On Deepening Insolvency and Wrongful Trading
Look Chan Ho
Freshfields Bruckhaus Deringer LLP
Journal of International Banking Law and Regulation, Vol. 20, August 2005
This piece seeks to compare and contrast the developing deepening insolvency theory in the US with the wrongful trading regime in the UK. Beneath the differences in semantic expression lies a common underlying idea. Hence the two principles share many similarities as follows. First, both principles recognise that undue prolongation of an insolvent corporation's life harms the corporation's interests and that, when the risk of insolvency looms, the management have a perverse incentive to continue trading as long as possible. Thus, both principles seek to arrest this perverse incentive and impose personal liability on those participating in the unnecessary trading. It follows that the management owe a duty to the corporation not to trade unnecessarily when insolvency is on the horizon. Second, both principles can apply to outsiders who exercise domination and control of the debtors. Third, neither principle imposes an absolute duty on the managers of an insolvent corporation to shut down and liquidate the corporation as soon as there is any insolvency risk. The New York bankruptcy court in In re Global Service Group completely misunderstood the English wrongful trading regime. Fourth, the measure of damages under either principle may be based on the corporation's increase in net deficit during the period of unjustified trading.
However, deepening insolvency and wrongful trading appear to diverge in the following areas. While deepening insolvency may be invoked outside the strict confines of liquidation proceedings, a wrongful trading claim can only be brought by a liquidator. The realm of application of the deepening insolvency principle is potentially very wide, whereas the wrongful trading provision applies only to directors (including shadow directors). Furthermore, while a deepening insolvency claim belongs to the insolvent corporation, a wrongful trading claim does not, though the current English position on this is wrong.
This piece will also consider the possibility of the English court developing an English tort of deepening insolvency. At any rate, much is to be gained from comparative law studies in this area.
Number of Pages in PDF File: 21
Keywords: Deepening insolvency, wrongful trading, liquidation, duty to creditors, duty of directors
JEL Classification: K13, K22, K29, K33, K39
Date posted: June 14, 2005