Rubin v Gunner & Anor

This is an application ("the Application") by David Anthony Rubin, in his capacity as liquidator of The Rod Gunner Organisation Limited ("RGO"). The Respondents are Roderick David Gunner, the First Respondent, and Christopher Maston Gunner, the Second Respondent, who were formerly directors of RGO.

The Application is for a declaration under the Insolvency Act 1986 ("IA") s.214 (wrongful trading) that the Respondents are liable to make contribution to RGO’s assets, compensation under IA s.212 (misfeasance), and relief under the Companies Act 1985 ("CA") s.322A (transactions involving directors).

RGO was incorporated in December 1996. The intention was to create what has been described in unchallenged evidence as "a leisure based production house which would operate in the field of live events, artist’s representation, corporate production and television/video production".

The First Respondent was appointed a director of RGO in December 1996.

Between the date of RGO’s incorporation and the beginning of 1998 RGO traded at a loss. The last audited accounts for RGO were for the period ending 31 December 1997. Those accounts show that, for that period, RGO incurred a net loss of £66,571. Those accounts also show a deficiency of £56,571 in respect of net assets.

At about the end of 1997 the First Respondent entered into discussions with Johnathan Stables about the possibility of Mr Stables introducing funds to RGO.

In about early February 1998 the Second Respondent, who is the First Respondent’s brother, was appointed a director of RGO. The Second Respondent’s responsibility was to be the day-to-day financial management of RGO.

In about February 1997 Michael Harrison, a chartered accountant, who had been appointed a director and the secretary of RGO in December 1996, resigned as a director. He remained in office as the secretary of RGO.

In February 1998 a draft budget for RGO for 1998 was prepared ("the Draft Budget"). The Draft Budget showed trading income of £611,500, trading expenditure of £615,065 ("the Budgeted Overheads"), and a consequential trading loss of £3,565. The Draft Budget also showed capital expenditure of £148,500.

Mr Stables and the First Respondent reached agreement as to future funding of RGO by Mr Stables. The terms of their agreement are, however, in dispute in these proceedings. A memorandum from Mr Stables to the First Respondent dated 26 February 1998 was intended "to solidify [his] understanding and suggestions of the various points raised". The Applicant maintains that Mr Stables agreed to fund only the difference between trading income and expenditure. The Respondents maintain that the agreement was that Mr Stables would provide funding for the entire Budgeted Overheads, namely £615,065. Mr Stables’ memorandum suggested and proposed that the funding by him should be treated as investment capital introduced by him into RGO, which would be repaid by RGO when able to do so out of trading profits.

Pursuant to the discussions and agreement between the First Respondent and Mr Stables, at a meeting of the board of directors of RGO on 13 March 1998 Mr Stables was appointed a director and the Chief Executive Officer ("CEO") of RGO with effect from 1 April 1998. The First Respondent became chairman.

By April 1998 RGO was substantially indebted to third parties. As at 5 April 1998, for example, £52,956.41 was owed to the Inland Revenue in respect of outstanding PAYE. On 3 April 1998 the Second Respondent wrote to the Inland Revenue proposing to settle that amount by way of four monthly payments, commencing with an immediate payment of £13,239.11 and then three further equal monthly instalments of £13,239.10.

On the initiative of Mr Stables, RGO became involved in the production of a £6 million motion picture called "The Clandestine Marriage" ("the Film"). The Film was originally to be funded in its entirety by RGO. The funding for the Film was to be provided by Mr Stables. The right to the Film became vested in Clandestine Ltd ("Clandestine"), a wholly owned subsidiary of RGO.

It was further agreed by the Respondents and Mr Stables that RGO would establish a television and video production company, and also a music company. A business plan or budget was prepared for the music company showing required funding of £500,000.

Mr Stables paid RGO instalments of funding from time to time between April 1998 and September 1998. The instalments were of varying amounts, of which the largest was the final payment of £50,000 on 2 September 1998. The net aggregate amount paid by Mr Stables to RGO (other than in respect of the Film) was £274,800.

Those payments by the First Respondent, and further funding provided by Mr Stables towards the production of the Film, were substantially less than the amounts required to meet the Budgeted Overheads, or the actual trading expenses, of RGO and its financial requirements for the funding of the Film. RGO only paid, for example, the April instalment for PAYE arrears under the proposal in the Second Respondent’s letter of 3 April 1998 to the Inland Revenue. None of the other instalments was ever paid. Nor did RGO ever account to the Inland Revenue for PAYE in respect of salaries paid to employees after April 1998.

From July 1998 Mr Stables gave the Respondents assurances that he would raise substantial funds in order to make a significant capital contribution to RGO in addition to the instalments he was making from time to time towards trading expenses and overheads.

Mr Stables informed the Respondents that the principal source of funds for such an injection of capital was to be the sale of his interest in International Copper Corporation Limited ("ICC"), which had a wholly owned subsidiary Eurocopper spa., for US$30 million. In that connection, the Second Respondent opened, in the name of RGO, a US$ bank account on 24 August 1998.

By 25 August 1998 the understanding of the Respondents was that the sale of Mr Stables’ ICC shareholding would generate two letters of credit ("the Letters of Credit") in the amount of US$15 million each, and those Letters of Credit would provide the security for an overdraft facility of up to US$30 million provided by Banque Internationale a Luxembourg ("BIL") for Clandestine ("the BIL Facility"). The terms of the BIL Facility were contained in a letter from BIL to Clandestine dated 25 August 1998. The letter stated that the proposal and the purpose of the BIL Facility were "to provide finance for the Film … and to provide finance … for RGO …". The letter from BIL of 25 August 1998 was countersigned by the First Respondent on 7 September 1998.

