So you have a freezing order against a start-up company, now what? Can that start-up use the assets which are the subject of your order, or any of its other assets, to continue to pursue its risky business, or must it stay idle and wait for the inevitable?
The Court of Appeal's recent decision in Organic Grape Spirit Ltd v Nueva IQT, SL1 provides some useful guidance on this issue in the context of the "ordinary and proper course of business" exception to freezing injunctions, holding that a start-up may be able to use the subject assets in certain circumstances, and that the Court has no business assessing an appropriate or acceptable level of risk.
Background to the case
Nueva IQT, S.L. ("Nueva") is a Spanish company ultimately owned by members of the Bertolino family. Mr Michele Guilno Bertolino was, at the relevant time, one of two managing directors of Nueva. The Appellant, Organic Grape Spirit Limited ("OGSL"), is a British company incorporated in May 2019; its only issued shares are held by Michele's son, Mr Federico Gulino Camerero.
Between 23 September and 11 October 2019, sums totalling €12 million were transferred to OGSL from Nueva pursuant to a contract by which Nueva purportedly agreed to lend OGSL up to €20 million. According to Federico's witness statement, filed in the proceedings, the plan "is to produce spirits with tailored flavours that can meet the standard of different markets by, first producing the desired aromatic compounds in the fermented wine and then to separate them with extreme precision and to blend them subsequently into the final product" which he claimed to have followed almost exactly (the "Business Plan"). Since then, some €1.6 million had been spent setting up a plant and purchasing equipment – the main items being three warehouses in Kent and other items such as distillation columns, fermenters, a yeast inoculator and buffer tanks.
Following the removal of Michele, and another of Nueva's directors, at a general meeting, and with new directors in place, Nueva issued proceedings against OGSL in Spain challenging the validity of the loan on the basis that, amongst other things:
- Michele did not have authority to enter into the contract;
- the contract required the approval of Nueva's shareholders; and
- Michele had acted in bad faith.
On 13 March 2020, Nueva issued a claim for a worldwide freezing order2. Mr Justice Nugee granted the injunction, effective until the end of the month. However, he explained that the order was not intended to prevent expenditure on the business that Federico was seeking to develop, stating that "[i]f you are genuinely trying to develop a new business, I do not regard that as dissipatory, even if the business may be imprudent, even if the business plan may be sketchy and somewhat shaky. Trying to develop a business is not the same as avoiding a judgment." Indeed, Nugee J was of the opinion that freezing orders should "not prevent Organic Grape from spending money in the ordinary course of its business and, for reasons that I have already made clear, I regard spending money on the continued development of its business, if that is what is genuinely being done, as not a dissipation that should be restrained…".
On appeal to the High Court, Mr Justice Morgan, unlike Nugee J, considered that Federico should not have free reign to dispose of the assets as part of his Business Plan. The order was amended such that Federico was obliged to seek permission from the Court in respect of any transaction exceeding €10,000 and expressly provided that he could not seek to diminish the value of the assets as part of the new business or as part of the Business Plan.
OGSL appealed that decision to the Court of Appeal. Notably, however, OGSL did not seek to set aside of the freezing order, but instead simply requested it be amended to allow OGSL to pursue the business outlined in the Business Plan, and Federico's witness statement. Nor did OGSL dispute that Nueva had a good arguable case against it in the litigation.
Freezing orders and assets
The judgment of the Court of Appeal, delivered by Lord Justice Newey (the "Decision"), provides a useful reminder of the general principles applicable to freezing orders. It restated the general purpose of such an order, as laid down by Lord Denning in Mareva Compania Naviera SA v International Bulkcarriers SA (The Mareva)3 that the Court will have jurisdiction to grant the eponymous Mareva injunction if "there is a danger that the debtor may dispose of his assets so as to defeat [a debt] before judgment". However, as stated in the Decision, this does not mean that the Court will constrain all conduct which could prejudice the defendant's ability to satisfy a judgment. The Court is actually concerned with the unjustified disposal of assets.
As such, a Court will not prevent a defendant from incurring expenses during the ordinary course of business4 and, furthermore, will retain a discretion to sanction dealings which are not part of the ordinary business of the defendant, subject to a number of key principles and restraints. Indeed, the Court should not sanction dealings or disposals which are outside of the ordinary business of the defendant unless:
- The claimant shows the defendant is not acting in good faith;
- Where it appears that the defendant wishes to undertake dealings/disposals with the object of putting his assets beyond reach;
- Where the apparent purpose is to ensure that funds are not available to satisfy any judgment;
- The dealings involve carrying on a business which can be seen to have no reasonable prospect of success or even prospects so poor that trading would evidence a director's unfitness for the purposes of the Company Directors Disqualification Act 1986, inasmuch as the proposed trading would not be proper; or
- Where there is a failure to meet "acceptable standards of commercial behaviour" in some other respect.
