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Insolvency Update – May 2018

Insolvency Update – May 2018

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High Court decides that liquidator’s appointment was valid despite failure to give notice of deemed consent

In Cash Generator Ltd v Fortune and others [2018] EWHC 674 (Ch), the court considered […]

In Cash Generator Ltd v Fortune and others [2018] EWHC 674 (Ch), the court considered whether failure to comply with the process to nominate a liquidator required by section 100 of the Insolvency Act 1986 (the Act) and the Insolvency Rules 2016 (the Rules) invalidated the subsequent appointment of the liquidator.

The applicant, Cash Generator Ltd (Cash Generator), challenged the appointment of liquidators to three companies of which it claimed to be a creditor on the basis that it had not been given notice of the deemed consent procedure for the nomination of a liquidator to each of the companies as required by rule 6.14 of the Rules. Cash Generator claimed that this failure invalidated the appointment of the liquidators so that new office holders were required.

Cash Generator also claimed that the liquidators should be replaced because of alleged actions and omissions by the liquidators following their appointment.

The judge therefore had to consider whether the appointment of the liquidators was invalid and whether they should be removed so that their conduct could be investigated.

What did the court decide?

In considering the first issue, the judge noted that section 100 of the Act is expressed in mandatory terms in that it requires the directors of a company to seek nomination of a person to be liquidator from the company’s creditors. Rule 6.14 of the Rules says that notice of the deemed consent procedure must be given to creditors and the judge noted that the purpose of the provisions and the mandatory language used was to ensure that all creditors who can vote are involved in the process. However, the legislative background was slightly subtler. The deemed consent procedure was introduced for the purposes of promoting involvement rather than to make sure that all creditors participated. Parliament’s purpose had been to achieve a speedy appointment of an insolvency practitioner nominated by creditors, not to incur uncertainty, delay and extra costs. There was always going to be the prospect of one or more creditors not being given notice of a proposed CVL for a number of reasons and it was reasonable to conclude that Parliament did not intend this to lead to an invalid appointment.

The consequence of failure to comply with the deemed consent procedure is that a director is guilty of an offence and can be fined. Neither the Act nor the Rules specify whether an appointment will be invalid if not all creditors are notified of the nomination process.

The judge concluded that while the Act created a binding statutory obligation, the consequence of non-compliance was not invalidity.

In relation to the second issue, Cash Generator claimed that there was need for an investigation into the liquidators’ actions and omissions after their appointment, particularly a pre-liquidation assignment of leases and a post-liquidation sale of stock. As those investigations concerned the conduct of the liquidators, new office holders should be appointed. The judge didn’t agree. He held that there was no basis for the removal of the liquidators as there was nothing to suggest that they would not carry out any investigations that they considered appropriate for the conduct of the liquidation. Crucially, the majority creditor, Her Majesty’s Revenue & Customs, did not support the removal.

WM comment

This decision should be welcomed by liquidators. It means that nominee liquidators need not worry about their appointment under the deemed consent procedure being declared invalid if a creditor is not sent notice of their nomination due to an oversight. Interestingly, the judge also issued a plea that the Rules are reconsidered saying that the rules that he had to refer to “were numerous, to be found in a variety of different places and feature so many requirements that they may be difficult to apply in practice”. Given that one of the aims of the Rules was to make them more user-friendly this is quite a telling remark and we shall have to wait and see whether it is acted upon.

A cautionary tale regarding the appointment of administrators using the ‘out of court’ route

Capital Funding One Limited (Capital) was a special purpose vehicle established for peer-to-peer lending. Capital […]

Capital Funding One Limited (Capital) was a special purpose vehicle established for peer-to-peer lending. Capital would arrange short term bridging finance at high rates of interest for borrowers who were unable to obtain loans from more conventional sources. Capital had no assets itself, instead the lending was funded by third-party investors. One such investor was King Street Bridging Limited (King Street).

The arrangement was that Capital, having found potential borrowers, would offer King Street a ‘lending opportunity’ outlining details of the borrower and the terms of the proposed loan. King Street would then consider the opportunity and decide whether or not to advance the funds to Capital. Capital would then lend the monies on. King Street would regularly put Capital in funds for lending to ultimate borrowers. This whole arrangement was by way of an informal joint venture, there was no written agreement and business was conducted orally or by email.

