Insolvency Oracle

Developments in UK insolvency by Michelle Butler


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Two cases of marshalling; support for ETO dismissals; a flawed Chairman’s report fails to help a debtor escape her IVA; and a Company’s challenge of its Administrators’ appointment

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Although I have promised myself an article on the Scottish Bankruptcy Bill and I see that the Deregulation Bill has not gone smoothly through the House of Commons Committee, I should catch up with some recent decisions:

Crystal Palace v Kavanagh: dismissals for an ETO reason are possible after all.
Smith-Evans v Smailes: is an IVA a nullity, if a Chairman’s report on the requisite majority achieved is challenged long after the S262 period?
Highbury v Zirfin: marshalling and the difference between equity of exoneration and the right of subrogation…
Szepietowski v the NCA: … but sometimes marshalling is restricted by the terms of the deal.
Closegate v McLean: the Company/directors were entitled to challenge the Administrators’ appointment.

Back to the future: dismissals can be for an ETO reason even where the objective remains a going concern sale

Crystal Palace FC Limited & Anor v Mrs L Kavanagh & Ors (13 November 2013) ([2013] EWCA Civ 1410)

http://www.bailii.org/ew/cases/EWCA/Civ/2013/1410.html

This successful appeal has been the subject of some helpful articles already, such as that written by Dr James Bickford Smith for R3’s Recovery News. My summary of the history up to this Appeal Court decision can be found at: http://wp.me/p2FU2Z-2R.

The Court of Appeal stressed the case-sensitive natures of both this case and Spaceright Europe Limited v Baillavoine, which had formed the basis for the previous EAT’s decision to the contrary. Lord Justice Briggs highlighted the need, per Regulation 7 of the Transfer of Undertakings (Protection of Employment) Regulations 2006, to analyse the “sole or principal reason” for dismissals “so that the Employment Tribunal needs to be astute to detect cases where office holders of insolvent companies have attempted to dress up a dismissal as being for an ETO reason, where in truth it has not been” (paragraph 26).

This Court agreed with the original ET’s analysis in this case that, whilst the Administrator’s ultimate objective remained the sale of the Club (as, Briggs LJ pointed out, would be the case in almost all Para 3(1)(b) Administrations), he made the dismissals because he needed to reduce the wage bill in order to continue running the business, i.e. they were for an ETO reason. This was contrasted with the facts of the Spaceright case, which had decided that the sole or principal reason behind the dismissal of the CEO was to make the business more attractive to a purchaser, illustrating how dismissals could fall outside of an ETO reason.

(UPDATE 15/06/14: On 14 May 2014, the Supreme Court refused permission to appeal this decision.)

If a Chairman’s report states that the IVA was approved and no S262 challenge is raised, does the IVA exist if the requisite majority had not been achieved?

Smith-Evans v Smailes (29 July 2013) ([2013] EWHC 3199 (Ch))

http://www.bailii.org/ew/cases/EWHC/Ch/2013/3199.html

I make no apologies for the length of this summary or the numerous quotes: I believe that this is a somewhat surprising and material outcome so that I felt it was wise to draw heavily from the judgment.

In a nutshell, the debtor appealed against her bankruptcy order, which was made as a consequence of a breached IVA. The debtor claimed that the IVA was a nullity, as the requisite majority had not voted in favour at the S257 meeting.

Two creditors, RBS and HSBC (who had voted via TiX), had voted to restrict the IVA’s duration to 2 years, but, although immediately after the meeting the Chairman had written to TiX “pointing out the divergences from the instructions received” (paragraph 15), in the absence of a reply the Chairman reported that the IVA was approved and its duration was 3 years. HH Judge Purle QC stated that “whilst the chairman of the meeting did not initially, in May 2008, have authority to cast the RBS and HSBC votes in the way subsequently indicated, RBS and HSBC have unequivocally ratified his actions by voting (albeit in the minority) for a determination upon the footing that the IVA was in place” (paragraph 17), referring to the creditors’ voting years’ later on the subject of how the Supervisor should react to the debtor’s breach of the IVA terms.

Purle HHJ commented on the application of the decision in Re Plummer, in which Registrar Baister described his view of the differences between a material irregularity and something that invalidates an IVA approval. Registrar Baister had provided as an example a case where the chairman had wrongly calculated the votes and reported approval when the requisite majority had not been achieved. He had said that this goes further than a material irregularity; in reality, there never was approval. “It cannot be that in those circumstances section 262(8) could be said to overcome the problem by making real that which simply never was. The reason it cannot is because of its wording, which presupposes approval: it is ‘an approval given at a creditors’ meeting’ which ‘is not invalidated’. Non-approval cannot, however, be transformed into approval” (paragraph 28).

