UK: Highlights of Recent Developments in Insolvency Law

How They Affect You and Your Business
Last Updated: 3 May 2002

Directors Disqualification

Use of Section 236 after commencement of proceedings

In the case of In Re Pantmaenog Timber Co. Ltd (14 November 2000), disqualification proceedings had been commenced against a former director of the insolvent company. The former director applied to strike-out the disqualification proceedings. The Official Receiver (OR), then issued three applications under Section 236 IA 1986, in the winding up proceedings, to obtain disclosure of documents which the OR intended to use in defending the application to strike-out. The district judge at first instance made three Orders.

On appeal, the Court stated that the purpose of Section 236 was to enable the liquidators acting in the winding up of a company to obtain information concerning the trading of the Company; that their functions in the winding up, pursuant to Section 143 IA 1986, were to ensure that the assets of the Company were got in, realised and distributed to the Company’s creditors and did not include a power to act in disqualification proceedings; that Section 236 could not be used by the OR to discover evidence with which to defend a strike-out application in disqualification proceedings; and that, since that was the express purpose of the OR’s applications, they should be refused.

Miscellaneous

Charge over “other debts and claims” - fixed or floating?

In Re ASRS Establishment Limited [2000] 2 BCLC 631, the Court of Appeal held that a charge purporting to create a fixed charge over book debts was effective only as a floating charge because the debenture did not provide for the chargee to have sufficient control over the debts and claims and their proceeds.

The Company granted a debenture to a finance company which purported to grant a fixed charge over book debts and also a fixed charge over “other debts and claims” due to the Company. The question was whether the charge over “other debts and claims” was upon a true analysis a fixed or floating charge.

The finance company appointed an administrative receiver in 1990, and in the following year the Company went into creditors’ voluntary liquidation. Before the receivership, the Company had paid approximately US$750,000 into an account with Barclays Bank, under an escrow agreement, in connection with a purchase by the Company of certain shares. When the Vendor of the shares defaulted, the escrow monies were repayable to the Company. The receiver claimed that the escrow monies were within the fixed charge created by the debenture over “book debts, bank account credit balances and other debts and claims”. The liquidators argued that the fixed charge was ineffective as such and that the escrow monies were subject only to a floating charge. The debenture required the Company to get in book debts and pay the proceeds into an account designated by the finance company, but the finance company never designated such an account. Applying Royal Trust Bank v. National Westminster Bank plc [1996] BCC 613, the Judge had found that since the debenture permitted the Company to deal with its book and other debts in the ordinary course of business, the debenture did not create a fixed charge. That was so whether the items of property mentioned in the debenture were considered as a category or separately.

On appeal, the Court of Appeal determined that the escrow monies came within the residual class of “other debts and claims” and the effect of the debenture, as correctly construed by the Judge, was that the finance company could not stop the Company from using the proceeds of the escrow monies in the ordinary course of its business. Although it was possible that some items of property of a particular category might not fulfil the second part of the threefold test for a floating charge laid down by Romer LJ in Re Yorkshire Woolcombers Association Ltd [1903] 2 Ch 284, because they would not be changing from time to time in the ordinary course of business, most items falling within the residual class of “other debts and claims” would be transient and the Judge was right to regard the escrow monies as not having any special quality which took them out of the ordinary operation of the debenture.

However, although the Judge held that a charge over “other debts and claims” is to be construed on an, in effect, “all or nothing” basis (ie if upon a true analysis the charge is a floating charge over one class of assets, it may well be a floating charge over all assets), the Court of Appeal declined to rule on this reasoning. It would therefore appear to be advisable to list each asset intended to be a fixed charge asset, in a separate schedule within the debenture.

Application for Removal as Office Holder

In Cork -v- Rolph (13 December 2000), the applicant, a licensed insolvency practitioner, holding 116 appointments variously as administrator, supervisor, liquidator or trustee in bankruptcy, applied for his removal from those offices on the ground that he had moved to a new firm. In order to minimise the costs, he also applied for permission to inform the creditors of the change of office holder through an advertisement rather than an individual letter.

The Court held, granting both applications, that notwithstanding the dictum of Chadwick J in Re Sankey Furniture Ltd [1995] 2 BCLC 594, each application had to be judged on its own merits and an office holder could be replaced even if he continued to practice as an insolvency practitioner. Furthermore, in the circumstances of this case, it was appropriate to make the Order and a power to notify the creditors of a change of office holder by advertisement was suggested by Rules 4.102(5) and 4.103(4) IR 1986 and the provisions of IA 1986. Since it was by far the cheapest option, the creditors should be informed of the change of office holder by an advertisement in The London Gazette.

Comment: That the creditors in 116 insolvencies should be “notified” in this way, that the identity of the person responsible for managing the insolvencies had changed altogether, seems extraordinary.

Transaction at undervalue - Brewin Dolphin appeal

In Phillips -v- Brewin Dolphin Bell Lawrie Ltd [2001] All ER 673, the House of Lords considered the question whether a share sale was at an undervalue, notwithstanding the value of a collateral agreement entered into by the Company with the original purchaser of the shares. The background facts are set out in detail in issue no.13.

