Gowling WLG's dedicated insolvency litigation team bring you their regular update on the cases and issues affecting the insolvency and fraud investigation industry.

No liability for equitable compensation where misapplied funds had been recouped before the company's insolvency

In Goldtrail Travel Limited (in liquidation) v Aydin and others the Court of Appeal has confirmed that dishonest assisters were not liable to pay compensation in relation to misapplied funds that were repaid before the company became insolvent.

Background

Goldtrail Travel Limited "Goldtrail) was a tour operator specialising in Turkish and Greek holidays. It purchased seats on flights from a Turkish airline, Onur Air Tasimaclik AS (Onur Air), and from a Swedish airline, Viking.  Black Pearl Investments Limited (Black Pearl) had a 40% interest in, and effectively controlled, Viking.

Goldtrail traded successfully for 15 years before it was placed into administration in July 2010, leaving thousands of Goldtrail customers stranded overseas. Shortly before Goldtrail went into administration, Mr Aydin, the owner and 100% shareholder of the company, attempted to sell 50% of his shares to each of Black Pearl and Onur Air, without either party knowing about the other.

The share sale agreements included a commitment by Goldtrail to purchase seats from Viking and FOAL (the Black Pearl deal), as well as a commitment to purchase seats from Onur Air (the Onur Air deal).

The Black Pearl deal required Goldtrail to pay deposits to Viking and FOAL in the sum of £250,000 and £500,000 respectively. It also required Viking to pay £1.4million as commission for Goldtrail's five-year seat commitment. This payment ended up with another company owned by Mr Aydin, Morning Light Limited (MLL), by virtue of alleged brokerage agreements. Goldtrail also paid Viking a further £500,000 - described by Black Pearl as an advance deposit for seats (the Extra Payment).

The Onur Air Deal provided for Onur Air to pay MLL £3.64 million in commission for Goldtrail's commitment to purchase seats from them for four years. This included a £1 million payment to Mr Aydin and £2.64 million to MLL - as broker. This latter payment was only made after Goldtrail had paid £2.65 million to Onur Air - to facilitate the share sale and allow it to proceed more quickly. That sum would allegedly have been recouped by regular deductions from the payments due to Onur Air for flight seats.

In fact no shares were ever transferred to Onur Air or Black Pearl and Goldtrail went into liquidation in November 2010. The liquidators of Goldtrail commenced proceedings against Mr Aydin and the other defendants who it was alleged had dishonestly assisted him in his misapplication of company funds and his breach of duties - Onur Air, Black Pearl and three individuals who were involved with Black Pearl (the Black Pearl defendants).
Mr Aydin left the jurisdiction and took no part in the proceedings.  The main claims were, therefore, against Onur Air and the Black Pearl defendants.

First instance decision

At first instance the court held that Mr Aydin owed a fiduciary duty not to misapply company funds.  He had misapplied company funds by paying the seat sale deposits of £750,000, the Extra Payment to Viking of £500,000 and the £2.65 million to Onur Air.

The court also held that he had acted in breach of his duty under S175 of the Companies Act 2006 (the CA) to avoid conflicts of interest - in arranging for the 'commission' payments to be made to him through MLL rather than to Goldtrail direct.

The conduct of Viking and Onur Air was such that they had dishonestly assisted Mr Aydin to misapply company funds and to divert the opportunity for Goldtrail to earn commission. The dishonest assistance was provided by the Black Pearl defendants as well as by Viking.

Mr Aydin was liable to Goldtrail for £3.775 million in respect of his misapplication of company funds, alternatively he was liable for just over £5 million as a result of his breach of S175 CA and diverting the commission payments to MLL.

Onur Air was liable to pay equitable compensation of £2.65 million for dishonestly assisting Mr Aydin with the misapplication of company funds; alternatively £3.64 million for dishonestly assisting in the breach of S175 CA.

The Black Pearl defendants were jointly and severally liable to pay equitable compensation of £1,125,000 in respect of the misapplication of company funds; alternatively £1.4 million for dishonestly assisting Mr Aydin to breach S175 CA and divert the commission away from Goldtrail.

Onur Air and the Black Pearl defendants appealed against the findings.

The appeal

The appeal concerned only the Black Pearl defendants - the appeal by Onur Air having been struck out for procedural reasons.

In summary the Black Pearl defendants argued that:

  • the judge had wrongly concluded that Goldtrail was deprived of an opportunity to earn commission; 
  • The judge was wrong to conclude the lost commission was worth £1.4million and that the lost opportunity should be valued at 100%; 
  • The judge was wrong to allow Goldtrail to advance an unpleaded contention that they (the Black Pearl defendants) had not intended to repay the deposits paid to Viking and FOAL;
  • The judge was wrong to treat the Extra Payment to Viking as void or effectively void and that the Extra Payment could not be set off against payments due for flights taken before Goldtrail was placed in administration; and
  • They did not have sufficient knowledge concerning the section 175 claim to be dishonest assisters and even if Goldtrail had been deprived of the opportunity to earn commission the Black Pearl defendants had already suffered losses in that sum by making payments direct to Mr Aydin. They should not have to pay twice.

