Wrongful trading and the burden of proofPrint publication
In Brooks and another v Armstrong , joint liquidators applied for orders against directors of the insolvent company (the Company) under section 214 of the Insolvency Act 1986 (the Act) (the wrongful trading provision) and for remedies to be awarded against delinquent directors under section 212 of the Act.
The Company had been run as a themed tourist attraction. The liquidators maintained that the directors had wrongfully traded in the knowledge that there was no reasonable prospect of the Company avoiding insolvent liquidation following certain events, namely: the production of the year-end accounts for 2005 and 2006; the receipt of professional advice concerning a large VAT liability; the 2007 accounts which showed a loss and which did not did not include the VAT liability or an increase in rent expected following a rent review; and the subsequent confirmation of the VAT liability from HMRC.
The first issue before the High Court concerned the burden of proof in respect of wrongful trading. The Court held that once it had been established that a director knew or ought to have concluded that there was no reasonable prospect of the Company avoiding insolvent liquidation, the onus was on the defendant director to show that he or she had taken every step to minimise the potential loss to creditors. It was not for the liquidator to establish that the director had not taken the necessary steps.
The Court also ruled that the liquidators merely had to prove knowledge at some time before the start of the winding-up rather than at a particular date. A liquidator’s case would not fail simply because a specific date was not made out.
The Court stated that there was no duty on the directors not to trade while insolvent, or at a loss and that a company could legitimately trade at a loss where the directors anticipated profit to accrue to the benefit of the creditors. The fact that the directors turned out to be wrong did not necessarily denote a failure to act as reasonable director would have done. However, on the facts of this case, the directors ought to have recognised by January 2007 that the Company had no reasonable prospect of avoiding insolvent liquidation.
Whether the directors had minimised the loss to creditors had to be judged by reference to the body of creditors as a whole. In this case, the directors had ensured that trade creditors were paid but not the VAT and rent liabilities; accordingly, the directors had not taken every step needed with the aim of minimising loss to all creditors.
On the compensation payable under section 214, the Court stated that objective was to recoup loss, not to be penal. The loss would normally be represented by the amount that the assets had been depleted and/or the debts to the creditors increased. Relevant considerations in the instant case were that the continued trading had not actually caused the VAT liability but had increased interest and penalties; it had increased the debt to the landlord; it had benefited trade creditors and reduced the overdraft and it had not been done dishonestly.
The case is a useful statement of the current judicial position in respect of wrongful trading. In this context it is worth noting the changes introduced to the law by the Small Business, Enterprise and Employment Act 2015. These make it possible for office-holders to assign wrongful trading actions and also make it possible for administrators – not just liquidators – to bring wrongful trading actions.
 Section 246ZD of the Insolvency Act 1986