Conduct of Directors

As you may be aware, I recently acted for a liquidator in pursuing directors for breaches of section 214 of the Insolvency Act, 1986 (the “Act”). ICAS published an article relating to this decision (“Worth A Punt”) which related (and hence the title of the article) to the sale by a bookmaker of pitches in the run-up to insolvency and the use of the funds to repay a director’s loan (the full decision is on the Scottish Courts website - Paton v Martin & others). Recently, in England, the High Court has also had to consider the conduct of the directors (the cases of BTI 2014 LLC v Sequana SA & Ors; BAT Industries Plc v Sequana SA & Anor).

In my case, the directors had managed (and the forethought involved in this was one of the issues that we focused upon) to delay the winding-up of the Company beyond the six-month period following the payment to the director, thus ruling out an application in terms of section 243 of the Act (or section 239 in England). This meant that, with a bit of lateral thinking, all we had available to us was the conduct of the directors in the circumstances – impending (as we argued) insolvency and a desire to keep the assets out of the hands of the petitioning creditor and to pay one of their number. The Sheriff agreed with our analysis of the events leading up to the payment and the reasons behind the actions taken and awarded repayment in full of the sums transferred to the director, with interest.

In the English cases, the conduct complained of by the directors was the declaration and payment of dividends to the parent company but, crucially, there was no evidence of impending insolvency being (or which should have been) in the minds of the directors. The decision is extremely lengthy and, in certain areas, extremely complex. There were two important points addressed: the duties of directors to creditors in terms of section 172 of the Companies Act, 2006; and the characterisation of the dividends as transaction defrauding creditors (section 423 of the Act) which applies in England and Wales only. There was also another strand relating to unlawful dividends (whether there are the distributable reserves to allow a dividend to be declared - what the Judge nicely described as the “Could Not” claim).

The decision in respect of directors duties (what the Judge called the “Should Not” claim), when they are not faced with impending insolvency (in other words, a “section 172” test, rather than a “section 214” test, if I may characterise the difference in that fashion) was that they do not need to consider the interests of possible creditors.

What the decision also addressed, however, was whether a dividend is able to be characterised as a transaction defrauding creditors and what is key is that whilst this provision appears in the Insolvency Act, there is no requirement that there be an insolvency event.

The first question is whether the person “makes a gift to the other person or he otherwise enters into a transaction with the other on terms that provide for him to receive no consideration” or “enters into a transaction with the other for a consideration the value of which, in money or money's worth, is significantly less than the value, in money or money's worth, of the consideration provided by himself”. As you will appreciate, this language is redolent of sections 238 (transactions at an undervalue – England) and 242 (gratuitous alienations – Scotland).

The second question is whether (in this case) the directors’ purpose was either: “of putting assets beyond the reach of a person who is making, or may at some time make, a claim against him” or “of otherwise prejudicing the interests of such a person in relation to the claim which he is making or may make”. As you can see, the Court is required to assess the mind-set of the director when making the decision. If found to exist, this purpose does not require to be either the sole or main purpose for the transaction.

For most practitioners, the Court’s analysis of the first question is the one that is most important (because, as I say, of the proximity of wording with provisions of the Act that are more commonly referred to by practitioners). I have argued before (successfully) that a dividend is a “gift” and “without consideration”, despite being met with claims that it is a “return” upon an investment, a “contractual right” in terms of the articles and similar arguments – the same arguments that were advanced in this case. The Judge, in paragraph 500 (I told you that it was long!) succinctly sums up the position as follows:

“It is true that the reason why the member of the company, rather than any other person, receives the dividend is because of the pre-existing relationship of company and shareholder. But the decision to pay the dividend and choice of its value is not the consequence of that relationship because it is discretionary not only in its amount but in whether it is paid at all.”

That, to my mind, is a clear and unequivocal confirmation that paying a dividend when verging upon insolvency is a contravention of sections 238 and 242 and should be seen as justification for an action to recover the payment made.

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