The decision

The Court of Appeal held that the judge was right to have concluded there was an opportunity that Goldtrail was deprived of, and the company's ability to earn commission on the five year seat commitment with Viking had been worth £1.4million.

Viking had paid the £1.4million to MLL for Mr Aydin, they had not paid it to Goldtrail. There was no argument that Viking was paying twice. The first payment was to Mr Aydin in relation to Goldtrail's opportunity, the second payment was for the loss Goldtrail had sustained.

On the misapplication claim it was enough for the judge to find that the deposits were paid in order to allow Viking to be able to fund the payments to MLL - this was a breach of Mr Aydin's fiduciary duty in which the defendants dishonestly assisted.

The defendants did have sufficient knowledge - they knew Mr Aydin's plan and went along with it by diverting funds through MLL to him.

However, the judge was wrong to hold that the defendants should be required to compensate Goldtrail for the Extra Payment. Mr Aydin's misapplication of Goldtrail's £500,000 did not cause Goldtrail any loss - the Extra Payment was recouped by Goldtrail for seats on flights flown before Goldtrail's insolvency. As Goldtrail had suffered no loss in respect of the Extra Payment the defendants could not owe compensation for dishonestly assisting Mr Aydin in the misapplication of this sum.

Appeal dismissed - save that the defendants were able to succeed in reducing the award of equitable compensation for the misapplication of Goldtrail's funds from £1.25 million to £750,000.

Comment

This case is a good reminder that in a claim for equitable compensation to be paid by a dishonest assistor the compensation can only cover the losses suffered by the company as a result of the misapplication of funds. If misapplied funds have already been recouped and the company has not actually suffered a loss, equitable compensation will not be ordered.

Satisfying the requirements to serve insolvency proceedings out of the jurisdiction.

The Companies Court has provided a helpful reminder of the requirements necessary to satisfy the provisions of the Practice Direction on Insolvency Proceedings (the Insolvency PD), in relation to service out of the jurisdiction in insolvency proceedings.

Background

The case of (1) Hosking (2) Mackay v Apax Partners LLP & others involved a claim by the liquidators of Hellas Telecommunications (Luxembourg) II SCA (Hellas) against a number of companies, some of whom were based outside the jurisdiction, in Guernsey.

Hellas was registered as the finance company for the Hellas Group.  Refinancing was raised by external investors in December 2006 and the funds were used by Hellas for the redemption of various Convertible Preferred Equity Certificates (CPECs). The liquidators alleged that the CPEC redemption price was exorbitant, without foundation and left Hellas over-leveraged and insolvent.

The liquidators obtained permission, on a without notice basis, for proceedings to be served out of the jurisdiction on the four respondents based in Guernsey (the Order). The liquidators were claiming relief on the basis that the CPEC redemption and/or the December 2006 refinancing constituted a transaction or transactions defrauding creditors within the meaning of s423 of the Insolvency Act 1986 (the IA) and/or fraudulent trading within the meaning of s213 of the IA.

The four respondents applied to set aside the Order.

Procedural requirements for service of insolvency proceedings out of the jurisdiction

The respondents submitted that (i) the liquidators could not establish a serious issue to be tried or reasonable prospect of success; and/or (ii) there was misrepresentation; and/or (iii) there had been material non-disclosure in the without notice application.

The court confirmed that the procedural requirements for service out of the jurisdiction in insolvency proceedings were contained in the Insolvency Rules 1986 (the IA Rules) - IA Rule 7.51A(1), Chapter 3 of Part 12A of the IA Rules - and the Insolvency PD.

Together the IA Rules and the Insolvency PD provide that the Civil Procedure Rules, 6.30 to 6.51 - which deal with service of the claim form and other documents out of the jurisdiction for non-insolvency litigation - do not apply. The procedural requirements are instead found in paragraphs 6.4 to 6.6 of the Insolvency PD.

IA Rule 12A provides that the Main Application issued by the liquidators is to be treated as a claim form - and paragraphs 6.4 to 6.6 of the Insolvency PD provide for service out of the jurisdiction of an application that is to be treated as a claim form.

Paragraph 6.4 sets out the requirement for permission to serve out to be obtained and paragraph 6.6 provides that the permission application needs to be supported by a witness statement setting out:

  • The nature of the claim or application and the relief sought;
  • That the applicant believes the claim has a reasonable prospect; and
  • The address of the person to be served or, if known, in what place or country that person is or is likely to be found.

The respondents argued that the liquidators needed to show (i) a serious issue to be tried; (ii) a good arguable case that the case fits within the required class; and/or (iii) that England is clearly or distinctly the appropriate forum for trial.

The liquidators argued that the respondents should not combine the CPR with the IA. The court agreed - although the Registrar did confirm that nothing really turned on this. The test of 'a serious issue to be tried' is not different to 'reasonable prospect of success'. The Registrar also confirmed that the 'good arguable case' test is only relevant when the court applies PD 6B of the CPR in non-IA cases.

