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Insolvency Matters – November 2019

Insolvency Matters – November 2019

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Administrators’ duties when selling assets – the importance of exercising independent judgment

The recent case of Brewer and Another v Iqbal [2019] EWHC 182 (CH) looks at […]

The recent case of Brewer and Another v Iqbal [2019] EWHC 182 (CH) looks at the scope and extent of administrators’ duties and highlights the importance of obtaining a proper valuation of the assets to be sold in order to obtain the best possible price.

ARY Digital UK Limited (the Company) was a company that acquired TV channels catering to the Southeast Asian community in the UK. It was part of the wider ARY Digital Group (the Group) which describes itself as a broadcaster of customised streaming content. The Company’s UK and Europe operations consisted of 3 channels – entertainment, current affairs and Islamic education. In order to facilitate the broadcasting of these channels, the Company required Electronic Programming Guides (EPGs); all of which were acquired from British Sky Broadcasting Limited (Sky). EPGs are non-interactive menus providing programme scheduling information that are shown by a cable or satellite television provider to its viewers on a dedicated channel. When viewers tune into the channel, a menu is displayed listing current and future programmes.

By April 2011, the Company had several creditors, and was also in arrears with its payments to Sky for the EPGs. The Company entered into administration in May 2011 on the advice of the defendant, Mr Iqbal, who was appointed administrator.

In the period prior to filing the notice of intention to appoint, Mr Iqbal approached an agent, whom he had used many times before, to provide a valuation for the EPGs. The agent said the three EPGs together may be worth £4,000 to £10,000. A director of the Company then offered a figure of £35,000. Once the Company had entered administration, Mr Iqbal instructed the agent to sell the EPGs and it was agreed that they would be advertised from 24 to 31 May 2011. On 27 May 2011 Mr Iqbal instructed the agent to raise an invoice for all the Company’s assets in the sum of £57,000 plus VAT (of which £40,000 plus VAT was attributed to the EPGs) to the only interested party, ARY Network Limited (the Associated Company), another company within the Group. Mr Iqbal then wrote a report to the creditors recommending that the Company enter into a creditors’ voluntary liquidation, and that he should be appointed liquidator. Mr Iqbal’s administration proposals were rejected and the Company entered into liquidation with different insolvency practitioners appointed as joint liquidators. Expert evidence in court later valued the EPGs at approximately £2 million.

Claim and Defence

The joint liquidators sought equitable compensation for a breach of fiduciary duty to the creditors and for a breach of Mr Iqbal’s duty to exercise reasonable care and skill care to achieve the best price for the EPGs. They claimed that Mr Iqbal had entered into an agreement with the directors to sell to the Associated Company. This was based on the fact Mr Iqbal had preferred information provided by the directors (who had an interest in the Associated Company) by: (i) failing to obtain a proper valuation for the EPGs; (ii) accepting a valuation provided by the directors; and (iii) only marketing the EPGs for a very short amount of time. In any case, Mr Iqbal had failed to exercise independent judgment when exercising his duties.

Mr Iqbal argued that the Associated Company was the only party to make an offer, and the sale needed to go through immediately or Sky would switch off the channels, rendering the EPGs valueless.

Duty of Care and Skill

The court found that Mr Iqbal had not acted with reasonable care and skill. This was based on several factors.

Firstly that Mr Iqbal did not obtain a proper valuation prior to marketing the EPGs; nor were they marketed properly, both in terms of forum and time. The advertisement also failed to even refer to the EPGs, the channel numbers and the likely audience figures. The court pointed out that there was no evidence that Mr Iqbal had obtained knowledge and understanding of the Company and its assets – Mr Iqbal should have recognised the EPGs were a specific type of intangible asset with a “restrictive but competitive market”. Furthermore, a competent administrator would have consulted more than one agent when working with unusual or unfamiliar assets.

Secondly, Mr Iqbal’s failure to appreciate the applicability of SIP 16 (pre-packaged sales in administrations) and to have any regard to SIP 13 (disposal of assets to connected parties in insolvency proceedings) were strong indicators that there had been a failure to act with reasonable care and skill.

