Introduction

According to the doctrine of limited liability, on the one hand, the shareholders’ liability, for the

company debts of an incorporated company, is limited to what they have paid or agreed to pay for

its shares. In other words, the company creditors cannot lay a claim against the shareholders’

personal assets, but only against the ones of the company. On the other hand, once the company

creditors have been paid, its shareholders can benefit from its success with no cap.

Since its invention, the concept of limited liability has been hugely criticized: as there is a cap on

the shareholders’ liability, it encourages incorporated companies to go on trading even though they

do not have the required financial means.

In order to erode its abusive use, the Insolvency Act (IA) 1986 introduced, as recommended by the

Cork Committee, the provision of wrongful trading (section 214). The enactment of that measure

was advocated to maintain the necessary balance between encouraging entrepreneurial growth in

society and discouragement of “downright” irresponsibility. In particular, that proviso was aimed at

ensuring that “those [the company’s directors] who abuse the privilege of limited liability can be

personal liable for the consequences of their conduct”.1

Nonetheless, the new remedy caused different reactions: someone feared that it could seriously

damage the health of the United Kingdom’s small business sector,2 others added that the provision

offered a further protection to creditors from the abuse of limited liability by the directors.3

The following paper will strive to show, that in the present regulation of section 214 1986 IA

(henceforward section 214), the reasons of the directors unreasonably outweigh the ones of the

creditors. In fact, not only have the latter to prove numerous circumstances, but the concrete

instauration of such a procedure is also discouraged by the exclusive locus standi of the liquidator.

That conclusion will be supported in the following paper, after an analysis of the phenomenon; its

mechanism; its requirements and the theoretical contribution.

1 K Cork (chairman), Insolvency law and practice : report of the Review Committee, London, 1982 para 1805(henceforth “The Cork Report”2 C Cook, “Wrongful trading – Is it a Real Threat to Directors or a Paper Tiger?” 1999 Insolv Law. 99 3 A Keay, “Wrongful trading and Liability of Company Directors: A Theoretical Perspective” (2005) 25 L.S. 432 at 442

1

Chapter 1

The ineffectiveness of the fraudulent trading provision

The fraudulent trading provision of the Company Act 19484 established a strict standard of proof

that “any business of the company has been carried on with the intent to defraud”5 requiring actual

dishonesty involving real moral blame.6 It amalgamated both criminal and civil liability. Now a

claim under section 213 1986 IA (henceforward section 213) only relates to a civil offence and,

particularly, when 1) the business of the company in liquidation has been carried on with intent to

defraud creditor or for any fraudulent purpose; 2) the respondent participated in the management of

the business; 3) the respondent participated knowingly.

In order not to fall with this provision, a positive involvement in the company’s affairs is required

as it was stressed in Re Maidstone Building Provisions Ltd7. In that case, a company

secretary/financial advisor who was not directly a director of the company stood aside and allowed

the directors to continue trading in spite of warnings about fraudulent trading. Nevertheless he was

held not to be liable himself for his failure to act more actively. Subsequently, the same view was

adopted in Re Peake and Hall Ltd. 8 In fact although a director of a family company left its running

in the hands of his parents he was held not to be liable for their fraudulent trading. So the major

factor behind the ineffectiveness of the law related to section 213 was the necessity to satisfy a

subjective test of dishonesty as stressed in Re William Leithc Bros Ltd 9, in Re Patrick & Lyon Ltd10

and also in Re E B Tractors Ltd. In the latter case, Murray J refused an application by a creditor to

make a fraudulent trading declaration although the evidence showed that the defendant’s hope to

save the business through continued trading were unrealistic.11

In the few cases where a claim for fraudulent trading was successful the Court enjoyed considerable

flexibility in assign the fruits of this action. Though the normal outcome of a successful claim

would be a direction that the defendant contributes a sum of money to the general assets available

4 Art 3325 Section 213 (1) IA 19866 Patrick and Lyon Ltd, Re [1993] Ch. 7867 [1971] 3 All.E.R. 3638 [1985] PCC 87 9 [1932] Ch 710 [1933] 1 Ch 78611[1987] PCC 313

2

for distribution amongst all creditors, an individual creditor could sue and the courts could order

compensation payments to him as in Re Cyona Distributors Ltd12. In the 1989 Order, there was no

modification in the substantive definition of fraudulent trading in particular with regards to the

requirement of dishonesty. As a matter of fact, the changes were essentially procedural: only the

liquidator is able to institute civil proceedings for fraudulent trading and any proceeds of such a

claim must be paid into the general pool of assets.