The House of Lords held that the requirements of Section 238(4)(b) IA 1986, are that the transaction has to be entered into by the Company for a consideration, the value of which, measured in money or money’s worth, was significantly less than the value, also measured in money or money’s worth, of the consideration provided by the Company. The provision directs attention to the consideration for which a Company has entered into a transaction and does not stipulate the person(s) by whom the consideration was to be provided. The consideration could include the value of a collateral agreement entered into by the Company with a third party.

Furthermore, for the purposes of Section 238(4), and the valuation of the consideration for which a Company has entered into a transaction, reality should be given precedence over speculation. Where the value of the consideration for which a Company entered into a Section 238 transaction was speculative, it is for the party who relies on that consideration to establish its value. On the facts of this case, it was plain that the consideration for the shares, apart from obligations assumed by the purchaser under the share sale agreement itself, had been the purchaser’s parent company entering into a collateral sub-lease agreement of the Company’s computer equipment, giving rise to four annual payments of £312,500 as rent. In valuing that agreement as at the purchase date, the critical uncertainty was whether the sub-lease would survive for long enough to enable all or any of the payments to fall due. Where events on which the uncertainties depended (eg termination of the lease) had actually happened, it seemed unsatisfactory and unnecessary for the Court to wear blinkers and pretend that it did not know what had happened.

Taking into account the liquidation of the Company in the year following the share sale agreement, the value of the purchaser’s parent’s covenant in the sub-lease was nil. Therefore, the value of the consideration for which the Company entered into the share sale agreement was confined to the value of the consideration under that agreement (£1). For the purposes of Section 238, the Company had therefore entered into a transaction at an undervalue.

Distinguishing an omission from fraudulent trading

In R. -v- Bevis (11 January 2001), the Court of Appeal, Criminal Division, held that an offence under Section 208 IA 1986 (failure to disclose Company property to the liquidator) which implied an element of dishonesty, was to be distinguished from one of fraudulent trading under Section 213 IA 1986.

The Defendant had been sentenced to 18 months’ imprisonment and disqualified for 4 years under Section 1 CDDA 1986, on conviction (after a guilty plea) for failure to disclose company property to the liquidator contrary to Section 208 (1). Section 208 (4) provides as follows:

“it is a defence (a) for a person charged . . . to prove that he had no intent to defraud and (b) . . . that he had no intent to conceal the state of affairs of the company . . .” Section 213 provides: “(1) if in the course of winding up of a company it appears that any business of the company has been carried on with intent to defraud . . .”

The Court stated that Section 208, implied an element of dishonesty, not an intent to defraud, which did not mean an intent to syphon the company’s money. The director had maintained that he did not take money for his benefit although the failure on his part to disclose property to the liquidator, did amount to fraud. Nevertheless, he had not been charged with fraudulent trading in which dishonesty was sharply defined and he was of good character. The offence, although distinct from fraudulent trading, was not to be regarded as a technicality. A custodial sentence (because of the element of dishonesty) was considered appropriate, but the sentence was reduced to 9 months and the disqualification to 2 years.

Directors should pay costs of public interest winding-up petition

In Re North West Holdings Plc; SoS -v- Backhouse (26 January 2001), the Court of Appeal considered whether the controlling director of two companies ordered to be wound up under Section 124A IA 1986 in the public interest, on petitions by the Secretary of State, should pay the Secretary of State’s costs in relation to the petitions and whether the costs incurred by the companies should be subordinated to payment in full of the companies’ creditors in the companies’ winding up.

The Secretary of State had presented two petitions for the companies, Holdings and Limited, to be wound up in the public interest. Both companies were controlled by B. Although Holdings’ accounts showed it to be dormant, it was used by B to conduct his business as a financial advisor. The petitions were presented after an investigation under Section 447 of the Companies Act 1985 and both companies, which were insolvent, were ordered to be wound up.

On a separate application, the Judge at first instance ordered B to pay the costs, not limited to those incurred directly as a result of opposing the petitions, on the basis that B had conducted the companies’ affairs for his own personal benefit, had treated the companies’ money as his own and had defended the petitions in his own rather than the companies’ interests.

On appeal, the Court of Appeal upheld the judge’s findings on the basis that he had been entitled to exercise his discretion under Section 51 of the Supreme Court Act 1981, to order a company director to pay the costs of a public interest petition to wind up a company, on the basis that the petition had been defended in the individual interests of the director, rather than those of the relevant Company.

Liquidation

Liquidation costs where liquidation follows receivership

In Re Leyland DAF Limited (17 November 2000), the Court held that where a liquidation follows an administrative receivership, expenses of the liquidation are payable out of the assets comprised in the crystallised floating charge as held by the receivers, in priority to the claims of the floating charge holder.

