Scottish Court of Session Decisions

In 1885 the directors of the State Steamship Company, Limited, for the accommodation of the company, discounted with the Clydesdale Bank a bill for £20,000 accepted by the company in their favour. This bill was renewed repeatedly by the bank, who were secured by mortgages over the company's steamers, until February 1889, when Mr James Reid Stewart, one of the directors, agreed himself to discount the bill at a lower rate than that charged by the bank. The bill was accordingly endorsed to Mr Stewart, and discounted by him. It was subsequently renewed on several occasions, the last renewal being on 3rd February 1891. The directors took no security for the bill from the company, believing that the mortgages over the steamers held by the bank continued good to them. Accordingly prior to and on 12th February 1891 the bill was unsecured.

On that date the directors (as the minute of meeting showed) resolved “to carry on the company's business as at present, pending a meeting of the shareholders and the adjustment of a scheme to be submitted to them, the necessary funds being obtained from the Clydesdale Bank on the guarantee of the directors, the directors to be secured by a bond of relief by the company, and the transfer of or a mortgage upon the reversion of the steamers.” At the time the company were already indebted to the bank for various advances secured by mortgages on the steamers and by the personal guarantee of the directors.

A new account was accordingly opened with the bank upon the guarantee of the directors, who received as security bills of sale of the reversion of the steamers belonging to the company which had been previously mortgaged to the bank, dated and registered 17th February 1891.

Upon 4th March 1891 the company resolved to go into voluntary liquidation, and Mr Alexander Moore, C.A., Glasgow, was appointed liquidator, with a committee of advice composed of Mr Reid Stewart, two of the other directors, and three shareholders.

In April 1891 the steamers which had been mortgaged to the bank were sold for £65,500, out of which the bank received payment of their whole advances, and discharged their mortgages upon the vessels. After payment of the debt due to the bank and other preferable charges there remained a surplus of about £11,300. The directors maintained that they had a valid security over this surplus for the debt of £20,000 still due to them.

Upon 19th March 1892 the liquidation was continued under the supervision of the Court, and upon 24th March 1892 the liquidator presented a note to Lord Stormonth Darling, the Lord Ordinary, to whom the liquidation had been remitted, for approval of a compromise which he had provisionally made with the directors. He reported that they claimed to be secured creditors to the extent of £11,300; that he declined to accede to their views, on the ground (1) that the security of 17th February 1891 having been granted within sixty days of the commencement of the liquidation was invalid except in so far as it covered moneys advanced after

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that date, and (2) because they had exceeded their power to pledge the property of the company; that the directors, on the other hand, maintained (1) that, the assets of the company having been sold before this question arose, the company could not be made notour bankrupt, and (2) that the limitation of their borrowing powers did not apply; that it appeared to be doubtful whether the company could be made notour bankrupt, but that, assuming the validity of the security, if his second contention were sound, the directors could only claim to be secured to the extent of £8118. The report did not contain any reference to the terms of the directors' resolution of 12th February 1891, or to the 164th section of the Companies Act 1862. The liquidator asked to be allowed to compromise the question by treating the directors as secured to the extent of £10,000, and as being entitled to an ordinary ranking for the balance of their claim. This compromise was sanctioned by interlocutor dated 25th March 1892. The directors did not appear in the proceedings under the note.

In December 1893 Messrs David and William Henderson & Company, shipbuilders, Partick, creditors of the company, brought an action of reduction against Mr James Reid Stewart and others, lately directors of said company, and against Mr Moore, the liquidator. By this action the pursuers sought to have the bills of sale of the steamers in favour of the directors and the interlocutor of 25th March 1892 sustaining the compromise reduced, and to have it declared that the directors were not secured creditors to any extent.

They narrated the circumstances set forth above, and stated that the bills of sale had been executed on 17th February 1891 solely to secure the directors for any subsequent advances they might make, and not to secure the then outstanding debt to them of £20,000. They averred that the sanction of the Court to the said compromise was obtained upon an insufficient statement of facts, and upon a suppression of material facts, which if fully disclosed would have led the Court to refuse its sanction. The securities in question were not only given in point of fact for the £20,000 bill, but were liable to be set aside as fraudulent preferences both at common law and under section 164 of the Companies Act 1862, which cuts down fraudulent preferences, and provides that “a resolution of winding-up the company shall in the case of a voluntary winding-up be deemed to correspond with the act of bankruptcy in the case of an individual trader.” The only question between the liquidator and the directors was, whether the latter were entitled to hold the bills of sale from a hopelessly insolvent company under their management, and which was about to be wound up, as a valid security for the amount due to them on the £20,000 bill. But neither that question nor the essential facts bearing upon it (including the facts disclosed by the directors' minutes) were put before the Court in the said report.

