The Official Receiver v Watson & Anor

In these proceedings the Official Receiver seeks disqualification orders under s.6 of the Company Directors Disqualification Act 1986 (“CDDA 1986”) against various former directors of AG (Manchester) Limited (formerly the Accident Group) (“TAG”) which went into administration on 23 May 2003 and was placed into compulsory liquidation on 15 January 2004. The statement of affairs (dated 25 May 2003) disclosed a total deficiency of £81.2m.

Following an investigation into the conduct of the former directors, notice of intention to commence disqualification proceedings was served on the following directors of TAG:

Mark Campion Langford (“Mr Langford”)

Deborah Langford (“Mrs Langford”)

Michael Watson (“Mr Watson”)

Gary Andrew Hoddes (“Mr Gary Hoddes”)

Andrew Christopher Hopper QC (“Mr Hopper”)

Philip John Bird (“Mr Bird”)

Jacqueline Brennan (“Mrs Brennan”)

Philip Anthony Hoddes (“Mr Philip Hoddes”)

Barry Nield (“Mr Nield”)

Neil Robertson Ross (“Mr Ross”)

No further action has been taken against Mr Hopper but on 24 April and 4 May 2005 undertakings pursuant to the CDDA 1986 were accepted respectively from Mr Philip Hoddes and Mr Gary Hoddes. Proceedings were then commenced on 25 August 2005 against the remaining directors and this resulted in further undertakings not to act as directors for periods up to three years being received and accepted from Mrs Brennan, Mr Ross, Mr Nield and Mr Bird.

The proceedings have therefore continued against Mr Langford, Mrs Langford and Mr Watson. On 9 April 2007 Mr Langford was killed in a motor accident in Spain. The proceedings against him therefore abated. At the request of Mrs Langford, I adjourned the trial fixed for 14 May 2007 having received submissions on her behalf indicating that she wished to and intended to instruct solicitors to act for her in the proceedings but needed time to make arrangements and to cope with the obvious distress caused by her husband’s death. Solicitors (DWF) were instructed on her behalf but on 20 June 2007 they came off the record and she has not taken any further part in the proceedings. The application has therefore continued against her in her absence and against Mr Watson who has been represented by solicitors and counsel throughout.

TAG was incorporated on 24 June 1993 as Motor Law Limited with an authorised share capital of £350,000 divided into 350,000 shares of £1 each. All the shares were issued and fully paid up. Until 30 June 2001 Mr and Mrs Langford each held 50% of the issued share capital. On that date Mr Langford transferred the entirety of his 175,000 shares and Mrs Langford 87,500 of her shares to Insinger Trust Company (“Insinger”), a Jersey company, as trustee of the Accident Group Limited Employee Benefit Trust (“the EBT”).

The shares transferred to Insinger on 30 June 2001 were transferred on the same day to Leverington Limited (“Leverington”), a BVI company whose own shares were held as trustees for Insinger by two Jersey companies, CH Limited and CN Limited. The result of these transfers was that from 30 June 2001 Mr Langford ceased to hold any shares in TAG, Mrs Langford held 87,500 shares and Leverington held 262,500 shares. On 1 August 2001 Mrs Langford transferred 43,750 of the shares retained by her to Mr Langford. Finally, on 21 January 2002 a company called Amulet Group Limited (which was incorporated on 31 August 2001) acquired all 350,000 issued shares of TAG which therefore became its wholly owned subsidiary. 75% of the share capital of Amulet was held by Leverington with the remaining 25% split between Mr and Mrs Langford. This remained the position when TAG was placed into administration in May 2003.

The EBT was a discretionary trust set up as part of a tax scheme devised and marketed by a firm of solicitors, Messrs Baxendale Walker, as what was described in their literature as a Private Share Liberation Plan. The beneficiaries of the principal trust were the present, past and future employees from time to time of TAG together with their spouses and issue, but excluding TAG and any person connected with TAG as defined by the Income and Corporation Taxes Act 1988. This includes shareholders and directors of the company.

The trust deed contains an overriding power to appoint all or part of the fund on the trusts of another settlement but again with a prohibition on any appointment in favour of connected persons. On 18 July 2000 this power was exercised so as to create eleven sub-trusts each one of which was in favour of the spouse, children and remoter descendants of one of the named directors. As with the principal trust, connected persons are excluded as beneficiaries but the sub-trusts (as did the principal trust) gave the trustee power to lend any part of the trust fund to any person including TAG on such terms as the trustee thought fit. An issue in these proceedings which I will come to later, is whether this power on its true construction enabled loans to be made to Mr and Mrs Langford as shareholders or to any of the directors.

The initial capital for the EBT was a nominal sum of £1000 advanced by TAG to Insinger on 30 June 2001 to set up the trust. But on the same day Mr and Mrs Langford made the share transfers described in paragraph 5 above, the result of which was that the EBT became the majority (75%) shareholder in the company and Mr and Mrs Langford’s holding was reduced to 25%. Throughout the remainder of 2001 the trust received dividends from TAG which were used to produce the initial capital for the sub-trusts (£11,000) and thereafter to fund loans made by each sub-trust to the director whose family members were named as beneficiaries of that particular trust.

I shall come to the detail and manner of these payments later in this judgment but the net effect of the trust arrangements was that between 1 July 2001 and 23 October 2001 some £8.786m out of a total of £11.42m paid in dividends was received by the EBT and distributed purportedly in the form of loans to directors through the various sub-trusts.

One of the principal allegations in these disqualification proceedings (made against both Mr and Mrs Langford and Mr Watson) is that they allowed TAG to create and operate the EBT without prior notice to or proper consideration by the other directors as a vehicle for the undisclosed payment of remuneration or other benefits. I shall return to the detail of this complaint later in this judgment, but the critical feature of the EBT was that it was funded directly by the payment of dividends following the transfer of the majority of the Langford shares to the various overseas companies involved in the administration of the trust.

The legality of the dividend payments is central to the case against Mr Watson and Mrs Langford. The Official Receiver contends that the dividends paid between 31 January and 22 October 2001 (amounting to £11.21m) were either unlawful because they were not made out of distributable reserves of profit as required by s.263 of the Companies Act 1985 or were at the very least imprudent having regard to the existence of a number of known uncertainties about the future profitability of TAG at the time.

This allegation is the most serious example of the way in which the management of TAG is said to have been conducted at the time. Complaint is made that Mr Langford, Mr Watson and Mr Gary Hoddes throughout 2001 (or at least until a new finance director (Mr Gordon Blair) was appointed in early November 2001) usurped the proper functions of the board of TAG and without any delegation of such powers to them by the full board took all the strategic and financial decisions including the authorisation and payment of dividends. It is also said that as part of this process neither the accounts or financial statements, nor the authorisation of dividends were ever properly put before or notified to the board even after the decisions had been taken and implemented.

Mr Watson was appointed a director of TAG (as Finance Director) on 16 November 2000 and became its CEO on 9 July 2001. On 23 May 2002 he was dismissed and left the company. As already indicated, the allegations against him are that with Mr Langford and Mr Gary Hoddes he formed what has been described in the proceedings as the inner group of directors and caused or permitted the inner group to usurp the functions of TAG’s full board and to make all strategic and financial decisions for TAG without prior notice being given to or the consent of the other directors. In particular, he is said (i) to have permitted the inner group between 31 January 2001 and 22 October 2001 to authorise the payment of the £11.21m of interim dividends when he either knew or ought to have known that these payments were either unlawful under s.263 CA 1985 or imprudent having regard to TAG’s current and foreseeable financial position; and (ii) to have authorised the operation of the EBT for the personal benefit of each director as a vehicle for undisclosed payments of remuneration. The EBT and its various sub-trusts were not, it is said, a legitimate and transparent means of paying bonuses to directors and the Defendants should have refused to allow TAG to participate in such a scheme.

The other complaint made against Mr Watson relates to the minutes of 15 board meetings purportedly held between 13 September 2000 and 31 August 2001 copies of which were supplied to Arthur Andersen, the company’s then auditors in November 2001as part of the year end audit under cover of a letter in which Mr Watson stated that the minutes constituted a full and complete record of all meetings of directors and shareholders held during that period. The minutes purport to be records of various meetings of the full board at which the interim dividends were authorised and approved. This information is alleged by the Official Receiver to have been false and deceptive to Mr Watson’s knowledge in that most (if not all) of the board meetings of TAG referred to in the minutes never took place or had not been duly convened so as to include the directors other than those in the inner group. It is also said that Mr Watson misled the auditors by suggesting that certain dividends had been approved by the whole board when they had not and by failing to notify them that the minutes disclosed did not cover all the dividends which had been paid. Reliance is placed on s.389B (1) CA 1985 which makes it an offence for the officer of a company knowingly or recklessly to make a statement to an auditor which includes information which is misleading in a material particular.

Mr Watson accepts that the minutes (which were signed by Mr Langford) are false in the particulars which they give of the dates of the meetings and the list of attendees. But he says that the dividends were in every case properly authorised at meetings which he attended with Mr Langford and Mr Gary Hoddes of which (he assumed at the time) the other directors had been given proper notice to attend. His case is that he did not see the minutes at the time they were sent to the auditors and assumed that they had been prepared as accurate records of what took place.

The case against Mrs Langford is slightly more restricted. She was a director of TAG (referred to as the business development director) from 26 February 1996 until the company went into liquidation. She is also alleged to have caused or allowed the strategic and financial management of TAG’s business to be handled by the inner group to the exclusion of the other directors and to have allowed the inner group to usurp the functions of the board particularly in relation to the payment of dividends. It is not in terms alleged that she was or ought to have been aware that the requirements of s.263 CA 1985 had not been complied with but it is said that she either knew or ought to have known that the payment of the dividends was imprudent and that she failed to satisfy herself that they had been properly paid.

The other allegation against her relates to the setting up and operation of the EBT and is in the same terms as that made against Mr Watson.

The demise of TAG attracted considerable publicity not only because of the scale of the losses involved, but also (and perhaps principally) because of the behaviour of Mr and Mrs Langford at and after the time when the company’s insolvency became known. There was extensive press coverage of the dismissal of staff by text message and of Mr and Mrs Langford apparently enjoying themselves on their yacht in Spain. But it is important that I should stress at the outset of this judgment that the allegations made against Mr Watson and Mrs Langford in these proceedings which form the basis of the application for disqualification orders, do not include an assertion that the payment of the dividends in 2001 (whether directly to the Langfords or to the EBT) was responsible for the collapse of the company in 2003.

It is important to bear in mind (and is a significant factor in Mr Watson’s defence of these proceedings) that in the year ended 31 August 2002 TAG returned profits after tax of £12.096m and had at the end of that year a deficit of distributable reserves of only £264,000 after taking into account not only the payment of £7.61m in dividends between 11 September 2001 and 23 October 2001 (there were no further dividends after that in the year to 31 October 2002) but also the re-statement of the statutory year end accounts to 31 August 2001 in May 2002 in order to factor in various contingencies such as an increased liability for ATE premiums, which had the effect of reducing retained profits from £3.656m to a deficit of £4.75m and distributable reserves from £4.006m to a deficit of £4.4m.

The case therefore against both Mr Watson and Mrs Langford concentrates upon the period in 2001 when the bulk of the dividends were paid and is limited to a consideration of the legality of the payment of those dividends at the time and the wider issues of corporate governance including the appropriateness of the EBT. A central part of the argument in this case has been whether any failings on the part of Mr Watson in that limited period can justify his disqualification as a director when (it is said) TAG remained a fully solvent trading company in independent hands for a further year following his departure.

Before considering in more detail the evidence relating to the specific allegations made against Mr Watson and Mrs Langford, it is necessary by way of background to say something about the nature of TAG’s business and the financial position of the company leading up to and including the period between January 2001 and October 2001 when the dividends under scrutiny were paid and the EBT was set up as the recipient of many of them.

As mentioned earlier, TAG was incorporated in June 1993 as Motor Law Limited but its opportunity for serious growth and profit came several years later when legal aid ceased to be available for personal injury claims (apart from cases of clinical negligence) and the Access to Justice Act 1999 (“AJA 1999”) widened the scope for recovering from an unsuccessful defendant the cost of insuring against the risk of having to pay that defendant’s costs were the claim to have failed.

The Courts and Legal Services Act 1990 created machinery to enable the Lord Chancellor by statutory instrument to permit claimants to enter into conditional fee agreements with solicitors (“CFAs”) under which the solicitors would in the event of the claimants succeeding in the litigation be able to recover their costs either with or without an uplift. Until then, such conditional fees were unlawful. This innovation was permitted in the hope or belief that it would assist litigants who were no longer eligible for legal aid to bring their claims essentially at the risk of their lawyers. But the regulations made under the 1990 Act imposed restrictions on the form which a CFA could take, on the type of cases in which CFAs could operate (in personal injury cases) and on the maximum permitted percentage by which the fees could be increased in the event of success (100%): see Conditional Fee Agreements Order 1995 (SI 1995/1674) Art. 3. This limit was continued when the 1998 Conditional Fee Agreements Order (SI 1998/1860) revoked the 1995 Order and permitted CFAs to be used in all types of proceedings.

One obvious drawback in the use of a CFA was that it provided no protection to the unsuccessful claimant against his liability for the defendant’s costs. The Law Society therefore, with the assistance of a number of insurance brokers, developed a form of cover in respect of the claimant’s potential liability for the defendant’s costs in the event that the action failed. This type of insurance is commonly referred to as after-the-event insurance (“ATE”) by contrast with insurance taken out before the event to guard against future risks including accidents and associated legal expenses (BTE insurance).

Between 1995 and 2001 the Law Society through what was called its Accident Line Protect conditional fee insurance scheme issued over 85,000 ATE policies. The original underwriter was an American company but it withdrew in 2000 after suffering major losses. Although ATE premiums were relatively low at the inception of the scheme, they increased considerably up to 2000 due to adverse claims experience compared to BTE premiums which continued to be readily available at modest cost.

In part in an attempt to counter the adverse effect of higher premiums the AJA 1999 introduced provisions enabling the premium for ATE insurance to be recoverable by the successful claimant as part of his costs. Section 29 of the Act provides that:

“Where in any proceedings a costs order is made in favour of any party who has taken out an insurance policy against the risk of incurring a liability in those proceedings, the costs payable to him may, subject in the case of court proceedings to rules of court, include costs in respect of the premium of the policy.”

The CPR were amended at the same time to accommodate these changes. CPR 43.2(1) introduced a definition of a “funding arrangement” by reference to s.29 but subjected a “premium” falling within s.29 to the generally applicable criteria of reasonableness under CPR 44.5(1). In addition, paragraph 11.10 of the new Costs Practice Direction required the Court when deciding whether the cost of insurance cover was reasonable to take into account a number of factors including:

“…

(1)

where the insurance cover is not purchased in support of a conditional fee agreement with a success fee, how its cost compares with the likely cost of funding the case with a conditional fee agreement with a success fee and supporting insurance cover; (2) the level and extent of the cover provided; (3) the availability of any pre-existing insurance cover; (4) whether any part of the premium would be rebated in the event of early settlement; (5) the amount of commission payable to the receiving party or his legal representatives or other agents.”

Mr Langford was a solicitor by training who saw an opportunity with the changes introduced by the AJA 1999 to make TAG the leading company specialising in the provision of ATE insurance. The broad outline of the scheme (which was introduced in about November 1999) is summarised in paragraphs 6 – 11 of the judgment of Buxton LJ in Sharratt v Central Bus Co (No.2)[2004] 3 AER 325 as follows:

“6. TAG went into administration in May 2003, in circumstances that are not the concern of this court. While it was still operating, it was a claims management company, similar to Claims Direct, that sold 'one-stop' services to members of the public who had or thought they might have personal injury claims. The scheme was vigorously marketed by a sales force of some 75 people, for instance by means of direct approach to members of the public in shopping malls and similar places, and many thousands of persons were attracted to it.

