UK: Preference Developments

Timothy Brown (as Liquidator of Cityspan Limited) v Nicholas Clark

Cityspan Limited ("Cityspan") carried on a business as the owner and operator of public houses. Cityspan purchased two public houses which were funded in part by a bank loan and in part by a loan from one of its directors, Mr Clark. Cityspan was unable to operate the public houses at a profit and they were therefore sold. The net proceeds of sale represented the remaining assets of the company and were held in the client account of Cityspan’s solicitors. In April 2000, Cityspan’s directors instructed its solicitors to make two payments to Mr Clark’s personal account totalling £28,000. In May 2000, the directors instructed Cityspan’s solicitors to make a payment to another director, Mr Dean in the sum of £5,000. The payments to the directors were made by way of repayment of lending to Cityspan by the directors. Cityspan entered into creditors’ voluntary liquidation on 24 July 2000. The liquidator subsequently commenced proceedings against Mr Clark for declarations that the payments to Mr Clark constituted preferences contrary to section 239 of the Insolvency Act 1986 ("the Act") and that Mr Clark acted in breach of his fiduciary duty to Cityspan by causing it to make the transfers to the directors.

Mr Clark accepted that the payments made to him personally constituted unlawful preferences contrary to section 239 of the Act. However, Mr Clark defended the claim arguing that the liquidator had agreed at an initial meeting with him to accept £5,000 in full and final settlement of all of the liquidator’s claims against Mr Clark and that he had made part payment of that sum to the liquidator.

Mr Philip Sales QC (sitting as a deputy judge of the High Court) rejected Mr Clark’s defence as there was no evidence that the liquidator had reached any agreement with Mr Clark to accept the sum of £5,000 in full and final settlement of his claims against Mr Clark. The discussions between the liquidator and Mr Clark at the initial meeting were simply exploratory conversations and there was evidence that the liquidator pursued Mr Clark for the full amount of the claim on numerous occasions following the initial meeting. The payments which Mr Clark had made to the liquidator related to the liquidator’s fees in connection with the preparation of the statement of affairs. Mr Clark was therefore ordered to pay the sum of £28,000 plus interest to the liquidator of Cityspan.

The Judge also decided that Mr Clark had acted in breach of his fiduciary duty to Cityspan by causing it to make the three transfers totalling £33,000. Mr Clark was aware that the company’s only assets were the proceeds of sale from the disposal of the public houses and that Cityspan had substantial liabilities in excess of those proceeds of sale. In those circumstances, by the time of the transfers, the fiduciary duties which Mr Clark owed to the company required him to act having regard to and so as to protect the general interests of its creditors. Mr Clark was therefore ordered to pay compensation to Cityspan in the sum of £33,000 plus interest.

The case demonstrates unsurprisingly that the courts will not recognise a settlement between parties to litigation unless there is clear evidence that the parties intended to settle the claims. Mere exploratory conversations on the terms of a settlement are insufficient to form a binding agreement. However, the case illustrates how any potential claimant to litigation needs to be aware of the significance of discussions like these; always indicate that any conversations along these lines are conducted on a "without prejudice" basis – and ensure there is no ambiguity as to whether or not a settlement has been reached.

Sonatacus Limited ("Sonatacus") was controlled by its sole director, an individual named Paul Susca. Mr Susca was a friend of Rahail Aslam who was a director and the effective controller of CI Limited ("CIL"). On 18 September 2000, CIL made a loan to Mr Susca personally in the sum of £65,000. However, at Mr Susca’s request the sum of £65,000 was paid directly to Sonatacus. The obligation to repay the loan remained with Mr Susca. On 29 January 2001, Sonatacus paid the sum of £50,000 into CIL’s bank account. The parties accepted that Sonatacus was insolvent at that time, or that it became insolvent as a result of the transfer. On 2 March 2001, Sonatacus ceased trading and it entered into creditors’ voluntary liquidation on 29 March 2001.

The liquidators commenced proceedings against CIL claiming that the payment of £50,000 from Sonatacus to CIL constituted a preference under section 239 Insolvency Act 1986 ("the Act"). CIL’s evidence was that the loan had been made to Mr Susca personally and that CIL was therefore a creditor of Mr Susca and not of Sonatacus. The liquidators then made an alternative application claiming that the payment was therefore a transaction at an undervalue under section 238 of the Act because CIL had not provided any consideration for the payment. The District Judge decided that the payment was a transaction at an undervalue and this was upheld by the Judge on appeal. However, CIL submitted that Sonatacus had given consideration of £50,000 and received the consideration of the pro tanto discharge or release of a debt due to Mr Susca so that the value of the consideration given by Sonatacus was identical to the value of consideration received by Sonatacus at the time the payment was made.

The Court of Appeal observed that on the payment of the sum of £65,000 by CIL to Sonatacus, Mr Susca became indebted to CIL for that amount and Sonatacus became a debtor to Mr Susca for that amount. On the payment of the £50,000 by Sonatacus to CIL, the debts of Sonatacus to Mr Susca and of Mr Susca to CIL were, to that extent, respectively discharged. Insofar as the payment of the monies discharged the debt of Sonatacus to Mr Susca, Sonatacus gave a preference to Mr Susca and the payment was therefore voidable by the liquidators. The liquidators could rely on section 241(1)(d) of the Act to seek an order against CIL, even though it had not been given the preference, as a person which received a benefit from the preference given by Sonatacus to Mr Susca. If CIL was to retain the £50,000 it had to show that it had received the sum in good faith under section 241(2) of the Act. The Court of Appeal stated that CIL’s evidence failed to establish good faith. With his previous knowledge that the £65,000 had been paid into Sonatacus’s bank account and that Mr Susca’s companies had been in some financial difficulty, Mr Aslam must have known that it was likely that the £50,000 had been repaid by Sonatacus and at a time when it was insolvent, or he must at least have shut his eyes to that possibility. The Court of Appeal therefore declared that the payment by Sonatacus to CIL constituted a preference given by the Company to CIL.

An unusual and complicated set of facts which demonstrate that a party may be the subject of a preference claim even though it is not a creditor of the insolvent company.

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.