By letter dated 7 September 1998 from Mr Stables to Adrian Scrope, of Films Limited, which was concerned with the arrangements for the production of the Film, Mr Stables gave details of the proposed sale of his interest in ICC and the issue of the Letters of Credit. Mr Stables added a handwritten postscript to that letter referring to two enclosed confidential letters from the Central Bank of Paraguay. It appears that those letters were, in fact, two pages of a faxed transmission. One of the pages was a letter dated 20 August 1998 from the Central Bank of Paraguay to Zooley Services Limited, 56 Fitzwilliam Square, Dublin 2, Ireland ("Zooley") stating that "the Bonds No 1815 & No 1687 from the Republic of Paraguay, issued in 1876, are authentic", that those Bonds ("the Bonds") had never been cashed, and were still owed by Paraguay, and that the Bonds were currently valued by the Central Bank of Paraguay at US$ 140,250,863.

Mr Stables led the Respondents to understand that Zooley was a vehicle owned or controlled by Mr Stables and Philippe-David Gubbay. Mr Stables also led the Respondents to understand that Mr Gubbay had a merchant bank, Pericia SL ("Pericia"), the headquarters of which was in Marbella, Spain. The Respondents understood that Mr Stables and Mr Gubbay were business associates.

Mr Stables made the Respondents aware of the Bonds mentioned in the letter from the Central Bank of Paraguay to Zooley dated 20 August 1998, and they were led to understand that Mr Stables was entitled to a share of their value.

BIL’s proposal was subsequently varied to provide that BIL would discount the two Letters of Credit, and credit the discounted value to an account of Clandestine. The revised terms were contained in a letter from BIL to Clandestine dated 7 September 1998.

Baker & McKenzie acted for Mr Stables, and S J Berwin acted for BIL, in connection with the BIL Facility. Baker & McKenzie wrote to the First Respondent on 10 September 1998 in that connection.

By letter dated 15 September 1998 Maurizio Zecchin, writing on ICC headed notepaper to Tim Buxton, of Portman Entertainment Group Limited ("Portman") which was involved in the production of the Film, described Mr Stables as his "associate and fellow shareholder" and confirmed that Swiss Security Finance Corporation had indicated to him that the Letters of Credit would be issued during the course of banking hours that day in Toronto, Canada. The First Respondent was aware of that letter.

Notwithstanding the terms of the letter of 15 September 1998 from Mr Zecchin, the Letters of Credit were not issued on that date. They were never issued.

Fred Kuhns, of Fred Kuhns Financial Inc., of Buenos Aires, Argentina ("FKF"), wrote to Stables Consultants Limited ("SC"), for the attention of Mr Stables, a letter dated 15 September 1998, in which Mr Kuhns confirmed that instructions had been issued to transfer to SC’s US$ client trust account US$I million, for credit to SC’s UK account on Monday 20 September 1998. Mr Kuhns also confirmed in the letter that there was a current balance "reserved for your account" of US$8,050,000. The letter was intended to be shown to third parties as a comfort letter, and Mr Kuhns concluded the letter by stating that he was happy to identify himself and "our firm" as being fund managers in Argentina. That letter was shown to the Respondents by Mr Stables. Mr Stables told the First Respondent that the US$1 million could be used to fund RGO.

The US$1 million mentioned in the letter of 15 September 1998 from Mr Kuhns was never paid to RGO.

Under cover of a letter dated 16 September 1998 Baker & McKenzie sent Mr Stables a lengthy draft loan agreement, intended to give effect to the proposed BIL Facility. Clandestine was shown as a party to that agreement, and was described in it as "the Borrower".

The US$30 BIL Facility had not been activated by the end of September 1998. It was never put into place. Mr Stables led the Respondents to understand that the Letters of Credit had never been issued.

Mr Stables never provided the Respondents with any clear reason why the Letters of Credit had never been issued or why the US$1 million mentioned in Mr Kuhns’ letter of 15 September 1998 never found its way into RGO.

By the end of September 1998 RGO was under intense financial pressure. Turnover was very substantially less than in the previous accounting period. Turnover for the period ending 31 December 1997 was £763,225. By contrast, according to management accounts, turnover for the period ending 31 December 1998 was £222,729. Those management accounts show that the net loss for the period to 31 December 1998 was £258,827, compared with £66,571 for the period ending 31 December 1997. The management accounts also show that, for the period ending 31 December 1998, there was a net deficiency of assets of £330,209. The funding of RGO by Mr Stables had been at a much lower rate than that at which trading expenses and overheads were running.

Further, Mr Stables had not provided the necessary funding for the production of the Film. Accordingly, by an agreement dated 1 October 1998 (the October 1998 Agreement"), Clandestine irrevocably undertook to assign to Techbury Limited ("Techbury"), a subsidiary of Portman, the copyright and all other right, title and interest in the Film and the screenplay on which it was based, together with the benefit of production contracts. It was also provided that Techbury would thereafter be responsible for the production and exploitation of the Film. The effect was to relieve RGO and Clandestine of any further obligation to fund or produce the Film.

The October 1998 Agreement conferred on RGO certain rights, including the right to an assignment of all music, soundtrack and record rights and music publishing rights in the Film and also to specified proportions of receipts from the exploitation of the Film.

