A recent judicial ruling out of the U.K. provides an interesting perspective on directors’ duties under applicable law when a bankrupt company is in liquidation. As discussed below, the Court held that a director’s duties continue in relevant respects even if the director’s powers cease as of the date of the bankruptcy filing. The circumstances of the case provide an interesting example of a claim that arose against a former director post-liquidation. As discussed below, the circumstances also provide an illustration of why the purchase of post-liquidation run-off coverage is advisable. Though the circumstances arose under U.K. law, the situation bears enough similarities to what might arise under equivalent U.S. law that the liability and insurance lessons are instructive even in the U.S. context.
A copy of High Court of Justice Insolvencies and Companies Court Judge Sally Barber’s January 20, 2020 decision in Re Systems Building Services Group Limited can be found here. A January 31, 2020 memo about the decision by the Stevens & Bolton law firm can be found here.
The Liquidation
At relevant times, Brian Michie was the sole director of Systems Building Services Group (the company). The company went into administration on July 12, 2012. Gagen Sharma was appointed as administrator. The company exited administration through a creditors voluntary liquidate on July 3, 2012, and the company dissolved on February 24, 2016.
Post-Liquidation Developments
In connection with a separate company proceeding with which she was involved, Sharma was found liable for misfeasance in her office-holder position and ordered to pay damages. She was herself declared bankrupt, and she agreed to an 8-year restriction on serving in bankruptcy positions.
Stephen Hunt subsequently was appointed as administrator for a number of the companies in connection with which Sharma had previously served, including Systems Building Services Group. Following an investigation, Hunt applied to have the company restored. The company was restored on May 3, 2017.
The Successor Liquidator’s Breach of Duty Action
Hunt then filed claims against Michie for breach of his director’s duties under the Companies Act 2006. Specifically, Hunt alleged that in connection with the prior liquidation proceedings Michie had purchased properties from the company (with Sharma acting as liquidator) at a price substantially under marketplace values. Hunt also filed claims against Michie with regard to three cash payments paid out of the company’s bank account after the company had entered administration. Hunt filed a number of other claims having to do with payments made by the company prior to entering administration.
The Director’s Defenses
In response to Hunt’s action, Michie raised a number of defenses. Among other things, he argued that Sharma should have been joined as a respondent to the proceedings. Michie also argued that his general directors’ duties did not survive the company’s entry into administration and voluntary liquidation and would only survive with respect to any exercise by that director of powers “qua director” (that is, in the function or capacity of a director). Michie argued further that Hunt had failed to show that any specific duty applied to him following the beginning of the liquidation.
Judge Barber’s Rulings
While noting the limited amount of case law addressing the point, Judge Barber rejected Michie’s arguments. Among other things, she accepted Hunt’s counsel’s argument that “in an administration or a creditors’ voluntary liquidation … the officeholder and the director owe independent duties to the company.” In insolvency context, the directors’ duties, as preserved by the applicable statute, require the director “to have regard to the interests of the creditors as a whole.”
She added that “in my judgment, the duties owed by a director to a company and its creditors survive the company’s entry into administration and voluntary liquidation,” adding that those duties “are independent of and run parallel to the duties owed by an administrator or liquidator appointed in respect of the company.”
Judge Barber then turned to the specific allegations against Michie. With respect to real estate that Michie purchased from the company in liquidation, Judge Barber noted, based on a detailed review of the evidence, that Michie “saw an opportunity to pick up an asset ‘on the cheap’ and took advantage of that opportunity,” which he knew about based on his position as the company’s sole director.
She further concluded that when he made the purchase, Michie “acted entirely out of self-interest” and “without regard for the impact which his actions would have on the interests of the creditors as a whole.”
Moreover, Sharma’s actions in selling the property to Michie at an undervalued price does not afford Michie a defense. Judge Barber noted that “the fiduciary duties owed by Mr. Michie to the Company as its director were independent of the duties owed by Mrs. Sharma as liquidator.”
Judge Barber ruled against Michie with respect to the real estate transaction, as well as with respect to the cash payments in issue.