Before the liquidation, the receivers had made significant distributions, but still held approximately £60 million subject to the floating charge at the date of the liquidation. The Judge considered Sections 115 and 175 IA 1986, dealing with the priority of expenses in a winding up. He accepted, on behalf of the liquidators, that, as held in Re Portbase Clothing Limited [1993] Ch 388, the meaning of “assets” in Sections 115 and 175 included assets subject to a charge which, as created, was a floating charge, regardless of whether it had crystallised beforehand, and regardless of whether the assets subject to the crystallised charge had been comprised in a prior receivership.

The Court conceded that its decision had unattractive sides, in particular the fact that the liquidation occurred more than 3 years after the receivership, such that it was likely that the assets comprised in the floating charge would have been wholly or substantially distributed. There would therefore be an element of chance as to whether any such assets would be held by the time of the liquidation.

Had the Court, contrary to its decision, considered the timing of crystallisation of the charge to be material, a selective application of Section 175 would have arisen such that the rights of the floating charge holder would vary according to whether its charge crystallised immediately after liquidation (when it would rank after liquidation expenses and preferential creditors), or immediately before (when it would rank only after preferential creditors). However, the language of the section did not suggest that that was Parliament’s intention.

It was not suggested by the Court that liquidators could have recourse to assets already distributed by receivers or make receivers accountable for any distributed assets. Liquidators could only have recourse to realisations still held by receivers.

Note: The decision has some troublesome practical implications including the possibility of cases where, despite the lack of any tangible benefit to unsecured creditors from a liquidation following a receivership, more liquidations will occur where the purpose or sole effect will be to enable practitioners who have encouraged the liquidations, to earn fees at the expense of the debenture holder.

Permission to appeal to the Court of Appeal has been given and we will report on the appeal in due course.

Individual Voluntary Arrangements

Secret side deals struck down

In Cadbury Schweppes Plc -v- Somji (16 January 20001), the Court of Appeal upheld the decision to strike down an IVA where potentially dissentient creditors were promised additional payments on the side in return for their agreement to the IVA at the Creditors’ Meeting.

A third party contributor had secretly dealt with two initially dissentient creditors on the basis that if the creditors would agree to support the IVA and if it was approved, they could assign their debts to a Jersey company on advantageous terms. A similar offer was rejected by Cadbury Schweppes on the ground that any funds which were available should be offered to all creditors pro rata . At first instance, the Judge ruled that: (1) the agreement was a fraud on the other creditors and was therefore illegal and void; the agreement was unenforceable as between the parties to it; failure to disclose the agreement to the creditors in general was a material omission which permitted a bankruptcy Petition to be presented and a bankruptcy Order to be made against the debtor. However, the Judge rejected submissions to the effect that the circumstances gave rise to unfair prejudice, such as to allow the IVA to be revoked.

The Court of Appeal concluded that the Judge was right to rule as he did and that he had jurisdiction to make a bankruptcy Order under Section 276(1)(b) IA 1986, and to make an Order on the ground of material omissions in information supplied to creditors. The Court confirmed that the principles laid down in the 19th Century cases still applied and that every proposal for an IVA should be characterised by complete transparency and good faith by the debtor. However, the Court declined to comment on whether the circumstances amounted to unfair prejudice under Section 262(1) but did overturn a further ruling of the Judge that there had been a material irregularity at or in relation to the IVA meeting under Section 262(1)(b).

Note: Commentators have already questioned why creditors should not generally deal with a third parties who, for personal or commercial reasons, wish to ensure that an IVA(or indeed CVA) is approved. Great care must be taken in this regard since the third party may be connected to the debtor and in turn certain other claims may not be bona fide. The third party deal may be one aspect of generally unsatisfactory conduct. Secondly, it has been suggested that since the deal in this case concerned taking assignments of debt, that should not be a matter of concern. However, the same points made above equally apply.

Proposals for Reform of Insolvency and Business Rescue

On 13 February 2001, the DTI published a White Paper including proposed reforms to bankruptcy law and business rescue entitled, “Opportunity for All in a World of Change -A White Paper on Enterprise, Skills and Innovation”. The Paper incorporates proposals set out in last April’s consultation paper, “Bankruptcy - A Fresh Start” and last November’s joint DTI/Treasury Report, “A Review of Company Rescue and Business Reconstruction Mechanisms - Report of the Review Group”.

The Paper states that the financial failure of individuals must be dealt with proportionately, with a distinction to be drawn between someone whose bankruptcy comes about as a result of fraud as opposed to, for example, the guarantee of a company’s overdraft.

The Paper proposes reforms including:

  • Reducing the bankruptcy term from 3 years to 12 months;
  • Identifying those whose failure is irresponsible, negligent, or dishonest and making them subject to restrictions for up to 15 years;
  • Investigating the viability of providing a single scheme, unifying bankruptcy and the County Court administration procedure, to deal with all personal insolvencies.

The Paper also briefly describes the establishment of a new joint Inland Revenue/Customs and Excise Unit by 1 April of this year, to ensure that voluntary arrangements are given individual consideration under strict timetables, rather than merely claiming Crown preference and rejecting a rescue proposal.

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.

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