Case law update

IPA Insolvency Practitioner newsletter, September 2023

An insolvency case law update prepared by Andrew Murphy, Associate Director at Manolete Partners PLC.

Engagement of the creditor duty following the Supreme Court’s decision in Sequana (Hunt v Singh [2023] EWHC 1784 (Ch))

Insolvency practitioners and their advisors can take encouragement from this decision of Zacaroli J on appeal, which potentially limits the basis on which directors can point to professional advice on the Company’s taxation liabilities in support of arguments that the duty to consider the interests of a company’s creditors is not engaged.

Brief background

Readers are likely to be familiar with this litigation, and in particular the decision handed down in April 2022 dismissing claims brought by Stephen Hunt as liquidator of Marylebone Warwick Balfour Management Limited (“the Company”). The claim sought damages from seven of the Company’s former directors, including alleged breaches of duty by causing the accrual of c£39 million to HMRC arising from the Company’s participation in a “robust” tax avoidance scheme.

By the time of the first instance trial, the liquidator had settled with some of the respondents, but his claims were dismissed against the others by ICC Judge Prentis (“the Judge”). However, with Sequana not yet having reached the Supreme Court by that stage, the Judge was bound by the Sequana test favoured by the Court of Appeal.

By the time that Hunt v Singh came to be heard on appeal to Zacaroli J, the Supreme Court had given judgment in Sequana, such that Zacaroli J could proceed on the basis set out by the Supreme Court.

The Appeal

In contrast to the circumstances in Sequana, the Company was plainly insolvent during the period in which the payments into the scheme were made, owing to liabilities to HMRC arising from it (of which HMRC had notified the Company). Accordingly, the principal question raised by the appeal was whether the directors’ duty to take into account the interests of creditors arose in circumstances where the Company was insolvent at the relevant time, but only as a result of a liability which the directors (then) wrongly believed had been avoided by a tax avoidance scheme entered into by the Company.

In determining this question, Zacaroli J assumed that it would need to be shown that the directors had knowledge of the Company’s insolvency at the relevant time, a point which remained unanswered following Sequana. Whilst in this case the directors asserted that they had taken and acted upon advice as to the merits of HMRC’s claim and how to provide for it in the Company’s accounts, including legal advice on the taxation consequences of the scheme, Zacaroli J held that the duty to consider the interests of the Company’s creditors nevertheless arose. One critical factor seems to have been the fact that the Company’s solvency was dependant on the tax liability in question.

Zacaroli J therefore remitted the case to be reconsidered at first instance, though given that the sole remaining respondent to the liquidator’s claim has since been made bankrupt, it remains to be seen whether any further action will be taken in this case.

The decision serves as a word of caution to directors facing claims arising from tax avoidance schemes, particularly when seeking to reconcile a potential HMRC liability with professional advice that the liability has been validly avoided.

Supreme Court clarifies the standing of bankrupts to challenge the conduct of a trustee in bankruptcy Brake v Chedington Court Estate Ltd [2023] UKSC 29

In a decision that will be welcome to personal insolvency office holders, the Supreme Court reiterated that there are only limited circumstances in which bankrupts (and discharged bankrupts) have standing to challenge the conduct of their trustee in bankruptcy.

Brief Background

The facts of the case are more complex than the scope of this note allows, as it involved the overlap between the liquidation of a partnership and the bankruptcies of two of its partners. The focus of this note however is that two discharged bankrupts, Mr and Mrs Brake, challenged the actions of their trustee in disposing of their interests in certain properties to third parties, namely Chedington Court Estate Ltd (“CED”) and its owner, rather than to the bankrupts. Principally, the bankrupts contended that the trustee’s actions were unreasonable as it ignored their position as special purchasers and their claimed beneficial interests in one of the properties, which had previously been treated as a partnership asset.

The trustee was removed from office in June 2019, having not resisted that part of the Brakes’ application, and remained neutral on the substantive application. The substantive application was instead resisted by CED, essentially to defend the transaction from which it was to acquire the properties.

First instance and Court of Appeal decisions

At first instance, CED obtained an order striking out the Brakes’ application on the basis that they lacked standing under section 303(1) of the IA 1986 to bring it.

