UK: Administration Developments (Spring 2007)

This case concerns the very high profile administration of Farepak Foods and Gifts Limited ("Farepak") which hit newspaper headlines in the autumn of last year. Farepak operated a Christmas hamper savings scheme whereby customers could spread their Christmas savings over the course of a year. Farepak operated its business through a system of approximately 26,000 agents. The agents would collect money from the customers each month and forward it to Farepak. By the end of November each year, the customer would have accumulated enough money to buy vouchers or a hamper or other goods in a range of stores.

However, in October 2006, Farepak ceased trading and went into administration. Farepak was unable to fulfil its Christmas 2006 orders and had over 100,000 creditors with claims of between £250 to £300 on average.

During the three days leading up to the administration of Farepak, the directors had sought to "ring-fence" the monies Farepak had received from customers so that those monies could be returned to customers if necessary. Farepak executed a declaration of trust (although there was a mistake as to the bank account identified in the declaration).

The administrators applied to court for directions as to whether and how they should distribute (a) the ring fenced monies and (b) the monies received during the administration period. The directors of Farepak argued that both sets of monies were held by Farepak on trust for the customers. The directors submitted that the trust arose either as (1) a Quistclose resulting trust; (2) a constructive trust arising out of the unconscionability of retaining customer monies received after the decision to stop trading had been made; or (3) an express trust.

The court held that the agents were agents of Farepak (and not of the customers) and that it followed that monies paid by the customers to the agents were monies paid to the agents and taken by them as agents of Farepak. The judgment continued that there was no suggestion that an agent who received money from a customer was expected to keep it separate from other money (or indeed his own). In fact, the money was mixed with the money of other customers and paid over to Farepak in a lump sum.

It followed that there was no Quistclose trust because there was no suggestion that the money received by the agents ought to have been put to one side by Farepak pending the transmutation of the monies from credited money to goods or vouchers.

The directors argued that the monies paid to Farepak by customers once they had decided to cease trading should be held by Farepak as constructive trustee from the moment that those monies were received. In the earlier decision of Neste Oy v Lloyds Bank Ltd [1983] NLJ 597 the court held that it was contrary to the ordinary notion of fairness that the general body of creditors should profit from the "accident" of a payment made to a company at a time when there was bound to be a total failure of consideration and, therefore, a constructive trust was inferred. However, the court said that if it was to apply Neste Oy to the Farepak case, it should be applied by reference to the time at which the monies should be taken to have been paid and received by Farepak. In Neste Oy payment and receipt of the monies by the company were effectively simultaneous whilst, in contrast, in Farepak the date that the monies were paid to and received by the company (through its agents) was not necessarily the same as the date that the monies appeared as a credit in Farepak’s current account. The court felt that this created sufficient uncertainty for the court to state that the monies did not come within a constructive trust.

The court held that, in principle, the mistake in the declaration of trust was rectifiable and that it did not scupper the directors’ argument that there was an express trust in favour of the customers. However, the court went on to say that, where monies had been paid to Farepak (via the agents), the relevant customers were already creditors of the company. If the court were to declare an express trust in those customers’ favour, those customers would be given a preference over other creditors. The court said that this was an obstacle, at a practical level, to any sums being paid out to customers on the basis of the rectified declaration of trust.

The court made the point that, whilst a proper case for a distribution to creditors had not been made out in the Farepak case, there was nothing to say that such an argument could not be made out in the future. Every case turns on its facts and it is important to seek legal advice where, during the course of an office-holder’s investigations, the issue of whether a trust has been created arises.

Trident Fashions Plc ("Trident") entered administration on 17 September 2003 and three IPs were appointed as joint administrators ("the First Administrators"). Trident operated the Ciro Citterio menswear retail chain. At the time of the appointment of the First Administrators, Trident traded from 98 retail units throughout the United Kingdom and Ireland, including a unit in Exeter ("the Exeter Property"). The First Administrators resigned as administrators on 20 April 2004. On the same day, two partners from a different firm were appointed joint administrators ("the Second Administrators") in their place. After an extension of the term, the administration finally expired on 17 March 2005.

On 7 April 2005, Trident’s only qualifying floating charge-holder appointed two partners of a third firm as joint administrators. This administration did not last long. The new administrators quickly concluded that the administration could not achieve the statutory purpose and applied to court for an order that the appointment should cease to have effect. On 27 April 2005, their appointment was discharged and Trident was ordered to be wound up.

The First Administrators and the Second Administrators had continued Trident’s occupation of the Exeter Property. Exeter City Council made an application for a declaration that non-domestic rates in respect of the Exeter Property, accrued while the Second Administrators were in office, should be payable as administration expenses under two heads:

• Rule 2.67(1)(a) IR86 – as expenses properly incurred by the Second Administrators in performing their functions in the administration of the Company; or

• Rule 2.67(1)(f) IR86 – as necessary disbursements incurred by the Second Administrators during the course of the administration.

Mr Justice Richards rejected the first alternative stating that rule 2.67(1)(a) IR86 should be confined to expenses where the administrator has incurred personal liability. However, the Judge accepted that nondomestic rates are payable as "necessary disbursements" under rule 2.67(1)(f) IR86.

The Judge referred to Re Toshoku Finance UK Plc in which the House of Lords decided that corporation tax on profits and rates incurred by a company in liquidation fell within rule 4.218(1)(m) IR86 as necessary disbursements and that payment of such expenses was not subject to any restriction that they must have been incurred for the benefit of the liquidation. The Judge decided that as rule 2.67(1)(f) IR86 was drafted in the same terms as rule 4.218(1)(m) IR86, the Insolvency Service had made a policy decision that non-domestic rates should be paid as an expense in an administration.