12[1967] Ch 8893

Chapter 2

The wrongful trading provision: People potentially liable and the bases on the liability under section 214 IA

The Cork Committee, having recognized the lack of effectiveness of the fraudulent trading

provision of the Company Act 1948, recommended the introduction of a specific regulation on

wrongful trading . In particular, it was advised that recognition of a new civil personal liability far

wider than the one postulated by fraudulent trading. In particular it was averred that it should arise:

a) without proof of fraud or dishonesty and; b) without requiring the criminal standard of proof.13

Last but not least, instead of the subjective test of section 332, Cork proposed an objective test.14

Subsequently, a section 214 was added to the Insolvency Act 1986 but its provisions are very

different from those proposed by Cork. As a matter of fact section 214 contains no specific power

to grant relief, whereas under Cork’s proposal liability arose from continuing to trade and incurring

further debts, under section 214 liability arises from failing to minimize potential losses to

creditors.15

Pursuant to that provision, a person who is or has been a director of the company would be engaged

and liable for wrongful trading if (cumulatively):

i) the company has gone into insolvent liquidation (subsection 2 a) and 6);

ii) at some time before the commencement of the winding up of the company, that person knew or

ought to have concluded that there was no reasonable prospect that the company would have

avoided going into insolvent liquidation, and that person was a director of the company at that time

(subsection 2 b) and c) and subsection 7);

13 “The Cork Report” Para 177814 “The Cork Report” Para 178315 “The Cork Report” Para 1784

4

iii) that person failed to take every step that ought to have been taken with a view to minimizing the

potential loss to the company's creditors. (subsection 3); and

iv) that person was a director of the company at that time.

2.1. People potentially liable under the section.

Section 214 openly states that it applies not only to de jure directors, but also to shadow directors

(subsection 6). The former are validly appointed directors, while the latter are defined by section

251 of the 1986 Insolvency Act: people, other than a professional adviser, in accordance with

whose directions or instructions the company’s directors (not only de jure, but also de facto as it

will be immediately showed) are accustomed to act. Moreover, in the decision Hydrodan (Corby)

Ltd,16 it was held that section 214 also applies to de facto directors, namely those who assume to act

as directors without having been validly appointed or at all. That decision was based on the

consideration that liability should be imposed on those responsible for the company’s management,

notwithstanding the existence of a valid appointment by the defendant company. Furthermore, it

was stated that those three positions are clearly separable and they cannot be vested in the same

person.

The extent of liability to a shadow director is very important for a number of reasons: e.g. it should

entail a parent company to be liable for the debts of its subsidiary, as well as many others who have

been involved to a significant extent in the management of companies affairs, especially the

company main bank.

Nonetheless, the aforementioned Hydrodan (Corby) Ltd case dealt with the question of shadow

directorship taking a restrictive approach.17

That case was characterized by the presence of a company (Hydrodan) that was a wholly owned

indirect subsidiary of Eagle Trust plc (Eagle Trust). Hydrodan's liquidator alleged wrongful trading

against 14 defendants, including Eagle Trust and all Eagle Trust's directors. Thus that case, is

important because it dealt not only with the responsibility of a parent company, but also with the

one of the parent company directors.

