Have corporate vehicles reached their limit?

A misfeasance claim under section 212 of the Insolvency Act 1986 (IA) is often a race against time to gather evidence and bring a claim before the limitation period expires. Not only can the breach pre-date the liquidation by years, but the difficulty is even greater where there is a maze of group companies and intra-group transfers. It takes time to properly work out whether a simple transfer of assets between group companies is actually a corporate shield hiding misappropriated assets.

The Supreme Court in Burnen Holdings (UK) Limited v Fielding and another [2018] UKSC 14 has come to IPs’ aid by unanimously confirming that section 21(1)(b) of the Limitation Act 1980 (LA80), which is primarily aimed at express trustees, extends to directors by analogy. However in doing so, the decision raises fundamental questions of corporate legal personality and anti-avoidance measures.

The case background

The claimant was a holding company with a number of trading subsidies operating in two business areas: the supply and construction of conservatories, and a combined heat and power business. Vital Energi Utilities Ltd (Vital) operated the combined heat and power business.

The directors of Burnen were at all material times the appellants (Mr and Mrs Fielding) and three other individuals (executive directors). The Fieldings were also the controlling shareholders. In or around July 2007, Scottish & Southern Energy Plc (SSE) offered to purchase a 30 per cent shareholding in Vital, subject to a significant number of conditions, including the complete separation of Vital from the conservatory business. To facilitate this, in October 2007 a number of prearranged transactions were carried out:

• On 4 October 2007, Burnen’s shareholders exchanged their shares for shares in a new group holding company, BHU Holdings Ltd (BHUH), with the shareholdings precisely mirroring the former shareholdings in Burnen.
• On 12 October 2007, a distribution in specie (ie a distribution paid using a non-cash asset) of Burnen’s shareholding in Vital was approved by unanimous resolution of the directors of Burnen and by a resolution in writing of BHUH as the sole member of Burnen. The distribution happened the same day, with the transfer of the only issued share in Vital from Burnen to BHUH being recorded in Vital’s register of members on that date.
• On 15 October 2007, BHUH went into members’ voluntary liquidation. A special resolution to that effect was passed on that day by the members of BHUH. The directors of BHUH made the usual statutory declaration as to the group’s solvency.
• On the same day, pursuant to reconstruction agreements made under section 110 IA, the liquidator of BHUH transferred the share in Vital to a new company, Vital Holdings Limited (VHL) and the shares in Burnen to a new company, Burnen Group Holdings Limited (BGHL). The two new holding companies issued shares to the former shareholders in BHUH, which again precisely mirrored their shareholding in BHUH and previously in Burnen.
• On 19 October 2007, Mrs Fielding sold a 30 per cent shareholding in VHL to SSE for £6 million. Of that sum, £3 million was lent to Burnen and the balance was, according to Burnen’s case, put towards the purchase of property for £8.3 million by Mr and Mrs Fielding in May 2008.

  In December 2009, Burnen went into liquidation and the present liquidator was appointed in December 2012.

  The liquidator argued that Burnen did not have sufficient accumulated, realised profits to enable the distribution in specie of the claimant’s shareholding in Vital toBHUH. Burnen subsequently amended its claim to include an allegation of fraudulent breach of trust. The appellants ‘hotly contested’ Burnen’s claim throughout. The claim form was issued on 15 October 2013, six years and three days after the date of the relevant breach, on the date the shareholding in Vital was distributed. At first instance, the Fieldings successfully applied for summary judgment to dismiss the claim as statute-barred under section 21(3) LA80. This was overturned on appeal by Burnen and the Fieldings subsequently appealed to the Supreme Court.

Supreme Court decision

The Supreme Court proceeded on the following assumptions: that the distribution was unlawful; that the appellants’ participation in it amounted to a breach of their fiduciary duties to Burnen and that, because the distribution was made to a company (BHUH) in which they were majority shareholders and directors, the distribution was one from which they derived a substantial benefit. Section 21(1)(b) requires two elements: that the trust property is in the possession of the trustee or previously received by them; and that the trustees convert that property for their own use.

Possession
For the purposes of section 21, it was common ground (and ‘clear beyond argument’) that the appellant directors were to be regarded as trustees (paragraph 11). The Supreme Court held that directors were fiduciary stewards of the company’s property and owed fiduciary duties to the company as a result.

