If a law firm is experiencing financial difficulties, and there is a possibility that it may have to enter into an insolvency process, it is vital to take professional advice from an insolvency practitioner as soon as possible. This advice will arm you with information that will allow you to make the best decisions as to how to proceed, for the benefit of your clients, creditors and staff – and will help to protect you.
One specific area that will be covered by the insolvency practitioner is the concept of antecedent transactions.
What is an antecedent transaction?
An antecedent transaction is something that is done in the run-up to the insolvency of a firm which results in one or more creditors being treated more favourably than the others; or where a person other than a creditor benefits from the actions of the practice and the creditors suffer as a consequence.
When a firm enters into an insolvency process, the appointed insolvency practitioner has a duty to review transactions, initially in the two years prior to the commencement of the appointment. Antecedent transactions can be challenged in court and an order sought to reverse the transaction to put the insolvent firm back in the position it was before the transaction was made. The aim is to ensure a fairer return for the firm’s creditors. However, there can be circumstances where directors in the case of a limited company, members in LLPs, or a partner in a partnership, can become personally liable in relation to an antecedent transaction.
The four most common transactions of this type are:
Transactions at an undervalue
Preferences
Transactions defrauding creditors
Avoidance of floating charges
A transaction at an undervalue is where a body corporate (a company or LLP) or an individual makes a gift where there is no consideration, or enters into a transaction for an amount significantly less than its value. For an order to be made, the firm must have been unable to pay its debts at the time of the transaction or became unable to pay its debts as a result of the transaction. The transaction must have occurred within two years of the commencement of the administration or liquidation for a body corporate, or within five years of the presentation of a bankruptcy petition in the case of an individual. Interestingly, if the transaction was with a connected person there is an automatic presumption of insolvency at the time of the transaction.
A preference is given when a person or company is a creditor of the law firm, or a guarantor for one or more of its liabilities, and the law firm does something that puts that creditor or guarantor into a better position than they would have otherwise been. For an action to succeed there must be proof of a positive wish to prefer the creditor. If the preference was to an unconnected party, the transaction must have occurred within six months of the commencement of the insolvency process. This period is extended to two years where a connected party is involved. If a connected party is involved there is an automatic presumption of a desire to prefer.
Transactions are deemed to defraud creditors if they are at an undervalue, and the court is satisfied they were entered into for the purpose of putting assets beyond the reach of a party who is making, or may at some point make, a claim against the law firm, and prejudicing their interests in relation to their claim. As there is a positive intent to defraud there is no time limit on when a challenge may be made. The court has the power to restore the position to what it would have been if the transaction had not been entered into.
The aim in respect of avoidance of floating charges is to prevent a law firm from benefitting a creditor by giving them a floating charge for an existing debt, without additional consideration. The relevant period is two years where the creditor is connected and one year for an unconnected party. If the charge is given to an unconnected party, the law firm needs to be insolvent at the time the charge was given, or the firm’s debts could not be paid off as a result of the charge being given, in order for the court to invalidate the charge. No insolvency test is needed for a charge granted to a connected party. Such a charge will be deemed by the court to be automatically invalid.
Other insolvency offences
There are further transactions that may be uncovered by insolvency practitioners when they are carrying out a review of a law firm’s transactions. These relate to law firms that are a limited company or an LLP. Here, the court will seek to have the director or responsible member pay compensation for the loss to the law firm caused by their actions. These offences include:
Wrongful trading
Fraudulent trading
Misfeasance
Wrongful trading is where a director/member knew or ought to have known that there was no reasonable prospect that their firm would avoid an insolvency process, and took the decision to carry on trading, to the detriment of creditors. In these circumstances, where the firm’s position is worse at the date of liquidation or administration, and knowingly insufficient steps were taken to minimise any potential loss to the firm’s creditors, a court order can make the director/member liable to provide a contribution to the firm’s assets as it sees fit.
A similar provision applies where an LLP enters into liquidation and members should be aware of the claw-back provisions under the Insolvency Act 1986. It applies to withdrawals by a member at any time in the two years prior to the liquidation. This includes drawings, repayments of loans and salaries. If a liquidator can prove to the satisfaction of the court that at the time of the withdrawals the firm was unable to pay its debts, and the member knew or ought to have concluded there was no reasonable prospect the firm could avoid liquidation, an order can be made that the member make such contribution the court sees fit.
Fraudulent trading is similar to wrongful trading except that there has to be a definite intention to defraud. The court order to contribute to the firm’s assets is not confined to the firm’s officers but to any party who was involved in the continuation of trading, leading to additional losses to creditors. This is also a criminal offence.
A director/member has a duty to act in the best interests of the firm and not, for example, to seek personal profit when carrying out their role as director/member. Where this duty has not been fulfilled this is misfeasance. Where money or assets have been misapplied, or retained, then the court can make an order for the director/member to repay, restore or account for these assets, or to contribute such sum to the firm’s assets by way of compensation in respect of the misfeasance.
Company Directors Disqualification Act 1986 CDDA
The Company Directors Disqualification Act (CDDA) places a duty on liquidators and administrators to send a report to the Secretary of State as soon as they think a director/member has shown conduct that makes them unfit to be concerned in the management of a limited company or LLP. These reports are vetted and if there is sufficient evidence of unfit conduct, particularly with regard to the antecedent transactions and insolvency offences described above, they can be disqualified from acting as a director/member for up to 15 years.
Seek early advice
This article illustrates the importance of obtaining expert advice at the earliest of stages if you consider that your law firm may be heading for financial instability. The correct advice can assist directors/managers in making the right decisions in the run up to an insolvency event, and avoiding personal liability for transactions and disqualification from acting in the management of a law firm in the future.
If your law firm is experiencing financial difficulty and you would like advice and support, please contact 0808 1445575 or email help@armstrongwatson.co.uk.
