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Insolvency Case Law Update

Insolvency Case Law Update

Published: 30 September 2016

Key points arising out of three important decisions are selected by Insolvency Partner, Alejandro Worthington.

1. Re Lehman Brothers International ( Europe) (in administration) – Lomas & Ors v Burlington Loan Management Ltd & Ors [2016] EWHC 2131 (Ch)

Administrators applied to the court for directions regarding supplemental issues arising out of two earlier judgments of re Lehman Brothers International (Europe) No 5) [2015] EWHC 2269 (Ch) and re Lehman Brothers International (Europe) No 5) [2015] EWHC 2269 (Ch). The main issues related to the entitlement of creditors to post-administration interest, including any such entitlement arising out of agreements entered into by the company (acting by its administrators) and many of the creditors in respect of claims for interest and non-provable currency conversion losses.

A currency conversion claim arises where there has been a depreciation in sterling by the time of a dividend distribution following a foreign currency debt having been converted at the exchange rate prevailing on the date the company entered administration (pursuant to Rule 2.86 of the Insolvency Rules 1986 (the “Rules”)). Where a creditor suffers a shortfall under such circumstances, he may submit a claim as a non-provable debt after the payment in full of statutory interest.

Rule 2.88 of the Rules was central to some of the supplemental issues raised: this governs the payment of statutory interest on proved administration debts and is a complete code for the payment of such debts to creditors.

Rule 2.88 does not deal with claims for interest on non-provable claims. Further, the court concluded that there is no basis in law for a creditor to be treated (in the context of contractual or other rights) as having taken a step it has not in fact taken which would result in a liability being imposed on the company in administration which did not exist as at the date of the administration. No interest being payable on a contingent debt until the occurrence of that contingency, no interest would be payable on any contractual rate in this regard. This has no bearing on creditor compensation flowing from any judgment interest.

Referring to issues relating to foreign judgments, the court confirmed that a judgment rate is not something to be paid pursuant to any underlying contract – it is completely distinct from a contractual right to interest. However, in the light of the submissions placed before the court, Lord Justice Richards declined to give directions on the specific issue of how to treat non-provable claims to interest on foreign judgments entered after the date of the administration.

The court concluded that no currency conversion claim arose as a result of set-off under Rule 2.85. The court further concluded that such a non-provable claim to interest on a currency conversion claim should not be reduced by any interest received by a creditor under Rule 2.88 on its proved debt. Under Rule 2.85(3) account is taken as at the date of the administrator’s notice (Rule 2.95) of his proposal to distribute. The claim is discharged, regarding any set-off, as at the date of the administration (contrast with liquidation and bankruptcy where there is a single date for set-off, debts being ascertained and any currency conversion). Once set-off has been applied, statutory interest then runs on the balance of the debt thereafter. Statutory interest being payable on the proved debt only, no interest had, therefore, been paid on the undischarged foreign currency debt (following the sterling depreciation) meaning that the creditor was entitled to full contractual interest on that part of the debt.

2. Laying bare the ledger- Re Kiss Cards Ltd, aka Smith v Lawson [2016] EWHC 2176 (Ch)

After Kiss Cards went into liquidation in 2012 the liquidators queried a number of the directors’ transactions under the Insolvency Act 1986.

Alejandro Worthington, partner at Fletcher Day says the eventual judgment reminds practitioners and directors that every possible ‘transaction’ could be subject to scrutiny in the event of insolvency if within the ‘relevant time’.

What are the practical lessons that those advising can take away from this case?

It is, as with any litigation, essential to establish from the outset that the facts and the relevant legislation are compatible. In terms of any claim issued pursuant to section 238 (2) of the Insolvency Act 1986, it is necessary to tick every box: for instance, has there been a ‘transaction’, was it entered into ‘at the relevant time’ and was it at ‘undervalue’? In Re Ovenden Colbert Printers Ltd; Hunt v Hosking [2013] EWCA Civ 1408, [2013] All ER (D) 188 (Nov), the liquidator’s case had essentially fallen at the first hurdle, his having failed to establish that a transaction had been entered into within the scope of s.238. It is also vital to understand at an early stage who the relevant parties or individuals are in any claim and what their respective roles were or might have been. The court also reiterated in Re Kiss Card Ltd that liquidators will often have no knowledge of the company’s affairs other than what the directors tell them and what they can glean from the books and records. It is imperative to review all available information as early as possible (including full bank statements).

