2020-04-02
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Directors’ duties survive formal insolvency

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Posted by Caroline Benfield on 02 April 2020

Systems Building Group Ltd (In Liquidation)

Directors of a limited company owe a raft of statutory and fiduciary duties to act in the best interests of the company.  The statutory duties are now set out in Sections 171 to 177 of the Companies Act 2006 (CA06) and include the following:

  1. Duty to act within powers
  2. Duty to promote the success of the company
  3. Duty to exercise independent judgment
  4. Duty to exercise reasonable care skill and diligence
  5. Duty to avoid conflict of interest
  6. Duty to not to accept benefits from third parties
  7. Duty to declare interest in proposed transaction or arrangement.

These duties are owed to the company but when a company encounters financial difficulties there is a change to the beneficiary of these duties in that the director’s primary duty is to act in the best interests of the company’s creditors as a whole.  Once a company enters into liquidation or administration it was previously thought that directors’ duties came to an end because responsibility for the affairs of the company rests with the liquidator or administrator.  However, the case of Systems Building Group Ltd [202]0 EWCH 54 (ch) confirms otherwise.

Background

On 12 July 2012 the company was placed into administration and SG was appointed administrator.  The company moved into creditors’ voluntary liquidation on 3 July 2013 and was dissolved on 24 February 2016.  In the meantime, in 2014 SG was found liable for misfeasance as a result of her conduct as liquidator in another case and lost her licence to act as an insolvency practitioner.  Another insolvency practitioner, SH, was appointed in respect of all SG’s cases under a block transfer order and a number of closed cases including this one were re-opened to allow SH to conduct a detailed investigation.  As a result of SH’s findings in this case the company was restored on 25th April 2017 and SH was appointed liquidator on 3rd May 2017.

SH discovered (i) a number of potential claims against the director (D) arising from his conduct prior to the administration (ii) that in 2014 SG had sold a property that belonged to the company to D for £120,000 which he believed to be an undervalue and (iii) that D had caused the company to make various payments after the commencement of the administration.

The property

The property in question had been purchased by the company in 2009 for £185,000.  In 2010 the company’s filed accounts included the property, valued at £188,065.  These accounts were signed off by D on 10 November 2010 and filed at Companies House in 19 January 2013.

In August 2012 SG filed her Statement of Administrator’s Proposals.  Within this document the property was valued at £200,000, this figure having been provided by D.  In the statement of affairs signed off by D on 5th September 2012 he valued the property at £180,000.  On 25th September 2012 SG obtained a drive by valuation which placed a value of £195,000 upon the property.

On 21 December 2012 SG and D agreed that he would purchase the property at a price reflecting its proper value.

In her final Progress Report as administrator dated 5 July 2013, shortly prior to the company moving into liquidation, SG reported that she expected to be in a position to make a distribution to unsecured creditors based upon the receipt of the net equity in the property.  The figures in the report assumed a sale of £180,000.

However, on 2 July 2014 agreement appears to have been reached between SG and the director whereby he would purchase the property for £120,000.  It is unclear what, if any, negotiations took place prior to arriving at this figure and there is no evidence that the property was ever placed on the open market for sale.  D paid £40,000 on or about this date but no contracts were exchanged.  SG recorded the sale in her first Progress Report as liquidator in August 2014.  The balance of £80,000 was paid to SG between 19th and 24th September 2014 and a transfer in form TR1 was filed at the Land Registry in December 2014.

SH formed the view that the property had been sold at an undervalue and commenced proceedings against D in relation to this and a number of other pre-liquidation transactions that had not been investigated by SG.  He took the view not to join SG as a party to the proceedings as, by this point, she was bankrupt and as such there would have been no benefit to the creditors in doing so.

The payments

D had personally caused the company to make payments to a creditor amounting to £19,000 as well as personally making a number of cash machine withdrawals.

Decision

The issue for the court to decide was whether D’s duties as director survived the onset of administration and subsequent liquidation.  The judge noted that by virtue of Section 170(2) CA06, even a person who ceases to be a director remains subject to the duties in Sections 175 and 176 CA06.   In any event, there are no provisions within the insolvency Act 1986 (IA86) which have the effect of removing a director from office when a company enters administration or liquidation. Furthermore, the Companies Act 2006 specifically states when a particular provision does not apply in the event of administration or liquidation.  There are no such exclusions in respect of Sections 171 to 177 CA06.

In light of the above the judge held that D continued to owe to the company all the duties set out in Sections 171 to 177 CA06 after the company entered administration.   He had purchased the property from SG at a significant undervalue and in doing so he had breached his fiduciary duty to the company under Section 172(3) CA06 as he had no regard for the interests of creditors and acted entirely out of self-interest.  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'.

The fact the SG had also acted in breach of her duty afforded D no defence.  The judge unsurprisingly rejected submissions on behalf of D that he acted honestly and fairly and ought reasonably to be excused under Section 1157 CA06.  

Although the judgment does not set out specific details of the order made against D, he would be ordered to pay the difference between the market value of the property as at July 2014 and the £120,000 he paid.

Regarding the payments, in causing or knowingly them to be made after the Company was placed in administration, D (1) failed to give proper consideration to the interests of the creditors as a whole, in particular their entitlement to share rateably in the Company's assets on a pari passu basis, contrary to s.172 CA 2006; (2) failed to exercise reasonable care, skill and diligence, contrary to s.174 CA 2006: and accordingly (3) was guilty of misfeasance under s.212 IA 1986.

Comment

The case represents a warning to all directors of insolvent companies wishing to acquire assets from an insolvency office holder.  An independent valuation should always be obtained and the fact that an office holder may be willing to sell at a particular price offers no protection to a future claim for breach of duty. 

This case makes it clear that directors’ duties survive the commencement of insolvency and directors should be mindful that insolvency office holders will now be scrutinising post insolvency conduct as closely as pre-insolvency conduct with a view to bringing proceedings for breach of duty where appropriate.

About the author

Caroline advises on all aspects of contentious and non-contentious personal and corporate insolvency matters.

Caroline Benfield

Caroline advises on all aspects of contentious and non-contentious personal and corporate insolvency matters.

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