A recent English case has considered for the first time whether and if so to what extent the general duties of a director survive a company’s entry into an insolvency process.

The Court held the fiduciary duties owed by a director to a company and its creditors survive the company’s entry into administration and voluntary liquidation, and that those duties are independent of and run parallel to the duties owed by an administrator or liquidator appointed in respect of the company. It is important that Insurers check whether their D&O policies will cover management liability for wrongful acts committed during a company’s insolvency.

The facts

Brian Michie was the sole director and shareholder of System Building Services Group Limited when it was placed into administration in 2012. The administration was converted into a creditors’ voluntary liquidation in 2013 and the company was dissolved in 2016. The company was restored to the register in 2017 to allow the company and its newly appointed liquidator to apply for relief in connection with various activities of Mr Michie whilst the company was insolvent.

The first head of claim concerned a residential property acquired by Mr Michie in 2014 from the company (acting by its former liquidator). It was alleged the property was purchased at a substantial undervalue, for Mr Michie’s own benefit and without regard to the interests of the creditors as a whole. The second claim concerned a series of payments that were paid out of the company’s bank account shortly after the company’s entry into administration. It was alleged that, in causing or allowing these payments to be made to a third party, Mr Michie acted in breach of his fiduciary duties.

Legal principles

In brief summary, the general duties of a director are as follows:

  • a duty to only exercise powers for the purposes for which they were conferred
  • a duty to promote the success of the company
  • a duty to exercise independent judgment
  • a duty to exercise reasonable care, skill and diligence
  • a duty to avoid conflicts of interest
  • a duty not to accept benefits from third parties
  • a duty to declare an interest in a proposed transaction or arrangement with the company.

These duties (as set out and/or referred to in Sections 171 to 177 of the Companies Act 2006) are fiduciary in nature.

Where a company is insolvent or likely to become insolvent, the duty of a director to act in the best interests of the company is regarded as a duty to act in the interests of its creditors as a whole. At this stage, the interests of the company are regarded as the interests of the creditors alone; their interests are generally regarded as becoming paramount.

The Court’s decision

There was considerable debate at trial on whether and if so to what extent the general duties of a director survive the company’s entry into an insolvency process. The claims against Mr Michie would effectively turn upon the answer to this issue.

The Court (Judge Barber) decided the general duties of a company director do survive the company’s entry into administration and creditors’ voluntary liquidation. Judge Barber held: “Whilst in office, a director continues to owe the company the duties laid down in ss171 to 177 CA 2006, as applied and interpreted in accordance with the underlying common law rules and equitable principles on which such duties were based … The fact that, on a company’s entry into administration or creditors voluntary liquidation, the Insolvency Act 1986 is engaged, imposing a series of additional specific duties on the part of a director and limiting his managerial powers to those authorised under or in accordance with the Act, does not, in my judgment, operate so as to extinguish the fundamental duties owed by a director of a company to the company as reflected in ss.171 to 177 CA 2006.”

Applying this principle to the facts, the Court found that in procuring and agreeing to an off-market sale of the property to himself at what he knew to be a significant undervalue, at a time when he knew the company to be insolvent, Mr Michie acted entirely out of self-interest and failed to have regard to the interests of the creditors as a whole. Accordingly Mr Michie had acted in breach of his fiduciary duty to consider and act in the interests of the creditors as a whole.

With respect to the payments made to the third party, the Court found that Mr Michie had acted in breach of his fiduciary duties in causing or knowingly allowing the third party payments to be made after the company was placed in administration. Mr Michie failed to give proper consideration to the interests of the creditors as a whole, in particular their entitlement to share rateably in the company’s assets on a pari passu basis; he also failed to exercise reasonable care, skill and diligence.

Comment

Whilst perhaps not surprising, this case helpfully clarifies that fiduciary duties owed by a director to a company and its creditors survive the company’s insolvency, and that those duties are independent of and run parallel to the duties owed by an administrator or liquidator appointed in respect of the company. It is important that Insurers check whether their D&O policies will cover management liability for wrongful acts committed during a company’s insolvency.