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Directors must repay sums withdrawn from company in liquidation, rules High Court

Out-Law Legal Update | 17 Jan 2018 | 11:54 am | 4 min. read

LEGAL UPDATE:  Two directors of a company which was in liquidation breached their fiduciary duties to the company by taking money out of the business when creditors were being left unpaid. The High Court said that the 1990 ruling in Guinness v Saunders was more relevant in deciding on this issue than the more recent case of Global v Hale. The two directors of PV Solar Solutions Ltd were found to be jointly and severally liable to repay the company the sum of £758,020, together with interest.

The court applied the principles outlined in the 1990 case of Guinness v Saunders rather than the more recent decision in Global v Hale in finding that the directors had acted in breach of their fiduciary duty to act in the best interest of the creditors. They misapplied the company's assets for their own benefit and failed to exercise their powers for the proper purposes. It ruled that the directors were misfeasant for the purposes of section 212 of the Insolvency Act 1986 and jointly and severally liable to repay the entire sum together with interest.

Prior to its liquidation the company had two successful years of trading in the supply and installation of solar panels, having benefitted from a government incentive in place at the time.

The liquidator claimed that the directors caused the company to make three unjustified credit entries against their directors' loan accounts in breach of their duties, which it said was in breach of section 212 of the Insolvency Act 1986.

Directors' duties when a company is in insolvency or of 'dubious solvency'

In deciding that the directors were in breach of their fiduciary duties, the court explored the scope of the directors' duty under section 172(3) of the Companies Act 2006 to act in the interests of the creditors of the company.

The duty to act in the best interests of the company is to be regarded as a duty to act in the best interest of the creditors at the point when a company is "insolvent or of dubious solvency". Whether a company is of dubious solvency is to be judged on a case by case basis and is not a snapshot analysis or a question of, arithmetically, whether the numbers add up on a given day. Rather, the question is a wider one taking into account the broader context, including in some cases the level of risk to which creditors were exposed by a director's action.

The key underlying principle is that directors are not free to take action which puts the creditors' prospects of being paid at real, as opposed to remote, risk, without first having considered their interests.

The duty imposed on a director to act in the best interests of a company or creditor is a subjective one, but this principle of subjectivity is subject to three qualifications;

  • in insolvency cases where the duty extends to the interest of the creditors, their interests are paramount;
  • the subjective test applies when there is evidence of actual consideration of the best interests of the company but where there is no such evidence, the test is an objective one, and
  • where there is a material interest such as one large creditor which has been overlooked without objective justification, then the test is again an objective one.

The court found that company was cash flow insolvent at the date each credit was made against the loan accounts and the directors had subjectively failed to have regard to the interest of the creditors. In applying the objective test, an intelligent honest person in the same position could not have reasonably believed any of the three credits to have been for the benefit of the creditors as a whole.

Withdrawal of remuneration and the Duomatic principle

The directors were unsuccessful in their submission that their loan accounts and the relevant credits were a withdrawal of remuneration. The company's articles of association required remuneration to be determined by an ordinary resolution, which had not been passed.

The directors sought to rely on the Duomatic principle, arguing that where they together held 100% of the shareholding and had agreed the transactions that led to the credits, the transactions ought to be considered as approved by an informal resolution.

For the Duomatic principle to apply, the shareholders must actually apply their minds to the question of whether to ratify the relevant transaction. On the contrary, the directors had considered whether to pay themselves remuneration and decided against it due to the PAYE implications. They instead arranged the credits to be made against the loan accounts and left no room for the Duomatic principle to be applied. In any event, the Duomatic principle does not apply where the company is insolvent or is rendered insolvent by the transaction in question.

The quantum meruit argument and the recent decision in Hale

In rejecting the directors' argument that they could not be expected to work for nothing, referred to as the quantum meruit argument, the court distinguished this case from Global v Hale. Unlike Hale the directors were not full time PAYE employees and had not signed service contracts. The company could not be considered unjustly enriched and the directors to "have worked for nothing" given they separately withdrew over £100,000 each from the company in the relevant years by way of "management fees".

It is worth noting the court's commentary when discussing Hale. It considered the decision in that case "open to question" and said that the earlier authority of Guinness plc v Saunders, a 1990 case, ought to have been considered.  In Guinness, a committee of the board of directors agreed to pay a director, Mr Ward, £5.2 million for his services in connection with a takeover bid being made by the company.  The entire board did not approve the payment. Guinness successfully claimed repayment on the grounds that the board had not authorised the payment, and Ward had received the payment in breach of his fiduciary duty as a director, having failed to disclose his interest in the agreement to Guinness' directors.

Ward appealed to the Court of Appeal and the House of Lords, but both applications were dismissed.  The House of Lords held that remunerating Ward without the authority of the board would be contrary to the company's articles and a breach of the principles of equity; and that Ward had no answer to the claim for recovery of the £5.2 million and should repay it.

Gemma Kaplan is a restructuring expert at Pinsent Masons, the law firm behind Out-Law.com.