PROVING THINGS 7: IF YOU DON’T PROVE A LOSS YOU DON’T GET AN ORDER: DIRECTORS DON’T HAVE TO CONTRIBUTE

This occasional series on the need to prove matters by evidence has covered a wide range of cases.  Today we consider company law and insolvency.  In Grant -v-Ralls [2016] EWHC 243 (Ch) Mr Justice Snowden rejected a claim by liquidators against the directors of an insolvent company. The basic issue is now familiar to us: a failure to prove a loss.

  1. I regret to say that a good deal of the written and oral evidence on both sides was tainted by a desire of the witnesses to argue the case for one side and to shape their evidence accordingly. This tendency was accentuated by an obvious hostility between the Directors on the one hand and the Joint Liquidators on the other, which had either spread to, or originated from, a manifest antipathy between solicitors and counsel. The unfortunate result was that the parties and their advisers tended to expend a good deal of effort engaging in argumentative skirmishes, often on peripheral factual matters going largely to credit, with the result that much of the live evidence and cross-examination generated far more heat than light.”

KEY POINTS

  • There had been wrongful trading by directors who were, potentially, liable for an order that they contribute to the company.
  • There was, however, no evidence that the period of wrongful trading had increased the company’s overall debt.
  • The judge, therefore, declined to make an order.

THE CASE

The claimant liquidators brought an action under section 2014 of the Insolvency Act seeking a declaration that the directors of an insolvent company were liable to make a contribution to the company’s assets. The applicants’ case was that by about July 2010 or 31 August 2010 the directors should have ceased trading immediately.

THE EVIDENCE

The case is an interesting read from the point of view of assessing witness evidence generally. The judge did not form a wholly favourable view of the evidence of the directors.

  1. Mr. Hailstones Mr. Hailstones gave the fullest witness statement of the Directors and was advanced as their main witness. That responsibility probably contributed significantly to the manner in which he gave his evidence. In my judgment Mr. Hailstones was well aware throughout cross- examination of the implications of what he was being asked and what he was saying, but when it suited him he sought to pretend otherwise. This led to him being at times defensive and evasive, to suggesting that he was not good with details or numbers and that he would have been largely reliant on the other Directors or Mrs. Warman, or indicating that he did not follow the questions he was being asked. On occasions, he gave answers that I think were simply untruthful.”

THE FINDING AND THE EVIDENCE

The judge found that the directors had caused the company to wrongfully continue trading after 31st October 2010 until 13 October 2010.
  1. I therefore turn to consider whether the Joint Liquidators have established that the continued trading by the Company after 31 August 2010 until 13 October 2010 caused a loss to the Company.
  1. I start by noting that the amounts claimed in the Schedules to the Points of Claim were not limited to loss caused to the Company by the wrongful trading. As I have indicated, the claim made by the Joint Liquidators in respect of the period from 31 August 2010 to 13 October 2010 was originally put at £1,045,040. The equivalent claim that was originally made for the period from 31 July 2010 to 13 October 2010 was £1,137,611.51. If these figures were supposed to represent the loss to the Company from continued trading over the two periods, the logical deduction from these two figures would be that trading during August 2010 caused only a small loss to the Company of under £100,000, but that trading for the remainder of the period from 31 August 2010 to 13 October 2010 caused a very substantially greater loss of over £1 million. That would be a very surprising result.
  2. The point was put to Mr. Lowry, the Joint Liquidators’ expert in cross- examination, and he accepted that these figures were not simply statements of the loss to the Company caused by the wrongful trading over the two periods. He accepted that they included losses caused by the process of ceasing to trade and/or realising the assets of the Company (i.e. its debtors),

“Q. Yes. What I suggest to you is that — appendix B … calculates the loss that is being claimed against my clients at over £1 million for a period of about six weeks.

A. Yes.

Q. So the liquidators are asking the court to infer that the company lost over £1 million in that short period of time.

A. No, this is not to do with trading loss. This is not a loss. This is how the creditors as a body have lost out, not how the company has lost – and that’s to do with realisations.