At the same time as Mr Stables was raising the possibility of a substantial capital injection into RGO from the sale of his interest in ICC, he was also pursuing the idea of a new corporate structure which would take over the business of RGO and would be the subject of a public offering. In this connection, he wrote a memorandum to the First Respondent on 5 August 1998. In that memorandum, he proposed the establishment of a new company, to be called The Gunner & Stables Group Limited ("G & S"). He said that such a company would "give a named identity to the two holders/managers of the company", and would be an ultimate holding company owning the various subsidiaries of RGO, and could be "listed on the NASDAQ exchange, or indeed, be listed in any other such flotation". The memorandum went on to say that G & S would purchase from RGO "the logo of RGO, Rod Gunner’s service contract, and any other positive and paid for assets, future contracts and pending contracts for an agreed sum, to which [G & S] would then expect to see [RGO] wind-down, dissolve and/or discharge any debts or liabilities and cease trading. Immediately thereafter [G & S] would commence trading under the logo of RGO".

G & S was formed in about September 1998.

Following Mr Stables’ memorandum of 5 August 1998, the Respondents understood that Mr Stables was proposing that G & S be floated on the NASDAQ exchange ("NASDAQ") by Mr Gubbay, through Pericia. The First Respondent travelled on two occasions to Marbella to meet Mr Gubbay in order to discuss the flotation proposal. The first visit was probably in about September 1998. The First Respondent’s second visit to Mr Gubbay was on 14 December 1998. For the purpose of that meeting, he prepared, at the request of Mr Gubbay, a mission statement and 3 year and 5 year projections for G & S.

The First Respondent says that he was told by Mr Gubbay, on the basis of the information Mr Gubbay was given, that it would be possible for G & S to be floated on NASDAQ, and that a payment of £500,000 would soon be paid by Zooley, which would handle the flotation.

The Respondents were concerned at the financial state of RGO, and had a meeting with Mr Harrison shortly before Christmas 1998. He advised them that, if they were confident that further adequate funds for RGO would be provided by Mr Stables or from elsewhere, which would enable RGO’s creditors to be paid, RGO could continue to trade.

It was decided to fix a board meeting for 5 February 1999, and to use the period before then to prepare a detailed list of creditors and a list of possible future contracts and events which would be the source of future income.

At the board meeting on 5 February 1999 Mr Stables produced a document of instruction to SC’s bank to transfer £126,000 to RGO. He also stated that G & S had entered into a contract with Zooley to market G & S’s shares, and there was due to be paid an initial payment of £500,000. The minutes of the meeting recorded that the £126,000 was to be applied in paying salaries, VAT, PAYE and other creditors, and the funds from Zooley and other sources would be applied so as to ensure that all creditors of RGO would be paid in full.

Following the board meeting of 5 February 1999, no money was, in fact, paid by Mr Stables or SC to RGO. Further, notwithstanding repeated requests by Mr Harrison, Mr Stables never produced a copy of any contract between Zooley and G & S.

At the end of February 1999 all RGO’s staff were dismissed and their contracts of employment terminated. The First and Second Respondents did not, however, cease to be directors of RGO.

The staff were then employed by G & S, which continued to carry on the same business as had been carried on by RGO, and from the same premises.

After February 1999 various payments were made out of RGO’s bank account, including payment of invoices submitted between March and June 1999, payment of various expenses incurred by the First Respondent on his Barclay’s Premier card ("Premier card") between March and May 1999, and also payments in respect of wages and salaries.

On 15 June 1999 RGO went into creditors’ voluntary liquidation, and the Applicant was appointed liquidator.

A bankruptcy order was made against Mr Stables on 3 November 1999.

IA s.214 provides, so far as relevant, as follows:

IA s.212 provides, so far as relevant, as follows:

CA s.322A provides, so far as relevant, as follows:

On the hearing of the Application, Mr Ian Lamacraft, counsel, appeared for the Applicant. Mr Nicholas Riddle, counsel, appeared for the Respondents.

The Applicant made a witness statement and gave oral evidence in support of the Application. He was consulted, as an insolvency expert, by the Respondents in April 1999. He was not involved in the affairs of RGO prior to then, and so he has no direct knowledge of the relevant facts and matters in 1998 and the first part of 1999. His evidence as regards that period was based upon the records and other documentation in his possession as liquidator and what he has been told by the Respondents themselves.

Both the Respondents made witness statements and gave oral evidence. Mr Harrison also made a witness statement and gave oral evidence, on behalf of the Respondents.

The Applicant alleges that the Respondents continued to incur liabilities after they ought to have known that an insolvent liquidation was likely. In a document described as "Details of Claim for Wrongful Trading & Misfeasance Summons" ("the Details of Claim") which was attached to the Originating Application, it is alleged that the Respondents had such knowledge from about June 1998. In Mr Lamacraft’s skeleton argument it is stated that they had such knowledge from about April 1998. In his concluding oral submissions, Mr Lamacraft submitted that the Respondents had such knowledge after May 1998, when RGO defaulted in payment of the second of the proposed instalments of arrears of PAYE to the Inland Revenue. In particular, the Applicant contends that the Respondents ought not to have continued to pay themselves, and the First Respondent’s wife, any salary after June or July 1998.

The First Respondent was paid remuneration of £68,750 for the 12 months ended 16 June 1998, and £85,000 for the 12 months ended 15 June 1999. The Second Respondent was paid remuneration of £20,000 for the period from 1 January 1998 to 31 August 1998, £16,666 for the period from 1 September 1998 to 31 December 1998, and £8,333 from 1 January 1999 to 28 February 1999. The First Respondent’s wife was paid a salary of £15,000 per annum.

