Failure to maintain books and records allows misfeasance action against directors
A Scottish court judgment has emphasised that directors can be pursued for misfeasance and considered where the burden of proof lies where books and records have not been delivered to the office holder in an insolvency.
Sheriff Lugton, sitting in the Sherrif Court at Kirkcaldy, considered matters in relation to an Order being sought by Linda Hastings as liquidator of Beath Retail Limited (in liquidation) (the company) against a director of the company and an alleged shadow director (the respondents). The Order, brought under section 212 of the Insolvency Act 1986, seeks the sum of £420,970 against the respondents which is the total value of claims received in the liquidation.
Background
The company operated a petrol station until around March 2020 after which it is reported to have transitioned into a car wash and repair business. It is alleged that the second respondent, the husband of the first respondent, functioned as a shadow director. On 15 November 2019 a Mr. Todor Tsikalov was appointed as a second director of the company in addition to the first respondent. Tsikalov has not been able to be traced, and the liquidator has reported that they have been unable to uncover evidence of his involvement in the business.
The company accounts for the financial years ending 30 June 2017 and 2018 filed with Companies House, indicated the company's total assets were £1. It is alleged that the accounts submitted to Companies House were false and misleading, with substantial trading activity reflected in the company's bank account, which contrasted sharply with the reported assets of £1. No accounts have been lodged beyond 2018.
Despite repeated requests, no books and records of the company have been provided beyond 2018.
The company failed to file VAT returns from June 2017 to December 2019.
In 2020, the company sought financial assistance, including a £25,000 retail, hospitality and leisure grant and a £50,000 loan. The second respondent completed both applications. Notably, the loan application stated the company's turnover as £1,800,000. Additionally, the loan was obtained under the premise that the company was still operating as a petrol station, although the liquidator believes that the company had stopped trading by that time.
Between 2018 and 2020 the respondents withdrew £128,795 from the company's bank account, using these funds for personal property transactions.Following the appointment of the liquidator in January 2023, contact was made with the first respondent as director of the company. They advised in an email on 30 March 2023 that they had not been actively involved in the business from around January 2018, that the staff ran the business themselves until the appointment of Tsikalov in November 2019 and that the company ceased to trade in March 2020 when the business was taken over by The Forecourt Group Ltd.
Allegations of misfeasance
In seeking the Order, the liquidator believes that the respondents breached their statutory and common law duties to the company by:
- Using company funds for their own benefit.
- Transferring assets to Forecourt without proper valuation or consideration.
- Failing to maintain adequate accounting records.
- Filing false and misleading accounts.
- Failing to file accounts from 1 July 2018.
- Failing to submit VAT returns.
- Securing a grant and loan based on false information and then misappropriating the funds.
The Court’s consideration
The liquidator is seeking an Order that the two respondents had jointly and severally misapplied funds of £420,970 (being the total value of the claims submitted in the liquidation). At this stage the court was not being asked to determine this, but to consider whether any factual averments made by the liquidator in their application that did not relate to the misapplication or retention of money were irrelevant and should be deleted. In addition, the respondents argued that the liquidator must demonstrate causation and quantify loss for each alleged breach thereby striking down the amount being sought from the total value of claims submitted.
While the published judgment sets out in great detail the consideration, in summary the Sherrif decided that:
- The normal strict pleading rules don't apply to Section 212 applications, but fair notice to the respondents is crucial. The court has broad powers to investigate and craft an appropriate remedy.
- The onus remains on the respondents to account for the company's financial dealings, given their fiduciary duties and the absence of proper records.
The court ultimately agreed that the case should proceed on the basis of the original submissions by the liquidator with the court to examine and determine any section 212 remedy in due course.
Conclusion
While this is a Sheriff Court judgment, it serves as a useful reminder that directors have wide ranging duties in statute and common law which are fiduciary. The nature of a fiduciary is such that the onus is on them to account to their principal. The lack of accounting records may as a result be more of a problem for the directors than the liquidator.
With the final remedy outcome still to be determined at a later date, it will be interesting to see how that process unfolds and ultimately what, if any, remedy the court determines.
