Ê

 

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 wrongfultrading (section 214). The enactment of that measure
was advocated to maintain the necessary balance between encouraging entrepreneurial growth in
society and discouragement of ³downright´ irresponsibility. In particular, that proviso was aimed at
ensuring that ³those [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•
 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 ³The Cork Report´
2
C Cook, ³Wrongful trading ± Is it a Real Threat to Directors or a Paper Tiger?´ 1999 Insolv Law. 99
3
A Keay, ³Wrongful trading and Liability of Company Directors: A Theoretical Perspective´ (2005) 25 L.S. 432 at 442
c
 




   
 




   

The fraudulent trading provision of the Company Act 19484 established a strict standard of proof
that ³any business of the company has been carried on with the intent to defraud´5requiring 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 ordernot to fall with this provision, a positive involvement in the company¶s affairs is required as
it was stressed in ÿ 
     •       7 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 ÿ   ••.8 In fact although a director of a family company left its running
in the hands of his parentshewas 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 ÿ   ••   
    , in ÿ  
   
and also in ÿ 
 . 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
for distribution amongst all creditors, an individual creditor could sue and the courts could order

4
Art 332
5
Section 213 (1) IA 1986
6
Patrick and Lyon Ltd, Re [1993] Ch. 786
7
[1971] 3 All.E.R. 363
8
[1985] PCC 87
9
[1932] Ch 7
10
[1933] 1 Ch 786
11
[1987] PCC 313
½
compensation payments to him as in ÿ     12. 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.

c½
c
  

£






  

     



 


  



   
 
Ê


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.13Last 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);

c£
³The Cork Report´
 c
cÔ
³The Cork Report´
 c£
c
³The Cork Report´
 cÔ
Ô
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.


  



   
 
  

Section 214 openly states that it applies not only to  ! 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   ! , but also   "
 as it
will be immediately showed) are accustomed to act. Moreover, in the decision  #  $
,16 it was held that section 214 also applies to  "
 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.

c
c

Ô 
c£
c
 

As it has already been underlined, section 214 can apply to shadow directors, only if the  "
 
and    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
 • 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   !
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 ÿ 


(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, ³Shadow directors and wrongful trading´ 1995 Co Law 16 313 ff

Moreover, according to Bhattacharyya that position is now strengthened by the decision in
ÿ  . 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,ÿ  %&

, 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.

  



 


 
 


 

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 ³inability to pay debts´ and, two different tests of insolvency
are proposed to identify when a company is insolvent. ( 54,55)

c

c

½  £Ô  £ 

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.

 

   

  

The point of time from which the director must have known or ought to have concluded that
insolvent liquidation was unavoidableis 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. 20In 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 ÿ '   (
  )and in ÿ 
   •(
 * "  *•
))

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 ÿ  +,  
  , in ÿ  *   and ÿ    
 

20
    
   
   !
c

£ "  ££  ££

21
c

  Ô  Ô½
22
½ c 
# $ ££  

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.24Thus, contrary to what it has been
held in ÿ    •(
,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 ³at 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 ÿ    # 
 $-seemed to
have shared such view. That judge qualified as an ³absolute 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 ÿ    # 
 $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
 %
  & !
½  # # c££ 
24
M. Simmons, ³ Wrongful Trading´ (2001) 14 Ê •Ê12 at 13.
25
[2001] B.P.I.R. 733 at 899.
26
[1999] B.C.C. 26 at 50
27
Ê - at 49

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.

 




 

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
criteria29to ascertain the level of skill and care which may be expected of directors.Thus, as
remembered in +, 
 , 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. ÿ   

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

28
L G. Doyle, ³Anomalies in the wrongful trading provisions´ (1992) Co Law, 96
29
Ibidem, 98
30
P Loose, M Griffith D Impey, The Company Director (9th ed. 2007), 307-308 (henceforward, P Loose, M Griffith D
Impey, The Company Director)
c
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)( ) 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.32In addition, Doyle maintains that formal qualification is not a
pre-requisite for the imposition of a heightened level of performance. Therefore, ³an 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 provisois very onerous for a
director as it imposes personal liability ³for 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
ÿ  

     #. )$ 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.

31
As stated by Knox
£½
 $

& #  'c  
c

c(  ½£
££


) * + #&
 & +
£ 
£Ô
 $
  )  ' ½( c

  ½ & %, "  
cc
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
problem in relation to the defence afforded by s 214(3) to a director faced with an action for
wrongful trading.

c½
 
  


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 ³reasonable prospect´ because of its
elusiveness is likely to pose the greatest interpretation problem in the application of the new
provision and ³the question remains whether reasonable prospects imports a fifty percent or more
chance or avoiding insolvent liquidation?´.36Oditahalso tries to answer several questions prompted
by the broad language ofsection 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 '
  "' "  Ê• -³the company legislation
does not impose on directors a statutory duty to ensure that their company does not trade while
insolvent´37The decision to go on trading was also taken in cases suchÿ    •(
p

pp
 and, more recently,     
 . 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

£
- . 
!  ! c

)/ ½   ½ 
£
# 
½ 
£
c

 c $ Ô Ô
 ÔcÔ
c£
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 20December 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 19July 1991 and, 2) assuming it
was insolvent on that date, the knowledge needed to establish that that assumption was ³technically
knowledge´ of such a specialized and sophisticated nature that the directors could not be reasonably
expected to possess.38

In     
 - 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.

£
½ c
#$ ££  &c 
c

½c
£
cÔ
 







 




    
 

Ê









 

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 ÿ    
 # 
 $.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 ³such 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 ³compensatory´ rather
than penal and that * "
³the 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 µin a way which will benefit unsecured creditors¶´42.

£

c


 
£
Ô
$
  )   £
Ôc
+ +

!    #  +  +!
." ½
Ô½
$
  )   Ô
c
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 ÿ        
 - 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.

!
 

 
 

   

‘
‘
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 anopen 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.


 

 

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 Cook
c
Nonetheless, several authors cast doubt on the effectiveness of that new provision. Particularly, that
criticism is founded on two cases, ÿ
 
  #.  )$and ÿ  / 

  
' 


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 ³expenses properly incurred in the
winding up´ since an action under section 214 was not ³asset 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 ÿ 
 

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 theexercise 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. 46By contrast, on the one hand, ÿ
 
  #. 
)$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, ÿ / 

  ' 
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, ³Wrongfultrading:animpotentremedy?´ 1996 J.F.C., 4(1), 38 at 39
at 39
46
F Didcote, ³Controlling the abuse of limited liability: the effectiveness of wrongful trading provision´ 2008 I.C.C.L.K
19 (12) 373 ; Carol Cook, 46 R Schulte, Wrongfultrading:animpotentremedy?´at 39
c
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* "
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.

‘ ‘

c
   

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) ³who lurks in the shadow³and 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 •
 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 * "
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.

c

å
 

*  
      ! c

   c £c£ 

 
   0 #   $   +  
& 
! c


# 



    
   
   !
c

£ "  ££

%  '(

#   & 1 &   $ 
 
c
½

- + 
      1       &! ½ 
#% c
'c½( ££

 * + 
      &! 'c

½(  

 

 %
      & +1  
&! '½ ( ½  Ô£½

 %
  & !
½  # # c££ 


) *  + #&
 & + '
   ½ (

- . 
!  ! c

)/ ½  

$

& #  'c  
c

c(

+ +

!    #  +  +!
." ½

$ 
[
 


  c
‘c ‘


) 
   ! '½ c( cÔ Êp Ê
c½