Sequana distinguished in tax avoidance case

Overview

This case considers when, following the decision of the Supreme Court in BTI 2014 LLC v Sequana SA, a director's duty to take into account the interests of creditors arises in circumstances where the company is insolvent, but its insolvency is due to a tax liability which the directors wrongly believed had been avoided by a valid tax avoidance scheme entered into by the company.

The Court ultimately distinguished Sequana, finding that the Supreme Court’s focus in that case was on the time before the company was actually insolvent. Here, there was no doubt that the Company was actually insolvent during the relevant period. The fact that the Company disputed that anything was due to HMRC did not change the fact that it was insolvent. The directors’ duty to creditors had been triggered by the Company’s insolvency, and the Court remitted the case to a judge below to consider whether that duty had been breached.

Background

Marylebone Warwick Balfour Management Limited (the "Company") was incorporated in 1994 to provide management services to Marylebone Warwick Balfour Group PLC and other companies within the corporate group.

In 2002, the Company entered into a "conditional share scheme" (the "Scheme") recommended by BDO, which was designed to enable the head office staff to receive payments – structured as non-contractual gratuitous bonuses – without the Company incurring liabilities to HMRC by way of Pay As You Earn ("PAYE") or National Insurance ("NI") contributions. The Scheme continued for eight years until 2010, resulting in payments to the directors and others of over £54 million. BDO continued to advise the Company that the Scheme was "robust" throughout the relevant period.

In November 2011, the Court of Appeal ruled that HMRC was entitled to payment of the PAYE and NI contributions in relation to a scheme for another company that was materially similar to the Scheme. The Company then received legal advice that it would also likely be liable to pay at least the NI contributions to HRMC. The Company was placed into voluntary liquidation and Stephen Hunt of Griffins was appointed liquidator (the "Liquidator").

The Liquidator brought various claims against several former directors of the Company, all of which were either settled prior to trial or dismissed by ICC Judge Prentis. The Liquidator then appealed as against one director, Jagtar Singh, in respect of the claim to recover the amount received by Mr Singh as a result of his alleged breach of s.212 of the Insolvency Act 1986 (specifically his alleged breach of the duty owed to creditors in circumstances where the Company was insolvent).

The Judgment Below

The parties had agreed that, based on the decision of the Court of Appeal in Sequana, a duty to consider the interests of creditors will arise when the directors know or should know that the company is or is likely to become insolvent (the “creditor duty”).

ICC Judge Prentis considered the Company’s financial state at the relevant time and concluded that, leaving aside the potential liability to HMRC, the Company was wavering in and out of a solvent position on its accounts. He noted that the directors accepted that they knew that, if there was a liability to HMRC, the Company would be insolvent, and said: "the question then becomes whether they ought to have realised that the Company was probably likely to be or become insolvent." He concluded, largely on the basis of the ongoing oversight by the Company’s auditor and BDO, that the Company’s directors did not realise that the Company was likely to become insolvent. Accordingly, ICC Judge Prentis found that the creditor duty had not arisen on the facts of this case and that, even if it had, it would not have mattered, since there was repeated assessment of HMRC’s status. The Liquidator appealed.

The Court’s Decision

Mr Justice Zacaroli based his decision on the fact that, in Sequana, there was no doubt that the company was solvent at the time the relevant dividends were paid, and it was therefore necessary to consider whether the company’s directors ought to have realised that the company was likely to become insolvent.

By contrast, in this case, there was no doubt that the Company was insolvent during the relevant period. Considering the liabilities for NI contributions alone, it was established that by September 2005 (the beginning of the relevant period) the Company owed in excess of £3.65 million, and that amounts due to HMRC increased each year without sufficient assets to cover the liability.

The fact that the Company disputed that anything was due to HMRC did not change the fact that it was insolvent. A disputed liability is not a contingent liability. At the time (i.e., throughout the relevant period) there either was an actual liability to HMRC or there was not. As is known now, there was an actual liability.

Accordingly, Mr Justice Zacaroli concluded that the judge below applied the wrong test for determining whether the creditor duty arose. Had he applied the right test, then he should have held that the creditor duty arose at the latest in September 2005, and continued thereafter throughout the relevant period.

Mr Justice Zacaroli declined to rule on the issue of whether Mr. Singh did, in fact, breach his fiduciary duty to the Company’s creditors. However, he did reject the judge’s finding that, even if the duty arose, it would not have mattered. In this regard, Mr Justice Zacaroli stated that the economic effect of the directors continuing the Scheme was materially the same as if salaries had been paid which gave rise to an arguable tax liability, but all remaining assets were routinely distributed by way of dividend to the shareholders, leaving nothing to pay that liability in the event that it was later established to exist. Therefore, it was not sufficient for the judge to conclude that there was no breach of duty on the basis simply that "there was repeated assessment of HMRC's status”. The issue ultimately needed to be re-assessed in accordance with the Sequana test.

Conclusion

Accordingly, Mr Justice Zacaroli ruled that the creditor duty existed in this case, but remitted the case to be reconsidered.

Judge: Mr Justice Zacaroli

Counsel: Lexa Hilliard of Wilberforce Chambers (instructed by Wedlake Bell LLP) for the Liquidator