Honest and reasonable?
By pursuing a tax efficient reward scheme, a director was found to have failed to act in the interests of his company, which later became insolvent
Dryburgh v Scotts Media Tax Ltd (in liquidation)  CSOH 147 illustrates the directors’ duties to a company. The points arose in a counterclaim by the liquidator to an action by the director, an accountant specialising in taxation.
The pursuer had formed the company with a colleague. The business was successful and expanded rapidly. The pursuer devised a scheme to reward his success in a tax efficient way. (His colleague appears to have been content to be rewarded in cash and suffer the tax charge.) He caused the company to establish a retirement benefits scheme for his benefit. Following board approval, the company granted a share option to the scheme trustee which benefited the scheme to the extent of £650,000, while the pursuer’s colleague received a cash bonus of £100,000 (“the September transaction”). In November, the company declared a dividend of £100,000, resulting in payment to the colleague of £30,000. The trustees of the pursuer’s family trust waived their entitlement to the dividend.
The company transferred its business to another company controlled by the pursuer, and ceased trading. Four years later the pursuer signed a declaration of solvency and put the company into liquidation. Following a tax assessment on the September transaction, which was not contested, the liquidation was converted to a creditors’ voluntary (insolvent) liquidation.
The liquidator sought to recover £756,649, the amount he alleged was lost to the company by the September transaction, which he argued had given the company no benefit and left it with no material assets. He pled inter alia that the directors owed the company fiduciary duties to act in good faith and bona fide in its interest; to act for a proper purpose; and not to allow personal interests to conflict with those of the company.
Lord Glennie reviewed the substantial case law and concluded that where the power conferred on the director has been exercised for a proper purpose, the question is whether the director honestly believed his act (or omission) was in the company’s interests, whether viewed objectively it can be shown not to have been so. If, however, the power is exercised for an improper purpose, honesty of belief does not matter and the exercise will be set aside. The duty not to allow his own interests to conflict with the company’s is but a facet of the fiduciary duty.
He held that the September transaction gave no benefit to the company, but either rendered it insolvent (or nearly so), or at any rate required to be justified because it made the company over £750,000 worse off. The company had no obligation to make the payments; the director had been remunerated; and irrespective of the success that he had brought to the company, this “reward” did not fall within the legitimate categories of reward. Indeed he held that the director never considered whether the scheme was in the company’s best interests.
On other issues raised, Lord Glennie indicated that in his view it was inevitable that a finding of breach of fiduciary duty would lead to a finding of breach of duty of care under s 214(4) of the Insolvency Act 1986.
He was not convinced that the transaction was a fraud on creditors, in the sense that the only relevant claim appeared to be that of HMRC. The director had taken tax advice which indicated that a tax liability was considered unlikely.
On the facts, the company had insufficient distributable reserves to declare a dividend in November. But were the directors in breach of their duty of care? That turned on what they knew at the time. There were no accounts available, and on the evidence the directors were in breach of duty because they had made no proper assessment of distributable profit. (The relevant figure was the authorised dividend of £100,000 and not the £30,000 paid, even if the directors were aware at the time of declaration that the majority shareholder would waive its entitlement.)
Lord Glennie held, however, that the liquidator’s claims had prescribed. The argument that they were imprescriptible in terms of sched 3, para (e) to the Prescription and Limitation (Scotland) Act 1973 was rejected; and there was no evidence that the company had been induced by the pursuer’s words or conduct not to make a claim: there had been a second director aware of the facts, and no fraud, breach of duty or the like was alleged against her.
The director would not have been relieved of liability in terms of the Companies Act 2006, s 1157: while Lord Glennie accepted that the pursuer had acted honestly, he had not acted reasonably, and both tests required to be satisfied for the court to exercise the statutory discretion.
However attractive a tax scheme may appear to be for a director or shareholder of a company, the basic principles attaching to directors’ duties will continue to apply. Directors will therefore require to consider their fiduciary duties to the company as a whole and take care that their actings, even if honest, can be considered reasonable in all the circumstances.
Alistair Burrow, partner, Tods Murray LLP