7.

The potential client filled in a simple application form, the purpose of which was first to establish the contractual relationship between the client and TAG, and second to enable TAG to decide whether to accept the case. The client undertook to enter into a 'legal expenses policy' which provided for: (i) a guarantee of a minimum sum of £500 damages after deduction of any obligation under the loan to be retained by the client if successful in his claim (this arrangement being known in this case as 'ring-fencing'); and (ii) if the claim was unsuccessful an indemnity against liability to pay the client's own disbursements and counsel's fees, the other side's legal costs, and any outstanding balance on the client's loan.

8.

The loan referred to was arranged under an agreement to take out a bank loan that the client was required to enter into at the same time as signing the application form. The loan was available to him because of block arrangements negotiated by TAG with particular banks. If TAG decided not to proceed with the case, the loan was simply cancelled. If TAG proceeded with the case, its fee or premium was debited to the loan account, on the basis that the fee would either be recouped from any damages that the client was eventually awarded, or repaid under the TAG insurance if the claim failed. There were certain other transactions put through the loan account, to which I shall refer below. Although the loan account was in the client's name, and on its face not subject to any restriction, Mr Dutton confirmed that the client had no control at all over the handling of the account, which was managed by TAG in accordance with the provisions of the scheme.

9.

Some application forms would be rejected on sight. The remainder were passed to an organisation called Accident Investigation Ltd (AIL) for investigation. AIL was a sister company of TAG, operating out of the same premises as TAG. It received a fixed fee of £310 plus VAT for every case referred to it. The legal status of this fee, and the role and status of AIL itself, are strongly in dispute in these proceedings. AIL then passed the papers to a 'vetting solicitor' who formed a view as to whether the claim had a more than 50% chance of success and whether the apparent value of the injuries was more than £1,500. If the claim thus qualified, he would then refer it to one of the solicitors on the TAG 'panel'. The solicitor had 48 hours to decide whether to take the case. If he accepted it, the client's insurance became operative, the solicitor issued him with a CFA, and the case thereafter proceeded as a normal piece of litigation. To obtain access to membership of the panel the solicitor had to enter into detailed, standard form, agreements, not only with TAG, but also with the funding banks and with AIL.

10.

At each stage of the process, if either TAG or the solicitor decided not to accept the claim the bank loan and other arrangements were simply cancelled.

11.The charge made to clients by TAG, described as a 'premium', in the two years with which we are concerned was £840 (£800 plus insurance premium tax (IPT)) in 2000 and £997·50 (£950 plus IPT) in 2001. The ATE insurance that formed part of the TAG service was arranged by TAG with a number of Lloyds insurers in 2000, and in 2001 with Lloyds insurers and an organisation called NIG. Out of the sum charged to clients by TAG, in 2000 £320 was paid over to underwriters, leaving £480 with TAG. In 2001, £300 was paid to NIG and £650 remained with TAG. In respect of Lloyds in 2001 underwriters succeeded in negotiating to raise the insurers' share of the client's payment to TAG to £550.”

An important aspect of the insurance arrangements negotiated with Lloyds which is not fully explained in this summary, was the inclusion of what has become known as the swing-premium. The Lloyds cover which was agreed and placed for the period from 1 February 2001 to 31 January 2004 through the underwriters’ agents Prentice Donegan & Partners Ltd contained the following statement of the premium payable:

“…

”Premium” - £950 each case plus IPT of £47.50 each case less £621.50 each case underwriters contributions to costs.

The net premium will be adjusted to ensure that cumulative paid loss ratio does not exceed 80% per annual period subject to a maximum net premium of £550 per certificate issued for the relevant annual period. This will be achieved by rebating underwriters contributions to costs. Any such adjustment shall be calculated and closed on a monthly basis.

….”

The premium for each case could therefore rise from £328.50 to as much as £550 in the event that the claims paid by Lloyds ultimately exceeded 80% of premium income for each year of cover. This could result not only from accepted claims which ultimately failed with a liability for the claimants’ outgoings and the defendants’ costs, but also from the underwriters becoming liable to compensate the claimant for elements of the “premium” paid to TAG which were held in any taxation or costs only proceedings between parties to be irrecoverable from the defendants even in an otherwise successful claim. So for example, the Lloyds policy covers any failure to recover as one of the assured’s “Own Disbursements” the AIL fee of £310 (payable as part of the initial investigation of the assured’s claim) and to recover the ATE premium in any case where these are claimed for but are held not to be payable by the defendant.

One of the amendments made to the CPR as part of the changes occasioned by the AJA 1999 was the introduction by rule 44.12A of a new form of procedure, commonly known as costs-only proceedings, which enable issues relating to costs to be decided in cases where the parties have reached agreement on all issues except costs before any proceedings have been commenced. From late 2000 onwards a series of cases (many of them in costs only proceedings) came before the courts raising issues both about what constituted a premium within the meaning of s.29 AJA 1999 and whether the premium under consideration was either reasonable or in some cases lawful having regard to the provisions of CPR Pt 44 (including the Costs Practice Direction) and various other regulations.

In summary, the principal issues raised were:

It can be seen from this summary that the final resolution of the major issues by the Court of Appeal did not occur until 2003 at about the time when TAG went into administration. By the end of 2001 the Court of Appeal’s judgments in Callery v Gray (1) and (2) had been delivered, but these had established only that a reasonable success fee was recoverable as part of a claimant’s costs and that the ATE premium could in principle be recovered as costs even where the claim had been settled before any substantive proceedings had been commenced. Callery v Gray (No. 2) gives only limited assistance on the question of what might constitute a reasonable premium under the Costs Practice Direction leaving particular issues to be determined on a case by case basis.

Therefore during the period with which these proceedings are concerned, there remained various doubts about the scope and limits of recoverability of what TAG and other companies providing ATE insurance cover might be able to include in the services they offered, which affected the potential and also the actual profitability of these businesses.

When Mr Watson joined the company as Finance Director in November 2000 he encountered a management structure largely derived from the early days of the business. The other directors (apart from Mr Langford and Mr Gary Hoddes) were departmental heads each of whom reported to Mr Hoddes as managing director. There were no regular board meetings and the company had operated without a Finance Director for some length of time. Mr Hoddes had experience in selling the company’s product but Mr Watson confirmed that he had no real expertise in the financial management of the company and Mr Watson was recruited to fill this gap.

On 9 January 2001 as a result of the audit of the accounts for the year ended 30 June 2000 Arthur Andersen, the auditors of TAG, produced suggestions for improving the accounting procedures and internal controls of the business. Their report spoke of a lack of control over many accounting functions resulting in inaccurate financial information and delays in producing statutory accounts. They recommended that Mr Watson should critically assess what structure needed to be in place and should ensure that all personnel involved in the accounting functions were aware of their specific roles and responsibilities.

Part of the impetus for change which accounted for Mr Watson’s appointment in the first place was the desire of Mr Langford by late 2000 to interest various venture capitalists in acquiring a stake in the company and in injecting new capital. Mr Watson had an established record in the type of corporate governance required to attract such a bid. He was 35 when he joined TAG. He had a degree in accountancy and was a qualified accountant. Between 1996 and 1999 he was the financial controller of Matalan PLC and had prepared that business for a successful flotation via a placing on the market. With the assistance of the Arthur Andersen report and his own experience he took steps to produce a model suitable for a listed company.

In this connection, Arthur Andersen had recommended in their report of 9 January 2001 that the company should consider adopting some of the requirements of the Combined Code on corporate governance in advance of any future share placing. These included the introduction of a balance of executive and non-executive directors on the board; a remuneration committee whose function would be to establish a formal and transparent procedure for developing policy on executive remuneration and for fixing the remuneration packages of individual directors; and the establishment of an audit committee. Although critical of various aspects of his conduct as a director up to May 2002, the Official Receiver acknowledges that Mr Watson did re-organise the corporate governance of TAG and bring to the company a much higher and more professional degree of organisation in the management of its business, although one which fell short of the more stringent recommendations contained in the Arthur Andersen report. In particular, he obtained the agreement of Mr Langford and Mr Hoddes to there being regular board meetings with set agenda at which each director would provide an update on issues affecting his department, which could then be discussed at the meeting.

In the period with which these proceedings are concerned, these meetings took place at the company’s offices on a regular basis at a time which was notified to all the directors by Mr Langford’s PA. The evidence of Mr Ross, Mr Bird and Mr Nield, is that they were provided with a board meeting agenda and the departmental material in a bound folder in advance of the meeting. All the directors able to attend would be present at the meeting and were free to ask questions of each director in relation to the issues raised and to contribute to the discussion as they thought fit. Mrs Jackie Brennan gave evidence that at the meetings she attended the directors were asked to wait outside the meeting room and were called in one by one to see the directors who formed the so-called inner group. She said that there was no general discussion or meeting of directors as such. Her evidence on this conflicts with that of the other directors who gave evidence and I have no hesitation in preferring their accounts of these meetings. Mrs Brennan said that although she had no personal dislike of Mr Watson she felt that he should be made to take responsibility for the decisions which she claims contributed to the downfall of the company and bankrupted her brother Mr Gary Hoddes. I formed the view that her evidence was coloured by this perception of the matters in dispute and needs to be treated with caution.

One aspect of the way in which TAG was run which also faced Mr Watson and would be of obvious concern to potential investors was the lack of any coherent dividend policy. Mr Langford historically had not taken a high salary but had received regular dividends. Mr Watson said that he recognised that investors would want to see what expectations of dividends the shareholders had and that after looking at rates for comparable companies, he came up with a target figure of 10% of profits after tax.

The policy was formulated in the early part of 2001 and is referred to in the Information Memorandum prepared by N.M. Rothschild & Sons (“NMR”) dated March 2001 for distribution to potential investors as part of what became known as Project Apollo. The Information Memorandum contained an overview of the TAG Group and its business and explained why its management believed it was ideally positioned to consolidate its position as the market leader in the provision of ATE insurance. By then, the Group was experiencing a rapid increase in its business (500% in 12 months) largely due to a sales campaign involving direct marketing as well as tele-sales. There were 300 panel solicitors available to take on accepted claims and up to 10,000 claims per month were being accepted at the time the NMR Information Memorandum was published.

The NMR Information Memorandum contained a detailed account of the TAG scheme, the cover it provided and the claims process. It rightly identified that the key business objective of the Group was to generate quality claims through its various marketing channels. This depended on adequate vetting by Messrs Rowe & Cohen who acted as the Group’s Independent Vetting Solicitor and whose task was to ensure that any claim was likely to result in damages of at least £1500. The claim would then be put forward to one of the panel solicitors and if accepted, the CFA would be signed and the insurance policy would be activated.

The Memorandum suggested that if an accepted claim was likely to fail, this would occur early in the process and that panel solicitors were (as it put it) incentivised (presumably by their irrecoverable time costs) not to pursue a claim once it became apparent that it was unlikely to succeed. A failed claim was estimated to cost the underwriters on average, about £1500 against £300 or £330 received by way of premium. On these figures, an average of five successful claims to one unsuccessful claim would produce a loss ratio of 100%. Up to early 2000 the history of completed claims indicated a failure rate of less than 10% of claims and a loss ratio to the underwriters of less than 50%. But with a huge increase in the number of cases taken on, the quality of the underwriting was always difficult to assess at any point in time and historical figures were not necessarily reliable as a guide to future profitability.

The NMR Memorandum outlined most of the issues which by March 2001 either had or were likely to arise in relation to the recoverability of the component parts of the TAG premium. This analysis was supported by one carried out by DLA as part of its Legal Review Report which was also made available to interested parties. The issues identified in these documents included:

The DLA report and the NMR Memorandum gave a balanced view of the arguments involved in relation to these issues of recoverability but it is clear from both the NMR report and a number of the former directors called to give evidence that neither Mr Langford, Mr Watson nor the other members of the board regarded the outcome of these cases and the general quality of the cases underwritten as likely to cause the loss ratio ever to reach levels approaching the 80% necessary to trigger the swing premium under the Lloyds’ policy. Mrs Brennan said that there was a general belief that TAG could become the market leader in the provision of ATE insurance and that from a sales point of view (which was her own area of responsibility) the company had a positive, dynamic team able to achieve this.

This view was not limited to the sales staff. Mr Ross (who was the director of operations and was perhaps best positioned to analyse the failure rates of current claims) said that during 2001 a lot of effort had been put into improving the vetting and management of claims by panel solicitors and that he and everyone else thought that TAG’s potential liability for swing premium was not an issue at the time. He was however concerned that the statistics for failed claims contained in the NMR Information Memorandum might be unreliable as a guide to performance in 2001 because of the huge increase in the number of policies issued over that period. But the view of management remained that the loss ratio would not get to 80% and that the risk of being exposed to the swing premium was therefore theoretical rather than real.

Mr Watson was cross-examined at some length about his understanding of the terms of the Lloyds policy and the circumstances in which a liability for swing premium might be incurred by TAG. He said that his own understanding of the legal issues was largely based on the DLA report. He said that the company was not unduly concerned about the issue of prematurity raised in Callery v Gray partly because a decision in favour of the defendant insurers would run contrary to the purpose of the changes introduced by the AJA 1999 and also because of a statement made by Mr David Lock, a minister in the Lord Chancellor’s Department (which is quoted in the DLA report) to the effect that the Government would reverse a decision in favour of the defendants by legislation although not with retrospective effect.

In relation to the issue of the recoverability of the AIL fee, the DLA report refers to the financial consequences of it being held to be irrecoverable in a successful claim as falling on the panel solicitors. Mr Watson said that based on this he did not regard this as a difficulty for TAG.

In fact, as explained earlier, the report’s treatment of the consequences of an adverse decision on these issues is not completely accurate. In an otherwise successful claim a failure to recover either the ATE premium or the AIL fee would trigger a liability on the part of the underwriters to compensate the claimant and would therefore impact on the loss ratio for purposes of the swing premium. But it is, I think, clear from the evidence of Mr Watson and the other directors called as witnesses that this was either not appreciated at the time or was thought to be sufficiently unlikely as to be discounted when considering the financial risk profile of the company.

One issue in this case is whether this view was at all realistic. It is noteworthy that at a meeting with DLA and NMR on 1 March 2001 Mr Langford and Mr Watson were told by Mr Fenwick of Rothschilds that the bank’s view on TAG’s value had moved adversely in the light of legal and regulatory issues and that Claims Direct (a major competitor) was said to have lost 90% of its value due to these issues. At the same meeting reference was made to a paper produced by Ernst & Young as part of its preparation of a vendor due diligence report (also commissioned as part of Project Apollo) which raised an issue about the accounting policy for turnover recognition. The policy at the time was to treat income as accruing from the point when a potential claim was notified as opposed to the time later in the process when the claim was referred to a claims solicitor and accepted. The then policy was based on the probability that the claim would be accepted having regard to historical experience. The change in policy to a later date (which had already been implemented by Claims Direct) was intended to increase the probability that the revenue identified was in fact earned and collectable and was described by Ernst & Young in their note as a more prudent approach to the calculation of turnover.

But as recorded in the note, TAG was not yet willing to change its existing policy. Mr Watson is recorded as having said that prudence was abandoned as an accounting standard by FRS 18 and that TAG’s policy better matched the company’s costs and revenues. If turnover was not to be accrued then a relevant proportion of direct costs should be deferred and carried in the figures for work in progress.

