Canada: Insolvency Litigation - Recent Cases And Issues- January 2019

In our update this month we take a look at some recent decisions that will be of interest to those involved in insolvency litigation. These include:

  • A technology & construction court decision providing for action to be taken against two individual directors who had caused a company to enter into insolvency to avoid paying a specific debt;
  • A decision of the high court that concluded privilege in a dissolved company's documents should be maintained until there is no prospect of the privilege being enforced; and
  • A chancery court decision that deals with the validity of a notice of appointment of an administrator, when the date and time of the appointment are not specified on the notice.

Procuring insolvency to avoid paying debts? Think again...

A building firm succeeded in a claim against two individuals for sums owed to it by a company. The individuals were held to have stood behind the company and colluded to bring about its liquidation, to avoid paying the builders for the work they had completed.

Background

Palmer Birch (a partnership) v Michael Lloyd (1) and Christopher Lloyd (2) [2018] involved claims for the unpaid value of work Palmer Birch (PB) had carried out for the employer firm, Hillersdon House Limited (HHL).

HHL had retained PB to carry out refurbishment and extension works to a property, Hillersdon House; Michael Lloyd's English residence. HHL had a leasehold interest in the property and Christopher Lloyd was HHL's sole director. The freehold of the property was owned by another company (SHL), which in turn was beneficially owned by Michael Lloyd. It was also alleged that Michael Lloyd was a defacto or shadow director of HHL.

HHL did not trade and had no independent financial resources. It was a shell company in reality, established for tax reasons. Initially, Michael Lloyd provided funds to HHL to pay for invoices raised by PB, however, the relationship between the parties broke down and invoices raised in December 2014 and January 2015 went unpaid.

In April 2015, HHL gave notice terminating its contract with PB, HHL confirmed it was unable to secure further funding and had no means of repaying its debt obligations as a result. The company would therefore be placed into liquidation.

In fact the contract did not provide for termination on the insolvency of HHL. HHL were therefore in repudiatory breach by giving the notice they did.

Michael Lloyd subsequently received funds on another project that would have allowed the outstanding PB invoices to be settled. Instead he chose to invest in a successor company to HHL, CSEL, for whom he was the sole shareholder and director. CSEL stepped in to complete the works on Hillersdon House, using a different building contractor. HHL went into liquidation.

Rather than claiming against a shell company in liquidation PB issued proceedings against Christopher and Michael Lloyd, claiming that they had induced HHL to breach its contract with them and that they were guilty of unlawful interference and unlawful means conspiracy.

Decision

The High Court acknowledged the starting point should be the long-standing principle of company law- that an English company has a separate corporate personality and its own limited liability. However, there may be circumstances when factors of inducement or unlawfulness allow the Court to pierce that corporate veil, to look beyond the company's separate legal personality and find those behind the company liable for losses caused by the company's acts. On the facts, Michael Lloyd was liable for inducing HHL's breach of contract and Michael and Christopher were liable for unlawful means conspiracy.

Inducing breach of contract

Michael Lloyd was not legally obliged to provide funds to HHL so that it could meet its contractual obligations. However, the court found that he had crossed the line from prevention to inducement when he procured HHL's repudiatory breach of contract by deciding to bring about its liquidation.

When the relationship broke down, Michael Lloyd chose to divert his personal funds elsewhere, causing HHL to repudiate its contract with PB. He chose to actively divert funds away from HHL to ensure that it entered into insolvency. His conduct was not a reflection of HHL's separate corporate personality, but an abuse of it. Michael Lloyd was therefore liable for the damages suffered by PB as a result.

Unlawful interference

This allegation failed because there had to be an intention to cause loss by the use of unlawful means. There was nothing unlawful about Michael Lloyd ceasing to fund HHL.

Unlawful means conspiracy

The court found that Michael and Christopher Lloyd had reached an agreement to bring about the liquidation of HHL, so that it might escape its obligations to PB under the contract. This agreement, and their actions pursuant to it, meant that Michael and Christopher had colluded together in an unlawful conspiracy to bring about a breach by HHL of its obligations towards PB. Michael and Christopher Lloyd were therefore held liable for PB's damages flowing from that unlawful conspiracy.