16 [1994] BCC, 163 17 ibidem

5

As it has already been underlined, section 214 can apply to shadow directors, only if the de facto

and de iure directors are accustomed to act in accordance with the former’s instructions. According

to Millet J, the shadow directors should exercise their influence over the whole board, and not

individual members or sub-groups of it. In addition, the whole board should have essentially

abdicated its duty to make its own decisions, choosing instead to follow the instructions of a third

party who himself has a conscious intention to control the board's decisions.

Nevertheless, in the case at hand, Millett J held that, although Hydrodan had mere titular de jure

directors (two companies of the Channel Island) and that Eagle Trust could be a shadow director of

the company, that was not enough to conclude that both its parent company and its directors were

shadow directors.

On the one hand, it was stated that the parent company can be liable for wrongful trading as shadow

director only if it clearly interferes with the management of the subsidiary to such an extent that all

the company's directors were not allowed to act and make decisions independently in the exclusive

interest of the subsidiary. Moreover, it will have to be shown that the parent company consciously

intended to cancel the role of the existing directors.

On the other hand, it was contended that the directors of the parent company cannot be held liable

for wrongful trading because they attended, voted and participated at board meetings of the

company's ultimate holding company. In fact, in in such a situation there would be no relevant legal

relationship between the directors of the parent company and the subsidiary, as the former owed

their duties only to the holding company. By contrast, they would become personally liable as

shadow directors of the company if they had individually and personally given directions to the

company in accordance with which the directors of the company were accustomed to act.

Bhattacharyya outlined that the above mentioned falls within a pro-bank stance that includes Re MC

Bacon (1990) and Millet J’s article written after that case.18

In that writ, that judge maintained that when a bank is faced with a customer in financial distress,

the former can impose certain conditions and requirements upon the continuation of its support. It

may, for example, appoint inspectors to report on the company's position, demand security or

further security and request certain information, such as the company's accounts, a business plan

and details of possible disposals. Nevertheless, the bank can be qualified as a shadow director only

when it substantially takes itself a particular course of action for the client and obviously, that will

happen in a very remote hypothesis.

18 G Bhattacharyya, “Shadow directors and wrongful trading” 1995 Co Law 16 313 ff6

Moreover, according to Bhattacharyya that position is now strengthened by the decision in Re

Hydrodan. In fact, that author underlines that, broadly speaking, that case embodies a very

restrictive approach towards the idea of shadow directorship and wrongful trading. Therefore, he

concludes that courts will qualify a bank as a shadow director of its customer only if there is clear

evidence of the interference in the management of the latter and its directors are substantially

deprived of their power to purse the interest of the latter.

In a more recent case, Re PFTZM Ltd, the courts restricted approach is continued in a case which

specifically involved a bank at the wrong end of shadow directorship allegations.

In fact, Judge Paul Baker QC stated that the bank could not be shadow director of a company even

though it took steps to recover, for instance, requesting information on the financial situation of the

company,19 its investments as soon as the company appeared insolvent.

2.2.Requirements

2.2.1 When has a company gone into insolvent liquidation?

Establishing the moment in which a company has gone into insolvent liquidation is the first

difficulty that an interpreter meets when he construes the proviso on wrongful trading. In particular,

while the concept of liquidation can be easily understood, the concept of insolvency is much more

problematic.

As regards the first concept, in the UK there are two types of liquidation: a) compulsory liquidation,

by order of the Courts (section 117 IA 1986) and b) voluntary liquidation, by resolution of the

company (section 84 IA 1986). In the latter case, the liquidation can either be i) a members'

voluntary liquidation (section 91 IA 198) or ii) a creditors' voluntary liquidation (section 97 IA

1986).

By contrast, the concept of insolvency is a controversial term. Notably, section 123 (1) IA 19886

embodies such concept in the phrase “inability to pay debts” and, two different tests of insolvency

are proposed to identify when a company is insolvent. ( 54,55)

19 [1995]2 BCLC 354 at 365 ff.7

According to the balance sheet test:56 that requirement is met if there is an excess of liabilities over

assets, thus, if the company's assets are insufficient to discharge its liabilities.

On the contrary, according to the cash flow test (or commercial insolvency test)57, it only matters

that the company is unable to pay its debts and liabilities as they become due.