The Applicant claims that the payment of those salaries after June or July 1998 constituted misfeasance, breach of duty and negligence.

The Applicant further alleges that, by 30 September 1998, the Respondents knew or ought to have concluded, within IA s.214(2) and (4), that there was no reasonable prospect that RGO would avoid going into insolvent liquidation.

In support of that submission, the Applicant relies upon the defaults of RGO in paying outstanding PAYE and National Insurance Contributions, including, in particular, the failure to make any payments in and after May 1998; the substantial and significantly overdue other debts owed by RGO in and after February 1998; the failure to pay various invoices from creditors in and after February 1998; the fact that (as the Applicant alleges) Mr Stables’ agreement in February 1998 to provide future funding was restricted to the difference between trading income and expenditure in accordance with the Draft Budget; the fact that the instalment payments by Mr Stables were never sufficient to meet the Budgeted Overheads or the actual trading expenditure and were often made late; and the fact that Mr Stables did not make any payments to RGO after 2 September 1998.

The Applicant further alleges that the Respondents ought not to have relied upon the numerous assurances by Mr Stables as to future funding, at least from the end of September 1998, and ought not to have relied upon any assurances by Mr Stables or Mr Gubbay as to the likely receipt of substantial funds, sufficient to pay off creditors, as a consequence of the proposed flotation of G & S on NASDAQ.

The Applicant further alleges, in support of his claim that there was wrongful trading by the Respondents, that the business and goodwill of RGO were transferred to G & S in February 1999 for no consideration.

Further, the Applicant’s evidence is that the records and bank statements of RGO show some 121 transactions, being payments into and out of RGO’s accounts, in the period after February 1999 and prior to the liquidation of RGO.

The Applicant claims, in these circumstances, that the court ought to make a declaration under IA s.214(1) that the Respondents are liable to make such contribution to the assets of RGO as the court thinks proper.

The Applicant maintains that, by virtue of the transfer of the business and goodwill of RGO to G & S in February 1999, G & S benefited, or may have benefited, from valuable business opportunities, which RGO might otherwise have exploited. Accordingly, the Applicant believes that the business of RGO may have had a value in February 1999. He points out that the accounts of RGO, prior to liquidation, show goodwill as having a value of £85,000.

The Applicant alleges that the transfer of the business of RGO to G & S in February 1999 for no consideration was a breach of duty by the Respondents, for which they are liable to account to RGO and to pay compensation. The Applicant makes no complaint, however, about certain assets that were purchased by G & S from RGO and for which payment was made.

Further or alternatively, the Applicant claims that the transfer was a transaction to which CA s.322A applies, by reason of the interest of the First Respondent and Mr Stables in both RGO and G&S. The Applicant claims that the First Respondent is, accordingly, liable to account under CA s.322A.

Finally, the Applicant claims that the First Respondent is liable for procuring RGO to pay him and for converting to his own use on about 28 May 1999 money belonging to RGO, in that he procured RGO to pay £2,546.88 in respect of the First Respondent’s Premier card account.

In broad terms, the Respondents’ case may be simply stated. They submit that, from February 1998 until after the board meeting on 5 February 1999, they genuinely and reasonably believed that RGO would receive sufficient funds to pay off all existing creditors in full and to pay current debts as they fell due.

They allege, as a starting point, that, contrary to the contention of the Applicant, the agreement with Mr Stables in February 1998 was that he would fund all the Budgeted Overheads for RGO in the amount of some £615,000 shown in the Draft Budget. Further, Mr Stables agreed to fund the production of the Film.

They say that, from about July 1998, they reasonably believed that Mr Stables would raise US$30 million for injection into RGO and the production of the Film. They rely upon the various letters that they were sent or shown in connection with the BIL Facility, particularly in September 1998. They rely upon the fact that reputable solicitors, Baker & McKenzie and S J Berwin, were acting for Mr Stables and BIL respectively in connection with that transaction.

The Respondents further rely upon the fact that, throughout the period from February to September 1998, Mr Stables was in fact making regular payments to RGO, and by the end of September 1998 had paid some £400,000 towards the production of the Film and more than £270,000 by way of additional funding of RGO.

The Respondents say that Mr Stables was a charming and thoroughly convincing man, and, since he was CEO of RGO, they were entitled to take at face value his assurances that they could continue to pay salaries, including a salary to the First Respondent’s wife, and trade and that RGO would receive adequate funding.

In the period between the end of September 1998 until shortly after the board meeting of 5 February 1999, the Respondents maintain that they were reasonably entitled to accept the advice of Mr Gubbay that G & S could be floated on NASDAQ and that, in that connection, £500,000 would be paid to G & S by Zooley. They were, accordingly, entitled reasonably to take the view that, through the structures suggested by Mr Stables in his memorandum of 5 August 1998, money raised from the flotation of G & S on NASDAQ could and would be applied in purchasing assets from RGO, so enabling RGO to pay off all its creditors.

The Respondents also claim that they acted honestly and reasonably in consulting Mr Harrison in December 1998 and, following his advice, deferring, until after the board meeting fixed for 5 February 1999, any decision about whether RGO should cease trading, by which time detailed lists of creditors and of possible future sources of income could be drawn up. In that connection, they also rely upon the prospects of future income from prospective business that was being negotiated at that time with Disney and from a consultancy agreement with Rank.

Finally, on this aspect, they claim that they were entitled to wait and see whether the assurances given by Mr Stables at the board meeting on 5 February 1999 would come to fruition.

