British Aviation Insurance Company Ltd, Re

The British Aviation Insurance Company Ltd (“the Company”) was incorporated in 1930. As its name suggests, it writes insurance and reinsurance in the aviation sector. Since 1 January 2002 it has ceased to write any new business; and has been in run-off. The Company is a private company, owned directly or indirectly by three major insurance companies: Royal & Sun Alliance Insurance Group plc (57.10%); AVIVA plc (38.14%) and AXA Investment Managers UK Holdings Ltd (4.76%).

The Company applies to the court for the sanction of a scheme of arrangement which it proposes to make with some of its creditors, in relation to certain classes of insurance and reinsurance business. The proposed scheme does not encompass the whole of the Company’s business. The scheme has been notified to the Financial Services Authority, which raises no objection from a regulatory point of view. The scheme is opposed by a number of creditors. I am told that this is the first case in which a scheme of this kind, in relation to a solvent insurer, has been opposed. The grounds of opposition are directed both at the court’s jurisdiction to sanction the scheme; and at the merits (or lack of them) of the scheme itself which, it is said, should persuade the court, as a matter of discretion, to refuse to sanction the scheme.

The Company wrote mainly aviation direct business or facultative reinsurance and was a recognised lead underwriter in the aviation risks in which it participated. The categories of risk underwritten by the Company (both directly and as reinsurer) included the following: hull; war risks; liability for passengers; third parties and baggage/cargo; airport liabilities; product liability cover; personal accident cover; loss of licence and cargo all risks insurance. The Company’s main potential liabilities affected by the scheme are claims and potential claims by policyholders in the USA under product liability and general liability insurance covering potential exposure to claims arising out of exposure to asbestos, pollution and other health hazards.

The Company also underwrote business through a Canadian branch from 1942 until the branch went into run off on 1 January 2002. Although the Company issued some 9,500 policies to Canadian residents after 1985, it is likely that there are currently only two Canadian resident creditors likely to be affected by the scheme; with known claims arising under business written by the Canadian branch with an aggregate reserve of CAN $360,000.

The evidence in support of the petition includes a table of the Company’s estimated liabilities:

The Company says that about 92 per cent of its asbestos liabilities are owed to direct insureds, all of whom are resident in the USA. The remaining 8 per cent of these liabilities arise under reinsurance policies issued by the Company. Mr Cracknell (a director of the Company) says that the Company has “current claims” arising under Scheme Business from 459 policyholders, the majority of which are in the USA and the UK, most of whom will have more than one claim.

The Company is solvent. Its audited balance sheet as at 31 December 2004 shows total assets of £227,136,000 as against total liabilities to third parties of £125,997,000. The Company’s total net assets in respect of all its business, including Scheme Business, were more than £100 million. This is just under double its estimated liabilities for Scheme Business.

The insurance and reinsurance policies underwritten by or on behalf of the Company for the United States and Canadian aviation industry that comprise the Scheme Business were primarily policies of a kind called “occurrence” policies. This type of policy provides unlimited prospective coverage against claims relating to the risks covered by the policy (for example, asbestos, chemical and product liability) as long as the underlying act or omission happened during the relevant policy period. These claims (known as long-tail claims) typically arise and are asserted years or even decades after the claimant’s latent exposure to the allegedly hazardous substance. This kind of policy is to be contrasted with a “claims made” policy, which covers only claims made during the period covered by the policy. An “occurrence” policy is a particularly valuable kind of policy, for which policyholders are prepared to pay (and did pay) a higher premium.

The kind of business covered by the scheme is principally related to the amounts claimed in the United States of America from U.S. policyholders and others under product liability and general liability insurance in respect of potential exposures to various environmental type liabilities such as Asbestos, Pollution and related Health Hazard (AHP liabilities). These potential claims are covered under occurrence policies.

Occurrence policies (at least for these kinds of claims) are no longer available in the market at any price.

