No escape: Directors’ duties survive company insolvency

18 February 2020

Law

The recent decision of the English Insolvency and Companies Court in Stephen Hunt & System Building Services Group Limited v Brian Michie & System Building Services Group Limited [2010] EWHC 54 (Ch) marks a milestone for directors’ duties post appointment of an administrator or liquidator in insolvency situations.

The facts:

Mr Michie was the sole director of System Building Services Group Limited – a passive fire protection company (the “Company”). The Company went into administration on 12 July 2012, and Mrs Sharma was appointed as liquidator. The Company subsequently exited administration and entered into a creditors voluntary liquidation on 3 July 2013, before ultimately being dissolved on 24 February 2016.

In 2014, Mr Michie, who remained the sole director at the time, purchased a property for £120,000 from the Company, acting by Mrs Sharma as liquidator. Mrs Sharma was later found liable for misfeasance in another matter and made bankrupt. Mr Hunt was appointed.

Mr Hunt alleged that Mr Michie was aware that the sale of the property for £120,000 was at a significant undervalue for his own benefit and that Mr Michie failed to have regard to the interests of the Company’s creditors. Therefore, Mr Hunt claimed that Mr Michie had acted in breach of his statutory duties, including particularly his duty to act in the best interests of the creditors under section 172 of the Companies Act 2006 (the Act”), from the time at which the Company became insolvent.

Legal principles:

Hailed as the first case to consider what directors’ duties survive company insolvency and what restrictions a director will encounter when purchasing assets from an insolvency practitioner, this ruling comes as a caution to company directors.

The duty imposed on directors under section 172 of the Act to act in good faith in the interests of the company (or its creditors) is subjective. The issue focuses on the director’s state of mind, and whether or not he or she honestly believed that his or her act or omission was in the interests of the company. However, the courts have added a caveat to this, stating that where the act or omission results in substantial detriment to the company, it will be more difficult for a director to persuade the court that he or she honestly believed it to be in the company’s interests.

Nonetheless, the subjective test is subject to qualifications, which were underlined in Re HLC Environmental Projects Limited [2013] EWHC 2876 Ch. Firstly, where the duty (as in insolvency cases) extends to consideration of the interests of creditors, their interests must be considered as “paramount”. Secondly, the subjective test is applicable only where there is evidence of actual consideration of the best interests of the company. Therefore, where there is no such evidence, an objective test is applied, and the court will consider whether an intelligent and honest person in the position of company director could, in the circumstances, have reasonably believed that the transaction was for the company’s benefit.

Judgment:

In her landmark ruling, the Judge emphasised that it is clear from the Act that the duties of a director extend beyond the exercise of any power exercised in the capacity of a director. Simply being a director triggers these duties, and the application of sections 170-177 of the Act does not depend upon the exercise of power by a director in their capacity as director.

Taking these factors into account, the Judge held that the duties owed by a director to the company and its creditors survive the company’s entry into administration and liquidation. She added that the duties are interdependent of the duties owed by an appointed administrator or liquidator. Therefore, it was no defence to Mr Michie that Mrs Sharma may have been at fault for selling the asset “on the cheap”. It was also no defence to Mr Michie that an independent third party (i.e. an administrator or liquidator) was involved throughout the process.

Given that Mr Michie purchased the property from the Company’s administrator at an undervalue when he was aware that the Company was insolvent, the Judge found that Mr Michie failed to have regard to the interests of the creditors. As a result, the Judge held that Mr Michie was in breach of his fiduciary duty under section 172(3) of the Act to act in the interests of the creditors. She ruled that Mr Michie was to hold the property on an institutional constructive trust for the Company.

Some commentators have said that this decision has re-written the rules of insolvency. This ground-breaking ruling could have extensive and wide-spread consequences, as it has confirmed that directors owe a duty to creditors beyond company insolvency. It goes without saying that directors should think long and hard about the price to be paid before buying assets from a company in administration or liquidation.

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