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IN RE CONTINENTAL ASSURANCE COMPANY
OF LONDON PLC
Chancery Division
Park J
27 April 2001
On 27 March 1992 an insurance company,
C Ltd, went into liquidation with an estimated deficiency
in excess of £14m. As at September 2000, it appeared that
the joint liquidators had received in the liquidation about
£6.25m and paid out about £5.9m, mostly on professional fees.
This was the trial of an application made by the liquidators
against eight former directors (two executive directors and
six non-executive) alleging wrongful trading and misfeasance.
The trial lasted 72 days, during which two of the directors
(including one of the executives) settled with the liquidators.
The remaining executive director was said to be suffering
from clinical depression and, although represented, did not
give evidence at trial. The judgments (two of which are reported
here as Annexes B and C to the main judgment) are together
very long and detailed but in broad terms the issues were
as follows.
Wrongful trading
Having traded with modest profits for
5 years, in June 1991 the board was informed of very poor
results for 1990 in respect of C Ltd's travel insurance business.
After a series of meetings to discover and consider the true
implications of the poor results, a board meeting was held
on 19 July 1991 ('the Date') when, notwithstanding the disclosure
of further heavy losses, the board determined that C Ltd remained
solvent and should continue to trade. In reaching this decision,
the board relied on a range of considerations, including (i)
management accounts to 31 May 1991 which showed net assets
of £4.5m ('the Management Accounts'); (ii) forecasts of modest
profits and (iii) that attempts could properly and should
be made to sell the business C Ltd. In October 1991 a balance
sheet as at 30 June 1991 was prepared ('the Balance Sheet').
From December 1991 to late March 1992, attempts were made
to sell C Ltd. During that period, Messrs Buchler and Wacey,
two licensed insolvency practitioners, were advising C Ltd
in the knowledge of and without advising against such attempts
to sell. In this application, the liquidators (one of whom
was Mr Buchler) made wide- ranging allegations about the poor
state of the books and records of C Ltd and alleged that the
directors ought to have known by or on the Date that there
was no reasonable prospect that C Ltd would avoid insolvent
liquidation. The liquidators' grounds changed several times
but became that the Balance Sheet and/or the Management Accounts
were wrong due to the use and application of inappropriate
accounting policies (concerning insurance issues and the provision
for bad or doubtful debts) and that the Balance Sheet ought
to have disclosed net liabilities of at least £l,101m. It
was further contended that (i) the directors ought to have
discovered the accounting errors and, thereby, the alleged
true financial position; (ii) there had been no reasonable
prospect of a sale; and (iii) (as a fallback position) the
directors ought to have concluded on or by the Date that the
Company was not complying with the DTI's margin of solvency
of £l,092m ('the Margin') which conclusion would have caused
them to place C Ltd into liquidation at an earlier date. As
to the amount of the contribution sought, the court had earlier
ruled that the appropriate method of calculation of any liability
for wrongful trading was 'the increase in net deficiency'
between a hypothetical liquidation on the Date and the actual
date of liquidation (see Annex B to the main judgment). On
that basis, the liquidators produced seven successive calculations
of the alleged increase which ranged from £5.941m to £3.569m
(the sum ultimately relied upon).
Misfeasance
First, it was alleged that the directors
should make a contribution for misfeasance equal to the increase
in net deficiency between the Date and the actual liquidation
on the general grounds that (i) the books and records of C
Ltd were historically so inadequate that it had been misfeasance
on the part of the directors to allow C Ltd to continue to
trade with such defective systems; and (ii) they had failed
to ensure prior to the Date that appropriate accounting policies
had been adopted and applied so as to enable any evaluation
of the financial position of C Ltd to be accurate. The liquidators'
case was that the non-executive directors had failed to exercise
the requisite skill and care as directors in relying on the
Management Accounts and other financial information as presented
to them from time to time.
Secondly, the liquidators alleged that
the directors should pay damages to C Ltd equal to the amount
of two specific payments made during January 1992 to IATA
and ABTA in the aggregate sum of about £118,000 ('the Payments').
On 20 December 1991 Mr Wacey had advised the board to cease
to trade and to stop paying creditors save 'any payments as
may be necessary to enhance preserve and/or collect in the
assets of the company'. The Payments constituted 20% of C
Ltd's liability under certain travel bonds (which had not
been re-insured). The directors had been advised that failure
to make the Payments would probably lead to the loss of C
Ltd's licence. There was a contemporaneous record of the managing
director which the judge found set out a clear and convincing
case for making the Payments. During cross-examination at
trial, Mr Buchler accepted that there had been good reason
for the Payments but objected to the fact that they had been
made without prior advice from or consent of his staff.
Held - dismissing
the application -
Wrongful trading
(1) On the facts, the Balance Sheet had
been wrong and, subject to adjustments, ought to have showed
that C Ltd was solvent but had a reduced surplus on 30 June
1991 of £1.166m and was accordingly in breach of the Margin.
(2) The Balance Sheet had not been available
on the Date. As at the Date, the directors did not possess
knowledge of most of the facts which gave rise to the need
to make adjustments and such relevant knowledge as they did
then possess would have led to an increase in the net assets
shown on the Balance Sheet so that C Ltd would not have been
in breach of the Margin.
(3) It followed that the liquidators
had not established that the directors ought to have concluded
on the Date that there was no reasonable prospect that C Ltd
would avoid going into insolvent liquidation.
