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Overview Of Connected Party Payments

Connected party payments that are made at a time when a company is insolvent and without legal obligation will perhaps inevitably attract attention like a moth to a flame.

It is not only desirable, not only legally essential, not only crucial, and last but least useful that a Director causes its company to keep company records of all its transactions and financial dealings. However, perhaps those transactions that are the most likely to be subjected to an insolvent company investigation are those that involve persons closely connected to the company ie. the Directors and or shareholders and or the controlling minds.

Statement Of Insolvency Practice 2

Indeed Statement of Insolvency Practice Number 2 instructs the Liquidator as follows:

In every case, an office holder should make an initial assessment as to whether there could be any matters that might lead to recoveries for the estate and what further investigations may be appropriate

Whilst there is no real hierarchy of records that a company Director is required to keep per se, it is axiomatic if ever there are transactions in need of company records to be kept, it is those relating to payments to Directors, shareholders, or those who might have exercised control over a company.

Director Conflict Of Interest

From the vantage point of self-interest alone which of course may well ironically be contrary to the duty of loyalty that a Director owes to a company by virtue of Section 175 of the Companies Act 2006 (to avoid conflicts of interest), one only has to train their sights on the litigation fests littering the Chancery Division, to see how often such transactions feature. And, as with the case of Manolete Partners Plc v Smith [2022] EWHC 364 (Ch) (“Manolete“), how frequent it is that an absence of company records is such a notable feature in such cases.

Directors And Company Records

Indeed it was perhaps surprising in Manolete (a case in which connected or closely related party transactions, director duties and company records collided), that the salutary warning afforded by the exegesis of Mr Justice Norris in Toone v Robbins [2018] EWHC 569 (Ch) (“Toone v Robbins”) was usurped by Re Mumtaz Properties Ltd [2011] EWCA Civ 610 (“Mumtaz”). Both cases tell the story that a failure to keep relevant records, although not the end of the story of liability, nevertheless causes problems for Directors, Liquidators, and Judges.

Even if a Director is found not to be liable as arose in Manolete, one imagines that with hindsight they might have wished they had kept detailed records to avoid enduring such litigation in the first place.

Toone v Robbins

toone v robbins

In Toone v Robbins the statement that makes the point like a knife through butter is:

Directors who receive money from the company cannot be heard to say: –

“We have received company money: but our record keeping is so bad that the basis upon which we received it is unclear. So by reason of our defaults we ask you to assume in our favour that we took the money lawfully”.

However, a notable feature in Manolete was the determination of whether a person consulted about company transactions was a Director. Whilst the burden may shift to the Directors when they receive company money and the records are inadequate, it does not shift (even with an absence of records) from the applicant who has to prove the discrete point that a given individual was a Director in the first place.

Mumtaz

In Mumtaz, this cardinal concept was articulated as follows:

… it was not open to the respondents to the proceedings in the circumstances of this case to escape liability by asserting that, if the books and papers or other evidence had been available, they would have shown that they were not liable in the amount claimed by the liquidator. Moreover, persons who have conducted the affairs of limited companies with a high degree of informality, as in this case, cannot seek to avoid liability or to be judged by some lower standard than that which applies to other directors, simply because the necessary documentation is not available.

The Manolete Case

Background To Manolete

The background to Manolete was summarised as follows:

City Build was incorporated on 19 September 2011. Its sole director at the date of incorporation was Mr Dartmouth’s son, Andrew Dartmouth. Mr Smith is recorded as having been appointed a director on 1 November 2012 with Andrew Dartmouth resigning the following day. City Build’s records show that at the time of incorporation, there were 100,000 allotted shares with a nominal value of £1 per share. City Build’s annual returns for the years 2012 to 2014 each state that the shares remain unpaid. The shares are shown as initially issued to Andrew Dartmouth, transferred on 1 February 2013 to Mr Dartmouth and transferred on 28 August 2013 to Mr Smith.

A resolution was passed on 6 November 2015 for City Build to enter creditors’ voluntary liquidation and the Liquidator was appointed.

ISS was incorporated on 12 July 2012. Its sole director at that time was Claire Lucas whom Mr Smith described in his witness statement as his and Mr Dartmouth’s secretary. Mr Smith was appointed as a director on 22 July 2013. Ms Lucas resigned on the same date. ISS’s annual return states its entire issued share capital to be a single share, initially held by Ms Lucas and transferred in 2014 to Mr Smith.

The Liquidator was appointed to ISS on 6 November 2015 when it entered creditors’ voluntary liquidation.

Manolete, Company Records And Connected Party Payments

In Manolete the Liquidator of City Build (London) Limited (“City Build”) and ISS London Limited (“ISS”) was not provided with any substantial company records. Reconstruction of those records appears to have caused some bank statements to surface.

A whole stream of payments were discovered to have been paid to the individual Charles Dartmouth and Charles Dartmouth Limited, who had at one time been a shareholder of City Build and in the case of ISS his secretary had been a shareholder:

The liquidator identified 68 such payments in respect of City Build between 18 September 2013 and 14 September 2015 totalling £853,476.83 – of which £545,216.62 took place in the two years preceding City Build entering CVL.

He has identified similar payments in respect of ISS. Between 28 March 2014 and 6 August 2014 (ie within two years of ISS entering CVL) payments totalling £831,530.57 were made in respect of entries bearing a Charles Dartmouth or CDL reference.