In November 2013, Capital granted King Street a debenture containing fixed and floating charges to secure all monies owed then and in the future to King Street. One of the terms of the debenture was that non-payment of sums due to King Street constituted an event of default which gave King Street the right to appoint administrators using the out of court process.

Between November 2013 and November 2015 numerous loans were advanced to Capital which in turn advanced them to the ultimate borrowers. Occasionally the borrowers were late in repaying the loans to Capital which in turn meant that King Street was repaid late but at no point did King Street make a demand under the debenture.

In September 2016 the business relationship turned sour. Two borrowers defaulted on their repayments to Capital which meant that King Street was out of pocket to the tune of £678,000 and King Street demanded repayment. Capital didn’t meet the demand and so King Street purported to appoint administrators under the terms of the debenture.

Capital, however, challenged the appointment and sought an order from the court that the administrators had not been validly appointed because no event of default had occurred (Re Capital Funding One Limited [2017] EWHC 3567 (Ch)).

What did the court decide?

The court agreed with Capital and found that the appointment was invalid and held that the administrators should be removed. The judge stated that the crucial issue was whether the monies advanced by King Street were repayable only in the event that Capital received equivalent payments from the borrower, in other words a ‘pay when paid’ arrangement. King Street contended that Capital’s liability to repay the advance arose when the ultimate borrower became liable to repay Capital, if the ultimate borrower was in default to Capital, Capital was in default to King Street.

Without a written agreement it was down to the court to identify what the parties understood the position to be in this situation. Did the parties intend that the risk of non-payment by a borrower fall on Capital or King Street? The judge decided that it was understood that the risk would fall on King Street. He picked out three particular factors in support of this conclusion:

King Street knew from the outset that Capital had no other source of funding for the loans and no other assets and therefore if a borrower defaulted on a loan, Capital would have no alternative means to repay King Street;
King Street was free to accept or reject any particular lending opportunity;
King Street made its decision to advance funds by independently assessing the risks of each proposed borrower.

The judge therefore found that there was no obligation on Capital to repay King Street when the borrower had defaulted on his loan repayment. As such there had been no event of default under King Street’s debenture and therefore the appointment of administrators had been invalid.

WM comment

From a general contractual point of view, this case highlights the danger of failing to fully reduce an agreement to writing. From an insolvency point of view, it exposes the hazards of appointing administrators through the out of court route. The nature of any floating charge must be carefully examined to ascertain whether an administrator can be validly appointed.

Contract interpretation – the importance of precise drafting

In Kason Kek-Gardner Ltd v Process Components Ltd [2017] EWCA Civ 2132, the Court of […]

In Kason Kek-Gardner Ltd v Process Components Ltd [2017] EWCA Civ 2132, the Court of Appeal considered the correct approach to the interpretation of related contracts, concluded at different times by the same seller with different purchasers, and to the test for implying a term where necessary to give business efficacy to a contract.

When interpreting a contract, the court’s task is to ascertain the objective meaning of the language which the parties have chosen to express in their agreement when read in the context of the factual background known or reasonably available to the parties at the time of the agreement, excluding prior negotiations (Wood v Capita Insurance Services Ltd [2017]).

Following the administration of Kemutuc Powder Technologies Ltd (the Seller), the administrators entered into two asset sale agreements. The first with Process Components Ltd (Buyer1), a new company formed by the former directors of the Seller, for the sale of the assets of two divisions of the Seller. The second was entered into a couple of weeks later with Kason Kek-Gardner Ltd (Buyer2) in relation to the remaining assets of the Seller. Both agreements suffered from a lack of clarity in their drafting.

Buyer1 and Buyer2 subsequently entered into a licence agreement under which Buyer1 licenced the use of intellectual property rights formerly owned by the Seller. Buyer2 was then purchased by a competitor of Buyer1 and as part of the due diligence process disclosed the licence agreement to the purchaser. Buyer1 promptly terminated the licence agreement on the basis of a purported breach of confidentiality. A dispute then arose about what rights Buyer2 had actually acquired from the administrators and whether the same rights had already been sold to Buyer1.

