Court of Appeal re-establishes case law on disqualification of directors

Director of Corporate Enforcement -v- Walsh & ors [2016] IECA 2 concerned an appeal by the Director of Corporate Enforcement (the Director) against a decision of Barrett J declining to make a disqualification or restriction order against three directors. The main complaint against the directors was that they had failed to file annual returns for two companies - Walfab Engineering Ltd (Walfab) and RPB Products Ltd (RPB) which resulted in those companies being struck off the Register.  All three directors (A, B and C) were directors of Walfab while A and C were also directors of RPB.

The application was brought by the Director under Section 160(2)(h) of the Companies Act 1990 which has as its focus directors who, through culpable inaction, have allowed an insolvent company to be stuck off the register when they ought to have the company wound up.

Facts
Directors A and C, who ran the companies, blamed the downturn in the economy for the decline of the companies and did not dispute the failure to file annual returns. They claimed that they had at all time acted honestly and responsibly in relation to the companies and that when the companies became insolvent, they were not in a position to afford to liquidate them. They said that they made every honest and reasonable effort to continue to ensure the survival of their livelihoods and the business in which they had invested significant human and capital resources over the years. It was their genuine intention to keep trading into a position of recovery. They did not take any significant remuneration from the companies for a considerable amount of time before the companies were struck off the register. Directors A and C stated that, notwithstanding the fact that their obligations as company directors were paramount, there were other matters including the discharge of liabilities, satisfying customers’ orders and finishing works in progress and sustaining their livelihoods which concerned them.

Director B (who was a director of Walfab only) stated that it was never her intention to be actively involved in Walfab and she took no active role in it. She never received any director’s remuneration, drawings, wages, salary or otherwise from the company. She said that she had always acted honestly and responsibly in relation to the conduct and affairs of the company.

Decision
Kelly J, giving judgment in the Court of Appeal referred to the case law on Section 160(2)(h) which existed prior to the High Court judgment in this case and particularly the decision of Finlay Geoghegan J in Re Clawhammer Ltd [2005] 1 IR 503 where she identified the purpose of the statutory provision as follows:

“There is potential prejudice to creditors of an insolvent company if the directors, by default, permit it to be struck off the register rather than taking steps to wind it up. In such circumstances such assets of the company as remain are not applied, as a matter of course, in the discharge of creditors according to statutory priorities. Even directors who seek to discharge liabilities of the company may do so in accordance with their own preferences and possible perceived future commercial needs or future commercial intentions or to escape liabilities under guarantees. It also may be of benefit to the directors in the sense of escaping the scrutiny of their conduct of the company's affairs which might follow an investigation by a liquidator including the possibility of being fixed with personal liability for liabilities of the company in circumstances where same is mandated by the Companies Acts. Accordingly, I accept the submission made on behalf of the Director that the Oireachtas regards the fact that directors may have permitted a company to be struck off the register as a result of their failing to make annual returns as more than a technical breach of their obligations under the Companies Acts.”

Kelly J noted that the approach set out by Finlay Geoghegan J was one which had been followed in all subsequent applications under Section 160(2)(h) and the only departure from the application of those principles was by Barrett J in this, and another, case. He further noted that Barrett J's departure from the Clawhammer principles was evident from an early stage in his judgment where he stated:

“Finlay Geoghegan J. delivered her judgment in Clawhammer in early 2005, some years in advance of the financial maelstrom that afflicted the State from late 2008 onwards. While her observations are as true now as they were then, the practical context in which s. 160 applications fall to be considered has changed utterly. In this regard, it is worth noting that the courts do not administer justice blinkered from general facts of which they are entitled to take judicial notice such as the collapse of the national economy around 2008, the protracted financial downturn that followed, and the adverse financial consequences that all of this has entailed for many people, including the respondents and indeed the creditors of the companies of which they were directors.”

However, Kelly J rejected this contention, noting that a “financial maelstrom” did not change the purpose of Section 160 which is the promotion of proper corporate governance.  Neither did it alter the obligations upon directors in circumstances where companies under their control become insolvent. In such a circumstance, they should take the necessary steps to bring about the company’s winding up. They cannot, as an alternative, fail to carry out their obligations by not making annual returns and waiting for the company to be stuck off the Register. Difficult trading conditions or financial pressure does not provide a form of absolution from the statutory duties undertaken by persons when they decide to become directors of a company.

Kelly J also criticised Barrett J's regard in his judgment to what he described as the “scale of enterprise and qualification of directors” and the “context in which director transgression" occurred. Kelly J did not agree that these factors could be regarded as relevant to the exercise of his discretion. The whole thrust of the legislative provision was to ensure that all directors of all companies complied with their obligations and it did not matter whether they were directors of family companies, or large publicly quoted companies. Kelly J was further of the view that neither the qualifications of the directors or the economic challenges that the companies may be facing affect the obligations of directors to act responsibly in respect of an insolvent company.

Kelly J also rejected Barrett J's contention that the past behaviour of the directors is something which ought to be borne in mind in applications of this nature noting that each of the wrongdoings identified in Section 160 were instances of conduct which warranted disqualification and the intent of the legislature ran the risk of being frustrated if an obligation were placed upon the Director to put before the court evidence of the entire past behaviour of directors.

Kelly J also dealt with that portion of the trial judge’s approach to the position of Director B when he stated:-

“…it does not appear that Ms. Catherine Walsh in her actions as director was or is tainted with that ‘real moral blame’ to which reference was made by Carroll J. in the renowned case of In Re Hunting Lodges Limited (in liquidation) [1985] I.L.R.M. 75 at p.85 as the basis for imposing personal liability on a purportedly passive director.”

Kelly J pointed out that Re. Hunting Lodges was an application under Section 297 of the Companies Act1963 which deals with fraudulent trading and the factors relevant to such an application have little to do with applications for disqualification or restriction. He went on to hold that it would be contrary to the whole notion of proper corporate regulation if passive directors could be exonerated from liability or relieved from disqualification or restriction on the basis of the passive nature of their role noting that there were a number of cases where that was made clear. Kelly J was of the view that all directors whether passive or otherwise are required to undertake all reasonable steps to file annual returns and there is no warrant to limit the disqualification or restriction of passive directors to one where there is a “real moral blame” on their part. Accordingly Kelly J in applying the test in Clawhammer and on a consideration of the evidence of the directors took the view that this was a case where the court ought to exercise its discretion not to make a disqualification order but instead impose a restriction order for a period of five years in respect of each of the Directors.

Comment
The decision clearly re-establishes the case law on matters surrounding the disqualification and restriction of directors and suggests that the Court of Appeal would show less tolerance towards director transgressions than has been shown by some recent decisions of the High Court.

For more information please contact Paula Mullooly at pmullooly@algoodbody.com.

Date published: 26 January 2016