Non party costs Orders and directors

Applications for non party costs orders (NPCOs) are coming thick and fast at the moment: on average I seem to be undertaking one every ten days or so. The applications arise in a number of contexts, but one context that arises time and again, is whether it is appropriate to make a NPCO against the director of an insolvent company in failed litigation.

In theory, the principles are well known and readily accessible: but the application of those principles to a particular case is always problematic, not least because the summary nature of the jurisdiction means that the evidential enquiry is not always thorough, and usually witness evidence is not tested by cross examination. The starting point is always the case of Dymocks Franchise Systems (NSW) Pty Ltd v Todd [2004] 1 WLR 2807 which established the principles for making a nonparty costs order which have been consistently applied in later caselaw. Per paragraph 25:

A number of the decided cases have sought to catalogue the main principles governing the proper exercise of this discretion and their Lordships, rather than undertake an exhaustive further survey of the many relevant cases, would seek to summarise the position as follows.

(1) Although costs orders against non-parties are to be regarded as “exceptional,” exceptional in this context means no more than outside the ordinary run of cases where parties pursue or defend claims for their own benefit and at their own expense. The ultimate question in any such “exceptional” case is whether in all the circumstances it is just to make the order. It must be recognised that this is inevitably to some extent a fact-specific jurisdiction and that there will often be a number of different considerations in play, some militating in favour of an order, some against.

(2) Generally speaking the discretion will not be exercised against “pure funders”, described in para 40 of Hamilton v Al Fayed (No 2) [2003] QB 1175, 1194 as “those with no personal interest in the litigation, who do not stand to benefit from it, are not funding it as a matter of business, and in no way seek to control its course”. In their case the court’s usual approach is to give priority to the public interest in the funded party getting access to justice over that of the successful unfunded party recovering his costs and so not having to bear the expense of vindicating his rights.

(3) Where, however, the non-party not merely funds the proceedings but substantially also controls or at any rate is to benefit from them, justice will ordinarily require that, if the proceedings fail, he will pay the successful party’s costs. The non-party in these cases is not so much facilitating access to justice by the party funded as himself gaining access to justice for his own purposes. He himself is “the real party” to the litigation, a concept repeatedly invoked throughout the jurisprudence-see, for example, the judgments of the High Court of Australia in the Knight case 174 CLR 178 and Millett LJ’s judgment in Metalloy Supplies Ltd v MA (UK) Ltd [1997] 1 WLR 1613. Consistently with this approach, Phillips LJ described the non-party underwriters in T G A Chapman Ltd v Christopher [1998] 1 WLR 12, 22 as “the defendants in all but name”. Nor, indeed, is it necessary that the non-party be “the only real party” to the litigation in the sense explained in the Knight case, provided that he is “a real party in … very important and critical respects”: see Arundel Chiropractic Centre Pty Ltd v Deputy Comr of Taxation (2001) 179 ALR 406 , 414, referred to in the Kebaro case [2003] FCAFC 5 , at [96], [103] and [111]. Some reflection of this concept of “the real party” is to be found in CPR r 25.13(2)(f) which allows a security for costs order to be made where “the claimant is acting as a nominal claimant”. (4) Perhaps the most difficult cases are those in which non-parties fund receivers or liquidators (or, indeed, financially insecure companies generally) in litigation designed to advance the funder’s own financial interests. Since this particular difficulty may be thought to lie at the heart of the present case, it would be helpful to examine it in the light of a number of statements taken from the authorities. First, Tompkins J’s judgment in the Carborundum case [1992] 3 NZLR 757, 765:

