Insolvency Oracle

Developments in UK insolvency by Michelle Butler


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Digital D-reporting: the Devil is in the Detail

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Many of us have been on tenterhooks, waiting to see the detail of the new D-reporting process… which comes into effect in two days!

I lost patience and got in direct contact with the Insolvency Service, who graciously allowed me an audience to convey many of my concerns and to learn more about how it is all intended to work.

We have been promised a Dear IP imminently, but here are the Service’s answers to my questions.

The Basics

I’m sure we’ve all learned the basics by now:

  • D-reporting for new appointments on or after 6 April 2016 will be carried out online via a .gov.uk portal and will need to be completed within 3 months.
  • IPs will have access to an online “dashboard” listing all their post-6 April (CDDA-relevant) appointments with the due dates for D-submissions using a traffic light system of flags.
  • The Service’s plan is that the system will allow IPs to delegate cases to staff to complete the D-report, although these will still be subject to approval by the IP. Staff access is hoped to be functional by mid/late April.
  • Submitted D-reports will remain accessible by the IP, fellow office-holders (only one submission is expected on joint appointments) and any subsequent office-holders.
  • Liquidators of Para 83 CVLs following from post-6 April Administrations will not be required to submit D-reports.
  • D-reporting for appointments prior to 6 April 2016 will continue under the old system.

The Question Bank

The new process has been “sold” to us on the basis that it will be so much simpler to complete as IPs will no longer need to decide whether, in their opinion, the directors’ conduct renders them unfit. Consequently, the Question Bank for the new D-report seeks to convey facts.  The questions are all multiple choice, the majority “simple” Yes/No, although some involve selecting from a range, e.g. regarding the number of creditors.  This is so that the answers can be processed through a rules engine to sift cases not requiring a human review.

In his webinar for the ICAEW last month, Mark Danks of the Insolvency Service did reveal some valuable information about the Question Bank, but I was left with the impression that the Service’s target was to have the process settled in June 2016, so that it is ready for receipt of the first online D-reports.

I expressed my concern to the Service that this is just not good enough. IPs would get criticised if they did not put their minds to the D-reporting task until the deadline was almost upon them and in any event it is not efficient to do so, not least because crunch-time falls in the middle of the summer holidays, so it would be ideal if IPs could get ahead of D-reporting deadlines.  How are IPs and staff supposed to prepare for the changes, if the Question Bank is not fixed and made available now?  There are checklists to amend and there is training to organise.

I was assured that the Service’s work with their IP panel indicates that the Question Bank is on the lines of current CDDA checklists and so they did not envisage (many) changes would be necessary. Now that I have seen the Question Bank, I regret to say that this is patently not the case.

If you want to revisit checklists to mirror the questions – which is how The Compliance Alliance’s revised checklist is being structured and which would be my recommendation so that you make sure that staff do the leg-work to get ready all answers before logging in – beware the following.

How can I access the Question Bank?

Unless the Service makes the Question Bank widely available, you will only be able to see it when you get a post-6 April appointment added to your dashboard. You should then be able to start the D-reporting process and click through the pages of questions.  Of course, this is not user-friendly for anyone trying to manage the work within the practice.

The Service has made available its current Question Bank to its test panel of IPs (and to others, like me, who asked). I am reluctant to provide the link here (it’s a bit too public!), but if you would like a copy of the questions, please drop me a line (insolvencyoracle@pobox.com).

I do fear, however, that the Service’s current Question Bank is not as valuable as we would hope in any event.  The Service expects these questions to change, not only before July but also thereafter, particularly when they start to see how IPs answer and react to the questions on live cases.

As Gareth Allen stated in the R3 magazine article (spring 2016): “this development is an ongoing process and we continue to refine and develop the system in response to continuous user input”. In other words, if you create a checklist to mirror the questions today, it seems to me that the chances are very high that the questions will have changed by the time your staff log in to complete the form!  I tried to stress to the Service person that I spoke to how unhelpful this would be.  I don’t want to be negative about the Service’s drive for continual improvement, but please do warn us all when/what changes are planned so that we can make appropriate changes internally in good time.  My personal preference would be that all of us on the Dear IP list (i.e. not just IPs) are given at least 3 months warning of any changes.

I know that my job is to pick at details, but I am surprised at quite how many issues I have with the current questions – some are poorly worded (e.g. “does the company appear to have ever kept records sufficient to show and explain its transactions..?” Ever? Well, yes, probably immediately on incorporation…); some are impossible for IPs to answer unless they undertake unnecessary investigation; I think that there’s a risk that some might generate false positives (e.g. “is there evidence that not all creditors have been treated equally?” Probably yes, but maybe for good reasons); and some items that I would expect to see (e.g. general misfeasance) are not covered at all.

Is the D-report just a string of multiple choice questions?

The prototype that has been made available is just this. The Service is keen to ensure that the Question Bank remains this way as far as possible so that their evaluation can be an automatic process.  If your answers hit their rules engine’s target, it will trigger a human review of the information and likely will involve an Insolvency Service staff member contacting you to ask further questions in order to decide whether it is a case worthy of taking forward.

At present, the prototype does not allow IPs to inform the Service online of any recovery actions that they intend to take/are taking, although the Service is very keen to receive this information. I understand that the ability for IPs to provide such information will form part of the online form (eventually).

What do we do if misconduct is discovered after the D-report has been submitted?

Personally, I think this is a serious disadvantage of the new process over the old. Firstly, I think that the need to submit D-reports in 3 months instead of 6 greatly increases the chances that you will discover or learn new information that would have affected your report.

However more importantly I think, the removal of the IP’s decision about unfitness removes the IP’s ability to act as any kind of filter: if you learn “new information”, you have to report it, whether or not you think it is material.  Therefore, it doesn’t mean you need only consider newly-identified “misconduct” – it goes much further than this.

What is “new information”?

The new rules define “new information” as “information which an office-holder considers should have been included in a conduct report prepared in relation to the company, or would have been so included had it been available before the report was sent”. If new information comes to the IP’s attention, he must provide this to the Insolvency Service as soon as reasonably practicable.  A failure to do so constitutes an offence.

I pointed out to the Service that, technically, “new information” could involve a wide range of immaterial changes to an IP’s original report. For example, the current questions include “what is the value of the likely dividend?”  If you answer “not known at this stage”, do the rules mean that you need to submit “new information” when this changes?

That may be an extreme example, but many other director-related questions may lead to “new information”. For example: “can all the company’s transactions with directors and any associated parties be identified?”  Just because your original “no” can later be changed to “yes”, does that mean you need to report it to the Service?  One would hope that IPs could exercise discretion in deciding whether technically “new information” is of any interest to the Service, but I do wonder if the rules prohibit this.

I am not certain how this issue can be overcome – the rules are the rules. The Service person gave me the impression that the process for delivering “new information” has not yet been formulated.  However, I hope that the Service sees – and will somehow deal with – the need to avoid burdening IPs (and Service staff) with a requirement to inform them of all “new information”.

What practically can we do to prepare for the new process?

Your to-do list might include these:

  • amend diaries for new appointments to reflect the 3-month timescale.
  • consider changing internal checklists. I guess that you don’t have to, but in my view it would be best to structure internal checklists so that every online question (and preferably no others) is addressed in turn. Certainly, this is how we at The Compliance Alliance are revising our CDDA checklists. Then the IP could review the staff’s completion of the checklist, agree the results and leave the staff member to upload the results into the online form. Ensuring that checklists mirror the online D-report will also help you make revisions whenever the Service makes changes.
  • consider staff resources. D-reporting on pre 6 April 2016 cases will continue as previously. Therefore, you are likely to see roughly double the number of D-reports falling due during July to September 2016, as you will have both 6-month deadlines on old cases and 3-month deadlines on new cases falling simultaneously. I recommend that you consider the effect on your staff resources, particularly as there will be a learning curve associated with the new process… and not to mention that most staff will want summer holidays!
  • ensure that staff are trained. Staff will need to be confident in dealing with the new process, but also important is embedding an awareness of the need to submit “new information” as and when it is discovered.
  • consider also adding a prompt to case review templates to reflect on whether all “new information” has been sent to the Service

I believe that the “new information” provisions present a particular challenge. You will need to ensure that “new information” is identified and reported as soon as reasonably practicable (even if, somehow, it is accepted by the Service and the RPBs that we need not report immaterial “new information”).  Being alert to report new information would seem to be particularly important where you have submitted a D-report before getting access to company records and where your later efforts identified misconduct.  It would also be relevant where you suspected misconduct – and answered “uncertain” or “no” where questions asked about the existence of evidence – and only later did you discover evidence.

Some other consequences of the new statutory provisions

The main statutory provisions are located in:

  • Section 107 of the Small Business Enterprise and Employment Act 2015 (http://goo.gl/NmcRlp);
  • The Insolvent Companies (Reports on Conduct of Directors) (England and Wales) Rules 2016 (http://goo.gl/6OORQn); and
  • The Insolvent Companies (Reports on Conduct of Directors) (Scotland) Rules 2016 (http://goo.gl/wZUj1K)

The Service has widely reported that old-style D-reports will continue to be received until October 2016, but in my view this overlooks the fact that there will be old-style D-reports due later than this.  For one thing, CVLs following from pre 6 April 2016 Administrations are subject to the old regime.  This will also affect old cases where you have submitted an interim D-return with the expectation of submitting a full D1 or final D2 after 6 October 2016.  Therefore, don’t delete all your old templates until you’re sure that you have reported every last old-style D-report.

From my reading of the rules, it seems to me that they provide a transitional period only up to 6 October 2016, but after this date the old D-forms will not be acceptable under the rules.  Presumably, the Service will devise a solution by October!

UPDATE 03/08/2016: I understand that the Insolvency Service would like IPs appointed on Para 83 CVLs after 6 April 2016 either (i) to send a copy of the D1/D2 submitted in the prior Administration with a letter confirming that this form presents the picture also for the CVL; or (ii) to notify the Service of developments since the Admin D1/D2 via the online DCRS system, as they would for “new information” under the new regime – a bit of a fudge, but what can one do if the legislation does not work?!  My thanks for Victoria L for sending me this information.

Liquidators following from post 6 April 2016 Administrations will not be required to submit a D-report.  Whilst this will be good news to any Administrators who keep hold of their Para 83 CVLs, I don’t think it is great for Liquidators who are new to the case.  From my reading of the legislation, it seems to me that these liquidators will be subject to the “new information” requirements and therefore will need to review what the Administrators had reported earlier.

The old rules are revoked in full (apart from the transitional provisions covering old appointments). As far as I can see, this means that there is no longer a 14-day timescale for IPs to submit a report on vacating office.  Presumably, this is because it was felt unlikely that an IP would vacate office before the 3-month deadline.

“Quicker and easier” for whom?

In theory, the move to a simple online form should be quicker and easier for everyone: IPs, their staff and the Insolvency Service alike. However, completing a D-report is more like filling in a self-assessment tax return than completing a passport application: you won’t have all the information at your finger-tips unless you do the prep work.

Most practices have their own tried-and-tested ways of gathering information, following trails, and reaching conclusions on CDDA and SIP2 matters. Structuring a D-report on a string of questions forces our hands.  To reach 4 April and not to have given all IPs access to the detail is, in my view, irresponsible.  Either it shows how little understanding the Service has of IPs’ work or it indicates that the Service has been chasing its tail with a near-impossible deadline.  Personally, I think that it’s a bit of both.

