Oldham v Katz [2018] EWHC 540 (Ch): administrators, misfeasance and funding arrangements with officeholders

Judgment on BAILII at: http://www.bailii.org/ew/cases/EWHC/Ch/2018/540.html

Background

MK Airlines Ltd (“MKA”) entered into administration in June 2008. The Appellant was one of three individuals appointed as administrators (“the Administrators”).

A prospective purchaser was found, Transatlantic Aviation Ltd (“TAA“), which wished to maintain MKA as a going concern so as to acquire its Civil Aviation Authority certificates. TAA agreed to fund the administration and the continuation of MKA as a going concern. Millions of dollars were paid by TAA into MKA’s bank account in accordance with that agreement. Of that money, £853,000 was drawn by the Administrators to pay their remuneration and disbursements.

MKA later went into liquidation and the Respondents were appointed as liquidators. They brought a claim against the Appellant on the basis that the Administrators had used MKA funds to pay their own remuneration in a manner that was inconsistent with the statutory priority rules (the claim was brought against the Appellant only due to a previous settlement with the other Administrators).

First instance decision

At first instance, Registrar (now ICC Judge) Derrett held that once TAA paid money to MKA, that money was an asset of MKA and therefore had to be distributed in accordance with the statutory scheme. In this instance, £853,000 was not used to pay the expenses of the administration but to pay the Administrators’ remuneration. That was inconsistent with the statutory scheme. Such (mis)use of MKA funds amounted to a breach of duty for which the Appellant was liable.

The Appellant appealed.

The decision on appeal

Sarah Worthington QC (sitting as a deputy High Court Judge) held as follows.

It is, of course, the case that administrators must apply a company’s assets in accordance with the statutory priority rules (which require expense creditors to be paid before the administrators’ remuneration). However, that only applies to company assets. It does not prevent third parties from providing new money to be used for specific purposes (provided that does not worsen the position of any existing creditor): at [85] – [86].

The terms on which TAA provided the money to MKA were that the Administrators would be paid first out of the fund (i.e. before expenses creditors): at [97].

The money was paid by TAA to MKA in order to pay the Administrators’ remuneration (a perfectly legitimate way of funding an administration as aforesaid). If the money had been paid into a segregated bank account then there could be no allegation of misfeasance in relation to payment of remuneration. Therefore, it follows that one would expect the same result if the money was not paid into a segregated bank account and was mixed with general company funds: at [112].

In short, MKA (or, strictly speaking, the expense creditors) suffered no loss (alternatively, there was no breach of duty).

 

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Burnden v Fielding [2018] UKSC 14: directors’ duties and limitation

Judgment on BAILII at: http://www.bailii.org/uk/cases/UKSC/2018/14.html

A significant Supreme Court decision relating to claims brought against directors.

Background

The Respondent, Burnden Holdings (UK) Limited (“the Company”), was a holding company for various trading subsidiaries. The Appellants were directors of the Company.

On 12 October 2007, the sole share in one of the trading subsidiaries was distributed in specie to another company which the Appellants controlled, for no consideration.

The Company subsequently went into liquidation. The Company (acting by its liquidators) brought a claim against the Appellants for breach of duty, i.e. for transferring a valuable asset for no consideration.

The claim was issued more than 6 years after the date on which the share was transferred. The Appellants claimed that they were entitled to rely on section 21(3) of the Limitation Act 1980 (“LA 1980”), which provides that there be a six-year limitation period for actions against trustees. The Company argued that the case fell within section 21(1) LA 1980, thus extending the limitation period indefinitely.

The Appellants applied for summary judgment application and, on the “assumed fact” that they breached their duties as directors, won at first instance. The Company successfully appealed to the Court of Appeal. The Appellants appealed to the Supreme Court.

The law

Section 21 LA 1980 provides as follows (emphasis added).

“(1) No period of limitation prescribed by this Act shall apply to an action by a beneficiary under a trust, being an action –

(a) in respect of any fraud or fraudulent breach of trust to which the trustee was a party or privy; or

(b) to recover from the trustee trust property or the proceeds of trust property in the possession of the trustee, or previously received by the trustee and converted to his use.

…

(3) Subject to the preceding provisions of this section, an action by a beneficiary to recover trust property or in respect of any breach of trust, not being an action for which a period of limitation is prescribed by any other provision of this Act, shall not be brought after the expiration of six years from the date on which the right of action accrued. For the purposes of this subsection, the right of action shall not be treated as having accrued to any beneficiary entitled to a future interest in the trust property until the interest fell into possession.”

It was common ground that for the purposes of section 21 LA 1980 a director is treated as a trustee and that a company is treated as a beneficiary. Accordingly, it was further common ground that where a director has (in breach of duty) directly received company property, (s)he is to be regarded as either being in possession of trust property or having received trust property “and [having] converted [it] to his use” within the meaning of section 21(1)(b) LA 1980, thus extending the limitation period beyond 6 years.

Discussion

However, the issue in Burnden was that the Appellants had not directly received company property. They had instead transferred company property to another company they controlled. Thus, the Appellants argued, the claim against them was not: (i) a claim to recover trust property in their possession (as the company they controlled was in possession); or (ii) to recover the proceeds of trust property previously received by them and converted to their use (as it was never received by them, it was received by the company they controlled).

