Rococo Developments Ltd (“the company”) was a property development company until it went into creditors’ voluntary liquidation on 21 April 2011. Mr and Mrs Jones were its two directors and own all the company’s issued share capital. In carrying out its development projects the company was reliant on borrowings, both from the banks and also from Mr and Mrs Jones.

One of the sites that the company wished to develop was at Llanunwas, Solva. It entered into a building contract with a company called WJG Evans Ltd (“Evans”). In the latter stages of the project Mr Jones himself acted as the contract administrator. As completed units were sold, both at Solva and at another site in Sennybridge Brecon, the company repaid out of the sale proceeds the various loans made to it by Mr and Mrs Jones. There were four such payments made in 2010 namely £97,272.73 made on 3 June, £10,000 and £90,000 both made on 4 October, £175,400 made on 27 October; and a fifth one (£76,000) made on 18 March 2011, just over a month before the company went into liquidation. These payments amount in total to £448,672.73. In addition on 1 June 2010 the company paid a dividend to its shareholders (Mr and Mrs Jones) of £75,000.

It is now accepted that each of the five payments counts as a “preference” for the purposes of sections 239 to 241 of the Insolvency Act 1986. It is also clear that each of the payments was made within the period of two years ending with the onset of the company’s insolvency. The liquidators of the company thus claim repayment of the five payments under section 239. Prima facie the giving of a preference to a person connected with the company (such as Mr and Mrs Jones) within the period of two years ending with the onset of the company’s insolvency is given at a “relevant time” for the purposes of those sections. But section 240 (2) provides:

“(2)

Where a company enters into a transaction at an undervalue or gives a preference at a time mentioned in subsection (1)(a) or (b), that time is not a relevant time for the purposes of section 238 or 239 unless the company—

(a)

is at that time unable to pay its debts within the meaning of section 123 in Chapter VI of Part IV, or

(b)

becomes unable to pay its debts within the meaning of that section in consequence of the transaction or preference;

but the requirements of this subsection are presumed to be satisfied, unless the contrary is shown, in relation to any transaction at an undervalue which is entered into by a company with a person who is connected with the company.”

Section 123 (1) (e) provides that a company is deemed to be insolvent if it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due. Section 123 (2) provides that a company is also deemed unable to pay its debts if it is proved to the satisfaction of the court that the value of the company's assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities.

The immediate cause of the company’s entry into insolvent liquidation was an adjudication award made on 27 March 2011 by an adjudicator following a claim by Evans. However, that claim had something of a history. On 28 May 2010 Evans presented a final account stating that the total amount due for building works was £561,000-odd and that taking into account sums already paid there was a balance in their favour of £191,487-odd. This was far in excess of the amounts which Mr Jones, as the self-appointed contract administrator, had certified. The parties did not narrow their differences, and by notice dated 18 February 2011 Evans referred the dispute to adjudication. The dispute referred to adjudication at this stage was limited to what were referred to as “headline items” for inclusion in the final account. The items included utility supplies, additional roof works, external works and a claim by Evans in respect of an extended contract period. A chartered surveyor was appointed as adjudicator. The parties made written submissions to him (which included disputes about his jurisdiction). Although Evans suggested widening the scope of the adjudication to include the assessment of the whole of the final amount, the company refused to do so. The company took legal advice from counsel, which the judge described in the following terms at [22]:

“The company took legal advice from counsel, who gave what was described as a very provisional view on 8 March 2011 that there was a 60-65% chance of success in arguing that Evans had lost the right to dispute the appointment of the contract administrator and that the certificates accordingly should be valid. He further thought that there was a strong case for saying that the adjudicator was not being asked to direct payment to be made, and he anticipated that what would be decided was simply a calculation rather than a direction that those sums be paid. His “best guess” on the anticipated outcome in respect of such a calculation was that £55,241.66 would be found due to Evans on the items in the reference, not including interest or adjudicator’s fees. He ended on this note: “I am concerned that our case on the quantum of the valuations is difficult to follow. What are we saying is wrong about the contractor’s figures? Why are our figures lower? Are these contractual arguments or what?”