Accordingly, in the light of these matters, the Respondents say that they were reasonably entitled to continue RGO’s trading activities until the end of February 1999.

With regard to the Applicant’s claim that the Respondents are liable to account or pay compensation, or at any event the First Respondent is so liable, for transferring RGO’s business to G & S at the end of February 1999, they claim that the evidence shows that there was never any such transfer. All that happened, they maintain, is that all the staff of RGO were dismissed at the end of February 1999, and the same staff were thereupon re-employed by G & S. They say that there was no transfer of business, because there was nothing capable of transfer. The new employees of G & S, however, simply continued the work that they had formerly carried on for RGO.

The Respondents claim that, as a matter of law, there is no cause of action for conversion in respect of the payment of money out of RGO’s bank account for items on the First Respondent’s Premier card. They accept, however, that all or some of the items, in respect of which such payment was made, ought properly to have been paid by G & S, and that the Respondents together, or the First Respondent, are liable accordingly. The amount of such liability is relatively trivial.

In my judgment, the Respondents are not liable in respect of payments made by RGO, particularly the salaries of the Respondents and the First Respondent’s wife, for the period prior to 15 October 1998.

I accept the Respondents’ analysis of the position during this period. In short, I find that, although RGO was insolvent by April 1998, the Respondents had a genuine and reasonable belief, during the period prior to 15 October 1998 (albeit diminishing substantially in reasonableness from the end of September 1998), that Mr Stables would provide sufficient funding for RGO to avoid the company going into insolvent liquidation.

The Applicant’s case, it should be noted, in respect of the entire period from April 1998 to February 1999, is not that the Respondents did not believe that an insolvent liquidation would be avoided, but rather that such a belief was unreasonable.

I find that, on the evidence, the agreement reached with Mr Stables in February 1998 was that he would pay the Budgeted Overheads to the amount shown in the draft Budget of £615,000.

The Draft Budget separated trading income and expenditure, on the one hand, and capital expenditure, on the other hand. It showed an anticipated trading loss of £3,565, and capital expenditure of £148,500. It is clear from the contemporaneous memoranda that Mr Stables was only prepared to fund the capital costs "on a deal per deal basis". On the Applicant’s case his commitment in February 1998 was only to fund the £3,565 trading shortfall. That seems to me to be inconsistent with the evidence as to the discussions and intentions at the time. It is also inconsistent with the payments made by Mr Stables to RGO in and after February 1998. Apart from the money paid by Mr Stables towards the production of the Film, a total of some £274,000 was paid by him to RGO. Furthermore, it is clear from BIL’s letter of 25 August 1998 that the US$30 million BIL Facility was intended to provide finance, not only for the Film, but also for RGO. These amounts, which were actually raised or intended to be raised by Mr Stables, support the Respondents’ evidence on this aspect.

I accept that the Respondents reasonably believed between July and the middle of October 1998 that Mr Stables would procure substantial funding of RGO by the sale of his interest in ICC, probably through the issue of the Letters of Credit and the BIL Facility. The Respondents were, in my judgment, reasonably entitled to hold that belief in the light of the letters and other documentation they received or were shown, including, in particular, BIL’s letter of 25 August 1998, the letter from Mr Zecchin to Mr Buxton of 15 September 1998, and the draft loan agreement sent by Baker & McKenzie on 16 September 1998.

The Respondents’ belief was further justified by the impression which they reasonably had that Mr Stables was a person of considerable substance and had access to very substantial funds. In particular, the letter from FKF of 15 September 1998, and the substantial payments that were in fact made by Mr Stables towards the production of the Film and the Budgeted Overheads would have supported that impression. As I have said, a total of over £274,000 was paid by Mr Stables to RGO, otherwise than for the production of the Film, prior to the end of September 1998. The Respondents maintain, and I accept, that at least £400,000 was paid by Mr Stables, prior to the end of September 1998, towards the costs of production of the Film. The Respondents’ evidence to that effect is supported by clause 1.1.26 of the October 1998 Agreement, which defined "the RGO Equity Investment" as meaning the sum of £400,000, "or such other sum as has actually been invested by RGO to-date towards the costs of production of the Film and can be evidenced by RGO". The quoted words can, in my judgment, only be referring to a higher sum than £400,000, if RGO could substantiate that it had spent more than that sum. Accordingly, by the end of September 1998, Mr Stables had paid nearly £700,000 towards RGO’s trading expenses and the production of the Film.

For these reasons, I reject the Applicant’s case that the Respondents should have ceased to pay the salaries of themselves and the first Respondent’s wife between June or July 1998 and the end of September 1998. The Respondents were not acting unreasonably, or in breach of duty, in continuing to pay salaries in the reasonable belief that Mr Stables would provide such funding as would avoid RGO going into insolvent liquidation. They were reasonable in holding the belief, during that period, that there was no need to cease paying salaries in the absence of any appreciable risk that Mr Stables would fail to provide the promised funding.

Further, I accept the evidence of the Second Respondent that, if his salary had ceased to be paid, he would not have been able to continue working for RGO. The First Respondent was never cross-examined about the absence of any decision to cease paying salaries as from June or July 1998. In those circumstances, I can draw no inference that, if his salary had been terminated, he could or would have continued to work for RGO. If the Respondents had ceased to work for RGO, it would have defeated the object of raising the funding from Mr Stables, namely to keep RGO in existence.

