2021 ZA Q1

How well do UK company law and insolvency law protect the interests of a company’s creditors?

Relative to the protection of creditors UK law have many different avenues that can assists in their
protection that are found within the Companies Act 2006 (CA). Also as stated in the question the
Insolvency Act 1986 (IA) is also an avenue that can be used to protect the interests of creditors.
These avenues will be discussed in this essay.

Firstly we will discuss protection under UK law via veil lifting. Veil lifting means that the courts have
ignored the corporate personality in favour of holding an owner or owners directly responsible
(Salomon v Salomon). Directors are prevented from abusing the firm through judicial veil lifting
when there are no statutory provisions in place. In order to enable the business to settle its debts,
veil lifting ignores the limited liability that is provided. Nevertheless, the application of this approach
is restricted.

Sections 213 and 214 of the IA may be invoked to safeguard creditors. Both clauses are insufficient.
Section 213 is difficult to use since it needs proof of dishonesty. This was addressed by lowering the
standard of responsibility under Section 214. Under s.214, those who are negligent may be held
accountable. The number of successful actions purchased under s.214 has been constrained, though.
Notwithstanding the fact that these laws are meant to safeguard creditors, the latter cannot initiate
legal action themselves (must be done by a liquidator). Liquidators are hesitant to use the remaining
funds to support the case. If legal action is taken, payments are made to the company rather than
the creditor who lost money as a result of the improper trade. A person who is accountable under
Section 213 may be a director, shareholder, employee, or creditor. In Re Todd, the director was held
to be responsible and was required to personally pay £70,000 toward the company's indebtedness.
Re Patrick & Lyon stated intent to defraud requires “actual dishonesty, involving, according to
current notions of fair trading among commercial men, real moral blame”. S.213 establishes a
significant deterrent to fraud but has the unfavorable effect of neutralizing the effect of s.213
because the burden of proof was difficult to demonstrate because there was a chance that a criminal
offence may occur (s.993 CA 2006). As a result, s. 214 included the lesser offense of
wrongful trading. According to S.214, directors will be held accountable for the company's debts if
they continue to operate when a reasonable director would have declared insolvency, as was the
case with Re Produce Marketing Consortium Ltd (No.2) 1989 the latest date at which the annual
accounts for that year should have been presented was determined to be the point at which the
directors should have realized there was no reasonable hope of the company escaping insolvency
liquidation. two directors did nothing wrong besides declaring the company insolvent at the point of
no return. They were had to pay £75,000 to settle the business's debts.

Directors have a responsibility to further the company's prosperity for the benefit of its shareholders
(s.172 CA) (shareholders). S.172(3) is in line with West Mercia Safetyware Ltd. in that the duty to
promote the success of the company has effect subject to any rule of law requiring directors to act in
the interests of creditors. If a company continues to trade while insolvent but in the expectation that
it would return to profitability, it should be regarded as trading not only for the benefit of the
shareholders but also for the creditors. When directors are supposed to put creditors' interests first,
however, is uncertain. Following the decision in BTI v Sequana (2016), even though the court found
that there was a "real risk of insolvency if the claim was lost," the duty to creditors had not
materialized because there had also been a "real prospect" of avoiding insolvency. This was the case
in Dickson v NAL Realisations (Staffordshire) Ltd. A "real risk" or a "recognized risk" alone are not
always necessary for the responsibility to arise.

Disqualification of directors is governed by the Company Directors Disqualification Act 1986

(CDDA). Through the disqualification process, legislation helps to protect the company, its
shareholders and stakeholders (eg. Creditors) from directors who may otherwise engage in repeat
offences. In accordance with Section 6 of the Corporate Directors Disqualification Act of 1986
(CDDA), creditors are also protected. According to S. 6 CDDA, the court must be persuaded that the
director's actions render him unable to participate in the company's management. Re Sevenoakes
Stationers (Retail) Ltd 1991 provided an explanation of S.6. According to Dillon LJ, the purpose of
the law is "to safeguard the public, and in particular potential creditors of corporations, from losing
money through the insolvency of firms when the directors of those companies are people unsuitable
to be interested in the operation of a company." Furthermore, Re Lo-Line Electric Motors' director
"has been proven to have engaged in a commercially liable manner" by using the unpaid Crown
obligations to finance such trading while knowing the limited firms to be bankrupt. S. 6 CDDA will
guarantee that directors are able to carry out their duties effectively and honestly, which will
guarantee that creditors are taken care of.
2019 ZA Q4

‘The regime for disqualifying directors is a much better way of protecting companies’ creditors
than are the provisions of sections 213 and 214 Insolvency Act 1986.’
Discuss.