In deciding whether the liquidators had done enough to satisfy the procedural requirements for a successful application for permission to serve proceedings out of the jurisdiction the court provided further guidance.

The Registrar confirmed the extent of detail required for evidence to satisfy the requirements of paragraph 6.6 of the Insolvency PD will depend on the case in question. However, the court does not encourage overly-lengthy evidence or submissions for a without notice application. What is required is;

  • identification of the cases of action;
  • a statement of facts and matters relied upon to satisfy the elements needed to be proved;
  • identification of potential defences within the context of full and frank disclosure being pragmatic and not being carried out to an extreme length; and
  • sufficient evidence to satisfy the belief required by paragraph 6.6 of the Insolvency PD.

While the court expressed concerns that the witness statements in this case did not meet the requirements unless the exhibits were taken into account, the Amended Complaint - when added to the statements - identified the facts and matters relied upon to satisfy the elements needed to be proved.

The court also identified breaches of the duty of full and frank disclosure. However, it was held that these were not sufficient to require the Registrar to set the Order aside.

Comment

The guidance provided by the court in this case provides a useful reminder that the requirements for obtaining permission to serve insolvency proceedings out of the jurisdiction are found in the Insolvency PD, not in the CPR.

However, that does not mean the evidential burden is any less. The Insolvency PD still requires applicants to ensure they have the evidence in place that they need to support an application for service out - before an application is made.

And finally...

A quick reminder of some key insolvency changes in force from April 2016...

April 2016 proved to be a busy month for insolvency changes. A quick reminder of some of the key changes....

  • Temporary exemption for insolvency proceedings that allowed the recovery of conditional fee agreement (CFA) success fees and after the event insurance (ATE) premiums from losing opponents - ended on 6 April 2016.

    From 6 April 2016 the general reforms to the operation of no win no fee conditional fee agreements, that came into effect in April 2013, will apply to insolvency litigation proceedings as well.

    This is disappointing for insolvency practitioners who very often can only engage in litigation to secure recovery for creditors if conditional fee agreements for their own costs, and after the event insurance covering their opponents' costs, are in place. If success fees and ATE premiums cannot be recovered from an opponent, and must instead be borne by the insolvency estate, there is a chance that the number of insolvency cases that can be pursued will drop.
  • New section 7A of the Company Directors Disqualification Act 1986 (CDDA 1986) - in effect for insolvencies starting on or after 6 April 2016.

    Insolvency practitioners are now required to submit a report on the conduct of directors of insolvency companies within three months of the company entering into insolvency, rather than six months, as was previously the case.

    The new section 7A also requires insolvency practitioners to report on the conduct of all directors of insolvent companies - regardless of the nature of their conduct.

    New rules regarding the electronic filing of reports on the conduct of directors also came into effect on 6 April requiring submission of such reports by means of 'the portal'.

    See more:

    The Small Business, Enterprise and Employment Act 2015 (Commencement No. 4, Transitional and Savings Provisions) Regulations 2016

    The Insolvent Companies (Reports on Conduct of Directors) (England and Wales) Rules 2016

    Small Business, Enterprise and Employment Act 2015
  • Changes to Statements of Insolvency Practice (SIP) 2 and 4 - in effect from 6 April 2016

    To reflect the changes that have been made to the obligation on office holders to report on the conduct of directors of insolvent companies - summarised above - changes have also been made to SIP 2 and SIP 4.

    The revised SIP 2 covers investigations by office holders in administrations and insolvent liquidations and the submission of conduct reports. The revised SIP 2 will apply to all cases starting on or after 6 April 2016 and will replace SIP 4 going forwards. SIP 4 will continue to apply to cases started before 6 April 2016. It will be withdrawn on 6 October 2016, by which time reporting under section 7A CDDA should be in place for all cases.
  • Law Society ceases to be a recognised professional body for insolvency practitioners with effect from 15 April 2016.

    The Law Society has ceased being a Recognised Professional Body (RPB) for insolvency professionals with effect from 15 April 2016.

    One of the reasons given for the decision included the fact that a reduction in the number of RPBs regulating the area will hopefully help promote consistency, and efficiency, and could in the long term reduce the overall cost of regulation.

    Arrangements have been put in place for insolvency practitioners to be regulated by other RPBs and arrangements have also been made for dealing with any professional conduct issues that may arise with these insolvency practitioners.
  • Insolvency Express Trials Pilot Scheme in effect from 1 April 2016

    As we confirmed in our March insolvency litigation briefing, a pilot scheme for Insolvency Express Trials (IET) began on 1 April 2016. The IET is intended to provide litigants in the Bankruptcy and Companies Court of the High Court with a speedy, streamlined procedure, and an early date for trial or disposal of simple applications by the Bankruptcy Registrars. When using the IET the costs of each party must not exceed £75,000.