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Winding Up Petitions

Background information and the process

A creditor can apply to the court for a company to be wound up on the basis that it is unable to pay its debts as they fall due. The court will generally presume that a company cannot pay its debts if:

• A creditor has served on the company a statutory demand for a debt of more than £750 and the sum has not been paid; or

• The company has cash flow insolvency i.e. it cannot pay undisputed debts as they fall due; or

• The value of the company’s assets is less than the amount of its liabilities.

The process is started by way of a winding up petition being issued at the court with a court fee. The petition is then personally served on the debtor and the debtor is given the opportunity to respond to the petition. There is then a court hearing and the court will decide whether to make a winding up order. If the Court makes a winding up order, an independent insolvency practitioner is appointed and gathers in and realises or liquidates the company’s assets before distributing the proceeds to the company’s creditors and members. There is a prescribed order in which the company’s creditors and members are paid. Once the creditors and members are paid, the company is usually dissolved.

Method of debt enforcement?

The threat or commencement of winding up proceedings can put considerable pressure on a debtor company to pay its debts promptly. Therefore, creditors sometimes view winding up proceedings as a method of debt enforcement. However, winding up proceedings should generally be regarded as a last resort. The court requires creditors to behave reasonably before commencing winding up proceedings. In particular, the court requires creditors to write to the debtor to provide details of the debt and demand payment.

Also, winding up proceedings should not be commenced if the debt is genuinely disputed as the court would consider this an abuse of process and in such a case, the court is likely to dismiss the winding up petition and order the creditor to pay the company’s costs, sometimes in full.

Statutory demands

Quite often, a statutory demand is issued to the debtor company before winding up proceedings are commenced. A statutory demand gives the debtor company 21 days to pay the debt. However, it is not strictly necessary to issue a statutory demand as a pre-cursor to commencing winding up proceedings. The advantage of serving a statutory demand however is that it may elicit payment from the debtor company without expensive and time consuming winding up proceedings being issued. The drafting and issuing of a statutory demand is relatively quick and inexpensive.

Consequences for a debtor company

The presentation of a winding up petition can have serious consequences for a debtor company. For example:

• If the debtor company wishes to continue trading or dispose of any property once the petition has been presented, it may have to obtain a validation order from the court. This is to ensure that the debtor company’s assets are preserved pending the hearing of the petition and that no unsecured creditor is paid ahead of any others.

• The fact a winding up petition has been presented, can, in itself, cause substantial harm to the reputation of the debtor company.

• The presentation of a petition against a debtor company can trigger a “default event” clause in contracts such as banking and finance agreements.

• When the debtor company’s bank discovers a petition has been presented against the debtor company (normally because winding up petitions are advertised in the London Gazette) then the bank may freeze the company’s bank accounts leaving the company unable to make any bank payments.

Opposing a winding up petition

It is possible to oppose a winding up petition and the options available to a debtor company are:

• Applying to the court for an injunction to restrain the creditor from advertising the petition.

• Applying to the court for security for costs i.e. an order that the petitioning creditor pays a sum of money into court to cover the debtor company’s costs if the winding up petition is ultimately dismissed by the court.

• Appearing at the court hearing and providing evidence to the court that the debt is disputed.

• Admitting the debt but asking the court to delay making a winding up order so that the company can make payment of the debt.

Alternatives to winding up proceedings

• Allowing the debtor time to pay. Creditors should always ensure debtors are given sufficient time to pay any debt and that reasonable notice is given of any intention to present a winding up petition.

• Alternative dispute resolution (ADR) procedures, such as mediation or expert determination, can be very effective in resolving disputes quickly and more cost effectively.

• Bringing a debt claim in the county or high court depending on the value of the debt.

• Enforce any existing security or agree with the debtor the grant of some security.

• Obtaining a freezing injunction from the court to restrain the debtor from disposing of or dealing with its assets.


Wrongful Trading

What is wrongful trading?

If you are a director of a company and you are worried that your company is insolvent, you must consider immediately whether to stop trading. If, during the course of an insolvent winding up or insolvent administration of a company, it appears that a director knew or ought to have known that there was no reasonable prospect of avoiding liquidation or administration, then the director can be ordered by the court to make a contribution to the company’s assets. Also, any director found to have conducted wrongful trading may be subject to a director disqualification order.

The court will not make an order for wrongful trading if, knowing there was no reasonable prospect that the company would avoid going into liquidation or administration, the director took every step possible to try and minimise the potential loss to the company’s creditors.

