In John David Hedger (the Liquidator of Pro4Sport Ltd) v David Adams , the Liquidator of Pro4Sport Ltd (Pro4Sport) made an application to the Court under section 212 of the Insolvency Act 1986. The claim arose out of one transaction which took place shortly before the liquidation of Pro4Sport on 20 July 2012. On 25 June 2012 Mr Adams, on behalf of Pro4Sport, transferred all, or practically all, of the assets of Pro4Sport to an associated company, Pro4Sport.co.uk Ltd (Pro4Sport.co.uk) for a deferred consideration of £47,000 plus VAT. The only security provided was a retention of title clause. Mr Adams was the majority shareholder and a director of both companies. Facts In May 2012 Mr Adams consulted business advisers BCIA Ltd (BCIA) over the financial position of Pro4Sport. Mr Adams was advised that some form of insolvency was inevitable. He was advised of the possible courses open to him. These included: • a sale by Pro4Sport of the assets to Pro4Sport.co.uk; • a sale by a liquidator of the assets as a going concern; and • a sale by a liquidator of the assets on the open market at auction. Mr Adams was also advised that there ought to be a valuation of the assets. Accordingly he authorised BCIA to obtain a valuation on his behalf. The business of Pro4Sport was valued as a going concern at £37,000 plus a maximum value of £15,000 for goodwill. In relation to goodwill the valuer advised that there were concerns about Pro4Sport’s business model and ability to sustain profitability if it were to be sold as a going concern and the judge said, in his judgment that goodwill was more than likely to be £5,000. The open market value of the assets was £24,000. The principal asset of Pro4Sport was stock and it was likely that a significant proportion of the stock had been supplied subject to retention of title provisions. The contract between the two companies was evidenced by an invoice dated 25 June 2012 on Pro4sport.co.uk writing paper. The price was specified as £47,000 plus VAT of £9,400, totalling £56,400. It was not in dispute that the Liquidator adopted the contract and agreed a payment schedule with Mr Adams. On 18 July 2012, Pro4Sport.co.uk paid Pro4Sport the sum of £5,640 (being 10% of the purchase price); four other payments of £5,640 were made between August and November 2012. In December 2012, a payment of £5,460 was made. Between February 2013 and January 2014, four further payments totalling £2,250 were made by Pro4 Sport. co.uk. No further payments were made. Pro4Sport.co.uk subsequently became insolvent and went into creditors’ voluntary liquidation on 31 July 2014. The total amount paid was £35,910. There was accordingly £20,490 outstanding. Informed Counsel Company update September 2015 7 Claim The Liquidator sought to recover his loss from Mr Adams. He contended that Mr Adams was in breach of his duties under sections 172, 174 and (possibly) 190 of the Companies Act 2006. Mr Adams argued that he had received advice from BCIA as to the best course of action to take and had followed it. Mr Adams said in evidence that he considered whether the agreement was in the best interests of Pro4Sport and its creditors. The sale was completed quickly and without incurring the costs of sale. In his view, the Liquidator would have had to sell the assets at auction and would have received a lower sum. Mr Adams also stated that the agreement would not have gone ahead on the basis of an immediate payment by Pro4Sport.co.uk and there had been no suggestion from BCIA that he ought to provide a personal guarantee. In any event, he would not have been willing to do so; he was already a substantial creditor of Pro4Sport and was not in a financial position to honour a guarantee. Mr Adams asserted that he honestly believed that the contractual arrangements between the two companies were in the best interests of Pro4Sport. On 16 August 2013, an Insolvency Manager employed by the firm of Insolvency Practitioners dealing with the liquidation, sought advice from a valuer as to whether the sale was a true value of Pro4Sport’s assets. In her instructions she acknowledged that the sale was conducted on the advice of BCIA. She also noted that there were a considerable number of retention of title claims which the Liquidator was directing to Pro4Sport.co.uk. The valuer advised that “the price paid was a fair representation of the value of the assets”. High Court decision Section 172 Companies Act 2006 The Court firstly considered section 172 of the Companies Act 2006, of which sub-section (1) provides as follows: 172 Duty to promote the success of the company (1) A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to: (a) the likely consequences of any decision in the long term, (b) the interests of the company’s employees, (c) the need to foster the company’s business relationships with suppliers, customers and others, (d) the impact of the company’s operations on the community and the environment, (e) the desirability of the company maintaining a reputation for high standards of business conduct, and (f) the need to act fairly as between members of the company. It was argued on behalf of the Liquidator that there was a breach of section 172 on three main grounds: 1. Mr Adams took account of Pro4Sport.co.uk’s interests to the detriment of Pro4Sport’s interests when causing the parties to enter into the contract. 