SSF Realisations Ltd v Loch Fyne Oysters Ltd & Ors

Section 847 of the 2006 Act applies where a distribution, or part of one, made by a company to one of its members is made in contravention of Part 23. If at the time of the distribution the member “knows or has reasonable grounds for believing that it is so made”, he is liable (a) to repay it (or that part of it, as the case may be) to the company, or (b) in the case of a distribution made otherwise than in cash, to pay the company a sum equal to the value of the distribution (or part) at that time: s.847(2). This is without prejudice to any obligation imposed apart from s.847 on a member of a company to repay a distribution unlawfully made to him.

In It’s a Wrap (UK) Ltd v Gula (above), the Court of Appeal held that it is enough, in order to establish that a shareholder knew or had reasonable grounds for believing that the distribution was made in contravention of the Companies Act 1985 that it had the relevant knowledge of facts which, if they existed, led to the conclusion that the distribution contravened the statute. It was not necessary that the shareholder had knowledge of the legal rules and the consequences of those rules when applied to the facts.

It was unnecessary for the Court of Appeal in that case to determine the precise meaning of “had reasonable grounds for believing”, but Arden LJ and Chadwick LJ went on to give (obiter) consideration to that question. The statutory provision was enacted in order to give effect to Article 16 of the second EC directive on company law (77/91/EEC). Article 16 provides as follows:

“Any distribution made contrary to Article 15 must be returned by shareholders who have received it if the company proves that these shareholders knew of the irregularity of the distribution made to them, or could not in view of the circumstances have been unaware of it.”

Arden LJ, at [24] considered that the concluding words of Article 16 (and thus the words “has reasonable grounds for believing” in the UK statute) “must be directed to a situation where the shareholders ought reasonably to have been aware of the factual situation that the distribution contravened the Act.” Chadwick LJ, on the other hand, at [52], considered that it was by no means self-evident that the words “has reasonable grounds for believing” were to be equated with constructive knowledge, “if by that expression is meant knowledge which a person would have but for his negligence”. He cited Swain v Natui ram Puri [1996] PIQR P442 (a case concerned with liability under the Occupiers Liability Act 1984) for the proposition that the phrase “has reasonable grounds to believe” was not equivalent to “ought to have known”. While it would not permit an occupier to turn a blind eye, it was not sufficient (in the words of Evans LJ at P488) to prove that the occupier ought to have known particular facts. The occupier must be proved “either to have actual knowledge of the relevant fact or to have known facts which gave reasonable grounds for the relevant fact.” Chadwick LJ’s provisional view, therefore, was that:

“The knowledge which the legislature has sought to describe in s.277(1) of the 1985 Act is, I think, knowledge which the member has and knowledge which the member “must be taken to have” or, perhaps, “may reasonably be taken to have”.”

The statutory remedy is without prejudice to any relief available at common law: s.847(3) of the 2006 Act. At common law, a distribution of a company’s assets to a shareholder, except in accordance with specific statutory provisions, is unlawful and ultra vires the company: Progress Property Co Ltd v Moore [2011] 1 WLR 1, per Lord Walker JSC at [15].

In Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447, Dillon LJ, at p.457H to 458A held that because the shareholder, who received a dividend pursuant to an ultra vires act on the part of the company, “had notice of the facts and was a volunteer in the sense that it did not give valuable consideration for the money”, it was a constructive trustee for the company, citing Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1986] Ch 246, 298 (per Slade LJ) and 303 (per Browne-Wilkinson LJ), who held that those who received money from a company as a consequence of its directors’ breach of duty were liable where they had notice of the breach.

The parties were in agreement that the liability of LFO under s.847 as recipient of the Distribution is limited to that part of the Distribution which LFO knew or had reasonable grounds for believing was made in contravention of Part 23. No argument was advanced that the measure of relief at common law would be different.

