Kaupthing Singer and Friedlander Ltd, Re

This appeal arises out of directions given by Norris J to the administrators of Kaupthing Singer & Friedlander Limited (“KSF”) by an order dated 2 October 2009. The appeal raises a short but important point on the provisions of the Insolvency Rules 1986 (“IR”) as to the set-off, in a company administration, of future debts owed by the company to its creditors and by those creditors to the company. The point, briefly stated, is whether the effect of those provisions is that, after the future debts are discounted to a present value for the purpose of set-off, leaving a balance due from the creditor to the company to be paid at the contractual date for repayment, the balance is to be paid in the discounted amount or alternatively in an equivalent undiscounted amount.

KSF is a bank. It was authorised to carry on deposit-taking and other regulated activities under the Financial Services and Markets Act 2000. It was placed in administration on 8 October 2008 by order of Floyd J on the application of the Financial Services Authority. The appellants were appointed joint administrators (“the Administrators”). The administration is presently being conducted with the objective of achieving a better result for KSF’s creditors as a whole than would be likely if KSF were wound up.

The creditors of KSF include individual, corporate and institutional depositors. Some 180 of those depositors are themselves indebted to KSF. The total value of their outstanding deposits is approximately £15.5 million, €3 million and US$5.7 million. The total value of their outstanding loans is approximately £678.4 million, €147.3 million and US$164 million, that is to say substantially in excess of their deposits. About half of those loans are repayable after August 2010. Some of them are not repayable until 2018.

On 20 May 2009 the Administrators gave notice in the London Gazette of their intention to declare a first interim dividend to preferential and unsecured creditors pursuant to IR 2.95. Creditors were required to submit their proofs of debt on or before 18 June 2009. The Administrators declared and paid a first interim dividend on 22 July 2009.

By ordinary application dated 24 June 2009 the Administrators applied to the Court for directions in respect of four issues concerning, broadly speaking, the way in which claims and cross-claims between KSF and its depositors are required to be calculated and set off against each other, and the treatment of KSF’s right to payment of the balance of any loans. That application was heard by Norris J, who gave judgment on, and made an order dated, 2 October 2009. This appeal is by the Administrators in respect of one aspect only of the applications and the directions, namely the proper treatment of the balance of any loan owed by a depositor to KSF after the set-off of cross-claims. By virtue of IR 2.85(8) such balance is not payable by the depositor until the contractual date for repayment has arrived. Before the Judge, it was not disputed by KSF that the balance payable by the depositor was the discounted amount (that is to say, present day value), even though not repayable until the contractual (future) date for repayment. It was argued by KSF, however, that, in discounting the outstanding loans to the depositors to present value for the purpose of set-off, contractual interest due up to the contractual date for repayment should be included in the amount to be discounted. The Judge rejected that argument. On this appeal, the Administrators no longer advance that argument, but they contend that the balance outstanding in favour of KSF after set-off should be the amount that would have been due if the balance had not been discounted to present value. This turns on the inter-relationship between, and the proper meaning and effect of, IR 2.85(7), which incorporates IR 2.105, and IR 2.85(8). The former deals with the discounting of future claims to their present value, for the purpose of calculating the amount of any set-off; and the latter deals with the payment to the company of any balance after set-off.

On 29 June 2009 Peter Smith J gave directions that the Administrators should instruct counsel to make submissions to the Court in support of their preferred construction in relation to each of the four issues on which they sought directions, and that they should instruct separate counsel to argue for any alternative construction to the extent that any such alternative construction would be in the best interests of those creditors affected and was properly arguable. Mr Robin Dicker QC (before this Court) and Mr Tom Smith (before the Judge and this Court) were appointed to act on behalf of the Administrators, and Mr Richard Fisher (before the Judge and this Court) was appointed to advance arguments on behalf of depositors who are themselves indebted to KSF. We are grateful for their excellent skeleton arguments and admirable concise oral submissions.

