Authors
Lorna Bramich

Lorna Bramich

Senior Associate

Read More

Emilie Kennedy

Associate

Read More
Authors
Lorna Bramich

Lorna Bramich

Senior Associate

Read More

Emilie Kennedy

Associate

Read More

7 December 2022

Fraud fundamentals – 4 of 6 Insights

Fraud fundamentals: the benefits of an insolvency process in uncovering and investigating fraud

While an insolvency process is not always welcomed with open arms, in fraud cases it can play a key role in uncovering frauds that might otherwise have remained concealed and may result in recoveries for victims. This is because an insolvency process paves the way for an independent investigation into the company's affairs and the directors' conduct to be carried out by an insolvency practitioner (IP).

Particularly advantageous in fraud cases is an IP's extensive investigative powers and power to challenge certain transactions and bring other statutory claims (officeholder claims) under the Insolvency Act 1986 (IA 1986), in addition to being able to pursue claims which the company could have pursued prior to the insolvency. In this next instalment of our 'Fraud fundamentals' series, we look at these powers, claims and other matters in the context of fraud.  

Investigative powers

IPs' investigative powers under the IA 1986 are extensive. They therefore have every chance of identifying and evidencing a fraud carried out by the company and those behind it. These include investigative powers under s234 and s235 of the IA 1986 to get in company property and require certain parties to provide information. They may also utilise the s236 IA 1986 process which includes applying to court for the private examination of an individual (including a director) before a judge. The penalties for failing to comply are severe, including a potential arrest warrant and/or seizure of property. 

Power to challenge 'reviewable' transactions

A company may have entered into any number of transactions before an insolvency process, designed to move assets away from the company, making them unavailable to creditors. An IP has the power to challenge such transactions, including:

  • Transactions at an undervalue (s238 IA 1986) - the disposal by the company of an asset for no consideration or for consideration worth significantly less than its market value. 
  • Preferences (s239 IA 1986) - a company transaction which has the effect of putting another creditor in a better position than it would otherwise have been in on the company's insolvency.  
  • Transactions defrauding creditors (s423 IA 1986) – where a transaction at an undervalue has been entered into with the intention of putting assets beyond the reach of creditors. Section 423 claims may also be brought by 'victims' outside of an insolvency process as insolvency is not a pre-requisite (whereas it is for s238 and s239 claims) and despite its name, neither is establishing dishonesty.

IPs therefore have a number of powers at their disposal to recover assets into the estate by challenging transactions without the need to commence proceedings for fraud, thereby avoiding the evidential burden that brings (you can read more about this in our previous article).

Claims against directors

Directors owe duties to the company, and only the company - or in certain circumstances its shareholders (by way of derivative action) - can enforce those duties. This means that it is highly unlikely that any action will be taken against fraudulent directors if they are also its shareholders. This changes in an insolvency process which is beneficial in instances of fraud as IPs may bring claims that the company could have pursued prior to insolvency, as well as claims under the IA 1986, which include claims against directors for:

  • Fraudulent trading (s213 or s246ZA IA 1986) - for knowingly carrying on a company's business with the intention to defraud its creditors or for any other fraudulent purpose.
  • Wrongful trading (s214 or s246ZB IA 1986) - where the directors knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into an insolvency process.

Limitation periods

The impact of insolvency on the time in which claims may be brought against wrongdoers is also of benefit. As officeholder claims arise as a result of an insolvency process, the time period within which such claims must be brought does not start ticking until the date the company enters liquidation or administration. The exception is a s423 IA 1986 claim (transactions defrauding creditors) as such claims may be brought by a 'victim'. 

While insolvency is not the limitation trigger for claims that could have been pursued prior to the insolvency (eg claims against directors for breach of duty), the limitation period for such claims may be extended or not apply in instances of fraud. For example, there is no limitation period in cases of fraudulent breach of trust and s32 Limitation Act 1980 can extend the limitation period where there has been a fraud or deliberate concealment. The fraud exception is covered in more detail in the third article of this series.

Cross-border fraud

Complex frauds often cover a number of jurisdictions and it may be necessary to obtain evidence from and/or commence claims against parties abroad. Undertaking this in an insolvency process can be advantageous due to the recognition of English insolvency proceedings and the extra territorial effect of some IP investigative powers and officeholder claims abroad, although Brexit has reduced the effectiveness in relation to the EU.  

Dissolution

In many instances, companies end up dissolved without entering into an insolvency process, typically due to Companies House striking off the company for failing to file documents, meaning that many frauds go undetected.

There is a straightforward process to follow to voluntarily strike off a company which includes notifying others of the application to allow interested parties an opportunity to object. Voluntary strike offs, however, reportedly account for a small number of the companies that are struck off, with a significant number each year being automatically struck off by Companies House due to filing failures. It's estimated that about half of these are of insolvent companies. 

A company being struck off doesn't mean the end as it is possible for interested parties to apply to restore the company and place it into an insolvency process. While issuing a winding up petition is typically used when a company is unable to pay its debts, it is possible to petition for winding up on other 'just and equitable' grounds such as fraud and the court has broad discretion as to whether to grant an order on that basis.

Distributions to creditors 

Creditors are generally treated equally in an insolvency process, meaning that they must share equally in any company assets available for distribution (ie they will receive the same pence in the pound) - the 'pari-passu' principle. While this means that a victim must share the fruits of any recovery, they will have been spared the cost of funding legal proceedings.

That said, if a creditor has a proprietary claim or interest and can establish a right to the property such as under a constructive or resulting trust which may well be the case in fraud claims, the pari-passu principle will not apply to that property. It belongs to that creditor and will not form part of the company's assets available for distribution. 

Funding

An insolvency process may mean that there are no - or limited - funds available to fund legal proceedings, but a funding solution may be available. A third party (such as a creditor or litigation funder) may be willing to fund legal proceedings, or an IP may assign claims to third parties.

Key takeaway

If you have been defrauded by a company or suspect you have been, seek professional advice as soon as you can about your options.  

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