Often limited companies are undercapitalised, relying on a
funder’s willingness to lend further money when needed in order to stay
solvent. The funder is typically a
holding company or the individual behind the company. The funder may be under no legal obligation
to provide further funds when required by the company, and accounts are
prepared on a going concern basis on the mere expectation they will do so.
Third parties contracting with such an undercapitalised
limited company would be well-advised to seek guarantees from the funder, but
in practice funders are often unwilling to give guarantees. The perils of contracting with such a company
without a guarantee were revealed by the case of Palmer Birch (A Partnership) v Lloyd & Another [2018] EWHC 2316, as the judge in that case noted in
his judgment. As he went on to say, the
case “also reveals less directly the potential pitfalls for those individuals
who choose to operate through the medium of such a limited company which proves
not to be good for its contractual obligations, including those who may have
directed its affairs from the shadows (or quite openly but perhaps not quite
constitutionally).”
Michael Lloyd had acquired a mansion house in Devon through
a corporate structure and was refurbishing it to serve as his English home and
for proposed business activities of corporate hospitality, conferences,
educational purposes, shooting and grazing.
The freehold of the property was owned by Seizar Holdings Limited, a
Cypriot company, which granted a 21 year lease to Hillersdon House Limited (“HHL”), an English company of which
Michael’s brother Christopher was sole shareholder and director. HHL contracted
with the Palmer Birch partnership for the refurbishment at a contract sum of
just over £5M. This structure enabled
HHL to recover the VAT on the building works, which Michael personally could
not have done. Michael funded the
project through a £5M loan facility to HHL, which was in turn part financed
with his bank.
By December 2014 the project was running over time and over
budget and Michael was running out of patience and of money, though further
funds were expected when a property development in Kenya produced a return on
his investment. Invoices from the
contractor went unpaid and by a solicitors’ letter of 22 April 2015 HHL gave
notice to terminate the building contract, purportedly on the basis of its own
insolvency. As the contract only allowed
termination on the basis of the other party’s insolvency, this was of itself a
repudiatory breach of contract.
Subsequently a new company, Country Sporting Experience Ltd. (“CSEL”), of which Michael was sole
shareholder and director, took over the property and was funded by the eventual
returns from the Kenya investment, which crucially came through just before the
formal liquidation of HHL.
Unusually Palmer Birch took legal action not against the
insolvent company but against its director Christopher and its funder (and arguably
shadow director) Michael personally, alleging that Michael had committed the
torts of inducing breach of contract and unlawful interference and that Michael
and Christopher had committed the tort of unlawful means conspiracy. Some of the claims have now succeeded on a preliminary
trial of the liability issues, though damages have still to be established.
Importantly for funders, the claim failed that Michael’s
failure to fund, which resulted in HHL failing to pay the sums due to Palmer
Birch, amounted to his inducing a breach of contract by HHL. The judge followed earlier cases that “the
inducement tort is not committed simply through a suggested failure on the part
of the defendant to feed the coffers of a limited liability company, to enable
it to meet its contractual obligations, when in fact there is no legal
obligation to do so”. This is known as “mere
prevention”, as distinguished from “inducement”.
However this can be a “thin dividing line” and Michael was
held to have crossed it in this case by causing HHL “to repudiate the Contract,
when the funds which were then made available to CSEL could instead have been
made available to HHL in time to enable it to perform the Contract and to meet
its contractual obligations”. On the
evidence, Michael was found to have been behind the decision to instruct the
solicitors to give notice purportedly to terminate the contract and the
insolvency practitioners to arrange the creditors’ voluntary liquidation of HHL,
when the last minute funds had become available which he could have used to
save the Contract and HHL. The judge
also found that “the evidence safely supports the inference that by no later
than late January 2015 Michael and Christopher had reached an agreement to
bring about the liquidation of HHL so that it might escape from the Contract
and thereby avoid meeting PB's existing and anticipated claims”, which was
sufficient for the claim of an unlawful means conspiracy to succeed.
The advice for funders is that yes you can set up such a
structure (a claim that the setting up of the structure was itself an unlawful interference
or unlawful means conspiracy had been struck out at an earlier hearing as
having no prospect of success) and in principle you can withhold further
funding that you are under no legal obligation to provide, even if it results
in the borrowed failing to meet its contractual obligations and becoming
insolvent. But you have to be careful
not to cross that “thin dividing line” and become actively involved in inducing
that breach of contractual obligations - especially if you do have the funds
that could have been used to comply with them.
If you do set up a structure which is run by a third party, let them get
on with it and be very careful not to interfere – especially when it runs into
trouble.
