United Kingdom insolvency law deals with the insolvency of firms and individuals in the United Kingdom. The important statutes are the Insolvency Act 1986, as amended by the Enterprise Act 2002, as well as the Company Director Disqualification Act 1986 and the Companies Act 2006.
Insolvency is a term which encompasses both companies and individuals, though the term bankruptcy is generally reserved for individuals in the UK. United Kingdom bankruptcy law follows a similar, but separate set of principles. This article focuses on corporate insolvency, and so is heavily connected to UK company law.
Corporate insolvency is defined as either cash flow insolvency or balance sheet insolvency. The Insolvency Act 1986, s.123 gives the definition of inability to pay debts, primarily if a creditor has given three weeks to be repaid over £750, but seen nothing (s.123(1)(a)) or,
| “ | (e) if it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due.
(2) A company is also deemed unable to pay its debts if it is proved to the satisfaction of the court that the value of the company's assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities. |
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Cash flow insolvency has recently been re-interpreted in Re Cheyne Finance plc [2007] All ER (D) 25[1] (regarding a structured investment vehicle) to not only consider whether current debts are unable to be paid as they fall due, but also consider whether future debts will not be able to be paid. This makes it possible for creditors to call for insolvency earlier.
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Some form of law for bankrupts can be seen tracing back to Ancient Babylon. In England, the first recognised piece of legislation was the Bankruptcy Act 1542. Bankrupts were seen as crooks, and the Act stated its aim to prevent "crafty debtors" escaping the realm.[2] A more humane approach was developed in the Bankruptcy Act 1705.[3] The Lord Chancellor was given power to discharge bankrupts, once disclosure of all assets and various procedures had been fulfilled. In Fowler v Padget[4] Lord Kenyon reasserted the old sentiment that,
"Bankruptcy is considered a crime and a bankrupt in the old laws is called an offender."
The bankrupt was seen bonded to his creditors. Under the Insolvent Debtors Act 1813, debtors could request release after 14 days in jail by taking an oath that their assets did not exceed £20, but if any of their creditors objected, they had to stay inside. Attitudes were changing, however, and the Bankrupts (England) Act 1825[5] allowed people to start proceedings for their own bankruptcy. Before only creditors could start the proceedings.
In the middle of the 19th century, attitudes towards corporations were also quickly changing. Since the South Sea Bubble disaster, companies were viewed as inefficient and dangerous.[6] But with the industrial revolution in full swing that changed. The Joint Stock Companies Act 1844[7] allowed people to create companies without permission through a royal charter. Companies had "separate legal personality", the ability to sue and be sued, and served as an easy mechanism for raising capital through the purchase of shares (an equitable title) in the company's capital. The Act's corollary, to bring the existence of these "legal persons" to an end was the Joint Stock Companies Winding-Up Act 1844. The Limited Liability Act 1855 produced a further innovation. Before, if a corporation had gone broke, the people that lent it money (creditors) could sue all the shareholders to pay off the company's debts. But the 1855 Act said that shareholders' liability would be limited to the amount they had paid in their shares. So if you had invested £100 in a company, but now the company owed millions of pounds, the creditors could not come after you for the debts. You would lose £100 and no more. Your liability to pay debts was limited to the value of your shares. The Joint Stock Companies Act 1856 consolidated the companies legislation in one, and the modern law of corporate insolvency was born. In 1869, the Bankruptcy Act 1869 was passed allowing all people, rather than just traders to file for bankruptcy.