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How risky is it to act contrary to a creditors’ committee’s wishes and other questions…

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  • Re. Brilliant Independent Media Specialists – will the court approve an Administrator’s fees when he acts contrary to the committee’s wishes?
  • Co-operative Bank v Phillips – is it an abuse of process for a charge-holder to seek possession of a property in negative equity?
  • Harlow v Creative Staging – when might a winding-up petition suspended on a QFCH appointment of Administrators come in handy?
  • JSC Bank of Moscow v Kekhman – in the absence of Russian personal bankruptcy law, is forum-shopping in England one of the “legitimate kind”?
  • Bank of Scotland v Waugh – what is the effect on Receivers where the charge has not been validly executed as a deed but has still been registered?
  • Airtours Holidays Transport v HMRC – what decides whether a company can reclaim the VAT paid on accountants’ review fees?
  • SoS v Weston – if a criminal court declines to disqualify directors, would the SoS have any better luck in the High Court?

Court fixes fees of Administrators who acted contrary to the committee’s wishes

Maxwell & Sadler v Brookes & Ors, Re Brilliant Independent Media Specialists Limited (23 September 2014) ([2014] EWHC B11 (Ch))http://www.bailii.org/ew/cases/EWHC/Ch/2014/B11.html

The Administrators’ Proposals were approved with a modification that the Administration move to CVL within 6 months of the commencement of the Administration; the Liquidators were to be different IPs to the Administrators.

The 6-month time period ended on 31 May 2012. Immediately before this, the Administrators convened a creditors’ meeting to approve revised proposals providing that the Administration would move to CVL within 28 days of resolution of an issue regarding the quantum of a secured creditor’s claim.  The revised proposals were rejected and on 18 June 2012 the Administrators applied for directions.  Before this was heard, settlement was reached with the secured creditor and the Administration moved to CVL on 12 August 2012.

The Administrators’ fees had been approved on a time costs basis but the creditors’ committee refused to approve that the Administrators draw fees in relation to time costs incurred after 18 February 2012 (having approved fees incurred prior to this date). The committee asserted that it was never envisaged that the Administrators would carry out the vast amount of work for which remuneration was claimed; the committee felt that the Administrators should have worked simply to bring their appointment to an end and allow the Liquidators to fully investigate matters.  Consequently, the Administrators applied for the court to fix their fees.

Mr Registrar Jones’ consideration addressed a number of areas:

  •  Did the Administrators’ actions fall outside the approved Proposals?

The judge stated that “whilst the views of a creditors’ committee should be taken into account during an administration.., it is not for the committee to determine how the administration should be conducted. That is a decision for the office holder in performance of the duties and powers Parliament has thought fit to entrust to administrators. The outcome of such decision making… will depend upon the office holder’s assessment of how best to achieve the purpose of the administration in accordance with the powers conferred upon them by paragraph 59 of Schedule B1 and within Schedule 1 to the Act” (paragraph 26).

The judge then had to consider whether the work done by the Administrators was for the purposes of the Administration objective or otherwise formed part of the Administrators’ duties and responsibilities. He said: There will always be grey areas when deciding whether work will result in a better return and therefore should be carried out. It will not be a black and white scenario with a plain dividing line. The decision will depend upon all the circumstances and involve commercial judgment calls by the office holder in the exercise of his powers.  The court will normally not question the commercial judgments of an administrator. Usually a misunderstanding of law or apparent unfairness or a breach of duty will be required before the court will review such judgments” (paragraphs 30.6 and 30.7).  Consequently, the judge stated that it could not be concluded that the Administrators’ actions fell outside the Proposals.  He felt that this applied even in relation to activities that were not expressly referred to in the Proposals, such as in this case debt recovery efforts, given that a delay in recovery actions usually results in lower realisations.

  • Were the Administrators entitled to be paid fees for the period after the 6-month timescale when the approved Proposals provided for the move to CVL?

The judge recognised the commercial decisions taken by the Administrators in seeking to resolve the issue regarding the secured creditor’s claim, acknowledging that any delay would have been disadvantageous given the high interest rate attached to the debt. Consequently, the judge considered that the decision could not be described as “perverse” and it was a decision that “fell within the parameters of their commercial decision making powers” (paragraph 36.4).  However, the judge disagreed that the move to CVL could not have been done within the 6-month period; he felt that there were always more than enough funds to set aside to cover the maximum amount of the secured creditor’s claim plus interest.

  • Were the Administrators entitled to be paid fees after they had ceased to act, given that they worked to assist the Liquidators?

The Administrators sought approval for costs incurred in relation to a number of tasks including answering the Liquidators’ enquiries, assisting in the recovery of a director’s loan, other debts and overpayments, and dealing with the committee’s questions. The judge’s view was that R2.106 was limited only to remuneration of the Administrator whilst in office.  Therefore, the judge declined to fix the remuneration after the termination of the Administrators’ appointment, stating: “that is a matter between the Administrators and the liquidators” (paragraph 43).

  • What about the quantum of fees sought?

Then the judge turned to the detail of the Administrators’ application. The judge referred to the Practice Direction (2012) and in particular paragraph 20.4 as providing guidance on the information required to support the fees application and the judgment suggests that in a number of places the Administrators’ evidence failed to satisfy the judge as regards “briefly describing what was involved, why it was necessary and why it took the time it did” (paragraph 47).

For example, the Administrators sought fees of £23,473 in relation to “PKF/BDO Review”. The Administrator’s witness statement referred to the need to investigate potential claims quickly and early and thus such work could lead to actions that would produce a better outcome for creditors.  However, the judge observed: “This is wholly unspecific. There is no narrative describing and explaining the work, whether as to what it was or specifically as to why it was justified under the Objective” (paragraph 50.40).  The judge did not award any remuneration in relation to this activity.

The result of the judge’s examination of each task for which remuneration was sought was that, from a starting point request to fix fees at £389,341, fees of only £233,147 were approved.

The downsides of discontinuances

The Co-operative Bank Plc v Phillips (21 August 2014) ([2014] EWHC 2862 (Ch))

http://www.bailii.org/ew/cases/EWHC/Ch/2014/2862.html

The Bank, having a second charge over the debtor’s properties, demanded payment from Mr Phillips as guarantor of a loan to his company. Notwithstanding that Mr Phillips’ IVA Proposal (which was approved) showed that the properties attracted negative equity after the first charge, the Bank commenced possession proceedings.  Mr Phillips applied for the claims to be struck out or dismissed as an abuse of process.  The Bank later served a notice of discontinuance and the principal questions for the court related to the treatment of the costs arising from the process.

The court was asked to consider whether the Bank was seeking possession of the properties for a collateral purpose beyond its powers as a chargee and whether the Bank’s claims to possession were an abuse of process. Despite the fact that it appeared the Bank would not gain any benefit from selling the properties (although there was some argument that the Bank might have been able to raise rental income from its possession), the judge felt that the pressure on the charger and his family resulting from the possession proceedings was neither a collateral purpose outwith the Bank’s powers nor an abuse of process.  Ultimately, the proceedings were brought for the purpose of obtaining repayment of the sums secured by the charge.

However, although the charge entitled the Bank to recover its costs incurred “in taking, perfecting, enforcing or exercising (or attempting to perfect, enforce or exercise) any power under the charge” (paragraph 8), the judge decided that the Bank’s own costs, together with its liability to pay Mr Phillips’ costs arising from the discontinuance of the proceeding, were not reasonably incurred and therefore were not recoverable under the charge: “The Bank got absolutely nothing out of these proceedings, which have been a waste of time and expense from its point of view” (paragraph 75).

Finally, because the Bank had started the proceedings after Mr Phillips’ IVA had been approved, the Bank was unable to set off its liability to pay Mr Phillips’ costs against its claim in the IVA, per clause 7(4) of the IVA’s Standard Conditions (which appear to have been R3’s standard conditions).

Suspended Petition comes home to haunt the Petitioner

Harlow v Creative Staging Limited, Re. Blak Pearl Limited (23 July 2014) ([2014] EWHC 2787 (Ch))

http://www.bailii.org/ew/cases/EWHC/Ch/2014/2787.html

The Administrator had applied for the ending of the Administration, together with the dismissal of the application of Creative Staging Limited to withdrawn its winding-up petition (which, under Paragraph 40(1)(b) of Schedule B1, had been suspended on the appointment of the Administrator by the QFCH), the dismissal of the application of another creditor to be substituted as petitioner, and finally for a winding-up order on the original petition.

Why was the Administrator so keen to have the suspended petition revived, rather than to petition for the winding-up himself under Para 79? If a winding-up order were made on the original petition, then S127 would kick in to make certain pre-Administration payments (including a payment of £88,000 to the original petitioner) vulnerable to attack.  However, if the Administrator were to seek a winding-up order on a new petition, S127 would only apply from the date of presentation of the new petition.

The judge was reluctant to go to the lengths of substituting the petitioner, which would only incur additional costs. He felt that there was sufficient precedent and support under S122 enabling a court to make a winding-up order without a petition and thus the court had jurisdiction to make a winding-up order on the existing petition and under the powers of Para 79(4)(d).  The judge said (although, personally, I do wonder if he is crediting Parliament with a little too much foresight): “In all the circumstances it does seem to me that this court ought to recognise that Parliament must have intended to keep the petition in being for a reason and one of the reasons is so that an order might be made on the suspended petition, taking advantage of the doctrine of relation back, despite any objections of the Petitioner” (paragraph 53).  Thus, he allowed the appeal, waived all procedural requirements that had not otherwise been complied with, and granted the winding-up order.

Russian bankruptcy tourist entitled to escape “law of the jungle”

JSC Bank of Moscow & Anor v Kekhman & Ors (9 April 2014) (not yet reported on BAILII)

http://cisarbitration.com/wp-content/uploads/2014/08/UK-High-Court-in-Buncruptcy-Bank-of-Moscow-and-Sberbank-Leasing-v-Vladimir-Kekhman-and-others-Judgment-April-2014.pdf

At the time of his bankruptcy petition and afterwards, Mr Kekhman was a Russian citizen, domiciled and resident in the Russian Federation. He had disclosed in the petition that he was going to remain in England for only two days and he wished to be made bankrupt in England, as he had been advised that there is no personal bankruptcy law in the Russian Federation and, in view of the international reach of his affairs, “the English jurisdiction as a sophisticated jurisdiction in these matters appears appropriate to help resolve my affairs in an orderly manner that will be recognised internationally” (paragraph 11).

The matter returned to Registrar Baister, who had made the bankruptcy order, in the format of applications by two major creditors to annul or rescind the bankruptcy on the basis, amongst others, that Mr Kekhman was a ‘bankruptcy tourist’ to England, a place with which he has no real connection, in an attempt to evade Russian law. One of the creditors also contended that, contrary to Mr Kekhman’s indications that his English bankruptcy would be recognised in Russia, Russia would not recognise or enforce the bankruptcy order, which bound Mr Kekhman’s English creditors, whilst allowing his other creditors to collect in his substantial Russian assets.

Registrar Baister mentioned that, particularly in corporate contexts, “the courts here are prepared to countenance what is in reality forum shopping, albeit of a positive, by which I mean legitimate, kind… I do not see why a debtor whose petition is not governed by that restrictive jurisdictional regime should not also be able to invoke an available jurisdiction for a self-serving purpose, provided of course, that he does so properly and there are no countervailing factors to which equivalent or greater weight should be given” (paragraph 104).

