what's in the news

BESTrustees v Kaupthing Singer & Friedlander [2012] EWHC 629 (Ch)
(High Court Chancery Division 16 March 2012)

Background

BESTrustees was the trustee of the Kaupthing Singer & Friedlander Limited Pension & Assurance Scheme. The Icelandic bank Kaupthing Singer & Friedlander was the sponsoring employer and in 2008 entered administration. The result of which triggered an employer debt under section 75 of the Pensions Act 1995 (the Act). Under section 75(4)(a) of the Act, when a section 75 debt arises, an assessment of the value of the scheme’s assets compared with its liabilities is undertaken.  The statutory debt is based on the buy-out liability, i.e. the cost of securing the pension scheme benefits in full with an insurance company.

A point of disagreement arose between the trustee and the employer regarding the date at which the cost of buying out the pension scheme liabilities should be calculated for the purposes of section 75. The trustee argued for the date when the scheme actuary carries out the calculation and certifies the amount. The sponsoring employer argued that under the Occupational Pension Schemes (Employer Debt) Regulations 2005 (SI 2005/678) (the Regulations), the scheme’s liabilities should be valued on the date the employer entered administration, that being 8 October 2008. The trustee applied to Court to decide on the proper construction of Regulation 5 of the Regulations, as at 8 October 2008.

Due to a significant shift in market costs of annuities over a short period of time, the valuation of the scheme’s liabilities by each party were very different. There was no dispute about the date the scheme assets should be valued, namely at the date of administration. On this date the scheme’s assets were valued at £105 million. If the Judge decided in favour of the trustee, the scheme’s liabilities would be £245 million, resulting in a section 75 debt of £140 million. If the employer was successful, the scheme’s liabilities would be £178.9 million, resulting in a £73.9 million employer debt.

Decision

The Judge found that on the true construction of Regulation 5, the time at which both the value of Pension Scheme assets and the notional cost of annuities in the market should be assessed was the “applicable time”, i.e. the date on which the Section 75 event occurred, 8 October 2008.

Comment

The Judge decided on the only sensible interpretation and to do so provided certainty in an area which causes much disagreement about the valuation methodology. The Judge commented that where assets and liabilities are both valued at the date of administration, there is at least the possibility of forming an early view on the likely outcome, not only for the pension scheme, but for creditors. Regulation 5 has further been amended since 2008 and reinforces the Judge’s decision.

Employers and trustees need to ensure that the correct date and valuation methodology is used to assess the employer debt to avoid disputes in an already uncertain area of pensions and insolvency.

For further information, please contact Pitmans Pensions Team.

Parminder Latimer
Director
T: 0118 957 0324
E: platimer@pitmans.com

It is looking increasingly likely that 2012 will be another difficult year for the automotive sector, leading to a decline, not only in vehicle sales, but also in goods and services supplied to the sector. As a result, businesses may experience cash flow problems and increased creditor pressure to pay invoices.

There are a number of ways in which a business may look to ring fence its existing unsecured debt. If the underlying business is sound, a company struggling to pay its creditors may propose a composition of its debts via a Company Voluntary Arrangement (“CVA”). A CVA is a legally binding agreement between a company and all of its unsecured creditors to pay off historic debt over a period of time, usually 3 to 5 years. Any CVA must offer a greater potential dividend return to creditors than would be achieved if the company were to enter into insolvent liquidation.

Once the CVA is approved by the requisite majority of creditors it becomes a contract between the company and its creditors and binds all unsecured creditors. However, the rights of secured or preferential creditors cannot be adversely affected without their express consent.

One of the fundamental issues with CVAs is that, for the majority of companies, there is no statutory moratorium to prevent creditor/s taking action to recover sums owed to them whilst the CVA is put to creditors. However, “small companies” can obtain the benefit of a statutory moratorium designed to prevent creditors taking action against the company whilst the CVA proposal is put to the creditors. A “small company” is defined as one whose turnover does not exceed £5.6 million; its balance sheet total does not exceed £2.8 million and has no more than 50 employees.

For companies that do not fall within the “small company” criteria it is possible to enter into a formal insolvency process, known as administration, with the intention of exiting it via a CVA once the CVA has been approved. The primary purpose of any administration is to try and rescue the company as a going concern. Administration allows time for a company’s affairs to be re-organised under the protective umbrella of a statutory moratorium.

If it is not possible to rescue the company as a going concern then the business/assets of the company may be sold to a third party via a “pre-pack.” A pre-pack involves the company entering into administration and immediately selling its business and/or assets to a third party under a sale the terms of which were negotiated before the administrators were appointed. It allows the business to continue trading via a new company and secures the employment (employees will transfer to the buyer) whilst leaving behind the burden of historic debt with the company in administration.

Pre-packs are frequently used where the core business is still viable, but the company carries significant historic debt that it can no longer service. Invariably there is no funding available for the business to continue to be traded by the administrators and, for whatever reason, any CVA proposals are not appropriate or have been rejected by a majority of the creditors.

If you have concerns or queries about any of the issues dealt with in this article or wish to explore confidentially the various methods of restructuring and/or refinancing your business please contact us and we will be happy to provide you with advice and assistance.