The administration procedure was first introduced by the Insolvency Act 1986 (“IA 1986”). Broadly speaking (and subject to certain exceptions with the consent of the administrator or the leave of the Court), on the making of the administration order the rights of creditors to enforce the company’s obligations are suspended until the conclusion of the administration. Until the Enterprise Act 2002 (“EA 2002”) the administration was typically concluded by, and the assets were distributed pursuant to, a scheme of arrangement, or a company voluntary arrangement, or a creditors' voluntary liquidation, or a compulsory liquidation on the discharge of the administration order. Among the changes made by EA 2002 was the introduction of a procedure under which a distribution could be made by an administrator to creditors in much the same way as in a liquidation. This was achieved by the introduction of the present paragraph 65 of Schedule B1 to IA 1986 (“Schedule B1”), which enables an administrator to make a distribution to creditors directly (but, in the case of unsecured creditors, only with the permission of the Court); and then to proceed under paragraph 84 of Schedule B1 to a dissolution of the company without the intervening step of a liquidation.

In order to facilitate this change, a new Chapter 10 of IR Part 2 was introduced, modelled on the equivalent rules applicable to liquidations, to provide the necessary machinery to enable such a distribution to be made. As the Judge explained in paragraphs [6] and [7] of his clear and careful judgment, Chapter 10 in essence adapts the language, concepts and mechanics of the payment of a dividend within a liquidation to the payment of a distribution within an administration. So a creditor claiming to participate in a distribution is referred to as "proving" his debt, and the document by which he seeks to establish his claim is referred to as his "proof"; and, if he so "proves", then that will suffice if the company proceeds from administration into creditors' voluntary liquidation. Further, the rules in Section C of Chapter 10 relating to quantification of claims for the purposes of the distribution are substantially similar to the rules which apply in a winding up and which are to be found in IR 4.86 to IR 4.99, including provisions for set-off where there have been mutual credits, mutual debts or mutual dealings between the company and any proving creditor. In the case of liquidation, those provisions as to set-off are contained in IR 4.90; and, in the case of administration, they are contained in IR 2.85.

Following amendments by the Insolvency (Amendment) Rules 2005, S.I. 2005/527 (“the 2005 SI”), IR 2.85 is as follows:

IR 2.105, to which reference is made in IR 2.85(7), is as follows:

The 2005 SI was accompanied by an “Explanatory Note”. So far as material, it said as follows:

It is necessary to mention only the following parts of the Judge’s judgment for the purpose of this appeal.

In paragraph [16] of his judgment the Judge determined that, for the purposes of the insolvency set-off in administration, a debt is “future” if it was not due for payment at the date of the notice of intention to make a distribution. He also held that the effect of IR 2.105 is that, for the purpose of taking the account of mutual dealings under IR 2.85, a future debt payable before the date of the distribution is taken at full value, but a future debt payable after the date of distribution is taken at its discounted value.

Under IR 2.88(1) pre-administration contractual interest is provable as part of any debt owed by the company, but not post-administration interest. The Administrators contended that, by contrast, post-administration contractual interest payable by creditors on loans by KSF should be taken into account for the purpose of set-off under IR 2.85 in respect of mutual dealings. The Judge rejected that submission, holding in paragraph [24] of his judgment that, for the purpose of striking the balance of mutual dealings, IR 2.88(1), as applied by IR 2.85(7), means that post-administration interest is left out of consideration on both sides of the account.

Turning to the balance remaining after the account is taken, the Judge held in paragraph [25] of his judgment that, if the balance is due to the creditor, it will already include any pre-administration interest, and under the general rule applicable in the administration the creditor is not permitted to prove for post-administration interest (save in the event of a surplus in the administration). On the other hand, if the balance is due to the company, he held in paragraph [26] of his judgment, rejecting the arguments for the depositors to the contrary, that the balance bears interest in accordance with the terms of the loan. His reasoning was as follows:

The Judge held in paragraph [28] of his judgment that such interest on the balance due to the company is payable as from the date of administration, but giving credit for any interest paid since the date of administration on so much of the borrowing as was extinguished by the process of set-off.

The Judge then turned to the inter-relationship between the provisions for the payment of future debts in IR 2.105(2) and the interest provisions in IR 2.88 as he had interpreted them. In particular, he addressed the operation of the discounting formula under IR 2.105(2) in respect of debts payable to the company at a future time. As I have said, he rejected the argument of the Administrators that in such a case “X”, which is defined by IR 2.105(2) as “the value of the admitted proof”, should include interest to the contractual future payment date. He held in paragraph [35] of his judgment that “X” is exclusive of interest (other than accrued interest as at the date of administration) when the formula is applied to discount an unmatured loan due to the company for the purpose of finding the balance on the account to be taken for the purpose of insolvency set-off. His reasoning was as follows:

The Judge acknowledged that his conclusion might have unfortunate consequences for the general body of creditors. He explained:

He gave the following example in paragraph [38] of his judgment:

He said, however, that he felt “compelled” to that conclusion “because of the terms of the statutory formula, and because the rules apply to “all sums” due to the company (not simply so much of the sums due to the company as are required to match the depositor’s claim in the account).”

