Insolvency Bulletin August 2011

Insolvency Bulletin is prepared by Edward Bible, Solicitor and Licensed Insolvency Practitioner at Brethertons LLP. Edward was recently appointed as Vice President of the Insolvency Practitioners Association.

Brown and Mayberry v Button and others

The High Court has recently considered the question of whether a liquidator’s claim to repay unlawful director’s loans were statute-barred under the Limitation Act in Brown and Mayberry v Button and others [2011] EWHC 1034 (Ch).

The case concerned Broadside Colours and Chemicals Limited (BCCL) which supplied dyes to the textile trade. BCCL commenced trading in 1979 in Bradford and by the early 1990s its turnover had grown to over £2 million. However, by 2004 the BCCL’s financial situation had deteriorated and it entered into creditors’ voluntary liquidation on 10 September 2004.

Geoffrey Button and his wife had been directors of BCCL since 1979. Their son, James, was appointed a director on 10 May 1999 and resigned on 24 July 2004. BCCL’s statutory books could not be found. The judge therefore had to rely on the company’s financial statements. These showed that Geoffrey Button owned 1,999 A shares and his wife owned 1 A share. Mr Button owned all 2,000 B shares and in 2000 and 2001 transferred 49% of the B shares to his son, James. The financial statements showed that in the year to 31 July 2003 Geoffrey Button had an outstanding loan account of £25,241 and James Button had an outstanding loan account of £33,369.

Historically, BCCL had declared a substantial dividend which was used to reduce or write off sums due to BCCL in respect of directors' loans made during the course of the year. The company’s accountant confirmed that the directors received a low salary and that no national insurance contributions were paid. BCCL granted the directors interest free loans which were repaid by the dividend payments.

The directors met in March and April 2004 to consider the accounts for the year to 31 July 2003. They agreed that a final dividend of £58,700 be paid. This equated to the balance on the directors’ loan accounts of £29,935.88 in respect of Geoffrey Button and £28,763.36 in respect of James Button, making a total due of £58,699.24. BCCL’s accountants advised that in order to receive future dividends there had to be distributable reserves. The directors also discussed an interim dividend for the period from 1 August 2003 to 31 March 2004. The directors considered that there were sufficient reserves to pay an interim dividend and that BCCL was profitable. An interim dividend of £41,463 was proposed to clear the overdrawn balances on the loan accounts of Geoffrey Button which stood at £18,211.13 as at 31 March 2004 and of James Button which stood at £23,253.05, making total payments of £41,463.18.

Further payments totalling £22,759.24 were made to Geoffrey Button and James Button between April 2004 and the date of liquidation. Geoffrey Button asserted that these payments were to be treated as salary rather than as loans on the basis of advice received from BCCL’s accountants. However, neither director had been appointed as an employee, there were no documents in relation to alleged salary payments and the company’s bookkeeper was not informed. No PAYE payments were made and James Button appeared to receive payments after he had resigned as a director.

The liquidators issued proceedings for misfeasance under section 212 Insolvency Act 1986 on the grounds that the directors’ loans were illegal pursuant to section 330 Companies Act 1985 and that as all three directors approved the loans, they were under a duty to indemnify BCCL in respect of any loss or damage which resulted from the loans. The directors asserted that the loans up to 31 July 2003 were repaid by the Final dividend of £58,700 and the loans between 1 August 2003 and 31 March 2004 were repaid by the Interim dividend of £41,463. The liquidators submitted that the Final dividend and Interim dividend were invalid and that all three directors were liable to repay them.

The liquidators pointed out that a dividend could only be declared out of realisable profits, that there had been no general meeting to approve the dividend and that BCCL’s financial statements for the year to 31 July 2003 did not represent a true and fair view of the company’s financial position. The High Court held that the valuation of stock in BCCL’s accounts did not represent its realisable value and that the financial statements did not represent a true and fair view of the company’s financial position and found that the Final dividend was unlawful. The High Court also found that the Interim dividend was unlawful as it was not able to pay its debts as they fell due at the time of payment of the dividend.

The respondents had asserted that the liquidators were out of time to issue the proceedings for recovery of the unlawful dividends. The proceedings were issued on 9 September 2010, more than six years after the payments were made. The High Court held that each of the respondents were fiduciaries and that the claim against them amounted to a breach of trust. The six year limitation period does not apply where the claim is to recover trust property such as a case where a director of a company has obtained property from the company in breach of trust.

The liquidators argued that Geoffrey Button and James Button were jointly liable in respect of all of the loans. The High Court held that there was a joint obligation on the directors pursuant to section 341(2)(b) Companies Act 21985 (now section 213(3)(b) Companies Act 2006) to indemnify the company in respect of its losses as a result of the illegal loans. The obligation arose when the loans were made and was not a continuing obligation. The liquidators had pursued the claim against the directors under section 212 Insolvency Act 1986. The High Court held that this was a procedural section and that a claim under section 212 does not have a limitation period distinct from the company’s underlying claim. Accordingly, no new cause of action was created when the liquidators were appointed.

