Paycheck Services 3 Ltd (Court of Appeal)

The Court of Appeal allowed Mr Holland's appeal on the central legal question whether he was a de facto director of 42 composite companies. The court held that acting as a director of a sole corporate director does not, without more, make the human director a de facto director of the subsidiary companies; the separate legal identity of the corporate director must be respected absent sham or façade. The court therefore set aside the judge's orders against Mr Holland under section 212 of the Insolvency Act 1986. The court endorsed the judge's factual findings that unlawful dividends had been paid and that the judge had correctly applied and reviewed issues under section 727 of the Companies Act 1985, but concluded the primary liability order could not stand once the de facto director finding was wrong.

Background and nature of the claim. HM Revenue & Customs issued 42 originating applications under section 212 of the Insolvency Act 1986 against Mr and Mrs Holland as alleged de facto directors of 42 insolvent companies, seeking restitution or contributions for unlawful dividends (circa £13m) paid without provision for higher rate corporation tax.

Facts and corporate structure. A group of composite companies were operated by a structure in which a corporate body (Paycheck Directors) was the sole de jure director of each trading company; Mr Holland and his wife were directors of Paycheck Directors. The composite companies paid regular dividends to employee-shareholders while believing the small companies' corporation tax rate applied. A structural defect meant they were in fact liable to higher rate corporation tax, discovered in 2004, and the companies subsequently became insolvent.

Procedural posture. The judge at first instance found Mr Holland to be a de facto director, dismissed claims against Mrs Holland, relieved Mr Holland for earlier periods under section 727 Companies Act 1985 in part, but found he caused unlawful dividends from 23 August to 19 October 2004 and ordered a contribution limited to the additional HRCT accruing in that period (about £144,000). Mr Holland appealed and HMRC cross‑appealed.

Issues framed.

• Whether Mr Holland was a de facto director of the composite companies despite acting solely as a director of their sole corporate director;
• whether Mr Holland was liable for unlawful dividends and whether he should be relieved under section 727 Companies Act 1985;
• the appropriate measure of relief under section 212 Insolvency Act 1986 and whether the first-instance judge erred in limiting the contribution to HRCT and in granting a short period of grace.

Court's reasoning and resolution. The Court of Appeal held that the judge erred in treating Mr Holland as a de facto director: following the principles in Hydrodam and related authorities, a director of a corporate director does not become a de facto director of the subject company merely by acting in that capacity; something more is required (for example stepping outside the capacity as organ of the corporate director or evidence of sham). The court therefore allowed the appeal and set aside the orders against Mr Holland. The court observed (obiter) that had the de facto finding stood it would have rejected Mr Holland's claims for section 727 relief for the post-18 August period and would have concluded the judge erred in granting a short ‘‘grace’’ period and in limiting restitution to HRCT rather than ordering repayment of the unlawful dividends; but these points were not determinative once the primary de facto director issue succeeded for the appellant.

Appeal allowed. The court allowed Mr Holland's appeal on the ground that the judge erred in finding him to be a de facto director of the composite companies: acting as a director of a corporate director does not, without more, make the human director a de facto director of the subject company. The court set aside the orders made against Mr Holland and dismissed HMRC's cross-appeal as moot. The court explained that (i) the separate legal personality of the corporate director must be respected unless there is evidence of sham or the individual acts beyond his role as organ of the corporate director, and (ii) policy reasons for imposing individual liability are for the legislature rather than the court to implement.

Appeal from a Chancery Division judgment given by Mr Mark Cawson QC (Deputy High Court Judge) delivered 24 June 2008 with an order dated 4 July 2008 (reported at [2008] 2 BCLC 613). The appeal was heard in the Court of Appeal (Civil Division) and decided 2 July 2009 ([2009] EWCA Civ 625).