Claims under insurance or reinsurance contracts of this kind may fall into one of three classes:

“unsettled paid claims”. These are losses for which the Company would be liable to indemnify a policyholder under an insurance or reinsurance contract, where the amount of the claim has already been ascertained, and the liabilities both of the policyholder to the claimant and of the Company to the policyholder have been established;

“outstanding losses”. These are claims that have been reported to a policyholder and for which the Company may be liable to indemnify the policyholder under a contract of insurance or reinsurance, but where there is not yet any established liability; and neither the quantum of the claim nor the Company’s liability to indemnify the policyholder has yet been agreed; and

“incurred but not reported” claims (“IBNR claims”). These are potential claims where the event giving rise to the policyholder’s liability (e.g. exposure to asbestos) has already taken place, but where no claim has yet been made against the policyholder or reported to the Company.

The Company has met and continues to meet its contractual liabilities in full. If the scheme is not sanctioned, there is no reason to suppose that it would not continue to do so in the future. The Company has promoted the scheme on the basis that it is solvent and is able to meet all its liabilities in full. Its estimated liabilities in relation to business covered by the scheme are some £53 million ($93 million).

It is an important consideration that the scheme does not include the whole of the business written by the Company. As regards business excluded from the scheme, the Company will remain in conventional solvent run-off.

It is common ground that asbestos related injuries are often latent for long periods before their existence becomes known; and the most serious asbestos related diseases, mesothelioma and lung cancer, usually do not appear until 30 or 40 years after exposure. In the aviation sector, the products which are typically alleged to have caused asbestos related diseases are brakes and other friction products, together with gaskets. Exposure to asbestos in aircraft hangars can also give rise to claims. The majority of claims are made by aviation mechanics who have been exposed to these products; although family members, who have been exposed to contact with a mechanic’s clothing, also make claims.

According to Dr Rabinovitz, the expert for the opposing creditors, aviation equipment manufacturers were not made defendants in the first or even the second wave of asbestos litigation that dates back to the 1970s. New asbestos claims, caused by exposures from the 1940s to the 1970s, are expected to continue to arise until about 2049; and aviation asbestos claims are expected to extend yet further into the future because asbestos continued to be used in aviation products into the 1980s, long after asbestos had been banned in other products. While the manufacturers of aviation products were not among the “traditional” primary asbestos defendants (most of whom are now bankrupt), the first non-traditional defendants were sued in the 1980s; and companies in the aviation industry are now being named in potentially very large and expensive claims and lawsuits. She characterises these claims as “an immature mass tort”. Mr Sanders, the Company’s expert, disagrees. He considers that there is a limited pool of potential claimants; and that it is obvious that, if a claim is brought, it will be brought against a well-known manufacturer of aviation products, such as Boeing, McDonnell Douglas, Lockheed, Honeywell or Goodyear. It is common ground that there was a surge of such claims in 2003. Dr Rabinovitz considers that claims of this nature are likely to increase in frequency, whereas Mr Sanders thinks that the surge was “one-off” and that an actuary, measuring probabilities, can take account of this in a number of different technical ways.

Dr Rabinovitz points to widely varying expressions of expert opinion presented to the US courts in asbestos cases. Whereas Dr Rabinovitz considers that the claims history in the aviation sector is too short and too small to allow reliable estimates of future liability to be made, Mr Sanders disagrees.

It is, however, important to note the extent of his disagreement. Mr Sanders accepts that the valuation of future claims involves a degree of uncertainty; and that the uncertainty will be greater in the case of claims that do not have a lengthy claims history. Claims of this kind go back to 1998. However, he says that the level of uncertainty relating to asbestos claims is decreasing, because of a lengthening claims history. He also says that, because of the limited pool of claimants in the aviation sector, the uncertainties are reduced on that account too. His conclusion is that the uncertainty may be estimated by applying stochastic or simulation techniques. By this approach a range of outcomes can be estimated. He considers that the range of outcomes for asbestos claims arising out of product liability in the aviation sector is unlikely to be significantly greater than the range of estimates for other asbestos liabilities.

Mr Powell, the actuary who was the “principal architect” of the Estimation Methodology for which the scheme provides, said:

None of these witnesses was cross-examined. I cannot choose between them. It seems to me that I should approach the decision that I have to make on the basis that each of them has expressed a reasonable and tenable view.

The following description of the scheme is largely taken from the Explanatory Memorandum which accompanied it.

