Directors of a solvent company are under no duty to prioritise the interests of potential creditors when entering transactions, even where there is a recognised risk of insolvency

14 February 2017

HENRY GEORGE DICKINSON (Claimant) v (1) NAL REALISATIONS (STAFFORDSHIRE) LTD (2) KEVIN JOHN HELLARD & GERALD KRASNER (JOINT LIQUIDATORS OF THE FIRST DEFENDANT) (Defendants) & JUDITH YAP DICKINSON (Third Party) & ROBERT WILLIAMSON (Fourth Party) [2017] EWHC 28 (Ch)

Norton Aluminium Limited ("the Company") went into administration in August 2012 when it received a draft judgment in favour of local residents in a claim for nuisance, which resulted in substantial damages being award and likely legal costs.   

Mr Dickinson, who was the managing director and controlling shareholder of the Company, brought a claim to recover in the liquidation various sums totaling over £100m which he said were due to him and secured by a debenture over the assets of the Company.  

The liquidators defended the claim and counterclaimed against Mr Dickinson (and two other directors of the Company). The dispute centered on the following transactions: 

  1. The transfer of the Company's factory premises to Mr Dickinson in 2005;  
  1. The Company's buy-back of most of its shares from Mr Dickinson and connected parties for £2.5m in 2010; 
  1. The Company's sale of one of its subsidiary companies, Norse Castings Limited ("Norse"), to Mr Dickinson in 2010 for £1; and  
  1. The Company's investments in and loans and supplies on credits to a related company in India ("NAI"), notwithstanding that Mr Dickinson had arranged for most of the shares in that company to be issued to him. 

The liquidators argued that these transactions formed a scheme by which Mr Dickinson restructured the affairs of the Company when it was threatened with the local residents’ litigation, with the object that the Claimants in that litigation would receive nothing if they won, and Mr Dickinson would be in a position to buy the main business from an administrator and continue it under a "phoenix" company (which he did in fact do).  

The allegations

Broadly, the above transactions were challenged by the liquidators on the following basis: 

  • The share buy-back and sale of Norse were transactions at an undervalue intended to put assets beyond the reach of creditors within s423 Insolvency Act 1986 (“IA”); and/or  
  • Were void or voidable by reason of lack of proper authorisation; and/or  
  • Were void or voidable by failure to comply with formalities required by the Companies Act 2006; and
  • The directors were in breach of their duty to consider the interests of the creditors, which they say were engaged at all material times, as well as those of the shareholders, and Mr Dickinson in particular preferred his own interests over those of the Company.

Factual background

At all material times, the Company had three shareholders: Mr Dickinson who held 50.6%, a pension scheme (the trustees of which were Mr Dickinson, his wife, and a professional trustee) which held 10.2%, and a discretionary settlement which held 39.2%.  

In 2005 the freehold factory premises from which the Company traded was transferred to Mr Dickinson for £224,000 and leased back for a period of 4 years at a rent of £40,000. The Company secretary at the time expressed concern that the purchase price might be below market value, but Mr Dickinson disagreed.  

In September 2006, Norton Aluminium India Private Limited ("NAI") was incorporated in India as a wholly owned subsidiary of the Company. NAI was funded by a combination of share capital and secured loans made pursuant to a term loan agreement, which totalled £1.4m.  

In November 2006, Mr Dickinson became aware that a firm of solicitors, Hugh James, had circulated letters amongst local residents stating that it was investigating the possibility of pursuing a group legal action against the Company claiming compensation for odour, dust and noise pollution, as well as an injunction to stop the Company from continuing the alleged nuisance in future.  A letter before claim was sent on 14 March 2007. Proceedings were issued as a class action and representative claims were pursued.   

