Creditor's Position in Case of Company's Insolvency - Coursework Example

?Creditor's position in the case of company's insolvency Introduction The instant case involves the question of the recovery of loans advanced to Norma-Creations Ltd by Cashbank ? 100,000 on “fixed charge” basis on fixed assets and “floating charge” basis on stock in trade and ? 30,000 by Easyloans Ltd on floating charge on stock in trade besides amounts owed to other creditors of the company. Creditors Creditors include lenders mainly who have advanced loans against security on fixed charge, floating charge basis or both, debenture and bond holders for long term debt, trade creditors for supply of goods and services, employees, claimants for torts and customers who have made advance payments for future supplies.1 Companies Act 2006 and Insolvency Act 1986 First, it has to be determined whether the company or its directors have violated provisions of Companies Act 2006 and Insolvency Act 1986 by knowingly taking loans from these two banks when the business of the company had already started showing signs of insolvency prior to availing of the said loans. Section 213 of Insolvency Act 1986 and section 993 of Companies Act 2006 (CA) refer to fraudulent trading. Section 214 of Insolvency Act 1986 refers to wrongful trading. These are the provisions which can be invoked against the company, its directors and others concerned for relief to the creditors.2 Besides, other provisions of Insolvency act are to be followed for realisation and pro-rata payments to all the classes of creditors of the company. Section 993 of the CA stipulates that it is an offence to continue to carry on business of a company intentionally to defraud creditors of the company or any other person or for any fraudulent purpose. Every person who is a party to above said acts is deemed to have committed an offence.3 Section 213 of Insolvency Act stipulates that if fraudulent trading is found to have been committed as above during the course of the winding up of a company, those who were knowingly parties to the above said offence shall be liable to contributions to the company’s assets as may be ordered by the court on the application of the liquidator.4 Section 214 of Insolvency Act stipulates that it is a wrongful trading committed by a director of a company and therefore a court can make a declaration that he is liable to make contribution to the assets of the company, if he has failed to make proper conclusions and take steps necessary for discontinuing the business knowing full well that the company’s going into insolvent liquidation was unavoidable. It is subject to the condition that company has gone into liquidation and that the person was a director of the company at that time. However, section 214 (3) stipulates that the court shall not pass any such declaration if the director has taken all possible steps to minimise potential loss to the creditors of the company. The director also includes a shadow director. This section is without prejudice to section 213 above.5 Fixed charge and Floating charge It is a means of creating security over specified or unspecified asset or property. Fixed charge is one which is fastened on an ascertained and defined property or a property capable of being ascertained and defined. In this case, the chargor is not free to deal with the property without the consent of the chargee. A floating charge is one which fastens on assets which the chargor can freely deal with, without the consent of the chargee. Thus fixed charge is generally on fixed asset, long-term asset or immovable property whereas floating charge is on movable property such as stock in trade. However, to decide whether one is a floating charge or fixed charge, it depends on the instrument of charge which spells out the intention of the parties regarding their mutual rights and obligations over the assets charged. Therefore mere labelling as fixed or floating will not prevent a court from treating a charge otherwise.6 Directors’ duty towards creditors Director’s duty is to act in good faith so as to promote success of the company for the benefit of its members subject to also act in the interest of its creditors under certain circumstances as may be required by any enactment. This obligation towards creditors arises when the company faces financial strain when creditors’ funds lying with the company are at risk whether or not it has become technically insolvent. Breach of this obligation can be a basis for a liquidator to make claim for wrongful trading under the Insolvency Act 1986.7 This case is immediately concerned with the rights of Cashbank and Easyloans as creditors as the company’s shareholders and directors have decided to go in for liquidation. As regards the position of Cashbank, question would arise whether it is in order for the company to have obtained increased overdraft facility when the company has started showing signs of insolvency by creating a first fixed charge over the company’s fixed assets. And whether Cashbank has been a party to defraud the existing creditors of the company though no details of existing creditors are available. It appears that section 213 would not attract as there was no apparent intent to defraud the existing creditors at the time of availing the increased overdraft facility. Hence, other creditors other than Cashbank and Easyloans have no case that directors of the company herein have acted in breach of section 213 of Insolvency Act for fraudulent trading. A conventional case of fraudulent trading would have facts similar to that of the case in Carmen v The Cronos Group SA. 8 It involved the people in control transferring the company’s assets to individuals and other companies where they had interest when the company had already reached a stage of insolvency. There was a clear intent to defraud the company’s creditors. In the instant case, the directors of Norma-Creations Ltd have not resorted to any such misapplication of funds. Cashbank was given first fixed charge and there is no case there was one already existing in someone else’s favour for the Cashbank to raise a plea that it was defrauded as far as fixed charge over the fixed assets of Norma-Creations Ltd. As such Cashbank, as a creditor, is not entitled proceed against the company under Section 213. Nor, are the other creditors entitled under this section.. As for the floating charge over stock in trade of Norma-Creations Ltd given to Cashbank, the condition was that should it come to its knowledge that the company had given a second charge over the stock in trade, the floating charge would immediately crystallise. In order to continue in business and to promote success of the company, the directors took loan from Easyloans but with intent to defraud its principal creditor bank Cashbank. Although the company did not divert the funds of the company as happened in Carmen v The Cronos Group SA above, it would amount to fraudulent trading on the part of the company. Its directors’ argument that they acted in order to promote the success of the company when creditors’ interest outweighed the best interests of the company, cannot hold good. A second floating charge is illegal on the part of the chargee unless it has given fresh funds to the company. In this case, Easyloans has given ? 