By and large, Courts apply the cash flow insolvency test, taking the view that section 123 IA

(coupled with section 214) 60 is more concerned with the actual availability of assets for the

payment of debts than with the accounting entries in the company's balance sheet.

However, the company going into insolvent liquidation is only a necessary precondition for the

liquidator's application to the court. In succession, the point from which the director can be held

personally liable must be identified. Therefore, that requirement will be dealt with in the next

paragraph.

2.2.2. The point of time from which liability commences

The point of time from which the director must have known or ought to have concluded that

insolvent liquidation was unavoidable is certainly one of the most difficult elements to be proved in

a wrongful trading action. There are two different approaches on that requirement. According to a

restrictive approach, the point from which liability commences is when directors have to

acknowledge the inevitable.20 In particular, the liquidator is required to decide an exact point of time

and to stick to it in court. Notably, that view was taken in Re Sherborne Associated Ltd21 and in Re

Continental Assurance Company of London plc22.

According to a liberal approach, the liquidator is permitted to argue at trial for different points of

time than the one originally pleaded or the court itself can establish it. This view was taken in

several proceedings such as in Re DKG Contractors Ltd, in Re Purpoint Ltd and Re Brian D

Pierson.

20 T Cooke and A Hicks, “Wrongful Trading -Predicting insolvency”, [1993] JBL 338 at 33921 [1995] B.C.C. 40 at 4222 [2001] B.P.I. R. 733 at 766-767

8

The need of an appellate court decision on that point is stressed by Keay. That author wonders

which of the two approaches is preferable in terms of fairness and he tries balancing different

arguments.23

Firstly, he stresses that identifying the point of liability might well be an extremely difficult task.

Therefore, that fact might justify the courts’ power to find that the director was engaged in wrongful

trading in a time different by the one pleaded by the liquidator.24 Thus, contrary to what it has been

held in Re Continental Assurance,25 Keay states that the complexity of the case can be a reason for

allowing some leeway in the exercise of the Court power.

Secondly, Keay maintains that there is nothing in section 214 itself that suggests that a liquidator is

obliged to nominate a date and prove it. In fact, it is provided that “at some time before the

commencement of winding-up” the director must have known or ought to have concluded that

insolvent liquidation was unavoidable. Therefore, in the opinion of that writer ”it might seem fair

that a liquidator should not be confined rigidly to any date or period that is pleaded, assuming that a

court can find that the director did engage in wrongful trading before the commencement of

winding up.”

Moreover, it is added that Hazel Williamson Q.C., in Re Brian D. Pierson (Contractors) Ltd,

seemed to have shared such view. That judge qualified as an “absolute rigidity” linking the success

of the liquidator pleadings to the correct identification of the date in which the director should have

known that there were no prospect to trade successfully26. Hence, that judge stated that, generally

speaking, the liquidator should be allowed to sustain its case also in relation to the period shortly

after the date pleaded. More specifically, in Re Brian D. Pierson (Contractors) Ltd the liquidator

was permitted to show that the relevant time covered 47 days. 27

On the other hand, it is stressed that if the relevant period covers an unreasonable long time, the

director could not be able to prepare a proper defense. Thus, Courts have to take into account also

this due process consideration.

In the light of those arguments, Keay concludes that the liquidator has to identify a reasonable

period in length in which the director is suspected of engaging in wrongful trading. Particularly, the

length of the period pleaded has to be determined by the courts taking into account the merits of

23 A. Keay, “Wrongful trading and the point of liability”, [2006] Insolv. Int. 133 ff.

24 M. Simmons, “ Wrongful Trading” (2001) 14 Insolv. Int 12 at 13.25 [2001] B.P.I.R. 733 at 899. 26 [1999] B.C.C. 26 at 5027 Ibid., at 49

9

each case. Nonetheless, he goes on saying that, even though a judge finds that the respondent was

engaging in wrongful trading at a time before the one nominated by the liquidator, any contribution

order should only be based on the time pleaded by the liquidator. In addition, if it is found that the

respondent was guilty of wrongful trading at a point later than the period pleaded, the claim should

not be accepted.

