England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION

		Royal Courts of Justice Rolls Building, 7 Rolls Buildings Fetter Lane, London EC4A 1NL
		31/03/2017

Master Marsh:

1. On 9 March 2017 at the disposal hearing of this Part 8 claim I heard the Claimant's application for a declaration that the decision by the directors of the Claimant to issue 490,000 B shares having a nominal value of £1 each was taken in breach of their fiduciary duties, is voidable and should be set aside. I granted the declaration sought by the company. This judgment explains my reasons for so doing.
2. The Claimant was incorporated on 9 December 1974 as a private company limited by shares under the Companies Act 1948. At all material times prior to 29 April 2015 its directors were the First Defendant, Steve Sweeney, his late father Peter James Sweeney and the Fifth Defendant Bill Howlett.
3. Prior to 29 April 2015 the issued share capital of the Claimant was £10,000 divided into 10,000 ordinary shares of £1 each which were held as follows:

i. 6,600 by Peter Sweeney.

ii. 500 by Steve Sweeney.

iii. 1,000 by Peter Sweeney and three others as trustees of the Sweeney Family Discretionary Trust ("SFDT").

iv. 1,900 by the Fifth and Sixth Defendants as trustees of the William Howlett Discretionary Trust ("WHDT").

4. The Claimant is a successful business. I was not provided with the company's audited accounts for the relevant period but I was told by Ms Bryant QC, who appeared for the Claimant, that the capital value represented by the balance sheet (and disregarding any other method of valuation) produced a value in the region of £15m.
5. The material events took place in April 2015 but need to be placed in their context. Peter Sweeney and Bill Howlett were two of the three founders of the company. Prior to 2015 Peter Sweeney had gradually been stepping back from day to day involvement in the business but he remained interested in it and remained a director. For some time, there had been concern about the size of Peter Sweeney's loan account. The Claimant was indebted to him for a sum in the region of £600,000 and it was believed that upon his death that amount would become immediately repayable. This would cause considerable difficulty for the Claimant. Bill Howlett also had a loan account, for a lesser sum, but there was less concern about the repayment of his loan account because he was about 15 years younger than Peter Sweeney.
6. In December 2014 Peter Sweeney was diagnosed with cancer and in the spring of 2015 the family was told that his illness was terminal. That brought the question of repayment of Peter Sweeney's loan account into focus and also caused the family to think more generally about estate planning.
7. The Claimant's auditors were Kingston Smith LLP. The firm also supplied general financial advice to the Claimant and, during the period in question, around April 2015, the firm was providing specialist tax advice to the Claimant and advice concerning estate planning triggered by Peter Sweeney's terminal illness. The role played by Kingston Smith, and its relevance to the application, is a matter to which I will return later in this judgment.
8. On 29 April 2015, the directors of the Claimant passed a number of resolutions which had the effect, when implemented, of the Claimant issuing 490,000 B shares and allotting those shares to Peter Sweeney. The B shares were allotted to him to extinguish the Claimant's liability to him for his loan account which by then had reduced to £490,000. In short, the debt was swapped for shares. This is the resolution which the court has now set aside. Although it does not seem to have been appreciated at the time, rather obviously, the allotment of 490,000 £1 shares to Peter Sweeney fundamentally altered the balance of interests in the company between the shareholders and had the effect of transferring a very significant proportion of the Claimant's value to him. The interests of the other shareholders in the company were correspondingly significantly diluted.
9. It was only after Peter Sweeney's death on 28 July 2015, following a valuation of the B shares for the purposes of probate, that the Sweeney family and the other shareholders became aware of the effect of issuing the B shares. Not only had significant value been transferred from the ordinary shares to the B shares but it had also created a potential for tax charges for Peter Sweeny's estate both as to inheritance tax and capital gains tax. The sums involved are very significant and the outcome of the issue and allocation of the B shares has had, or has the potential to have, far reaching consequences.
10. All the shareholders in the Claimant have been joined as Defendants. In addition, HMRC has been joined as a Defendant because it has a potential interest in the relief granted by the court. All the Defendants have filed acknowledgments of service indicating that they do not intend to defend this claim.