The case related to occupied non-domestic rates. However, the Judge commented that there is no basis for a distinction between occupied non-domestic rates and unoccupied non-domestic rates. Unoccupied non-domestic rates are also therefore an expense in an administration under rule 2.67(1)(f) IR86.

The Judge recognised that the automatic treatment of non-domestic rates as an expense of an administration is likely "to have an adverse effect on the achievement of rescues in at least some cases". However, he was not persuaded that the true meaning and intent of rule 2.67(1) IR86 had to be determined in the context of administrations and the policy considerations underlining them, which provide a very different context to liquidations i.e. to promote the rescue of companies and their businesses as opposed to simply realising assets and distributing the proceeds among creditors. The Judge stated that the decision as to whether non-domestic rates were administration expenses was one of policy.

Administrators will need to give serious consideration to whether the objective of the administration can continue to be achieved now that non-domestic rates are payable as administration expenses ahead of remuneration or distributions to floating charge holders and unsecured creditors. Unlike a liquidation, an administrator cannot disclaim a lease.

The current position on the payment of non-domestic rates can therefore be summarised as follows:

• Non-domestic rates are not automatically payable in a pre Enterprise Act administration in respect of either occupied or unoccupied property but the court may in appropriate cases direct their payment as an expense under the principle in Re Atlantic Computers Plc.

• Non-domestic rates for both occupied and unoccupied property are necessary disbursements within rule 2.67(1)(f) IR86 and payable as an expense of the administration. Liquidation n Non-domestic rates for occupied property are necessary disbursements within rule 4.218(m) IR86 and payable as an expense of the administration

• Non-domestic rates in respect of unoccupied property in a liquidation are not payable by virtue of the Non-Domestic Rating (Unoccupied Property) Regulations 1989.

This decision does have retrospective effect and the industry is therefore closely monitoring whether the rating authorities now intend to claim back non-domestic rates in respect of companies which went into administration after 15 September 2003.

This case concerned the pre Enterprise Act administration of Lune Metal Products Ltd ("Lune Metal").

The administrators had been unsuccessful in their first application for court sanction to make a distribution to unsecured creditors.

The administrators’ proposals, as approved, envisaged Lune Metal entering into a CVA once its assets had been realised; however, having resolved all outstanding matters in the administration, the administrators concluded that it would be more advantageous for creditors if they were paid out early. On this basis, the unsecured creditors would have received 35p in the pound whereas if Lune Metal went into liquidation or entered into a CVA the unsecured creditors would have received 31p in the pound.

Notwithstanding the benefit to creditors of making an early distribution, the court at first instance dismissed the administrators’ application for sanction to make a distribution. The judge there held that he was bound by the decision Re Designer Room Limited (2005) 1 WLR 1581 and that accordingly the court had no power under the Insolvency Act 1986 ("the Act") to sanction administrators paying out creditors on a free standing application (which is what it was being asked to do). It held that the administrators could not rely on section 14(3) of the Act as that provision envisaged the court giving an administrator directions "in connection with the carrying out of its functions" and that the administrators’ functions are governed by section 8(3) of schedule 1 to the Act (and do not extend to paying out to creditors). The court also held that its power to make an order under section 18(3) of the Act only came into play on a hearing of an application under section 18(1) (i.e. on an application to discharge, vary or add an additional purpose to an administration order).

It was suggested to the administrators that they should consider amending the application and apply for a discharge of the administration order. In this way, it was argued, the proposed distribution to creditors could be sanctioned on the basis that it was in connection with the discharge. On appeal, the administrators sought permission to vary their application, which was granted. The court agreed that it was able to sanction the proposed distribution to creditors under section 18(3) because the application to make the distribution was now ancillary to the application for discharge of the administration order.

There were a number of conflicting first instance decisions, some reported and others not, often with different reasoning applied on the issue of distributions to creditors in pre Enterprise Act administrations. Inevitably, this led to some confusion for administrators involved in these types of cases. The Court of Appeal commented that "those administering and advising on insolvencies, and those with interests in insolvencies, need to know where they stand as certainly, cheaply and promptly as possible". As such, this is a welcome decision from the Court of Appeal as it is now settled that administrators in a pre Enterprise Act administration may obtain the court’s sanction to make a distribution to creditors if the distribution is a condition of their discharge.

The Enterprise Act enables an administrator appointed on or after 15 September 2003 to make distributions to secured and preferential creditors and (with permission of the court) unsecured creditors under Paragraph 65 of Schedule BI.

This case answers the question as to whether, in pre Enterprise Act administrations, the court has power to authorise an administrator to make a distribution to creditors who would be preferential creditors in the event of a winding up.

The court made the point that this question had been considered at first instance in recent time by no fewer than eight judges who had reached different conclusions.

Having considered these differing first instance decisions, the court held that it had power, both under section 18(3) of the Insolvency Act 1986 and under its inherent jurisdiction to sanction a distribution to creditors of a company who would be preferential creditors in the event of a winding up on an application for discharge of the administration order.

The court in this case said that the time had come for the law to be taken as settled without the need for argument. Otherwise, the judge said, the costs of administration were being driven up to the detriment of the creditors. The court took a common sense approach and said that the "plain fact" was that there would be more money for creditors if an early distribution were made then there would be if the company was wound up and a distribution were made in the course of a winding up. In this case, the Insolvency Service, which stood to benefit if the company was wound up, did not oppose the application and in those circumstances the court had no hesitation in sanctioning the payment to creditors.

See also the Court of Appeal’s decision in Re Lune Metals Products Limited (in administration) on the previous page.

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.