Adrian Wilmot
Director
T: 0118 957 0595
E: awilmot@pitmans.com

Suzanne Brooker
Partner
T: 0118 957 0516
E: sbrooker@pitmans.com

We previously reported on Raithatha v Williamson (4 April 2012) where the High Court held that a bankrupt’s right to draw a pension was subject to an income payments order (“IPO”) even if the individual had yet to draw his pension. This judgment represented a significant departure from previous practice under the Welfare Reform and Pensions Act 1999 which protected future pension rights from IPOs and distinguished them from pensions in payment. It also effectively allowed a trustee in bankruptcy to compel a bankrupt to draw pension against his wishes.

This case has been appealed and the appeal hearing is due to take place between 3 September and 2 November 2012.

For further information, please contact:

Symon Rowley
Director
T: 0118 957 0301
E: srowley@pitmans.com

The EU insolvency law has resulted in insolvent debtors shopping for a better jurisdiction in which to become bankrupt.  This article examines why and how.

Why?

The EC Regulation on Insolvency Proceedings 2000 (the ECIR), came into effect in May 2002, providing a framework for the national jurisdictions to work together by recognition of each states insolvency mechanisms.  However the EC Regulation does not harmonise substantive differences in insolvency law between the subscribing nations.

England and Wales aim to encourage entrepreneurialism and the comparatively friendly insolvency legislation has caused bankrupts to establish their centre of main interest (COMI) in England or Wales.  Automatic discharge of a bankrupt after 12 months and wiping of all pre bankruptcy debts so that the bankrupt can effectively start afresh (subject to certain exceptions) has caused England and Wales to become known as a ‘debtor friendly’ state.

Our ‘debtor friendly’ state is more marked when compared with Germany where the discharge from bankruptcy can take up to 9 years and Irish law where currently there is no automatic discharge and bankruptcy lasts 12 years.

How?

Recital 4 of the ECIR states that the regulation should not be used for forum shopping.  However, there is no clear definition of COMI and the ECIR therefore enables some insolvent debtors to establish a COMI in a more favourable jurisdiction.  The court will usually regard the country where the debtor carries on a business or earns their living as their COMI.  Recital 13 of the ECIR states that an individual’s COMI will be ‘the place where the debtor conducts the administration of his interests on a regular basis and is therefore ascertainable by third parties’.  The court will also have regard to the place where the debtor normally lives, how long they have lived their and how often they travel abroad.  The location of a debtor’s COMI will be a question of fact to be decided on the specific circumstances of each case.

Change?

Concerns have been raised that there is not sufficient policing of the line between genuine and fictional relocations.  Chadwick LJ in Shierson v Vlieland-Boddy [2005] BPIR 1170 said ‘that there is nothing… which prevents a debtor’s centre of main interests from being changed from time to time’.  There have however been a number of recent “cross border” bankruptcies which have been annulled in the courts of England and Wales following findings that the debtor’s COMI was not correct at the commencement of proceedings.  In Official Receiver –v- Huck [2011] BPIR 702, and Sparkasse Hannover –v- Korffer [2011] B.P.I.R the courts held that the debtors COMI was not England.  Both cases emphasise that in establishing a COMI there must be a necessary element of permanence.     In practice, for a debtor to establish their COMI, the debtor will have to have had their arrangement for a minimum of 6 months for the court to consider such arrangement to be credible.

In 2010 there were 59,173 bankruptcies in England and Wales compared with only 9 bankruptcies in the Republic of Ireland.  In quarter 3 of 2011, there were 9,567 bankruptcies in England and Wales compared with 301 bankruptcies in Northern Ireland.  Ireland’s financial difficulties have been well noted since 2008 and it seems at odds to see so few bankruptcies compared with England and Wales.  Arguably these statistics demonstrate the ability to shop for bankruptcy.

The creditor perspective is that reform of the ECIR is needed to limit the scope for insolvent debtors to switch their COMI in anticipation of filing for bankruptcy.   The European Commission has committed to reviewing the position by 1 June 2012 and its recommendation for any change to the EU law will be awaited with interest.

For further information on this article please contact Pitmans Insolvency & Restructuring Team.

Hannah Wright
Solicitor, Insolvency & Restructuring
T: 0118 957 0354
E: hwright@pitmans.com

Limited liability is not complete protection for directors and they must carefully consider their actions and, indeed, failures to act in order to avoid “piercing the corporate veil”.  Directors may be ordered to contribute to the assets of the company even where they have not acted dishonestly.

Wrongful trading is often called “trading whilst insolvent” but this is only half the story. Directors may find themselves personally liable for wrongful trading where, at some point in time, they should have concluded that the company would not be able to avoid insolvent liquidation but continued to trade. In those circumstances the director may be ordered, by the court, to contribute to the assets of the company for the benefit of its creditors.

A director will be able to raise a defence to such a claim if he took every step to minimise losses to creditors that he ought to have taken.

The acts and omissions of the director are considered both subjectively and objectively. The court will take into account the facts and matters that a reasonably diligent director ought to have known or been able to ascertain and steps that he ought to have taken. The fictional “reasonably diligent person” will be taken to have the general knowledge, skill and experience expected of a person carrying out the same functions as the director and the general knowledge, skill and experience that the director actually had. Ignorance is not a defence.

This is not the only pitfall that a director of an insolvent company may face.

The Court has wide powers to order that a director should make a contribution to a company’s assets where a director has misapplied, retained or become accountable for company property or has been guilty of any misfeasance or breach of any fiduciary or other duty.