Q. Right, okay. So you accept that the company did not lose £1 million as a result of continued trading between 1 September and 13 October; correct? (Pause)

A. I do accept that.

Q. The calculation of loss therefore is a loss that is largely derived from the cessation of trading; correct?

A. It is derived from the realisation of the debtors.

Q. And the impact of ceasing to trade on the recovery of debtors?

A. That may well be an ingredient. But the loss — you can have a trading loss if the debtors don’t pay. You are linking the two, and logically I’m sort of meeting you on it. If the company continued to trade and no one had paid them, they’d have made a loss. They didn’t continue to trade and a few people didn’t pay them, so there was a loss. I don’t know what would have happened on a going concern basis.

Q. Right. I think the principle between us is accepted, but what you’re saying is you can’t confirm precisely what element of the loss of over £1 million was caused by the decision to cease trading, and what element was caused by a decision by a debtor not to pay. Correct?

A. Yes.”

  1. For the reasons which I have explained, I do not think that this is an appropriate basis for quantification of a claim under section 214(1). I do not think that this position was altered when the Joint Liquidators recast the figures in the Schedules to the Points of Claim in an amended format at the start of the trial. The revised format resembled a pair of abbreviated balance sheets which were said to show an increase in the net deficiency of the Company. Those balance sheets were as follows:
  As at 31/8/2010 As at 13/10/2010
As at 13/10/2010 £ £
Assets    
Plant etc 33,000 33,000
Contract debts 1,306,349 577,108
Retentions 75,775 75,775
Cash at bank       –         24,330  
  1,415,124 710,213
Liabilities    
Bank overdraft 530,201
Trade creditors 1,597,037 2,197,559
VAT 156,576 117,764
PAYE/NIC 192,398 318,205
Corporation tax 32,985
Employee claims   96,133     96,133  
  2,572,345 2,762,646
Net deficiency (1,157,221) (2,052,433)

Increase in net deficiency = £2,052,433 – £1,157,221 = £895,212.

