Finnerty & Anor v Clark & Anor

What are good and sufficient grounds for the court’s exercise of its discretion under the Insolvency Act 1986 to remove administrators from office? In what circumstances should a court on appeal disturb a first instance decision to remove administrators? These questions arise on this second appeal.

At first instance the Registrar granted the appellants’ application for the removal of the respondents as administrators of St George’s Property Services (London) Limited (the Company). On appeal by the respondent administrators the Chancellor set aside the order on the ground that it was not justified by the findings of fact, which did not establish a good or sufficient ground or cause for their removal. He dismissed the originating application. In this court the appeal is argued on a point of principle: that the Chancellor was not entitled to set aside an order made in the exercise of the Registrar’s wide discretion. The appellants submit that there was no proper legal basis for interfering with the Registrar’s order on the first appeal and that, on this appeal, the court should re-instate the Registrar’s order.

The chronology of the legal proceedings is that on 4 March 2010 an originating application was issued on behalf of the appellants for an order that the respondents be removed from their office pursuant to paragraph 88 of Schedule B1 to the 1986 Act and for an order appointing Mr Stephen Grant as the Company’s administrator in their place. On 30 July 2010 Registrar Derrett granted the application by the appellants and ordered that the respondents be removed forthwith from their office as administrators of the Company and that Mr Stephen Grant be appointed administrator of the Company. The Registrar refused permission to appeal, which was granted by Newey J on 4 August 2010. He stayed the Registrar’s order pending the determination of the appeal or further order. On 14 October 2010 the Chancellor allowed an appeal against that order, set it aside and dismissed the application with costs: [2010] EWHC 2538 (Ch). On 10 November 2010 Jacob LJ granted permission for a second appeal on the ground that the appeal raised an important point of principle.

The main ground of the application to the Registrar was that the appellants, who represent the largest group of unsecured creditors of the Company, were prejudiced by the unwillingness of the respondents to bring legal proceedings. The Registrar found that the respondents were “efficient, vigorous and unbiased” administrators and that, having taken legal advice on the point, they were “entitled to reach the conclusion that they were not prepared to bring the proceedings” that the appellants wanted them to institute. The Registrar removed the respondents on the ground that there was a triable issue, that the appellants had made the removal application to the court in good faith and that appointing a new administrator in their place would not prejudice the body of creditors of the Company. A new administrator would bring an independent mind to bear on the question whether the legal proceedings campaigned for by the appellants should be commenced.

The Company was incorporated on 30 April 2007 as part of the appellants’ business venture to buy refurbish and sell two properties in Fulham: 68 Ringmer Avenue and 84 Gowan Road (the Properties). The appellants are the only shareholders in the Company. They are also substantial unsecured creditors. They are experienced in banking and property development. They entered into the loan agreements, which they want the respondents to challenge, with full knowledge of the terms.

The Properties were acquired with the benefit of short-term loan facilities from Davenham Trust plc supported by fixed and floating charges and unlimited personal guarantees of the Company’s obligations from the appellants. The Company drew down the sum of £849,000 under the Ringmer 9 month facility and £730,000 under the Gowan 9 month facility. Both facilities provided for a basic rate of interest of 1.6 per cent per month (the Basic Rate), but gave Davenham the right to increase that rate to 3 per cent per month, compounded, in the event of default (the Default Rate). Default included failure to repay the loan at the end of the 9 month period.

In the course of 2008 the changing conditions in the property market caused the appellants to defer the sale of the Properties. They decided to let them in the meantime to obtain income with which to service the loan facilities. The Ringmer facility was repaid in February 2009 following a refinancing with Barclays Bank plc. The Company is seeking refinancing for the Gowan facility. It has been negotiating unsuccessfully with Davenham for the removal of the Default Rate. An interim payment of £340,000 was made in July 2009.

On 17 September 2009, without warning, Davenham appointed the respondents, who are insolvency practitioners, as administrators, having previously considered, but then decided against, the appointment of receivers under the Law of Property Act.

