UK: Insolvency Litigation: Recent Cases And Issues In March 2018

In our update this month we take a look at a recent Supreme Court decision which has made it clear a director will not have a limitation defence to a claim for breach of fiduciary duty involving a disposition of company property.

This is good news for insolvency practitioners. Breach of trust claims involving company property cannot be defended simply because a statutory deadline has passed.

No limitation period for claim against directors benefitting from a breach of fiduciary duty

The usual rules on limitation require an action to be commenced within a specified time frame, known as the limitation period. If the limitation period has expired, then the defendant will have a complete defence to the claim being made.

Section 21(3) of the Limitation Act 1980 (LA 1980) confirms a six year limitation period for an action by a beneficiary to recover trust property or in respect of any breach of trust. However, section 21(1) of the LA 1980 confirms that no limitation period shall apply where an action by a beneficiary under a trust is an action in respect of any fraud or fraudulent breach of trust (21(1)(a)), or in an action against a trustee to recover trust property (21(1)(b)).    

Background

In Burnden Holdings (UK) Limited v Fielding the defendants were the former directors and controlling shareholders of the claimant holding company (C), which operated a number of trading subsidiaries including in particular a subsidiary called V. The defendants transferred C's shareholding in V to a new holding company, B, of which they were also the controlling shareholder.  Shortly after that C went into liquidation.

Just over six years after the transfer the liquidator of C issued proceedings against the defendants.  The liquidator alleged the defendants had engaged in the unlawful distribution in specie of C's shareholding V, receiving trust property belonging to C and converting it to their own use. The liquidator claimed an account of profits or equitable compensation.

The defendants asserted that the claim had been issued outside the limitation period and as a result they had a complete defence. They applied for and obtained summary judgment on that basis.

The liquidator appealed to the Court of Appeal.

Court of Appeal decision

For the purpose of the appeal hearing it was assumed by all that there had been an unlawful distribution by the defendants, although that fact remained contested in the main proceedings.   

The Court of Appeal set aside the decision, accepting the argument made on behalf of the liquidator that under section 21(1)(b) no limitation period applied to the claim.

The defendants had argued that a claim for an account of profits or equitable compensation did not fall within section 21(1)(b) at all.  The Court of Appeal rejected that argument, holding that a claim for equitable compensation, in a case where the trustee's indirect interest in the trust asset had been converted to the use of the trustee, was an appropriate remedy to seek in an action falling within section 21(1)(b).

The defendants argued that the relevant trust property was never in their possession.  From start to finish the shareholding had been in the legal and beneficial ownership, and therefore possession, of a succession of corporate entities.  Although the directors were from time to time shareholders and directors in all of those corporate entities, the shareholding was never in their possession, neither was it previously received by them and converted to their use.  They argued that to hold otherwise would involve the lifting of one or more corporate veils, or ignoring the separate legal personality of the companies concerned.

The Court of Appeal acknowledged the submission did have some merit when undertaking a literal reading of section 21(1)(b).  However, interpreting the section on that basis would be "a recipe for avoidance by trustees because, in the modern world, it is commonplace for companies to be used to hold assets, where the beneficial ownership is vested in the company but the entire economic benefit is available for the shareholders".

In order to achieve its purpose, section 21(1)(b) had to be construed so as to include within its terms a transfer (in breach of trust) to a company directly or indirectly controlled by the defaulting trustee.

The defendants appealed to the Supreme Court.

Supreme Court Decision

Lord Briggs confirmed that section 21(1)(b) is about actions "to recover from the trustee trust property or the proceeds of trust property...".  He held that it is common ground (and clear beyond argument) that, as directors of an English company who are assumed to have participated in a misappropriation of an asset of the company, the Defendants are to be regarded for all purposes connected with section 21 as trustees. This is because they are entrusted with the stewardship of the company's property and owe fiduciary duties to the company in respect of that stewardship. 

Lord Briggs accepted that the deliberate use of a corporate vehicle to distance a defaulting trustee from the receipt or possession of misappropriated trust property might justify lifting the corporate veil, and would in most cases justify a finding of fraud, within the meaning of section 21(1)(a), in any event. However, this did not mean section 21(1)(b) should not apply to the assumed circumstances in this case.

The purpose of the rules enshrined in section 21 had long been established. The intention of the statute was to give the trustee the benefit of a lapse in time when he had done something legally or technically wrong, but not something morally wrong or dishonest.  The statute was not intended to protect a trustee in receipt of something he should not be, i.e. trust property received by him and converted to his own use.

The Supreme Court dismissed the defendants' appeal.  On the assumed facts the defendants had "converted" the company's shareholding when they procured or participated in its unlawful distribution. It was conversion "to their own use" because of the economic benefit they derived from being majority shareholders in the company to which the distribution was made.  By the time of the conversion the defendants had "previously received" the property because, as directors of the Company, they had been its fiduciary stewards from the outset.

Comment

This is a helpful decision.  It confirms that directors of companies will be treated as being in possession  of the company's property from the outset for the purpose of section 21(1)(b) LA 1980, and a defaulting trustee who benefits from receipt of company property cannot hide behind a corporate vehicle for protection from claims arising from a breach of fiduciary duty. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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