The outcome of the adjudication was the award of 27 March 2011. The adjudicator rejected Evans’ claim to an extended contract period, and also decided that the certificates issued by Mr Jones were invalid, because he was not entitled to appoint himself as contract adjudicator. He also decided that the company had no claim for delay. The overall result, therefore, was that he decided that a total principal sum of £66,881.80 for the headline items should be in the final account. The company was also liable to pay, in addition to that sum, legal and other fees amounting to £16,000. The company had made no provision in its accounts for payment of anything to Evans and therefore could not pay. It was that total liability that triggered the decision to enter insolvent liquidation. The decision to that effect was made on 1 April 2011. According to the Statement of Affairs the company had no funds to proceed with the matter or to contest any further referral. The deficiency as regards unsecured creditors was £52,479. Apart from a relatively small sum of £3,939 all the directors’ loans had been repaid.

Two weeks later Evans referred another dispute to adjudication. That dispute related to the failure to agree the final account, and by a second award dated 15 May 2011 the same adjudicator awarded Evans a total sum of £122,670.15.

The current joint liquidators were appointed on 20 June 2011 replacing earlier liquidators. In the course of his investigations into the company one of the joint liquidators became concerned that the dividend of £75,000 that the company had paid to Mr and Mrs Jones on 1 June 2010 had been unlawful. There were two reasons for his concern. First, the company’s statutory accounts showed an available distributable profit of £57,934 as at 31 May 2010. Second, the company’s accounts made no provision for any possible liability in the face of Evans’ claim for £191,487-odd. When the allegation that the dividend had been unlawful was put to Mr Jones he denied it, first in correspondence from his solicitors, and then in his witness statement of 22 August 2013. It was not until shortly before trial that on 6 March 2014 Mr and Mrs Jones accepted that the dividend had indeed been unlawful.

In preparation for the trial the parties instructed a single joint expert, Mr Roger Isaacs to prepare a report on the solvency of the company at the various dates in play. Mr Isaacs is an accountant and licensed insolvency practitioner, and he made it clear that his report was confined to matters of accountancy and the preparation of accounts. In effect the exercise that he carried out was to reconstruct the company’s accounts to determine what they would have shown if they had been prepared in accordance with UK Generally Accepted Accounting Practice (“UK GAAP”). As I have said the company’s accounts made no provision for any liability to Evans. Mr Isaac considered that this aspect of the accounts failed to comply with Financial Reporting Standard 12 (“FRS 12”). Although FRS 12 did not apply directly to the company, equivalent provisions did. Mr Isaac’s view was that whether to make a provision for a debt to Evans would have been a matter of judgment, but that in order to comply with UK GAAP that judgment had to be made on a reasonable basis. Having considered the material before him he took the view that it was unreasonable to have made no provision at all. The level of provision that should have been made would have depended on the advice that the company received about the claim. It could have been perhaps £50,000 or even £100,000; but it would have been difficult to have justified making a provision of less than £20,000. He went on to consider a number of other accounting issues which have played no part in the argument. Based on his overall conclusions he then reconstructed the company’s balance sheets as he thought they ought to have been presented. In carrying out that reconstruction he allowed a constant sum of £20,000 by way of provision for the Evans debt. Having done that he concluded:

On this basis, the company was insolvent on a balance sheet basis at three of the four dates in play. However, Mr Isaacs then considered the question of the dividend. He first concluded that there were insufficient distributable reserves to justify the payment of the dividend. He then considered the consequences that followed from that. In relation to each of the three dates on which the company appeared to be insolvent on a balance sheet basis he said:

“If, however, one were to treat, for accounting purposes, the dividend that was paid on 3 June 2010 as being unlawful and therefore void, the result would be to increase the net assets of the Company by £75k, thereby returning it to solvency.”

Mr Isaacs was asked to clarify this conclusion which he did by e-mail on 12 March 2014:

“My reference to the dividend being void is intended to refer to my understanding that if the dividend was unlawful then it could not be treated (for tax purposes at least) as a dividend. Were HMRC to consider the matter, it would require that the transaction be categorised as something other than a dividend and probably as a loan to the person to whom it was paid. In other words, if a dividend is unlawful, then for tax purposes it is not capable of being treated as a dividend.”