This would appear to be a rather compelling argument, relying on the basic company law principle that a company has a separate legal personality to its directors and that company property is held by the company, not by its directors.

The Supreme Court did not agree. Lord Briggs gave the unanimous judgment of the Court, which can be summarised as follows.

The purpose of section 21 LA 1980 is to give a trustee the benefit of the lapse of time in respect of a legal or technical wrong but not to protect him or her where (s)he would otherwise “come off with something he ought not to have, ie, money of the trust received by him and converted to his own use”: at [17].

In the corporate context, “directors are to be treated as being in possession of the trust property from the outset” because they “are the fiduciary stewards of the company’s property”: (at [18], emphasis added).

Accordingly, as in this case, where a director transfers property to a company which (s)he controls then: (i) the director will have previously received the property as (s)he will have been the fiduciary steward of the company’s property during his/her time in office; and (ii) in transferring the property to a company (s)he controls, the director will have converted that property to his own use. In short, there will be no limitation period.

This is an important case for liquidators, even if it does seem slightly artificial to describe a director has having “received” company property simply by virtue of his or her directorship. Where (as is common) directors transfer property to companies in which they have an interest, there will be no limitation period for breach of duty/ misfeasance claims.

 

Ve Vegas v Shinners [2018] EWHC 186 (Ch): officeholder conflicts of interest and removal of administrators

Judgment on BAILII at: http://www.bailii.org/ew/cases/EWHC/Ch/2018/186.html

Ve Interactive Limited (“the Company”) was a company involved in providing e-commerce services. It entered into administration and the Respondents, members of Smith & Williamson LLP (“S&W”), were appointed as administrators. The Company’s business and assets were sold by way of a “pre-pack” sale to a company controlled by the Company’s directors for the sum of £1,750,000.

The Applicants were creditors of the Company. They applied for the Respondents to be removed so that new administrators could consider whether the Company’s former directors or the Respondents were guilty of misfeasance in relation to the pre-pack sale, which was alleged to be at an undervalue.

Midway through the hearing, the Respondents indicated that they would resign on the grounds of conflict of interest.

Although the Respondents indicated that they would resign, Registrar Jones gave a reasoned decision. He held as follows.

When such an application is made (for removal on the grounds of conflict of interest), the court needs to decide whether there is a “serious issue for investigation”: at [18]. Removal may be ordered if an independent review cannot be carried out because of conflict: Clydesdale Financial Services Ltd v Smailes [2009] BCC 810 at [30]

In this case, there were two competing explanations as to what happened (though the truth could be somewhere in between). First, that the Company’s dire financial position and deficient books and records meant that the directors and the Respondents did the best they could in the circumstances and/or in any event achieved the best possible price under the pre-pack sale. Second, and alternatively, that the Company’s directors took advantage of their position as directors to exclude others from a realistically competitive pre-pack process thus enabling the company they controlled to agree a pre-pack purchase on terms at an undervalue: at [20].

The second possible explanation (which was not baseless) made it clear there was a serious issue for investigation: at [22].

It is worth quoting in full the following passages from the judgment as officeholders should bear these words in mind.

“[24]. It should have been apparent to the Respondents that those inquiries would or might need to consider whether S&” ought to have: provided different advice; ensured a better marketing and sale process; intervened to prevent or mitigate the actions of the directors.

[25] In my judgment the Respondents ought to have concluded, effectively from the date of their appointment or soon thereafter, that they as members of S&W were conflicted and could not carry out those investigations. S&W were inextricably bound up in the process by reason of their contractual retainer and, therefore, so were the Respondents. This is not technical legal analysis. It is obvious.

[26] That does not necessarily mean they should have resigned from their appointments. It may be (but for the resignations) there were alternative solutions. For example, the appointment of an additional administrator or replacement by only two new administrators who would be specifically and only responsible for the investigations.

[27] However, whatever the practical steps which should have been taken, it is clear the Respondents did not (properly) appreciate that conflict of interest until their notice of intention to resign. That is clear from: the events leading up to the hearing of the Application including their continued failure to draw (adequate) attention to the conflict and to deal with it; their continuous opposition to the Application until day 5; their attacks upon the Applicants in the evidence; the evidence of Mr Shinners and Mr Hardman in particular under cross-examination; and the terms of the intention to resign notice itself.

….

[29] The correct position is that the conflict and its consequences ought to have been readily apparent to them at all material times following their appointments. They ought not to have opposed the Application except to the extent that they raised with the Court alternative solutions which might result in them (or some of them) remaining in office whilst investigations were carried out by independent parties. They ought to have raised the problem of conflict with the creditors’ committee in a positive manner and sought directions from the Court insofar as matters could not be resolved or it was otherwise appropriate to do so.

[30] It is to be emphasised that administrators, undisputed creditors and shareholders (to the extent they hold an interest) should be working together to achieve the purpose of the administration. It was in the interests of the Company to identify whether claims exist which might replenish its estate including claims against the Respondents. That was the interest of the Respondents, as administrators. This could not be said to be a case for which there is no possible merit in the claims or other justification for not pursuing investigations which the Respondents could not themselves carry out because of conflict. The Respondents do not suggest a deficiency of funds or that it is not in the interests of creditors that investigations should not be pursued. Their resignations impliedly accept there is no commercial or other reason for not pursuing investigations.

