Good news for individuals acting as directors of corporate directors: Holland (Respondent) v The Commissioners for Her Majesty’s Revenue and Customs (Appellant) and another  UKSC 51
Since the Companies (Guernsey) Law, 2008 (the “Law”) came into effect on 1 July 2008, Guernsey administration businesses are continuing to take advantage of the ability to use corporate director companies to provide directors to client companies that they administer.
The Law permits a Guernsey company (referred to in this Red Line as an “underlying company”) to have another company as its director and in this Red Line we refer to the director company as a “corporate director”. Typically, the corporate director will appoint a number of individuals to its board, and if the underlying company wishes to execute documents, it will be one of those individual directors of the corporate director who signs the documents. Unlike the position in England and Wales, however, an underlying company in Guernsey does not need one or more individual directors to sit on its board alongside the corporate director. Instead, it is permissible under Guernsey law for a corporate director (or directors) to be the only director on the board of an underlying company.
There are a number of advantages in taking this approach. These include that there is no need to appoint and register alternate directors for each administered company for which a director is provided (as would be the case if individuals were appointed as directors) – instead, it is only necessary to appoint alternates at the corporate director level. Another perceived advantage is protection from liability for acts of directors. However, there has always been some doubt as to whether an individual director of a corporate director could be considered to be a “de facto” director of the underlying company, thus removing any potential liability advantages of using a corporate director arrangement. In this regard, the decision of the Supreme Court in Holland (Respondent) v The Commissioners for Her Majesty’s Revenue and Customs (Appellant) and another  UKSC 51 should provide some comfort to administration businesses and, in particular, those individuals in Guernsey acting as directors of corporate directors of underlying companies as well as individuals seeking to protect themselves by the use of such structures.
In this case the Supreme Court of England and Wales considered whether an individual director of a corporate director was really a de facto director of the underlying company, and therefore liable for breach of fiduciary duties as a de facto director of that underlying company, in circumstances where all of the individual director’s acts could be attributed in law solely to the activities of the corporate director.
The Supreme Court held by a 3:2 majority that to impose fiduciary duties on the individual in relation to the underlying company in such circumstances would be an unjustifiable extension of the concept of de facto director and that such an extension was a matter for the legislature and not the Court. The Court held that in the present case the individual director was doing no more than discharging his duties as a director of the corporate director of the underlying companies.
This is now the leading case in England and Wales on de facto directors and corporate directors and, whilst the decision would not be binding on a Guernsey court, it would be regarded as highly persuasive if the Guernsey courts had to consider the issue.
A summary of the facts giving rise to the issue, the decision of the Supreme Court and its reasoning is set out below. If more detail is required the case is available at http://www.supremecourt.gov.uk/decidedses/ docs/UKSC_2009_0131_Judgment.pdf.
Mr and Mrs Holland operated a business which administered the tax and other business affairs of contractors (working in various sectors) who did not wish to set up and run their own companies. After obtaining tax advice in 1999, Mr and Mrs Holland set up the following structure for their business:
- Paycheck Services Limited (“Paycheck Services”) was established, of which Mr and Mrs Holland were co-shareholders and co-directors.
- Paycheck Services owned 100% of the shares in two further companies, Paycheck Directors Limited (“PD Limited”) and Paycheck Secretarial Services Limited (“PS Limited”). Mr Holland was the only active director of PD Limited.
- PD Limited and PS Limited were specifically incorporated to act respectively as the sole corporate director and secretary of 42 client trading companies (the “Composite Companies”).
- Each Composite Company had a single A voting share which was held by a company, Paycheck Trustee Services Limited on trust (the “Trust”) for the benefit of the contractors pursuant to a trust deed of which Mr Holland was the settlor. The remaining 50 non-voting shares (each of a separate class) in each Composite Company were held by the contractors directly.
- Paycheck Trustee Services Limited had the same ownership and control structure as Paycheck Services.
- The services of the contractors were contracted out by the Composite Companies which, out of the income they received, would pay a fee to Paycheck Services for its administrative services, a salary to each contractor and, after provision for the payment of corporation tax at the small companies rate, a dividend to each contractor.
It was crucial to the viability of the scheme that the Composite Companies should have annual taxable profits of no more than £300,000 in order to benefit from the small companies tax rate.
