Ignorance is bliss? Not for directors!

06 July 2021

In the recent case of TMG Brokers Ltd (in liquidation) (also known as: Baker v. Staines) the High Court held a director of a company to be jointly and severally liable for payments made by his co-director out of the company’s bank account that were made without proper authority and amounted to  disguised distributions of capital. The fact that he had placed trust in the other director for the company's financial affairs did not excuse him from performing his duties.

TMG Brokers Ltd (TMG) and its liquidator (the applicants) applied for declarations under s212 of the Insolvency Act 1986 in relation to certain payments made out of TMG’s bank account by its directors – D1 and D2. 

The payments in question were: 

• £175,053.32 from TMG’s bank account with bank Frick & Co in Liechtenstein (the Frick account) to D2 made during the period 12 September 2013 to 1 December 2016 (the Frick payments);

• cash withdrawals of €50,409.11 (£43,182.70) from the Frick account, which the liquidator considered were most likely made by D2 (the Frick cash withdrawals); and

• £213,791.94 that D2 directed one of TMG’s debtors to pay into the account of a connected company, TMG Pay Limited (TPL), under the control of D1 and D2 (the TPL payments). 

The applicants claimed that the Frick payments and Frick cash withdrawals were made without proper authority and amounted to disguised distributions of capital, or that in causing or permitting the payments D1 and D2 had acted in breach of the fiduciary duties which they owed to TMG as its directors pursuant to sections 171, 172, 173 and 174 of the Companies Act 2006. They also claimed that the TPL payments were diverted away from TMG in breach of the D1 and D2’s fiduciary duties. 

D1 maintained that he had received a single payment, which he understood to be salary, and had repaid it to TMG when he realised it had not been properly accounted for in TMG’s accounts. He did not deny also receiving some £13,000 from TMG's account, but stated that it had been a reimbursement of legitimate company expenditure. He explained that D2 had ultimate control of TMG and TMG’s finances and that any other payments had been made without his (D1’s) consent. D1 asked the court to exercise its discretion under s212 to release him from liability.

D2 denied wrongly receiving payments from TMG and that he had breached his duties to TMG. 

The court held that the payments were made without proper authority and amounted to disguised distributions of capital. The fact that D1 had placed trust in D2 in relation to TMG’s financial affairs did not excuse D1 from performing his duties as a director. Having acquiesced in D2’s practice of making payments, without knowing, understanding, or even asking about them, D1 was to be treated as having authorised the payments. 

This decision should serve as a timely reminder to directors of their duty to scrutinise the conduct of their fellow directors and not simply pass the buck when it comes to certain roles and responsibilities. As can be seen from this case, agreeing that one director will primarily be responsible for a company's financial affairs does not absolve the other directors from responsibility.

In this case, D1 admitted to ignorance of his duties as director and to signing accounts showing TMG to be dormant when it was not. He had knowingly allowed D2 to make unauthorised payments. He had not seen TMG's bank statements but as director he was entitled to see them and should have made sure he reviewed them regularly. In this case, a number of matters should have put D1 on enquiry to check that D2 was properly handling matters. Had he checked, it would have been clear that D2 was not.

It is important to note that directors will not generally be held in breach of the duty to exercise reasonable care, skill and diligence (s174 CA 2006) simply for trusting other persons who are in a position of trust for the purpose of managing the company (ie fellow directors). However, a director with grounds for suspecting the honesty of a fellow director will be liable if they refuse to act on those suspicions.

This article first appeared on the Kingsley Napley insights blog.

Katie Allard is an associate at Kingsley Napley.