Earlier this year we commented upon the widely-reported Sequana case, in which the Court of Appeal considered whether in paying a dividend the directors of a company had (i) unlawfully put assets beyond the reach of creditors and (ii) failed to consider the interests of the company’s creditors. You can see our commentary on that important case by clicking here.
The willingness of the courts to scrutinise the decisions of directors in declaring dividends didn’t end there. More recently, in Burnden Holdings (UK) Ltd (in liquidation) and anor v Fielding  EWHC 1566 (Ch), the High Court has considered a claim by a company and its liquidator against certain company directors alleging an unlawful distribution of its shares to another company of which those same directors were also directors as well as the majority shareholders.
We discuss this case and some of the key takeaways more fully below, but as a general comment it provides a health warning to any director considering approving a distribution, as it illustrates the different ways in which such transactions can be attacked especially where the company that makes the distribution subsequently enters insolvency.
A brief digression
But before we delve into the details of the case mentioned above more fully, it would be remiss of us not to mention first that this is a case that has kept the UK courts busy. Just last year in separate proceedings emerging out the liquidation of the same company, the Supreme Court held that a claim by a company against its directors alleging an unlawful distribution of its shares made to another company in which the directors were majority shareholders attracted by analogy the application of section 21(1)(b) of the Limitation Act 1980. This provides that no period of limitation prescribed by the Limitation Act 1980 applies to any action by a beneficiary of a trust to recover from the trustee trust property in the possession of the trustee. A link to the Supreme Court’s decision in that case can be found by clicking here. It is worth noting because the defendant directors were unsuccessful in arguing that the claim against them was statute-barred because of the expiry of the six-year limitation period referred to under section 21(3) of the Limitation Act 1980.
Onto the case
The case itself arose out of the liquidation of a holding company, Burnden Holdings (UK) Limited (“BHUK”), which had hit a cash crisis in 2007 following a long-running dispute (albeit one in which BHUK was ultimately successful) with one of its competitors. At the time the defendants, Mr and Mrs Fielding, were the majority shareholders in and also directors (but not the only directors) of BHUK.
In order for BHUK to plug a need for some urgent cash funding, a demerger transaction was implemented whereby BHUK made a distribution in specie of its shares in Vital Energi Utilities Limited (“Vital”), followed by the sale of 30% of the shares in Vital to Scottish and Southern Energy PLC for £6 million, with the Fieldings on-lending £3 million of the sale proceeds back to the BHUK group of companies.
Mr and Mrs Fielding were alleged to have breached their fiduciary duties as a result of the following:
- The provision on 9 July 2007 of a fixed and floating charge in favour of Mr and Mrs Fielding by way of security for the loans referred to above (the “Grant of Security”).
- The distribution in specie by BHUK on 12 October 2007 of its entire shareholding in Vital (the “Distribution”).
The issues before the High Court and its findings
In considering and ultimately dismissing the claimants’ claims, the High Court covered quite a lot of ground in a lengthy Judgment. Among those issues considered by the High Court were the following:
- Is the liability of directors involved in making an unlawful distribution strict or fault based?
On this point Mr Justice Zacaroli determined that liability was fault-based. In reaching this conclusion, he concluded that directors, although not trustees, were to be treated in the same way as trustees in relation to the company’s funds. Moreover, if they were aware of the facts which constituted an unlawful dividend, they would be liable for breach of trust irrespective of whether they knew that the dividend was unlawful. However, if they were unaware of the facts which made the dividend unlawful, then provided they had exercised reasonable care to secure the preparation of accounts to establish the availability of sufficient profits to render the dividend lawful, they would not be personally liable if it turned out that there was in fact insufficient profits for that dividend. In addition, directors were entitled to rely upon the opinions of others, including a company’s auditors, as to the accuracy of the company’s accounts.
In reaching the above conclusion, Mr Justice Zacaroli cited the comments of Nelson J in Bairstow v Queen’s Moat Houses plc  BCC 1,025 in which he said that “No repayment of an improperly paid divided will however be ordered where the payment was made without fault on the part of the directors”.
- Was there a declaration of a dividend at a properly convened board meeting?
On this point the claimants alleged that the Distribution was never the subject of proper consideration at a properly convened board meeting of BHUK. The claimants relied upon various alleged deficiencies in the run-up to the date on which the Distribution was made, including a failure to give proper notice of the meeting to all directors, unreliable board minutes of the meeting itself and the non-circulation of interim accounts ahead of the meeting.
Notwithstanding these deficiencies, the High Court considered that BHUK had complied with the requirement under its articles for the Distribution to be recommended by its directors and declared by its members (evidence of a written resolution of BHUK approved by its shareholder was presented to the court). It did not matter if the directors of BHUK did not properly adopt or adequately consider the contents of the relevant interim accounts in declaring the Distribution. Moreover, the requirement under the articles that BHUK could not declare a dividend in an amount greater than that recommended by the directors was one which could be waived by its shareholders acting unanimously on the basis of the Duomatic principle.