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Although the basic rule of UK insolvency law for distribution of assets among creditors was pari passu, except where statute creates preferential creditors, it is possible through a contract between a creditor and a company to be elevated in the insolvency queue by taking a security interest over a company's assets. A security interest arises through contract, and allows the secured creditor to take the specific assets over which they take security if the company cannot service its debts. Security also serves the functions of allowing the creditor to trace the value in an asset through different people if the property is wrongfully disposed of, allowing for independent out-of-court enforcement for debt repayment (subject to the statutory moratorium on insolvency), and providing a lever against which the secured lender can push for control's over the company's management.[8] However a primary advantage of security is the effective priority it creates over unsecured creditors in insolvency. In 2001 recovery rates were found to be 53% of one's debt for secured lenders, 35% for preferential creditors but only 7% for unsecured creditors on average.[9] The economic effect of secured lending is therefore a negative externality,[10] as a private contract between a secured lender and company diminishes the assets available to other creditors without their consent, or being privy to the bargain. While this may be true, security interests are commonly argued to facilitate the raising of capital and hence economic development, and therefore indirectly benefit all creditors.[11] The UK law's approach is to provide unencumbered enforcement of security interests, but only if it applies to a "fixed" or "specific" asset, rather than a floating charge that would cover a range of assets that a company trades with. The holders of a floating charge take subject to preferential creditors and a "ring fenced fund" for up to a maximum of £123,000 reserved for paying unsecured creditors.[12] It requires that details of most kinds of security interests are filed on a company charges register located at Companies House. However this does not include transactions with the same effect of elevating creditors in the priority queue, such as a retention of title clause or a Quistclose trust.[13]
In commercial practice the term "debenture" typically refers to the document that evidences a secured debt, although in law the definition may also cover unsecured debts (like any "IOU").[14] The legal definition is relevant for certain tax statutes, so for instance in British India Steam Navigation Co v IRC[15] Lindley J held that a simple "acknowledgement of indebtedness" was a debenture, which meant that a paper on which directors promised to pay the holder £100 in 1882 and 5% interest each half year was enough, and as a result subject to pay duty under the Stamp Act 1870. The definition depends on the purpose of the statutory provision for which it is used, as it also matters because debenture holders have the right to company accounts and the director's report,[16] because debenture holders must be recorded on a company register which other debenture holders may inspect,[17] and when issued by a company, debentures are not subject to the rule against "clogs on the equity of redemption". This old equitable rule held that one could not contract lose their right to pay off and be free from debt after the debt had been created, with the consequence that two parties could not convert a mortgage into a sale[18] and that one could not contract for a perpetual period for interest repayments. However given this rule was designed as a limit on contractual freedom where one party was vulnerable to the bargaining strength of another, it was thought that the rule was inappropriate for companies. In Kreglinger v New Patagonia Meat & Cold Storage Co Ltd[19] the House of Lords held that an agreement by New Patagonia to sell sheepskins exclusively to Kreglinger in return for a £10,000 loan secured by a floating charge would persist for five years even after the principal sum was repaid. The contract to keep buying exclusively was construed to not be a clog on redeeming autonomy from the loan because the rule's purpose was to preclude unconscionable bargains. For companies the rule as a whole was abolished in what is now section 739 of the Companies Act 2006. In Knightsbridge Estates Trust Ltd v Byrne[20] the House of Lords applied this so that when Knightsbridge took a secured loan of £310,000 from Mr Byrne and contracted to repay interest over 40 years, Knightsbridge could not then argue that the contract should be void, because the deal constituted a debenture under the Act, and so avoided this rule of equity.
While all records of all a company's debentures need to be kept by the company, debentures secured by a "charge" must additionally be registered under the Companies Act 2006 section 860 with Companies House,[21] along with any charge on land, negotiable instruments, uncalled shares, book debts and floating charges, among other things. The purpose of registration is chiefly to publicise which creditors take priority, so that creditors can assess a company's risk profile when making lending decisions. The sanction for failure to register is that the charge becomes void, and unenforceable. This does not extinguish the debt itself, but any advantage from priority is lost and the lender will be an unsecured creditor. In National Provincial Bank v Charnley[22] there had been a dispute about which creditor should have priority after Mr Charnley's assets had been seized, with the Bank claiming its charge was first and properly registered. Giving judgment for the bank Atkin LJ held that a charge, which will confer priority, simply arises through a contract, "where in a transaction for value both parties evince an intention that property, existing or future, shall be made available as security for the payment of a debt, and that the creditor shall have a present right to have it made available, there is a charge". This means a charge simply arises by virtue of contractual freedom. Legal and equitable charges are two of four kinds of security created through consent recognised in English law.[23] A legal charge, more usually called a mortgage, is a transfer of legal title to property on condition that when a debt is repaid title will be reconveyed.[24] An equitable charge used to be distinct in that it would not be protected against bona fide purchasers without notice of the interest, but now registration has removed this distinction. In addition the law recognises a pledge, where a person hands over some property in return for a loan,[25] and a possessory lien, where a lender retains property already in their possession for some other reason until a debt is discharged,[26] but these do not require registration.
