Company Personality and Insolvency
How is the function of a company’s separate personality altered by insolvency? And to what extent may that give rise to an action in civil fraud? Nicola Sharp of Rahman Ravelli outlines the situation.
Since the end of the 19th century and the decision in Salomon v A Salomon and Co Ltd [1897] AC 22, it has been settled law that a company has its own separate personality. But as company law and insolvency law have evolved, the function of the company’s separate legal personality has developed.
In a recent Supreme Court decision in Stanford International Bank Ltd (in liquidation) (Appellant) v HSBC Bank Plc (Respondent) [2022 UKSC 34), Lord Sales shone a spotlight on the function of the company’s distinct legal personality. The substantive case relates to the Ponzi scheme operated through Stanford International Bank Ltd (SIB), of which Mr Stanford was the culpable director, and the ultimate beneficiary. For a summary of the recently appealed strike out decision relating to the losses (or lack thereof), please read our recent case analysis.
In this article, we consider the complex points raised in Lord Sales’ dissenting judgment, in which he unpacked the function served by treating a company as having a separate personality. We consider the extent to which that function may be altered by the circumstances of insolvency, and the ways in which that may give rise to an action in civil fraud.
Function of treating a company as having a separate personality
In Lord Sales’ judgment, he sets out a twofold purpose for the corporate personality:
- It means that a company transacts on its own behalf.
- It serves a representative function. A company stands for the interests which the corporate personality is there to represent and protect.
It’s the second function that attracts the most scrutiny in Lord Sales’ judgment. The representative function affects those managing the company’s affairs, by “delineating the content of their duty to act in the interests of the company.” [96]
Or, to put it another way, the duties of the directors are precisely informed by the representative function of the corporate personality. In practical terms, the directors are under duties to act in the best interests of the company, which (for solvent companies) means acting in the interests of the shareholders as a general body.
The effect of liquidation
During the liquidation process, the company’s corporate personality serves a new function: to protect the interests of the creditors entitled to protection under the statutory scheme.
The company’s representative responsibilities are owed to the people who are affected by the management of its affairs. And the corporate personality serves the function of ensuring that those responsibilities are fulfilled.
Accordingly, a fundamental change occurs as regards those responsibilities when a company is on the verge of, or enters, insolvent liquidation. Rather than acting in the interests of the shareholders as a general body, the directors’ duties are owed to the creditors as a general body.
In other words, when liquidation is unavoidable, the interests of the shareholders fall away. The company’s interests are treated as equivalent to those of the creditors alone, which is the “creditor duty” affirmed in BTI 2014 LLC v Sequana SA [2022] UKSC 25; [2022] 3 WLR 709, (Sequana),
Directors’ fiduciary duties are either owed to its members or its creditors, depending on the financial position of the company.
In Sequana, the Supreme Court accepted that the fiduciary duty owed by directors to the company itself would become a duty to protect the interests of the creditors of the company at the point when the company entered into liquidation or was imminently about to do so.
Directors can therefore be in breach of their fiduciary duties by failing to act in the best interests of the creditors when the company is on the verge of insolvency.
Dishonestly concealing the true financial position of the company
What happens if the financial position of the company is dishonestly concealed by one of its managing directors? (as was the case in Stanford International Bank v HSBC).
The concealment does not alter the true financial position of the company. So in terms of the directors’ duties, the duty is still owed to the creditors as a class, from the time at which the company was hopelessly insolvent and headed inevitably for liquidation.
If the function of the corporate personality is to serve and protect the interest of those it exists to represent, then when it is irreparably insolvent (whether known or concealed), the duty should be owed to the creditors.
In Stanford International Bank v HSBC, Mr Stanford was aware of the true financial position of the company. Following Lord Sales’ logic, he was also aware that he owed a duty to the company to retain its funds in the bank, which could be used to maximise the payments to be made to the general body of creditors. Instead, allegedly in breach of his fiduciary duties, Mr Stanford did not intervene when SIB instructed the bank to pay out the money to requesting customers.
The duty owed reflects the interests of the company itself. The knowledge of the directors is only relevant to trigger their personal fiduciary obligation to take steps in recognition of what are the true interests of the company in such circumstances.
Comment
While the legal personality of the company is constant, and always separate in law, the function of the corporate personality can vary.
When the company is in liquidation, the representative function of the company is to protect the rights of the creditors, as opposed to the shareholders when the company is solvent.
In terms of civil fraud, that may give rise to certain actions in breach of fiduciary duties, fraudulent trading, or wrongful trading if directors continue to prefer the interests of the shareholders.
