In a case which has attracted public, press and legal attention, the High Court recently found that the directors of a family-run business should have ensured that the company's interests took precedence over any personal and private loyalties felt towards their family members where those competing interests came into conflict.(1)
In the judgment, which was highly critical of the company's directors, the former owner of a football club was characterised by the judge as "untrustworthy" and ordered to repay £2.05 million to a council which had loaned substantial sums towards a stadium redevelopment.
By a deed of assignment (the assignment) made on 10 December 2015, Northampton Town Football Club Limited (NTFC) assigned to Northampton Borough Council (NBC) all of its rights, title, interest and benefit in certain debts and claims.
The specified debts were said to be owed by 1st Land Limited, in administration, County (Oundle) Limited (Oundle) and County Developments (Northampton) Limited (CDNL), in liquidation.
The specified claims were all and any claim, counterclaim or cause of action, which NTFC then had or may have had against Anthony Cardoza (the first defendant), David Cardoza (the second defendant) and others, including 1st Land, CDNL and Oundle.
In this case, NBC alleged that:
- the first and second defendants had received or benefitted from payments in breach of their statutory duties as directors of NTFC; and
- the second defendant's transfer, by way of a gift, of his interest in his family home to his wife, Christina Cardoza (the third defendant), on 3 July 2015 was a transaction at an undervalue designed to put a valuable asset of his beyond the reach of creditors of NTFC, whether now or in the future.
The relief sought by NBC against the defendants included:
- an inquiry into the dealings by the first defendant with a sum of £2.05 million received from Oundle and 1st Land, and what (if anything) remained of that sum;
- an account of what was due from the defendants in respect of breaches of their fiduciary duties and payment thereof;
- a declaration that they hold such sums as may be found to be due on trust for NBC;
- damages or equitable compensation in excess of £1 million;
- restitution of amounts due as monies had and received; and
- other relief including interest.
The relief sought against the second and third defendants included:
- a declaration that the transfer of the family home constituted a transaction defrauding creditors under Section 423 of the Insolvency Act 1986;
- orders to restore the position to what it would have been but for that transfer; and
- other relief including interest.
NTFC and NBC entered into three loan agreements for the purpose of redeveloping NTFC's stadium. In order to fund the development, which involved not just the stadium but also the facilities and an adjacent 30-acre brownfield site, NTFC drew down £10.25 million under the loan agreements.
In 2002 the first defendant and his son, the second defendant, acquired control of NTFC. They were directors of NTFC from 2003 until mid-2015. Together, they acquired a 65% shareholding in NTFC. During 2015, the defendants further increased their shareholding, which by then was some 68%, to more than 75%. Subsequently, the defendants resigned as directors and sold their controlling shareholding on 25 November 2015.
As at 30 June 2002, and shortly before the defendants acquired control of NTFC, NTFC had net liabilities of £2.5 million and accumulated losses of almost £4 million, having made a loss for the year to 30 June 2002 of some £875,000. For all but three of the 13 years that NTFC was under the defendants' control, it was loss making. Its net liabilities increased from £2.5 million at 30 June 2002 to £8.8 million at 30 June 2015 and its accumulated losses increased from almost £4 million to £12.2 million over the same period.
It was in view of the parlous financial state of NTFC that NBC decided to pursue recovery of the loan monies, which included the assignment by NTFC to NBC of all of its rights, title, interests and benefit in and to specified debts and claims.
From early 2015, NBC raised queries with NTFC. NTFC, acting through the second defendant, failed to give satisfactory answers, both in response to emails and at meetings. NTFC also continued to default on making payments when they became due. On 24 September 2015 NBC gave NTFC formal notice of default under the first and second loans and demanded payment of £10.3 million in respect of principal and interest.
Within months, NBC learned that out of the sums drawn down, £160,000 had been used to pay interest and instalments of principal to NBC and more than £830,000 had been paid to NTFC's solicitors. Further, in early November 2015, NBC learned that Her Majesty's Revenue and Customs had presented a winding-up petition against NTFC.
In November 2015 NBC discovered that money drawn down under the loan agreements had been used for unauthorised purposes and not for the intended development. Accordingly, NBC acquired the right to bring claims against the defendants and others, through the assignment. The subsequent investigations resulted in proceedings being brought against the defendants for breach of their fiduciary and statutory duties as directors.