2.2.3 The standards of skill and care

The standards of skill and care are established both by the Common Law and by section 214. The

Common Law imposes the fundamental obligations on a director to act in good faith in the interest

of a company and to exercise duties of skill and care. The standard required is that which may

reasonably be expected from a person with his particular knowledge and experience. Statute

imposes such obligations on directors as: to prepare and file annual accounts; to disclose to fellow

directors any personal interest which may conflict with that of the company and such like.

Section 214 makes clear that a person, who is a director or a shadow director of a company has to

have:

(a) the general knowledge, skill and experience that may reasonably be expected of a person

carrying out the same functions as are carried out by that director in relation to the company; and

(b) the general knowledge, skill and experience that that director has.

Several authors underline that this provision imposes an objective test, albeit with a subjective

element, on all directors for the purposes of wrongful trading. In particular,28 Doyle underlines that

the proviso represents a welcome and long-overdue move away from the traditionally subjective

criteria29 to ascertain the level of skill and care which may be expected of directors. Thus, as

remembered in DKG Contractors, the fact that knowledge, experience and skill might hopelessly

be inadequate is no more sufficient to protect directors from wrongful trading allegations. Notably,

according to Loose, Griffiths and Impey, section 214 (4) clearly imposes a duty to make the

necessary inquiries about the company’s affairs and to be constant viglant.30

The test to be applied by the court, according to what stated by Knox J. in Re Produce Marketing

Consortium, should judge the ability of any particular director in the light of the standard of what

28 L G. Doyle, “Anomalies in the wrongful trading provisions” (1992) Co Law, 96

29 Ibidem, 9830 P Loose, M Griffith D Impey, The Company Director (9th ed. 2007), 307-308 (henceforward, P Loose, M Griffith D Impey, The Company Director)

10

can reasonably be expected of a person fulfilling his functions and showing reasonable diligence in

doing so31. Moreover, that judge accepted the submission of the directors that, in order to establish

the functions of the directors, the particular company and its business must be taken into account.

So the general knowledge, skill and expertise postulated will be much less extensive in a small

company in a modest way of business than it will be in a large company with sophisticated

procedures.

Furthermore, according to section 214(4)(b ) the level of skill and care will be more onerous where

a particular director is endowed with a greater level of general knowledge, skill and experience than

may be expected of a director in his position as the case of a production director who is also an

experienced and qualified engineer.32 In addition, Doyle maintains that formal qualification is not a

pre-requisite for the imposition of a heightened level of performance. Therefore, “an enhanced level

of skill and care will be expected of a director who has, for example, considerable experience or

knowledge in a particular field albeit that it is not evidenced by appropriate formal qualification”.

Finally, it must be noted that the level of skill and care required to a director will also take into

consideration all those functions which were entrusted to him33, irrespective of whether or not he

carried them out personally. Consequently, Doyle avers that that proviso is very onerous for a

director as it imposes personal liability “for operations which, at least from a commercial point of

view, it may be prudent for him to delegate elsewhere”.

Another effect of section 214 (3) is to assume that all directors possess a certain level of knowledge

in relation to their company's activities irrespective of the relative simplicity or complexity of the

relevant accounting procedures applicable to the company.34Consequently, directors are required to

comply with all the accounting provisions set out in the 2006 Company Act, and, notably too keep

the accounting records, to prepare annual accounts and to lay them before the company in general

meeting and the Registrar of Companies. Therefore, the directors of companies encountering

financial difficulties have to ensure that the accounts are up to date. In fact, in Re Produce

Marketing Consortium (No 2) two company’s directors were condemned to paid £75,000 on the

grounds that they should have been aware that there was no reasonable prospect of the company

avoiding insolvent liquidation although the directors did not have the relevant accounts for the

suspected period.

