In Hunt v Singh, the High Court further considered the scope of the creditor duty owed by directors following on from a landmark Supreme Court in October 2022.
The High Court concluded that the directors’ duty to consider the interests of creditors arose once the company directors became aware that there was a real risk that a tax mitigation scheme (that had been structured to eliminate the company’s tax liability) would fail, meaning that the company would therefore be unable to pay its debts.
Background
In BTI 2014 LLC v Sequana, the Supreme Court confirmed that company directors should have regard to creditors’ interests when they know or ought to have known that the company is insolvent or in borderline insolvency state; or that a liquidation or administration is probable. This is known as the ‘creditor duty’. You can read more about the Supreme Court’s decision here.
In this case, however, the High Court had to consider whether the creditor duty arises where a company is insolvent, but the directors wrongly believed that the liability giving rise to the insolvency has been effectively avoided by a valid tax avoidance scheme.
The Facts
Between 2002-2010, Marylebone Warwick Balfour Management Limited, (“the Company”) operated a complex tax avoidance scheme structured to allow bonuses to be paid to senior management without the company itself incurring liabilities to HM Revenue & Customs (“HMRC”) for PAYE or NIC contributions. The company paid over £54 million to senior staff through this scheme.
For the majority of the time that the scheme was in operation, the Company received professional tax advice that it was ‘robust’. However, from 2004, HMRC increasingly sought to investigate and challenge such schemes and in September 2005, it made a market-wide offer to participants in such schemes, including the Company, to settle the liability arising under such schemes. By this stage, the Company was already operating with a net deficit but it declined to settle and continued to dispute liability due to HMRC.
HMRC then notified the Company that it would resolve the matter through litigation and in 2010, the tax tribunals held on appeal that PAYE and NIC contributions were due on payments made under such schemes.
The Company then stopped operating the scheme and was placed into voluntary liquidation in 2013 and subsequently dissolved.
HMRC claimed over £38 million from the Company and in turn, the liquidator of the Company, Mr Hunt, brought various claims against the former directors, claiming that they were in breach of their duty to take the company’s creditors into account.
In April 2022, the Insolvency and Companies Court dismissed the claim, finding that the directors had acted reasonably in taking advice as to the merits of HMRC’s claim. The liquidator then appealed specifically in respect of the breach of the creditor duty claim relating to the period from when HMRC made its market-wide offer in September 2005 until the scheme ceased operating in 2010.
The Court’s Decision
The High Court noted that in the Sequana case, the company in question was solvent at the time the relevant dividends were paid but faced a contingent liability of an unknown amount. In this case, however, it was not in doubt that the Company was insolvent during the relevant period. The fact that the Company disputed the liability to HMRC did not change this because a disputed liability is not a contingent liability.
It went on to say that the court at first instance had applied the wrong test; since the Company’s solvency was dependent on it successfully challenging HMRC’s claim for NIC, PAYE and interest, the duty was triggered if the directors ‘knew or ought to know that there was at least a real prospect of the challenge failing’. On the facts, the court held that the creditor duty arose at the latest in September 2005, when HMRC made its market-wide offer and continued until the company went into liquidation.
The case was sent back to the Insolvency and Companies Court to consider whether that duty had actually been breached.
A Key Takeaway for Employers
The key message for directors is that if they become aware of a claim or other current liability (including in respect of any tax mitigation scheme) that would, if not successfully challenged or defended, result in the insolvency of the company, they should properly consider that claim and make a full assessment of the relative merits and chances of successfully defending/challenging it.
Directors should be mindful that if there is at least a real prospect of the challenge/defence failing, they are likely to be under a duty to also consider the interests of the company’s creditors when making decisions going forward.
If your business has similar concerns in the face of insolvency, contact our expert solicitors today via email.
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