The Ernst & Young note goes on to consider the question whether the current accruals based income recognition policy was acceptable or whether TAG should be moving to a cash based accounting policy. Ernst & Young’s response was in summary that there was no specific guidance on income recognition in UK GAAP and that the current accounting policy could be justified as in accordance with UK GAAP in its current form. What the note does not do is to discuss the impact on the balance sheet of changing to the more conservative policy. At the meeting on 1 March 2001 this point was raised. The adoption of the new policy would reduce TAG’s profit for the year ended 30 June 2001 from £23m to £1m with an obvious consequential effect on distributable reserves. In Rothschild’s note of the meeting Ernst & Young were said to be nervous about the issue but Mr Watson was recorded as believing the current policy to be reasonable. The resolution of the issue was however identified as time critical and as we shall see when I come to review the later history of the change in accounting policy between September and November 2001, it is central to the question whether the dividends declared and paid in September and October 2001 were lawful. The Official Receiver contends that the policy was changed in September 2001 thus creating distributable reserves as at the end of August of only £3.015m. Mr Watson accepts that on the basis of those figures it would not have been lawful to have authorised and paid dividends in August and September of some £7.61m without reversing the change in policy. His case is that the change in accounting treatment did not occur until November 2001 and that when the dividends were authorised and paid he and the other directors responsible relied on the management accounts to July 2001 which on the basis of the original accruals policy showed that there were sufficient distributable reserves to satisfy the requirements of s.263 of the Companies Act.

On 23 March 2001 Mr Watson attended a meeting with Mr Holman of Ernst & Young to discuss the issues about income recognition raised in the earlier paper. One of these issues seems to have been whether there was scope for treating any claw back under the swing premium provisions in the Lloyds policy as an additional part of revenue. Nothing in the end came of this but it does, I think, perhaps illustrate the relatively confident attitude of Mr Watson and the other directors to the risk of any liability for the swing premium ever occurring.

Following these discussions, Ernst & Young on 6 April 2001 produced their draft report on TAG which included a review of the company’s accounting policies relating to revenue recognition. The report recognises the possibility of needing to convert to a new policy of recognising income at a later stage in the claims cycle should the Accounting Standards Board adopt an approach in the future similar to US GAAP which had already placed a greater onus on demonstrating certainty that the revenue was realised or realisable. The report also notes the impact which this would have on operating profit and net assets for 2001. But the actual conversion rate of notified to accepted cases as of November 2000 was given as 30.3% compared with the rate of 30.6% applied as the accrual rate under the existing policy in respect of notified claims. Based on these figures that policy historically at least had a high degree of accuracy and Ernst & Young summed up the position in these terms:

“A new financial reporting standard, FRS 18 – Accounting Policies (effective for years ending on or after 22 June 2001), highlights that, where financial information is prepared under conditions of uncertainty, a degree of caution (ie prudence) needs to be applied in exercising judgement and making the necessary estimates.

This highlights the need for management to review continually the extent to which it accrues income because the Group does have a relatively short history from which to draw statistics and there is a risk, as the market matures, that conversion rates will decline. Management recognises this to be the case and accordingly is monitoring, on a monthly basis, the actual conversion ratios and considers the ongoing appropriateness of the rate used to calculate accrued income.

On the basis that management does continue to perform a perpetual review of the actual conversion rates, amends the rates applied to reflect the actual rates and performs post period end reviews of the actual revenue generated compared with the accrued income we consider the basis applied by the Group to be acceptable and in accordance with UK GAAP. This view has also been confirmed by Andersen in carrying out their audit of the 2000 accounts. ”

About six venture capitalists expressed some interest in TAG and one of them (Capital Z) went so far as to make an indicative offer of £25m for a minority stake in the business. This valued the company at £80m. But by early June only Capital Z remained and Mr Langford decided to abort Project Apollo and to end the negotiations with Capital Z. There is a note of a telephone conversation between NMR and Mr Lewis-Jones of Ernst & Young which outlines the reasons for withdrawing from the negotiations. Capital Z wanted more time to complete due diligence and also asked to await the outcome of Callery & Gray in the Court of Appeal. Mr Langford was unhappy about this and thought that the value put on TAG was in any case too low. Mr Watson said in evidence that Mr Langford believed that the offer undervalued the company because it did not take into account the value to be attributed to the financial services element of the business involved in the provision of the loan facility. The Ernst & Young note goes on to record that Mr Langford had abandoned any idea of a flotation for the time being and wanted to consolidate TAG’s position, await the result of the pending court cases and to proceed beyond the year end with a strong and clean audit.

More detail of Mr Langford’s thinking in the aftermath of Project Apollo can be gleaned from an attendance note of NMR of a meeting with him and Mr Watson on 13 June 2001. It confirms that any flotation or merger had been discounted for the time being. The note then goes on as follows:

“…Langford believed that there remained a period in which the TAG core business should go from strength to strength (ie. while the Court of Appeal case drags on and before the insurance industry has forced HMG to change existing legislation and act against claims management companies). As a consequence, he was minded to continue as follows:

•

Drive the core business as fast and far as possible, dividending out as appropriate

•

Start making publicly conciliatory noises towards the insurance industry

•

Investigate j-vs as a means of commencing TAG’

•

Sell Motor Law

...”

Mr Watson confirmed that with the ending of Project Apollo the 10% dividend policy was abandoned. Mr Langford indicated that he wanted to draw out higher dividends for 2001 in order to take money out of the business. The policy he said was still only to dividend out profits up to a level that was reasonable and Mr Watson said that this would obviously require the company to look at its distributable reserves available and the effect of the dividends on the remaining reserves. It was intended to be a policy for 2001. After that they would take stock of the situation and decide whether to pursue investment from a venture capitalist or a sale.

Between July 2000 and February 2001 when the 10% dividend policy was adopted there were regular monthly dividend payments to the Langfords of £30,000. No such payment was made in November 2000 but in January 2001 the payment made was one of £200,000. After the £30,000 paid in February 2001 there were no further dividend payments until June of that year when a payment of £300,000 was made on 15 June. There then followed a series of substantial payments up to 23 October 2001. The financial year of TAG ends on 31 August and the dividend payments made in the years ended 31 August 2001 and 31 August 2002 were as follows:

Year ended 31 August 2001

Date Amount Payee

£

31.07.00

30,000 Mr & Mrs Langford

31.08.00

30,000 Mr & Mrs Langford

30.09.00

30,000 Mr & Mrs Langford

30.10.00

30,000 Mr & Mrs Langford

01.12.00 30,000 Mr & Mrs Langford

08.01.01 200,000 Mr & Mrs Langford

06.02.01 30,000 Mr & Mrs Langford

06.02.01 30,000 Mr & Mrs Langford

15.06.01

300,000 Mr & Mrs Langford

13.07.01

149,000 Mr & Mrs Langford

19.07.01

1,700,000 Insinger

20.07.01

290,000 Insinger

20.07.01

11,000 Insinger

30.07.01

337,000 Insinger

21.08.01

280,000 Leverington

29.08.01

333,000 Leverington

Total 3,810,000

Year ended 31 August 2001

Date Amount Payee

£

11.09.01

1,000,000 Mr Mark Langford

11.09.01

3,000,000 Leverington

21.09.01

280,000 Leverington

28.09.01 396,000 Leverington

01.10.01 330.000 Leverington

04.10.01 (396,000) Repayment

23.10.01

2,225,000 Leverington

23.10.01

750,000 Mrs Deborah Langford

Total 7,610,000

I propose to deal separately with the allegations made by the Official Receiver about the artificiality of the EBT and the sub-trusts. But it is important to bear in mind that the decision to set up the EBT pre-dates the failure of Project Apollo. At the meeting with Rothschilds and DLA on 1 March 2001 at which the issue of turnover recognition was raised, the possibility of setting up an EBT was mentioned. By then Mr Langford and Mr Watson had already had a meeting with Mr Auden of Baxendale Walker who (according to DLA’s note) had recommended the use of an offshore EBT for Mr and Mrs Langford. It is clear from both the timing and the content of this discussion that the primary purpose of the EBT at that time was to avoid the payment of CGT on any sale by the Langfords of their shares in TAG as part of Project Apollo. The evidence is that Mr Langford was put in touch with Baxendale Walker by Mr Darwen of DLA and at the meeting Mr Darwen recommended that DLA and Arthur Andersen should be asked to view the efficacy of the scheme which Mr Auden had suggested.

On 9 May 2001 (again about a month before Project Apollo was terminated) Mr Auden wrote to Mr Langford confirming his instructions to Baxendale Walker to set up what is described in the letter as a Private Shares Trust. The letter does not go into detail about the structure proposed but it was to involve the transfer of shares to Channel Island trustees the beneficiaries of which would be employees of TAG and their dependants. Draft documents appear by then to have been supplied to Mr Langford by FSL Services Limited, a company connected to the senior partner of Baxendale Walker and Baxendale Walker undertook as part of their instructions to review these documents and advise on whether any modifications to what is described as the FSL Retirement Trust Plan were necessary in the Langfords’ case.

There is in the evidence a document prepared by Baxendale Walker and dated 11 May 2001 which is in terms a report to the board of TAG about the proposed trust arrangements. But there is nothing to confirm that the document was shown to all board members at the time. Mr Watson was adamant that some documents from Baxendale Walker were provided to directors at a special meeting in either May or June and we know, of course, that all of the directors initially participated in the scheme through their sub-trusts. I shall return to the question of board approval later, but the Baxendale Walker report of 11 May states in terms that it was written at the request of Mr Langford.

The report describes TAG’s objective and sole purpose in setting up the EBT as the establishment of a commercial executive incentive programme. Paragraph 3.5 states that the company derives no corporation tax advantage from the EBT because direct bonus payments would themselves be fully deductible in computing the company’s taxable profits. The report goes on to say that the scheme cannot therefore properly be described as tax avoidance but as an employee benefit scheme it would take advantage of s.239 of the TCGA 1992 so that the disposal of the Langfords’ shares into the trust would be treated as made on a no loss/no gain basis. This relief is however only available if the Langfords have no right to benefit from the capital of the trust. This is picked up in paragraph 4.6.3 of the report which states that:

“Any controlling shareholders plus connected family members (and former controlling shareholders) in the Company are excluded from benefit under the Trust and only non-shareholder directors and employees can benefit (see below). There is no element of disguised distribution to shareholders. Therefore, the contribution to the Trust can only be said to be made exclusively for the purposes of the Company’s trade.”

In paragraph 5 of the report instructions are given about the setting up of the trust. Paragraph 5.2 states that the directors of TAG will need to discuss how the EBT will be used to implement the executive incentive programme. The company must then hold a board meeting “evidenced by proper minutes at which the directors’ resolutions on these matters will be voted upon in the usual way” (see para 5.2.2). The company will then provide the initial funds for the EBT. The shareholders will then gift their shares to the EBT by executing the appropriate deed of assignment and stock transfer form.

Paragraph 5.9 states that the trustees of the EBT can provide benefits to members of the trust in the form of cash bonuses, benefits in kind and loans, but that the share donors must be excluded (underlined) from membership of the trust.

It is not necessary for me to express any view for the purposes of these proceedings about the tax advice contained in the report. But it is clear that Baxendale Walker were keen to stress that for the scheme to be accepted by the Revenue and to be able to take advantage of the beneficial CGT treatment afforded by s.239 the Langfords and any other connected persons (as defined) could not be beneficiaries under the trust. A connected person included a director of TAG as the settlor. It is significant that this applied to the provision of benefits whether paid as cash bonuses or by way of loans. Paragraph 5.9 of the report contemplates that these would be made available only to members of the trust.

Significantly, none of this advice was heeded or implemented in the setting up of the trust. On 30 June 2001 Mr Langford executed the EBT on behalf of TAG which was the settlor and founder of the trust. The initial capital was £1000. The trust deed conforms to the outline contained in the report of 11 May and contains in cl.1.1.4.1 a definition of an excluded person (which includes the founder and any person connected with or a participator in the founder). Clause 1.1.5 contains a definition of “Prohibited benefits” which include (cl.1.1.5.2) “any sum or benefit or property provided to or for or at any time capable of being provided to or for any excluded person”.

The beneficiaries are the present, past and future employees of the founder but do not include any excluded persons: see cl.1.1.4. Similarly, although paragraph 1.2.18 of Schedule 1 to the deed contains a power for the trustees to appoint any part of the fund on the trusts of a new settlement that power is subject to a proviso that the trusts “shall not permit the payment of any prohibited benefit”.

Notwithstanding these provisions, Mr Langford (again on behalf of TAG) signed a letter of wishes (also dated 30 June 2001) addressed to Insinger which contained “a list of persons who we would wish to receive discretionary benefits whether by way of bonus or otherwise in the amounts indicated against each of their respective names”. The only names on the list are Mr and Mrs Langford with a suggested discretionary benefit of 67% and 33% respectively.

This letter, (which is relied on heavily by the Official Receiver as indicating the artificiality of these arrangements) is really quite extraordinary. Although there is no direct evidence on the point, it seems likely that it was drafted by Baxendale Walker as a standard form letter of wishes for use in a discretionary scheme. There is a letter from Mr Auden to TAG dated 28 June 2001 in which he lists the documents required to be executed “as proposed with Mark and Debbie Langford for Saturday 30 June 2001 at 10.00 a.m. (venue to be confirmed)”. The list includes the letter of wishes. Had the letter included only the names of employees who were not shareholders or directors it would have been unexceptional. But the way in which it was completed is completely inconsistent with the express terms of the trust. This can only mean that Mr Langford either never bothered to read the report from Baxendale Walker and the advice it contained or simply regarded these arrangements as little more than window dressing.

For present purposes however the letter of wishes is significant in what it indicates about how the EBT was put together and how it was perceived by Mr and Mrs Langford. We know that on 17 May 2001 the Langfords and Mr Watson flew to Jersey for the day with Mr Auden to meet the representatives of two trust companies (Insinger and Atlas Trust Company) who Baxendale Walker had suggested as possible trustees. In his email to Insinger Mr Auden said that the Langfords were “looking to do a PSLP, with a rapid completion well before the end of the month”.

Further insight into the Langfords’ thinking at the time can be gleaned from an attendance note prepared by DLA of a meeting with Mr Langford on 14 May 2001. This records that Baxendale Walker had proposed a trust to Mr Langford as part of a tax planning scheme to save income tax on any dividend payments and capital gains tax on any further disposal. The note goes on:

“The advantages and disadvantages of these types of schemes in general were discussed both on a tax planning and from the prospective of marketing any initial public offering. In substantive terms, ADD advised that DLA would be unable properly to assess the proposed scheme with a view to assessing its impact on TAG without seeing firm proposals. ADD suggested to Mr Langford that Baxendale Walker should be invited to set the scheme down in writing and Mr Langford could then approach independent tax counsel for a view on the robustness of the tax planning.”

It is clear from this document that Mr Langford at least saw the EBT solely in terms of enabling him and Mrs Langford to receive their dividends free of income tax. None of the documentation produced by Baxendale Walker at the time described the scheme in this way and no payment made to the Langfords either by way of dividend or as remuneration would be free of income tax even if paid by a Jersey company. The tax advantages of the EBT (if it took effect according to its terms) were potentially that the shares could be transferred to Insinger free of CGT and any dividends subsequently paid to Insinger would not be taxable in its hands.

