Directors’ Creditor Duty: A Starting Point Only
While tax evasion and tax avoidance are two different things, it is not accurate to say they are polar opposites. One person’s tax avoidance (or mitigation) could still be considered in dim terms by HM Revenue and Customs who may legitimately come after them. The outcome could prove costly to the person subject to a demand for repayment from HMRC.
The important question in a recent case1 arose out of a company scheme, supported by professional advisers, to avoid tax liabilities.
The issue was: when did a director’s duty to take into account the interests of creditors arise, where the company was insolvent at the time due to a tax liability which the directors believed had been avoided by a valid scheme?
The background
The company concerned provided management services to a PLC (and other companies). The PLC began to wind down its business and the company provided head office staff to assist the PLC.
Over an 8-year period to 2010, the company operated a tax avoidance scheme. Essentially, staff at the head office could receive payments without the company incurring PAYE or NIC liabilities to HMRC (which had been notified of the scheme). The company was consistently reassured by its tax advisers and counsel that the scheme was robust.
In December 2004, the Paymaster General announced a crackdown on such schemes and made clear that HMRC would be challenging them where appropriate. HMRC then made a market-wide offer to companies involved in these types of scheme, requiring them to pay NIC plus interest, but with certain corporation tax relief available.
The company refused that offer and, true to its word, HMRC pursued it for an initial total of some £16m. Meanwhile, the company scheme continued until August 2010, by which point more than £36m was owed to HMRC.
Creditors’ duty
The liquidator also brought a claim against two directors of the company for breach of creditor duty (a settlement was eventually reached with one of the directors). Company financial records showed that, taking into account the debt to HMRC, the company was substantially insolvent at the relevant time.
Indeed, the directors accepted that had they known there was a liability due to HMRC the company would have been insolvent. (Even so, the judge did not find that the statutory insolvency test had been met.)
So, the crucial question on appeal was: had the creditor duty arisen in those circumstances?
The court had to consider at what point prior to actual insolvency did the company’s duty to creditors arise, and what was its content. The important Supreme Court ruling in Sequana was carefully considered (though in that case the focus was on the time before the company was actually insolvent).
The court concluded that the creditor duty arose at the latest in September 2005, when HMRC made its market-wide offer, and the duty continued until the company entered liquidation and thereafter.
However, once triggered that is just the starting point for a claim for breach of duty. The consequences of the duty being triggered vary enormously depending on the facts.
What does this mean?
It is important to understand that even where the creditor duty has arisen, that does not automatically mean the creditors’ interests are paramount (eg, above those of the shareholders).
Once the creditor duty has arisen, it is a question of fact as to whether the creditors’ interests themselves have been damaged. In this case, the judge made no ruling on that question and remitted it for determination at a later date.
1Hunt v Sing [2023] EWHC 1784
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