Duties of directors have been developed through common law over many years and were codified by the Companies Act 2006.  Directors and the board must remember that a company is a separate legal entity of which they are merely employees and custodians but their role and position of trust means that they must achieve high standard of responsibility and duty of care and act in good faith at all times. 

Directors’ duties are to:

• promote the success of the company;

• exercise reasonable care, skill and diligence;

• exercise independent judgment;

• avoid conflicts of interest.

Ordinarily these duties are owed to the company and its shareholders but directors of insolvent companies owe these duties to the creditors. A failure to observe these duties may lead to personal liability.
Each legislative provision that a director may fall foul of cannot be considered in isolation.  Any act or omission could lead to claims under a number of statutory provisions or common law and support an application by the Secretary of State for a director to be disqualified from acting as such.

Misapplication of company property may also lead to a clawback from the recipient, whether that is a director or third party, where assets are transferred less than their market value.

Directors should avoid paying any creditors, including themselves, in priority to other creditors since such payments may be clawed back if they are a “preference” made (or deemed to have been made) with a view to putting the recipients in a better position on insolvency than they would otherwise have been.

Transferring assets and preferring creditors would also be circumstances that would support an application by the secretary of state to disqualify a director from acting as such in the future.

What should directors do when their company may be insolvent?

Directors should:

• ensure that up to date and accurate management information is available and monitor the company’s finances and cash flow on a regular, at least monthly, basis and more regularly if the financial situation worsens;

• prepare cash flow statements so that they can anticipate the times when the company may not be able to pay creditors and plan for them e.g. through communication and negotiation with creditors;

• if insolvency cannot be avoided, consider whether the company can continue to trade. This should only be considered an option if the board determines that insolvent liquidation is not inevitable and creditors will not be prejudiced e.g. a continued period of trading will improve the company’s fortunes or a cost cutting exercise and/or turnaround strategy will return the company to solvency.  Directors should record their decision to continue to trade and the reasons for them in the form of board minutes and a review of the decision should take place regularly;

• take professional advice and have that advice recorded in writing;

• consider whether to continue to take a salary at the level currently awarded or at all and reduce or suspend remuneration is necessary. Directors should be aware that HMRC and the Secretary of State will take a dim view of directors who effectively “bank roll” their company with “credit” from HMRC unless an agreement has been reached, particularly in circumstances where funds that could have been used to pay HMRC have instead been used to pay the directors;

• treat all creditors fairly and equally. New supplies should not be ordered unless they can be paid for nor should new contracts be entered into unless they can be performed;

• avoid transferring assets of the company away from it, including intangible assets such as intellectual property, without taking advice and ensuring that full market value is paid;

• consider whether to invoke an insolvency process, such as a liquidation or administration or seek a formal arrangement with creditors through a Company Voluntary Arrangement.

Resigning as a director will not absolve a director from liability.  Further non-directors may be liable as if they were a director where their behaviour, in controlling the affairs of the company and the actions of the board, is akin to that of a director such that they may be considered to be “shadow directors”.

For further information contact Pitmans’ Insolvency & Restructuring team in London or Reading.

Suzanne Brooker
Partner
T: +44 (0)118 957 0516
E: sbrooker@pitmans.com

Nicola Kirk
Partner
T: +44 (0) 118 957 0226
E: nkirk@pitmans.com

Denise Fawcett
Partner
T: +44 (0)207 634 4642
E: dfawcett@pitmans.com 

David Archer
Partner
T: +44 (0)207 634 4651
E: darcher@pitmans.com

This article first appeared in Solicitors Journal www.solicitorsjournal.com

Nortel and Lehman decision is upheld

The Court of Appeal has upheld the decision of the High Court in the matters of Nortel GMBH and Lehman Brothers International (Europe) (both in administration).  The High Court had decided that liability under a Contribution Notice issued by the Pensions Regulator against a company in administration or liquidation, in relation to liabilities of a defined benefit pension scheme, is an expense of that insolvency process.  Accordingly, this further extension of the types of expenses that have super-priority an insolvency process is confirmed. 

This decision will be of enormous concern to office holders who may find themselves with insufficient funds available, after payment of Contribution Notice liabilities, to fund their own remuneration and to floating charge holders and unsecured creditors who will find the funds available to them to satisfy their claims depleted.

Financiers will need to factor into lending decisions the possibility of substantial liabilities, not shown on a company’s balance sheet that would, if they arose, have priority over much of the secured and all unsecured lending.

Industry groups will continue to lobby the government for a change in legislation.  The government will have to balance protecting pension schemes, and therefore the Pension Protection Fund, at the cost of trade creditors and even HMRC and stifling investment and lending into groups with a final salary pension scheme.

Paymex Repayments Guidance

R3, the Debt Resolution Forum and other recognised professional bodies have issued a guide to the practical implications of the decision in Paymex Limited –v- The Commissioners for Her Majesty’s Revenue and Customs.

In this case, the First Tier Tax Tribunal held that the services of a company that arranged and implemented individual voluntary arrangements (“IVA”) were exempt from VAT since these services constituted negotiation in relation to debts and handling of payments, which attract the exemption under Article 135(1)(d) of Council Directive (EC) 2006/112/EC.  The Tribunal held that the question of whether a supply is exempt depends upon an objective economic assessment of the nature of the supply being made and not the nature of the taxable person making the supply. 

HMRC has confirmed that it will not be appealing the decision and will pay claims for overpaid tax falling within the findings of the Tribunal decision in this case.  Refunds must be treated as third party funds and paid into the relevant estate accounts or, where a case is closed, into client account, to be distributed without delay.