The Respondents’ evidence was that the question of continuing to pay salaries, including payment of the salary of the First Respondent’s wife, was expressly raised with Mr Stables, and he indicated that they should be paid and business should continue as normal since funding would be provided. In my judgment, the Respondents were reasonably entitled to rely upon those specific assurances and representations, as well as on the other matters to which I have referred.

On the other hand, I consider that by 15 October 1998 the Respondents ought to have concluded that there was no reasonable prospect that RGO would avoid going into insolvent liquidation.

The last payment made by Mr Stables to RGO was a payment of £50,000 on 2 September 1998.

By the end of September 1998, there was intense financial pressure on RGO. The Respondents must have been aware that its debts at that time substantially exceeded its assets. As I have said, the management accounts show that there was a dramatic drop in turnover during 1998, and an equally dramatic increase in net loss. The turnover had dropped from £763,225 for the year ended 31 December 1997 to £222,729 by the end of 1998, matched by an increase in net loss from £66,571 to £258,827 in respect of the same periods. As I have said, notwithstanding the proposal of the Second Respondent in the letter of 3 April 1998 to pay the outstanding amounts due to the Inland Revenue by four monthly instalments, nothing was paid in any month after May 1998 in respect of that accrued indebtedness or in respect of PAYE as it fell due.

Mr Stables had made instalment payments towards the Budgeted Overheads and trading expenses of RGO at substantially less than was necessary to meet his commitment which had been agreed in February 1998. As the Respondents said in their evidence, he continually paid too little and too late.

Further, by the end of September 1998, Mr Stables had failed to meet his commitment to funding the Film. That was the reason why the October 1998 Agreement was entered into, providing for the transfer of the responsibility for the production of the Film from RGO and Clandestine to Techbury.

By the end of September 1998, Mr Stables had repeatedly failed to cause his promises and assurances of a substantial capital injection to materialise. The possibility of funds being raised from the sale of Mr Stables’ interest in ICC and the BIL Facility had originally been mooted in about July 1998, but nothing whatever had materialised by the end of September 1998, despite the intense and growing financial pressure on RGO.

Mr Kuhns’ letter of 15 September 1998, which was apparently written, at Mr Stables’ request, in order to reassure third parties, stated that US$1 million in SC’s client trust account could be transferred to SC’s UK account by Monday 20 September 1998. The Respondents were aware that the transfer never took place.

Further, the letter from Mr Zecchin to Mr Buxton of 15 September 1998 stated that Mr Zecchin was able to confirm that Swiss Security Finance Corporation had indicated that the Letters of Credit were due to be issued during the course of banking hours that day in Toronto, Canada. The Respondents were aware that the Letters of Credit were never issued.

Further, the Respondents were aware, by the end of September 1998, that the Bonds mentioned in the letter of 10 August 1998 from the Central Bank of Paraguay, said to have a value of over US$140 million, had never produced any cash for RGO.

The Respondents’ evidence was that they had asked Mr Stables why the Letters of Credit had never been issued, the BIL Facility had never been made available, the money mentioned in Mr Kuhns’ letter had never been transferred, and the Bonds had never produced any funds. Their evidence was that Mr Stables failed to give any explanation, or at any event any coherent and cogent explanation, in respect of those matters.

By letter dated 30 September to Mr Stables, which was copied to the First Respondent, Mr Scrope said that he believed that the availability of the BIL Facility would be extended if Clandestine or RGO made an immediate payment of £25,000 as a deposit against costs already incurred by BIL. Mr Scrope reminded Mr Stables in the letter that Clandestine had undertaken to pay such costs, and RGO had guaranteed their payment. As the First Respondent was aware, the £25,000 was never paid by Mr Stables, Clandestine or RGO.

The First Respondent’s oral evidence, in cross-examination, was that, by the early part of October 1998, he ceased to rely on the proposed BIL Facility and the likelihood that Letters of Credit would be issued, and he no longer intended to rely on the Bonds as a source of funds.

The First Respondent’s evidence was that, although there were all manner of other promises from Mr Stables, he discounted them.

The evidence shows that letters were written on 27 October 1998 by Mr Stables to Mr Scrope concerning the BIL Facility and the discounting of the Bonds, but, on the Respondents’ own evidence, these were no longer relied upon by the Respondents as a likely source for saving RGO from insolvency. In any event, I conclude, on the basis of the facts and matters I have set out, that, by 15 October 1998 at the latest, neither the sale of Mr Stables’ interest in ICC, nor raising of funds from the value of the Bonds, nor the issue of the Letters of Credit, nor the payment of funds by FKF could have provided any reasonable basis for the Respondents to conclude that RGO would avoid going into insolvent liquidation. That date was a month after the letters of 15 September 1998 written by Mr Kuhns and Mr Zecchin respectively, over 7 weeks after BIL’s letter of 25 August 1998, and over 5 weeks since Mr Stables wrote to Mr Scrope on 7 September 1998 giving details of the Bonds. The failure of all those matters to come about ought, in the mind of any reasonable director in the position of the Respondents, to have out-weighed whatever benefit of the doubt they had previously given Mr Stables by virtue of the funds he had provided for RGO and the production of the Film, his charming and persuasive manner, and the desire that Mr Stables could be expected to have to save RGO in view of his substantial investment in it.