2. The contract did not constitute the best deal for Pro4Sport as the sale price was not the best price available to Pro4Sport. 3. The sale of the stock and associated items on a deferred consideration basis constituted a high risk strategy which was not in the best interests of Pro4sport’s creditors. It was common ground that the duty under this section is subjective. As was said by Jonathan Parker J in Regentcrest plc v Cohen . “The duty imposed on directors to act bona fide in the interests of the company is a subjective one…The question is not whether, viewed objectively by the court, the particular act or omission which is challenged was in fact in the interests of the company; still less is the question whether the court, had it been in the position of the director at the relevant time, might have acted differently. Rather, the question is Informed Counsel Company update September 2015 8 whether the director honestly believed that his act or omission was in the interests of the company. The issue is as to the director’s state of mind. No doubt, where it is clear that the act or omission under challenge resulted in substantial detriment to the company, the director will have a harder task persuading the court that he honestly believed it to be in the company’s interest; but that does not detract from the subjective nature of the test.” Where the duty extends to consideration of the interests of creditors, their interests must be considered as paramount. It was not in dispute that Pro4Sport was insolvent in June 2012 and that there was therefore a duty owed to the creditors when Pro4Sport entered into the transaction. It was submitted on behalf of Mr Adams that he did consider the interests of creditors and honestly believed that his actions were in the interests of creditors. He drew attention to the fact that he consulted BCIA, that he had a valuation of the assets and that he had entered into the agreement on the advice of BCIA. He consulted his two major suppliers who confirmed that credit would be extended to Pro4Sport.co.uk. In those circumstances he was entitled to believe that Pro4Sport.co.uk would be able to honour the payment schedule under the agreement. The Court rejected the claim that Mr Adams was in breach of section 172 for the following reasons: • The Court accepted that Mr Adams had considered the interests of creditors and that he considered the contract was in their best interests. • The contract avoided the costs of a sale. • The valuer had given three valuations for the stock and fixtures. In assessing the price to be paid Mr Adams was not obliged to take the maximum figure in respect of each. He was entitled to take into account the fact that the Liquidator might not be able to sell the business as a going concern. He was entitled to rely on advice. • Although the contract involved a deferred consideration, an immediate consideration was not on offer. The question for Mr Adams was whether a sale with deferred consideration was a better deal for the creditors than no sale at all. • Mr Adams formed the view that Pro4Sport.co.uk would be able to fund the sale after checking with the two main suppliers. In the view of the Court, Mr Adam’s views were honestly held. • The Liquidator took no steps to avoid the contract after his appointment and agreed a schedule of repayments with Mr Adams when the contract was formed. Section 174 Companies Act 2006 The Court then turned to the claim under section 174 of the Companies Act 2006 which provides as follows: 174 Duty to exercise reasonable care, skill and diligence (1) A director of a company must exercise reasonable care, skill and diligence. (2) This means the care, skill and diligence that would be exercised by a reasonably diligent person with (a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and (b) the general knowledge, skill and experience that the director has. Informed Counsel Company update September 2015 9 It was argued on behalf of the Liquidator that Mr Adams was in breach of this section on the basis of the same three matters which formed the basis of the claim under section 172 (see above). In addition, it was argued that Mr Adams should have provided a personal guarantee to compensate for the fact that the consideration was deferred. The Court recognised that the terms agreed between the two companies could have been more favourable to Pro4Sport. The price to be paid by Pro4Sport.co.uk could have been higher. The consideration could have been payable immediately. There could have been a personal guarantee by Mr Adams. These factors, however, did not establish that Mr Adams was not exercising reasonable skill and care. Whilst it was true that the price agreed (£47,000) was less than the valuation on a going concern basis, (£37,000) plus the maximum likely consideration for goodwill (£15,000), it was, however more than the open market value of the assets (£24,000). Thus, the question that had to be considered by Mr Adams and his advisers was the likelihood of any liquidator obtaining a sale as a going concern in the light of the concerns expressed by the valuer as to the business model and the ability of the company to sustain profitability. Mr Adams would also have had to take into account the costs which the Liquidator would have incurred in realising the assets. As to the personal guarantee, which was redolent of hindsight, no-one asked for a personal guarantee at the time. Importantly, the Liquidator