Unlawful distributions and breach of fiduciary duties

13th November 2019

In Burnden Holdings (UK) Ltd (in liquidation) v Fielding [2019] EWHC 1566 (Ch), the High Court rejected numerous challenges brought by a liquidator in respect of the demerger of a subsidiary by way of a dividend in specie which the liquidator claimed was unlawful and the potentially unauthorised grant of security in favour of loans made by the shareholders.

Mr and Mrs Fielding were directors and majority shareholders of the Burnden group of companies including Burnden Holdings (UK) Limited (BHUK), the holding company. The business of most of the companies in the group was the manufacture and sale of conservatories. However, one subsidiary, Vital Energi Utilities Ltd (Vital), provided construction consultancy services. By May 2007, it had become clear that the financial position of the group was deteriorating and that cash was very tight.

In June 2007, the board of BHUK authorised the company to enter into a facility agreement with Mr and Mrs Fielding documenting the provision of £4.64 million which had been lent to BHUK over several years previously, together with a new fixed and floating charge to secure the lending.

In October 2007, a demerger of Vital was achieved by way of a dividend in specie by BHUK of its shares in Vital to Mr and Mrs Fielding. This was followed by a sale of 30% of the shares in Vital to a third party for £6 million. Mrs Fielding immediately loaned half of the sale proceeds to BHUK.

BHUK went into administration in October 2008 followed by a compulsory winding-up order in December 2009. The liquidator brought proceedings against Mr and Mrs Fielding for breach of fiduciary duty in respect of the two transactions affecting BHUK prior to administration, namely the granting of the security and the dividend in specie.

Security

The liquidators claimed that the security was unauthorised because the decision to grant it was not made at a valid board meeting and that the other directors were unaware that the loans had already been advanced by the Fieldings. The liquidator argued that the directors of BHUK had breached their duties in granting the security on the basis that there had been no commercial benefit to BHUK. In the alternative they argued that the grant of new security constituted a transaction defrauding creditors under section 423 of the Insolvency Act 1986.

The court dismissed each of these claims. The judge found that the granting of the security had been duly authorised with the intention that it be given for advances already made. It was also held that there was a commercial benefit to BHUK because of the group’s cash flow difficulties and the fact that the Fieldings were owed substantial sums which they could have demanded repayment of at any time. Since there was a commercial benefit, it was not a transaction at an undervalue and therefore section 423 of the Insolvency Act 1986 did not apply.

Dividend in specie

The liquidators claimed that the dividend in specie was unlawful because it did not meet the requirements of section 270 of the Companies Act 1985 (which was the relevant legislation at the time). In particular, the accounts that had been used did not allow a reasonable judgment to be made regarding the assets, liabilities, profits and losses of the company and in fact, there had been insufficient distributable reserves to declare the dividend. It followed that the dividend was unlawful and had been declared in breach of the directors’ fiduciary duties. It was also argued that if the dividend was unlawful, the defendants were strictly liable.

The liquidators also argued that Mr and Mrs Fielding were in dishonest breach of their fiduciary duties because at the time the dividend in specie was declared (or as a result of it), they knew that BHUK was insolvent or likely to become insolvent and they failed to take account of the interests of BHUK’s creditors. As such the dividend was a transaction defrauding creditors within the meaning of section 423 of the Insolvency Act 1986.

The court dismissed all of the liquidators’ claims. The judge held that the accounts were sufficient to allow a reasonable judgment to be made as to BHUK’s ability to declare a dividend and that distributable profits were indeed available. The dividend in specie was therefore not unlawful. Even though not strictly necessary, the judge went on to explore whether liability for unlawful distributions was strict or fault based. After a comprehensive review of the case law, the judge departed from the provisional view expressed by the Supreme Court in Re Paycheck Services 3 Ltd [2010] UKSC 51 and stated that liability for unlawful dividends was fault based. A director will be liable in respect of an unlawful dividend only if he:

• knows that the dividend is unlawful
• knows the facts that establish the impropriety of the payment (whether or not he appreciates that they render the dividend unlawful)
• must be taken in all the circumstances to know the facts rendering the payment unlawful
• ought to have known, as a reasonably competent and diligent director, that the payments were unlawful.

The court also rejected the argument that Mr and Mrs Fielding were in dishonest breach of their duties. The liquidators had not discharged the burden of showing that BHUK had been rendered insolvent as a result of the dividend in specie and accordingly the creditors’ interests had not arisen. The court accepted that neither of the defendants were actually aware that BHUK was insolvent and so they had not dishonestly breached the duty.

WM comment

This decision is important reading for anyone planning a demerger or distribution and in particular with regard to its conclusion on the nature of a director’s liability for unlawful dividends. Directors are not required to be accountants and can rely on the advice of others who have a more specialist role. So long as directors take reasonable care when establishing the availability of profits, they will avoid personal liability if it turns out the distribution was in fact unlawful.