As it is the nature of the supply that needs to be considered in order to determine whether the supply is exempt from VAT, it appears that services relating to Company Voluntary Arrangements and Partnership Voluntary Arrangements could also be exempt.  However, HMRC has said that it will only consider refunds within the scope of the Paymex decision and, therefore, this will only apply to IVA’s.

Duty of Good Faith in IVA’s

In Kapoor –v- National Westminster Bank plc the debtor proposed an Individual Voluntary Arrangement.  He procured that one of his friends, an unconnected person, would pay a sum to a connected creditor, being more than the return in the Individual Voluntary Arrangement, in return for an assignment of part of the debt (thereby constituting an equitable assignment).  The friend then voted in favour of the IVA and outweighed the votes of other creditors opposed to the proposal. 

The Court of Appeal held that an equitable assignee of a debt could vote upon an IVA proposal.  However, it held that the debtor had a duty to be open and transparent in return for avoiding the investigations that would be likely in the event of a bankruptcy.  The assignment was on terms that were not commercial and was effected for the sole purpose of securing the approval of the IVA against the wishes of the general body of creditors.  On those grounds the IVA approval was revoked.

No Extension of Invalid Administration Appointments

There have been a number of cases recently looking at whether procedural irregularities may render an administration appointment invalid.

The case of Re Frontsouth (Witham) Limited is another in this line of cases.

An extension of the period of the administration had been obtained, purportedly, with the consent of the charge holders.  However, one charge holder had acknowledged the request for consent but had not given a full response.  

On the second application to the Court to extend the administration, the absence of the charge holder’s consent came to the court’s attention.

Paragraph 77(1)(b) of Schedule B1of the Insolvency Act 1986 provides that the administrators’ term of office may not be extended after the expiry of that term. If the first extension was invalid then the term of the administration would have expired and the Court would lack the jurisdiction to extend the term of office unless the defect could be remedied. 

This was particularly problematic since, during the extended periods of the administration, properties had been sold. 

The administrators asked the Court to use Rule 7.55 of the Insolvency Rules 1986 to find that the appointment was valid notwithstanding the procedural error.  Rule 7.55 provides that no insolvency proceedings shall be invalidated by any formal defect or irregularity unless the Court considers that substantial injustice has been cause by the defect or irregularity which cannot be remedied by Court order.

The Court refused to make an order extending the administration.

During the course of giving judgment, the Court referred to decisions made in earlier cases where the court had been asked to waive or remedy a defective and invalid administration appointment.

In Re G-Tech Construction Limited (“G-Tech”) and in Re Kaupthing Capital Partners II Master LP (“Master”), the wrong form of Notice of Appointment of an Administrator was used.  In Re Blights Builders Limited (“Re Blights”), an out of Court appointment was made at a time when a winding up petition was in existence (of which the shareholder appointing was unaware) such that the appointment should not have been made. In none of these cases did the Court consider itself able to waive procedural requirements and find that the appointments were, nevertheless, valid.

In Frontsouth, the Court also considered that rule 7.55 could not be used.  Firstly, where an appointment is invalid there are no “insolvency proceedings” and therefore Rule 7.55 has no application.  This reasoning was also applied in Re G-Tech and in Master. The Court also considered that Rule 7.55 was not to be used to remedy a fundamental flaw such as a failure to satisfy a procedure prerequisite for an appointment, thereby rendering a mandatory requirement optional.

In both Frontsouth and Re Blights the Court noted that Rule 7.55 is a strange provision in itself since it suggests that where the invalidity of an appointment causes prejudice, it can be remedied by Court order.

Having had the application to extend the administration refused, the administrators asked the Court to make a back dated administration order and then immediately extend the period of it. 

However, a question arose as to the ability of the administrators to apply for an administration order.  They applied on behalf of the company, in their capacity of shareholders of the company’s parent company (over which they were also appointed as administrators).  However, the company’s Articles of Association provided that the business of the company be conducted by its Directors.  On that basis the Court saw difficulty in making the order on the shareholder’s application.

In any event, an application for an administration order was then made by a qualifying floating charge holder such that the Court did not need to consider the point further.  This issue is, nevertheless, worthy of note, given the decision of the Court in Minmar(929)-v- Freddy Khalatsschi in which an administration appointment made by the directors of the company was considered to be invalid since the decision to appoint was not reached in accordance with the provisions of the Articles of Association.

These cases bring to light the importance of ensuring strict compliance with the Insolvency Act and Rules when making an appointment.  The requirements are mandatory and Rule 7.55 is not a “slip rule” under which mistakes can be remedied.

Security over Principal’s Assets is No Defence to Statutory Demand

In White –v- Davenham Trust Limited, the Court clarified the principle that a statutory demand served upon a guarantor could be set aside, in circumstances where a demand, if made against the principal debtor, could have been set aside.

In this case the debtor was a company.  A debt due to the creditor (D) had been secured by fixed and floating charges over company assets.  The shareholder and director of the company (W) had guaranteed the company’s liabilities. The company went into administration and D wished to rely upon the guarantee to recover sums due from W.  D served a statutory demand on W.

The Insolvency Rules 1986 state that, where a creditor has security over a debtor’s assets for repayment of a debt (and has not waived that security) any statutory demand served should state the full amount of the debt and value of the security and claim only the unsecured balance.  If it does not then the statutory demand may be set aside.

