Unreasonable director conduct: a reminder from the High Court

Article

25 August, 2015

A recent decision in the High Court serves as a reminder to directors that their statutory duties must be complied with.

In Re: Finch (UK) PLC (in liquidation) [2015] EWHC 2430 (Ch), joint liquidators issued a claim to recover over £1.1m from Mr and Mrs Finch, the only directors and shareholders of a property development company - Finch (UK) PLC ('the Company') . The claim sought declarations that the directors were guilty of misfeasance and breach of trust in relation to the issue, allotment and redemption of 875,000 redeemable shares in the Company of £1 each, and in the personal retention of properties which beneficially belonged to the Company. The Liquidators also sought a declaration that a credit to the directors' loan account in the sum of £875,000 constituted a preference in favour of the directors.

It was accepted that Mr Finch took on a primary role in the management and operation of the Company, with his wife taking a more distant position. From lengthy evidence and complicated ledger entries, it emerged that the Finches had established a complicated network of trusts holding property - some for the benefit of the family, some for the Company.

The Judge found that many of the decisions made by the directors could be interpreted to be approved at shareholder level; under the Duomatic principle where the shareholders and directors are the same people, the conduct of the directors may be deemed to be approved at shareholder level, even where explicit approval was not obtained.

However, it was not possible to rely on this in relation to the redemption of 875,000 shares. In their capacity as members, Mr and Mrs Finch resolved to amend the terms on which 875,000 redeemable shares were held; the change removed the requirement for one month's notice to redeem the shares and allowed for immediate redemption. Mr Finch then sought to redeem the shares, the consideration for which would be the transfer of properties held by the Company on trust to Mr Finch. Mr Finch argued that the urgency to complete this transaction was brought about by his concern to ensure the director's loan account was in credit.

The Court rejected this explanation and ruled that Mr Finch knew that the Company was going insolvent and the transaction constituted a preference under Section 239 of the Insolvency Act 1986. The Court therefore ordered for the cancellation of the redemption of shares and gave a declaration that the Company retain the beneficial interest in the various properties transferred.

The Court also held that the shares ought to have only been redeemed out of distributable profits and such profits were only in the sum of £240,502. The directors should not, therefore, have arranged the redemption of more than 240,502 shares. The transaction to redeem more was a breach of their duties, which was not capable of remedy under the Duomatic principle; as this principle does not apply where a company is insolvent, in financial difficulties or where creditors are put at risk.

The Judge found that Mr Finch had not acted reasonably or honestly. Mr Finch could not, therefore, avail himself of section 1175 of the Companies Act 2006; which allows the Court a discretion to grant relief where a director has committed a breach, albeit honestly or reasonably. The Judge condemned Mr Finch's refusal to take legal advice on how to comply with his duties as a director.

Mrs Finch was equally criticised. It was held that her refusal to actively partake in the management of the business was a complete abrogation of her duties. The Judge reiterated the position in case law that inactivity by a director is evidence, in itself, of unreasonable conduct.

Forbes Comment

This case highlights the importance of compliance with directors' duties. It is encouraging for insolvency practitioners that, notwithstanding the leeway given to some informal aspects of a company's management, the Courts are being seen to enforce the duties upon directors where there has been a clear breach.

If you require further advice or assistance in relation to directors duties or any other issues referred to above please contact Lucie Cocker, a specialist insolvency solicitor, on 0800 689 0831.

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