Fraudulent trading
Encyclopedia
Fraudulent trading is an insolvency law concept, and in particular a UK insolvency law
concept. It refers to a company that has carried on business with intent to defraud creditor
s.
it appears to the liquidator that fraudulent trading has occurred, the liquidator may apply to the court for an order any persons who were knowingly parties to the carrying on of such business are to be made liable to make such contributions (if any) to the company's assets as the court thinks proper.
Conceptually, fraudulent trading is similar to a fraudulent conveyance
, but the key distinction is that an application to have a transaction set aside as a fraudulent conveyance usually requires to the third party beneficiary to disgorge the benefit of the conveyance to undo the loss to the company's assets, whereas a court order in relation to fraudulent trading it is the responsible parties (usually the directors
) who must make up the loss and the third party beneficiaries will usually retain the benefit. However, it is perfectly possible for a single transaction to be simultaneously fraudulent trading and a fraudulent conveyance, and to be the subject on concurrent applications. Some legal systems permit a director who makes a contribution to the company's assets pursuant to an order for fraudulent trading to subrogated
to any claim that the company might have with respect to a fraudulent conveyance.
In practice, applications for orders in respect of fraudulent trading are rare because of the high burden of proof associated with fraud
. Usually, even where fraudulent trading is suspected, an application is made with respect to an allegation of "wrongful trading
" (or "insolvent trading") where the burden of proof is lower. Where applications are brought for fraudulent trading it is usually because when the trading occurred, the company was not insolvent at that time (insolvency at the time of the trading is normally a requirement to establish wrongful trading, but not fraudulent trading).
The effect of a successful application for fraudulent trading varies between different legal systems. In some countries the assets contributed by the directors are treated as general assets which may be taken by any secured creditor
s who may have a security interest
which attaches to all the company's assets (characteristically, a floating charge
). However, some countries have "ring-fenced" payments made for fraudulent trading so that they are made available to the pool of assets for unsecured creditor
s.
Fraudulent trading is entirely separate and distinct from "insider trading
", which focuses purely upon the abuse of inside information in relation to financial markets for personal financial gain, and is wholly unrelated to creditor's rights or insolvency law.
UK insolvency law
United Kingdom insolvency law deals with the insolvency of firms and individuals in the United Kingdom. The important statutes are the Insolvency Act 1986, as amended by the Enterprise Act 2002, as well as the Company Director Disqualification Act 1986 and the Companies Act 2006.Insolvency is a...
concept. It refers to a company that has carried on business with intent to defraud creditor
Creditor
A creditor is a party that has a claim to the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property or service to the second party under the assumption that the second party will return an equivalent property or...
s.
Law
Where during the course of a winding-upLiquidation
In law, liquidation is the process by which a company is brought to an end, and the assets and property of the company redistributed. Liquidation is also sometimes referred to as winding-up or dissolution, although dissolution technically refers to the last stage of liquidation...
it appears to the liquidator that fraudulent trading has occurred, the liquidator may apply to the court for an order any persons who were knowingly parties to the carrying on of such business are to be made liable to make such contributions (if any) to the company's assets as the court thinks proper.
Conceptually, fraudulent trading is similar to a fraudulent conveyance
Fraudulent conveyance
A fraudulent conveyance, or fraudulent transfer, is a civil cause of action. It arises in debtor/creditor relations, particularly with reference to insolvent debtors. The cause of action is typically brought by creditors or by bankruptcy trustees...
, but the key distinction is that an application to have a transaction set aside as a fraudulent conveyance usually requires to the third party beneficiary to disgorge the benefit of the conveyance to undo the loss to the company's assets, whereas a court order in relation to fraudulent trading it is the responsible parties (usually the directors
Board of directors
A board of directors is a body of elected or appointed members who jointly oversee the activities of a company or organization. Other names include board of governors, board of managers, board of regents, board of trustees, and board of visitors...
) who must make up the loss and the third party beneficiaries will usually retain the benefit. However, it is perfectly possible for a single transaction to be simultaneously fraudulent trading and a fraudulent conveyance, and to be the subject on concurrent applications. Some legal systems permit a director who makes a contribution to the company's assets pursuant to an order for fraudulent trading to subrogated
Subrogation
Subrogation in its most common usage refers to circumstances in which an insurance company tries to recoup expenses for a claim it paid out when another party should have been responsible for paying at least a portion of that claim....
to any claim that the company might have with respect to a fraudulent conveyance.
In practice, applications for orders in respect of fraudulent trading are rare because of the high burden of proof associated with fraud
Fraud
In criminal law, a fraud is an intentional deception made for personal gain or to damage another individual; the related adjective is fraudulent. The specific legal definition varies by legal jurisdiction. Fraud is a crime, and also a civil law violation...
. Usually, even where fraudulent trading is suspected, an application is made with respect to an allegation of "wrongful trading
Wrongful trading
Wrongful trading is a type of civil wrong found in UK insolvency law, under s 214 Insolvency Act 1986. It was introduced to enable contributions to be obtained for the benefit of creditors from those responsible for mismanagement of the insolvent company....
" (or "insolvent trading") where the burden of proof is lower. Where applications are brought for fraudulent trading it is usually because when the trading occurred, the company was not insolvent at that time (insolvency at the time of the trading is normally a requirement to establish wrongful trading, but not fraudulent trading).
The effect of a successful application for fraudulent trading varies between different legal systems. In some countries the assets contributed by the directors are treated as general assets which may be taken by any secured creditor
Secured creditor
A secured creditor is a creditor with the benefit of a security interest over some or all of the assets of the debtor.In the event of the bankruptcy of the debtor, the secured creditor can enforce security against the assets of the debtor and avoid competing for a distribution on liquidation with...
s who may have a security interest
Security interest
A security interest is a property interest created by agreement or by operation of law over assets to secure the performance of an obligation, usually the payment of a debt. It gives the beneficiary of the security interest certain preferential rights in the disposition of secured assets...
which attaches to all the company's assets (characteristically, a floating charge
Floating charge
A floating charge is a security interest over a fund of changing assets of a company or a limited liability partnership , which 'floats' or 'hovers' until conversion into a fixed charge, at which point the charge attaches to specific assets...
). However, some countries have "ring-fenced" payments made for fraudulent trading so that they are made available to the pool of assets for unsecured creditor
Unsecured creditor
An unsecured creditor is a creditor other than a preferential creditor that does not have the benefit of any security interests in the assets of the debtor....
s.
Fraudulent trading is entirely separate and distinct from "insider trading
Insider trading
Insider trading is the trading of a corporation's stock or other securities by individuals with potential access to non-public information about the company...
", which focuses purely upon the abuse of inside information in relation to financial markets for personal financial gain, and is wholly unrelated to creditor's rights or insolvency law.
Cases
- R v. Grantham [1984] QB 675
- Re Augustus Barnett & Son LtdRe Augustus Barnett & Son LtdRe Augustus Barnett & Son Ltd [1986] BCLC 170 is a UK insolvency law case on the standard of fault required to show that directors have been guilty of fraudulent trading.-Facts:...
[1986] BCLC 170 - Re Sarflax LtdRe Sarflax LtdRe Sarflax Ltd [1979] Ch 592; [1979] 1 All E.R. 529 is a UK insolvency law case concerning voidable preferences and fraudulent trading, now in the Insolvency Act 1986. It concerns the definition of "intention to defraud", which is found in a number of legal provisions.-Facts:Sarflax Ltd was in...
[1979] Ch 592