In February 2008, the Company's solicitors, Weightmans, wrote to Mr Dickinson advising the Company to reserve £300,000 to cover its potential liability in the nuisance claim. Weightmans’ letter gave only a very preliminary view; it was not based on any precise calculation and did not address merits. In June 2008, Weightmans wrote to Mr Dickinson again and advised him that the potential exposure could in fact be as much as £2.55m. Mr Dickinson withdrew instructions from Weightmans, and from then until December 2009 dealt with correspondence himself.  

Mr Dickinson maintained that he at all times considered the likely maximum exposure of the Company to be the £300,000 originally estimated by Weightmans. In February 2009, Mr Dickinson wrote to the Company's auditors and proposed making a provision in the accounts of £100,000. From this point onwards, the liquidators alleged, Mr Dickinson began to develop his plan to protect assets against the risk of losing the claim.  

In October 2009, the Company secretary wrote to the auditors saying that Mr Dickinson wanted to look into a capital reduction of the Company, with the Company purchasing its shares from Mr Dickinson, who would then loan the money back to the Company and take a charge over its assets. 

In January 2010, the Company’s new solicitors, Carter Lemon Camerons ("CLC") wrote to Mr Dickinson and advised him that an award of damages to the Claimants was likely. Shortly thereafter, Mr Dickinson followed up on the proposed share buy-back. He also proposed selling one of the Company's subsidiaries, Norse, for a nominal sum on the basis that it was of negative worth. 

In February 2010, CLC advised Mr Dickinson that the amount of general damages ranged from £800,000 to £2.4m, and that they feared the chances of successfully defending the claim were reducing. Later that month, Mr Dickinson wrote to his auditors informing them that he had bought Norse out of the Company for £1. Mr Dickinson then goes on to suggest setting up a phoenix company to absorb the Company in the event that the litigation goes badly. 

In March 2010, the auditors advised that the most tax efficient way of proceeding would be to buy back up to £2.5m shares at nominal value. The buy-back was effected on 10 May 2010. The Company did not make actual payment of the purchase price of the shares, as it was Mr Dickinson's intentions that the funds be left in the Company. However, no document was executed to record the terms of this loan, which Mr Dickinson maintained was by "verbal agreement". The loan was subsequently protected by way of debentures over the assets of the Company.  

In July 2011, Mr Dickinson informed his auditors that the capital base of NAI had been substantially enlarged, and that he had used the cash released from the share buy-back to subscribe to the increased share capital. As a result, Mr Dickinson now owed 51% of the equity of NAI and the Company now owed 49%.  

As the litigation progressed into 2012, it appears that Mr Dickinson maintained his view that the claim would fail. In an email to his auditor he stated that "the reality is [the Company] will go bust rather than pay [the claimants] a penny".   

The case went to trial in May 2012, following which HHJ McKenna circulated a draft judgment which upheld 15 of the 16 lead claims and awarded damaged of some £160,000. If extrapolated to the other claimants the damages would have reached about £1.2m. The Company went into administration on 18 September 2012, and the administrators immediately completed a prepack sale of most of its assets to a company controlled by Mr Dickinson for £425,000. Judgment was formally handed down on 28 September 2012.  

The transactions challenged: 

  1. Transfer of freehold premises in 2005: 

The Court found that no proper board resolution had been made in respect of this transfer, and as such the relevant requirements of the Companies Act had not been met. The Court rejected the argument that the purchase was authorised or ratified by the unanimous approval or acquiescence of the shareholders. Counsel for Mr Dickinson argued that Mr Dickinson ought to be relieved of liability pursuant to section 1157 of the Companies Act, namely that a court might excuse a director for breach of fiduciary duty in circumstances where he acted "honestly and reasonably". The Court refused to grant Mr Dickinson relief, as it found no evidence that he had acted in the best interests of the Company, as distinct from his own. The Court found that, had Mr Dickinson been acting honestly and reasonably in the best interests of the company, he would have obtained a professional valuation to support the price being paid by him and explained why the sale was in the best interests of the Company.  

Mr Dickinson was found to have held the property on trust for the Company throughout and was liable to restore it to the Company and pay compensation of £415,000, being equal to the amount of rent creditor or paid to him.  