Thirdly, Mr Iqbal relied too heavily on the advice of the directors of the Company. While he was entitled to rely on them to provide information on the Company’s finances, assets and liabilities, and the reasons for its insolvency, he placed too much reliance on their valuation of the EPGs. He further failed to negotiate a better price and allowed the directors to push through the sale before the end of the marketing period.

Finally, throughout his engagement, Mr Iqbal had failed to keep a diary or attendance notes of meetings and telephone conversations. This meant he had little evidence, apart from the odd email to support him in his defence. The court’s view is that an administrator, just as any professional, should know to keep records, especially of important meetings and conversations on which he may later wish to rely.

The court recognised that while the EPGs were worth in the region of £2 million, potential purchasers would have taken advantage of the financial position of the company. Taking a reduction in price into account, an order was made for equitable compensation of £743,750 for the breach of fiduciary duty.

WM Comment

There are a number of practical implications that arise from this case:

it is a reminder to practitioners of the importance of maintaining independent judgment and taking proper advice when realising company assets
it is possible in an appropriate case to prove breach of fiduciary duty (as opposed to mere negligence) on the part of an administrator even though the hurdle is a high one
where a breach of fiduciary duty is proved, a ‘substitutive performance’ measure of equitable compensation (ie the value of the assets in question at the date of trial), as distinct from a quasi-negligence measure at the date of the sale of the assets, may be available.

Unlawful distributions and breach of fiduciary duties

In Burnden Holdings (UK) Ltd (in liquidation) v Fielding [2019] EWHC 1566 (Ch), the High […]

In Burnden Holdings (UK) Ltd (in liquidation) v Fielding [2019] EWHC 1566 (Ch), the High Court rejected numerous challenges brought by a liquidator in respect of the demerger of a subsidiary by way of a dividend in specie which the liquidator claimed was unlawful and the potentially unauthorised grant of security in favour of loans made by the shareholders.

Mr and Mrs Fielding were directors and majority shareholders of the Burnden group of companies including Burnden Holdings (UK) Limited (BHUK), the holding company. The business of most of the companies in the group was the manufacture and sale of conservatories. However, one subsidiary, Vital Energi Utilities Ltd (Vital), provided construction consultancy services. By May 2007, it had become clear that the financial position of the group was deteriorating and that cash was very tight.

In June 2007, the board of BHUK authorised the company to enter into a facility agreement with Mr and Mrs Fielding documenting the provision of £4.64 million which had been lent to BHUK over several years previously, together with a new fixed and floating charge to secure the lending.

In October 2007, a demerger of Vital was achieved by way of a dividend in specie by BHUK of its shares in Vital to Mr and Mrs Fielding. This was followed by a sale of 30% of the shares in Vital to a third party for £6 million. Mrs Fielding immediately loaned half of the sale proceeds to BHUK.

BHUK went into administration in October 2008 followed by a compulsory winding-up order in December 2009. The liquidator brought proceedings against Mr and Mrs Fielding for breach of fiduciary duty in respect of the two transactions affecting BHUK prior to administration, namely the granting of the security and the dividend in specie.

Security

The liquidators claimed that the security was unauthorised because the decision to grant it was not made at a valid board meeting and that the other directors were unaware that the loans had already been advanced by the Fieldings. The liquidator argued that the directors of BHUK had breached their duties in granting the security on the basis that there had been no commercial benefit to BHUK. In the alternative they argued that the grant of new security constituted a transaction defrauding creditors under section 423 of the Insolvency Act 1986.

The court dismissed each of these claims. The judge found that the granting of the security had been duly authorised with the intention that it be given for advances already made. It was also held that there was a commercial benefit to BHUK because of the group’s cash flow difficulties and the fact that the Fieldings were owed substantial sums which they could have demanded repayment of at any time. Since there was a commercial benefit, it was not a transaction at an undervalue and therefore section 423 of the Insolvency Act 1986 did not apply.