While both need to be registered, the distinction between a fixed and a floating charge matters greatly because floating charges are subordinated by the Insolvency Act 1986 to insolvency practitioners' expenses under section 176ZA,[27] preferential creditors (employees' wages up to £800, pension contributions and the EU coal and steel levies) under section 175 and Schedule 6 and unsecured creditors' claims up to a maximum of £123,000 under section 176A. The floating charge was invented as a form of security in the late nineteenth century, as a concept which would apply to the whole of the assets of an undertaking. The leading company law case, Salomon v A Salomon & Co Ltd,[28] exemplified that a floating charge holder (even if it was the director and almost sole shareholder of the company) could enforce their priority ahead of all other persons. As Lord MacNaghten said, "Everybody knows that when there is a winding-up debenture-holders generally step in and sweep off everything; and a great scandal it is." Parliament responded with the Preferential Payments in Bankruptcy Amendment Act 1897, which created a new category of preferential creditors - at the time, employees and the tax authorities - who would be able to collect their debts after fixed charge holders, but before floating charge holders. In interpreting the scope of a floating charge the leading case was Re Yorkshire Woolcombers Association Ltd[29] where a receiver contended an instrument was void because it had not been registered. Romer LJ agreed, and held that the hallmarks of a floating charge were that (1) assets were charged present and future and (2) change in the ordinary course of business, and most importantly (3) until a step is taken by the charge holder "the company may carry on its business in the ordinary way".[30] A floating charge is not, technically speaking, a true security until a date of its "crystallisation", when it metaphorically descends and "fixes" onto the assets in a business' possession at that time.
Businesses, and the banks who had previously enjoyed uncompromised priority for their security, increasingly looked for ways to circumvent the effect of the insolvency legislation's scheme of priorities. One way of doing this originally was to stipulate in the charge agreement that the charge would convert from "floating" to "fixed" automatically on some event before the date of insolvency. According to the default rules at common law, floating charges would impliedly crystallise when a receiver is appointed, if a business ceases or is sold, if a company is would up, or if under the terms of the debenture provision is made for crystallisation on reasonable notice from the charge holder.[31] However an automatic crystallisation clause would mean that at the time of insolvency - when preferential creditors' claims are determined - there would be no floating charge above which preferential creditors could be elevated. The courts held that it was legitimate for security agreements to have this effect. In Re Brightlife Ltd[32] Brightlife Ltd had contracted with its bank, Norandex, to allow a floating charge to be converted to a fixed charge on notice, and this was done one week before a voluntary winding up resolution. Against the argument that public policy should restrict the events allowing for crystallisation, Hoffmann J held that in his view it was not "open to the courts to restrict the contractual freedom of parties to a floating charge on such grounds." Parliament, however, intervened to state in the Insolvency Act 1986 section 251 that if a charge was created as a floating charge, it would deem to remain a floating charge at the point of insolvency, regardless of whether it had crystallised. The response then of business was to contract for fixed charges over every available specific asset, and then take a floating charge over the remainder. It attempted to do this as well over book debts that a company would collect and trade with. In two main earlier cases the courts held this could be done. In Siebe Gorman & Co Ltd v Barclays Bank Ltd[33] it was said to be done with a stipulation that the charge was "fixed" and the requirement that proceeds be paid into an account held with the lending bank. In Re New Bullas Trading Ltd[34] the Court of Appeal said that a charge could purport to be fixed over uncollected debts, but floating over the proceeds that were collected from the bank's designated account. However the courts overturned these decisions in two leading cases. In Re Brumark Investments Ltd[35] the Privy Council advised that a charge in favour of Westpac bank that purported to separate uncollected debts (where a charge was said to be fixed) and the proceeds (where the charge was said to be floating) could not be deemed separable: the distinction made no commercial sense because the only value in uncollected debts are the proceeds, and so the charge would have to be the same over both.