Canada: Insolvency Litigation: Recent Cases And Issues - June 2017

The Court of Appeal has confirmed that a company must have a settled intention to appoint an administrator before it can file a notice of intention to appoint and benefit from the interim moratorium that applies as a result. We cover this, and other issues affecting the insolvency and fraud industry, in this month's update:

A notice of intention to appoint an administrator requires a settled intention; a conditional proposal will not be sufficient

The Court of Appeal has held that a company seeking to give notice of intention to appoint an administrator (Notice of Intention) under the Insolvency Act 1986 (IA86), schedule B1, paragraph 26, must have a settled intention to appoint an administrator at the time. A conditional intention will not be sufficient to allow a Notice of Intention to be filed under IA 86, schedule B1, paragraph 27, thus triggering the 10-day moratorium.

Background

In the case of JCAM Commercial Real Estate Property XY Limited v Davis Haulage Limited (2017), the court was asked to consider whether a company or its directors could give Notice of Intention without there being a genuine intention to actually appoint an administrator at that time.

Davis Haulage Limited (Davis Haulage) was a tenant in premises owned by JCAM. Davis Haulage was in arrears with its rent and reached an agreement with JCAM to settle those arrears in instalments. Despite the agreement, Davis Haulage failed to keep up with the payments and the arrears continued to rise.

On 18 January 2016, JCAM notified Davis Haulage of its intention to recover possession of the premises if payment was not received within seven days. Proceedings were subsequently issued on 28 January. Unknown to JCAM, Davis Haulage's sole director had already filed a Notice of Intention with the court, triggering a moratorium and thereby preventing any alternative insolvency proceedings or other legal process being commenced against it until the appointment of an administrator or the end of ten business days.

Three further Notices of Intention were filed at court by Davis Haulage, while the company attempted to put a creditors' voluntary arrangement (CVA) in place. Administration was only being considered as an alternative in the event that the CVA was not approved or failed.

Ultimately, a CVA was entered into but failed and an administrator was finally appointed. In the meantime, JCAM applied for an order that the fourth Notice of Intention be vacated and removed from the court file on the grounds that it constituted an abuse of process. This would then also allow the possession proceedings to proceed.

At first instance, the issue for the court to decide was whether it was necessary for the company or the directors to have a settled intention to appoint an administrator when a Notice of Intention was filed at court, or whether it was sufficient that the director of a company saw the appointment of an administrator as a fallback option.

The court held it was not necessary to have a settled intention to appoint an administrator. Notices of Intention could be filed where directors intended to appoint an administrator as an alternative to a CVA or another recovery solution. JCAM appealed to the Court of Appeal.

Court of Appeal decision

The Court of Appeal allowed the appeal and commented as follows:

  • Notices of Intention, and the relevant parts of Schedule B, refer repeatedly to an intention rather than to a possibility;
  • With the exception of small companies (as defined), there is no process that allows for a moratorium whilst a CVA (or other recovery) proposal is considered;
  • A Notice of Intention can only be filed if a copy has already been served on a qualified floating charge holder (QFCH), i.e. a party who would be entitled to appoint its own choice of administrator. The purpose of the notice process and resulting interim moratorium is to protect the company and its assets while a decision is made by the QFCH about whether to appoint an administrator;
  • If there is no QFCH to whom notice must be given under paragraph 26(1), there is no reason to use a Notice of Intention as the company should be moving directly to the appointment of an administrator; and
  • Even though a company proposing a CVA might have the appointment of an administrator in mind as a possible alternative if the CVA is not approved, there is a chance that any QFCH who has received a copy of the Notice of Intention may choose to exercise its right to appoint an administrator, thereby frustrating any proposed CVA.

In this case the notice was deemed invalid. It is a statutory pre-requisite that there be a settled intention to appoint an administrator, and that was not satisfied in this case. The Court of Appeal confirmed a conditional proposal would not be sufficient.