The apparent concern in late May and early June to conclude the establishment of the trust and the transfer of shares before the end of June was almost certainly caused by the prospect of a sale to a venture capitalist as part of Project Apollo. Mr Watson said in his evidence that the EBT (although it would initially provide benefits for the directors) was set up with a view to payments being made in time to a wider class of employees. But it is clear (as he was aware at the time) that its initial purpose was to minimise tax for the Langfords in the disposal of their shares. Quite how this was going to be done is not however clear. Even though the transfer of shares to the EBT would not attract CGT any sale of part of the company to a venture capitalist would then be a matter for Insinger. There is no suggestion that they were ever involved or even informed about the discussions with Capital Z or any other interested parties.

The Baxendale Walker scheme was clearly a concern to TAG’s professional advisers. On 1 June 2001 DLA (whose own earlier advice that Mr Langford should obtain counsel’s opinion and allow them to scrutinise the scheme had not so far been taken) recorded in an internal email that Ernst & Young had strongly advised him not to use the scheme. Once Project Apollo had come to an end in mid-June the immediate pressure to deal with a potential liability to CGT had gone but all the evidence indicates that Mr and Mrs Langford wished to press ahead with the EBT. The focus of the trust arrangements (at least so far as the Langfords and Mr Watson were concerned) clearly shifted to saving tax on the monies to be dividended out by the company. Mr Langford’s strategy (as described above) was to expand the business as quickly as possible and to dividend out the profits. The EBT fitted in with this strategy because it provided the company with a means of paying dividends free of income tax on receipt by Insinger which would then be invested (again free of tax) and used to provide benefits to all of the directors.

The scheme was never intended by the Langfords to be a charity for the benefit exclusively of others and the letter of wishes executed on 30 June 2001 makes this plain. But it was intended to provide incentives to the other directors whose own commitment was, of course, vital if the business was to be rapidly expanded within the relatively short timescale contemplated by Mr Langford.

Some evidence of this is to be found in a memorandum from him to Mr Watson dated 15 June 2001. This raises various issues about the ongoing court proceedings about ATE premiums and about TAG’s cash receipts. But in the second paragraph Mr Langford says this:

“I am anxious to resolve the Directors jam. Can you let me have the table that shows how many cases we have accrued in prior months and how many we have actually been paid on. Have we yet formed a view on what is collectable prior to August. We also need to consider this in conjunction with the Baxendale Walker scheme and also in terms of the structure in salaries/bonuses going forward.”

The reference to “jam” in this note is clearly a reference to some form of additional payment for the directors and one can see from the documentation disclosed how this was taken forward during the remainder of June. Mr Watson said that Mr Langford was very focussed on cash and that the “jam” was to be some form of payment or bonus to take account of the fact that as a result of the failure of Project Apollo share options held by the directors had not been exercised. Everyone had been working hard and there was, he said, an expectation on the part of the directors of getting something. What in fact happened was that on 20 June Mr Watson and each of the other directors received a letter from TAG signed by Mr Langford confirming that with effect from 1 June their basic salary would be increased and they would be entitled to a discretionary annual bonus of up to 100% of their basic salary which would be payable monthly based on the “successful achievement of objectives”.

This was a reference to something called “Challenge TAG” which set targets for written claims in each month and rewarded staff for achieving them. There is a memorandum of 22 June 2001 signed by Mr Gary Hoddes setting out what is described as the additional bonus structure for July/August and September of that year and which confirms that the bonuses were dependent on meeting the cash receipts targets. It is important to bear in mind that although technically beneficiaries under the proposed EBT none of the employees listed in the memorandum were to receive their bonuses under that scheme. As explained earlier, the EBT was to be confined at that time to the Langfords and the other directors. In relation to this, there are in the evidence two sheets headed respectively “Dividend payments/bonus” and “Sub Trust payments” the first of which was signed by Mr Langford and Mr Watson. The schedule of dividend/bonus payments lists a total of £2.84m being paid to all the directors (except Mr and Mrs Langford) in differing amounts over the three month period between July and September 2001. The sub-trust document is a list of the payments to be made into the EBT by TAG on 31 July for onward transfer to the sub-trusts. These were individual trusts set up in July 2001 under the power contained in Schedule 1 to the EBT for the benefit of the spouse and family of each of the directors and into which the bonus payments were paid. The figures for each director (totalling £627,000) correspond to the bonus payments for July in the other document but Mr Langford has added in manuscript against his and his wife’s name the sums of £1m each to be left “in trust for purchase of Spanish property – completion 20.7.01.”

This is a reference to a house in Marbella which the Langfords purchased in July for about £1.5m with the monies advanced to their sub-trusts and it looks as if this expenditure was contemplated by the time that the trust arrangements came to be implemented.

The revised salary arrangements for the directors represented a very considerable increase for them. In the case of Mr Watson, his basic salary increased from £150,000 to £390,000 with a possible bonus of an equal sum. This was before taking into account the EBT and the payments which were made into the sub-trusts. Under these arrangements Mr Watson eventually received a further £400,000; a total payment including bonus of £1.18m. The directors were therefore given very considerable financial incentives by TAG to expand its turnover in accordance with the Challenge TAG targets. But these arrangements did not apply to the Langfords themselves. As mentioned earlier, they had always drawn relatively modest salaries and derived most of their income from the company by way of dividend. Under the strategy outlined by Mr Langford on 13 June 2001 this would not change and Mr Watson was on notice from that meeting that the majority shareholders would look to the company to fund a significant rise in dividends over a relatively short period of time. Absent a finance committee it is the duty of a finance director properly to assess a company’s ability to pay dividends and other expenses and to inform the board (and through them the shareholders) of any concerns which might exist about the affordability of the proposals. In a public company the directors will normally recommend a dividend to the shareholders in general meeting but in the case of a private company where the majority shareholders are also directors any tensions about the payment of dividends are likely to surface at a board meeting and have to be resolved there. If the shareholders are determined to pay themselves dividends at a level which the company cannot afford and are prepared to overrule any objections which the board may have, then the directors have no option but to resign. What they are not entitled to do is merely to rubber stamp or acquiesce in dividend decisions which may be inappropriate without actively considering the issues involved. Their ultimate duties as statutory directors include an obligation to ensure that the company continues to operate on a solvent basis and in accordance with the requirements imposed upon them by the Companies Acts. A failure positively to carry out these obligations is a dereliction of duty on their part.

The principal allegation of unfitness made against Mr Watson concerns his failure to ensure that these basic rules of corporate governance were observed at TAG. Starting on 15 June 2001 large sums by way of dividend began to be paid out by the company. The first payment was one of £300,000 made to the Langfords. It was not authorised at any meeting of the full board prior to the date of payment nor is there any contemporaneous record in the form of a board minute which refers to or authorises it. The payment is purportedly authorised by a minute of a meeting of the full board held on 15 June at which Mr Watson together with all the other directors is recorded as being present, but it is common ground that this was one of the minutes created in October 2001 in response to Arthur Andersen’s request for minutes authorising the dividends and that the meeting which it records did not take place.

To save unnecessary repetition it is worth summarising at this stage what Mr Watson’s case is in relation to the sanction by the board of dividends. The Articles of Association of TAG incorporated regulation 102 of Table A and thereby permitted dividends to be approved and declared by TAG in general meeting. Mr Watson accepts that this course was not followed in relation to any of the disputed dividends and there is no record in the evidence of any shareholders meetings taking place during the period in question.

The Articles of Association also incorporate regulations 88 and 103 of Table A so that the board of TAG was authorised at a properly summoned and quorate meeting to approve the payment of dividends. Mr Watson accepts that the minutes produced to Arthur Anderson of meetings of the full board at which dividends were approved are fabricated. What he says occurred was that in every case the dividends were approved at meetings attended by himself, Mr Langford and Mr Gary Hoddes. These meetings have been characterised by the Official Receiver as meetings of the so-called inner group who it is said usurped the functions of the whole board. Mr Watson accepts that at none of these dividend meetings were any other members of the board physically present. But, he says, he attended the meetings and approved the payment of the dividends proposed by Mr Langford in the belief that all other board members had been given notice of the meetings and that they were quorate.

I should say at once that I do not accept his evidence on this. It is clear from the evidence of all the directors who attended the hearing that they were never given notice of these meetings and did not in fact consider it to be part of their role to attend. I suspect that long before Mr Watson joined the company Mr Langford and Mr Gary Hoddes had become used to making key financial decisions on their own and this system was simply perpetuated after Mr Watson joined. One of my main reasons for rejecting Mr Watson’s evidence on this is that his alleged understanding of events is inconsistent with what occurred at the meetings of the full board which followed the dividend meetings. The board packs did, it is true, contain a cashflow statement one line of which listed the dividends paid in the relevant month. But there was no explanation given in the pack of the reasons or basis for the payments, nor was the board invited in terms to approve or ratify them. They were simply presented as a fait accompli.

Mr Watson had understandable difficulty in explaining why he did not think it necessary to offer any explanation of the figures to the board and he made various suggestions to the effect that they could work the position out for themselves from the material available to them. Mr Booth was also at pains to point out (which I accept) that had any member of the board asked for an explanation he would have been provided with one. But the fact that no explanation or summary was provided in the pack or orally by Mr Watson at the meetings, coupled with the fact that no director ever attempted to question the figures, points inexorably in my judgment to it having become accepted practice in the company for the inner group to decide on dividends and other important financial matters without reference to the full board. Even if Mr Watson had assumed at the very first dividend meeting he attended that the other directors had been invited he cannot have continued to labour under that misapprehension when they failed to attend every single meeting thereafter. Witnesses such as Mr Nield and Mr Ross, spoke of it being common knowledge and accepted practice for the inner group to deal with the financial matters I have referred to and it is, I think, inconceivable that this understanding of the position did not communicate itself to Mr Watson at an early stage as the reason for their non attendance. I am afraid that I regard his explanation in evidence as an afterthought and not a genuine recollection of his understanding of the position at the time.

A similar controversy surrounds the setting up of the EBT. There is a note by Mr John Perkins of Insinger of a telephone conversation which he had with Mr Auden of Baxendale Walker on 28 June. Mr Auden is said to have explained that the intention was for TAG to pay out £1m in bonuses and that for this reason the trust would need to be established before 30 June which was then the end of the company’s financial year. £1m was to be paid into the sub-trusts. The figure of £1m does not marry up with the sums eventually transferred to the sub-trusts in July but the note may explain the rush to complete the setting up of the EBT by 30 June. Whatever the explanation for the timing, on that date a meeting of the board of TAG is recorded as having taken place at 12.30 at the Langfords’ home in Cheshire attended only by Mr and Mrs Langford. It looks as if Mr Auden of Baxendale Walker may also have been there because he has signed the stock transfer form.

The minute of the meeting refers to the Chairman reporting that it was quorate. This is incorrect because none of the other directors was invited to the meeting or attended it and this is consistent with the planning of the EBT which appears from the documents to have been conducted entirely between Mr Langford, Mr Watson and Baxendale Walker. Mr Watson said in his evidence that the minute was not false because he presumed that it was a meeting of the full board. He did not know if the others had been invited. He was invited but declined to attend, he said, because he tried to keep his weekends free to be with his family. Again, I do not accept this evidence. The background to the setting up of the EBT and the sub-trusts shows that it was very much Mr Langford’s and Mr Watson’s project and was linked at its inception with the Langfords’ desire to minimise or exclude tax on the disposal of their shares and subsequently on the payment of dividends. The full board received little or no explanation of the EBT during its planning. Consistently, with the exclusion of the board from decisions taken on dividends and other financial matters, it is, I think, almost inconceivable that Mr Langford would have made an exception on this occasion and invited the full board to the meeting. Mr Watson was, I believe, fully aware of this at the time and his suggestion to the contrary is not credible. He did, however, accept that there was no mention of the setting up of the EBT by the company at the next full board meeting on 9 July and it follows that there was certainly no prior authority given by the board for the EBT or any ratification of it at that meeting.

Once again, the overwhelming probability is that this was seen by the other directors as a matter for Mr Langford to deal with. He and Mrs Langford were the owners of the shares. The company was contributing no significant capital as such to set the trust up and the dividends which would follow to provide the loans from the sub-trusts were not something the directors had any desire to quibble about. The only meeting at which the full board was provided with detailed information about the EBT was in October 2001 when Mr Auden of Baxendale Walker visited TAG’s office and gave some kind of presentation about the EBT, Insinger and the loans from the sub-trusts. This was at a time when several directors were expressing unease about the tax consequences for them of using the sub-trust arrangements to receive their additional bonuses and we know that a number of them (Mr Bird, Mr Ross and Mr Hopper) eventually repaid the loans and chose to take their bonuses more conventionally paying income tax on the sums involved. But it is also clear from some correspondence from Baxendale Walker following this meeting that it was not arranged as some kind of ratification exercise, but rather as an attempt to assist the directors in deciding how to deal with their personal tax positions.

In summary, therefore, the position on board approval for the payment of dividends appears to be this. There was never any formal delegation to the inner group of the power to approve the payment of dividends. These were routinely decided upon by the members of the inner group at meetings which took place at irregular intervals between the scheduled monthly board meetings. The dividends were then paid. The full board was never asked formally to ratify the payments which had been made nor was it given any information about the payments beyond their amount which featured in the cash flow reports contained in the board information packs. As is apparent from the minutes of these meetings and from the evidence of the other directors such as Mr Ross, Mr Bird and Mr Nield, there was no discussion of the dividends at the regular board meetings and Mr Watson did not raise any points about them for consideration by the other directors.

It was accepted by these directors that financial decisions (including the payment of dividends) were made by the inner group. They were aware that this was the procedure adopted and accepted it. None of them ever complained or sought to challenge this. Some of them (such as Mr Bird) said that they regarded the inner group as best placed to make these decisions. There was however a culture of acquiescence which was undoubtedly due in part to an attitude of secrecy about payments to directors. Mr Nield said in evidence that Gary Hoddes told him that he was not to discuss dividends and salaries. Faced with this attitude the directors seem simply to have accepted the position.

It is also clear as I have indicated that the level of dividends paid was largely dictated by the financial needs of the Langfords. The level of provision for the other directors which was to be funded by dividends paid to the EBT and their sub-trusts was set out in the schedules I described earlier and settled in either late June or early July 2001. These contemplated payments to the directors (including Mr Watson) via the EBT of £627,000 in July, £613,000 in August and £610,000 in September. But the total dividend payments in July were £2.487m. This included the £11,000 used as the initial capital for the eleven sub-trusts set up on 18 July (paid on 20 July 2001) and the £627,000 (paid in two amounts of £290,000 and £337,000 on 20 July and 30 July). The £290,000 was used on 23 July to make payments of £140,000 to Mr Watson’s sub-trust and £150,000 to that of Mr Gary Hoddes. The £337,000 was paid into the sub-trusts set up for the other directors in the sums of £67,000 for Mrs Brennan, Mr Philip Hoddes and Mr Ross and £34,000 for Mr Hopper, Mr Nield, Mr Bird and Ms Susan Whyte. The balance of £1.849m was paid to enable the Langfords to acquire the house in Marbella. They had already received £300,000 by way of the dividend paid on 15 June. The £149,000 required for the deposit on the house was paid direct to Mr Langford on 13 July. On the same day Mr Watson faxed a copy of a letter from the Langfords’ Spanish attorney to Insinger in anticipation of the completion of the purchase on 22 July which was to be funded through the Langfords’ sub-trusts. The £1.7m dividend necessary to finance this was paid on 19 July by TAG to Insinger on the instructions of Mr Watson. The bank accounts for the sub-trusts had been opened on 16 July and on 19 July the two payments of £850,000 each were made to Mr and Mrs Langford’s sub-trusts out of the £1.7m received from TAG. This money was then routed back from the trustees of the sub-trusts to the Langfords on the same day and used by them to complete the purchase of the house in their own name. On 23 August 2001 loan agreements were eventually executed between the trustees and the Langfords in respect of the £850,000 advanced to each of them on 19 July. The timing of these agreements is of course relied upon by the Official Receiver in support of his argument that the trust arrangements were entirely artificial but I shall come to this point later. I am concerned at the moment only to identify the scale of and the circumstances in which the dividend payments came to be made.

