The case of Hunt (as Liquidator of System Building Services Group Ltd) v Michie & Ors  EWHC 54 (Ch) examines whether directors' duties continue after the company has become insolvent and confirms that they do, bringing welcome clarity to the point. As such, Insurers will need to review their policies to make clear if they wish to cover this risk.
In this case, System Building Services Group Limited (the Company) was placed into administration on 12 July 2012 and dissolved on 24 February 2016.1 Mr Michie had been a director of the Company on and off for many years and was the sole director of the Company from April 2012.
Following Mr Hunt's appointment as liquidator, claims were brought against Mr Michie for, inter alia2, (i) breach of fiduciary duties in relation to a purchase by him of a property belonging to the Company and (ii) misfeasance (under section 212 Insolvency Act 1986 (IA 1986)) and breaching his fiduciary duties to the Company by causing or allowing payments to be made to one creditor.
Head (i) largely relied on section 172 Companies Act 2006 (CA 2006) which provides that "a director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole." Where a company is insolvent, this duty is to act in the best interests of the creditors as a whole (Re HLC Environmental Projects Limited  EWHC 2876 (Ch)).
The breaches of fiduciary duties alleged under head (ii) focussed on section 172 and section 174 CA 2006, which requires a director of a company to exercise reasonable care, skill and diligence.
Counsel for the defendant sought to argue that once a company enters into administration or a creditors' voluntary liquidation (CVL), the duties owed by directors under CA 2006 only continue insofar as the director is actually exercising the powers of a director, in the capacity of a director, under powers preserved or permitted by the IA 1986. In so arguing, Counsel sought to contend that Mr Michie could, therefore, not be in breach of his fiduciary duties under CA 2006.
- The Judge rejected this argument for
a number of reasons:
- The duties in sections 170-177 CA
2006 "extend beyond the exercise by a director of any
given power qua director." He gave various examples for
- section 175, which provides that a director must avoid conflicts of interest, is not dependent on the exercise of a given power qua director;
- section 176(1), which provides that a director of a company must not accept a benefit from a third party conferred by reason of his being a director, is clear that "being" a director is enough; the section does not trigger only once a director is exercising director powers;
- section 170(2) expressly prescribes that the section 175 duty continues even if the person in question ceases to be a director of the company.
- The CA 2006 makes clear when its provisions are not to apply when a company is in administration or a CVL. If the draftsman had intended a director's duties to cease at this point, this would have been expressly stated in the provisions.
- Despite some of the directors' duties in CA 2006 not making sense in an insolvency context, as they are based on common law and equitable principles, they are "plainly of sufficient flexibility to extend beyond the company's entry into a formal insolvency process."
- Section 172(3) expressly provides for directors "to consider or act in the interests of the creditors of the company" in certain circumstances.
- Directors are not removed from office when a company enters into administration or a CVL. This is expressly set out in IA 1986.
- Whilst acknowledging that there is a paucity of case law and commentary on this point, this does not lead to the conclusion that the duties cease to exist when a company enters into administration or a CVL. As the Judge put it "in my judgment, it simply reflects the fact that, for the most part, licensed insolvency practitioners in this country are highly effective guardians of the assets of those companies in respect of which they are appointed."
- The duties in sections 170-177 CA 2006 "extend beyond the exercise by a director of any given power qua director." He gave various examples for this position:
On these bases, the Judge held that directors continue to owe the duties in sections 171-177 CA 2006 after a company enters into administration or a CVL. These duties are independent of and run parallel to the duties owed by any appointed office holder.
Having come to this conclusion, the Judge considered the various heads of claim, noting the lack of credible evidence of Mr Michie and the fact that records were scarce.
Head (i) – the purchase of 55 Crown Road (the Property)
Mr Hunt contended that Mr Michie knowingly purchased the Property off-market at a substantial undervalue for his own benefit, without consideration of the Company or its creditors, in breach of section 172 CA 2006.
The Judge at length examined the evidence, finding that Mr Michie sought to get an asset "on the cheap" to the detriment of creditors. There were many facts which supported the Judge's conclusion and he had no trouble in finding that Mr Michie thus acted in breach of his fiduciary duty under section 172(3) CA 2006. The fact that the previous liquidator may also have been at fault was held to be no defence and the Judge rejected calls for relief under section 1157 CA 2006.
Head (ii) – payments to a creditor after administration
The allegation made by Mr Hunt in this regard was that Mr Michie caused or allowed several payments to be made to a creditor, CB Solutions (CBS), after the Company went into administration, in breach of his fiduciary duties and he was, therefore, also guilty of misfeasance under section 212 IA 1986.
Despite Mr Michie's attempts to claim that the payments were not made by him, the Judge found his evidence unreliable and not credible. It was clear to the Judge that Mr Michie had a long-standing relationship with CBS (and had also made several payments to CBS, effectively depleting the Company's bank account in the time immediately preceding the administration date), had access to the accounts, knew about the payments at the time and, further, that there was no other credible explanation for how the payments got made or why. He was, therefore, satisfied on the balance of probabilities that the liquidator's claim was made out and Mr Michie was, thus, in breach of his fiduciary duties and guilty of misfeasance. The Judge ordered Mr Michie to contribute £19,000 plus interest to the Company's assets.
Corporate insolvencies are on the rise according to the latest Insolvency Service statistics and when insolvencies occur, management liability will be closely assessed. The UK insolvency regime requires insolvency professionals to consider the conduct of all of the insolvent company's directors and management to assess whether there are grounds to take action against any of the directors on behalf of the company (for example, for wrongful trading, fraudulent trading, misfeasance or breach of fiduciary duty).
Claims brought by liquidators/administrators of insolvent companies are therefore a significant potential source of claims against directors. This confirmation from the Court that directors' duties survive insolvency brings clarity to what is expected from a director of an insolvent company. Directors should therefore not consider themselves "off the hook" once an administration or CVL has been entered into. Directors' roles in pre-pack deals in particular are likely to continue to be an area for scrutiny.
The period of time when a company is financially distressed is likely to represent an increased risk profile for claims, because of the heightened potential for directors acting in their own interests (as in this case) rather than the interests of the company. Some policies will include an insolvency exclusion or a change of risk or control clause or similar provision alongside a run off endorsement which will make clear that on the appointment of insolvency practitioners a D&O policy is converted into run off – i.e it will only respond for wrongful acts committed up to the date of insolvency. In light of this decision, Insurers should review if and how their policies will respond to an insolvency situation and the underwriting approach they wish to take.
Given the broadening of wordings in the recent past, there are a number of additional coverage issues that can arise upon insolvency, such as whether cover exists for enquiries made by office holders in relation to books and records. Clarity over the extent of cover is therefore likely to benefit insurers and D&Os alike.
This case also demonstrates the need for litigators to test their witness's evidence, especially where the underlying documentation is insufficient. Further, the case serves as a reminder that the parties' pleadings should be reviewed well ahead of the trial date to ensure that proper notice is given to opponents and the Court of substantive changes to admissions and points of law relied on. The Judge criticised Counsel for the defendant for making late changes which had a substantial impact on the case and reminded them of their duty under CPR 1.3 to help the Court further the overriding objective.
1. It was subsequently restored to the register on 25 April 2017 by Mr Hunt, who had been appointed liquidator on 3 May 2017. Mr Hunt was appointed and pursued these claims following the case of Top Brands v Sharma , in which judgment was entered against Ms Sharma (the original liquidator for the Company) for misfeasance whilst acting as an office-holder of another company.
2. This note focusses on the heads of claims relating to directors' duties.
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.