Reed Smith Client Alerts

Authors: Colin Cochrane

In February 2016, Mr Justice Snowden handed down his judgment in the High Court proceedings concerning Ralls Builders Limited (in liquidation) [2016] EWHC 243 (Ch). This matter concerned an application by the liquidators of Ralls Builders Limited (in liquidation) (the company) for a declaration regarding the alleged wrongful trading of the company by its directors, under section 214 of the Insolvency Act 1986 (the Act).

The detailed and considered judgment sets out the historical case law regarding wrongful trading, and addresses some of the uncertainty in this area.

Mr Justice Snowden considered, as is usual, the dates from which it was alleged that the directors knew, or ought to have known, that there was no reasonable prospect of avoiding an insolvent liquidation (the usual threshold for a finding of wrongful trading). The directors were found to have been in a position whereby they knew (or ought to have known) by 31 August 2010 that there was no such reasonable prospect. The company went into administration on 13 October 2010, and was since placed into liquidation.

In considering whether the directors ought to be required to personally contribute to the estate of the company in administration as a result of this wrongful trading, Mr Justice Snowden considered whether the directors had taken ‘every step’ with a view to minimising the loss to creditors to avail themselves of the defence under section 214(3) of the Act. The directors in this case had continued to trade in the hope of making better returns on mostly-completed projects in their (historically) busy summer period, and had also been in negotiations with a potential investor, which ultimately failed.

In assessing the availability of the section 214(3) defence, the court commented that the ‘every step’ requirement was designed to be a “high hurdle for directors to surmount”. It was held that the directors had fallen short of this requirement, because the company’s continued trading meant that some creditors, including the company’s bank, were paid, while other creditors went unpaid. Mr Justice Snowden was clear in his judgment that this prevented the availability of the defence to the directors and that it was not the purpose of that section of the Act to provide “differential redress for individual creditors.” This approach was supported by an observation that any contribution made by directors under section 214(1) would be distributed pari passu (i.e. in the same proportion to creditors within the same class) among the general body of unsecured creditors.

In addition, Mr Justice Snowden helpfully stated, as an obiter comment, that the directors should not be precluded from the defence on the basis that they continued to draw salaries from the company, which were “reasonable” and to which the directors were “entitled for work actually done during the period,” bringing some judicial clarity on the appropriateness of directors drawing salaries while the company is approaching, or in, an insolvency process.

Having found that the directors had, for a period, wrongfully traded the company, and that the section 214(3) defence was unavailable, Mr Justice Snowden turned to considering the quantum of any contribution required of the directors. The basis applied was to consider the “increase or reduction in the net deficiency of the company” between the date from which the directors were held to have wrongfully traded (31 August 2010) to the date of the administration (13 October 2010). He added that “some causal connection” to the change in the deficiency was needed, i.e. that the wrongful trading itself must have led to the increased deficiency. Therefore, the costs of the administration itself, which would have arisen in any event, were to be excluded from this assessment. Mr Justice Snowden considered the financial position of the company upon various dates and concluded that “if anything, the continued operations of the company until 13 October 2010 produced a modest improvement in the net deficiency of the company”.

Mr Justice Snowden declined to make the declaration sought under section 214(1) of the Act, commenting that the “real sin” of the directors regarding unsecured creditors was that the continued trade “facilitated the repayment of the bank and some existing creditors whilst leaving new creditors unpaid.” However, he added that this was beyond the structure and intention of section 214 of the Act, being a matter for Parliament, and not the court, to amend.

It may be useful for directors and insolvency practitioners to note that, throughout the judgment, Mr Justice Snowden considered the extent to which the directors relied on professional advice. This reiterates the importance of seeking appropriate professional advice when directors consider their company to be in financial difficulty. Seeking advice may assist directors in establishing a defence under section 214(3) of the Act following a finding of wrongful trading. However, seeking advice would not provide a defence in isolation. Advice should be kept up-to-date, and directors must remember they will not be able to absolve themselves of responsibility by taking advice alone. They should also conduct regular reviews of the company’s financial position and ensure they keep up-to-date with commercial pressures and the overall status of the company.

Read a full copy of the judgment here.


Client Alert 2016-064