Liabilities in the Insolvent Liquidation of IT Solutions Ltd

Introduction

This essay is in the nature of advice to the liquidator on the liabilities that arise from the insolvent liquidation of IT Solutions Ltd. The pertinent issues on which this advice is created relate to the liability of Marvin and Reynolds under relevant provisions of the Insolvency Act 1986 and the Companies Act 2006. Marvin, Reynold and Theodore incorporated IT Solutions Ltd, which specialises in IT installations in medical practices and they each hold 33% of the shares in the company.

Liabilities arising on liquidation

Insolvent liquidation

Under Section 122 of the Insolvency Act 1986, compulsory winding up can be ordered by the court if the company is unable to pay its debts. A company is said to be insolvent if it is unable to pay its debts for 3 weeks after the demands of its creditors as per Section 123 of the Insolvency Act 1986. Where winding up is compulsory, as in the case of insolvency, directors are dismissed from office and management and assets of the company are now under the liquidator’s control as per the provisions of Section 144 of the Insolvency Act 1986. In this case, the accountant for IT Solutions Ltd, has already informed the company that the company is not able to meet its debts and should be wound up. In case a liquidator is now appointed for the company for the winding up process, the liabilities of Marvin and Reynold can be looked into.

Under Sections 213 and 214 of the Insolvency Act 1986, the liquidator responsible for the winding up of the company investigates the conduct of the individuals who were in charge of the affairs of the company, who would likely include the directors of the company. The investigation relates to the conduct of such individuals in the period of two years prior to the commencement of winding-up of the company. The purpose of the investigations by the liquidator is to assess whether such individuals in the management of the company were also involved in any fraudulent or wrongful trading. If this involvement is proved through the investigations of the liquidator, the individuals can be asked by the court to contribute personally to the assets of the company. This personal liability of delinquent directors is provided under Section 212 of the Insolvency Act 1986 and is applicable in cases involving malfeasance or misappropriation. Under Section 212, if an officer of the company is found to have misappropriated, retained, or become accountable for, any money or property of the company, or has committed a breach of any duty to the company, the Court may order such person to repay or restore the money or property to the company.

Liabilities of directors

In general, any wrongful or fraudulent trading by any directors of the company can come within the purview of Sections 213 and 214 of the Insolvency Act 1986. For Section 213 to be applicable, it has to be proved that there is an intention of the director to defraud the creditors of the company; therefore, knowledge or intention of fraud is essential for the application of this section. Without this intention, there cannot be an application of Section 213. In this case, there does not seem to be an intention on the part of Marvin to defraud the creditors however he does have knowledge that the company should not continue trading as it is approaching insolvency

Therefore, even if Section 213 is not applicable, Section 214 will still be applicable. Under Section 214, a director can be made liable for wrongful trading if he/she is aware that there is no prospect for the future transactions but continues to make such transactions without taking any steps to minimise the loss of the creditors. Section 214(3) allows directors to avoid liability only if he can show that he took steps to minimise the loss to creditors. The standard of knowledge and skill of the director becomes relevant for determining liability as per Section 214, clauses(4) and (5).

Under Section 214, directors who are aware of the imminent insolvency of the company, yet fail to take sufficient steps to minimise the potential loss to the company’s creditors, are made liable for the actions that they take. The principle of duty of care is applicable in such cases, which relates to the general knowledge, skill and experience to be reasonably be expected of the director in the case. The duty to apply reasonable skill and care is codified in Section 174 of the Companies Act 2006. Generally, as per the duty of care principles, directors should apply a standard of care in their actions with relation to the company. However, these standards can be subjective as they will depend on the skill and knowledge of the specific director in question.

How a prudent director is supposed to conduct the affairs of the company is a matter that is central to the liability that may arise for Marvin in this case. In Re Loquitor Ltd, IRC v Richmond, the court held that recommendation of dividends in a situation where the company was not in a condition to meet the claims of creditors would be considered imprudent conduct. Thus, one way of defining imprudent behaviour is the failure to consider the interest of the creditors. In another case, director was held liable for breach of duty when he caused the company to make certain payments, knowing that the company was on the brink of insolvency, and the director was made to pay back to the company on the suit of the liquidator.

Marvin, the managing director of IT Solutions Ltd, has conducted the business of IT Solutions Ltd inefficiently in the last two years. It is being said that one of the reasons why the Company may be insolvent is the imprudent behaviour of Marvin. Marvin also insisted on carrying on trading and entering into new contracts with three medical practices despite knowledge from his accountant that the company is approaching insolvency. Therefore, it can be said that Marvin breached his duties as directors and failed to exercise skill and prudence in his actions for the company. Moreover, he also continued trading knowing that company was on the brink of insolvency. Therefore, Section 214 is attracted in this case.