However, Purle HHJ held a different view. He reflected on another example in which a requisite majority is obtained on a vote marked objected to: “But let us suppose that no creditor in fact challenges the result. We are left with an IVA which has been approved on a disputed debt, which turns out later never to have been owed. Then, just as much in that case as in the example given by Registrar Baister, it can be said that there never was, as a matter of fact and law, the requisite majority. It would follow that the debtor could, when in breach of the IVA, let us say two years later, turn round and say: ‘There was no IVA and I cannot be made bankrupt for being in breach of its terms’, thus making the time-limited right of challenge or appeal redundant. It seems to me that that is such a startling result that it cannot possibly have been intended by Parliament and the draftsman of the Rules. For my part, I would not and do not construe this part of the 1986 Act or the rules as giving rise to those consequences. I would on the contrary construe section 262(8) and rule 5.22(6) as precluding that result” (paragraph 29).

Consequently, in relation to decisions made at, or in relation to, a S257 meeting, Purle HHJ concluded that “If those decisions are not challenged, in my judgment, they should stand once the relevant report has been made. The time limits, which are tight, set out in both the Act and the Rules, should be applied and not subverted by a collateral attack months or even years down the line” (paragraph 32). In this case, he therefore decided that “as there was no challenge under section 262, the matter cannot be taken now by the debtor. Likewise, there was no challenge (assuming there could have been one) under paragraph 5.22, under which the court’s power is expressly exercisable only if the circumstances giving rise to the appeal are such as to give rise to unfair prejudice or material irregularity. There is no unfair prejudice in holding the debtor to an IVA which he promoted nor was the irregularity material in light of the affected creditors’ knowledge and subsequent ratification” (paragraph 36).

Marshalling and the difference between equity of exoneration and the right of subrogation

Highbury Pension Fund Management Company & Anor v Zirfin Investments Management Limited & Ors (3 October 2013) ([2013] EWCA Civ 1283)

http://www.bailii.org/ew/cases/EWCA/Civ/2013/1283.html

I summarised the first instance decision at http://wp.me/p2FU2Z-23. The key conclusion of that decision – that Highbury had a right to marshal securities, even though there was no common debtor (the claims attached to properties of the debtor and the guarantors) – was not the subject of the appeal. Highbury sought to appeal Norris J’s conclusion that its rights over the properties charged to Barclays could not be exercised until Barclays had been paid in full, because Highbury’s rights were restricted so by the wording of the guarantee.

The Appeal judges agreed that the guarantee did not restrict the application of the principle of marshalling. Lord Justice Lewison explained the difference between (i) Zirfin’s right to become subrogated to Barclays’ rights by reason of the guarantee but only after Barclays had been paid in full and (ii) the right of equity of exoneration existing between Zirfin and the Affiliates (the primary debtor): “Where two persons are liable to a creditor for the same debt, but as between themselves one of them is primarily liable and the other is only secondarily liable, the debtor with the secondary liability is entitled to be exonerated from liability by the primary debtor. This equity, unlike the remedy of subrogation, is not dependent on actual payment by the secondary debtor. As soon as the liability is crystallised he is entitled to go to a court” (paragraph 19).

Consequently, it was decided that, on the application of the principle of marshalling, Highbury was entitled to realise the securities notwithstanding that Barclays had not been paid in full, Barclays still retaining priority to repayment over Highbury.

Marshalling again: it can come down to the wording

Szepietowski v The National Crime Agency (formerly SOCA) (23 October 2013) ([2013] UKSC 65)

http://www.bailii.org/uk/cases/UKSC/2013/65.html

In 2005, the Assets Recovery Agency (which later became SOCA and, later still, the NCA) pursued assets acquired by Mr Szepietowski and this resulted in a settlement involving the granting of a second charge in favour of SOCA over a property, which was charged also to RBS, entitling SOCA to recover up to £1.24m from the proceeds of sale of the property. In 2009, the property was sold but, after RBS’ debt was paid off, SOCA received only £1,324. Consequently, SOCA sought to invoke the right to marshal against another property charged to RBS (“Ashford House”). The lower courts had held that SOCA’s marshalling claim was well-founded and Mrs Szepietowski appealed to the Supreme Court.

Although the Supreme Court unanimously allowed the appeal, the justices’ reasons for doing so fell roughly into two camps.

