FIFO Cannot Extinguish Concealed Transfers Outside the Agreed Running Account

1. Introduction

This decision concerns a director’s liability for concealed transfers of company money to another company in which he held an interest. Its central contribution is to explain why the “first in, first out” allocation of payments cannot automatically extinguish liabilities arising from transactions deliberately kept outside the parties’ known running account.

PHLO Technologies Limited, an online pharmacy business, sought compensation from its founder and former chief executive for payments to Universal Pharmacy Limited (“UPL”). The defender maintained that the transfers supported financing arrangements essential to PHLO’s survival. Alternatively, he argued that subsequent payments from UPL had extinguished the relevant debts under the rule in Clayton's case.

Lord Richardson rejected those arguments. The defender had used his payment powers for UPL’s benefit, acted dishonestly in concealing the transactions, and failed to establish that PHLO had received corresponding value. The court awarded £1,756,998 and expenses.

The action formed part of wider litigation concerning PHLO’s control and leadership. The defender’s disputed removal as a director was not determined here. Earlier opinions, [2025] CSOH 55 and [2026] CSOH 62, supplied procedural background rather than the substantive basis of this decision.

2. Material Facts and Evidential Background

The companies’ financial relationship

PHLO originated as a technology spin-out from UPL, an established pharmacy business. The companies initially shared resources, and UPL provided funding while PHLO developed its software and business.

A November 2019 agreement provided PHLO with a £700,000 revolving loan facility. The defender also produced an agreement said to have increased that facility to £1.5 million in June 2021, with substantially higher facility fees. PHLO’s other relevant witnesses had not known of that variation. Nevertheless, PHLO ultimately quantified its claim on the assumption that the variation was valid and did not pursue its challenge to it. The court therefore did not need to invalidate the variation to find the defender liable.

The disputed transfers

Between 4 August 2022 and 30 March 2023, the defender instructed transfers through PHLO’s Tide account:

These figures serve different purposes. The award represented the disputed outgoing payments to UPL, not merely the transfers into Tide or the entire balance ultimately owed by UPL.

Exclusive access and concealment

The defender alone could access and inspect PHLO’s Tide account during the relevant period. That account was not linked to PHLO’s Xero accounting system. Repeated requests from senior finance staff for statements and access were unsuccessful.

In December 2023, the defender supplied a falsified statement showing a balance of £1,737,999 at 31 March 2023. The true balance was zero. He admitted altering the statement, explaining that disclosure of PHLO’s true position would have endangered further funding.

There was also evidence from three witnesses concerning admissions made in July 2024. Although the precise language was disputed, the evidence described acknowledgments of wrongdoing, references to personal debts or UPL’s debts, and an undertaking to repay money. The court considered those accounts inconsistent with the defender’s later explanation that the payments had simply benefited PHLO.

The asserted financing justification

The defender said UPL had borrowed from Cubefunder for PHLO’s benefit and that the disputed transfers enabled UPL to service that borrowing. He also relied on an alleged guarantee by PHLO.

However, no relevant UPL bank statements, Cubefunder loan documentation concerning UPL, or copy of PHLO’s alleged guarantee was produced to substantiate that explanation. The accepted accounting evidence did not establish that the disputed payments reduced PHLO’s indebtedness to Cubefunder. UPL subsequently entered administration on 4 August 2025.

3. Summary of the Judgment

• Section 171(a): PHLO did not establish that making the payments breached its constitution merely because there had been no separate board decision approving them.
• Section 171(b): The defender exercised his payment powers for an improper purpose: promoting UPL’s economic interests rather than PHLO’s.
• Section 172: The defender breached his duty to act in good faith to promote PHLO’s success. Deliberate concealment and falsification were objectively dishonest.
• FIFO: Subsequent payments from UPL did not presumptively extinguish the concealed transfers. Those transfers had been kept outside the known intercompany account.
• Loss: The defender failed to establish that PHLO had received corresponding value or otherwise suffered no loss.
• Section 1157: Relief was unavailable because the defender had not acted honestly or reasonably.

The court granted decree for £1,756,998 and awarded PHLO the expenses of the action.

4. Legal Reasoning

A. Authority to make payments is distinct from a proper purpose

PHLO argued that its articles required the payments to be approved either by a majority at a board meeting or through the prescribed unanimous decision-making procedure.

Lord Richardson rejected that argument. The articles conferred general management powers, and the company’s established practice placed responsibility for making payments principally with the defender. There was no evidence that separate board approval had ordinarily been required before he exercised that operational function.

The distinction is important:

• Section 171(a) asks whether the director acted within the company’s constitutional framework.
• Section 171(b) asks whether an available power was exercised for the purpose for which it was conferred.