With regard to the liability of Reynold, the relevant provisions to be considered are related to disclosure of self-interest and conflict of interest. Directors have statutory duties related to disclosure of self-interest and to avoid conflict of interest. Under Section 175 of the Companies Act 2006, directors have the duty to avoid conflict of interests. Under Section 177 of the Companies Act 2006, directors have the duty to declare interests in transactions and arrangements. Duty to avoid conflict of interests is also a fiduciary duty of the directors, which is owed to the company and its shareholders. As directors have certain powers of management of the company’s property and assets, they are fiduciaries to the company. In case of fiduciary duties, the directors of the company can be made to restitute to the company.

There is one area that needs to be considered specifically under Section 175, which is ‘corporate opportunities’ that may present themselves to the directors of the company. Corporate opportunities are the opportunities that may come to the directors as directors of the company. Taking advantage of such corporate opportunities for the purpose of self-interest, can lead to the imposition of liability on the directors at the time of winding up of the company. If the directors take corporate opportunities and even if the company does not lose anything from this action of the directors as the company itself was not in a position to make this investment, the directors would still be accountable to the company for the profits that they made from such opportunities. The only way in which the directors do not have to pay the profits to the company are if they received consent to retain profits from the general meeting of the company and such consent is not prejudicial to the minority. Section 239 of the Companies Act 2006 provides that ratification for the acts of the directors can be given in the shareholders meeting. As per Section 239, an ordinary resolution by simple majority can be passed in shareholders’ meeting to ratify the action of the director, which is this case would mean that both Marvin and Theodore have to ratify the action in the shareholders’ meeting. This ratification has not been taken as yet.

Considering corporate opportunities, IT Solutions Ltd was approached by Dr Smart who offered revolutionary new software to the company for £500,000 along with a share in future profits. As IT Solutions Ltd was not in a position to invest in this opportunity due to lack of funds, the board of directors had to decline this offer. However, Reynold approached Eve, an IT specialist, and together they decided to invest in this opportunity by forming another company called Comp Ltd, for developing and marketing this software. The new software proved profitable.

The liquidator can approach the court to order Reynold to give the profits that he made through the corporate opportunity offered by Dr Smart as per the authorities discussed above. As the caselaw on this issue indicates, a director who makes profits out of corporate opportunities that came to him as director has to receive consent or ratification from the company or give up the profits to the company. In this case, Reynold did not approach the company to sanction his taking of opportunity from Dr Smart. On the other hand, he entered into an arrangement with Eve, which clearly signifies conflict of interest as the new company that he formed with Eve also deals with the development of medical software. He also made profits from this venture without informing or disclosing these profits to IT Solutions Ltd and without getting sanction or ratification under Section 239 of the Companies Act 2006. Therefore, he may be made liable to return the profits to the company.

With respect to the new contracts that IT Solutions Ltd has entered into with three medical practices, the accountant has already advised the directors that they should wind-up the company after which the company entered into new contracts on the insistence of Marvin. Under Section 214, continued trading when the director knows that the company is approaching insolvency is to be avoided. In Re Hawkes Hill Publishing Co Ltd, some clarity on this issue can be found as it was considered in the case that the who said that the relevant question is "not whether the directors knew or ought to have known that the company was insolvent” but that “they knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation". If the directors make efforts to reduce costs and secure new business while thinking that this would help them trade out of insolvency, Section 214 may not be attracted.

Conclusion

To conclude, the liquidator can ask the court to order Marvin and Reynold to pay to the company as per the authorities and laws discussed in this essay. Reynold should be asked to pay the profits he made and Marvin should be asked to compensate the company for the breach of duty to exercise skill and care.

Table of cases

• Bristol & West Building Society v Mothew, [1996] 4 All ER 698
• Cook v Deeks (1916) 1 AC 554
• Hellard v Carvalho (Ch), [2013] EWHC 2876 (Ch)
• Industrial Development Consultants Ltd v Cooley [1972] 1 WLR 443
• Re City Equitable Fire Insurance [1925] Ch 407
• Re Hawkes Hill Publishing Co Ltd (2007) 151 S.J.L.B. 743 (Ch D)
• Re Loquitor Ltd, IRC v Richmond [2003] 2 BCLC 442
• Regal (Hastings) Ltd v Gulliver [1942] 1 AC 554
• Re Produce Marketing Consortium Ltd (No 2) [1989] 5 BCC 569
• Towers v. Premier Waste Management Limited [2011] EWCA Civ 923

Books

• Hannigan B, Company Law (4th ed, Oxford University Press 2012)

Journals

• Lowry J, ‘The Duty of Loyalty of Company Directors: Bridging the Accountability Gap Through Efficient Disclosure’ (2009) 68 (3) The Cambridge Law Journal 607