Directors' duties in a formal insolvency context

United Kingdom

Introduction

The decision of ICC Judge Barber in the case of Stephen Hunt & System Building Services Group Limited -v- Brian Michie & System Building Services Group Limited [2020] EWHC 54 (Ch) was recently handed down and it is an interesting decision about directors’ duties post the appointment of an administrator or liquidator.

Facts

The facts are quite involved and matter specific, and gave rise to a number of issues, but for present purposes the key issues are as follows.

System Building Services Group Limited’s (“Services”) sole director was Mr Michie. Services went into administration on 12 July 2013. It subsequently went into liquidation, on 3 July 2013. A Mrs Sharma was appointed as both administrator and subsequently liquidator. Mrs Sharma was subsequently found liable for misfeasance in another matter, and was ultimately made bankrupt. Stephen Hunt was appointed liquidator of Services following a block transfer of Mrs Sharma’s cases. 

One of Services key assets was a property. It was sold by Services, acting by Mrs Sharma as liquidator, in 2014 to Mr Michie for £120,000. Mr Michie was still director at this time. Mr Hunt claimed that the sale was at what Mr Michie knew to be a substantial undervalue for his own benefit and without regard to the interests of the creditors. Mr Michie therefore, it was claimed, acted in breach of duties owed by him to Services as its director under sections 171 to 175 of the Companies Act 2006 (“CA 2006”) including in particular his duty to act in the best interests of Services’ creditors as a whole from the time at which Services was insolvent. It was common ground that if Mr Michie was found to have acted in breach of his fiduciary duty in procuring or agreeing a sale of the property to himself, an institutional constructive trust would arise.

Legal principles

In broad summary, the relevant directors’ duties are:

  1. Section 171 provides that a director of a company must only exercise powers for the purposes for which they were conferred.
  2. Section 172(1) provides that a director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. Section 172(3) goes on to provide that the duties imposed by Section 172(1) and (2) have effect 'subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company'.
  3. Section 174 provides that a director of a company must exercise reasonable care, skill and diligence.
  4. Section 175 provides that a director of a company must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company.

Where the company is insolvent or likely to become insolvent, the duty of a director to act in the best interests of the company is regarded as a duty to act in the interests of its creditors as a whole; their interests are generally regarded as becoming paramount.

The duty imposed on directors to act bona fide in the interests of the company (or, in cases of insolvency, its creditors) is ordinarily regarded as a subjective one. The question is not whether, viewed objectively by the court, the particular act or omission which is challenged was in fact in the interests of the company; still less is the question whether the courts, had it been in the position of the director at the relevant time, might have acted differently. Rather, the question is whether the director honestly believed that his act or omission was in the interests of the company. The issue is as to the director's state of mind. No doubt, where it is clear that the act or omission under challenge resulted in substantial detriment to the company, the director will have a harder task persuading the court that he honestly believed it to be in the company's interest; but that does not detract from the subjective nature of the test.

This general principle is however subject to certain qualifications, including:

  1. Where (as in cases of insolvency) the duty extends to consideration of the interests of creditors, their interest must be considered as "paramount", so in applying the subjective test, any consideration of whether an act is in the company’s interests must be assessed on the basis as to whether it is believed to be in creditors’ interests.
  2. The subjective test only applies where there is evidence of actual consideration of the best interests of the company. Where there is no such evidence, the proper test is objective, namely, 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 company.

The court considered to what extent these duties continued post administration/liquidation. Mr Michie argued that they only survived to any exercise of a directors powers in their capacity as director. The court rejected this. The court held that it was clear from Sections 170-177 themselves that the 'general duties' of a director set out therein extend beyond the exercise by a director of any given power qua director.

