Brooks and another v Armstrong and another [2015] EWHC 2289 (Ch)
In a rare judgment considering wrongful trading in detail, the memorably-named "Robin Hood" case considers at which point the directors ought to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation. It also reiterates that the burden of proof lies with the directors to show that "every step" was taken to minimise loss for the creditors as a whole.
The liquidators of Robin Hood Centre plc ("the Company"), a company that had operated a Robin Hood themed tourist attraction in Nottinghamshire, alleged that, following a sequence of events, the respondents ("the Directors") continued to trade the business when they knew it would not be possible to avoid insolvent liquidation.
The "Knowledge Condition"
Under section 214(1) of the Insolvency Act 1986 ("the Act"), the court may order a director who has been found to have wrongfully traded a company to make such contribution to the assets of the company as the court thinks proper. A prerequisite for liability is that the director, at some time before the commencement of the winding up of the company, must have known, or ought to have concluded, that there was no reasonable prospect that the company would avoid going into insolvent liquidation (the "Knowledge Condition"). It is for the liquidator to prove that the Knowledge Condition was met.
In this case, Mr Registrar Jones (the "Registrar") considered in detail whether or not, and on which date, the Knowledge Condition had been satisfied. The Registrar concluded that the Directors knew or ought to have known by 31 January 2007 that the Company did not have sufficient assets to meet its liabilities and had no reasonable prospect of avoiding insolvent liquidation. A large factor was that at that time the Directors were aware of a large VAT liability and a significant increase in rent which was likely to be due under a rent review of the premises, which the Company could not meet.
In the case of wrongful trading, the balance sheet test of insolvency is applied to show a company's assets are insufficient to pay its creditors. The court considered BNY Corporate Trustee Services Limited v Eurosail1 in this regard, and the Registrar's view was that the Directors could not reasonably have envisaged that all creditors would have been paid when taking into account the VAT liability.
Under s.214(3) of the Act, the defence of having taken every step with a view to minimising the potential loss to the Company's creditors was available to the Directors, and was also considered in detail.
The "Minimising Loss Defence" (the "Defence")
In order to avail themselves of the Defence, the Directors had to establish that they took "every step" to minimise the potential loss to the Company's creditors; it is not for a liquidator to prove that the Directors had failed to do so. Examples of how a Director might successfully demonstrate that every step had been taken could be by ensuring that the trading and financial position of the company was regularly monitored and preparing a business plan considering future trading.
It was held that the Directors were reasonable in continuing to trade for a period, as the Company was making a small profit at this time, though circumstances changed by 3 May 2007, when it became clear that the financial position of the Company had deteriorated by a significant margin. After this point, the Registrar concluded that trading was only possible because the Company was paying certain creditors, whilst failing to pay HMRC or its landlord the outcome of the rent review, which increased their annual rent from £29,000 to £92,500. The Directors should have reassessed the situation in order to have taken "every step."
When a change of circumstances such as these arises, it would be reasonable to produce a new business plan, budget and cash flow. The Directors failed to take any steps to minimise loss and instead continued to trade. Despite the contention that steps had been taken to minimise loss for some creditors, the Defence requires steps to be taken in relation to creditors as a whole. Furthermore, the failure by the Directors to consider and take advice on alternative solutions to protect creditors, such as placing the Company into administration or liquidation, meant that they failed to satisfy the "every step" test. In light of these failures, the Registrar held that the Directors had not acted as reasonably diligent directors and had failed to establish the Defence.
Consequently, on the basis of assuming a hypothetical liquidation on 3 May 2007, the Directors were held to be jointly and severally liable to pay a minimum contribution of £35,000 in compensation.
Comment
This case adds welcome clarity on how the courts assess directors' conduct in the period leading up to, and following, the point at which insolvent liquidation becomes inevitable. The decision in this case highlights the importance of directors being aware of the financial conditions of their company, and of taking steps to minimise loss to creditors as a whole where insolvency seems likely. Taking professional advice, considering revised business plans and closely monitoring performance are all activities which may assist directors who find themselves having to rely on the s.214 Defence. However, in carrying out such activities, one would hope that wrongful trading might be avoided.
Footnote
1 BNY Corporate Trustee Services Ltd & Ors v Eurosail-UK 2007- 3BL plc & 2 other cases [2013] UKSC 28
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