by Catherine Jane O'Rourke , Michael Hanley December-12-2018 in Banking & Financial Services, Corporate

Since the introduction of The Companies Act 2014, directors have relied on the Summary Approval Procedure as a means of sanctioning certain activities that are otherwise prohibited.

While it has been a welcome development in simplifying financial transactions, directors need to be mindful of the appropriate steps to be taken so they are not leaving themselves open to committing an offence or being personally liable for the debts of a company.

 

Background

The Companies Act 2014 (“the 2014 Act”) streamlined certain approval processes by introducing the Summary Approval Procedure (“SAP”) which is utilised regularly in banking and finance transactions. The SAP is most frequently applied to sanction loans to directors, or inter-company loans or guarantees in connection with such loans, which would otherwise be prohibited under s.239 of the 2014 Act. One of the requirements for the SAP is that the directors of a company make a declaration of solvency on behalf of the company, confirming it is solvent at the point of the SAP being carried out and for the following 12 months.

S.239 replaced s.34 of the 1990 Companies Act which allowed for a white-wash procedure. That section also required a report from an independent expert auditor opining that a directors’ declaration was reasonable.  Auditors were very reluctant to give such a report, indeed they were all but impossible to obtain, making the s.34 white-wash largely unworkable.  The removal of this requirement has led to the regular use of the SAP for this purpose.

 

LRH Services Limited (in liquidation) v Trew and others [2018] EWHC 600 (Ch)

A recent UK case, LRH Services Limited (in liquidation) v Trew and others [2018] EWHC 600 (Ch), brought to light the potential dangers for directors in making a solvency statement without having properly formed the opinion that the company is solvent. In that case, the liquidator of LRH Services Limited brought an action against three former directors of that company in connection with a reorganisation of the group of companies which they had carried out and which involved a reduction of share capital pursuant to s.643 of the UK Companies Act 2006. The reorganisation resulted in a £21 million dividend being paid to the parent company; shortly after, the company went into liquidation.

In order to avail of the s.643 procedure, a solvency statement was made by the directors of LRH Services Limited. Similar to the Irish declaration of solvency, it is a statement that each of the directors of the company have formed the opinion that there is no ground on which the company could be found to be unable to pay its debts on the date of the statement and also the opinion that the company will be in a position to pay its debts for the following 12 months. In forming this opinion, directors are required by the legislation to take into account all the company’s liabilities, including any contingent or prospective liabilities.

It was held that the solvency statement made by the directors was invalidly made on the basis that the opinion of solvency had not been properly formed by one director. When the court looked in to the facts of the case that led to the opinion of solvency being formed, it transpired one of the directors – Mr Trew – was relying on the parent company of LRH to discharge the company’s liabilities (with no binding agreement that it would do so) in order to support the opinion that the company was solvent.

It was further held that in making this assumption, the directors failed to make any enquiry or give any consideration to the company's actual liabilities as is required by the legislation. The result was that the solvency statement was found to be invalid and the capital reduction made on the basis of that statement was thus unlawful.  The court held that each director was personally liable to the company for the £21 million dividend paid out in consequence.

 

Irish context

In consideration of the judgment held by the UK High Court in LRH Services Limited, the question arises as to whether a similar judgment could be held in the Irish court system as a result of the declarations of solvency made in connection with a SAP. As set out above, this procedure is frequently availed of in banking and finance transactions to sanction loans to directors, inter-company loans or the provision of guarantees from connected companies within the meaning of s.220 of the 2014 Act. An example of connected companies would be having a director in common but not being part of the same group where a holding company and subsidiary relationship exists. Loans/guarantees of this nature would otherwise be prohibited under s.239 of the 2014 Act. The SAP can also be used to sanction financial assistance for the purchase by a company of its own shares (s.82 of the 2014 Act) and any related activity such as a target company providing a guarantee and security in connection with its own acquisition.

Declarations of solvency under the 2014 Act are required to state that the declarants have made a full inquiry into the affairs of the company in forming the opinion that the company will be able to discharge its debts and other liabilities in full as they fall due during the period of 12 months after the date of the transaction.  There is no definition as to what a ‘full inquiry into the affairs of the company’ requires, however, it arguably could be deemed to be a higher threshold than the UK threshold of ‘taking into account all of the company's liabilities (including contingent and prospective liabilities)’.

 

What does this mean for directors?

If the declaration of solvency made in support of a SAP which sanctions a prohibited activity is deemed to be invalid, and if the company goes into liquidation and is unable to pay its debts (as was the case in LRH Services Limited) directors who benefitted from the transaction, could be held personally liable for those debts.

This case reminds us of the importance of directors applying caution when availing of the SAP to sanction prohibited activities under company law. Directors should be aware of the potential consequences of signing declarations of solvency without having carried out the necessary inquiries. They must be able to ground a view that the company is solvent at the point of the SAP being carried out and that it will be for the following 12 months. If they don’t, they could find themselves being held personally liable for the debts of the company.

 

For further information please contact Michael Hanley mhanley@hayes-solicitors.ie or Catherine Jane O'Rourke cjorourke@hayes-solicitors.ie at Hayes solicitors. 

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