Summary

The High Court considered the liability of the majority directors of an insolvent company in respect of a grant of security to themselves for a loan made by them to the company and in respect of a distribution in specie of the company's shareholding in a subsidiary. The court determined that liability was fault-based (as opposed to strict liability), and considered the statutory requirements in relation to distributions, the degree of detail and formality required of interim accounts, and the duty to consider the interests of creditors.

Facts

A company and its liquidators brought proceedings against its two majority directors in respect of two transactions effected by them.

The first transaction comprised a grant, to themselves, of security for loans made by them to the company. The grant was alleged to be a dishonest breach of fiduciary duty, in the absence of a board meeting to authorise it, and a transaction defrauding creditors. The second transaction was a distribution in specie by the company of its shareholding in a subsidiary (V). The distribution was said to be unlawful and in breach of fiduciary duty because it did not meet the requirements of the Companies Act 1985, particularly s.263, which specified that distributions could only be made from profits, and s.270, which required distributions to be justified by reference to accounts. It was also characterised as a dishonest breach of fiduciary duty under s.172(3), because the directors knew that the company was, or likely to become, insolvent, and failed to consider creditors' interests.

Held

Directors' liability for unlawful dividend - Liability was fault-based, not strict. Authorities on this conflicted over a period of 150 years, but the position by 1901 was that directors should be treated as trustees in relation to the company's funds. If they knew the facts constituting an unlawful dividend, they would be liable as if for breach of trust, irrespective of whether they knew the dividend was unlawful. However, if they were unaware of the facts rendering the dividend unlawful, they would not be personally liable if they had taken reasonable care to secure the preparation of accounts which showed that a lawful dividend could be paid, even if it emerged that there were insufficient profits to do so. That position remained, and nothing in the leading authorities for the strict liability view undermined that conclusion, Dovey v Cory [1901] A.C. 477 followed, Exchange Banking Co (Flitcroft's Case), Re (1882) 21 Ch. D. 519, Lands Allotment Co, Re [1894] 1 Ch. 616, Sharpe, Re [1892] 1 Ch. 154Revenue and Customs Commissioners v Holland [2010] UKSC 51 considered (see paras 103-106, 112-114, 123-139, 157-159 of judgment).

Compliance with formalities relevant to making distribution in specie - A board meeting had taken place. The board had determined to recommend a dividend in specie and briefly considered the interim accounts. The company's holding company, as its sole shareholder, was to be taken as having waived, on Duomatic principles, any provision that the company could not declare a dividend in a sum greater than that recommended by the directors, Duomatic Ltd, Re [1969] 2 Ch. 365 applied (paras 165, 169-171, 183).

Interim accounts: compliance with s.270 - The distribution was not rendered unlawful, either on the basis of a lack of distributable profits or on the basis of the interim accounts being incapable of ensuring a reasonable judgment as to the company's assets, liabilities, profits and losses. The court considered the degree of detail and formality required of interim accounts if they were to satisfy s.270, and the effect of mis-descriptions or over-valuations of an asset in the accounts. The fact that it was necessary to amalgamate different entries to identify the net value of an asset did not invalidate the accounts for the purposes of s.270(4). The company's investment in one of its subsidiaries had a value less than that identified in the interim accounts but, by virtue of s.275, no realised loss was created, Vardy Properties v Revenue and Customs Commissioners [2012] UKFTT 564 (TC) approved, BTI 2014 LLC v Sequana SA [2019] EWCA Civ 112 considered (paras 187-188, 192-200, 203, 273-274, 278-280, 327).

Defendants' liability - Even if the value of any assets in the interim accounts should have been written down, or other liabilities included, and even if that had resulted in there being insufficient reserves to enable the distribution to be lawful, the directors were not culpable. It had been reasonable for them to rely on the various professionals involved in preparing the accounts and conclude that the accounts met statutory requirements (paras 328-338).

s.172(3): creditors' interests - The court applied the balance sheet test of insolvency in BNY Corporate Trustee Services Ltd v Eurosail-UK 2007-3BL Plc [2013] UKSC 28, assessing the real value (not the accounting value) of the company's assets and taking a commercial view of its contingent and prospective liabilities. It also considered the effect on a parent company of an insolvent subsidiary. The claimants had not discharged the burden of showing that the company's assets were worth less than its liabilities. If that were wrong and the company was insolvent, the directors had not been aware of the insolvency. Neither the financial circumstances of the whole group of companies, nor the cash flow insolvency of a subsidiary could be equated with the company's solvency or insolvency, Eurosail followed, Sequana considered (paras 344, 346-352, 354-356, 386-387, 394, 396-401).

Transaction at an undervalue - The distribution was not a transaction at an undervalue because the directors' intention had not been to put the shares in V beyond the reach of creditors (paras 404, 406).

Relief from liability under s.1157 - The court considered its discretion to grant relief even though its rejection of the breach of duty allegations made it unnecessary to do so. Its discretion was not fettered where the directors were the recipients of an unlawful dividend (even if the company subsequently went into liquidation), though such circumstances were a powerful factor against granting relief (paras 408, 413-418).

Grant of security - There had been effective authority by the company for the grant of security. The grant had been for the company's benefit and could not, therefore, be a transaction defrauding creditors. Such a transaction had to be for "no" consideration. The fact that the company benefited meant that there was at least some consideration, MC Bacon Ltd (No.1), Re [1989] 11 WLUK 409 applied, Hill v Spread Trustee Co Ltd [2006] EWCA Civ 542 considered (paras 487, 492, 498, 501-507).

Claim dismissed