CI Ltd v Sonatacus Ltd (Joint Liquidators of)

This appeal raises questions under Part VI of the Insolvency Act 1986 (Miscellaneous provisions applying to companies which are insolvent or in liquidation), sections 238 (Transactions at an undervalue) and 239 (Preferences).

The material facts can be taken from the judgment in the court below of His Honour Judge Hodge QC, sitting as a judge of the Chancery Division in Manchester. They can be stated mainly in his own words, though it is now unnecessary to state them as fully as he did.

Sonatacus Ltd (“the Company”) was incorporated on 19 November 1997 under the Companies Act 1985 as a company limited by shares. It began trading shortly thereafter, its principal activity being the sale and distribution of mobile telephones and accessories. The sole director of the Company was Paul Santo Susca.

Mr Susca was a friend, though not a close one, of Rahail Aslam, who was a director and the effective controller of the appellant, CI Ltd (“CIL”). By a deed described as a loan agreement dated 18 September 2000 and expressed to be made between Mr Susca (both as borrower and surety) and CIL (as lender), it was provided that, in consideration of the sum of £65,000 lent to Mr Susca by CIL, Mr Susca covenanted with CIL to repay the said sum to it on written demand, together with interest, Mr Susca and CIL agreeing that “the loan to be the subject of a fixed term arrangement the full amount together with all costs interest and charges to be paid by 18 February 2001.” At that time, CIL had insufficient funds to advance the sum of £65,000 to Mr Susca directly. It therefore procured an associated company, Proweb Ltd, to advance the funds on its behalf. The judge said that he need say no more about the involvement of Proweb Ltd, since it was merely a source of funds to enable CIL to advance monies to Mr Susca.

At Mr Susca’s request the sum of £65,000 was paid direct to the Company by Proweb. However, as the judge observed, the obligation to repay that sum remained, pursuant to the written loan agreement, an obligation of Mr Susca personally. He said that there was no evidence as to what happened to the £65,000 after it had been received by the Company, but that the moneys had been advanced to the Company in a commercial transaction which, in cross-examination, Mr Henry (see below) had agreed had led to an obligation upon the Company to repay them to Mr Susca.

On 29 January 2001 (some three weeks before the fixed term expired), a sum of £50,000 was paid into CIL’s bank account by way of a CHAPS transfer made by the Company at the direction of Mr Susca. It was accepted before Judge Hodge that the Company was insolvent at that time, or that it became insolvent as a result of that transfer. It is unnecessary to deal with the fate of the remaining £15,000.

On 2 March 2001, the Company ceased trading, and a formal resolution was passed placing it into creditors’ voluntary liquidation on 29 March 2001. On the same day, joint liquidators of the Company were appointed and Mr Susca swore an estimated statement of affairs indicating that the Company had assets estimated to realise £20,140, preferential creditors totalling £7,474 and non-preferential creditors totalling £54,318.77.

On 11 March 2005, after a delay of nearly four years, for reasons, which, as the judge observed, had not been explained in evidence, the joint liquidators issued an application against CIL in the Manchester County Court (“the first application”) pursuant to sections 239 and 240 of the 1986 Act claiming a declaration that the payment of £50,000 made by the Company to CIL on 29 January 2001 constituted a preference and was void or voidable accordingly. The application was supported by a witness statement of Neil Henry, one of the joint liquidators, dated 9 March 2005, in which it was alleged that, on or about 20 September 2000, the Company had received a loan from CIL in the sum of £65,000 thus making CIL a creditor of the Company. Mr Henry went on to allege that, in receiving the repayment of £50,000 on 29 January 2001, CIL had been treated preferentially as compared to other non-secured creditors of the Company. Evidence in answer to the first application was put in by Mr Aslam in the form of an undated witness statement, which it is agreed was made before 25 July 2005. It will be necessary to refer to Mr Aslam’s statement in greater detail in due course. At present it is only necessary to say that his evidence was to the effect that the loan of £65,000 had been made to Mr Susca personally, and that CIL was therefore a creditor of his and not of the Company.

As the judge said, Mr Aslam’s witness statement provoked the issue of a further (in substance an alternative) application by the joint liquidators in the County Court on 25 July 2005 (“the second application”), claiming a declaration that the payment of £50,000 made by the Company to CIL on 29 January 2001 constituted a transaction at an undervalue pursuant to the provisions of sections 238 and 240 of the 1986 Act and was void or voidable accordingly. The second application was supported by a witness statement of Timothy James Foreman, an assistant solicitor in the employment of the solicitors acting for the joint liquidators, in which he claimed that CIL provided no consideration to the Company for receiving the payment of £50,000. In answer to the second application, Mr Aslam put in a further witness statement dated 13 November 2005, in which he contended that the allegation that the Company had received no consideration for the payment of the £50,000 was fallacious.