Baister summarised Mr Kekhman’s connections with England, largely involving contracts providing for English law and English jurisdiction. He also put some emphasis on the purpose of bankruptcy being the debtor’s rehabilitation, observing that plenty of bankruptcy orders have been granted on English debtors’ petitions in cases where there were no likelihoods of recoveries for creditors. In any event in this case, the report of the Trustee in Bankruptcy, which explained that he was continuing to pursue certain assets, persuaded the judge that there was “utility” in the bankruptcy, Baister did not consider that utility necessarily required there to be a distribution to creditors; he found the prospect of an orderly realisation of the debtor’s assets “more attractive and more constructive that the law of the jungle advocated” by Counsel for the creditors (paragraph 141).

Baister reviewed the expert testimony of three prominent Russian academic lawyers and concluded on the balance of probabilities that the English bankruptcy order was unlikely to be recognised or enforced by the Russian courts. However, this conclusion seemed to work in Mr Kekhman’s favour: the judge noted that “if the English bankruptcy will never be recognised in Russia, then the free-for-all can continue over there in relation to the few assets that might be left over after execution; as to assets elsewhere, all the creditors will be in the same position vis-à-vis one another” (paragraph 142).

Although Baister stated that the arguments were “finely balanced”, he decided that the utility of the bankruptcy order was not outweighed by the creditors’ current complaints, “so that even if this court had known the true position regarding the problems of recognition and resulting from the arrest of the Russian assets, it still could and probably would have made the bankruptcy order on the basis that there was commercial subject matter on which it could operate, it would have enabled Mr Kekhman’s affairs to be looked into, made possible an orderly realisation of his non-Russian assets and assisted his own financial rehabilitation even if only outside the Russian Federation” (paragraph 144).

(UPDATE 14/03/15: JSC Bank’s appeal was dismissed: http://goo.gl/BkoIxd.  Although the judge agreed that the Chief Registrar had not applied the correct test, the appeal judge made his own decision that the bankruptcy order ought to have been made.  A more detailed summary of the appeal will be posted soon.)

Bank and Receivers entitled to rely on registration of a deficient deed

Bank of Scotland Plc v Waugh & Ors (21 July 2014) ([2014] EWHC 2117 (Ch))

http://www.bailii.org/ew/cases/EWHC/Ch/2014/2117.html

The Bank pursued repayment of a loan to a Trust and appointed Receivers over a property. Some time later, the Trustees applied to the Registry for cancellation of the charge over the property on the basis that the charge did not comply with the Law of Property (Miscellaneous Provisions) Act 1989, primarily because none of the signatures on the charge were attested.  Subsequently, the Bank applied for summary judgment that the Trustees be estopped from denying the validity of the charge.

The judge agreed that the charge had not been validly executed as a deed and therefore it was void for the purpose of conveying or creating a legal estate. However, the charge had been registered.  “The effect of registration of the charge was to create a charge by deed by way of legal mortgage” (paragraph 66) but if the Trustees were successful in having the register rectified, this would only operate for the future, not retrospectively.  “It follows that acts (such as the appointment of Receivers) carried out by the Bank under the charge prior to any order for rectification and acts of the Receivers are not void as alleged by Mr Waugh. Both the Bank and the Receivers were entitled to rely on the effect of registration of the charge” (paragraph 67).

On the question of estoppel, however, the judge was not persuaded by the arguments that the solicitor for the Trustees had represented the document as executed and on this basis the Bank had lent the monies; because the charge simply had not been executed as a deed, the Trustees were not estopped from relying on the invalidity of the legal charge. However, the judge stated that, notwithstanding the defects, it took effect as an equitable mortgage.  Left open for another hearing is the question of whether the Bank will succeed in obtaining an order that the Trustees execute documents to perfect the legal charge.

Company paid fees but not entitled to reclaim the VAT

Airtours Holidays Transport Limited v HMRC (24 July 2014) ([2014] EWCA Civ 1033)

http://www.bailii.org/ew/cases/EWCA/Civ/2014/1033.html

PwC had been instructed to review a financially distressed group of companies as it explored and pursued a restructuring plan. The restructuring process was successful, but HMRC disputed that the company was entitled to deduct the VAT that it had been invoiced and had paid in respect of PwC’s fees.

The First Tier Tribunal (“FTT”) reviewed PwC’s letters of engagement and terms and conditions, which effectively comprised a tri-partite contract between PwC, the Group, and the “Engaging Institutions” and found that the company, as well as the Engaging Institutions, had requested and authorised the work. However, the Upper Tribunal (“UT”) disagreed with the FTT’s approach; it concluded that the substance of the transactions was that there had been a supply of services by PwC to the Engaging Institutions and that the company had not received anything of value from PwC to be used for the purpose of its business in return for payment.

Although Lady Justice Gloster led the judgment in the Court of Appeal, she was in the minority in concluding that the company’s appeal should be allowed. She felt that the company had required PwC to provide valuable services to it for the purpose of its own business – in her view, the provision of PwC’s services was the only way that the financial institutions could be persuaded to support the company’s attempts to survive and that this was a distinctive supply of services from that supplied to the Engaging Institutions.

Lord Justice Vos, however, saw the economic reality in a different light. He felt that “it was as likely that PwC might have advised the Banks to pull the rug… The substance and economic reality was that PwC was supplying its services to the Banks in exchange for Airtours’ payments” (paragraph 87) and that the UT had been correct to conclude that the company was a party really only for the purpose of paying PwC’s bills, not to receive any service from the firm.  Lord Justice Moore-Bick also noted that, although the use of “you” in the terms and conditions suggested that PwC had certain obligations to the Group, they were a standard form document that must be applied in a way that is consistent with the letter of engagement, which is the “controlling instrument” (paragraph 96).  The question was “not whether the Group needed the report to be produced or whether it obtained a benefit as a result of its production, but whether in producing it PwC were providing a service to the Group for which the Group paid” (paragraph 99).  The majority of appeal judges decided that the service was not provided to the Group and thus the company could not reclaim the VAT input paid on PwC’s bills.

(UPDATE 14/03/15: permission to appeal to the Supreme Court has been granted.)

Court rejects attempts at second bite of the cherry

Secretary of State v Weston & Williams (5 September 2014) ([2014] EWHC 2933 (Ch))

http://www.bailii.org/ew/cases/EWHC/Ch/2014/2933.html

Two directors had been found guilty and sentenced in a criminal court, which had also been asked to consider disqualification orders, but because the matter had slipped the mind of prosecuting counsel at the original trial, this was dealt with only some two months later. The judge declined to make such orders, feeling that it would be “perhaps kicking a dog whilst he is down” (paragraph 14).

The SoS later applied to the High Court for disqualification orders under S2 of the CDDA86. S2 provides that the court may make a disqualification order where the person is convicted of an indictable offence in connection with the promotion, formation, etc. of a company.  The two year timescale for the SoS to apply for disqualification orders under the usual S6 of the CDDA86 had expired.

Counsel for the directors argued that the application was an abuse of process: the High Court was being “asked to exercise exactly the same jurisdiction as the criminal court but to decide the matter the other way” (paragraph 15). The argument for the SoS was that he had not been party to the prosecution and so had not had an opportunity to contest the original decision.

Although David Cooke HHJ recognised that the SoS was not a claimant seeking to vindicate a private right, but a restriction for the public good, he also considered what was fair to the directors. He noted that there was a wide range of potential applicants under S2 of the CDDA86, including company shareholders and creditors: “Fairness to the defendant must mean, it seems to me, that he should not be exposed to the same claim on multiple occasions by different litigants unhappy with the outcome of the earlier claim or claims” (paragraph 51) and that such subsequent claims could be described as “collateral attacks” on the first decision.

Even though the judge said that, in this case, he would have made disqualification orders (if he were found wring on the issue of abuse of process): “standing back, this claim is no more than an attempt by the Secretary of State to obtain a different decision from this court than was given on identical issues by the criminal court, which had the issues placed before it and made a positive decision to refuse an order. It is in my view unfair that the defendants should be thus exposed to the same claim on two occasions. The unfairness is not relieved by the argument that the claim is being pursued by a different entity… There is the general point that where the basis of the claim and the relief sought is essentially identical it is just as much unfair to the defendant to have to face it twice at the hands of two applicants as it would be if there were only one” (paragraph 52).


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The Small Business, Enterprise and Employment Bill: Part 1 – Directors

IMGP0277 This “Small” Bill will have a big impact on IPs. Not only does it include the widely-publicised reserve powers to ban pre-packs and appoint a single insolvency regulator, but it will result in a completely new D-reporting process and will relegate physical creditors’ meetings to something that only creditors can request. The Bill contains many other smaller items that will require significant overhauling of templates and checklists… far more than the 7 hours estimated in the Impact Assessment!

The Bill’s government webpage is at http://goo.gl/VwKvPe and I have sketched out (to help myself get an overview) the clauses that will impact IPs here: Insol relevant provisions Jul-14

In this first post, I cover the key changes to reporting on directors and actions arising from directors’ misconduct. My next post will deal with the changes to the IP regulation regime, pre-packs, and the numerous technical changes to the Act.

D-Reporting

I know that R3 spins this as a success – the move from burdensome paper reports to something far speedier online – but I have to say that I am more sceptical about the advantages of this process for IPs.

The Impact Assessment (“IA”) describes the present problem as delayed reporting because “the IP must be satisfied that there is evidence of unfit conduct… The proposed design of the new form would require the IP to highlight (at an earlier stage) information or behaviour which may indicate unfit conduct as opposed to providing a significant amount of justification and evidence at that stage.” The Bill sets the timescale for submitting a report to within three months of appointment – the rationale, it says, being that “the SoS would be able to better consider behaviour identified by the IP” at this earlier stage [why?] and “the quality of information should improve due to the return being submitted with greater proximity to events” [really?] – although I thought it was charming that, in the same breath, the Bill is providing the Service with an extra year in which to commence disqualification proceedings.

Personally, I expect that this change will result in a greater number of ‘clean’ reports, as IPs will have less knowledge of past events at three months than at six months. However, as IPs will be “under an ongoing obligation to report any new information that he/she considers should have been included in the return”, I cannot see that this will result in less, or even the same amount of, work for IPs in the long run. The forms themselves might also require more work, as “there are also other pieces of information not currently requested which R3 states that IPs could usefully provide”.

The IA estimates only one hour for IPs (nothing for other staff) to familiarise themselves with the new process and one hour per director in completing the new return where misconduct is indicated, which I can see, depending on the final form of the return, would be a reduction over the present demand, although the IA has provided no time costs in relation to providing additional information to the SoS after a return has been submitted.

One sentence that really got my goat was: “Analysis undertaken on a sample of 250 cases where D1 reports were submitted but not proceeded with indicated that a significant percentage of them should not have been submitted”. Should not have been submitted?! What can the government mean? Are IPs failing to meet their statutory obligations?

I am reminded of a question raised by the House of Commons BIS Select Committee when it interviewed Richard Judge and Graham Horne in 2012 about the apparent disparity between the number of D1s filed – around 5,000 per year – and the number of disqualifications. I remember Dr Judge stating that this meant there were “5,000 indications of misconduct… there are people that are innocent in that” and Mr Horne chipping in quickly to clarify that IPs are required by statute to report directors who, by analogy, drove at 31 mph in a 30 mph zone; technically, the conduct might be reportable, but of course not all such directors will be pursued to disqualification. Although switching to a system in which IPs simply provide the facts and leave the SoS to decide whether the director’s behaviour merits action may avoid future discomfort in answering such questions, it seems to me that nothing here changes the statutory obligation for IPs to waste time reporting on the 31 mph drivers.

