High Court dismisses claims against directors of insolvent company

Out-Law Legal Update | 01 Aug 2019 | 11:08 am | 5 min. read

Directors of a company had not defrauded creditors when they took security for loans to the company as a liquidator had argued, the High Court in England has ruled.

  • Granting of security is not a transaction at an undervalue - Re MC Bacon followed
  • Test for liability for wrongful dividends is fault based
  • Burnden Holdings (UK) Ltd v Fielding and another [2019] EWHC 1566 (Ch)

The court said that the directors of Burnden Holdings (UK) Limited (BHUK) had reasonably relied on the advice of professionals and had acted in the best interests of the company in entering into the transactions which the liquidator later challenged.

The court also confirmed that the liability of directors for unlawful distributions is not strict but is fault-based. It considered the balance sheet insolvency test and reviewed in detail the statutory requirements in relation to distributions. The court has also followed the reasoning in the case Re MC Bacon that the granting of security is not a transaction at an undervalue.

The liquidator of BHUK brought claims against BHUK directors and majority shareholders Gary John Fielding and Sally Anne Fielding relating to two transactions in 2007. BHUK was placed into administration on 2 October 2008 and a compulsory winding-up order made against it on 7 December 2009.

The Fieldings had made a number of loans to BHUK under a loan agreement made in December 2004, secured by a debenture. More loans were made after December 2004 and the board, minus the Fieldings because of their conflict of interest, decided that the original loan documentation should be amended to reflect this. In June 2007 the board authorised a new loan agreement and new security.

The liquidator argued that the granting of new security constituted a transaction defrauding creditors under section 423 of the Insolvency Act 1986 (IA86). Section 423 applies where a transaction is entered into for no consideration or consideration worth significantly less than the consideration provided. The transaction must be for the purpose of putting the assets of the company out of the reach of creditors.

Whether the granting of security is capable of being a transaction at an undervalue has been considered at length under section 238 IA86, where the relevant language is identical to section 423, and is open to debate. In Re MC Bacon Ltd [1990] BCC 78 the court said that by granting security for existing indebtedness a company parted with nothing of value and, therefore, the granting of security was not capable of being a transaction at an undervalue.

However, the position has been unclear since comments in Hill v Spread Trustees [2007] WLR 2404, where the judge commented that she "would provisionally not have accepted the argument that the grant of security in this case did not involve the disposition of any property right in favour of the trustees." She said that "there seems to be no reason why the value of the right to have recourse to the security and to take priority over other creditors, which the debtor creates by granting the security, should be left out of account."

In the BHUK case the judge preferred the reasoning in Re MC Bacon and said that the granting of security did not involve any transfer in value and, therefore, that the claim did not fall within section 423 and the Fieldings had not made a transaction defrauding creditors.

The liquidator also unsuccessfully argued that the new security had not been properly approved by the board on the basis that the board minutes referred to "new" loans only. He also failed in his argument that there was no commercial benefit to BHUK in entering into the new loan agreement and security.

Distribution in specie

Since early 2007 the directors of BHUK had been contemplating the demerger of one of the subsidiaries of the Burnden group, Vital Energi Utilities Limited (Vital), primarily because Vital's business interests were different to those of the rest of the group and it was thought that its prosperity would increase once ties with the group had been severed. The group had also expended significant sums on protracted litigation which had drained its cash reserves and it was agreed that a sale of Vital would assist in raising funds for the group.

BHUK distributed its shares in Vital as a dividend in specie, which is where a dividend is paid in something other than cash. Following the distribution a series of transactions were entered into and the shares in Vital were eventually owned by a newly formed holding company owned by the Fieldings. Sally Anne Fielding sold 30% of the shares in the newly formed holding company to a third party for £6 million. £3 million from the sale proceeds were then advanced to the Burnden group by way of a loan to assist with liquidity issues. BHUK's finance director and its auditors prepared interim accounts showing that BHUK had sufficient distributable reserves to make the distribution and it was approved at a board meeting on 12 October 2007.

The liquidator unsuccessfully claimed that the distribution failed to comply with Companies Act 1985 (CA85) on the basis that it was not approved at a properly convened board meeting and that it was based on interim accounts that did not comply with CA85.

Although the court found that the distribution was not unlawful under CA85, the judge went on to consider whether the directors would have been culpable and in breach of duty had the distribution been unlawful.

The judge said that the test is fault-based rather than strict: if the directors knew of facts which constituted an unlawful dividend they would be liable whether or not they knew that the dividend was unlawful. However, if they were unaware of the facts that rendered the dividend unlawful but had taken reasonable steps to secure the preparation of accounts to establish that there were sufficient profits for that purpose they would not be liable if it later turned out there were insufficient profits. He said that directors are entitled to reasonably rely on the advice and accounts prepared by the various professionals, particularly auditors.

The liquidator also claimed that the distribution was a dishonest breach of section 172(3) of the Companies Act of 2006. Section 172 sets a director's duty to promote the success of their company and subsection 3 makes that duty subject to any enactment or rule of law requiring the directors to consider or act in the interests of the company's creditors.

Following the case BTI 2014 LLC v Sequana S.A. [2019] that duty arises when a company is or is likely to become insolvent, and 'likely' means 'probable'. The liquidator argued that BHUK was balance sheet insolvent at the time of the distribution, or became so as a consequence of it.

Applying the test in Eurosail the court rejected this argument and further found that even if BHUK had been insolvent or likely to become insolvent, that the directors were not aware of this. In making this finding the court helpfully shed some light on the insolvency test, reaffirming the principle that the value to be attributed to an asset or liability is its commercial value as opposed to its accounting value and that it was wrong to equate the financial circumstances of the group with the solvency of a parent where a subsidiary company in that group is insolvent.

Finally, the liquidator argued that the distribution was a transaction at an undervalue in accordance with section 423 of IA86. Following Sequana the payment of a dividend is capable of being a transaction at an undervalue within section 423, therefore the court only needed to determine whether the purpose of the transaction was to put the assets beyond the reach of creditors.

On this point too the court found in favour of the Fieldings, recognising that the purpose of the distribution was to separate Vital from the group as a result of its business operations being vastly different to those of the group and further to provide additional liquidity to the rest of the group.

Additional reporting by Manpreet Khehra