[36] In Re Spectrum Plus Ltd,[37] the House of Lords finally decided that because the hallmark of a floating charge is that a company is free to deal with the charged assets in the ordinary course of business, any charge purported to be "fixed" over book debts kept in any account except one which a bank restricts the use of, must be in substance a floating charge. Lord Scott emphasised that this definition "reflects the mischief that the statutory intervention... was intended to meet and should ensure that preferential creditors continue to enjoy the priority that section 175 of the 1986 Act and its statutory predecessors intended them to have."[38]
As a company nears insolvency, UK law provides four main procedures by which the company could potentially be rescued or wound down and its assets distributed. First, a company voluntary arrangement,[39] allows the directors of a company to reach an agreement with creditors to potentially accept less repayment in the hope of avoiding a more costly administration or liquidation procedure and less in returns overall. However, only for small private companies is a statutory moratorium on debt collection by secured creditors available. Second, and since the Enterprise Act 2002 the primary insolvency procedure, a company which is insolvent can go under administration. Here a qualified insolvency practitioner will replace the board of directors and is charged with a public duty of rescuing the company in the interests of all creditors, getting a better result for creditors, or if nothing can be done effecting an orderly winding up and distribution of assets. This was introduced following the Cork Report's recommendations that UK law should develop a rescue culture to rehabilitate companies over breaking them up. Third, administrative receivership is a procedure available for a narrow list of companies where the insolvency practitioner is appointed by the holder of a floating charge that covers a company's whole assets. This stems from common law receivership where the practitioner's primary duty was owed to the creditor that appointed him. After the Insolvency Act 1986 it was increasingly viewed to be unacceptable that one creditor could manage a company when the interests of her creditor might conflict with those holding unsecured or other debts. Fourth, when none of these procedures is used, the business is wound up and a company's assets are to be broken up and sold off, a liquidator is appointed.
Under the Insolvency Act 1986 sections 1 to 7, a company's directors may instigate a voluntary arrangement with creditors, that is designed to reduce the company's debt burden in the hope of restructuring the business. If already appointed, an administrator or liquidator can also propose it. The procedure takes place under the supervision of an insolvency practitioner, to whom the directors will submit a report on the company's finances and a proposal for reducing the debt. For instance, directors might propose that each creditor accepts 80 per cent of the money owed to each, and to spread repayments out over five years, in return for a commitment to restructure the business' affairs under a new marketing strategy. The weakness of the procedure on its introduction was that the arrangement could be scuppered by a single creditor who did not agree. Since 2002 under a new section 1A, a company may apply for a moratorium on debt collection if it is smaller than two of the following criteria (1) under £6.5m in turnover (2) under £3.26m in balance sheet, or (3) fewer than 50 employees.[40] After an arrangement is proposed creditors will have the opportunity to vote, and if 75 per cent approve the plan it will bind the whole.[41] Nevertheless, the introduction of the ability for administrators to be appointed out of court, and the complicated procedure for obtaining a moratorium, still only for small companies, means that the company voluntary arrangement remains considerably under-used compared to the individual voluntary arrangement available for people in bankruptcy.