Compensation Awards

The IA gives us a clear hint at what has driven this measure. It states that “a frequent complaint in Ministerial correspondence from creditors is that although disqualification can prevent a director acting as a director in future, it provides no compensation to those who have suffered from their misconduct”. What types of cases might attract compensation awards? The IA states that “it is reasonable to believe that compensation could be sought from, at least those cases where there has been an identifiable loss to creditors, for example: misapplication of assets, transactions to the detriment, criminal matters and accounting records” – that’s quite a list! The IA continues: “it is also reasonable to assume that whatever the allegation, the SoS will also seek compensation for those cases where there are a lot of unsecured creditors or ‘vulnerable’ members of the public who have lost out”.

However, the IA presents a confusing picture as to how the government envisages the process of seeking compensation awards against disqualified directors working – in tandem? – with the activities currently carried on by office holders in challenging antecedent transactions. For example, the IA states: “the option of the SoS seeking a compensation order or agreeing a compensation undertaking from a miscreant director will enable greater financial redress for creditors, where the office holder (IP) has not taken any of the available actions him/herself or it is considered that further action in addition to that taken by the IP is merited”. Fair enough, as the IA points out, this may be because the office holder has insufficient funds to pursue the case (although I am irritated by the comment that an IP might feel “they don’t have the specialist expertise to bring a claim”). But, I wonder, will this exacerbate the difficulties in reaching settlements with directors who, notwithstanding any settlement agreed with the IP, could then be pursued by the SoS? At least the IA recognises that there are likely to be fewer disqualification undertakings under the future regime, as directors are less likely to give in without a fight.

Do you wonder whether this could result in the SoS and IP fighting between themselves as to who might chase after the director’s finite pot first? The IA states that IPs “should be able to proceed with any action they deem appropriate before the SoS”. Well, that’s alright then.

The Bill also indicates that compensation may be awarded to a particular creditor or creditors, a class or classes of creditors, or it may form a contribution by the director to the assets of the company. However, the IA states “the compensation award will be awarded direct to creditors” (although it makes no provision for the Service’s costs in collecting the monies from the director, adjudicating on creditors’ claims, or paying a distribution). This quote appears in the context of “free-riding amongst liquidators”! It seems that some consultation responses suggested that office holders might not pursue claims themselves, but they might sit back, wait for the Service to do the work, and then pop up to collect the funds and take a fee. The IA does nothing to counter this libellous title and simply states that, because the award is direct to creditors, they “do not think the risk of ‘free-riding’ is high” and “no evidence exists on the likely number of cases of free-riding by liquidators”. Come on, Insolvency Service, we expect better of you than that!

I am also puzzled by the repeated references to improving gateways so that the SoS and IPs might share information better, for example, “to better enable successful recovery actions to be taken forward by the office holder”. As far as I can tell, the gates only swing one way (unless there is something in the OR’s handover) and will continue to do so; there are no proposals in the Bill to help IPs have greater access to information, although the IA suggests that things may change “through updating internal guidance used by Insolvency Service staff”.

I was also puzzled at the IA highlighting a “risk” that “this will result in compensation orders being made for the benefit of HMRC as they are the major unsecured creditor in the majority of insolvencies”. Personally, I don’t see that a bit of recompense to the public purse is a bad thing. Instead of the IA pointing to the Bill’s reference to factors that the court/SoS would consider – the amount of loss, nature of misconduct, and any recompense already paid – it answered this by referring to the fact that the court/SoS could determine that compensation be awarded to a particular creditor or class or group of creditors “taking into account what is equitable in all the circumstances”. Could the prospect of deviating from the pari passu rule, especially if HMRC might not get a look-in at all, result in some creditors calling for office holders to resist taking action and leaving it to the SoS?

Power to assign certain rights of action to third parties

The apparent “problem” that the government is seeking to fix is the lack of court applications as regards wrongful and fraudulent trading (which are both extended under the Bill to Administrators), transactions at undervalue etc. However, the IA acknowledges that “a lot” of claims are settled out of court (they have heard upwards of 90%) and it reports that the other principal reasons for lack of court actions given in the consultation responses were the targets’ lack of assets and the high evidential bar necessary, so the government acknowledges itself in the IA that the Bill’s provisions are unlikely to result in many more cases going to court.

The IA does not mention the issue for an IP who agrees to share in the proceeds of any action assigned to a third party: won’t the risk of an adverse costs order deter IPs from entering into some assignments? The IA points out a risk “of speculative or opportunistic claims being brought against directors who may be ill placed to defend themselves. However, this risk should be small as we expect insolvency professionals to have regard to existing professional and ethical standards in judging when to assign causes of action.” But in the next paragraph the IA refers to the IP’s duty to maximise returns to creditors: could an IP really be justified in turning away third parties offering to pay for rights of action, if it represented a good deal for creditors?

The IA appears more thoughtful in relation to the justification for IPs selling to a third party, who after all is looking to make a profit from the action: they feel that IPs may be justified as the third party’s greater appetite for risk and economies of scale in taking the action forward compensate for the discount on the action suffered by the estate. The IA also makes the sensible point that simply opening the way for third parties may improve IPs’ negotiating position in pursuing claims directly from directors.

My part 2 on the Bill will follow in a week or so (once I’ve done some real work!)

(UPDATE 25/09/14: I read an excellent blog on the subject of the director provisions of the Bill from Neil Davies & Partners – http://goo.gl/uYp3RU.  I was particularly intrigued by the observations on the complications that could arise from the provision to empower the SoS to pursue compensation orders.)


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The Perilous Neglect of the Fragile Insolvency Service Enforcement Directorate

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“Trust is essential to every commercial transaction. We neglect its fragility at our peril”, says Vince Cable in his foreword to the “Transparency & Trust” Government Response. Having read the Government’s proposals, I am inclined to repeat the often-cried warning that we neglect the ever-decreasing resources of the Insolvency Service at our peril. Although some of the Government’s proposals have the veneer of reducing the costs of disqualifying directors, whatever small gains are achieved will be wiped out by the hidden burdens that look to be added the Directorate.

It’s not all about the Insolvency Service, however. The Government has tagged on what appear as afterthoughts some ideas that will impact on IPs’ approaches to antecedent transaction challenges. These ideas are poorly covered in the Government Response – they escape all the Impact Assessments – and thus it is not surprising that R3 immediately commented on its “specific concerns” regarding these proposals (http://www.r3.org.uk/index.cfm?page=1114&element=19780).

The key objective of Cable’s “Transparency & Trust” drive is the creation of a public register of beneficial owners, but in this post I have summarise the more material plans that will affect insolvency work. The Government’s full response can be found at https://www.gov.uk/government/consultations/company-ownership-transparency-and-trust-discussion-paper.

Changes to the CDDA

The original proposals suggested that Schedule 1 of the CDDA, Matters for Determining Unfitness of Directors, might be added to in order to ensure that the following are taking into account in relation to disqualification orders and undertakings:

• Material breaches of “sectoral” regulation (especially the banking sector);
• The “wider social impacts” of a failure;
• Whether vulnerable creditors or those who had paid deposits had lost out in particular; and
• The director’s previous failures, possibly with a finite number of failures being allowed before unfitness is presumed.

The Government response accepts that simply adding to the Schedule 1 is not the solution, as directors might conclude that any factor not explicitly listed will not be taken into account. The response states: “we will recast a more generic set of factors that the court must take into account” (paragraph 222), although it also lists pretty-much the items described above, but with the exception of the X strikes and then you’re out idea, which does not appear to have made it through.

However, the paper does state that the court (or the Insolvency Service) will need to take into account “any previous positions as director of a company that has become insolvent and any relevant aspect of the director’s track record in running these companies… We are sympathetic to concerns we heard about the possible unwanted effect the inclusion of a ‘track record’ could have on those involved with early stage companies, or in rescuing companies that are in difficulties”, although I wonder at the depth of their sympathy: “We are clear that a director will, of course, be able to present any argument he or she might have (for instance as a business rescue professional or that the insolvency was not due to any element of unfit conduct on the director’s behalf)” (paragraph 225).

The consultation also sought views on whether – in fact, the consultation asked which – other “sectoral” regulators (again, looking mainly at the banking sector) should have the power to apply to court, or accept an undertaking direct, to disqualify a director. Although the ICAEW felt that this was appropriate, the Government’s response aligns more closely with R3’s response: disqualifications will remain with the Service, but the CDDA and gateways will be amended so that information might be exchanged more effectively, and there might be greater collaboration, between regulators. It has also suggested that expertise might be shared between regulators, which might include secondments.

The consultation proposed that the time period within which disqualification proceedings need to be commenced be increased from two years to five. The response explains that “views were mixed” (paragraph 279). However, I note that there was no support for any extension of the time period from R3, ICAEW or ICAS (the IPA did not respond – well, not the Insolvency Practitioners Association, but the Institute of Practitioners in Advertising did) – all three bodies noted that the BIS consultation document had stated that the two year timescale did not pose a barrier in the vast majority of cases and that the court can consider extensions. R3 also observed that five years would be a long time for an investigation to ‘hang’ over an individual and the ICAEW noted the potential difficulties if office holders needed to keep a case open for a long period. Despite these views, the Government proposes to increase the time limit to three years.

“Better Compensating Creditors for Director Misconduct”

The Transparency & Trust paper runs to 283 paragraphs, but this section, which contains the meaty proposed changes for IPs, runs to only 17 paragraphs! I don’t like that heading either…

The Government has expressed dissatisfaction with the fact that so few actions have been taken to challenge antecedent transactions. “Since 1986, there have only been

• around 30 reported wrongful trading cases;
• around 50 preference claims; and
• around 80 reported cases arising from undervalue transactions” (paragraph 260).

However, the response does not acknowledge that, as R3 pointed out in its response, many more cases are settled out of court. Neither does it acknowledge in any meaningful way that, in a great deal of other cases, the disqualified director simply has no money!

The Government’s proposed remedies are:

• To allow such causes of action to be sold or assigned to a third party “to increase the chances of action being taken against miscreant directors for the benefit of creditors” (paragraph 272); and
• To empower the Secretary of State to apply to court for a compensation order against, or to accept a compensation undertaking from, a director who has been disqualified.

The Government response barely makes a passing comment at some of the objections to these proposals raised by R3, the ICAEW, and ICAS, such as:

• Insolvency practitioners already have the means – and the duty and expertise – to pursue monies from errant directors, although the future of these is at risk when the insolvency exemption from the Jackson reforms ends.
• Why would a third party be any better equipped to take action than a liquidator?
• The possibility of a liquidator assigning their right to a claim already exists in Scotland.
• IPs are also limited in what they can achieve, as too few cases are being passed to IPs from the OR.
• Creditors’ returns may end up being lower, because a third party would only buy a claim in the expectation of making a profit.
• Third parties will not have the same investigative powers as liquidators.
• It would be impossible to prevent directors – or a friend etc. – from acquiring a claim with the intention of quashing it.
• It is difficult to see how assigning claims away from a liquidator to a third party intent on making a profit would increase confidence in the insolvency regime.
• It is difficult to see how compensation might be paid to anyone other than the company’s creditors via the office holder.
• If the Service were to distribute monies to creditors, it could duplicate the work done by the IP in adjudicating on claims, and the costs to the Service would be prohibitive. “The Insolvency Service would be better focusing its resources on disqualifying more directors rather than seeking to take on new activities such as distributing monies, which is already performed efficiently by insolvency practitioners” (R3).
• A compensatory award could prejudice civil claims being brought by the office holder (and, in my personal view, I could see a race develop between the IP and the Secretary of State, to see who gets their hands on the director’s limited purse first).
• “We do not think that the Insolvency Service has the resource to provide the evidence required to ensure a fair compensatory award upon which the Court can rule” (R3).
• The Service’s costs for bringing disqualification actions likely will increase substantially, and with fewer undertakings offered, given that directors will risk being pursued for compensation.

