Swan (liquidator) v Sandhu & Anor

Section 212 of the Insolvency Act 1986 provides a summary procedure for enforcing existing rights; it does not create new substantive rights. A director’s fiduciary duty requires an honest belief that the transaction serves the company’s interests. The court does not substitute its own view of commercial reasonableness for that honest judgment. A separate common-law duty of care is assessed by objective and subjective standards. A breach requires proof of loss. Where a company disposes of its business to a related company, the relevant consideration and value must be established on the evidence. A transaction is not at a substantial undervalue merely because the price is below one valuation if it is not unreasonably less than the value proved.

The liquidator of K&K Knitwear Ltd sought relief against two directors under Insolvency Act 1986, section 212. The claims concerned the subordination and postponement of loans made to a related company, the transfer of K&K’s clothing business to Kay Textiles Ltd, and the later capitalisation of the loans into shares in the related company.

The liquidator alleged breaches of fiduciary duty and common-law duty of care, and contended that the transactions involved an undervalue or were intended to put assets beyond creditors’ reach. The central issues were whether the directors acted honestly in K&K’s interests, whether they failed the applicable duty of care, whether loss was proved, and whether the business transfer was for a substantial undervalue.

1. The application under section 212 of the Insolvency Act 1986 failed. Section 212 was procedural and did not create new rights. The liquidator therefore had to establish an underlying breach of fiduciary or other duty and consequential loss.

2. The February 1999 loan transactions and the December 2000 capitalisation were undertaken in circumstances capable of supporting the directors’ genuine belief that they served K&K’s interests. The directors were not materially motivated by the interests of the related company except where those interests coincided with K&K’s interests. The fiduciary-duty claims therefore failed.

3. The common-law duty of care involved separate objective and subjective tests. The directors failed the objective standard by not obtaining a second floating charge over the related company’s assets and by accepting repayment postponement until 2009 without appropriate protection if the senior lender required repayment. However, the liquidator failed to prove that such security would have had value or that the loans could have been recovered. The claim consequently failed for want of proved damage.

4. The transfer of K&K’s business was assessed by reference to the evidence of creditors discharged, stock and debtors taken over, and the agreed valuation methodology. The appropriate valuation scenario was one in which the director did not continue assisting a purchaser, producing a value between £190,000 and £235,000. The respondents established that approximately £497,000 of trade creditors had been discharged, exceeding the value of the stock and debtors by about £170,000. The transfer was not shown to be at a substantially or unreasonably low price.

5. The court declined to grant relief under section 727 of the Companies Act 1985; although unnecessary to the result, the court stated that it would not have relieved the directors even if the substantive conclusions had been different.

The liquidator’s application was dismissed.