W claimed that, as D could not issue a statutory demand against W, unless it waived its security over the company assets or valued the security, it would be unjust for D to be allowed to proceed with a statutory demand against W.

The Court of Appeal held that a creditor can choose how to recover a debt due to it.  It could pursue a guarantor notwithstanding that it has not pursued the principal debtor.  The existence of security over the principals’ assets did not affect this.  Therefore the statutory demand served upon W would not be set aside.

The Court considered the case of Remblance –v- Octagon Assets Limited where a statutory demand issued against the surety was set aside on the grounds that the principal debtor had a counterclaim that would not have been available to the surety.

In the case of W, the Court considered that a statutory demand could be set aside where there was a dispute that affected the amount claimed, such that the surety’s debt would otherwise be greater than the sum due from the principal debtor.  However, this was not the case here.

Court Refuses Relief for a Transaction at an Undervalue

In Trustee of Gordon Robin Claridge –v- Claridge & Claridge the Court was satisfied that there had been a transaction at an undervalue when a bankrupt husband allowed his wife to use his half share in a loan to renovate her property. However, the Court did not set aside the transaction.

The Judge exercised his discretion on the basis that the bankrupt’s wife had spent the money, thinking that she was entitled to do so and there was no evidence that the renovations had increased the value of the property.

The Court followed the 2007 case of Singla –v- Brown which is authority for the proposition that that the Court has a discretion not to order relief where justice requires it.

The Singla case concerned the purchase of a property in joint names followed by a severing of the joint tenancy and the transfer of 49% of the bankrupt’s interest to the joint owner.  The evidence showed it was always the parties’ intention that the property be owned beneficially by the transferee alone and it was clear that the transfer had been entered into to reflect this intention. The property had been purchased in joint names solely at the insistence of the mortgage company.

The decision in Claridge is likely to come under criticism as this does not appear to be the kind of exceptional case where the Court should use its discretion in this way.  In Singla an order setting aside the transaction would have resulted in an unintended windfall for the bankrupt and his creditors.  This Claridge case does not seem comparable with these facts.

For further information on this article, please contact Pitmans Insolvency & Restructuring team.

Denise Fawcett
Partner
T: +44 (0)207 634 4642
E: dfawcett@pitmans.com

The Court of Appeal has upheld the decision of the High Court in the matters of Nortel GMBH and Lehman Brothers International (Europe) (both in administration) and other companies.  The High Court had decided that liability under a Contribution Notice issued by the Pensions Regulator against a company in administration or liquidation, in relation to liabilities of a defined benefit pension scheme[1], is an expense[2] of that insolvency process.  Accordingly, the Court of Appeal has confirmed the further extension of the type of expenses that may be considered to have the priority given to an expense of an insolvency process. 

This decision will be of enormous concern to office holders who may find themselves with insufficient funds available, after payment of Contribution Notice liabilities, to fund their own remuneration and to floating charge holders and unsecured creditors who will find the funds available to them to satisfy their claims depleted by the prior satisfaction Contribution Notice obligations.

The liability in question arises out of the provisions of the Pensions Act 2004.  The Act gave the Pensions Regulator (tPR) the power to impose a Financial Support Direction (FSD) upon a company connected and associated[3] with an employer of a defined benefit pension scheme[4].  This power was given to tPR, in particular, to assist the members of an underfunded pension scheme where the employer is a company with no or few assets but is within a group of companies that have assets that the employer has no direct recourse to where the “rich” group companies benefit from the activities of the “poor” employer.  Service companies are specifically referred to in the Act as falling within the reach of tPR but any employer within a group may have the characteristics (of being “insufficiently resourced”) that may expose the rest of the group to becoming a target for tPR’s use of these “moral hazard” powers. 

Companies within the relevant group can be required, by tPR, to provide support to the pension scheme by issuing an FSD against them.  tPR does not specify the support required but this may, for example, be in the form of a guarantee and/or security. If the recipient of an FSD fails to provide support to the pension scheme, then tPR can issue a notice requiring payment of a sum up to the full amount of the pension scheme liability.  This notice is a Contribution Notice.

In the case of Lehman Brothers the liability to the scheme is £125 million.  In Nortel it is £2.1 billion.  An FSD has not yet been issued by tPR in relation to most of the parties to the appeal but Warning Notices setting out tPR’s intention to do so are currently the subject of an appeal to the Upper Tribunal (Tax and Chancery Chamber).

In an administration or liquidation assets are realised and distributed to creditors in an order prescribed by the Insolvency Rules 1986.  Expenses of the insolvency process have priority over other creditors save for those with fixed charges. 

The payment obligation imposed by a Contribution Notice is not stated, in the Pensions Act 2004 nor in insolvency legislation, to be a debt provable in an insolvency process.  The question for the Court was as to whether the obligation is nevertheless provable and, therefore, an unsecured claim or should be treated as an expense of an insolvency process or fall into a “black hole” only being paid in the highly unlikely event that funds are available after payment of expenses, charge holders and unsecured creditors.

A provable debt is one which a company is subject to at the date of liquidation or may become subject to pursuant to an obligation arising before that date[5]. 