“Where proceedings are initiated by and controlled by a person who, although not a party to the proceedings, has a direct personal financial interest in their result, such as a receiver or manager appointed by a secured creditor, a substantial unsecured creditor or a substantial shareholder, it would rarely be just for such a person pursuing his own interests, to be able to do so with no risk to himself should the proceedings fail or be discontinued. That will be so whether or not the person is acting improperly or fraudulently. In many cases a major consideration will be the reason for the non-party causing a party, normally but not always an insolvent company, to bring or defend the proceedings. If a non-party does so for his own financial benefit, either to gain the fruits of the litigation or to preserve assets in which the person has an interest, it may, depending upon the circumstances, be appropriate to make an order for costs against that person. Relevant factors will include the financial position of the party through whom the proceedings are brought or defended and the likelihood of it being able to meet any order for costs, the degree of possible benefit to the non-party and whether, in all the circumstances, the bringing or defending of the claim-although in the end unsuccessful-was a reasonable course to adopt. The directors of a company may frequently be in a position different from other non-parties with a direct financial interest in promoting or defending proceedings. Even where a company is in receivership, directors may have a duty to prosecute or defend a claim through the company in the interests of creditors other than the creditor that had appointed the receiver, or in the interests of the shareholders. Other creditors and shareholders are entitled to expect that those responsible for the management of the company will use all proper endeavours to ensure that their financial interests are protected or that there is a fund out of which such creditors can be paid …”

(emphasis added)

The position of directors who must act bona fide in the interests the company bringing or defending proceedings, has been considered in many cases. The special position of directors was clearly set out by Millett LJ as he then was in one of the earlier cases that of Metalloy Supplies Limited v MA (UK) Ltd [1997] 1 WLR 1613 (“Metalloy”)

The court has a discretion to make a costs order against a non-party. Such an order is, however, exceptional, since it is rarely appropriate. It may be made in a wide variety of circumstances where the third party is considered to be the real party interested in the outcome of the suit. It may also be made where the third party has been responsible for bringing the proceedings and they have been brought in bad faith or for an ulterior purpose or there is some other conduct on his part which makes it just and reasonable to make the order against him. It is not, however, sufficient to render a director liable for costs that he was a director of the company and caused it to bring or defend proceedings which he funded and which ultimately failed. Where such proceedings are bought bona fide and for the benefit of the company, the company is the real plaintiff. If in such a case an order for costs could be made against a director in the absence of some impropriety or bad faith on his part, the doctrine of the separate liability of the company would be eroded and the principle that such orders should be exceptional would be nullified.

(emphasis added)

The leading case now is that of Goknur Gida Maddaleri Enerji Imalat Ithalat Ihracat Ticaret Ve Sanati AS v Aytacli [2021] EWCA Civ 1037 (“Goknur”) in which a full review of the law on applications for NPCOs in the context of directors and shareholders was undertaken by Coulson LJ. In his judgment he stated:

Without in any way suggesting that these authorities give rise to a sort of mandatory checklist applicable to a company director or shareholder against whom a section 51 order is sought, I consider that the relevant guidance can usefully be summarised in this way: *

(a)  An order against a non-party is exceptional and it will only be made if it is just to do so in all the circumstances of the case ( Gardiner,Dymocks,Threlfall ).

(b)  The touchstone is whether, despite not being a party to the litigation, the director can fairly be described as “the real party to the litigation” ( Dymocks , Goodwood , Threlfall ).

(c)  In the case of an insolvent company involved in litigation which has resulted in a costs liability that the company cannot pay, a director of that company may be made the subject of such an order. Although such instances will necessarily be rare ( Taylor v Pace) , section 51 orders may be made to avoid the injustice of an individual director hiding behind a corporate identity, so as to engage in risk-free litigation for his own purposes ( North West Holdings ). Such an order does not impinge on the principle of limited liability ( Dymocks , Goodwood , Threlfall ).

(d)  In order to assess whether the director was the real party to the litigation, the court may look to see if the director controlled or funded the company’s pursuit or defence of the litigation. But what will probably matter most in such a situation is whether it can be said that the individual director was seeking to benefit personally from the litigation. If the proceedings were pursued for the benefit of the company, then usually the company is the real party ( Metalloy ). But if the company’s stance was dictated by the real or perceived benefit to the individual director (whether financial, reputational or otherwise), then it might be said that the director, not the company, was the “real party”, and could justly be made the subject of a section 51 order ( North West Holdings , Dymocks , Goodwood ).

