Case law: Directors can be personally liable if they wind up company to avoid paying debts
Directors of a company in financial difficulties should take professional advice if they plan to wind up the company to avoid paying its debts (or any other scheme with that aim in mind), otherwise they risk being personally liable for inducing a breach of contract and conspiracy.
This update was published in Legal Alert - November 2018
Legal Alert is a monthly checklist from Atom Content Marketing highlighting new and pending laws, regulations, codes of practice and rulings that could have an impact on your business.
A contractor agreed to carry out renovation work on a house for a client company. The company was owned by two brothers, one of whom had been appointed as a director of the company. The second brother was held by the court to be a de facto director because he was funding the company and controlling its finances.
A de facto director is someone who has not been formally appointed as a director, but behaves as if they were a director such that certain company and insolvency law applies to them as if they had been formally appointed as a director.
The second brother was funding the company but got into financial difficulty, leaving the company underfunded. Two years into the renovation agreement, the company owed the contractor around £444,000. However, the second brother was able to raise sufficient funds to carry on the work, but rather than put it into the original company and pay the contractor what he was owed, he put it into another company he owned and was sole director of - then engaged a different contractor to finish the work.
The original company terminated the contract with the contractor and was put into liquidation by the brothers. The contractor was owed £1,082,000.
Contractors in this situation sometimes argue that the court should ‘pierce the corporate veil’, ie, look through the company, and make the shareholders accountable for their company’s debts. However, this is difficult to do – usually the contractor needs to show the involvement of the company was a sham or that there was a fraudulent misrepresentation.
In this case, the contractor (unusually) brought various claims including that the brothers had induced the first company to breach its contract with the contractor, and that there had been a conspiracy to injure the contractor by unlawful means.
On the inducement claim, the High Court drew a distinction between acts which were an ‘inducement’ to a breach of contract, and acts which were ‘mere prevention’ of the performance of a contract. It ruled that the brother’s failure to fund the original company was not inducement, but the active decision to do the following was inducement:
- divert the fresh funding away from the original company to another one;
- put the original company into liquidation, in order to benefit from the work already done by the contractor without paying for it; and
- then complete the work through another company, using another contractor.
The Court therefore ruled that the second brother had induced the first company to breach the contract (so if the brothers had simply walked away from the whole renovation, without completing it, it may not have amounted to inducement).
The Court also found that the brothers had colluded to put the original company into liquidation to avoid having to pay the contractor for the work already done, which meant they were also guilty of conspiracy to injure by unlawful means.
- Directors of companies in financial difficulties should ensure they take professional advice on any schemes they devise to avoid paying third parties – or risk personal liability for inducement and conspiracy.
Case ref: Palmer Birch v Lloyd  EWHC 2316
Disclaimer: This article from Atom Content Marketing is for general guidance only, for businesses in the United Kingdom governed by the laws of England. Atom Content Marketing, expert contributors and ICAEW (as distributor) disclaim all liability for any errors or omissions.
Copyright © Atom Content Marketing