Since then the appellants have pursued a two-pronged campaign to rescue the Company as a going concern. They have serviced the Barclays loan from their own resources and they have paid off the Company’s trade creditors so that they or their associates are the substantial majority of the Company’s unsecured creditors. They have deposited with their solicitors a sum sufficient to repay principal and interest under the Davenham facility at the Basic Rate (£950,000).

The appellants have also sought to persuade the respondents to challenge the Default Rate pursuant to s. 244 of the 1986 Act (Extortionate Credit Transactions) or as a contractual penalty. Section 244 is modelled on similar provisions then contained in the Consumer Credit Act 1974. It applies where the company is, or has been, a party to a transaction for, or involving, the provision of credit to the company. The court may, on the application of the office-holder, make an order with respect to the transaction if the transaction is or was extortionate and was entered into in the period of 3 years ending with the day on which the company entered administration. A transaction is extortionate if, having regard to the risk undertaken by the person supplying the credit, its terms require “grossly exorbitant payments to be made” or “it otherwise grossly contravened ordinary principles of fair dealing.” A transaction is presumed to be extortionate unless the contrary is proved. If the transaction is found to be extortionate the court has at its discretion a wide range of powers.

For the purposes of s. 244 proceedings the appellants have offered to fund the respondents’ costs of such an application and have provided an unlimited undertaking by their solicitor, Mr Coyle, in respect of any adverse costs order. The appellants’ solicitor claimed that he and counsel have advised that the Davenham loans were grossly exorbitant and unfair and that the merits were strong: Davenham would have to prove that the loans were not extortionate. Counsel rated the prospects of success at 50-55% but also advised that a s.244 application faced considerable difficulties because there was no clear explanation as to why the Company entered into the Davenham loans if there were much more favourable and reasonable rates available. In all the circumstances the appellants argued that the respondents would have nothing to lose in bringing s.244 proceedings which, if successful, would rescue the Company as a going concern and would enable the appellants to finance a repayment of the Davenham loan and pay off the unsecured creditors.

Thus, it was submitted that there is in place a risk-free mechanism for challenging the Default Rate, which the respondents have declined to take up. According to the appellants the consequences of the respondents’ stance is that the Company’s survival as a going concern is threatened, as the Properties are likely to be sold for a sum insufficient to meet the amounts due to secured creditors; the unsecured creditors (principally the appellants) will receive nothing; Davenham will pursue the appellants under the personal guarantees for the shortfall; and the appellants will lose the sums provided by them to pay the trade creditors and the interest on the Barclays loan.

By contrast, if the position with regard to the Default Rate can be resolved, the Company would survive, all unsecured creditors, apart from the appellants, would be paid and the appellants would wait for payment of the amounts owing to them.

The respondents’ position was that they were prepared to consider re-opening the Davenham loans, but they wanted to have the benefit of a positive opinion of counsel on the merits of a s.244 application; they were concerned about funding the costs of pursuing the s.244 application, bearing in mind that there were no funds in the administration; and they were unsure how the appellants proposed to pay off the Company’s indebtedness and secure the Properties for themselves. Despite assurances the respondents did not receive from the appellants satisfactory answers to their concerns so as to justify launching proceedings against Davenham. Despite various requests the appellants’ solicitors did not supply a detailed Opinion from counsel. The respondents received advice from two firms of solicitors specialising in insolvency. The advice was cautious and warned of the difficulties of persuading a court to re-open credit agreements on the grounds of being extortionate saying that the provisions had rarely been invoked with success and that the challenge would be “very much an uphill struggle.” The appellant’s solicitors did not provide evidence to address the concerns raised by counsel as to why the appellants entered into the Davenham loans and agreed the rates of interest in the first place. As for the costs undertaking offered by the appellants’ solicitor, evidence was not provided to demonstrate that he would satisfy the undertaking in the event that the appellants did not pay.

The court has power to remove an administrator from office under the Insolvency Act 1986 Schedule B1 paragraph 88. It is not a totally unqualified power, as the court must have good grounds for making such an order. As the Chancellor said (paragraph 23) “What is good or sufficient must be ascertained by reference to the purposes of the office and the facts of the case.”