[31] The Respondents’ failure to approach this matter correctly persuaded me that I should remove them as administrators and not wait until their resignation took effect to appoint replacement administrators. The Respondents were ready to hand over the

Bakhshiyeva v Sberbank [2018] EWHC 59 (Ch): CBIR 2006, recognition orders and the “rule” in Anthony Gibbs

Judgment on BAILII at: http://www.bailii.org/ew/cases/EWHC/Ch/2018/59.html

OJSC International Bank of Azerbaijan (“IBA“) is the largest commercial bank in Azerbaijan. It fell into financial difficulties and entered into a restructuring proceeding under Azeri law. The Applicant was appointed as IBA’s foreign representative and successfully applied to the English court for an order, pursuant to the Cross-Border Insolvency Regulations 2006 (“CBIR 2006”), recognising the Azeri restructuring as a foreign main proceeding.

The effect of a CBIR 2006 recognition order is to impose a wide-ranging moratorium preventing creditors from commencing or continuing any action against IBA or its property without the permission of the court.

IBA and its creditors agreed a wide-ranging restructuring plan as part of the Azeri restructuring process, which was to have the effect of discharging IBA’s existing liabilities (in return for the creditors acquiring a suite of new economic rights against IBA).

However, the Respondents were creditors of IBA pursuant to contracts governed by English law. According to the “rule” in Anthony Gibbs (1890) LR 25 QBD 399, a debt governed by English law cannot be discharged by a foreign insolvency proceeding. In other words, so far as the English court was concerned, the debts owed to the Respondents (arising out of contracts governed by English law) continued to subsist and the Respondents could obtain judgment and enforce against assets in this jurisdiction (once the CBIR 2006 moratorium had come to an end).

The rule has been subject to sustained academic criticism for being (essentially) anachronistic and Anglo-centric. Thus, the Applicant proposed a “procedural solution” to (what was said to be) the problem posed by the rule in Anthony Gibbs.

The Applicant applied for an order that the moratorium imposed by the CBIR 2006 be extended indefinitely. It was said that this was a power the court possessed under the CBIR 2006. It was argued that such an order would mean that: (i) the rule in Anthony Gibbs would be formally adhered to (as there would be no discharge of the debt); but (ii) the application of the rule would be much circumscribed as a permanent moratorium would act as a procedural bar preventing the Respondents from enforcing their claims. The Applicant argued that such an order would be appropriate in light of the principle of “modified universalism” (i.e. the idea that in relation to corporate insolvency the English court should strive to administer the estate of an insolvent company in the spirit of international comity).

Hildyard J held as follows.

Although the Applicant might claim that the relief sought (i.e. a permanent moratorium) was purely procedural, it was not. In practical terms, such an order would effectively discharge the Respondent’s substantive rights under the English law contracts. The provisions of the CBIR 2006 do not allow the English court to vary or discharge such substantive rights (particularly given the well-established rule in Anthony Gibbs). As a result, the court had no jurisdiction (in the strict sense) to make the order sought: at [146] and [147].

In any event, if the court did have jurisdiction in the strict sense, the Judge would not exercise his jurisdiction to make the order sought. That was for five reasons: at [158].

First, the rule in Anthony Gibbs was binding on the court and it was not appropriate to permit its practical abrogation by procedural means.

Second, any substantive alteration of English contractual rights ought to be sanctioned by some substantive provision of English law (common law or statute) not by procedural side-stepping.

Third, although the Judge understood the criticisms of the rule in relation to the collection and distribution of assets (i.e. liquidation), it was not clear that the criticism of the rule had such force in relation to corporate restructuring (as in this case), which involved the variation or substitution of contractual rights. Where such contractual rights were governed by English law, it was not clear that the principle of modified universalism had the same application.

Fourth, in the context of a restructuring rather than an insolvency, the Judge would be hesitant to to remove or vary individual rights for the greater good and in the name of universalism.

Fifth, IBA could have sought to promote a parallel scheme of arrangement in England which would, if approved by creditors and sanctioned, have overcome the rule in Anthony Gibbs (which, in fact, has become the usual course).

Cherkasov v Olegovich [2017] EWHC 3153 (Ch): recognition orders and public policy

Judgment on BAILII at: http://www.bailii.org/ew/cases/EWHC/Ch/2017/3153.html

The Respondent was the official receiver (i.e. liquidator) of a Russian company called Dalnyaya Step LLC (“DSL”). The English court had granted him a recognition order pursuant to the Cross-Border Insolvency Regulations 2006 (“CBIR 2006”).

The Applicants were individuals connected to the Hermitage Group, a group which had previously invested in Russian companies so as to (apparently) shed light on alleged corruption in order to drive up the share price. This had been strongly opposed by the Russian state. The Applicants had been expelled from Russia and their lawyer, Sergei Magnitsky, imprisoned. He subsequently died in custody. This led to the US Congress implementing specific prohibitions against those connected to Mr Magnitsky’s death (the so-called “Magnitsky Act”).

