Of debts and dividends (LRH Services Ltd v Trew)

The case of LRH Services Ltd (in liquidation) v Trew underlines that a company and its directors must take great care when reviewing information leading to the making of a solvency statement under the Companies Act 2006. Failure to do so has the potential for criminal repercussions and possible personal liability in the future. Rebecca Zaman, of 3 Verulam Buildings, explains a case that offers clarity for insolvency practitioners.
LRH Services Ltd (in liquidation) v Trew and others [2018] EWHC 600 (Ch), [2018] All ER (D) 161 (Mar)

What are the practical implications of this case?

Companies, directors and their advisers considering using the solvency statement procedure under section 643 of the Companies Act 2006 (CA 2006) to reduce share capital should be aware of the High Court’s decision in LRH Services Ltd (in liquidation) v Trew and others.

Companies seeking to reduce share capital (in order, for example, to pay out a dividend or as part of a group restructure) may do so using CA 2006, s 643. This provision requires each company director to make a solvency statement, which is a declaration that each director has formed the opinion that, if the capital reduction takes place, there is no ground on which the company would then be unable to pay its debts over the 12-month period following the statement. If a director makes a solvency statement without having reasonable grounds for holding that opinion, that director may face criminal penalties, under CA 2006, s 643(4)–(5). Section 643 does not, however, provide that the solvency statement is itself invalid if a director lacks reasonable grounds for the opinion so long as the director honestly and genuinely formed that opinion. The significance of a solvency statement being invalid is that all actions done pursuant to it, such as the payment out of a dividend, would in turn be invalid and those who carried out those actions would face potential liability, up to the full amount of the dividend. It can therefore have draconian consequences.In BTI 2014 LLC v Sequana [2016] EWHC 1686 (Ch), [2016] All ER (D) 96 (Jul), Rose J held that a solvency statement would be valid so long as the director honestly and genuinely formed the required opinion, even if the director did not have reasonable grounds for holding it. The policy underlying this decision was the recognition of the potentially serious consequences of having to unravel (some years later) a distribution made pursuant to an invalid solvency statement.LRH Services follows Sequana but nonetheless marks its limits. While courts will not scrutinise the reasonableness of the director’s opinion in determining validity, a solvency statement will nonetheless be invalid unless the directors involved have at minimum:

  • actually turned their minds to the contingent and prospective liabilities of the company, and
  • only taken into account assets that are properly available to the company in considering whether it will be able to meet its debts

‘Assets available’ does not include ad hoc support from group companies, but requires the existence of binding legal obligations. In short, LRH Services requires that directors not only form the required opinion genuinely and honestly, but also have asked themselves the right question in so doing.

What was the background?

LRH Services concerned claims brought by the liquidator of LRH Services Ltd against three of the company’s former directors. In 2009, the three directors had carried out a reorganisation of a group of companies, including the company. As part of the reorganisation, the company’s share capital was reduced through the solvency statement procedure to £1. A dividend of £21m was paid to the company’s sole shareholder, CSGH (also a group company).

Of the three defendants, only one (Mr Trew) was director of LRH at the time the solvency statement was made. The second defendant, Mr Brewer, became the finance director of the company after Mr Trew made the declaration of solvency, but before the dividend was paid. The third defendant, Mr O’Neill, was the finance director of the company in the months leading up to the reorganisation, and had been instrumental in planning the reduction of share capital and dividend payment. Mr O’Neill, however, had resigned as director of the company on the day the reorganisation took place, hours before the solvency statement was signed.

The company was left with leasehold premises, for which it was ostensibly to receive rent from the occupiers and for which it had to pay rent to its landlords. It was also provided with an ‘onerous leases’ reserve (in the form of cash and debt) and was, ostensibly, balance sheet solvent (in that it had £1 more assets than debts on its balance sheets).

The company’s assets were, however, grossly insufficient to meet its liabilities, in that all it would take was one occupier failing to pay rent for the company to become unable to meet its debts. In fact, in the quarter before the reorganisation took place, one such occupier (LCF) had in fact failed to pay its rent. It was LCF’s continued non-payment that ultimately led to a landlord initiating the winding-up process of LRH. However, the directors each said that they had been unaware at the time that LCF had missed its quarterly rent payment. The first defendant, Mr Trew, also said he had been confident that the company would be able to meet its debts because he controlled its ultimate shareholder, CSGH, and would ensure the company was kept in funds by CSGH as needed.

What did the court decide?

The court found that each of the directors had breached his duties to act in the best interests of the company (which was by then a duty to act in the interests of creditors) by taking actions to carry out the reorganisation in a way that left the company doomed to insolvency.

The court further found that the solvency statement was invalidly made, and that each director was responsible to the company for the £21m dividend paid out in consequence.

The court held that Mr Trew had failed to form the opinion required by CA 2006, s 643, because:

  • he did not in fact make any enquiry or give any consideration to the company’s actual liabilities, including the extent to which those liabilities were being met at the time of the reorganisation, and
  • because he had assumed the company could have its liabilities met as needed by another group company, without any binding agreement (such as a guarantee) that would require this group company to step in and perform

As such, the prospect, and even the likelihood, of ad hoc inter-company assistance was not an ‘asset’ which Mr Trew could properly have taken into account. In reaching this conclusion, the court followed by analogy the approach of Jonathan Crow QC in Re in a Flap Envelope Co Ltd [2003] EWHC 3047 (Ch), [2003] All ER (D) 216 (Apr), a case dealing with whitewashing procedures.

Mr Brewer was responsible for the unlawful payment of the dividend, but so too was Mr O’Neill (despite having resigned before the solvency statement was made) for his part in causing the entire set of transactions to take place, knowing that Mr Trew was making the solvency statement on the improper basis set out above.

Conclusion

The key takeaway for those advising on or carrying out a group restructure is to ensure that:

  • the solvency statement includes a detailed account of the assets and liabilities taken into account, so that a director cannot be accused of having failed to turn his or her mind to the question at all, and
  • where a company has always relied on intra-group support in meeting its debts, if the company is intended to have that support post re-structure, then a legally binding agreement such as a guarantee must be put in place in order for the support to be treated as an ‘asset’ to which a director may properly have regard in forming the CA 2006, s 643 opinion

Further reading

If you are a LexisPSL subscriber, click the links below for further information on directors' issues:

Directors and insolvency—roles, powers and duties (subscriber access only)

Recovery of unlawful dividends by an insolvency office-holder (subscriber access only)

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First published on LexisPSL Restructuring and Insolvency

Interviewed by Julian Sayarer.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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