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Directors’ Declarations of Solvency – A Cautionary Tale

AUTHOR(S): Emma Doherty, Fergus Bolster
PRACTICE AREA GROUP: Corporate
DATE: 06.06.2019

Summary

In a recent case of the High Court of England and Wales (LRH Services Limited (in liquidation) v Trew and Others [2018] EWHC 600 (Ch)), a solvency statement given by the directors of LRH Services Limited (the “Directors”) was deemed invalid because sufficient inquiries had not been made into the affairs of the company. It was also determined that the Directors had failed to act in the company’s best interest. In light of these factors, the Directors were found personally liable for the £21 million debts of the company.

What happened?

LRH Services Limited (“LRH”) carried out a reorganisation involving a share capital reduction, the transfer of LRH’s assets (including its trading subsidiaries), and the payment of a £21 million dividend to LRH’s sole shareholder, Contracting Solutions Group (Holdings) Plc (the “Parent”). Shortly after the payment of this dividend, LRH went into liquidation, defaulting on its debts. Consequently, LRH (through its liquidator) brought an action against the Directors.

Why were the directors made liable?

As part of the share capital reduction, the Directors were required to provide a solvency statement. This stated that the Directors, taking into account all of LRH’s liabilities, had formed the opinion that LRH would be able to pay its debts during the 12 months following the share capital reduction. The solvency statement was made by Mr Trew, being LRH’s sole director at the time. Of the other two directors concerned, one (Mr O’Neill) had resigned shortly before the statement was made, while the other (Mr Brewer) was formally appointed as a director after the making of the solvency statement. Notably, both Mr Trew and Mr O’Neill were substantial shareholders of the Parent.

Mr Trew had based his opinion of solvency on the understanding that either the Parent or LRH’s sister company,  Contracting Solutions Group Limited (“CSG”) would discharge LRH’s liabilities; despite no agreement being in place entitling LRH to have its liabilities discharged. In making this assumption, the court determined that Mr Trew had only considered whether the Parent or CSG would be in a position to pay LRH’s debts and not whether LRH itself would be able to do so. Accordingly, it was deemed that Mr Trew had failed to make any inquiry or give any consideration into LRH’s actual liabilities.

The court also held that Mr O’Neill and Mr Brewer were equally liable, despite not having made the solvency statement. This was because both directors had failed to consider LRH’s prospective or contingent liabilities while enabling the reorganisation. Though Mr O’Neill had resigned before the statement was made, he had planned the reorganisation which would inevitably lead to LRH’s insolvency and had known that Mr Trew’s statement would be improperly based on the assumption that the Parent or CSG would provide financial support. For his part, Mr Brewer had participated in the resolutions required to implement the share capital reduction and the subsequent dividend to the Parent. He had done this without making any inquiry into whether such steps were in the interests of LRH, the company he had assumed a responsibility to serve as director.

In addition to these facts, the court discovered that none of the Directors had attempted to reclaim a £339,000 balance owed to LRH by the Parent, despite it being in the interest of LRH for them to do so. This receivable had also not been properly documented. Furthermore, as substantial shareholders of the Parent, it was noted that both Mr Trew and Mr O’Neill stood to benefit from LRH’s payment of the £21 million dividend.

Having considered the above facts, the court declared that the solvency statement had been invalidly made, that the share capital reduction was unlawful and that the Directors were personally liable for LRH’s debt of £21 million.

Why is it relevant to you?

While this was a decision of the High Court of England and Wales, it is a reminder of the potential liability faced by the directors of Irish companies who do not make adequate inquiries when making solvency statements and/or who fail to act in the best interest of their companies.

Under Irish law, a company may carry out a share capital reduction by way of the Summary Approval Procedure (the “SAP”). As part of the SAP, the directors of a company must provide a declaration of solvency (the “Declaration”) stating that they have carried out a full inquiry into the affairs of the company and have formed the opinion that the company will be able to pay its debts as they fall due during the 12 months following the share capital reduction. In order to be effective, the Declaration must be accompanied by an independent auditor’s report stating that the Declaration is ‘not unreasonable’ (the “Auditor’s Report”).

Both the Declaration and the Auditor’s Report must be filed with the Companies Registration Office (“CRO”) within 21 days of the share capital reduction commencing. It should be noted that the Declaration and the Auditor’s Report (along with the shareholders’ special resolution approving the share capital reduction) will be publicly available once they have been filed with the CRO. If the company becomes insolvent during the subsequent 12 months and is unable to pay its debts, the company’s directors may be made liable for those debts without limitation in circumstances where the Declaration is deemed to have been unreasonable.

The similarities between Irish law and the law of England and Wales in this regard are notable and this case is likely to be persuasive.

What can directors do to protect themselves?

When making the Declaration, directors should bear the following points in mind:

  •          The directors should ensure that they make a full inquiry into the affairs of the company and, importantly, that their inquiries are recorded in the minutes of the related board meeting.
  •          When making such inquiries, the directors should consider the company’s current and future assets and liabilities.
    •     In taking into account contingent and prospective liabilities, directors should consider all circumstances relevant to whether a liability will fall on the company.
    •     The directors should also consider what assets will be available to meet liabilities, including future liabilities. If future receivables are relied on, are there any risks that they will not be received? In particular, the payer of the receivable may become insolvent or may not be legally obliged to continue making payment in certain circumstances.
  •          Directors should document the information and other evidence relied upon by them in making the Declaration. For example, where the directors of a subsidiary make a Declaration on the basis that the parent company will discharge the subsidiary’s liabilities (as was the case with LRH), it would be advisable for the directors to seek written confirmation of same and/or binding documentation from the parent company. The appropriate form of such written confirmation will depend on the circumstance of each case.
  •          The directors should ensure that the independent auditor preparing the Auditor’s Report is provided with full and accurate information.
  •          Finally, the directors should make sure that all aspects of the SAP are followed correctly. For further information on the role of directors in the SAP, please read our firm’s guidance note here prepared by corporate partners Emma Doherty and Fergus Bolster.

This article was co-authored by Corporate partner Emma Doherty, Corporate partner Fergus Bolster and Corporate solicitor Paul Breslin

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