It did not end there. The Russian state alleged that the Applicants had been guilty of criminal activity and sought assistance in the form of information and documents from the UK authorities. The UK government declined to provide assistance on public policy grounds. The Russian courts sentenced the Applicants (or at least one of them) to significant prison sentences in their absence.

Upon the granting of the recognition order, the Respondent brought an application pursuant to section 236 of the Insolvency Act 1986 against the Applicants for the provision of documents and information (essentially the same information previously sought by the Russian state and declined by the UK).

There was a fair amount of procedural wrangling. The Applicants sought to set aside the recognition order of the basis of the Respondent’s alleged breach of his duty of full and frank disclosure (for failing to disclose the broader political context). The Respondent agreed to withdraw the section 236 application, terminate the recognition order (though not on the basis of a failure to disclose) and pay the Applicants’ costs on the indemnity basis.

Given the unusual background, and the fact that the parties had agreed the substantive outcome (namely, that the recognition order was to terminate and the Respondent was to pay the Applicants’ costs) the court had to answer two questions: (i) whether it should even entertain a hearing to decide whether the Respondent breached his duty of full and frank disclosure ; and (ii) if so, whether the Respondent did in fact breach his duty of full and frank disclosure.

The Chancellor held as follows.

It was appropriate to entertain the hearing because it was in the public interest to do so. It would not be appropriate to simply terminate the recognition order if in reality the Respondent had been in breach of his duty of full and frank disclosure. It appeared that the Russian state was not prepared to accept “no” for an answer regarding requests for assistance and the recognition order was related to that. There were serious allegations of wrongdoing, the UK government had already made clear its view about connected aspects of the case and in those circumstances the court simply could not stand by: at [76] – [81].

As to the merits of the alleged (non) full and frank disclosure. It was wrong to say, as the Respondent did, that full and frank disclosure was only necessary in relation to the consequences that automatically flow from the recognition order itself (as opposed to what might or might not happen thereafter, such as the section 236 application): at [86].

In this case, the Respondent always intended to make the section 236 application. He knew the Applicants would say that it was political. He “knew or ought to have known that UK public policy issues would be raised by his request for the recognition order and the steps that he intended to take in consequence of it. He ought to have given the court the opportunity to consider [public policy matters]”: at [87]. Even if the Respondent had not sought termination of the recognition order, the court would have set it aside: at [90].

Premier Motorauctions v PwC [2017] EWCA Civ 1872: claims brought by companies in liquidation and security for costs

Judgment on BAILII at: http://www.bailii.org/ew/cases/EWCA/Civ/2017/1872.html

Premier Motorauctions and a wholly-owned subsidiary (“the Companies”) were car auction companies. In 2008, they were suffering financial difficulties. Lloyds Bank was their banking provider. PwC was engaged to conduct a review of the Companies’ cash-flow needs. The review identified a need for further finance, which was provided by Lloyds.

Despite the Lloyds financing, the Companies went into administration and two PwC partners were appointed as administrators. Their business and assets were disposed of by way of a “pre-pack” sale. The Companies subsequently went into liquidation.

Acting by its liquidators, the Companies brought proceedings against PwC and Lloyds alleging that: (i) PwC’s identification of the need for additional finance was fictitious and was done because they had conspired with Lloyds to create a situation whereby Lloyds would provide additional finance; (ii) the additional finance gave Lloyds effective control over the Companies; and (iii) the final stage of the conspiracy was to force the Companies into administration so that their business and assets could be sold at an undervalue for the benefit of Lloyds.

The Companies acquired ATE insurance. The insurance policies contained a provision that liability could be avoided for non-disclosure or misrepresentation. PwC and Lloyds issued applications for security for costs.

CPR r.25.13 provides (as far as is relevant) as follows.

“(1) The court may make an order for security for costs under rule 25.12 if,

(a) it is satisfied, having regard to all the circumstances of the case, that it is just to make such an order; and

(b) (i) one or more of the conditions in paragraph (2) applies …

(2) The conditions are:-

(c) The claimant is a company … and there is reason to believe that it will be unable to pay the defendant’s costs if ordered to do so.“

Before Snowden J, the Companies succeeded in opposing the application. Snowden J found that the Companies’ contractual rights under the ATE policies amounted to assets of the Companies and that, therefore, the existence of the policy could be taken into account. In relation to the risk of avoidance for non-disclosure or misrepresentation, he said that the evidence of the former majority shareholder was unlikely to be as central as suggested by PwC and Lloyd. In essence, he found that the risk of avoidance was slight and that in those circumstances he had no reason to believe the Companies would be unable to pay any costs if ordered to do so (because the insurer would pay out).

PwC and Lloyds appealed. As Longmore LJ said at [1], the issue before the Court of Appeal was “the extent to which the existence of After-the-Event (“ATE”) insurance is relevant when the court is considering an application for security for costs sought by the defendants in a claim brought by an insolvent company in liquidation.”

The Court of Appeal held as follows.

First, that the Judge was right that the existence of an ATE policy is, in principle, capable of being taking into account as an asset when considering whether a claimant would be unable to pay any costs if ordered to do so (at [24]).