Conversion
The purpose of section 21(1)(b) was laid down by Kekewich J in In re Timmis Nixon v Smith [1902] 1 CH 176: ‘The intention of the statute was to give a trustee the benefit of the lapse of time when, although he had done something legally or technically wrong, he had done nothing morally wrong or dishonest, but it was not intended to protect him where, if he pleaded the statute, he would come off with something he ought not to have, ie money of the trust received by him and converted to his own use.’ 

The appellants fell within section 21(1)(b) because of their analogous status as trustees who converted Burnen’s shareholding in Vital when they procured or participated in the unlawful distribution of it to BHUH. On the basis of the assumed facts, the Supreme Court dismissed the appeal. 

On the back of this finding, Lord Briggs did not consider it appropriate to reach any final view about section 32 LA80, which stops the limitation clock ticking where there has been fraud, concealment or mistake.

Implications

Prior to Burnen, it was already thought that the six-year limitation period did not apply to claims to recover trust property (such as unlawful dividends) from a director under section 212 IA. Given the assumed facts, the Supreme Court’s decision should not come as a surprise. As Vice-Chancellor Norris J observed in an earlier interlocutory hearing ([2014] EWHC 1908 (Ch)), the heart of the matter was that the appellants had procured Burnen to enter into a transaction by which it had lost the value of a business worth £10.48 million in return for a loan of £3 million.

The Supreme Court did caveat its decision by highlighting that section 21 LA80 is primarily aimed at express trustees and applicable to company directors by a ‘process of analogy’. The problem with analogies is that they break down on the facts. While an express trust has many similarities to a company, it is not the same. Equating the vesting of trust property in trustees to the control that directors have over company property arguably undermines corporate legal responsibility. This point was made by the appellants, who argued that from start to finish the relevant trust property (the shareholding in Vital) had been in the legal and beneficial ownership, and therefore possession, of a succession of corporate entities, namely Burnen, then BHUH and later VHL. To hold otherwise would, the appellants submitted, involve the lifting of one or more corporate veils or ignoring the separate legal personality of the companies concerned, in circumstances that fell outside the principles of Prest v Petrodel Resources Ltd [2013] 2 AC 415. 

While accepting these submissions had real force, the Supreme Court nonetheless dismissed them: notwithstanding the fact that the misappropriated property had remained legally and beneficially owned by corporate vehicles, the directors were fiduciary stewards of the company’s property. However, while recognising a substantial overlap, there are fundamental differences between a company and a trust. 

For example, majority shareholders have much less than absolute control over company property, because of the requirement to have regard to the interest of other stakeholders such as minority shareholders and creditors. Faced with increasingly complex and inventive group structures or remuneration strategies (such as the part-salary and quasi-dividend structure in Global Corporate v Hale [2017] EWHC 2277 (Ch)) the Supreme Court has shown its willingness to peer behind these structures to examine the reality of the situation rather than accept them on face value. The lower courts will undoubtedly follow this approach, which should encourage IPs who are dealing with employee benefit trusts and other remuneration schemes to challenge directors. Now that the limitation bar appears to have been lowered, directors should carefully consider their insurance policies to ensure that potential claims are covered. 

Notwithstanding this judicial encouragement (based on the assumed breach of fiduciary duties), these cases turn on their own facts. Specialist advice should be sought to consider the position, including the advice received by the director at the time and their reliance upon that advice. It may be the case, as was considered in the High Court in Burnen ([2017] EWHC 2118 (Ch)), that a director who has acted in breach of duty can no longer claim to have acted honestly and reasonably in anything but the most extreme of cases. As part of any advice, IPs should explore the opportunity for quick deals with directors who are likely to be eager to settle potential liabilities.

Emboldened IPs

The risk for directors is not isolated to the insolvency context given that their dealings with company property may now be subject to scrutiny without limitation. Therefore, even in times of bounty, shareholder-directors who want to declare dividends to extract value from their companies need to have careful regard to the structure of any transaction or risk future creditors challenging them. The decision in Burnen should embolden IPs and litigation funders alike.

This article was published in the summer 2018 edition of Recovery Magazine by R3.