Sailing into the sunset? The High Court warns against misuse of a director’s loan account: Re Saint George Investment Holdings Ltd Manolete Partners plc v Matta and others [2020] EWHC 2965 (Ch)

At the end of last year judgment was handed down by Pat Treacy J in a matter notable for the unusual attitudes of a director towards the company’s director’s loan account. By the time the company entered into administration, the loan account was overdrawn to the tune of £1.35m, with the director having withdrawn funds to (amongst other things) finance the purchase and maintenance of a personal yacht.

An application was subsequently made by Manolete PLC (‘Manolete’) for declarations and orders under sections 238 and 239 of the Insolvency Act 1986 (‘IA 1986’) and sections 171 – 176 of the Companies Act 2006 (‘CA 2006’).

Manolete was an insolvency litigation financing company. The First Respondent, Dr Matta, was the former sole director of Saint George Investment Holdings Ltd (‘the Company’) which was the holding company for a number of care homes in North West England. The Second and Third Respondents were Dr Matta’s family members; the Fourth Respondent was a limited company named MMJ Global Limited.

Factual Background

Between March 2015 and October 2016, the Company made various significant payments to the Respondents. By the time of the Company’s entry into administration on 4 October 2016, a director’s loan account (‘the DLA’) was overdrawn by some £1,365,422.64. Any claims that the Company or its administrators had were assigned to Manolete on 8 February 2019 and then on 10 July 2019 Saint George Investment Holdings was dissolved.

The Application

Broadly Manolete’s application fell into two categories:

1. Firstly, it was alleged that Dr Matta breached the duties he owed to the Company as its director pursuant to s171 – 176 CA 2006 by:
   • Causing or permitting payments to be made to himself via the DLA which, at the time of entry into administration, was substantially overdrawn
   • Causing or permitting unjustifiable and inexplicable payments to be made to the Second and Fourth Respondents.
   • Manolete therefore sought an order compelling Dr Matta to pay £1,507,079.17 to it, being the sum of the contested payments and the outstanding balance of the DLA.
2. Secondly, it was alleged that the payments to the Third and Fourth Respondents were transactions at an undervalue pursuant to s238 IA 1986, or (in relation to the Third Respondent) were preferential payments pursuant to s239 IA 1986. Manolete sought an order compelling the Third and Fourth Respondents to pay back the relevant sums.

The Law

S171 – 176 CA 2006

The statutory duties owed by a company director are set out in the CA 2006 s171 – 176. These include:

1. Section 171: to act within his or her powers, i.e. in accordance with the company’s constitution and only exercising that power for their intended purpose;
2. Section 172: to promote the success of the company, having regard, inter alia, to the factors set out in s172(1)(a) – (f) CA 2006;
3. Section 173: to exercise independent judgment;
4. Section 174: to exercise reasonable care, skill and diligence;
5. Section 175: to avoid conflicts of interest; and
6. Section 176: not to accept benefits from third parties.

The statutory duties are not exhaustive but nonetheless represent a high-level restatement of many basic principles underpinning this area of law.

S238 – 239 IA 1986

As outlined by Pat Treacy J at [25] of the judgment, where a company has entered a formal insolvency process, certain prior transactions can be challenged by the administrators in order to assist creditors. Transactions which were arguably improper are susceptible to review by the Court and may be undone. Directors and their families are subject to statutory presumptions given that they are ‘connected’ to the company.

1. Section 238: where a company has entered into a transaction at an undervalue, the administrator can challenge that transaction. S238(4) defines such a transaction as one in which the company makes a gift to a person or enters into a transaction with that person without receiving any consideration, or where the consideration provided by that person is significantly less that the value of the consideration provided by the company.
2. Section 239: s239(2) provides that where a company has given preference to a person, the administrator can challenge that preference. S239(4) defines a preference as (in the event of the company going into insolvent liquidation) doing or suffering something to be done that puts a creditor/surety/guarantor of the company in a better position than he or she would have been in if that thing had not been done.

Section 240 IA 1986 sets out the relevant time during which the transaction at an undervalue or preference must have occurred in order for the statutory framework to be engaged.

