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Citation 2009 Scot (D) 14/7
Alternative Citations [2009] CSOH 93
Hearing Date 30 June 2009
Court Outer House, Court of Session
Judge Lord Hodge
Representation O'Brien (instructed by Shepherd & Wedderburn LLP) for the pursuers. The defenders represented themselves.
Abstract
Insolvency – Administration. Court of Session: In an action in which administrators sought to recover funds allegedly misappropriated by the directors of an insolvent company, who had failed to perform their statutory duty to maintain proper financial records, the court determined the sums due to and from the directors.
Catchwords
Insolvency – Administration – Breach of fiduciary duty – Administrators seeking to recover funds allegedly misappropriated by company's directors – Directors failing to perform statutory duty to maintain proper financial records – Determination of sums due to and from directors.
Summary
This was an action by T Ltd, a company in administration, against its directors, AS and LS, to recover funds which it alleged they misappropriated. The first defender, AS, who was an experienced property developer, wished to retire in 2000. He and his wife purchased a house in France. But as his son, LS, the second defender, wished to continue in property development, AS funded T Ltd as a vehicle for that. T Ltd was incorporated in February 2000. The shareholders were AS and his wife, HS. The original directors were LS and his wife, CS. LS was the company secretary and initially was principally responsible for its management. AS came out of retirement and became a director in December 2002 after the company encountered financial problems. At the same time CS resigned as a director. T Ltd faced commercial and administrative problems.
Delays in relation to a development of 59 houses at West Kilbride caused serious financial problems. As a result AS made substantial loans to the company and involved himself in its business as a director from December 2002. The principal administrative problem was the defenders' failure as directors to keep proper records of the company's business affairs and financial position. They failed to complete and lodge company accounts for the financial years ending 28 February 2004 and 2005 within ten months of the end of the relevant accounting reference periods. Accordingly, the last audited accounts for T Ltd, prepared by GH & Co, were the accounts to 28 February 2003. They showed a deficit of £643,779 on the balance sheet and recorded a director's loan of £219,779 by AS, stated to be unsecured, interest free and repayable on demand. Because of the inadequacy of T Ltd's financial records its auditors wrote a disclaimer in the 2003 accounts.
They also wrote to the directors in September 2004 to warn them of the serious inadequacy of the company's accounting records. In May 2005 the directors engaged PKF as the company's auditors. They produced detailed draft accounts for the year ended 28 February 2004. However, the directors never approved those accounts. On 31 July 2006, DH and JS were appointed joint administrators of the company on the application of its bankers, the Royal Bank of Scotland. JS estimated that T Ltd owed the bank about £540,000 at that time. It also had unsecured creditors with claims of about £150,000. LS did not co-operate with the administrators' staff, in breach of his duty under s 235(2) of the Insolvency Act 1986. He delayed providing the administrators with the company's books and papers. He told them his father lived in France and had not been involved in the company's day-to-day affairs. He did not disclose his home address to them. The defenders did not produce a statement of affairs to the administrators, contrary to their obligation under the 1986 Act. In the summons the pursuers averred that the defenders were in breach of their fiduciary duties and sought payment of sums either as loss and damage arising from that breach or under an accounting for the benefit of unlawful payments. They had three joint and several conclusions, namely (i) for £343,855.48 plus interest, which was averred to be the balance due by AS to T Ltd after allowing for the loans he made to the company; (ii) for £179,500 plus interest, which was averred to be the sum LS misappropriated from T Ltd, net of a loan of £40,000 he made to the company; and (iii) for £46,500 plus interest, being payments made to HS, to Colinton Country Cattery and Goldacre Racing which the pursuers asserted were misapplications of T Ltd's funds. The pursuers sought payment jointly and severally on the basis that the defenders both withdrew substantial sums from T Ltd and were both responsible for the failure to keep proper accounting records. AS and LS in their evidence explained the informal way in which they carried on T Ltd's business. AS spoke of their practice of drawing cash from the company's bank account to pay tradesmen and miscellaneous expenses associated with the West Kilbride development. When the company's bank started to dishonour its cheques, the directors had to use personal funds to meet its liabilities. One of the problems for the defenders was their failure to keep any cash books, ledgers or management accounts to vouch T Ltd's business expenditure. There was no bank reconciliation, no wage records other than incomplete weekly wage sheets, very limited PAYE documents and no VAT records. As a result the defenders were not able to vouch by management accounts and other financial records that expenditure was incurred and money withdrawn from T Ltd was used on the company's behalf. The court found some of the defenders' evidence significantly unsatisfactory. Nonetheless, it accepted their evidence of a course of conduct in which they both made many cash payments on the company's behalf with money withdrawn in round sums from its bank accounts without keeping adequate records of the expenditure. It also accepted that they used personal funds to pay the company's subcontractors and suppliers, particularly in 2004 when the bank stopped some of T Ltd's cheques.
