Insolvency Litigation: recent cases and issues - May 2018

16 May 2018

In our update this month we take a look at some of the recent cases that will be of interest to those involved in insolvency litigation. These include;

  • A decision of the Chancery Court which confirms the rule against contractual penalties will not apply to the terms of a company's own voluntary arrangement;
  • Some guidance on the priority of payments in insolvency, in a case where administrators' remuneration was paid out of the company's accounts;
  • Consideration by the Court of Appeal as to the correct approach to determining liability for breach of trust involving avoided transactions.

Our insolvency experts have reviewed the decisions and tell you what you need to know.



Company's voluntary arrangement? No rule against contractual penalties.

In the case of Re SHB Realisations Ltd (formerly BHS Ltd) (in liquidation); Wright and another (as joint liquidators of SHB Realisations Ltd (formerly BHS Ltd) (in liquidation)) v Prudential Assurance Company Ltd (2018) the Chancery Court was asked to determine the effect of certain provisions of a company's voluntary arrangement (CVA), including whether a contractual penalty could be applied.

Background

SHB Realisations (the Company (C)) was the principal trading company in the BHS group. Following years of increasing losses the Company proposed, and the Company's creditors and members approved, a CVA in March 2016. The Company subsequently entered into administration at the end of April 2016 and the CVA and the administration ran in tandem for a period.

The Company was then put into creditors' voluntary liquidation on 18 November 2016 and the CVA was terminated with effect from 16 December 2016.

The CVA provided, amongst other things, for some of the landlords of the Company to receive less than the full amount of rent falling due under the leases granted to the Company. However, when the CVA was terminated, clause 25.9 was triggered. This clause provided that on termination:

the compromises and releases effected under the CVA shall be deemed never to have happened, such that all landlords and other compromised CVA creditors shall have the claims against [the Company] that they would have had if the CVA Proposal had never been approved (less any payments made during the course of the CVA).

One of the landlords (P) argued that on the basis of this provision (a) it was owed the full amount of the outstanding rent payable under the relevant leases and (b) part of the balance was payable as an administration expense for the period during which the administrators continued to trade from the premises.

Three issues arose as a result of the arguments raised by P. The liquidators sought directions from the court on the following:

  • The penalty issue - whether the provisions of the agreement requiring C to pay additional sums on termination of the CVA rendered P's claims a penalty and therefore unenforceable;
  • The pari passu issue - whether the effect of the provisions meant that P's claims contravened the pari passu principle;
  • The administration expense issue - whether P could claim the additional sums as an administration expense.

Decision

The Chancery Court held that the full amount of the outstanding rent payable under the relevant leases was due and part of the balance was payable as an administration expense.

The penalty issue

The High Court held that the CVA provision that reinstated the landlords' rights to the full rent amount upon the termination of the CVA - as if the CVA had not been agreed - was effective and not a penalty. In summary:

  • A CVA is a hypothetical contract - creditors are deemed to have agreed to the CVA even where they have not, as long as the CVA is approved as required by statute. The law on penalties required the court to assess the respective bargaining power of the parties and their legitimate commercial interests, and consider whether one party had been oppressed. A CVA was not negotiated. It was proposed in the interests of C and could not therefore be said to have oppressed C at the same time.
  • C had only obtained the benefit of reduced rents because it had agreed to reinstatement of P's rights to full rent if the CVA should fail. C could not insist on the full effect of clause 25.9 while denying the proper effect of clause 9.
  • P had a legitimate commercial interest in the CVA and it could not be exorbitant, extravagant or unconscionable to return P to its pre-CVA position if the CVA should fail.
  • The reduction of rent provided for in the CVA was not a variation of the leases. Any variation had to be by deed. The CVA was not a deed of variation providing for a permanent reduction in rent. Rather it was a contractual agreement allowing a period during which reduced rent was payable by C.

The pari passu issue

There was no breach of the pari passu principle.

The liquidators had argued that clause 25.9 of the CVA provided for a substantial increase in P's claims against C, in the event of C's insolvent collapse. The CVA was a variation of C's liabilities to P - creating a new liability where none existed before.

This was not accepted. The clear intention of the CVA was to ensure that landlords were not disadvantaged if the CVA was terminated, being required to continue with a concession that was only expressed to apply while the CVA remained in force.

The administration expenses issue

The full rent due to P during the administration was payable as an administration expense. The full rent was always a contingent liability while the CVA continued. The rent accruing during the administration included all sums payable for that period, even if the rent was contingent or not yet ascertained at that time.