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The Insolvency Act 1986, Schedule B1 contains the procedure for a company entering administration, as updated by the Enterprise Act 2002. It was first introduced following the Cork Report's priorities for transparency, accountability and collectivity and, crucially, fostering a rescue culture for business.[42] The key points are that when an administrator is appointed, she will replace the directors.[43] Under paragraph 40 creditors are precluded by a statutory moratorium from bringing enforcement procedures to recover their debts, including a bar on secured creditors taking and or selling assets subject to security with leave of the court.[44] The moratorium is fundamental to keeping the business' assets in tact and giving the company a "breathing space" for the purpose of a restructure, and even extends to a moratorium on the enforcement of criminal proceedings. So in Environmental Agency v Clark[45] the Court of Appeal held that the Environment Agency needed court approval to bring a prosecution against a polluting company, though in the circumstances leave was granted. In Re Atlantic Computer Systems Ltd (No 1),[46] the company in administration had sublet computers that were owned by a set of banks who wanted to repossess them. Nicholls LJ, in outlining the considerations for giving leave to execute repossession held that leave should be given if it would not impede the administration's purpose, and while the banks were bound to apply for permission, discretion was exercised in their favour. The moratorium is effective for a default, but extendable, period of one year.[47] While this is in effect the administrator's core purpose and duty under paragraph 3 is to rescue the company, or if impracticable, typically transfer the business as a going concern, or as a last resort break up the business and distribute proceeds to creditors.[48]
The duties of an administrator in Schedule B1, paragraph 3 are theoretically meant to be exercised for the benefit of the creditors as a whole. However the theoretical duty on administrators of neutrality and even-handedness between creditors lies in tension with how the administrator is factually appointed. When applying to the court, the petitioners for administration may be either the company's directors, or any creditor.[49] But an important change since the Enterprise Act 2002 is that it is also possible for a director and, crucially, the holder of a floating charge over the company's whole property to apply for appointment of an administrator out of court.[50] If a director applies for an out of court appointment, they must give 5 days' notice to any such qualifying floating chargee, who may in turn intervene in court to have their own 'specified person' appointed as the administrator.[51] The court may refuse if the 'particular circumstances of the case' (undefined) suggest otherwise.[52] The effect is that the holder of a qualifying floating charge is in a robust position to have their preferred insolvency practitioner installed. Otherwise the conditions for a court to grant an administration order is first, and simply, whether the company is insolvent, or 'is or is likely to become unable to pay its debts'. Second, it has to be shown that one of the purposes of administration in paragraph 3 will be achieved.[53] In Re Harris Simons Construction Ltd Hoffmann J held that 'likely to achieve the purpose of administration' meant a test lower than balance of probabilities, and more like whether there was a 'real prospect' of success or a 'good arguable case' for it. So here the company was granted an administration order, which led to its major creditor granting funding to continue four building contracts.[54]
Once in place, the first task of an administrator is to design a restructuring proposal. This should be given to the registrar and unsecured creditors within 8 weeks, followed by a creditor vote to approve the plans by simple majority. If creditors do not approve the court may make an order as it sees fit.[55] Until then, the powers of administrator extend under Schedule B1, paragraph 59 to 'anything necessary or expedient for the management of the affairs, business and property of the company'.[56] In Re Transbus International Ltd Lawrence Collins J made the point that the rules on administration were intended to be "a more flexible, cheaper and comparatively informal alternative to liquidation" and so with regard to doing what is expedient "the fewer applications which need to be made to the court the better."[57] This wide discretion of the administrator to manage the company is reflected also in paragraph 3(3)-(4), whereby the administrator may choose between which result (whether saving the company, selling the business, or winding down) "he thinks" subjectively is most appropriate. This places an administrator in an analogous position to a company director.[58] Similarly, further binding duties allow a broad scope for the administrator to exercise good business judgment. An administrator is subject to a duty to perform her functions as 'quickly and efficiently as is reasonably practicable',[59] and must also not act so as to 'unfairly harm' a creditor's interests. In Re Charnley Davies Ltd (No 2) the administrator sold the insolvent company's business at an allegedly undervalued price, which creditors alleged breached his duty to not unfairly harm them.[60] Millett J held the standard of care was not breached, and was the same standard of care as in professional negligence cases of an "ordinary, skilled practitioner". He emphasised that courts should not judge decisions which may turn out sub-optimal with the benefit of hindsight. Here the price was the best possible in the circumstances. Further, in Oldham v Kyrris it was held that creditors may not sue administrators directly in their own capacity, because the duty is owed to the company.[61] So a former employee of a Burger King franchise with an equitable charge for £270,000 for unpaid wages could not sue the administrator directly, outside the terms of the statutory standard, unless responsibility had been directly assumed to him.[62]
