The English Technology and Construction Court recently held that the directors were liable in tort for the failings of their insolvent construction company.
It is not uncommon for construction companies set up to act as the employer on a specific contract to turn out to be insolvent after the work is completed, unable to pay their subcontractors in full. If you’re the subcontractor this is very upsetting as in normal situations you would go unpaid.
Is there anything you can do about this?
Can you go behind the corporate veil and get the court to order your employer’s directors and shareholders to pay up personally?
Companies are their own legal entity in the eyes of the law, separate from their directors and shareholders, so their debts normally die with the company, creditors struggle to get to the directors and shareholders. But while it might be difficult, even unusual, for subcontractors to get behind the corporate veil, this case has shown that it is not impossible, but it does depend on the specific circumstances of the case. And in construction companies, the circumstances that give rise to such personal liability do occur quite often… so this case is not that unusual that you should discount it, whether you’re the contractor or employer.
Let’s explore this…
Going back to first principles, the courts can make directors personally liable for a company debt if they believe:
- The company is a mere sham
- The directors have made some fraudulent misrepresentations or
- There has been a personal injury.
The burden of proof lies on the person looking to go behind the corporate veil and the standard of evidence required is high.
But that’s not quite we are talking about here…
In this case, Palmer Birch v Lloyd, the contractor, Palmer Birch (‘PB’), made a claim in tort based on the directors’ conduct.
Palmer Birch was working on a country house for its employer, Hillersdon House Limited, under a standard form JCT contract.
The Lloyds were brothers, one was the sole director and shareholder of Hillersdon (Hill 1), the other (Hill 2) was held to have been a ‘de facto’ director of Hillersdon because it was he who sfinanced Hillersdon’s business and controlled its spending.
Hillersdon had no money of its own and depended entirely on money from Hill 2. He became short of cash at the end of 2014, causing Hillersdon to miss making several payments to PB. The cash problems were solved some time later on but nevertheless Hillersdon failed to pay PB – Hill 2 put the money into a new company he had set up to carry out exactly the same work.
In Spring 2015, Hillersdon terminated the contract with PB on the basis that it would be going into liquidation – this being a repudiatory breach of the JCT.
PB argued that: ·
- Hill 2 had caused Hillersdon’s repudiatory breach of the JCT
- Hill 2 had committed a tort of ‘unlawful interference’ by setting up the company structure through which Hillersdon had employed PB in such a way as to works for his own personal benefit; and
- The Hills were both guilty of conspiracy in causing the repudiatory breach of the JCT.
The important issue here was the degree to which the Hills had been involved in the breach of contract.
The judge decided that the mere fact that Hill 2 had diverted funds from Hillersdon to his new company did not by itself constitute an inducement of breach of contract, as he was not legally obliged to finance Hillersdon. However, there had been such an inducement brought about by Hill 2’s transfer of money to newco, instead of using the money to pay PB. The judge said this was an obvious and intentional effort to cause the repudiatory breach of the JCT so as to avoid paying PB.
To prove a tort of unlawful interference there has to be a conspiracy to injure a party, in this case PB. The judge decided there had indeed been a conspiracy here between the Hills to cause the repudiatory breach by (1) liquidating the Hillersdon and (2) sending the cash to newco rather than paying PB.
The judge decided that both Hills had committed torts, making them both personally liable.
This decision is an important one because it shows:
- Subcontractors’ options include not only seek recompense from a company’s directors and shareholders, they can attack shadow and de facto directors if the circumstances fit.
- Where there is a connected phoenix continuing the same business as oldco, it’s easier to prove there has been some form of abuse and conspiracy rendering the directors personally liable. Had there been no phoenix, it would perhaps have been more difficult for PB to prove their case.
- Often small family owned and group companies alike depend on the family / group for finance – the circumstances of this case are not so unusual after all.
- Both employers and contractors need to be mindful of this case – it’s important for both.
If you need any insolvency advice in respect of your construction company, get in touch.