Thus, the existence of banking authority did not determine whether the transfers were lawful exercises of that authority. Equally, the judgment does not require a board resolution for every payment made by a company director.

B. The substantial purpose was to benefit UPL

The court applied the four-stage proper-purpose analysis: identify the power, identify its proper purpose, ascertain the substantial purpose for which it was actually exercised, and decide whether that purpose was proper.

The relevant power was the ability to operate PHLO’s accounts and deal with its assets. Its proper purpose was to advance PHLO’s commercial interests and survival.

The defender’s explanation failed against the financial evidence. During the relevant period, UPL became increasingly indebted to PHLO. The transfers therefore appeared to create an expanding loan to UPL, without the contractual protections governing lending in the opposite direction. That pattern contradicted the suggestion that PHLO was merely repaying funding supplied for its own benefit.

Concealment reinforced that conclusion. If the arrangements genuinely served PHLO, the defender had not adequately explained why its finance staff and other directors were denied accurate information. His December 2023 funding explanation did not account for concealment extending back into 2022.

The July 2024 admissions and agreement to repay provided further support. On the balance of probabilities, the court found that the payments promoted UPL’s economic interests. It was that affirmative finding, rather than missing documents alone, which established the improper purpose.

Personal enrichment was not essential to liability. The finding that the defender diverted PHLO’s resources for UPL’s benefit was sufficient; the court did not need to establish the ultimate personal destination of the money.

C. Good faith requires objectively honest conduct

Section 172 ordinarily focuses on what the director genuinely considers would promote the company’s success. However, the court held that the statutory requirement of good faith also demands honesty.

The analysis therefore involved two questions:

1. What facts did the defender know or believe at the time?
2. Was his conduct honest when assessed against the standards of ordinary decent people?

Lord Richardson doubted whether the defender’s professed belief could be reconciled with his contemporaneous conduct. Nevertheless, he did not need finally to resolve whether that belief was genuinely held. Even assuming it was, concealing the transactions and falsifying the bank statement were objectively dishonest. The section 172 defence therefore failed.

The court also gave an alternative reason. Beyond general assertions, there was no evidence that the defender actually considered PHLO’s interests when making the 26 payments. Applying the objective approach associated with Charterbridge Corp Ltd v Lloyds Bank Ltd, an intelligent and honest director could not reasonably have regarded the increasing unsecured lending to UPL as beneficial to PHLO in the circumstances established.

This does not convert section 172 into a general judicial review of commercial wisdom. The objective alternative was engaged by the absence of demonstrated consideration of PHLO’s interests, while the principal reasoning concerned dishonesty.

D. FIFO depends on the parties’ agreement and intention

The accounting experts agreed that, if all transactions were combined retrospectively and FIFO applied, the disputed payments would have been extinguished by 12 December 2023. Their disagreement concerned whether that allocation was legally appropriate.

The court treated FIFO as a presumption grounded in the parties’ express or implied agreement about their account—not an automatic mathematical rule applicable to every transfer between two companies.

There was no express allocation of later payments to the concealed transfers. Nor could the surrounding circumstances support an implied agreement. PHLO’s relevant finance staff and other directors did not know the transfers had occurred; the transactions were consequently absent from the contemporaneous intercompany ledger.

The defender’s concealment had separated those payments from the known running account. Later receipts could not simply be presumed to discharge debts which PHLO had neither knowingly included in that account nor agreed should be treated in that way.

The court distinguished this position from an ordinary single running account in which a party may temporarily lack knowledge of every entry but has nonetheless agreed to the account’s operation. The decisive feature was deliberate exclusion from the agreed accounting relationship, not mere momentary ignorance.

PHLO’s later reconstruction of a complete ledger did not change the result. Recording the full indebtedness after discovery, including in the 2025 financial statements, could not retrospectively create an intention about appropriation in 2023.

E. Restoration of the misapplied value

The court applied the restorative approach to compensation for misapplied company property. Where the property cannot itself be returned, the objective is to restore its value to the company. The defaulting director bears the burden of establishing that the breach nevertheless caused no loss.

The defender failed to prove that the payments discharged PHLO’s obligations, delivered equivalent benefits, or had been repaid through a legally effective appropriation. The accepted expert analysis likewise did not establish that the disputed transfers reduced PHLO’s Cubefunder indebtedness.

The award therefore equalled the £1,756,998 transferred to UPL. PHLO’s separate accounting recognition of a debt owed by UPL did not itself establish that the company had recovered the value diverted by the defender.

F. Statutory relief could not excuse dishonest conduct

Section 1157 permits relief only where the officer acted honestly and reasonably and ought fairly to be excused in all the circumstances.

The defender failed the honesty requirement because of the concealment and falsified statement. He also failed to establish reasonableness: transferring money for another company’s benefit without a regulated and secured lending framework could not reasonably be justified on the evidence.