Three justices held that marshalling failed partly because the charge did not create, or acknowledge the existence of, any debt from Mrs Szepietowski to SOCA; it simply provided that she was bound to pay SOCA an amount up to £1.24m from the sale proceeds. Lord Neuberger concluded that “where the second mortgage does not secure a debt owing from the mortgagor to the second mortgagee, the right to marshal should not normally exist once the common property is sold by the first mortgagee and the proceeds of sale distributed, because there would be no surviving debt owing from the mortgagor to the second mortgagee. In such a case, equity should proceed on the basis that the second mortgagee normally takes the risk that the first mortgagee will realise his debt through the sale of the common property rather than the sale of the other property” (paragraph 56). He could not conceive of a case, but did not rule out its existence in exceptional circumstances, in which marshalling effectively could create a secured debt, where in the absence of marshalling no debt existed at all.

However, the two other justices did not consider that the existence or non-existence of a personal liability was the key to deciding whether marshalling was possible. Lord Carnwath agreed that the appeal should be allowed because the terms of the settlement entitled SOCA to recover a sum from property with the specific exclusion of Ashford House and the wording impliedly excluded recourse to any source for payment other than those identified. “If SOCA had wished to include Ashford House as potentially recoverable property, they should have done so specifically, rather than hope to bring it in later by an equitable backdoor” (paragraph 91).

Company/directors were entitled to challenge Administrators’ appointment (but failed in any event)

Closegate Hotel Development (Durham) Limited & Anor v McLean & Ors (25 October 2013) ([2013] EWHC 3237 (Ch))

http://www.bailii.org/ew/cases/EWHC/Ch/2013/3237.html

The companies challenged the validity of the Administrators’ appointments by a QFCH on the basis that the floating charge was not enforceable.

Firstly, the companies had to overcome the hurdle as to whether they had authority to make the application, given that Paragraph 64 of Schedule B1 states that, without the Administrators’ consent, a company may not exercise management power – defined as a power that interferes with the exercise of the Administrators’ powers. Richard Snowden QC did not see this as a difficulty for the companies: “I do not think that paragraph 64 is intended to catch a power on the part of the directors to cause the company to make an application challenging the logically prior question of whether the administrators have any powers to exercise at all” (paragraph 6).

The facts of this case involved lengthy exchanges between the companies and the bank in relation to the companies’ complaints against the bank subject to litigation and proposals to settle the debt due to the bank, which ended with the bank’s appointment of Administrators. It was the companies’ case that “the Companies reasonably understood the communications from the Bank and the course of conduct between them to be a representation that neither side should take any action whilst negotiations between them were continuing” (paragraph 44) and thus the bank had been estopped from taking the action of appointing Administrators. Mr Snowden QC decided on the evidence presented that the companies stood no real prospect of establishing that the bank’s statements or conduct amounted to a clear and unequivocal representation that the bank would not exercise its rights to take enforcement action and therefore the bank was not estopped from appointing Administrators.


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Three cases: (1) Marketing failures did not amount to breach of duty to take reasonable care; (2) CVA no protection for persistent non-payer of rent; and (3) marshalling across two debtors

Kayrul Meah v GE Home Finance Ltd – the court decided that the best price reasonably achievable for a property was obtained, despite flaws in the marketing process
Shah Din & Sons Ltd (CVA) v Dargan Properties Management Ltd – a Northern Ireland case, which I think demonstrates the need to consider the context of a company’s activity before presenting a CVA proposal
Highbury Pension Fund Management Company & Anor v Zirfin Investments Ltd & Ors – a case for insolvency geeks: an example of marshalling security over a second debtor

Shortcomings in marketing a property not considered fatal to discharging duty to take reasonable care to obtain the best price reasonably achievable

Kayrul Meah v GE Money Home Finance Limited ([2013] EWHC 20 (Ch)) (18 January 2013)

http://www.bailii.org/ew/cases/EWHC/Ch/2013/20.html

Summary: The claimant sought compensation from his mortgagee for allegedly selling a property at an undervalue. Whilst there was no formal insolvency or IP involved – the sale was conducted by the mortgagee in possession – I thought it provided some useful pointers on how the court views the duty to take reasonable care to obtain the best price reasonably achievable for a property. The judge levelled some criticisms at the marketing process, but ultimately decided that the property had been sufficiently exposed to the market.

The Detail: The property was put on the market at the beginning of 2006 for £185,000 through a local agent who had valued the property between £165,000 and £185,000. Within a matter of days, offers were received at and then above this asking price. Meah complained that the asking price had been set too low and in February 2006 GE consulted another agent who valued the property at £235,000 and suggested raising the asking price to £245,000. The local agent reluctantly did this and the property was sold in March 2006 to a developer for £221,500. Based on the value of the property post-development, Meah’s expert assessed the “true market value” of the property at the time of the sale having regard to the obvious development potential at £325,000.