In his witness statement the First Respondent refers to an occasion on 28 October 1998 when Mr Stables accompanied him to the offices of the Inland Revenue in Harrow to demonstrate to the Inland Revenue Mr Stables’ commitment to RGO and to confirm that funds would be forthcoming from him in the near future to settle RGO’s obligation to the Inland Revenue. The First Respondent also refers in his witness statement to an occasion on 23 December 1998 when Mr Stables asked employees to join him at an expensive restaurant in Docklands, he provided them with bottles of champagne and a four course meal, he made a speech of thanks to the staff for getting RGO through a difficult period, and he played a record recently released by RGO’s music company which had become very successful. For the reasons I have given, neither of those events ought to have led the Respondents to believe that there was a reasonable prospect that RGO would avoid going into insolvent liquidation, and, indeed, as I have said, it was the First Respondent’s own evidence, in cross-examination, that after early October 1998 the First Respondent no longer believed that funding was likely to come from the Letters of Credit, the BIL Facility or the Bonds.

Accordingly, after 15 October 1998 the only possible outside source of funding for RGO was that suggested by Mr Stables in his 5 August 1998 memorandum, namely a flotation of G & S, which might provide funds which could be applied by G & S in acquiring assets from RGO, so enabling RGO to pay off its creditors. There was no reasonable basis, from that time, for any belief that the negotiations with Disney and the consultancy agreement with Rank would, with the ordinary ongoing business of RGO, but without any substantial injection of capital, be sufficient to avoid insolvent liquidation.

Between 15 October 1998 and the meeting with Mr Gubbay on 14 December 1998 there was no basis on which the Respondents could form any reliable view as to the likely flotation of G & S. Until the mission statement and projections were supplied to Mr Gubbay on 14 December 1998, Mr Gubbay was, on the Respondents’ own evidence, unable to express a view as to the likely success of a flotation with any certainty.

The evidence of the First Respondent was that he made two visits to Mr Gubbay in Marbella in connection with the possibility of a flotation of RGO. His evidence was that the first visit was probably in September 1998, and that the second visit took place on 14 December 1998. His evidence was that Mr Gubbay indicated to him, before the second meeting, that he should prepare a mission statement, and 3 and 5 year projections, in order for Mr Gubbay to advise on the prospects of a successful flotation. The First Respondent’s evidence in relation to those documents was as follows. They were duly prepared, and were supplied to Mr Gubbay on 14 December 1998. Mr Gubbay informed him that the information would allow the matter to go forward, and US$500,000 would be available as an initial payment in respect of the flotation. Mr Gubbay thought that was the kind of funding that was possible. Mr Gubbay told the First Respondent that the first instalment from the NASDAQ flotation would happen very soon. Mr Gubbay told him that the initial payment of US$500,000 was to be paid through Zooley. By travelling to Marbella, the First Respondent satisfied himself that Mr Gubbay did exist, as did Pericia, the offices of which were staffed.

Mr Gubbay has not given oral evidence, and no witness statement by him has been proffered in evidence.

Mr Riddle submitted that the Respondents were entitled to take at face value the assurances of Mr Gubbay that a flotation of G & S on NASDAQ was feasible, and would be taken forward, and that an initial payment of US$500,000 would be paid through Zooley, in connection with the flotation, within a short period.

In my judgment, the Respondents could not properly have concluded, on the basis of what they allege Mr Gubbay advised about the flotation of G & S, that there was a reasonable prospect that RGO would avoid going into insolvent liquidation. I consider that no reasonably diligent director, having the general knowledge, skill and experience that might reasonably be expected of a person carrying out the Respondents’ functions, and having the general knowledge, skill and experience of the Respondents, could have reached that conclusion.

The stark facts were that G & S was intended to take over the business of RGO, but RGO had been trading at a substantially increasing loss for some time. Indeed, so far as I am aware, RGO had never traded at a profit. The last audited accounts of RGO related to the period ended 31 December 1997, and showed a net loss of £66,561 for that year and a deficiency of net assets of £56,571. Those audited accounts were already historic. Management accounts for the subsequent period would have shown the substantial decrease in turnover and increase in net loss, to which I have already referred. They would also have shown a deficiency in the net assets as at 31 December 1998 of over £330,000. The Respondents have not disclosed the 3 and 5 year forecasts which were apparently shown to Mr Gubbay on 14 December 1998. Nor were copies of any such forecasts contained in the documents left with RGO, and taken into the possession of the Applicant as liquidator. Mr Harrison gave oral evidence that the projections which he was shown in 1999, were, at least in some respects, optimistic and unlikely.

Further, there was no evidence before me that there had been, at that stage, any independent valuation of the assets intended to be acquired by G & S from RGO.

Further, the First Respondent’s evidence was that he understood that Pericia and Zooley would handle all the arrangements for the flotation, including, in particular, dealing with lawyers, bankers and accountants, without any involvement by the Respondents, other than having to sign a contract at some stage.

In my judgment, the notion that a new company, whose business was intended to be that acquired from another company which had made consistent and substantial losses, and whose latest audited accounts were over a year out of date, could be successfully floated within a very short time on NASDAQ, without any involvement of the board of directors in the lead up to the flotation, and that, within a very short time, US$500,000 would be provided in respect of the flotation and then passed to RGO, even though there had been no independent valuation of the assets to be transferred to G & S, is fantastic. I do not accept that any reasonably competent director, in the position of the Respondents, could reasonably have believed that.