The parties were also in agreement that the relevant legal principles as to the liability of a director for causing the company to pay an unlawful dividend were as recently summarised in Burnden Holdings (UK) Ltd v Fielding [2019] EWHC 1566 (Ch) at [139] and [157]:

“First, directors, although not trustees, were to be treated as if they were trustees in relation to the company’s funds. Second, if they knew the facts which constituted an unlawful dividend, then they would be liable as if for breach of trust irrespective of whether they knew that the dividend was unlawful. Third, however, if they were unaware of the facts which rendered the dividend unlawful then provided they had taken reasonable care to secure the preparation of accounts so as to establish the availability of sufficient profits to render the dividend lawful, they would not be personally liable if it turned out that there were in fact insufficient profits for that purpose. Fourth, they were entitled to rely in this respect upon the opinion of others, in particular auditors, as to the accuracy of statements appearing in the company’s accounts.”

The parties disagreed, however, as to the extent of a director’s liability in respect of a dividend which was partially made out of profits and partially out of capital.

The claimant relied on Re Paycheck Services 3 Ltd [2010] 1 WLR 2793 for the proposition that a director is liable for the whole of the dividend, not merely the difference between the unlawful distribution and the distribution which could lawfully have been paid. At [49], Lord Hope said:

“Where dividends have been paid unlawfully, the directors’ obligation is to account to the company for the full amount of those dividends: see Bairstow v Queens Moat Houses Plc [2001] EWCA Civ 712, [2002] B.C.C. 91, [54], per Robert Walker L.J.”

He went on, however, to conclude that it was open to the court to limit the amount the director should pay to what the only creditor in the liquidation of the company had lost (relying upon a discretion which he considered arose under s.212 of the Insolvency Act 1986).

In Bairstow, it was contended that directors were liable to the extent that their actions caused the company loss, in accordance with the decision of the House of Lords in Target Holdings Ltd v Redferns [1996] 1 AC 421 and, on that test, it was apparent that there was no actionable loss occasioned by the unlawful dividends since they could have been declared and paid by the company in a lawful manner, if the company’s subsidiary had first paid up its distributable profits to the company (see [52]). Robert Walker LJ rejected that argument (at [53] to [54]), noting that the case was very different from Target Holdings: the directors in Bairstow had deliberately and (at least in relation to one of the relevant years of account) dishonestly paid unlawful dividends.

In Paycheck in the Court of Appeal ([2010] Bus LR 259), a similar argument based on Target Holdings was advanced. Rimer LJ rejected it, at [96], concluding that the basic remedy was one of restitution because directors, if not trustees in the strict sense, owe a duty as a trustee not to misapply the company’s assets, and referring among other things to the judgment of Robert

The first, second and fifth defendants in this case advance a different argument to that run in Bairstow and Paycheck. Mr Hinks submitted, not that the directors’ liability was limited to loss caused to the Company, but that they were liable (subject to any defence based on s.1157 of the 2006 Act) for the Distribution to the extent that it was unlawful, that is to the extent that the October management accounts (once adjusted by a reduction of the distributable profits to reflect the creditor cut-off and accruals issues) did not reveal sufficient distributable reserves.

In my judgment, the defendants’ approach is to be preferred both as a matter of principle and on authority. So far as authority is concerned, that was the conclusion reached by HHJ Richard Seymour in Re Marini Ltd [2003] EWHC 334 (Ch), at [48] to [50]. As a matter of principle, there is a difference between (1) seeking to justify an unlawful dividend on the basis that the company could have done something different which would have enabled it to make a distribution in the relevant amount and (2) a dividend which, on the basis of what the company in fact did (and the accounts which it in fact had in front of it) was only out of capital as to part of the payment.

Accordingly, the liability of the directors to compensate the Company in respect of the Distribution is limited in amount by reference to that part of the Distribution which was made out of capital and thus in contravention of Part 23.

It was common ground that the directors also owed the statutory duties set out in s.171, 172 and 174 of the 2006 Act: (1) to act in accordance with the company’s constitution and not to make dispositions which are ultra vires the company; (2) to exercise powers only for the purposes for which they were conferred; (3) to act in ways which they considered, in good faith, would be most likely to promote to the success of the company, including the duty to act in the interests of creditors where the company is, or is likely to become, insolvent; and (4) to exercise reasonable care, skill and diligence.

