The Court of Appeal, composed of Chief Justice Vincent De Gaetano (now retired), Mr Justice Joseph A. Filletti and Mr Justice Geoffrey Valenzia, on May 14, 2010, in the case Andrew Borg Cardona as liquidator of Priceclub Operators Ltd vs Victor Zammit, Christopher Gauci and Wallace Fino, held, among other things, that a director could not avoid responsibility on the pretext that he did not appreciate the true situation of the company or that he relied on advice of others. It was not excusable for a director to plead that he was a ‘non-executive director’ and/or a minority shareholder. A director shared equal responsibility with other co-directors and was under an obligation to know and to carry out his duties, which were imposed by law.

The facts in this case were as follows:

This case was one of the several cases filed in the Price Club saga, where the liquidator of Priceclub Operators Ltd (PCO) filed legal proceedings against ex-directors of PCO Mr Zammit, Mr Gauci and Mr Fino – for wrongful and/or fraudulent trading under our Companies Act provisions. Priceclub operated eight supermarkets and stopped trading in 2001.

The issue was whether the ex-directors should be held personally and unlimitedly responsible for all PCO’s debts in solidum.

Article 315 (1) Companies Act on fraudulent trading provides: “If in the course of a winding up of a company, whether by the court or voluntarily, it appears that any business of the company has been carried on with the intent to defraud creditor… the court may, if it thinks proper so to do, declare that any persons who were knowingly parties to the carrying on of the business in the manner aforesaid be personally responsible, without any limitation of liability for all or any of the debts or other liabilities of the company as the court may direct.”

There was wrongful trading under Article 316 (1) Companies Act “where the company has been dissolved and is insolvent” and it appears that a person who was a director knew or ought to have known prior to the dissolution of the company that there was no reasonable prospect that the company would avoid being dissolved due to its insolvency.

It was stated that its directors should be held responsible for trading when PCO was virtually insolvent. They chose to commence and continue trading, despite of PCO’s precarious financial position, to the prejudice of creditors.

From the onset, PCO was saddled with considerable debts, Lm2.6 million, and was unable to pay its creditors. It was alleged that they acted abusively, with gross incompetence, in breach of their duties and fraudulently, to deceive PCO’s creditors. PCO was also found to be under-capitalised without sufficient funds and/or capital base to pay its operational debts and carry out its activities. Allegedly PCO operated with finance provided by its creditors.

It resulted that:

• Its directors should have known that PCO was insolvent;

• The directors failed to keep proper books of account;

• The directors did not act honestly with PCO’s creditors. They made false statements, and misled creditors as to PCO’s true financial position;

• The directors did not draw up any serious business plan to protect creditors.

On October 12, 2007 the First Hall of the Civil Court gave judgment by declaring that all three defendant directors, under Article 315 Companies Act, acted with the intention to defraud PCO’s creditors, and were accordingly jointly and severally liable for all PCO’s debts and obligations without any limitation.

Aggrieved by decision of the First Court, all three defendants entered an appeal, calling for its revocation.

Mr Fino submitted that:

(1) The First Court had given a wrong interpretation of Article 315 (fraudulent trading) and Article 316 (wrongful trading) of the Companies Act. These provisions should be applied in Malta, as they were construed in the UK, pre-1986 amendments.

(2) Directors could not be held liable for fraudulent trading on the basis of under-capitalisation and the particular corporate structure of the group. These issues were decided by the shareholders and not the directors.

(3) They should not be held personally liable, without limitation.

Mr Zammit also pleaded that the First Court misinterpreted Article 315. It presumed that the directors were aware of certain things and assumed fraud, without considering their real intentions. He denied acting fraudulently, or having any intention of making any illicit gain at the expense of the company’s creditors.

Mr Gauci in addition claimed that the court failed to distinguish between fraudulent and wrongful trading. Allegedly it applied the concept of wrongful trading to fraudulent trading. It was stated that fraudulent trading required fraud, at the expense of the creditors. He also denied any deceit and/or making any illicit gain.

On May 14, 2010, the Court of Appeal gave judgment by dismissing their appeal, and by confirming the decision of the First Court.

The following reasons were given for its decision:

• The First Court gave a correct interpretation: Prior to the Grantham case, it was held: “A proper inference of intent to defraud could be made if a company continues to carry on business and to incur debts at a time when there is to the knowledge of the directors no reasonable prospect of the creditors ever receiving payment.” In subsequent cases it was decided that the intention to defraud and fraudulent purpose meant “actual dishonesty involving, according to the current notions of fair trading among commercial men, real moral blame”.

