Wrongful Trading - Barriers To Wrongful Trading Actions

Barriers To Wrongful Trading Actions

It was thought prior to 1997 that the amount paid by a director following a wrongful trading claim was simply paid to the liquidator and it became available to swell the assets of the company generally. In most instances there would have been substantial bank borrowings secured by a debenture and personal guarantees given by the directors. Many directors chose not to fight the claims, reasoning that any amounts paid to company (hence the bank under its mortgage security) via a wrongful trading claim, simply reduced the director’s liability under their personal guarantees. It was therefore irrelevant how the directors repaid the bank. This changed with the Court of Appeal’s decision in 1998 that a claim for wrongful (or fraudulent) trading, is different from a normal 'asset' of the company. In particular, it held that such claim cannot be secured by a debenture. The Court held that the fruits of a claim for wrongful trading are instead held in trust by the liquidation for the general body of unsecured creditors. It then followed that the costs of a wrongful trading action could not be drawn from the company’s assets held by the liquidator, and fell to be paid personally either by the liquidator (which he would not do), or would require a unanimous decision of unsecured creditors. The position has now been clarified with the Enterprise Act 2002 changing the law to allow the costs of wrongful trading actions to be included as a cost of the liquidation. These can be met from the company’s assets.

As is often the case, a company in liquidation has no assets with which to bring an action for wrongful trading. How can the liquidator bring, or fund an action? Can the liquidator sell or assign the claim to a specialist litigation company?

Because a claim for wrongful trading is a personal action brought by the liquidator, it follows that if it is unsuccessful, the liquidator is personally liable for the legal costs of the defendants. This was found to be the case following a 5 months trial in which the liquidator of Continental Assurance Company of London plc sued a number of its directors. Although the costs of an action (whether successful or otherwise) can now be properly paid by the liquidator out of company assets where there are adequate funds available, the House of Lords in 2004 altered the hitherto accepted priority of costs in a liquidation, making the liquidator's costs (including the legal costs of a wrongful trading action) rank last in priority behind both preferential creditors and the sums due to debenture holders. The decisions in Continental Assurance and Leyland Daf make wrongful trading actions unattractive to liquidators.

It is now usual practice for liquidators to enter into conditional fee arrangements with lawyers and have insurance against adverse costs in place in the event that he is unsuccessful. The liquidator is able to assign the action regardless of the normal rules relating to champerty and maintenance. (He is empowered by statute to sell any of the company’s property). As an alternative, there are commercial litigation funding organisations that take over management and funding of the entire claim, and pay the liquidators a percentage of recoveries.