The business covered by the scheme (“Scheme Business”) is insurance and reinsurance business underwritten by the Company during the period 24 February 1930 to 31 December 1990; and by its Canadian branch up to and including 31 December 1991. The scheme will bind all Scheme Creditors of the Company in respect of any claim against the Company arising under or out of an insurance contract written by the Company as part of Scheme Business. This includes liquidated and unliquidated claims; both present and future. The claims will be valued as at 31 December 2004 (“the Ascertainment Date”).

Scheme Creditors must notify their claims within 120 days after the scheme comes into operation (“the Bar Date”). If they do not, their claims will be valued at nil; and will be deemed to have been paid in full. Each Scheme Creditor must submit a claim form in support of a claim. The claim form must be accompanied by documents and information of a kind set out in the “Estimation Methodology” annexed to the Scheme. Scheme Creditors must:

identify each insurance contract, together with broker details, under or in relation to which its claim in relation to a Scheme Liability arises;

specify the amount of each Scheme Liability arising under or in relation to each insurance contract;

supply documents and other information in accordance with the Estimation Methodology; identify and specify details of any security interest, letter of credit, trust, set-off or counter-claim and any other sums owed to the Company which will be set-off under the Scheme in reduction of the Scheme Liabilities of that Scheme Creditor.

Scheme Creditors are also required to provide values, estimates and supporting information relating to their Scheme Liabilities as at the Ascertainment Date.

The claim will be considered by the Scheme Manager. The Scheme Manager will review each claim form in accordance with the Scheme and the Estimation Methodology. If the Scheme Manager agrees with the information given in a Claim Form and any supporting documentation, including amounts in relation to set-off, it will notify the relevant Scheme Creditor in writing to that effect as soon as is reasonably practicable.

If the Scheme Manager does not agree with all or part of the information given in a claim form or requires further information, it will notify the relevant Scheme Creditor in writing, specifying the matters which are not agreed, the reasons for failing to agree such matters and any additional information or documentation required. If a Scheme Creditor fails to provide the additional information requested by the Scheme Manager, the Scheme Manager can make a determination about the Scheme Creditor’s Scheme Liabilities based on the information it has available.

The Scheme Manager will consider, amongst other things, the Company’s books and records, and whether there are any estimates relating to future or contingent Scheme Liabilities are reasonable; and whether there are any amounts owing (whether actual, future or contingent) by that Scheme Creditor to the Company.

In case of dispute the dispute is to be referred to the Scheme Adjudicator. The Scheme Adjudicator will review the Scheme Manager’s review of the disputed claim or matter and where relevant may apply the Estimation Methodology to determine what constitutes a reasonable estimate of the Scheme Creditor's Scheme Liability. The Scheme Adjudicator is an independent actuary, well-known in this field. The Scheme Adjudicator may request additional information where required from the Scheme Creditor, the Scheme Manager, the Company and/or the Company's actuaries; or may require the Scheme Creditor or Scheme Manager and/or the Company's advisors/actuaries to appear before him to address him on such matters as he determines.

A final determination in respect of each disputed Scheme Liability will then be made in accordance with the Dispute Resolution Procedure contained in the Scheme and the Scheme Adjudicator's decision will be final and binding in so far as the law allows.

Once all Scheme Liabilities of a Scheme Creditor have been determined (whether through agreement or adjudication) and, after the application of any right of set-off, counterclaim or deduction as provided for by the Scheme, those net Scheme Liabilities will become the Established Liability of that Scheme Creditor which will be payable in full to that Scheme Creditor. A discount for the time value of money will be applied to payments made under the Scheme. This will be calculated by applying a discount rate to the expected future payment pattern associated with the Scheme Liability under consideration. This process may be simplified by using an average time to payment as appropriate.

A typical discount rate for net present value calculations would ordinarily be based on the long term bond rate. The Company will however use a lower rate which may be advantageous to Scheme Creditors who will benefit from the difference between a commercial discount rate and the actual rate applied by the Company.

The Scheme also contains a prohibition on the bringing of any legal proceedings against the Company. Accordingly, the evaluation and payment of the claim under the Scheme replaces all the policyholders’ existing legal rights.

