The High Court’s recent decision in BM Electrical Solutions Limited provides useful clarification (or perhaps a restatement) of the court’s approach to several commonly-encountered issues in insolvency claims.
The facts and the liquidator’s claims
The facts were familiar enough and the judgment (of Lance Ashworth QC, sitting as a Judge of the High Court) is succinct and readable.
A sole director-shareholder paid himself a salary below the taxable threshold and topped up his earnings by way of intermittent payments throughout the year. According to the director those payments were booked as dividends in the company’s accounting software at the time (albeit the software and records had apparently become inaccessible). Historically, the company’s accountants would conduct a reconciliation of those amounts at year-end by which to ‘confirm’ the dividends or, to the extent the company had not made sufficient profits, designate the shortfall as a director’s loan. However in the final period of trading prior to liquidation the director failed to consult with the accountants and no such reconciliation exercise was carried out.
The director also made a number of cash withdrawals and payments for (among other things) accommodation, hospitality and gambling.
The liquidator claimed that the ‘dividends’ and all of the other payments should be treated as outstanding director’s loans, that the director was in breach of his duties in allowing his loan account to become overdrawn, and that he must account for those sums.
The court’s decision
The court held that:
- It was correct to treat the purported dividends as director’s loans. The director had not declared any dividends by which the director’s loan balance might otherwise have been ‘cleared’ and so the director was liable to repay those loans.
- The director had adequately explained how some (but not all) of the cash withdrawals and other payments were made in good faith and for the benefit of the company: he would be liable to account only for those payments where no good explanation had been provided.
Whilst this was not a novel case, the judgment does provide some useful guidance and restatements of established principles, including the following:
- Even if the director could have shown that he had taken decisions to declare dividends, he would still have needed to demonstrate that those dividends were lawful, i.e. that Part 23 of the Companies Act 2006 was complied with (in particular, to identify ‘relevant accounts’ justifying the dividends). If not, he would still have been liable to repay them in his capacity as a shareholder, as unlawful distributions under section 847 CA 2006, rather than as a debt.
- The court was prepared to accept the director’s explanations, as to why certain payments were made in good faith and for the benefit of the company, even though the director i) produced no documentary evidence whatsoever to support those explanations, ii) had failed to reply to the letter before claim or to comply with a disclosure order, and iii) only provided detailed explanations for the payments when cross-examined at trial. The judge was satisfied that the director had satisfied his obligation to account for those amounts – albeit very late in the day. The liquidator had not adduced any evidence to rebut those explanations and had relied only on the director’s lack of explanation to justify the claims. The court noted that the liquidator had passed up an opportunity to attempt to access the software on which the director said records relating to those payments and withdrawals were stored.
- The court awarded an amount in excess of the known liabilities to creditors. In our experience it is quite common for defendant directors to argue that their liability is ‘capped’ at the quantum of creditor claims. That argument does not appear to have been raised by the director in this case (he was a litigant in person) and the court held the sums in question to be simple debts owed to the company, to be collected in the usual way. The judge nonetheless commented that, had the liquidator claimed repayment of the same amounts as unlawful dividends and/or by way of equitable compensation for breach of the director’s duties, then he would nonetheless have ordered the director to pay the same amount. Presumably any argument that such a ‘cap’ exists in respect of breach of duty claims, or claims for repayment of unlawful dividends against shareholders, would have failed had the director raised it.
- The court ordered payment by the director even though i) the liquidator had not adjudicated upon the creditor claims and ii) the director alleged that the petition debt owed to HMRC (which he did not challenge at the time of the petition) should be reduced to account for sums deducted from contractors and clients under the Construction Industry Scheme. Again, we have experience of directors seeking to avoid or reduce their liability in those circumstances – arguments which presumably would have failed here had the director raised them.