The Brakes partially succeeded on appeal as it was held that a bankrupt’s standing is not just limited to cases where there is potential for a surplus in estate realisations. The Court of Appeal instead framed the test as requiring (i) a substantial interest which has been adversely affected by a trustee’s conduct and (ii) a direct interest in the relief sought. On the facts, the Court of Appeal found that the Brakes had standing to challenge the trustee’s conduct under section 303(1), though the requirement for a direct interest in the relief sought was seemingly held to result solely from their capacities as former bankrupts, rather than requiring any surplus or other financial interest.

Supreme Court Decision

The Supreme Court (“SC”) considered the Court of Appeal’s test for standing to be far broader than that settled in previous authorities, and warned that it risked increased challenges to trustee’s decisions if bankrupts need only show that that their rights were wrongfully interfered with by a trustee acting in that capacity. The SC also referred to the possibility of challenges to actions of trustees by bankrupts under section 304 of the IA 1986 on grounds of misfeasance, which does not require there to be a potential surplus for a bankrupt to have standing (though is subject to leave of the Court).

In overturning the Court of Appeal’s decision, the SC helpfully summarised the position for challenges by bankrupts as being limited to cases where there is likely to be a surplus, with a limited class of cases beyond that.

The reinforcement of this narrower scope of standing will be of particular comfort to personal insolvency office holders. However, it will be important for trustees and their advisors to consider whether the bankrupt falls within the limited class of having standing notwithstanding the absence of a potential surplus, for example (as referenced at paras 19 and 99 of the SC judgment) a bankrupt’s interest in minimising a trustee’s fees when seeking annulment.

Provisional liquidator unsuccessful in seeking to limit the quantum of a cross undertaking in damages in support of a freezing order (Hunt v Ravneet UBHI [2023] EWCA 417)

In April 2023, the Court of Appeal (“CA”) set aside a freezing order obtained by the provisional liquidator of the general partnership known as Black Capital, on an appeal brought by an individual alleged to have been one of its partners (“Mr Ubhi”).

Brief Background

Disgruntled investors claiming to be owed more than £18 million presented a winding up petition against Black Capital, seeking the appointment of Stephen Hunt as provisional liquidator at the same time. Shortly following his appointment, the provisional liquidator obtained freezing orders against Mr Ubhi and another individual alleged to have been his partner in Black Capital (“the Partners”), limited to £19 million.  

In support of his application, the liquidator gave a restricted form of cross-undertaking in damages essentially limited to the net realizable unpledged assets of Black Capital in his control during the course of the liquidation.

Subsequently, the petitioners presented bankruptcy petitions against the Partners, which were heard simultaneously with the winding up petition by Deputy ICC Judge Raquel Agnello KC (“the Deputy ICC Judge”) in November 2022 and dismissed. Deputy High Court Judge Vos (“the Judge”) determined in December 2022 that the freezing orders against the Partners should continue, and the dismissal of the winding up petition was subsequently stayed to allow for an appeal by the petitioners.

The Appeal

This article focuses on Mr Ubhi’s appeal against the Judge’s decision to order the continuation of the liquidator’s freezing order.

The CA’s judgment predominantly focused on the basis on which the Judge had departed from the default position that an applicant for a freezing order should give an unlimited cross undertaking in damages. The liquidator’s arguments that the departure was justifiable included that he was acting in the interests of all creditors of Black Capital but, by that point, could only call upon the petitioners to give financial support for any cross-undertaking, with the remainder of Black Capital’s investors as-yet unidentified.

The CA reiterated that status as a liquidator (provisional or otherwise) alone does not justify the absence of an unlimited cross-undertaking. Newey LJ (at para [35]) even went so far as to describe the liquidator’s capped undertaking as worthless, particularly as he might not have any Black Capital assets under his control if the winding up petition against Black Capital were to be dismissed. The CA also considered the potential financial limitations applicable to office holders, such as the availability of insurance and creditor funding, none of which were decided in the liquidator’s favour.

The CA also declined to allow the liquidator to provide, if advised, an amended cross-undertaking, and instead set aside the freezing order.

This judgment serves as a reminder of the narrow circumstances in which courts will depart from the default position of requiring an unlimited cross-undertaking in damages to support freezing orders, even where the applicants are under the time and resource pressures of acting as provisional liquidators.

Content courtesy of IPA corporate partner Manolete Partners PLC.

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