Supreme Court pronounces on de Facto directors.

December 16, 2010

Company Group

Supreme Court pronounces on de Facto directors.

Holland v Revenue & Customs Commissioners [2010] UKSC 51

Facts: In simple terms H was a director of P Ltd. P Ltd was the director of 42 trading companies. The 42 companies were formed to offer the services of contractors. The contractors held some of the shares in those companies, with the A shares being held by P Trustee Ltd. The object of the structure was to administer the business and tax affairs of contractors so as to give them the benefit of the tax advantages of having their own companies without them having the bother of running their own companies. The companies paid fees to P Ltd, a basic salary to the contractors and, after making provision for corporation tax at the small companies’ rate, the surplus was distributed to the contractors as dividends. Unfortunately the scheme was flawed, as for tax purposes the profits of the 42 companies fell to be aggregated so that the small companies’ rate was not applicable. This meant that dividends had been paid when there were not in fact sufficient distributable reserves to pay creditors. The Revenue as the only creditor claimed that H was liable in misfeasance for causing the companies to pay the dividends and therefore the sums paid out were recoverable from him personally. Whether H was liable depended on whether he was a director of the 42 companies. P Ltd, not H, was the de jure director of the 42 companies and H was the director of P Ltd. The Revenue argued that H was a de facto director of the 42 companies.

Held: The Supreme Court divided 3:2. The majority held H was not a de facto director. They reasoned that the companies had a de jure director, P Ltd. The law allows companies to be directors. A company is a separate legal person from its directors and shareholders. If H was a de facto director, then whenever a company was a director its directors would be de facto directors of the company of which it was a director. The question was (per Lord Collins) whether H had assumed a role in the 42 companies’ corporate governing structure which imposed on him the fiduciary duties of a director. H did not act as director of the 42 companies but of P Ltd.

The minority took the opposite view. They distinguished the situation where the director of Topco Ltd takes part in a collective decision by the board of Topco Ltd in relation to BottomCo Ltd and the situation in this case, where H was the only person taking decisions and directing the affairs of P Ltd. In this situation he was a de facto director of P Ltd.

Comment: Practitioners are likely to be as divided as the Supreme Court as to what the right answer should be. The real vice is allowing companies to act as directors of other companies. S.155 Companies Act 2006, which requires there to be at least one human director, does not prevent this. Other jurisdictions, in particular parts of the U.S., Australia and Canada do not allow companies to act as directors.

There was disagreement between the majority and minority as to how the facts should be assessed. The majority took the view that they were dealing with a question of principle and law. For the majority the test was whether the act of paying the dividends in relation to the 42 companies was an act directed by P Ltd or one directed by H. On the facts it was directed by P Ltd. Therefore the question was one of principle: was H automatically liable as a de facto director of the 42 companies, because he was the director of P Ltd. The minority considered that the question of whether someone was a de facto director depended on what he did on his own initiative and not simply as part of a collective decision making process. It was a factual question. They looked at the range of his activities and concluded that in reality he was acting as a director of the 42 companies. In particular he was the person who caused the wrongful dividends to be paid.

Although it was not argued that H was a shadow director (unlike s.214 Insolvency Act, s. 212 does not apply to shadow directors), it seems that the majority would not have regarded H as a shadow director. The court did make some observations about the distinctions between shadow and de facto directors. The court, including the dissenters, agreed that the concepts are not mutually exclusive, contrary to Millett L.J. view in Hydrodam (Corby) Ltd [1994] 2 BCLC 80. There is no single test for deciding whether someone is a de facto or shadow director. All relevant factors have to be taken into account.

Richard Ritchie – XXIV Old Buildings