Liability imposed on an insolvent LLP’s members for breach of fiduciary duty and wrongful trading
McTear v Eade and anr (Re C.J. & R.A. Eade LLP (in liquidation)) [2019] EWHC 1673 (Ch), ICCJ Jones, 11 June 2019
This case, before I.C.C. Judge Jones, was the first reported case under section 214A of the Insolvency Act 1986. This provision, which relates to wrongful trading, allows the liquidator of an insolvent Limited Liability Partnership (“LLP”) to clawback drawings made by the LLP’s members or any shadow members in the two-year period before the LLP was wound up.
To recover property withdrawn by a member, a liquidator must prove to the court that, on the balance of probabilities, the relevant member:
(i) Withdrew property from the LLP; and
(ii) Knew of the LLP’s impending insolvency at the time of the withdrawal; and
(iii) Knew (or ought to have known) that there was no reasonable prospect of the LLP avoiding insolvent liquidation.
Drawings can include profits, salary and repayments of loans and their interest.
The Facts
Mr Christopher Eade (“Mr C. Eade”) and Mr Middleton operated a partnership business trading as “Olympic Signs”. By an agreement dated 3 July 2009, Mr C. Eade purchased Mr Middleton’s half share in the business for consideration of £320,000 and an indemnity by Mr C. Eade for the payment of all existing partnership debts and liabilities.
C.J. & R.A. Eade LLP (“The LLP”) was incorporated on 6 July 2009. Shortly after, the business was transferred to the LLP with Mr C. Eade and his son, Mr Richard Eade (“Mr R. Eade”) both as designated members.
The LLP used a Lloyds TSB Bank account in the names of Mr C. and Mr R. Eade for its trading. It was into this account that A 10 year fixed-term loan made to Mr C. Eade and Mr R. Eade totalling £474,700 was made. The loan was used to pay:
(i) the £320,000 due to Mr Middleton together with his legal costs for the purchase; and
(ii) capital and interest payments on the loan; and
(iii) the partnership liabilities which Mr C. Eade had undertaken to pay.
The balance of the loan was used for LLP’s working capital.
Unfortunately, the LLP did not prosper and entered into Creditors Voluntary Liquidation on 21 August 2011. Mr C. and Mr R. Eade expressed a significant loss of customers to a new business established by Mr Middleton.
The Liquidator’s Claim
The Notice of Claim of the LLP’s Liquidator was made up of two claims:
(i) The first claim sought to recover all drawings on account of anticipated profits paid to Mr C. and Mr R. in the relevant period on the basis that:
(1) According to Regulation 7(4) of the Limited Liability Partnership Regulations 2001 (“The Regulations”) members are not entitled to remuneration for acting in the business or management of a limited liability. Accordingly, it was argued that each payment was a breach of the fiduciary duty each member owed the LLP; and
(2) In any event, it was wrong to make those drawings when the LLP was insolvent or likely to become insolvent and there were no profits.
(ii) The Application also challenged all payments the LLP made under the Lloyds bank loan on the basis that the LLP should have made no payment because the loan was made by Lloyds Bank to Mr C. and Mr R. Eade not the LLP.
The Decision
As the liquidation commenced on 24 August 2011, the two-year period to which section 214A applied started on 25 August 2009. During this period the LLP withdrew property in the form of a share of profits and in repayment and payment of interest on a loan.
It was established as a finding of fact that:
(1) the LLP had assumed liability for the Lloyd’s bank loan. This was evidenced by the fact that the joint account into which it had been paid was effectively taken over by the LLP and used as its trading account.
(2) Mr C. and Mr R. Eade knew or ought to have known after each withdrawal of anticipated profits and Lloyds bank loan payment that there was no reasonable prospect of the LLP avoiding liquidation.
Mr C. and Mr. R Eade were found liable to pay to the LLP the sum equal to all the drawings taken from the LLP on account of profits and the payments made by the LLP towards the Lloyds bank loan.
Commentary
This case has attracted interest for several reasons.
Firstly, it is the first reported decision on the operation of section 214A of the Insolvency Act 1986 (i.e. the application of the wrongful trading regime to LLPs). The case also provides useful confirmation of the fact that members are not allowed to set off liabilities under section 214A against sums due to them as members, as member’s capital is not treated as debt. Finally, the judgement provides a useful reminder of the principles concerning knowledge of impending insolvency. IICJ Jones noted that the duty to promote the success of the company was “superseded” by the duty to have regard to the interests of creditors.
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