I will consider, first, the liability of LFO in respect of the Distribution. It is common ground that the knowledge of Mr Sutherland, Mr Craig and Mr Davidson is to be imputed to LFO.

In my judgment each of Mr Sutherland, Mr Craig and Mr Davidson was aware of all of the facts which give rise to the legal conclusion that the Management Charge was in substance a voluntary distribution. They knew, in particular (as I have already found), that at no time prior to their approval of the Management Charge had there been any discussion, let alone any decision or agreement, that the Company would reimburse LFO. They also knew (because it was obvious on the face of the October management accounts) that a distribution in the sum of the Dividend plus the Management Charge would exceed the amount of distributable profits.

LFO accordingly knew the same, such that it was aware of the facts which rendered the Distribution unlawful (at least to the extent that the amount of the Distribution exceeded the distributable profits as disclosed in the October management accounts) and therefore knew or had reasonable grounds for believing that the Distribution was made, to that extent, in contravention of Part 23 of the 2006 Act. That is so whichever view is taken – that of Arden LJ or Chadwick LJ in the It’s a Wrap case – as to the meaning of “has reasonable grounds for believing”.

Whether LFO also knew or had reasonable grounds for believing that the Distribution was made in contravention of Part 23 to the further extent that it exceeded the distributable profits which should have been stated in the relevant accounts (i.e. £428,057) depends on the knowledge of the directors of LFO of the fact that the October management accounts overstated the Company’s distributable profits by a further £178,000. I consider the knowledge of Mr Craig and Mr Davidson in detail below (when addressing their personal liability). Since, however, Mr Sutherland was a director of LFO (particularly as he was the director with primary responsibility for preparing the accounts of the Company), even if he alone had the requisite knowledge, that is sufficient to fix LFO with liability.

I have referred above to the fact that Mr Sutherland was prompted, by an email from Cook & Co of 8 November 2011, to appreciate that there may have been an understatement of the Company’s liabilities in the 2010 audited accounts (and that this would have carried through into the subsequent management accounts, including the relevant accounts), and that he had appreciated the full extent of this (i.e. that there was a net understatement of £178,000) by the end of December 2011 at the latest.

In the absence of any evidence from Mr Sutherland himself, it is necessary to draw inferences from such evidence as there is. There is nothing inherently unfair in doing so, notwithstanding that Mr Sutherland was not able to defend himself, since he was a director of LFO (to which his knowledge is to be imputed) and LFO has played a full part in the proceedings.

Neither Mr Craig nor Mr Davidson has any recollection of Mr Sutherland telling them at any time that an adjustment was required to the 2010 audited accounts. (I address this point further when considering their own potential liability below, but for present purposes the relevant point is that they do not provide any evidence against Mr Sutherland on this issue.)

Mr Lucas said in his statement that Mr Sutherland had told the board meeting on 21 November 2011 that a prior year adjustment (i.e. to the accounts for the year ending 30 June 2010) had been approved, but without giving specific details. He also said that Mr Sutherland had told him about the prior year adjustment in the weeks prior to the board meeting. In his oral evidence, he reiterated that Mr Sutherland, who had sat at a desk opposite him, had indeed told him about the prior year adjustment before the board meeting. He was less clear, however, about whether it had been mentioned in the board meeting, saying that he thought there had been prior deductions discussed at the meeting, and that he assumed that they were talking about the one that Mr Sutherland had told him about before. He does not say that he told any of the other directors prior to the board meeting what Mr Sutherland had told him.

I place little weight on Mr Lucas’ evidence on this point. It is clear that Mr Sutherland was working on various matters relating to the 2011 audit in the run-up to the board meeting. Given, as he accepted, Mr Lucas had no understanding of accounting matters I am doubtful that he would be able to recollect, at this distance in time, having been told about a specific adjustment to the 2010 accounts.