The pursuers pleaded—“(1) The said compromise having been sanctioned, and the interlocutor sought to be reduced having been pronounced under essential error due to the suppression by the defenders, or one or other of them, of material facts as condescended on, decree of reduction ought to be pronounced as craved. (5) In respect that the said directors had not, at the date when the compromise was sanctioned, and never had any right to a preferential ranking, decree ought to be pronounced in terms of the conclusions of the summons with expenses.”

The directors pleaded, inter alia—“(1) The pursuers' averments are irrelevant. (2) The liquidator having issued a deliverance ranking the defenders as preferable creditors for £10,000, and said deliverance not having been appealed against, is now final. (4) No material facts having been suppressed or concealed from the Lord Ordinary when the compromise in question was sanctioned, the interlocutor of the Lord Ordinary sanctioning said compromise cannot now be reduced. (5) Separatirn — No material facts having been suppressed or concealed by the defenders, and the compromise in question having been, after full consideration, entered into by the liquidator, with the advice and consent of the shareholders' committee, and subsequently approved of and sanctioned by the Lord Ordinary, said compromise cannot now be reduced. (6) The compromise in question being a fair and reasonable one, and having been acted upon as stated, it cannot now be set aside. (7) The defenders having, at the date of the compromise in question, held valid securities over the property of the company, as above set forth, they were entitled to a preferential ranking for the whole sums for which they were creditors of the company.”

The liquidator pleaded, inter alia—“(3) The compromise referred to being lawful and effected in bona fide, this defender should be assoilzied.”

Upon 18th July 1894 the Lord Ordinary ( Stormonth Darling) pronounced the following interlocutor:—“Finds that the defender James Reid Stewart and the other directors of the State Steamship Company, Limited, in whose favour and for whose behoof the bills of sale and endorsements or assignations sought to be reduced were granted, did not under these bills of sale and indorsements or assignations acquire or hold any security for the amount contained in the bill [for £20,000 mentioned on record, and are not entitled to a preferential ranking for any portion of said sum of £20,000 in the liquidation of said company: Allows the defender Alexander Moore to satisfy the production as regards the interlocutor or decree eighth called for in the summons, and this having been done at the bar, holds the production satisfied so far as regards said interlocutor or decree, holds the record already closed as the record on the merits, and reduces said interlocutor or decree, and to that extent and effect decerns and declares in terms of the conclusions of the summons,” &c.

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“ Opinion.—When a company is involuntary liquidation, a compromise with creditors requires the sanction of an extraordinary resolution of the company, but where the liquidation is under the supervision (as in the case of an official liquidation) a compromise can only be made with the sanction of the Court. The Court is thus a necessary party to the arrangement, and it is settled by the case of Clarke v. Hinde, Milne, & Company, 12 R. 347, that if the sanction of the Court has been granted in ignorance of material facts the compromise cannot stand. I should myself be disposed to add to that statement of the law, that the same results ought to follow where, without any actual mistatement or suppression of facts, the question which is the subject of compromise, has not been fairly or fully stated to the Court.

This action is brought by certain creditors in the liquidation of the State Steamship Company, Limited, against the directors and liquidator of the company, and it seeks to reduce a compromise between the directors and the liquidator, which I sanctioned as Lord Ordinary officiating on the Bills, by interlocutor dated 25th March 1892, six days after the supervision order had been pronounced.

The circumstances which led to the compromise were these. Prior to 12th February 1891 the company was due to the directors £20,000, being the amount of a bill (the last of a series) accepted by the company to all the directors, and by them endorsed to the defender Mr Reid Stewart, one of their number. The earlier bills had been discounted by the company's bankers under a cash-credit, which was secured by mortgages over the company's steamers, but the later bills were discounted by Mr Stewart personally, and notwithstanding a somewhat halting allegation in Ans. 3 and 4 for the liquidator, and Stat. 4 for the directors, it cannot be seriously maintained that in Mr Stewart's hands the bills were covered by the security held by the bank. The debt of £20,000 was therefore an unsecured debt as at 12th February 1891. On that date the directors had before them an unfavourable report by a firm of accountants on the financial position of the company, and they considered what steps should be taken in view of possible liquidation. They were of opinion that it was desirable to carry on the company's business pending a meeting of shareholders, and as this could only be done by raising money, it was resolved to obtain the necessary funds from the bank on the guarantee of the directors, who were to be secured by a bond of relief by the company, and the transfer of, or a mortgage upon, the reversion of the steamers. In pursuance of this arrangement hills of sale in favour of the directors of the six vessels belonging to the company were laid before the next meeting on 17th February, and the security was ultimately completed by indorsation of the policies of insurance on the vessels. On 24th February the directors issued a circular to the shareholders in which they stated that, unless a sum of from £80,000 to £90,000 of additional capital could be raised, there was no alternative hut liquidation; and at a meeting of shareholders held on 4th March it was resolved that the company should be wound up voluntarily, and Mr Moore was appointed liquidator.

