UK: Litigation and Insolvency

Notice of the insolvency of your litigation opponent need not mean that any further action is a waste of time and money. Steering the right course through the technical consequences of a particular form of insolvency on your litigation is essential to assess the risk and cost effectiveness of continued litigation.

ADMINISTRATIONS AND LIQUIDATIONS

An automatic moratorium will apply on the presentation of an administration petition or the making of an administration or winding up order.

In addition, once a winding up petition is presented in a compulsory liquidation, the company or its creditors may apply to the Court for a stay of proceedings. In a voluntary liquidation, only a liquidator may apply to the Court for directions that a stay should apply.

The Court has slightly different criteria to bear in mind when giving leave to commence or continue proceedings depending on whether the insolvency process is an administration or a liquidation. In brief, if the case involves a monetary claim, no leave to pursue the claim will be given. The quantum of any claim can be adequately determined using the procedures set out in the Insolvency Act and Rules. Proprietary, trust or other security interest claims will probably be allowed to proceed. Claims already being handled by insurers or to which an insurance policy may respond may also be allowed to continue.

SCHEMES OF ARRANGEMENT, VOLUNTARY ARRANGEMENTS AND ADMINISTRATIVE RECEIVERSHIP

At the moment, there is no automatic moratorium in a voluntary arrangement, an administrative receivership or a scheme of arrangement. Certain provisions of the Insolvency Act 2000 (which are likely to come into force in December 2002) will provide that a small company (as defined in the Companies Act 1985) will have the right to an automatic moratorium pending the consideration of their voluntary arrangement proposals by the creditors.

However, at the moment, a creditor may pursue any remedies against the company prior to the approval of any voluntary arrangement or scheme proposals.

However, once the voluntary arrangement has been approved by creditors and is effective then all creditors who receive notice are bound by the proposal whether they voted or not. No creditor who is bound by a voluntary arrangement is entitled to pursue any claims against the company in respect of pre-arrangement liabilities.

In the case of a scheme of arrangement, while there is no automatic moratorium, it is common to precede a scheme proposal with the appointment of a provisional liquidator. That appointment will trigger a moratorium in respect of actions against the company without leave of the Court similar to that imposed on compulsory liquidation.

The scheme itself will propose a moratorium on proceedings and detail the mechanism in place for the determination of disputes regarding liability and quantum. As with voluntary arrangements, you should satisfy yourself that the terms being proposed are fair and satisfactorily protect your interests. Once the scheme has been approved by the creditors and sanctioned by the court, you will be bound by its terms.

In an administrative receivership, there is no automatic moratorium. The administrative receiver will argue that since as the bank’s floating charge has crystallised on his appointment, the company’s assets are not available for the enforcement of any judgments. The proceeds of those assets will be used to pay the indebtedness owed to the lender ahead of any unsecured creditor’s claim.

None of the procedures described above will prevent the office holder from continuing proceedings against another party in order to swell the company’s assets or to avoid their depletion by a successful claim. The liquidator must seek sanction either from the Official Receiver or the Creditors’ Committee if one has been appointed, to either commence or continue proceedings. There are no such restrictions on other office holders although a supervisor and a scheme administrator will only commence proceedings if they have the requisite powers to do so in the voluntary arrangement or scheme documentation.

So how will an insolvent company pay any adverse costs awards? In the case of a liquidation, any legal costs incurred by a company acting by the liquidator in defending or pursuing an action unsuccessfully are payable out of the company’s assets in priority to the general costs of winding up. However, the liquidator is still entitled to his costs of getting in and realising those assets. If there is any doubt as to whether there will be sufficient assets to pay for costs, then you should seek security of the costs for all pre and post-liquidation costs of the litigation. Security can be given in the form of cash, a bank guarantee or a personal undertaking from the liquidators. A similar approach should be taken if you are being sued by a company in administration, administrative receivership, voluntary arrangement or which is subject to a scheme of arrangement. The administrative receiver or the administrator may offer to pay the costs as an expense of the receivership or administration. If costs are paid as an expense, they will be payable ahead of the office holders’ own remuneration. Security for costs should be obtained unless the action is in the name of the office holder personally. In that case, security for costs will probably not be necessary since he will be personally liable to pay the costs in the event that he is unsuccessful in the claim.

Even if you are unable to continue the action due to the insolvency of the respondent, all may not be lost. Any funds paid into an escrow account or into court during the course of proceedings prior to the insolvency will be held on trust for the ultimate successful party. If the action is too expensive for the insolvency practitioner to continue with, it may well be expedient for him to agree to payment out of the fund to you, particularly if he is concerned as to his position on costs if proceedings continue.

When notice of the insolvency of the "other side" lands on your desk, consider the following:

1 At what stage are the proceedings? If they are ongoing, is there an automatic moratorium or can you continue regardless? Is there any point in continuing if the claim is a monetary one?

2 If there is an automatic moratorium, does your claim qualify as one which should be allowed to continue in any event?

3 If you are being pursued by the insolvent entity, contact the office holder immediately and request an indication of his intentions. Negotiations may well be easier with a party who is not interested in the political ramifications of the dispute, only in the net return to the plaintiff.

4 You should consider the effect of set-off to minimise any claims against you. Set off in a liquidation will apply to all mutual credits, debts and mutual dealings. The dealings simply have to be between the same parties in the same right and do not have to relate to the same or closely connected transactions. Further, any contractual agreements restricting the right of set off are void in an insolvency.

5 If the office holder or company confirms that proceedings will be continued, consider making an application for security for costs and include all costs to date, not just post insolvency costs.

6 Are there any funds in escrow or paid into court? Consider whether you can agree with the office holder to accept those funds in part or full settlement of your claim.

7 Scrutinise the terms of any voluntary arrangement or scheme of arrangement carefully. You will need to negotiate any changes to them prior to any final approval being given by the creditors or the court to the scheme or arrangement.