The grounds need not involve misconduct, personal unfitness, or imputation against the integrity of the administrator: Clydesdale Financial Services Limited v. Robert Smailes [2009] EWHC 1745(Ch);[2009] BCC 463 at [82] to [90]. The discretion of the court must, of course, be exercised judicially on the basis of evidence, on the application of the correct legal principles and having regard to all the relevant circumstances. Those circumstances include having regard to the wishes of the majority of creditors. The concern raised by the applicant need not be resolved in his favour at the time of the application, as long as the evidence raised a serious issue for investigation.

At the conclusion of her judgment the Registrar helpfully summarised her reasons for holding that, in the particular combination of circumstances taken together, (a) there was a good ground for removing the respondents and (b) the discretion of the court should be exercised to make such an order.

“57.

On the basis of the representations made on behalf of the Applicants in my judgment there is no prejudice to the body of creditors as a whole in allowing the Application. As I have indicated this is not a decision I take lightly. In my judgment the Respondents are entitled to reach the conclusion that they are not prepared to bring the proceedings and in virtually all cases that would be the end of the matter. However in this case, I am satisfied that the facts show that there are certain exceptional circumstances which persuade me that I should allow the Application. The following facts are of particular importance: the Applicants are now in effect the majority of unsecured creditors: in my judgment they have demonstrated their good faith; they are continuing to pay Barclays out of their own resources; they have deposited a significant sum with their solicitors in excess of £950,000 to discharge all costs and expenses of both the action and the administration and they have confirmed at this hearing that they will abide by the outcome of any decision of the court in relation to the Default Rate: this is a small company in effect a quasi-partnership; it has two shareholders and two assets; the change in the financial and property markets has meant that the Company has had to alter its business operations. Whilst accepting the fact that the Company is in default of its obligations to Davenham, Davenham’s position is not in my judgment jeopardised; it has the benefit of a debenture, fixed charge and personal guarantees. The Applicants tried to negotiate a settlement and believing that a deal could be done on the Default Rate they paid a substantial capital sum towards the debt and made a reasonable settlement offer.

58.

As the Applicants counsel stated, removing the Respondents from office and appointing a new administrator means no more than that an independent mind will be brought to bear on the issue. It does not automatically mean that the claim will be brought and even if proceedings are commenced against Davenham it does not automatically mean that they will negotiate a settlement. The Applicants should be under no illusion about the impact of this decision. Nevertheless in my judgment they should be allowed to succeed and the Respondents should be removed as administrator and I do so pursuant to Paragraph 88 of Schedule B1. ”

The Chancellor held that there had to be a good or sufficient reason for the removal of the administrators from office and that the combination of facts relied on by the Registrar did not amount to a good or sufficient reason for removing the respondents from their office.

The Registrar had acquitted the respondents of bias and concluded that they were entitled to reach the conclusion they did that proceedings under s244 and for a declaration that the provision for default interest was a penalty should not be commenced. The fact that another mind might reach a different conclusion may be a reason to challenge their decision, but it could not be a good reason to remove them altogether. The Chancellor held that the decision of the administrators should be respected if it was unbiased and was available to them on the material before them.

The existence of a triable issue and the consequences of their decision for the guarantors of the Company’s debt were not enough to justify the order for removal with the upheaval and expense of appointing another, who might also reach the same view as those removed and be unprepared to pursue the cause of action that the appellants wanted him to. There was nothing of substance to support the appellants’ assertion that the removal of the respondents would lead to the rescue of the Company as a going concern.

The Chancellor also considered the alternative remedies available, such as the administrators seeking the directions of the court and directing the administrators to use an independent solicitor and counsel to investigate the Company’s claims and give advice to the administrators.

The Chancellor questioned the suggestion that starting proceedings would achieve the statutory objective of rescuing the company as a going concern which was put forward to distinguish the approach to removal of administrators from that of the removal of liquidators who were winding up a company. It was difficult to see how a preliminary step, such as starting legal proceedings, would achieve the statutory objective.

The appellants emphasised that the appeal from the Registrar to the Chancellor under Insolvency Rule 7.47(2) was a true appeal. That meant that the Chancellor was only entitled to interfere with the Registrar’s discretion if he found that it was one that no judge, properly instructed as to the law with regard to the relevant facts, could have reached: Re MTI Trading Systems Limited [1998] BCC 400 at 404E-F.