In August 2001 a further £613,000 in dividends was paid to Insinger in two tranches on 21 August (£280,000) and 29 August (£333,000). Mr Watson informed Insinger on 20 August that the £280,000 was about to be paid and that a request would then be made for a loan of £150,000 to Mr Gary Hoddes. The remaining £130,000 was to be credited to his sub-trust and kept on a fixed deposit. The £280,000 was paid to Leverington (which by now was the shareholder in TAG) on 21 August and then distributed to Mr Gary Hoddes’ and Mr Watson’s sub-trusts in accordance with Mr Watson’s earlier instructions.

The £333,000 was paid by TAG to Leverington on 29 August and then transferred to the other sub-trusts through the EBT. £67,000 was paid to the sub-trusts of Mr Philip Hoddes, Mrs Brennan and Mr Ross. £33,000 was paid to those of Mr Hopper, Mr Bird, Mr Nield and Ms Susan Whyte.

On 11 September TAG paid further dividends of £1m to Mr Langford and £3m to Leverington. The £3m was transferred on to the EBT on 13 September and then distributed on the same day to the sub-trusts for the family of Mr and Mrs Langford (as to £1.5m each). If one treats the monies paid into their sub-trusts as available to them whether by loan or otherwise, the Langfords therefore received a further £4m in September. On 21 September a further dividend of £280,000 was paid to Leverington and used to produce additional payments to the sub-trusts of Mr Watson and Mr Gary Hoddes of £130,000 and £150,000 respectively. These payments accord with the schedules agreed back in June when the bonus scheme was implemented. On 29 August a further £396,000 was paid out but this was subsequently re-credited to TAG and can therefore be ignored for the purposes of these applications.

The other directors (apart from Mr and Mrs Langford) received their further payments for September by means of a dividend of £333,000 paid to Leverington on 1 October. In accordance with the June schedules this would have been used to fund additional payments to the various sub-trusts of £33,000 for Mr Hopper, Mr Nield, Mr Bird and Susan Whyte and £66,000 for Mr Philip Hoddes, Mr Ross and Mrs Brennan. By now, however, Mr Hopper and Mr Bird had decided that they no longer wished to make use of their sub-trusts as a means of receiving additional payments and they took their bonuses of £33,000 as additional salary and paid UK income tax on the sums in the usual way. It was therefore only necessary for £264,000 to be transferred to the other sub-trusts which was done by way of two payments of £231,000 on 4 October and £33,000 on 11 October.

This leaves the remaining dividends of £2.25m and £750,000 paid on 23 October to Leverington and Mrs Langford. The £2.25m was divided and paid as to £1.125m each into the sub-trusts of Mr and Mrs Langford on 30 October.

On 9 October Mr Langford sent a memorandum to Mr Watson raising a number of issues on different topics ranging from the audit review of ongoing cases to the arrangements for the Christmas party. The last item on the memorandum is headed dividend policy. It reads as follows:

“Dividend Policy – Can you arrange for £2.25 million to be transferred to Insingers and £0.75 million to Coutts. This will bring us up to date up to the end of October. For the period November 2001 to August 2002 £375,000 needs to be transferred and £125,000 respectively into Insingers and Coutts on the first working day of each starting 1 November 2001.”

As we know, the payments requested for November onwards were never made. A new finance director was in place by 15 November and no further dividends were paid. But the £3m paid to or for the benefit of the Langfords in October brought their share of the dividends since 15 June to £9.149m out of a total of £11.01m. It is quite clear therefore that the driving force behind the dividend payments and the person most concerned to ensure that the payments were made was Mr Langford. The memorandum of 9 October is I believe also indicative of the way in which decisions about dividends came to be made. From mid-June onwards there was no company dividend policy as such. The policy adopted for the purposes of Project Apollo had been jettisoned in favour of Mr Langford’s desire to dividend out substantial profits in place of the sale of part of his shareholding. The sums requested by him bore no relation to anything but his own financial requirements (e.g. the purchase of the house in Marbella) and there is no documentary evidence to indicate that either he or the inner group gave any consideration to distributable reserves or future profitability in determining what should be paid. The evidence in fact discloses that every single demand for payment made by Mr Langford between June and October 2001 was met in full. When Mr Watson was asked in cross-examination why he had not accounted for 25% of the dividends to Mrs Langford on account of her shareholding he said that he was told by Mr Langford who to pay the money to and simply followed his directions.

This is all consistent with the complete absence of any proper minutes or records of what on Mr Watson’s case were intended to be meetings of the board. He said that Mr Langford kept notes but they have not been disclosed and if kept can only have been of the most informal kind. I say that because the minutes eventually produced to the auditors of these meetings (which Mr Watson says were prepared by Mr Langford) are wholly contrived. They list directors present who were never invited to the meetings and in the case of the meetings recorded for 13 July and 21 August which are said to have approved the July dividends of £2.487m and the August dividend of £613,000, they even record that Mr Langford was not present. These are not honest documents and even if Mr Langford was solely responsible for their preparation it casts considerable doubt as to whether he can have regarded the system used for approving the payment of dividends as legitimate.

In fact, every one of the dividend payments during the disputed period was in one sense pre-determined rather than the result of a proper consideration of what the company could properly afford to return to its shareholders. I say this because all of the payments were made either in response to a request by Mr Langford for cash or in order to meet the schedule of bonus payments agreed by Mr Langford and Mr Watson back in June 2001.

The most therefore that could have taken place at the meetings of the inner group was simply a consideration by Mr Watson of whether TAG could literally afford to pay the money. The discussions never started so to speak with a blank sheet of paper and one of the real difficulties about the arrangements for paying bonuses to directors through contributions to the EBT was that it gave them all (particularly Mr Watson and Mr Gary Hoddes) an interest in the company making the dividend payments. None of them was independent of the results of any dividend decision. This has particular relevance (in the case of Mr Watson) to the issue to which I now turn which is the legality of the dividends and the question of financial prudence.

As explained earlier, the legality of the dividends depends upon the date when the accounting policy for the recognition of income was changed to one based on accepted claims (see para 53). Mr Watson’s evidence and case in a nutshell is that the company did have sufficient cash (including borrowings) to pay for the dividends at the time and under its existing accounting policy had sufficient accumulated reserves of profit to comply with the requirements of the Companies Act. He would not therefore have changed the policy between August and October 2001 if it would have needed to be changed back in order to accommodate the dividend payments tabled by Mr Langford and agreed to by the inner group. The change in policy came on 1 November 2001 when the dividends for September and October had been paid and was then incorporated into the statutory accounts for the year end 31 August 2001.

Section 263 of the Companies Act 1985 provides that:

“….

(1)

A company shall not make a distribution except out of profits available for the purpose.

3)

For purposes of this Part, a company's profits available for distribution are its accumulated, realised profits, so far as not previously utilised by distribution or capitalisation, less its accumulated, realised losses, so far as not previously written off in a reduction or reorganisation of capital duly made.

This is subject to the provision made by sections 265 and 266 for investment and other companies.

….”

Section 270 of the 1985 Act contains further provisions to the effect that the amount of a distribution which may be made is to be determined by reference to the company’s relevant accounts at the time. These are its last annual accounts but under s.270 (4) the company may rely on subsequent interim accounts to justify payment of the dividends where the proposed distribution would not be lawful under s.263 on the basis of the last filed annual accounts. The interim accounts must however be such as to enable a reasonable judgment to be made about the amount of the company’s available distributable profits as described in s.263 (2). It is therefore common ground that in relation to the payment of the September and October dividends the directors were entitled to rely both on the filed accounts to 30 June 2000 and on the most recent monthly management accounts then available.

The audited accounts of TAG for the year ended 31 August 2002 treat the £7.6m paid in September and October 2001 as an interim dividend with no final dividend being paid in the year. There is a note to the accounts (which were audited by KPMG) which states that:

“…

The dividend payments were made by reference to prior year audited accounts and management accounts available at the time.

11 Prior year adjustment

Income recognition

The directors have revised the accounting policy for income recognition in light of the requirement to adopt the most appropriate accounting policies under FRS18 ‘Accounting Policies’ and the Accounting Standard Board’s Discussion Paper on Revenue Recognition and have decided upon a more appropriate policy. This revision is to be treated as a prior year adjustment in accordance with FRS 3, ‘Reporting financial performance’.

…..”

The profits after tax for that year were £12.096m which after deducting the interim dividend left a retained profit of £4.486m. After taking into account an accumulated loss on the profit and loss account from the previous year, this created a deficit on reserves of £264,000.

These figures are based on the application of the new accounting policy which was introduced in 2001 and was also applied to the preparation of the statutory accounts for the year ended 31 August 2001. Those accounts were originally signed off by Mr Langford and Mr Watson on 1 November 2001 and showed profits after taxation of £5,440,618 which after payment of the dividends for the year to the end of August of £3.81m left retained profits of £3,656,845 at the year end after taking into account a restatement of retained profit as at 1 July 2000. Note 11 to the accounts explained the changes to accounting policy as follows:

“The directors have reviewed the accounting policy for income recognition in light of the Accounting Standard Board’s Discussion Paper on Revenue Recognition and have decided upon a more appropriate policy. This is to be treated as a prior year adjustment in accordance with FRS 3, ‘Reporting financial performance’”

Following Mr Watson’s dismissal as CEO in 2002 the statutory accounts for 2001 were re-stated on 24 June 2002 with a reduced turnover and some £6m of increased costs of sales. This had the effect of extinguishing the retained profit at the year end and of creating a deficit on reserves of £4.763m but these changes are not relevant to the issue of legality which turns solely on the state of the accounts in September and October when the dividends for those months came to be paid.

The notes to the statutory accounts give no indication of when the change in accounting policy was implemented. Mr Watson, as I indicated earlier, was insistent in his evidence that it did not take effect until the statutory accounts were signed off on 1 November 2001. The Official Receiver does not suggest that the change took place before July 2001 or that it affected the legality of the August dividends but in the August management accounts (dated 28 September 2001) the figure given for retained profit was £3.015m which was clearly inadequate for paying £7.61m worth of dividends in September and October. The management accounts for September 2001 were not produced until 7 November and therefore when the £3m of dividends paid on 23 October came to be requested earlier that month it would have been obvious to Mr Watson then (if not before) that there were insufficient reserves of profit out of which to make the payments.

The August management accounts are the first set of accounts which set out the effect of the change in policy. In the June and July management accounts the figures for retained profits are £12.308m and £17.303m respectively. However, on the basis of the August accounts and the change in accounting policy these would no longer be relevant and the £3,015m existing at the end of August 2001 took no account of the £4.28m already paid by way of dividends in September.

Mr Watson of course accepts this, but his case is that the September and October dividends were paid on the basis of the July management accounts (dated 30 August 2001) which incorporated the old accounting policy and clearly did show the existence of sufficient distributable reserves. His evidence in cross-examination is that the August management accounts were not issued on 28 September 2001 as indicated on their face and were not available in October. The procedure was for Mr Steven Slater, TAG’s Group Financial Controller, to produce the draft accounts for Mr Watson to review and subject to his input to issue them. Mr Watson says that he asked Mr Slater to draw up provisional management accounts for August based on the new accounting policy but not to issue them. He was to hold them until a decision had been made as to whether and if so, when to implement the policy. Similarly, the accounts for September and October were held until November. Mr Watson said that this allowed him and the other directors to see both pictures. Without adjustment the August management accounts showed some £27m as available for distribution. He said that he did not ignore the document when considering whether to pay the £3m of dividends in late October but he made his decision partly on the figures derived from the existing accounting policy (rather than the adjusted figures) and partly from taking into account some financial data for September. When pressed to explain what he meant by this, he said that he could not recall precisely what he did beyond saying that his decision was based on the July accounts plus an assessment of August and September.

It was not made clear by Mr Watson precisely what September figures were available to him given that the September management accounts are dated 7 November and he confirmed that the date on management accounts is usually their date of issue. The only exception to this were, he said, the August accounts which he described as special. They were special because they were intended to give Mr Watson the first opportunity of seeing the effect on profits of a change to the income recognition policy. However, he said Mr Slater dated the August accounts before showing them to him.

It was put to Mr Watson that all the figures in the August profit and loss summary were based on an adjustment to reflect the change in income recognition. This is a reduction in turnover of some £21,113m which when applied to the year to August reduces the figures for earnings before tax from £27,345m to £6,232m and the net profit figure to £5,504m. Mr Watson said that to assess what the figures would be without the change in policy he had to add back in the figure of £21.113m and then re-compute the tax. He said that he did this exercise and on that basis knew that without the change in policy the dividends could be justified but not otherwise. A decision was therefore made not to change the policy for the meantime until the dividends had been paid.

Mr Watson was then asked when Mr Langford first requested the dividends of £7.6m for September and October. He said that the request was first made in August and that he was not told how it was calculated. It was not finalised then and there was to be a further meeting in September when Mr Watson was to look at the forecast of distributable reserves for the coming month. Subject to that the payment would be made, he said, if the Challenge TAG targets had been met.

As we know, the full £7.6m was not paid until October. Mr Watson when asked about the reasons for this, said that it was because he was thinking about and wanted to propose the new accounting policy if possible. In fact, no mention of any of this was made in the material prepared for the monthly meeting of the full board which took place on 6 September, nor does it appear from the minutes to have been discussed at the meeting. Mr Watson said this was because he assumed that the other directors already had some idea of the global amounts in June and July but this is obviously not the case because on his evidence it was not until August that the demand by Mr Langford for the £7.6m was first made. He also suggested that he assumed that Mr Gary Hoddes had told the other directors about the sums involved but this is again speculation and is entirely inconsistent with the evidence I referred to earlier about the degree of secrecy which Mr Gary Hoddes always attached to financial matters such as dividends.

I am afraid that I regard most of this evidence as little more than a defensive smokescreen put up by Mr Watson during cross-examination. I found much of this evidence both unlikely and unconvincing for the reasons I have given. The only clear facts to emerge which are supported by and consistent with the documents are that on October 9 Mr Langford had requested Mr Watson to pay an additional £3m in dividends and that on 23 October Mr Watson instructed TAG’s bankers accordingly. I am not persuaded that there was a request for £7.6m in August although the figure of £7.6m may have been discussed then. It seems more likely that Mr Watson’s attention only came to be focused on the £3m when Mr Langford made his request in October. By then the August management accounts had been prepared and issued. Even on Mr Watson’s own evidence they arrived on his desk from Mr Slater signed and dated 28 September. He said that he delayed payment of the full £7.6m (which on his evidence was demanded in August) because he was trying to see if there was a way in which the accounting policy could be changed alongside the payment of the dividends. That was why, he said, the payments were spread out. But this is difficult to reconcile with his evidence that the August management accounts were only intended to be illustrative of the effect of the change in accounting policy and that he relied on the unmodified figures. On this basis, the dividend payments could have gone ahead without delay.

