On 19 June 2019, Zacaroli J handed down a judgment concluding the long running proceedings brought by Burnden Holdings (UK) Ltd (“BHUK”) and its liquidator against two former directors, Mr and Mrs Fielding (the “Fieldings”), in respect of a grant of security to themselves for a loan made by them to BHUK and in respect of a distribution in specie of the BHUK’s shareholding in a subsidiary. The Court dismissed all of the claims against the defendants including allegations that the distribution in specie was unlawful, that it involved a dishonest breach of fiduciary duty and was a transaction defrauding creditors.
The Court also considered whether directors’ liability for unlawful distributions was strict or fault based, the statutory requirements for interim accounts, the duty to consider the interests of creditors in an insolvency situation, the application of the Eurosail insolvency test, and whether a grant of security can be a transaction defrauding creditors.
Facts
The Fieldings were the majority owners of the Burnden group of companies (the “Group“). Between them they held all of the ordinary A and B shares (comprising 78% of all of the issued share capital) of BHUK, the Group’s holding company and the first claimant. The remaining shares (consisting of D ordinary shares) were owned by Mr Whitelock (a director of various companies in the Group), Mr Beckett (the finance director of the Group companies) and the trustee of an employee share scheme. BHUK was placed into administration on 2 October 2008. A compulsory winding-up order was made against it on 7 December 2009. The directors of BHUK were the Fieldings, Mr Whitelock, Mr Beckett and a Mr Eamon Kavanagh.
The claim was issued on 15 October 2013 by BHUK and by its liquidator (the second claimant, Mr Stephen Hunt) against the Fieldings, alleging breach of fiduciary duty in respect of two transactions effected by BHUK in 2007. The first was the execution of a fixed and floating charge in favour of the Fieldings as security for loans made by them (the “Grant of Security“). The second was a transaction by which a subsidiary of BHUK known as Vital Energi Utilities Limited (“Vital“) was demerged from the Group (the “Demerger Transaction“), involving a distribution in specie by BHUK of the entire shareholding in Vital (the “Distribution“). The Grant of Security was dated 9 July 2007. The Distribution was effected on 12 October 2007.
The Group and the Fieldings were defendants in a long-running dispute with Ultraframe (UK) Limited, a competitor to the Group. This culminated in a trial commencing on 11 November 2004. In a judgment handed down on 27 July 2005, Lewison J found almost entirely for the defendants. Between them, the Fieldings and certain Group companies had spent many millions of pounds on the litigation. In a ruling dated 7 October 2005, Lewison J awarded the defendants a substantial part of their costs of the litigation. By the time of the two transactions in question, only an interim payment of £1.84 million had been received. The precise further amount which the defendants (and particular entities within the Group) could reasonably expect to recover is in dispute, but they in fact subsequently recovered only a further sum (before deduction of substantial costs) of £1.58 million, in February 2008.
By the spring of 2007, the Group was facing a severe cash crisis. This was anticipated to be critical by the winter of 2007/2008. The Group was accordingly looking for ways to generate cash. The demerger of Vital was identified as a potential solution. Ultimately it was structured by way of the Distribution followed by a sale of 30% of the shares in Vital to a third party, Scottish and Southern Energy PLC (“SSE“), for £6 million, with £3 million of the sale proceeds then being loaned to the Group by the Fieldings.
Judgment
Zacaroli J dismissed all of the claims against the defendants and gave important rulings on many issues of interest to restructuring and corporate lawyers:
- The Judge held that Directors’ liability in relation to the payment of an unlawful dividend is fault based rather than strict. After a full review of the case law spanning over 150 years (paras 108 to 156), Zacaroli J followed the decision in the case of Dovey v Corey [1901] AC 477 holding that “First, directors, although not trustees, were to be treated as if they were trustees in relation to the company’s funds. Second, if they knew the facts which constituted an unlawful dividend, then they would be liable as if for breach of trust irrespective of whether they knew that the dividend was unlawful. Third, however, if they were unaware of the facts which rendered the dividend unlawful then provided they had taken reasonable care to secure the preparation of accounts so as to establish the availability of sufficient profits to render the dividend lawful, they would not be personally liable if it turned out that there were in fact insufficient profits for that purpose. Fourth, they were entitled to rely in this respect upon the opinion of others, in particular auditors, as to the accuracy of statements appearing in the company’s accounts. Fifth, nothing in the authorities cited as the leading authorities for the strict-liability view (Flitcroft’s Case, Lands Allotment and Re Sharpe) undermines that conclusion.” (see para 139).