Comment

This decision provides a helpful reminder that a CVA will operate as a contract. It is not a deed and cannot be said to have permanently altered the amount of rent payable. Rent variations must be made by way of deed. Also, a company who is a party to a CVA 'contract' must abide by its terms. A party cannot rely on those clauses in a CVA that provide benefit while the CVA is in place, but then try to avoid clauses that are less favourable when the CVA comes to an end.

No misfeasance when administrators' remuneration paid from funds specifically provided for that purpose

A joint administrator was not guilty of misfeasance where administrators' remuneration had been paid out of the company's accounts in breach of the Insolvency Rules 1986 (IA 86), rule 2.67. This was the outcome of an appeal to the Chancery Court in The Matter of MK Airlines Limited.

Background

MK Airlines Limited (MKA) went into administration in 2008 and three joint administrators were appointed. Negotiations commenced for a proposed sale of MKA to a purchaser (T), who hoped to keep MKA going and benefit from its valuable civil aviation authority air operator certificate (AOC). To facilitate that objective, T agreed to provide substantial funding of up to US$18 million to allow MKA to continue to trade and US$750,000 by way of lump sum funding to pay certain pre-administration creditors and support the implementation of a CVA.

A deed of indemnity was entered into which set out the terms on which the funds were provided to MKA (the Indemnity). The Indemnity expressly provided for the administrators' fees to be paid from the funds received from T. Funding was provided by T as agreed, however, it was paid into MKA's bank accounts and was not separated from 'company money'.

New administrators were appointed in March 2009. MKA subsequently went into liquidation in June 2010. The liquidators brought proceedings against the three original joint administrators, alleging misfeasance under the Insolvency Act 1986 Sch B1 on the basis that they had made payments out of company funds in breach of the priority rules.

Two administrators entered into settlement agreements but the claims against the third administrator (O) continued. At first instance the Registrar held that the money paid into MKA's account under the loan facility had become assets of the company and the original administrators had therefore made payments to themselves out of company assets and repayment must be made. O appealed the decision.

Appeal decision

The deputy High Court Judge acknowledged that under the priority rules, expense creditors were to be paid before the administrators' remuneration, however that applied in relation to the company's assets.

In this case the Indemnity specified that additional funds were provided on terms that required them to be used for nominated purposes only. T wanted to ensure that the business of MKA survived. T's objective was to purchase MKA and obtain the benefit of the AOC. MKA was trading substantially at a loss and it was natural that the administrators would want to secure alternative payment of their fees; it was unlikely they would receive anything if the business failed and expense creditors were paid first in accordance with the priority rules. The Indemnity was properly entered into, particularly as it may have provided the only chance of rescuing MKA.

It was correct that the remuneration had been paid out of money that beneficially belonged to MKA. However, the funds received from T were provided specifically to pay certain debts and expenses, including the administrators' remuneration and the money was not at MKA's free disposal. There could be no shortfall of payment to expense creditors caused by the payment of the administrators' remuneration. The position was the same as if the funds had been placed in a separate account. Any assets available to pay expense creditors were not affected by the payment of the administrators' fees out of the additional 'Indemnity' funds.

If the funds had been paid into a separate account they would have been the subject of a Quistclose trust - the parties knew that the funds were not to be at MKA's free disposal and they would not beneficially be the company's money.

The construction and effect of the deed of Indemnity meant that O could not be guilty of misfeasance

Comment

This case highlights the need for any agreement for funding the payment of administration expenses, including administrators' remuneration, to be carefully drafted. Clear terms will avoid confusion and will prevent such funds from becoming mixed with company monies.

Determining liability for breach of trust in the context of avoided transactions

In (1) Kashif Ahmed (2) Bushra Ahmed (3) Tesneem Ahmed (4) Tabasum Hussain V (1) David Ingram (2) Michaela Hall (Joint Trustees In Bankruptcy Of The Estate Of Eaitisham Ahmed) (2018) the Court of Appeal provided guidance on the correct approach to determining liability for breach of trust in the context of avoided transactions.

Background

The claim arose as a result of the transfer, by Eatisham Ahmed (EA), of his minority holding of shares (the Shares) in various companies to his brother (KA), and through KA to his sisters, BA, TA and TH (the Siblings). EA transferred the Shares after presentation of a bankruptcy petition on him in January 2007, but before the bankruptcy order was made in April 2009.