The broad operational payment power recognised under section 171(a) did not validate those particular transactions or satisfy the separate requirements for discretionary relief.

5. Precedents and Other Authorities

Proper purpose and directors’ good faith

Extrasure Travel Insurances Ltd v Scattergood and anr [2003] 1 BCLC 598

This supplied the four-stage proper-purpose test expressly adopted by the court. It also supported the distinction between identifying the director’s actual motives and objectively assessing whether the resulting purpose was proper. Dishonesty is not a necessary ingredient of every section 171(b) breach.

Howard Smith Ltd v Ampol Petroleum [1974] AC 821

PHLO cited this authority for identifying the dominant or primary purpose behind an exercise of directors’ powers. Its significance lay in directing attention beyond the formal availability of a payment power to the substantial reason for using it. The court’s operative analysis followed the more explicitly structured Extrasure Travel Insurances Ltd v Scattergood and anr approach.

Saxon Woods Investments Ltd v Costa [2025] BCC 902

Lord Richardson expressly agreed with the English Court of Appeal’s analysis of honesty within section 172. It supported the two-stage inquiry into the director’s factual beliefs and the objective honesty of the conduct. This was central to holding that a professed company-saving motive could not make deliberate falsification good faith.

Charterbridge Corp Ltd v Lloyds Bank Ltd [1970] Ch 62

This supplied the alternative objective test where actual consideration of the company’s interests was not demonstrated: whether an intelligent and honest director could reasonably have believed the transaction benefited the company. The court applied it to the increasing unsecured exposure to UPL, not as an unrestricted substitute for section 172’s subjective language.

Appropriation of payments and running accounts

Clayton's case

The judgment discussed the familiar presumption that the earliest credit in a running account discharges the earliest debit. It rejected the defender’s attempt to treat that presumption as necessarily governing all transactions once accountants assembled them in a single retrospective ledger.

Macdonald, Fraser & Co v Cairn's Exrs 1932 SC 699

PHLO relied on this Scottish authority’s approval of Bell’s account of appropriation. Where neither party allocates payments, the law ordinarily applies them in order, especially in an account current. But a different arrangement or course of dealing can displace that presumption. This qualification was fundamental to the court’s reasoning.

Docklock Limited v Christo & Co Limited [2024] EWCA Civ 45

The defender relied on this case to show that running accounts are not confined to banking and involve agreement that individual transactions will not be separately settled. Lord Richardson accepted that general account of the relationship. Its emphasis on agreement, however, undermined the proposed inclusion of deliberately concealed transactions.

Lacey v Hill (1876) 4 Ch. D. 537

This was the closest factual analogy. A partner had concealed withdrawals through fictitious accounting entries and subsequently made ordinary payments into the partnership account. The English Court of Appeal rejected an attempt to use FIFO to treat those later payments as clearing the hidden withdrawals.

Lord Richardson applied the same reasoning here. Ordinary credits to a known account do not presumptively repair concealed diversions excluded from it. Importantly, the quoted reasoning recognised that a specific repayment, knowingly appropriated to the concealed withdrawal, would be different. The decision therefore does not make genuine repayment legally impossible.

Bradford Old Bank v Sutcliffe [1918] 2 KB 833

PHLO cited this for the proposition that separate bank accounts remain separate running accounts rather than automatically merging. It supported PHLO’s resistance to retrospective aggregation, although Lord Richardson’s conclusion principally rested on concealment, intention and the analogy with Lacey v Hill.

Jackson v Nicoll (1870) 8 M 408

PHLO relied on this authority against retrospective alteration of payment attributions. The court’s conclusion was consistent with that submission: rebuilding the ledger after discovery did not change the parties’ earlier intentions or create an appropriation that had not existed.

Compensation for misapplied assets

Mitchell v Al Jaber [2025] 3 WLR 849

This UK Supreme Court authority supplied the controlling remedial framework: restore the misapplied property or its value, with the defaulting fiduciary bearing the burden of explaining why no loss resulted. It placed the evidential consequences of the unproved benefit and repayment explanations on the defender.

Re Loquitur Ltd [2003] 2 BCLC 442

PHLO cited this in support of compensation measured by the depletion of company cash where payments made in breach of duty yield no corresponding value. It supported PHLO’s quantification, although the court’s final reasoning focused particularly on the Supreme Court framework and the following Court of Appeal authority.

Auden McKenzie (Pharma Division) Limited v Patel [2020] BCC 316

Lord Richardson expressly regarded the award as consistent with this analogous authority. Its importance was the recognition that payments made in breach of duty, without corresponding value to the company, can justify compensation equal to the amount paid away.