Second, that the evidence of the former majority shareholder would be central to the resolution of the claim (at [27]). Therefore, the prospect of avoidance by the insurer was more than merely illusory (at [29]) and there was reason to believe that the Companies would be unable to pay the costs if ordered to do so (at [33]).

Third, given that the court had jurisdiction to order security for costs (as there was reason to believe that the Companies would be unable to pay the costs if ordered to do so) it should exercise its discretion to do so and order security in the sum of £4,000,000 (at [37] – [39]).

The takeaways for liquidators are as follows.

• The existence of ATE insurance obtained on behalf of a company in liquidation is capable of defeating an application for security for costs.
• However, in reality, whether ATE insurance will be sufficient depends on the terms of the insurance policy.
• Where the policy does not contain anti-avoidance provisions (and the prospect of the insurer seeking to avoid liability is more than merely illusory) it is likely that the court will order security for costs.

Where the policy does contain anti-avoidance provisions, it is possible (if not likely)

Ball v Hughes [2017] EWHC 3228 (Ch): directors’ duties, EBTs, unjust enrichment and the Duomatic principle

Judgment on BAILII at: http://www.bailii.org/ew/cases/EWHC/Ch/2017/3228.html

PV Solar Solutions Ltd (“the Company”) was in the business of supplying and installing solar panels. In September 2011, the government announced that feed in tariff rates (a form of government subsidy) for solar installations were to be reduced (that decision has spawned litigation of its own – see Breyer v DECC [2015] EWCA Civ 408).

In 2012, the Company’s directors (“the Directors”) procured the Company to enter into three transactions (“the Transactions”). The Transactions were complicated but the effect was to: (i) create a £750,000 debt from the Company to the trustees of an employer financed retirement benefit scheme (“EFRBT”, an employee benefit trust); (ii) assign the benefit of that debt from the trustees to the Directors; and (iii) set off an equivalent £750,000 previously owed by the Directors to the Company. In short, the Directors’ loan accounts were reduced by £750,000.

The Company later went into liquidation. Its liquidators (“the Liquidators”) brought a claim against the Directors alleging breach of duty in procuring the Transactions.

The Directors defended the claim on the basis that the Transactions were part of a “remuneration structure” and therefore legitimate payments to themselves.

Registrar Barber found as follows.

First, that the Company’s articles provided that directors could only be remunerated in accordance with an ordinary resolution passed by the Company’s members. There was no such resolution and therefore, to the extent that they represented remuneration, the Transactions breached the Company’s articles and the Directors acted in breach of duty in procuring them: at [140].

Second, that the Directors could not rely on the Duomatic principle because they did not apply their minds to ratifying the Transactions as remuneration: at [147]. It is questionable whether that conclusion is correct. The issue ought to have been whether the Directors ratified the Transactions at all, not whether they ratified the Transactions as remuneration. Given that the Directors were the only shareholders, it is hard to see how it could be said that they procured the Transactions but did not ratify them.

Third, and in any event, the Company was insolvent at the time of each Transaction and therefore the Duomatic principle had no application (the Duomatic principle does not apply at a time of insolvency or doubtful solvency because the interest of the creditors intrude): at [148].

Fourth, that the Directors’ argument that they were in any event entitled to remuneration pursuant to the law of unjust enrichment and as per HHJ Matthews in Global Corporate v Hale (discussed here) failed. Registrar Barber doubted the decision in Global Corporate for much the same reasons as previously discussed on this blog (essentially, that the House of Lords decision in Guinness v Saunders [1990] 2 AC 663 prevents a director from relying on the principles of unjust enrichment) but ultimately was able to distinguish the decision on the facts.

Having no defence to their breach of duty, the Directors were found liable in respect of the Transactions and ordered to repay the sum of £750,000 to the Company.

Re Agrokor DD [2017] EWHC 2791 (Ch): recognition of foreign insolvency proceedings

Judgment on BAILII at: http://www.bailii.org/ew/cases/EWHC/Ch/2017/2791.html

Agrokor DD (“the Company”) is the holding company of a Croatian conglomerate. The conglomerate accounts for approximately 15% of Croatian GDP.

In April 2017, the Croatian legislature passed the “Extraordinary Administration Law” (“the EA Law”), a law designed to facilitate the restructure of systematically important Croatian companies (but clearly designed with the Company in mind). The day after the EA Law was passed, the Company made a successful application to the Croatian court to enter extraordinary administration.

The Company’s administrator applied for recognition of the extraordinary administration as a “foreign proceeding” pursuant to article 15(1), schedule 1 of the Cross-Border Insolvency Regulations 2006 (“CBIR 2006”). Upon such recognition, the “commencement or continuation of individual actions or individual proceedings concerning the debtor’s assets, rights, obligations or liabilities is stayed”: article 20(1), schedule 1, CBIR 2006.

Sberbank (“the Bank”), a significant creditor, opposed the application on six grounds.

First, it was said that the extraordinary administration was not a “foreign proceeding” within CBIR 2006 because it was dealing with the Company and its associates (i.e. a group) rather than just the Company itself. HHJ Paul Matthews rejected that argument. He said that, although a group proceeding could not be recognised as such under the CBIR, a group proceeding as a proceeding in respect of a particular debtor could be recognised: at [52]. In this case, it was the proceeding in respect of the Company for which the Company’s administrator sought recognition. That was permissible.

