Directors’ duties and demergers: transactions defrauding creditors
In 2007, the board of Burnden (BHUK), the parent company of a group engaged in the manufacture and sale of conservatories, demerged Vital Energi Utilities Ltd (Vital) by way of a dividend in specie by BHUK of its shares in Vital to BHUK’s shareholders. The commercial rationale was that the business of Vital was being restricted by its membership of the BHUK group and BHUK needed to generate cash. Following the demerger 30% of the shares in Vital were sold to a third party for £6m. Half of the proceeds were then loaned to BHUK.
BHUK went into administration in October 2008 and a compulsory winding-up order was made in December 2009. The company and its liquidator sued the directors of BHUK, Mr and Mrs F (who were also the majority shareholders at the time of the demerger), in relation to:
- the demerger
- the distribution of the Vital shares, and
- the documenting of £4.64m of loans previously advanced by Mr and Mrs F to BHUK and the granting of security favour of Mr and Mrs F in relation to the loans.
The main substance of the claims was that:
- The demerger was flawed as it resulted in no consideration for the disposal of Vital being received by BHUK.
- The distribution was unlawful as no valid board meeting of BHUK took place and the requirements of the Companies Act in relation to the distribution were not met, amounting to a breach by Mr and Mrs F of their fiduciary duties as directors of BHUK.
- At the time of the distribution Mr and Mrs F knew that BHUK was insolvent (or likely to become insolvent) and they failed to take account of the interests of BHUK’s creditors.
- The granting of the security was unauthorised as no board meeting was held by BHUK to approve it.
The granting of the security was a breach by Mr and Mrs F of their fiduciary duties as directors of BHUK as the grant was of no benefit to BHUK.
Decision and comment
The claims on the demerger, the distribution and the granting of the security were all rejected by the court. The noteworthy points in the judgment included:
- Where ownership of separate businesses is structured through subsidiaries of an ultimate holding company, and provided the holding company is solvent and complies with the statutory rules applicable on distributions, then a separation of those subsidiaries from the group into the direct ownership of the holding company’s shareholders without consideration being paid to the holding company is acceptable.
- When making distributions, directors must actively consider whether the company has sufficient distributable profits and whether the distribution complies with the Companies Act. If they fail to do so, and the statutory requirements are not met, then they can be held personally liable.
- When declaring distributions, directors are not required to be accountants and they are entitled to rely on the opinions of those appointed to carry out financial roles. In this case, Mr and Mrs F were entitled to rely on BHUK’s finance director and the external professional advisors to determine whether the distribution of the shares in Vital complied with the Companies Act.
- When making the distribution, neither Mr nor Mrs F were actually aware that BHUK was insolvent and accordingly they had not breached their fiduciary duties.
The decision serves as a timely reminder of the importance of careful planning and execution of any demerger. Whilst the judge found in favour of Mr and Mrs F, the poor documenting of the transaction and particularly the rationale for the decisions taken left them on the defensive when justifying their actions. The judge commented that if Mr and Mrs F had been found in breach of their fiduciary duties, then they would have been liable to pay compensation to BHUK to the value of Vital at the date of the distribution and this would have been in the region of £15m.