On 29 November 2005, the proceedings having been transferred to the Chancery Division, both applications came before District Judge Needham, who dismissed the first and acceded to the second by making a declaration that the payment of £50,000 made by the Company to CIL on or about 29 January 2001 constituted a transaction at an undervalue pursuant to the provisions of sections 238 and 240 of the 1986 Act. Since that declaration was made on a ground that the joint liquidators have not relied on, it is unnecessary to examine the district judge’s reasoning. He made an order for payment by CIL to the joint liquidators of £50,000 plus interest of £15,300.

CIL appealed to the judge against the declaration and order made by the district judge. The appeal came before Judge Hodge on 8 June 2006. At the outset of the hearing, he gave the joint liquidators permission to put in a late respondents’ notice relying on the preference claim that had been dismissed by the district judge. However, he refused an application by the joint liquidators to adduce fresh evidence at that stage. After hearing argument on the substantive appeal, the judge dismissed it, affirming the district judge’s decision on the transaction at an undervalue, though for different reasons. That made it unnecessary for him to consider the preference claim under the respondents’ notice, and he did not do so.

On 25 July 2006 Lord Justice Jonathan Parker gave CIL permission to bring a second appeal to this court. Again, the joint liquidators have put in a late respondents’ notice (for which we have given permission) seeking, in the alternative, a declaration in relation to the preference claim.

So far as material, section 238 of the 1986 Act provides:

the company enters administration, or

the company goes into liquidation;

Where the company has at a relevant time (defined in section 240) entered into a transaction with any person at an undervalue, the office-holder may apply to the court for an order under this section.

Subject as follows, the court shall, on such an application, make such order as it thinks fit for restoring the position to what it would have been if the company had not entered into that transaction.

For the purposes of this section and section 241, a company enters into a transaction with a person at an undervalue if–

So far as material, section 239 of the 1986 Act provides:

Section 240 of the 1986 Act makes provision for the “relevant time” under sections 238 and 239. Since it is agreed that the provisions of section 240 are satisfied in the present case, it is unnecessary to rehearse them.

So far as material, section 241 of the 1986 Act headed “Orders under ss 238, 239” provides:

In order to understand how these provisions apply to the present case, it is necessary to make a close analysis of the relationships between the parties and the effect of the payments that were made. About the following propositions there can be no doubt:

These propositions were the basis of Judge Hodge’s decision on the question of a transaction at an undervalue. Having stated (paragraph 29) that the only consideration on which CIL could rely to defeat the suggestion of undervalue was the preferential payment to Mr Susca, he accepted the submission of Mr Cousins QC, for the joint liquidators, relying on the speech of Lord Scott of Foscote in Phillips v Brewin Dolphin Bell Lawrie Ltd [2001] 1 WLR 143, 153, that, as a matter of law, a preferential payment which is inevitably susceptible to challenge cannot amount to consideration for the making of that very payment. The judge stated his conclusion as follows:

On the basis of the arguments presented to the judge his reliance on the principle underlying what Lord Scott said in the Brewin Dolphin case and his decision to affirm the district judge’s decision on the transaction at an undervalue on that ground appear to have been correct. However, a five page case report published in Tolley’s Insolvency Law and Practice on 1 October 2006, (2006) 22 IL & P 183, was highly critical of the judge’s decision, concluding as follows:

In a supplementary skeleton argument dated 14 December 2006 Mr Cooper, who has appeared for CIL here and in both courts below, invited us to read the case note in support of CIL’s arguments on the appeal. Apart from a quotation of the conclusion, no guidance was given as to the nature and extent of the support which was said to be derived from the case note. In opening CIL’s appeal on 19 December, Mr Cooper made it clear that he did not adopt the whole of the reasoning of the authors of the case note, but it remained unclear to us what he did or did not adopt. Accordingly, we directed him to put in a further supplementary skeleton argument in order to clarify CIL’s case.

The oral argument was concluded on 19 December, when judgment was reserved. On 20 December Mr Cooper put in his further supplementary skeleton argument, from which the following summary of his submissions may be taken:

The position in regard to the transaction at an undervalue is not at all satisfactory. The reasoning of the authors of the case note as adopted by Mr Cooper, though it may possibly be specious, cannot simply be rejected. Nor could their reasoning be accepted without Mr Cousins having been accorded a proper opportunity for giving it a considered response. Had it not been for the views hereafter expressed on the preference claim, it would have been necessary for the matter to be adjourned for further written submissions and perhaps for further oral argument.

Although the preference claim has largely gone unnoticed, it is worth remembering that it was that claim that was first made by the joint liquidators. That is hardly surprising. The payment of £50,000 having been made by an insolvent company, it would be natural to assume that it was the actual payee which had been given the preference. However, once it is established that it was not CIL that was the creditor of the Company, the joint liquidators must rely on section 241(1)(d), subject to the defence provided by section 241(2), which, so far as it applies to the present case, provides:

There can be no doubt that CIL was a person which received a benefit from the preference given by the Company to Mr Susca. So, quite apart from the question of value, if CIL is to retain the £50,000, it must be shown that it received that sum “in good faith”. Moreover, it is to my mind obvious, both from the language and structure of section 241(1) and (2) and as a matter of common sense, that the onus of showing good faith rests on CIL.