Nonetheless, even where a particular transaction, or business, involves a "degree, even a substantial degree, of risk or speculation", this should not, according to the Decision, necessarily be prohibited. Indeed, it is not for the Court to determine whether a business venture is reasonable, or whether a defendant who is the subject of a freezing order should be allowed to pursue a course of dealing even if:
- it carries substantial risk;
- its reasonableness has not been considered; and
- a balancing exercise has not been undertaken.
In the present case, the following questions had to be addressed to determine whether OGSL's Business Plan should be captured by the freezing order:
- Would pursuit of the business outlined in the Business Plan and Federico's witness statement constitute the "ordinary and proper course of business" of OGSL such that it fell within that exception?
- If not, should the Judge nonetheless have sanctioned dealings and disposals in pursuit of that business?
What constitutes the ordinary and proper course of business?
As to the first question, "ordinary and proper course of business" should be given a "narrower rather than a wide meaning"5. The Court of Appeal, favouring Nueva's submissions on the subject, held that the proposed expenditure as part of the Business Plan could not be considered to be part of the ordinary course of business, given that OGSL had not even established a course of trading. In fact, the company was too fledgling to have established a course of business (it had not, as yet, "progressed as far as either sales or manufacture and it is some way off even having everything that it would need to start production"). As such, parties in OGSL's position, which do not have established patterns of trading, "cannot simply rely on the 'ordinary and proper business' exception to a freezing order but must specifically ask the Court to authorise pursuit of its fledgling business".
The rationale for this was that the protection afforded by a freezing order would be "significantly eroded" if the defendant could claim that transactions fell within the exception, when there was "no benchmark against which the activities could be assessed".
Which dealings and/or disposals should be sanctioned by the Court?
As to the second question, the Court of Appeal considered that the High Court should have permitted OGSL to pursue its fledgling business.
As general principles, plainly, the Court should not sanction dealings where the claimant has shown that the defendant is not acting in good faith, i.e. if it appears that the defendant's object is to put assets beyond reach. Similarly, the Court should also decline to authorise a defendant to carry on a business "which can be seen to have no reasonable prospect of success". Nonetheless, a business should not be prohibited "merely because it involves 'a degree, even a substantial degree, of risk or speculation'". It is not for the Court to consider whether the business venture is reasonable. "'Question marks', 'real risk' and the fact that the business could be described as "speculative" do not provide adequate reasons for preventing trading."
Furthermore, in the specific context of start-up companies, "the fact that a start-up company might have liabilities in excess of its assets cannot of itself mean that it should be barred from pursuing its business." Preventing OGSL from developing its business in this way "could surely be expected to crystallise a depletion of its assets rather than to avoid one."
Having regard to these factors, the Court of Appeal concluded that the High Court had approached the question on an incorrect basis. The High Court should have allowed OGSL to deal with and dispose of assets in pursuit of its intended business. The appeal was allowed on this basis and the injunction wording was amended accordingly.
- Freezing injunctions are often considered to be a 'watertight' means of controlling or restricting the conduct of the defendant company by preventing it from dealing with and/or disposing of substantial assets.This may not always be the case, and the present judgment serves as a welcome reminder of the scope of freezing injunctions: a party who is the subject of an injunction will not be prevented from carrying on its business or, indeed, potentially even embarking on new business ventures.
- Of particular note is the Court of Appeal's reference to start-up entities, whose liabilities will, commonly, exceed their assets; this financial status "cannot of itself mean that it should be barred from pursuing its business".Parties seeking a freezing injunction against such a fledgling entity should consider carefully the actual extent of the protection such an injunction would afford and, indeed, should explore other possible protections for their position.Further, if loans have been extended to a borrower who perhaps invests in more speculative ventures, it will not necessarily be the case that any single, larger trade could fall foul of a freezing injunction. Such activity may, in fact, fall within the scope of the ordinary and proper course of business.
- Finally, parties considering seeking freezing injunctions against others should remember that the test remains whether, on the whole of the evidence before it, the refusal of such an injunction would involve a real risk that a judgment or award in favour of the claimant would remain unsatisfied.
Originally published 21 August 2020
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