Re Patrick and Lyon [1933] Ch 786

Facts

• The litigation arose under the fraudulent-trading provision then in force, which empowered the court to impose personal liability on directors (and others knowingly party to the fraud) where the business of a company had been carried on “with intent to defraud creditors.”
• Fraudulent trading, as addressed by the judges, concerns the deliberate continuation of commercial activities when those directing the company know that existing or future creditors will not be paid and nevertheless continue to contract on that false footing.
• The court emphasised that corporate failure is a common commercial risk; companies frequently trade on credit, experience downturns, and even enter insolvency without any implication of fraud.
• The judgment therefore sought to draw a principled line between:
  1. Ordinary mismanagement, incompetence, or over-optimism (which may justify civil claims such as negligence or misfeasance but not the punitive consequences of a fraud finding); and
  2. Conscious dishonesty, evidenced by statements or conduct designed to create a false impression of the company’s financial health or its ability to pay.
• Directors facing financial pressure often make decisions—such as obtaining fresh credit, deferring payments, or disposing of assets—that, with hindsight, prejudice creditors. The court confirmed that those decisions are not automatically tainted unless the intent behind them was to deceive.
• Accordingly, Re Patrick and Lyon became an authoritative clarification that the statutory phrase “intent to defraud” is not satisfied merely because business decisions were ill-judged or led to eventual loss.

Issues

1. Whether a company’s collapse, accompanied by evidence of mismanagement or speculative trading, is enough to prove fraudulent trading in the absence of direct proof of deceitful intent.
2. How the court should identify and articulate the mental element required—i.e., what level of knowledge or purpose must a director possess before liability attaches.
3. Which party carries the evidential and persuasive burden, and whether that burden is discharged on the ordinary civil standard (balance of probabilities) or a heightened standard given the seriousness of an allegation of fraud.

Decision

• The court held unequivocally that fraudulent trading cannot be inferred solely from insolvency, loss-making, or even gross mismanagement; there must be affirmative evidence of dishonesty.
• Dishonesty, for these purposes, involves a “real and knowing intent” to mislead creditors—an intent the court will not presume from circumstances but must find proven on credible material.
• While direct admissions are rare, the court required cogent primary facts from which dishonesty could properly be inferred: for example, falsified accounts, knowingly false assurances, or deliberate concealment of the company’s true position.
• Optimistic forecasts, mistaken judgments, or unsuccessful rescue attempts, however unreasonable they may later appear, do not of themselves cross the line.
• Consequently, the judges dismissed the allegation of fraudulent trading because the claimant failed to satisfy the burden of proof; suspicion and hindsight criticism were insufficient to overcome the high evidential threshold.

Legal Principles

• High Threshold of Dishonesty: A claimant must establish that those controlling the company intended to deceive, not merely that they should have realised creditors might suffer. Proof of negligence or recklessness, without more, is inadequate.
• Distinction Between Fault and Fraud: Company law recognises varying degrees of managerial fault. Fraudulent trading occupies the most culpable end of the spectrum and therefore attracts personal liability and potential criminal sanctions; ordinary negligence does not.
• Burden and Standard of Proof: The burden lies squarely on the alleging party. Although the civil standard applies, courts demand particularly strong and convincing evidence because a finding of fraud carries severe moral and financial consequences.
• Evidential Indicators: Typical indicia—while not exhaustively listed in the judgment—include fabrication of accounting records, deliberate suppression of material facts, or the use of new credit for purposes that directors know cannot be honoured. Absence of such indicators weighs heavily against a fraud finding.
• Governance Implications: Directors who keep proper books, obtain professional advice, and act transparently will normally be able to rebut allegations of dishonest intent, even if their judgments ultimately prove disastrous. Conversely, opacity and falsification strengthen an inference of fraud.

Conclusion

Re Patrick and Lyon [1933] Ch 786 remains a seminal authority for the proposition that allegations of fraudulent trading demand stringent proof of conscious dishonesty. The decision reassures directors that genuine but unsuccessful attempts to rescue a struggling enterprise will not, without more, expose them to personal liability for fraud. At the same time, it cautions that where deliberate deceit is shown, the law will pierce the corporate veil and impose liability commensurate with the wrongdoing.