In Re Hastings-Bass, deceased [1975] Ch 25 ("Hastings-Bass")

11. The Claimant relies upon the principle known as the rule in Hastings-Bass. Stated simply, the principle is that the decision of a fiduciary (Hastings-Bass was a case involving trustees) can be set aside if in making a decision they neglect to take into account matters which they ought to have taken into account, or if they take into account irrelevant matters. The principle is similar to that applicable to public bodies where it is known as the Wednesbury principle after Associated Provincial Picture Houses v Wednesbury Corporation [1948] 1 KB 223. The Hasting-Bass principle is applicable to all fiduciaries.
12. The law as it applies to directors of companies is conveniently summarised in the judgment of Mr John Randall QC sitting as a Deputy Judge of the High Court in Hunter v Senate Support Services Limited and others [2004] EWHC 1085 (Ch) [165] – [179]. It is not in doubt that the Hastings-Bass rule applies to the directors of companies.
13. The principles have been considered recently by the Supreme Court in Futter and another v HMRC and Pitt and another v HMRC [2013] UKSC 26. Futter involved the decision of trustees. Pitt involved a less common form of fiduciary, namely a receiver under the Mental Health Act 1983. In the course of his judgment in Futter and Pitt, Lord Walker accepted as a correct statement of the law the following summary provided by Lightman J in Abacus Trust Co (Isle of Man) v Barr [2003] Ch 409 at para. 23:

"What has to be established is that the trustee in making his decision has, in the language of Warner J in Mettoy Pension Trustees Limited v Evans [1990] 1 WLR 1587, 1625, failed to consider what he was under a duty to consider. If the trustee has in accordance with his duty identified the relevant consideration and used all proper care and diligence in obtaining the relevant information and advice relating to those considerations, the trustee can be in no breach of duty and its decision cannot be impugned merely because in fact that information turns out to be partial or incorrect."

14. In Futter the issue considered by the trustees principally concerned a liability to capital gains tax. They sought advice which proved to be wrong because an amendment to the relevant legislation had been overlooked. Thus, they considered the correct point but acted on incorrect advice.
15. In Pitt, Mrs Pitt took professional advice from solicitors and specialist consultants about the creation of a Special Needs Trust ("the SNT") but unfortunately the advice she received concerning the provisions of the SNT proved to be incorrect.
16. In both cases reliance upon the Hastings-Bass rule was unsuccessful. The trustees, in Futter, and Mrs Pitt as receiver in Pitt, had fulfilled their fiduciary duties. They had entirely properly sought advice and relied upon it. There was therefore no failure in the exercise of their fiduciary duties.
17. At paragraphs 91 and 92 of his judgment Lord Walker considered whether it had to be shown that fiduciaries would not have taken the decision they did had they taken into account the right matters, or might not have taken that decision had they taken into account the right matters. His conclusion was that it was unnecessary to lay down a rigid rule about which was correct because to do so would inhibit the court in seeking best practical solution in the application of the Hastings-Bass rule in a variety of different situations. The Supreme Court did determine, however, that Lloyd LJ in the Court of Appeal was right in holding that;

"…if an exercise by trustees of a discretionary power is within the terms of the power, but the trustees have in some way breached their duties in respect of that exercise, then (unless it is a case of a fraud on the power) the trustees act is not void but may be voidable at the instance of a beneficiary who was adversely affected."

The facts

18. The principal evidence is provided in a detailed written statement from Steve Sweeney. His evidence is supported by a witness statement from Bill Howlett and from Ray Colbert who was the financial controller of the Claimant at the relevant time. In addition, the court has been provided with three witness statements from partners at Kingston Smith. Karen Wardell at the time was the audit manager for the Claimant and has more recently become the relationship manager. Mike Hayes was a specialist tax adviser his role was principally to assist the Sweeney family with estate planning including the transfer of assets to the Sweeney Family Trust. Brian Pope was at the time the relationship partner but he was due to leave Kingston Smith at the end of April 2015 and, therefore, his involvement was relatively limited.
19. It is unnecessary to summarise by reference to each witness statement the evidence which has been prepared, helpfully, in painstaking detail. The immediate context in which the relevant events occurred was that:

i. Peter Sweeney was terminally ill;

ii. There was concern about the Claimant's ability to immediately repay Peter Sweeney's loan account on his death; at the material time, the loan was £490,000 and not £600,000;

iii. The directors of the Claimant believed it was essential for action to be taken before the end of 2015. Steps were therefore taken in some haste.

20. It is not clear whether the idea of exchanging the loan account shares came from Ray Colbert or Brian Pope, or whether the idea of having B shares came from them or possibly from Steve Sweeney. In any event, it is common ground between all concerned that the issue was discussed first at an audit clearance meeting on 2 April 2015. In an email sent on 9 April 2015 by Steve Sweeney to Brian Pope, he questioned whether it made sense to issue the Class B loan shares for the £600,000 of loan. In the course of his email he makes reference to the overall tax planning position being considered by Mike Hayes. The tax implications of the arrangement were then referred to Mike Hayes. In an email dated 21 April 2015 Karen Wardell commented:

"Brian [Pope] and I have discussed the transaction, of converting the £490k debt to equity and can see no issues, apart from the usual company secretary procedures…".