  1. Those balance sheets were criticised by Mr. Fanshawe for a number of reasons. First, he pointed out two corrections to the figures which were accepted by the Joint Liquidators: the figure for VAT as at 31 August 2010 should have been £125,744, and the figure of £32,985 for corporation tax should have appeared in both balance sheets.
  2. Secondly, and more importantly, Mr. Fanshawe pointed out that the stated value of the contract debts as at 31 August 2010 was in fact simply the amount of cash received by the Company between 1 September 2010 and 13 October 2010 (£1,306,349); and that the figure used for the value of the contract debts as at 13 October 2010 was the amount recovered from the contract debts (including retentions) in the administration/liquidation (£577,108). He suggested that whether or not such cash receipts could properly be said to reflect the value of the contract debts, those two amounts were not presented on a consistent basis, because they represented the realisations of debts under very different circumstances – i.e. one whilst the Company was still trading (referred to as a “going concern” basis) and the other in the administration (a “gone concern” basis).
  3. Mr. Fanshawe suggested, and I accept, that even though the Administrators engaged specialist quantity surveyors to assist them in the recovery of the Company’s debts, the level of recoveries made from debts owed to the Company after it went into administration is very likely to have been significantly affected by the very fact that the Company had ceased to trade and entered a formal insolvency process. It is, indeed, notable that the Administrators’ Statement of Affairs showed the contract debts at a book value of £1,679,000 (including retentions) but estimated that the recoveries in the administration would be between £360,000 and £625,000. In fact, the contract debts realised about £577,000 (excluding retentions).
  4. Mr. Fanshawe’s primary contention was that the figure of £1,603,000 from the Statement of Affairs should have been used for the contract debts (excluding retentions) in the balance sheet as at 13 October 2010 so as to eliminate the effects of the Company going into insolvency on the collection of the debts (the “going concern” basis). Alternatively (though not as his preferred solution) he was of the opinion that the figure of £1,306,349 for contract debts as at 31 August 2010 should be discounted by the same proportion as actually achieved for recovery of the contract debts in the insolvency – i.e. by a factor of 577,108/1,603,000 = 0.36 (a very similar factor of 0.39 was also mentioned in the evidence). On that basis the value of the contract debts on a “gone concern” basis at 31 August 2010 would have been about £470,000.
  5. The same point was made in a different way by Mr. Boardman in his closing submissions. He submitted that the effect of what the Directors did during September was to keep the Company trading whilst the Bank managed the account, approving only certain payments out of the account while reducing the overdraft. In doing so, the Bank was effectively paid from contract debt realisations over which it had a fixed and floating charge. This, he said, was to the benefit of creditors as a whole, because if the Company had gone into liquidation at an earlier date the Bank would still have had to be repaid the overdraft, but from much lower realisations of debts made on a ‘gone concern’ basis. Assuming the same rate of realisations that actually occurred (of 0.36 or 0.39), the repayment of the Bank’s overdraft of £530,000 as at 31 August 2010 would have required about £1.47m in book debts; but by continuing to trade the Company realised its book debts on a going concern basis without any such discount and was able to repay the Bank and achieve a surplus to benefit the unsecured creditors.
  6. There is much force in this point, and I accept that for consistency, the figure for contract debts in the Joint Liquidators’ balance sheets as at 31 August 2010 and 13 October 2010 should have been included on the same basis in each.
  7. As regards the liabilities side of the balance sheets, Mr. Fanshawe suggested that the actual figure for the trade creditors admitted to proof in the liquidation (£2,001,000) should be used in the balance sheet as at 13 October 2010 rather than the £2,198,000 shown in the Company’s SAGE records. I do not accept Mr. Fanshawe’s suggestion in this respect. The difference (about 9%) doubtless reflects the inevitable fact that some creditors simply do not prove in an insolvency, but I do not see why the lower figure admitted to proof in the liquidation should be used if the balance sheet is being drawn up on a “going concern” basis. I can, however, see that, by parity of reasoning with Mr. Fanshawe’s point about drawing up accounts consistently to eliminate the effect of insolvency, if the balance sheets are being prepared on a “gone concern” basis, a similar reduction (of 9%) should be made to the trade creditor figure as at 31 August 2010.
  8. If these adjustments are made to the Joint Liquidators’ balance sheets, the result is that on a “going concern” basis, the net deficiency of the Company was actually reduced from a deficit of £1,159,374 to £1,026,541 by the continued trading between 31 August 2010 and 13 October 2010. In other words the Company’s net position improved by about £132,833 over the period. If calculated on a “gone concern” basis, including a reduction in the trade creditors as at 31 August 2010, the net deficit would have been very slightly increased by about £3,885 from a deficit of £1,851,989 to £1,855,874 over the period.
