude expressed by owner/directors to excuse the fact that they've cleaned out the company bank account to pay off the finance on their Audi TT - or whatever the latest fad status symbol is - but the simple fact in law supports a different perspective. Essentially, once the company is demonstrably insolvent the over-riding duty owed by directors is to the company's creditors, and protecting assets to minimise their loss and ensure that they are treated fairly. Of course, director's are still entitled to a fair level of remuneration whilst they continue to manage the company's affairs (although I have come across District Judges who would question the right to any payments whatsoever) but any additional benefit is an obvious no-no.
So what are we talking about? Some classic examples would include:
1) Repayment or reduction of a director's loan account either through the payment of cash or the transfer of assets.
2) Settlement of a debt subject to a personal guarantee while other creditors without that protection remain unpaid. Most commonly this could be the reduction of a bank overdraft, but in those circumstances you need to be able to show that the director made a conscious choice to do this, rather than it being achieved through the actions of the bank. The existence of a debenture which would entitle the bank to the benefit of assets will also impact upon any such allegation.
3) Increased remuneration either through direct payments or payments in respect of benefits, such as a pension scheme.
4) Settlement of an inter-company debt, or payments made to an associated/connected party to expunge or reduce an existent liability.
5) Use of company labour or assets for a personal benefit e.g. a building company being used to knock up an extension on a director's home.
6) Migration of book debts to a new venture through the issue of credit notes in the old comapny and re-issue of invoices in the new one's name.
The list is pretty much endless and all you are essentially looking for is a reduction in the value of assets which would otherwise have been available for creditors, with a corresponding benefit to the director(s), whether that be direct or indirect. If the sum involved is material in the context of the deficiency, and the transaction occurred late in the company’s trading, then there is a strong probability of unfitness being provable.
In many small companies the human instinct to look after family members will often prove irresistible, and whatever your moral opinion about the man in the street versus the faceless multi-national corporation, the failure to treat all creditors the same will almost certainly constitute misconduct.