It was apparently in the light of this report that, as I have said, Mr and Mrs Jones conceded on 6 March 2014 (some three and a half years after the dividend had been paid) that it had been unlawfully paid. They offered to repay it to the company and asked for time to do so.

The judge heard evidence before reaching his conclusions, although Mr Isaacs was not required to give oral evidence. He was unimpressed by the evidence of Mr Jones whom he regarded as “singularly unimpressive”. He found that when Mr Jones had given information to the company’s accountants in December 2010 for the purpose of preparing the accounts he had included a figure of £68,000 as provision for the Evans claim. Based on that, the judge considered that the provision that should have been made in the accounts was not the minimum figure of £20,000 that Mr Isaacs had used, but was £68,000. That would have increased the deficiency as at June and October 2010; and would have turned the small surplus in March 2011 into a deficiency.

However, the judge noted that it was common ground that Mr and Mrs Jones had at all times held the unlawful dividend on constructive trust for the company and were under a duty to convey it as directed by the company. He concluded in paragraph [15] as follows:

“The statutory scheme is clear in my judgment. It was unlawful to pay the dividend on 1 June 2010, and it has remained unlawful at all material times since. The Joneses held the dividend on trust for and liable to repay it to the company. In assessing whether at the time of any of the payments, made subsequently, the company was insolvent, regard must be had not only to the amount of its liabilities, but also to the value of its assets. The amount of the unlawful dividend was, in my judgment at the time of each of the payments, an asset of the company.”

The judge also made adjustments to Mr Isaacs’ figures to take account of work in progress. In their revised skeleton argument of June 2015 Mr Bompas QC and Ms Davies, on behalf of the liquidators, set out a table of the figures which I reproduce. The table shows the dates of the various sales and payments and the amount of each. The table also shows in italic font, in the last column, the company’s net liabilities (or net assets in one case) at the date of each of the payments as explained by Mr Isaacs. In the last column the table shows in ordinary font those same figures, but adjusted by substituting a provision of £68,000 for the WJG Evans debt in the place of the £20,000 minimum included by Mr Isaacs and further adjusting for work in progress (as the judge did) when the company still had any. All the figures in the table ignore the dividend of £75,000. These figures remained unchallenged until shortly before the hearing of the appeal; and seem to me in any event to be soundly based on the evidence called before the judge. Although Mr Sims QC, for Mr and Mrs Jones, submitted that if we were to engage with detailed figures we should remit the case for further argument at first instance, I do not think that it is necessary to do so. If there were to have been any challenge to the table it should have been made much earlier than it was.

The table shows that at each of the dates in question, and leaving aside the unlawful dividend, the company was insolvent on the balance sheet basis. Thus the result of treating the company as having an asset worth £75,000 at the date of each of the payments was to return it (notionally) to solvency. The judge declined to take into account the amount that the adjudicator actually awarded Evans because, he said, it was not permissible to use hindsight in determining whether the company was unable to pay its debts at any particular date. In so saying he relied on the decision of Mr Colin Edelman QC, sitting as a deputy High Court Judge, in Deiulemar Shipping SpA v Transfield ER Futures Ltd [2012] EWHC 928 (Comm). Deiulemar was a case which concerned the interpretation of the definition of an “Event of Default” in six forward freight agreements. An Event of Default would occur if a party or a party’s credit support provider became insolvent or unable to pay its debts or failed or admitted its inability generally to pay its debts as they became due. Mr Edelman applied the test laid down by the Court of Appeal in BNY Limited v. Eurosail Plc [2011] 1 WLR 2524: namely that a company was only to be regarded as balance sheet insolvent when it had reached the point of no return because of an incurable deficiency in its assets. One question that arose was how to deal with contingent liabilities in making that assessment. Mr Edelman dealt with that as follows:

[28] … It is wholly unrealistic to suggest that the assessment of whether or not a party is insolvent for the purposes of an “Event of Default” is to be judged by reference to events which occur after the date as at which the question of the existence of insolvency falls to be judged. If, of course, a reasonable commercial person would regard the defence to a disputed liability as being fanciful as at the time of the alleged Event of Default, the liability would fall to be taken into account in full for the purposes of the assessment of insolvency. If, however, as at the time for the assessment of the existence of an Event of Default, a reasonable commercial person would consider that there were reasonable grounds for disputing the asserted liability, it would fall to be treated as a contingent liability in respect of which some assessment would have to be made as part of the process of deciding whether the party had indeed reached “the point of no return”.”

