Misfeasance claims against directors of companies in liquidation

This article summarises the key points made by Popplewell J, in the recent case of Madoff Securities International Limited (in liquidation) v Raven and Others (2013) in relation to statutory and common law defences to misfeasance claims against directors. His judgment provided a concise review of the law and also resolved an issue regarding actionable loss.

In many misfeasance/breach of duty cases against directors/former directors of a company now in liquidation, the facts evidencing that breach or breaches are relatively clear cut and uncontroversial. This draws into focus the question of whether the director has any common law or statutory defence available to a claim against him/her for restitution to the company. This is important to officer holders and directors alike as it impacts upon the prospects of successfully pursuing/defending a claim and any settlement negotiations.

Common law defence: The Duomatic Principle

The principle, first established in Re: Duomatic Limited (1969) by Buckley J applies:

“where it can be shown that all shareholders who have a right to attend and vote at a general meeting of the company assent to some matter which a general meeting of the company could carry into effect, that assent is as binding as a resolution in general meeting would be”.

The core essence of the defence is that shareholder assent renders the alleged misfeasance an act of the company itself thereby precluding action by the company against the director(s).

Madoff re-states the parameters of this defence; namely that:

1. It cannot be relied upon where the company was insolvent at the time of alleged ratification
2. Insolvency is an objective test (and the honest belief of the directors is irrelevant)
3. Those seeking to rely upon Duomatic must prove solvency (although the office-holder must as a pre-requisite adduce evidence of insolvency)

Statutory defence

In cases where an office-holder succeeds in establishing a breach of duty, a director/his advisors will seek to invoke Section 1157 Companies Act 2006 which is in identical terms to its predecessor, Section 727 Companies Act 1986, namely that:

“if in proceedings for negligence, default, breach of duty or breach of trust against … an officer of the company - it appears to the Court hearing the case that the officer or person is or may be liable but that he acted honestly and reasonably and that having regard to all the circumstances of the case … he ought fairly to be excused the Court may relieve him, either wholly or in part from his liability on such terms as it thinks fit”

The statutory defence is routinely pleaded as the last line of defence (more in hope than in expectation) but Madoff has potentially reinvigorated its usefulness. Popplewell J held that:

1. It was apparent from the fact that the section is applicable to liability for negligence that “reasonably” is broad concept
2. Relief is available even where a director has been in breach of the duty to exercise reasonable care and skill
3. A court should take into account factors such as loss to the company; personal benefit; whether shareholder approval has been provided; the degree of blameworthiness and proportionality

This suggests that judges may in future adopt a more sympathetic approach to directors particularly where his/her actions were undertaken honestly.

Extent of compensation

If common law and statute fails to afford a defence, then Madoff reinforces the principle that only genuine loss to the company is actionable. A judge must take into account any benefit that may have accrued to the company from the impugned transaction and the company cannot be “overcompensated”.

As such, Madoff finally resolves the issue of actionable loss in the case of unlawful dividends. If a lawful dividend could have been paid up to a certain amount then it is only the balance that can be claimed and not the entire dividend itself.