Gavin Hoccom, Senior Associate at Berry Smith, considers the implications for directors and shareholders following a recent decision of the High Court in relation to the use of a limited company to avoid payment to a building contractor for construction works.

According to the most recent government statistics, there were 5.7 million small and medium sized enterprises in the UK in 2017, accounting for 99% of all businesses. Of that, 1.88 million carried on business through a limited company.

The effect of incorporating a limited company is to create a legal person which is distinct in law from its directors and shareholders. A limited company can, amongst other things, own its own property, make its own profit and, importantly, incur independent liability for any debt incurred during the course of its business. As a consequence, the liability of a shareholder of a limited company can be limited to the amount the shareholder agreed to pay for their shares on incorporation or purchase. The shareholder cannot be held liable for anything in excess of that sum. Similarly, a director of a limited company cannot generally be held personally liable for the company’s debt. In the event of the insolvency of a limited company, it is the company’s creditors that bear the loss of the debt not being repaid.

The limitation of liability afforded to directors and shareholders is a feature which makes the limited company an attractive method of carrying on business for the risk averse business owner seeking to obtain almost guaranteed protection from creditor claims. The principle of limited liability can, however, be abused by those seeking to avoid payment for goods or services by entering into contracts through limited companies that are no more than empty “shells”. Despite goods or services having been provided, the supplier finds themselves unable to recover payment from the limited company, which subsequently enters liquidation.

With the recent decision of the High Court in Palmer Birch (A Partnership) v Lloyd, however, such practice looks set to expose those seeking to abuse the principle of limited liability to the risk of claims being brought against them personally for “economic tort”.  

Palmer Birch was a building contractor which provided construction services to a limited company, HHL. HHL was a tenant of the property to which the construction works were undertaken. The ultimate owner of the property was Lloyd, an individual based overseas and who directed the construction works, despite not being a director of HHL.

As HHL had no independent financial means it was reliant on funding from Lloyd. Despite the construction works having been completed satisfactorily, HHL failed to pay Palmer Birch and entered insolvency.

Palmer Birch commenced a claim against Lloyd for, in part, inducing HHL to breach its contract with Palmer Birch for non-payment. The claim was successful. It was clear that Lloyd had conspired to cause Palmer Birch to suffer loss by intentionally contracting through a limited company with no financial resources and withdrawing funding from that company at a time when it owed money to Palmer Birch. In doing so, Lloyd had gained a significant benefit at the expense of Palmer Birch, having conspired to abuse the principle of limited liability.

In providing clarity as to the circumstances in which a claim for “economic tort” may succeed, the Judgment in Palmer Birch may encourage creditors of limited companies in liquidation to pursue payment not only from the company, but also from those involved in its management or operation. The principle of limited liability alone may no longer provide sufficient protection to those conspiring to use the limited company to avoid payment for goods or services; a potentially welcome development for business owners seeking payment for goods or services supplied to limited companies in good faith. 

Please contact us if you would like more information about the issues raised in this article or any other aspect of construction litigation law at 02920345511 or ghoccom@berrysmith

Gavin Hoccom is a Senior Associate in the Dispute Resolution team at Berry Smith.