Section 175(1), for example, provides that 'a director of a company must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company.' The application of this section is not dependent on the exercise of a given power qua director. The distinction is again exemplified in Section 176(1), which provides that 'a director of a company must not accept a benefit from a third party conferred by reason of (a) his being a director; or (b) his doing (or not doing) anything as director.' Simply 'being' a director is sufficient to trigger this duty; it is not dependent upon the exercise of a power qua director. Section 170(2) is also relevant in this context. This provides, inter alia, that 'a person who ceases to be a director continues to be subject to the duty in section 175 (duty to avoid conflicts of interest) as regards the exploitation of any property, information or opportunity of which he became aware at a time when he was director.' This is a clear example of the 'reach' of these provisions; the duties imposed by section 175 continue to apply to a person even after that person ceases to be a director; a fortiori, beyond the point at which a given individual is exercising any powers qua director. Furthermore, s.172(3) expressly preserves the duties of a director in certain circumstances 'to consider or act in the interests of creditors of the company'. There was nothing in the caselaw preceding the CA 2006 (or indeed post-dating it) to suggest that such duties cease on a company's entry into a formal insolvency process.

Taking these, and other factors into consideration, the court held that the general duties of a director of a company to the company set out in sections 171 to 177 CA 2006 do survive the company's entry into administration and liquidation. Whilst in office, a director continues to owe the company the duties laid down in sections 171 to 177 CA 2006, as applied and interpreted in accordance with the underlying common law rules and equitable principles on which such duties were based.

The decision

On the evidence, the court held that Mr Michie knew at all times that he was getting a property at a significant undervalue for his own benefit. He took advantage of an opportunity to pick up an asset ‘on the cheap’, an opportunity that he only knew about due to his position as sole director. Interestingly, the court found that instead of relying on Mrs Sharma’s valuation of the property, if anything Mr Michie was advising Mrs Sharma as to the price the property should be sold for. 

As stated above, generally the issue of assessing whether there has been a breach of duty is a subjective one and whether the director honestly believed that his act or omission was in the interests of the company, in this case the creditors. However, the court held that there has been no such consideration. Therefore the test becomes an objective one, namely, 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 company. The court held the answer was plainly ‘no’.

Moreover even if Mr Michie did pause to consider the interests of the creditors as a whole, the court was satisfied that Mr Michie did not honestly believe that his act in purchasing the property off-market for the sum of £120,000 was in the interests of the creditors as a whole.

The case also considered this issue in the context of certain payments Mr Michie caused or knowingly allowed to be paid to a creditor called CB Solutions UK Limited, an entity described by the court as being of significance to Mr Michie, shortly after the administrator’s appointment. A significant part of the judgment dealt with the evidence dealing with whether Mr Michie had caused or knowingly allowed the payments to be made. Once the court concluded that on the balance of probabilities he had, it held that Mr Michie failed to give proper consideration to the interests of creditors as a whole, in particular their entitlement to share rateably in Services assets on a pari passu basis contrary to section 172 CA 2006, failed to exercise reasonable care, skill and diligence contrary to section 174 CA 2006 and accordingly was guilty of misfeasance under section 212 of the Insolvency Act 1986. The fact that Mrs Sharma may have also been at fault was no defence.

Comment

The case brings into sharp focus the extent to which directors’ duties continue post the appointment of an administrator or liquidator. In the case the court had grave concerns over the conduct of both the director and liquidator, was of the view that the director exerted influence over the liquidator and was mindful of the fact that the property had not been actively marketed and no independent valuation had been obtained. It is therefore not surprising that the Judge found Mr Michie to be liable.  

More broadly however, the question remains as to the extent that directors’ duties continue post the appointment of an administrator or liquidator. It is particularly interesting that the Judge found that even though Mr Michie acquired the property from a liquidator, that was no defence to any claim as his fiduciary duties were owed independently of the duties owed by the liquidator. This may cause directors who are looking to buy assets from a company in administration or liquidation, in particular if as part of a pre-pack sale, to pause over the price to be paid. The involvement of an independent third party in the process (the administrator or liquidator) is not, it seems, any defence. However, where an administrator or liquidator exercises independent judgement with the benefit of one or more independent valuations, it would be thought that the position of a director acquiring a business and assets should be more secure. It remains to be seen how far this decision reaches.