Relief from liability

Gillespie Investments Limited v Gillespie [2010] CSOH 113

This Scottish decision identified the requirements of honesty, reasonableness and fairness under section 1157. Lord Richardson referred to it when concluding that the defender’s application failed at the first hurdle and also failed on reasonableness.

In Re Duomatic Ltd [1969] 2 Ch 365

The defender invoked its formulation of reasonable conduct by a person of affairs exercising appropriate care and circumspection. Here it was cited on statutory relief, not as the basis for a ruling on informal shareholder approval.

PNC Telecom plc v Thomas (No 2) [2007] EWHC 2157

This was cited as applying the same reasonableness standard. It did not assist once the defender failed to establish honesty and reasonable justification for the payments.

Textbook materials and the missing documents

Bell's Principles, section 536, was important to the agreement-based explanation of appropriation. Palmer was cited by the defender on proper purpose and business judgment, while Walker, Civil Remedies supported PHLO’s submission concerning its remedy against the fiduciary.

Phipson on Evidence, paragraph 45-36, arose in a significant evidential ruling. PHLO sought an adverse inference from the missing UPL statements, but the court refused it. The evidence did not sufficiently establish that the defender had access to the documents and was responsible for their absence, particularly following UPL’s administration.

That refusal did not make the defender’s explanation persuasive. It preserved an important distinction: absence of supporting evidence can leave an assertion unproved without justifying an inference that documents were deliberately withheld because they were damaging.

6. Significance and Potential Impact

Limits on retrospective accounting defences

The judgment demonstrates that an arithmetically correct reconciliation does not necessarily answer a legal question about repayment. A reconstructed ledger may establish overall indebtedness without establishing that later credits discharged particular concealed liabilities.

Future disputes involving manipulated accounts will therefore require attention to the contemporaneous accounting relationship: what was known, what was included, and what allocation the parties expressly or impliedly accepted.

Protection against misuse of related-company arrangements

Close commercial links, shared founders and a history of reciprocal financing do not eliminate the need to justify transactions by reference to the interests of the particular company whose assets are used. An asserted benefit to the wider business relationship requires evidential support.

The decision also confirms that diversion for another company’s benefit may establish liability without proof that the director personally retained the money.

Honesty remains distinct from commercial optimism

A director cannot answer objectively dishonest conduct merely by asserting that it was intended to save the company. Accurate disclosure and genuine consideration of the company’s position remain legally significant even during financial pressure.

Expert evidence cannot determine the legal account

The experts largely agreed on the calculations. The decisive issue was whether the legal premise for FIFO existed. This illustrates the proper division between expert assistance on financial reconstruction and judicial determination of intention, appropriation and liability.

The court also distinguished between the defender’s expert reports: the first report was not adopted in evidence. Its existence did not supply proof of propositions which the admitted evidence failed to establish.

Limits of the precedent

As an Outer House judgment, this is first-instance Scottish guidance applying established authorities, rather than an appellate creation of a wholly new doctrine. Its significance lies in their application to concealed intercompany transfers and a director’s compensation liability.

It does not prohibit FIFO in ordinary intercompany accounts, make every undisclosed transaction permanently incapable of repayment, or establish a general requirement for individual board approval of operational payments. Nor did it resolve the wider directorship dispute or determine a separate doctrine governing creditor interests on insolvency.

7. Complex Concepts Simplified

Fiduciary duty

A duty arising from a position of trust. A director must use entrusted powers for the company, not divert them to an improper beneficiary.

Proper purpose

Having permission to use a power does not mean it may be used for any objective. Authority to operate an account is not permission to favour another company.

Running account

A continuing financial relationship in which transactions are treated together rather than each being separately settled.

Appropriation or ascription

Allocating a payment to a particular debt where several debts exist.

FIFO

“First in, first out”: ordinarily, the oldest outstanding debit is discharged by the next credit. It is a rebuttable allocation rule, not an inevitable result of spreadsheet ordering.

Subjective belief and objective honesty

The court asks what the director actually believed, but assesses the honesty of the conduct against ordinary standards. A claimed beneficial motive does not automatically excuse deception.

Restorative compensation

Compensation intended to replace the property or value improperly removed, rather than punish the director.

Decree and expenses

In Scottish procedure, decree is the court’s formal judgment; expenses are litigation costs.

8. Conclusion

The judgment’s central principle is that a director cannot use FIFO mechanically to erase concealed transfers that were kept outside the parties’ agreed running account. Later reconstruction does not retrospectively supply the missing agreement or appropriation.

The decision also carefully separates operational authority from proper purpose, genuine belief from honest conduct, and accounting indebtedness from actual restoration. On the evidence, the defender’s transfers benefited UPL, breached sections 171(b) and 172, and caused PHLO a compensable loss of £1,756,998. Deliberate concealment and falsification foreclosed relief under section 1157.