Roberts v Frohlich & Anor

Directors may honestly believe that a risky transaction benefits a company, so commercial misjudgment does not by itself establish breach of fiduciary duty or negligence. However, where a company is insolvent or of doubtful solvency, the directors must consider the interests of creditors. They must stop incurring liabilities when continued trading is no longer honestly defensible and no reasonably competent director could regard continuation as proper. For wrongful trading, liability arises where the directors knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation. The court must assess the directors’ decision without hindsight, but objective circumstances may make continued optimism wilfully blind.

The claimant, the liquidator of Onslow Ditchling Ltd, sought declarations and relief against its two directors, Peter Frohlich and Godfrey Spanner. The claims alleged misfeasance, breach of fiduciary and common-law duties, and wrongful trading under Insolvency Act 1986. ODL had acquired development land and commenced construction using borrowed money, but the anticipated fixed-price building contract, pre-sales and further funding did not materialise. The central questions were whether the directors had honestly acted in ODL’s interests, whether they had exercised reasonable skill and care, and when they knew or ought to have concluded that insolvent liquidation could not reasonably be avoided.

1. Fiduciary duty. The test for whether directors acted in the company’s interests remained essentially subjective. The fact that an act caused substantial detriment made the evidential task more difficult, but did not replace the requirement to determine whether the directors honestly believed the act was in the company’s interests.
2. Where a company is insolvent, of doubtful solvency or on the verge of insolvency, the directors must take the interests of creditors into account. In that context, the relevant interests of the company may in reality be those of its existing creditors.
3. The directors honestly believed, when ODL acquired the Site and when the initial building orders were placed in July 2004, that funding might become available. Their decisions involved serious risks and poor judgment, but the claimant had not shown that no reasonably competent director could have made those assessments without hindsight. No breach was established for that earlier period.
4. By 14 September 2004, the position had materially changed. There were substantial existing and prospective liabilities, no realistic prospect of satisfying the bank’s funding conditions, no fixed-price or capped contract, no meaningful pre-sales, and no further funding from Easier or a co-venturer. The directors could no longer honestly regard continued work or further orders as being in ODL’s interests. They were in breach of fiduciary duty and the duty of care by failing to halt unperformed work and disclose the true funding and contractual position to FCL and HBoS.
5. The applicable skill-and-care standard was that in section 214(4) of the Insolvency Act 1986, assessed in the context of ODL’s doubtful solvency and by reference to the directors’ actual knowledge, skill and experience.
6. The wrongful-trading test was also satisfied from 14 September 2004. The directors ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation. Their continuation of the development thereafter constituted wrongful trading under section 214.
7. Relief under section 1157 of the Companies Act 2006 was refused. The question of financial consequences was adjourned for a subsequent hearing.

First-instance decision. No appellate history was stated in the judgment.