The types of payments becoming due, in the course of an administration, that are treated as expenses has been clarified and some would say extended through case law, from Toshoku[6] in 2002 to Goldacre (Offices) Ltd –v- Nortel Networks UK Ltd[7] in 2009. In the latter case it was decided that rent obligations of a company, although obligations of the company subject to lease entered into prior to its administration, would be an expense of an administration if they fell due during the process and whilst the administrators were deemed to be using the premises for the purpose of the administration.

Before the High Court, it had been determined that, in certain situations, a Contribution Notice would be provable in an insolvency process.  This would be the case where an FSD was issued in an administration of a company and a Contribution Notice followed after the company had moved from administration into liquidation or if the Contribution Notice followed the FSD and the company then moved into liquidation.  The Contribution Notice would arise in the liquidation from a pre-existing obligation and was therefore a provable debt in the liquidation but not the administration.  This was not the subject of the appeal.

The appeal was around the issue of categorising the Contribution Notice liability where liquidation does not follow the administration or liquidation does follow but the FSD and Contribution Notice are issued in the liquidation and not the prior administration.  The High Court held that the Contribution Notice would, in these circumstances, be treated as an expense giving the obligation under it “super priority”.  In the appeal the Nortel administrators argued that the liability was a provable debt.  The Lehman administrators argued that it fell into a black hole.

The High Court and the Court of Appeal considered whether the fact that an FSD may arise from circumstances that exist prior to any insolvency process meant that the resulting Contribution Notice was a contingent claim in existence at the time of the insolvency, rendering it a provable debt.  Both Courts found that it did not.  It was considered that there was insufficient certainty that tPR would use its discretionary powers to render a company liable for an obligation to a pension scheme that, up until its powers were invoked, only the employer company could have been liable for.  The Court of Appeal did not consider whether the obligation could have arisen earlier than upon the issue of an FSD, for example, at the time that tPR’s Determinations Panel determines that the FSD should be issued or upon the earlier issue of a Warning Notice.

Having decided that a Contribution Notice did not, when issued against a company in administration or liquidation, create a provable debt in that process, the Court was left with a choice of either deciding that the obligation created had super-priority and therefore greater priority than the scheme debt held as against the employer or was neither a debt nor an expense and therefore had lower priority than the scheme debt held.  Neither the High Court nor the Court of Appeal considered either conclusion to be satisfactory, particularly when comparing the purpose of an FSD and Contribution Notice i.e. protecting scheme members, against the competing interests of unsecured creditors. 

Both Courts considered that the position as decided in Toshoku was to be applied to the circumstances before them.  In Toshoku the Court found that tax liabilities imposed by statute were  an expense of an insolvency process where the relevant statute specifically intended and provided that the obligation would be imposed upon a company in insolvency.  In Nortel and Lehman it was acknowledged that the Pensions Act 2004 did no such thing and left it to insolvency law to determine the priority of a Contribution Notice.  However, it was considered to be highly likely that that the regime would be used in the case of an insolvent employer and a real risk that other potential targets in the group would also be insolvent at the time that tPR came to use its powers.  For that reason the obligations of a company under a Contribution Notice imposed upon it whilst in an insolvency process is an expense of that process.

Office holders of group companies in the same situation will need to consider applying to the Court for an order varying the order of priority of expenses or face difficult decisions as to how to progress an insolvency where office holder remuneration and expenses may not be paid.  It was acknowledged by the High Court that, unless the order in which expenses are to be discharged is varied by the Court, the decision in this case could deal a crippling blow to the rescue culture in cases where defined benefit pension schemes are involved.

Financiers will need to factor into lending decisions the possibility of substantial liabilities, not shown on a company’s balance sheet that would, if they arose, have priority over lending secured by a floating charge and all unsecured lending.

The main beneficiary of this decision is likely to be the Pension Protection Fund (PPF), the government’s lifeboat for pension funds which would otherwise foot the bill for underfunded schemes with an insolvent employer.
 
It is expected that the decision will be appealed to the Supreme Court.  Various sector groups will continue to lobby for a change to pensions and/or insolvency legislation.  The government will have a difficult policy decision to make, supporting business and the rescue culture or pension scheme members and the PPF.  For now, its pension schemes 1 – business and rescue culture 0.

Denise Fawcett
Partner
T: 020 7634 4642
E: dfawcett@pitmans.com

1 A defined benefit pension scheme (or final salary scheme) is a benefits funding method in which the liability to the scheme is based on the benefits that would arise if the scheme were to be discontinued on the valuation date and the contribution rate is that necessary to cover the cost of benefit payments due.
2 Expenses are defined in Rule 12.2(1) of the Insolvency Rules 1986. Also see Rule 4.218 Insolvency Rules 1986 in relation to liquidation expenses and Rule 2.67 Insolvency Rules 1986 in relation to administration expenses.
3 Sections 249 and 435 Insolvency Act 1986.
4 Note that an FSD can also be imposed upon the employer itself.
5 Rule 13.12 Insolvency Rules 1986.
6 Re Toshoku Finance UK Plc [2002] UKHL 6, [2002] 1 WLR 671
7 [2009] EWHC 3389 (Ch), [2010]Ch 455

This article first appeared in Solicitors Journal www.solicitorsjournal.com

Majority Rule

In the case of Minmar (929) Ltd –v- Khalastchi and another [2011] EWHC 1159(Ch) the Court considered whether an out of court appointment of administrators, made by the directors of a company, was valid where the decision of the directors was not taken in accordance with the company’s Articles of Association.

