In the recent case of Phillips Roberts (Liquidator of Onslow Ditching Ltd) v (1) Peter Frohlich (2) Godfrey Spanner [2011] EWHC 257 (Ch), the High Court was asked to decide whether the respondent directors had breached their fiduciary duties by continuing with a land development project when it was not in the best interests of the company or its creditors.

The purchase of the land was funded, in part, by a £437,000 loan from the Bank of Scotland. This loan was obtained on a number of conditions being met, in particular, that any building work done was under a fixed price contract and that a number of the trading units had been pre-sold. The site was purchased in June 2004. There was a dispute between the intended main contractor for the development, as a result of which, work was suspended in November 2004. The company went into liquidation in September 2005.

The liquidator sought a declaration from the court that (1) the directors were guilty of misfeasance and in breach of their duty as directors by causing, procuring or permitting the company to commence the development when they knew or ought to have known that it was speculative, inadequately funded, and bound to fail; and (2) the directors had wrongfully traded as they knew or ought to have concluded on around 1 July 2004, or alternatively on or around 1 September 2004, that there was a reasonable prospect that the company would go into liquidation.

Mr Justice Norris held the following:

1. the directors had honestly believed that, at the time when the acquisition of the land was completed, it was in the company’s best interests to go through with the transaction. Although the directors had misrepresented to the Bank the true position in saying that the company had secured a fixed price contract and that they had pre-sold some units, the bank had not relied on these representations.
2. at the beginning of July 2004, the directors were not acting in breach of their fiduciary duties as they had honestly believed that when the time came for payment they would have a good chance that the money would be available to pay the bill.
3. the position by September 2004 was very different. There had been no pre-sales and it was not possible to negotiate with the contractor a fixed price contract. The directors could not honestly have believed that a continuation with the work already ordered and the placing of fresh orders was in the interests of company. The only honest thing would have been to stop the development. Therefore, from mid-September, the directors were not acting bona fide in the best interests of the company and its creditors.
4. no reasonably competent director, equipped and placed as the directors both were, would have continued with the development after early to mid-September. The directors were therefore negligent as at 14 September 2004.
5. as to whether the directors could be held to be negligent at an earlier date, the liquidator had not made out its case by demonstrating that the directors were incompetent in placing orders. Allowing the development to continue at that point required a judgment about what was likely to happen in the future. Although the directors had made a misjudgement of the risk, misjudgement was not of itself negligence.
6. by 1 September 2004, the directors ought to have concluded that there was no reasonable prospect of avoiding an insolvent liquidation, as by this date the company was in fact insolvent on a balance sheet basis. Therefore, their continuation with the development after mid-September 2004 constituted wrongful trading.