Out-Law Analysis | 29 Apr 2016 | 3:55 pm | 2 min. read
As well as being a recent, rare example of a wrongful trading case making it to court, the Re Ralls Builders case is also significant as it sets out guidance for directors and trustees on what they should be doing when, for example, a company or institution is in financial difficulty.
Directors of educational institutions, or trustees if the institution is a charity, owe fiduciary duties both to the institution and its creditors. These duties become particularly important where the institution is in financial difficulty and in the so-called 'twilight zone' where potential insolvency becomes a real possibility, as directors who act in breach of their fiduciary duties to creditors run the risk of being held personally liable for the offence of wrongful trading.
In Re Ralls Builders, the High Court held the directors of a construction company liable for wrongful trading under section 214 of the 1986 Insolvency Act. This was because they continued to trade, and incurred further debts, after the date when they should have known that the company could not avoid insolvent liquidation and there was no reasonable prospect of securing significant outside investment.
However, the judge also found that the directors were not personally liable to make financial contributions to account for the new trading losses of the company incurred during the 'twilight zone', making the judgment in some respects helpful for directors and trustees. In addition, the judge gave a detailed overview of what would and would not be relevant to a defence to wrongful trading.
What should directors be doing?
Under UK law, there are two grounds on which a party can be considered insolvent:
When an institution becomes insolvent - or, potentially, is merely of doubtful solvency - the primary focus of its directors' and trustees' duties shift from the shareholders to the creditors. To minimise the risk of liability for wrongful trading and vulnerable transactions, directors should take steps to avoid losses to creditors from an early stage.
Practically, for an institution in financial difficulty, this will mean:
The 2006 Companies Act sets out the broad duties of directors. Significantly for institutions, there is no distinction between the duties of executive and non-executive directors.
What defences are available?
Directors can defend themselves against claims of wrongful trading by showing that they took every step that they ought to have taken with a view to minimising the potential loss to the creditors; and that they took informed advice on their position and acted accordingly.
The decision in the Re Ralls Builders case gave detailed consideration and analysis of the circumstances in which directors can be liable for wrongful trading, and considered in detail the extent of that liability in monetary terms. It will be a useful decision for those assessing their potential exposure if they continue to trade in stretched financial circumstances.
Amy Flavell is an insolvency law expert at Pinsent Masons, the law firm behind Out-Law.com.