In practice, it is possible that a company's board of directors will comprise of individuals of varying

standards of competence and performance and it is this fact which gives rise to an unresolved

31 As stated by Knox32 See R Pennington, Corporate Insolvency Law (1st ed., 1991) at 235 33 See P Loose, M Griffith D Impey, The Company Director, 30734 See Re Produce Marketing Consortium (no 2) [1989] BCLC 520 per Knox J. at 550

11

problem in relation to the defence afforded by s 214(3) to a director faced with an action for

wrongful trading.

12

2.2.4 Taking every step

Pursuant to subsection 3 of the wrongful trading provision and after the conditions set out in

subsection 2 are applicable, the court may declare the director to be personally liable to make such

contribution to the company’s asset unless: that person took every step with a view to minimizing

the potential loss to the company’s creditors as (assuming him to have known that there was no

reasonable prospect that the company would avoid going into insolvent liquidation) he ought to

have taken.

So directors of companies in financial difficulties have to decide to continue trading or to cease

trading and immediately enter into formal liquidation proceedings.

In order to continue trading, directors may consider that there is a reasonable prospect avoiding

insolvent liquidation. According to Oditah35, the phrase “reasonable prospect” because of its

elusiveness is likely to pose the greatest interpretation problem in the application of the new

provision and “the question remains whether reasonable prospects imports a fifty percent or more

chance or avoiding insolvent liquidation?”.36 Oditah also tries to answer several questions prompted

by the broad language of section 214 (7). In his opinion, directors will escape liability if they have a

genuine belief that a company could pay its debts in the future, provided the belief is reasonable in

the circumstances. As far as the reasonable length of time to escape liability is concerned in

Oditah’s view, it is a matter of conjecture because the Courts took different views in a number of

cases. Finally, according to Oditah, the problem whether directors can escape liability for wrongful

trading on account of sustained credit from its financier is unclear.

In some circumstances directors may decide to continue trading to safeguard the creditors’ interest.

In fact, as remember in Secretary of State for Trade and Industry v Taylor, “the company legislation

does not impose on directors a statutory duty to ensure that their company does not trade while

insolvent”.37 The decision to go on trading was also taken in cases such Re Continental Assurance of

London plc and, more recently, Brian D Pierson Contractors Ltd. In the first case, Park J rejected a

wrongful trading action and stated that directors had reasonable traded. The case under

consideration was about a small insurance company whose assets secured a bank loan. Continental

made trading profits for four years but large losses were reported in 1991. At a board meeting, the

executive directors revealed a disastrous financial result for the year ending on the 31 December

35 F Oditah,”Wrongful trading” 1990 LMCLQ 205 at 20736 Ibidem, 20837 [1997] 1 WLR 404, at 414

13

1991. Subsequently, the directors held other four board meetings and consulted a firm director and

the company’s auditors. It was decided on July 1991 that the company was still solvent and that it

should continue trading. However, on the 20 December 1991, the board was forced to accept that

the company was insolvent and could not continue to trade, but a formal resolution to put the

company into insolvent liquidation was only passed on the 27 March 1992. The liquidator then filed

a section 214 application against the whole board of directors. Park J found none of the directors

liable for wrongful trading because 1) the company was not insolvent on the 19 July 1991 and, 2)

assuming it was insolvent on that date, the knowledge needed to establish that that assumption was

“technically knowledge” of such a specialized and sophisticated nature that the directors could not

be reasonably expected to possess.38

In Brian D Pierson Contractors Ltd, Hazel Williamson Q.C. held the opposite view. She stated that,

in spite Mr Pierson outlined that at the 13th of June 1994, he could not be expected to have

concluded that the company was going into an insolvent liquidation, since the particular nature of

his industry he attributed the eventual downfall of the company mainly to bad weather conditions in

1994-1995. He said the account were not qualified, no-one neither his advisor, nor his formal

accountants, nor the bank had suggested, at or before the relevant time, that the company ought to

go into liquidation, or was in serious financial difficulties. Hazel Williamson, tough recognizing

that the combination of points the liquidator made were formidably, she maintained that it is easy to

be wise with hindsight. She also stated that the standard to be applied was that of the reasonable

prudent businessman, but she also gave a proper respect to Mr. Pierson’s evidence as to how his

industry operated.