The Judge observed in paragraph [40] of his judgment that neither counsel had thought that any particular importance was to be attached to the words “for the purpose of dividend (and no other purpose)” in IR 2.85.

This appeal is, as I have said, restricted to the question of the amount payable to KSF after the taking of the account for the purposes of insolvency set-off. On this point, the Administrators have (1) abandoned the argument that “X” in the formula in IR 2.105(2) includes contractual interest to the date of maturity of the loan, and (2) raised a wholly new argument that the balance due to KSF is not reduced to present value in accordance with the formula in IR 2.105(2). In effect, they now rely on the words of limitation in IR 2.105(2) – “For the purpose of dividend (and for no other purpose)” – to which, as the Judge had pointedly observed in paragraph [40] of his judgment, neither counsel had attached any importance before him. The Administrators submit that those words, in the context of insolvency set-off and the cross-reference to IR 2.105 in IR 2.85(7), are to be interpreted as meaning “For the purpose of set-off (and for no other purpose)”.

A Respondent’s Notice sets out additional grounds for upholding the Judge’s judgment. I shall consider them in the course of discussing the submissions of counsel.

The Judge’s conclusion, on the arguments before him, that the balance payable by the creditor to the company under IR 2.85(8) in respect of a future debt is a sum discounted to present value under IR 2.105 produces a result which is extraordinarily beneficial to the creditor in question and highly detrimental to the general body of creditors. Insolvency set-off always benefits the creditor over other unsecured creditors because, instead of having to prove with those other creditors for the whole of the debt, he or she can set off pound for pound what is owed to the company and prove for, or pay, only the balance: Stein v Blake [1996] 1 AC 243, 251 E. If, however, the Judge is correct on the operation of insolvency set-off in an administration, the creditor has the further significant advantage that any balance due to the company does not have to be paid until the contractual date for repayment, but then only in an amount which has been discounted, for notional acceleration, to the value as at the date of administration. This not only disadvantages the general body of creditors, but it results in a strikingly more advantageous position for those creditors who have both a future debt to the company and a cross-claim against the company, however small in amount, compared to other creditors who are indebted to the company without any cross-claim.

The core of Mr Fisher’s reasoning, in opposing the appeal, is that insolvency set-off is a creature of statute, to be determined exclusively by the terms of the legislation in question, and that the intended meaning and effect of IR 2.85 (and, in particular, IR 2.85(7) and (8)) are clear and unambiguous. His case is that the Judge’s conclusion as to the meaning of those provisions is not obviously irrational, indefensible or absurd, whereas the interpretation for which the Administrators contend is strained and artificial and attributes to IR 2.85 a meaning which the words cannot bear.

Mr Fisher’s analysis proceeded along the following lines. The sums which are to be regarded as due for the purpose of the account are expressly identified in IR 2.85(3) and (4), and include all sums payable in the future. There is no restriction in the wording of either IR 2.85(3) or IR 2.85(4) which limits the taking of the account to such sums as are necessary to satisfy any amount due by the company to the creditor, and no basis for implying such a restriction. So far as quantification is concerned, Rule 2.85(7) clearly and unambiguously provides that IR 2.105 applies “for the purposes of this Rule to any sum due to or from the company which is payable in the future” (emphasis added). That includes all sums which are due, and not merely those which are needed to satisfy any claim that may exist against the company. Finally, IR 2.85 provides for the “balance” to be provable against the company, or payable by the creditor to the company. That balance is the product of taking the statutory account. There is no provision in IR 2.85(8) or elsewhere in IR 2.85 which suggests that the balance is subject to any recalculation in order to reverse the effect of the application of IR 2.105.