If, at any time before the Company makes any payment in respect of an Established Liability, the Company believes that the Scheme is no longer beneficial to it, the Company may send notice to all Scheme Creditors of whom it is aware that the Scheme will terminate.

In the event of such notice being given, no payments will be made under the Scheme and Scheme Business will revert back to being run-off in the manner as it was prior to the Effective Date.

The Company has information about policyholders, derived from a number of sources. These include some 300,000 index cards; and a computerised database. The former contain basic details such as the name of the insured and the amount of premium paid. The latter contains details of some 37,000 claims against the Company, of which claims from 459 policyholders are still extant. Over a period of some 18 weeks a team of personnel seconded from Price WaterhouseCoopers (“PWC”) logged policy details and searched for addresses of policyholders. They managed to find 17,500 addresses of policyholders (not all of which were up to date). PWC estimated that these addresses constituted 32 per cent of policyholders. By extrapolation, this means that there must have been about 35,000 policyholders for whom the Company has no address, making some 50,000 policyholders in all.

Although the Company estimates that over 90 per cent of its potential exposure to claims relates to policyholders resident in the USA, it in fact has over 2,000 policyholders world-wide from Afghanistan to Zimbabwe; or, as Dr Johnson would have said, “from China to Peru”.

Notification of the scheme was sent to the 17,500 addresses that the Company had ascertained. Advertisements were also placed in the Financial Times and the Times (in both cases in the UK and international editions); in the Wall Street Journal and newspapers circulating in Canada; and in specialist aviation publications. The Company also wrote to 30 insurance brokers who had placed Scheme Business, asking for the names and addresses of policyholders. After some chasing, eight replied; some of whom gave details of some policyholders.

The Company intended to apply to the Court on 11 January 2005 for permission to convene a meeting for the purpose of approving the scheme. Notification of the application was sent to the 17,500 addresses on 20 December 2004, just before the Christmas holiday. The advertisements were placed on the same day.

The Company in fact appeared before Mr Registrar Nicholls on 18 January 2005. No Scheme Creditor was present or represented at that hearing. The Registrar made an order that:

the Company do convene a meeting of its Scheme Creditors, to be held on 15 March 2005 at 2.30pm at the offices of Herbert Smith, for the purpose of considering and, if thought fit, approving (with or without modification) the Scheme;

the Scheme Documentation (comprising a covering letter, the Notice of Meeting, the short-form Explanatory Statement and the Proxy and Voting Forms) be sent to all Scheme Creditors, not less than 45 days before the Scheme Meeting;

advertisements be placed in 9 publications, notifying Scheme Creditors of the Scheme Meeting and the availability of the Scheme Documentation; and

the voting procedure proposed by the Company be approved. The proposal (incorporated into the order) was that Scheme Creditors would be invited to provide supporting evidence for claims estimation which would enable the Company to consider the reasonableness of claims for voting purposes. The order incorporated the description of the process for resolving disputes in the Company’s evidence, which was:

The Chairman of the meeting was to be Mr Cracknell, one of the Company’s directors. The order did not contain any liberty to apply. No Scheme Creditor has sought to have that order set aside.

The Company duly complied with the Registrar’s order about notification of the time and place of the meeting.

The meeting, chaired by Mr Cracknell, took place on 15 March 2005 as ordered. 77 policyholders tried to vote at the meeting. 72 of them were admitted to vote. Of those 72, 46 voted in favour of the scheme (63%) and 27 (37%) voted against. The value of the claims in favour of the scheme was £36,784,826 (78.5%) and the value of claims against was £10,057,695 (21.5%).

The Chairman’s report recorded that of the creditors who were admitted to vote, a number of votes required review. These fell into two categories:

those which contained errors; and

those which were based on estimated claims, which the Company considered to be unreasonable for voting purposes.

Following review and adjustment, the revised voting figures were:

The opposing creditors asked for more information about the voting and the adjustment of claims, which was provided. This further information shows that:

Those creditors who voted consisted of 38 insureds and 34 reinsureds;

11 of the insureds voted for the scheme and 27 against. Of the 34 reinsureds, 33 voted in favour of the scheme and one against.

