Insolvency litigation briefing - June 2014

30 June 2014

Our dedicated insolvency litigation team bring you their monthly update on the latest cases and issues affecting the insolvency and fraud investigation industry.

This month Alex Jay, Kanika Kitchlu-Connolly and Ian Weatherall look at:

1. Insolvent company brings claim for breach of fiduciary duties and dishonest assistance

A company in liquidation brought claims against its former sole director and shareholder for breach of fiduciary duties owed to it and for breach of s175 of the Companies Act 2006 (duty to avoid conflicts of interest).

The director had misapplied the company's money by entering into deals with third parties to purchase seats on airlines for the company's customers. Large sums of money were paid by the third parties to the director, not the company, enabling him to make a personal profit.

Claims against those third parties, who were joined as defendants to the proceedings in Goldtrail Travel Ltd (in liquidation) v Abdulkadir Aydin, Black Pearl Investments Ltd, Onur Air Tasimaclik AS and others were brought for dishonest assistance, both in relation to the misapplication of the company's money and the breaches of the director's duties.

The defendants applied to strike out the claim against them on the basis that the director's fraud was attributable to the company, of which he was the controlling mind and beneficial owner, and the company couldn't therefore be the victim of the fraud and, as such, couldn't bring the claim.

The High Court held that the company could bring such a claim and that the director was in breach of his duties. Once the company went into liquidation, the director could not approve the misapplication of the company's funds in his capacity of sole shareholder, as the director no longer owed duties just to the company but also to its creditors.

The High Court agreed that claims could also be pursued for dishonest assistance. Where a company seeks compensation for breach of fiduciary duty owed to it by a director, the company is the victim of the wrong and the director cannot defeat the claim by attributing his wrongful conduct to the company. That is different to the position where the wrong has been committed to an innocent third party. In that situation, the fraud of a director would be attributed to the company of which he was the sole director and beneficial owner. There was no innocent third party here.

Goldtrail could claim against both the director and the second and third defendants. The court held there was sufficient evidence that they had assisted the director in his breaches of fiduciary duty and had known that the transactions were thoroughly dishonest.

Things to consider

This case shows the willingness of the courts to make findings of dishonest assistance in appropriate circumstances so it is always worth considering whether there is the evidence present to bring such a claim. This also highlights the court's support of officeholders pursuing claims where directors have caused companies to engage in improper conduct - a point that is particularly prevalent in carousel or MTIC fraud cases among others.

2. Quantifying damages recoverable pursuant to a cross-undertaking in damages

When an interim injunction (freezing or search order) is sought from the court, the applicant is almost always required to give a cross-undertaking in damages. The undertaking is to compensate the defendant for losses suffered should it subsequently be determined by the court that the injunction should not have been granted.

The Court of Appeal has restated the legal position on recoverability of losses suffered pursuant to the cross-undertaking in Hone and others v Abbey Forwarding Ltd (in liquidation) and Revenue & Customs Commissioners.

For a loss to be recoverable, the starting point is that the court will usually apply the rules on remoteness as derived from the law of contract. The applicant will be responsible for reasonably foreseen loss of the type actually suffered by the defendant. It does not have to have foreseen the particular loss within that type. If an applicant has knowledge of special circumstances giving rise to a potential type of loss, or actual knowledge of a particular loss, that loss would also be recoverable. What amounts to such knowledge will be fact-sensitive.

However, the court also held that logical and sensible adjustments might be needed as the court was not in fact awarding damages for breach of contract but compensating the defendant for loss which should be compensated.

In Hone, the liquidator had successfully applied for a worldwide freezing injunction against the company's directors on the basis they had breached their duties to the company in permitting it to become subject to an assessment for evasion of excise duty. When the injunction was discharged, the defendants sought general and aggravated damages and compensation for loss of potential profits from business opportunities.

The Court of Appeal found that:

  • the injunction had not been the effective cause of some of the lost opportunities (so no compensation was payable) but that the liquidator had clear notice of others for which compensation should be awarded.
  • the trial judge was over-restrictive in his approach to compensation for the effect the order had on the directors i.e. for distress and anxiety - even though such damages are not usually recoverable in breach of contract claims.
  • realistic compensation for the wrongful restrictions on the directors' way of life and the reflection on their credit should have attracted compensation, as should the aggressive approach the liquidators' solicitors had taken to the enforcement of the injunction.