Despite being neither a director nor shareholder of HHL, Michael had been involved in drawing up HHL's business plan, securing funding for the company, appointing PB as the initial contractor, liaising with HHL's solicitors, replacing the project managers and handling many of the dealings between HHL and PB. He had treated himself as PB's client and the evidence showed that he was effectively running the project. He was therefore held to be a de facto director of HHL.

Christopher Lloyd, on the other hand, was held not to have been exercising his independent duties owed to HHL as a director. Instead, the court found that he was serving the interests of Michael. That abnegation of his director's duties, and the fact that he conspired with Michael to bring about HHL's liquidation, "shredded" his ability to seek the protection of HHL's corporate veil.

This allegation succeeded against both defendants because of their collusion to bring about the repudiatory breach of contract. The evidence showed that Michael and Christopher Lloyd had reached an agreement to facilitate HHL's liquidation, so that it could avoid its obligations under the contract with PB and avoid the claims for payment of outstanding invoices. That was the requisite intention to injure.

Christopher Lloyd was also guilty of this offence because it was clear he had not acted constitutionally in respect of HHL. He had clearly served his brother's interest and not the interests of HHL. He could not, therefore seek the protection of a corporate veil that had been shredded largely by his own actions and the abnegation of his director's role during the life of the contract.

Comment

The contract structure used by Michael and Christopher Lloyd was not "unlawful" for the purpose of either the tort of unlawful interference or unlawful means conspiracy, but it was important when considering the commercial relationship between HHL, Michael and Christopher Lloyd. They used the structure to try and obtain protection from the corporate veil and for Michael Lloyd to distance himself from the project for tax reasons. For those reasons they were held to be liable to PB for the damage it suffered as a result of their conduct.

This decision provides some welcome guidance on the circumstances when the corporate veil may be lifted. It seems the court will not be afraid to look behind the corporate veil to ensure liability lies firmly at the feet of those trying to hide behind the corporate structure.

Legal professional privilege will continue where there is a chance the company could be restored to the register

In Addlesee & Ors v Dentons [2018] the court was asked to decide whether documents in client files held by the defendant solicitors, in respect of a dissolved Cypriot company (the Company), were protected by legal professional privilege, or whether the privilege no longer applied following the company's dissolution.

Background

The claimants were investors in an investment scheme operated by the Company. The scheme closed in 2010 and the majority of investors were left unpaid. The claimants alleged that the scheme was fraudulent, as a result of which they collectively lost about £6.5 million. The defendant was a solicitor's firm who had previously acted for the Company.

The parties agreed that the documents being sought were relevant and were likely to be important to the claim. Furthermore, if the Company had not been dissolved there was no doubt the documents would have been subject to legal professional privilege and would not have been disclosable unless and until that privilege had been waived.

The issue for consideration was what effect, if any, the Company's dissolution had on the legal professional privilege attached to the Company's documents.

Previous case law had confirmed that where a company was entitled to assert legal professional privilege in respect of a document or class of documents, that right was lost when the company was dissolved and the privilege fell away.

The claimants argued that the same principle should be applied in this case. A dissolved company could not own property or have the benefit of any rights. If any right to privilege existed, it would pass to the Crown on dissolution; the Crown would have no proper interest in maintaining it and, accordingly, such a right should not be enforced.

The defendant argued that the position in this case was different. Amongst other things, the right to assert privilege must be maintained where there was a chance the company could be restored to the register. In this case there was scope for a restoration application to be made for many years to come.

Decision

The high court held that the privilege must be maintained.

The fact that a company could be restored to the register in the future meant that, if dissolution of a company extinguished the right to assert privilege legal professional privilege in company documents, a restored company could find itself being placed in the position it was in before dissolution but having irretrievably lost the rights it should have held under legal professional privilege.

