Sequana Revisited: Hunt v Singh

Introduction

The long-awaited Supreme Court decision in BTI 2014 LLC v Sequana SA and others [2022] UKSC 25 (which we reported on last October) raised perhaps as many questions for practitioners as it answered about the so-called “Creditor Duty” – ie. the duty of directors to take into account the interests of creditors in certain circumstances.

The recent case of Hunt v Singh [2023] EWHC 1784 (Ch) has given further consideration of the Creditor Duty – specifically in the context of whether the duty arises where a company is in fact insolvent, but the directors wrongly believe the liability giving rise to the insolvency has been effectively avoided.

 

The context: tax avoidance schemes

In the early 2000s, conditional share schemes – designed to enable companies to make payments to staff structured in such a way that the company itself would not incur liability to HMRC for PAYE or NIC contributions – grew in popularity. Conditional share schemes, and other similar structures, were often put in place on the advice of a company’s tax advisors. However, HMRC keenly investigated such schemes and by December 2004, the Paymaster General announced a crackdown on schemes avoiding PAYE and NIC in Parliament. Following that, in September 2005, HMRC made a market-wide offer to participants in the schemes – the basis of which was payment of all NIC contributions with interest, but with certain corporation tax reliefs being made available.

 

The current case

In 2002, Marylebone Warwick Balfour Management Limited (the Company) entered into a conditional share scheme, which had been recommended to them by their tax advisors, designed to enable head office staff to receive payments, structured as non-contractual gratuitous bonuses, without the Company incurring PAYE and NIC liabilities to HMRC (the Scheme). The Scheme operated until 2010 and, throughout the lifetime of the Scheme, the Company’s tax advisors continued to advise the Company that it was “robust”.

The Scheme was first notified to HMRC in May 2003 and, following enquiries, in June 2004 HMRC confirmed their position that if the payments under the Scheme were in reality earnings, then PAYE and NIC would be payable together with interest.

Notwithstanding that warning, the wider crackdown from 2004 onwards and a landmark tribunal decision where it was also concluded that HMRC was entitled to payment of NIC in relation to a scheme that was materially similar (the PA Holdings Ltd scheme), the Scheme continued to operate until 2010 - resulting in payments to the directors and others of over GBP54 million. The evidence before the court showed that by September 2005, when NIC and interest thereon payable to that date were factored in, the Company was already operating with a net deficit, and the position continued to worsen.  

It was not until November 2011 - when the Court of Appeal, hearing an appeal in the PA Holdings Ltd litigation, held that the company in that litigation was in fact liable for both NIC and PAYE - that the Company was advised that its position was not distinguishable from that of PA Holdings Ltd. The Company was liable for NIC, PAYE and interest on those amounts.

The Company was placed into creditors voluntary liquidation (CVL) and was subsequently dissolved. By the point of liquidation, the Company’s liability to HMRC for NIC, PAYE and interest thereon exceeded GBP36 million.

Dissolution could have been the end of the story. However the Company was then restored to the register, still in CVL, in 2017 and Stephen Hunt was appointed as liquidator (the Liquidator).

 

The Liquidator’s claims

The Liquidator brought various claims against several former directors of the Company, including claims under section 212 of the Insolvency Act 1986 for breach of duty – specifically breach of the Creditor Duty – for allowing payments out at a point where the Company was already insolvent. After the claims were dismissed at first instance in the Insolvency and Companies Court, the Liquidator then appealed specifically in respect of the breach of Creditor Duty claim relating to the period from September 2005 (when HMRC made its market-wide offer to participants in such schemes) until the Scheme ceased operating in 2010. The appeal in respect of Mr Singh was the only one to proceed to a hearing, and the Liquidator sought from Mr Singh the amount he personally received as a result of the breach of duty. 

 

The appeal

Hearing the appeal in the High Court, Mr Justice Zacaroli considered the decision in Sequana but noted an important difference.

In Sequana there was no doubt that the company was solvent at the time the relevant dividends were paid, and it was therefore necessary to consider whether the company’s directors ought to have realised that the company was likely to become insolvent.

By contrast, in this case, there was no doubt that the Company was insolvent during the relevant period. The fact that the Company disputed the liability due to HMRC did not change this. A disputed liability does not make it a contingent one - throughout the period of the Scheme there either was an actual liability to HMRC or there was not. As is known now, there was indeed an actual liability.

Zacaroli J found that ICC Judge Prentis in the Insolvency and Companies Court, deciding that the Creditor Duty was not engaged essentially because the directors acted reasonably in taking advice as to the merits of HMRC’s claim, had applied the wrong test for determining whether the Creditor Duty arose. Rather, Zacaroli J held that, in this case – where the Company’s solvency was dependent on it successfully challenging HMRC’s claim for NIC, PAYE and interest thereon, the duty was triggered if the directors “knew or ought to know that there was least a real prospect of the challenge failing”.

This is different to the “real risk of insolvency” test which the Supreme Court rejected in Sequana (which concerned a real risk of future insolvency). Here the Company was either solvent (if the directors were found to be right on the tax position) or it wasn't (if HMRC was right about the tax position). And if it wasn’t, the economic interest in the Company had already shifted to the creditors. The “real risk” the directors needed to be aware of here was that they (and their tax advisors) were wrong and the tax liability would be found to be due.

Zacaroli J declined, however, to go further and make a finding on whether, the Creditor Duty having arisen, that duty had actually been breached – that question was sent back to the Insolvency and Companies Court for consideration.

 

Insight

The appeal has provided helpful guidance on how and when the Creditor Duty is triggered in circumstances where directors are aware of a claim which, if recognised in the company’s books, renders the company insolvent. The appropriate test in such circumstances depends on “knowledge of a real risk that the company’s challenge to the claim may fail”.

The question of whether, given that the Creditor Duty had arisen, Mr Singh was in breach of it, would involve interesting consideration of the factors for determining the content of the duty – as discussed by the Supreme Court in Sequana.  However, while we will keep a keen eye out for any subsequent movement on this case, given that Mr Singh was declared bankrupt prior to the hearing of the appeal, it is possible that it will not be pursued further.

Finally, one interesting aside on this case - although he had previously been a statutory director, he had resigned and, for the period in question (September 2005 to 2010), Mr Singh was actually a de facto director. A reminder perhaps then that breach of duty claims can also be pursued against de facto and shadow directors.