The damages payable to the directors would be increased.

Things to consider

The rules on remoteness ensure that a defendant wrongly injuncted is compensated for losses that it should not have suffered but also that the applicant is not saddled with losses that it was not in a position to know about and that no reasonable applicant would have foreseen.

When considering a freezing injunction and the associated cross-undertaking in damages that will need to be given, you should always have in mind what type of loss could be caused to the defendant and whether there are any special circumstances which could give rise to a loss which would not otherwise be reasonably foreseeable.

3. Jurisdiction to determine beneficial ownership

Freezing and receivership orders were obtained by the claimant against Ablyazov in the long running litigation in JSC BTA Bank v Ablyazov and 16 others (defendants) and Lapointec Ventures Ltd, Limia Holidings Ltd and Dregon Land Ltd (Third Parties).

Those orders were subsequently amended to include shares in Dregon Land Ltd (D) that the claimant believed Ablyazov owned but had failed to disclose. The third parties claimed beneficial ownership of those shares and applied to remove D from the scope of the order on the basis it was not under the ownership or control of Ablyazov or any of the defendants.

The judge dismissed the application, holding there should be a trial of the issue of ownership. He considered there was a good arguable case that Ablyazov and another Russian businessman had entered into a sham agreement whereby Ablyazov's interest appeared to have been extinguished by the enforcement of a pledge but where he did actually retain beneficial ownership.

Issues before the Court of Appeal included whether there was a good arguable case to suspect Ablyazov retained beneficial ownership and whether the court had jurisdiction to determine the point.

The Court of Appeal considered there was sufficient evidence before the court to establish that there was a good arguable case on beneficial ownership which needed to be tried. The Court of Appeal also confirmed that the court had jurisdiction to hear that trial.

When the orders were amended to include reference to D, Ablyazov was still, arguably, the beneficial owner of those shares. Ablyazov was within the jurisdiction of the court when the orders against him had been made. He could legitimately be restrained from disposing of companies of which he was the beneficial owner, whether or not those companies were within the court's jurisdiction and whether or not they were party to the proceedings.

Things to consider

The Ablyazov litigation has led to a string of cases on the issue of freezing injunctions. It is clear that one option open to an applicant looking to prevent the disposition of assets by companies which may be owned and controlled by the respondent would be to seek to bring such companies within the ambit of the freezing order on the basis that the companies are, at the very least, beneficially owned by the respondent.

In this case, the claimant will still have to prove, at trial, that, on the balance of probabilities, the transaction was a sham and that beneficial ownership of the shares still rests with Ablyazov but at least in the meantime, they are caught by the orders and Ablyazov should not attempt any further dealings with them.

4. Refusing to mediate? A brave decision...

Although the courts can strongly encourage parties to litigation to engage in alternative dispute resolution (ADR), including mediation, it is not compulsory. A long line of cases confirm that the courts can, and do, impose serious cost consequences upon a party for unreasonably refusing to engage in ADR.

Even if a party considers it has reasonable grounds for refusing to mediate, following the High Court decision in Phillip Garritt-Critchley & Others v Andrew Ronnan & Solarpower PV Limited, it will be a brave decision to refuse to so engage.

In Garritt-Critchley, the court held that considering the parties to be "too far apart"; believing the claim or defence was watertight; viewing ADR as having no realistic prospects of success and that the acrimonious relationship between the parties would prevent settlement were not reasonable justifications for refusing to mediate. It considered all such issues could be dealt with by a skilful mediator trained to deal with such situations. In this case, the defendant's refusal to mediate for such reasons lead to the court awarding the successful claimant its costs on an indemnity basis.

For a fuller analysis of this case see Refusing to mediate? A brave decision...

Things to consider

It is clear that it should always be at the forefront of parties' minds to consider alternatives to full blown litigation at various stages of the proceedings. This has always been the case and continues to be so. Indeed, the cost consequences of not engaging in some form of ADR could be significant and the court will take a hardline view as to what is a reasonable refusal to consider ADR.


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