The claimant’s counsel argued that the low asking price depressed offers from potential purchasers and that the low asking price had been set because the agents had failed to appreciate the property’s development potential. GE’s agent argued that the asking prices needed to be set to attract a good level of interest and that many of the recipients of the sales particulars were property developers to whom the development potential would have been obvious. The judge was not wholly convinced that putting a grossly inadequate asking price on a property to generate interest was sensible and he observed that the agent had valued the property at less than the asking price, so clearly the agent had been mistaken as to the value. Neither was the judge entirely convinced that it was sensible not even to mention the development potential in the sales particulars, although he also was not convinced that, as the claimant had argued, the agent should have gone to the length of commissioning a residual development assessment, noting that potential purchasers would carry out their own assessments. GE’s agent also came in for criticism when the court learned that he had expressed to the then front-runners who had offered £218,500 his view that the revised asking price, which he had been instructed by his clients to seek, was unrealistic. The judge referred to the principle in Raja v Austin Gray that, if the valuers were negligent, the borrower had a good claim against the receiver who did not discharge his duty of care to the borrower by entrusting the sale to apparently competent professionals.

However, notwithstanding these shortcomings, the judge concluded that the property had been sufficiently exposed to the market to enable all potential purchasers to bid for it if they so wished. With regard to the expert’s valuation of £325,000, the judge stated: “unless a bidding war developed between two or more such developers who had made similar calculations, this sum cannot be said to represent the best price reasonably achievable for the Property at that time” (paragraph 23). The judge used a phrase that IPs know well: “The market value of a property is the price which a willing purchaser is prepared to pay for the property to a willing vendor after the property has been exposed to the market for a reasonable period of time”.

It should be noted that the accepted practice of sales by mortgagee involves the advertising by so-called “public notice” in a local newspaper inviting further offers above the price accepted subject to contract. It appears that GE’s agent relied on this process to flush out the best offer, rather than seeking sealed bids.

N Ireland: CVA no protection for persistent non-payer of rent

Shah Din & Sons Limited (CVA) v Dargan Properties Management Limited ([2012] NICh 34) (5 December 2012)

http://www.bailii.org/nie/cases/NIHC/Ch/2012/34.html

Summary: Although this is a Northern Ireland case, I feel that it serves as a reminder to take care to consider the context of a company’s pursuit of a CVA, whether it is fair and whether the company’s past behaviour supports the case for its protection.

In refusing to grant relief from forfeiture in this case, the court considered “the backdrop of culpable and wilful non observance of [the company’s] obligations” (paragraph 22).

The Detail: The company in CVA applied for relief from forfeiture. The only asset in the CVA was a lease on a property that the company had vacated some six years earlier, but which the landlord had only re-entered and recovered possession of shortly before the proposal was put together. After exploring the chronology of events, the court found that the company had wilfully failed to pay rent over a number of years; Burgess J stated that the company had “to all intents and purposes taken a free ride from the outset” (paragraph 21) and he found that “the plaintiff’s attitude towards its responsibilities in the face of legal proceedings and warnings has been culpable to the highest degree” (paragraph 22). The judge also had difficulty with the terms of the arrangement, which introduced an uncertainty as to what would happen if the lease had not been assigned in the CVA’s 18-month period, noting that the landlord would continue to have to meet its obligations to the Council and to maintain the property during that time. Relief from forfeiture was refused.

A case for insolvency geeks: marshalling across two debtors

Highbury Pension Fund Management Company & Anor v Zirfin Investments Limited & Ors ([2013] EWHC 238 (Ch)) (14 February 2013)

http://www.bailii.org/ew/cases/EWHC/Ch/2013/238.html

Summary: This is a complex case, with which, to be honest, I only persevered out of a sense of stubbornness that I would not be beaten! It demonstrates the exception to the general rule that there must be a single debtor for marshalling. If marshalling holds no interest for you, then you might want to stop reading now… but if ever you do want to explore the principles of marshalling, this summary might come in handy.

The Detail: Barclays Bank Plc loaned monies to Zirfin Investments Limited and to four associated companies, “the Affiliates”. The loans were secured by means of legal charges over a property owned by Zirfin, “No. 31”, and properties owned by the Affiliates. As additional security for the loans to the Affiliates, Barclays also had the benefit of a guarantee from Zirfin, secured by means of the same charge over No. 31. Subsequent to Barclays’ charge, two other charges were granted over No. 31, in favour of Highbury Pension Fund Management Company and Cezanne Trading (described collectively as “Highbury”).

