Pitfalls to avoid for directors

This article was co-authored by Hannah Wathes, Trainee Solicitor.

Some company directors are far better at trading than at company administration. The potential consequences for directors in failing to comply with company law was highlighted following a successful, triple-summary judgment application by Kennedys in the Insolvency and Companies Court (ICC).

Background

Kennedys acted in relation to the defence of three shareholders’ unfair prejudice petitions brought by Mr Richard Padun (the Petitioner). The Petitioner alleged that he had been improperly forced out of the management of two companies associated with Interactive Media Group Limited (IMG), which caused his shares in all three companies to become worthless. These three companies are now all in liquidation.

On review of the Petitions, it became apparent that IMG had been the original owner of the other two companies, and that the directors had mistakenly thought they had personally become owners of the two companies in place of IMG, by merely submitting a Companies House filing stating that - without any stock transfer form or payment to IMG. ICC Judge Jones found that the Petitioner had never owned shares in the two companies and so gave reverse-summary judgment in favour of Kennedys’ client in the two Petitions. The remaining IMG Petition faces substantial amendment before it can continue.

The error about shareholding was not the only criticised conduct. ICC Judge Jones opened his judgment stating, “this is a case for which one could be forgiven for thinking it concerned directors’ disqualification proceedings rather than consisting of three unfair prejudice petitions,” and the case was referred to the companies’ liquidator and the Insolvency Service.

We have highlighted below key observations made by ICC Judge Jones, which may be a useful reminder to Directors & Officers insurers and brokers, their SME insured directors, and professionals within the insolvency space.

Companies House Filings

The directors' incorrect belief about the legal ownership of shares resulted in inaccurate information being filed at Companies House. There were further incorrect filings whereby other directors purported to take the Petitioner’s shares.

Section 1112 of the Companies Act 2006 establishes that filing a ”misleading, false or deceptive” document is a criminal offence, though prosecutions are rare.

Lack of Shareholder Register

ICC Judge Jones commented that “none of the companies, subsidiaries or parent, have complied with section 113 of the Companies Act which requires each company keep a register of its members and provides for a criminal offence in the event of a default”. (A shareholders’ register was since found in the companies’ online corporate-secretarial subscription service).

A breach of section 113 entails a failure to keep a register “without reasonable excuse”. The penalty can be a considerable fine.

Interests of creditors

The directors’ attempt, unsuccessfully, to transfer the shares of two subsidiaries to themselves, was apparently done to “save them” prior to winding up the parent company, IMG. However, ICC Judge Jones commented, “Directors cannot simply transfer a company’s assets to themselves for no consideration whether the company is solvent or insolvent or the subject of immediate insolvency.”

The Petitioner also claimed to have personally taken dividends from the two subsidiaries, which the Judge criticised because IMG was the one entitled to any dividends.

It is important for directors to remember in the context of insolvency, they owe a duty to prioritise the interests of creditors. The Judge noted that the transfer of shares here would have amounted to an obvious misfeasance or misappropriation contrary to the directors fiduciary duties.

Accurate information to creditors

The Petitioner had informed a creditor, via e-mail, that IMG had no assets, just before putting it into liquidation. However, this email, and the Statement of Affairs authored by another director, overlooked IMG’s ownership of various subsidiaries. These were therefore not accurate statements.

It is an offence per section 211 of the Insolvency Act 1986 to make “a false representation for the purpose of obtaining consent to wind up”, the penalty being a fine or imprisonment. Making a false representation could amount to fraud/dishonesty, with potential coverage implications.

Comment

This judgment acts as an important reminder of the various duties owed by directors, including corporate secretarial duties, that can be overlooked. Directors should be mindful to stay on top of ‘housekeeping’, and perhaps (if in doubt) use a professional corporate secretary, to avoid falling foul of the Companies Act.

Seeking legal advice is always prudent when dealing with unfamiliar or complex activities such as share transfers or restructuring. When contemplating or facing insolvency, Directors must remember their duty to all the company and its creditors or face potential disqualification or other consequences.

A director’s responsibilities include proper company administration, not just trading.

Read other items in Professions and Financial Lines Brief - July 2024