The High Court was asked to determine whether, under the terms of its asset sale agreement, Buyer2 had acquired any (and if so what) intellectual property rights formerly belonging to the Seller.

The judge determined that all the parties had acted on the common assumption that Buyer1 had acquired the whole of the Seller’s intellectual property but that, construed as a whole, Buyer1’s sale agreement merely transferred the intellectual property rights in the divisions it had acquired. She considered what intellectual property rights were comprised in those divisions and necessary for trade to continue. The judge held that Buyer2 was permanently estopped from denying that Buyer1 owned the relevant intellectual property.

Buyer2 appealed. Buyer2 argued that as both agreements were made as part of the same administration, they should be read together. If this were done, the effect was that Buyer1 acquired the intellectual property rights it needed for its business and Buyer2 acquired the intellectual property rights it needed for its business. Furthermore, it would have been obvious to all parties that the administrators would not have intended to sell the assets they did to Buyer2 without the accompanying intellectual property rights and that therefore it could not have been the intention that those intellectual property rights would transfer to Buyer1.

Court of appeal decision

The Court of Appeal held:

The general rule was that parties’ conduct after concluding an agreement could not affect the interpretation of the agreement. The second asset sale agreement, concluded ten days after the first and with a different purchaser, could not be used to interpret the first agreement.
Admissible background was limited to facts that were known or reasonably available to all parties. There was nothing in the admissible background, or in the language of the agreement for the sale of the assets to Buyer1, to support the proposition that the intellectual property rights were divided according to purpose.
Buyer2’s interpretation of the agreements relied on commercial common sense and background and devalued the importance of the language of the agreements. Interpreting Buyer1’s sale agreement without reference to Buyer2’s sale agreement, Buyer2 had not acquired the intellectual property rights in the divisions it had purchased.
The judge was entitled to conclude that the trade mark referred to in Buyer1’s sale agreement was the registered trade mark with the different number. This was an exercise in judicial interpretation, involving application of the principle of falsa demonstratio non nocet (”a plain misdescription does no harm”). Either the number of the trade mark mentioned in the asset sale agreement must be rejected or the description of the mark as “registered” must be rejected. The KEK mark was one of a number of trade marks described as registered. In the circumstances, the judge was entitled to attach weight to that part of the description and to reject the number. The court emphasised that it was not rectifying the contract (in the sense of dealing with the equitable remedy of rectification); rather, it was a matter of interpretation. If it were a question of rectification, the intervention of third party rights might lead the court to refuse to grant the remedy. That did not apply where the question was one of interpretation.
That a term will not be implied into a detailed commercial contract unless it is necessary to give the contract business efficacy or if it is so obvious it goes without saying.

WM comment

The Court of Appeal decision does not formulate any new law but confirms the current approach of the courts to contract interpretation. It reflects the ongoing shift away from reliance on common sense and business context, and instead focussing on the precise language of the contract. It is a reminder to all of us to make sure that contracts are sufficiently clear and precisely drafted.

Are Receivers obliged to obtain the best price when selling property?

In a nutshell, Centenary Homes Limited defaulted on a loan which was secured against several […]

In a nutshell, Centenary Homes Limited defaulted on a loan which was secured against several properties, including one property (Warne Court) which comprised a number of residential flats.

The lending bank appointed receivers who proceeded to sell several properties within the borrower’s portfolio realising sufficient funds to discharge the debt owed to the bank in full and the receivers’ appointment ended. Warne Court was sold as a single block for £3.25 million rather than as individual flats which the borrower contended would have achieved a higher price.

Centenary Homes Ltd subsequently issued a claim against the receivers alleging that they had acted in breach of their duties. The company claimed that the receivers had a duty to take reasonable steps to obtain the best price reasonably obtainable. The company’s argument was that Warne Court should not have been sold as a block but as individual flats and that the combined market value for the flats sold separately was £3.885 million representing a loss of £635,000.

The receivers applied for summary judgment and strike out of the claim arguing that sale of the flats as a block was preferable due to factors such as the increased length of time it would take to sell the flats individually and the risk that market conditions could worsen over that time.