The appellants contended that there was an insufficient basis for the Chancellor’s interference with the Registrar’s discretion which, in the special circumstances of this case, served the dual purpose of meeting the wishes of the majority of the unsecured creditors to ensure the survival of the Company, whilst providing for the possibility of a challenge to the Default Rate under the Davenham facilities.

There is a problem that requires a solution and the Registrar supplied one. The Default Rate in the security documents was said to be extortionate and to be a serious issue for a fresh investigation in the interests of the majority of the unsecured creditors justifying the removal of the respondents, who are not prepared to challenge the Default Rate. The investigation might lead to the survival of the company as a going concern.

The appellants submitted that, as unsecured majority creditors, they had suffered a wrong and should not be denied a remedy. They pointed to the different principles that apply to the removal of liquidators. They are appointed to realise the company’s assets and pay a dividend to unsecured creditors. Administrators must decide on their achievable purposes in accordance with paragraph 3 of Schedule B1 to the 1986 Act and give proper consideration to balancing the conflicting interests of secured and the unsecured creditors.

The appellants said that they had made their position and their wishes clear and were prepared to pay for them and to underwrite them. The respondents should act so as to serve the interests of all the creditors. Davenham, with the benefit of its security and guarantees, would recover its loan and would not be prejudiced by the removal of the administrators. The appellants had been denied any prospect of recovering their outlay by the inactivity of the respondents and the decision of the Chancellor.

The Chancellor took the mistaken view that there was an alternative remedy for the problem through the making of directions or an application under paragraph 74(2) of Schedule B1, which is available where the administrator is not performing his functions as quickly or as efficiently as is reasonably possible. But that route did not provide an answer to the problem. The creditors, as distinct from the administrators, have no right to apply to the court for directions. The creditors are unable to get the matter before the court. The Chancellor’s proposed solution overlooked the finding of the Registrar that the respondents were not wrong to reach the view they did about s. 244 proceedings. Even if the appellants could get the matter before the court, they would face the problem of having to persuade the court to require the respondents to do something which they were entitled to refuse to do.

For similar reasons paragraph 74 (1), which is available where the creditor claims that the administrator is acting or proposing to act so unfairly as to harm the interests of the applicant, was of no use to the appellants, who would have to meet the high test of “unfair harm.”

The appellants therefore relied on paragraph 88 which is wider than paragraph 74 and is available where there is harm to creditors without them having to prove unfairness.

The Chancellor was also criticised for not having regard to the wishes of the majority of the secured creditors. The reason why they sought the removal of the respondents was that the Default Rate represented for them a serious issue for investigation by a fresh mind. That was a good reason for removing the respondents. The Chancellor had confused that reason for removing them with the effect of removing them i.e. that the replacement administrator might also decline to challenge Davenham’s Default Rate. As the majority of the unsecured creditors had made their wishes clear and were prepared to pay for them, their wishes should not have been disregarded. The Registrar’s solution paid regard to their wishes and should not have been overturned.

I agree with Ms Williamson, who forcefully argued the case for the appellants, that (a) the statutory discretion of the Registrar on an application to remove an administrator under paragraph 88 is very wide indeed and (b) on an appeal against such a discretion there is only limited scope for setting aside the Registrar’s order based on the factual material available at first instance. I also accept, as is common ground, that the court can remove an administrator without a finding of misconduct or personal fault or criticism.

It must, however, be established by the evidence that there is a good or sufficient ground or cause for the removal of the administrators and for their replacement by another administrator. Only then can the court properly proceed to consider the exercise of its discretion by having regard to all the relevant factors for and against an order for removal, such as the beneficial consequences of success in possible legal proceedings.

In this case the appellants’ ultimate objective in removing the respondents from office is so that legal proceedings can be brought and, if they are successful, the liability of the Company to Davenham and their personal liability on their guarantees of the Company’s debt would be reduced. The immediate purpose of removing the administrators is to put someone else in their place who has consented to act, can give fresh independent consideration to the legal position and might be willing, where the respondents were unwilling, to institute s.244 proceedings against Davenham.