  9. I accept that neither Mr. Fanshawe’s adjustments nor Mr. Boardman’s submission as regards the recovery of contract debts are likely to be entirely accurate, because they both assume that the make-up of the debtor book was the same at 31 August 2010 and 13 October 2010. That is unlikely to be the case, since the actual debtors were different and it is likely that the contracts were at different stages of completion. I did not have any satisfactory evidence of this (the point was briefly addressed by Mr. Lowry in cross- examination but not dealt with in the expert reports) and hence I cannot reach any firm conclusions. But even taking this point into account, what Mr. Fanshawe’s analysis of the Joint Liquidators’ figures shows is that it is entirely possible that the continuation of trading between 31 August and 13 October 2010 did not increase the net deficiency of the Company by any, or any material, amount.
  10. Apart from this work done on the Joint Liquidators’ figures in their claim, the experts were not able to reconstruct an accurate balance sheet for the Company at 31 August 2010 which could be compared with the deficiency in the Administrators’ Statement of Affairs as at 13 October 2010.
  11. However, as I have indicated, Mrs. Warman did produce management accounts to the end of August 2010 from the SAGE records of the Company for the Bank in early September 2010. These were only obtained from the Bank and disclosed by the Joint Liquidators to the Directors on 2 June 2015. Such management accounts are, of course, also subject to the difficulty that it was common ground between the parties and the experts that the SAGE records were, by themselves, not capable of producing a complete and accurate set of accounts for the Company at any point in time, but needed to be adjusted.
  12. Nonetheless, in cross-examination, Mr Fanshawe told the Court that he had briefly undertaken the same kind of reconciling analysis he had done for the accounts produced at the end of July 2010 and considered that, while the debtors and creditors position were each overstated, the overstatements cancelled each other out and the net deficiency of £705,000 shown in those accounts was about right. Mr. Fanshawe also said that if he was comparing the August 2010 management accounts deficiency with the Statement of Affairs deficiency of £884,000 (on a book value basis) he would need to remove the employee claims of £129,000 in respect of redundancy and notice, giving a deficiency of about £750,000. On that basis, Mr. Fanshawe’s evidence was that the continuation of trading after 31 August 2010 would have worsened the net deficiency as regards unsecured creditors on a “going concern” basis by about £45,000.
  13. Having regard to the range of figures to which I have referred above, which range between an improvement in the position of the Company by a reduction in the net deficiency of about £132,833 to an increase in the net deficiency of £45,000, I am not satisfied on the balance of probabilities that the continuation of trading by the Directors after 31 August 2010 caused any, or any material, increase in the net deficiency of the Company. In my judgment, if anything, the figures suggest that the continued operations of the Company until 13 October 2010 produced a modest improvement in the net deficiency of the Company.
  14. The Joint Liquidators submitted that it is simply not credible that the position for creditors as a whole could have improved over the period of wrongful trading. They point out that the Company made a substantial loss in the year ending 31 October 2009 and had continued to make losses in the nine months until 31 July 2010, and suggest that it is implausible that this trend could have reversed during August, September and October.
  15. I do not accept those submissions. I have already indicated that there are real reasons to believe that a period of continued trading to complete existing contracts during the busy summer months is likely to have produced a significantly better result for the Company as a result of the enhanced collection of contract debts than would have occurred if there had been an immediate cessation of trading.
  16. Nor do I think that it is incredible that trading during that period could not have produced a net profit or broken even. I have indicated above that the background is that the Company’s financial difficulties in the year to 31 October 2009 were substantially aggravated by the very large provisions made in the accounts for that period which recognised the losses caused by the irrecoverable payments to Fareham FC in earlier years, together with problems caused by the defective wall-ties. The problems were aggravated by the harsh winter of 2010. But these were abnormal factors and extraordinary items in the accounts and did not suggest that the Company’s business was inherently incapable of trading at a net profit.
  17. There is also contemporaneous evidence (including the evidence and projections from Mrs. Warman) which indicates that the Company put measures in place to reduce overheads, and produced detailed projections showing that the Company’s trading between August and October 2010 was anticipated to be profitable. And whilst Portland did not verify the figures produced by Mrs. Warman, Mr. Tickell’s letter of 6 August 2010 did not express any surprise at the suggestion by the Directors and Mrs. Warman that the Company was trading profitably at the time. Nor, when Mr. Tickell was instructed again on 24 September 2010, and inquired far more closely into the state of the Company and continued operations continued for several weeks under his guidance, did Mr. Tickell advise an immediate halt to trading.
  18. Further, although Mr. Tickell expressed concern on 8 October 2010 that there might be a wrongful trading claim, that concern was based upon the fact that the debt to the Bank had been replaced by an equivalent amount of about £0.5 million owed to new creditors, rather than a concern that trading in the interim had been loss-making or had worsened the position of the Company overall. There is also nothing in the Administrators’ proposals to which I have referred in paragraph 159 above to suggest that the Company’s trading during the period immediately preceding the administration had been loss-making.