Mr Watson’s response to questions about this was not easy to follow. He said that he paid only about £4m of the £7.6m in September because he wanted to retain a chance of potentially changing the policy. This led to him being pressed about the sequence of dividend payments in late August and September and the dates when they were authorised. Eventually he resiled from his earlier evidence about the August meeting and I think accepted that it was not until sometime in September that the meeting of the inner group was held to authorise the £7.6m of dividends for September and October and that there was another meeting in October when Mr Langford asked why the full amount had not been paid. But again this sequence of events leaves unanswered the question why (and if so how) the dividends needed to be spread out to accommodate a possible change in the income recognition policy.

All the evidence indicates that from early 2001 onwards a change in the accounting policy was being recommended by the auditors and those advising on Project Apollo. Although some of the urgency may have gone out of this with the end of that project, the change of policy was still seen as desirable and was on Mr Watson’s evidence something he was keen to implement if possible. The documentary evidence shows that Arthur Andersen remained keen to implement the change and the strongest evidence of this is the fact that the statutory accounts to 31 August 2001 were drawn up and approved on that basis on 1 November 2001. The issue is therefore only one of timing and as to that we know that on 28 September Mr Slater signed off the August management accounts in a form which adopted the new policy.

The timing and format of these accounts is consistent with earlier practice. The July accounts for example were signed off by Mr Slater on 30 August and differ only in the absence of any line for the accounting policy change in the figures for actual earnings before tax. Mr Slater did not produce a comparative document as such for discussion purposes but actually implemented the policy change in the figures he produced as part of the actual profit figures for August. It seems to me unlikely that he would have signed the accounts off without having them approved by Mr Watson in the usual way, or if Mr Watson had in fact explained to him that it was to be a provisional document only. The complicated and unconvincing answers which Mr Watson gave to the questions as to why he had delayed payment of the £7.6m approved in September if he was relying on the unadjusted figures for retained profit, are only necessary if one proceeds on the footing that the full £7.6m was agreed in September and that no policy change took place until November. Mr Watson’s explanation that he was trying to smooth out the dividend whilst introducing the change in policy is difficult to accept simply because he would have known from the figures contained in the August accounts that any change in dividend policy based on those figures would rule out payment of the October dividends until sufficient reserves of profit had been built up in the new financial year. The September management accounts were not made available until 7 November by which time the October dividends had been paid. Those accounts record retained profits of £1.623m but after taking into account dividends of £4.676m paid in September (including the £396,000 subsequently repaid). Even if Mr Watson had received these figures earlier (as he claimed) they would not have supported payment of the £2.934m in October. Notwithstanding this a decision was taken to move permanently to the new policy on 1 November thereby ruling out any continuation of the wait and see strategy he says he relied on. No explanation for this was given in evidence but it must have been because he and Mr Langford had accepted prior to that date that this was the appropriate income recognition policy to apply to the 2000/2001 accounts if there was to be a future flotation or sale of the company.

Faced with Mr Watson’s implausible account of these events, I take the view that there is really nothing to rebut the inferences from the August accounts being signed off on 28 September. It may be that Mr Watson believed that Mr Langford would be prepared to delay payment of the balance of the £7.6m until sufficient resources had been built up under the new policy but was then faced in early October with the demand for payment of the balance. But whether or not this came as a surprise, I believe and find that the change of policy was implemented on 28 September in the sense that these accounts were issued as management accounts for August and therefore became relevant accounts for the purpose of s.270 CA 1985.

I strongly suspect that Mr Watson believed that the position would be corrected during the new financial year and that if he was conscious of the mismatch with distributable reserves, he regarded the problem as temporary and not of sufficient importance to justify his attempting to forestall Mr Langford’s demands for the balance of the dividend payments. This is I believe consistent with what else has emerged about their relationship and what I have mentioned earlier about the essentially casual way in which dividend payments came to be authorised.

Mr Booth submitted that it would have been absurd for Mr Watson to have agreed to the change in policy if it meant that there were insufficient distributable reserves of profit from which to pay the October dividends. But that assumes that Mr Watson was focussed throughout on the need to adhere to the relevant provisions of the Companies Act. The evidence of the way in which dividend decisions were taken in fact shows that Mr Watson always attempted to accommodate the proposals put forward by Mr Langford provided that the funds existed out of which to make the payments. The September dividends had been paid to the Langfords before the August management accounts were produced on 28 September. A change to the new accounting policy after that date required the payment of the £3m October dividends to be postponed until sufficient reserves had built up. But in cash terms the company was able to make the payment and my own view is that Mr Watson decided to do that in the belief that over the new financial year sufficient reserves would be accumulated from what was believed to be an expanding and profitable business to justify the October payment. The fact that the change in policy was implemented in respect of the annual accounts for 2000/2001 signed off on 1 November is consistent rather than inconsistent with a decision having been taken earlier to switch to the new policy. The August management accounts are consistent with this.

On the alternative hypothesis advanced by Mr Booth, Mr Watson waited to see if the £3m could be paid under a change of policy which he hoped to be able to introduce. He does not explain how this translated itself into a decision to move to the new policy on 1 November when the statutory accounts for 2001 were signed off but he was aware from the August accounts (on 28 September) that the £3m could not be paid under the new policy and must (on his case) have decided to pay it on 23 October before the policy changed on 1 November in order to avoid the consequence of what he believed to be the appropriate accounting policy for assessing the company’s turnover. I am not sure that I regard this as a more attractive version of events but in my judgment it is certainly the less credible of the two alternative possibilities.

The Official Receiver relied very heavily on three documents as supporting the allegation which I have found to be proved. Because they are controversial I need to comment briefly on each of them.

The first is a memorandum prepared by Arthur Andersen which summarises the audit procedures “being performed” to address points raised at an audit planning meeting with Mr David Hughes of TAG held on 13 July 2001. The memorandum states that:

“….

Revenue recognition policy has been changed so that no revenue is now recognised until a case has been accepted and the claimant has signed up (this will be accounted for by PYA). This removes a major element of uncertainty in auditing revenue recognition, as previously judgemental percentages were applied to recognise a proportion of revenue during the claim vetting period.

….”

The memorandum is not dated and Mr Watson said that it must have been prepared after October 2001. I doubt that. Although it is not dated the statutory accounts had been prepared and were signed off on 1 November 2001 only a week after the final £3m in dividends was paid. It seems to me likely that the memorandum pre-dates the finalisation of the accounts but it is not possible to be more accurate than that.

The second document is a letter from Arthur Andersen to the directors of TAG dated 1 November 2001 which encloses various suggestions for improving accounting procedures arising from the interim audit of TAG for the period ended 31 August 2001. Paragraph 2.1 of the report states that:

“Update at 31/8/2001

The change of accounting policy on income recognition has removed the need for any allowance for the age of claims. An analysis of the ageing of all cases on the database is prepared weekly to assist managers in monitoring work in progress.”

The point being made in the report was that the records of accrued income did not contain any ageing analysis which resulted in all initiated claims being assigned the same probability of success regardless of age. This document was not put to Mr Watson and Mr Booth submitted that it should be read as simply indicating what (viewed as at 1 November 2001) would be the position as at the year end. It did not of itself prove that the change of policy was made then.

I am not convinced about this. It seems to me that the reference to “Update at 31 August 2001” is just as likely to be a footnote to the report of the interim audit which states what had occurred as at that date. But because no-one from Arthur Andersen was called to resolve this ambiguity, I have not based my conclusions on this document.

The other document arose out of the exchanges between Mr Watson and KPMG following their appointment by TAG in 2002 to report on various financial issues relating to the statutory accounts for the year ended 31 August 2001. KPMG produced a report dated 23 April 2002 in which they identified what they said were weaknesses in financial controls and balance sheet reconciliations; errors in the financial statements and judgmental issues. It was this process which led eventually to the dismissal of Mr Watson and the re-statement of the 2001 accounts.

The most serious errors identified by KPMG were the recognition of income on some 3000 cases which were actually void leading to an overstatement of profits by some £2.7m and the failure to make any provision for exposure to swing premium (£7m). The second item is relied on in part by the Official Receiver as making the payment of dividends by TAG in 2001 imprudent even, if not illegal, and I shall come to this point shortly. But for present purposes the Official Receiver relies on a passage in paragraph 3.4 of the report which is directed to the warning signs that existed and which should have alerted Mr Watson to the growing financial problems of the company. The relevant paragraph reads as follows:

“…

The main indicator that should have alerted MW to the fact that there was a problem is that the profits that were reported as apparently being made were not translating into cash, but instead into increasing levels of working capital.

This should have been apparent from the management accounts. We have not reviewed copies of the management accounts over the relevant period nor other potentially relevant information and so we are unable to confirm when this could/should have been identified. We also note that the accounting policy for income recognition was changed during the year and this may have distorted the picture presented by the management accounts for part of the year.

…”

Mr Watson replied to these criticisms in a document dated 3 May 2002. In relation to the passage quoted above he said this:

“…

Later in the report under warning signs the report makes reference to warning signs that profit was not turning into cash and that this should have been picked up from the management accounts. However, a review of the management accounts and the pattern of voids would show that this view is unreasonable. Firstly, the change in the accounting policy was only applied with the preparation of August accounts. The management accounts prior to August therefore were compiled with estimates of income which recognised cases much earlier in the process. As a result income figures were much higher and relative size of voids was much lower. This was compounded by difficulties in estimating income which caused monthly movements in the accruals figures and the build up of voids which only incurred in the last months of the financial year.

… ”

Mr Booth submitted that the response from Mr Watson does not deal with the timing of the August management accounts which on his evidence was November 2001. But that, with respect, does not really answer the point. The premise behind KPMG’s criticism was that the warning signs were apparent from the management accounts although the policy for income recognition was changed “during the year” i.e. during the financial year to 31 August 2001. They were obviously treating the August management accounts as having taken effect on 31 August 2001 and Mr Watson says nothing to contradict this in his reply. In fact his reference to the change of policy being applied via the preparation of the August accounts seems (if anything) to confirm KPMG’s understanding of the position. This is therefore evidence which supports the conclusions I have reached.

The other ground on which Mr Watson’s involvement in the payment of dividends is challenged is an alleged lack of financial prudence. At one level this complaint could be said to embrace all the issues of corporate governance involved in the making of dividend and other financial decisions by the inner group without prior reference to or subsequent ratification by the full board but the two specific issues which were pursued were the failure (on Mr Watson’s case) to adopt the more conservative income recognition policy in relation to the 2001 dividends and the failure of Mr Watson (along with Mr Langford and Mr Gary Hoddes) to give sufficient weight to the potential downside for the business created by adverse court decisions on the recoverability of ATE premiums and other charges and more generally by TAG’s exposure to increased liabilities for swing premiums.

In relation to the first issue it seems odd to put it mildly that the decision could have been taken on 1 November 2001 to move to the new income recognition policy for the year ended 31 August 2001 whilst not applying it to the dividends declared in October that year, by which time its adoption had become desirable if not imperative in the mind of Mr Watson. It seems to me that if the policy was desirable for reasons of financial prudence in relation to TAG (which Arthur Andersen and others clearly thought that it was) then it ought to have been applied at the very least to dividends declared and paid at a time when a decision must have been taken to introduce it into the statutory accounts. Mr Booth Q.C submitted that it could not be either imprudent or unbefitting conduct on the part of Mr Watson as a director to use an accounting policy or standard permitted under the standard permitted under the existing UK GAAP rules. But in my judgment that misses the point. Once Mr Watson and Mr Langford had decided (as they did) to accept the recommendation of the auditors and the other advisors to adopt the more stringent policy for TAG it is difficult to see how they could justify imposing the policy for the year ended 31 August 2001 and beyond but at the same time decide not to apply it to the payments for the first two months of the new financial year.

In the end, however, nothing turns on this point because my finding that the August management accounts were relevant accounts for the purposes of s.270 of the CA 1985 makes it unnecessary to consider the legality or suitability of the October dividends further. The £3m paid on 23 October was for that reason alone unlawful.

That leaves the other issue which is the failure to make proper provision for the swing premium in deciding to pay the dividends. As explained earlier, Mr Watson seems to have had an imperfect understanding of the circumstances in which TAG could find itself exposed to an increased liability for swing premium but this aside, it seems fairly clear that both he and all the other directors took what with hindsight at least was a far too optimistic view of the risks involved.

The Official Receiver’s case is that Mr Watson should have realised throughout 2001 and certainly by September of that year, that if the average policy costs were to exceed 80% of £550 then the maximum swing premium would apply and TAG would have to pay Lloyds £221.50 (£550 - £328.50) on every case underwritten between 1 February and 31 August 2001. This could be as much as £6m. The proper course, it is said, for Mr Watson to have taken was to obtain legal advice on the operation of the policy, to ask Mr Ross to provide statistical information about recoverability; to carry out a financial risk assessment of the worst case scenario and to raise these issues for consideration and debate by the full board.

Much reliance is placed on the fact that in April 2002 KPMG estimated the maximum exposure to swing premium to be £7m and that the accounts to 31 August 2001 were then re-stated to provide for this. In their report of 23 April 2002 KPMG said this:

“…

With regard to swing premium, whilst it is the case that this has been and continues to be an evolving issue and accepting that it was difficult to form a view on the appropriate level of provision, MW as FD, could have been expected to raise the treatment of swing premium with his fellow directors as a significant issue and assess its possible impact under differing scenarios. We understand from Mark Langford that he did not do so.

Accepting that it was difficult to determine with accuracy the level of provision which would be required, it would have been appropriate to at least disclose the potential liability in a note to the accounts. We can see no good reason why no such disclosure was made especially given the significance of the issue to a reader of the accounts.

We are surprised that at a minimum no note was made in the August 2001 accounts of a potential liability to swing premium. We are also surprised that the possible range of impacts on current profitability appears not to have become an issue for serious discussion by MW with his fellow directors during his time as Finance Director in the context of actually perceiving that true profitability was substantially lower than that being reported.

…”

There is no reference in this report to the absence of provision for swing premium liability casting doubt on the legality or prudence of the dividends declared and Mr Watson in his evidence said that he did take these issues into account when deciding to pay the dividends declared in 2001. But even if this was not the case, the complaint adds very little to the issues about corporate governance and the legality of the dividends. If the original policy for recognising income had remained in place, nothing could turn on this point because the retained profits would still have been adequate to support the level of dividends paid even after making full provision for the £7m up to 31 August 2001. Once the new policy came into effect the payment of at least £3m of the £7.610m paid in dividends for September and October 2001 became impermissible even without making any further deductions or allowances for potential swing premium liabilities.

It is also difficult without expert evidence to make any realistic assessment of the level of provision that should have been made by a prudent finance director in Mr Watson’s position at the time. This would require a detailed analysis of the claims history involved and the quality of the underwriting none of which has been explored in any depth in these proceedings. We know that KPMG (who had carried out an actuarial review in November 2001) were then undecided about the appropriate level of provision for swing premium because the data was too immature to allow them to project accurately what the likely level of profit and loss on accepted Lloyds cases would be. The record of the audit close meeting with Arthur Andersen held on 26 October 2001 indicates no concern about swing premium and Mr Ross said in evidence that it was believed at the time that the loss ratio would not get to 80%. It was only much later in April 2002 that KPMG expressed the view that full provision should be made after it had become clear towards the end of 2001 that there had been a major setback in underwriting performance which was likely to eliminate most of the profit to date. But this realisation was certainly not reported to or discussed by the board before that time. The fact that KPMG chose to provide for the full £7m in May 2002 is not therefore in my judgment conclusive of the position during 2001. I therefore take the view that it would not be safe or appropriate to make any findings on this issue adverse to Mr Watson.