Because an administrator can, since the Enterprise Act 2002, be appointed out of court, a new practice of pre-packaged administration became increasingly popular, whereby typically the company directors negotiate with a prospective administrator for the sale of the business to take place immediately after entering administration, and often to the company's former management.[63] The perceived benefits of this practice, originating in the 1980s in the United States,[64] is that a quick sale without hiring lawyers and expending time or business assets through formalities, can be effected to keep the business running and employees in their jobs. The potential downside is that because a deal is already agreed among the controlling interested parties (directors, insolvency practitioners and usually the major secured creditor) before broader consultation, unsecured creditors are left behind as the momentum behind the deal carries events forward. The concern in the business community is thus that a plan gets foisted on creditors without much time for consideration that works most in favour of the people who ran the company or the large secured lender. In Re Kayley Vending Ltd, which concerned an in-court appointed administrator,[65] HH Judge Cooke held that a court will ensure that applicants for a prepack administration provide enough information for a court to conclude that the scheme is not being used to disadvantage unsecured creditors. Moreover, while the costs of arranging the prepack before entering administration will count for the purpose of administrator's expenses, it is less likely to do so if the business is sold to the former management. Here the sale of a cigarette vending machine business was to the company's competitors, and so the deal was sufficiently "arm's length" to raise no concern. In their conduct of meetings, the Court of Appeal made clear in Revenue and Customs Commissioners v Maxwell that administrators appointed out of court will be scrutinised in the way they treat unsecured creditors. Here the administrator did not treat the Revenue as having sufficient votes against the company's management buyout proposal, but the court substituted its judgment and stated the number of votes allowed should take account of events all the way in the run up to the meeting, including in this case the Revenue's amended claim for unlawful tax deductions to the managers' trust funds and loans to directors.[66]
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Under the Insolvency Act 1986 section 212,[67] a liquidator or administrator can bring a summary in the company's name to vindicate any breach of duty by a director owed to the company. This means the directors' duties found in the Companies Act 2006 sections 171 to 177, and in particular a director's duty to act within her powers, her duty of care and duty to avoid any possibility of a conflict of interest. "Director" in this sense is given a broad scope and includes de jure directors, who are formally appointed, de facto directors who assume the role of a director without formal appointment, and shadow directors, under whose directors the official directors are accustomed to act.[68] The candidates for de facto or shadow directors are usually banks who become involved in company management to protect their lending, parent companies, or people who attempt to rescue a company (other than insolvency practitioners). In Re Paycheck Services 3 Ltd a majority of the Supreme Court held that acting as a director of a corporate director cannot make someone a de facto director unless they voluntarily assume responsibility for a subsidiary company.[69] Similarly to be shadow director, according to Millett J in Re Hydrodam (Corby) Ltd[70] it is not enough to simply be on the board of a parent company.
As an emphasis to the standard codified list of duties, and now reflected in the Companies Act 2006 section 172(4), at common law the duty of directors to pay regard to the interests of creditors increases as a company approaches an insolvent state. While ordinarily, a director's duty is to promote the company's success for the members' benefit,[71] in the vicinity of insolvency a director's actions affect the financial interests of the creditor body the greatest.[72]
Because the misfeasance provision reflects causes of action vested in the company, any money recovered under it is held so that it will go to pay off creditors in their ordinary order of priority. In Re Anglo-Austrian Printing & Publishing Union[73] this meant that a liquidator who had successfully sued directors for £7000 had to give up the funds to a group of debenture holders, who had not yet been paid in full, so there is no discretion to apply the assets in favour of unsecured creditors. A potential benefit is that because the causes of action are vested in the company, they may be assigned to third parties, who may prefer to take the risk and reward of pursuing litigation over the liquidator or administrator.[74] These features are the reverse for money recovered through the statutory based causes of action of fraudulent and wrongful trading.
