Directors’ duties from beyond the corporate grave
Re System Building Services Group Limited  EWHC 54 (Ch)
A recent High Court ruling has considered the character and extent of directors’ duties in the context of insolvency.
In System Building Services, Insolvency and Companies Court Judge Barber (“ICCJ Barber”) considered, amongst other things, the nature of a director’s duties to a company and whether those duties survive the company’s entry into an insolvency process.
In what is thought to be the first case to deal with this specific issue, ICCJ Barber held that the “duties owed by a director to the company and its creditors survive the company’s entry into administration and voluntary liquidation.”
System Building Services Group Limited (the “Company”) was placed into administration in July 2012 and Gagen Sharma (“Ms Sharma”) was appointed as administrator. The administration was converted into a creditors’ voluntary liquidation in July 2013 and Ms Sharma was appointed as liquidator. At the time the Company entered administration and thereafter liquidation, Brian Michie (“Mr Michie”) was the Company’s sole director. The Company was dissolved in February 2016 but was restored by Stephen Hunt (“Mr Hunt”), the First Applicant in this case, in April 2017.
The background to the Company’s restoration is that, in 2014, Ms Sharma was found liable for misfeasance in office (in unrelated proceedings) and was struck off. After Ms Sharma’s misfeasance proceedings, Mr Hunt took over various of Ms Sharma’s appointments pursuant to a Block Transfer Order. Following his investigation into the affairs of the Company and the conduct of Ms Sharma, Mr Hunt made his application to restore the Company. Once the Company was restored, Mr Hunt was appointed as liquidator and brought the instant proceedings. Ms Sharma was made bankrupt in 2016 and Mr Hunt therefore had no realistic prospect of bringing misfeasance proceedings against her.
The Company owned a property known as 55 Crown Road (the “Property”). In 2014, while the Company was in liquidation, Mr Michie purchased the Property from the Company (effected by Ms Sharma as liquidator) at what Mr Hunt contended was a substantial undervalue – being £120,000. This amount was lower than: (i) the price at which the Company purchased the Property; (ii) the value attributed to the Property in the Company’s accounts, (iii) the estimated value of the Property in the Statement of Administrator’s Proposals prepared in August 2012 (£200,000); and (iv) the independent valuation of the Property obtained by Ms Sharma in September 2012 (£195,000).
In cross-examination it became apparent that in December 2012 Mr Michie reached an agreement in principle with Ms Sharma to purchase the Property for “its proper value” although no specific figure was identified. On 2 July 2014, Mr Michie and Ms Sharma agreed that the purchase price would be £120,000, and Mr Michie paid a £40,000 deposit into Ms Sharma’s client account. The balance was paid in September 2014 and completion took place in December 2014.
At no point during the liquidation was the Property ever listed on the open market, and Mr Michie admitted in cross-examination that the deposit of 33% – significantly higher than the usual deposit paid for a residential property – was paid to ensure that Ms Sharma would continue to refrain from openly marketing the Property.
A joint expert, appointed to value the Property for the purposes of the claim, reported that the value of the Property as at February 2019 was £300,000 and that in July 2014 – when the sale price of £120,000 was agreed – the value of the Property was £265,000.
In February 2017, Mr Michie listed the Property on the market for £365,000.
Directors are subject to various duties under the Companies Act 2006 (“CA06”) which regulate the manner in which they must behave as regards their companies. In particular, under section 172(1) of the CA06, a director must act in good faith for the benefit of the company. Additionally, section 172(3) of the CA06 provides that where a company is insolvent or is likely to become insolvent, the duty of a director to act in the best interests of the company includes a duty to have regard to the interests of the company’s creditors as a whole. This duty is fiduciary in nature.
Case law makes clear that where a director breaches a fiduciary duty, an automatic trust will arise, the consequence of which will be that any benefit that the director derives in breaching that duty will be held on trust for the Company.
At paragraph 110, ICCJ Barber explained that she was satisfied that “…at all material times, Mr Michie knew that the Property was worth significantly more than the price he paid for it.”
Further, in paragraph 117, ICCJ Barber said that “Mr Michie acted entirely out of self-interest and failed to have regard to the interests of the creditors as a whole” before adding in paragraph 118 that “the Court must ask itself whether an intelligent and honest man in the position of a director of the Company could, in the circumstances, have reasonably believed that the transaction was for the benefit of the creditors as a whole. The answer is plainly ‘no.’”
It was held, therefore, that Mr Michie had breached his duties to the Company in purchasing the Property from the Company at an undervalue notwithstanding the fact that: (i) the Company was in liquidation at the time of the transaction; and (ii) the transaction was effected on behalf of the Company by Ms Sharma as liquidator rather than Mr Michie as director (as his powers to act as a director ended once the Company entered administration). ICCJ Barber held that Mr Michie had breached his duties as in purchasing the Property at an undervalue he failed to have proper regard to the interests of the Company’s creditors and, instead, acted in his own interests. Therefore, the Court ruled that Mr Michie held the Property on trust for the Company with credit given for the £120,000 purchase price.
Separate from the matters concerning the Property, this case dealt with several other claims against Mr Michie and others. The claims against Mr Michie concerned payments which Mr Michie caused or allowed to be made to one of the Company’s creditors after the Company entered administration (the “Post-Administration Payments”), and an alleged outstanding balance on Mr Michie’s director’s loan account (the “DLA”).