Second, it was said that the extraordinary administration was not a “foreign proceeding” because the EA Law was not a “law relating to insolvency” (a requirement under CBIR 2006). The Judge also rejected that argument. Having considered the authorities, he found that the requirement that the law pursuant to which the proceeding is brought be “an insolvency law” is satisfied if insolvency is one of the grounds (even if only one of several) on which the proceeding can be commenced: at [63]. In this instance, it was clear that the EA Law was a law relating to insolvency as it was one of the grounds pursuant to which an extraordinary administration could be commenced.

Third, it was said that the extraordinary administration was not a “foreign proceeding” because it was not subject to the control or supervision of a foreign court (a requirement under CBIR 2006). The Judge rejected that argument. He said that the control or supervision required can be potential rather than actual and/or indirect rather than direct: at [79]. Considering the various provisions of the EA Law, which gave certain supervisory and other powers to the Croatian court, he found that “once the proceeding has been commenced, and for so long as it lasts, it is under the control or supervision of the court, through the medium of the extraordinary administrator”: at [93].

Fourth, it was said that the extraordinary administration was not a qualifying “foreign proceeding” because it was not a “collective proceeding”. The Bank said that the fundamental nature of a collective proceeding is to have regard to the separate legal personality of each debtor and creditor. In this case, the outcome of the extraordinary administration will be to settle claims between the Company and its associates and their respective creditors. The Judge also rejected this argument. He said that, in fact, the objection was that the proceeding was too collective in that it proposed to amalgamate the process of settling claims against the Company and its associates into a single process: at [99].

Fifth, it was said that the extraordinary administration was not a qualifying “foreign proceeding” because it was not for the purpose of “reorganisation”. The Bank said that the true purpose of the EA Law was not to reorganise the Company’s affairs but to protect the Company as a going concern in light of its systemic importance to the Croatian economy. The Judge rejected this. He said that the two purposes were not incompatible and that although the EA Law was designed to protect a systemically important Croatian business it was also designed to reorganise the Company’s affairs; at [105].

Finally, it was said the extraordinary administration should not be recognised as it was manifestly contrary to English public policy. The Bank said that it was contrary to public policy as it did not accord pari passu treatment to creditors and/or did not give creditors the right to object to the compromise of their rights. Again, the Judge rejected the argument. He said that there was no evidence that the pari passu principle was not to be applied. In any event, the mere “fact that the priorities of the Croatian law in reorganising or liquidating the company are different from those which apply or would apply under English law, is simply not enough”: at [131]. Indeed, in appropriate cases the pari passu principle can be overridden as a matter of English law.

Accordingly, the application for recognition was granted.

Goel v Grant [2017] EWHC 2688 (Ch): administrators and unfair harm

Judgment on BAILII at: http://www.bailii.org/ew/cases/EWHC/Ch/2017/2688.html

The majority shareholders (“the Applicants”) of a company in administration (“the Company”) applied for an order pursuant to paragraph 74, schedule B1 Insolvency Act 1986 (“IA 1986”) against the Company’s administrators (“the Administrators”).

The Company had been seeking to bring to market a mobile phone charger that automatically backs up and saves a phone’s data each time it is charged. Its directors (“the Directors”) resolved to put the Company into administration. By way of a “pre-pack” sale, the Administrators sold the Company’s assets (including its intellectual property rights) to a company connected to the Directors.

The Applicants alleged that the Directors had conspired to place the Company into administration so as to dispose of its assets at an undervalue to a vehicle they controlled. Accordingly, the Applicants said that the Company had an unlawful means conspiracy claim against the Directors (“the Claim”).

The Applicants wished to acquire the Claim. They proposed to pay a nominal sum to the Administrators and hold any recoveries (after payment of costs) on trust for the Company. The Administrators did not wish to enter into such a transaction; they wished to auction the Claim.

The Applicants said that an auction would unfairly harm their interests within the meaning of paragraph 74, schedule B1 IA 1986, which provides, so far as is relevant, as follows.

“(1) A creditor or member of a company in administration may apply to the court claiming that—

…

(b) the administrator proposes to act in a way which would unfairly harm the interests of the applicant (whether alone or in common with some or all other members or creditors).

…

(4) In particular, an order under this paragraph may—

(a) regulate the administrator’s exercise of his functions;

(b) require the administrator to do or not do a specified thing;

(c) require a decision of the company’s creditors to be sought on a matter;

(d) provide for the appointment of an administrator to cease to have effect;

(e) make consequential provision.”

The basis of the Applicants’ case was as follows. They said that the Claim was inherently unsuitable for disposition by auction as it was extremely difficult to value. Further, the only possible purchasers were the Applicants and the Directors. If the Directors were successful (which was likely because they were wealthy), that would stifle the claim but would not be of benefit to the creditors generally. However, the Applicants’ proposal that they take an assignment of the Claim and hold the fruits on trust for the Company would confer a real benefit on the Company and its creditors.

(There was also  a side-issue as to whether the Applicants had entered into a binding contract to acquire the Claim from the Administrators. This was rejected on the facts.)