The district judge dismissed the first application on the simple ground that CIL was not a creditor of the Company. He did not have to decide any question of good faith. Nor did Judge Hodge, who, having held that there had been a transaction at an undervalue, expressly stated (paragraph 37) that he did not need to enter into questions of good faith. Nevertheless, CIL’s good faith was potentially an issue in each of the courts below, and it is clear from Mr Aslam’s first witness statement, which was prepared under professional advice, that the point was well in mind.

The material passages in Mr Aslam’s first witness statement are the following:

The good faith issue having been decided in neither court below, it would have been a possible course for us to remit it to the district judge to be decided by him. However, Mr Cousins submitted that this court was in just as good a position to make the decision on the basis of Mr Aslam’s first witness statement, which is the only evidence bearing on the point. Mr Cooper accepted that the onus was on CIL to show good faith. On that footing, I am of the opinion that we can and should decide the issue of good faith ourselves.

In my judgment, Mr Aslam’s first witness statement falls short of establishing that CIL received the £50,000 in good faith. The evidence is that, in and around September 2000, Mr Aslam knew that Mr Susca’s companies were in some financial difficulty; that he would not have lent money direct to the Company even if Mr Susca had asked him to do so; and that Mr Susca asked him to pay the £65,000 into the Company’s bank account because that would be more convenient for Mr Susca. That was the position on 18 September 2000 when the loan agreement was entered into.

On 29 January 2001, barely four and a half months later, £50,000 was received in CIL’s bank account by a CHAPS payment made on that date. Mr Aslam says that he did not know until his accountant examined CIL’s bank statement in about March 2001 that the money had been transferred out of the Company’s bank account. But he does not say that he did not know that the £50,000 had been repaid on 29 January. The clear implication is that he did. With his previous knowledge that the £65,000 had been paid into the Company’s bank account and that Mr Susca’s companies had been in some financial difficulty, he must have known that it was likely that the £50,000 had been repaid by the Company and, moreover, at a time when it was insolvent, or he must at the least have shut his eyes to that possibility. On either footing Mr Aslam has failed to establish that CIL acted in good faith.

For these reasons I would substitute for the declaration made by the district judge a declaration that the payment of £50,000 made by the Company to CIL on or about 29 January 2001 constituted a preference given by the Company to CIL within sections 239 to 241 of the 1986 Act. I would affirm the district judge’s order for payment or make such other order for payment as may be appropriate. I would dismiss the appeal accordingly.

Had the appeal been allowed, it would have been necessary for us to rule on an application by the joint liquidators for an order that there be a re-trial before Judge Hodge, on the ground that there was new and compelling evidence that CIL had forged the loan agreement dated 18 September 2000, had given untruthful evidence and had committed a fraud on the court. It was that evidence that was the subject of the application made by the joint liquidators at the outset of the hearing before Judge Hodge (see paragraph 11 above), which he, correctly as it seems to me, dismissed at that stage. In the event it is unnecessary for us to consider that application and we have not done so.

I have read both judgments in draft and agree with them.

I agree with the judgment of Sir Martin Nourse and add only a few words of my own to explain further why I was unwilling simply to uphold the judge’s decision that the payment of £50,000 by the company to CIL must be set aside as a payment at undervalue.

Much of the argument during the hearing related to the question of whether the authors of the article in Tolley’s Insolvency Law and Practice were correct in their criticism of the judge’s decision. Although Mr Cooper did not fully embrace the argument advanced in the article, I found it at least theoretically persuasive. I think that the judge might have been wrong to hold that the payment of £50,000 by the company to CIL was a transaction at undervalue because the consideration given by CIL (namely a partial discharge of Mr Susca’s debt) was precarious in that it was liable to be set aside as a preferential payment. The argument advanced in the article was that the very fact that the consideration (discharge) was voidable meant that the payment itself was also voidable and therefore recoverable. The reduction in value to the company of the discharge (due to its precariousness) was precisely counterbalanced by the reduction in value of the payment made by the company (due its recoverability). Therefore the transaction was financially neutral. I see the theoretical logic of that argument. However, it seems to me that, in practice, the reduction in value of the discharge due the chance that it would be set aside is not necessarily precisely counterbalanced by the chances of recovery of the money payment. The chances might be different. Although as a matter of law, the money would be recoverable if the preferential transaction were set aside, in practice it might not be; it might have disappeared. If CIL were of doubtful solvency, the transaction might not be financially neutral.

Accordingly, it seems to me that the basis of the judge’s finding was, if not actually wrong, somewhat uncertain. I do not imply any criticism of the judge. The argument discussed in Tolley was not raised before him. Indeed, it is possible that the judge was right. However, in my judgment, what happened in this case was obviously a preferential transaction and I agree with Sir Martin Nourse that it should be dealt with as such. If that is done the burden of showing that it received the £50,000 in good faith rests upon CIL. I also agree, for the reasons given by Sir Martin Nourse, that CIL failed to discharge that burden. I agree with the proposed disposal that he makes in paragraph 30 of the judgment.