In April 1891 the liquidator, with the consent of the bank and the directors, sold the steamers of the company to Messrs Allan of the Allan Line for £70,000, out of which the bank received payment of their whole advances, and discharged their mortgages upon the vessels. The directors were thus relieved of the responsibility which they had incurred to the bank on 12th February, and the only claim remaining to them was the old debt of £20,000 to which I have referred.

Now, when the liquidator came to deal with this claim there were two, and I think only two, questions with regard to it, viz., (first) whether in point of fact the bills of sale were granted for anything but an immediate advance of money; and (second) if they were, whether the security was not an undue or fraudulent preference within the meaning of section 164 of the Companies Act of 1862. The liquidator had some negotiations with the directors, and on 30th March 1891 obtained from them a letter, under which they agreed that in any question with them the Companies Act 1886 should be held to apply, and that their securities should be dealt with as if the liquidation was being carried on under the supervision of the Court, and as if a supervision order had been pronounced on the date of the letter. So far the liquidator was proceeding on right lines. When, a year later, the actual supervision order was pronounced, and he applied to the Court for sanction of the compromise which he had provisonally made with the directors, he had either lost sight of the real question's at issue, or he contrived most effectually to obscure them in the written report which he presented along with his application.

On the first of the questions which I have mentioned the report is altogether silent. It contains no reference to the minutes of the directors, and it does not call attention to the fact that as shown thereby the bills of sale were granted simply and solely to secure the directors against their guarantee to the bank. It is now said that, even though that were the case, they were entitled to retain the security until the prior debt was paid. I do not think they were. The case of Hamilton v. Western Bank, 19 D. 152, cited by the defenders, is no authority for that proposition, because the bank were there held entitled to retain their security not for prior, but for subsequent advances, which were held to have been made on the faith of the security. It would be a strange result if directors, being unsecured creditors for a past debt, could obtain security for it without any stipulation to that effect, and simply by the expedient of undertaking a fresh liability, and obtaining a security in respect of that. Neither does the analogy of pledge to which the defenders appealed afford any support to their contention, for the subject of the

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pledge must undoubtedly be restored when the debt for which it was granted has been paid. The bills of sale are no doubt absolute in their terms, but their effect is controlled by the acknowledgment of the directors in their own minutes that they were granted for a particular purpose. It seems to me therefore that the omission to disclose the terms of the minutes was in itself a fatal flaw in the liquidator's report.

On the second question, the report is also, I think, most misleading. It makes no reference to the 104th section of the Companies Act, and it expends a great deal of misplaced ingenuity in arguing a question about the limit imposed by the articles of association on the directors' power to pledge the property of the company. It deals with the figures in such a way as to suggest that the true question was between the directors' view on the one hand, that they were secured to the extent of £11,300, and unsecured to the extent of £8700, and the liquidator's view, on the other, that they were secured to the extent of £8118, and unsecured to the extent of £11,882. If that had been the true question, a compromise by which they were to be held as secured to the extent of £10,000, and unsecured to the extent of £10,000 might have been fair enough. There is also a great deal in the report about the difficulty of making the company notour bankrupt, but no point is made of the fact that the bills of sale (if capable of being held as a security for the prior debt) were granted in contemplation of a winding-up, and within sixty days of a resolution to wind up. Now, the resolution to wind up in the case of a voluntary liquidation is by the 164th section made equivalent to the bankruptcy of an individual trader, and if an individual trader had granted such a security as this (assuming it to apply to the prior debt) within sixty days of his sequestration undoubtedly it would have been illegal.

I have come to the conclusion therefore that the compromise and my own interlocutor approving of it ought to be rescinded. It might have been impossible to do so if matters had not been entire, but just as in Clark's case the assets are still undivided, and rescission will not in any way prejudice the right of the directors to an ordinary ranking. I say that neither the facts nor the arguments were fully before me when I sanctioned the compromise, and that if they had been I would have refused to sanction it. I regret now that I did not order intimation of the liquidator's note to the creditors, or convene a meeting of creditors for consideration of the compromise. But I do not see that except in that way I could have acted otherwise than I did on the materials before me. I demur altogether to the notion that it is the duty of a judge in a liquidation to act as a detective. He has not the means of making independent investigations, and he must of necessity rely not only on the accuracy and sufficiency of the statements put before him by the liquidator, but on the exercise of the liquidator's discretion being probably sound. In the vast majority of cases the compromise proposed is the expedient course, and of the many proposals for compromise which have come before me within the last four years I do not remember more than one in which I refused my sanction. As it happens, the case occurred in this very liquidation, but I refused my sanction not on the ground that the claim was necessarily bad, but that in the circumstances the claimants ought to be put to prove it.