A flaw in the structure was not spotted when it was set up and, during the period March 2001 to 25 June 2004, HMRC took issue with the structure. HMRC’s position was that section 13(3) of the Income and Corporation Taxes Act 1988 (“ICTA”) limited the benefit of the small companies tax rate by providing that, where a company had two or more “associated companies”, then during any accounting period those associated companies would have to share a single £300,000 limit. As Mr Holland was the settlor under the Trust he was regarded as being in control of all of the Composite Companies, with the effect that they were “associated” within the meaning of section 13 of ICTA. The result was that the collected profits had to be aggregated, and the Composite Companies had to be treated for the purposes of the tax rate as a single company entity. This has not been appreciated when the structure was set up.
The Hollands sought further legal and tax advice, during which period the Composite Companies continued to declare dividends. On 19 October 2004, administrators were appointed to the Composite Companies and the Composite Companies were left with a total deficiency of about £3.5 million in respect of unpaid corporation tax. HMRC brought 42 originating applications against Mr and Mrs Holland under section 212 of the Insolvency Act 1986 on the basis of allegations that they, as de facto directors of the 42 Composite Companies, had been guilty of misfeasance and breaches of duty in causing the payment of unlawful dividends to the shareholders of the Composite Companies when the Composite Companies had insufficient distributable reserves to pay their creditors (HMRC being the only creditor).
The High Court dismissed the claims against Mrs Holland but found that Mr Holland was a de facto director of each of the Composite Companies. Mr Holland appealed and HMRC cross appealed. The Court of Appeal unanimously allowed Mr Holland’s appeal against the orders made by the trial judge. The Court of Appeal accepted that the critical issue was whether Mr Holland assumed the status and function of a company director so as to make himself responsible as if he were an actual director, and that it mattered not what the individual called himself but rather what he did. The Court found that the act in relation to the underlying company was an act directed by the corporate director and not one directed by the corporate director’s individual board of directors. HMRC appealed against the decision of the Court of Appeal.
The Supreme Court dismissed the appeal by a majority of 3:2.
Reasoning of the Court
Lords Hope, Collins and Saville gave the majority judgments, with the dissenting judgments given by Lords Walker and Clarke. In summary, the Court held that:
- For almost 150 years de facto directors in English law were persons who had been appointed as directors, but whose appointment was defective, or had come to an end, but who acted or continued to act as directors. There was a striking judicial innovation in Re Lo-Line Electric Motors Ltd and Others,  Ch 477 and Re Hydrodam (Corby) Ltd,  2 BCLC 180 by which (at the risk of over-simplification) persons who were held to be part of the corporate governance of a company, even though not directors, could be treated as de facto directors for the purposes of statutory provisions relating to such matters as wrongful trading by, and disqualification of, directors.
- To extend that line of authority so as to impose fiduciary duties on Mr Holland in relation to the Composite Companies, when all of his acts could be attributed in law solely to the activities of PD Limited, would be an unjustifiable judicial extension of the concept of a de facto director, and an extension which was best left to the legislature. It was noted in particular that it was as recently as 2006 that Parliament had intervened to require that at least one director of a company be a natural person (section 155(1) of the Companies Act, 2006) who could if necessary be held to account for the company’s actions.
Parliament could have intervened at this point to require that all directors be natural persons as has been done in other jurisdictions, but it did not, and the proposed extension which was inherent in HMRC's case was a matter for the legislature and not for the court.
- The guiding principle, unless and until the legislature provided otherwise, was that so long as the relevant acts were done by the individual entirely within the ambit of the discharge of his duties and responsibilities as a director of the corporate director, it was to that capacity that his acts must be attributed.
The dissenting minority, Lords Walker and Clarke, held that, if what the individual did amounted to taking all the important decisions affecting the underlying company, and seeing that those decisions were carried out, he was acting as a director of that company. It made no difference that he was also acting as the only active actual director of the corporate director of the company. To attribute everything the individual did to his capacity as a director of the corporate director was arid formalism and could make it easier for individuals to use artificial corporate structures to insulate themselves against liability.
It should be noted that the Law (as was the case with the earlier English Companies Act, 1985) does not contain an equivalent provision to section 155 of the Companies Act 2006 requiring that a Guernsey company have a natural person as its director. It is therefore arguable that the decision of the Supreme Court accords with the intention of the Guernsey legislation.
In our view the decision of the Supreme Court is a favourable one, not only because it confirms the importance of the distinction that a company is a separate person in law, but also because it provides commercial certainty for individuals who are directors of corporate directors of underlying companies, and individuals seeking to protect themselves by the use of such structures. The confirmation means that, provided that everything they do can be attributed to acting as a director of the corporate director, it is unlikely that individual directors of a corporate director will be held to be “de facto” directors of an underlying company and that their liability to any underlying company and its creditors is limited.