Insolvency litigation briefing - August 2015

19 August 2015


Our dedicated insolvency litigation team brings you its monthly update on the cases and issues affecting the insolvency and fraud investigation industry.

The court exercises its inherent jurisdiction to enable joint special administrators to make a final distribution of client money despite disputed and unidentified claims

The High Court has exercised its inherent jurisdiction to permit special administrators to make a final distribution of client money where the administrators had taken all reasonable steps to identify or notify all potential client money claimants of such distribution.

The court considered that the interests of established clients and others who might have serious, but unresolved, claims to be treated as clients had been properly balanced by the special administrators.

Background

In Re Worldspreads Ltd (in Special Administration), Worldspreads was an investment bank within the definition in the Banking Act 2009 s232 (the Act). Readers may be aware that the Investment Bank Special Administration Regulations 2011 (the Regulations) modifies insolvency laws as they apply to investment banks. Worldspreads was placed in special administration given a substantial deficit in the client money which it held on statutory trust governed by the Client Assets rules (CASS rules) made by the Financial Conduct Authority (FCA) under s137B of the Financial Services and Markets Act 2000 (s137B).

Under the Regulations, regulation 10 provides that one of the objectives of the special administrator is to ensure the return of client assets to clients as soon as reasonably practicable. Regulation 11, in support of that objective, enables the administrator to set a long stop date for submissions of claims in order to expedite the return of client assets. However, by regulation 11(8), regulation 11 does not apply to client assets governed by rules made by the FCA under s137B. Thus, regulation 11 does not apply to client money, although the overall objective in regulation 10 still does. There is no other provision in the Regulations which provides a procedure governing distribution of client money in a special administration.

In this case, there were a number of disputed claims and claims which had not been submitted despite potential claimants having been notified. The administrators needed to make a final distribution and close the client money pool, but the CASS rules do not provide for a situation where claims are outstanding.

The FCA agreed to modify its rules for a limited period (for Worldspreads only) to enable a final distribution to be made, providing certain steps had been taken including contacting clients who had not made a claim, advertising the distribution plan and allowing a certain period for submissions.

Notwithstanding the modifications, the administrators sought directions and an order from the court under the Insolvency Act 1986 Sch B1 para 63 (para 63), which enables the court to give directions in connection with the administrator's functions and which equally applies to special administrations.

The administrators also applied under the court's inherent jurisdiction in relation to trusts which enables it to give directions to trustees to distribute trust property on a particular basis when it is satisfied that it is just and expedient to do so.

Orders were sought permitting the administrators to set a long stop date for outstanding claims, to make provisions for costs and expenses, to deal with claims to client money which were not agreed and to make a final distribution to those with agreed client money claims notwithstanding the disputed claims and potential claims that were still outstanding.

Decision

The High Court questioned whether the para 63 jurisdiction was wide enough to deal with disputed claims given that the client money also fell outside the insolvent estate. However, the court's inherent jurisdiction applied. 

The court considered the administrators had taken all reasonable steps to identify and notify all potential client money claimants, which included further proposals for making contact with non-responsive clients. The court held that the proposals properly balanced the interests of known clients and a timely return of their money and the interests of those with unresolved, potential or rejected claims. It was in the best interests of the proper administration of the client money trust and of the clients for an order to be made and regulation 10 to be complied with.

Comment

The CASS 7A rules on distribution do not envisage the existence of a non-responsive client, nor do they provide a mechanism for dealing with funds which would otherwise be due to clients but for their failure to submit a claim. The result is not in the best interests of the special administration as it would necessarily have to remain open pending resolution of the unresolved claims, which would not accord with regulation 10 of the Regulations of ensuring the return of client assets as soon as reasonably practicable.

While the court's inherent jurisdiction does not allow it to vary beneficial interests, it does permit it to give directions to trustees to distribute trust property on a particular basis when the court is satisfied that it is just and expedient to do so. The court's decision provided the mechanism to the administrators to deal with rejected and unknown claims with a degree of certainty and protection to them.

