Out-Law / Your Daily Need-To-Know

No breach of fiduciary duty where director considered interests of creditors, High Court rules

Out-Law Legal Update | 17 Jul 2018 | 1:04 pm | 3 min. read

LEGAL UPDATE: The High Court has decided that a liquidator's claim against a director for breach of fiduciary duty could not succeed as the director in question had acted honestly in what he considered to be the best interests of the creditors. The case re-enforced the rule that where a company is insolvent, the interests of creditors are paramount and the duty to act in the best interests of the company is regarded as a duty to act in the best interests of its creditors as a whole. The ruling suggests that directors of insolvent companies can take into account other considerations provided that the final course of action is consistent with acting in the interests of the creditors. The case also serves as a reminder that where an officeholder alleges breach of fiduciary duty against a director, the burden of proof is on the officeholder to prove the breach and the losses which have been said to flow from the breach.

Richard White was the managing director of Laishley Limited, a building company that ceased trading during the week of 10 May 2010. The company went into administration on 9 June 2010 before ultimately being placed into creditors' voluntary liquidation on 13 May 2011.

At the time of ceasing to trade, the company was performing a number of building contracts. One such contract was for the construction of a new health centre and another was for the conversion of an office building into a hotel.

White executed deeds of release in relation to those two contracts on 14 May and 20 May 2010 respectively, by which both the contract employers and the company were released from their future performance obligations. The employers were also released from liability for any payment obligations which had accrued but remained unpaid.

White had taken advice from a firm of insolvency practitioners which advised that a novation would enable him to avoid terminating the existing contracts by allowing a new company to take over the performance of those contracts. White thought novation was the best option as it would prevent the employers suffering any loss, the employees would still be employed and the creditors would not lose as much as they otherwise would. White believed that the deeds of release were the first step in the novation process.

Several contractors had an interest in taking over the company's contracts. One contractor offered £75,000 and £200,000 for the novation of the contracts. Nevertheless, the contracts could not be novated as White had already entered the company into the deeds of release.

The liquidators of the company claimed that White had breached his fiduciary duties to the company under Sections 171 (the duty to act in accordance with the company’s constitution) and 172 (the duty to act in good faith to promote the success of the company) of the Companies Act 2006. They argued that by entering into the deeds of release, White had caused the company to lose the value of the contracts and the company had lost the rights to the payments due under the contract.

The judge was satisfied that White had considered the best interests of the company and the creditors prior to entering into the release deeds. As a result, the judge decided that the method for determining if White had acted in the best interests of the company was to apply the subjective test set out in the case between Regentcrest plc (in liquidation) and Cohen from 2001, which is concerned with a director's state of mind. The judge also noted the established rule that where a company is insolvent, the duty to act in the best interests of the company is regarded as a duty to act in the best interests of its creditors as a whole.

The key question was therefore whether White had honestly believed that entering into the deeds of release was in the interests of the creditors of the company.

The judge decided that White had honestly believed that a novation of the company's contracts would be in the interests of everyone. Although White had taken into account considerations other than those of the creditors, he had concluded that all of the considerations pointed in the same direction and so was not required to prioritise the interests of the creditors.

The judge was also satisfied that White had genuinely considered, on the advice of trusted professionals, that signing the deeds of release would be the first step in obtaining the novations. Whilst this was clearly a mistake on White's part, judged subjectively it did not amount to a breach of his fiduciary duties. Accordingly, the liquidators' claim failed.

A separate point concerning burden of proof was also considered by the judge. The liquidators argued that the burden of proof was on White to show that his actions did not cause loss to the company. The judge squarely rejected that argument and said that in a claim for equitable compensation for breach of fiduciary duty, the burden was on the applicants to prove the breach and the losses said to flow from the breach.

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