Restriction of Directors – recent case law

In two recent High Court decisions concerning the restriction of directors, the Court considered circumstances where directors continued to trade after their respective companies had gotten into difficulties.

The Court, in both cases, had regard to the dictum of MacMenamin J in Re MDN Rochford Construction Limited; Fennell v Rochford & Anor [2009] IEHC 397 where he stated:

“While each case must be judged on its facts, there comes a point where optimism becomes hubris, and where belief that a company can trade out of its difficulties is simply wilful self-delusion. Commercial acumen is necessary. Hope must be matched by verification and objectivity. The absence of all of these necessary characteristics constitutes irresponsibility."

In each case the directors did not dispute that the Company was unable to pay its debts at the commencement of its winding up. Nor did they deny that they were each a director of the company at the material time. It followed that the Court was obliged to make a declaration of restriction unless it was satisfied that the directors acted honestly and responsibly in relation to the conduct of the Company’s affairs.

Leahy v Doherty & ors [2016] IEHC 588, High Court, Keane J, 21 October 2016 concerned an application for the restriction of three directors pursuant to Section 150 of the Companies Act 1990.

The Company was incorporated in November 1993 and carried on the business of timber merchants and builders providers until its winding up in May 2011.  The first and second named respondents were directors of the Company throughout its existence; the third named defendant became a director in August 2006.

The Court noted that the Company traded profitably until 2008 but after the dramatic collapse of the construction sector, it made a loss in 2009. In response, it quickly reduced its overheads and took action to deal with its debts. The directors believed that these measures and the anticipated bottoming out of the downturn in the construction industry, would allow the Company to continue to trade. However, severe weather in December 2010 further hampered activity in the construction sector, and following professional advice the directors placed the Company in liquidation in early 2011.

The Company had a liability to the Revenue Commissioners of €189,843, comprising unpaid VAT and PAYE/PRSI. The company ceased to file VAT returns after the period November/December 2010 and ceased to pay its VAT liabilities with effect from the end of the period January/February 2010. The company filed all PAYE/PRSI returns up to March 2011 and, having paid €6,000 per month in respect of its PAYE/PRSI liabilities to the end of June 2010, ceased to make any such payments after that date.

The Company filed its annual returns in the Companies Registration Office until 2009 but failed to submit its return for 2010. However, the Court noted that the mere fact that a company is in breach of its obligations in that regard for a relatively limited period will not, of itself, indicate dishonesty or irresponsibility on the part of its directors, without something more.

The specific issue raised by the liquidator was whether each of the directors could satisfy the court that he acted responsibly as a director in relation to the conduct of the Company’s affairs in permitting it to continue to operate between the Spring or Summer of 2010, when the liquidator contended that it was clearly insolvent, and March 2011, when the Company ceased trading.

The directors denied that they were irresponsible in allowing the Company to continue to trade. They pointed to the uncontroverted evidence that the Company addressed the losses it incurred in both 2009 and 2010 by making drastic cost reductions; that, until November 2010, the Company was engaged in meaningful discussions with its bankers to secure the credit facilities necessary to keep the Company afloat; and it had retained the services of a professional consultant throughout that year to assist it towards that end.

The directors argued that, in considering whether a director has acted responsibly, the Court should have regard to the entire tenure of the director and not merely the months in the run up to the liquidation. In this case, under the stewardship of the directors, the Company had a perfect revenue record for over sixteen years.

In the circumstances, the Court concluded that, having due regard to the entire tenure the respondents as directors of the Company and to their engagement with professional advisers and financial institutions throughout the period at issue, the directors had satisfied the Court that, although they had made commercial errors and misjudgements, they have acted responsibly in relation to the conduct of the Company’s affairs.  Accordingly, the application for restriction was refused.

The same Court reached a different conclusion in Leahy v O’Keefe & anor [2016] IEHC 589, High Court, Keane J, 21 October 2016, which concerned an application for the restriction of two directors under Section 819(1) of the Companies Act 2014. Failte Logistics and Distribution Limited (the Company) carried on business as a courier service, was incorporated in May 2011 and was wound up in August 2014. When the Company commenced trading in June 2011, the respondents were employed by it. The respondents became directors (and joint managing directors) of the Company in November 2012, replacing the company’s previous directors. At that point, the Company had a liability to the Revenue Commissioners of €158k.

A separate company named Fáilte Couriers Limited (‘Couriers’) had gone into liquidation in July 2011, having traded in the same business sector for approximately 20 years. At the commencement of its winding up, Couriers owed a substantial debt to the Revenue Commissioners. The business of Couriers was operated by the respondents’ father, and each of the respondents was a director of that company at the commencement of its winding up.

The Company sought to acquire or take over Couriers’ customer base.

At the commencement of its winding up, the Company had a debt to the Revenue Commissioners of €171,735 for outstanding VAT and PAYE/PRSI and an estimated total deficiency of €533,067.

The Company did comply with its obligation to file annual returns in the Companies Registration Office with the exception of its returns for the year 2014. The liquidator acknowledged that the directors had co-operated with him throughout the liquidation.

The liquidator alleged that the Company incurred significant additional losses due to the decision to continue to trade after November 2012 and queried whether the directors could satisfy the Court that they acted honestly and responsibly in accepting appointments as directors of the Company in November 2012 without taking any, or any sufficient, steps to satisfy themselves:

(a) that the company was solvent; and

(b) concerning the nature and extent of the company’s liabilities to the Revenue Commissioners, at that time.

The respondents acknowledged that, before becoming directors, they were made aware that the Company had a Revenue debt, but claimed that they were told that an instalment repayment agreement was in place and was being met.

The directors believed that despite its continuing losses, the Company could trade out of insolvency but that their personal involvement in its management was essential to its survival and they developed a plan to cut costs. However, the Court noted that no detail was provided to support this belief.

The Court pointed out that ordinary commercial misjudgement is not sufficient to establish irresponsible conduct on the part of a director and one must be careful not to be wise after the event and to refrain from engaging in a ‘witch hunt’ simply because a business failed. Nonetheless, in considering whether the conduct of a director has been so incompetent as to amount to irresponsibility, it is appropriate to have regard to whether that director took legal or professional advice and, if so, whether the director followed it. In this case, when the directors agreed to become directors of a company with a consistent history of trading losses and a significant historical Revenue debt, there was no suggestion that either of them sought or obtained professional advice in reaching the decision that the company could trade out of insolvency. Furthermore, the directors did not have the benefit of being able to point to a lengthy tenure as directors of the company prior to the period in the run up to its liquidation. The Court was of the view that a failure to recognise that a company is hopelessly insolvent and unlikely to be able to trade out of its difficulties could show a lack of commercial probity.

The Court also considered that while the mere fact that a company has failed to make its tax returns or tax payments for a relatively limited period prior to the commencement of its winding up does not of itself indicate dishonest or irresponsible conduct, it was important to have regard to the precise scope and circumstances of the company’s delinquency in each case.

In this case, the Company was never profitable; the directors commenced employment with it shortly after a company, of which they were directors and with a similar name in the same business, went into liquidation owing a significant debt to the Revenue Commissioners; the respondents later took control of the Company at a time when it was already in default of its Revenue obligations; and there was scant evidence of any, or any sufficient, attempt by the respondents to properly apprise themselves of the extent of the company’s continuing trading and revenue difficulties at that time, or to take professional advice before they made the decision that it should continue to trade.

Accordingly, the Court concluded that the directors had failed to satisfy it that they acted responsibly in the conduct of the Company’s affairs and made a restriction order in respect of each of them.

For further information please contact Paula Mullooly or your usual contact in A&L Goodbody

Date published: 22 November 2016