In reaching this conclusion, Mr Justice Zacaroli noted that when asking whether directors reached a determination as to whether to recommend a dividend, no specific formality was required. It was sufficient that, by time the distribution was made, all directors had as a matter of fact concurred or informally acquiesced in it. The opposite was true as to the requirements under companies legislation for relevant accounts to be adopted evidencing sufficient distributable profits for a distribution; strict compliance was required here.
- Did the interim accounts used for the purposes of making the Distribution comply with the statutory requirements under the applicable companies legislation (as now set out under section 841 under the Companies Act 2006)?
The claimants pointed out a number of deficiencies in the interim accounts used by the directors at the time of the Distribution, which were the subject of criticism by the claimants because they comprised just two sheets of paper and lacked extrinsic evidence. The Court concluded that there was however sufficient detail to meet the relevant statutory requirements. The claimants also alleged, however, that certain assets were substantially overvalued and some liabilities wrongly excluded. Ultimately Mr Justice Zacaroli concluded that the Distribution was not rendered unlawful either on the basis of insufficient distributable profits or inadequate interim accounts.
- Did the Distribution amount to a dishonest breach of fiduciary duty by Mr and Mrs Fielding under section 172(3) of the Companies Act 2006?
Having concluded that Mr and Mrs Fielding were not at fault in causing the Distribution to be made, and having considered that it was reasonable for them to have relied upon the advice of different professionals in preparing the interim accounts and concluding that they were acceptable, the Court then considered whether they had nonetheless breached their duties under section 172(3) of the Companies Act 2006. This is the section which imposes a duty on directors to promote the success of a company for the benefit of its members as a whole, but which (under section 172(3)) switches that duty so that in certain circumstances directors must consider or act in the interests of creditors of the company instead. Applying Sequana, the High Court noted that the duty switched from the members to the creditors when the company is or is likely to become insolvent, where “likely” means probably.
The High Court applied the balance sheet test of insolvency, assessing the real value (as opposed to the accounting value) of BHUK’s assets at the time of the Distribution and taking a commercial view of its contingent and prospective liabilities. On balance, the Court considered that the claimants had failed to discharge the burden of demonstrating that BHUK’s assets were worth less than its liabilities. Moreover, no case was made out that the defendants “ought to have” known of BHUK’s impending insolvency. As such, the duty to consider the interests of creditors was not engaged, and so it was not necessary to determine whether the defendants had failed to comply with that duty.
- Was the Distribution a transaction at an undervalue under section 423 Insolvency Act 1986?
Whilst accepting as settled the fact that a dividend could in principle amount to a transaction at an undervalue, the High Court considered that what was relevant was whether, in making the Distribution, Mr and Mrs Fielding intended to put the shares in Vital beyond the reach of creditors. On the basis of the facts, the Court was satisfied that there was no such intention on the part of Mr and Mrs Fielding.
- Were Mr and Mrs Fielding entitled to relief under section 1157 of the Companies Act 2006?
On the basis of its conclusions, the High Court noted that the question of granting relief was not relevant. However, were any of its conclusions incorrect, the Court considered whether it might nonetheless be able to grant relief to Mr and Mrs Fielding under section 1157 of the Companies Act 2006. This is the provision which says that in any proceedings against a director for negligence, breach of duty etc. where the relevant individual is liable, if it appears to the court that the officer acted honestly or reasonably and ought therefore to be excluded, the court may nonetheless relieve him, either wholly or in part, from his liability on such terms as it thinks fit. Interestingly, the Court concluded that its discretion would not have been fettered where the directors were themselves the recipient of the distribution in question (even if the company subsequently went into liquidation). The Court did accept, however, that such circumstances were likely to be powerful factors against granting relief.
- Did the Grant of Security constitute a transaction defrauding creditors under section 423 Insolvency Act 1986?
The Court also considered whether the Granting of Security constituted a transaction at an undervalue, and was entered into for the purpose of putting assets beyond the reach of creditors under section 423 of the Insolvency Act 1986. It concluded that the grant in question had ultimately been for BHUK’s benefit and that in order for such a transaction to engage section 423(1)(a) of the Insolvency Act 1986 (which provides that a person enters into a transaction at an undervalue with another person if he makes a gift to the other person or enters into a transaction with the other on terms that provide for him to receive no consideration), the transaction would have to have been entered into for no consideration. Looking at the facts, Mr Justice Zacaroli concluded that there was at least some consideration for the Grant of Security and accordingly it did not fall within the relevant provisions of section 423 of the Insolvency Act 1986.
In the case discussed above, Mr and Mrs Fielding were ultimately successful in their defence, but as a general comment directors need to be very mindful of their duties whenever they consider approving a distribution. In particular, directors must be careful to ensure that any steps they take to declare a distribution are robust and can stand up to third-party scrutiny at a later date. Mr Justice Zacaroli’s comments around the fault-based nature of a director’s liability for unlawful distributions are also worth noting.