The decision to appoint administrators was made by the majority of the directors of the company but the decision was made without a proper board meeting, no notice of the meeting had been given to directors, there was no quorum and only one person was in attendance.

The effect of Paragraph 105 of Schedule B1 of the Insolvency Act 1986 is that, where something is to be done by the directors of a company, it is to be done by a majority of the directors.  The court held that this did not mean that the majority of directors could dispense with the rules of internal management set out in the Articles of Association.  On these grounds it was held that the appointment was invalid and should be set aside.

In addition, the appointment was found to be invalid on the grounds that notice of intention to appoint an administrator was not given to the company.  It was argued that this was not necessary since this is merely an additional obligation imposed by Insolvency Rule 2.20(2), to be complied with only in circumstances where persons entitled to appoint an administrator or administrative receiver were to be served with such notice, in compliance with Paragraph 26(1) of Schedule B1.  The Court considered that the additional persons to be served with notice would be concerned with this whether or not there were persons to be served under Paragraph 26(1) and that notice should be given regardless.  It was noted that there is no prescribed form or period of notice specified.  As no notice was given to the company at all, the appointment of administrators was considered invalid on this ground too.

The Court acknowledged that it is difficult to reconcile paragraphs in Schedule B1 when trying to determine the notice that needs to be given. However, this decision gives some clarity as to the practice that the Court expects to be adopted in circumstances where the Insolvency Act is not only ambiguous but contradictory. 

Moral Hazard

The Pensions Regulator (“tPR”) has reached a settlement with Michel Van De Wiele NV (“VDW”) in relation to its claim against VDW for a contribution to the Bonas Group Pension Scheme, a scheme of which Bonas Machine Company Limited (“Bonas”) was the employer. VDW has, as a result, been issued with a Contribution Notice (one of tPR’s “Moral Hazard” powers) in the sum of £60,000.  This is substantially lower than the £5 million contribution that tPR’s Determinations Panel (the “DP”) decided should be made and a small contribution to the “buy out” deficit in the scheme of around £23 million.

The settlement follows a hearing in the Upper Tribunal of VDW’s application to bar tPR from pursuing certain allegations made against it.  Whilst Mr Justice Warren was not required to decide the claims against VDW, he considered them in some detail.  In the course of giving judgement, he expressed a view that the amount that the DP had decided should be paid by VDW was too high and that the amount should not have been more than around £100,000.

TPR is able to serve a Contribution Notice, under the Pensions Act 2004, upon a person associated and connected with an employer (i.e. an employer who is obliged to provide a final salary pension to its employees past and/or present) where (amongst other things) tPR is of the opinion that the person was a party to (or knowingly assisted in) an act or deliberate failure to act and where the main purpose or one of the main purposes of it was to prevent recovery of the whole or any part of a debt due to the pension scheme.  tPR is required to act reasonably.

VDW was Bonas’ parent company.  Its only client was a company in the VDW group.  Bonas was loss making and entirely reliant upon VDW’s support.  VDW decided to withdraw that support and Bonas went into Administration.  The assets of the company were immediately sold to another VDW group company incorporated by VDW for that purpose.

TPR relied on three acts in support of its claim: walking away from the pension scheme without openly engaging with the Trustees of the scheme or TPR; minimising the sum paid by VDW for the  assets of the business; and retaining the business while avoiding ongoing liabilities.

It was clear, from the evidence, that VDW had taken professional advice and had considered the possibility of contacting tPR to seek advance clearance from tPR.  It had also considered the possibility that tPR may use its Moral Hazard powers against VDW as a result of the sale.  VDW had chosen not to seek clearance.  The DP were in doubt that VDW took a calculated and deliberate risk in relation to the use of tPR’s powers and had a  purpose of minimising the amount that it paid into the scheme by failing to consult with creditors and by selling the business assets to a subsidiary without properly marketing the business for sale. Mr Justice Warren noted that there was no obligation to contact tPR or the Trustees but concluded that there could be a deliberate failure to do something even where there is no obligation to do it.

Mr Justice Warren considered that the liability imposed under a Contribution Notice could not be more than the amount that had been lost by the scheme as a result of relevant act or failure to act and that the amounts to be imposed on persons under Contribution Notices were intended to be compensatory and not a penalty.  Therefore, if it was the case that the employer would not have been able to pay the debt to the scheme, had the act or failure to act not occurred, then there would be no loss.  In the case of Bonas, the loss to the scheme was the amount that it would have received in its insolvency had the assets been sold a higher market price. 

Mr Justice Warren considered whether the cessation of the business of Bonas, causing the non-payment of future contributions to the scheme, could be said to be an act preventing payment of the debt to the scheme.  He considered that it did not have this effect, it merely caused the debt itself to increase.

Mr Justice Warren’s views do not have to be followed in the Upper Tribunal.  However, if this is the view that the Upper Tribunal takes in future then the threat of a Contribution Notice may have less impact as a deterrent to others contemplating the same type of arrangements as VDW. It would appear that the most that tPR could require a person to contribute to the scheme, in the event of a sale at an undervalue, is the amount that it should have paid in any event, reduced further where there are other creditors that would have shared the additional proceeds of sale.  Such persons will therefore be dissuaded from applying for clearance in advance of the event since the price attached to clearance is likely to be higher than the amount payable under a Contribution Notice.