Any liquidator or administrator seeking an order of wrongful trading from the court does not have to prove dishonesty on the part of the director. Nonetheless, a liquidator or administrator will need to produce evidence to the court not only of the director’s wrongful trading but also that the wrongful trading resulted in a loss to the creditors that would not otherwise have occurred.

Avoiding wrongful trading

There are a variety of ways in which directors can avoid being found guilty of wrongful trading.

• Calling regular full board meetings if the company is in financial difficulties and ensuring that commercial decisions made by directors are reported in full in the company’s minutes.
• Reaching commercial decisions on an independent basis on the basis of financial and legal information and advice available to the directors.
• Ensuring the company’s financial information is up to date at all times.
• Taking immediate independent financial advice if the company’s directors become aware there is no reasonable prospect of avoiding liquidation or administration.
• Immediately ceasing to trade in order to minimise any potential loss to the company’s creditors.

Please note, however, that simply resigning as a director of the company will not prevent a director being found guilty of wrongful trading. Furthermore, the court’s look unfavourably at directors who resign in order to try and minimise their responsibilities.


Fraudulent Trading

What is fraudulent trading?

If, in the course of a winding up or administration of a company, it becomes clear that any person (not necessarily directors) has taken steps to try and defraud creditors, then a liquidator or administrator can seek an order from the court that the relevant person makes a contribution towards the company’s assets. As well as the civil courts being able to make orders, fraudulent trading is also a criminal offence under the Companies Act 2006 and directors who are guilty of fraudulent trading can also be disqualified as acting as a director.

Proving fraudulent trading

The liquidator or administrator would have to provide evidence to the court that a director or other person have acted deliberately to avoid payment of company liabilities. The burden of proof that the liquidator or administrator would have to satisfy is high. Therefore, fraudulent trading claims are less common than wrongful trading claims.


Misfeasance

What is misfeasance?

The definition of misfeasance is contained in the Insolvency Act 1986. Misfeasance encompasses the misapplication or retention of money/property belonging to a company, becoming accountable for money/property belonging to the company and breaching a fiduciary duty relating to the company.

Breach of duty is an essential element in bringing a misfeasance claim. An action for misfeasance is only capable of being brought where an officer of a company breaches some duty that he/she owes in their capacity as an officer. The following examples have been found to be a breach of duty for the purpose of proving misfeasance:

• A director causing a company not to pay VAT;
• Directors making secret profits;
• Directors purchasing property that was then sold onto a company;
• Directors granting preferences to creditors.

This is not an exhaustive list and other actions by directors and company secretaries may constitute misfeasance.

Who can be sued for misfeasance?

Where a company has gone into liquidation, under section 212 of Schedule B1 of the Insolvency Act 1986, a misfeasance claim can be brought against an officer or former officer of the company in liquidation, a person who has acted as liquidator or administrative receiver of the company and a person who has been involved in the promotion, formation or management of the company.

“Officer” means de-facto director, company secretary or manager of the company.

Leave of the court is required before a misfeasance claim can be brought against a liquidator who has already been released of their duties. If a liquidator is still acting, the liquidator will have to be removed from office before he/she can be sued for misfeasance.

Where a company has been placed into administration, under paragraph 75 of Schedule B1 of the Insolvency Act 1986, a misfeasance claim can be brought against a person who is or purports to be the administrator of the company or who has been or purported to be an administrator of the company.

Leave of the court is required to bring a misfeasance claim against an administrator who has already been discharged from his/her duties. If an administrator is still appointed, the administrator will have to be removed from office before he/she can be sued for misfeasance.

Who can bring a misfeasance claim?

Where a company is in liquidation, a misfeasance claim can be brought by a liquidator of the company, a creditor of the company, a contributory to the company’s capital (as long as leave from the court is obtained) or the Official Receiver. An administrator cannot bring a misfeasance claim where a company is in liquidation however administrators can take action in the insolvent company’s name.

Where a company is in administration, a misfeasance claim can be brought by an administrator of the company, a liquidator of the company, a creditor of the company, a contributory to the company’s capital or the Official Receiver.

Court Remedies

If the court finds that a person has been misfeasant or to have breached its duty (fiduciary or otherwise) to the company, the court may order him/her to:

• Repay, restore or account for any misappropriated money or property to the company with interest.

• Compensate the company for any misfeasance or breach of duty by contributing to the insolvent company’s assets.

