What duties are we talking about?
Sections 171 to 175 of the Companies Act 2006, requiring a director of a company to:
- Section 171 – Exercise their powers for the purposes for which they were conferred.
- Section 172(1) – Act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. Section 172(3) goes on to say that when a company nears or becomes insolvent he must consider or act in the interests of creditors of the company.
- Section 174 – Exercise reasonable care, skill and diligence.
- Section 175 – Avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company.
So why do I ask this now?
A legal case involving probably the UK’s most litigious Insolvency practitioner has been reported in the last few days in which he successfully argued that these duties survive liquidation and/or administration.
So what did he argue?
He took action against the director of a company he is liquidating, System Building Services Group Limited (‘SBSG’) seeking court orders that:
- A property held by the director (Mr M) be declared as being held on trust for SBSG, he having bought it an undervalue from an earlier insolvency practitioner of SBSG.
- The director reimburse SBSG for £15k it paid out to a creditor immediately before and immediately after SBSG’s earlier administration.
- The phoenix company in which the director was involved (SBSL) repay SBSG for monies paid to it by the former IP as an ‘unjust enrichment’, there being no valid reason for such payments.
- Mr M repay to the company for the balance on his overdrawn director’s loan account, representing monies paid to him over a period of time, less his properly recorded dividends and salary.
How come another liquidator got appointed?
The new liquidator had been appointed to about 100 companies where their previous IP had been made bankrupt, having arguably not carried out her job to the best of her ability. The intention of the bulk appointments was to put in place an IP who would investigate what opportunities there might be to take legal action in the cases to enhance the creditors’ distribution prospects. Once appointed to SBSG the new liquidator then went on the attack against its director and its phoenix company. With the previous IP bankrupt, the director and phoenix were the sole target of the new liquidator’s actions.
So what was said about directors’ duties?
Here are some direct quotations from the judgment and earlier judgments quoted in this one…
‘Where the company is insolvent or likely to become insolvent, the duty of a director to act in the best interests of the company is regarded as a duty to act in the interests of its creditors as a whole. At this stage,… (ie that of near or actual insolvency)… the interests of the company are regarded as the interests of the creditors alone; their interests are generally regarded as becoming paramount’
‘The question is not whether, viewed objectively by the court, the particular act or omission which is challenged was in fact in the interests of the company; still less is the question whether the courts, had it been in the position of the director at the relevant time, might have acted differently. Rather, the question is whether the director honestly believed that his act or omission was in the interests of the company. The issue is as to the director’s state of mind. No doubt, where it is clear that the act or omission under challenge resulted in substantial detriment to the company, the director will have a harder task persuading the court that he honestly believed it to be in the company’s interest; but that does not detract from the subjective nature of the test.
Mr M’s legal advisors argued that directors no longer owe any statutory duties under CA 2006 once the company is placed into liquidation/administration.
The court disagreed, deciding that the directors’ duties under Sections 171 to 175 CA 2006 survive any formal insolvency (ie administration or liquidation) of the company. Several reasons were put forward, the most compelling one for me was the fact that the CA 2006 generally says on a section by section basis where formal insolvency changes things, and the legislation doesn’t say formal insolvency changes anything in respect of these particular directors’ duties.
The Facts…
It is a messy case, at least in terms of trying to get to agreed facts. You see there was a distinct lack of records / evidence on certain important matters regarding SBSG. Whether that was because Mr M failed to give the papers to previous IP or that IP simply lost or destroyed them is unclear. No blame was attributed to Mr M for this, nevertheless the court tried its best to form its view as to what had happened, when and why, even though neither the previous IP nor the phoenix’s director was called to provide evidence, there were no company books and records, and no records for SBSG’s previous administration. The court did not allow the lack of hard evidence to get in the way of forming its judgement!
The Property…
As regards the property, a house, trying to get to the bottom of what happened was particularly difficult, but what can be gleaned is the director paid the previous IP £120k for a property that was clearly worth between £180k and £200k at the time of the alleged agreement to sell and about £¼m by the time Mr M had made any payments.
The court decided the sale by the previous IP was at an undervalue, going on to quote ‘fiduciary duties are stringent. A director is liable to account for a profit that he obtained from a breach of duty even if the company has suffered no loss’….’the level of conduct for fiduciaries… is… kept at a level higher than that trodden by the crowd’ and where there is a ‘breach of fiduciary duties owed to the Company in relation to the purchase, an institutional constructive trust would arise’.
The judge said ‘In procuring and agreeing to an off-market sale of the Property to himself at what he knew to be a significant undervalue, at a time when he knew the Company to be insolvent, Mr M acted entirely out of self-interest and failed to have regard to the interests of the creditors as a whole. In such circumstances, the objective test is applied: Re HLC Environmental Projects Ltd [2013] EWHC 2876 (Ch) at [91] – [93]. The court must ask itself whether an intelligent and honest man in the position of a director of the company could, in the circumstances, have reasonably believed that the transaction was for the benefit of the creditors as a whole. The answer is plainly ‘no’.
