The costs of avoiding formal insolvencies

Recently it has been identified that heavy losses are being suffered by HMRC and creditors when companies cease trading due to insolvency and fail to enter into any formal insolvency event. The relevant insolvency events in these circumstances would be administration and liquidation.

However, many insolvent companies and/or their directors simply cannot afford the cost of placing the failed business into an insolvency event. Creditors are often reluctant to incur the costs of forcing an insolvency event where there is little prospect that the costs of doing so, let alone the principal debt, will be recovered. 

In addition to this, even where a creditor may see the benefit of a liquidator or administrator investigating the affairs of the company and the conduct of the directors, that creditor will be resigned to the fact that any legal action against directors personally would result in any recovery being shared between all the creditors and may also be fruitless if the directors enter bankruptcy. 

Furthermore the pursuance of a director, of a company which has entered a formal insolvency event, under the Company Directors Disqualification Act 1986, is in the hands of the Insolvency Service and thus outside of the creditors' influence or control.

Additionally a director may be keen to avoid a formal insolvency event which would lead to the Official Receiver, a liquidator or an administrator, investigating his or her conduct and company's affairs. In such circumstances the director may decide to cease trading in the hope that creditor apathy will enable the failed company to eventually disappear from the Companies Register quietly.

As a consequence of this, accountancy firm Moore Stephens estimates that creditors, including HMRC, could have lost up to £200 million in the last year. By its nature it is difficult to know how accurate this estimated figure is but there can be no doubt that losses are being suffered as a result of the current legislation in place.

One simple change to the current legislation may be to allow any recoveries under Section 212 (misfeasance) and Section 214 (wrongful trading) to survive a director's bankruptcy.  This may provide an important route to recovery for the creditors from those directors who have acted in breach of their duties and/or traded their companies whilst those companies were insolvent.

For more information relating to this or any aspect of insolvency, please contact Fraser Brown’s Insolvency team on 0115 9888 777.

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