Non-party costs order contrary to pari passu principle?

Ventures Food Ltd v Little Dessert Shop Limited [2022] EWHC 2437 (Ch)When will the court make a non-party costs order against the director or shareholder of an insolvent company?

Overview

This case addresses the factors a court will consider in determining whether to make a non-party costs order against the director or shareholder of an insolvent company, and also considers whether such an order contravenes the pari passu principle of insolvency law.

Background

Little Dessert Shop Limited (the “Franchisor“) is in the business of franchising Little Dessert Shops. Ventures Food Limited (the “Company“) was incorporated in 2017 to operate as a Little Dessert Shops franchise. Muhammad Khuram Shahzad Afzal was the sole registered director and shareholder of the Company, and his brother Abdul Naveed Afzal was alleged to be a de facto director. Together, they are referred to as the “Third Parties“.

In 2018, the Franchisor, as tenant, entered into a lease of premises which were occupied by the Company pursuant to the franchise agreement. The Franchisor terminated the franchise agreement in 2020, but the Company continued to occupy the premises. The Company then brought a claim seeking a declaration that the Franchisor held the lease on trust for the Company. It relied on an email purportedly sent to it by the Franchisor, which stated that the lease was being secured on the Company’s behalf, and that the name on the lease could formally be changed to the Company’s name.

The Franchisor produced a different version of that email which did not contain those statements, and stated that the email produced by the Company was doctored. Both parties then served expert reports concluding that the other party’s email was modified. However, the Company stopped giving instructions to its solicitor and failed to pay its bills, with the result that its solicitor was granted permission to be removed from the record. The Franchisor later obtained an order setting aside permission for the Company to rely on its expert report, and granting the Franchisor permission to bring a counterclaim seeking a declaration that the Company was in occupation of the premises pursuant to a contractual licence, which had been terminated.

The Company ultimately failed to attend at the pre-trial review and the trial, and the judge ruled in favour of the Franchisor. He ordered the Company to pay the Franchisor’s costs, which would be assessed if they could not be agreed to by the parties. Shortly thereafter, the Company was placed in a creditors’ voluntary liquidation. The Franchisor then applied for non-party costs against the Third Parties.

Can a director or shareholder of an insolvent company be liable for costs?

The judge cited a recent Court of Appeal case where the Court reviewed the principles applicable to the potential for a director/shareholder to be made subject to a non-party costs order, including the following (director in the following excerpt is shorthand for director and shareholder):

1. An order against a non-party director is exceptional. The touchstone is whether, despite not being a party to the litigation, the director can fairly be described as “the real party to the litigation”;

2. In the case of an insolvent company involved in litigation which has resulted in a costs liability that the company cannot pay, a director of that company may be made the subject of such an order. Although such orders will be rare, they may be made to avoid the injustice of an individual director hiding behind a corporate identity, so as to engage in risk-free litigation for his own purposes;

3. In order to assess whether the director was the real party to the litigation, the court may look to see if the director controlled or funded the company’s pursuit or defence of the litigation. But what will probably matter most in such a situation is whether it can be said that the individual director was seeking to benefit personally from the litigation;

4. If the litigation was pursued or maintained for the benefit of the company, then common sense dictates that a party seeking a non-party costs order against the director will need to show some other reason why it is just to make such an order. That will commonly be some form of impropriety or bad faith on the part of the director in connection with the litigation;

5. Such impropriety or bad faith will need to be of a serious nature and would ordinarily have to be causatively linked to the applicant unnecessarily incurring costs in the litigation.

The Parties’ Submissions

The Franchisor did not argue that the Third Parties were seeking to benefit personally from the Company’s pursuit of the litigation, but rather that justice required that the Third Parties be held liable for costs in that they were guilty of serious misconduct by, amongst other things, pursuing a claim based on fabricated documentary evidence and/or failing to attend or participate in the procedural steps leading up to and including the trial.

For their part, the Third Parties relied on the pari passu principle of insolvency law to argue that the Franchisor was using this claim to cheat other creditors. According to the Third Parties, the claim against them was effectively that they breached their fiduciary duties by causing the Company to engage in expensive litigation, and that this was properly a summary-remedy claim to be brought by the liquidator under section 212 of the Insolvency Act 1986 on behalf of all creditors, not just the Franchisor.

The Court’s Decision

The judge rejected the Third Parties’ arguments, finding that none of the relevant authorities mention the potential for third-party costs orders contravening the pari passu principle enshrined in insolvency law. To the contrary, the authorities confirm that insolvency is not a bar to exercising the discretion to make a non-party costs order against a director.

Ultimately, the judge concluded that it was just to exercise his discretion and make the Third Parties subject to a costs order. The judge found that both of the Third Parties controlled the Company (they both referred to it as a joint venture between them) and, in exercising that control, the Third Parties chose to initiate and pursue the action against the Franchisor. However, in the run up to the trial, the Third Parties chose to abandon the litigation without giving any proper notice of that decision to the Court or to the Franchisor, thereby causing both the Court and the Franchisor needlessly to spend considerable time and resources on completing a litigation process initiated by the Third Parties. As such, the judge found them guilty of serious litigation misconduct, which justified making a costs order against them.

Judge: Judge Richard Williams

Counsel: Nicholas Pilsbury (instructed by HMA Law Solicitors) for the Franchisor; Martin Budworth (Direct Access) for the Third Parties