How compliance is for the benefit of an insolvency practitioner.

Compliance is effectively defined in SIP 1 and the Ethics Code as the fundamental principle of professional competence and due care. An insolvency practitioner should act diligently and in accordance with applicable technical and professional standards and do a good job. The stress caused by the regulation of this can then lead to a tendency to assume that these principles and standards are solely for the benefit of creditors, directors and others who become inadvertently involved in an insolvency process.

Achieving a high standard of compliance, professional competence and due care is also very much to the benefit of the insolvency practitioner. Insolvency practitioners who are known to have high standards of professional integrity and to be competent are likely to have more work referred to them. The commercial risk to the insolvency practitioner of not achieving a high standard of professional competence and due care is that this could lead to claims for negligence or damages being made against the insolvency practitioner.

A very good example of how this could happen is in members’ voluntary liquidations. As far as shareholders are concerned the purpose of most members’ voluntary liquidations is to enable a distribution to be made to the shareholders as quickly as possible and liquidators inevitably come under a lot of pressure from the shareholders to achieve this.

The liquidator’s role is also to pay any remaining creditors in full together with statutory interest, before making a payment to the shareholders. HMRC, always a potential creditor, cannot give tax clearance until the final tax return has been received and processed. Tax clearance is a statement from HMRC that all pre liquidation tax returns have been received and that based on information available there are no further pre liquidation liabilities owed by the company to HMRC.

The time taken by HMRC on occasion to give tax clearance is the subject of legend and in any event the final tax return cannot be submitted until after the date of liquidation, again possibly causing further delay.

If the liquidator was to distribute funds to the shareholders without first being certain that those funds would not be needed to pay creditors and there is a subsequent claim from a creditor, say HMRC, then the creditor would look to the liquidator to make good any shortfall and possibly consider making a claim for negligence against the liquidator.

Insolvency practitioners should not make any distribution to shareholders in members’ voluntary liquidations without first receiving tax clearance or as a minimum without being able to provide in full for the final tax liability by checking the final tax return and other tax records.

Liquidators also obtain an indemnity from the shareholders in members’ voluntary liquidations, as best practice. This has always been seen as a belt and braces procedure to protect the liquidator against the risk of an unexpected claim against the company after the date of liquidation. A claim from HMRC for tax owed following tax returns submitted by the company is not however an unexpected claim against the company.

It seems that in some members’ voluntary liquidations funds are now distributed to shareholders before tax clearance has been obtained or even, in some cases, before the final tax return has been submitted to HMRC. These liquidators appear to rely on the shareholders’ indemnity to protect them against the risk of a claim by HMRC.

Reliance on an indemnity is itself very high risk as there is no guarantee that the funds would ever be repaid. The wording of the indemnity may not be fit for purpose, by the time a claim is made against the indemnity the shareholder may no longer have sufficient funds to make a repayment and even a successful claim on the indemnity is likely to involve delay and the cost of instructing a solicitor. 

Reliance on an indemnity as protection against the risk of an unexpected claim against the company is also very different from using an indemnity as a way of obtaining funds to pay a known creditor such as HMRC if the liquidator had previously made a distribution without taking sufficient care to establish whether the company had any creditors.

A insolvency practitioner acting diligently and in accordance with technical and professional standards would obtain tax clearance before making a distribution to shareholders or as a minimum would ensure that it was possible to provide in full for the final tax liability by checking the final tax return and other tax records. This would be professional competence and due care, compliance, and it would be very much to the liquidator’s personal benefit to work in this way.

RMCSC carries out insolvency and anti money laundering compliance reviews of the highest standard and provides bespoke reports that include suggestions and recommendations for achieving compliance that is to the benefit of the insolvency practitioner, not just the regulators. RMCSC is based in London and has clients throughout England and Wales.

Please contact me on caroline.clark@rmcsc.co.uk or 07854 967976 if you have any queries or if you would like to discuss this further.