What was the background to the case?

The company, Kiss Cards Limited, was a one director company. It was a gift card retailer and, effectively, a phoenix company, its predecessor having ceased trading having been heavily insolvent. Kiss Card Limited was, in fact, company no. 3 in the chain, the first company also having become insolvent. The estimated deficiency at the commencement of the administration which preceded the liquidation was in the region of £2.3m, HMRC being owed an estimated £584,000. This HMRC claim subsequently rose, creditors then being owed in excess of £2.8m. The company only traded for little over a year (in its latest guise). Several payments totalling £105,000 had been made into a joint account in the names of the director and his wife (also employed by the company as its bookkeeper). The claim was eventually continued in respect of only £37,588.97 as claims against the director were discontinued, his having entered into an IVA.

What were the issues before the court?

One key issue was to establish what the intention of the individuals was as to who was to benefit from the payments: were they to be for the benefit of the director alone and, if so, would his wife be treated as a party to a ‘transaction’ (if there had even been a transaction as between the company and both account holders individually) with the company on account of her having a join interest in the account into which payments were made. Secondly, that the payments were made during the ‘relevant time’ was quickly established by the court. Thirdly, the court had to decide how certain expenses payments should be treated and how the director’s wife’s remuneration package ought to be treated. Finally, the court would hear argument on the nature of and reasons for certain lump sum payments as well as in respect of credits that had been claimed by the director.

What were the main legal arguments put forward?

The main legal arguments can be summarised as follows: The case was cited of Re Taylor Sinclair (Capital) Ltd (in liquidation); Knights v Seymour Pierce Ellis Ltd [2001] 2 B.C.L.C. 176: was there, in the current case, any element of mutual dealing between the company and the recipient of certain payments? The recipient in the Knights case was a stockbroker acting as agent for a client and it was that client for whom the sums in question were intended. Were payments (including ‘rent payments’) into the joint account made to discharge expenses payments made on behalf of the company by the director? Were the payments to the wife of motor expenses and car finance payments and insurance and other ancillary sums made at undervalue (s.238 Insolvency Act 1986)? The Liquidators contended that they were because there was simply no good reason for the bookkeeper of the company to travel on the company’s business at all.

What did the court decide, and why?

The Court granted some of the declarations sought by the Liquidators but accepted some of the explanations given by the director and his wife. As regards the Liquidators’ contention regarding payments to the wife for the car, the court ruled that it is not possible to separate one part of an employee’s remuneration package and analyse its value to the company in isolation. The whole of the package must be assessed by comparing it with the whole value of services provided by the employee. In this case, remuneration was primarily the provision of a car rather than salary. The court also accepted the explanations of the director and wife in respect of certain payments into their account, based on the factual evidence adduced. Any unexplained payments (not least in the face of redacted bank statements and with no company records to support the argument that the company had, or needed, to rent certain space) were considered gifts to both joint account holders, the court ruling in favour of the Liquidators. All credits being claimed (which amounted to almost the full value of the Liquidators’ original claim) were adjudged to have been reimbursed or accounted for already. Full copies of the bank statements eventually provided to the Liquidators (having allowed certain credits) revealed that the director had in fact paid himself twice for the same amount on at least three occasions.

To what extent is the judgment helpful in clarifying the law in this area?

The judgment reminds practitioners and directors that every possible ‘transaction’ could be subject to scrutiny in the event of insolvency and within the relevant time. It reiterates the need to properly assess, from a legal and factual perspective, every such ‘transaction’ or dealing in which a company is involved before issuing proceedings and to be prepared to analyse contracts and transactions as a whole in certain circumstances. The judgment also reinforces that the onus is on the Liquidator to show that there has been a ‘transaction’ and that it is either a gift or otherwise at undervalue. The court also took the opportunity to remind directors of their statutory duties to co-operate with office holders (s.235 IA 1986) when, for instance, producing a statement of affairs and that the duty to co-operate is ongoing and not restricted simply to answering questions and providing documentation and access to records as might specifically be requested by the office holder.