20,000 in cash. Rather than being accused of being a party to defraud the original creditor Cashbank, Easyloans as a genuine creditor can proceed against the company’s directors for fraudulent trading. The liquidator can file claims both under section 213 and 214 since section 214 has been stated to be without prejudice to section 213. Thus, directors would become personally liable to make good the deficit resulting from proceeds of sale of company assets. Easyloans cannot be accused being a party to assist the company to defraud the other existing creditors. In Morris v State Bank of India 9 , the liquidators could prove that the defendant bank State Bank of India was involved in assisting BCCI by series accommodation transactions in a fraudulent with full knowledge by its officials. Thus it was established that the defendant was liable under section 213 for fraudulent trading.10 In the instant case, Easy loans was not involved in fictitious transactions. It actually lent ? 30,000 in cash. Wrongful trading is actually a civil remedy and arises when a company goes into liquidation. On being satisfied, a court can order a past, present or shadow director to contribute to the assets of the company. It is the aim of the court to obtain compensation to creditors rather than penalise the company directors in cases of wrongful trading. Absence of fraudulent intent does not entitle a director to pay only a token amount. The director will be liable to pay interest, legal costs incurred by the persons initiating action besides the contribution amount. Fraudulent trading provisions have not been effective since it is very difficult to prove fraudulent intent or bad faith. In some cases no new liabilities have actually arisen.11 In the instant case, fraudulent intent is difficult to establish since the directors have acted in good faith to keep the company alive. They did not stop with ? 100, 000 loan from Cashbank. They took another ? 30,000 later from Easyloans only keep the company as a going concern. There is no case that they misappropriated the additional funds or existing funds. Creditors’ ranking under the provisions of Insolvency Act 1986. Under the Company Voluntary Arrangement (CVA), the above insolvent company Norma-Creations Ltd can bring forth a proposal before its creditors for restructuring of its debts for which the Insolvency Act has no restrictions except that such a proposal cannot alter the rights of fixed and floating charge holders unless they give their individual consent. A CVA can only be commenced by the company and not its creditors. But as it has decided to wind up the company, the question of proposing a CVA does not arise for the company. However, it must be noted that a CVA is binding on all creditors except secured creditors if approved by 75 % of the unsecured creditors subject to not more than 50% of the unconnected creditors being present in person or proxy and voting against CVA. However a dissatisfied creditor or shareholder can object to the CVA within 28 days of approval. There can also be arrangement with creditors as schemes under Parts 26 and 27 of the Companies Act 2006 instead of a CVA. In the case of schemes, voting requirements are different. The creditors must be segregated as per their classes and the scheme must be put to vote and approved by 75 % of those present and voting whether in person or proxy from each class. Court’s approval will still be required after the approval of the scheme by the creditors so as to ensure that there was no unfair voting and no stake holder was deprived of his rights. Since liquidation has been decided in this case, it has to be either voluntary as started by a share holder resolution or compulsory by a court order. A liquidator is then appointed to take control of the company and distribute the realisation of assets in cash or specie to the creditors of the company. The ranking of creditors to be eligible to receive pro-rata payments will be as follows. First, the fixed charge holders will receive the realisation of fixed charged assets less direct realisation costs. Second, liquidation expenses. Third, preferential debts such as amounts owed to employees of the company. Fourth, a prescribed part reserved for unsecured creditors from realisations from floating charge assets subject to ceiling of ? 600,000. Fifth, floating charge holders from the proceeds of floating charge assets less preferential payments to employees and prescribed part to unsecured creditors as above. Sixth, unsecured creditors who are in equal ranks unless they come under a binding subordination agreement. Balance, if any, in surplus is to be distributed to shareholders according to the company’s articles of association or any other constitutional document.12 Bibliography Books .Keay, A. Company Directors’ responsibilities to creditors. Routledge, Oxon, UK. 2007. Yates, G Mike Hinchliffe, M. A Practical guide to Private Equity Transactions (Cambridge University Press, Cambridge, UK, 2010 Articles ‘Companies Regulated By The Companies Acts/ (22) Borrowing And Securing money/ (ii) Floating Charges/1269. Meanings of 'fixed charge' and 'floating charge'.’ Halsbury's Laws of England/Companies (Volume 14 (2009) 5th Edition, Paras 1-692; Volume 15 (2009) 5th Edition, Paras 693-1841)/2. ‘Companies Regulated By The Companies Acts/ (13) Directors/ (V) General Duties Of Directors/B. THE GENERAL DUTIES/ (B) Promoting Success Of The Company/545. Director's Obligation To Consider Or Act In The Creditors' Interests’ Halsbury's Laws of England/Companies (Volume 14 (2009) 5th Edition, Paras 1-692; Volume 15 (2009) 5th Edition, Paras 693-1841)/2. Website Maher, M. Forsyth, J ‘Fraudulent Trading- an under-used remedy’. 2002 (accessed 19 August 2011) Bugg, T. Elliott, R. ‘Brief Guide to English Corporate Insolvency Law’. 2008 (accessed 19 August 2011) Legislation Companies Act 2006 Chapter 46 S 993 Offence of fraudulent trading, Fraudulent Trading, Part 29, http://www.legislation.gov.uk/ukpga/2006/46/pdfs/ukpga_20060046_en.pdf (accessed 19 Aug 2011) Insolvency Act 1986 C.45, S 213 Fraudulent Trading, Part IV Chapter X Penalisation of directors and officers, http://www.legislation.gov.uk/ukpga/1986/45/section/213 Insolvency Act 1986 C.45, S214 Wrongful Trading, Part IV Chapter X Penalisation of directors and officers, http://www.legislation.gov.uk/ukpga/1986/45/section/213 (accessed 19 Aug 2011) Cases Carmen v The Cronos Group SA, 2005, EWHC 2403 (Ch); [2006] BCC 451. Morris v State Bank of India, 2004, EWHC 528 (Ch); [2004] BCC 404; [2004] 2 BCLC 279. Read More