  19. I also reject the Joint Liquidators’ alternative submission that I should order a contribution based upon the increase in trade creditors over the relevant period. I do not think that the shortcomings that have been identified in the Company’s management accounts produced directly from the SAGE records, or indeed in the Company’s accounting systems more generally, mean that I should simply order the Directors to make a contribution to the Company’s assets equal to the aggregate increase in the purchase ledger over the period from 1 September 2010 to 13 October 2010 of about £600,552.
  20. The reasons for which such a course was adopted in Re Purpoint and Re Kudos were markedly different from the facts of the instant case. In both those cases, there was simply no attempt to maintain proper accounting records upon which any form of accounts could be produced or reconstruction could be attempted. In Re Purpoint, no accounts had ever been produced, and Vinelott J described the accounting records as “exiguous”. He indicated that the only documents available consisted of bank statements, a wages book and a cash book: [1991] BCC 121 at page 123C. In Re Kudos, although accounts appear to have been prepared for earlier periods, the director gave evidence uncorroborated by any documents that he had “tried to keep a sales-type book on his personal computer” and that he “was aware of the general overheads of the company and the wages and salary costs”: [2011] EWHC 1436 (Ch) at paragraph 37.
  21. Further, in both cases it was clear that throughout the relevant period of wrongful trading, the company in question was making heavy losses rather than engaging in profitable trading. In re Purpoint, Vinelott J expressed the view that it was doubtful that a reasonable director would have allowed the company to commence trading at all due to its lack of a capital base and the fact that it had inherited a loss-making business from another company that had failed. And in re Kudos, it was found as a fact that the company was never in a position to fulfil the relevant contracts for which substantial pre- payments had been made; that those monies had been largely dissipated to the directors; and that the company did not derive any significant profits from other activities.
  22. In the instant case, in contrast, the Company had an accounting system which was operated by a number of staff and overseen by Mrs. Warman. It is certainly true that criticism can be made of the manner in which accounts produced directly from the SAGE system were not reliable and would have to be manually adjusted by Mrs. Warman. I also accept that it is not satisfactory that no accurate management accounts were produced which show the position of the Company as at 31 August 2010. But a claim for wrongful trading is not designed to penalise directors for keeping inadequate accounting records. Further, I do not think that it would be appropriate simply to resort to the increase in trade creditors in circumstances in which that increase in the Company’s debts was off-set to a significant extent by the repayment of other liabilities of the Company to the Bank.
  23. There was, in any event, a material objection by the Directors to the Joint Liquidators’ use of the increase in the trade creditors shown in the Company’s purchase ledgers between 31 August 2010 and 13 October 2010. The Joint Liquidators’ use of the purchase ledger in that way presupposed that all such entries on the purchase ledgers between the two dates represented new credits incurred during the same period. However, the Directors’ expert witness, Mr. Fanshawe, gave evidence that from his work he had ascertained that the Company’s accounting process was to post liabilities on its purchase ledger on receipt of an invoice from the supplier. He had conducted an analysis of the creditor balances of over £10,000 on the ledger as at 13 October 2010, and had found that of a total of £921,151, about one half (£452,839) were the result of a commitment to buy entered into before 31 July 2010, about one quarter (£231,058) were entered into after 31 July 2010, and the origins of the remainder could not be ascertained. It must, I think, follow – and I did not understand Mr. Lowry to dispute – that the increase in the purchase ledger balance reflects the timing of entries on the Company’s accounting systems, and does not accurately correspond to the amount of new credit incurred between those two dates.
  24. Standing back, whatever other criticisms can be made of the manner in which the Directors conducted the business of the Company between 31 August 2010 and 13 October 2010, I think it is entirely plausible that such continued activity did not cause loss to the Company overall or worsen the position of the creditors as a whole. The real sin of the Directors, so far as the unsecured creditors left in the liquidation are concerned, is the manner in which the continued trading facilitated the repayment of the Bank and some existing creditors whilst leaving new creditors unpaid. I have already indicated my view that this is not something that the Directors ought to have permitted to occur, but for the reasons I have explained, I cannot see that it justifies a contribution to be made to the assets of the Company under section 214(1). That may be thought to be a shortcoming in the structure of section 214, but I do not think it is one that I can remedy: any such change would be for Parliament.
  25. For these reasons I do not intend to make a declaration under section 214(1) requiring the Directors to make any contribution to the assets of the Company in respect of any losses said to have been caused to the Company during the period of wrongful trading.

RELATED POSTS

The “proving things” series

Proving damages

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