Sections 213 and 214 of the IA may be invoked to safeguard creditors. Both clauses are insufficient.
Section 213 is difficult to use since it needs proof of dishonesty. This was addressed by lowering the
standard of responsibility under Section 214. Under s.214, those who are negligent may be held
accountable. The number of successful actions purchased under s.214 has been constrained, though.
Notwithstanding the fact that these laws are meant to safeguard creditors, the latter cannot initiate
legal action themselves (must be done by a liquidator). Liquidators are hesitant to use the remaining
funds to support the case. If legal action is taken, payments are made to the company rather than
the creditor who lost money as a result of the improper trade. A person who is accountable under
Section 213 may be a director, shareholder, employee, or creditor. In Re Todd, the director was held
to be responsible and was required to personally pay £70,000 toward the company's indebtedness.
Re Patrick & Lyon stated intent to defraud requires “actual dishonesty, involving, according to
current notions of fair trading among commercial men, real moral blame”. S.213 establishes a
significant deterrent to fraud but has the unfavorable effect of neutralizing the effect of s.213
because the burden of proof was difficult to demonstrate because there was a chance that a criminal
offence may occur (s.993 CA 2006). As a result, s. 214 included the lesser offense of
wrongful trading. According to S.214, directors will be held accountable for the company's debts if
they continue to operate when a reasonable director would have declared insolvency, as was the
case with Re Produce Marketing Consortium Ltd (No.2) 1989 the latest date at which the annual
accounts for that year should have been presented was determined to be the point at which the
directors should have realized there was no reasonable hope of the company escaping insolvency
liquidation. two directors did nothing wrong besides declaring the company insolvent at the point of
no return. They were had to pay £75,000 to settle the business's debts.

In Brooks v Armstrong the main legal issue addressed was whether the directors had wrongfully
traded. The High Court ruled that the respondents knew or should have known that there was no
chance at all that the company would avoid going bankrupt. The directors were compelled to pay
compensation because at that point they should have taken action to reduce losses to all creditors.
Under section 214 of the Insolvency Act of 1986, the liquidators of Robin Hood Centre Plc requested
a contribution from the company's directors. The directors allegedly knew the company was
bankrupt for many years, according to the liquidators' motion. The court approved the petition filed
by the liquidators. It was determined that the liquidators did not have to allege and then
demonstrate a specific date or dates on which the directors knew the firm could not avoid insolvent
liquidation. It was sufficient for the liquidators to claim that the directors knew the core of the case
against them and were able to defend it, and that they had or ought to have had the knowledge
required prior to the liquidation.

Under section 246ZA IA, there is yet another provision for holding directors accountable for
misbehaviour. This enables liquidators to designate a director in a fraudulent or unlawful trading
action. If a liquidator decides they do not wish to pursue an action on their own, they may sell and
assign the action to a third party who would be permitted to pursue the action. In this method, the
risks involved in initiating the claim rest on the third party and the liquidator receives some
compensation for the benefit of the creditors. In the event that this action is successful, the third
party will profit.

Disqualification of directors is governed by the Company Directors Disqualification Act 1986

(CDDA). Through the disqualification process, legislation helps to protect the company, its
shareholders and stakeholders (eg. Creditors) from directors who may otherwise engage in repeat
offences.

In accordance with Section 6 of the Corporate Directors Disqualification Act of 1986 (CDDA),
creditors are also protected. According to S. 6 CDDA, the court must be persuaded that the director's
actions render him unfit to participate in the company's management. With reference to Re Polly
Peck Interntional Plc No.2 (1994) instead of referring to a particular company or type of company,
the term "unfit" denotes "unfit to manage companies generally." The directors disqualification
regime therefore bars directors from acting as a director of the company, acting as a receiver of the
company's property, or directly or indirectly being involved in the promotion (Official Receiver v
Hannan (1997)), formation, or management of the company (R v Campbell (1984)) without the
court's permission for a period up to 15 years (s.1A CDDA). This essentially shields creditors from
directors who might act in a way that would be detrimental to them. The grounds for disqualification
are due to a conviction of an offence, constant breaches of companies legislation, fraud, unfitness,
disqualification after investigation of the company and participation in wrongful trading.

Re Sevenoakes Stationers (Retail) Ltd 1991 provided an explanation of S.6. According to Dillon LJ,
the purpose of the law is "to safeguard the public and in particular potential creditors of
corporations, from losing money through the insolvency of firms when the directors of those
companies are people unsuitable to be interested in the operation of a company." Furthermore, Re
Lo-Line Electric Motors' director "has been proven to have engaged in a commercially liable
manner" by using the unpaid Crown obligations to finance such trading while knowing the limited
firms to be bankrupt. S. 6 CDDA will guarantee that directors are able to carry out their duties
effectively and honestly, which will guarantee that creditors are taken care of.

However, under sections 213 and 214, creditors may recover debts, whereas the disqualification
system only protects them from disqualified personnel in the future and makes no provisions for
debt recovery. Hence, s. 213 and 214 as well as the disqualification regime will be useful to achieve
the greatest creditor protection.