Court Clarifies Directors’ Duties On Sale Of Assets Before Insolvency

4 December 2015

Directors of companies who dispose of assets or a business while in financial difficulties should comprehensively review all alternative courses of action, show they honestly believe the course of action they take is in the company’s best interests, and take advice where appropriate.

A company was in financial difficulties. The company’s director (and majority shareholder) took advice from business advisors who set out three options:

he could arrange the sale of the company’s assets to an associated company;
the company could go into liquidation and the liquidator could sell the assets as a going concern;
the company could go into liquidation and the liquidator could sell the assets on the open market.

The advisors recommended a valuation of the company’s assets, and a valuer was instructed. The valuer valued the assets on the open market at £24k, and the assets as a going concern at £37k, together with a maximum possible £15k for goodwill – amounting to a total of £52k.

However, the valuation of the goodwill was subject to reservations about the company’s business model and its future profitability if sold as a going concern. In the event, the court found that the goodwill was probably worth about £5k. Also, the main assets of the company were stock, much of which was subject to retention of title clauses.

The director transferred virtually all of the company’s assets to an associated company of which he was also the majority shareholder and a director. The agreed price was £47k plus VAT of £9.4k. However, payment was deferred.

When the company went into liquidation, the liquidator accepted the sale and agreed a payment schedule for the associated company to make the deferred payments. However, the associated company also went into liquidation, at which point it still owed the original company just over £20k. The liquidator of the company claimed the balance from the director, alleging he was in breach of the following duties and obligations to the company:

to promote the success of the company;
to exercise due skill, care and diligence.

The liquidator argued that there had been a breach of these duties because:

the director had put the interests of the associated company before those of the company when arranging the sale;
the sale was not for the best price available;
sale of the assets for a deferred payment was a high-risk move and not in the best interests of the company’s creditors;
the director should have given a personal guarantee for the deferred payments.

The director, however, contended that:

He had taken professional advice and followed it.
He had considered whether or not the sale was in the best interests of the company and its creditors and honestly believed it was.
He had consulted two of the company’s major suppliers who had told him they would be prepared to give credit to the associated company if the sale went through. He had therefore taken steps to ensure the associated company could make the deferred payments.
The sale to the associated company avoided the extra legal costs that the other options would have incurred.
The director was not obliged to go for the option that attracted the highest sale price. He was entitled to factor in the advisor’s advice that sale of the assets as a going concern might not be achieved, so it was a riskier option, and if the liquidator had sold the assets at auction a lower sum would have been realised.
Payment of the sale price had to be deferred, otherwise the sale could not have gone ahead.
No one had asked for, or advised that the director give a personal guarantee for the sale price, but he would not have been able to give it in any event as he was already a significant creditor of the company himself, and was himself in financial difficulty. The sale would not therefore have gone ahead if he had been required to give a guarantee.
The liquidator had accepted the contract after his appointment and agreed a schedule for the deferred payments.

The High Court ruled that the director had acted in what he honestly believed to be the best interests of the company and its creditors, and with due skill, care and diligence.

Whilst it was true that the £47k sale price was less than the valuation as a going concern (£37k plus £15k), it was more than the open market value of the assets (£24k). The director therefore had to decide the chances of achieving a sale of the assets as a going concern. He was entitled to take into account the advisor’s reservations about the business model and its ability to sustain profitability, and the costs of the alternative options.

Operative date

Recommendation

Directors of companies who dispose of assets or a business while in financial difficulties should ensure they comprehensively review all alternative courses of action, and can show that they honestly believe their chosen course of action is in the company’s best interests, and take advice where appropriate.

Case ref: John David Hedger (the Liquidator of Pro4Sport Ltd) v David Adams [2015] EWHC 2540