If the parties had not joined issue on the question whether the security was good it might have been proper to deal only with the interlocutor sanctioning the compromise, leaving it open to the directors still to make out their claim to a preference for the whole £20,000 if they could. But the question of their right to a preference has been fully argued with all the parties in the field, and therefore I think the best course is to decide not merely that the sanction of the Court was obtained without full disclosure of the facts and arguments, but that the directors are not entitled to more than an ordinary ranking.

The debate was conducted by the parties (and I took the case to avizandum) on the footing that it was ripe for judgment on the merits. It now appears that when the debate took place production had not been satisfied, but both parties were anxious to get over this formal difficulty, and accordingly they suggested a form of interlocutor to which I have given effect.”

The directors reclaimed, and argued—(1) The action was irrelevant. It was not said from the beginning to the end of the record that the directors had done anything they should not have done, or had abstained from doing anything they should have done. The whole case was based upon the alleged fault of the liquidator in omitting to state all the circumstances he might have set forth, and in failing to bring forward certain pleas-in-law. That was no reason for setting aside the compromise with the directors. To do that it was necessary to show fraud on their part in bringing about or obtaining the sanction of the Court. They and the liquidator were at arm's length in arranging for a settlement. They were not entitled to know what passed between the liquidator and the Court. If they were to know the weakness of the liquidator's position they might object to the compromise. By compromising they took their chance, and such a compromise was protected. The rights of the other creditors were protected by the liquidator—See Buckley's notes on section 159 of the Companies Act 1862, and the English cases of re Home Counties Life Assurance Association, ex parte Garstin, 1862, 6 L.T. 374; re Leeds Banking Company ex parte Clarke, 1866, 14 L.T. 789; in re Central Darjeeling Tea Company, Weekly Notes, 1866, p. 361. The only Scotch case where a compromise sanctioned by the Court had been set aside was Clark, &c. v. Hinde, Milne, & Company, Dec. 17, 1884, 12 R. 347, but in that case there had been active interference on the part of the creditor. (2) Assuming the action not to be irrelevant, and that the

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Court might interfere, enough had been put before the Court when the sanction was asked to make such a course unwarranted. It was not suggested that the directors held securities other than the bills of sale. The sole question was as to their rights under them. They claimed to be secured thereby with respect to their debt of £20,000, the liquidator saw several legal difficulties which he could not solve without the expense of litigation, so he compromised the case. One legal difficulty was as to making a company notour bankrupt so as to cut down preferences. That difficulty he had stated to the Court. His failure to state other difficulties would not invalidate the compromise, the great object of which was to avoid all such difficulties. It was argued on the other side that it was certain the directors held no security for prior claims. But the title to the bills of sale was ex facie absolute, and therefore a complete security, which the creditors were only bound to reconvey after all their claims of whatever date had been satisfied— Robertson v. Duff, 1840, 2 D. 279; Hamilton v. Western Bank, 1856, 19 D. 152; National Bank v. Forbes, 1858, 21 D. 79. The Court was not bound to institute further inquiries. Its function was to enable the liquidator to carry out compromises upon being satisfied that the liquidator had fairly and fully considered the matter. The application of the 164th section of the Act of 1862 was not free from difficulty— National Bank v. Macqueen, July 13, 1881, 18 S.L.R. 683; Benhar Coal Company v. Turnbull, February 6, 1883, 10 R. 558.

Argued for the liquidator—He had endeavoured to give the Court all the information then in his knowledge.

Argued for the respondents—The Lord Ordinary's judgment was right. He explained how he had been misled, and in face of that explanation it was impossible the sanction given under misapprehension could stand. His duty was not merely to confirm the liquidator's opinion; he had to exercise a judicial function after being informed of all the facts— Northumberland and Durham District Banking Company, 1860, 1 Drewry & Small, 273. The liquidator had failed to set forth material facts, particularly the terms of the resolution of 12th February 1891; that was sufficient to set aside the compromise. It was not necessary to show essential error or fraud. The minute of 12th February 1891 showed that the security to be given was for particular advances thereafter to be made. The transaction was also bad under section 164 of the Companies Act— Gaslight Improvement Company v. Terrell, 1870, L.R., 10 Eq. 168. “Act of bankruptcy” as applied to Scotland plainly meant the same as notour bankruptcy.

At advising—