Time is no saviour for Malfeasant Directors
Directors can no longer use limitation periods to defend misfeasance claims where they have benefitted from their alleged misfeasance. In a sobering decision, the Supreme Court has recently brought the serious nature of the duties and liabilities of company directors into sharp focus.
The facts of the case:
- Company directors, as stewards of a company’s property, act as ‘trustees’ in that respect; and
- Consequently, where they act in breach of their fiduciary duties and receive a benefit from doing so, there will be no time limit on claims against them personally.
The facts of the case:
- Burnden Holdings (UK) Limited was a holding company with various trading subsidiaries operating in two areas: (i) The conservatory business - operated by 2 subsidiary companies (“S1” and “S2”); and (ii) the combined heat and power business Vital Energi Utilities Ltd (“Vital”).
- The defendant directors were the directors and controlling shareholders of Burnden. In 2007 a buyer (“Buyer”) offered to buy a 30% shareholding in Vital, on condition that it was completely separated from the conservatory businesses (being S1 and S2).
- To facilitate this the defendant directors created another holding company (“NewCo”) above Burnden (mirroring the shares held in Burnden), which acquired the entire shares in Burnden. They then arranged a series of transactions as follows:
12 October 2007:
Burden’s shares in Vital were distributed – via distribution in specie (approved by a unanimous resolution of Burnden’s directors and a resolution of Burnden’s sole shareholder, being NewCo) - from Burnden to NewCo. NewCo was registered in the register of members of Vital the same day.
15 October 2007:
The directors of NewCo made a statutory declaration of its solvency, and the shareholders placed it into members’ voluntary liquidation. Via a reconstruction structure the liquidator of NewCo transferred the share in Vital (then NewCo’s) to another new company (Vital Holdings Limited - “VHL”), and NewCo’s shares in Burnden to a further new company. Those 2 other new companies then issued shares to the former shareholders of NewCo, mirroring their shareholdings in NewCo (and prior to that Burnden).
19 October 2007:
One of the defendants sold a 30% shareholding in VHL to the Buyer for £6m, of which £3m was lent to Burnden and the balance was put towards the purchase of a property for £8.3m by both defendants jointly in May 2008.
2 October 2008:
Burnden, K2 and Cestcon all went into administration. In December 2009 Burnden went into liquidation. The liquidators alleged that the distribution of the shares in Vital away from Burnden constituted a breach of the directors' fiduciary and statutory duties on the basis that:
- The transfer of Burnden’s share in Vital to NewCo was unlawful because Burnden did not have sufficient accumulated and realised profits to enable the distribution to be properly made at the time; and
- The defendants’ participation in the arrangement amounted to a breach of fiduciary duties (as directors of Burnden) because it was made to NewCo (in which they were majority shareholders and directors) and therefore one from which they received a substantial benefit.
The key issue:
The initial question was one of limitation. The limitation period for the claims brought by the liquidators in England is usually 6 years. The liquidators issued proceedings 6 years and 3 days after the shares were distributed out of Burnden, which is outside of that 6 years period. The defendants asked the Court to dismiss the case on the basis that the claim was out of time.
In response the liquidators relied on a part of the Limitation Act 1980 which states that no limitation period applies to a claim by the beneficiary of a trust to recover, from the trustee, either:
- Trust property;
- The proceeds of trust property in the possession of the trustee; or
- Trust property previously received by the trustee and converted to his use.
They argued that:
- The directors of Burnden were 'trustees' of the company’s assets because they were entrusted with the stewardship of Burnden's assets, and that Burnden should be treated as a beneficiary for these purposes;
- Even though the shares in Vital were transferred to NewCo (as a new holding company) the shareholding was exactly the same as Burnden; and
- Therefore, assuming that the distribution was unlawful (which was still to be proven), although the share in Vital were never held directly by the defendants, the shares in Vital had been received and "converted to their use" by the defendant directors.
The Supreme Court agreed and decided that the directors could not rely on limitation as a defence; and that no limitation period applies to the liquidators' claim if the payments are found to be unlawful (which is yet to be fully litigated – the question of whether the distribution was lawful or not was not a point to be decided at the hearing. The question at the hearing was one of limitation periods).
There are two key lessons to be learned from this:
- Where director shareholders are restructuring their group holdings, it should be carried out with caution because, if any of those distributions are declared unlawful, there is no time limit on when the company (or a liquidator / administrator) can pursue you for their return; and
- The passage of time will not allow you to avoid claims. It is best to ensure that you comply with your duties (and that any distributions are undisputedly lawful), and fully document the process, so that the question of whether you have been malfeasant does not even arise.
Knowledge is power – and if you’re aware of the risks you can mitigate them. Don’t ever assume it ‘will be alright on the night’, chances are it might not! As always – if in doubt seek advice.
For further information on this topic, you can contact Frank Bouette or you can give us a call on 0345 070 6000.