Secrets and lies The penalty for fraudulent trading is based on a director’s knowledge that the business is ultimately not salvageable, writes Ailbhe O’Neill In the last issue, this column looked at the problem with salaries paid out of company’s assets. Continuing the focus on the position of the company director, this month’s column looks at the issue of fraudulent trading under the Companies Acts. Fraudulent trading is defined in sections 296 and 297A of the Companies Acts 1963 as knowingly being “a party to the carrying on of any business of the company with intent to defraud creditors of the company, or creditors of any other person or for any fraudulent purpose”. Liability for fraudulent trading can be criminal or civil. As a criminal offence, where tried on indictment, it carries a maximum penalty of e63,487, seven years imprisonment or both. As a civil wrong, fraudulent trading is actionable by either any creditor or contributory of the company or by its liquidator, receiver or examiner. The remedy is unlimited liability for all or part of the debts of the company. In an Irish case, Re Hunting Lodges Ltd., it was held that whether full or partial liability is imposed can depend on the circumstances of each directors. In that case, (discussed further below), the defendants were treated differently due to their differing circumstances. Two directors were jointly liable without limitation, two others were liable only up to a certain amount.

Directors and other officers of the company may be held liable but fraudulent trading also applies to any person involved in the business who was a knowing party to the fraud. This means that, for instance, the creditors of the company can be caught as well if they are involved in the fraud. The point of the provisions regarding fraudulent trading is to catch dishonest conduct which is designed to defraud creditors of the company. Continuing to trade when a company is insolvent will not normally constitute fraudulent trading. (Although see next issue’s discussion of reckless trading). One English judge noted that: “There is nothing wrong in the fact that the directors incur credit at a time when, to their knowledge, the company is not able to meet all its liabilities as they fall due. What is manifestly wrong is if directors allow a company to incur credit at a time when the business is being carried on in such circumstances that it is clear that the company will never be able to satisfy its creditors. However, there is nothing to say that directors who genuinely believe that the clouds will roll away and the sunshine of prosperity will shine upon them again and disperse the fog of their depression are not entitled to incur credit to help them get over the bad time.” A good example of the type of conduct at which the legislation is aimed is an Irish case, Re Aluminum Fabricators Ltd. (No. 2) where two directors of a company were made liable for all of the debts of the company without any limitation. The company in that case was being wound up as it was insolvent. It transpired that all of the cash payments to the company were not recorded in the accounts forwarded to the auditors. Instead, they were recorded in a hidden register which disappeared from the premises of the company. The two directors had been putting the money into personal offshore bank accounts. The judge in the case held that: “The privilege of limitation of liability which is afforded by the Companies Act…cannot be afforded to those who use a limited company as a cloak or shield beneath which they seek to operate a fraudulent system of carrying on business for their own personal enrichment and advantage.” What is meant by trading? The legislation refers to “carrying on the business”. In another Irish case, Re Hunting Lodges Ltd., directors and the secretary of an insolvent company which owed large sums to the Revenue Commissioners arranged to sell the main asset of the company – a public house. The full amount from the sale was not paid to the company’s accounts – some of it was diverted into the secretary and director’s own accounts. It was held that the sale of the pub constituted “carrying on the business” of the company. Unlike reckless trading it is difficult to “fall into” fraudulent trading. The requirement of dishonesty makes even a civil case for fraudulent trading relatively difficult to prove. The penalty, whether civil or criminal, is however very severe. n Ailbhe O’Neill is a barrister-at-law This article appears in the January/February edition of Irish Construction Industry Magazine