Central to company law is the concept of the "corporate veil". Once a company is incorporated, it is an artificial legal person totally distinct from those who run and own it. Every law student is familiar with the case of Salomon v Salomon & Co Ltd which first laid down this concept.
Having said this, there are a number of instances where either the Companies Act, the Insolvency Act or case law requires or permits the corporate veil to be pierced. One such area is in respect of wrongful trading by directors.
A director can be held personally liable for wrongful trading under section 214 of the Insolvency Act. This is trading the company on beyond the point of no return. Here, two pieces of forensic evidence from accountants is critical for any liquidator considering pursuing such a claim:
- First, there must be established a date at which the directors should have realised that the company had reached the point of no return, in other words a date when they should have realised that the company had no reasonable prospect of avoiding an insolvent liquidation.
- Secondly, there must be established the downturn suffered by the company from that date.
The number of wrongful trading cases which actually get to court are perhaps surprisingly few. In part, this is because the action has to be brought by a liquidator who will, almost inevitably, be bringing the proceedings from a point of weakness. The more insolvent the company, the less money the liquidator will have to commence proceedings against delinquent directors. Moreover, there is little or no incentive for a creditor who feels they have been particularly prejudiced by the wrongful trading to offer to fund the proceedings because any recovery made by the liquidator goes into the pot for creditors generally as the court has no power to target the award in the direction of a specific creditor.
However, the Court of Appeal has recently recognised the possibility of a creditor suing a director and recovering for their own benefit. This can be viewed as a potential alternative to a wrongful trading action. The right arises under a little used statutory provision from the early nineteenth century. Section 6 of the Frauds (Amendment) Act provides that:
The language is archaic and is certainly not easy to understand. Nor is it helped by being expressed in the negative. However, when it is changed into the positive, its significance becomes more apparent. It then says that an action may be brought:
- against a person who has made a representation in writing
- as to the ability of another person
- to pay for goods or credit supplied to that other person.
In Contex Drouzhba Ltd v Wiseman, the Court was faced with the following facts:
- Wiseman, a director, signed on behalf of their company a document which contained a promise that the company would pay for goods to be ordered in the future.
- The trial judge found that, as a matter of fact, the company did not have the capacity to pay, nor had it any realistic chance of gaining that capacity.
It is settled law that a director cannot avoid liability for their own wrongdoing by claiming they were merely acting on behalf of their company. Accordingly, the director was not able to defend the claim on the basis they had signed the document on behalf of the company rather than in their own personal capacity. Against this background, the Court of Appeal found the director to be personally liable for their own wrongful deceit.
Why is this case significant?
This is a useful case and a potential alternative for insolvency practitioners and creditors to consider in respect of wrongful trading actions. Sellers might even consider asking the directors of a company buying goods or services from them to write a letter confirming the ability of the company to pay for whatever is ordered. Then, in the event of the company being unable to pay, the directors could be personally sued.
We have a long history of advising on insolvency law issues and assisting those involved in, or affected by, insolvency issues. If you have an insolvency issue and would like to contact us - we would be happy to share our wealth of expertise in this area. So please do feel free to contact me on 01908 660966 or by e-mail at Christopher.Buck@franklins-sols.co.uk.