Update: insolvency

In addition to an increasing number of administrations and liquidations the economic downturn will inevitably spawn more insolvency and recovery related cases and some interesting decisions have already been handed down.

'Pre-packs'

'Pre-packs' are the current buzz word in insolvency. Although they are not a new concept, 2009 has already seen a Statement of Insolvency Practice on pre-packaged administration sales (SIP 16) released, and discussion by the House of Commons BERR committee.

A pre-packaged sale, otherwise known as a 'pre-pack', is an arrangement for the sale of an insolvent company's business and assets which is lined up before the company goes into a formal insolvency process (usually administration). The deal is worked out before the insolvency practitioner (IP) is formally appointed, and then is rapidly executed once the appointment is made. The business is usually sold with little or no open marketing and unsecured creditors are usually not informed of the pre-pack until after it has been completed.

The courts have held that, where circumstances of the case warrant it, an administrator has the power to sell assets without the prior approval of the creditors or the permission of the court. However, reliance on the authority does not exclude administrators from potential challenges to their conduct under para.74 or claims for misfeasance under para.75 of sched.B1 to the Insolvency Act 1986.

Pre-packs are an invaluable tool for an IP to keep a business trading, save jobs and provide a better return for secured creditors when compared with their prospects should the company be simply liquidated. R3, The Association of Business Recovery Professionals' president Nick O'Reilly recently stated that 'in the current downturn with few buyers around, a pre-pack is a good option for many distressed businesses'.

A number of negative assertions have been made against pre-packs in the press, when businesses are sold back to previous owners, causing creditors to lose out.

SIP 16 was introduced by the Joint Insolvency Committee on 1 January 2009. The aim of SIP 16 is to maintain and harmonise professional standards. It sets out a series of matters that administrators are required to address. IPs are required to disclose to creditors why the decision was taken to use a pre-pack, and set out the associated information concerning the decision and the connection between the purchasing company and the company in administration.

The application of the Transfer of Undertakings Protection of Employment Regulations 2006 (TUPE) has been tested recently in an Employment Tribunal decision in Oakland v Wellswood (Yorkshire) Ltd UKEAT/0395/08.

Wellswood (Yorkshire) Ltd was a fruit and vegetable wholesaler which, on the day that it went into administration, had its business sold by the administrator to a buyer but excluding two of the employees, including Oakland, who brought an unfair dismissal claim. Regulation 8(7) of the 2006 TUPE Regulations states that such dismissals will not be automatically unfair if the seller is subject to bankruptcy or analogous insolvency proceedings instituted with a view to liquidation. While BERR has stated in a guidance note that reg.8(7) does not apply to administration because its primary purpose is, it is said, always to rescue a company as a going concern, the Appeal Tribunal did not agree. In Wellswood, the administrators stated the intention was to put the company into liquidation and thus it was held that reg.8(7) did apply as an exception to TUPE.

The case suggests that administration pre-pack sales may not be subject to automatic employee transfers under TUPE, depending on a subjective analysis of the purpose of the administration. As the president of the Insolvency Lawyers Association stated in January, 'buyers will have to decide whether to rely on the decision or to factor in the costs of TUPE'.

Administrators' actions

The Court of Appeal's detailed analysis of the administrators' actions in Coyne and Hardy v DRC Distribution Limited and Foster [2008] EWCA Civ 488 led to the setting out of practical guidelines as to what is expected of office holders when undertaking their work. The number of cases in which costs orders are made against IPs personally is increasing. There appears to be an inference that now that most administration appointments are made without a court hearing, they are not approached with the same care as before. In this case the administrators had taken the decision to not recover assets and their consent to act did not disclose that they had previously advised the company before accepting the position. This case emphasises the caution administrators need to take in achieving the statutory purpose of administration '“ both before and after appointment '“ in order to avoid a personal costs order against them by a disgruntled creditor demonstrating a breach of duty.

Misfeasance and preference transactions

Despite the number of times that misfeasance claims are threatened there are still relatively few reported cases. In Gemma Ltd (In Liquidation) v Davies [2009] Bus. L.R. D4, the applicant liquidators applied for orders that the respondent director and company secretary, who were also husband and wife, pay sums to the company because of their misfeasance in the management of the company's affairs under s.212 of the Insolvency Act 1986. The liquidator made the claim against the company secretary as a de facto director or person concerned in the management of the company. The misfeasance included causing money to be misappropriated to pay off a mortgage on the matrimonial home and a personal debt, paying money described in the company's accounts as 'labour costs' to an associate who had not provided any labour to the company and making a number of improper cash withdrawals from the company. The liquidators further contended that the director should repay the value of the cheques disbursed after it had become obvious to him that the company was insolvent.