3. Horton v Henry [2016] EWCA Civ 989

The Court of Appeal has upheld the decision of the High Court (Mr Robert Englehart QC, sitting as a deputy judge). The Court dismissed the appeal of the trustee in bankruptcy (“Trustee”) that a bankrupt’s unexercised rights to draw down on any of his personal pension plans, which might become payable were the bankrupt to exercise his contractual rights under those policies, should constitute ‘income’ pursuant to s.310(7) of the Insolvency Act 1986 (“IA ’86”). The Court of Appeal further held that a trustee in bankruptcy could not compel a bankrupt to bring his pension plans into payment and so become available for the benefit of the bankrupt’s creditors. The decision in Raithatha v Williamson (a bankrupt) [2012] EWHC 909 (Ch) was, accordingly, wrongly decided.

At the heart of the appeal lay issues of statutory interpretation of s.310 of the IA ’86 and s.11 of the Welfare Reforms and Pensions Act 1999 (“WRPA”). The Court also considered with great interest two non-binding decisions in Re X [2014] BPIR 1081 and Hinton v Wotherspoon [2016] EWHC 623 (Ch).

The Trustee sought an income payments order (“IPO”) under s.310 of IA ’86. The respondent contended, first, that the relevant benefits in respect of the pensions did not constitute income to which he had “become entitled” (as per s.310 (7) IA’ 86) and, secondly, that it was not reasonable in the circumstances to require election to draw benefits as he wished to preserve as much capital value as possible to enable the balance to be passed to his children on his death. The respondent further maintained as follows: (i) that s.310 IA ’86 only permitted pensions actually in payment to be the subject of an IPO; (ii) that there was nothing in legislation clearly enabling the Court to interfere, as was being requested here, with a person’s possessions; (iii) the WRPA amended s.310 IA ’86 so as to exclude pensions from a bankrupt’s estate (rights were protected, income was not – and the Court also noted that pre-bankruptcy pensions are not protected (and so a judgment creditor’s position in this context is improved qua that of a trustee seeking an IPO, as in the current case)). The Court also noted that s.283(6) IA ’86 (defining a “bankrupt’s estate”) was “subject to the provisions of any enactment not contained in this Act under which any property is to be excluded from a bankrupt’s estate”.

The Court agreed with the respondent.

Arguments were proffered by the Trustee’s counsel that due consideration should be given by the Court to the “Cork Report” of 1982. Counsel’s view was that it emphasised that the Court’s power to make an IPO should be wide and should relate to most sources of income, and should be applied in the current case. This was not accepted by the Court: any such discretion was effectively superseded by the WRPA.

The Court concluded that the language of s.310 IA ’86 “is addressed to capturing income; there is no suggestion in the language that it is conferring a power on the court to require the bankrupt to exercise a power – in relation to property expressly excluded from the bankruptcy estate – to generate income”.

A trustee could not rely on a bankrupt’s general duty to co-operate with his trustee to the extent in contemplation (i.e. a bankrupt exercising his contractual rights against his will). A trustee’s function and power as regards property did not extend to expressly excluded property (which had not, therefore, vested under s.306 IA ’86). The Court, in drawing its conclusion and in countering an argument raised by the Trustee’s counsel, considered that a trustee could not compel a bankrupt to work or to request that payment be made/facilitated by him from a discretionary trust so as to create “income” which could, in turn, become subject to an IPO.

The Court highlighted the fact that the Trustee could not place any reliance on sections 342 A to 342C IA ’86. These sections were designed simply to enable a trustee to claw back excessive pension contributions (such sums thereby becoming available for distribution to the bankrupt’s creditors). The Court also noted that, in any event, pensions rights could never become after-acquired property (s.307(2) IA ’86).

The Court was of the view that Parliament had made a clear decision to draw the balance between the interests of the State in encouraging people to save by way of private pensions and the interests of creditors in benefitting from a trustee’s powers to maximise realisations for their benefit.

Accordingly, rights under private pensions as well as occupational pension schemes are protected, leaving trustees unable to succeed in obtaining an IPO in these circumstances.

Alejandro Worthington
Partner, Insolvency & Restructuring