Liquidators should consider carefully any possible limitation period which may arise as a result of a possible claim against directors for breach of trust. Whilst the general rule is that the six year limitation period does not apply where the claim is to recover trust property, liquidators should be aware that their appointment does not trigger a new six year limitation period.

White v Davenham Trust Ltd

In White v Davenham Trust Ltd [2011] EWCA Civ 747 the Court of Appeal considered whether a surety could set aside a statutory demand where the lender had security over the principal debtor’s assets. The case concerned a guarantee which had been given by Mr White in respect of the liabilities of St George’s Property Services (London) Limited (SGPS). SGPS had granted a fixed charge over land to Davenham Trust and also a fixed and floating charge. Mr White and his co-director had provided guarantees. SGPS went into administration on 18 September 2009. Davenham Trust demanded payment from Mr White under his guarantee. As he did not pay, they issued a statutory demand in October 2009. The amount of the undisputed debt was £750,000. Mr White applied to set aside the statutory demand and the deputy registrar granted the application. The High Court allowed the appeal of Davenham Trust and Mr White appealed to the Court of Appeal.

The Court of Appeal considered the question of whether the existence of the security given by SGPS affected Davenham Trust’s ability to take action against Mr White by way of a statutory demand and possible bankruptcy proceedings and if so how.

Mr White relied on the case of Remblance v Octagon Assets Ltd [2009] EWCA Civ 581 which concerned a statutory demand served on a surety. He also relied on Rule 6.5(4) Insolvency Rule 1986 which provides:

“The court may grant the application if –
(a) the debtor appears to have a counterclaim, set off or cross demand which equals of exceeds the amount of the debt or debts specified in the statutory demand; or
(b) the debt is disputed on grounds which appear to the court to be substantial; or
(c) it appears that the creditor holds some security in respect of the debt claimed by the demand, and either rule 6.1(5) is not complied with in respect of it, of the court is satisfied that the value of the security equals or exceeds the full amount of the debt; or
(d) the court is satisfied, on other grounds, that the demand ought to be set aside.”

The debtor argued that as the principal debtor had a cross claim against the creditor which, if the principal debtor had been an individual, would have allowed it to rely on Rule 6.5(4)(a) which provides that the statutory demand can be set aside if the debtor has a counter claim, set off or cross claim which equals or exceeds the amount of the debt. The Court of Appeal held that in such a case, the surety was entitled to have the statutory demand set aside under Rule 6.5(4)(d), where the court is satisfied on other grounds that the statutory demand ought to be set aside, on the grounds that the surety’s liability should be regarded as co-extensive with that of the principal debtor.

Mr White argued that the co-extensiveness principle applied where the creditor had sercurity over the assets of the principal debtor and so could not serve a statutory demand on the principal debtor due to the provisions of Rule 6.5(4)(c). Mr White also argued that the rate of interest was extortionate contrary to section 244 Insolvency Act 1986. The High Court had held that Mr White was not able to rely on section 244. Mr White had also applied to remove the administrators of SGPS but had not been successful in his application.

The Court of Appeal analysed Rule 6.5(4). It felt that where a principal debtor had a cross claim which would extinguish the debt, then the guarantor should have the benefit of this argument for the purpose of bankruptcy proceedings. However, they felt that the position under Rule 6.5(4)(c) where the principal debtor had granted security to the creditor was different. The Court of Appeal held that where the creditor holds sufficient security, there is no reason to allow the creditor to pursue bankruptcy proceedings as the existence of the security means that the creditor has no interest in the debtor’s estate.

The fully secured creditor is not entitled to present a bankruptcy petition not merely because of the injustice that he should not be able to serve a statutory demand but because there is no justification for allowing the creditor to take a first step toward insolvency proceedings which the creditor would not be allowed to invoke.

The Court of Appeal noted that if Davenham Trust had issued proceedings against Mr White, it would have obtained judgment and having obtained judgment would have been entitled to enforce the judgment by the usual procedures including the service of a statutory demand and presentation of a bankruptcy petition. The Court of Appeal held that there was no good reason to apply the co-extensiveness principle between one debtor over whose debts the creditor is fully secured and another debtor who has given no security or insufficient security.

The Court of Appeal made the point that in the case of the administration of SGPS, Davenham Trust would not be able to take steps to enforce its security over the assets of SGPS without the consent of the administrators or the permission of the court. It was not certain whether such consent or permission would have been obtained. Even if they had done so, it was not a propitious time to sell the charged property.

Whilst the Remblance case gave some hope to guarantors under the co-extensiveness principle, the Court of Appeal has made it clear that where a guarantor has guaranteed a debt which is secured against the principal debtor’s assets, the guarantor cannot rely on the security.
 
For further information about our insolvency services contact:

Edward Bible
Head of Insolvency
 
Tel: +44 (0)1295 661489
Email: edwardbible@brethertons.co.uk