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Wrongful trading claims - how important is quantifying the loss to creditors?

Quantifying the loss to creditors in any wrongful trading claim has proved crucial in recent High Court decision.

The High Court has allowed, in part, an appeal against an order that two directors compensate a company in liquidation for losses arising from wrongful trading in Brooks v Armstrong (Re Robin Hood Centre plc in liquidation) [2016] EWHC 2893 (Ch).  

This is a useful reminder to liquidators and administrators to quantify loss to creditors as a result of any alleged wrongful trading at an early stage in the case, or risk incurring litigation costs where there is no prospect of a recovery for creditors.

Background

The joint liquidators of the Robin Hood Centre plc brought a claim against two of the company's directors for £701,000 in compensation for wrongful trading and misfeasance.  The claim was heard in 2015 before a High Court Registrar.  The court at first instance held that the directors were jointly and severally liable to pay £35,000 to the company in compensation.  

At a subsequent hearing, the Registrar held that there should be no order as to costs.  The general rule that the unsuccessful party be ordered to pay the costs of the successful party  was distinguished because:

  • the level of compensation awarded was significantly less than the level originally claimed by the liquidators; and 
  • the directors successfully defended a number of the claims brought by the liquidators.

Both the liquidators and the directors appealed the decisions on wrongful trading.  The liquidators also appealed the cost order.

How do wrongful trading cases arise? 

A liquidator or administrator can apply to court for a declaration that a person who is or was a director be liable to make a contribution to the company's assets if, in the course of the winding up, it appears that they knew or ought to have concluded before the commencement of the liquidation that there was no reasonable prospect of the company avoiding insolvent liquidation or administration.   It is a defence for the director to show that they took every step with a view to minimising the potential loss to the company's creditors. Since 1 October 2015, administrators have also been able to bring wrongful trading claims.

Liability will only arise if it can be shown, on a net basis, that the creditors' position was worsened as a result of the continued trading.  The court will not make a contribution order if there has not been any increase in the net deficiency of assets over the period of wrongful trading.  The maximum liability for wrongful trading will be equal to the net deficiency of assets.  Accordingly, the court will not make punitive orders for compensation under this provision of the Insolvency Act 1986.  

The High Court has also recently confirmed that a liquidator's costs and expenses of bringing a wrongful trading action cannot be recovered from the directors where there has been no net deficiency in the company's assets (Re Ralls Builders (in liquidation) [2016] EWHC 1812 (Ch)).

The grounds of appeal

The appeal was heard in the High Court before a Deputy Judge of the Chancery Division.  

The liquidators and directors both challenged the Registrar's decision as to the date on which the directors knew (or ought to have known) that the company would not avoid insolvent liquidation.  They also appealed the Registrar's calculation of the level of compensation that was due.  

The decision

The finding of wrongful trading was upheld.

The Deputy Judge rejected both the liquidators' appeals and the directors' cross appeals as to the date on which the wrongful trading commenced.    

But the directors succeeded in their cross appeal on the Registrar's calculation of compensation payable for wrongful trading.  The Deputy Judge held that the Registrar should not have ordered any payment by the directors to the company because:

  • The liquidators had failed to advance and establish a properly formulated case that there had been an increase in net deficiency during the period of wrongful trading. For example, the schedules setting out the liquidators' case as to the extent of the company's loss were only served on the directors on the first day of the hearing. 
  • On the facts found by the Registrar, the wrongful trading did not, in any event, cause any increase in the company's net deficiency.
  • When calculating the level of loss, the Registrar incorrectly applied an analysis of the facts which was not advanced by either party at the hearing.  If this analysis had been open to consideration at the hearing the directors would have been able to object to it either on the grounds that there was insufficient evidence or, if the analysis was properly followed through, that no compensation was payable.    

The issue of costs was reserved to a later hearing.

The implications

There are very few reported wrongful trading cases, and even fewer appeals.  This decision illustrates the importance of quantifying the loss to creditors at an early stage of any wrongful trading action.  The forensic analysis of creditor losses should distinguish between those losses caused by the decision to continue trading (when the directors knew or ought to have known that insolvent liquidation or administration would not be avoided) and those caused by the eventual decision to cease trading.

In the absence of a full calculation of the net deficiency to creditors caused by wrongful trading, there is a real risk that liquidators or administrators will achieve a pyrrhic victory, incurring the costs of bringing a claim but failing to achieve any recovery for creditors.

Contributor: Tessa Glover

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at January 2017. Specific advice should be sought for specific cases. For more information see our terms & conditions.


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