(4) In any event, in June and July 1991
the non-executive directors had not accepted unquestioningly
the Management Accounts and other available financial information
but had asked questions at the various meetings and had wanted
to be satisfied with the answers such that it had been reasonable
and proper for them to have relied upon such information and
they could not have been expected to have had an appreciation
of recondite accounting principles and details peculiar to
the insurance industry.
(5) On the evidence, it was not open
to the liquidators to allege that the directors had been at
fault by including in their reasons for deciding to continue
to trade an assumption that there was a reasonable prospect
of a sale of C Ltd.
(6) If liability for wrongful trading
had arisen, the Court would not have been satisfied that the
liquidators' evidence could be relied on safely to support
an allegation of an increase in net deficiency, in particular,
the liquidator's principal witness on quantum was understandably
partisan and could in no way be regarded as an independent
expert whose opinion the Court could properly accept as such.
Per curiam:
(a) [106] None of the previous cases
in which directors have been held to be liable for wrongful
trading has been remotely like this one. Typically they have
been cases in which the directors closed their eyes to the
reality of the company's position, and carried on trading
long after it should have been obvious to them that the company
was insolvent and that there was no way out for it. In those
cases the directors had been irresponsible, and had not made
any genuine attempt to grapple with the company's real position.
In the only reported case where the directors did make an
effort to understand the position, and where they decided
that the company should trade on only after they had thought
about it first, the judge refused to hold them liable.
(b) [281] An overall point which needs
to be kept in mind throughout is that, whenever a company
is in financial trouble and the directors have a difficult
decision to make whether to close down and go into liquidation,
or whether instead to trade on and hope to turn the corner,
they can be in a real and unenviable dilemma. On the one hand,
if they decide to trade on but things do not work out and
the company, later rather than sooner, goes into liquidation,
they may find themselves in the situation of the respondents
in this case - being sued for wrongful trading. On the other
hand, if the directors decide to close down immediately and
cause the company to go into an early liquidation, although
they are not at risk of being sued for wrongful trading, they
are at risk of being criticised on other grounds. A decision
to close down will almost certainly mean that the ensuing
liquidation will be an insolvent one. Apart from anything
else, liquidations are expensive operations, and in addition
debtors are commonly obstructive about paying their debts
to a company which is in liquidation. Many creditors of the
company from a time before the liquidation are likely to find
that their debts do not get paid in full. They will complain
bitterly that the directors shut down too soon, they will
say that the directors ought to have had more courage and
kept going. If they had done, so the complaining creditors
would say, the company probably would have survived and all
of its debts would have been paid. Ceasing to trade and liquidating
too soon can be stigmatised as the cowards' way out.
(c) [378] Before a court will be prepared
to impose liability on directors in a case where there has
been an unjustified decision to carry on trading, it is not
enough for a liquidator claimant merely to say that if the
company had not still been trading, a particular loss would
not have been suffered by the company. There must be more
than a mere 'but for' nexus of that type to connect the wrongfulness
of the directors' conduct with the company's losses which
the liquidator wishes to recover from them.
The main judgment contains valuable observations
on the court's approach to the Question whether and. if so
to what extent there should be joint and several liability
for wrongful trading [382-391]. The first interim judgment
(at Annex B to the main judgment) also gives guidance on the
approach to be adopted when assessing the loss (if any) caused
by wrongful trading in respect of which directors might be
expected to make a contribution.
Misfeasance
(7) The books and records of C Ltd were
such that it was possible within a reasonable time to obtain
a clear and accurate picture of its financial position at
any given moment.
(8) The non-executive directors had not
followed blindly the advice of the finance director and auditors
but had been in the habit of probing and testing the financial
information provided from time to time and it had been reasonable
and proper for them to have relied on such financial information.
(9) Even if the directors had been in
breach of duty in relation to the accounting allegations,
the liquidators had failed to establish that any such breach
could properly be said to have caused any particular loss
to C Ltd in that, if the increase in net deficiency had been
established, it would have been caused by such matters as
adverse trading results or heavy expenditure incurred by the
liquidators and not by any failure to adopt and apply appropriate
accounting policies.
(10) In relation to the Payments, the
directors had taken the wholly appropriate step of consulting
Mr Wacey, and although they might have expected more positive
and clearer advice from him, nevertheless they did their conscientious
best to put into effect the advice given and the conclusion
that the balance of advantage was in favour of making the
Payments was not reached in breach of any duties owed by the
directors to C Ltd.
(11) In any event, this was not a preference
claim and C Ltd (as opposed to its creditors) had suffered
no loss as a result of the Payments having been made.
Per curiam:
[399] It is accepted that one of the duties of non-executive
directors is to monitor the performance of the executive directors
and that the managing director of a company has a general
responsibility to oversee the activities of the company, which
presumably includes its accounting operations. It is not considered
that those responsibilities can go so far as to require the
non-executive directors to overrule the specialist directors,
like the finance director, in their specialist fields. The
duty is not to ensure that the company gets everything right.
The duty is to exercise reasonable care and skill up to the
standard which the law expects of a director of the sort of
company concerned, and also up to the standard capable of
being achieved by the particular director concerned.
Source or File Reference : BPIR 2001
Volume 5 Page 733
Additional Pages in Library : 157
Copyright : © Jordans
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