Unlawful distribution of shareholding: application of Limitation Act clarified

In Burden Holdings UK Limited v Fielding the Supreme Court considered the application of Section 21(1)(b) of the Limitation Act 1980 with respect to claims against the directors of a company for an unlawful distribution of the shareholding.

Background

The appellants were directors and shareholders of the respondent – a holding company with a number of trading subsidiaries. The subsidiaries operated in the supply and construction of conservatories and a combined heat and power business. The combined heat and power business was carried out by Vital Energi Utilities Ltd.

In or about July 2007, Scottish and Southern Energy plc (SSE) made an offer of £6 million to purchase a 30% shareholding in Vital. One of the conditions of the sale was the complete separation of Vital from the respondent's conservatory business.

On October 4 2007 the respondent's shareholders (which included the appellants) exchanged their shares in the respondent for shares in a new holding company, BHUH Holdings Ltd.

On October 12 2007 the directors of the respondent approved a distribution in specie of the respondent's shareholding in Vital, which transferred the respondent's shares in Vital to BHUH.

On October 15 2007 BHUH went into members' voluntary liquidation. Pursuant to reconstruction agreements, the liquidator transferred:

• the shares in Vital to a new company, Vital Holdings Limited; and
• the shares in the respondent to Burden Group Holdings Limited.

Vital Holdings Limited and Burden Group Holdings Limited issued shares to the former shareholders of BHUH in proportion to their former shareholdings in BHUH.

On October 19 2007 one of the appellants (Ms Fielding) sold a 30% shareholding in Vital Holdings Limited to SSE for £6 million.

The respondent went into liquidation in December 2009.

Limitation Act 1980

Section 21(3) of the Limitation Act 1980 stipulates that beneficiaries are subject to a six-year limitation period in which to bring an action to recover trust property or in respect of any breach of trust. However, Section 21(1)(a) makes clear that this provision does not apply to any action by a beneficiary in respect of a fraudulent breach, while Section 21(1)(b) states that the provision does not apply to any action to recover trust property, or the proceeds thereof, from the trustee.

Procedural history

First instance
The respondent commenced proceedings against the appellants in December 2009, alleging that:

• the distribution in specie of the appellants' shareholding in Vital to BHUH was unlawful; and
• the appellants had breached their fiduciary duties to the respondent in making that distribution.

The respondent argued that because the distribution was made to BHUH (of which the appellants were majority shareholders and directors), the distribution was one from which they derived a substantial benefit.

In turn, the appellants sought summary judgment dismissing the respondent's claim on the ground that it was statute barred by virtue of Section 21(3) of the Limitation Act. They argued that the distribution had occurred outside the six-year limitation period, having taken place six years and three days before the issue of the claim form in the proceedings. The appellants succeeded with their application for summary judgment.

Court of Appeal
The respondent appealed to the Court of Appeal, relying on the Section 21(1)(b) exception to the general six-year limitation provision under Section 21(3) of the Limitation Act. It was argued that the Section 21(1)(b) exception was satisfied as this was a claim against the appellants as trustees to recover trust property previously received by the appellants and converted to their own use.

The Court of Appeal allowed the appeal, holding that the respondent's claim was not statute barred by virtue of Section 21(1)(b) of the act. It held that a claim for equitable compensation, in a case where the trustee's indirect interest in the trust asset had been converted for the trustee's use, was an appropriate remedy to seek in an action falling within Section 21(1)(b) of the act.

Supreme Court
The appellants appealed to the Supreme Court. They argued that the Section 21(1)(b) exception did not apply to them because they had never been in possession of trust property (ie, the shares in Vital) as those shares had been both legally and beneficially owned by the holding companies – namely, the respondent, BHUH and then Vital Holdings Limited. The appellants alleged that although they had from time to time been shareholders and directors in the holding companies, the shareholding in Vital was never in their possession, nor was it previously received by them and converted to their use. They argued that holding otherwise would involve lifting the corporate veil or ignoring the separate legal personality of the holding companies.

Supreme Court decision

The court dismissed the appeal, ruling that Section 21(1)(b) of the Limitation Act applied to the respondent's claim. The six-year limitation period under Section 21(3) of the act therefore did not apply to the proceedings and the respondent's claim against the appellants could continue to be pursued.

It was common ground that directors of a company who were assumed to have participated in a misappropriation of company assets are "regarded for all purposes connected with section 21 as trustees". The company was held to be "the beneficiary of the trust for all purposes connected with section 21".

The court held that directors of a company "are entrusted with stewardship of the company's property and owe fiduciary duties to the company in respect of that stewardship". As such, the appellants were treated as being in possession of the respondent's property by virtue of their role as directors.

The court ruled that it did not matter that the misappropriated property (ie, the shares in Vital) remained legally and beneficially owned by holding companies. If the appellants' misappropriation of the Vital shares amounted to a conversion of them to their own use, they would still necessarily have previously received them by virtue of being the fiduciary stewards of the company as its directors.

The court found that the appellants had converted the respondent's shareholding in Vital when they procured or participated in the unlawful distribution of it to BHUH. It was held to be a conversion because, if unlawful, it was a taking of the respondent's property in defiance of the respondent's rights of ownership. It was deemed to be a conversion of the shareholding to their own use because of the economic benefit which they stood to derive from being the majority shareholders in BHUH.

The court acknowledged that Section 21 was primarily aimed at express trustees, and that it was found to be applicable to company directors "by what may fairly be described as a process of analogy". It considered the Court of Appeal's analysis that finding otherwise would have been a "recipe for avoidance" by trustees, given that in the modern world it is commonplace for companies to be used to hold assets, where the beneficial ownership is vested in the company, rather than in the directors themselves.

Comment

The judgment displays a purposive approach to the legislation, with the Supreme Court noting that Section 21's purpose was to give trustees the benefit of lapse of time where they had done something legally or technically wrong – as opposed to morally wrong or dishonest – but not to protect them where the statute could be used to allow them something they ought not to have. The court's analysis of the limitation period with respect to such claims is useful in clarifying the application of Section 21(1)(b) of the Limitation Act and its associated interplay with Section 21(3).

Practitioners should be mindful of the court's comments when dealing with clients who employ complex trust structures. The judgment illustrates that directors will not be sheltered by such structures to avoid liability for misappropriation of trust assets. Indeed, as "fiduciary stewards of the company's property", directors are to be treated as in possession of trust property from the outset and therefore unable to rely on a six-year limitation period where they are in possession of trust property or with respect to any breach of trust.