The judge said ‘Mr M has acted in breach of his fiduciary duty under s.172(3) CA 2006 to consider and act in the interests of the creditors as a whole… Mr M allowed the level of his conduct to drop to ‘that trodden by the crowd’. ‘The fact that the previous IP may also have been at fault, however, is no defence. The fiduciary duties owed by Mr M to the Company as its director were independent of the duties owed by the previous IP as liquidator’.
The Payments to the Creditor…
Again the facts on this are not free of doubt, especially as to who authorised or made the payments – 3 payments having been made immediately before and immediately after administration by bank transfer from the company’s bank account
The court decided that it was probably Mr M who made or caused the payments to the creditor. Who else if not Mr M could have made or caused those payments was the court’s view?
The court decided that in making those payments, Mr M had failed to exercise reasonable care, skill and diligence contrary to s172 CA 2006 so was guilty of misfeasance under s212 IA 1986. The court again said that the fact the previous IP might also been at fault was no defence, the director’s duties are independent of those owed by the previous IP.
The payments to the Phoenix…
The facts behind the £60k paid by the previous IP to SBSL are again not free of doubt because of the absence of records for the administration – the money had been paid to SBSL by the previous IP. The upshot is that the court made its decisions based on the reports filed at Companies House by the administrator and the inability of SBSL and Mr M to provide any hard evidence – surely SBSL would have some evidence had the transactions been bona fide? As a consequence the court ordered the repayment of the £60k by SBSL.
The Director’s Loan Account…
On the subject of the director’s loan account, the court said that the burden was on Mr M to justify the payments to him, because ‘where a person in a fiduciary position receives property of his principal, the burden is on him to account’.
Again, trying to get to agreed facts was difficult because of a lack of hard evidence. The court looked through each of the relevant tax years for Mr M, using Mr M’s personal tax records. It eventually decided that rather than the £138k sought by the liquidator, the overdrawn loan stood at £66k, credit having been given for remuneration accounted for by Mr M in his personal tax records.
Any other pertinent facts?
SBSL appears to me to have been set up to get around the restriction on the re-use of company names post liquidation, with Mr M firstly allegedly only acting as a manager – a friend of his acting as MD – but soon (within the 5 year period) becoming its sole director and 90% shareholder.
Conclusion
If this had been a football match the score would have been New IP 4 – Director/Phoenix 0.
And this is despite the New IP having to put out his second team (due to the lack of hard evidence), the statutory duties imposed on directors trumping that absence of hard, documentary evidence.
What are the learnings?
- The big one – your statutory duties as a director survive administration / liquidation. It’s an ongoing test. Even resigning will not get you out of them.
- Go to the wrong IP for support and you could see your liquidation being taken on, even re-opened by another IP some years down the line, and yourself attacked.In this instance the liquidator was appointed over 44 live cases and plans were made for the restoration to the register and his appointment over another 57 closed/dissolved cases.
The learning – Choose your IP very carefully.
- The liquidator was not able to gather all the documents and records he ideally would have needed in SBSG’s liquidation, because the previous IP for whatever reason did not deliver up everything. Nevertheless, the court did its best to come to a decision.The learning – A lack of hard evidence will not always stop legal action being taken.
- Buy an asset from a liquidator at an undervalue and you could be held to have breached your directors’ duties to the company and be liable to repay the undervalue or see the property held by you on constructive trust for any new IP.The learning – Assess how reasonable are your actions vis-à-vis your IP and creditors. Think how an outsider would view them and if in doubt, seek independent professional advice.
- Pay any creditor post insolvency, even if an unconnected third party, from company funds / assets and you as director could be forced to reimburse the company for the payment, regardless of the fact you did not personally benefit.The learning – Just because your IP isn’t doing their job properly doesn’t give you a get out of jail free card.
- Directors who breach their fiduciary duties are dealt with very harshly by the courts.The learning – UK legislation and the courts are setting ever higher standards required of directors, those that involve fiduciary duties in particular.
- Keep copies of the evidence / paperwork you give your IP. Keep evidence of the transactions passing through your director’s loan account, you may be asked to justify / explain them later, and the burden is on your to prove what they are, not on the IP.
The learning – the burden of proof might be on you, ensure you have the evidence you need to explain the position otherwise the court, as it did here, will make presumptions that might or might not be right.
Links / Further reading
Click here to read the detailed judgement.
Click here to go to the Companies Act 2006.
Click here to go a nice summary I found written by a lawyer about directors’ duties.