(e)  In this way, matters such as the control and/or funding of the litigation, and particularly the alleged personal benefit to the director of so doing, are helpful indicia as to whether or not a section 51 order would be just. But they remain merely elements of the guidance given by the authorities, not a checklist that needs to be completed in every case ( SystemCare ).

(f)  If the litigation was pursued or maintained for the benefit of the company, then common sense dictates that a party seeking a non-party costs order against the director will need to show some other reason why it is just to make such an order. That will commonly be some form of impropriety or bad faith on the part of the director in connection with the litigation (Symphony, Gardiner, Goodwood,Threlfall).

(g)  Such impropriety or bad faith will need to be of a serious nature ( Gardiner, Threlfall ) and, I would suggest, would ordinarily have to be causatively linked to the applicant unnecessarily incurring costs in the litigation.

In Goknur it was decided that the touchstones of funding of litigation and control of litigation are not enough to justify an NPCO being made against a director/shareholder: for a director/shareholder to be made liable there must be something more: which is either personal benefit or bad faith/ impropriety. Per paragraph 41:

Therefore, without being in any way prescriptive, the reality in practice is that, in order to persuade a court to make a non-party costs order against a controlling/funding director, the applicant will usually need to establish, either that the director was seeking to benefit personally from the company’s pursuit of or stance in the litigation, or that he or she was guilty of impropriety or bad faith. Without one or the other in a case involving a director, it will be very difficult to persuade the court that a section 51 order is just. Mr Benson identified no authority in which a section 51 order was made against the director of a company in the absence of either personal benefit or bad faith/impropriety. Conversely, there is no practice or principle that requires both individual benefit and bad faith/impropriety on the part of the director in order to justify a non-party costs order. Depending on the facts, as the authorities show, one or the other will often suffice.

Bad faith and impropriety are readily understood concepts, although again there can be problems in their application to a particular case. Usually one looks for something akin to abuse of process: the use of litigation for improper means. The fact that litigation has failed, or there has even been negligence or a mistaken belief in the strength of a company’s case, is usually not enough.

The alternative factor is that of personal benefit. It is sometimes argued that a director/shareholder will personally benefit from litigation if they derive a salary or dividends from the company, or will see the value of their shareholding increase, or by reason of the litigation hope to avoid the insolvency of the company. None of these factors amount to a personal benefit. As the Court of Appeal further noted:

Furthermore, from a practical perspective, I consider that the judge was right to focus on the possibility of personal benefit to Mr Aytacli: the authorities demonstrate that this is potentially a very significant matter. Mr Benson accepted that proposition during the hearing. A director who is controlling and funding the litigation to help preserve the company or advance its legitimate interests cannot usually be said to be seeking to gain personally from the litigation. He or she is merely doing what their duties as a director require them to do. Conversely, the director who is looking for a personal windfall from the litigation, or is seeking to preserve his personal position or reputation, knowing that the company has no money to pay the other side’s costs if they lose, is vulnerable to an order under section 51 , because he or she is “the real party” to the litigation. The question therefore becomes: on the facts, which side of the line was Mr Aytacli?

(emphasis added)

The prospect of recovering money owed to the company in litigation, which then becomes part of the company’s assets is not a personal benefit to the director or shareholder. It is a benefit to the company and is capable of being used by the company to pay trade creditors, to pay the HMRC or other public authorities, to pay overheads, or staff salaries and forms part of the “pot” of company assets. Whether payment might then be paid to the director/shareholder out of an increased pot of company assets, does not detract from both any recoveries in the litigation, and the “pot” itself being both company money.

As the country continues to slide into the economic pit, I predict that more companies will lapse into insolvency, there will be more litigation rather than less, and this in turn in exorably, will lead to more applications against directors at the end of failed litigation.


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