Discussion
I acknowledge at the outset that this case arises under U.K. law. There undoubtedly are important specific differences between U.K. law and U.S. law. In particular, Judge Barker’s conclusions about the director’s continuing duties are very much a reflection of the applicable U.K. statutes. However, even if there are important specific difference between the law applicable in the two jurisdictions, the two legal systems’ approaches in this context are sufficiently similar as a general matter that the outcome of these proceedings is instructive both in the U.S. as well as in the U.K.
With respect to Judge Barber’s conclusions about the director’s continuing duties when a company is in administration, the law firm memo to which I linked above notes that this case provides “a cautionary statement of the law for any directors who might seek to use an insolvency proceeding as a means to purchase assets at a reduced prices from a weak or ineffective insolvency practitioner.” As to whether the ruling represents a substantial deviation from settled practices or reasonable expectations, the law firm memo quotes unnamed practitioners as saying that the ruling “merely underscores what most of the profession felt was already the position, i.e., a director’s duty continued beyond insolvency and were not just confined to the duty to cooperate with the appointed insolvency office-holder.”
While the primary precedential value of Judge Barber’s decision is its conclusion with respect to directors’ continuing duties when a company is in administration, the overall circumstances of the case are also instructive as a thought problem for insurance issues in the insolvency context.
The important thing to focus on when thinking about the insurance issues is that the successor liquidator only asserted his claim against Michie after the company went through liquidation and after the company itself was legally dissolved. Even after all of those seemingly terminal events, Michie was hit with a liability action seeking to recover damages from him for alleged wrongful acts he allegedly undertook in his capacity as a director, during the bankruptcy process.
I have no first hand way of knowing, but I can only suspect that Michie’s costs of defending himself against Hunt’s actions were substantial. (Indeed, assessing this case from the perspective of Judge Barber’s decision, I have to assume that this was a painstakingly thorough proceeding of the kind that can only be processed at considerable expense.) Moreover, Michie stands liable for substantial damages as a result of Judge Barber’s rulings against him.
When Michie was served with Hunt’s action against him, Michie clearly would have wanted to have had a D&O insurance policy in place to which he could turn for defense and indemnification. Michie would only have had insurance to which he could turn to then if at some point prior to the final dissolution and liquidation of the company, the company had purchased run-off D&O insurance policy that would protect him in the future for claims based upon prior alleged wrongful acts.
Indeed, the circumstances in this case provide a sterling example of the reason why any well-advised company embarked on bankruptcy proceedings would make sure that run-off insurance protection is put into place to protect against the possibility of future claims arising from events prior to the completion of the bankruptcy proceedings.
But there is more to thinking about the insurance issues here than just considering the advisability of having run-off insurance in place.
These further issues have to do with the date of the alleged wrongful acts. A run-off policy will only apply to provide coverage for alleged wrongful acts that take place before the date the run-off policy goes into effect. Ideally, the run-off policy would not go into effect until the date of the termination of the bankruptcy proceedings. (I will leave it to U.K law practitioners to weigh in on whether that date in these circumstances is the liquidation date or the dissolution date).
Of even greater importance, the run-off coverage should apply not just to wrongful acts that took place prior to the initial bankruptcy filing. The run-off coverage should also extend to wrongful acts that took allegedly place during the bankruptcy proceedings – as, by way of illustration, here, Michie is alleged to have committed wrongful acts during the process of the administration of the estate. Under these circumstances, the company would want to maintain its existing D&O insurance coverage in place through the completion of the bankruptcy, with the policy to convert to run-off upon completion of the bankruptcy.
The bottom line for me is that this case shows how a claim can arise against a director even after the director’s company has been liquidated and dissolved. It is important to think about the possibility of these kinds of claims arising to think about the best way to structure the D&O insurance coverage in order to try to ensure that if one of these post-bankruptcy claims might arise, that there is insurance in place to help the former directors respond to the claims.
One final note. I was deeply impressed with Judge Barber’s consideration of the issues in this case. Her decision is detailed, painstaking, and thorough. If her consideration of these issues is at all representative of the U.K. courts overall, the attorneys who appear in U.K. courts and the parties the attorneys represent are very fortunate.