Defending a Misfeasance Claim

Where the company is in liquidation, an officer of the company can use section 1157 of the Companies Act 2006 to avoid liability. This relief is available where a director, company secretary or liquidator has acted honestly and reasonably and the circumstances of the case mean that it is fair to excuse him/her from any liability.

Where a company is in liquidation or administration, the so-called Duomatic principle may be available as a defence. This is where all shareholders who have a right to attend and vote at a general meeting have ratified the misfeasance or breach of fiduciary or other duty.

The Procedure for Bringing a Misfeasance Claim

The person bringing the claim must prove, on the balance of probabilities, the alleged misfeasance or breach of fiduciary or other duty.

The time limit for bringing a misfeasance claim is 6 years from when the misfeasance of breach of duty occurred. The time limit does not restart when the company enters administration or liquidation.

Where a successful claim is brought, the general rule is that the successful applicant will recover its legal costs from the defendant.


Transactions at an Undervalue

Definition and Requirements

Either an administrator or a liquidator can apply to the court to set aside any transaction at an undervalue.

The court may set aside a transaction at an undervalue if:

• The insolvent company made a gift or otherwise entered into a transaction where the company received no consideration;

• The insolvent company entered into a transaction where the consideration payable is significantly less than the true value of the transaction;

• The relevant transaction was entered into 2 years before the onset of insolvency e.g. entering into administration or liquidation;

• The company was unable to pay its debts at the time the transaction was entered into or became unable to pay its debts as a result of the transaction.

Defending a Transaction at an Undervalue Claim

The court will not make an order to set aside a transaction at an undervalue if it is satisfied that both:

• The company entered into the transaction in good faith and for the purpose of carrying on its business; and

• At the time it did so there were reasonable grounds for believing that the transaction would benefit the company.

Court Orders that may be made

If a transaction at an undervalue claim is successful, there are a number of orders the court may make. In particular, the court may:

• Require any property transferred as part of the transaction be re-vested in the company;

• Require proceeds of sale from a property to be re-vested in the company;

• Release or discharge any security given by the company;

• Require any person who received a benefit from the insolvent company to pay such sums to the administrator or liquidator of the company;

• Require a person whose obligations to the insolvent company were released or discharged to provide new or revived obligations;

• Require security to be provided relating to the discharge of any obligation;

• Provide that a person whose property is ordered to be vested in the company or on whom obligations are imposed to be allowed to prove a claim against the insolvent company.

Tips for Minimising Risk

Any party dealing with a company in financial difficulties and is worried a transaction may be viewed as a transaction at an undervalue should take appropriate action such as obtaining an independent valuation of the assets and buying after an auction or other public process.


Preference Payments

What is a preference payment?

A company gives a preference to a person if each of the following apply:

• The person is one of the company’s creditors or a surety or a guarantor for any of the company’s debts or other liabilities.

• The company does something which has the effect of putting that person into a position which is better than the position the person would be in in the event of the company going into insolvent liquidation.

• The company was influenced in deciding to give the preference by a desire to prefer the party. This is a subjective test, not an objective one. It is necessary to establish that the company positively wished to put the party in a better position. Pressure for payment by the creditor may provide a defence, as may tax mitigation or group re-organisation.

• The preference was made at least 6 months before the onset of the company’s insolvency (this time limit is increased to 2 years if the preference is made to a connected person e.g. a director, a shadow director or a person who has control over the company’s decision makers).

• The company was unable to pay its debts at the time of the transaction or became unable to pay its debts as a result of the transaction.

Examples of preference include:

• Paying an unsecured creditor ahead of others.

• Granting security to a previously unsecured creditor.

• Allowing a supplier to change its terms and conditions to include a retention of title clause.

• Repaying a director’s loan account or reducing a company debt guaranteed by one of the directors.

This is not an exhaustive list and other actions/decisions may constitute preference payments.

Court Orders

Where a preference payment is proved, the court may make any order it thinks fit for restoring the position as if the company had never given the preference. In particular the court may:

• Require any property transferred as part of the transaction be re-vested in the company;

• Require proceeds of sale from a property to be re-vested in the company;

• Release or discharge any security given by the company;

• Require any person who received a benefit from the insolvent company to pay such sums to the administrator or liquidator of the company;

• Require a person whose obligations to the insolvent company were released or discharged to provide new or revived obligations;

• Require security to be provided relating to the discharge of any obligation;

• Provide that a person whose property is ordered to be vested in the company or on whom obligations are imposed to be allowed to prove a claim against the insolvent company.


