Insolvency update

Pension schemes

The Court of Appeal's decision to uphold the High Court ruling in Nortel GMBH and Lehman Brothers International (Europe) [2011] EWCA Civ 1124 will be of enormous concern to creditors of companies 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. The appeal judges have confirmed accordingly the further extension of the types of expenses that have super-priority in an insolvency process.

As a result, office holders may find themselves with insufficient funds available, after payment of contribution notice liabilities, to fund their own remuneration, and floating charge holders and unsecured creditors may 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 Ltd v HMRC [2011] UKFTT 350 (TC).

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 directive 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.

On 10 November, HMRC changed its position in relation to company voluntary arrangements and stated that this ruling would also apply to them and to trust deeds.

Good faith in IVAs

In Kapoor v National Westminster Bank plc [2011] EWCA Civ 1083 the debtor proposed an IVA. 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 IVA, 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 on 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.

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) Ltd [2011] EWHC 1668 (Ch) 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 caused by the defect or irregularity that cannot be remedied by court order.

The court refused to make an order extending the administration, referring to decisions made in earlier cases where the court had been asked to waive or remedy a defective and invalid administration appointment. For instance, in Re G-Tech Construction Ltd and Re Kaupthing Capital Partners II Master LP [2010] EWHC 836 (Ch) the wrong form of notice of appointment of an administrator was used. In Re Blights Builders Ltd [2006] EWHC 3549 (Ch), 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. First, 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 was 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 backdated 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 Khalatschi [2011] EWHC 1159 (Ch) 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.

Defence to statutory demand

In White v Davenham Trust Ltd [2011] EWCA Civ 747, the court clarified the principle that a statutory demand served on 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 on 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 Ltd [2009] EWCA Civ 581 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.

Relief for a transaction at an undervalue

In Trustee of Gordon Robin Claridge v Claridge & Claridge [2011] EWHC 2047 (Ch) 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 [2007] EWHC 405 (Ch), 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 per cent 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. The Claridge case does not seem comparable with these facts.