Directors' duties and assessing insolvency

When will a respondent director be held liable to repay sums to the company for breaches of duty and how will the courts determine when a company is insolvent?

Original news

Hellard v Carvahlo—HLC Environmental Projects Ltd (in liquidation) [2013] EWHC 2876 (Ch), [2013] All ER (D) 240 (Sep)

The respondent was the former director of a company to which the applicants were appointed as joint liquidators. The applicant's claim was brought under section 212 of the the Insolvency Act 1986 (IA 1986). The applicant claimed relief against the respondent for sums paid out of the company in breach of his duties as a director, in circumstances where the company had substantial creditors and liabilities and without the respondent giving any consideration to the best interests of the company's creditors as a whole.

What happened in the case?

HLC Environmental Projects Ltd (the company) was a holding company for a Portuguese entity and there were also a number of associated companies in the UK. The company's business was conducted through four direct subsidiaries (the group). The group's core business was providing waste management services to public authorities. A number of these projects ran into difficulties.

The company's accounts for 2007 showed that a trend had built up over the years of net current liabilities increasing steadily. Between 2004 and 2007, net liabilities increased from £535,000 to £2.7m. Retained losses and shareholders' deficit also increased. The company also had many contingent liabilities. The company eventually collapsed and joint liquidators were appointed.

What was the claim for?

The applicants' claim (brought under IA 1986, s 212) was for financial relief against the respondent in respect of a number of payments that he caused the company to make between November 2005 and October 2008 (at a time when the company was insolvent) (the payments). The applicants alleged that the respondent had breached the duties owed to the company as a director either under the common law (for payments made before 1 October 2007) or under the general duties laid down the in Companies Act 2006 (CA 2006) for payments made post-codification.

What duties are owed?

When a company is solvent and has no financial concerns, broadly speaking, the company and its directors owe fairly limited duties to creditors. However, when a company is insolvent, or is verging on insolvency (the insolvency point), there is a shift in the directors’ duties. The shift moves the directors’ primary duties away from the company’s members and towards the company’s creditors as a whole (the insolvency duties). Breach of insolvency duties can result in personal liability for that director, or disqualification and, in some instances, a criminal prosecution.

For this particular case, the duties breached were set out in common law (for the payments made before 1 October 2007) or under the general duties laid down by CA 2006 (for payments made post-codification).

How did the court assess insolvency?

It is settled law that when determining whether a company was insolvent for the purposes of IA 1986, s 123(2), the court is required to make a judgment. That is not as simple as aggregating all contingent and present liabilities at their face value with debts presently due, but rather making a judgment as to whether it has been established that, looking at the company's assets and making proper allowance for its prospective and contingent liabilities, it could not reasonably be expected to be able to meet those liabilities (as per the recent case of BNY Corporate Trustee Services Ltd v Eurosail-UK 2007-3BL plc [2011] EWCA Civ 227, [2011] 3 All ER 470).

In this case, the company's accounts provided strong evidence of insolvency (under both IA 1986, ss 123(1) (e) and (2)). This was reinforced by a number of factors, apparent from the evidence, which demonstrated the company's inability to pay its debts as they had fallen due over a number of years.

On the evidence, the company had been unable to pay its debts as they had fallen due, for the purposes of IA 1986, ss 123(1) (e) and (2) and the value of its assets was less than the amount of its liabilities, taking into account its contingent and prospective liabilities throughout the period during which the payments complained of were made. The court was therefore satisfied that the company was insolvent at the time of the payments.

What was the outcome?

The court found the decision to make the payments was made by the respondent without any consideration to the best interests of the company's creditors as a whole, nor those of its contingent creditor, despite the company having:

  1. substantial creditors
  2. substantial net liabilities
  3. overall net liabilities
  4. no live projects or revenue stream, and
  5. no realistic prospect of gaining any

The respondent had, in effect, been choosing which creditors to pay and which to leave exposed to a real risk of being left unpaid. Any intelligent and honest person in the respondent's position could not, in the circumstances, have reasonably believed that making the payments had been for the benefit of the company, nor of its creditors as a whole. Accordingly, the court found in favour of the applicants and decided the claim had been made out in regard to the payments.

What does the case mean?

This case is a timely reminder of the way the court will make a judgment on the company's insolvency and the approach it will take. It is also a good reminder of the what needs to be established to successfully bring a breach of duty claim against the company's former directors.

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