The court ruled:
The starting point of any consideration of the administrators' claims had to be the failure of T Ltd's directors to perform their statutory duty to maintain proper financial records. As a result the administrators had had to spend large sums attempting to recreate a reasonably accurate financial picture of the company's business. When insolvency occurred the court would take a strict view of the rights of people who had sought to benefit from trading through a vehicle with limited liability while failing to perform the legal duties imposed on them. They could not be heard to complain if, through their own failures, they were not able to vouch the entitlements they claimed. In support of various claims they asserted against T Ltd the defenders founded on copy company documents they produced to their solicitors in April or May 2007. The defenders did not have the principal documents but suggested that they would have been with T Ltd's company file, which LS said he had handed over to the administrators' staff in August or September 2006. Counsel for the administrators challenged the authenticity of the documents. The court accepted the administrators' evidence that LS did not give them the principal documents with the company's papers. It was satisfied on the balance of probabilities that the defenders did not create the disputed documents after the litigation was underway but was not satisfied that they had proved that the documents were executed on the dates they bore. It appeared that the documents were produced at some stage to provide documentary vouching for claims by the directors against the company. The court considered the individual documents and whether they had any legal effect. (i) The defenders sought to set off claims for remuneration they asserted was due to them under written service agreements against T Ltd's demand that they repay money obtained from the company. LS also asserted that some of the money he withdrew from the company was payments of his salary as a director. The agreements, and purported written resolutions by the shareholders, bore to be dated 1 March 2003. Because the defenders had not established when the service agreements were executed and in any event because the agreements were never implemented, the court was satisfied that, at best for the defenders, they did not intend that the documents should have contemporaneous legal effect. The documents were defensive documents the defenders created to protect themselves in the context of insolvency procedures against T Ltd. Accordingly they did not vouch valid legal claims. The defenders advanced no other legal basis for LS's drawings of £141,500. As a result, the court rejected his claim for drawings of salary and his alternative claim for undrawn salary. It also rejected AS's claim for £154,792 in respect of undrawn salary. That meant that the defenders did not have a claim for reimbursement for the work they did for the company from 1 March 2003 onwards. On one view that was a harsh judgment and the company and its creditors were enriched by not having to give credit for their services. But as fiduciaries the defenders were under a duty to have any remuneration approved by the company and they did not do so. By their failure to keep proper financial records they had caused the administrators to incur significant costs, thereby reducing the funds available to T Ltd's creditors. (ii) The defenders also argued that from 1 March 2003 they were entitled to interest on the balances in their directors' loan accounts. They founded on an alleged minute of a meeting of T Ltd's directors dated 1 March 2003 and an alleged written resolution of its members for the purposes of s 320 of the1985 Act. As the defenders had failed to prove when the relevant documents were executed and had never disclosed them to the company's lawyers or accountants, notwithstanding their potentially significant effect on its financial position, the court was satisfied that those documents again were latent defensive documents with no legal effect. The defenders also founded on a personal bond dated 24 February 2004 in which T Ltd acknowledged receipt of a loan of £50,000 from AS, supported by a purported written resolution of the same date. While there was no dispute about the loan, the court was again not satisfied, for the same reasons, that the personal bond had any legal effect. Accordingly, the defenders were not entitled to claim interest from T Ltd on any credit balances on their directors' loan accounts. (iii) T Ltd faced a financial crisis in second half of 2004 when the Bank of Scotland sought a reduction in the company's indebtedness under its West Kilbride facility. To reduce its indebtedness, AS purchased 164 Woodhall Road, Edinburgh from the company. It had purchased that property as a potential development site in February 2004 for £1m. In the missives of sale to AS, in the disposition by T Ltd and in the Land Register the consideration for his purchase was stated as £1.1m. In February 2007 the pursuers' solicitors wrote to the solicitors who acted for T Ltd in the transaction. They confirmed that AS had bought the property from the company for £1.1m, its open market value in December 2004. The purchase had been funded in part by a loan of £825,000 to AS from a division of the Bank of Scotland, and in