Despite these concerns, the Government is going to bring in these two remedies “when Parliamentary time allows”. Sales or assignments will be allowed of the following causes of action: fraudulent and wrongful trading – both of which will be extended to administrators to pursue (per the Red Tape Challenge outcomes); transactions at an undervalue; preferences; and extortionate credit transactions. The compensation awards/undertakings will be allowed by the court or the Secretary of State “to a particular creditor or group or class of creditors, or the creditors as a whole” (paragraph 274), although there is no mention as to how this may work in practice.

I shall leave the final word to the ICAEW, which, in its response to the consultation question on whether the proposal would improve confidence in the insolvency regime, stated: “We consider that confidence would be more likely to be improved if the Insolvency Service were resourced adequately to take disqualification action in every case where it appears to be justified.”


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What will “Transparency & Trust” mean for IPs?

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My thanks to Mr Cable for re-appearing in the headlines and making this two month old consultation suddenly seem current again. The proposal in his “Transparency & Trust” paper that got everyone talking was the attempt to curb future excesses of the banks and demand by legislation that their directors take care to be socially responsible, but is there anything in the paper for IPs..?

The consultation can be found at https://www.gov.uk/government/consultations/company-ownership-transparency-and-trust-discussion-paper, although regrettably it closed to responses yesterday. Well, it’s been a busy summer!

Identifying Beneficial Owners

I’ve been doing a bit of work recently on compliance with the Money Laundering Regs and it has reminded me of the rigmarole around identifying, and verifying the identities of, an insolvent company’s beneficial owners. Identifying the >25% shareholders is the easy bit (although, of course, it gets a bit more complicated where the shareholders are corporate entities), but how, on day minus-one of an insolvency appointment, are you supposed to identify other beneficial owners, those who “otherwise exercise control over the management of the company”? People don’t often stand up and introduce themselves as shadow directors. The consultation describes other complications to identifying the beneficial owners, such as where a number of shareholders have agreed to act in concert.

BIS’ suggested solution: let’s make it a requirement for companies to disclose their beneficial owners. The consultation considers the details of such a system: when companies would be required to make such disclosure; to which companies it would apply; what about trusts; what powers would need to be granted and to whom to ensure compliance; whether such a registry would be publicly available or restricted only to law enforcement and tax authorities… but what I cannot help asking myself is: if a company is being misused for illegal purposes by some hidden beneficial owner, would the company really have complied with the legislation and disclosed him/her? Or is it more likely that such requirements would just put more burden on law-abiding companies in ensuring that their registers of beneficial owners, in which no one is really interested (the information only really has any value if money laundering has taken place, doesn’t it?), are kept up-to-date?

Although, personally, I cannot see such a system doing anything much to help prevent illegal activity, at least if IPs are able to see information on companies’ beneficial owners, it might help in their Anti-Money Laundering checks, and I think that anything that helps with that chore would be a bonus. So how likely is it that the information would be made public? It seems from the consultation that it is the Government’s preference and, even if that doesn’t happen, the second option is that it might be accessible to “regulated entities”, i.e. anyone who is required to make MLR checks.

There’s a sting in the tail, however. Slipped into the consultation is: “If they were given access to the registry, regulated entities would incur additional costs if they were required to check and report any inconsistencies between their own data and that held on the register” (paragraph 2.74). Can you imagine? Would they seriously require office holders to inform whoever that a defunct company’s register of beneficial owners was not up to date? My perception is that IPs do not really feature as a separate group in the minds of those who oversee the MLR, so I doubt that they would see the pointlessness of such a task.

Changing Directors’ Duties

Okay, this proposal won’t directly affect IPs, but I couldn’t help passing a quick comment. As no doubt you’ve heard, the proposal is to amend the directors’ duties in the CA06 “to create a primary duty to promote financial stability over the interests of shareholders” (page 61). It is noticeable that more consultation space is taken up listing the potential drawbacks of the proposal than its advantages. In addition to the described issues of how to enforce such a duty, how shareholders would react, how UK corporate banks would fare competing against banks not caught by the CA06, I was wondering how you could measure promoting financial stability: it seems to me that it would depend on whether you were to ask Vince Cable or George Osborne.

The consultation includes many other proposals, which would affect the disqualification regime – some of these are:

• whether the regime should be tougher on directors where vulnerable people have suffered loss (is the absence of a jubilant Christmas for a Farepak customer a more worthy cause than that for a redundant employee who’d worked hard up to the end of an insolvent company’s life?)
• whether the courts should take greater account of previous failures, even if no action has been taken on them (surely the just and socially-responsible solution would be to fund the Service adequately to tackle any misconduct of the first failure?)
• whether to extend the time limit for disqualification proceedings from two to five years (what about the Service’s method of prioritising cases? I appreciate that this is a gross simplification, but don’t they hold a big pile of potentials and progress those that they feel are in the public’s greatest interest, leaving the rest in the pile until it gets to the critical time when they have to make a decision one way or the other? Won’t the extension to five years simply mean that their potential pile holds four years’ worth of cases, rather than one year’s? Again, unless the Service is granted more resources, I cannot see that this measure would really help. I also object to the consultation’s comment that “it can quite easily be several months before the relevant insolvency practitioner reports to the Secretary of State detailing the areas of misconduct that may require investigation. In such cases, the limitation period might mean that misconduct is not addressed” (paragraph 12.2))
• whether “sectoral regulators”, such as the Pensions Regulator, FCA and PRA, should be granted the ability to ban people from acting as a director in any sector.
• whether directors who had been convicted/restricted/disqualified overseas should be prevented from being a director in the UK.

“Improving Financial Redress for Creditors”

The Government anticipates that, if liquidators and administrators (as the Red Tape Challenge outcome proposes to extend the power to take S213/4 actions to administrators) were entitled to sell or assign fraudulent and wrongful trading actions, a market for them would develop. Do you think so..?

BIS has thought about the possibility that directors (or someone connected to them) might bid for the action and, although they suggest an, albeit not water-tight, safeguard, they also point out that, if the director did buy the right of action, at least the estate would benefit from the sale consideration. Although, personally, I’d feel uncomfortable with that – and I’m not sure what the creditors would say (but, of course, the office holder could ask them, and maybe that would be a better safeguard?) – I guess it makes commercial sense.

The consultation also proposes to give the court the power to make a compensatory award against a director at the time it makes a disqualification order. The consultation states: “This measure could potentially affect the timeliness of obtaining disqualifications if it deterred directors from offering a disqualification undertaking and therefore resulted in more disqualification cases needing to be taken to court” (paragraph 11.16), but personally, I would have thought that this measure would increase exponentially the number of director undertakings, as there seems to be no suggestion that an undertaking would expose a director to the risk of an award.

It is envisaged that the award would not be used to cover the general expenses of the liquidation and “there is a question as to who should benefit from any compensatory award. This could be creditors generally or it could be left to the court to determine based on the facts of the case” (paragraph 11.14), although I assume that, if it were for the general body of creditors, the office holder would be expected to pay the dividend. I wonder how the office holder’s fees and costs would be viewed, if he had to keep the case open purely for the purposes of seeing through the outcome of any such action.

The consultation also states that “Liquidators would still be expected to consider whether there are any actions they could bring themselves, as they ought to now” (paragraph 11.15). Could liquidators be criticised for taking actions, the proceeds of which would settle first their costs, when, if it were left to the court on the back of a disqualification order, the creditors would see the full amount? It is a liquidator’s function to get in and realise the assets, so probably not, but administrators..?

The same paragraph states: “If by the time the disqualification action comes before the court, liquidators have successfully recovered monies from the directors, that is something the court would be expected to take into account when deciding whether or not to make a compensatory award (or in setting the amount of it)” – it could get fun if the actions were running in parallel.

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Despite my quibbles, generally I think the proposals are a step in the right direction. However, I wonder how those in the Service’s Intelligence and Enforcement Directorate feel about the proposals, which would lead to so much more work and high expectations laid upon them. Let’s hope that these proposals give them a sound case for increasing their access to funds and people.


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SIP2 – No Spin

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A couple of months ago, I presented a webinar for R3 on SIP2. I thought I’d make the most of my efforts and post here some key points of that presentation. There’s nothing critical or new here; it’s just offered as a reminder of the contents and application of SIP2.

For ease of reference, SIP2 (or at least the E&W copy) can be found at http://www.r3.org.uk/index.cfm?page=1746 along with R3’s Practical Guidance Note, to which I also refer below.

The Purpose of SIP2

I think there’s a risk that SIP2 is viewed sometimes as setting the standards of investigation for D-reporting purposes. That seems to be how the Insolvency Service presents it in its Guidance Notes for Completion of CDDA Reports/Returns (http://www.bis.gov.uk/insolvency/Publications/publications-by-theme/insolvency-practitioners-publications). However, that’s clearly not the emphasis of SIP2 itself. The only reference to CDDA work is way down at paragraph 18: “an office holder should be mindful of the impact of the outcome of investigations on reports on the conduct of directors”.

The key purposes behind SIP2 are set out in the introduction. One purpose is to help office holders “to carry out appropriate investigations in order to address the specific duties of the office holder” (paragraph 2), which are described as investigating “what assets there are (including potential claims against third parties including the directors) and what recoveries can be made” (paragraph 1).

The introduction also describes the need for an office holder to carry out appropriate investigations “to allay if possible the legitimate concerns of creditors and other interested parties”. In the webinar, I described what those legitimate concerns might be and how office holders could allay them, although, to be honest, I found it a difficult topic to cover: unless the office holder goes to great lengths to investigate and explain the circumstances of a company’s demise, would creditors’ concerns ever truly be allayed? And is there a risk that an office holder could spend too much time (and money) exploring creditors’ concerns, which hold out no hope of enhancing any dividend prospect? Is that really what SIP2 is endorsing?

Therefore, in the webinar I majored on what I believe is the key purpose of SIP2: to identify what assets there are, including potential recoveries from challenges to antecedent transactions. As this objective is quite different from identifying what might be appropriate for a D-report (albeit that it might reveal matters relevant to a D-report), personally I feel SIP2 should have a different place in the case administration process. I do not believe that any SIP2 review/checklist should be nestled within a CDDA review. I also believe that it should be carried out – at least informally – much earlier than the traditional timing of CDDA reviews, which pretty-much seems to happen in month 5. Identifying the potential of hidden assets is often what being an office holder is all about and it is where office holders can really demonstrate their skills and add value to the insolvency process.

The R3 Practical Guidance Note

I suspect that there are many SIP2 checklists out there that pre-date the revised SIP2, which was released in May 2011, and I can see that, apart from the extension of SIP2 to Administrations, the current SIP2 plus R3 Guidance Note do not differ much from the old SIP2. However, there was a purpose in stripping out much of the prescription that was in the old SIP2. One of the two overriding principles of the current SIP2 is that investigations should be “proportionate to the circumstances of the case”. The JIC recognised that not every checklist item in the old SIP2 was a proportionate measure on every case. I know how IPs love to create step-by-step recipes for most aspects of case administration, but I think that the motive behind the 2011 SIP2 revision included an attempt to encourage IPs to be more intelligent about investigations.