I accept (as the defendants contended) that it is unlikely that Mr Sutherland had concluded his work on the adjustments to be made to the 2010 audited accounts by the time of the board meeting. I accept therefore that he had not by then concluded that there was an understatement of liabilities in those accounts (and thus the ensuing monthly management accounts) in the sum of £178,000. That is because, had he known that, he was bound to have concluded that the amount of the Dividend (£500,000) was less than the distributable profits following the adjustment (£428,057) and so could not be lawfully made. It is also inconsistent with the document he sent himself on the morning of the board meeting which identified an increase in liabilities of only £100,000. There is no evidence that Mr Sutherland was other than honest. I find it unlikely, therefore, that he would knowingly have caused the directors to declare an unlawful dividend.

I am satisfied, however, on the basis of the contemporaneous documents, particularly the spreadsheets referred to at [33] above, the document Mr Sutherland emailed to himself on the morning of the board meeting and the subsequent adjustment to the October management accounts, that Mr Sutherland knew three things: first, he had by this time appreciated that there was a problem with the understatement of liabilities in the 2010 accounts and, therefore, the subsequent management accounts (prompted by Cook & Co’s email of 8 November 2011) and he had done a significant amount of work on this by the time of the board meeting; second, his work to that point indicated that liabilities appear to have been understated in the accounts to the year ending 30 June 2010 by about £100,000; and, third, that since his work was ongoing he could not be sure that, ultimately, the liabilities would not turn out to have been overstated by a greater amount.

In my judgment, that knowledge of Mr Sutherland is sufficient to constitute reasonable grounds for believing that to the extent that the Distribution exceeded £428,057 (being the amount of distributable profits once the creditor cut-off issue and the accruals issue was resolved), it contravened Part 23. That is so even if the test is as defined by Chadwick LJ in the It’s a Wrap case (above).

In the language of Chadwick LJ at [54], a person who knows that there is an error in the relevant accounts such that the amount of distributable profits is overstated, but who does not know the precise amount of the overstatement because they have not completed their work on the issue, must be taken to know, or have reasonable grounds for knowing, that the overstatement is in the sum which it eventually turns out to be. The only reason such a person does

I turn to the position of the other directors. As a starting point, I accept that they would have had no reason to be alerted to the possible understatement of liabilities in the relevant accounts unless Mr Sutherland told them about it. That is because the tasks of preparing the accounts and liaising with the auditors were delegated to Mr Sutherland, someone with relevant expertise, and the auditors had signed off on the annual accounts for the year ending 30 June 2010 (from which the problem stemmed) without noticing the issue.

The claimant contends that the defendants must have known of the possibility, at least, that the Company’s liabilities were understated in the relevant accounts, and relies on the numerous references to “audit issues” or “audit queries” in the contemporaneous documents. I have referred to some of these above, but draw them together here:

As I have already noted, neither Mr Craig nor Mr Davidson recalls being told anything at all about an adjustment having to be made to the accounts for the year ending 30 June 2010 by reason of the creditor cut-off issue or the accruals issue, or about a similar adjustment having to be made to the October management accounts.

As for the numerous references to “audit issues” in the documents, Mr Craig was adamant in his oral evidence that the only issues of which he had been made aware were that “the auditors were very keen to square off balances between the companies”, that “the auditors were asking for the intercompany balance to be tidied up” and that they were to do with the “settling of the intercompany balance”.

Both he and Mr Davidson said that, at the board meeting itself, the only audit issues discussed related to the Management Charge. There is some support for this in the draft minutes of the board meeting, in that the only issue specifically mentioned under the heading “Audit Queries” was the lack of a cross-charge.

In his written evidence Mr Craig said that he was very clear that neither Mr Sutherland nor anyone else had told him in advance of or at the board meeting that there was any issue with the 2010 accounts or the October management accounts. Had he been aware, then he would have wanted to know the impact on the Company’s ability to declare a dividend. As a possible explanation of

When asked why the Dividend was in the sum of £500,000, when the October management accounts indicated there were sufficient distributable profits to declare a dividend in a sum of £600,000, Mr Craig said that the £500,000 figure had come from Mr Shirlaw of SSCL as the amount needed to reduce the value of the Company in the books of LFO. There was nothing to this effect in Mr Craig’s witness statements. Nor is there any documentary record of Mr Shirlaw having required a dividend to be paid in the sum of £500,000. The debt owed by LFO was, between June 2011 and November 2011, in excess of £900,000. I consider that Mr Craig was therefore mistaken in saying that the reason the Dividend was in the sum of £500,000 was due to that being a specific requirement of SSCL.