Further, in the present case, there were particular matters which could and should have alerted the Respondents to treat Mr Gubbay’s alleged advice with particular caution and circumspection. The Respondents understood Mr Gubbay to be a business associate of Mr Stables. They understood that Zooley was a vehicle which Mr Gubbay and Mr Stables jointly controlled or owned or directed. They understood that Mr Gubbay was, in some way or other, involved with Mr Stables in the ownership of the Bonds. By 14 December 1998, the Respondents knew that every single one of the promises of Mr Stables for a substantial capital injection into RGO had failed. They knew that one of the matters on which Mr Stables had relied, in his relations with themselves and others, in seeking to give assurances as to his worth and his ability to source outside funds, was the letter from the Central Bank of Paraguay addressed to Zooley concerning the existence and value of the Bonds. They knew that those Bonds had never produced any value for injection into RGO or the production of the Film.

I consider that, in those circumstances, any reasonably diligent director, in the position of the Respondents, facing the overwhelming losses and very substantial accrued debts of RGO, would have placed little weight on the advice of Mr Gubbay in the absence of clear written advice from him addressed to RGO and written assurances from, if not a formal contract with, Zooley for the payment of the promised US$500,000.

The Respondents rely upon the fact that they sought advice from Mr Harrison in December 1998 as to what they, and RGO, should do in the light of the financial state of RGO. The evidence of the Respondents and of Mr Harrison, which I accept, is that he told them that, if they genuinely believed that funds would be forthcoming from Mr Stables or the flotation, then they should continue to trade through RGO for a period of time, and that a detailed list of creditors and of possible future sources of income should be prepared in the meantime, and that the matter should be reviewed at the next board meeting. That board meeting was fixed for 5 February 1999, as I have said. Mr Harrison himself gave oral evidence that he thought that flotation was a possibility, and he drew a comparison with the dot-com companies, which had been successfully floated with little or no trading record.

In my judgment, the fact that the Respondents consulted Mr Harrison, and that he advised as he did, does not undermine the conclusion that Mr Gubbay’s advice was not such as ought reasonably to have led the Respondents to conclude that RGO would avoid going into insolvent liquidation. In December 1998 Mr Harrison did not know the true extent and rate of the increasing losses and indebtedness of RGO. Having regard to his evidence as a whole, I consider it improbable that he knew of the specific timetable for payment of the US$1 million mentioned in Mr Kuhns’ letter of 15 September 1998 or of the timetable for issue of the Letters of Credit in ICC’s letter of the same date. It is also improbable that he knew the precise details of the instalment funding by Mr Stables, and the precise extent to which it had always fallen short and been made too slowly to meet the requirements of RGO and the demands of the Respondents.

The fact is that Mr Harrison’s advice was predicated on the Respondents’ honest and reasonable belief that Mr Stables would provide the necessary funding; but, in the light of the Respondents’ actual knowledge of the events which had happened, there was no reasonable basis for that belief.

It is further to be observed that, notwithstanding the advice given by Mr Gubbay on 14 December 1998, the Respondents apparently felt sufficiently uncertain about the prospects of RGO to warrant them seeking the advice of Mr Harrison shortly before Christmas 1998. The fact that they sought such advice, notwithstanding what Mr Gubbay had said about the prospects of flotation and the receipt of US$500,000 from Zooley, is an indication of the doubt that they themselves must have held about what he had apparently told the First Respondent.

In short, while the Respondents may have believed that a flotation of G & S was a possibility, they could not reasonably have concluded that its likelihood was such that there was a reasonable prospect that RGO would avoid going into insolvent liquidation. As Mr Lamacraft submitted, the Respondents doubtless wanted to believe the assurances they were given; but, by this stage and in all the circumstances, there was no reasonable basis for concluding that a successful flotation was likely to take place, and US$500,000 would be received by RGO, in the short term.

Finally, as to the assurances made by Mr Stables at the board meeting on 5 February 1999, I consider that any reasonably competent director, in the position of the Respondents, and having their knowledge, would have placed no weight on those assurances, in the absence of a signed written contract by Zooley, and until the actual transfer of the £126,000 in respect of which Mr Stables produced a purported instruction to the bank.

I conclude that the Applicant has discharged the burden of establishing the matters in IA s.214(2). Mr Riddle accepted that, if I came to that conclusion, the Respondents could not satisfy the Court of the matters in IA 214(3). The Applicant is, accordingly, entitled to a declaration under IA s.214(1) in respect to the period from 15 October 1998.

It is common ground, in the light of that finding, that it is not necessary for me to express conclusions in this judgment on the Applicant’s allegations concerning a transfer of the business of RGO to G & S in February 1999 and the payments out of RGO’s accounts in the period after February 1999. For the sake of completeness, however, I should record that, on the evidence, I find that there never was any formal transfer of the business of RGO to G & S. I also record, as I have already said earlier in this judgment, that it is now accepted by the Respondents that the payment made by RGO in respect of the First Respondent’s Premier card account after February 1999 was, in whole or in part, in respect of matters which ought properly to have been paid by G & S.

I shall direct an account as to what contribution should be made by the Respondents to the company’s assets pursuant to IA s.214(1).

For the sake of completeness, I should mention that there was in evidence a document dated 2 October 1998 purporting to assign RGO’s rights under the October 1998 Agreement to G & S ("the Assignment"). The Assignment was signed by Mr Stables purportedly on behalf of both RGO and G & S. The Respondents’ case and evidence were that the Assignment was made without their knowledge or consent. I accept that evidence. In any event, I understand that the Applicant has, in the course of the liquidation of RGO, recovered rights in respect of the Film. By the end of the hearing, I did not understand either side to be relying on the Assignment for the purpose of the Application.

For the reasons set out in this judgment, the court will grant a declaration that the Respondents are liable to make such contribution to the assets of RGO as the court thinks proper; and I shall direct an enquiry for the purpose of establishing what such contribution should be.