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Before a company formally enters an insolvency procedure, the directors (including de facto directors and shadow directors) will commit a criminal offence if they dishonestly keep the company running to defraud creditors, and will be liable to pay compensation if keep trading when they ought to have known a company would not avoid liquidation. The first, fraudulent trading provision lies in the Insolvency Act 1986 section 213,[75] A director must have actually been dishonest, in the sense of the criminal law case R v Ghosh[76] that it was dishonest by ordinary standards and she recognised that.[77] The amount a director may have to pay is not in itself punitive, but only the amount to compensate for the losses incurred in the period when he dishonestly kept the company running. In Morphites v Bernasconi[78] Chadwick LJ held, obiter, that it was not the intention of Parliament to enact a punitive element for damages. Instead, under the Companies Act 2006 section 993, there is a specific offence of fraudulent trading, carrying a fine of up to £10,000.[79] Beyond the directors, anyone who is knowingly party to the fraud will also be liable. Before someone can be an accessory to fraud, there must be an initial finding or allegation that a principal was also fraudulent. So in Re Augustus Barnett & Son Ltd[80] Hoffmann J struck out a liquidator's suit for fraudulent trading against the Spanish wine manufacturer, Rumasa SA, and parent of Barnett & Son, because although it had given a comfort letter for its subsidiary's debts, and although the subsidiary was advised that a fraudulent trading charge may arise, that had not actually been alleged yet. Fraudulent trading depends on "real moral blame" attributable to someone.[81]
By contrast, wrongful trading is a cause of action that arises when directors have acted negligently. The Insolvency Act 1986 section 214 states that directors (including de facto and shadow directors[82]) are culpable for wrongful trading if they continue to trade when "at some time before the commencement of the winding up of the company, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation". To determine whether someone "ought" to have concluded this, a director is judged by the skills one ought to have for their office, and a higher standard if the director has special skills (such as an accountancy qualification). In Re Produce Marketing Consortium Ltd (No 2)[83] two directors presided over the insolvency of a Spanish and Cypriot orange and lemon business. One had experience in bookkeeping. Knox J held that although in small companies procedures and equipment for keeping records will be less than in large companies, under section 214 "certain minimum standards are to be assumed to be attained" like keeping the accounts reasonably accurate. Here the accounts were done late even as debts were mounting. While the basic measure of compensation payable by directors for wrongful trading is assessed according to the loss a director creates from the point in time where insolvency was plainly unavoidable, in assessing the level of damages awardable, the court has the discretion to take into account all factors that it feels is appropriate. In Re Brian D Pierson (Contractors) Ltd[84] Hazel Williamson QC held that the directors of a golf course business were culpable for wrongful trading, but reduced their contribution by 30 per cent, given that poor weather had made profitable golf business more difficult than normal.
One limitation of the unlawful trading provisions is that the cause of action vests solely in the liquidator or administrator, as a matter of statute, unlike for a misfeasance proceeding. While both kinds of action can be pursued concurrently,[85] a fraudulent or wrongful trading case may not be assigned to a third party. In Re Oasis Merchandising Services Ltd[86] the company's former directors sought to challenge a wrongful trading claim because the liquidator had sold the right to sue them to a specialist litigation firm, London Wall Claims. The Court of Appeal held that such an assignment contravened the old common law prohibition on champertous causes, or ones which involve a party in litigation for payment when they have no interest. The disadvantage of this approach is that liquidators or administrators may be too cautious to bring claims, when a specialist firm could bring them.
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Since the Fraudulent Conveyances Act 1571, transactions entered into by a bankrupt have been voidable if they would result in assets otherwise available to creditors becoming unduly depleted or particular creditors becoming unjustly enriched. Initially transactions made only with the intention of depriving creditors of assets, or perverting the priorities for order of distribution were vulnerable, while the modern approach of the Insolvency Act 1986 contains more provisions that unwind transactions simply because their effect is deprivation of assets available to creditors'. Reminiscent of the 1571 Act,[87] under the Insolvency Act 1986 section 423, a company may recover assets if they were paid away at a "significantly less than the value" of the thing, and this was done "for the purpose of" prejudicing other creditors' interests. In Arbuthnot Leasing International Ltd v Havelet Leasing Ltd (No 2)[88] Scott J held that the motive of the company or its directors was irrelevant, so that even though Havelet Leasing Ltd's lawyers had advised (quite wrongly) that their scheme of starting another company and transferring assets to it would be lawful, because the scheme's purpose was to put the assets out of other creditors' reach it breached section 423. This rule applies at any time before insolvency, but other provisions have limits set before the date of winding up. Under section 238, transactions at an undervalue may be avoided regardless of their purpose, but only up to two years before the onset of insolvency.[89] So in Phillips v Brewin Dolphin Bell Lawrie Ltd[90] the liquidators of an insolvent company, AJ Bekhor Ltd, could rescind the transfer of assets to a subsidiary, whose shares were then purchased by the investment management house Brewin Dolphin for £1, because the only other consideration given by Brewin Dolphin was the promise to carry out a lease agreement for computers, which itself was likely to be unwound and therefore worthless.