As regards the Post-Administration Payments, ICCJ Barber held that Mr Michie was complicit in allowing the payments to be made post-administration and, in so doing, was in breach of his duties as director of the Company by, amongst other things, failing to give proper consideration to the interests of the Company’s other creditors and their rights to share in the Company’s assets on a pari passu basis. ICCJ Barber therefore ordered Mr Michie to contribute a sum equal to that paid out as the Post-Administration Payments.
Mr Michie argued that the DLA represented amounts due to him from the Company in respect of salary and dividends. There was significant discussion at trial about the netting off of various payments between the Company and Mr Michie and the total amount allegedly due from Mr Michie. In her judgment, ICCJ Barber held that, while Mr Michie was not dishonest in withdrawing sums from the Company in excess of his salary and dividend entitlements – Mr Michie claimed that any drawings were made on the basis of the advice of his accountant – he had drawn amounts in excess of those to which he was entitled and ordered Mr Michie to repay those sums to the Company with interest.
Had this transaction taken place at a time when the Company was solvent, this would have been a relatively ordinary case of a breach of duty by a director. The fact that the transaction occurred when the Company was in liquidation – where the director no longer had control over the Company’s affairs – makes this a novel case. The approach taken by ICCJ Barber appears to be a significant development (and departure from established practice) in the law of directors’ duties, and will be of particular note for Insolvency Practitioners who are considering transactions with directors, in particular ‘pre-pack’ transactions, and for directors dealing with ‘friendly’ liquidators during the course of insolvency proceedings.
This case brings into question whether office holders can enter into ‘pre-pack’ transactions with directors at all. Numerous authorities have endorsed the validity and desirability of ‘pre-packs’ as the directors are often the only people who are able to act sufficiently quickly (because they understand the underlying business) to preserve continuity, save employee jobs, and thereby enhance creditor recoveries. It is not clear from this case whether directors will be able to enter into ‘pre-packs’ going forwards or whether they will be required to appoint a third-party director to conduct the negotiations so as to avoid the inherent conflict between their apparent continuing duties to the creditors and their interests as purchaser. Alternatively, it may be that the Court made its determinations because Ms Sharma was bankrupt and no recoveries could be made against her for the loss caused by her misfeasance and the Court simply manoeuvred itself in a manner to ensure that some recoveries were made for creditors.
This case also highlights the responsibility of directors to ensure that they consider the interests of the company’s creditors even after an office holder has taken over the affairs of a company. Whilst a director may no longer have control over the company’s affairs, his or her duties remain in force and directors should be alive to the potential risks posed by a transaction between them and an office holder.
Clearly, the importance of Insolvency Practitioners and directors receiving proper advice on these matters is difficult to overstate. Further clarity from the Court in this area, particularly in how this decision impacts insolvency transactions henceforth, would be most welcome.
Sponsor Licence Compliance: Key considerations & how to be audit ready
Join us for the third in our series of mini webinars on post Brexit immigration about sponsor licence compliance.
The Future of Property Careers
Join to our panel discussion and Q&A with industry leaders on the range of opportunities within the property and construction sector.
No “New Look” in the latest landlord challenge to a tenant CVA
Daniel and Hannah look at the impact of the recent New Look CVA judgment
New tax on property developers - consultation paper published
The government published a consultation paper on the design of the new residential property developers tax.
Procuring modular housing: Is MMC becoming mainstream?
Is Modern Methods of Construction becoming mainstream? Read what it means for Development and Procurement here.
Dual class share structures: how do they work and what are the pros and cons?
Dual class share structures allow a shareholder, for example the founder, to retain voting control over a company.
Q&A: Talking the telecoms talk
Georgina Muskett and Jonathan Wills answer queries on Electronic Communications Code agreement.
Property Patter: Navigating the complexities of Pharmacy Property
Pharmacy property is a specialist area which contains many traps for the unwary.
COVID-19 Vaccination – can an employer make it compulsory for employees?
We review what legal issues to take into account when considering to make vaccination compulsory as an employer.
The Lawyer, New Law Journal, International Adviser, CDR Magazine and eprivateclient report on the firm's partner promotions
Charles Russell Speechlys promoted five lawyers to partner, effective 1 May 2021.
Linking ESG and Executive Pay
How does a business go about embedding a focus on strong ESG performance into the structures and culture of its organisation?
National Security and Investment Act granted Royal Assent
The Act establishes a new regime for the review of mergers, acquisitions and other transactions that could threaten national security.
Recent Trends In Firewall Legislation: BVI, Bermuda And Gibraltar
Charles Russell Speechlys advises Waverton on acquisition of Cornerstone Asset Management
Established in July 2010 and with offices in Edinburgh and Glasgow, Cornerstone offers wealth management and financial planning advice.
What do the new Debt Respite Scheme Regulations mean for Landlords and Tenants?
This will provide legal protection from creditors in the form of either a breathing space or a mental health crisis moratorium.
Charles Russell Speechlys promotes five to Partner
The promotions are effective 1 May 2021 and are accompanied by one Legal Director and 15 Senior Associate promotions.
Risk allocation in commercial leases: the High Court considers rent suspension, insurance and frustration arguments
Read our summary of the full judgement on the latest Covid arrears case.
Charles Russell Speechlys boosts private wealth offering with the hire of an international tax team
Robert Reymond will be joined at the firm by Leigh Nicoll, Emma Tyrrell and Oliver Cooper.
Proposed Takeover Code Amendments – Key Changes
The Consultation Paper has now been followed by a corresponding response paper which made certain modifications to the initial proposals.
Building Back Better: Future Gazing
What’s next for the hospitality industry post-pandemic?