No duty at common law beyond s304 of the Insolvency Act 1986 owed by trustee

The Chancery Division, in dismissing the bankrupts' claim, held that a surplus in the bankrupts' estate did not give rise to a duty in the tort of negligence on the trustee's part to the bankrupts. A trustee did not owe a bankrupt a duty at common law outside of s304 of the Insolvency Act 1996 (the Act) and, further, it was not part of the trustee's role to review the legitimacy of a judgment affecting a bankrupt, which directly or indirectly had been subject to appeals which had been rejected.

The background

In Oraki and Oraki v Bramston and Defty, the claimant husband and wife were made bankrupt in 2005 and 2006 respectively and the defendants were appointed, at various times, as their trustees in bankruptcy. The claimants made various applications and appeals in relation to the bankruptcy orders on the basis that the judgment upon which they were based was deficient and they were wrongly made bankrupt.

An order annulling the bankruptcies under s282(1)(a) of the Act upon condition that the claimants pay the trustees' costs and the costs and expenses of the bankruptcies was eventually made in January 2013. The claimants brought proceedings against the trustees alleging they were not entitled to their costs as they had caused the bankruptcies to be unnecessarily prolonged, had failed to pursue debtors, had not maintained property in the estate and had mismanaged their estates, thereby causing them loss and damage.

They alleged professional negligence and improper conduct contending that their assets were more than sufficient to discharge all possible claims and costs. As the condition attached to the annulment order had not been satisfied, the bankruptcy orders remained in place.

The issues

The court had to determine whether:

  • A trustee owed any duty at common law outside s304 of the Act such that the existence of any surplus in the estate gives rise to a duty in the tort of negligence. S304 of the Act provides for repayment or accountability by the trustee to the estate where the court is satisfied that the trustee has misapplied or retained or is accountable for money or property in the bankrupt's estate, or loss has been suffered due to misfeasance or breach of fiduciary or other duty by a trustee carrying out his/her functions;
  • The defects in the judgment should have been apparent to the trustees; and
  • The trustees had failed to carry out their duties including failing to proceed expeditiously and failing to chase debts allegedly owed to the claimants.

The court's findings

The High Court held:

  • A bankrupt's ability to challenge the actions of a trustee in bankruptcy is limited as the bankrupt ceases to have an interest in his assets or liabilities except in so far as there may be a surplus. It would be inconsistent with the requirement that the permission of the court must be given if the bankrupt had an unfettered right to take proceedings against his trustee. There is no general right of action in negligence apart from the statute. However, trustees should not ride roughshod over someone who either should obviously not have been made bankrupt in the first place or who had assets greater than liabilities and the estate proves to be solvent (s330 (5) of the Act).
  • In certain circumstances it might be appropriate for a trustee to look behind a judgment but there is no basis in principle or policy for placing the trustee under a duty to review the legitimacy of a judgment forming the basis of his/her appointment. In this case there had been numerous unsuccessful applications in relation to the judgment both prior to and after the bankruptcies. It had not been incumbent on the trustees to look behind those orders even if, with the benefit of hindsight, it became apparent that there were procedural defects in the judgment.
  • The duty of skill and care in a trustee exercising his managerial discretion had to be judged against the standard of a reasonably skilled and careful insolvency practitioner. A trustee could not be criticised unless he had taken or had failed to take some action a reasonably competent office holder would have taken, or not taken, in the exercise of his discretion. Even if the exercise of discretion had been wrong, no liability would attach unless it was an error that an ordinary skilled insolvency practitioner would not have made. Here, the trustee had no funds available to chase debts and insufficient information, due to the claimants' contradictory evidence, that the claims were good and not merely speculative. In such a situation the bankruptcy court would be slow to direct a trustee to embark on such litigation. Further, it was the claimants in this case, not the trustees, who had failed to deal with the bankruptcies expeditiously to enable the bankruptcies to come to an end.

Comment

Given the bankrupts' alleged solvency in this case, they would perhaps have been better served by making applications to annul the bankruptcy orders under s282(1)(b) of the Act by either paying or securing the bankruptcy debts and expenses to the court's satisfaction and then pursuing their various grievances.

The judgment does, however, give comfort to trustees that so long as they act with the reasonable skill and care of careful insolvency practitioners, no additional duty will be imposed upon them over and above the duties they already owe to the bankrupt's estate.


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