- The Judge considered the statutory requirements in relation to distributions, including both (a) the procedural steps to declare a distribution; and (b) what is required to constitute “interim accounts” under the Companies Acts.
- In respect of (a), the Judge found that a board meeting had taken place at which the board had determined to recommend a dividend in specie and had briefly considered the interim accounts. The company’s holding company, as its sole shareholder, was to be taken as having waived, on Duomatic principles, any provision that the company could not declare a dividend in a sum greater than that recommended by the directors.
- In respect of (b), the Judge held that the Distribution was not rendered unlawful, either on the basis of a lack of distributable profits or on the basis of the interim accounts being incapable of ensuring a reasonable judgment as to BHUK’s assets, liabilities, profits and losses. The court considered the degree of detail and formality required of interim accounts if they were to satisfy section 270, and the effect of mis-descriptions or over-valuations of an asset in the accounts. The fact that it was necessary to amalgamate different entries to identify the net value of an asset did not invalidate the accounts for the purposes of section 270(4). BHUK’s investment in one of its subsidiaries had a value less than that identified in the interim accounts but, by virtue of section 275, no realised loss was created. The effect of section 275 of the CA 1985 (section 841 of the CA 2006) was that no realised loss was created so long as the aggregate value of the company’s fixed assets was not less than the aggregate amount at which they were stated in the books, even if the fixed assets had been written down.In respect of (b), the Judge held that the Distribution was not rendered unlawful, either on the basis of a lack of distributable profits or on the basis of the interim accounts being incapable of ensuring a reasonable judgment as to BHUK’s assets, liabilities, profits and losses. The court considered the degree of detail and formality required of interim accounts if they were to satisfy section 270, and the effect of mis-descriptions or over-valuations of an asset in the accounts. The fact that it was necessary to amalgamate different entries to identify the net value of an asset did not invalidate the accounts for the purposes of section 270(4). BHUK’s investment in one of its subsidiaries had a value less than that identified in the interim accounts but, by virtue of section 275, no realised loss was created. The effect of section 275 of the CA 1985 (section 841 of the CA 2006) was that no realised loss was created so long as the aggregate value of the company’s fixed assets was not less than the aggregate amount at which they were stated in the books, even if the fixed assets had been written down.
- In respect of the Defendants’ liability on these issues, the Judge held that even if the value of any assets in the interim accounts should have been written down, or other liabilities included, and even if that had resulted in there being insufficient reserves to enable the distribution to be lawful, the directors were not culpable. It had been reasonable for them to rely on the various professionals involved in preparing the accounts and conclude that the accounts met statutory requirements (paras 328-338).
- In relation to when the duty to consider the interests of creditors arises under section 172 (3) CA 2006, the Judge followed the test confirmed by David Richards LJ in the Court of Appeal in BTI v Sequana [2019] EWCA Civ 112 at [220] as being: “when the directors know or should know that the company is or is likely to become insolvent”, and in interpreting this, “likely” means “probable” and “not some lower test such as that adopted by Hoffman J in construing the statutory test of the making of an administration order: see Re Harris Simons Construction Limited [1898] 1 WLR 368”. Zacaroli J further applied the balance sheet test of insolvency set out in BNY Corporate Trustee Services Ltd v Eurosail-UK 2007-3BL plc [2013] 1 WLR 1408 to the context of a group of trading companies, including the proper assessment of contingent and prospective liabilities and the impact on the parent of an insolvent subsidiary. The test being (as per Lord Walker JSC at [42] of Eurosail) “Essentially, section 123(2) requires the court to make a judgment whether it has been established that, looking at the company’s assets and making proper allowance for its prospective and contingent liabilities, it cannot reasonably be expected to be able to meet those liabilities. If so, it will be deemed to be insolvent although it is currently able to pay its debts as they fall due. The more distant the liabilities, the harder this will be to establish.” The burden lies on the party asserting the balance-sheet insolvency.
- In respect of section 423 claims (transactions defrauding creditors), the Judge discussed the threshold and whose intention was relevant in determining whether the purpose was to put assets beyond the reach of creditors. The Claimants had two claims under section 423; (i) the Distribution; and (ii) the Grant of Security.