Mr Davidson said in his witness statement that while he cannot recall doing so, he believes he would have asked Mr Sutherland and Mr Craig whether they were satisfied that an interim dividend could have been paid and would have “taken it on their advice”. He did not recall the document Mr Sutherland sent to himself on the morning of the board meeting being discussed either at the breakfast meeting or at the board meeting itself. He said that while there was some discussion at the board meeting of assuming a management charge to LFO, he does not think it was in the level of detail referred to in Mr Sutherland’s document.

In contrast to Mr Craig, Mr Davidson said that the references to audit queries in the emails prior to the board meeting (including his own of 14 November 2011) were to a range of points that had been raised by Cook & Co. In some of his answers in cross-examination, it appeared that Mr Davidson was accepting that he was aware that there was an issue with the 2010 audited accounts. In view of the fact that in places the questioning did not clearly distinguish which year of account was being referred to, I accept Mr Davidson’s subsequent clarification that he understood all points raised by Cook & Co to relate to the 2011 audit. He also explained that he considered that the level of adjustment that was needed to the 2011 accounts was in the region of £30,000, and he did not imagine that it would be more than £100,000. He did not recall Mr Sutherland telling him or the other directors at any time that there was a creditor cut-off issue relating to the 2010 accounts in the sum of £100,000.

I do not accept Mr Craig’s evidence that the only issues identified by the auditors in the run up to the board minute related to the inter-company crosscharge. On the contrary, I do not think that Cook & Co had raised that issue at all. Not only is there no evidence that Cook & Co ever told Mr Sutherland or anyone else that the accounts should reflect a debt due from the Company to LFO in respect of the matters that were later included in the Management Charge, it is unlikely that they would have done so for three reasons:

The only point Cook & Co had raised in relation to the intercompany position, as I have noted above, was the need to reconcile the amounts shown as debtor (in the Company’s books) and creditor (in LFO’s books). I conclude that Mr Craig – insofar as he recollects that the Management Charge was an issue raised by the auditors – was confusing this with the reconciliation of the intercompany debt.

Equally, however, I find that none of the audit issues raised by Cook & Co prior to the board meeting of 21 November 2011 related to the creditor cut-off issue or accruals issue in relation to the 2010 accounts. As I have explained above, that was an issue which Mr Sutherland himself had spotted, having been alerted by Cook & Co to a similar issue with the 2011 audit.

The critical question, therefore, is whether Mr Sutherland raised that issue with the other directors, whether in advance of the board meeting or at it.

Notwithstanding Mr Craig’s and Mr Davidson’s evidence that Mr Sutherland did not do so, for the following reasons I find on the balance of probabilities that at the board meeting on 21 November 2011 (if not also at the breakfast meeting on that date), Mr Sutherland referred to the fact that on the basis of his work (which was ongoing) there appeared to be an overstatement of distributable profits in the 2010 audited accounts and the October management accounts of around £100,000.

First, given my finding that Mr Sutherland had himself appreciated the problem before the board meeting, it is inherently likely that he would have brought it to the other directors’ attention. Moreover, it is likely that he did so at the board meeting, given that it was the first board meeting for three years and it had been called (as Mr Craig’s email of 17 November 2011 indicated) because there were “answers to be given to audit queries” and, to Mr Sutherland’s knowledge at least, to consider the declaration of an interim dividend.

Second, that conclusion is reinforced by the document which he sent to himself identifying an understatement of liabilities in the 2010 audited accounts in the sum of £100,000. As I have already noted, the most likely inference to be drawn from his action in sending it to himself immediately before meeting with the other directors is that he needed it for the purposes of the meeting later that morning.