EA's trustees in bankruptcy (TIBs) challenged the transfer of the Shares under section 284 of the Insolvency Act 1986 (IA 86), which provides that any disposition of property by a bankrupt after presentation of a bankruptcy petition, but before a TIB is appointed, is void. Shortly before trial, the Siblings accepted that the transfers were void and they delivered executed transfer forms to the TIBs.

The court was left to determine whether the respondents were also liable as trustees to pay equitable compensation for the diminution in value suffered by the estate - as a result of the Shares being wrongfully retained.

First Instance Decision

The trial judge held that the Shares had been held on trust since they were transferred and the effect of section 284 was to backdate the TIBs' title to the Shares to this date. The siblings were ordered to pay equitable compensation to the TIBs as a result of their breach of trust and wrongful retention of the Shares, which had deprived EA's bankrupt estate of value. The fair value of the Shares was determined at £2.26 million, representing the fair valuation of the Shares as at the date of the transfer, less the value as at the date of restoration.

The Siblings disagreed with the decision and appealed to the Court of Appeal. Amongst other things they argued that:

  1. Section 284 (IA 86) did not provide a free-standing right for the TIBs to recover the value of the shares as awarded by the trial judge (i.e. the difference in value at the transfer date and at the date of redelivery to the TIBs). Section 284 was silent as to the remedy available when a disposition had been avoided;
  2. If Section 284 did not apply the TIBs could only be compensated in respect of the difference in value if they could prove the estate had actually suffered a loss as a result of the breach of trust. There was no automatic right to compensation; and
  3. The TIBs were required to prove the loss, which the estate had actually suffered as a result of the breach of trust. They had not done so and their claim should be dismissed.

Decision

The Court of Appeal determined the issues as follows:

Freestanding remedy?

No freestanding right existed under Section 284. It only operated to avoid dispositions made in the relevant period and was silent as to the remedy available to a bankrupt estate when a disposition has been avoided. The appropriate remedy is governed by the general law.

Approach to determination of liability

The law provides that compensatory relief, in addition to the restoration of property, is available where the claimant beneficiary can establish a loss to the estate caused by the trustee's breach of trust. In this case, in order to recover equitable compensation, the TIBs would need to prove how the Siblings were in breach, when the breach of trust occurred and what loss was caused to the estate as a result of the breach.

The judge had been wrong in law to accept that that the bankrupt estate had suffered an actual loss at the date of transfer because there was an obligation on the Siblings to restore the shares on that date and they failed to do so.

The word restitutionary meant restoring trust property actually lost as a result of the breach of trust. The TIBs were only entitled to be compensated for any diminution in value of the Shares which they could prove had actually been suffered as a result of the Siblings' breach of trust.

Pleading and evidence point

It would have been preferable if the points of claim had clearly pleaded the alleged loss and the basis upon which the claim was made. However, by the time of the hearing the relevant issues had been sufficiently articulated in a non-binding agreement on the outstanding issues. The real problem was that the judge had been wrong in law to fix the Siblings with liability at the date of transfer without requiring them to show actual loss.

Date of calculation of loss

The loss should have been calculated by the difference between the value when the shares could have been sold and the value when they were actually returned to the TIBs. In this case the TIBs would not have been in a position to sell the shares until 14 months after the transfer, so the loss had to be calculated from that date.

The Siblings were all engaged in serious dishonesty when the transfers were made. Their knowledge of the facts made them bare trustees and they therefore had an immediate obligation to restore the estate as soon as a TIB was appointed - so the Shares could be realised for the benefit of creditors. The Siblings were jointly liable for compensation for breach of trust.

Comment

This case provides clear confirmation that Section 284 (IA 86) does not provide an automatic right to compensation when it is used to void a disposition made in the relevant period. Any right to compensation will depend on proof of the loss actually suffered as a result of the breach.

The case provides a helpful summary of the law that should apply if a claim for compensation is going to be made.

And finally...

New Practice Direction on Insolvency Proceedings (PDIP) - In force from 25 April 2018

The new Practice Direction on Insolvency Proceedings (PDIP 2018) was published on 25 April 2018 and immediately came into effect.

The new practice direction updates the previous one by making reference to the Insolvency Rules 2016, taking account of recently decided cases and changes in the CPR (in particular with regards to the Business and Property Courts Practice Direction), specifying new arrangements for the distribution of insolvency business across the different levels of the judiciary, and clarifying the routes of appeal in insolvency cases.

Finance litigation: the latest cases and issues in April 2018

Gowling WLG's finance litigation experts consider consent orders in the context of a regulated activity, when a discharged bankrupt is still liable for bankruptcy debts and whether a deed of assignment pre or post-dated a winding up petition.


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