Dividend in specie

The liquidators claimed that the dividend in specie was unlawful because it did not meet the requirements of section 270 of the Companies Act 1985 (which was the relevant legislation at the time). In particular, the accounts that had been used did not allow a reasonable judgment to be made regarding the assets, liabilities, profits and losses of the company and in fact, there had been insufficient distributable reserves to declare the dividend. It followed that the dividend was unlawful and had been declared in breach of the directors’ fiduciary duties. It was also argued that if the dividend was unlawful, the defendants were strictly liable.

The liquidators also argued that Mr and Mrs Fielding were in dishonest breach of their fiduciary duties because at the time the dividend in specie was declared (or as a result of it), they knew that BHUK was insolvent or likely to become insolvent and they failed to take account of the interests of BHUK’s creditors. As such the dividend was a transaction defrauding creditors within the meaning of section 423 of the Insolvency Act 1986.

The court dismissed all of the liquidators’ claims. The judge held that the accounts were sufficient to allow a reasonable judgment to be made as to BHUK’s ability to declare a dividend and that distributable profits were indeed available. The dividend in specie was therefore not unlawful. Even though not strictly necessary, the judge went on to explore whether liability for unlawful distributions was strict or fault based. After a comprehensive review of the case law, the judge departed from the provisional view expressed by the Supreme Court in Re Paycheck Services 3 Ltd [2010] UKSC 51 and stated that liability for unlawful dividends was fault based. A director will be liable in respect of an unlawful dividend only if he:

knows that the dividend is unlawful
knows the facts that establish the impropriety of the payment (whether or not he appreciates that they render the dividend unlawful)
must be taken in all the circumstances to know the facts rendering the payment unlawful
ought to have known, as a reasonably competent and diligent director, that the payments were unlawful.

The court also rejected the argument that Mr and Mrs Fielding were in dishonest breach of their duties. The liquidators had not discharged the burden of showing that BHUK had been rendered insolvent as a result of the dividend in specie and accordingly the creditors’ interests had not arisen. The court accepted that neither of the defendants were actually aware that BHUK was insolvent and so they had not dishonestly breached the duty.

WM comment

This decision is important reading for anyone planning a demerger or distribution and in particular with regard to its conclusion on the nature of a director’s liability for unlawful dividends. Directors are not required to be accountants and can rely on the advice of others who have a more specialist role. So long as directors take reasonable care when establishing the availability of profits, they will avoid personal liability if it turns out the distribution was in fact unlawful.

When should a court exercise its discretion under the Insolvency Rules?

The decision in Martin v McLaren Construction Ltd [2019] EWHC 2059 (Ch) serves as a […]

The decision in Martin v McLaren Construction Ltd [2019] EWHC 2059 (Ch) serves as a useful reminder of when a statutory demand can be served and discusses when the court can use its discretion under rule 10.5(5) of the Insolvency Rules to set one aside.

Mr Martin had given a guarantee to a construction company for the payment or discharge of his own liabilities and those of three companies. The construction company had then assigned its rights in the documents to the respondent, McLaren Construction Ltd (McLaren). Under the guarantee, the guarantor was obliged to pay immediately on demand, with the guarantee also specifying that all notices and demands had to be in writing and personally delivered or sent by post or fax.

McLaren did not send a written notice to Mr Martin demanding payment under the guarantee but instead issued a statutory demand in the sum of approximately £7 million, which it said was owed by Mr Martin under the terms of the guarantee. The statutory demand was expressly made under section 268(1)(a) of the Insolvency Act 1986 (the IA 1986), involving a debt for a liquidated sum payable immediately. Mr Martin refused to pay and argued that the debt was not “payable immediately”, as the guarantee provided that he would only become liable to make payment when he had been served with a written demand for payment, and he had not been served with a written demand.

Mr Martin asked the court to set aside the statutory demand under rule 10.5(5) of the Insolvency (England and Wales) Rules 2016 (the Insolvency Rules), which gives the court a discretion to set aside a statutory demand if “satisfied, on other grounds, that the demand ought to be set aside”.

