 Autumn leaves are falling and the
first torrential rains played havoc in low lying areas. Yet the
autumn fresh air has also morphed into a landside court decision
that took five years in the making. The Times of Malta reported last
week that Mr Justice Tonio Mallia, sitting in the First Hall of the
Civil Court, concluded that Victor Zammit, Christopher Gauci and
Wallace Fino had committed fraudulent and wrongful trading in
connection with PCO and the company’s creditors. They were held
personally and unlimitedly responsible for the debts incurred by
Priceclub Operators Ltd (PCO).
The court said that this manoeuvring took place to facilitate the
workings of the private companies owned by Mr Zammit and Mr Gauci to
the detriment of PCO’s creditors. Mr Justice Mallia added that PCO
had commenced operating with a deficit and without a capital base
culminating in the plight of unsecured suppliers been ignored by the
directors. In a separate judgment, Mr Justice Tonio Mallia, also
held Priceclub Holdings Ltd (PCH), Priceclub Birkirkara Ltd (PCB),
Priceclub Swatar Ltd (PCS), and Priceclub Burmarrad Ltd (PCBU)
unlimitedly responsible for the debts incurred by Priceclub
Operators Ltd (PCO).
The impact of the collapse of the Priceclub on a tiny island ‘s
business community is probably equal to or could even be in excess
of that of the possible impacts of the Parmalat scandal.
This is a milestone judgement in the short history of our insolvency
rules within the 1995 Companies Act. Insolvency practitioners point
to article 214 of the Companies Act, 1995 which describes an
insolvent company as one which is unable to pay its debts. Wrongful
trading can be defined as occurring when a director of a company
that has gone into insolvent liquidation and at some time before the
commencement of the winding up of the company, knew or ought to have
concluded that there was no reasonable prospect that the company
would avoid going into insolvent liquidation. The court may hold him
liable to make such a contribution to the company’s assets .
 The court will not make such a declaration if it is satisfied that
the director in question took every step with a view to minimising
the potential loss to the company’s creditors. In insolvency law,
fraudulent trading refers to a company has carried on business with
intent to defraud suppliers.
Where during the course of a winding-up it appears to the liquidator
that fraudulent trading has occurred, the liquidator may apply to
the court for an order any directors were knowingly parties to the
carrying on of such business are to be made liable to make such
losses.
Fraudulent trading also existed in cases where the directors had no
good reason to think funds would become available to pay the
company’s creditors when the debts became due or shortly thereafter
Let me give some legal background to the terms wrongful trading and
fraudulent trading. The main purpose of making directors responsible
in law for wrongful trading was to reduce the number of phoenix
companies being set up by the unscrupulous and crooked and protect
the public and creditors from losses.
Whether that objective is being achieved is for others to say but it
does mean that the honest director does not have to act fraudulently
or negligently for the provisions to apply.
Wrongful trading is thus a form of civil liability which can result
in a financial order for a return of funds to the company.
Directors have to ensure that the company has proper accounting and
reporting systems in place and that you receive and act on financial
information on a regular basis.
It is customary for directors to be vigilant and not rely solely on
historical accounting information. They need to review future
trading projections and question the underlying assumptions. It is
no excuse that they relied on paid subordinates to give them up to
date information on the daily trading status of the company.
Directors are duty bound to compare actual performance with budgets
and amend future budgets in the light of those comparisons.
The Price Club Supermarkets case is the casus classicus. Initially,
the chain enjoyed one of Malta’s best turnovers. However, the
chain’s demise was equally as outrageous. It is has ended up in July
2002 owning some Lm 8.5 million to over 200 creditors. Assuming the
banks recover their money from Priceclub and as is likely the trade
creditors do not, the loss in tax revenue would be in the region of
Lm3 million, assuming Lm9 million creditors unpaid.
Not much disclosure was given by the financial press since the
liquidation started five years ago.
However the late Julian Manduca (a journalist with Malta Today) had
single-handle followed the case and covered the case unctuously. He
pursued the legal proceedings and wrote about how the mystery of the
sudden demise of the largest supermarket chain had occurred.
 In his uncovering of court documents, Julian had revealed how the
owners of the defunct supermarket chain managed to usurp massive
funds from a company destined to face bankruptcy, diverting the
funds into their own personal channels and fabricating stock figures
and accounts.
Typically one reads in his reports how John Zarb is a leading
auditor with PricewaterhouseCoopers and a consultant to the big six
creditors that lost money in Priceclub.
He was appointed by liquidator to examine the books of a Certainly the foremost auditing
authority on the island, John Zarb, in his report for
Pricewaterhouse Coopers on the Price Club demise, revealed how the
multimillion market leader had continued to buy goods from its
suppliers when the directors knew the company would never be in a
position to pay for the goods ordered. In his court affidavit, Zarb
showed how the Priceclub, despite being in severe financial trouble,
decided its stock values without keeping stock records or carrying
out substantial stock-takes.
So one may ask if the auditors of an insolvent company can be held
liable for directors wrongful or fraudulent trading. Prima facie the
answer is no. Quoting International Standard on Auditing 400: Risk
Assessment and Internal Control (IFAC Handbook, 2003d), it states
inter alia that an auditor should only be concerned with functions
within the internal control structure relevant to the financial
statements. The auditor would obtain an understanding of such a
system and determine its limitations. No responsibility is placed
upon the auditor by the standard.
In Malta, the Maltese Companies Act 1995 (the 1995 Act) is clear as
to what should be the end result of an audit.
 The auditor is responsible for drawing up a report, being a
manifestation of his/her opinion on the financial statements of the
company. The 1995 Companies Act specifically states (s 179) that the
report represents the auditors’ opinion as to whether the annual
accounts are in accordance with the relevant legislation and show a
true and fair view. One should note that Section 176(1) of the
Companies Act 1995 gives the responsibility for a company’s
financial statements to the directors. The board of directors
approves and signs the financial statements to be presented at the
annual general meeting.
This decision will have far reaching albeit positive implications
for corporate governance in Malta. Let us hope that a lesson is
learnt by all officers of trading companies to make sure to observe
to their best ability the duties to protect the interest of the
suppliers and consumers.
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