Insolvency Act – a guide for claims against directors and other parties

When an individual or a business is unable to pay bills from its debtors or has more liabilities than assets on its balance sheet, it can enter insolvency proceedings which are the formal steps taken to resolve the debt.

Upon insolvency, appointed liquidators and administrators can levy various applications against company directors or recipients of company money, the consequences of which can be significant.

Successful applications can result in imprisonment of up to ten years; an unlimited fine; an order to repay creditors or disqualification for directors; or repayment of funds or reversal of transactions for recipients of company money.

We examine the investigative tools available from The Insolvency Act 1986 (‘the Act’) which can lead to significant financial recoveries, as well as the available defences.

When can claims against directors or recipients of company money be made?

Insolvency act claims can generally only be made once a company has entered insolvency proceedings and is no longer actively trading.

Applications should ideally be made as promptly as possible to avoid loss of records, fading witness memory or assets being dissipated.

The court has wide discretion and may grant interim orders including:

• Disclosure orders, which require individuals to provide documents or information, such as financial documents or correspondence.
• Examination orders, which compel directors or third parties to answer questions under oath.

What type of claims can be made under the Insolvency Act 1986?

There are a range of claims that can be made under the Act. Which one is applied is determined by the conduct and demonstrable intention of company directors or recipients of company money during the relevant period. Claims can include:

Wrongful Trading

• This is a claim against directors who continued trading when they knew (or should have known) the company had no reasonable prospect of avoiding insolvency.
• What must be demonstrated: The director knew or ought to have known that insolvency was inevitable and/or failed to take every possible step to minimise losses to creditors.
• Consequences: Directors can be personally liable for creditor losses caused by wrongful trading.

Fraudulent Trading

• This is a more serious offence than wrongful trading, which applies when a company has been run with the intent to defraud creditors or for fraudulent purposes. This claim requires actual dishonesty.
• What must be demonstrated: The company carried on business with intent to defraud creditors or a fraudulent purpose, there was actual dishonesty (not just poor judgment) and the individual accused was knowingly involved in the fraudulent conduct.
• Consequences: Directors can be personally liable for creditor losses along with other losses caused; directors can be disqualified, given an unlimited fine or imprisoned for up to ten years.

Breach of Directors’ Duties (Companies Act 2006)

• This is a claim against directors for failing to act in the best interests of the company or using their position for personal gain.
• What must be demonstrated: The director breached a specific duty, such as:
  1. Duty to act in good faith
  2. Duty to avoid conflicts of interest
  3. Duty not to accept benefits from third parties
• Consequences: The director may have to compensate the company for financial losses.

Misfeasance

• This is a claim against directors or others who have misapplied company money or breached fiduciary duties.
• What must be demonstrated: The defendant or other individual, misapplied company funds, acted dishonestly, or otherwise breached their duty.
• Consequences: The court may order the director to repay company funds and/or pay damages.

Transactions at Undervalue

• This is a claim to recover assets transferred for less than market value before insolvency.
• What must be demonstrated: The company transferred assets for no consideration or significantly less than their value.
• Timeframe: The transaction must have occurred within two years prior to the company entering administration or liquidation.
• Consequences: The recipient may be ordered to return the asset or compensate the company.

Preferences

• This is a claim to set aside transactions where a creditor was given preferential treatment over others before insolvency.
• What must be demonstrated: The company favoured one creditor over others (e.g., repaid a director’s loan before insolvency).
• Timeframe: The transaction must have taken place either within either six months (or two years if the recipient was a connected party) of the company entering administration or liquidation.
• Consequences: The court may reverse the transaction and require repayment from the recipient.

What defences can be used against claims made under the Insolvency Act 1986?

Respondents such as the directors or other parties against whom the claim is brought, can challenge these applications by arguing various defences. These can include:

• The company was not insolvent at the relevant time – If insolvency cannot be proven, the claim may fail.
• The payments were made outside the statutory period – transactions that occurred before the lookback period, being either six months prior to insolvency for connected parties, or two years prior to insolvency for transactions at undervalue or preferences, cannot be challenged.
• The funds were paid in to offset debts – If money was transferred as part of a legitimate business transaction, it may not be recoverable.
• A lack of jurisdiction or improper procedure – If the application was not properly served, it may be dismissed.

Consequences of successful applications made under the Insolvency Act 1986

If an application is granted, the consequences can be severe for directors or recipients of company money.  These can include:

• Penal notices can be issued – non-compliance with court orders may lead to contempt proceedings, fines, or imprisonment.
• Recovery of assets – Misapplied funds or property may be returned to the company.
• Further legal action – The evidence obtained can support fraud claims, director disqualifications, and freezing orders.

Conclusion

The Insolvency Act 1986 can be wielded as a powerful investigative and recovery tool. Insolvency practitioners should use claims strategically, while directors and third parties must take any applications seriously and seek legal advice when necessary.

Hamlins acts both for insolvency practitioners and for individual directors and third parties.

The Hamlins Commercial Disputes team has a depth of experience in resolving disputes swiftly and painlessly, and provides sensible, practical solutions and sound advice. We understand individuals and businesses need realistic solutions to their issues and we take a commercial approach, providing pragmatic and straightforward advice to guide clients to the route best suited to their situation. Please get in touch to find out more.