In the Grantham case (1984), the following principles were established: “A finding that a person was knowingly party to the business of a company having been carried on with intent to defraud creditors may be made if the following two conditions are satisfied:

“(1) if that person realised at the time the debts were incurred that there was no good reason for thinking that funds would be available to pay the debt in question when it became due or shortly thereafter; and (2) There was actually dishonesty involving, according to current notions of fair trading among commercial men, real moral blame.

“A proper inference of fraud could be made if there was no good reason to believe that payment would be made as aforesaid.

“Dishonesty could be inferred from a reckless disregard of the interests or creditors.”

Reference was made to the author, Hanningan B, “proving that the company continued to trade while insolvent is not enough. The person bringing the action must prove that the respondent has carried on business with intent to defraud creditors or for any fraudulent purpose”.

In addition, “for a person to be held knowingly party to carrying on a company’s business with intent to defraud creditors, requires findings and inferences as to the facts known to that person at the relevant times. At those times the business might either have succeeded or failed”.

Article 316 (Fraudulent Trading) did not define fraud, and the court had to decide this issue in the light of the circumstances. The court agreed with the conclusion of the First Court. It felt that the directors acted dishonestly by continuing trading, to the prejudice of their creditors, well knowingly that the company was insolvent and was unable to pay its debts. The company was also under-capitalised and burdened by heavy debt.

Structure of the company group: The court said that the directors were liable for fraudulent trading by operating an under-capitalised company: re professor Andrew Muscat: “The thinly capitalised company cannot be equated with fraud … Other considerations may however apply in the case of a company which had been provided with illusory or trifling finance. Such a subsidiary stands virtually no chance of success. Its failure is written on the wall. Even directors with just a modicum of sense will visualise the risks. The directors will know that if the subsidiary obtains credit – as it would have to do in order to commence trading – the likelihood would be that the creditors will not be paid. In effect, the business would be carried on at the expense of its creditors. In such circumstances, the ingredients of fraudulent trading – in particular the ‘intent to defraud’ would be probably exist.”

In this case, the company’s financial position was such that the directors should have been aware of the harm to creditors. Creditors should not have been deceived.

The directors were obliged to provide the operating company, PCO with tangible assets, as security for its creditors, to ensure that the company had a good chance to succeed.

It was clear that the directors did not want to inject more money into the company. They wished to expand rapidly, despite having inadequate capital base. The company was unable to finance the acquisition. The directors were obliged to ensure that PCO was not further burdened with debt. Instead its directors piled more debt, to the prejudice of its creditors. They acquired other businesses such as a day-to-day supermarket and embarked on a refurbishment project at a huge cost for PCO.

The directors definitely did not safeguard the interests of PCO’s creditors, pointed out the court.

• The directors had no experience in managing supermarkets. No proper stock taking was carried out. The company was poorly managed. Changes were implemented where it was already too late. By June 1999, it was obvious that the company was in financial ruin. The directors should have been aware that the company was not in a position to repay on time. The business was being financed by its creditors and suppliers. Instead of reducing losses, they incurred substantial debts, which could not have been repaid. The court said that the directors abused their position by compelling their suppliers to accept long credit terms. In this respect they did not act honestly.

There was no prospect that the company could avoid insolvency. It did not meet its repayment terms. Its situation became worse in 2000/2001. In the meantime, the directors gave assurances that the cash flow problems were temporary. It results that though the directors were well aware that the company was unable to repay its debts, they continued to incur losses, without any possibility of recovery. This was fraudulent trading, indicated the court.

Responsibility of the directors: Mr Zammit and Mr Gauci claimed that they did not act fraudulently. They blamed Mr Fino instead.

The court noted, however, that even these two directors were aware of the situation and had not raised any objections. Creditors of the company had reported that all three directors claimed that the company had a solid financial base.

The court pointed out that a director could not avoid responsibility on the pretext that he did not appreciate the true situation of the company or that he relied on the advice of others.

It was not excusable for a director to plead that he was a “non-executive director” and/or a minority shareholder. A director shared equal responsibility with other co-directors and was under an obligation to know and to carry out his duties, which were imposed by law.

Reference was made to professor Andrew Keay: “Today it is very difficult for a director to argue that he was not a party to the carrying on of the business of the company (unless such director registers a dissenting opinion), especially since it is one of the duties of directors to actually participate in the business of the company.”

The court said that Mr Zammit was an active board member and no decision could be taken without his consent.

For these reasons, the court concluded that the directors were personally liable without limitation for the debts of Price Club Operators Ltd.

Dr Grech Orr is a partner at Ganado & Associates.