Can trying to keep the company going become fraudulent trading?

The case Catherine Buhagiar u Frank Buhagiar (the “Plaintiffs”) vs. Claudio Caruana u Josephine Caruana għal kull interess li jista’ jkollha (the “Defendants”) was brought before the Court of Appeal (the “Court”) on the 12 July 2023, and was presided over by Prim Imhallef Mark Chetcuti, Imhallef Christian Falzon Scerri and Imhallef Josette Demicoli. This judgement examines the essential elements in order for fraudulent trading to subsist.

Through the submission of a sworn application filed on April 11, 2017, the Plaintiffs stated that through a private deed entered into on April 25, 2008, CNJ International Limited (the “Company”) constituted itself as a debtor in favour of the plaintiff, Catherine Buhagiar, for the sum of €107,150. On 30 April 2015, through a sentence of the First Hall Civil Court (the “FHCC”), in the names Catherine Buhagiar et v. CNJ International Ltd (Rik Gur No: 1013/13), the Plaintiffs were deemed as creditors of the said company in the amount of €72,471.82. The Plaintiffs held that on the date of the filing of their application, the Company was going through liquidation procedures, and held the view that the Company was not being managed appropriately.

The Plaintiffs accused the Defendants of running the business of the Company with the aim of defrauding or intending to defraud its creditors. Pursuant to Article 315 of the Companies Act, Chapter 386 of the Laws of Malta (the “Act”), the Plaintiffs asked the First Court to find the same Defendants personally liable without any limitation, for all the debts that the Company had against them.

The FHCC had rejected the claims against Josephine Caruana and held that the behaviour of Claudio Caruana rendered him liable under Article 315 of the Act.

The Defendant appealed from this judgement and filed an application on November 19, 2018. More specifically, in brining this action, the Defendant is requesting the Court of Appeal (the “Court”) to rule on the following matters:

That a wrong application of the law by the FHCC was made when it concluded that the elements of Article 315 of the Act resulted from facts and evidence which the Court had before it. Arguing that a broad interpretation was given, resulting in the application of the law being widened in a prejudicial way towards him.
That the FHCC arrived at the inference of malicious intent by focusing on an act that could possibly be considered as wrongful trade and not fraudulent trade.

The Plaintiffs also put forward their response as to why the appeal should be dismissed for the Court to consider.

The Courts Considerations

In considering the Defendants claims, the Court examined the above-mentioned claims as follows:

Article 315 of the Act holds that “if in the course of the winding up of a company, whether by the court or voluntarily, it appears that any business of the company has been carried out with intent to defraud creditors of the company or creditors of any other person or for any fraudulent purpose, the court on the application of the official receiver, or the liquidator or any creditor or contributory of the company, may, if it thinks proper so to do, declare that any persons who were knowingly parties to the carrying on of the business in the manner aforesaid be personally responsible, without any limitation of liability for all or any of the debts or other liabilities of the company as the court may direct”.

Fraudulent Trading

The Court, investigated whether the business of the company was carried out with the intent to defraud its creditors, which is the determining factor in Article 315. However, what is interesting about this Article, is that the wrongdoers i.e., those who have effective management and control over the company could be found personally liable for their actions with unlimited liability.

Despite the arguments put forward by Defendant that the downfall of the Company occurred due to external circumstances out of his control, the Court claimed that such downfall was attributable to its business model, where its revenue could be generated almost entirely by loans.

Fraudulent Intent and Dishonesty

The FHCC had concluded that the business of the Company had been managed with the intent to de-fraud its creditors. The Court then went on to state that in order to prove fraudulent trading, one must prove actual dishonesty (i.e., there must exist the intention on the part of the Directors to prejudice a/the creditor/s). Reference was made to Professor Andrew Muscat who holds the view that the test of intent will only be satisfied if there is ‘actual dishonesty involving, according to current notions of fair trading among commercial men, real moral blame.’

The intention follows from the behaviour, even if by inference, after considering all the circumstances of the case. The Court held that if it is then proven that a director requests a credit advance when he knew or was aware of the fact that there was a real risk that there was no possibility to pay in the agreed time, then the behaviour would qualify as fraudulent trading.

The Court therefore held that in this case, apart from finding the above fraudulent intent, also found that dishonest measures were also taken by the directors. The Court held that the Defendant was aware that the Company had no cash and or assets to pay back the loans he took. Moreover, despite the fact that he repaid the first loan he took from the Plaintiff, the Court held that this was done in order to reassure the Plaintiff that he will always repay any future loan.

Obligations as a Director and the requirement of Knowledge

It is essential that financial statements are presented to the Registrar of Companies, so that the public (including creditors) can have an insight as to the financial status of the Company, which is an obligation imposed under Article 167(1) of the Act.

The Court further linked the intention to de-fraud creditors to the fact that the Defendant did not have the Company’s accounts kept according to law. This element was given importance because (i) it shows that the Defendant did not consider it necessary for the Company to comply with its legal obligations; and (ii) no creditor had the chance to examine the state of the Company. Therefore, the Court held that despite the fact that there was clear evidence that the Company was in financial difficulty, the Plaintiff had no access to the Company’s financial statements.

The Courts Conclusion

Owing to the above, the Court (as was previously decided by the FHCC), ruled that the behaviour of Claudio Caruana falls exactly within what is provided for under Article 315 of the Act. Therefore, the appeal was rejected, and the previous judgement was confirmed, with the costs to be borne by the Defendant.

The author would like to thank Emma Attard Bondi, an intern at Ganado Advocates, for her assistance during the drafting of this law report.

Disclaimer: Ganado Advocates is responsible for contributing this law report but was not in any way involved as legal advisor for the parties in the judgement being covered in this law report.

This article was first published in The Malta Independent on 20/09/2023.

Author: Bettina Gatt (Associate, Ganado Advocates)