Comment

This is a helpful decision in this area of often muddled decisions. Although there is no ban on filing successive Notices of Intention, it is clear now that there does need to be a settled intention to appoint an administrator at the time of filing. The decision also makes clear that a Notice of Intention can only be filed if there is a QFCH who must be served. If there is no QFCH, there is no one to serve and the company should move directly to the appointment of an administrator.

An innocent party's right to benefit from an equity of exoneration is affirmed

For the first time in over 100 years, the court has considered what factors are relevant to the equity of exoneration.

The principle

A property is jointly owned by A and B. B incurs a debt which is solely for his own benefit but which is secured over the whole property. A will be entitled to a charge over B's interest in the property to the extent that B's indebtedness is discharged out of A's share of the property.

The practical result of this is that, where the property is sold, the secured creditor will be paid out of B's share first, and will only have recourse to A's share of the property once B's interest in the property has been exhausted.

The right arises because A is presumed to be in the position of surety unless a contrary intention can be shown (for example, if the loan benefitted both A and B). In general, if one cohabitee joins in granting a charge over the jointly-owned property to secure a loan to the other cohabitee, there is a presumption that the former is entitled to exoneration.

Background

In Armstrong (as trustee in bankruptcy of Andrew Obinna Kalu Onyearu) v Onyearu & another (2017), the Court of Appeal was required to consider whether a bankrupt's wife (Mrs O) was entitled to a charge on her husband's half share in the matrimonial home, by way of an equity of exoneration for a loan granted to her husband (Mr O), which was used to pay his business creditors.

The property was purchased via an interest free mortgage by Mr O in 2000. Although he was the sole registered proprietor, it was accepted that he and his wife, Mrs O, held the property beneficially in equal shares.

Until 2010 Mr O paid the mortgage and Mrs O the household expenses. Mr O obtained a loan, secured by a charge over the matrimonial home in 2005, which was used to pay the debts of his legal practice. Mrs O knew about the loan, although Mr O did not seek her consent prior to entering into it.

In 2009 the legal practice found itself in financial difficulties which resulted in the business failing in 2010. Mr O was subsequently declared bankrupt in 2011.

Mr O's trustee in bankruptcy (TiB) applied for an order for sale of the property. Mr and Mrs O maintained that they owned the property in equal shares.

First instance decision and first appeal

The TiB's application was dismissed. The Deputy Registrar held that the equity of exoneration applied and Mrs O's share in the property was protected and was not subject to Mr O's debt.

The TiB appealed the decision. He argued that Mrs O benefited indirectly from the loan taken out by Mr O given that it helped Mr O carry on his business, which in turn allowed him to make the mortgage payments. Ultimately, this allowed Mrs O and the rest of the family to reside in the property.

The High Court Judge dismissed the appeal and the TiB appealed to the Court of Appeal.

Court of Appeal decision

The Court of Appeal dismissed the appeal. The purpose of the loan was to pay Mr O's creditors. Mr O and those creditors were therefore the only beneficiaries of the loan.

The benefit to Mrs O was too remote to allow it to be inferred or presumed that she intended to bear the burden of the loan equally with Mr O. When the loan was taken out, the prospect of benefit to Mrs O was uncertain and incapable of valuation.

Comment

This case provides helpful authority on the application of the principle of equity of exoneration when a joint owner is alleged to have received an indirect benefit.

While the case reaffirms the notion that the equity may be defeated if the joint owner has directly benefitted from the loan, it also clarifies that the prospect or reality of a non-debtor co-owner receiving an indirect benefit does not necessarily prevent the equity from arising in their favour. The benefit to that non-debtor cannot be too remote or intangible, otherwise the equity of exoneration may well apply. This means that the relevant benefit must be either directly or closely connected with the indebtedness in order to deny the co-owner's right to claim it.

