Directors' duties on company insolvency

A decision on liability has recently been passed down which provides timely commentary on the duties of directors in the event a company is insolvent, or near insolvent. The Court provides a reminder that a director’s duty to promote the success of the company, exercise independent judgment and avoid conflicts of interest does not change even when the company is unable to take advantage of property, opportunities or information; if anything a company requires greater protection at such time.

The factual background to the matter is complex, and according to the Judge “somewhat confused”. In summary, however, Mr Davies incorporated a business “Greenbox Recycling Limited” (GBR) on 1 March 2010. The intention was for GBR to take over an existing skip and hire recycling business (the Business) operating from premises near Ashford, Kent; at the time it was run by a company called Skip It (Kent) Ltd (SIK). Mr Davies’ case is the Business was transferred from SIK to GBR in about November 2010.

Mr Ford and Mr Monks were directors (and shareholders) of GBR, appointed in September and November 2010 respectively. Mr Davies held the remaining 80% of GBR’s issued share capital. Mr Davies stepped back from day-to-day involvement of GBR during 2010, and moved abroad.

Another company, Greenbox Recycling (Kent) Ltd (GBRK), was incorporated by Mr Ford and Mr Monks on January 2011; both individuals directors and shareholders on incorporation, although Mr Ford resigned as a director after only a few days, later selling his shares to Mr Monks at some point in 2013.

The crux of the claim brought against Mr Ford and Mr Monks is that they diverted the Business, which was intended to be operated through GBR, to GBRK, and that such diversion put them in breach of contract, and in breach of the duties owed as directors of GBR - failing to promote the success of GBR and putting themselves in a position of conflict (in breach of s.172-175 Companies Act 2006). Only Mr Monks participated in the proceedings. His position (broadly) is that the decision to incorporate GBRK in early 2011, and his business activity thereafter, was a response to the state GBR was in at the time. He said that:

1. the waste management business formerly carried on at the Ashford Site was never in fact transferred to GBR, and so GBR never had ownership of the Business;
2. although he became a director, he never became bound by any contract of employment with GBR;
3. by early 2011 GBR was insolvent (or close to insolvency) and for various reasons was not able to trade lawfully;
4. he and Mr Ford were concerned about potential personal liabilities to which they might be exposed because of the physical state of the Ashford Site; and
5. GBR had effectively been abandoned by Mr Davies, who is said to have misled Mr Monks in various ways (including by failing to disclose that he (Mr Davies) was the subject of proceedings under the Directors Disqualification Act, which resulted in him being disqualified as a director for a period of 11 years with effect from 8 October 2010)

Several issues (including limitation) were put to the Judge for determination at the liability hearing. Of particular interest is the findings of the Judge relating to Mr Monks’ duties as a director of GBR, particularly against the backdrop of his assertions as to the scope of his duties, given that GBR was insolvent in late 2010, or of doubtful insolvency (the Court unable to conclude as such, but assuming it was insolvent or near insolvent when considering the scope of Mr Monk’s duties to GBR).

Key points to note are as follows:

The focus ought not to have been solely on whether Mr Monks breached his duties by misappropriating existing assets, the Court noting that duties can be breached in other ways, for example, by a director putting himself in a position of conflict and thereby making an unauthorised profit; i.e. the question to be asked is “were the director’s actions wrongful”.

Mr Monks was in breach of the Companies Act 2006 section 175 (Duty to avoid conflicts of interests), the Judge citing the steps taken by Mr Monks on behalf of GBRK as being polar opposite to the interests of GBR; GBR looking to develop the exact same trading business, operating from the same premises, as GBRK.

Reference was made to the argument made by Mr Monks that GBR was not in a position to exploit the opportunities presented to GBRK; the Court finding that it is no answer to a claim for breach of duty for a trustee to say that the opportunity he has exploited was not one which could ever have been taken up by the beneficiary.

The Judge dismissed the argument that, where a company is insolvent and not able to trade (and hence not capable of exploiting any business opportunity presented to it), there is no conflict in a director seeking for himself to exploit that same opportunity. He noted that such an argument would cut across the most basic principles of fiduciary law, namely that a fiduciary cannot escape liability by saying that the benefit acquired in breach of duty was not one the principal could have acquired or exploited, noting that “Inability to take advantage of any relevant property, information or opportunity is immaterial to the assessment of whether the duty is owed...it can make no different to that analysis to say…that the reason for the inability is the insolvency of the company”.

Further, the Court agreed with the claimant that if correct, there would be an anomaly, such that a director who diverted a business opportunity from a solvent company would be liable to account, but a director who diverted the same opportunity from an insolvent company would not, which could not be correct.

Default judgement was entered against Mr Ford (he played no role in the action until the first day of trial, when he made an application for permission to serve a Defence, which was refused). The Court found that Mr Davies was entitled to judgment as against Mr Monks, the Court going as far as to say that he acted "dishonestly (and therefore fraudulently)" when taking the business decisions he did, which were all in the interests of GBRK. The case serves as a reminder of the duties which directors owe to the companies they serve, even when a company is insolvent or close to insolvency. Directors need to ensure that they do not put themselves in a position where they seek to prefer their own interests over that of the company, or the company’s creditors.

Further reading: Kenneth Davies v (1) Stephen Ford (2) Richard Monks (3) Greenbox Recycling Kent Ltd [2020] EWHC 686 (Ch).