The same points underlie Mr. Fisher’s rejection of the Administrators’ suggestion that the words in IR 2.105 (and in particular the phrase “For the purpose of dividend (and for no other purpose)”) can be read in a manner which limits the extent to which the discounting effect of IR 2.105 operates; specifically, their suggestion that, for the purpose of IR 2.85(7), IR 2.105 is to be treated as applying “For the purpose of set-off (and no other purpose)”. Such an interpretation is, he submitted, inconsistent both with the wording of Rule 2.85 and the established effect of insolvency set-off. He said that those words in IR 2.105 are to be ignored as irrelevant in the context of IR 2.85(7) or, alternatively, are to be interpreted in that context as meaning “for the purpose of Rule 2.85”. He submitted that, in any event, what would be required to achieve the result for which the Administrators contend is not the phrase “for the purpose of set-off (and no other purpose)” but a provision that IR 2.105 is to apply for the purpose of, and only to the extent required for, set-off sufficient to meet any claim by the creditor against the company. No such provision can, he said, be found expressly or by implication in IR 2.85. On the contrary, on the wording and the mechanism specified in IR2.85(7) and (8), it is not possible to have a debt due at a future time which forms part of the balance but was not subject to the taking of the account pursuant to IR 2.85(3) and not therefore subjected to the discounting mechanism in IR 2.105.

Mr Fisher reinforced those submissions by reference to general principles of insolvency law, and also the historical context of the 2005 S1. As to the former, he relied upon the principle that the consequence of taking the account for the purpose of insolvency set-off is that the original causes of action underlying the cross-claims are extinguished and replaced by a statutory balance: Stein v Blake esp. at 255B. That principle is, he submitted, consistent with a literal interpretation of IR 2.85 (7) and (8) under which the balance payable to or by the creditor is the statutorily discounted amount and not the original contractual amount.

As to the historic context of the 2005 SI, he observed that in Re Park Air Services [2000] 2 AC 172 the House of Lords had considered the operation of IR 11.13, which contains the discounting provisions for future debts in a liquidation equivalent (but not identical) to those now found in IR 2.105 for administration. At that time IR 11.13(3) contained provision for adding back the discount in favour of a creditor if there were surplus funds. Lord Millett was critical of those provisions in Park Air Services. When, however, the provisions in IR 11.13 and IR 2.105 were amended by the 2005 SI, including the removal of 11.13(3), there was no attempt to clarify or provide that any balance due to the company after the set-off was to be for an undiscounted amount. Further, Mr Fisher emphasised, the Explanatory Note which accompanied the 2005 SI contained no suggestion that any discount would be added back to a balance due to the company or that any such balance was to be treated differently to any debt or balance due from the company to the creditor.

Mr Fisher rejected any suggestion that the Judge’s interpretation produces so surprising a result that it cannot reflect the intention and policy considerations behind IR 2.85. In particular, he relied on the Judge’s decision that, following the taking of the account and the insolvency set-off, the creditor must pay contractual interest on any balance in favour of the company until final repayment. He acknowledged that such a creditor is in a better position than a creditor who does not have a cross-claim against the company; but he pointed out, as indeed is the case, that a creditor who has had mutual dealings with the company is and has always been treated, as a result of the statutory set-off, more favourably than an unsecured creditor who has not had any such dealings.

For all those reasons, Mr Fisher submitted that, if there are policy concerns about the operation of IR 2.85(7) and (8) in relation to the payment by the creditor of the discounted balance, those concerns cannot be met by applying a strained interpretation to the clear and unambiguous words of those provisions. The concerns can only be met by an amendment of the Rules.

Notwithstanding those powerful and well-presented arguments, I would allow this appeal. The interpretation of IR 2.85, for which Mr Fisher contends, has no sensible policy rationale and is, on the contrary, inconsistent with the basic principles and objectives of insolvency administration. It is not a policy objective of the procedures for administration or the liquidation of an insolvent company to remove or diminish the indebtedness of those liable to the company. On the contrary, one of the principal objectives is to preserve, and where possible to maximise, the value of the company and its assets. The provisions for insolvency set-off are intended to promote speedy and efficient administration of the assets so as to enable a distribution to be made to creditors as soon as possible and in a manner which achieves substantial justice between the parties to the set-off and, so far as practicable, equality in the treatment of creditors. The purpose of insolvency set-off has nothing to do with the release of liabilities owed to the company save to the extent necessary to achieve those objectives.

Prior to 2005, where a creditor was indebted to an insolvent company in respect of a future debt, there was no provision or mechanism for compulsory early payment to the company or discounting of the debt to present value or set-off. There is no reason whatever to think that the introduction of a mechanism for set-off of future debts, and the discounting of such debts for that purpose, was for any other reason than the usual objectives I have mentioned. In particular, there is no coherent or rational policy reason to release the creditor from a substantial part of the creditor’s indebtedness to the company when, and to the extent that, such release is not necessary to achieve a set-off of cross-claims.

