Date 22 September 2006
A recent decision of the Court of Appeal has held that a director who knowingly allowed loans from a company to a fellow director had in effect authorised the individual payments, and in doing so was jointly and severally liable for the fellow director's debt to the Company.
The Companies Act forbids a company from making loans to any of its directors (section 330, Companies Act 1985) (the Act) - except within strict exceptions. Where a company enters into such a transaction for a director of the company, breaching section 330 of the Act, that director and any other director of the company who authorised the transaction is liable (Section 341(2) of the Act) to repay the company for any gain made by the transaction (either directly or indirectly), and jointly and severally to indemnify the company for any loss or damage resulting from the transaction.
If however, the fellow directors can show that, at the time of the transaction, they “did not know the relevant circumstances constituting the contravention”, then they will have a have a statutory defence to the potential claim against them. (Section 341(5), 1985 of the Act). In this case the only two directors of a company (at the time of the loans) were father and son. Over a three year period, the company's balance sheet showed loans to both of them. It is worth noting that the company's auditors qualified the accounts each time.
Over a year after both directors had left the Company it became insolvent and entered Administration. The Administrator took action against both directors for breaching section 330 of the Act in receiving these loans. The Administrator successfully applied for an Order that both directors were jointly and severally liable for each other's debt to the Company. The father appealed, arguing that although he was responsible for this own debt he should not be held jointly and severally liable for the sons debt. It is worth noting the respective loan amounts were approximately £1.3million to the son and some £100k to the father.
The Court of Appeal decided against the father and in favour of the Administrator. Even if the father knew nothing of his son’s level of debt, he could not escape responsibility for the company's accounts, which were prepared, signed and delivered by the board of directors (i.e. both of them).
A director who knowingly allows the practice (by a company) of lending money to a fellow director to continue has in effect authorised the payments which are then made under the aegis of that practice, even if he did not have actual knowledge of each of those payments when they were made from the Company to the director. The father was under a duty to stop the loans and recover the debt. As he had failed to do this the Court granted a declaration of misfeasance against both the father and son.
Conclusion:
Both Insolvency Practitioners and Directors should note the value of this judgement in clarifying director’s duties:
- Directors are jointly and severally liable for loans to fellow directors of a Company. Further if a director turns a blind eye to such loans to directors (and allows them to continue), they cannot effectively seek to avoid their joint and several liability by claiming that they did not know of each individual loan made to their fellow directors.
- Directors have an active duty to put a stop to breaches of the Companies Act. In this case the father’s duty was to put a stop to the loans and order the Company to recover the debt.
- The Companies Bill (currently going through Parliament) is due to replace the current strict regime with a more relaxed one that abolishes the prohibition on loans, quasi-loans etc to directors and replaces it with a requirement of shareholder approval.
Case:
Neville (Administrator of Unigreg Ltd) & Another v Krikorian & Others [2006] EWCA Civ 943.
Please contact Guy Thomas or Sharon Stone with any queries on any Corporate Recovery matters. Telephone 01727 798092 or email guy.thomas@salaw.com or sharon.stone@salaw.com.
© SA Law 2006
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