The Chancellor was, in my judgment, entitled to set aside the Registrar’s order, even though it was made in the exercise of a very wide discretion because no good ground was established by the evidence for removing the respondents from office. As a ground for removal the appellants relied simply on the possibility of a replacement administrator bringing s.244 proceedings about the Default Rate. Those proceedings had to be instituted: and they had to be brought to a successful conclusion, either by judicial decision or prior settlement, in order to produce all the favourable consequences desired and spelt out by the appellants in their evidence and argument. The combination of consequences relied on by the Registrar as favourable for the appellants were all dependent on (a) the possibility of bringing litigation against Davenham under s.244 and (b) the success of that litigation. In those circumstances what ground was established by the evidence that could justify the removal of the respondents from office?

First, there were no grounds for criticising the respondents’ decision not to bring s.244 proceedings. The respondents acted as independent officers of the court with statutory management powers to be exercised with a view to achieving the statutory purpose and taking into account the interests of the creditors as a whole. As the Chancellor said:-

“26.

In the ordinary case the decision whether or not to institute proceedings in relation to property of the company is one for the office-holder, whether liquidator or administrator. In the event of substantial disagreement amongst the creditors the office-holder may, in the last resort, seek the directions of the court… ”

I also agree with the Chancellor that, if an administrator is unbiased and entitled on the material before him to reach a relevant decision, such as a decision not to bring legal proceedings, his decision should be respected until the court concludes otherwise and the fact that another administrator might reach a different conclusion may be a reason to challenge the decision, but cannot be a reason to remove the administrator altogether.

In this case the respondents knew and understood the wishes of the appellants as the majority of unsecured creditors and their status as investors and guarantors; received and took account of submissions from them and their advisers; received independent specialist advice from two firms of solicitors; properly investigated the matter of possible proceedings; weighed up the prospects; and decided against bringing s.244 proceedings.

Secondly, there is no evidence of any real benefit or advantage to be gained by the appellants simply from securing the removal of the respondents. The appellants may derive benefit from the consequences of legal proceedings if they are brought and if they are successful. The favourable consequences of possible proceedings on which the appellants relied before the Registrar depend on a prior preliminary decision to bring such proceedings in the first place. They may never be brought. At the end of the day, the removal of the respondents “means no more than that an independent mind will be brought to bear on the issue.” The Registrar thought that the possibility of s.244 proceedings was a serious issue for investigation, but, as the Chancellor commented, the Registrar was well aware of “the limited efficacy” of her order. It is simply not known whether a new administrator would be likely to bring legal proceedings at all, let alone whether or to what extent they would succeed. Concern for the wishes of the majority of creditors and the consequences of the respondents’ decision not to litigate the s. 244 issue is insufficient in this case to be a ground for the upheaval of removing the respondents from office.

I would dismiss the appeal on the ground that the Registrar’s order was plainly wrong on the evidential material before her. No good or sufficient ground was made out for removing the respondents from their office as administrators. The Registrar acted on the basis of various consequential factors which did not, taken together, constitute a ground for their removal. The factors were all focused on the benefits of successful s. 244 proceedings. The appellants’ only reason for removing the respondents was the possibility of s. 244 proceedings by administrators challenging the Default Rate. There was no solid evidence that the replacement of the respondents by another administrator was likely to lead to any different decision than the one that the respondents had already reached against bringing such proceedings.

In brief, the position was that the respondents had taken a commercial decision not to bring legal proceedings to challenge the Default Rate. They had done so competently, without bias and with the benefit of independent legal advice. It was a perfectly proper decision with which the appellants disagree. Their hope is that a new administrator would reach a different decision. In my judgment, the mere possibility that another administrator might reach a different conclusion about s.244 proceedings is just not good enough to be a ground that justifies an order for removing the respondents and replacing them.

As the Chancellor pointed out the appellants should have given consideration to alternative remedies available, such as obtaining appropriate directions from the court short of removing the respondents from office. Although it is unnecessary in the circumstances to consider this issue in detail, I cannot see any reason why it would not have been open to the creditors, whether under the rules or the general jurisdiction of the court, to make such an application.

I agree.

I also agree.