From a practical perspective, the equity of exoneration can be advanced as a defence to a trustee in bankruptcy's application regarding property in relation to which the bankrupt is a co-owner, and which has been mortgaged to secure their debts only, and not those of their co-owner(s). This means that a trustee will need to consider carefully the potential application of this principle when assessing the value of a co-owned asset in a bankruptcy. That said, if any co-owner has received a direct benefit of that loan, the equity does not apply, so if such a direct benefit can be proven, this will not be an issue.

Security for costs ordered against a Russian liquidator in relation to an application under the Cross-Border Insolvency Regulations 2006

The High Court has allowed an application for security for costs to be made in relation to an application to set aside a recognition order under the Cross-Border Insolvency Regulations 2006 (CBIR).

Background

In the case of (1) Ivan Cherkasov (2) William Browder (3) Paul Wrench v Nogotkov Kirill Olegovich (the Official Receiver of Dalnyaya Step LLC (2017), three former managers of a Russian company (the Managers) applied for security for the costs of a hearing to set aside a recognition order obtained by the Russian liquidator (the Liquidator) of that company (DSL).

The recognition order was made without notice and the Liquidator failed to inform the court about the contentious circumstances surrounding DSL's restoration to the Russian companies' register and the fact that insolvency proceedings against the Managers were being revived.

The Managers alleged DSL had been resurrected to enable the Russian government to attack them, whereas the Liquidator said the liquidation had been reopened as a result of extensive asset stripping, which (he alleged) had only recently come to light. These allegations were not disclosed to the court when the Liquidator made his without notice application for the English court to recognise the liquidation of DSL as a foreign main proceeding.

The Managers applied for the recognition order to be set aside on the basis that the making of the order was manifestly contrary to public policy (the Set Aside Application). They subsequently applied for security for the costs of that hearing (the Security Application).

The Liquidator opposed the Security Application, arguing that the Set Aside Application was a freestanding proceeding in which the Managers should be treated as the claimants. If they were claimants, they could not rely on part 25 of the Civil Procedure Rules to apply for security for costs.

Decision

Security for costs was granted by the court.

The court had to consider whether the application was a claim or proceeding within the meaning of Rule 25.12 of the Civil Procedure Rules (CPR 25.12).

The court held that the Set Aside Application was a claim or proceeding within the meaning of CPR 25.12. There were a number of regulations in the CBIR that supported this fact, including provisions specifying how the application was to be commenced, conducted and determined.

The Managers could properly be described as defendants to the application for recognition. It was correct they were not named but the CBIR clearly contemplated a number of circumstances in which there would be a party opposing the grant of a recognition order. This included the current situation where the Managers were arguing that the grant of the recognition order was contrary to public policy.

The Set Aside Application could not be regarded as free standing and entirely separate from the order which it sought to challenge (the recognition order) and was part of the recognition proceedings commenced by the Liquidator. Challenging the recognition order meant that the Managers were the defendants in those proceedings. The Set Aside and Security for Costs Applications were not freestanding; they arose only as a result of the recognition proceedings.

The court therefore had jurisdiction to order security for costs against the Liquidator. The conditions of CPR 25 still needed to be satisfied but the court was happy that they were. In summary:

  • The Liquidator was resident in Russia and, if the Managers successfully applied to set aside the recognition order, it would be difficult, if not impossible, for any costs order to be enforced against the Liquidator in Russia;
  • The Liquidator had no assets within the jurisdiction;
  • The costs of the set aside hearing were likely to be substantial;
  • The Managers had a reasonable prospect of succeeding in setting aside the recognition order; and
  • The Liquidator had sufficient funds to enable him to put up money for security for costs and his ability to participate in the hearing would not therefore be stifled if security was ordered.

Comment

This case provides helpful guidance as to what can constitute a claim or proceeding for the purpose of a security for costs application under CPR 25. It also confirms that the CBIR will not prevent the court from ordering security for costs against a foreign liquidator in the appropriate circumstances.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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