The DLA

It was argued against Dr Matta that the significant debt in respect of the DLA existed at the time of administration, and was therefore a debt owed to the Company which required repayment to Manolete as the assignee. Moreover, the Applicant contended that Dr Matta used the DLA for personal expenditure and as such was in breach of his duties to the Company, particularly s172 – 174 CA 2006. Dr Matta said in response that at the time of the relevant transactions the Company was thriving, but he failed to dispute the central contention against him: that the expenditure was personal in nature.

The Court found that Dr Matta was required to repay the outstanding loan arising from the DLA. At [33] of the judgment, Pat Treacy J observed that the duties owed under s171 – 176 CA 2006 were owed to the company and not to its shareholders. The ‘principal and overarching duty’, it was held, is set out in s171: a director must act in accordance with the company’s constitution and exercise his or her powers only for the purpose for which they are conferred. More specifically, pursuant to s172, those powers must be exercised so as to promote the success of the company for the benefit of its members as a whole, and in doing so exercise reasonable care, skill and diligence as required by s174.

Applying the above, the Court found at [34] of the judgment that a director’s powers to authorise payments from a company’s funds ‘are not granted to enable directors to pay for or fund very significant personal items of expenditure on a long term basis’. Dr Matta was therefore in breach of his duties under the CA 2006; his argument that the Company well able to afford the payments at the time provided no answer to the issues arising pursuant to the 2006 Act. There was no reason not to require Dr Matta to repay the outstanding loan.

Payments to the Second and Third Respondents

The Applicant submitted that there was no basis for the payments made to the Second and Third Respondents. There was therefore a question as to whether they were for the benefit of the Company and/or whether they were transactions at an undervalue contrary to s238 IA 1986 or preferences contrary to s239 IA 1986.

The factual matrix with regard to the employment status of the relevant Respondents was partial, complex and unclear. Pat Treacy J concluded at [49] that ‘Matters fall to be determined without a full hearing only where the Court is persuaded that the case is capable of being made out on the basis of the evidence before it.’ The Court went on to find that it was not possible in the context of a short two-hour hearing, with no ability to probe the evidence in any depth, to reach conclusions about the propriety of payments made to the Second and Third Respondents. The same constraint arose in respect of establishing when the Company became insolvent, which was said at [55] of the judgment would require ‘proper review of the evidence which goes far beyond what is possible in a summary hearing’. That finding reflects the observation offered by Henderson J in Phillips & Another v McGregor-Paterson [2009] EWHC 2385 (Ch):

…the question whether the Company was unable to pay its debts within the meaning of s123 [IA 1986] at the time when each of the disputed payment was made is a question that cannot possibly be determined on a summary basis.’

In Phillips, Henderson J commented that the presumption of s239(6) IA 1986 – that a company which has given a preference to a connected person is presumed, unless the contrary is shown, to have been influenced in deciding to give it by the desire to better the recipient’s position as per s239(4)(b) – will usually require exploration at trial in order to determine whether it has been rebutted, ‘save in the clearest of cases’.

Accordingly, the applications in relation to the payments to the Second and Third Respondents were refused.

Payments to the Fourth Respondent

The Court found that by authorising the payments to the Fourth Respondent (which primarily concerned charitable donations to Coptic Church causes in Egypt), Dr Matta acted in breach of his duties under CA 2006 and he was liable in respect of them under that Act.

However, the evidential difficulties set out above meant that it was impossible to conclude whether those payments were reviewable transactions as provided for by IA 1986 for which the Fourth Respondent was liable. Pat Treacy J therefore declined to make the orders and declarations sought in respect of the Fourth Respondent.

Conclusions

Dr Matta was found to have breached the CA 2006 duties in respect of the DLA. Not only was he liable to Manolete for the overdrawn DLA sum, but he was also liable to Manolete for the payments he authorised to the Fourth Respondent.

In view of the summary nature of hearing, the applications in respect of the payments to the Second, Third and Fourth Respondents were refused.

Comment

This decision confirms that a director’s loan account is not a cash repository for a director’s personal expenditure. To treat one as such is likely to contravene the duties set out in CA 2006 and may give rise to personal liability on behalf of the offending director. It may be a further breach not to regularise the position. Unsurprisingly, is not a defence to argue that as at the time of the transactions the company was sufficiently pecunious and profitable.

However, a summary hearing will rarely be the appropriate venue to determine contentious and factually complex issues arising pursuant to an application under s238 or s239 IA 1986, which will likely require a thorough probing of the evidence at trial in order for the Court to be able to reach a conclusion.

Michael Maris
February 2021