In Roberts v Frohlich, Norris J considered whether the directors of a property development company, Onslow Ditchling Limited (ODL), had acted improperly prior to ODL’s liquidation.
ODL was incorporated as a special purpose vehicle to buy and develop a single site at Ditchling that had planning permission for 30 industrial units. The development was to be financed entirely with borrowed money and, ultimately, all the units were to be sold freehold. Both directors (Mr Frohlich and Mr Spanner) were experienced professionals and both had extensive experience in property development companies.
Things did not go smoothly and, in September 2005, ODL appointed administrators. After the sale of assets and the appointment of a liquidator, there was a shortfall of some £900,000. The liquidator started proceedings, claiming Mr Frohlich and Mr Spanner were guilty of:
- Misfeasance and breach of duty as directors of ODL.
- Wrongful trading, in breach of section 214 of the Insolvency Act 1986 (IA 1986).
Norris J acknowledged that the development was “speculative”, but that this was an inherent risk of economic activity. He commented on the directors’ “wilfully blind optimism” that “something might turn up”, but held that both directors were guilty of:
- A breach of directors’ duties, which were owed to ODL’s creditors. They failed to act in what they honestly believed was in ODL’s best interests by:
- instructing the contractor to undertake works knowing that ODL had insufficient funding (and knowing that the funder was strictly adhering to funding terms that ODL could never meet);
- failing to obtain pre-sales, which was not only a funding requirement but essential for the viability of the development; and
- failing to obtain supplementary funding, rendering ODL unable to pay trade creditors who were pressing for payment.
- Misfeasance. Both directors failed to exercise reasonable skill and care as, in the circumstances, no reasonable director would have continued with the development in light of the lack of pre-sales and funding issues.
- Wrongful trading, in breach of section 214 of the IA 1986. Both directors knew or ought to have concluded that, from September 2004, there was no reasonable prospect that ODL would avoid going into insolvent liquidation as, at that stage, ODL was both balance sheet and cash flow insolvent.
Norris J’s comments are a timely reminder to directors of the need to consider their duties and position on an ongoing basis and take action, if necessary. This is especially so for directors of property development companies who should continually monitor the company’s position, as opposed to “wilful blindness” where the directors do not “enquire or consider lest an unpalatable truth be exposed.” As a result, ODL’s directors will be liable for a fine and could, potentially, be the subject of disqualification proceedings.