I take the same view of the rather more general allegation that it was imprudent of Mr Watson and the other directors not to have taken a much more conservative approach to the payment of dividends in the light of the uncertainties surrounding the recoverability of ATE premiums which as mentioned earlier subsisted throughout the period of Mr Watson’s directorship. Insofar as these matters required to be considered separately from the general issue of provision for swing premium discussed in the KPMG report, it is not possible (absent expert evidence from those involved in that type of business at the time) to reach any firm or reliable conclusion that the payment of the dividends in 2001 was imprudent given the state of knowledge and reasonable expectations of a competent board at the time. It is not therefore necessary for me to deal with Mr Booth’s other objection to this aspect of the Official Receiver’s case which is that it formed no part of the Official Receiver’s report and ought not to be allowed to stand as an allegation of unfitness.

At the audit close meeting held on 26 October 2001 attended by Mr Watson one of the matters listed as outstanding was the receipt by Arthur Andersen of signed general and minute representation letters. Mr Watson therefore sent to Arthur Andersen a letter stating that:

“…

In connection with your audit of our financial statements for the year ended 31 August 2001 we have submitted to your representative minutes covering meetings of Directors and Shareholders, held on the dates stated below. These minutes constitute a full and complete record of all meetings of Directors and Shareholders, held during the period from 1 July 2000 to

… ”

There then followed a list of board meetings held between 13 September 2000 and 21 August 2001 all of which are described as regular board meetings.

Most (but by no means all) of the minutes referred to in the letter and supplied to Arthur Andersen relate to the dividend payments in that financial year. The other minutes cover a variety of matters such as the appointment of directors, the approval of accounts and the taking of a lease of additional office space in Manchester. But the common feature of all these minutes is that they bear no relation in the details they record to any of the board meetings which took place during that period.

As already explained, the dividends were agreed to at meetings of the inner group which took place at irregular intervals. The dividend decisions were neither taken by nor ratified at the regular meetings of the full board and accordingly do not feature in the minutes of those meetings. Faced with the request from the auditors for minutes to support the financial statements it was therefore necessary to manufacture minutes covering the dividend decisions. All the minutes are in the same format and were signed by Mr Langford. Most appear to have been signed on 29 October 2001. Some of the earlier ones are dated 8 June 2001. It is, however, common ground that the dates of the meetings are false and that most of the directors stated to be present or to have given their apologies were neither present nor had been invited to attend.

It is, I think, significant that Mr Langford or whoever prepared the minutes thought it necessary to portray the meetings as regular meetings of the full board. This in itself gives the lie to any suggestion that the meetings of the inner group which actually decided on the dividends were in any sense authorised meetings of the board under some form of delegated authority. It is also obvious that neither Mr Langford nor Mr Watson (if he saw them) could have regarded the minutes as accurate and truthful accounts of what had occurred. Not only were the minutes sent false but they were not a complete record of all board meetings held during the financial year because they excluded the genuine minutes of the regular board meetings that were in fact held.

There is therefore no doubt that in signing the minutes for transmission to the auditors Mr Langford was guilty of an offence under s.389B(1) CA 1985 which provides that:

“(1)

If a person knowingly or recklessly makes to an auditor of a company a statement (oral or written) that—

(a)

conveys or purports to convey any information or explanations which the auditor requires, or is entitled to require, under section 389A(1)(b), and

(b)

is misleading, false or deceptive in a material particular,

the person is guilty of an offence and liable to imprisonment or a fine, or both.”

The only issue is whether Mr Watson as the sender of the letter also knew or was reckless as to the making of the false statement which it contained.

He says in his witness statement that TAG operated a filing system organised by Mr Graham Parker and that he was not personally approached for a list of the minutes. He was simply handed the letter which had already been prepared and typed on TAG notepaper listing the minutes of meetings for the year. Arthur Andersen confirmed that they had received the minutes from Mr Parker and Mr Watson said that he checked with Mr Parker that he had listed all meetings including the monthly meetings and had confirmed this with Mr Langford. Mr Parker told him that he had done so. He said that he relied on what Mr Parker had told him and did not check further. He looked at the list of meetings which appeared to be complete. He was also satisfied that all the key financial decisions had been approved or ratified by the board.

Some of this evidence is linked to Mr Watson’s assertion (which I do not accept) that he believed that the meetings of the inner group were regular board meetings. There is also no doubt that the decisions taken at those meetings were not subject to any process of formal ratification at the board meetings which followed. But during cross-examination it was put to him not only that he was aware of the inadequacies in the list but also that he was the author of the false board minutes signed by Mr Langford.

He strongly denied this and continued to maintain that the minutes were produced by Mr Langford and that he had believed that the list was complete. It is clear that he was on any view grossly negligent in allowing the letter to go to the auditors with its contents unchecked when he ought to have realised from looking at the list of meetings that it was at the very least incomplete if not inaccurate as to date. As Mr Davies pointed out Mr Parker had not attended any of the board meetings and Mr Watson was aware that no minutes of the inner group were prepared at the time or had been submitted to him for approval. But this is an allegation of dishonesty and in the absence of any evidence from Mr Parker or Mr Langford I have to be satisfied I think to a point where there is no serious element of doubt as to Mr Watson’s knowledge and intentions. Given his own evidence and the absence of any conflicting evidence from other relevant witnesses, I am not able to be so satisfied.

The allegation of unfitness made against Mr Watson in relation to the EBT is that he allowed the inner group to decide upon, authorise and operate the EBT for the personal benefit of each director as a vehicle for the undisclosed payment of remuneration or other bonuses to them. The report of Mr Cropper, the Official Receiver, highlights the fact that the EBT was set up without formal notice to or consideration by the board but at a meeting at the Langfords’ home on 30 June 2001 to which no other directors (apart from Mr Watson) had been invited. It also alleges in terms that the payments by way of loan under the various sub-trusts were disguised remuneration. Mr Cropper questions whether the trustees of the EBT and the sub-trusts were ever intended to exercise a genuine discretion in deciding what payments to make and to whom and particular reliance is placed on the terms of the letters of wishes signed by Mr and Mrs Langford which I referred to earlier.

A number of the directors were interviewed about these arrangements, some of whom have given evidence. Mrs Brennan, for example, said that she paid little or no attention to the formalities involved and treated the money she received from the sub-trust as her own even though it was documented as a loan from the trustees. She said that her only concern was to get the money into her account free of tax and that she was prepared to sign anything for that purpose. She would not have been prepared to enter into the arrangements had she not been given to understand (she says by Mr Watson) that she would have effective control of her sub-trust and therefore of the loan.

Her position can be contrasted with that of Mr Bird who said that he was unhappy with the scheme precisely because he was told (and accepted) that he was not certain to receive monies from the sub-trust and that any loan would be dependent upon the discretion of what were independent trustees.

Earlier in this judgment I referred to the background to the setting up of the EBT and the sub-trusts and to the fiscal benefits which the trust arrangements were designed to achieve. The structure of the trust arrangements was obviously designed to take advantage of the beneficial CGT treatment for employee benefit trusts on the transfer of the shares and the off-shore situs of the trustees who would have no liability to income tax on the payment of the dividends they receive. But the tax treatment of any payments made by the trustees to the directors in England obviously depended upon the character of those payments and for the monies to be enjoyed free of income tax they had at the very least to be genuine discretionary loans and not simply distributions by the trustees in accordance with a pre-determined bonus scheme.

The sub-trusts were established on 18 July 2001 by Insinger exercising the power of appointment referred to earlier. In each case the principal beneficiaries were the spouse, children and remoter issue of the director concerned. Like the EBT the sub-trusts are discretionary in nature but contain a power to lend any part of the trust fund to any person on such terms as the trustees think fit.

Insinger remained the trustee of each of the sub-trusts but the individual directors, although not beneficiaries, were appointed the protectors of the eleven sub-trusts created. The power of appointing new and additional trustees is vested in the protector of each trust. Each director also signed a letter of wishes as protector of his or her respective sub-trust. These appear to have been in standard form and requested the accumulated income and other capital to be applied during the protector’s life according to his or her wishes and after his death to be held for the widowed spouse and then the director’s children.

The payments to the Langfords and the other directors from the sub-trusts were however documented as loans. The Official Receiver has analysed the arrangements made in the case of Mrs Brennan which appear to be typical. She wrote a letter to the trustee on 31 July 2001 requesting a loan of £67,000. The money was then lent to an offshore company (Deep Water Limited) under a discount agreement for the purpose of providing loan finance to Mrs Brennan. Essentially, the same procedure was followed for all three of the payments of £67,000, £67,000 and £66,000 made to her in July, August and September 2001 in accordance with the schedule of bonus payments agreed in June of that year.

Mr Cropper says that there is no evidence that Mrs Brennan substantiated her ability to re-pay the loans and that the payments were in reality in the nature of bonuses. The Official Receiver relies, for example, on the fact that in the case of the initial loans made to the Langfords to enable them to purchase the house in Spain the loan documentation post-dated the payment of the money. One can also point to the fact that the payments made ostensibly by way of loan are the very payments which in the June schedule were clearly designed to be bonuses for the directors in connection with their performance as employees.

All that said, one needs I think to be clear about the nature of the challenge to these arrangements. The EBT and the sub-trusts were set up as part of a tax avoidance scheme marketed by Baxendale Walker. Although their literature (quoted earlier) goes out of its way to disclaim this as its purpose, it was clearly introduced to Mr Langford in this case as a means of avoiding CGT on the transfer of his shares and income tax on the payment of the dividends. The scheme was therefore artificial in the sense that the transfer of the shares to the Jersey trust company and the creation of the sub-trusts as the recipients of dividend payments was solely referable to the fiscal purposes involved. That does not necessarily mean that the loans were a sham. The directors, although not asked to approve the setting up of the EBT, were certainly told about its existence and offered the opportunity of taking their bonuses through the trusts as a means of avoiding income tax on the payments. The scheme was not compulsory for them and Mr Bird, for one, declined to participate. He said that he was concerned not about its legality but because the payments to him depended on the exercise of a discretion by independent trustees. Mr Ross said that he was told by Ernst & Young that the scheme was legal but was likely to involve him in a protracted dispute with the Revenue about its effectiveness. He therefore repaid the loan and took his bonus as additional salary subject to income tax.

As I mentioned earlier, Baxendale Walker’s guide to the scheme stresses the importance of following the rules laid down for its operation.

“..

The trust must be genuine. It must not be a “sham”. You prove that the trust is genuine by showing that it has followed the rules laid down for its operation. The rules are set out in the trust deed. The trustees cannot waive the rules.

…

The protection of the trust assets from tax and from creditors of the beneficiary (and founder) depends upon the rules being duly followed. If the beneficiaries or the founder deal with trust assets as if the trust and the trustees did not exist, then so will the Revenue and creditors.

The taxation benefits provided by the trust depend upon it maintaining its reality and integrity. Tax benefits are maximised by following the rules. Tax and creditor liabilities will inevitably be suffered if the rules are broken.

…”

Mr Watson’s evidence is that he certainly did follow the rules. His sub-trust has received payments which have been invested by the trustees in accordance with the terms of the trust. He says that he regards and has always regarded the arrangements as genuine. He assumed that everything would be set up in accordance with the Baxendale Walker scheme and that monies would be advanced to the directors who wanted them as commercial loans. Baxendale Walker presented themselves and were relied on as experts in their field and although some of the professional advisors such as DLA had reservations about the effectiveness of the scheme it was never presented or intended to be operated other than in accordance with its terms.

It seems to me important to try to identify which aspects of the trust arrangements are said by the Official Receiver to disguise the payment of remuneration as loans and what this allegation amounts to. The trusts involved are a form of discretionary trust commonly used in offshore jurisdictions. It is usual in my experience for there to be a protector with control over the appointment of new trustees and for the protector or even the settlor to address a letter of wishes to the trustees indicating how he would like them to consider exercising their discretion. There is nothing objectionable about these arrangements provided that the trustees retain and exercise a genuine discretion in these matters.

The initial capital for the EBT was provided by TAG but the bulk of its capital was contributed by the Langfords in the form of their shares. They were free to dispose of these as they thought fit and their decision to transfer them into an offshore trust is not something about which the Official Receiver can or I think does complain. There is no challenge to the effectiveness of those transfers and consequently Insinger and subsequently Leverington became the shareholders in TAG entitled to the payment of the dividends. Although the amount and timing of the dividends is challenged for the reasons already discussed their payment to the trustees of the EBT was simply the consequence of the change in shareholders and again is not complained about in itself.

The challenge to the EBT and to the sub-trusts therefore concentrates not on the establishment of the trusts as such but on the exercise by the trustees of their power to make loans in favour of the directors. So far as I am aware, all of the payments made to the directors by the trustees were documented as loans. Although the Langfords signed letters of wishes in respect of the EBT which contradict the terms of that trust the payments made to them were routed through their sub-trusts and recorded as loans from those trustees. The terms of the loans were, it is said, inconsistent with prudent commercial lending but that is a matter for the trustees and is not as such the concern of the Secretary of State. It is only relevant insofar as it might be said to indicate that the loan agreements were some kind of device and this is what Mr Davies did allege in his opening submissions. The EBT was, he said, a sham designed to disguise the fact that the dividends were declared and paid for the purpose of making an unlawful return of capital and the loans from the sub-trust which were identical in amount to the bonuses agreed in June 2001, were artificial and a means of paying remuneration in a disguised form.

Companies like anyone else are at liberty to arrange their affairs in a way which minimises the tax liability of themselves and their employees provided that they act lawfully. It goes without saying that it would be both unlawful and an issue of fitness for the directors of a company to enter into a scheme which was intended to defraud the Revenue. But that is not alleged in this case nor is there any evidence to support it. Although the creation of the EBT and the sub-trusts was intended to enable the directors to take what they would otherwise have received as bonuses free of tax, the Baxendale Walker scheme was devised by a firm of solicitors specialising in this kind of work as a legitimate tax scheme and implemented in that belief. This is confirmed by the evidence of directors such as Mr Ross and Mr Bird who were clearly told that the scheme was intended to operate strictly according to its terms. Mr Watson’s evidence of his own involvement and understanding of the scheme is consistent with this.

The only realistic challenge to the scheme on the material before me is that it was not effective for tax purposes either because of the way in which particular directors arranged their dealings with the trustees or because the scheme permitted persons connected with the settlor to take benefits under the trust.

A tax scheme which does not satisfy the requirements of s.239 TCGA 1992 is not per se a fraud on the Revenue nor is it unlawful. It is simply ineffective with the result that the payments made bear the tax which they would otherwise have attracted. Although one is entitled to disapprove of artificial schemes of this kind, it is quite another thing to regard their promotion as conduct which renders a person unfit to be director of a company. There is no suggestion in this case of any attempt being made by Mr Watson or the other directors to conceal from the Revenue the true facts of the trust arrangements. Once disclosed, it would be a matter for each director as the taxpayer to deal with any refusal by the Revenue to recognise the effectiveness of the scheme.

Much of the evidence on this point has been directed to the way in which Mr and Mrs Langford dealt with their loans. Part of the Official Receiver’s case is that the restrictions contained in paragraph 1.2.18 of Schedule 1 to the EBT did not empower the trustee to appoint part of the fund on trusts which permitted the payment of any prohibited benefit as defined and that this therefore either invalidated the sub-trusts or limited the power contained in paragraph 1.2.17 to lend part of the fund to “any person” to the making of loans to persons other than shareholders or directors of the company. This is clearly not what the draftsman intended as is apparent from the fact that the power to lend contained in the sub-trusts expressly includes the founder and so far as I need to decide the point, I am inclined to the view that cl.1.1.5.2 of the EBT is limited to a payment or benefit which on being made becomes the property of the recipient. A loan would not therefore be included.