Mr David Halpern QC (sitting as a Deputy High Court Judge) held as follows at [44]:

“(i) The paradigm case under paragraph 74 arises where the administrator treats the applicant (either alone or together with further creditors) less favourably than another creditor or creditors. This constitutes harm, but it is not necessarily unfair harm. In order to be unfair, the applicant has to show that the decision cannot be justified by reference to the interests of the creditors as a whole or to achieving the objective of the administration…..

(ii) I accept that the concept of unfair harm in paragraph 74 is not limited to differential treatment but can include a decision of the administrator to sell an asset at an undervalue, thereby causing harm to all creditors. However, in a case where there is no differential treatment of creditors, the court will not interfere with the administrator’s decision to sell an asset unless the decision does not withstand logical analysis. This probably means the same thing as perversity.

(iii) A cause of action is typically a difficult asset to value. If it appears that it might have a substantial value, no reasonable administrator would sell it for a fixed price without properly considering its value or finding a sensible way of bypassing the need to do so. In many cases it will not be possible to consider its value properly without obtaining expert assistance.

(iv) However, it does not follow that the administrator is necessarily acting unreasonably if he sells it by auction. Whether or not this is unreasonable will depend on an analysis of the facts in each case. In an appropriate case, the process of testing the market by holding an auction may make it reasonable to proceed without seeking valuation advice, particularly where the claim is a difficult one to value.

(v) Robert Walker LJ suggested in Faryab that there may be a public interest in preventing claims from being bought by defendants in order to stifle them, but he accorded little weight to this principle, at least on the facts of that case, and I have not been taken to any authority in which it has played a significant role in the decision. It is a relevant factor but one which is likely to be, at best, a marginal factor, save in an extreme case amounting to an abuse, such as the facts of Giles v. Rhind [2006] Ch 618 at [66].”

On the facts, the proposal to dispose of the Claim by auction was not such as to cause unfair harm to the interests of the Applicants. First, the alternative (selling it to the Applicants for a nominal figure with any recovery being held for the Company) would lead to considerable uncertainty for the Administrators, the Company and any creditors. Second, there was no public interest concern about the auction process stifling the claim. The Applicants were of substantial means and/or could access third-party funding so as to acquire the claim: at [46].

Burlington v Lomas [2017] EWCA Civ 1462: surplus in administration, statutory interest

Judgment on BAILII at: http://www.bailii.org/ew/cases/EWCA/Civ/2017/1462.html

This is the latest decision in the litigation following the collapse of Lehman Brothers in 2008 (and, specifically in this jurisdiction, Lehman Brothers International (Europe) (“LBIE”)). The administration has led to a surplus of £7.4bn and, unsurprisingly, a significant amount of litigation between creditors claiming to be entitled to elements of the surplus.

The litigation has been generally referred to as Waterfall I, Waterfall II and Waterfall III. The Supreme Court’s decision in Waterfall I was important, particularly for those with an interest in the theoretical underpinnings of English insolvency law.

As the Court of Appeal noted in Burlington (at [14]), “following the Supreme Court’s decision in Waterfall I, it is clear that the…reversion to contract analysis in general, no longer prevail in the way they had previously done”.

The “reversion to contract” analysis is the view that, once the statutory insolvency scheme has run its course and resulted in a surplus, a creditor can revert to his or her contractual rights and be entitled to payment out of the surplus in accordance with those contractual rights (where the creditor’s contractual rights were worth more that he or she received in the statutory insolvency scheme). That analysis appears to be gone, not without controversy. Indeed, it appears from Lord Neuberger’s comments in Waterfall I that the effect of payment in full of a provable debt in an insolvency is to extinguish a creditor’s underlying contractual rights and replace those with a set of statutory rights under the insolvency legislation.

That analysis influenced the Court of Appeal in Burlington, which was dealing with a number of issues on appeal.

Findings

Issue 1: Application of dividends for purpose of calculating interest entitlement

Rule 2.88(7) of the Insolvency Rules 1986 (now rule 14.23(7)(a) of the Insolvency Rules 2016) provides that: “any surplus remaining after payment of the debts proved shall, before being applied for any purpose, be applied in paying interest on those debts in respect of the periods during which they have been outstanding since the company entered administration”.

The question was whether such statutory interest is calculated by allocating dividends to: (i) first the payment of statutory interest and then principal; or (ii) first to the payment of principal and then statutory interest.

At first instance, the Judge preferred option (ii). The Appellants appealed and said that option (i) was the proper approach because it was consistent with ordinary commercial contracts, was in accordance with the judge-made rule in Bower v Marris (1841) Cr&P 351, 41 ER and better ensures that shareholders do not receive that which, apart from the insolvency, would have been paid to creditors.

The Court of Appeal dismissed the appeal. The rule is clear and “built-in assumption that the whole of the principal of the relevant debts will already have been paid by dividend since, otherwise, there will be no relevant surplus” (at [27]). Further, the fact that option (i) would likely produce a result closer to the creditors’ contractual rights could no longer be a factor of any real weight following the Supreme Court’s rejection of the “reversion to contract” approach in Waterfall I.

