The recent High Court case of Stacks Living Limited & Ors v Shergill & Ors (“Stacks Decision”) has further highlighted the importance of taking advice and documenting decisions following the much-publicised decision of Wright v Chappell (the “BHS Case”).

By way of reminder (see our previous blog here), the BHS Case introduced the concept of misfeasance trading and found that a director can be liable for misfeasance trading if they continue trading in breach of their duties when the company should have gone into administration or insolvent liquidation. Notably, this claim could arise much earlier than a wrongful trading claim, bringing into sharper focus the need for directors to be very mindful of their duties.

The BHS Case provided useful lessons about steps directors ought to take, to reduce the chance of a claim against them for misfeasance trading (and therefore personal liability) including holding regular, fully documented board meetings and taking (and applying) appropriate professional advice. The Stacks Decision expands further on the importance of contemporaneous documentation and proper record keeping when approaching insolvency.

Background

The case concerned applications by the joint liquidators of two companies, Stacks Living Limited (“Stacks”) and Staffs Furnishing Limited (“Staffs”), which entered compulsory liquidation following a failure of the companies to pay national non-domestic rates tax to the Council. The companies were wholly-owned by Mr Balvinder Shergill who also acted as director. For a limited period, Miss Miranda Smith, Mr Shergill’s partner, was appointed as director of Staffs, although Miss Smith admitted to having no involvement at all in the affairs and business of Staffs.

The liquidators brought claims: i) for fraudulent trading; ii) for wrongful trading; and iii) misfeasance against both Mr Shergill and Miss Smith in respect of allegedly unexplained and/or otherwise improper or unjustified payments by the companies. The claims were opposed and Mr Shergill and Miss Smith sought to rely on s 1157 of the Companies Act 2006 (“CA 2006”) to claim relief from liability, which was rejected.

The findings against the directors

Fraudulent trading

The Court found Mr Shergill liable for fraudulent trading, due to “no real or honest belief that those debts would be discharged and no real expectation of a reduction or discount”.

The judge criticised Mr Shergill for an intention to trade through a series of phoenix companies and incurring, but not paying, the rates liability and HMRC debts.

Wrongful trading

The Court found both directors liable for wrongful trading (albeit Miss Smith for Staffs only during the period of her directorship), notwithstanding Miss Smith had no actual knowledge of the prospect of insolvent liquidation – in her capacity as a director Miss Smith ought to have enquired into the company’s financial position.

Crucially the Court found that the company could not evidence how it could pay the monies owed. In addition, despite suggestions that there was a hope of trading through difficulties, the Court noted that there was:

1. no evidence of any advice to support a believe of any genuine prospect of doing so, particularly where Staffs took over from the business of Stacks with no discernible shift in business plan;
2. no business plan, management accounts or other detailed financial or management records and no foundation on which to conclude that the business could survive; and
3. no evidence to support Mr Shergill’s assertions that he was acting on a genuine belief that relief was available.

Misfeasance

Company directors owe several duties to the company, including a fiduciary duty to apply the company’s assets for the proper purposes of the company and to account for their use. In this case, the liquidators identified:

1. several payments to Mr Shergill personally (which were labelled as “wages”, but Mr Shergill provided inconsistent oral evidence to argue that this was to pay supplies);
2. cash withdrawals; and
3. payments to certain organisations (e.g. Sky), which did not appear to be legitimate business expenditure.

The court noted that once a liquidator identifies a payment has been made, the burden of proving the payment was made for proper purposes falls upon the respondents. The directors ought to be able to rely on contemporaneous documentation to prove the origins of any payment. The Court was very critical of the quality of Mr Shergill’s oral evidence and was therefore reluctant to place much reliance on his submissions, in the absence of any documentary evidence to demonstrate that such payments were for the company’s benefit.

The court noted that non-production of documentation may be conspicuous by its absence, if it is likely that it would exist, and that the court may draw inferences from its absence.

Therefore, as Mr Shergill was unable to provide credible evidence that the withdrawals/payments were for a proper purpose, owing to a failure to keep proper records (e.g. receipts and/or contracts), the court ordered the directors to compensate the respective companies for the unexplained payments.

The Importance of Contemporaneous Evidence

In this case, the respondents adduced little to no documentary evidence to support their assertions, and the judge was heavily critical of Mr Shergill’s oral evidence, noting that it was “fundamentally inconsistent with known facts and documents”.

The Court referred to various “observations” made in previous cases regarding the importance of contemporaneous evidence, namely:

1. memory is “especially unreliable” when it comes to recalling past beliefs, which are revised to make them “more consistent” with present beliefs
2. the best approach is to place “little if any reliance” on recollections of conversations and to base factual findings on documentary evidence and known/probable facts
3. the importance of contemporary documentation to ascertain the motivation and state of mind of those concerned (particularly internal documents)
4. the value to be placed on contemporaneous evidence for credibility – it was noted in particular that lacking contemporaneous evidence may be conspicuous and lead a judge to draw negative inferences from its absence
5. the “fallibility” of human memory and the need for memory to be assessed alongside contemporaneous documentary evidence

Crucially, the council (a creditor in respect of the rates liabilities) had records of telephone conversations and emails, providing contemporaneous evidence in which the company acknowledged that it could not pay the rates liabilities – contrary to Mr Shergill’s version of events.

Concluding Thoughts

The case highlights the importance of contemporaneous documentation and proper record keeping by directors who may later be required to provide an explanation for past events. As noted “recollections” of conversations and “memory” are not as credible as written documentation. 

We cannot comment on whether the existence of such would have changed the outcome for the respondents in this particular case, but the case does demonstrate that without contemporaneous paperwork directors will find it much harder to convince the court of the reasons for their actions.

Abigail Harcombe also contributed to this article.