Third, there had been no written response to Mr Craig’s email of 18 November 2011 asking Mr Sutherland to respond by Sunday night on three questions, including as to the outstanding audit points. Mr Craig’s evidence was that his questions were answered on the Monday morning by being provided with the October management accounts. That is unlikely, however, as there is nothing in those accounts which addressed the “outstanding audit points”. It is inherently more likely that Mr Sutherland answered Mr Craig’s queries in person on the Monday morning, there having been no other opportunity to do so.

Fourth, the fact that Mr Sutherland believed the amount of the misstatement in the accounts at that stage to be £100,000 is significant, because that alone would not have rendered the Dividend unlawful. Seen in that light, the lack of recollection of the directors of this being mentioned is less significant. The fact that they were given this information is not, for example, inconsistent with Mr Craig’s evidence that the main information from Mr Sutherland at the breakfast meeting was that there was sufficient balance on the profit and loss account to pay the Dividend.

An important question is whether Mr Sutherland told the other directors that the misstatement was in the precise sum of (or no more than) £100,000, or whether he told them that he believed (or was even confident) that the misstatement was in the sum of £100,000 but that his work had not finished. In trying to square my finding as to Mr Sutherland’s knowledge with the accepted fact that neither he nor the other directors were dishonest, I conclude that the latter is more likely. While it meant the directors would have been taking a risk that the misstatement may turn out to be more, they were not approving a dividend in a sum which they knew, on the basis of the financial information they had (ignoring the Management Charge) to be in a sum greater than the Company’s distributable profits.

Fifth, I am reinforced in this view by the evidence both Mr Davidson and Mr Craig gave as to their reaction when they discovered, within a matter of weeks, that the misstatement in the accounts was in fact much worse, such that the Dividend had certainly been paid at least in part out of capital, and the combined effect of the declaration of the Dividend and the Management Charge was to cause the Company to become insolvent. Notwithstanding the seriousness of this, on learning it, neither of them was prompted to do, or it appears say, anything at all.

Mr Davidson’s evidence was that he accepted he would have appreciated this from the November management accounts, but that his priority was in trying to get “the transaction” completed, by which he meant the investment by SSCL in LFO, and that he did not give sufficient attention to the payment out of capital. It was put to Mr Craig that the negative position indicated by the November 2011 management accounts would not have concerned him “because you knew that you had an overall solution coming along”, to which he responded “exactly”. He, too, was referring to the plan to sell the Company and to recapitalise LFO. He acknowledged that the Company itself would need to be recapitalised, but expected that would be done by its new owners.

Sixth, this provides further support for discounting the fact that neither Mr Craig nor Mr Davidson remembers the issue being raised by Mr Sutherland. Given that they did not do, or say, anything when they found out that the Dividend must have been paid in part out of capital, this is not a case where I can draw an inference in their favour by reason of the fact that, had Mr Sutherland told them what I have found he knew, they would be bound to have reacted to it by not approving the Dividend.

So far as Mr Lucas is concerned, as I have noted, his evidence was that Mr Sutherland had indeed told the directors at the board meeting of the prior year adjustment to the 2010 accounts. Although I have placed little weight on Mr Lucas’ recollection in this respect, it in fact accords with the conclusion I have reached based on the inherent probabilities arising from the other available evidence.

Finally, part of the problem in identifying the facts on this issue is that no minutes (other than draft minutes) were ever produced of the board meeting on 21 November 2011 and those draft minutes record no discussion at all as to the propriety of the dividend by reference to the distributable profits disclosed in the October management accounts. That is not a point, however, which counts in favour of the directors, as it was the responsibility of all of them to ensure that proper books and records were maintained: see s.386 of the 2006 Act and Re Mercury Solutions UK Ltd [2009] BCC 190, at [17].

Turning to the liability of the directors in light of these findings of fact, I consider that each of Mr Craig, Mr Davidson and Mr Lucas failed to comply with the standard required of directors. I stress that there is no question of any of them having acted dishonestly, and I consider separately below whether any of them ought to be excused from liability under s.1157 of the 2006 Act.