The High Court agreed and used its discretion to set aside the statutory demand as the creditor had failed to make demand under the guarantee itself first. The court held that owing to McLaren’s failure to serve a written demand under the guarantee, the requirement of s.268(1) that the debt forming the subject of the statutory demand should be “payable immediately”, was not met. Even by the date of the hearing, the respondent had not served a formal demand under the guarantee or filed evidence stating whether and, if so, when it proposed to do so, meaning that, as at the date of the hearing, it did not comply with IA 1986. Any residual discretion conferred on the court under the Insolvency Rules had to be considered and exercised in a manner consistent with primary legislation. The judgment stated that the court should be slow to exercise its discretion against the setting aside of a statutory demand under rule 10.5(5)(d) when essential prerequisites of s.267 and s.268 of IA 1986 had not been met.

WM comment

This case is as a useful reminder that before making any statutory demand, it is necessary to make a demand under the guarantee itself. In addition it illustrates the discretion that the court has under rule 10.5(5) of the Insolvency Rules as to whether a statutory demand ought to be set aside. The judgment highlights that the court should be slow to exercise its discretion where the essential prerequisites to issuing the statutory demand have not been met, such as where the creditor has not made demand under a guarantee and has therefore failed even to establish the statutory presumption of insolvency.

Recovery of void payments under section 127

The case of Re MKG Convenience Ltd (in Liquidation) v Nisa Retail Ltd [2019] EWHC […]

The case of Re MKG Convenience Ltd (in Liquidation) v Nisa Retail Ltd [2019] EWHC 1383 (Ch) has clarified the law surrounding applications to recover payments invalidated by section 127 of the Insolvency Act 1986.

What were the facts?

MKG Convenience Ltd (MKG) operated convenience stores under the Nisa Retail brand. MKG went into compulsory liquidation on 7 May 2015 following the presentation of a winding-up petition by Nisa on 16 March 2015. Direct debit payments were taken from MKG’s bank accounts shortly after the winding-up petition was presented and continued to be taken by Nisa on a weekly basis for the supply of stock after the petition was advertised and after the winding-up order was made. In total twenty-eight payments were made totalling £162,307.36.

The liquidators of MKG brought proceedings under section 127 of the Insolvency Act 1986 to recover the payments. The liquidators sought an order declaring that the direct debit payments made after the presentation of the winding-up petition were void and should be repaid.

Nisa accepted that the direct debits were prima facie void due to the effect of section 127 but made a cross-application for a validation order. It argued that it should not have to repay the money as it had changed its position in good faith on the basis that the payments had been validly made. The so-called ‘change of position’ defence.

What did the court decide?

The High Court (David Cooke HHJ) did not grant a validation order in respect of any of the direct debit payments and ordered the amounts to be repaid. The court dismissed Nisa’s change of position defence on the facts, however, the court confirmed that such a defence could theoretically be available against a claim for the return of void payments. Interestingly, the judge went on to say that if a validation order was declined, it was not easy to think of circumstances in which a court could subsequently find it inequitable to order the repayment of a benefit received.

WM Comment

The judge’s analysis of the change of position defence in this case is helpful to liquidators. It emphasises that it would be unusual for a court to refuse a validation order to the defendant but uphold a change of position defence.

Bankruptcy statutory demands and an explanation of creditor security

In Promontoria (Chestnut) Ltd v Bell & Anor [2019] EWHC 1581 (Ch), the High Court […]

In Promontoria (Chestnut) Ltd v Bell & Anor [2019] EWHC 1581 (Ch), the High Court held that the test for whether a creditor is a secured creditor in the context of the bankruptcy legislation (including statutory demands) should be whether their security would benefit the general bankruptcy estate if it was surrendered.

What were the facts?

Mr and Mrs Bell were directors and shareholders of a company which had borrowed money from a bank. The Bells entered into a personal guarantee (with an indemnity if the guarantee was unenforceable) in respect of the company’s borrowing, up to a limit of £170,000. The loan facility was also secured over company property. In addition, the respondents executed third-party mortgages over properties they owned to secure the facility. However, those securities expressly negated any personal liability on the respondents’ part to pay to the bank any of the company’s liabilities. The company failed to repay the loan facility and the bank assigned its rights under the facility, guarantee and mortgages to the creditor, Promontoria (Chestnut) Limited (Promontoria).