did not ask for one when he agreed the repayment schedule. The Court accepted that section 174 obliges Mr Adams to exercise his own independent judgement. However, the fact that he was relying on professional advice was an important factor in determining if he was in breach of his duty to exercise reasonable care. Furthermore, again the agreement between Pro4Sport and Pro4Sport.co.uk was drawn up by BCIA and entered into on its advice. Mr Hedger was present when it was drawn up and did not object to its terms. He agreed a repayment schedule at the time. He did not complain or seek to avoid the agreement when he was appointed liquidator one month later. Plainly a sale with deferred consideration carried with it the risk of default by Pro4Sport.co.uk. However, Mr Adams contacted his two major suppliers and had to assess that risk in the light of the responses he received. Pro4Sport. co.uk was not in a financial position to make immediate payment so the question of an immediate payment did not arise. Given these circumstances, the Court was not satisfied that Mr Adams was in breach of section 174. Section 190 Companies Act 2006 The Court then considered the claim that Mr Adams was in breach of section 190 of the Companies Act 2006, of which sub-section (1) provides: 190 Substantial property transactions: requirement of members’ approval (1) A company may not enter into an arrangement under which: (a) a director of the company or of its holding company, or a person connected with such a director, acquires or is to acquire from the company (directly or indirectly) a substantial non-cash asset, or (b) the company acquired or is to acquire a substantial non-cash asset (directly or indirectly) from such a director or person so connected, unless the arrangement has been approved by a resolution of the members of the company or is conditional on such approval being obtained. “Substantial” is defined in section 191 of the Act as being of a value which exceeds 10% of the company’s asset value and is more than £5,000 or exceeds £100,000. Section 195 of the Act provides for the civil consequences of contravention and includes at sub-section (3) that any director is liable to account for any gain (sub-section (3)(a)) and to indemnify the company for any loss or damage (sub-section (3)(b)). It was argued by the Liquidator that Pro4Sport.co.uk was connected with Mr Adams, that Pro4Sport.co.uk had acquired a substantial non-cash asset from Pro4Sport and that accordingly the arrangement infringes section 190 of the Companies Act 2006. Accordingly, Mr Adams was liable under section 195(4) to indemnify Pro4Sport under section 195(3)(b) for its loss. He also submitted that Mr Adams was liable to account for any gain he had made from the transaction. Informed Counsel Company update September 2015 10 However, the claim under section 190 was not clearly pleaded and procedural problems with the claim, given that the application to the Court was made under section 212 of the Insolvency Act 2006, were put before the Court. In the circumstances, the Court declined to deal with the claim under section 190. Relief under section 1157 Companies Act 2006 The judge said in his judgment that if there was a breach by Mr Adams of his duties the Court would have held it was appropriate to grant relief under section 1157 of the Companies Act 2006 (Power of court to grant relief in certain cases). The relevant principles are summarised in Re HLC Environmental Projects Ltd (in liquidation) . “(a)in order to be relieved of liability a director must establish three things; (i) that he acted honestly, (ii) that he acted reasonably and (iii) that having regard to all the circumstances he ought fairly to be excused. The first of these is a subjective requirement, the second an objective requirement: Coleman Taymar Ltd v Oaks ; (b) the burden of establishing honesty and reasonableness lies on the director: Bairstow v Queens Moat Houses Plc ; and (c) it is only if both of the first two requirements of honesty and reasonableness are established that the court needs to consider the third requirement, that in all the circumstances the director ought fairly to be excused.” The judge was satisfied that Mr Adams was acting both honestly and reasonably in entering into the transaction. He was acting on advice. The Liquidator was present when it was entered into and did not object. The Liquidator was content to adopt the transaction and confirmed the repayment schedule. If there was a breach of section 190 of the Companies Act 2006, it was a breach which, in all of the circumstances, ought fairly to be excused. There was no evidence of any gain made by Mr Adams as a result of the transaction. Thus the claim relating to a gain under section 195(3)(a) of the Companies Act 2006 failed. The application was dismissed. Comment Any disposal of all or part of the business and/or assets of a company in the period leading up to formal insolvency will come under close scrutiny. The case illustrates the importance of directors’ obtaining and following professional advice in complying with directors’ statutory duties, combined with honestly and reasonably believing that the action being taken is in the best interests of the company or creditors. All the circumstances of a proposed transaction need to be carefully considered and weighed against what, if any, other possible courses of action might be available.