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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.
Henry and another v Finch and another Subnom Re Finch (UK) plc (in liquidation)  EWHC 2430 (Ch),  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.
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:
Principally, the liquidators alleged that:
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.
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:
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).
The judge determined that:
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  2 Ch 365,  1 All ER 161. However, the case confirms that that principle is inapplicable in relation to:
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  EWHC 2496 (Ch),  All ER (D) 455 (Oct) at  were cited with approval.
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.
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
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First published on LexisPSL Restructuring and Insolvency
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