The principle 'once privileged, always privileged' would compel the court to maintain the privilege, unless and until there is no prospect of the privilege being enforced by the person entitled to it.

Comment

This decision confirms (albeit at first instance) that documents of a dissolved company will continue to be privileged until it is no longer possible for the company to be restored to the register. Does this mean privilege in documents of a dissolved company could last indefinitely? An application to restore a company to the register has no time limit where it is made for the purpose of bringing claims against the company for damages for personal injury. We wait (with interest) to see whether and if so, how the decision will be followed.

Appointment of administrator by a company or its director - absence of time and date on the appointment will not impact on validity

In Re Spaces London Bridge Ltd [2018] the chancery court held that the administrators of the company had been validly appointed, notwithstanding the director's failure to state the date and time of the appointment in the notice of appointment.

Background

In May 2018, the directors of the company, four individuals who were also members of the company, resolved to place the company into administration and to appoint joint administrators.

In June 2018 one of the directors completed the notice of appointment (NOA), including the statutory declaration. The completed NOA was filed at court but it did not include the date and time of the appointment.

The directors of a company or the company itself can appoint an administrator using an out-of-court process. Rules 3.24 and 3.25 of the Insolvency (England and Wales) Rules 2016 (IR16) set out what a company or directors' NOA must contain and both rules include the requirement for the NOA to state the time and date of the appointment (rules 3.24(1)(j) and 3.25(2)(k)). As the NOA did not include the date and time of the appointment, the joint administrators applied for a declaration to confirm they had been validly appointed.

Decision

The court found their appointment was valid, the fact the date and time of the appointment was not on the NOA did not make it invalid. The question to be asked was whether the requirement to specify a date and time of appointment referred to the time of the directors' decision to appoint administrators, or to when the NOA is actually filed at court and the appointment takes effect?

IR16, rule 3.26 provides that once a NOA is filed, the court is to seal it and endorse it with the date and time of filing. Until that point, the administrators have not been appointed.

The court accepted the proposition that it was impossible to see what purpose would be served by a requirement that the notice specify the date and time of the directors' decision to place the company into administration. The date and time of the appointment would be clear from the court's endorsement, there was no purpose served in a separate requirement for the notice to additionally specify such date and time. In fact, even if that information was inserted it would be meaningless and potentially misleading as it would not be the effective date and time of appointment. The effective date and time of appointment would be that as endorsed by the court.

The court acknowledged, for the sake of clarity, it may be considered preferable for the notice to state that 'the administrators' appointment was made on the date and time this notice was filed', as was the case in the earlier decision of Re NJM Clothing Ltd [2018]. Although omitting to do so would not affect validity.

Finding that there was no issue with the validity of the appointment it was not necessary for the court to consider the application of IR 2016, r12.64. However, the court held that even if it were wrong on the first point, it would have held that the failure to specify the date and time was a mere irregularity that caused no injustice and it would have been cured by an order.

Comment

This is the third decision in recent months that deals with the validity of a NOA, as a result of the requirement to complete the time and date of the appointment on the notice itself. The first decision came in NJM Clothing Ltd, where the court suggested a literal interpretation of the rules could lead to a notice being defective if the NOA failed to state the time and date of the decision to appoint an administrator. Albeit in NJM Clothing, the court decided there would be a presumption of regularity which would assume directors had chosen to appoint an administrator by the time the NOA was filed.

The decision in Re Towcester Racecourse Company [2018] came next and went a step further. The court in that case said that a NOA would not be defective if it records the date and time of the decision to appoint by reference to the point of filing. So the date and time of the decision to appoint an administrator could be the same as the date and time at the point of filing.

This third decision helpfully clarifies the position of the Court. It acknowledges that the structures of IA 1986 and IR 2016, envisage a two-stage process. However, the judgment concludes that the requirement in IR 2016, to specify the date and time of the appointment can only refer to the second stage. The date and time of the appointment does not have to be specified by a director when completing the NOA.

Read the original article on GowlingWLG.com

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