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Statement of solvency - a reminder of director’s duties

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Statement of solvency - a reminder of director’s duties

Statement of solvency - a reminder of director’s duties

The recent High Court decision LRH Services Ltd (in liquidation) v Trew & others is a stark reminder that a statement of solvency must not be sworn lightly, and the consequences carry through to other directors implementing actions based upon it.

The headline points are:

  • Do not assume you are exempt from the consequences because you didn't swear it – you are not! Ask questions about it, keep notes of your thinking and retain minutes of any conversations with fellow directors concerning any issues around it before it is sworn.

  • Include, in any statement of solvency, details all of the information considered when reaching the opinion in it, and set out all of the assets and liabilities of the company (to show they have been fully considered).

  • Do not blindly rely on the availability of inter-group funds without a formal and binding guarantee arrangement in place, and even then still consider whether it is reasonable and proper to rely upon it if called upon.

We would always suggest that proper and complete professional advice and assistance is sought before a declaration of solvency is sworn. If you want to know more about this case, please read on.

In 2009, as part of a reorganisation, LRH Services Ltd (LRH) reduced its share capital to £1 and declared a dividend to its parent company shareholder of around £21.3 million. The process involved its sole director (A) –at the relevant time - swearing a statement of solvency declaring that LRH was able to pay its debts as and when they fell due over the following 12 months. Another director (B) had resigned hours before the statement was sworn by A, and another (C) became a director after it had been sworn but before the dividend based on it was paid.

Directors must not swear such a statement unless they have has reasonable grounds to do so. If a director makes such a statement without having reasonable grounds to do so they may incur criminal liability; but this does not mean it is automatically invalid so long as the director had formed the opinion stated in it both honestly and genuinely (whether reasonably held or not). If it was not honestly and genuinely formed then it is invalid and all actions resulting from it (including any dividends paid out) are invalid; and all the directors who took part in the process (whether they swore the statement or not) could be personally liable for the losses resulting (e.g. the entire value of the dividends).

The court here clarified that when deciding whether the opinion of any director was held genuinely and honestly it will consider whether that director had (at the very minimum): (i) Considered the contingent and prospective liabilities of the company; and (ii) considered all of the assets available to the company to pay its debts (and, if necessary, set aside specific assets / put in place arrangements sufficient to discharge the company's liabilities as they fall due).

LRH was a tenant of a number of commercial properties, some of which were occupied by its subsidiaries. One of the subsidiaries subsequently failed to pay its rent, and a landlord commenced winding up proceedings against LRH (the tenant). LRH went into liquidation, and its Liquidators brought claims against its 3 former directors (A, B & C) on the basis that the decision to reduce the share capital, and the payment of the dividend, were in breach of their duty to act in good faith in prompting the success of LRH and to exercise reasonable care and skill.

On the facts, the court found that A had failed to make enquiries into (or give any thought for) LRH's actual obligations, including under the various leases, when swearing the statement. He had wrongly assumed that LRH would be able to rely on support from its parent company – despite no parent guarantee or formal obligation to support LRH being in place. The court did not consider that ad-hoc support from a parent company was an asset of LRH that could be relied on for solvency here. All 3 directors were held liable, on the basis that B had known that the statement sworn by A had been sworn on an improper basis and that C had taken part in the payment of the dividend based on it.

For further information about statements of solvency, please contact Kam O’Neill, or you can give us a call on 0345 070 6000.