Supreme Court confirms scope of liability in fraudulent trading claims

Gemma Kaplan of Pinsent Masons was commenting after the Supreme Court dismissed the appeal of Tradition Financial Services Ltd (Tradition), an English broker and intermediary in carbon credit trading, which had brokered transactions for companies engaged in VAT fraud.

In its ruling, the court affirmed that liability for fraudulent trading extends beyond individuals who exercise control or managerial functions within a company. It also examined an appeal by Nathanael Eurl Ltd (Nathanael) and Inline Trading Ltd (Inline) against the time-bar of their claims of dishonest assistance of the fraud. Tradition acted as an interdealer broker for five companies – Bilta (UK) Ltd, Weston Trading UK Ltd, Nathanael, Vehement Solutions Ltd, and Inline. The companies participated in a missing trader intra-community fraud scheme during the summer of 2009. Through trading EU carbon credits, these companies made VAT payments to third parties instead of remitting them to tax authorities, accumulating significant tax liabilities that led to their liquidation.

Legal proceedings were initiated, including against Tradition. While most claims were settled, two issues remained unresolved: whether fraudulent trading liability applied to Tradition under section 213(2) of the Insolvency Act 1986 (IA86); and whether, as argued by Tradition, claims of dishonest assistance brought by Nathanael and Inline were time-barred.

The High Court initially ruled that Tradition fell within the scope of a fraudulent trading claim and that the claims brought by Nathanael and Inline were time-barred. Tradition, Nathanael and Inline appealed to the Court of Appeal, which unanimously upheld the High Court ruling on both issues.

All three companies then appealed to the Supreme Court. Inline and Nathanel appealed the ruling on limitation and Tradition appealed the ruling on the application of s213. In relation to the scope of fraudulent trading liability, Tradition contended that liability under s213(2) applies only to individuals who manage or control the fraudulent business. The company sought to rely on section 993 of the Companies Act 2006 (Companies Act), which concerns criminal liability for fraudulent trading, to argue for a narrower interpretation of s213.

The Supreme Court dismissed this argument, ruling that fraudulent trading claims can be brought against anyone who dishonestly assists in, or contributes to, the fraudulent breach of duty committed or procured by those controlling the company.

The Supreme Court outlined three key principles in its reasoning.

First, it said that the language of s213(2) does not restrict its scope merely to directors or managers. Instead, it said that, on its natural meaning, liability is only limited in three respects: that the mere failure to advise does not make a person a party; that the person must be a party to the carrying on of a fraudulent business by the company and not merely involved in a one-off transaction; and that the person liable must have had an active involvement.

Second, it noted that other provisions within IA86 use distinct language to specify liable parties. It considered that there was no reason to deviate from the natural interpretation of s213(2).

Third, it reflected on the historical context, which it considered did not provide any reason for departing from the natural meaning of the words. Nor did the court consider the analogous criminal provisions in s.993 of the Companies Act 2006 to justify doing so either.

Nathanel and Inline unsuccessfully relied on section 32 of the Limitation Act 1980 (LA80), which suspends the running of time where a claimant can prove that it did not and could not have with reasonable diligence discovered the fraud.

Both companies alleged that Tradition assisted their directors’ breaches of duty between May and July 2009. The companies, struck off in 2010 and 2011 after being abandoned by their directors, were subsequently restored with appointed liquidators in 2012 and 2015.

Nathanel and Inline argued that, under s1032(1) of the Companies Act, their deemed existence during dissolution would necessarily involve the assumption that there were no directors or liquidators in this period. It followed, they argued, that their claim was not time-barred as they could not have discovered the fraud before the liquidators were appointed.

The Supreme Court rejected this argument, reaffirming the settled legal principle that deeming provisions create only the necessary legal fiction. The deeming provision in s1032(1) of the Companies Act merely establishes that a company is considered to have existed during its dissolution, without extending further assumptions.

Whether a company had officers during its deemed existence is a factual question, to be assessed on a balance of probabilities. Allowing dissolved companies to automatically benefit from the fraud exception would permit claims even when dissolution resulted from a company’s own default. Since Nathanael and Inline failed to prove they could not reasonably discover the fraud, their claims remained time barred.

Kaplan said: “Neither of the points determined by the Supreme Court are of great surprise, but the s213 clarification is important for insolvency practitioners to ensure they have suitable remedies to seek compensation from all any perpetrators, in line with how the section has been used and broadly interpreted by parties and by the courts for many years.”