When are directors liable for distributions?—(Burnden Holdings (UK) Limited (in liquidation) v Fielding)

In the long-running proceedings Burnden Holdings (UK) Limited (in liquidation) v Fielding, the High Court has dismissed all claims. The case had been brought by Burnden Holdings (UK) (BHUK) and its liquidator against two former directors, Mr and Mrs Fielding, who were accused of dishonestly breaching their fiduciary duty as directors. James Potts QC and Matthew Parfitt of Erskine Chambers acted for the defendants in the case and comment the significance of the case.

Burnden Holdings (UK) Limited (in liquidation) v Fielding  [2019] EWHC 1566 (Ch)

What are the practical implications of this case?

This case provides important guidance for practitioners advising directors on the payment of dividends or the grant of security, and for litigators (particularly in an insolvency context) reviewing such transactions with a view to bringing proceedings against the directors.

The court summarised the circumstances in which a director would be liable for the payment of an unlawful dividend, holding such liability was fault-based rather than strict. It was also held that a grant of security is not susceptible to challenge as a transaction at an undervalue or a transaction defrauding creditors under sections 238 and 423 of the Insolvency Act 1986 (IA 1986).

Fault-based liability means that if directors were unaware of the facts which rendered a dividend unlawful, then provided they had taken reasonable care to secure the preparation of accounts which showed that a lawful dividend could be paid, they would not be personally liable if it turned out that in fact there were insufficient profits lawfully to declare a dividend. Directors are entitled to rely on the expertise of others, such as accountants and lawyers.

What was the background?

The litigation related to two transactions. Chronologically, the first was the grant of security by BHUK to the defendants in July 2007, in relation to lending to the group. That was challenged as a dishonest breach of duty by the directors, and also as a transaction defrauding creditors under IA 1986, s 423.

The second transaction was a corporate reconstruction which took place shortly thereafter, in October 2007, and which demerged BHUK’s business into separate groups, one of which was involved in conservatories and double glazing, and the other was involved in consultancy in the combined heat and power. The demerger involved a distribution in specie by BHUK of its shareholding in a subsidiary called Vital.

The distribution was attacked on numerous grounds, the most significant of which were allegations that it was an unlawful dividend in contravention of the provisions of the Companies Act 1985, a dishonest breach of duty by the defendants in failing to consider the interests of BHUK’s creditors, and a transaction defrauding creditors under IA 1986, s 423.

BHUK went into administration around a year after the impugned transactions, followed by liquidation one year later.

What did the court decide?

Mr Justice Zacaroli dismissed all the claims. He made the following findings.

Directors’ liability in respect of an unlawful dividend is fault-based rather than strict. He reviewed authorities going back over 150 years (including recent Supreme Court decisions) and followed the decision of the House of Lords in Dovey v Corey  [1901] AC 477.

The judge also considered the statutory requirements in relation to distributions, including both the procedural steps to declare a distribution (including the application of the Duomatic principle) and what is required to constitute ‘interim accounts’ under the Companies Acts. In particular, he considered the effect of a mis-description of an asset in a company’s accounts.

Despite finding that the company’s investment in one of its subsidiaries had a value less than that identified in the interim accounts, he held that there had been no obligation to impair its carrying value in the interim accounts. The effect of section 275 of the Companies Act 1985 (CA 1985) (section 841 of the Companies Act 2006 (CA 2006)) was that no realised loss was created so long as the aggregate value of the company’s fixed assets, even if the fixed asset had been written down, was not less than the aggregate amount at which they were stated in the books.

The judge considered the duty to consider the interests of creditors, recently confirmed by the Court of Appeal in BTI 2014 LLC v Sequana and others [2019] EWCA Civ 112. In particular, he applied the balance sheet test of insolvency set out in BNY Corporate Trustee Services Ltd v Eurosail-UK 2007-3BL Plc [2013] UKSC 28, to the context of a group of trading companies, including the proper assessment of contingent and prospective liabilities and the effect on a parent of an insolvent subsidiary.

Although he rejected the allegations of breach of duty against the directors, the judge considered whether he would have given them relief (had they been found liable) under CA 2006, s 1157. The judgment held that the discretion was not fettered, even where the company was insolvent and the director was the recipient of the unlawful dividend, noting that this would depend upon matters such as the causal link between the dividend and prejudice to creditors (including whether the distribution could lawfully have been made), the length of time between the dividend and the action being commenced and whether the director retained the benefit of the dividend.

As regards the IA 1986, s 423 claims, the judge discussed the threshold and whose intention was relevant in determining whether the purpose was to put assets beyond the reach of creditors.

The judge also determined that a grant of security cannot be a transaction defrauding creditors under IA 1986, s 423, re-establishing the orthodoxy in Re MC Bacon [1990] BCLC 324 and not applying the obiter dicta in Hill v Spread Trustee [2006] EWCA Civ 542.

The judge considered the application of the Limitation Act 1980 to claims under IA 1986, s 423 and the circumstances in which six- or 12-year limitation periods will apply. He held that, given that the relief being claimed was for a sum of money, the claims relating to security under IA 1986, s 423 were time-barred.

Case details

  • Court: High Court of Justice 
  • Judge: Mr Justice Zacaroli 
  • Date of judgment: 19 June 2019

Interviewed by Anne Bruce.

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

Filed Under: Insolvency

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