However, the downside of less prescription is a nervousness on the part of some IPs as to how the regulatory bodies would measure concepts such as proportionality. How is an IP to know whether the extent of investigations he feels are proportionate meets the RPB’s expectations? Although I have some sympathy with this, I would suggest that IPs who keep in touch with their RPBs via newsletters, roadshows, and monitoring visits, with developing case law, and with what their peers are doing, by means of a healthy exchange of competent staff and by having a friendly IP or two (or a consultant, of course) to chat things over with, should be able to make a reasonable judgment of what is acceptable and appropriate. And IPs who document their thought-processes adequately should be in a position to set out a reasonable defence of their actions, if challenged.

But, once upon a time, when SIPs were “best”, rather than required practice, the old SIP2’s prescriptive steps-to-take-for-a-successful-investigation had been useful to IPs. As a consequence, this information was reproduced in the R3 Practical Guidance Note so that it was not lost forever. But it is worth remembering that this note is only guidance – it would be wrong to follow it slavishly for every case without having regard for the specific circumstances.

The Structure

The SIP identifies a two-stage process:

• Steps expected on all cases, culminating in an “initial assessment”
• Deciding on and proposing further investigation, seeking appropriate sanction and communicating with creditors

Steps expected on all administrations and insolvent liquidations

Locate, secure and list books and records

Helpful resources (if you need/want any such material!) include:

• Insolvency Guidance Paper: “Systems for Control of Accounting and other Business Records” (March 2006): http://www.icaew.com/~/media/Files/Technical/Insolvency/insolvency-guidance-papers/tech-03-06-insolvency-guidance-paper-systems-for-control-of-accounting-and-other-business-records.pdf (strangely not publicly available on the R3, IPA or Insolvency Service websites)
• R3 Technical Bulletin 104, section 5 (June 2013)
• Dear IP 57, page 10.54 (March 2013): http://www.insolvencydirect.bis.gov.uk/insolvencyprofessionandlegislation/dearip/dearipmill/hardcopy.htm. Whilst this relates to disqualification cases, it does help, I think, to convey the difficulties the Service has encountered when an IP’s record-securing process is less than robust.
• Insolvency Service’s CDDA guidance notes – again, this is not strictly SIP2 territory, but it is worth noting that, in disqualification proceedings, “the courts will expect the office holder to have made every reasonable effort to secure accounting records which inevitably means requesting them on more than one occasion” (page 19).

Invite parties to provide information

Invitations are to be sent to creditors (at the first communication/meeting – don’t forget that this applies to Administrations too), committee members, and predecessors in office. The SIP states that you’re asking them “whether prior transactions by the company, or the conduct of any person involved with the company, could give rise to action for recovery” (paragraph 6), so again the purpose is to unearth hidden assets, not to gather information for a D-report.

Make enquiries of directors and senior employees

It is pretty standard procedure for IPs to send questionnaires to the directors… but do you think about senior employees? Also, whilst standard questionnaires do the job adequately, I have seen forms tailored to the specific circumstances of a case. After all, often IPs quickly develop suspicions of where potential recoveries might be hiding – why not slip in the odd question to get right to the point?

The “Initial Assessment”

This should be done “notwithstanding any shortage of funds”, but how much work do you put into this? It might help to focus on what you’re trying to achieve. The SIP states that you should get to a position of being able to decide “whether there could be any matters that might lead to recoveries for the estate and what further investigations may be appropriate” (paragraph 10), so you’re not expected to have positively identified causes of action, but you are expected to have identified possibilities and to have an idea of what you might do to get to that stage.

The R3 Guidance Note recommends (i) comparing the SoA with the last filed/management accounts and (ii) carrying out a preliminary review of the books, records and minutes over the last 6 months. I also think it is a good idea simply to list the possible rights of action – the list of sections of the IA86 and CA06 that appears in the Guidance Note – and ask yourself: have I any suspicion that any of these might have occurred?

Over and above this, the extent of your investigations should be determined by taking account of:

• The public interest
• Potential recoveries
• The funds likely to be available to fund an investigation; and
• The costs involved (paragraph 11).

What exactly is the office holder’s public interest role and how much of an influence will this have over the extent of your investigations? Good question, particularly considering that I’m sure we all know of CDDA cases that were not taken forward on the basis that it was not in the public’s interest. I thought the comments of Mr Justice Newey in Wood & Anor v Mistry [2012] (http://www.bailii.org/ew/cases/EWHC/Ch/2012/1899.html) were helpful in noting the liquidator’s public interest role – the case involved liquidators making their own application for a disqualification under the CDDA. Newey J describes the circumstances that might prevail for such an application (paragraph 30).

Seeking Sanction

The statutory requirements for a Liquidator seeking sanction are contained in Schedule 4 of the IA86 and Rules 4.218A to E (for litigation expenses to be paid from floating charge realisations). The statutory requirements for an Administrator are..? Given that Administrators can challenge many antecedent transactions – S213 and 214 being the obvious exceptions – I’m surprised that there seems to be a perception that a Liquidator is better-placed to pursue these matters (although, of course, the duration of likely actions is a consideration). In particular, I understand that HMRC is still in the habit of modifying Administrators’ Proposals to seek the swift move into liquidation on the apparent basis that more will be done about antecedent goings-on… maybe HMRC wants the control over the office holder provided by the statutory requirements to seek sanction (yes I know, it’s highly unlikely that the HMRC appreciates this subtlety). If so, it might be disappointed to note that the recent Red Tape Challenge consultation includes the proposal that the sanction requirements on liquidators of Schedule 4 be dropped.

Although SIP2 does not add further requirements to seek sanction, it does recommend that IPs consider consulting or seeking sanction where they “conclude that the outcome is uncertain and the costs that would be incurred would materially affect the funds available for distribution” (paragraph 13). This makes sense: sometimes creditors are happy for you to spend the estate funds in pursuit of a potential recovery, especially if they think it may mean some pain for the directors, but in some cases they may prefer to cut their losses and run.

Disclosure

In order to obtain sanction, it will be necessary to provide some information on what you’re planning to do. The SIP recognises that it may be more discrete to consult with select creditors, either the major ones or committee members (subject to the statutory requirements mentioned above).

However, the SIP also sets out expectations of communicating with the entire body of creditors “regarding investigations, any action taken, and whether funding is being provided by third parties” (paragraph 17). It does acknowledge the issues of privilege and confidentiality. R3’s recent Technical Bulletin 103 provides some useful information on legal professional privilege and, in relation to confidentiality, you could do worse than consider the Insolvency Ethics Code’s description of the principle.

It may be a difficult balance to achieve, but SIP2 does require “as a minimum” that the office holder includes within the first progress report “a statement dealing with the office holder’s initial assessment, whether any further investigations or action were considered, and the outcome; and include within subsequent reports a statement dealing with investigations and actions concluded during the period and those that are continuing” (paragraph 17). It should be remembered that usually in effect creditors’ money is being used to further investigations and the Ethics Code’s principle of transparency requires office holders to observe their professional duty to report openly to those with an interest in the outcome of the insolvency. In addition, keeping in mind that SIP2 investigations are primarily concerned with identifying hidden assets, it is clear that a bland statement in progress reports such as “the office holders have complied with their requirements to report to the Insolvency Service in relation to CDDA matters but the contents of such a report are confidential” does not meet the SIP2 disclosure requirement.

Further Investigations

The R3 Practical Guidance Note suggests some areas that, “where it is agreed to conduct further investigations.., may be usefully borne in mind, depending on the circumstances of the case and the nature of the investigations”. The suggested areas are pretty-much the old SIP2 points, but my personal opinion is that, if IPs have got to this stage, they should be in an position to decide for themselves how best to conduct further investigations. Surely this is the point at which an IP’s professional judgment comes into play.


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More on the ERR Bill and two cases: (1) Scottish Court shows more than the usual interest in provisional liquidator’s fees; and (2) Court avoids “unpardonable waste of scarce resources” by striking out evidence

I present a bit of a mixed bag here:
• The Enterprise & Regulatory Reform Bill – developments since my blog post of 12 January
Nimmo – the Scottish Court of Session takes more than a passing interest in a provisional liquidator’s fees
Secretary of State v Potiwal – despite the seeming absence of a technical argument, the court saves the taxpayers’ money in proving a case a second time

Update on the Enterprise & Regulatory Reform Bill

New Bankruptcy Application Process

On 12 January, I posted to this blog my thoughts on the insolvency parts of the ERR Bill. Last week, some interesting tweaks to the Bill had been proposed: that the adjudicator be allowed to apply to the court for directions (which might have helped if the adjudicator had been presented with a bankruptcy application with tricky COMI dimensions); and that, if the adjudicator felt that an alternative remedy were more suitable, the individual be given ten days to seek advice and potentially withdraw the bankruptcy application. Unfortunately, both these proposals were withdrawn following the House of Lords’ debate.

In relation to the subject of applying to court for directions, Viscount Younger of Leckie said: “Persons appointed as adjudicators will have the skills they need to do the job without the need for recourse to the court. It is acknowledged that the court still has a role to play. Where the adjudicator refuses to make a bankruptcy order because the criteria are not met, the debtor will have the right to appeal to the court. That provides a route to court in those cases where it is needed” (Lords Hansard on House of Lords Grand Committee 16 January 2013, http://www.publications.parliament.uk/pa/ld201213/ldhansrd/text/130116-gc0002.htm).

With regard to allowing the individual time to explore alternative solutions, Viscount Younger said: “I reassure noble Lords that before making their bankruptcy application, applicants will be strongly encouraged to take independent debt advice to ensure that bankruptcy is really the right option for them. My officials will work with the Money Advice Service and providers within the debt advice sector to ensure that applicants have the information they need to make an informed decision. Furthermore, within the electronic application process itself, we propose to include a series of warnings to ensure that applicants are made fully aware of the serious implications of bankruptcy before they make their application. We will also ensure that the process flags up any alternative debt remedies that may better suit their circumstances. The Government consider that these safeguards are sufficient to ensure that debtors are empowered to make an informed decision as to whether or not bankruptcy is the right option for them before they take the serious step of making a bankruptcy application. The Government believe that these amendments would unnecessarily complicate the process by requiring the adjudicator to exercise discretion on a case-by-case basis. That would increase administration costs with an impact on the application fee. It would also delay access to debt relief for the debtor, who would have elected for bankruptcy in full knowledge of their other options.”

Whilst I understand the government’s intention to formulate a simple administrative process to replace the current court-led debtor’s bankruptcy petition process (although those IA86 provisions are not being repealed via the Bill, presumably so that individuals who cannot/do not wish to apply online can still instigate their own bankruptcy), it seems inevitable to me that such a process will be ill equipped to deal with out-of-the-norm cases.

Continuation of contracted supplies in corporate insolvencies

It seems that R3’s “Holding Rescue to Ransom” campaign is paying off! Added to the list of proposed amendments to the Bill are the following proposed changes to S233 of IA86:

• To include “a supply of computer hardware or software or infrastructure permitting electronic communications” as another utility that must continue to be supplied (subject to the current S233 conditions) on request by the office holder.
• Utility supplies to be caught by the provisions irrespective of the identity of the supplier.
• To include that “any provision in a contract between a company and a supplier of goods or services that purports to terminate the agreement, or alter the terms of the contract, on the happening of any of the events specified in subsection (1) [i.e. administration, administrative receivership, S1A moratorium, CVA, liquidation, or appointment of a provisional liquidator] is void” – this does not seem to be limited only to utility supplies.

It remains to be seen, however, if these proposed changes survive the debate in the House of Lords (next sitting is scheduled for 28 January 2013).