Contrary to the approach of the Judge and the submissions of Mr Fisher, I consider that it is perfectly possible to interpret IR 2.85(7) and (8), without straining their language, so as to produce a sensible meaning, in accordance with a sound policy objective and general principles of insolvency administration. IR 2.105(2) provides for the discount of a future debt to current value, by application of the statutory formula, “for the purpose of dividend (and no other purpose)”. That is consistent with the purpose of IR 2.85, which, as appears from the express provisions of IR 2.85(1), is triggered by, and is for the purpose of, making of a distribution. I see no difficulty in the circumstances in reading the words “for the purposes of this Rule” in IR 2.85 as confining the effect of the incorporation of IR 2.105 to what is necessary to calculate what should be paid by way of dividend to the creditor, and, for that purpose, the making of the insolvency set-off, and as not touching at all upon what remains due to the company after the insolvency set-off has taken place. In the course of his oral submissions, Mr Robin Dicker QC, for the Administrators, adopted that as an alternative way of putting the Administrators’ case on this appeal. I do not accept that such an interpretation is inconsistent with the words “any sum due to or from the company” in IR 2.85(7) or with the provisions for the taking of the account in IR 2.85(3) and (4).

It follows that I do not accept the Administrators’ first line of argument that the words in IR 2.105(2) in the present context mean “For the purpose of set-off (and no other purpose) ...”, not least because any balance due in favour of the creditor after the set-off has been calculated will plainly be proved in the discounted amount. Their alternative argument, however, which I accept, has the same practical effect on the facts of the present case. The Administrators’ skeleton argument shows how, on that interpretation, IR 2.85 works in relation to the Judge’s example, as follows:

I do not accept that the principle in Stein v Blake, that on the taking of the account for the purpose of insolvency set-off the original causes of action are extinguished, has any relevance to the present issue. That case concerned the question whether, where A and B have mutual claims against each other and A becomes bankrupt, A’s claim against B continues to exist so that A can assign it to a third party or whether the effect of the set-off is to extinguish the claims of A and B and to substitute a claim for the net balance owing after setting off one against the other. It was held that the original causes of action were extinguished. That has nothing to do with, and cannot assist in resolving, the question whether, as a matter of the proper interpretation of IR 2.85(7) and (8), the discounting mechanism in IR 2.105 applies further than is necessary for the purpose of establishing the amount of a distribution to be made to the creditor.

Further, Mr Fisher’s reliance in the present context on the Stein v Blake analysis of the extinguishing effect of the insolvency set-off on the original causes of action presents him with a difficulty. He relies on the Judge’s decision that interest is payable on the balance of the debt due to the company as undermining the Administrators’ case that the Judge’s interpretation has such extraordinarily damaging results for the company and the general body of creditors that it cannot reflect the meaning and intent of IR 2.85. The Judge, however, came to that decision on interest on the basis that the original contractual liability remains, save to the extent that it has been extinguished by the insolvency set-off, rejecting Mr Fisher’s submissions to the contrary. That decision of the Judge has not been appealed. Mr Fisher frankly submitted that, notwithstanding the absence of any appeal on the point, it is very difficult to see that the Judge was right on that issue as a matter of law. There is nothing in IR 2.85 or IR 2.88 which expressly provides for the payment of such interest. If that is correct, then the effect of Mr Fisher’s analysis, relying on Stein v Blake, is that the creditor is only liable to pay any balance due to the company at an amount discounted to the value at the date of administration but not payable until the future contractual date for repayment and without interest in the meantime. There could be no policy justification for such a remarkable result.

I do not consider that any assistance can be obtained from Park Air Services or the Explanatory Note that accompanied the 2005 SI. Neither Park Air Services nor IR 11.13, which was the subject of analysis and criticism in that case, are concerned with the balance of future debts owed by the creditor to the company. They are concerned with debts owed by the company to the creditor and the amount of the creditor’s proof. So far as concerns the Explanatory Note, its contents were of the most general kind. It contains no positive assertion inconsistent with the Administrators’ case. The absence of any specific comment in the Explanatory Note in support of the Administrators’ case is not a sound foundation for reaching any conclusions about the point in issue on this appeal.

Accordingly, I would allow this appeal.

I agree.

I also agree.