I accept that the terms of the EBT and the sub-trusts (if construed in this way) may undermine the effectiveness of the scheme as a piece of tax avoidance because of the ability to confer benefits in the form of interest-free loans on the settlor and connected parties. But that is a comment on the quality of the Baxendale-Walker scheme and the thinking behind it and the way in which the trustees were prepared to deal with the Langfords and the other directors.

But Mr Watson was not responsible as a director of TAG for the way in which the Langfords chose to operate their own trust arrangements. Understandably, he had some difficulty in cross-examination attempting to explain how the letter of wishes signed by Mr Langford for the EBT or the failure to execute the loan agreement until after the monies had been advanced for the purchase of the house in Marbella, could be squared with the terms of the trust and the way in which the sub-trusts were intended to operate. But he had no real involvement in this beyond authorising the payment of the dividends to Insinger. Once these payments were made his responsibility as a director ended. The conduct of the Langfords or perhaps that of Mrs Brennan in relation to the payment of the monies to them from the sub-trusts may have nullified any tax advantages which those arrangements might otherwise have brought them, but I fail to see how Mr Watson as a director could be said to be involved in or affected by this.

I therefore reject this complaint so far as it is based on the suggestion that Mr Watson was in some way responsible for setting up a dishonest or improper scheme in relation to the company. The scheme did of course depend upon the payment of the dividends but it really adds nothing to the strength of the Official Receiver’s case on the propriety of those payments. Where I think Mr Watson does have a case to answer is in relation to the failure to obtain board approval for the use of TAG’s funds to provide the original capital for the EBT and to sanction it being set up. But this is really only another example of the way in which the inner group took effective control of all financial decisions and effectively sidelined the board and I propose therefore to consider it in that context when I come to deal with the allegations of unfitness at the end of this judgment.

Section 6(1) of the 1996 Act provides that:

“(1)

The court shall make a disqualification order against a person in any case where, on an application under this section, it is satisfied –

a that he is or has been a director of a company which has at any time become insolvent (whether while he was a director or subsequently), and

b that his conduct as a director of that company (either taken alone or taken together with his conduct as a director of any other company or companies) makes him unfit to be concerned in the management of a company.”

There is no comprehensive definition of unfitness in the Act but s.9 requires the Court when considering whether a person’s conduct as a director does render him unfit to be concerned in the management of a company, to have regard in particular to the matters mentioned in Parts 1 and II of Schedule 1 to the Act. In the present case, the only specific matters which are potentially relevant are those set out in paragraph 1 of Pt 1: i.e. any misfeasance or breach of any fiduciary or other duty by the director in relation to the company. In the case of an insolvent company the Court is required under paragraph 6 of Part II to have regard to the extent of the director’s responsibility for the causes of the company becoming insolvent but as indicated earlier in this judgment, it is not alleged in this case that the payment of the disputed dividends or the operation of the EBT were the cause of the company’s insolvency.

The relevant principles to be deduced from earlier decided cases under s.6 are conveniently summarised in the judgment of Etherton J in Secretary of State for Trade & Industry v Swan (No.2) and counsel on both sides were content to adopt this analysis as a correct statement of the law. For convenience, I shall set out the relevant passage as follows:

“[76] The burden of proving unfitness lies on the SoS. Although the standard of proof is the civil standard, that is to say on the balance of probabilities, the seriousness of the allegation is reflected in the need for evidence of appropriate cogency to discharge the burden of proof: Re Living Images Ltd[1996] 1 BCLC 348, [1996] BCC 112, 355-356; Re H[1996] AC 563, [1996] 1 All ER 1, 586-587 (Lord Nicholls).

“[77] The determination of unfitness under s.6 is a two-stage process. First, the SoS must establish as facts, to the requisite standard of proof, the matters on which the allegation of unfitness is based. Second, the court must be satisfied that the conduct alleged is sufficiently serious to warrant disqualification.

[78] In determining whether past conduct leads to the conclusion of “unfitness” the court is entitled to consider any relevant contemporary extenuating circumstances.

[79] The question is whether, viewed cumulatively and taking into account any extenuating circumstances, the director's conduct in relation to the company has fallen below the standards of probity and competence appropriate for persons fit to be directors of companies: Re Grayan Building Services Ltd[1995] Ch. 241, [1995] 3 WLR 1, 253 (Hoffmann LJ).

[80] So far as incompetence is concerned, the authorities indicate that a high level of incompetence is required to satisfy s.6 of the Act. In Re Barings plc (No.5) [1999] 433 of pp. 483-484 Jonathan Parker J said:

“Where, as in the instant case, the Secretary of State's case is based solely on allegations of incompetence (no dishonesty of any sort being alleged against any of the respondents), the burden is on the Secretary of State to satisfy the court that the conduct complained of demonstrates incompetence of a high degree. Various expressions have been used by the courts in this connection, including “total incompetence” (see Re Lo-Line Electric Motors Ltd [1998] BCLC 325 at 337, [1988] Ch 477 at 486 per Browne-Wilkinson V-C), incompetence “in a very marked degree” (see Re Sevenaoks Stationers (Retail) Ltd[1991] BCLC 325 at 337, [1991] Ch 164 at 184 per Dillon LJ) and “really gross incompetence” (see Re Dawson Print Group Ltd[1987] BCLC 601 per Hoffmann J). Whatever words one chooses to use, the substantive point is that the burden on the Secretary of State in establishing unfitness based on incompetence is a heavy one. The reason for that is the serious nature of a disqualification order, including the fact that (subject to the court giving leave under section 17 of the Act) the order will prevent the respondent being concerned in the management of any company.”

[81] On appeal from the decision of Jonathan Parker J, Morritt LJ, giving the judgment of the Court of Appeal, said at [2000] 1 BCLC 523, 534:

“. . .the judge made a number of observations on the proper construction and application of the Act to which we refer, not because we disagree with the judge, but because we wish to emphasise the propositions to which he referred. . . . Third, where the allegation is incompetence without dishonesty it is to be demonstrated to a high degree. . . This follows from the nature of the penalty. Nevertheless the degree of incompetence should not be exaggerated given the ability of the court to grant leave, as envisaged by the disqualification order as defined in s.1, notwithstanding the making of such an order.”

[82] If the court finds the allegations of unfitness proved to the requisite standard and degree, then the court must, under s.6, disqualify the director for a period of two years at least.

[83] The fact that the director may be unlikely to offend again may be relevant to the length of the period of disqualification, but not to whether or not he should be disqualified: Re Landhurst Leasing plc[1999] 1 BCLC 286, 344h-345b.

[84] The disqualification is mandatory in order to protect the parties, raise standards and to act as a deterrent. Hoffmann LJ expressed the position as follows in Re Grayan Building Services Ltd at p 253H-254D:

“Parliament has decided that it is occasionally necessary to disqualify a company director to encourage the others. Or as Sir Donald Nicholls V-C. said in In re Swift 736 Ltd.[1993] BCLC 896, 899:

“Those who make use of limited liability must do so with a proper sense of responsibility. The directors' disqualification procedure is an important sanction introduced by Parliament to raise standards in this regard.”

If this should be thought too harsh a view, it must be remembered that a disqualified director can always apply for leave under section 17 and the question of whether he has shown himself unlikely to offend again will obviously be highly material to whether he is granted leave or not. It may also be relevant by way of mitigation on the length of disqualification. . .

It follows that I agree with the approach of Vinelott J in In re Pamstock Ltd[1994] 1 BCLC 716, [1994] BCC 264 when he said that it was his duty to disqualify a director whose conduct “fell short of the standard of conduct which is today expected of a director of a company which enjoys the privilege of limited liability” even though he did so with regret because, he said, at p 737:

“The respondent seemed to me (so far as I can judge from the evidence before me) to be a man who today is capable of discharging his duties as a director honestly and diligently.”

But the court is required to disqualify a director whose conduct has made him unfit, as the judge said:

“even though the misconduct may have occurred some years ago and even though the court may be satisfied that the respondent has since shown himself of capable of behaving responsibly.”

[85] Lord Woolf MR summarised the policy behind the legislation as follows in Re Blackspur Group plc [1998] 1 WLR 422, [1998] 1 BCLC 676 CA at p 426:

“The purpose of the Act of 1986 is the protection of the public, by means of prohibitory remedial action, by anticipated deterrent effect on further misconduct and by encouragement of higher standards of honesty and diligence in corporate management, from those who are unfit to be concerned in the management of a company.”

[86] The relevant period of disqualification is in the discretion of the judge, to be exercised in accordance with the relevant principles set down in Re Sevenoaks Stationers (Retail) Ltd[1991] Ch. 164 at p 174 E-G (Dillon LJ) (particularly serious cases: 11-15 years; serious cases which do not merit the top bracket: 6-10 years; relatively, not very serious cases: 2-5 years).”

To this I would add a further quotation from the judgment of Jonathan Parker J in re Barings plc (No. 5) (supra) which usefully explains the relevance of the Schedule 1 considerations to the question of unfitness. At p.486 the Judge said this:

“…Although in considering the question of unfitness the court had to have regard (among other things) to 'any misfeasance or breach of any fiduciary or other duty' by the respondent in relation to the company, it was not a prerequisite of a finding of unfitness that the respondent should have been guilty of misfeasance or breach of duty in relation to the company. Unfitness might be demonstrated by conduct which did not involve a breach of any statutory or common law duty: for example, trading at the risk of creditors might be the basis of a finding of unfitness even though it might not amount to wrongful trading under s 214 of the Insolvency Act 1986. Nor would it necessarily be an answer to a charge of unfitness founded on allegations of incompetence that the errors which the respondent made could be characterised as errors of judgment rather than as negligent mistakes. It was possible to envisage a case where a respondent had shown himself so completely lacking in judgment as to justify a finding of unfitness, notwithstanding that he had not been guilty of misfeasance or breach of duty. Conversely the fact that a respondent might have been guilty of misfeasance or breach of duty did not necessarily mean that he was unfit. Schedule 1 made it clear that there were a number of matters to which the court was required to have regard in considering the question of unfitness, in addition to misfeasance and breach of duty.

…”

Mr Davies made clear in his closing submissions that the principal allegation of unfitness relates to the system of corporate governance adopted by the board of TAG and Mr Watson’s involvement in and responsibility for that. Although satisfied that the payment of the October 2001 dividends was technically in breach of the provisions of s.263 of the Companies Act this was, in my judgment, merely symptomatic of the way in which the financial management of TAG was conducted.

As explained earlier in this judgement, the inner group continued to make all the key financial decisions including those relating to dividends and effectively reduced the role of the other directors to departmental managers with no serious input at board meetings on issues affecting the running of the company. The dominant figure was undoubtedly Mr Langford and although Mr Watson introduced a welcome measure of administrative reform including the institution of regular documented board meetings, he was either unwilling or unable to make these the effective means of governing the company. Instead, he (like the other directors) acquiesced in a system under which the members of the inner group took all key decisions without reference to the board as a whole and did not even seek the subsequent ratification of these decisions. That system was, I believe, largely dictated by Mr Langford’s attitude to the company and his own disregard of even the most basic legal formalities.

There was never any effective delegation of these powers to the inner group and absent the ratification of their decisions, no authority (e.g.) for the dividend payments that they made. The reality of the situation was that Mr Langford presented his financial demands and Mr Watson and Mr Gary Hoddes agreed and implemented them.

The meetings of the inner group were not minuted and no report of those meetings was made to the board subsequently. The inadequacy of these arrangements meant that when the auditors requested copies of minutes authorising dividend payments Mr Langford or someone at his direction had no alternative but to manufacture false minutes of full board meetings which as I have detailed earlier bore no resemblance to reality. The fact, however, that they were portrayed as meetings of the full board and not those of the inner group, which had no recognised authority or status, is highly significant and indicates a complete lack of confidence on the part of Mr Langford in the propriety of these arrangements.

The impression I have formed of Mr Langford is that he was prepared to do or sign almost anything that was necessary in order to meet his financial needs. The letter of wishes which he signed in connection with the EBT is but one example of this. It was however the duty of Mr Watson and the other directors to ensure that the company was run in accordance with its articles and the requirements of the Companies Act. The interests of the company and its creditors alike depended on that. In a number of obvious respects Mr Watson has failed to do this. He allowed the inner group arrangements to continue unchecked knowing that dividend and other financial decisions were thereby effectively removed from the board. There was no or no adequate attempt by him to update the board about these matters at their meetings and the failure to consult them or seek their authority for the dividend payments and the EBT are emblematic of this failure.

In mitigation Mr Booth submitted that the other directors were content for financial matters to be dealt with in this way and that a fully informed decision by the board on these matters would not have produced a different result. I am not convinced about that. I think that the requirement for Mr Langford to disclose to the board in advance his dividend requirements and to discuss their impact on the company’s future prosperity is likely to have tempered his demands and to have introduced much more objectivity in the decisions that were taken. If, for example, Mr Watson had presented the board in the summer of 2001 with a paper setting out the pros and cons of changing to the new income recognition policy and the impact this would have on the scale and timing of dividend payments I think that the problems which occurred in October that year would almost certainly have been avoided. Once the culture of secrecy had been broken the need to justify the level of dividends to the board would have produced its own discipline. As it was, all of this was concealed from the board and Mr Watson simply kept pace with Mr Langford’s demands.

But even if the correct view is that the board would itself have remained supine and simply acquiesced in whatever Mr Langford demanded, that does not in my judgment provide Mr Watson with any justification for adopting a similar stance. A likely failure of duty by the other directors made it all the more important that the finance director should do his own. In a private company he is often an essential brake on the financial ambitions of shareholders and the new finance director appears to have been able to curb Mr Langford’s demands for further dividends.

On the findings I have made, the case against Mr Watson is based on lack of competence rather than lack of probity in the sense of dishonesty. But I do believe that his acquiescence in the system of governance I have described in the payment of dividends which he ought to have realised were illegal and in the setting up of the EBT without board approval was at least in part attributable to the very considerable financial rewards provided to him and the other directors which made them all interested in the continuation of these arrangements and seems to have blinded them to their obligation to challenge them. I am afraid that I regard this conduct as falling well below the standards required of Mr Watson as a director and I consider that it is conduct which does or did make him unfit to be concerned in the management of a company. I have little doubt that Mr Watson has been bruised by his experience at TAG and is now much more careful and astute as a result of it. But it follows from my findings against him that a period of disqualification is inevitable. As agreed at the hearing, I shall decide on what that period should be once Mr Watson and those acting for him have had the opportunity of considering this judgment.

There is very little evidence about the exact nature of Mrs Langford’s role as business development director and I have not had the benefit of any evidence from her. Her title almost certainly exaggerates the degree of involvement which she had in the running of the company. She was certainly involved in organising various charitable activities which TAG was associated with and she did attend some board meetings. But like the other directors she appears to have taken a secondary role to the inner group and allowed her husband with Mr Watson and Mr Gary Hoddes to make the important financial decisions.

As a shareholder she was, of course, instrumental in the setting up of the EBT and was the recipient of significant dividends. But beyond that her role in the affairs of TAG appear to have been very limited.

I therefore consider that in terms of unfitness the case established against her is essentially that (like the other members of the outer board) she left the financial and strategic decisions (including the setting up of the EBT) to be made by the inner group and failed to act independently and in the best interests of the company by ensuring that decisions of this kind were brought to and discussed by the full board on a properly informed basis. The reality is that she was content to allow her husband and Mr Watson to run the company and to take substantial dividends from it regardless of how and whether they should have been paid. An abdication of responsibility of this kind does amount to unfitness to be a director. Mrs Langford will be disqualified for a period of four years.