What did the court decide?

The court found in favour of the receivers and in doing so set out existing case law restating the duties owed by receivers including:

a receiver’s primary duty is to realise the security in the best interests of the bank
a receiver has only a secondary duty to the borrower to exercise care to avoid preventable loss
a receiver is only required to protect the interests of the borrower where doing so is consistent with the primary duty to realise the security
a receiver is free to sell a property in the condition it is in
in exercising a power of sale, a receiver will owe a duty to the borrower to take reasonable care to obtain the best price reasonably obtainable at the time of sale and to exercise his powers in good faith and for a proper purpose.

On the basis of the above, the master concluded that it was not enough for the borrower to simply identify alternative strategies or decisions that the receivers might have made. The master was not convinced that the borrower could obtain any expert opinion that could sufficiently establish at trial a breach of duty and therefore struck out the claim.

WM comment

Receivers will welcome the decision as recognition that the primary duty of receivers is to realise the security to recover the secured debt. In order to protect themselves however, receivers should ensure that they document any decisions as to sale strategy and that they give appropriate consideration to the all the options available.

Administrators beware the pitfalls of a pre-pack!

Pre-pack sales in administration The term “pre-pack” is used, in the context of administration, to […]

Pre-pack sales in administration

The term “pre-pack” is used, in the context of administration, to describe the process through which a company is put into administration and its business and/or assets immediately sold by the administrator in a sale that was arranged before the administrator was appointed. The process can be contentious where a company’s assets are sold to a new vehicle formed by the company’s former management, particularly where there is a lack of transparency around the sale and questions around whether proper market value has been obtained.

In order to address such concerns, professional guidelines have been adopted by the regulators of insolvency practitioners, requiring them to adhere to key standards around the marketing and transparency of such deals (Statement of Insolvency Practice (SIP) 16). The standards also highlight the need for insolvency practitioners appointed in contemplation of a pre-pack to be clear that the former directors’ interests are separate from those of the company and its creditors.

Lead up to the VE pre-pack

VE Interactive was a tech start-up company that developed software, including website pop-up windows and email alerts designed to boost sales. It was a rare British “unicorn” – a start-up valued at more than $1 billion. The company won a string of awards and was named as one of the most promising young British businesses by a government backed organisation called Tech City.

However despite the plaudits and high valuation the business was making heavy losses and in March 2017 the chief executive and founder was forced out and management of the business was taken over by a consortium called Treyew. The new management, having failed to turn around the company’s business, sought insolvency advice and then appointed insolvency practitioners (IPs) to advise on and effect a pre-pack sale of VE Interactive’s business and assets.

A week after the IPs’ retainer, and a week before the self-imposed deadline for a pre-pack sale, only one external purchaser had been identified. The IPs had evidently found it hard to obtain financial information from the directors and it was unclear what assets were owned by the company and therefore there was insufficient information available for any would be third party purchaser. A day before the deadline for the sale, the IPs were appointed administrators of VE Interactive by the court. The administrators did not disclose to the court the problems that they had had in obtaining sufficient information from the company’s directors to enable a sale on an arm’s length basis. The administrators then proceeded to sell VE Interactive’s business and assets to the new company owned by the directors the day after their appointment for the sum of £2 million and in the process leave behind £50 million of debts.

The removal proceedings

Various creditors of VE Interactive subsequently brought proceedings seeking the removal of the administrators from office. The grounds for this were that the administrators had a conflict of interest that prevented them from investigating firstly whether the pre-pack sale had been at below market value and secondly whether VE Interactive’s directors and the administrators had breached their duties to creditors in effecting the sale. The claimant creditors’ barrister told the court that the administrators were “completely blind” to the potential for conflicts of interest when selling a failing business to its own directors. He went on to say that the administrators had mishandled the sales process by leaving it until one day before the bid deadline before contacting potential bidders even though the administrators had been hired some 11 days earlier.

The administrators contested this application for the first five days of a six-day hearing. At the end of the fifth day they provided the court with a letter of intention to resign, drafted to be effective eight days later. On the sixth day of the hearing the administrators also offered the following concessions:

They should pay the costs of the proceedings on an indemnity basis.
They would bear their own legal costs and not seek reimbursement from VE Interactive’s assets.
They would not apply for their own discharge from liability as exiting administrators.
They would hand over the affairs of the administration to the proposed replacement administrators the next day.

