No such luck - attempt by stakeholders to avoid debt by placing company into liquidation fails

One of the beautiful things about the law is that if you and I decide to create a company, then that company boasts separate legal personality from each of us. Company founders seem to like this principle because if all else fails, and the company goes under, then ordinarily (and we stress, ordinarily) their home and other prized possessions should remain intact. But just occasionally people abuse this principle of corporate personality, and then the courts might reluctantly step in to “pierce the corporate veil” and reign in the individuals who are pulling the strings. 

This is precisely what the High Court did recently in the case of Palmer Birch (A partnership) v Lloyds [2018] EWHC 2316 (TCC). In this remarkable case, an unsecured creditor in an insolvency succeeded in bringing a claim against two brothers running the company for inducing breach of contract in letting their company fall into insolvent liquidation. The liquidator was not involved and there was no claim by or on behalf of the company for wrongdoing by the directors. The case cuts across principles of the corporate veil and separate legal personality in quite dramatic fashion, particularly given that one of the brothers was not even a director or shareholder but "called the shots” behind the scenes.

Background and High Court’s decision

This case arose out of a construction dispute. Palmer Birch (“PB”), a building contractor, carried out building work under a standard JCT building contract with Hillersdon House Limited (“HHL”). The defendants, Christopher and Michael Lloyd, stood behind HHL either as director, shareholder and/or funder. In addition, Michael stood behind Seizar Holdings Limited, which held the freehold interest in Hillersdon House. In practice, Michael stood to gain the benefit of the works done to the property.

Michael provided the bulk of HHL’s funding through Seizar Holdings Limited, but during the course of the works he withdrew his funding and HHL was placed into liquidation. Funds which were originally intended for HHL to pay PB were diverted to a new company, Country Sporting Experience Limited, which completed the works leaving PB unpaid. PB sued the brothers alleging three economic torts: unlawful interference, unlawful means conspiracy and inducing breach of contract. While the first claim failed, the second and third succeeded.

HH Judge Russen QC stated that inducing breach of contract must be distinguished from conduct which prevents a party from performing a contract - there needs to be conduct which goes beyond a simple failure to provide funds to a company to meet its obligations where there is no legal obligation to provide such funds. This is clearly correct, as otherwise the entire basis of separate legal personality would be undermined. As such, neither brother incurred tortuous liability purely because of their failure to fund HHL.

However Michael crossed the line into inducement territory by putting HHL into liquidation, resulting in a termination of the contract following a suspension of works. The judge drew a contrast between depriving funding to HHL and the dissipation of assets. Although there was no legal obligation on Michael to fund HHL, he should have provided the funds in the particular circumstances of this case. He acted towards PB as if he was the client, not HHL. He had funds available which he could have provided to HHL for it to perform the contract. Instead, by putting HHL into liquidation, he failed to act in the company’s commercial interests and on the facts this amounted to an abuse of the concept of separate legal personality.

For an unlawful means conspiracy claim to succeed there must be an intention to injure the claimant. In this case the two brothers colluded to bring about the liquidation of HHL and the repudiatory breach of contract. Accordingly, they were found to have the necessary intention to injure PB and PB was entitled to recover the value of its works. The two brothers were unsuccessful in their attempt to shelter behind HHL and deny any personal liability in the matter.

Insight  

This is a rare example of the court piercing the corporate veil to attach liability to those persons who sit behind a corporate body. The judge clearly had a great deal of sympathy for PB and very little sympathy for the two brothers, who used the fragile financial position of HHL as leverage in its negotiations with PB. So justice in the broader sense may be said to have been achieved by allowing PB to recover the cost of the works from the brothers.

Whilst this is probably a case of hard cases making bad law, it is a sanitary lesson that a limited liability company is not an absolute shield to liability, particularly where the concept of separate legal personality is abused in a deliberate attempt to leave creditors high and dry. Deciding whether an abuse has occurred, however, will always be fact specific and there is no exact science to any such assessment.

As HH Judge Russen QC observes in his judgment, this case also illustrates the perils of contracting with an undercapitalised company, with no guarantees from the individuals associated with it. Creditors would be foolish to assume that they can always pierce the corporate veil whenever their counterparty fails, and wherever possible creditors should diligence their counter-parties carefully before committing to contract. If they are unsatisfied with their counterparty’s creditworthiness, they should seek additional contractual protection such as payment upfront or in instalments, perhaps coupled with guarantees or security from related third parties. Although this was a construction dispute, such mitigation measures are worth bearing in mind whenever embarking upon an important contract.

Readers interested in reading the transcript of this case can access this by clicking here.

Contact our experts for further advice

View profile for Jonathan PorteousJonathan Porteous, View profile for Elena CaforaElena Cafora

Search our site