There was no dispute as to the duties of a director or, in this particular case, the scope of the duties owed by the first and second defendant as directors of NTFC. The only areas of dispute concerned:
- the fulfilment of those duties;
- the consequence, if any, for the first defendant and/or second defendant of a breach of duty;
- the remedy, if any, available to NTFC; and
- whether the first and second defendants, if otherwise liable, should be excused from liability under Section 1157 of the Companies Act 2006.(2)
Directors' duties are set out in Sections 171 to 177 of the Companies Act. Accordingly, directors must:
- owe fiduciary duties to act within their powers (Section 171);
- act in the way that they consider, in good faith, would be most likely to promote the success of the company (Section 172);
- exercise independent judgment (Section 173);
- avoid conflicts of interest, whether actual or potential and direct or indirect (Section 175);
- not accept benefits from third parties (Section 176); and
- declare any interest, direct or indirect, in proposed transactions (Section 177).
The pervasive theme of these duties is the obligation to act in the interests of, and show loyalty to, the company. There is a further duty to exercise reasonable care, skill and diligence (Section 174). In relation to the company's assets, the directors are in a position akin to trustees and they must account for any assets they receive.
Among others, oral witness testimony was given by the first and second defendants. The judge's findings were a damning indictment on their characters and presented a useful analysis of the approach the courts will take to oral evidence.
In these proceedings, the court referred to the factors identified for the evaluation of a witness's evidence in Painter v Hutchinson when addressing the unsatisfactory nature of a defendant's approach to giving evidence.(3) These included:
- evasive and argumentative answers;
- tangential speeches avoiding the question;
- blaming legal advisers for shortcomings in statements of case, disclosure and evidence; and
- self-contradiction, internal inconsistency, shifting case, new evidence and selective disclosure.
The guidance in Painter was further developed in Gestmin SGPS SA v Credit Suisse (UK) Limited in which the court noted that human memory is fallible and that the process of litigation and preparing for trial tends to interfere further with the reliability of human memory, particularly where a lawyer has had a hand in drafting a witness's evidence and the witness's memory has been refreshed by reading documents.(4) Applying the guidance in Gestmin, the courts will always strive to base factual findings on facts and documentary evidence and the inferences to be drawn therefrom. By contrast, witness evidence (whether oral or written) is to be regarded and relied on only with a great deal of caution.
In following this guidance, the evidence of the first and second defendants in the present case was largely dismissed as wholly unreliable. Of the former, the judge found that his "demeanour as a witness was urbane and engaging. However, his demeanour is a front for a person who, at least in business and in litigation, is thoroughly untrustworthy". Of the latter, the judge found that:
truth is a concept of no value or significance to [the second defendant], even when on oath. As with [the first defendant], unless consistent with undisputed facts or supported by independent documents, [the second defendant]'s evidence was, and is to be viewed as, unreliable.
As to the substantive matters in dispute, each of the sums received through the loan draw downs, totalling £2.05 million, had been received in breach of the defendants' duties as directors. The first defendant argued that the payments were regarded by him as part repayments of his director's loan account and that he asked the second defendant to record them in NTFC's accounts. The court rejected those arguments. Instead, it held that the defendants had diverted and misappropriated the £2.05 million and deliberately routed it through corporate vehicles "so as to avoid having to record them as reductions in" the loan account.
The evidence as to the first and second defendants' conduct as directors pointed to them, at all times, treating NTFC as their own corporate vehicle and disregarding its status as a separate legal entity owed duties extending beyond the defendants' personal interests. The court found that the defendants had regarded the fact of their majority control of NTFC, the fact that the first defendant had been a major financial backer of the football club, the second defendant's positions as managing director and chair of the football club as sufficient justification to do largely as they pleased when directing NTFC's affairs and business and dealing with its assets, particularly money.
The judge found scant evidence of the defendants paying anything more than lip service to the views of their fellow directors and other stakeholders. Indeed, even in their own evidence, they made very little reference to doing so beyond nebulous suggestions that the other directors knew or must have known what the first and second defendants were doing. In simple terms, the first and second defendants failed to give any independently minded thought to what the interests of NTFC might be.
Accordingly, in respect of the first defendant, it was found that had he genuinely intended to reduce his director's loan account by drawing or appropriating sums totalling £2.05 million, there was a straightforward and honest route which he could have followed. He did not do so. As such, the only conclusion to be drawn was that the payments totalling £2.05 million to the first defendant had been deliberately routed through Oundle and 1st Land so as to avoid having to record them as reductions in the first defendant's loan account. The first defendant knew and intended that the payments came from loan draw downs. Each of the sums received by the first defendant totalling £2.05 million had therefore been received in breach of his duty as a director of NTFC.
