Directors' duties survive insolvency

Directors' duties survive insolvency

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In the landmark decision in Re Systems Building Services Group Limited [2020] EWHC 54 (Ch), ICC Judge Barber held that the duties of a director survive the insolvency of a company.

While a director’s powers cease on the appointment of a liquidator (as was the case here, although the same principle equally applies in administration), importantly this case reminds us that simply continuing to be a director is sufficient for director’s duties to arise, and those duties are not limited to circumstances in which a director exercises his powers.

Background

Systems Building Services Group Limited (in Liquidation) (the “Company”) was a provider of passive fire protection, fire stopping and intumescent coat services and run principally by its director Brian Michie. The Company went into administration on 12 July 2012 and Mrs Gagen Sharma was appointed as administrator. The Company then exited administration into a creditors voluntary liquidation on 3 July 2013, and the Company was dissolved on 24 February 2016.

Following the judgment in Top Brands v Sharma [2014] EHWC 2753, Mrs Sharma was found liable of misfeasance in her position as office-holder in relation to another company and ordered to pay over £500,000. In June 2016, Mrs Sharma was adjudged bankrupt and agreed an eight-year bankruptcy restrictions undertaking with the Secretary of State.

As a result, Mr Stephen Hunt took over 44 of Mrs Sharma’s appointments and following his own investigations into the Company, made an application to restore the Company and then as liquidator to bring this case including claims against Mr Michie and another company System Building Services Ltd, a company incorporated prior to the administration of the Company (on Mrs Sharma’s advice).

The Claims

Mr Hunt’s heads of claim comprised:

  1. claims against Mr Michie:

a.) for breach of his director’s duties under sections 171 to 175 of the Companies Act 2006, regarding his purchase of a property from the Company (acting by its liquidator Mrs Sharma) for a substantial undervalue (“Breach of Duty Claim”);

b.) in relation to three sums of £5000,  £6000 and £8000 paid out of the Company’s bank account in favour of one its creditors, CB Solutions UK Limited, after the Company entered into administration;

c.) in relation to payments made by Company prior to entering administration, of which £137,674.59 was left unaccounted for; and

  1. a claim against System Building Services Ltd in relation to five payments totalling £169,537.06 made between 8 August 2012 and 28 June 2013 by the Company (acting by Mrs Sharma) for little or no consideration.

Whilst the liquidator was successful on all four heads of claim (albeit to a limited extent under heads 1(c) and 2), it was Judge Barber’s analysis of the Breach of Duty Claim that was most interesting.  

Legal Principles: Breach of Duty Claim

The general duties of a director are set out in sections 171 to 175 of the Companies Act 2006 (“CA 2006”). Where a company is insolvent or likely to become insolvent, the duty to act in the best interest of the company (under section 172(3) CA 2006) is to be regarded as a duty to act in the interest of creditors as a whole. This duty is ordinarily a subjective one, i.e. whether the director honestly believed his act or omission was in the interests of the company, or as the case may be, its creditors as a whole. It was not disputed that Mr Michie remained a director following the Company’s entry into administration and subsequent liquidation by virtue of paragraphs 61 and 64 Schedule B1 of the Insolvency Act 1986 (“IA 1986”).

Counsel for Mr Michie raised the argument that the general directors’ duties do not survive the company’s entry into a formal insolvency process and would only survive in respect of any exercise by that director of powers “qua director” (i.e. in the function or capacity of a director) preserved by or permitted in accordance with the IA 1986. Further, they argued that the applicants had failed to demonstrate how or why any specified duty applied following the commencement of liquidation.

This argument was swiftly rejected by Judge Barber. She referred to section 175(1) CA 2006, whereby a director must avoid a situation in which he has or could have a direct or indirect conflict of interest with the company, and which is not dependent upon the exercise of a given power “qua director”. She further referred to Section 176(1) CA 2006, under which a director must not accept a benefit from a third party conferred by reason of his being a director or his doing anything as a director.  Simply being a director is sufficient to trigger this duty and is, again, not dependent upon the exercise of a given power “qua director”. Section 170(2) CA 2006 also sets out that a person who ceases to be a director continues to be subject to the duty in section 176 CA 2006, as regards to the exploitation of any property, information or opportunity of which he became aware at the time he was a director. This indicates that the ‘reach’ of these duties continue to apply even after a person ceases to be a director.

While Judge Barber accepted that there is little case law and commentary in this area, she stated that what little case law and commentary did exist did not lead to the conclusion that the general duties of a director cease to exist on a company’s entry into administration or creditors’ voluntary liquidation. Judge Barber accepted submissions from counsel for the liquidator that “the officeholder and the director owe independent duties to the company. In an insolvency context, first and foremost of a director's duties is the duty expressly preserved by s.172 (3) CA 2006: to have regard to the interests of the creditors as a whole.”

Conclusion

In reaching the conclusion that a director’s duties survive insolvency, Judge Barber held that “Mr Michie saw an opportunity to pick up an asset 'on the cheap' and took advantage of that opportunity; an opportunity which he came to know about through his position as sole director of the Company”. It was held that Mr Michie used his position to drive down the price of the property with a view to benefitting himself and “without any regard for the impact his actions would have on the interests of the creditors as a whole”. Further, using the subjective test, Judge Barber held that Mr Michie did not honestly believe that the transaction was in the interests of the creditors as a whole.

Judge Barber added that although it was Mrs Sharma who chose to sell the property to Mr Michie at an undervalue, her actions were not a defence for Mr Michie in the present proceedings.  As referred to by counsel for the liquidator above, the fiduciary duties owed by Mr Michie to the Company as a director were independent of the duties owed by Mrs Sharma as liquidator. Mr Hunt had chosen not to join Mrs Sharma as a respondent because she had been adjudged bankrupt and it was considered that entering into expensive litigation with a bankrupt would not be of any benefit to creditors.

Whilst the judgment did not specify the quantum, Mr Michie was ordered to repay a significant sum to the Company.

Tim Carter, Co-Head of Restructuring & Insolvency at Stevens & Bolton LLP, comments:

The case provides a cautionary statement of the law for any directors who might seek to use an insolvency process as a means to purchase assets at a reduced price from a weak or ineffective insolvency practitioner and for advisors acting for directors acquiring the business and assets in a pre-packaged administration sale, to ensure that they do not breach their fiduciary duties - either prior to, or following, an insolvency.

Some commentators have considered this decision as a “rewriting of the rules of insolvency” and that it is “significant on a number of levels”; however, R3, the trade association for the UK’s insolvency professionals has stated that it merely underscores what most of the profession felt was already the position i.e. a director’s duties continued beyond insolvency and were not just confined to the duty to cooperate with the appointed insolvency office-holder. It will be interesting to see whether there is now a legislative change, making it mandatory to refer any pre-pack deal involving connected directors to the pre-pack pool. The pool consists of an independent body of experienced business people, but any referral to it is currently optional and it has been little used (partly perhaps because of the associated cost).

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