Directors’ duties: a recent case study

A Deputy Insolvency and Companies Court Judge has ruled that a director whose business went into liquidation in 2014 must repay money to his former company, Wow Internet Limited.

It was ruled that he had wrongfully used company money to pay illegitimate company expenditure (e.g. to pay his own personal expenditure), that he had failed to repay his overdrawn director’s loan account and that he had allowed unexplained cash withdrawals from the company.

All of these were in breach of the director’s statutory and fiduciary duties and in the absence of adequate records proving that the expenditure was for a legitimate company purpose, he was personally liable.

The facts
Wow Internet Limited was a digital marketing company and Mr Qasim Majid was sole director. The company was in business for just four years before entering into creditors’ voluntary liquidation (CVA) on 8 July 2014.

An insolvency practitioner, Ms Gagen Sharma, was appointed to liquidate the company, with the statement of affairs revealing debts of £84,468.69; most of which was HMRC debt (nearly £72,000). Nothing was paid to these creditors whilst Ms Sharma was acting as liquidator, and the liquidation was closed.

In 2017, findings of misfeasance and breach of duty against Ms Sharma, led to a second insolvency practitioner, Stephen Hunt, becoming involved in some of her previous cases, including that of Wow Internet Limited. Mr Hunt’s findings resulted in the claim against Mr Majid.

What was owed?
The liquidator brought five separate successful claims against Mr Majid:

  1. Repayment of £851.24 paid by the company to an accountancy firm on behalf of a second company owned by Mr Majid.
  2. Repayment of £5,923 owed by Mr Majid under an overdrawn director’s loan account (Mr Majid alleged that this had been repaid).
  3. Repayment of £5,119.82 for withdrawals made from the company post liquidation.
  4. Repayment of £10,880.97 for illegitimate company expenditure (e.g. payments for sport and leisure, a luxury hotel chain and regular supermarket payments).
  5. Repayment of £29,656.27 for unexplained cash withdrawals made from the company’s account.

Mr Majid gave various reasons for his expenditure during cross-examination including payment to suppliers, expenditure for the benefit of the company’s staff and the fact that he was owed money by the company. However, a lack of company records to prove these explanations led the judge to rule in favour of the liquidator.

How did Mr Majid breach his duties?
Under Section 387 of the Companies Act 2006, a director has a duty to maintain adequate day-to-day company records. A director also has a duty to promote the success of the company (section 172 Companies Act 2006), a duty to exercise independent judgment (section 173 Companies Act 2006), a duty to exercise reasonable care, skill and diligence (section 174 Companies Act 2006) and a duty to avoid conflicts of interest (section 175 Companies Act 2006). Failure to comply with these statutory duties, gives rise to strict liability. As in this case, a director will be liable to account financially to a company where he or she fails to meet these statutory duties. It is not a requirement for a director to have acted dishonestly.

Whilst Mr Majid maintained that the expenditure was legitimate Company expenditure, he could not prove it by reference to Company records. The Court accepted that it was a directors’ obligation to evidence that a payment was legitimate and where he could not do so, due to failure to maintain adequate Company records, the Court would draw adverse inferences against the director with the Liquidator getting the benefit of any doubt.

The Court made it clear that if a director conducts business informally and takes a lackadaisical approach to contemporaneous records, they do so at their own risk. This is because it would be wrong for a director to profit from their own non-compliance with Section 387 of the Companies Act.

What can be learned from this case?
In cases where a court is asked to assess whether a company transaction was a legitimate business expense, in the absence of company records that supports a director’s account, the court will give the benefit of doubt to an appointed liquidator. The focus for directors therefore is to keep contemporaneous records of all payments (including cash withdrawals) by the company, to include a record of their purpose and receipt.

Where a company makes a payment to a director or shareholder, documenting what the payment is for (e.g. contractual wage, expense or legitimate dividend) is crucial if the director is to later justify transactions, with recourse to company records, therefore avoiding personal liability.

For advice on directors’ duties, please contact our Maria Koureas-Jones.

https://www.casemine.com/judgement/uk/5f9b9b702c94e005e4e753a7

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