Directors’ Liability for Wrongful Trading

LIFTING THE CORPORATE VEIL: DIRECTORS’ LIABILITY FOR WRONGFUL TRADING  

Introduction

A major incidence of incorporation is that a company maintains separate legal personality as distinct from its members and officers. The principle of separate legal personality enunciated in the seminal case of Salomon v Salomon & Co Ltd (1877) AC 22 generally immunes members and officers from their company’s liabilities. However, in given circumstances, the separate legal personality of a company can be dispensed with. In this regard, the veil which as a general rule protects the members and officers from being personally liable is pierced. Accordingly, the liabilities which ought to be the exclusive preserve of the company can no longer be so.

In the United Kingdom, as well as other common law jurisdictions, judicial and legislative interventions will lift the veil of incorporation in circumstances where the principle of separate legal personality is a subject of abuse or will operate unfairly. In this connection, this article considers section 214 of the Insolvency Act 1986 (IA) as a statutory exception to the fundamental rule established in Salomon. Thereafter, a distinction will be made viz-a-viz section 214 IA and other related provisions of the Insolvency Act that enforces the personal liability of directors to their company’s debt. It is noteworthy that unlike the general liabilities of directors to shareholders and the company, statutory exceptions under the Act has an unusual focus because they obligate directors’ not to manage the company’s affairs to “the economic detriment of third parties” (Goulding, 1999, p.79).

Directors’ Liability for Wrongful Trading (s.214 IA)

The introduction of the Wrongful Trading Provision was necessitated as a result of inadequacies of the fraudulent trading provision in curbing irresponsible trading (The Cork Report, 1982, paras. 1776-1780). A major downside of the provision is the strict and arduous requirement of establishing directors’ “intent to defraud creditors” before liability is uphold (Keay, 2014, p.2). Consequently, the imposition of civil liability was advocated which will operate where the director acted honestly but unreasonably in managing an insolvent company (The Cork Report, para.1777). this has the effect of ensuring that directors act responsibly by taking “appropriate steps where the avoidance of insolvent liquidation was not a reasonable prospect” (Keay & Murray, 2005, p.30).

The provision of s.214 IA can only be invoked where a company is in the course of winding up. The liquidator of the company is statutorily empowered to institute an action against any of the company’s directors to make such director(s) liable to contribute to the company’s asset as the court deem fit (s.214(1) IA). Keay & Murray argued that the exclusion of creditors as potential claimant will create grave injustice to creditors as the action will be dependent on the liquidator discretionary power to so act (p. 44).

For a claim to sound under s.214 IA, the court will make a finding whether before the commencement of the winding up, the affected director(s) knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation (s.214(2) IA). Since directors are by law required to prepare and keep accounting records, actual knowledge of the company’s financial position will be easily attributed (Simmons, 2001, p. 15). The actual date at which the director ought to have realized the unavoidability of the company’s insolvent liquidation is a material consideration for the liquidator, as the determination will guide the court in aggregating the contribution of the affected director (Simmons, p.12). Thus, the resignation of a director after s/he became aware or ought to have reached the conclusion will not eliminate the director’s liability (Goulding, p. 83). At best, the court may order the reduction in the affected director’s contribution if the substantial quantum of the company’s liabilities were incurred after the resignation (Goulding, p.83).

However, directors will not be found liable if they “took every step they ought to take” in mitigating creditors’ losses even after the reasonable prospect of the company going into insolvent liquidation had been established or ought to have been established (s.214(3) IA).

The conditions for establishing liability (in ascertaining the conclusion that ought to have been reached) and pleading a successful defense (in determining steps ought to be taken) under the Wrongful Trading Provisions are both objective and subjective. Regarding the former, the standard required of the director is based the expertise of a reasonable person in a comparable position (s.214 (4) (a) IA). The latter requirement judged the director’s own expertise in relation to a reasonable person having the same skillsets (s.214(4) (b) IA). The application of this standard will be subject to varying factors such as the industry, size and form of the company (Finch, 2009, p. 699). The two prong standards operate conjunctively, hence, an otherwise “honest but incompetent” director would be liable if a reasonable person in a comparable position would have acted differently (Girgis, 2006, p.683).

Distinguishing the Wrongful Trading Provision from related provisions of the Act.

  1. 212 IA Claim:

Unlike the wrongful trading provisions which empowers only the liquidator to commence an action, s.212 IA allows an official receiver, a liquidator, a creditor, or a contributory to bring a claim against a present or former director (s.212(3) IA). In this regard, a claim will operate where the director has misapplied or retained or become liable or accountable for any money or property of the company or have been guilty of misfeasance or breach of fiduciary or other duties in relation to the company and the director will be ordered to contribute to the company’s assets (s.213 IA).

The Wrongful Trading Provision implicates directors for the company’s liabilities incurred during the trading period when insolvent liquidation becomes unavoidable. By implication, a director who resigned before the company’s insolvency will be absolve of responsibility under this provision. However, claims under s.212 IA will arise where the director has committed misfeasance or breach any of its duties to the company which in fact could apply retrospectively. Thus, the fact that a director used the company’s money for an improper or unauthorized purpose or approved an unauthorized loan and afterward resigned before the company became insolvent is immaterial in assessing his liability (Conway, 2019, p.11)

  1. 213 IA Claim:

For a claim to subsist under s.213 IA, two important considerations are decisive. First, it must be established that the director acted dishonestly in undertaking the company’s trading activities to defraud creditors or for fraudulent purpose (213 (1) IA). Second, similar to the requirement under s.214 IA, the liquidator is the proper claimant to bring an action against the director to make contributions to the assets of the company (s.213 (2) IA).

The major differentiator between the Fraudulent Trading Provision and the Wrongful Trading Provision is the requirement of “actual dishonesty”. Thus, it will be insufficient that the director acted unreasonably in the absence of actual dishonesty Re L. Todd (Swanscombe) Ltd (1990) BCC 125. This incorporate the very strict criminal standard of proof beyond reasonable doubts, which makes its application of little practical use. It is not surprising that the difficulty presented by this provision led to the introduction of the Wrongful Trading Provision which requires a lower threshold (Uzoechi, 2013, p.87).

  1. 216 & 217 IA Claims:

Claims under these provisions is implicated where a new company is formed with an identical or similar name as that of an insolvent company. Specifically, s.216 IA makes it an offence for a person who was a director of an insolvent company during the period of 12 month prior to that company’s liquidation to be associated with a company with an identical name as the insolvent company or a name so similar as to suggest an association with the insolvent company unless the leave of the Court is sought and obtained.

Where a director is found to have contravene s.216 IA, h/she will be liable for all debts incurred by the company during the infringement (s.217 IA).

The rationale underpinning the foregoing prohibition is to prevent directors from transferring the asset of the liquidated company to a new company thereby leaving the debts of the liquidated company unsatisfied and also to break the potential chain of abuse which may result from mistaken identities of both companies (Uzoechi, p.100).

Unlike the Wrongful Trading Provision, creditors may commence an action to enforce directors’ personal liability (Uzoechi, p101). Here, it is sufficient if the creditor proves that the “two company names had the tendency to mislead” (Uzoechi, p.101).

Conclusion

The essay has considered instances when the veil of the company can be lifted under the United Kingdom’s Insolvency Act, 1986.However, the provisions explored revels inadequacies which could impede their implementation. For instance, the fraudulent trading provision is fraught with difficulties owing to its strict standard of proof. Also, the sole designation of the liquidator has the proper claimant denies the creditor who, for better or worse, is the most important party in the company’s winding up process.

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