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:

  • another decision which deals with an application for security for costs where the claimant was in liquidation;
  • a Court of Appeal decision providing guidance on the effect of an unanticipated claim emerging after the approval of a company voluntary arrangement; and
  • confirmation that a director will not be in breach of fiduciary duty if he or she has acted in the best interests of the company.

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

Security for costs? No - if saying yes will stifle a genuine claim.

In the case of Absolute Living Developments Ltd (in liquidation) v DS7 Ltd & Others (2018) the Chancery Court held that it was not appropriate to make an order for security for costs where it would stifle a serious or genuine claim, even if there was reason to believe the claimant would be unable to pay the defendant's costs.

Background

The Claimant company (A) had issued proceedings against the defendants (D), alleging that D had paid money away from A in breach of duty. A was insolvent and D issued an application seeking security for costs from A in the sum of £500,000.

A successful security for costs application requires satisfaction of a two-stage test under the Civil Procedure Rules (CPR) 25.13(1) and (2)(c);

  1. there must be reason to believe that the Claimant would be unable to pay the Defendant's costs; and
  2. whether it is, in all the circumstances, just that an order for security for costs be made.

A conceded that the first requirement was met, however, it argued that the second limb should fail because it would not be just (in all the circumstances) for an order for security for costs to be made.

Decision

The court accepted A's assertions and held that it was not appropriate to make an order for security for costs. In reaching this decision the court followed long established guidance in the exercise of its discretion:

  • Whether the claim is bona fide and not a sham.

    The court was prepared to accept (and it was conceded by D) that the claim was bona fide, genuinely brought and clearly not a sham. In an interlocutory application the court needed to be wary about being drawn into an analysis of the merits. The question of whether there is a high chance of success was therefore left open.
     
  • Whether the Claimant's want of means has been brought about by the conduct of the Defendants;

    On the facts of the case as asserted by A this would appear to be true. However, as with the first consideration, it was not appropriate for the court to conclude (at this stage), whether the fact A is in liquidation is down to D.
     
  • Whether the application for security for costs has been brought too late;

    In light of the conclusion reached by this stage there was no need for the Court to address this factor. Notwithstanding this, the court confirmed that D could not be criticised for the timing of the application and the application would not have been rejected because of it.

The critical factor would be whether making the order would stifle a serious or genuine claim? The application would therefore turn on the last factor to be considered:

  • Whether the application for security for costs is being used oppressively to stifle a serious or genuine claim;

    There was a clear risk that making an order for security for costs would stifle a bona fide and genuine claim. There was no prospect of the claimant itself being able to pay any sum by way of security. There was also no prospect of the litigation being funded by the liquidator, which would be contrary to normal practice. The claimant and the liquidator had also given a credible explanation for not approaching A's creditors for funding - they were not wealthy and would be unlikely to be in a position to provide the funding required.

    A balancing exercise had to be conducted between the interests of D and A. As A was in liquidation the interests of A's creditors had to be considered and it was clear in that regard that the balance favoured the liquidator continuing with the claim for the benefit of its creditors.

As a result no order for security for costs was granted.

Comment

Security for costs will not always be ordered where an insolvent entity is unable to pay any costs order that may be made against it. If there is evidence that a genuine claim may be stifled, if security is ordered, that may be enough to successfully resist an application - even if it is clear that an insolvent claimant will be unable to pay any costs order that may subsequently be awarded against it .

There is a mature market for after the event (ATE) legal expenses insurance which many insolvency practitioners will be aware of. Such ATE policies can defeat a security for costs application if they are properly drafted, are from a reputable insurer and they are considered to provide sufficient protection in all the circumstances of the case.

See our February 2018 update for more on security for costs applications involving insolvent companies.

Unanticipated claims emerging after the approval of a CVA - will they stop the CVA becoming effective?

The Court of Appeal has considered the terms of a company voluntary arrangement (CVA) in light of a significant claim emerging after the CVA had been approved.

Following an expedited appeal the Court of Appeal overturned the earlier decision made by the High Court in the case of Richard Heis and others v Financial services Compensation Scheme and another (2018).

Background

The case involved a CVA for a company that had been in administration for a number of years. Most creditors had already received dividends of 90pence for each pound. The CVA would allow a small number of participating creditors to buy out the exiting creditors for £64 million. The exiting creditors would walk away with a further dividend, the participating creditors would remain in the insolvency proceedings and benefit from any future recoveries.

The CVA had been approved but before the bar on new claims came into effect a significant contingent claim was made in the sum of £126.7 million.

The administrators had not anticipated the claim and they disputed it. The bank (who had made the claim) appealed, but the appeal would not have been heard before the time stipulated for the CVA to be implemented. If the CVA was not implemented by that date it would lapse.

The CVA contained conditions precedent that had to be met - or waived by the CVA supervisors - before it could take effect. One of those conditions provided that "if there are disputed claims after the Challenge Period has ended, the Administrators have confirmed that this should not preclude the CVA from becoming effective".