When Zirfin and the Affiliates defaulted on the loans, receivers were appointed over No. 31 and the eventual sale proceeds were applied to settle Zirfin’s debt to Barclays and to settle in part the Affiliates’ debt to Barclays by reason of Zirfin’s guarantee. The immediate consequence, therefore, appeared to be that Highbury had lost the benefit of their charges over No. 31 and sat as unsecured creditors in relation to the monies owed to them by Zirfin. However, this would not have been the case had Barclays looked to the Affiliates’ properties to discharge their debt, rather than calling on Zirfin’s guarantee.

To further complicate matters, the Serious Fraud Office obtained a Restraint Order over the assets of Mr Kallakis (consultant to a shareholder of Zirfin and the Affiliates) and the SFO regarded the assets held by Zirfin (including No. 31) and the Affiliates as subject to the Restraint Order.

The questions for the court were: (i) is a creditor of a guarantor entitled to marshal (or be subrogated to) securities which have been granted to another creditor of the guarantor by the primary debtor liable under the guaranteed debt and (ii) does any such claim to marshalling or subrogation take precedence over prohibitions contained in the Restraint Order?

The principle of marshalling “operates where a debtor (D) owes money to two creditors (C1 and C2), and where C1 has security over two properties (or some other call on two funds) (S1 and S2) but C2 has security over (or a right of resort to) only one (S1). In those circumstances C1 has a choice of recovering his money out of either S1 or S2. If C1 chooses to enforce the security over (or resort to) S2, then that leaves S1 available for C2. But if C1 chooses to enforce security over (or resort to) S1, then C2 has nothing to look to, and the security over S2 is not relied on at all, and becomes available to unsecured creditors (amongst whom C2 is now numbered). In that situation, in order to do justice equity applies a principle of maximum distribution and by a process akin to subrogation in effect gives C2 the benefit of C1’s unused security over S2, thereby ensuring that both C1 and C2 are paid by D as far as possible” (paragraph 15).

In this usual application of the principle, the debtor, D, is common to both creditors, C1 and C2. However, in this case, the Affiliates were debtors only to Barclays, not also to Highbury. Counsel for Highbury submitted that “although the general rule is that two or more creditors must be able to resort to two funds belonging to the debtor, this general rule is subject to an exception where… there is a common debtor who owes money to both creditors and he has a right, as between himself and a debtor who owes money to only one creditor, to ensure that the latter bears the ultimate liability” (paragraph 25). Counsel for Highbury acknowledged that there was no decided case in England and Wales that applied this principle, but relied on statements in text books and decisions in other jurisdictions.

In Norris J’s view, the doctrine of marshalling applied in this case: “Barclays has a claim against Zirfin as surety. It can look to two funds to satisfy that indebtedness. The first is the Zirfin Charge. The second is the Affiliates’ Charge. As regards Highbury’s claim to marshal, the Affiliates’ Charges can be bought into account (even though they are not over property belonging to Zirfin) because in equity Zirfin could call on the Affiliates to bear the burden of the debt and the Affiliates had the Affiliates’ Properties to enable them to do so” (paragraph 45). A limitation that Norris J noted regarding the rights acquired by Highbury on marshalling was that, “if Zirfin would not be subrogated to Barclays’ rights until such time as the Barclays debt had been entirely repaid, then Highbury cannot by a process akin to subrogation become entitled to any greater right” (paragraph 50).

Then the judge considered the SFO’s argument that Highbury has no “interest” in the Affiliates’ properties subject to the Restraint Order. Norris J did not believe that the Proceeds of Crime Act 2002 should be construed so as to “enrich the Crown by depriving Highbury of the right it otherwise would have had to marshal the securities” (paragraph 68). He therefore held “that the actions of Barclays have not deprived Highbury of the ‘interest’ which was previously recognised by the Restraint Order, and that if Highbury were to seek to bring itself within paragraph 25 of the Restraint Order or to seek a variation of the Restraint Order so as to make clear that it (rather than Barclays) was now contingently entitled to enforce the Affiliates’ Charges, the discretion given to the court ought to be exercised to permit that variation” (paragraph 70).

[UPDATE 26/11/2013: On 03/10/2013, Highbury’s appeal was allowed in relation to an element of the earlier decision that Highbury was not entitled to realise the securities until Barclays had been paid out in full (http://www.bailii.org/ew/cases/EWCA/Civ/2013/1283.html). In a more recent post, http://wp.me/p2FU2Z-4I, I summarise the appeal decision, which highlighted the difference between rights of subrogation and equity of exoneration.]