Fraudulent trading: A summary in light of Bouchier v Booth

In the context of the winding up or administration of a company, if any business of the company is deemed to have been carried on with the intention of defrauding the company's creditors or the creditors of any other person, or any other fraudulent purpose, any person who was knowingly party to that business may be liable for fraudulent trading.

"Defrauding" and "fraudulent purpose" are typically taken to require "actual dishonesty involving… real moral blame". Intent to defraud arises where a person acts in a manner which is "beyond the bounds of what ordinary decent people engaged in business would regard as honest".

The offence of fraudulent trading is set out in sections 213 and 246ZA of the Insolvency Act 1986 (the "Act").  The evolution of case law has confirmed that, in order to be found liable for fraudulent trading, it must also be proven that the person had both knowledge of the fraudulent activity and that their conduct was dishonest.  In assessing whether a person had knowledge of the fraud, it must be proven that they were aware of the fraud, but they need not have known every detail or the precise mechanics of it. As highlighted in Bouchier v Booth; Re Tiuta International Limited [2023] EWHC 3195 (Ch), this can include "wilful blindness arising out of the deliberate shutting of eyes because of a desire not to know or because of a conscious fear that to enquire will confirm suspicion of wrongdoing". Dishonest conduct will be judged by reference to the objective standards of ordinary decent people.

A liquidator or administrator may make an application under section 213 or 246ZA of the Act (respectively) and if a person is found liable for fraudulent trading, they may be ordered to make such contributions to the company's assets as the Court thinks proper.

Under section 993 of the Companies Act 2006 ("CA 2006"), fraudulent trading is also a criminal offence.  If a person is held liable in respect of fraudulent trading under the Act, they may also be the subject of a disqualification order under the Company Directors Disqualification Act 1986.

A claim was brought by joint liquidators (the "JLs") against two former directors (the "Directors") of a group of bridge finance companies.  Tiuta PLC and Tiuta International Limited ("TIL") provided short-term bridging loans that were secured by legal charges over properties.  The financial position of the two companies had deteriorated during the financial crisis.

The JLs allegations of fraudulent trading related to the refinancing of a portfolio of approximately £14m of short-term bridging loans that TIL had advanced to a property developer ("Mr R"), or to associates of Mr R (which, in reality, were used as a medium for borrowing and ultimately sought to benefit Mr R's portfolio) (the "Loans").  A number of the Loans were not repaid on their initial due dates and TIL consequently refinanced them in reliance upon valuations which the Directors knew to be incorrect, and in the knowledge that the "borrowers" did not constitute good creditworthy customers.

The Court found that, in instructing that the Loans be refinanced, the Directors had allowed trading to continue without the need to recognise Mr R's unpaid Loans as bad debts. This, in turn, meant that TIL's accounts for the years ending in 2009 and 2010 did not provide a true and fair value of TIL's financial position.  Had the Loans been recognised as bad debts on TIL's balance sheet at this point, the accounts would have revealed the loss and rendered TIL insolvent.

The JLs argued that the Directors were liable for fraudulent trading in accordance with section 213 of the Act.  It was acknowledged that the threshold to prove fraudulent conduct is very high, however the JLs argued that this bar was surpassed due to the ongoing trading with Mr R at a time when the Directors were aware of the inherently unprofitable refinancing of the Loans.

The JLs identified a number of issues with the Directors' approach to the refinancing of the Loans. In particular:

1. The refinancings were based on inflated property valuations and therefore resulted in excessive loan to value ratios.
   
   
2. TIL was doing business with Mr R (and the apparent associates) on the basis of unacceptable borrower risk profiles.  Continuing to lend on this basis was described as a "cavalier approach to the identity of the borrower" and indeed opened TIL to unwarranted over-exposure to a single borrower with an unprofitable track record.
   
   
3. The Directors had assisted in establishing a fund for the purpose of providing liquidity to TIL (the "Fund"). The refinancing of the Loans using monies from the Fund was not in accordance with the terms upon which the Fund had agreed to finance TIL nor the terms upon which the investors had invested in the Fund. The Directors were aware of this but continued to allow TIL to advance loans that no "reputable mortgage lender" would have made.
   
   
4. The preparation and filing of TIL's accounts based on the refinanced Loans did not provide a true and fair view of TIL's actual financial position in 2009 and 2010.

The Directors argued that there was no intention to defraud the creditors of TIL, that they did not act dishonestly and that the decisions that they made were with the intention of best serving the interests of TIL. However, when questioned on some of the decisions taken and emails sent in relation to the arrangements with Mr R, the Directors had failed to provide comprehensive and convincing arguments as to their honest intent to serve TIL.

The Court considered that the high threshold of fraudulent conduct had been surpassed in the circumstances and that the Directors had acted dishonestly and had carried on the business of TIL with the intention of defrauding creditors of TIL or creditors of the Fund (i.e. the investors).

Upon reviewing correspondence, the judge concluded that the Directors were cognisant of the fact that the lending proposals relevant to the Loans aimed to refinance and repackage existing failing Loans in order to continue the relationship with Mr R and to avoid marking the Loans as bad debts. As a result, it was concluded that the Directors were aware that the restructuring of the Loans was not in the best interests of TIL. 

The JLs were also successful in their claim for equitable compensation in respect of the loss caused to TIL as a result of refinancing the Loans with Mr R (the relief provided for under section 172 of the CA 2006).  The Directors were held to be liable to make a contribution to TIL's assets. The compensatory sum arrived at was £19,990,358 – an amount held to be equal to the value of the assets knowingly misapplied or misappropriated by the Directors.

The case of Bouchier v Booth provides a helpful reminder as to the principles that will be applied by the Court in relation to claims of fraudulent trading and also demonstrates the Court's discretion and ability to make claims for equitable compensation under section 172 of the CA 2006. 

Directors of a company must act in a way that they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. When a company is facing financial difficulties, the directors must also have regard to the interests of the company's creditors. This is a fundamental fiduciary duty of directors. For further details in this regard, please see our briefing note here.

The Court also acknowledged in this case that the Directors did not account for the fact that the Tiuta business was made up of separate undertakings and that the Directors were required to consider the success of each individual entity. Thought should always be given by directors of multiple group companies as to the independent financial position and interests of each company, regardless of their position within the wider group structure.