Mr Justice Warren was of the view that a Financial Support Direction (“FSD”) could be issued, in some cases, in order to recover additional funds or support for the Scheme.  An FSD can be issued where the employer has insufficient assets to pay half of the debt to the scheme but an associated and connected person could pay the balance.  That person could be required to provide support to the scheme e.g. payment, a guarantee, a charge over assets etc.  The effect of this is to ensure that an underfunded scheme has access to all of the value in a group of companies.  If Mr Justice Warren is correct then a party to a deliberate attempt to cause detriment could not be penalised for this but merely required to provide compensation to the scheme for its actual loss whereas a company that merely finds itself in a position of wealth, whilst the employer is not, without any deliberate act or intention to cause detriment to the scheme, may be required to support the scheme up to the full value of the debt due from the employer.

No Surrender

In Peoples Phone Ltd –v- Theophilos Nicolaou [2011] EWHC 1129 (Ch) the High Court held that the supervisor of  an Individual Voluntary Arrangement could not conclude the IVA and thereby prevent a potential creditor (“P”) from participating in the final dividend, where P’s entitlement was the subject of court proceedings yet to be determined.

P was a landlord who had entered into a Deed of Surrender that released the debtor from liabilities under the lease.  However, P was seeking rectification of the deed on the grounds that it was not intended that liability for rent arrears would be released. 

The supervisor took the view that the question of whether P’s claim was valid was to be considered at the time of the distribution and at that time there was no debt due under the terms of the Deed of Surrender.

On hearing P’s application to reverse or vary the supervisors’ decision, the Court considered that it should be adjourned and the rectification application decided in the first instance.  In the event that the Deed of Surrender was rectified, P’s status as a creditor would be reinstated from the date of the Deed of Surrender and P would therefore be entitled to a dividend.

Meanwhile, in Re WW Realisation 1 Ltd (In Administration) [2010] EWHC 3604, the Court held that a distribution could be made to secured creditors without any further provision being made for liabilities that may be payable as an expense of the administration unless such claims were notified to the administrators within 28 days of further letters being sent to potential claimants. 

The decision followed an application for directions made by the applicants as administrators (under paragraph 63 Schedule B1 of the Insolvency Act 1986) and liquidators (under section 168(3) Insolvency Act 1986).  The administrators had already sent letters to landlords and local authorities inviting them to submit claims as expenses of the administration. 

Anti-Social Administration Orders

An application was made for an administration order in relation to a social club on the grounds that it was a company under paragraph 111(1A) of Schedule B1 of the Insolvency Act 1986. 

The Court held that the club was not an unregistered company and could not be the subject of a winding-up order.  The application for an administration order was then refused.

Social clubs will have to turn to their constitution where the business needs to cease and the club needs to dissolve.

Understanding Employers

On 18 May 2011 Jobcentre Plus, R3 and the Insolvency Service entered into a Memorandum of Understanding.  This was an extension of an existing voluntary partnership between the three bodies.

The purpose of the partnership is to ensure cooperation and sharing of information between the organisations and development of joint practises.  The intention is to assist Jobcentre Plus in providing a service to redundant employees and to actively support Insolvency Practitioners by having experts on hand to answer questions and deal with employee queries.  Insolvency Practitioners will be encouraged to give “early warning” of potential redundancies to Jobcentre Plus.

It will be for R3 to communicate to Insolvency Practitioners the practise to be followed.

Denise Fawcett
Insolvency & Restructuring Partner
+44 (0)207 634 4642
dfawcett@pitmans.com

Improved Rights for Unsecured Creditors of Insolvent Companies

Under the Third Parties (Rights Against Insurers) Act (1930), there have long existed provisions which, provided certain hurdles can be overcome, enable parties who have a claim against an insolvent insured party to make a recovery direct from the insurance policy, rather than simply ranking with other unsecured creditors in the insolvency.  The hurdles under the 1930 Act in practice deterred claimants from making claims because it was not always easy or possible to get information about the extent of insurance (and therefore decide whether any costs outlay was likely to be worthwhile).  In addition claimants faced the expense of having to restore a defunct company to the Register in order for it to bring or defend legal proceedings. 

The new Act aims to bring the 1930 Act up to date and improve the rights of third parties whilst reducing litigation, expense and delay.  Under section 1 a third party will be able to bring proceedings directly against an insurer to establish both the liability of the insured party and the potential liability of the insurer.  If a third party has reason to believe that an insolvent insured has incurred a liability to him, he may request information from anyone who might have knowledge of the insurance as to the identity of the insurer, the terms of the insurance, any limits of liability and whether there are any fixed charges which would apply to any sums paid out.  This information has to be provided within 28 days.  In the past it has been difficult to obtain such information but now people such as brokers, former employees and others authorised to hold policy information can be approached and are bound to answer.

The rights which can be enforced by a third party are no greater than those which the insured itself would have had.  Accordingly, the insurers can defend themselves under the insurance policy if they believe they are entitled to do so.  So whilst the claimant will be in no better position than the insured would have been, he will certainly be stealing a march on other unsecured creditors. 

The Act was expected to come into force in April 2011, but at the time of writing a date is still awaited.

For further information please visit Pitmans’ Dispute Resolution website or contact:

Sue O’Brien
sobrien@pitmans.com
+44 (0) 118 957 0513

TMA (UK) Reading is delighted to welcome Mark Byrne, Managing Director of Calverton Factors, David Levey, Managing Director of Headway Management and Allan Booth, Director of TMA.  Read the rest of this entry »