Director Counts Cost of Preferential Payments

Company directors should know that as well as their duties to shareholders, they also have a duty under both common and statute law to protect the interests of creditors. When this duty is not adhered to, the consequences can be severe, as a recent case illustrates.

The director concerned was a director of a group of companies which built waste recycling facilities. The company incurred substantial losses and administrators were appointed to manage the group companies in 2005.

Between the appointment of the administrators and October 2008, when liquidators were appointed, the company was unable to pay its debts as and when they fell due and was therefore insolvent.

During this time, the director had authorised payments of more than £2.8 million, some of which were made to him personally and some to a company in Portugal that he controls and which was owed money.

The liquidators sought to recover the sums he had caused to be paid on the basis that he had failed in his duty to act in the best interests of the creditors. Whilst this is essentially a subjective test, the High Court considered that a director’s duties as regards creditors are ‘paramount’ when considering the exercise of his or her discretionary powers.

In addition, the Court considered that an objective test must apply when there is no actual evidence that the director’s actions were in the best interests of the company and its creditors. In this case, the question was whether an intelligent and honest man in the director’s position would reasonably have believed that the action taken was in the best interests of the company and its creditors.

The director claimed that he had reasonably considered that one large creditor was not a creditor at all and that payments he had made to himself, which he had used to discharge a private loan, were indirectly to the benefit of the company as he could thereby advance further sums into the company. There was no dispute that some of the payments had been used to reduce the company’s liabilities.

On the evidence, the Court considered that the director had chosen whom to pay and whom not to pay, rather than considering the interests of creditors as a whole.

His claim that he had acted honestly and reasonably having regard to all the circumstances was also rejected. The Court ordered the director to reimburse the company for the improper payments, with a reduction for the sums used to reduce the company’s liabilities, subject to the proviso that a contribution with regard to these be made such that the recipients of those payments were not unfairly advantaged relative to the creditors as a whole.

The result was that the director was ordered to repay more than £2,500,000.

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Categorised in: Company and Commercial Law, Latest news

This post was written by Colemans Solicitors LLP