As regards the second defendant, he was found to be in breach of his fiduciary duties on the basis that the misappropriation of funds by the first defendant could not have happened without the second defendant's knowledge. Further, over a two-year period, the second defendant had made net withdrawals from his director's loan account exceeding £650,000 when NTFC was insolvent. The court held that the second defendant had been treating his loan account "as a current account available for day to day drawing". In doing so, the second defendant had put himself and his interests before those of NTFC, including its creditors.
The court also held that the transfer by the second defendant to the third defendant of the family home was a transfer at an undervalue, which had the effect of putting assets beyond the reach of any creditor that might make a claim against the second defendant.
The judge commented that, on the evidence, neither the first nor the second defendant had ever considered whether or how their interests might differ from or conflict with the interests of NTFC, nor did they consider what the interests of NTFC might be. However, the judge's condemnation of the first and second defendants' conduct did stop there. Instead, he went on to find that at the core of the case was the first defendant's "lack of candour". He had orchestrated the diversion of money to himself via Oundle and 1st Land with the express intention that it was not to be accounted for as repayment of his loan account. As the judge observed:
If the rhetorical question is posed: for what honest purpose were the payments totalling £2.05million made in the way that they were? No answer realistically founded in honesty would be given. As the three conditions for engagement of the discretion under s.1157 are cumulative, that suffices to dispose of the point.
Likewise, the second defendant's conduct was found to be "neither honest nor reasonable". He too was concerned only with his own interests and had no regard for the interests of NTFC. The second defendant's conduct was plainly neither reasonable nor honest. In the circumstances, he too was not entitled to relief from liability under Section 1157 of the Companies Act.
From the public's perspective, this case was of interest because it served to reveal the misappropriation of public funds, intended for the benefit of a community football club, by dishonest individuals acting in their own self-interests. However, the judgment did not provide the final chapter to the matter. The first and second defendants sought permission to appeal the first-instance judgment. Lord Justice Davis, sitting in the Court of Appeal, refused to grant such permission. However, that final outcome offered little succour. Anthony Cardoza, the first defendant, has now been declared bankrupt, with the misappropriated funds remaining unaccounted for, and an investigation by Northamptonshire Police and the Crown Prosecution Service now understood to be underway.
Whatever the lasting impact on NBC, NTFC and the defendants, the court's findings offer a number of helpful reminders of crucial considerations for both businesspeople and legal professionals:
- First, it is vital to bear in mind that a director of a company must avoid a situation in which they have, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company. It is only right to note that the obligation to avoid potential conflicts is qualified by Section 175(4) of the Companies Act, which provides that the duty is not infringed "if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest" and that that is an objective test, to be assessed on the basis of the view that a reasonable director would reach with the same facts available to them. Therefore, it is not enough that a director subjectively thinks that a situation is unlikely to give rise to a conflict of interest; their view must be reasonable. However, fundamentally, a fiduciary, such as a director, must act in good faith and must not act with the intention of furthering the interests of one principal or objective, to the prejudice of those of another. Directors certainly must not allow the performance of their obligations owed to the company to be influenced by familial relationships.
- Second, lawyers often try to gauge whether a particular person will or, perhaps more importantly, will not make a good witness. The value of that assessment at an early stage cannot be overstated. However, having made such an assessment, there is a the risk that undue reliance will then be placed on the evidence to be given by a witness. In the present case, the judgment suggests it should have been abundantly clear that the first and second defendants were thoroughly disreputable individuals, in whose evidence little confidence could be placed. However, the potential shortcomings in a witness's testimony are not always so immediately apparent. In such circumstances, practitioners must keep at the forefront of their minds the remarks of Leggatt J in Gestmin: "it is important to avoid the fallacy of supposing that, because a witness has confidence in his or her recollection and is honest, evidence based on that recollection provides any reliable guide to the truth".
(2) Section 1157 of the Companies Act 2006 confers on the court a discretion to relieve a director, either wholly or in part, from liability for breach of duty or breach of trust where, notwithstanding that the director would otherwise be liable, he has acted honestly and reasonably, and, having regard to all the circumstances of the case (including those connected with his appointment), he ought fairly to be excused.
This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.