|November 5, 2013|
Previously published on November 2013
The English Court has devised a new route to impose liability on a company's UBO who strips assets from the company leaving creditors to claim in its insolvency. UBOs feeling comfortable about the security of their corporate veil after the Supreme Court’s decision in Prest, will need to look carefully at this recent decision, which may be applied in other jurisdictions with corporate laws based on English law, such as BVI and Cyprus.
Overturning the approach that had appeared settled since the landmark Ultraframe decision in 2005, the Chancery Division has decided that the UBO was a “shadow director” and owed fiduciary duties to the company not to order depletion of its assets prejudicing creditors. The UBO’s actions breached those duties and he was liable to compensate the company for the losses it suffered as a result and so, indirectly, provide a remedy for its creditors.
In Vivendi v Murray Richards  EWCA 3006 (Ch), Newey J., decided a claim by V (as assignee of a company in liquidation (“CH3”)) against the UBO of CH3 who had arranged for the transfer of its liquid assets, leaving it insolvent. CH3 had a professional director but he was the UBO's "legman", devoting significant amounts of time to the management of the company but "not his own man: he acted on instructions from Mr Richards. He gave effect to Mr Richards' decisions". Those decisions included the transfer of liquid assets.
The Judge decided that in these circumstances the UBO was a "shadow director". However, this was not sufficient to impose liability on the UBO. The claim was made on the basis that, as a shadow director, the UBO owed fiduciary duties to CH3 which were breached by the transfer.
In Ultraframe v Fielding  EWHC 1638 (Ch) Lewison J., held that the "indirect influence exerted by a paradigm shadow director... will not usually... be enough to impose fiduciary duties upon him." He observed that a practice of giving instructions which were against the company's interest appeared to be an inconsistent basis for imposing a duty to act in the company's best interests although he recognised that actions going beyond the exertion of mere indirect influence may be sufficient to lead to duties being imposed. The example he gave was voluntarily becoming sole signatory of the company's bank account. This may lead to the imposition of a fiduciary duty not to misuse the funds in the account.
In Vivendi, Newey J., rejected that analysis. Instead he adopted the increasingly accepted objective approach to the imposition of duties, including fiduciary duties. He reasoned that a shadow director has "assumed to act in relation to the company's affairs... and ... ask the [registered] director to exercise powers that exist exclusively for the benefit of the company" and so he owed fiduciary duties. He considered that the fact "that a shadow director may not subjectively wish to assume fiduciary duties cannot matter as such".
Nonetheless, the Judge recognised that, although owing duties of a fiduciary character, a shadow director does not necessarily know the full range of fiduciary duties owed by a registered director. He concluded that "a shadow director will typically owe [fiduciary] duties in relation at least to the directions or instructions he gives to the [registered] directors. More particularly ... a shadow director will normally owe the duty of good faith."
The common law duty of good faith requires directors "to exercise their powers in what they considered to be the interests of their company". The interests of the company are usually equated with those of the shareholders. That approach finds one of its expressions in the so-called "Duomatic" principle, namely, that a director's actions will not amount to a breach of duty if all the shareholders concurred with it, even informally. That principle could, of course, inhibit claims for breach of fiduciary duty in relation to actions carried out at the request and for the benefit of a UBO.
However Newey J., pointed out that "while the interests of the company are normally identified with those of its members, the interests of creditors can become relevant if a company has financial difficulties." He relied upon the Court of Appeal decision in Liquidator of West Mercia Safetywear v Dodd (1988) 4 BCC 30 in which a registered director was held to be in breach of fiduciary duty for making a transfer "for his own purposes... in disregard of the interests of the general creditors of the insolvent company". That authority has been relied upon in number of subsequent first instance decisions in England, including Re Stakefield (Midlands)  EWHC 3175 (Ch) in which Newey J., used it as authority for establishing an exception to the Duomatic principle. Whilst the Companies Act 2006 did not go so far as to codify the duty to take account of the interests of creditors, s 172 (3) set out that a director's duty to promote the success of the company was subject to "any rule of law requiring directors... to consider or act in the interests of creditors of the company".
The Vivendi decision importantly confirms the existence of a fiduciary duty that will impose liability when action is taken by an insolvent company without regard to the interests of creditors which prejudices their position.
It will be particularly important as extending that liability beyond registered directors. The Judge imposed these duties on the UBO on the basis that he was a "shadow director". However, his reasoning suggests that it may not be necessary to establish that a defendant is a shadow director. On the contrary, it suggests that it will only be necessary to show that the requisite degree of influence was exercised, because the touchstone of liability on his analysis is not the position held but rather the nature of the actions taken.
This is important firstly because a shadow director is defined as "the person in accordance with whose directions or instructions the directors of the company are accustomed to act". It is not clear whether this will apply to an isolated intervention, such as a decision to administer a final coup de grace, transferring the lifeblood assets of the company beyond the reach of its creditors. Secondly, s 251 (3) of the Companies Act 2006 provides that a parent company is not a shadow director "by reason only that" the directors of its subsidiary are accustomed to act in accordance with its directions. There may be important reasons why a claimant may wish to claim that a fiduciary duty should be imposed on a parent company which may not fall strictly within the definition of a shadow director, not least because it is by no means unusual for the proceeds of wrongdoing to be held in such a corporate structure. It is not clear why a corporate controller should be insulated from this non-statutory equitable duty applying to individuals.
Vivendi's claim related to a number of payments made at a time when the company was insolvent (albeit that the Judge accepted that the defendants may not have been aware of that). The payments were not in the interests of the creditors and so the registered director and the UBO as shadow director were each in breach of their fiduciary duties to take account of the interests of creditors and were found liable to reimburse the company for the wrongful payments. Interestingly, the Judge also referred to comments in recent cases suggesting that the duty to account of the interests of creditors was not limited to the point at which the company was actually insolvent but arose when it was of "doubtful solvency or on the verge of insolvency". Indeed he also relied on Australian cases suggesting that "it is sufficient... if there is a real and not remote risk that [the creditors] would be prejudiced by the dealing in question". This is an important issue because in many cases it is the very transaction which gives rise to the claim which exposes the company to the risk of insolvency. If the fiduciary duty only arises once the company is actually insolvent it could be of no assistance.
Although a number of questions remain to be resolved in subsequent cases, Vivendi appears to be a significant addition to the Court's armoury for dealing with misuse of corporate structures, an addition which is of particular importance following the limitations upon the doctrine of piercing the corporate veil imposed by the Supreme Court. Indeed, UBOs will need to pay careful attention to this decision which may provide a more powerful and targeted weapon in the hands of creditors and insolvency appointees than the much criticised and largely emasculated veil piercing doctrine.