In return the administrators asked the court to effectively end the proceedings immediately (without making a decision as to whether to remove them). They asked the court to shorten (abridge) the five days’ notice of resignation that administrators normally have to provide to creditors.

Decision

The court refused the abridgement of time application. Furthermore it refused to terminate the proceedings without deciding whether or not to remove the administrators and went on to order the removal of the administrators from office with immediate effect despite their pending resignation. The court made it clear that the grounds for the administrators’ removal was in the interest of VE Interactive’s creditors and shareholders. It was also in the public interest to be confident in the statutory insolvency regime (as enforced by the court in this instance).

The court did not make a substantive finding on whether the underlying pre-pack sale was made at below market value or whether there were related breaches of duty by the directors and the IPs. However, the potential compromise of the administrators’ objectivity was a serious issue for investigation, which justified removal. This was all the more so as the administrators’ own role should be to objectively investigate whether the pre-pack sale gave rise to potential claims by VE Interactive.

The court made the following substantive findings on the existence of a conflict of interest and the shortcomings in the decisions made by the administrators before and after their appointment:

The administrators should have concluded from the day of their appointment as administrators that, due to their pre-administration retainer to advise on the pre-pack, they had a conflict of interest that prevented them from effectively investigating whether the circumstances of the pre-pack gave rise to a claim by VE Interactive.
The administrators’ proper role was to work with VE Interactive’s undisputed creditors and shareholders to identify claims that were realisable assets for VE Interactive. This included assessing whether there were claims against the IPs before they were appointed as administrators. There was no reason for the administrators not to pursue these, other than a conflict of interest. The eventual resignation of the administrators shows they accepted this.
Given that the existence of a conflict of interest was readily apparent once the administrators were appointed, the administrators should not have opposed the application for their removal other than to suggest solutions such as the appointment of additional independent administrators to investigate the pre-pack. The administrators should have expressly raised the problem of conflict with the creditors’ committee, and sought directions from the court if necessary.
The administrators had lost perspective of what their proper role was. They had been primarily concerned to defend the creditors’ claim against their firm, not with the interests of the company over which they were appointed. Their letter of resignation suggested that the court hearing had led to a perception that they had a conflict of interest: the administrators did not accept the extent of their conflict that existed from the start of the administration. There was no reason why the creditors should have any confidence in the administrators.
Even the eventual decision by the administrators to resign was not necessarily in the interests of VE Interactive, as this prevented the court from considering whether one or other of the administrators should remain in office to deal with ongoing contentious matters, working with the new administrators.
Finally, the administrators should not be able to recover their remuneration, costs and expenses whilst in office and should bear their own costs of their resignation.

WM Comment

Critics of the practice of pre-packs will believe they have many of their views confirmed by this case. Whether this is true is open to question. The case is fact specific and involves a scenario that the court could easily conclude required further investigation. The court made it clear that it was not giving a decision on the merits of the pre-pack or a detailed analysis of the conduct of the administrators in effecting it. However, the court had a clear view that where a firm of IPs is retained by the management of a company before an administration to advise on insolvency options and the management then pursue the option of buying the company’s business and/or assets in circumstances which require further investigation, the administrators who are appointed to effect the sale will be unavoidably conflicted (where they are employees of the same IP firm) from the date of their appointment because they are “inextricably bound up in the process by reason of their [firm’s] contractual retainer” and will therefore need to put other measures in place such as appointing an independent administrator.

The solvency statement procedure – a salutary warning to take care when forming the necessary opinion

Companies wishing to reduce their share capital as part of a group restructure or in […]

Companies wishing to reduce their share capital as part of a group restructure or in order to pay out a dividend can do so under section 643 of the Companies Act 2006 (the Act). Before the share capital can be reduced, the Act requires each director to declare that he has formed the opinion that, if the capital reduction takes place, there is no ground on which the company would then be unable to pay its debts over the 12-month period following the declaration. This declaration is called the solvency statement.