The total value of the Payments is £1,685,007.40 of which £1,376,747.19 were made in the period of two years before the Companies entered CVL (the “TUV Payments”).

Was Mr Dartmouth A Director?

In this matter the Court formed the view that Mr Dartmouth was not a Director notwithstanding his reasonably close association:

Mr Dartmouth continued as the sole director of CDL, of which Mr Smith was an employee or to which he provided his services. In my judgment it is not surprising, therefore, that Mr Smith considered Mr Dartmouth to “run the whole show”. However Mr Smith’s oral evidence was sufficiently clear to persuade me that at the time, he was aware that he was the Companies’ sole director. He consulted Mr Dartmouth and chose to agree courses of action with him because the companies’ businesses were so closely related. The fact that he chose to keep Mr Dartmouth informed and to work cooperatively and collegiately with him, even arranging for him to be a signatory on the Companies’ bank mandate and to have a company debit card, in my judgment falls short of proving on the balance of probabilities, in the words used by Jonathan Gaunt QC in Re Gemma Ltd (relying on the judgment of Timothy Lloyd QC in the directors’ disqualification case Re Richborough Furniture Ltd [1996] 1 BCLC 507), that Mr Dartmouth was either the person directing the affairs of the Companies or acting on an equal footing with Mr Smith in directing the affairs of the Companies. As Arden LJ noted in Smithton v Naggar, the fact that a person is consulted about directorial decisions or his approval is sought, does not in general make him a director. He must be shown to have assumed the status and functions of a company director and to have exercised real influence over the corporate governance of the company. In my judgment, the Applicant has failed to show that

Whilst the Respondents should not, as noted by Arden LJ in Re Mumtaz Properties, be judged by some lower standard than that which applies to other directors, simply because they failed to keep or, in this case, to provide the necessary documentation, that does not shift the burden of proving that Mr Dartmouth was a de facto or shadow director from the Applicants to Mr Dartmouth. In Re Richborough Furniture Ltd, Timothy Lloyd Q.C. held that if it is unclear whether the acts of the person in question are referable to an assumed directorship or to some other capacity, the person in question is entitled to the bene?t of the doubt. The absence of documentary evidence and the key witnesses’ health difficulties undoubtedly makes the Court’s task unusually challenging in this case. I am nevertheless satisfied that in concluding that there is insufficient evidence to determine that Mr Dartmouth was a de facto director I have not inadvertently strained the facts in deference to this observation.

Several of the factors listed as having influenced my decision that Mr Dartmouth was not a de facto director similarly persuade me to conclude that he was not a shadow director of the Companies. Quite simply, beyond Mr Smith’s written evidence which I have addressed above, there is no other evidence before the Court of Mr Smith being accustomed to act in accordance with Mr Dartmouth’s instructions or directions. I have explained why I do not consider Mr Smith’s statement that Mr Dartmouth “ran the whole show” to justify the court concluding that Mr Dartmouth was a de facto director. The same reasons prevent me from inferring from Mr Smith’s stated approach of consulting and seeking to agree courses of action with Mr Dartmouth across the three companies to which they were appointed directors, that he was accustomed to act in accordance with Mr Dartmouth’s directions or instructions.

Breach Of Duty Claim Against Mr Smith For The Connected Party Payments

Although Mr Smith was not the recipient of any of the impugned payments to Charles Dartmouth and Charles Dartmouth Limited, nevertheless a claim was brought against him for a causing, permitting or:

otherwise acquiescing in the Companies making the Payments in circumstances where they were under no legally enforceable obligation to make those payments

Consistent with Toone v Robbins it was held as the payments were accepted to have been made the burden of showing their legitimacy lay with Mr Smith.

However, the Court rejected this part of the application as well for the following reasons:

In my judgment, and for the following reasons, Mr Smith should not be ordered to pay compensation to the Companies for any of the Payments:

i) it forms no part of the Applicant’s case that Mr Smith personally benefited from any of the Payments;

ii) the Applicant made no submissions regarding Mr Smith acting unreasonably;

iii) his dementia is likely to have played a significant part in his inability to remember or provide any explanation for the Payments; and

iv) when considering the Applicant’s claim against Mr Dartmouth and CDL under section 238 of the Act, I found sufficient evidence to conclude that it was more likely than not, as stated by Mr Dartmouth, that there was a course of dealings between the Companies, CDL and Keltbray for which some or all of the Payments were made. There is no documentary or other evidence before the Court which would enable it to identify which of the Payments were legitimate and which were not. Consequently, in my judgment, there is no reasonable basis upon which the Court, in the exercise of its wide discretion, could arrive at any justifiable figure that Mr Smith could be ordered to pay by way of compensation for transactions which might just as well have had a legitimate business purpose, as not.

Oliver Elliot Comment: Connected Party Payments

This case usefully perhaps highlights the issues that can arise when seeking to show that someone was a Director who was never registered as one and also the question of pursuing proceedings against a Director who has not benefitted from payments that litigation sought to impugn. The Court may in some instances want to see persuasive evidence as to the egregious nature of such transactions.

It also was a case in which the two main respondents had dementia and that appears to have caused difficulties for them as well as the Court in its assessment of the case based on the evidence it had available.

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Disclaimer: Connected Party Payments Without Legal Obligation

This page Connected Party Payments Without Legal Obligation is not legal advice and should not be relied upon as such. This article Connected Party Payments Without Legal Obligation is provided for information purposes only. You can contact us on the specific facts of your case to obtain relevant advice via a Free Initial Consultation.

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