Case law update

IPA Insolvency Practitioner newsletter, November 2023

An insolvency case law update prepared by Charlotte May, Associate Director at Manolete Partners PLC.

Charlotte is Regional Associate Director, based primarily in the South West and Wales. She is experienced in complex commercial disputes with specialist expertise in property, negligence and insolvency. Charlotte qualified as a solicitor in 2009. In December 2018, Charlotte joined Manolete from national firm Burges Salmon LLP where she worked on high profile retail and property insolvencies. Charlotte is an Associate Member of R3, INSOL Europe and Women in Property.

Public Interest Winding-up and Extended Civil Restraint Order against Director

Mortgage Five Zero Limited v The Secretary of State for Business and Trade [2023] EWHC 2654 (Ch)

The Secretary of State has successfully wound up a business which offered services based on misconceived mortgage arguments. The Judge upheld the winding up order on appeal and also dismissed various applications and a Part 8 claim on incorrect mortgage law, resulting in an Extended Civil Restraint Order and costs against the director personally.

The company would assist borrowers to argue that their mortgage was fundamentally flawed and unenforceable on the basis of a breach of s.2 of the Law of Property (Miscellaneous Provisions) Act 1989. Section 2 requires an agreement to create security to be executed by both borrower and lender. In most cases, a mortgage deed is only signed by the borrower (s.53 of the Law of Property Act 1925 only requires the disponer of the interest to sign).

However, Mortgage Five Zero operated on a well-documented misunderstanding. Section 2 only applies to an agreement to create an interest in property or sale. It does not apply to the security document itself. The Court of Appeal had long along confirmed the position in Helden v Strathmore Limited [2011] EWCA Cov 542 though noted it was “a misunderstanding which appears to be not uncommon”.

Mortgage Five Zero was wound up on public interests grounds because “The Company’s continued operation cannot be justified on the basis that a decision of the Court of Appeal is wrong. There is no reason whatever to doubt the decision in Helden and it must be accepted as correct, and a business whose function is to exploit the contrary proposition, and to provide false hope to vulnerable consumers who are already likely to be in financial difficulty, is plainly not in the public interest.”

The Secretary of State obtained an Extended Civil Restraint Order (ECRO) against the director of the company. An ECRO requires “persistent” (meaning at least 3) applications or claims to have been made totally without merit. An ECRO would be made against the company or person making the without merit applications. In this case, the applications were all made in the name of the company. The Judge treated the director as having personally made several of the applications because at the time he had no authority to act for the Company. Further, even where the applications could be made in the name of the Company, the Judge treated the director as the “real” party behind the applications. The Judge considered by analogy when a director of an insolvent company might be personally liable for a costs order if he had controlled and funded the litigation for his own benefit. Here, the director sought the personal benefit of the deferment or possible abandonment of his intended public examination. For completeness, the Judge added the director as a party to the appeal and ordered costs against him personally.

This case demonstrates the wide and flexible approach taken by the Courts in assessing a public interest winding up. Whilst it is not against the public interest to disagree with a Court of Appeal decision, the issue here was that the company’s customers were likely already financially vulnerable and the service offered was hopelessly flawed. An ECRO is a useful tool for dealing with an obstructive litigant.

Breach of duty test and failure to inspect records

Official Receiver v Omar Nadeem (Re Bodystretch (UK) Limited) [2023] EWHC 2735 (Ch)

The Company manufactured clothing and ceased trading in 2015 after selling its main asset, a property, for £725,000. Thereafter company funds were dissipated to the director, Mr Nadeem, and various other creditors before the company entered liquidation in 2016. The OR argued that Mr Nadeem was in breach of his duties by “conducting an informal winding up” when the company was insolvent.

The facts of this case are fairly typical but this case is interesting for two points; the analysis of the breach of duty test and the respondent’s failure to inspect records and adduce evidence.

In looking at whether Mr Nadeem was in breach of s.172 Companies Act 2006 (duty to promote the success of a company), ICCJ Mullen provided a detailed analysis of whether a subjective or objective test should apply.  Usually, the test is subjective as to whether the director genuinely believed he was promoting the interests of the company (Regentcrest plc v Cohen [2001]) – save for three exceptions (Re HLC Environmental Projects Ltd):

  1. Where the interests of the creditors are engaged
  2. Where there has been no actual consideration of the best interests of the company
  3. Where a material factor (such as a large creditor and the company is of doubtful solvency) is overlooked or not taken into account

The Court concluded that, despite the company becoming insolvent, there had been no genuine consideration for the company’s creditors as a whole. Further, the Court was also prepared to order that Mr Nadeem compensate the company for payments made prior to its insolvency alleged to be expenses and salary as transactions at an undervalue. This was on the basis that the director as a fiduciary ought to be able to explain the payments but there was no evidence of any salary or expenses being considered or approved or that they formed dividends.

In conclusion, ICCJ Mullen found that the payments away from the company were “not so much an “informal winding up” as a wholesale subversion of the principle of equal treatment of creditors on an insolvent winding up.”

Mr Nadeem argued that he had not been able to inspect the company’s books and records because the OR had only offered him one date. However, ICCJ Mullen found that he had not sought any alternative dates when asked by the OR and, applying Re Mumtaz “I cannot infer that there is anything in the records of the Company that would assist Mr Nadeem or undermine the Official Receiver’s case where Mr Nadeem has had ample opportunity to inspect those records and identify the documents available that would support his case. He has chosen not to do so.”

Content courtesy of IPA corporate partner Manolete Partners PLC.

Please note that guest content does not necessarily represent the views of the IPA.