The creative approach to insolvency offences—Henry v Finch

How will the courts approach a non-standard preference and unlawful distribution in the context of liquidation? Katherine Hallett, barrister at 13 Old Square Chambers, examines the decision in Henry v Finch and explains how this case demonstrates the need for courts to look creatively at the facts to assess whether insolvency offences have been committed.

Original news

Henry and another v Finch and another Subnom Re Finch (UK) plc (in liquidation) [2015] EWHC 2430 (Ch), [2015] All ER (D) 96 (Aug)

The Chancery Division considered an application by the joint liquidators of a company against its respondent directors, in which the liquidators sought, among other things, a declaration that the respondents were guilty of misfeasance and breach of trust in retaining properties that had belonged to the company. The application was dismissed, save in relation to the cancellation of a share redemption and the consequent effect upon properties which had remained in the commercial arrangement. However, in the light of the respondents’ conduct, no relief would be granted to them under section 727 of the Companies Act 1985 (CA 1985) or section 1157 of the Companies Act 2006 (CA 2006) as applicable.

What was the background to the hearing?

Mr and Mrs Finch, the respondents, were the sole directors and shareholders of the company, which was a property development business. In its filed accounts, the company recorded its apparent ownership of various properties that it developed. In the 2003 accounting year, the company allotted 875,000 redeemable shares to Mr Finch. In January 2008, the company redeemed the shares, crediting Mr Finch’s director’s loan account with £875,000. On the same day, Mr and Mrs Finch ‘removed’ various properties from the company, at the same time crediting the corresponding mortgages to the company—via the director’s loan account.

The company went into creditors’ voluntary liquidation in July 2008. Principally, the liquidators challenged:

  • the allotment of the shares
  • their subsequent redemption, and
  • the removal of the properties from the company

What were the legal issues that the judge had to decide in this application?

Principally, the liquidators alleged that:

  • the issue/allotment of the shares constituted breach of trust and/or misfeasance within section 212 of the Insolvency Act 1986 (IA 1986)
  • the redemption of the shares and the removal of the properties constituted a preference pursuant to IA 1986, s 239 and/or an unlawful distribution pursuant to CA 1986, s 263 and/or CA 1986, s 264, and
  • the respondents’ retention of the properties constituted breach of trust and/or misfeasance within IA 1986, s 212 because they were beneficially owned by the company

The Finches relied upon various family trust documents, which they said meant that the company was only ever a nominee, with the beneficial interest in the properties being vested in the trust and the Finches themselves holding the legal titles. The company only had the properties in its ‘keepership’ in an effort to pay back a debt to the trust and to make a profit for itself—over and above the debt said to be owed to the trust, which arose when the properties ‘entered into’ the company.

What were the main legal arguments put forward?

The arguments focused on three main legal areas. Firstly, the liquidators argued that the trust documents were shams. The parties were on common ground in relation to the law in that area.

Secondly, the parties argued about whether events in January 2008 constituted a preference and/or an unlawful distribution. The Finches sought to distinguish between their different capacities as:

  • directors in relation to the company
  • ‘investment managers’ pursuant to the trust
  • beneficiaries pursuant to the trust
  • legal title holders for the benefit of the trust

There was also an argument about whether the company was insolvent in January 2008 and the level of distributable reserves at that time.

Thirdly, regardless of what the Finches had believed contemporaneously, what was the correct legal analysis of their actions? The liquidators argued (as an alternative to the trust documents being shams) that the trust had in fact sold the properties to the company when they were ‘entered into’ the company—via its books and records, and as recorded in the filed accounts.

There were also various specific allegations about failure to account in relation to the sale of individual properties (which were not said to fall within the trust).

What did the judge decide, and why?

The judge determined that:

  • the trust documents were not shams or retrospective forgeries—the judge did not accept that such complicated documents would have been produced if they were other than genuine
  • there had been no failure to account as regards the individual properties outside the trust—that turned on the judge’s specific findings in relation to each non-trust property
  • the company had indeed purchased the various properties from the trust, but that had been subject to a call option in favour of the trust—that explanation best fitted the dealings between the parties, as evidenced by the ledger entries, the company’s filed accounts, written representations made contemporaneously by Mr Finch to the company’s accountants and Mr Finch’s evidence
  • the redemption of the shares and the removal of the properties constituted both a preference and an unlawful distribution—the liquidators’ evidence on insolvency in January 2008 was accepted, as was their case on the levels of distributable reserves
  • to the extent of the preference (£875,000) or, alternatively, the unlawful distribution (£634,498), the company retained a beneficial interest in the properties which the Finches had purported to remove from the company in January 2008

To what extent is the judgment helpful in clarifying the law in this area?

This was a very complicated case factually, with a lot of last-minute documentation produced by the Finches.

However, legally, the case is a good example of a non-standard preference and unlawful distribution. The Finches used the director’s loan account effectively as the trust’s bank account, providing (as they saw it) ‘security’ for the company’s debt to the trust. They ‘introduced’ properties (and their mortgages) into the company via the director’s loan account. Subsequently, the Finches reversed the process, exercising the call option. However, by then it was too late—the company was already insolvent and did not, in any event, have sufficient distributable reserves.

Various technical breaches of company law by the Finches were cured by the application of the principle in Re Duomatic Ltd [1969] 2 Ch 365, [1969] 1 All ER 161. However, the case confirms that that principle is inapplicable in relation to:

  • unlawful distributions, and
  • a situation where the company is insolvent or in financial difficulties such that its creditors are at risk

In addition, there was no question of any relief being granted to the Finches pursuant to CA 1986, s 727 or CA 2006, s 1157. Mr Finch had been motivated by a desire to prefer and had failed to seek legal advice on his duties as director. Mrs Finch completely abrogated the discharge of her duties, leaving everything to her husband—the comments of Briggs J in Lexi Holdings plc v Luqman [2007] EWHC 2496 (Ch), [2007] All ER (D) 455 (Oct) at [224] were cited with approval.

What practical lessons can those advising take away from the case?

This case illustrates the importance of looking creatively at any set of facts in order to assess whether any insolvency offences may have been committed.

Furthermore, where a complicated accounting system has been employed, it is vital that office-holders obtain all relevant documentation (especially the ledger) as early as possible and discuss with the directors how the system has been run. If necessary, a private examination pursuant to IA 1986, s 236 should be carried out.

Katherine acted for the applicant liquidators in this case.

Interviewed by Nicola Laver.

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

Further Reading

If you are a LexisPSL subscriber, click the link below for further information:

A summary procedure under section 212 of the Insolvency Act 1986 and the process for bringing a misfeasance claim

Recovery of unlawful dividends by an insolvency office-holder

Director's guide to dealing with a company in financial difficulty

Not a subscriber? Find out more about how LexisPSL can help you and click here for a free trial of LexisPSL Restructuring and Insolvency.

First published on LexisPSL Restructuring and Insolvency

Relevant Articles
Area of Interest