Scottish Court of Session not content to take as read the court auditor’s and reporter’s recommendations of approval of provisional liquidator’s fees

Nimmo, as liquidator of St Margaret’s School, Edinburgh, Limited [2013] ScotCS CSOH 4 (11 January 2013)

http://www.bailii.org/scot/cases/ScotCS/2013/2013CSOH4.html

Summary: Despite both the reporter and the court auditor recommending that the provisional liquidator’s remuneration of c.£120,000 be allowed, the court sought further information in justification of the fee. Whilst IPs can take some comfort in the result that the judge allowed the fees in full, his comments suggest some lingering concern and hinted at a desire for a review of the court procedures.

The Detail: Over 20 days, a provisional liquidator managed “a high profile and extremely sensitive appointment” (paragraph 9) over a school and incurred time costs of c.£120,000. Later, the IP was appointed liquidator of the same company with his fees for the liquidation being approved by the liquidation committee. Interestingly, Lord Malcolm disapproved of the use of the word “cost” when referring to as yet unauthorised remuneration: “For the future I would advise that in reports to committees the proposed fee should not be described as ‘a cost’ already incurred by the liquidator. It should be made clear that the committee is being asked to exercise a judgment as to whether the proposed remuneration is reasonable and appropriate (or words to that effect). A proposed fee is in a different category from outlays. The scope for disagreement or questioning should be obvious to the readers of the report” (paragraph 31). The IP’s fees as provisional liquidator remained to be approved by the court.

Both the reporter and the court auditor considered that the provisional liquidator’s fees were reasonable, but the judge requested further information. Despite learning of the complexities handled by the IP, Lord Malcolm stated: “nonetheless I retain a sense of surprise and concern at a proposed fee of over £120,000 (exclusive of vat) for 20 days work, and I suspect that many will find it remarkable that the winding up of a middling size private school can generate fees of over £620,000 (again exclusive of vat)” (paragraph 31). However, the judge allowed the fee, noting that “the court cannot simply reject the clear advice of the reporter and the auditor of court without cogent and objectively justifiable reasons for doing so” (paragraph 35).

Lord Malcolm’s closing comments suggest a desire for more widespread consideration of the issue of insolvency office-holders’ remuneration: “Perhaps it is no bad thing that, now and again, an opinion is issued which shows how these matters are presented to, and addressed by the court. Generally they are resolved without any public hearing or publicity. There is at least a risk that the fee levels and general practices and procedures seen as normal in the corporate insolvency world become, when the court is asked to adjudicate, in a sense self-fulfilling. This highlights the important role of the auditor of court in the current system, given that he is not directly involved in such work. It may also be that, from time to time, and in the light of experience, the judges should review current practice to check whether there is room for improvements in the court’s procedures which might help it to exercise its jurisdiction under the insolvency rules” (paragraph 38).

Court avoids “unpardonable waste of scarce resources” by striking out director’s evidence in disqualification proceedings

Secretary of State for Business, Innovation & Skills v Potiwal (Rev 4) [2012] EWHC 3723 (Ch) (21 December 2012)

http://www.bailii.org/ew/cases/EWHC/Ch/2012/3723.html

Summary: In relation to disqualification proceedings, the Secretary of State (“SoS”) sought to rely on the fact that a VAT Tribunal had already proven a director’s knowledge of his company’s fraud. The court found that, although the SoS’ argument that the director was estopped from denying knowledge failed because the SoS and HMRC were not privies, it agreed that it would be manifestly unfair and it would bring the administration of justice into disrepute to require the SoS to prove the director’s knowledge a second time.

The Detail: An earlier VAT Tribunal had concluded that the director knew of the company’s VAT fraud, but in evidence to defend disqualification proceedings the director denied having such knowledge. The SoS sought to have that part of the director’s evidence struck out on the grounds that he was estopped from denying that he had this knowledge; or that his denial was an abuse of process, as it would be manifestly unfair for the SoS to be put to the substantial cost and delay of proving the allegation; and/or that to permit the issue to be re-litigated would bring the administration of justice into disrepute.

For the argument of estoppel to win out, the parties to the disqualification proceedings – the SoS and the director – had to be in privity with the parties to the earlier VAT Tribunal – HMRC and the insolvent company. Given the director’s role in the company and in the VAT Tribunal proceedings, the judge had no difficulty in concluding that the director and his company were privies. However, he decided that the SoS and HMRC were not privies: “I consider that it would therefore go against the grain of the development of the law about abuse of process to identify for the first time a new class of privity of interest between two very different arms of government pursuing different aspects of the public interest, and being motivated in particular cases by different policy and funding considerations when doing so” (paragraph 21). Consequently, in relation to the first ground, Mr Justice Briggs concluded that, because there was no privity of interest between the SoS and HMRC, the proven position in the VAT Tribunal could not be carried forward into the disqualification proceedings.

However, Briggs J then considered whether “hundreds of thousands of pounds” of tax-payers’ money should be used to prove the allegation a second time. Having considered the circumstances of the VAT Tribunal, which was funded by the taxpayer throughout, the judge concluded that it would be manifestly unfair to impose the cost of re-litigating the issue on the SoS. With regard to the argument that re-litigation would also bring the administration of justice into disrepute, Briggs J stated: “Where, as here, the issue as to a director’s knowledge of a complex MTIC fraud has been fully and fairly investigated by an experienced tribunal and the director found to have had the requisite knowledge, it seems to me that right-thinking members of the public would regard it as an unpardonable waste of scarce resources to have that issue re-litigated merely because, by a simple denial and without deducing any fresh evidence, Mr Potiwal seeks to require the complex case against him to be proved all over again” (paragraph 29). Thus, he ordered that parts of the director’s evidence be struck out as an abuse of process.


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Some inflammatory remarks made as the BIS Committee interrogates the Insolvency Service

On 23 October 2012, the BIS Committee put questions to Dr Richard Judge, the Inspector General and Chief Executive of the Insolvency Service, and Graham Horne, the Deputy Inspector General and Deputy Chief Executive.  The recording of the session can be found in the archive section of www.parliamentlive.tv.

Here I have set out the main points I drew from it and I have used quotes to avoid putting my own spin on the proceedings (although I could not refrain completely from adding some of my own observations).  It is a long entry, I’m afraid, but here are the topics that I have covered:

  • Allegation of “age-old problem” of asset sales at an undervalue by IPs
  • What is being done about forcing suppliers to continue to supply?
  • Apparent disjoint between number of D1 reports and number of disqualifications being pursued
  • Proposals to affect pre-packs and what is to be done about continuously “disappointing” levels of SIP16 compliance?
  • Is the lower level of complaints as a whole a reflection of the current low-value cases or an indication of increased confidence in IPs?
  • The evolving plans to change complaints processes
  • Prospects for a single regulator
  • Progress in enhancing creditors’ powers to challenge excessive fees
  • Ideas arising from the Red Tape Challenge
  • “Perceived cosy relationship between IPs and asset-based lenders”

The session also covered questions on the Insolvency Service’s current and prospective resources, their projections of insolvency case numbers, the drop in their customer satisfaction rates, and more, but I realised that I had to stop somewhere!

Asset sales at an undervalue (timed at 9.47am in the recording)

Brian Binley (Conservative MP) started the discussion: “I’m particularly concerned about many small businesses who should be in receipt of some return for a sizeable build-up of debt and that build-up occurs because they daren’t be too heavy because the business has been fragile for 5 years or so and yet insolvency agents sell off at 10% irrespective and they feel very badly let down”.

I thought that Graham Horne did a reasonable job of explaining the considerable write-down of asset value on facing a fire-sale for a company in an insolvency process, but Mr Binley had not finished: “I do know how angry it makes people and particularly people running small businesses when they know the value is sizeably higher but where there is a culture of, because of the firewall (sic.) that you talk about, oh get rid of it, 10% will do…  Can I ask you seriously to look into this matter and can I ask you to come back to me because I’m not satisfied with your answers and I think they have been sizeably complacent and I think that a consideration of SME is where hopefully the growth is going to come from and it needs to be higher up your list of priorities than it appears to be.”

It seems to me that there is still much work to do, primarily by R3 I would suggest, in progressing education of the public and politicians about the realities of insolvency.  I would add that I think this is largely outside of insolvency regulation, is it not?  An IP instructs a professional agent to do a professional job; I cannot see that they can be criticised for using accredited agents (say, by RICS and/or NAVA; I’m not sure of any other such bodies) to do their job, can they?

Continuation of supplies (10.00am)

Graham Horne stated that, in relation to the “regulated industries… we should do something about it and are doing something about it, so it’s no right that regulated industries should seek to profit because a company is going insolvent, whereas with a contracting party, it’s trickier.  We’re aware of the issues; we are discussing them with IPs and others.  It will require legislation.  It’s really those unforeseen consequences – if you put a lever over here, you’re not totally sure what the consequences are over there at the moment – but certainly I think there’s a fair amount of forbearance around at the moment.”

The Insolvency Service’s record on director disqualifications (10.10am)

Mike Crockart (Lib Dem MP) observed that last year 5,401 D-reports were submitted, but only 1,151 resulted in disqualifications and he suggested that the perception is that directors who have been alleged as guilty of misconduct are not being tackled.  Dr Judge responded by explaining the Insolvency Service’s strategy in prioritising high risk cases.  He also explained that some cases are not taken forward because, inter alia, the evidence may not be there and he accepted that the Service has not been particularly good at explaining to IPs why cases have not been taken forward.

Mike Crockart responded: “You seem to be handing it back to IPs and saying, you’re sending too many… IPs are seeing something there that they believe you should be dealing with because the numbers are going up, but you seem to be quite satisfied with the number that you’re dealing with.”

I was surprised that Dr Judge responded: “To be clear on what I’ve said, there are 5,000 indications of misconduct – I say ‘indications’ because I think that’s an important point; not every one is going to be severe or even, you know, there are people who are innocent in that…”  At least Graham Horne tempered this a little with the observation that IPs are statutorily obliged to report metaphorically those driving 31mph in a 30mph zone and consequently not all cases are taken forward, but even so I thought it was interesting to hear what comes into the new Inspector General’s mind.

Pre-packs (10.22am)

The Committee Chairman started: “Widespread dissatisfaction with them [pre-packs]; proposals that had been mooted were shelved earlier this year…”  Was there scope for further reform?

Dr Judge repeated the Insolvency Service’s view that pre-packs are seen as a useful tool in the rescue culture, they have saved jobs, and in conducting their monitoring “we haven’t come across widespread evidence of abuse”.  He also explained the general view that the real concern is sales to connected parties and that SIP16 has “tried to” address concerns over transparency.

Graham Horne explained the reason the proposals for 3 days notice was shelved, due to a desire to avoid introducing legislation affecting small businesses, “although it has not been ruled out”.  He also hinted at the relevance of the director disqualifications, reporting that 161 disqualifications were where directors had entered into transactions to the detriment of creditors; 56 for misappropriating assets; and 102 for “conduct that was quasi-criminal”.

He continued: “Transparency is something that we continue to work on and we’re not satisfied that IPs are doing enough to persuade creditors that they’re doing a good job in the way that they’ve handled pre-packs.  We don’t see evidence that the pre-pack wasn’t the right thing to do or that it wasn’t the best option in the circumstances.  What I don’t think IPs are doing enough of is explaining to people why they chose that option and giving the circumstances for that”.  He confirmed that no other specific suggestions arising from the stakeholder meetings into improving confidence in pre-packs are being considered.

Brian Binley queried the relevance of the disqualification statistics.  He added: “It is about SMEs in pre-packs, small businesses who often think that the whole deal is done above their heads; they don’t get any information whatsoever and they feel either that the Inland Revenue or the banks or the big companies have wrapped it up without any recognition of the relative size of the hit to a small business.  To a bank, £50,000 is not a great deal of money, but to a small business it’s very often the difference between survival or going under and in terms of pre-packs it is often the SME, the very small business, that is totally left out of any considerations.  Is that fair and if there is a hint of concern there, what are you doing about it to find out how great that concern is?”