So far as the recharacterization of the Management Charge is concerned, I have already held (at [115] above) that Mr Craig and Mr Davidson were aware of the facts which rendered the Management Charge in substance a voluntary distribution. I am satisfied that Mr Lucas knew the same. While I accept that they genuinely believed the Company had benefitted from services and goods provided by LFO, and that they genuinely believed that they were entitled to cause the Company to assume a liability to pay for those services and goods, on the basis of the test at [104] above, their knowledge of facts which rendered this a voluntary distribution is sufficient to render them culpable for breach of duty in respect of the Distribution at least to the extent that it exceeded the distributable profits as revealed by the relevant accounts.

It is no defence that the precise amount of the Distribution had not been identified at the board meeting (because the Management Charge fluctuated due to continued trading between the two companies). On the contrary, I consider it would be a breach of duty for directors to approve a dividend in an uncertain amount without being sure that however large it might turn out to be, it would be properly made out of distributable profits. Moreover, the directors

As to their liability to the further extent that the Distribution exceeded the distributable profits that should have been stated in the relevant accounts, on the basis of my finding that Mr Sutherland had brought to their attention the fact that his work to date (as at the time of the board meeting) revealed an increase in liabilities of around £100,000 and that his work was ongoing, I consider that the directors ought not to have gone ahead and approved the Distribution without satisfying themselves that there were in fact sufficient distributable profits for that purpose.

Though I think it is inherently likely that Mr Sutherland expressed his belief, even confidence, that the Dividend could nevertheless be paid, it was not sufficient for the other directors to rely on that assurance, once the misstatement in the October management accounts had been raised, without having satisfied themselves that the point had been fully investigated and addressed. I consider that a prudent director acting in accordance with the duty to act in the best interests of the Company would not so have relied, but would have required the work to be completed by Mr Sutherland so that the relevant accounts could be prepared on an accurate basis. Not to do so constituted a failure to take reasonable care that the relevant accounts gave a reasonable view of the profits available for distribution.

The most likely explanation for their failure to do so, in the case of Mr Craig and Mr Davidson, given their evidence referred to at [147] above, is that they were focused not on the interests of the Company as a separate entity but on the “overall solution” involving the sale of the Company and recapitalisation of LFO. While understandable, particularly in circumstances where LFO was itself in financial difficulties so that the value of the debt due to the Company from LFO was already in doubt, I consider that this nevertheless constituted a breach of duty. Mr Craig and Mr Davidson were subject to an inherent conflict of interest in connection with the Distribution, given their role as directors of LFO. In acting as they did I consider that they gave undue consideration to the interests of LFO and failed to give proper consideration to those of the Company as a separate economic entity. It was not enough to hope that the Company’s new owners (whoever they may be) would address its lack of capital.

It is relevant in reaching this conclusion that the Company was known to be in serious financial difficulties, that things were likely to get worse over the next few months (during the quiet trading period), that if the liabilities were understated by even £100,000 the Dividend and Management Charge would have left the Company, even on the numbers as presented to the board meeting, with virtually no net assets and, as it turned out (and as the directors would have found out within a matter of weeks) they left the Company insolvent, with net liabilities of £142,000.

While it is unnecessary to investigate the extent to which the directors’ conduct amounted to a breach of any of the other statutory duties, it is clear that this at least constituted a failure to act in the interests of creditors at a time when the company was or likely to become (as a result of the Distribution) insolvent.

So far as Mr Lucas is concerned, notwithstanding his overall defence that he relied wholly on the other directors who he regarded as having relevant accounting and financial expertise, I do not accept that his lack of financial expertise is an answer to the claim that he too was in breach of duty. As Mr Cook pointed out, a director has an individual responsibility to “inform himself about [the company’s] affairs and to join with his co-directors in supervising and controlling them” (Re Westmid Packing Service Ltd (No.3) [1998] 2 All ER 124, per Lord Woolf MR at p.130a). Overall responsibility is not delegable, and directors owe “a continuing duty to acquire and maintain a sufficient knowledge and understanding of the company’s business to enable them properly to discharge their duties as directors”: Re Barings Plc (No.5) [1991] 1 BCLC 433, at p.487g and p.489a.

