Tales of large payments being made to connected creditors, or assets being transferred at a substantial undervalue are not uncommon. That can lead to those transactions being challenged by the liquidator as either 'unfair preferences' or 'gratuitous alienations' (under sections 243 and 242, respectively, of the Insolvency Act 1986 Act (as amended) (the "Act"). The effect of a successful challenge can be the 'undoing' of the transaction in question, or an order to make a payment to the insolvent estate. Challenges under these sections are brought against the other party to the transaction - so the party that received the payment, or obtained the property.
Section 212 - misfeasance claim
Challenges under sections 242 and 243 are not the only weapons in the liquidator's arsenal. The liquidator can also look to section 212 of the Act. That section gives a remedy against a director of the company (or, as the heading given to section 212 in the Act notes, a remedy against 'delinquent directors'). That section applies where a person who is or has been an officer of the company has "misapplied or retained, or become accountable for, any money or other property of the company, or been guilty of any misfeasance or breach of any fiduciary duty in relation to the company." Where the section applies, the court can make on order against the director for payment to the company.
The Liquidator of Glasgow and Weir Blacksmiths Limited v David Fraser Glasgow
The recent case of The Liquidator of Glasgow and Weir Blacksmiths Limited v David Fraser Glasgow deals with a case brought under section 212 and provides an example of how useful section 212 can be.
In the case the liquidator of Glasgow and Weir Blacksmiths Limited established that certain payments that ought to have been made to the company were diverted so that, instead, those payments were made to another company - of which the director, co-incidentally, was also a director and controlled (alongside his former wife). This all happened at a time when the company was insolvent, although wasn't yet in liquidation. A note to the sheriff was submitted under section 212 seeking payment from the director of the funds which had been diverted from the company. The sheriff at first instance reached the conclusion that the director had misapplied the funds (albeit without acting dishonestly) and therefore made an order for payment against the director for the sums diverted from the company.
The director appealed the decision. He argued that (1) section 212 was simply procedural and so did not provide a remedy in law; and (2) in any event, the measure of payment should be the loss to the company and in this case there was no loss to the company since by making the payments to the third party the sums owed by the company to that third party were reduced.
The Sheriff Principal of Lothian and Borders rejected both arguments.
Delivering her judgment, she found that, although section 212 is procedural (since it relies on there being a wrong or a breach of duty already in existence rather than creating a new duty), importantly it provides a summary remedy for any such breach. She said that "it is correct to characterise the section as providing a mechanism in the context of a liquidation to obtain a summary remedy where there has been a wrongful act by a director or other officer of the company".
She also found that there was no requirement for the court to have regard only to the actual loss to the company when assessing the order to be made against the director. She said that the court is required to examine the conduct of the director and then consider a remedy under section 212(3). Section 212(3) is not confined to making an order in respect of the actual loss sustained by the company. In this case the court considered that the funds diverted to the director's other company should have been available to the liquidator for the benefit of other creditors of the company and noted that the court is entitled, under the section, to make an order for compensation of such sum…"as the court thinks fit".
This case serves as a reminder to Insolvency Practitioners of the tools provided by the Act to seek recovery of funds or assets which have been wrongfully diverted from the company - while they can look to the third party who receives the funds or assets, they can also look to the directors. On the flip side, it also serves as a reminder to directors that they should be aware of the duties incumbent on them as directors and the possible consequences for breaching those duties.