Wrongful trading: worth a punt?

Canary Wharf
Calum Jones By Calum Jones, Kepstorn

9 September 2016

Wrongful trading actions are relatively rare occurrences. The recent case of Paton (as Liquidator of Ricky Martin (Racing) Ltd) v Martin, Martin and Martin considered what constitutes 'trading' and the culpability of directors not actively involved in the company. Calum Jones of Kepstorn, who acted for the Liquidator, reports on the case.

The Defenders are Mrs Elizabeth Martin (the 'Mother'), Ms Kelly Martin (the 'Daughter') and Richard Martin (the 'Son').

All three of the Defenders were directors of Ricky Martin (Racing) Limited (the 'Company') in the years leading up to liquidation and the only directors at the relevant times. The 'Ricky Martin' in the Company's name was the husband and father (respectively) of the Defenders and had died several years before liquidation.

When I was first instructed, the Company had entered liquidation as a result of a creditor's petition but the background to this case is important to understand the outcome. A friend of the Martin family had lent various amounts to the Company as it sought to avoid failing. It had then been agreed that the loans would capitalised by way of conversion into shares giving the creditor a stake in the Company. At all material times, the Daughter took the lead in the negotiations with the creditor. The Mother had suffered two brain aneurisms and so her health at the time was poor and her memory at the time of the Proof was very vague or non-existent. The Son had no involvement of any sort with day-to-day management of the Company.

The negotiations on the share issue broke down and the creditor sought repayment of his loans on 23 March, 2010. The loans were not repaid and, eventually, he obtained decree (after several months - which I will come back to shortly) and then put the Company into liquidation. The Petition date was 18 January, 2011.

The Liquidator ascertained that the race course pitches at various racecourses around the UK owned by the Company had all been sold before liquidation. Having obtained the files from the solicitors who acted for the Company, it became clear that on 24 March, 2010 and the days following (almost 10 months prior to the date of liquidation), the Daughter had arranged to sell the pitches. The Daughter had arranged for sufficient of the proceeds of sale to repay the bank overdraft (which was personally guaranteed by the Mother, supported by a fixed security over her house) to be paid into the Company's bank account but the balance of the proceeds of sale had been paid into the Mother's personal bank account. The Mother had a substantial director's loan account due to her (although this was never accurately quantified by her).

It also became clear from the files that there had been a deliberate attempt by the Daughter to delay the action for recovery of the loan by the creditor. Whilst it seemed that this delay had been designed to, firstly, buy time for the directors to deal with the affairs of the Company and, secondly, to try and put off the inevitable, the effect had been to ensure that the eventual date of liquidation was more than six months after the payment to the Mother. As there was clearly a sizeable director's loan account due to the Mother, any claim of a gratuitous alienation in terms of section 242 of the Act seemed to me to be likely to fail and we were outside the time limits for an unfair preference in terms of section 243 of the Act.

The solution, therefore (given how blatant the actions seemed to be), was to commence proceedings in terms of section 214 of the Act. As one director seemed to have acted to benefit another and the third was a member of the family, it was thought safest to join all the directors in the proceedings.

The directors tried to argue several lines of defence.

The first was that the directors did not know and could not have reasonably known that he Company would not avoid insolvent liquidation. This was supposedly based upon the professional advice that had been given to the Daughter at the time but was not borne out by the evidence of the solicitor or the accountant of the Company.

The second was that the sale of the assets of the Company was not 'trading' in terms of section 214 and so could not be 'wrongful'. The Sheriff rejected this proposition and found that the selling of the assets was, indeed, 'trading'.

The third was that by paying a creditor (the Mother's substantial director's loan account) the directors had complied with their obligations by reducing a substantial claim. As the Mother was a creditor, the directors had been looking after the interests of the creditors as a whole. It was also claimed that the obligation to treat all creditors equally did not apply when considering the terms of section 214. The Sheriff rejected this analysis of the law.

Finally, it was argued that it was mere coincidence that the sale of the assets had started the day after the creditor had demanded repayment. The Daughter claimed that the directors had decided upon the sale of the pitches the previous October, when she had discovered that she was pregnant and would not be able to attend the various race meetings. The Sheriff rejected this claim on the evidence. Whilst he did not, therefore, need to consider the point, I would have thought that, even if the Daughter had been believed, the directors would not have avoided liability for their disposal of the income from the asset sales. If circumstances change, the directors must react to the position at the time that they make any decisions about the trading of the Company.

Whilst the Defenders did not seek to exclude the Son from liability, the Sheriff specifically considered his apparent lack of any involvement in the actions complained of. The Sheriff determined that a director has duties incumbent upon him and could not avoid them just because there was no evidence of actual knowledge. That is, of course, different from saying that a director is responsible for the actions of other directors if he can show that he had no such knowledge. On this aspect, I think that it is likely that the facts of each case will be determinative.

Any views expressed in this article are the views of the author and do not necessarily represent the views, policies or regulatory approach of ICAS.


  • Insolvency

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