  1. Share buy-back 

Pursuant to section 691(2) of the Companies Act, where a limited company buys its own shares, the shares must be paid for on purchase. Counsel for Mr Dickinson argued that the loan arrangements between Mr Dickinson and the Company were to be treated as payment. The Court rejected this submission. It held that if the consideration payable under a sale transaction is not actually satisfied at the time, the result is that a debt automatically arises. Acknowledgment of it by entering into a loan agreement does not constitute payment on purchase, but varying the terms of the arrangement such that payment is to be made at a later date.  

The Court held that the share buy-back was void. 

The Court went on to find that Mr Dickinson, in converting his rights as a shareholder into claims for secured debts, had both prejudiced the interests of the claimants by increasing the pool of liabilities competing with their claim, and put assets beyond their reach by ensuring that his debt would be paid in priority being secured on the assets of the Company. The court found this had been Mr Dickinson's dominant intention. The Court granted relief under section 423(2) IA and ordered that Mr Dickinson restore the Company to the position that it would have been in had the transaction not been entered in to.  

Finally, in relation to the share buy-back aspect of the claim, the Court considered whether Mr Dickinson was in breach of his fiduciary duty codified in section 172 of the Companies Act, to act in good faith and in a way most likely to promote the success of the Company, bearing in mind the obligation to have regard to the interests of creditors, notwithstanding the Company was solvent. 

The Court held that Mr Dickinson had not breached his fiduciary duty in this regard. It held that the general duties of directors do not require them to give priority to the interests of creditors, simply because there is a recognised risk of adverse events that may lead to insolvency. Assuming that the buy-back had been valid, it did not place the Company on the verge of liquidation. The Company was trading successfully, and had ample capital and liquidity to continue doing so.  

  1. Transfer of the Norse shares

The Court rejected the argument that Mr Dickinson had implied or informal authority in advance to make the sale, nor was there any subsequent action from which ratification or acquiescence sufficient to amount to approval could be inferred. There was no evidence of any other directors being involved in, or even being aware of, the transaction until after the event. No board meetings took place and no resolutions passed.

On that ground, the Court held that the sale was avoided.  

The Court also held that the transfer of the shares was at an undervalue (section 423 IA). The Court was satisfied that the transfer formed part of the overall scheme developed by Mr Dickinson to move assets out of the Company in order that they would not be available to the claimants if they succeeded. The Court did not accept that Mr Dickinson genuinely believed that the shares were only worth £1.  

The Court held that Mr Dickinson had breached his fiduciary duty to act in the best interests of the Company in respect of this sale. However, as with the share buy-back, Mr Dickinson had not breached his fiduciary duties to the Company’s creditors.   

  1. NAI  

The liquidators alleged that the Company directors acted in breach of duty in causing the Company to subscribe for further shares in NAI at a cost of £139,000 odd at a time when it was no longer the majority shareholder and in making further unsecured loans to NAI amounting to c. £750,000, thereby preferring Mr Dickinson's interest to that of the Company and its creditors; and paying away funds to put them out of reach of the creditors if the claim succeeded.  

The Court declined to reach such a finding, because it had already concluded that the duty to consider creditors' interests had not arisen.  

The Court went on to say that it is not per se a breach of duty to invest in a minority shareholding or to make loans to a company in which the lender has minority holding. Further, there was no allegation that at the time the shares were purchased they were an uncommercial investment, or that the directors should have concluded that the loans would not be repaid. Without that, the Court was unable to see how either amounted to a "preference" of Mr Dickinson's interests.  

Mr Dickinson's own claims 

As the debenture created in relation to the share buy-back was invalid, any claims Mr Dickinson had in the liquidation are unsecured.

Mr Dickinson was found to be entitled to be indemnified for the c.£40,000 in legal costs that he incurred in defending the application brought by the resident claimants against him personally. 

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