Manolete Partners v Karim - lessons on directors' duties

In this update we turn once again to directors’ duties in the case of Manolete v Karim [2024] EWHC 2053 (Ch). This case concerned the particularly egregious behaviour of the directors of a family run travel agency.

It is interesting to note that in this case, while the company was insolvent and the “creditor duty” was undoubtedly engaged, the claims did not focus (or rely) upon this exclusively – instead being framed more broadly in terms of the direct ors’ statutory duties, and demonstrating the inter-relation between these different duties and other heads of claim (for example, in respect of unlawful dividends).

Background

Evershine Travel Limited (the Company) was a family company in the business of offering package holidays and online car rentals. The company entered insolvent administration in January 2017, with a significant shortfall to creditors amounting to an estimated £17.58m. It subsequently entered creditors’ voluntary liquidation in January 2018.

The claim was brought by litigation funder Manolete Partners Plc, as the assignee of claims from the Company and its liquidators. The defendants included brothers J, B and F - all directors of the Company and beneficial owners of the Company’s shares – as well as their (now estranged) spouses M and A. The latter were alleged to have been the knowing recipients of various unlawful payments from the company. M was the only defendant represented at the hearing.

Claims

The claims related to numerous transactions executed by the Company’s directors over a long period of time, either for their own personal benefit or for that of close connections. The Company was (relatively) cash rich, but balance sheet insolvent or bordering on insolvency from as early as 2012, and unable to pay its debts as they fell due from (at latest) autumn 2014.

The directors effectively treated the Company’s funds as their own, displaying what was, in the judge’s damning assessment, a “cavalier and disingenuous approach towards the management of the Company's financial affairs, the proper custodianship of its assets, and consideration of the interests of its creditors.” The transactions in question are too numerous to detail here, but included:

• significant payments in connection with speculative investments which were contrary to the Company’s best interests;
• the use of company funds for personal purposes including payment of personal tax bills, cash expenditure, and credit card expenditure of over £922,000;
• payments to other corporate entities controlled by one or more of the directors, variously characterised as loans or payments of legal or management fees;
• payment of almost £500,000 to the directors in alleged bonuses or further remuneration;
• significant sums paid to other family members or connections; and
• unlawful dividends paid to the directors in the financial years ending 2014 and 2015, in the total sum of £267,500.

The judgment

In the absence of any defence from the directors themselves, Richard Spearman K.C. (sitting as a Deputy Judge of the Chancery Division) found for Manolete on all points, including in relation to the following:

Financial information and corporate governance

• The importance of directors basing their decisions on properly prepared and timely financial information was emphasised. In this case, it was found to have been impossible for the board to discern the financial position of the Company at any point in time – no management accounts or cashflow forecasts were prepared. Instead “the directors appear to have taken financial and management decisions on the basis of an impression of turnover and a general estimate as to the costs which were likely to be incurred.”
• The Company’s annual accounts were found to be materially inaccurate, recording as assets certain debts which were either not owed to the Company at all, or at best were entirely speculative, thereby making it impossible for the Company to declare a lawful dividend.

Breaches of duty under the Companies Act 2006 (CA 2006)

• The judgment demonstrates the close relationship between certain of the statutory duties arsing pursuant to CA 2006.
• The directors were in breach of their duty to promote the success of the Company pursuant to s.172. There was nothing to show that any of the directors had considered whether any of the transactions were likely to promote the success of the Company, or (from 2012, when the Company was insolvent or bordering on balance sheet insolvency) that they had any regard to the interests of creditors.
• The directors were also in breach of their duty under s.171(b) to act in accordance with the company’s constitution and only exercise powers for the purposes for which they are conferred. The proper purpose for which the power to deal with the Company’s assets is delegated to directors is to advance the Company’s business and commercial interests, which the transactions plainly did not do.
• Furthermore, the directors were in breach of their duty to exercise reasonable care, skill and diligence pursuant to s.174 in failing to take proper care of the Company’s assets, or consider whether the transactions were commercially justifiable or would benefit the Company.

Unlawful dividends

• Manolete’s claim for repayment of the dividends was made on several grounds against J, B and F: (i) as directors, for breach of duty under ss. 172 and 174, in causing or permitting the unlawful dividends to be made; (ii) as shareholders under s. 847 CA 2006, to recover the value of the dividends unlawfully made; and (iii) on the basis of the directors’ unconscionable receipt of the Company’s property.
• In this case, there was said to be “no recognisable attempt” to comply with the statutory process for declaration of dividends. Even if there had been, the directors knew (or ought to have known) that the Company’s accounts materially misstated the Company’s financial position, and that it was contrary to the best interests of the Company to declare or pay such dividends.

Burden of proof is on the directors

• As fiduciaries, directors are required to account for their dealings with trust property. Therefore, where a prima facie case is made out that a director has received company money or property, it is for that director to show that the transaction was proper. Where there are many transactions in question, it is for directors to justify each transaction.

Matthew Padian comments:

The conduct of the defendants in this case demonstrated an almost total disregard for good corporate governance. It is also another illustration of directors misunderstanding that English companies have separate legal personality, and that monies in company accounts should not be dipped into to fund the personal expenses of directors or their relatives unless, in very exceptional cases, directors can clearly point to how they have discharged their statutory duties in making those payments. Any well managed company will know that dividends should not be made without reference to properly drawn up accounts which establish profits available for distribution, and there appears to have been no effort made here to get anywhere close to that requirement. In many ways this case illustrates the advantages of having litigation funders such as Manolete Partners with the resources to pursue cases such as this, as it helps to ensure that director wrongdoing on this sort of scale does not go unchecked.