Of the insureds who voted for the scheme, one of the largest claimants (United Airlines) had no IBNR claim; and two (Honeywell and Viacom) did not split their claims between accrued claims and IBNR claims, but were admitted to vote their unsplit claims in full;

16 of the reinsureds (all of whom voted in favour of the scheme) are also reinsurers of the Company;

the majority of reinsureds had no or only modest IBNR claims;

those insureds who had IBNR claims, and who voted for the scheme, were (with two exceptions) admitted to vote those claims in full;

those insureds with IBNR claims, and who voted against the scheme, were admitted to vote substantially reduced IBNR claims, and in six cases their IBNR claims were disallowed completely.

The scheme is opposed by eighteen companies all of which are, I think, US corporations who are directly insured by the Company under occurrence policies. Each of them has potentially large IBNR claims. Mr Sheldon QC and Ms Stonefrost appeared for eleven of them, and Miss Nicholson for the seventh. Seven more creditors have written to support the opposing creditors. Mr Moss QC and Mr Bayfield appeared for the Company.

The grounds of opposition can be grouped under a number of heads. Like Mr Moss QC, I shall list them in chronological procedural order, rather than the order in which they are pleaded.

First, the process of notification of the initial hearing for directions on 18 January 2005 and of the proposed Scheme itself is fundamentally flawed. In particular:

The Company has identified addresses for only some one third of its creditors to whom notices have been sent.

Even where the addresses have been identified, addresses used were out of date and notices did not properly specify the intended recipient.

As regards the majority of the creditors who were not sent notices, there are potentially thousands of creditors worldwide who will have their contractual rights affected and in all likelihood extinguished without their knowledge if the Scheme comes into effect.

The advertisements placed were wholly inadequate.

Second, the information provided to the Scheme Creditors was inadequate. In particular:

The Company’s assertion that all creditors will be paid ‘in full’ is misleading.

The statement that the proposed Scheme ‘will establish a method of valuation’ is misleading.

The provision entitling the Company in its absolute discretion to revert to run-off is inadequately explained and the statement that one of the advantages to creditors of the Proposed Scheme would be ‘certainty and finality’ is wrong.

The risk that the proposed Scheme might not be effective in the United States if the orders sought under s 304 of the US Bankruptcy Code were not obtained is inadequately explained.

The disadvantages of the proposed Scheme are inadequately explained.

The notice of the initial hearing for directions did not give any information about the date or place of the hearing, failed adequately to inform Scheme Creditors of the consequences to them of the proposed Scheme or the importance of that hearing and failed to give Scheme Creditors adequate time to respond.

Third, the Court does not have jurisdiction to sanction the Scheme because the Company has failed properly to constitute the classes of its creditors. The Company has treated its Scheme Creditors as falling into a single class, whereas the opposing creditors argue that separate classes should have been constituted.

Fourth, the Court should not sanction the proposed solvent Scheme on the basis of the: “tiny minority of the Company’s creditors who voted in favour”. In addition:

The claims of opposing creditors for voting purposes were incorrectly adjusted downwards (and the Company has yet to respond to the opposing creditors’ objections to the downward adjustments).

Those who voted in favour of the proposed Scheme had special interests which were not representative of those in the position of the creditors who opposed the proposed Scheme.

Fifth, the scheme is unfair. In particular:

The Company, which is solvent and able to meet its contractual obligations as they fall due, would plainly benefit from the proposed Scheme: it would achieve certainty and finality by permanently extinguishing its contractual obligations to pay its policyholders’ long tail liabilities thereby enabling the surplus to be released to its shareholder, Royal & Sun Alliance, to the detriment of Scheme Creditors.

The insurance and reinsurance creditors of the Company also have an interest in the extinction of long tail liabilities.

By contrast, the effect of the proposed solvent Scheme on the Opposing Creditors and other long tail policyholders is that their valuable and irreplaceable insurance cover would be extinguished at a time when asbestos and other latent injury claims under the policies are beginning to materialise. The proposed Scheme involves the re-writing of contracts freely entered into by the Company and the withdrawal of the cover the policyholders bargained for. It forces upon such policyholders a commutation of their policies without their agreement and on terms that are more favourable to the Company than could be achieved by negotiation. Contrary to the Company’s assertion, it is impossible to ascertain whether policyholders with long tail claims such as those of the Opposing Creditors will be paid ‘in full’ under the proposed Scheme.

