Recent case warns directors of the consequences following company insolvency

Stacks Living Limited & Ors v Shergill & Ors

Liquidators have brought a successful wrongful trading application against multiple directors, in addition to fraudulent trading and breach of duty. This case highlights that even that even inactive directors can be held accountable for company misconduct and financial mismanagement. In our article, we summarise the key takeaways from the judgment.

Background

The joint liquidators of two insolvent businesses, Stacks Living Limited ("Stacks") and Staffs Furnishing Limited ("Staffs") (the "Companies") have brought a successful claim against the directors for fraudulent trading, wrongful trading and misfeasance. The claims were in respect of tax liability owed to the Stafford Borough Council (the "Council") and HMRC.

This case is a significant example of a successful wrongful trading claim against the principal director of Staffs, Mr Shergill, as well as his partner, Miss Smith, who was a de jure director of Staffs but had almost no involvement in the business. The judgment also places considerable importance on the lack of documentation and company records.

Facts of the case

Both companies operated as furniture retailers, buying items from suppliers to display and sell in store. Mr Shergill was the sole registered statutory director of Stacks and Staffs at all times except for a period when he resigned, and Miss Smith was appointed. It was accepted that Miss Smith had no active involvement in the management of Staffs.

Neither company was registered for National Insurance tax or PAYE. By the time of their liquidation the Companies collectively owed over £77,000 to creditors of which £58,000 was due to the Council in National Non-Domestic Taxes. Stacks and Staffs were wound up in July 2018 and December 2019 respectively on winding up petitions presented by the Council.

The evidence provided by the liquidators showed that Shergill had been a director (or shadow director) of a number of former entities (including Houghton Furnishing and Montgomery) operating a remarkably similar business out of the same premises. Shergill's son, Jack, was the sole director of Montgomery although he had no involvement in the business. Judge Greenwood described Staffs as a phoenix company of Stacks and commented that the number of previous iterations of the same business demonstrated an "established pattern of misconduct". The nominal appointments of Miss Smith and Jack as directors were attempts to conceal Mr Shergill's control of the various entities.

Liquidators' application

The liquidators brought an application under the Insolvency Act 1986 ("IA") for fraudulent trading against Mr Shergill and wrongful trading and misfeasance against Shergill and Miss Smith in respect of the money owed to the Council. The respondents sought to rely on the Companies Act 2006 ("CA"), section 1157: that they acted honestly and reasonably and ought fairly to be excused from liability. In relation to wrongful trading, Mr Shergill also sought to rely on s214(3) IA that he had taken every step with a view to minimising the potential loss to creditors.

The liquidators' application was successful on all claims, including a finding of wrongful trading against Miss Smith, despite a consensus that she was honest and had no involvement in the business.

Judgment

A number of key takeaways can be gleaned from this judgment:

Wrongful trading established against an inactive director

In relation to Miss Smith, it was plain from the evidence that she had no role in the management of the business and that Shergill was at all times the director or shadow director of Staffs. Despite her lack of actual knowledge as to the financial failure of Staffs, however, none of the facts were actively concealed from her. Miss Smith's duties under section 214 IA were the same as any director's and the court found that had she fulfilled even the most basic of her duties, she would have known that Staffs had no hope of avoiding insolvency. Miss Smith was ordered to pay a contribution to the net deficit of Staffs from the date of insolvency until her resignation. Mr Shergill was, of course, also liable under section 214 IA (the defence under section 214(3) being "plainly unsustainable" according to Judge Greenwood). However, this was of no consequence given the successful fraudulent trading application which covered the same loss.

An example of a successful fraudulent trading application

The court considered what conduct is required to establish fraudulent trading. Judge Greenwood considered that Mr Shergill was conscious that liability to HMRC and the Council did or might arise but chose to deliberately ignore it by failing to register for tax. In the Judge's view, Mr Shergill had traded with "impunity" and "deliberately engineered" the outcome to avoid exposing the Companies to the risk of tax liability that he had no intention or means with which to pay.

Following the authority in Re Overnight Ltd (No.2) [2010] EWHC 613 (Ch), the Judge considered that since there were insufficient funds to cover the Companies' debts, the transactions in question could only have been carried out at a loss and that Mr Shergill must have been aware of this. The standard of section 213 IA was described as requiring an intent to defraud creditors, "involving actual dishonesty and real moral blame according to the objective standards of ordinary people".

The importance of company records in misfeasance claims

The misfeasance claim against both Mr Shergill and Miss Smith highlighted that the lack of contemporaneous documentation and company records was both conspicuous and significant. The substance of the claim was that numerous payments were made from the Companies to Mr Shergill personally and to various suppliers whilst the Companies were insolvent; there were also significant withdrawals of cash from the Companies' bank accounts. Since there was no evidence to support that these payments were made for the benefit of the Companies or their creditors, adverse inferences could be drawn from the absence of contemporaneous documentation.

As to Miss Smith's liability in respect of Staffs, her breach of duty was in failing to maintain proper records, to inform herself about Staff's affairs and safeguard its property and failing to prevent the use of company assets for improper purposes (those other than to benefit the company and its creditors.) Both respondents sought to rely on section s1157 CA that they had acted honestly and reasonably and ought fairly to be excused from liability. Mr Shergill's obvious dishonesty precluded this defence; although Miss Smith was considered to be honest, her complete inactivity as a director was not reasonable in the circumstances.

How we can help

Foot Anstey has expertise across contentious and non-contentious insolvency matters and is experienced in advising liquidators on and pursuing claims against directors of insolvent companies. Please contact our Dispute Resolution team for any assistance relating to insolvency litigation or office-holder claims and our colleagues in Restructuring & Insolvency for advice in relation to an insolvency process.