If a director makes a solvency statement without having reasonable grounds for holding that opinion, that director may face criminal penalties under the Act. Section 643 of the Act does not however provide that the solvency statement is itself invalid if there are no reasonable grounds for the opinion so long as the director honestly and genuinely formed that opinion. A solvency statement will be valid as long as the director honestly and genuinely formed the required opinion, even if the director did not have reasonable grounds for doing so (BTI 2014 LLC v Sequana [2014]).

LRH Services Ltd (in liquidation) v Trew [2018] takes this a step further. A solvency statement will be invalid unless the directors have, at a minimum, actually turned their minds to the contingent and prospective liabilities of the company and only taken into account assets that are properly available to the company in considering whether it will be able to meet its debts. In other words, directors not only must form the required opinion genuinely and honestly, but also have asked themselves the right questions in doing so.

The significance of a solvency statement being invalid is that all actions done pursuant to it, such as payment of a dividend, will in turn be invalid and the directors will become personally liable, potentially up to the full amount of dividend.

Facts of the case

The case concerned claims brought by the liquidator of LRH Services Ltd against three of the company’s former directors. The directors had carried out a group reorganisation some years previously and as part of the reorganisation the company’s share capital had been reduced through the solvency statement procedure and a £21 million dividend paid out to the company’s sole shareholder (also a group company).

Despite the solvency statement having been made, the company’s assets were, however, grossly insufficient to meet its liabilities. All it would take would be for one tenant to fail to pay its rent and the company would be unable to meet its debts. One of the defendants, Mr Trew, had said that he had been confident that the company would be able to meet its liabilities because he controlled its ultimate shareholder and he would ensure that the company was kept in funds by the shareholder.

What did the court decide?

The court found that each of the directors had breached his duties to act in the best interests of the company (which was by then a duty to act in the interests of creditors) by carrying out the reorganisation in a way that left the prospect of insolvency inevitable.

The court further found that the solvency statement was invalidly made, and that each director was responsible to the company for the £21m dividend paid out in consequence.

The court held that Mr Trew had failed to form the opinion required by the Act, because:

he did not make any enquiry or give any consideration to the company’s actual liabilities, including the extent to which those liabilities were being met at the time of the reorganisation
he had assumed the company could have its liabilities met as needed by another group company, without any binding agreement (such as a guarantee) that would require this group company to step in and perform. Ad hoc inter-company assistance was not an asset which could be properly taken into account.

WM comment

The key point to note from this judgement for those advising on or carrying out a group restructure is to ensure that there is a detailed account in the board minutes of the assets and liabilities that have been considered so that a director cannot be accused of failing to consider the question properly. In addition, where a company has always relied on inter-company support then this should be evidenced in writing so that it can be treated as an asset.

Is a liquidation valid where notice is not given to a qualifying floating charge holder?

A voluntary winding up of a company is commenced by its members passing a special […]

A voluntary winding up of a company is commenced by its members passing a special resolution that the company be wound up voluntarily (section 84 of the Insolvency Act 1986). Before a company passes a resolution for voluntary winding up, it must give written notice of the resolution to the holder of any qualifying floating charge. This is to allow the charge holder the opportunity to appoint an administrator before the resolution to wind up can take effect.

In Re Domestic & General Insulation Limited [2018] EWHC 265 (Ch), the High Court considered whether failure to give such notice invalidated the liquidation. Domestic & General Insulation Ltd passed a special resolution to wind the company up voluntarily but notice was not given to HSBC which was the holder of a qualifying floating charge.

The liquidators became concerned as to the validity of their appointment and asked the court for direction. The court held that the lack of notice provided to HSBC did not invalidate the liquidation. Once a special resolution has been passed to wind a company up, that resolution is effective to put the company into liquidation notwithstanding any failure to give notice to a qualifying floating charge holder. The lack of notice may well provide a qualifying floating charge holder with a remedy if dissatisfied with the result of the liquidation, for example petitioning for the compulsory winding-up of the company or applying for a stay of the winding-up so as to enable an administrator to be appointed. However the validity and effect of the resolution cannot be questioned so long as it is passed in accordance with the company’s articles of association.

Contacts

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

Gawain Moore
Partner
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