Director's Remuneration as Misfeasance?
The High Court has recently handed down judgment in a case that required it to consider whether directors of a company, who did not have an employment contract, service contract, or any form of recognition of status as employee of the company, were entitled to remuneration or to withdraw monies from the company.
The case (Ball (PV Solar Solutions Ltd) v Hughes and another  EWHC 3228 (Ch)) concerned an owner-director business, PV Solar Solutions Ltd, (the "Company") which was entered into a form of employer-financed retirement benefit scheme (EFBRS) by its two directors, who were also the only two shareholders in the Company. The EFBRS was set up as a discretionary trust in March 2012 and the directors caused the following credits to be made to their director loan accounts under the terms of the trust arrangement:
19 April 2012 - £220,000 against each director's loan account;
30 June 2012 - £75,000 against each director's loan account; and
4 December 2012 - £62,400 as against one director's account and £98,400 against the other director's account.
The total value of the credits applied to the directors' accounts was £750,800. The purpose of the EFBRS trust, and the application of the credits to the loan accounts, was to avoid paying tax on the director's remuneration.
The Company began to experience financial difficulties in May 2013 and entered administration, ultimately resulting in creditors' voluntary liquidation in November 2014.
The liquidator of the Company alleged that the directors were in breach of their duties as directors and therefore made an application under section 212 of the Insolvency Act 1986 to pursue them for misfeasance.
Misfeasance is a claim available to a company (and/or a liquidator or administrator on the company's behalf) against the company's director(s) or anyone managing the company's affairs. Misfeasance occurs where director(s) (or managers) of an insolvent company has misapplied, retained or become accountable for any money (or other property of the company) or has breached any fiduciary or other duty in relation to the company. Director's general duties are set out in sections 171 to 177 of the Companies Act 2006 ("CA 2006").
The allegations levelled at the directors were that in causing the credits to be made to the directors loan accounts, at a time that the Company was cashflow insolvent (in respect of the April and June credits) and both cashflow and balance sheet insolvent (in respect of the final credit), the directors acted in breach of duty. Namely that the directors had misapplied the assets of the Company for their own benefit, failed to exercise their powers for proper purposes (section 171 CA 2006) and acted in breach of their fiduciary duty to act in the best interests of the Company's creditors (section 172 CA 2006).
The court agreed and found the directors guilty of misfeasance under section 212 of the Insolvency Act 1986. The court was satisfied that an intelligent and honest man in the position of a director of the Company could not reasonably have believed that the credits were for the benefit of the Company's creditors.
The court found that the directors were not entitled to make the withdrawals from the Company in the form of credits to the directors accounts as they had no formal contract of employment with the Company, nor had they (as shareholders) passed a resolution that they were entitled to payment. It is generally only on the basis of a formal contract or member's resolution that directors are entitled to legitimate remuneration from a company.
Further, the court found that at the time of each credit, the directors had not acted so as to promote the success of the Company because they had not considered the interests of the Company’s creditors as a whole. The duty to consider the creditors interests as paramount arises in circumstances where a company is insolvent, which the Company was found to be at the time of the first credit payment to the director's accounts (and thereafter).
Finally, the court rejected an attempted defence under the Duomatic principle. That is, where the actions of a director are ratified or authorised by the shareholders. The argument was raised on the basis that since the directors owned the entire issued share capital of the Company, they must be taken to have approved the application of the credits to the directors' accounts. However, not only was there no evidence that the directors had applied their minds as to ratifying the transactions, the Duomatic principle does not apply where a company is insolvent or rendered insolvent by the actions of the director(s). The Duomatic principle, therefore, would not come to the directors' aid.
The directors were ordered to repay over £750,000 back to the Company, plus interest.
Notwithstanding any further submissions in the case, nor any comment as to the trust scheme entered into by the Company directors, the situation could potentially have been avoided by the directors ensuring they had a contractual right to payment – either via a service or employment contract or by ordinary resolution. This serves as a stark warning to any directors without a right to payment from a company for which they act as director.