21. Mike Hayes discussed the position with Steve Sweeney but no concerns were raised. As the email exchanges progressed, the notion of 490,000 B shares being issued at a nominal value of £1 emerged as the orthodoxy and was not challenged. Consideration was given to other issues such as voting rights and dividends but as Mr Howlett states in his witness statement he:

"… did not consider the issuing Group B shares would have any bearing on the existing ordinary shares. From my perspective, the B shares were to be issued solely for the purpose that the company was not liable to pay the total of the directors' loan account in one lump sum immediately in the event of Peter Sweeney's death."

22. Steve Sweeney confirms that it was never his intention, nor he believes the intention of his father, that the creation and issue of the B shares would dilute the ordinary shares or create a transfer of value from the holders of the ordinary shares to the holders of the B shares. He says he would not have approved the proposal had he known that this would be the effect nor would he have signed the resolution to approve the issue of B shares on this basis.
23. The evidence on this issue is compelling. It is plain the directors did not understand the effect of the transaction they approved by passing the resolution and, had they understood it, they would not have passed it. The transaction was essentially a defensive one. Its sole purpose was to accommodate what was perceived to be a problem (perhaps incorrectly) that Peter Sweeney's loan account would become immediately repayable on his death. It was not a transaction that was essential for the Claimant and its shareholders to undertake and it was carried through in something of a rush.
24. During the course of the hearing, it was of concern to me to establish whether it might be said the directors, instead of failing in their fiduciary duties, had fulfilled them by seeking appropriate advice from Kingston Smith. The involvement of Kingston Smith, of itself, does not negate those breaches of duty. That will only happen if the directors used all proper care and diligence in obtaining advice about the consequences of the transaction. The extent of the care and diligence in obtaining advice will, however, vary depending upon the circumstances.
25. There is no doubt that a good deal of consideration was given to the transaction by the three partners from Kingston Smith to whom I have made reference (particularly Karen Wardell and Mike Hayes). Indeed, Karen Wardell said she could see no issues with the transaction. In the context of other proceedings, it might have been relevant to examine the precise scope of Kingston Hill's retainer and its duties to the Claimant. But it is not for the court in the context of this claim to make any observations about the failure to spot the flaw in the proposal to pass a resolution to issue 490,000 B shares with a nominal value of £1 each. To my mind, the essential question is whether the directors of the Claimant did enough to fulfil their fiduciary duties by instructing Kingston Smith in the manner described in the evidence, or was more required of them?
26. There may be circumstances in which, for example, the sole director of a small company, who is lacking in experience and sophistication, might fulfil his fiduciary duties merely by the involvement of an expert from whom full guidance could be expected, much as Mrs Pitt did. Here, however, the Claimant is a substantial trading concern and the board of directors possessed a considerable degree of experience and sophistication. The idea of swapping debt for equity was not of itself flawed. There was no failure on the part of the directors to fulfil their fiduciary duties in deciding, in principle, that the director's loan should be swapped for equity. Where things went wrong was the directors' decision to issue shares with a nominal value of £490,000 where the existing share capital had a nominal value of only £10,000.
27. Futter and Pitt are examples of fiduciaries identifying the relevant issue and seeking advice about it. (This is less obvious in Pitt because Mrs Pitt could not be expected to have any knowledge at all about a Special Needs Trust. However, she identified that an SNT was needed and thereafter she was in the hands of her advisors). But it is not the mere involvement of professional advisors that is sufficient to prevent reliance upon the Hastings-Bass principle. In this case, even if, which is not alleged in the evidence, the directors were entitled to advice from Kingston Smith as to the way in which the transaction was to operate, in a real sense the decision to issue the B shares was that of the directors. The seeking of professional advice by the directors, which was mainly focused on the overall family tax planning, does not lead to similar consequences to those in Futter and Pitt. Some attempt to obtain advice was made but to my mind it cannot be said the directors used all proper care and diligence in the manner in which Kingston Smith was involved.
28. It is not entirely obvious where the boundary will lie where professional advisers are involved but (arguably) fail to spot a point arising from the structure of the transaction. I am satisfied, however, on the facts of this case that there was a breach of their fiduciary duties by the directors who did not intend the transaction to dilute the value of other shares and transfer a significant proportion of the value the Claimant to Peter Sweeney. The directors did not fulfil their fiduciary duties because, principally, they failed to take into account relevant considerations such as the massive dilution of the value of the ordinary shares and the potentially very serious tax consequences for the shareholders that would flow from the transaction. These were matters within their remit and they could reasonably have been expected to have spotted to obvious mismatch between the value of the existing share capital and the new shares.