Grant & Anor v Ralls & Ors (re Ralls Builders Ltd)

Wrongful trading is concerned with whether there was no reasonable prospect of avoiding insolvent liquidation, not merely whether the company was insolvent or trading at a loss. The court must assess the directors’ subjective knowledge and the objective standard in section 214, without hindsight. Reasonable prospects of external funding may be relevant.

For contribution, the starting point is loss caused to the company by continued trading, commonly assessed by changes in its net deficiency. The section 214(3) defence requires every appropriate step to minimise potential loss, including protection of new creditors. Continued trading which benefits secured or existing creditors while leaving new creditors unpaid may defeat the defence, but does not itself establish compensable loss to the company.

The joint liquidators of a construction company sought declarations under section 214 of the Insolvency Act 1986. They alleged that the three respondent directors knew, or ought to have concluded, by 31 July or 31 August 2010 that the company had no reasonable prospect of avoiding insolvent liquidation.

The company was heavily insolvent, subject to creditor pressure and dependent upon a proposed investment by a third party. The directors continued trading, completed contracts and collected substantial receipts before the company entered administration on 13 October 2010. The central issues were when the statutory threshold was reached, whether the directors had a section 214(3) defence, and whether continued trading caused loss to the company.

1. The claim under section 214(1) was dismissed. The directors ought to have concluded by 31 August 2010 that there was no reasonable prospect of avoiding insolvent liquidation, but the liquidators failed to establish loss caused to the company by continued trading.
2. Insolvency alone did not satisfy section 214. A company may trade while insolvent where there remains a reasonable prospect of trading out of difficulty or obtaining external finance. The relevant question concerned the prospects of avoiding insolvent liquidation, assessed without hindsight. The prospects of raising new capital could be taken into account.
3. The directors did not have actual knowledge by 31 July or 31 August that the proposed investor would not provide funding. Expert insolvency advice obtained in early August supported the conclusion that continued trading was not then wrongful. By the end of August, however, the investor’s repeated failure to provide funds meant that reliance upon him had become hope and optimism without a rational basis.
4. The contribution under section 214(1) should ordinarily be assessed by reference to loss caused to the company by continued trading, starting with any increase or reduction in the net deficiency of unsecured creditors. Losses resulting from the formal insolvency process itself, or not caused by continued trading, were excluded.
5. The section 214(3) defence imposed a high hurdle. It required the directors to take every step they ought to have taken, both with a view to reducing the company’s overall deficiency and to minimising the risk of loss to individual creditors. The directors could not rely on the defence because their trading regime enabled the bank and some existing creditors to be paid while new creditors remained unpaid.
6. That failure did not establish a contribution. The evidence showed that continued trading may have reduced, or caused no material increase in, the company’s net deficiency. Inadequate accounting records did not justify treating the increase in the purchase ledger as the loss, since the records were capable of analysis and the ledger did not accurately identify new credit incurred.
7. The claim for the general costs of the administration and liquidation was too wide. Any recoverable costs would have to be limited to additional loss caused by wrongful trading. The parties were directed to address the remaining costs issue after judgment.