- The Judge determined that in respect of the Distribution it was now settled law, following Sequana that the payment of a dividend is capable of constituting a transaction at an undervalue within the meaning of section 423 of the IA 1986. The only issue in this case, therefore, was whether the defendants’ intention in making the Distribution was to put the shares in Vital beyond the reach of creditors. The purpose must be a real substantial purpose (not merely a by-product of the transaction under consideration) but it does not need to be the sole or dominant purpose: IRC v Hashmi [2002] BCC 943, at [23]-[25] per Arden LJ. Zacaroli J went on at [405] that although knowledge of insolvency, whether at the time of the transaction or in consequence of it, was not a necessary precondition for a finding that the requisite purpose was present, it was at least a relevant consideration that the defendants did not believe that BHUK was rendered insolvent as a result of the Distribution. That was because prejudice to creditors is more remote if the company’s solvency is not affected by the transaction. It remained possible that the defendants nevertheless envisaged a potential future insolvency of BHUK and sought to insulate Vital from that eventuality.
- The Judge determined that a grant of security cannot be a transaction defrauding creditors under section 423 of the IA 1986 thus re-establishing the orthodoxy in Re MC Bacon [1990] BCC 78 and not applying the obiter dicta in Hill V Spread Trustee [2007] 1 WLR 2404. In Hill, it was found that there was no consideration given to the bankrupt for the grant of security by him. It was therefore unnecessary to consider whether the transaction fell within section 423(1)(c). At [138], however, Arden LJ addressed an argument advanced on behalf of the bankrupt that as a matter of law the grant of security involved no diminution in the value of the bankrupt’s assets and said: “I 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 considered 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.” Zacaroli J’s view was that Millett J, in M C Bacon, provided a reason why that value should be left out of account, namely that it had a value only from the point of view of the creditor, whereas the section requires value given and received to be viewed from the company’s point of view.
- Although Zacaroli J rejected the allegations of breach of duty against the directors, he did consider whether he would have given them relief (had they been found liable) under section 1157 of the CA 2006 which empowers the court to grant relief in claims where negligence, default, breach of duty or breach of trust are brought against (a) an officer of a company; or (b) a person employed by a company as auditor (whether he is or is not an officer of the company). If it appears to the court hearing the case that the officer or person is or may be liable but that he acted honestly and reasonably, and that having regard to all the circumstances of the case (including those connected with his appointment) he ought fairly to be excused, the court may relieve him, either wholly or in part, from his liability on such terms as it thinks fit. The Judge held at [413] that the discretion was not fettered, even where the company was insolvent and the director was the recipient of the unlawful dividend, noting that this would depend upon matters such as (i) the causal link between the dividend and prejudice to creditors (including whether the distribution could lawfully have been made); (ii) the length of time between the dividend and the action being commenced; and (iii) whether the director retained the benefit of the dividend.
- The Judge also considered the application of the Limitation Act 1980 to claims under section 423 IA 1986 and the circumstances in which the 6 or 12 year limitation periods would apply. He held that, given the relief being claimed was for a sum of money, the claims relating to security under section 423 were time-barred. The claimants accepted (on the basis of Hill v Spread Trustee Co Ltd [2007] 1 WLR 2404, per Arden LJ at [126]-[128]) that a claim under section 423 is subject to a limitation period under either section 8(1) or section 9(1) of the Limitation Act 1980 and that time began to run on the appointment of the administrators to BHUK on 2 October 2008. Section 8(1) of the Limitation Act 1980 provides a 12 year limitation period for an action on a specialty. By section 8(2), that is subject to any shorter period of limitation prescribed by any other part of the Act. By section 9(1), a six-year limitation period is prescribed for a claim to recover a sum of money by virtue of an enactment. The Grant of Security claim was commenced on 20 January 2017, the date it was introduced by amendment, and is therefore time-barred if it falls within section 9(1). In re Priory Garage (Walthamstow) Ltd [2001] BPIR 144 it was held that an action under section 238 of the 1986 Act (transactions at an undervalue) will come within section 9(1) if it can fairly be said that the substance or the essential nature of the action is to “recover a sum recoverable by virtue of” that section. John Randall QC, sitting as a deputy judge of the Chancery Division, said: “One example of a case caught by s.9(1) is where the transaction to be set aside is a simple payment of a sum of money. Another might be where the only substantive relief available to the applicant is an order for the payment of money, such as where s.241 (2) precludes the setting aside of the transaction.” It is necessary to see what is the substance or essential nature of the relief “truly sought by the applicant in the particular case before it“. Zacaroli J held that the same principles apply to a claim under section 423. The assets that were subject to the charge had long gone so that the only relief available was the payment of a sum of money, therefore the claim was time barred.
- We understand that the Liquidator is appealing the decision.