Personally, I do wonder at the level of acumen of a business that provides life-or-death levels of credit to a company and thus how sensibly they could contribute to, or absorb the details of, any pre pre-pack completion process.

Graham Horne responded that he understood the concern.  He believed that the forbearance of HMRC and the banks is helping; companies are not being pushed into insolvency, but he recognised that it is the absence of information before the sale that is the concern.  “That is why we’ve not ruled out going back to the idea that people should give notice and we do encourage – and it is part of the practice of IPs – to market the company’s assets because I think one answer here would be to say to people: what is anyone prepared to pay for these assets? Because this is what it’s all about… a fair open market to say what’s anyone prepared to pay? And I think the issue on pre-packs is often that it’s behind closed doors.  The SIP is supposed to be telling IPs to give information about what marketing they’ve done and this is where we pull them up and their compliance I’m afraid is disappointing”.

I was interested to note that Graham Horne referred to sales of assets, not businesses, which supports my perception that perhaps he still does not quite appreciate the damage that can be done to some businesses in indiscreetly seeking to attract purchasers before the commencement of insolvency.  Having said that, I do wonder if some IPs may still feel that as long as sale consideration is comparable to, or a slight improvement over, a valuation, then it is as good as selling on the open market and I wonder if adequate contemplation of open market selling occurs.

In response to Ann McKechin’s (Labour MP) question of whether the Service was satisfied with the last SIP16 monitoring report’s results – 32% not fully compliant and 7% substantially deficient – Graham Horne stated: “No, I’m not at all satisfied with that.  It is disappointing that the industry has been unable to get that level up to where I’d expect it to be.  I mean, they are professional people, it’s a complicated SIP and it’s got quite a lot of elements to it, but one would expect them to be able to comply with that to a far higher level that 68%.  I would say that the non-compliances are slightly technical, so it’s not as though in those cases that the pre-pack is in any way wrong or was the wrong thing to do or there was abuse.  It is simply the point that they’re not giving enough information to creditors and that’s why again as part of the reforms we are looking at strengthening the rules and regulations relating to the supply of information to really put it on a statutory footing, rather than the footing that it is with the SIP”.

I was disappointed that, whilst Ann McKechin was seeking confirmation that “the SIP is at the moment voluntary guidance provided by your department”, Graham Horne nodded and muttered “yes”.  Ms McKechin continued by asking whether Mr Horne would prefer it to be statutory.  He responded: “I’m not sure that my personal opinion particularly carries much weight, but it is something that ministers would want to look at and it’s part of the consultation that went out”.  Then Ann McKechin asked: “Have any of the professional regulators that are involved adopted the SIP16 guidance into their own regulatory environments and the fact that there are penalties for non-compliance?”  Disappointingly again, Graham Horne did not put the Committee straight on the status of SIPs within the RPBs, but he responded: “Oh there are penalties for non-compliance, yes, and when we complain, penalties are imposed, fines are imposed and undertakings are given, so there are some regulatory consequences of the failure to comply.  My disappointment is that those penalties have not had the impact of improving compliance levels and I think what we’re trying to do with the RPBs is urge them to up the game to say, look, you need to do more, to ensure they do reach acceptable levels of compliance.  I think our view is that the penalties imposed so far have not really been of the size, of the level, that we would have liked to have seen in some cases.  In some cases we think that perhaps RPBs could have taken a little bit of a firmer line with some of the non-compliance cases.”

Personally, I was really disappointed at the style and wording of SIP16 when it was released (my disappointment perhaps is heightened, as I was the IPA secretariat attendee at the JIC when the SIP was being worked on – I believe that there was plenty of effort on the IPA’s part to get the SIP into a better shape).  I do believe that the checklist style has led to some SIP16 disclosures lacking real substance or a sensible explanation of why and how the pre-pack was undertaken.  I do think that more could be done to make the disclosures useful, although I fear that the Insolvency Service’s apparent checklist style of monitoring has not helped, as I wonder if some IPs are sticking to the checklist approach in order to prove to the Service that a disclosure does meet SIP16 requirements.  If that is the case, perhaps these IPs put too much emphasis on the bullet point list in the SIP when they perhaps should be reflecting on SIP16’s paragraph 8: “It is important, therefore, that they [unsecured creditors] are provided with a detailed explanation and justification of why a pre-packaged sale was undertaken, so that they can be satisfied that the administrator has acted with due regard for their interests”.

I would hope that the JIC could be left alone to revise SIP16 (and perhaps SIP13 too?) – and when I left the IPA in May this year, a JIC working group (including someone from the Insolvency Service) was working on this endeavour.  However, it is clear that the threat of the current SIP16-style legislation remains alive.

Complaints in general (10.39am)

Ann McKechin followed up an observation that complaints against IPs had fallen by 16% with an interesting question: does this reflect the value of cases at present or is it an indication of increased confidence in the profession?  Unfortunately, the Insolvency Service did not grasp hold of this idea, but instead Graham Horne responded: “If you read the OFT report, you might think it was possibly because of a lack of awareness of how to complain and maybe there’s a little bit of an issue there about the mechanisms by which you complain, the way in which you complain.  Levels of insolvency are fairly static at the moment, so we would not expect increasing levels of complaints and IPs in fairness do a difficult job and do it well in the main and the level of complaints is comparatively small compared to the sorts of cases they deal with.”

Evolving plans for changes to complaints processes

Graham Horne immediately continued: “What we are doing is trying to work with the RPBs on a measure to have a single gateway for complaints and we’re pretty close to hopefully announcing a basket of measures where we will host a gateway for complaints so people will be able to see the way in which they can complain.”

He confirmed to Ms McKechin that this was considered an alternative to the creation of a single complaints body and he added: “we’re close to hopefully getting ministerial approval to launch shortly.  We’re also working on common sanctions so it won’t matter which body you’re complaining to, there’ll be a consistent approach to the misconduct, common appeals process as well, so you get many of the advantages of a single regulator but by bringing it together with a single front-end and approach to complaints.”

Prospects for a single regulator (10.41am)

In response to Brian Binley’s question regarding the apparent demise of the proposal for a single regulator, Graham Horne acknowledged that the consultation had generated “quite a lot of strong support for that”, but that “ministers have ruled out at this stage legislation.  The previous minister said he would want to explore achieving the same aims through voluntary means, which is this package of measures I’ve been talking about…  We haven’t ruled out and ministers haven’t ruled out a single independent regulator, needs Parliamentary time, needs to think about that, but what we’re trying to achieve through this set of measures is some of the advantages it would give us.”

Mr Binley observed that R3’s survey reported that the vast majority would like fewer regulatory bodies and asked how quickly the Service was moving, to which Mr Horne observed that it is in the hands of ministers.  Dr Judge added that they “could probably reinforce” the Service’s oversight function; he noted that they are limited to the “nuclear action”, but he pointed out that it did not stop the Service from making their expectations clear to the RPBs.

Creditors’ powers to challenge excessive fees (10.48am)

Rebecca Harris (Conservative MP) asked what progress was being made in enabling creditors to challenge excessive fees.  Graham Horne responded: “This is an area where we’ve made some progress, but I have to say not as much progress as we would have liked with our dealings with the RPBs…  They will be able to raise complaints about fees and RPBs will look at those where the circumstances surrounding the fees amount to misconduct – so an IP has not got proper authority for fees, where an IP cannot support a calculation for the fees, or where the fee levels are very egregious – so they will look at those and that will give creditors some avenues to complain. The position is still that in most cases the recourse is to the court if you’re not happy with the way IPs have handled fees.  Most fees are approved by creditors…  We are looking at whether we can push this voluntary measure a little further because the recourse again would come back to legislation and we haven’t ruled out looking at secondary legislation to give RPBs the right to examine the quantum of fees and I think their natural concern is getting into a commercial discussion/debate about: was that the appropriate fee in that particular case?  We think it is right that there should be some mechanism where someone looks at that and decides whether, not down to the last pence (he was interrupted by a Committee member asking another question)…  We are doing all we can in our role as creditor, albeit we become a creditor after the event, to use our powers as a creditor to look at IPs’ conduct and to raise issue and HMRC do quite a lot as well, although they would have to take it on a resource basis; they can’t take on every case because they are a creditor in every case.”  Mr Horne’s additional comments suggest that the Insolvency Service has devoted new resources to this endeavour and recently formed an RPO team to look particularly, from a creditor’s perspective, at how IPs have administered cases.

The Red Tape Challenge (“RTC”) (10.53am)

Graham Horne set out the timescale: the revised rules are planned to come into force in October 2014 and a set of rules will be sent to a focus group in early 2013.  He said that the revised rules would be made available to the public at least 6 months before implementation, as he appreciated that people needed time to adjust their systems.  Personally, I thought that suggestion of any public consultation on revised rules was conspicuous by its absence.

Mr Horne explained that the “D-form issue” was a particular issue arising from the RTC; the rest of the suggestions were generally around the process of insolvency, meetings, whether modern means of communication could be incorporated more widely, for example with the current need to use first class post.  He said there were no big ideas, but “incremental pruning” should make reasonably significant improvements overall.

Mike Crockart referred to the apparent desire amongst IPs for an electronic D-form, but commented that it seemed a “moratorium” had stalled this development.  Graham Horne confirmed that the idea was certainly not shelved but he acknowledged there were some legislative barriers to look at.  He also said that the Service wants to take a wider look at the whole D-report/return process, for example is a D2 nil return really necessary?  Should there be a form or reporting requirement?  He noted that the risk of a form is that it becomes something completed by rote.

“Perceived cosy relationship between IPs and asset-based lenders” (11.01am)

The above words were what the Chairman used to introduce the next subject and he then handed over to Brian Binley: “I understand you are to meet with officials from the BIS department and with the Treasury and the Campaign for Regulation of Asset-based Finance – due to take place this week”, although Graham Horne later said that discussions were ongoing, rather than confirming a meeting this week.  Mr Binley referred to a case involving a bakery which was given 2.5 days over the Jubilee period by Bibby to find other funders and then Bibby wanted a £92,000 termination fee.  He asked whether this kind of power was unfair and continued: “Some factoring companies put companies into administration and appoint a friendly insolvency firm and some go even further – they pass leads to lenders who are owned by the insolvency practice firm themselves.  Now this is pretty-much of an unacceptable mess, isn’t it?”

Dr Judge acknowledged that this was a relatively recent concern brought to the Service’s attention and pointed out that the Service’s function is limited to insolvency and that this appeared to fall to other departments.  He encouraged people to provide specific evidence of any concerning events.  Graham Horne’s follow-up comments suggest to me that the Service may not have fully grasped Mr Binley’s particular concern: “I think that the regulatory framework is in place.  We don’t need any more tools.  If people have taken out charges late-on prior to the insolvency, those charges could be rendered invalid.  These sorts of things can be looked at in the way the company’s business was restructured just before the insolvency.  This is stuff that we can do with our current powers, so what we need to do is get complaints to us.  We’ve got powerful powers to investigate companies.”

Mr Binley was keen to highlight the banks’ role in this matter, although in so doing, I wonder if he is muddling two different issues: “It’s the banks that almost stipulate that some of their small businesses actually use an associated factoring company, so the whole loop sort-of has the smell about, which is not overly savoury.”

Shortly afterward, the Chairman wrapped up the session by reminding the Service representatives that further written evidence covering a number of matters was expected – the story continues…