It was held that the liquidators were entitled to an order of repayment of the misappropriated sums for the repayment of their mortgage and personal benefits. The associate had been owed money by the husband and wife personally, not in their capacity as director and company secretary, and therefore the liquidators were entitled to an order that it was repaid. By writing the cheques it was clear the director was trying to confer on the trade creditors with whom he hoped to have a continuing relationship a preference within the meaning of s.239 of the Insolvency Act 1986. The court ordered the restoration of the position. However, no repayment was ordered for the cash withdrawals as it was probable that they would have gone to subcontractors.

No order was made against the company secretary as she had not acted as a de facto director of the company, nor had she been a person concerned in the promotion, formation or management of the company, and she was not guilty of any misfeasance or breach of any fiduciary or other duty because her role had been found to be purely clerical, without decision making.

So far as possible

The Court of Appeal held in Sigma Finance Corporation (in Administrative Receivership) [2008] EWCA Civ 1303, that the construction of a security trust deed allowed the receivers to use the company's assets to pay liabilities as they fell due rather than distributing the assets on a pari passu basis between all its secured creditors. This seems a surprising outcome as the case pushes back the pari passu rule enshrined in English insolvency law.

Sigma was a structured investment vehicle incorporated under Cayman Island law, whose creditors partially consisted of holders of US dollar and euro notes, who in the majority were secured creditors under an English law-governed security trust deed. The deed created a floating charge, which had crystallised. A US$9bn deficit to the creditors was estimated by the receivers appointed by the trustee.

The deed contained a clause giving the trustee a 60-day 'realisation period' in which to realise or deal with the assets in order to establish short-term and long-term pools intended to match Sigma's outstanding liabilities as they fell due. A further clause stated: 'during the realisation period the trustee shall so far as possible discharge on the due dates any short-term liabilities falling due for payment during such period'.

The shortfall in assets available combined with the construction of the clause created conflict between the various classes of creditors. The receivers therefore asked the court to determine the proper construction of the clause.

The Court of Appeal held that the proper construction of the clause was a 'pay as you go' construction, because the deed contained a specific obligation on the trustee to pay liabilities as and when they fell due. The obligation was not conditional on the trustee being of the view that there were sufficient assets to discharge corresponding liabilities.

The court acknowledged that a pari passu distribution has obvious appeal in circumstances where the available assets are insufficient to pay all creditors in full, but it was not the court's role to apply the rules of a conventional insolvency regime when the deed reflected a commercial bargain.

Lawsuit pending

The High Court considered the conflict between a Polish insolvency and pending arbitration proceedings issued against the Polish debtor in Josef Syska (acting as the Administrator of Elektrim SA (in bankruptcy) and Elektrim SA (in bankruptcy) v Vivendi Universal SA & Ors [2008] Folio No 367. This case involved an agreement between Elektrim, a Polish company and Vivendi, a French company, which contained a clause providing for arbitration in London, governed by English law. Vivendi commenced an arbitration pursuant to the agreement and an interim award was made in their favour by a tribunal in London. Elektrim, which had entered into bankruptcy in Poland, sought an order to set aside the tribunal's award on the basis that art.142 of the Polish Bankruptcy and Reorganisation Law was applicable. This stated that any 'arbitration clause concluded by the bankrupt shall lose its legal effect as at the date bankruptcy is declared and any pending arbitration proceedings shall be discontinued'. Vivendi sought to rely on art.4 of the EC Regulation, which states that the law applicable to insolvency proceedings shall be that of the member state within the territory of which such proceedings are opened and art.15 of the EC Regulation which states that the effects of insolvency proceedings on a lawsuit pending shall be governed solely by the law of the member state in which that lawsuit is pending.

It was held that the arbitration proceedings fell within the definition of 'lawsuit pending' and accordingly the High Court upheld the decision of the tribunal and rejected Elektrim's application. Elektrim has been given permission to appeal.