Unlawful Payments of Dividends

What are they?

A distribution which either contravenes common law or Part 23 of the Companies Act 2006. A distribution may contravene common law if it is made out of capital. A distribution may contravene Part 23 of the CA 2006 if a dividend is declared in excess of the company’s distributable profits or if a dividend is justified by a public company’s interim accounts which have not been filed.

If a distribution is in excess of distributable profits, the distribution is unlawful to the extent of the deficiency in the available profits, not in its entirety.

Examples

The following is a non-exhaustive list of what may constitute unlawful payments of dividends:

• Interim accounts are not prepared and the last annual accounts show insufficient distributable reserves.

• A parent company declares and pays a distribution when the requisite profits have not been received and recorded by way of proper dividends from its subsidiaries, even when subsidiaries had sufficient profits to pass onto the parent company.

• A public limited company fails to file interim accounts, that have been prepared in respect of an interim dividend, with the registrar of companies.

• A subsidiary carries out a capital reduction and prepares interim accounts which show a positive reserve and distributes dividends to the parent company, only for it to transpire that not all of the legal procedures relating to the capital reduction were carried out and therefore the capital reduction is invalid.

• A parent company receives a dividend from its subsidiary and then makes a distribution to its shareholders. The dividend, however, causes an impairment in the subsidiary’s value which is not reflected in the parent company’s accounts and the loss arising wipes out some of the distributable reserves in the parent meaning there is insufficient reserves to cover the dividend paid.

Liability of Shareholders and Directors

A shareholder who knows or has reasonable grounds to believe that a distribution (or part of it) contravenes the rules on distribution of dividends, is liable to repay the dividend. However, where it cannot be shown that a shareholder knew or had reasonable grounds to believe the dividend payment was unlawful, the shareholder will not be liable to repay and the directors who recommended the unlawful distribution may be liable to the company instead.

A director who authorises the payment of an unlawful distribution may be in breach of statutory and common law duties (e.g. duty to exercise reasonable care, skill and diligence) may be personally liable to repay the company even if they are not a shareholder.

Rectification

Where a company has paid an unlawful dividend, it should consider rectifying the position. The shareholders cannot rectify the unlawful payment of the dividend but they may ratify various rectifying actions and release the directors from liability. Depending on the circumstances, the company may seek shareholder approval for the following rectification action:

• The rectification of accounting entries in respect of the unlawful dividend;

• The entry by the company into deeds of release which releases shareholders from any liability to repay any amounts received;

• The distribution of an amount equal to the original dividend to be made out of profits available for distribution at the time the original dividend was declared;

• The entry by the company into further deeds of release releasing directors from any liability having declared the unlawful dividend.


Director Disqualification

Director Disqualification Proceedings are most commonly commenced pursuant to the Company Directors Disqualification Act.

It is not just directors registered at Companies House who may be targeted. Both de-facto and shadow directors can face proceedings.

Proceedings usually have to be commenced against a director within 2 years of a company entering a formal insolvency process e.g. administration or liquidation.

Disqualification usually lasts between 2 and 15 years, depending on the severity of the director’s conduct. Proceedings usually have to demonstrate that the director has been involved in or allowed others to be involved in “unfit conduct”, usually arising out of a failed company. What constitutes “unfit conduct” will depend on the individual circumstances. Examples of “unfit conduct” include:

• The director allowing the company to trade for too long to the detriment of the company’s creditors and trading with the knowledge that the company is insolvent.

• The director allowed the company to run up VAT, PAYE and Corporation Tax debts.

• The director entered into transactions at an undervalue or preference payments (see above).

• The director failed to maintain, preserve or deliver up the books and records of the company to its insolvency practitioner and losses have flowed from that failure.

This is not an exhaustive list and other actions may constitute “unfit conduct” and leave a director at risk of being disqualified. Being disqualified as a director usually precludes the disqualified director from being involved in the promotion, formation or management of another limited company during the period of disqualification. To carry out such activities whilst disqualified is serious and carries both civil and criminal sanctions.

The Secretary of State, who brings the proceedings, may not seek to recover the costs of bringing the proceedings from the director if matters can be resolved prior to the issuing of any proceedings. However, if proceedings are issued and the Secretary of State is successful, the director may be liable to pay costs. Often the best way of ending proceedings is to agree and sign an undertaking setting out what the director may and may not do. Such undertakings should be scrutinised carefully to ensure the director is not left open to other civil or criminal action.

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