The participating creditors argued that the drafting of the CVA required the administrators to state that the new disputed claim precluded the CVA from becoming effective. The claim was of such a magnitude that they would not be getting what they thought they would when they voted for the CVA.

The exiting creditors on the other hand argued that the CVA had been clear there was always a risk of fresh claims being made before the bar on any new claims came into effect. The commercial bargain encapsulated by the CVA had not changed.

The administrators did think that the CVA was still capable of being implemented, however they adopted a neutral stance and sought directions from the court in how clause 3.1(e) should be interpreted and how they should exercise their discretion under it.

The High Court held that clause 3.1(e) could not be interpreted to mean that the administrators had the right to terminate the CVA because the original commercial bargain was no longer possible. This interpretation would give the better commercially sensible result and would save the CVA and preserve its other advantages. Furthermore the court did not have the power to order that the CVA should not come into effect on the grounds of fairness.

The participating creditors appealed.

Court of Appeal decision

The Court of Appeal was very critical of the High Court decision, it went as far as stating that no reasonable person would have understood clause 3.1(e) to mean what the High Court had held that it did.

The Court of Appeal did have some concerns about the alternative interpretation put forward by the participating creditors. However, despite those concerns they held that as drafted the reasonable person would have little doubt its intention was to give the administrators discretion not to implement the CVA if disputed claims had materially changed the commercial landscape.

That interpretation also made commercial common sense - the gap between the date of approval and the date from when any further claims would be barred allowed time for new claims to be made that would dilute CVA recoveries. The value of the disputed claims was so materially different it affected the premise on which the creditors had voted for the CVA. If the claim was allowed in full and the CVA went ahead as drafted the effective recovery of the participating creditors would be drastically reduced. The fairest position, and therefore the judgment made, was that the administrators should be directed to confirm that the CVA was precluded from becoming effective.

Comment

The CVA was silent on what should happen in the event a claim was made after it had been approved but before it was implemented. The Court of Appeal used the normal principles of contractual interpretation to decide what would be the fairest outcome. Practitioners should ensure any CVA is clearly drafted and reflects what the parties have agreed. To avoid any uncertainty the CVA should state what impact the submission of a new claim should have in the period after approval until the bar on new claims is in force.

Acting in the best interests of creditors - a subjective or objective test

The Chancery Court has confirmed a director of a company had not breached his fiduciary duties to the company where he honestly believed he was acting in the best interests of the company's creditors.

In (1) Francis Wessley (2) Peter Hughes-Holland (Joint Liquidators of Laishley Ltd, in Liquidation) v Richard White (2018) the liquidators applied for equitable compensation in respect of alleged breaches of fiduciuary duty by the managing director (MD) of the company (C).

C ceased trading during the week of May 2010, went into administration on 9 June 2010 and then into creditors voluntary liquidation on 13 May 2011. At the time it ceased trading C was engaged as a building contractor and was performing a number of building contracts.

In relation to two of those contracts MD executed a deed of release, under which the employer and C were released from future performance and under which the employer was released from liability in respect of accrued but unpaid payment obligations. The liquidators alleged that MD's insistence that C enter into these deeds was a breach of his duties owed to C. The breach caused C to suffer losses, firstly as a result of losing the contract and secondly losing the right to any stage payments or retentions to which C had by then become entitled.

Decision

The Chancery Court found that in entering into the two deeds of release MD had not acted in breach of duty.

MD gave evidence that he had received advice from insolvency practitioners. They had advised MD about the possibility of a pre-pack sale of the company's business and also about novation of C's contracts. They explained that novation was a way of avoiding termination of C's contracts and bringing in a new company to take over their performance.

MD thought this would be the best result in all the circumstances. However, he did not really understand the process of novation. He did not appreciate that any novation had to take place before deeds of release were executed. Once the deeds of release had been executed there were no longer any contracts to novate.

The court held that the test to establish whether a director had acted in the best interests of the company - or the creditors of the company - is an objective test where there is no evidence of actual consideration of the best interests of the creditors, or where a material interest has been overlooked. In circumstances where there is evidence of actual consideration of the best interests of the creditors the test to be applied was a subjective one.

The court accepted the evidence given by MD that he had considered the best interests of the creditors of C. He genuinely thought that novating the contracts would be best for everyone and he did not realise that deeds of release should not be executed first. His conduct must be judged at the time he took the actions he did. He might have acted naively and he may have been mistaken but judged subjectively he had not acted in breach of his duties.

Comment

This decision stresses that the interests of creditors are paramount when a company is in an insolvent position. However, if the director can show that he acted that way because he genuinely thought that was in the company's best interests he will not be in breach of duty if the course of action chosen is not successful.

That is in keeping with the statutory discretion afforded to the Court under section 1157 of the Companies Act 2006, to excuse or relieve an officer of the company for negligence, default, breach of duty or breach of trust where the officer acted honestly and reasonably, having regard to all the circumstances of the case. Such cases turn on their facts and for larger companies directors should obtain not just the views of an insolvency practitioner but also legal advice to ensure that they are acting reasonably in all the circumstances before a decision is made.