Mr Bompas advanced two main arguments in support of the liquidators’ appeal. First, he argued that at the various dates at which the solvency of the company was in question the potential liability of Mr and Mrs Jones to repay the unlawful dividend was unknown. Since Mr and Mrs Jones both believed until the delivery of Mr Isaacs’ report that the dividend was lawful, there would have been no occasion to investigate the question of the lawfulness of the dividend. That came about only because of subsequent events and in particular the company’s entry into insolvent liquidation and the appointment of the current joint liquidators. Even then, Mr and Mrs Jones disputed liability until shortly before trial, and recovery of the money had involved substantial expenditure on costs by the company. Merely to characterise them as being liable to account as constructive trustees did not mean that at the various dates in question there was an asset which the company could, at any of those dates, have deployed in payment of the company’s debts. Second, he argued that there was a logical inconsistency in the judge’s judgment because his assessment of the nature of the unlawful dividend as an asset of the company was itself an exercise in hindsight. Since he had disavowed the use of hindsight in the assessment of the value of the Evans claim, he ought to have done the same in dealing with the unlawful dividend.

Mr Sims argued that the judge was right to have treated the dividend as he did. The liability of Mr and Mrs Jones was simply an application of the law to the facts as they were; and those facts were all in existence at each of the dates at which the solvency of the company was in question. In any event the judge was entitled to deploy hindsight where it was appropriate to do so: Philips v Brewin Dolphin Bell Lawrie Ltd [2001] UKHL 2, [2001] 1 WLR 143 at [26]; Re Thoars (deceased) [2002] EWHC 2416 (Ch), [2003] 1 BCLC 499 at [17]. Mr Edelman’s view may not be the last word on the subject particularly where, as here, the court is engaged in a retrospective exercise whose starting point is that the company is in fact insolvent and known to be insolvent. The judge was entitled to conclude that it was appropriate to use hindsight to the extent that he did both in analysing the nature of Mr and Mrs Jones’ liability to account for the unlawful dividend and in assessing what provision ought to have been made on account of the disputed Evans claim.

The correct approach to section 123 of the Insolvency Act 1986 is now the subject of authoritative guidance in BNY Corporate Trustee Services Ltd v Eurosail-UK 2007-3BL plc. We were referred to that decision at all its stages: before Morritt C [2010] EWHC 2005 (Ch), [2011] 1 WLR 1200; the Court of Appeal [2011] EWCA Civ 227, [2011] 1 WLR 2524 and the Supreme Court [2013] UKSC 28, [2013] I WLR 1408. The case concerned the interpretation of a contractual provision which incorporated the definition in section 123 (1) (e) and 123 (2). The company had entered into a number of swap agreements with Lehman Brothers which filed for bankruptcy protection in the USA. It had made claims in the liquidation of Lehman Brothers, and one of the questions was how those claims were to be taken into account. Morritt C said at [30]:

“First, the assets to be valued are the present assets of the company. There is no question of taking into account any contingent or prospective assets. …The subsection provides no guidance as to the basis of that valuation. As the assets in question are those of the company presumably they are to be assessed at their value to the company but whether on a going concern or break-up basis is unclear. That problem does not arise in this case due to the nature of the issuer's business and its assets. What does arise is the question whether the claims of the issuer in the liquidation of Lehman Brothers are present assets and if so their value. In my view they are clearly existing assets notwithstanding that they have not been admitted. Their present value may be more debatable but the evidence suggests that unadmitted claims are being traded on a secondary market at 35% to 37% of their face value (subject to recourse requirements to the seller). I can see no reason why they should not be included in the assets of the issuer at that value.”

