Corporate Law Update: 16 - 22 October 2021

22 October 2021

In this week’s update: Funds in a holding company’s bank account belonged to a subsidiary and could be used to pay the costs of a subsidiary’s acquisition, the FCA publishes a series of Q&A on the cessation of LIBOR and the Government publishes a roadmap towards greening finance and sustainable investing.

Funds in holding company’s bank account belonged to subsidiary

The High Court has held that payments from a bank account in the name of an insolvent company to its directors were not made in breach of duty to that company, because the money in that account was actually held on trust for a subsidiary.

The court also found that it was legitimate for those funds to be used to pay costs connected with the acquisition of the subsidiary’s shares.

What happened?

Re Brookmann Home Ltd [2021] EWHC 2610 (Ch) concerned a company (BHE) which had been established by two individuals with the sole purpose of acquiring the business of another company (1877). Those two individuals were appointed as BHE’s directors on incorporation and ultimately controlled BHE through an intermediate Isle of Man company.

The acquisition had originally been structured such that 1877 would sell its business and assets to BHE. In contemplation of this, BHE set up a bank account in its own name to make day-to-day payments in relation to the continuing business after the acquisition was complete.

The transaction was subsequently restructured so that BHE would acquire the shares in 1877 from 1877’s shareholders, rather than the business itself. This meant that, following the acquisition, 1877 would continue to run its business, albeit as a subsidiary of BHE.

The price for the acquisition, as well as costs and expenses incurred in connection with it, were to be financed by a loan taken out by 1877.

The acquisition completed and the directors of BHE also became directors of 1877. However, no changes were made to the bank account, which remained in BHE’s name. The funds to be lent to 1877 were paid into the bank account in BHE’s name. Those funds were later used to make payments directly to BHE’s directors on account of management services they had rendered, as well as services rendered in connection with the acquisition itself.

In due course, BHE entered liquidation. Its liquidator attempted to claw the payments back on the basis that BHE (the entity named as holding the bank account) was insolvent and the payments had been made in breach of duty to BHE (specifically, the duty to consider the interests of BHE’s creditors).

What did the court say?

The court disagreed. The judge found that the funds that had been placed in the bank account belonged to 1877, not BHE. They had been raised using 1877’s loan facility, itself based on a factoring agreement relating to 1877’s own book debts. The purpose of the funds had been to discharge 1877’s business liabilities and expenses, not for BHE to use them as it wished.

As a result, although the bank account was in BHE’s name, BHE was holding the monies in that account on trust for 1877. In authorising the payments, the directors has been acting as directors of 1877, not directors of BHE. As they were not acting as directors of BHE when they made the payments, they were not in breach of duty to it.

The judge also said that it was an acceptable use of 1877’s funds to pay expenses in connection with the transfer, in particular because they were paid on the understanding that 1877 would be reimbursed in due course by the Isle of Man company.

What does this mean for me?

The facts here are slightly peculiar but they illustrate an important point. When deciding to whom assets belong and whether they have been used properly, the courts will look at the substance of arrangements rather than the form.

However, the case does illustrate the importance of ensuring that arrangements reflect the structure of an acquisition and the way in which a business will be run going forwards. Although, in this case, the court recognised the real purpose of the funds in question, the position may not always be so clear. By adapting mechanics when transaction arrangements change, parties can avoid potential disputes further down the line.

There are a couple more points in this case worth noting.

First, the judge acknowledged that the use of 1877’s funds to finance the acquisition and related expenses amounted to financial assistance by 1877 in connection with the purchase of its own shares. Under UK law, a private company is permitted to provide financial assistance of this kind. However, this will not always be possible. Had 1877 been a public company, this kind of assistance might well have been illegal and amounted to a criminal offence. A public company should always be very careful and take legal advice if it is considering entering into an arrangement of this kind.

Secondly, payments by a company to its ultimate controllers can, in certain circumstances, amount to a deemed distribution. If so and the company does not have sufficient distributable profits to cover the payments, they will need to be paid back to the company and the directors may, in authorising the payments, be in breach of their duties. In this case, however, the issue did not arise: the judge found that the payments were remuneration for services and not distributions.

Other items

  • FCA publishes Q&A on LIBOR transition. The Financial Conduct Authority (FCA) has published a series of Q&A for firms in connection with the wind-down of the London Interbank Offered Rate (LIBOR). For most currencies and tenors, LIBOR will cease to be published on its current basis at the end of 2021, with a temporary “synthetic LIBOR” to be made available for limited use (see the Q&A). Although aimed primarily at regulated financial institutions, the Q&A may be useful for other organisations that employ LIBOR as a benchmark in contractual arrangements. 
  • Government publishes roadmap to sustainable investing. The Treasury has published a policy paper setting out the Government’s three-step plan to make the UK a leader for green and sustainable investment. The paper focuses on the first step: ensuring that the information exists to enable every financial decision to factor in climate change and the environment.

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