Promontoria appointed receivers over the company’s property and the Bells’ properties. The receivers realised assets of the company and reduced the outstanding balance on the loan facility from approximately £600,000 to £185,000. Promontoria sent letters to Mr and Mrs Bell demanding £170,000 under the personal guarantee that they had provided. When they failed to pay, Promontoria served them with statutory demands pursuant to section 268(1) of the Insolvency Act 1986. However, the demands were set aside on the basis that Promontoria held some security over Mr and Mrs Bells’ properties in respect of the debt and, contrary to the rule 6.1(5) of the Insolvency Rules 1986, it had failed to specify the nature of that security and its value in the statutory demands.

Promontoria appealed the setting aside of the statutory demands. It submitted that the security it held over Mr and Mrs Bells’ properties by way of the third-party mortgages was in respect of the company’s indebtedness and did not secure the personal debt the respondents owed under the guarantee. It therefore was not necessary to include the third-party mortgages in the demand as the security did not secure the personal debt of Mr and Mrs Bell against whom the demand was served.

What did the court decide?

Promontoria’s appeal was dismissed. The judge held that the third-party charges provided by Mr and Mrs Bell for the indebtedness of the company to Promontoria were security in respect of the debt upon which the statutory demands were based, within the meaning of rule 6.1(5) of the Insolvency Rules 1986 interpreted in accordance with its underlying rationale and purpose. The judge went on to say that they were two different debts, one owed by the Bells under the guarantee and one owed by the company. As such the Bells had guaranteed both, and provided a third-party charge for, the company’s debt.

On the facts of the case, it was clear that for every pound of value of the secured property released from the Bells’ mortgage security, one pound of value would augment to the assets available for distribution in the bankrupt estate for the benefit of the general body of creditors. Consequently, it was a security, the existence of which affected the creditor’s right to participate in the bankruptcy of Mr and Mrs Bell.

WM Comment

The judgment did not consider the application of the Insolvency Rules (England and Wales) 2016 and so the same decision would not necessarily be reached if the case was brought today. Furthermore, the case is unlikely to have application in the context of statutory demands served on companies but it will be interesting to see if it is used, nonetheless, to try to expand the definition of secured creditors.

Persons resident abroad can be ordered to produce documents under the Insolvency Act 1986

The High Court was asked to consider whether it could order a person in Ireland […]

The High Court was asked to consider whether it could order a person in Ireland to produce documents under section 236(3) of the Insolvency Act 1986 in relation to the liquidation of an English company.

In Wallace v Wallace [2019] EWHC 2503 (Ch), the High Court has held that the liquidator of an English company was entitled to an order against a former book-keeper of the company, resident in Ireland, to produce documents of the company in his control or possession.

Previously there have been conflicting decisions on the jurisdiction of the court to order the production of documents or the supply of information under section 236(3) of the Insolvency Act 1986 (Section 236).

In Re MF Global UK Ltd [2015] the High Court held that it did not have jurisdiction to make an order under Section 236 against persons not in the jurisdiction. However in Official Receiver v Norriss [2015] the High Court held that it could make an order for the production of documents and information against a person abroad under Section 236.

In the current case, the court followed Norriss, and held that the liquidator was entitled to an order delivering up documents. On the facts, the book-keeper held critical information and could not reasonably complain about having to supply information. The company’s centre of main interest was in the UK and the order of the court would be recognised and enforced in Ireland. The court therefore had a legitimate interest in regulating the book-keeper’s conduct abroad and in requiring him to make documents and information available to the liquidator.

The judgment highlighted the following two issues:

the power to require the production of documents under Section 236 should be regarded as a standalone power separate from the power to summon a person out of the jurisdiction (section 235)
the court should take account of the international dimension in its assessment and be wary of making orders seeking to regulate the conduct of third parties abroad in respect of matters having no real connection with the jurisdiction or which involved excessive or exorbitant exercise of jurisdiction.

WM comment

The decision is a useful addition to case law on the extra-territorial application of Section 236. It is now clearer than before that jurisdictional reach under Section 236 must be considered separately from the power to summon a person to appear before the court under section 235(2).

Contacts

Gawain Moore, Partner, Banking, Restructuring & Insolvency Group at Walker Morris LLP

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