Section 238 aims to prevent undue depletion of a company's total assets, and so the creation of a security interest is not caught.[91] For this purpose, in order to ensure that creditors do not lose the priority they would have had otherwise in relation to one another, there are two further provisions. Under section 245, any floating charge created up to one year before the onset of insolvency is avoidable at the company's instance if new money was not advanced to the company in return. So a company cannot grant a floating charge to a creditor to secure past advances made by that creditor, unless given at least "at the same time". In Re Shoe Lace Ltd[92] Hoffmann J held that £350,000 advanced in April and May was not close enough to a floating charge created in July to be considered "at the same time" and allow the floating charge to cover those amount. Because the context of the legislation was a business one, and in view of the fact that floating charges can be registered up to 21 days after their creation, a few months was far too long. This only rescinds the charge, and not the debt itself, which remains in effect as before but the creditor becomes unsecured.[93] One advantage given to banks operating accounts for companies in overdraft is that it was held in Re Yeovil Glove Co Ltd[94] that if the overall level of debt remains the same, before and after a floating charge is created, is that if money turns over by payments of the company in and withdrawals out, the bank's continued extension of credit will continually "harden" their floating charge. So despite the fact that the Yeovil Glove company was at a constant level of debt to the bank, before a floating charge was created, and at the point of insolvency, because it had deposited and withdrawn a greater amount, the bank's floating charge was considered secure.[95] In this way a floating charge is marginally more vulnerable than other kinds of security, which may only be challenged if they are executed, under section 239, with a "desire to prefer" one creditor over another. In Re MC Bacon Ltd, a company which gave a floating charge to Natwest bank in return for a continued overdraft as its business declined, was held not to have desired to prefer the bank, because rather than some special affection for its bank, it only agreed to the charge to ensure survival. By contrast, in Re Agriplant Services Ltd[96] Jonathan Parker J held that the payment of £20,000 due on a leasing contract for earth moving equipment to a company that was an unlawful preference, because Agriplant's major shareholder Mr Sagar, had guaranteed that sum's repayment, and so repayment absolved his liabilities above other creditors.
Two further provisions to avoid transactions with slightly different objectives are found in the Companies Act 2006 section 874, and the Insolvency Act 1986 section 127. Under CA 2006 section 874, any charge, including a floating charge, that is not registered is considered void. More significantly, IA 1986 section 127 operates to declare every transaction void entered after the presentation of a winding up petition unless it has the approval of the court. In Re Gray’s Inn Construction Co Ltd[97] Buckley LJ held that courts would habitually approve all contracts that were plainly beneficial to a company entered into in good faith and the ordinary course of business. The predominant purpose of the provision is to ensure unsecured creditors are not prejudiced, and the company's assets are not unduly depleted. In this case, however, because a host of transactions honoured by the company's bank, that was in overdraft, between the presentation and the winding up petition being granted meant unprofitable trading, the deals were declared void.[98] One consequence of this rule is that ordinary trade must effectively come to a standstill, and so suspend business unless an administration order may be approved.
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There are a number of provisions which deal with employees' rights upon insolvency, influenced by European Union law's harmonisation measures.
The Cork Committee, chaired by Kenneth Cork produced the Report of the Review Committee on Insolvency Law and Practice, Cmnd 8558 (1982). The central argument of the report was that too many companies were simply left to die, when they could be revived, saved or brought to a close in a more orderly way. Cork advocated that the law should encourage a "rescue culture", to restore companies back to profitability, which would be in the longer term interests of creditors. The Cork report was followed by a White Paper in 1984, A Revised Framework for Insolvency Law, Cmnd 9175 (1984), and these led to the Insolvency Act 1986.
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