part by reducing his director's loan account by the balance of £275,000. In support of their evidence about the transaction the defenders referred to a purported written resolution of T Ltd's shareholders dated 24 November 2004 approving the sale, and a minute of a directors meeting on the same date which stated that all parties had agreed that the purchase price was to be £825,000. The court did not accept the defenders' evidence that the sale was at that price, or their assertion that the company's solicitor knew that that was the actual purchase price, notwithstanding the price stated in the missives and disposition. Were it otherwise, the sale would have been at a substantial undervalue as AS could have marketed the property shortly after taking title and made a profit of about 25%. The documents on which the defenders founded had no legal effect. They had not established in evidence when the documents were prepared. They were at best a latent defensive mechanism to cover the company's possible insolvency. Accordingly the balance on AS's loan account required to be reduced by £275,000. (iv) The pursuers asserted that the defenders misappropriated the free proceeds of the sale of a property which T Ltd owned in Johnstone. In September 2005 it sold the property for £610,000. It repaid a loan secured over the property from the sale proceeds and transferred £292,539.59 to AS's Jersey bank. The defenders' evidence was that the money was transferred to AS to reduce the company's indebtedness to him. They also said that AS had asked his son to lend the company £40,000 during its 2004 financial crisis and that LS had raised the money against the security of his home. Contemporaneous documents vouched the secured loan of £50,000 and LS's transfer of £40,000 to T Ltd. AS explained that he repaid his son at the earliest opportunity by transferring £50,000 of the sale proceeds of the Johnstone property to him. The administrators did not dispute that transfer and the court saw no reason to doubt the accuracy of the defenders' evidence that he transferred the sum for the reasons he stated. As a result, in striking a balance of sums due to and from the directors, LS fell to be treated as having received £50,000 of T Ltd's money and £242,539.59 should be debited against AS's loan account. (v) The defenders also claimed that AS was entitled to be indemnified by T Ltd for the costs he incurred in purchasing properties from the company in its 2004 financial crisis. He purchased not only 164 Woodhall Road but also plot 45 at the West Kilbride site. In relation to the latter purchase the defenders founded on an alleged minute of a meeting of T Ltd's directors dated 1 November 2004 resolving that the company should reimburse all costs which AS incurred in that purchase, and on a substantially identical minute in relation to 164 Woodhall Road. The court was prepared to recognise the agreement to reimburse the costs of acquiring plot 45 as it was likely that the defenders agreed that the company would do so, but was not satisfied that they had proved such an agreement in relation to 164 Woodhall Road. (vi) The administrators also challenged many cheques drawn on the company's bank accounts in favour of AS or LS, and parties disputed whether sums the defenders paid out of their own funds might properly be attributed to expenditure on T Ltd's behalf. The court accepted that various items of miscellaneous expenditure by AS were incurred on behalf of T Ltd and to deduct them from his liability. It was prepared treat £26,000 which LS withdrew from the company's accounts in cash, which he said was used to pay the wages of T Ltd's employees, as expenditure on behalf of the company. Between 1 March 2003 and T Ltd's administration LS withdrew £141,500 from the company in monthly payments of remuneration as director. In view of his breaches of fiduciary duty the court could see no way of giving him any credit for his work as a director in the absence of approval of his remuneration by the company. It therefore had to treat the £141,500 as misappropriated. AS and LS gave evidence that T Ltd employed HS to market the company's properties and that she incurred expenses, inter alia, in fitting out show houses. She explained that she purchased goods on her own account and presented the invoices to her son, LS, for reimbursement. The company made three payments to her totalling £35,000. Documentary vouching of the expenditure said to be reimbursed was in short supply. However, the court accepted that the payments were legitimate payments connected to T Ltd's business. AS explained that T Ltd's payments of £6,500 to Colinton Country Cattery in June 2005 were for maintenance works on 164 Woodhall Road while T Ltd owned it. While again concerned about the poor quality of the vouching, the court was prepared to accept the defenders' testimony on that matter. As a result they were not liable to repay any of the sums sought in the third conclusion of the summons. The court calculated the balance due by AS to T Ltd as £175,305 and the balance due by LS as £124,931.
Decree would be granted against the defenders jointly and severally for payment to the pursuers of (i) £175,305 in terms of the first conclusion and (ii) £124,931 in terms of the second conclusion of the summons.
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