Hellard & Anor (Liquidators of HLC Environmental Projects Ltd) v Carvalho

When a company faces a real, rather than remote, risk of insolvency, its directors must consider creditors’ interests. Those interests are paramount once the duty is engaged. A director cannot justify selective payments to connected creditors, himself, a guarantor’s lender, or another group company without considering the company’s creditors as a whole.

The duty is normally subjective, but an objective inquiry applies where the director made no actual consideration or unreasonably overlooked a material creditor. Under Insolvency Act 1986 section 212, the court may require restoration of misapplied funds even where payment discharged a genuine debt, with a tailored proviso preventing a windfall in the insolvency distribution.

The joint liquidators brought a misfeasance application under section 212 of the Insolvency Act 1986 against the company’s principal director.

They challenged payments made between November 2005 and October 2008 to an associated company, the director or for his benefit, the company’s bank, and an individual employed by another group company. The company had ceased to have a live trading business, had substantial liabilities, and was exposed to a contingent put-option liability which later crystallised.

The central issues were whether the company was insolvent throughout the payment period, whether the director breached duties owed to the company and its creditors, whether statutory relief was available, and what restorative relief should follow.

1. The liquidators’ claim succeeded. The company was unable to pay its debts as they fell due and its assets were worth less than its liabilities, including contingent and prospective liabilities, throughout November 2005 to October 2008. The cash-flow inquiry under section 123(1)(e) was flexible and fact-sensitive. Under section 123(2), the court had to make a practical judgment about prospective liabilities. The put-option liability was commercially inevitable and had to be substantially provided for.

2. The director’s duty to consider creditors’ interests arose before formal insolvency where there was a real, not remote, risk to creditors. The court held that the director had selected which creditors to pay without considering creditors as a whole, including the contingent creditor under the put option. Although the best-interests duty is generally subjective, the objective test applied because material creditor interests had not been considered.

3. The director also exercised the company’s power to deploy its assets for improper purposes. The proper purpose was to advance the company’s commercial interests and, once the creditor duty arose, its creditors’ interests. The substantial purposes found were to assist the associated company, the director personally, the bank guarantor, and to discharge liabilities of other group companies.

4. The payments to the associated company, the director or for his personal benefit, and the bank breached the relevant common-law or statutory duties. The payments to Mr Ferro were not liabilities of the company and similarly breached sections 172 and 171(b) of the Companies Act 2006. It was unnecessary to decide the alternative conflict and reasonable-care claims.

5. Relief under section 1157(1) was refused. The director bore the burden of proving honesty and objective reasonableness. He had not acted reasonably, so the court did not reach the separate question whether he ought fairly to be excused.

6. Under section 212, restoration was appropriate. The director was to repay £507,000 in personal payments and £55,000 in Ferro payments. He was also liable to restore £697,063.21 paid to Engenharia and £1,557,907 paid to NordLB, subject to adapted West Mercia Safetywear Ltd v Dodd provisos which notionally restored the paid debts in the insolvency distribution and recouped the resulting dividend to him.

not stated in the judgment.