On Mr Lucas’ own case, he was aware that a prior year adjustment had been made to the 2010 audited accounts, but he was prepared to accept Mr Sutherland’s word that the Dividend would be paid out of distributable profits. This did not absolve him, in my judgment, of the duty to maintain sufficient knowledge and understanding of the company’s business - specifically that the relevant accounts demonstrated sufficient distributable profits – to enable him to discharge his duty as director in authorising the Distribution.

For the above reasons, I conclude that each of Mr Craig, Mr Davidson and Mr Lucas were in breach of their duties as directors in authorising the Distribution to the extent that it exceeded the amount of £428,057, being the amount of distributable profits which should have been stated in the relevant accounts.

Section 1157(1) provides that:

“If in proceedings for negligence, default, breach of duty or breach of trust against– (a) an officer of a company, or

(b)

a person employed by a company as auditor (whether he is or is not an officer of the company),

it appears to the court hearing the case that the officer or person is or may be liable but that he acted honestly and reasonably, and that having regard to all the circumstances of the case (including those connected with his appointment) he ought fairly to be excused, the court may relieve him, either wholly or in part, from his liability on such terms as it thinks fit.”

On behalf of Mr Craig and Mr Davidson it was submitted that they acted honestly and reasonably in relying on Mr Sutherland’s expertise and experience and that, in all the circumstances, they ought to be excused from liability. I do not accept this. Both Mr Craig and Mr Davidson were highly experienced businessmen with a clear understanding of financial statements and the legal and accounting requirements of Part 23 of the 2006 Act. My findings as to their state of knowledge of the understatement of the Company’s liabilities in its accounts means that this is not a case where they are entitled to shelter behind the fact that financial matters were delegated to Mr Sutherland.

I also take into account the fact that within a matter of weeks it was abundantly clear to both of them that the combined effect of the Dividend and Management Charge was to render the Company insolvent and to create a deficit in the profit and loss account of over £442,000. I do not make any finding that their failure to reverse the transactions when they discovered this fact was a separate breach of duty. Although Mr Cook sought to advance such an argument during the hearing no such alternative case had been pleaded and the question whether it would have been possible, taking into account the potential interest of third parties such as SSCL as an investor in LFO, to have reversed the transaction at that point was not explored in evidence. Nevertheless, the fact that they did nothing – even to investigate that possibility – when they discovered the consequences of the transaction is relevant in considering all the circumstances for the purposes of s.1157.

I regard Mr Lucas, however, as being in a different position, for a number of reasons. First, he had no financial or accounting expertise at all and was as a matter of fact much more reliant on Mr Sutherland than the other directors.

Second, Mr Craig, Mr Davidson and Mr Sutherland were (as Mr Davidson accepted) the main decision makers on the board and Mr Lucas felt, not unreasonably, that the Company would do whatever they decided. Unlike them, Mr Lucas was not affected by any conflict between promoting the interests of LFO and those of the Company.

Third, this is reinforced by the very limited role played by Mr Lucas in relation to the Distribution. He had no warning, before turning up at the board meeting on 21 November 2011, that there was to be even any consideration given to a potential distribution, let alone that the meeting was being convened to authorise one. There was nothing to that effect in the agenda which he received. Unlike the other directors, he had not been sent a copy of the relevant accounts prior to the meeting. He was not invited to the breakfast pre-meeting. As he explained in his evidence, by the time of the board meeting he had been awake for something like 26 hours having unexpectedly been required to work the nightshift at the Company’s premises in England before flying to Scotland early on the Monday morning. These factors combined to make Mr Lucas that much more reliant on Mr Craig, Mr Davidson and Mr Sutherland in relation to the business transacted at the meeting.

Fourth, Mr Lucas had no further involvement with either the Dividend or the Management Charge after the board meeting. He was not sent either version of the draft minutes and he played no part in approving the amount of the Management Charge or effecting the accounting entries which gave effect to it or the Dividend.

While these factors do not mean that Mr Lucas was not in breach of duty as a director, they are sufficient in my judgment to mean that he should be relieved of liability pursuant to s.1157. Accordingly, I do not make any order against Mr Lucas requiring him to compensate the Company in respect of his breach of duty.

For the above reasons, I conclude that: