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Farrer & Co | Thinly veiled: directors held personally liable for inducing company’s breach of contract

While this case was unusual in many ways, it should nonetheless serve as a significant warning to those doing business via undercapitalised companies and hoping to rely for protection on the company’s limited liability and separate legal personality. In this briefing, Jolyon Connell reviews the important decision in Palmer Birch (A Partnership) v Lloyd [2018] and discusses its implications for directors and for those seeking to hold to account those behind a company who are suspected of wrongdoing.

Background

The claimant building contractors (Palmer) entered into a contract with a company, called HHL, which owned the leasehold in an English residential property (the property). The sole shareholder and sole director of HHL was Christopher Lloyd (Christopher). The property was the English residence of Michael Lloyd (Michael) – Christopher’s brother – and the freehold of the Property belonged to another company, called SHL, which was owned beneficially by Michael. HHL carried on no trading activities and had no income or assets (besides the leasehold interest in the property which was so heavily encumbered by SHL as to be worthless); HHL was effectively a shell company established for tax reasons, including the ability to reclaim VAT on the building works and to ensure that the activities related to the property were one step removed from Michael (so as to maintain his non-UK-domiciled residence status for tax reasons). HHL was financed entirely by Michael using his personal money and third party lending he had secured.

Palmer was retained by HHL to carry out extensive renovation works to the property. During the course of those works, Michael and Palmer fell out. This led (among other things) to HHL failing to pay certain of Palmer’s invoices and HHL then going into liquidation. HHL was replaced by a new corporate vehicle associated with Michael which completed the renovation of the property using a different building contractor. Palmer had been replaced by a third party and was left with very substantial unpaid invoices for its work, but only a shell company in liquidation against which to claim.

Instead, Palmer sued Michael and Christopher for its losses alleging (among other things) that: (1) Michael had induced HHL to breach its contract with Palmer; and (2) Christopher and Michael had conspired unlawfully to put HHL into liquidation to avoid paying HHL’s debt due to Palmer while allowing SHL (as the owner of the freehold of the newly renovated property) to benefit from Palmer’s work without paying for those services. Among other defences put forward: Michael argued that he was not a director of HHL so ought not to be liable for its actions; and Christopher argued that any liability for HHL’s actions should rest with HHL, rather than him personally as its director.

Judgment

The High Court reiterated that the starting point is the long-standing principle of company law that an English company has separate corporate personality and its own limited liability. However, the Court made it clear that there are (very limited) circumstances in which factors of inducement or unlawfulness allow the Court to pierce that corporate veil and look beyond the company’s separate legal personality in finding those behind the company liable for losses caused by the company’s acts. In this case, the circumstances were met in the following ways:

  • Michael and Christopher were held to have reached an  agreement to bring about the liquidation of HHL so that it might escape its obligations to Palmer under the contract. The Judge concluded that this agreement, and the actions pursuant to it, meant that Michael and Christopher had colluded together in an unlawful conspiracy to bring about a breach by HHL of its obligations towards Palmer. Michael and Christopher were therefore held liable for Palmer’s damages flowing from that unlawful conspiracy.
  • Michael was held by the judge to have taken the decision to remove Palmer from the project, and then to continue with an alternative contractor instructed by an alternative corporate vehicle, in the knowledge that SHL (beneficially owned by him) would benefit from the works carried out on the property but that HHL would be unable to pay Palmer for those works. Separately he diverted any further funding away from HHL which caused its insolvency. Taken together, this had the effect of Michael inducing HHL to breach its contractual obligations towards Palmer. Michael was therefore held liable for Palmer’s damages flowing from that conduct. 
  • Despite being neither a director nor shareholder of HHL, Michael had been involved in drawing up HHL’s business plan, procuring funding for the company, appointing Palmer as the contractor, liaising with HHL’s solicitors, replacing the project managers and handling many of the dealings between HHL and Palmer. He had effectively treated himself as Palmer’s client. As the judge put it, Michael “appeared to be running the project generally” and his “decision making in relation to [the contract between HHL and Palmer] was open and plain for all to see”. That may hardly have been surprising given Michael’s obvious beneficial interest in the works being carried out to what was effectively his property. As such, Michael was held to be a de facto director of HHL. 
  • Christopher was held not to be exercising his independent duties owed to HHL as a director. Instead, he was serving the interests of Michael. That abnegation of his director’s duties taken together with his own actions in conspiring with Michael were held by the judge to have “shredded” his ability to seek the protection of HHL’s corporate veil. 

Lessons to be learned

While each case turns on its own facts and the evidence in this particular case pointed towards a particularly egregious attempt to rely on a shell company’s corporate veil in the circumstances of an unlawful conspiracy to induce a breach of contract, there are nonetheless important lessons that all companies and directors can learn. In particular:

1. For directors, if you fail to fulfil your fiduciary duties to the company and instead serve a different master, you may not be able to rely on the company’s corporate veil for protection from the consequences of your actions. That is all the more likely if you have conspired unlawfully with another and the victim of your conspiracy seeks redress.

2. For those controlling companies: 

  •  If you are in fact running the company, you may be held to be a de facto director of the company, irrespective of your formal title; and
  • While there is nothing inherently unlawful about structuring a transaction via a shell company (perhaps interposed for tax reasons, as here), you are likely to face a serious challenge to any corporate veil defence if you have exercised control over the shell company in a way which caused it deliberately to breach its contractual obligations in circumstances in which you are attempting to reap the shell company's benefits without meeting its obligations. As the judge observed in this case, such conduct would not be "a reflection of ... separate corporate personality, but an abuse of it".

3. For those dealing with undercapitalised companies and fearful that the company may have no assets against which to enforce a judgment for breach of contract, all is not lost. While cases for inducing breach of contract and unlawful means conspiracy remain rare due to the high evidential threshold required, this case has reiterated that innocent victims of unscrupulous directors and company controllers may be able to bypass an insolvent shell company and seek redress against those wrongdoers instead.

If you require further information about anything covered in this briefing, please contact Jolyon Connell (+44 (0)20 3375 7205) or Marie Bates (+44 (0)20 3375 7443) or your usual contact at the firm on +44 (0)20 3375 7000. You can find further information about our Disputes team here.

This publication is a general summary. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, November 2018

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