The proposition of law was that contingent assets cannot be taken into account. If there is a present asset consisting of a chose in action (such as a claim in a liquidation) it can be given a value, and what it fetches in a market is good evidence of that value. In the Court of Appeal Lord Neuberger MR took the same approach at [70] and [71]. I note in passing that the claims in the Lehman Brothers liquidation were not shown as assets in the company’s accounts, but nevertheless the court took them into account at the value at which the claims were trading. Nothing was said to cast any doubt on the proposition of law that Morritt C stated in paragraph [30] of his judgment. In the Supreme Court Lord Walker gave the leading judgment. At paragraph [39] he referred with apparent approval to Morritt C’s exposition of the law (including paragraph [30]); and noted at [40] that the Court of Appeal had not disagreed with anything in the Chancellor’s judgment “so far as it related to statutory construction.” He referred again to those paragraphs at [43]. I cannot see any criticism of the proposition of law stated by Morritt C at [30] of his own judgment. Bearing in mind that section 123 (2) explicitly refers to contingent and prospective liabilities, but not to contingent or prospective assets, I consider that that proposition is correct.

How, then, should the judge have approached the question of the unlawful dividend? At the dates when he was considering the question of the company’s solvency those in control of the company (Mr and Mrs Jones) believed that the dividend was lawful. They had no idea that there was any possible claim against them. No asset corresponding to the claim was shown in the company’s accounts. There was, as Mr Bompas said, no reason for anyone to investigate whether or not such a claim existed, and there never would be unless and until the company became insolvent.

On these very peculiar facts I agree with Mr Bompas that the company’s claim was a contingent claim. It was contingent in the first place on being discovered; and in the second place on being pursued which was itself unlikely so long as Mr and Mrs Jones remained in control of the company. In effect, therefore, the asset itself was contingent on the company’s subsequent insolvency. It was a qualitatively different claim to the Evans claim which had been presented to the company. What was uncertain about the Evans claim was whether it would succeed and to what extent. To borrow Mr Donald Rumsfeld’s well-known distinction, the eventual amount of the company’s liability to Evans was a “known unknown”; but the claim against Mr and Mrs Jones was an “unknown unknown”. The judge should not have taken it into account.

In addition, however liberal an approach to the use of hindsight is permissible, what is not permissible in my judgment is to rewrite history. The judge’s approach, which was to treat the company as having a present asset of £75,000 involved a number of counter-factual assumptions: first, that the unlawfulness of the dividend was known (which it was not); second that someone on behalf of the company would have pursued the claim before it went into liquidation (which they did not); third that Mr and Mrs Jones would not have disputed the claim (which they did); fourth that the monies would have been recovered from Mr and Mrs Jones without cost (which they were not); and fifth that the company had the funds to pursue the claim (which the statement of affairs clearly said that it did not). If the sum of £75,000 is removed from the company’s notional balance sheet, then it was insolvent at each of the dates in question.

One of the lessons that emerges clearly from Eurosail is that the statutory test in section 123 must not be mechanistically applied, but must be applied in a way that has regard to commercial reality: Lord Neuberger at [62], which I do not think was criticised in the Supreme Court. In the course of his judgment at [33] Lord Walker referred to the “perceptive” judgment of Briggs J in Re Cheyne Finance plc [2007] EWHC 2402 (Ch), [2008] Bus LR 1562. In the course of that judgment Briggs J pointed out at [51] that even though a company may continue to pay its debts it may yet be “on any commercial view insolvent”. See also Bucci v Carman [2014] EWCA Civ 383, [2014] BCC 269 at [28]. In my judgment the judge’s treatment of the unlawful dividend failed to accord with commercial reality.

For those reasons I would allow the appeal.

At the hearing of the appeal Mr Bompas sought to introduce an amendment to his grounds of appeal, to the effect that if it were permissible to use hindsight when evaluating a contingent asset or liability, the judge ought to have included the debt to Evans at the full amount awarded by the adjudicator. That amendment had not been foreshadowed before the hearing. Mr Sims opposed the amendment on the ground that there were materials before the judge (which were not before us) which he would have wished to deploy in resisting that argument. Although the argument has logical attractions, and some support in the authorities, we were not satisfied that Mr and Mrs Jones’ position could be adequately safeguarded in the light of Mr Sims’ submissions. Accordingly we refused permission to amend.

I agree.

I also agree.