38 [2001] BPIR 733 at paras 106, 109, 281 , 37814

Chapter 3

Other aspects of the application under section 214 IA and its criticism.

3.1. Amount of the contribution

The starting point for assessing the appropriate amount to be paid by the director is the difference

between the net assets of the company at the date that directors should not have traded beyond and

the net assets of the date of liquidation. The Court as a wide discretion and may award just a

percentage of this. For instance, it ordered to pay 75% of the drop in net assets in Re Brian D

Pierson (Contractors) Ltd.39 This was on the basis of the judge estimate that 70% of the drop in net

assets was due to the actions of the director and 30% be attributed to extraneous causes like bad

weather. Section 214(1) IA 1986 empowers the Court to declare anyone held liable under the

section to make “such contributions” (if any) to the company’s asset as the Court thinks proper.

Knox J considered the Court’s jurisdiction under section 214 to be primarily “compensatory” rather

than penal and that prima facie “the appropriate amount that a director is declared to be liable to

contribute, is the amount by which the company’s assets can be discerned to have been depleted by

the director’s conduct which caused the discretion to be exercised under sub-s (1) to arise”.40

Prentice held the way in which the Court should approach its jurisdiction under the section is to

treat the extent of liability as one based on causation, that is to what extent as the conduct of the

director caused loss to the company’s creditors.41 Knox J also indicated the factors which have to be

taken into consideration in determining the amount that the director should contribute: 1) that the

warning of the auditors of the dangers of continuing to trade was ignored; ii) the fact that any

contribution would go in the first place to satisfy the claims of the bank as a secured creditor and

correspondingly reduce the liability of the director on his guarantee to the bank, and iii) because the

bank as a secured creditor would be the first to benefit from any contribution, the court should

exercise its jurisdiction ‘in a way which will benefit unsecured creditors’”42.

39 [1999] B.C.C. 90340 Re Produce Marketing Consortium at 55341 D D Prentice,” Creditor’s Interests and Director’s Duties”, O.J.L.S. 27042 Re Produce Marketing Consortium at 554

15

In Re Purpoint Ltd, Vinellot J was faced with the problem of quantifying a wrongful trading loss in

a case characterized by virtually no company records. Vinelott J cut through the difficulty by

ordering the liquidator to calculate the total debts incurred, after the date in which the directors

should have realized that there was no reasonable prospect to avoid insolvency, and unpaid debts

when trading stopped.

In Re Brian D Pierson Contractor, Hazel Williamson QC ordered the executive director of the

company to make contribution to the assets of the company to an amount equal to 70 % of the loss.

3.2. How the wrongful trading allegation is funded.

The regulation on the funding of an application under section 214 is another hurdle to its recourse.

Contrary to the litigation under the disqualification provisions in which the public purse pays for the

cases, the initiative for a wrongful trading application has to be normally funded using available

assets of the company. The applications under section 214 are generally expensive and time

consuming. Therefore, as the company’s assets are already inadequate, the liquidator will often

have to resort to benevolent creditors or to get an indemnity from creditors. Consequently, he will

make a 214 application only if the defendant has enough assets to recover the loss attributable to the

wrongful trading and there is an open evidence that wrongful trading has taken place.

Moreover if the liquidator’s claim is struck out, the burden of any costs orders are made against

him. Nonetheless, those expenses will have to be met by the creditors but will not benefit from the

super-priority accorded to the liquidation expenses.

3.3. Criticism of wrongful trading

Broadly speaking, the academic literature welcomes the departure from the test of dishonesty

required under the fraudulent trading provision.43 In fact, the introduction of the proviso on

wrongful trading is seen as a radical change as far as the privilege of limited liability is concerned.