Issue 2: Continuing accrual of interest after payment of dividends

By rules 2.88(7)-(9) IR 1986 (now rule 14.23(7) IR 2016), in a surplus, a creditor is entitled to interest on the debt from the date of administration at the higher of the Judgments Act 1838 rate or the contractual rate. The Applicants argued that where the contractual rate is a compounding rate, the accrued statutory interest should continue to compound even after payment of the debt through dividends.

The Court of Appeal rejected that argument and said that in the statutory scheme “there is no room for the concept of interest, let alone compound interest, being payable in respect of [the period after payment of dividends]” (at [41]).

Issue 3: Compensation for late payment of statutory interest

Issue 3 was similar to issue 2. The Appellants argued that in the period from payment of dividends to payment of statutory interest in a surplus, the court should recognise a common law entitlement to compensation following Sempra Metals Limited v IRC [2008] 1 AC 561.

The Court of Appeal also rejected that argument. Rule 2.88 IR 1986 specifies no time at which a payment of statutory interest must be made. The general right to compensation following Sempra Metals only arises when there is a cause of action for non-payment of money owed. Where there is no allegation that the administrators have been guilty of unreasonable or culpable delay (in this case), there is no cause of action against which a common law claim for interest can hang (at [46]).

Issue 4: Interest on contingent debt

As explained, “a contingent debt is provable in an administration even though the contingency upon which it becomes payable has not occurred at the date of the administration. Dividends are payable in respect of it regardless whether the contingency has occurred by the time of dividend” (at [50]). The issue was whether statutory interest is payable in respect of a period when the debt remains contingent.

The Appellants argued that it was not because: (i) if the contingency occurs before dividend, the debt may be proved for and admitted in full; (ii)    if the contingency occurred shortly before payment of dividend, and interest was payable on it from the date of administration, the creditor would receive statutory interest in relation to a long period when the debt was neither interest-bearing nor outstanding in the ordinary sense of the word; and (iii) the above would run contrary to the pari passu principle.

Again, the Court of Appeal rejected that argument because “rule 2.88(7) provides the same regime for statutory interest for all provable debts, whether due at the date of administration, due then only in the future, or subject then to a contingency which may, in fact, never occur” (at [53]). Statutory interest is payable to compensate creditors for the late payment of their provable debt (in the case of a contingent debt, the provable debt is calculated by discounting it by reference to the prospect of the contingency occurring), not the underlying claim.

Issue 5: Foreign judgment rates of interest

The issue was whether “rate applicable to the debt apart from the administration” in rule 2.88(9) (now rule 14.23(7)(c)) can include: (i) a foreign judgment rate of interest applicable to a foreign judgment obtained after the date of administration; or (ii) a foreign judgment rate of interest which would have become applicable to the debt if the creditor had obtained a foreign judgment, when it did not in fact do so.

The Appellants said that it could. The Court of Appeal agreed with the judge at first instance that it could not. As to part (i), “it would be wrong to have regard under rule 2.88(9) to a rate of interest applicable to a foreign judgment obtained only after the cut-off date constituted by the commencement of the administration, unsupported by or by reference to any pre-existing contractual right of the creditor as at the cut-off date” (at [68]). As to part (ii), “the words “the rate applicable to the debt apart from the administration” cannot be read as including a hypothetical rate which would be applicable to a debt if the creditor took certain steps” (at [62]).

Issue 6: Application of contingent contractual interest rate

The issue was whether, where the creditor is entitled to an interest rate contingently and the creditor has taken steps post-administration to trigger that contingency, the creditor is entitled to that contractual interest from the date of triggering the contingency (assuming it is higher than the Judgments Act rate). The example used was the default interest payable on sums due from an out-of-the-money party (in administration) to an ISDA governed derivative after close-out triggered by the counterparty creditor.

The Appellants said the counterparty creditor ought not to be entitled to contractual interest. The Court of Appeal disagreed and summed up its views at at [77] – [78]:

“77. Rule 2.88(9) constitutes a clear but limited departure from the emerging principle (fortified by the majority of the Supreme Court in Waterfall I) that the process of proof of debt and dividend in insolvency, including administration, replaces and extinguishes creditors’ previous contractual rights. So far as concerns interest, the statutory regime permits regard to be had to those rights to enable it to be seen whether, under their contractual (or other) pre-existing rights against the insolvent debtor, creditors would have achieved a higher level of compensation for the delay in distribution after the cut-off date than they would, if compensated at the Judgments Act rate. This is not by way of specific enforcement of those contractual rights. They have been extinguished. Rather it is an examination of the parties’ contractual relationship as at the cut-off date, to ascertain what is the appropriate statutory rate of interest payable thereafter. To that limited extent creditors are not treated equally, although compensation at the Judgments Act rate is an irreducible minimum to which they are all entitled, out of any available proceeds of the administration.

78. The yardstick for that examination is by reference to the contractual rate of interest which each creditor would have enjoyed, applied to the proved debt, during the period or periods between the cut-off date and the date or dates of distribution of dividend. For that purpose we can see no good reason why that rate should not be ascertained by reference to all the creditor’s contractual rights to interest, whether current, future or contingent, when viewed from the cut-off date, but having regard to the benefit of hindsight to see what rate of interest those rights would in fact have generated if they had not been extinguished by the administration.”