43 See Carol Cook16

Nonetheless, several authors cast doubt on the effectiveness of that new provision. Particularly, that

criticism is founded on two cases, RE M.C. Bacon Ltd (No 2) and Re Oasis Merchandising Services

Ltd.

In the former case, the liquidator pursued a speculative action under section 214.44 The action was

unsuccessful and the liquidator was ordered to pay costs. When he sought to recover those costs

from the company’s asset, the court held that they were not “expenses properly incurred in the

winding up” since an action under section 214 was not “asset of the company”. The effect of that

provision was that the liquidator was not under a duty to consider an action in the interests of

creditors.45 In fact, the liquidator's function is to secure, realise and distribute only the assets of the

company. Thus, any claim the liquidator had for costs following an application under section 214

rank with unsecured creditors.

In the latter case, the liquidator sought to get around the deadlock presented in Re M.C. Bacon Ltd

by selling the section 214 action and in so doing to transfer the associated risk of costs. At the same

time making the creditors benefit from the action. The Court of Appeal, although generally enabling

that particular transaction, held that in the case under consideration, the operation had to be avoided

as it gave to the buyer of the action an inadmissible power to interfere in the exercise of the

liquidator’s power.

Numerous authors aver that those decisions represent a serious barrier to the satisfaction of the

creditors’ expectations: it is maintained that the greatest hurdle to the potency of the wrongful

trading provision lies, in turn, on the regulation of who can invoke the section and the lack of

flexibility in relation to the beneficiaries.46 By contrast, on the one hand, RE M.C. Bacon Ltd (No 2)

case disincentives the liquidator to file an application under section 214 as it will have to use its

personal assets to pursue the interests of the creditors. In addition, the liquidator will have, in the

insolvency distribution of the company’s assets, the same position of unsecured creditors. On the

other hand, Re Oasis Merchandising Services Lt diminishes the possibility to sell the proceeds of an

action under section 214.

In the opinion of the present writer that criticism makes a good point. In fact, the limitation of the

liability of the directors, so as to protect free enterprise, cannot justify an absolute impunity and

44 [1991] Ch 127

45 Cf. R Schulte, “Wrongful trading: an impotent remedy?” 1996 J.F.C., 4(1), 38 at 39

at 3946 F Didcote, “Controlling the abuse of limited liability: the effectiveness of wrongful trading provision” 2008 I.C.C.L.K 19 (12) 373 ; Carol Cook, R Schulte, Wrongful trading: an impotent remedy?” at 39

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leave out of account the creditors’ interest. Therefore, it is submitted that section 214 should be

emended in the light of the above mentioned suggestions. Moreover, in my opinion, an application

under section 214 should be funded by the public purse, along the light of the Company Directors

Disqualification Act (CDDA) 1986, every time that claim is prima facie relevant, but the assets of

the company were totally depleted by the conduct of the directors. In fact, that would be an

important and effective restraint on the unreasonable exercise of the power to manage the company.

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Conclusion

In this paper, it has been strived to show that, on balance, the proviso on wrongful trading has not

substantially improved the position of an incorporate company creditors. In fact, that piece of

legislation has been applied only in few cases and very often the liquidator’s application was

dismissed.

That proviso has been analytically analyzed. In the opinion of the present writer, the strict

requirements pose at the base of the liability are justified in the light of the social value of the

principle of free enterprise. However, two weaknesses have been underlined in the regulation of

wrongful trading.

Section 214 has been firstly challenged since it cannot be easily applied to the person (natural or

artificial) “who lurks in the shadow“ and substantially manages the company. Particularly,

according to the most recent cases on that matter, it has been showed that the former has to deprive

the directors of the latter of all their directors power.

Subsequently, it has been added that the regulation on wrongful trading does not foster its actual

use. In fact, only the liquidator has exclusive locus standi although he will have, in most cases, no

interest in bringing that action. Consequently, a reform of section 214 has been advocated along the

light of the CDDA 1985. In that way, the wrongful trading cases which are prima facie relevant will

be funded with public money and the directors of the company could not escape liability because

they company’s assets have become empty coffins.

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