There is no methodology set out in the proposed Scheme for valuing claims, and in particular IBNR claims.

The provisions of the proposed Scheme – and in particular the scheme adjudication process – unfairly deprive the Scheme Creditors of their rights of access to the courts; of having their rights determined by an independent and impartial tribunal; and deprive the policyholders of the forum to which they are contractually entitled to have disputes determined.

The process of the administration of the proposed Scheme is shrouded in secrecy and cannot be effectively policed.

There are provisions of the proposed Scheme – such as the Company’s right in its absolute discretion to revert to run-off, the bar date, the Company’s ability to continue to commute claims, the Company’s ability to make early payments and the Scheme Adjudicator’s ability to impose costs on creditors – which are one-sided and are likely to result in the unfair treatment of creditors.

Sixth, the Company has failed to make full and frank disclosure. In particular there has been inadequate disclosure of agreements and arrangements made between the Company and creditors who were prepared to support the scheme.

Section 425 of the Companies Act 1985 says:

As Chadwick LJ pointed out in Re Hawk Insurance Co Ltd [2001] 2 BCLC 480 the approval of a scheme of arrangement is a three-stage process. Since the opposing creditors make criticisms of each stage, it is necessary to set them out. First, there must be an application to the court under s 425(1) of the 1985 Act for an order that a meeting or meetings be summoned. It is at that stage that a decision needs to be taken as to whether or not to summon more than one meeting; and, if so, who should be summoned to which meeting. Second, the scheme proposals are put to the meeting or meetings held in accordance with the order that has been made; and are approved (or not) by the requisite majority in number and value of those present and voting in person or by proxy. Third, if approved at the meeting or meetings, there must be a further application to the court under s 425(2) of the 1985 Act to obtain the court’s sanction to the compromise or arrangement. Each of those stages serves a distinct purpose. At the first stage the court directs how the meeting or meetings are to be summoned. It is concerned, at that stage, to ensure that those who are to be affected by the compromise or arrangement proposed have a proper opportunity of being present (in person or by proxy) at the meeting or meetings at which the proposals are to be considered and voted upon. The second stage ensures that the proposals are acceptable to at least a majority in number, representing three-fourths in value, of those who take the opportunity of being present (in person or by proxy) at the meeting or meetings. At the third stage the court is concerned (i) to ensure that the meeting or meetings have been summoned and held in accordance with its previous order, (ii) to ensure that the proposals have been approved by the requisite majority of those present at the meeting or meetings and (iii) to ensure that the views and interests of those who have not approved the proposals at the meeting or meetings (either because they were not present or, being present, did not vote in favour of the proposals) receive impartial consideration.

In the light of deficiencies in the practice that Chadwick LJ identified in Re Hawk Insurance Co Ltd, a Practice Statement was issued by Morritt V-C on 15 April 2002: [2002] 1 WLR 1345. The statement included the following:

The function of the court at the first stage is “emphatically not” to consider the merits or fairness of the proposed scheme: Re Telewest Communications plc [2004] BCC 342, 348 (per David Richards J). It is primarily to decide whether there should be one meeting, or more than one; and to decide the manner in which that meeting should be summoned and conducted. The requirement in the Practice Statement that the company “take all steps reasonably open to it to notify any person affected by the scheme that it is being promoted” must be read in that context. Thus, in my judgment, the extent of the notification of the application to the court at the first stage need not be as extensive as the notification that the court may order on the application at that stage. Moreover, the requirement of notification is not absolute. It applies “unless there are good reasons for not doing so”. Time and expense are, in my judgment, capable of being good reasons.

The question what is a “class” of creditors was dealt with by Chadwick LJ in Re Hawk Insurance Co Ltd. He said:

However, he sounded a note of warning. It is necessary to ensure not only that those whose rights really are so dissimilar that they cannot consult together with a view to a common interest should be treated as parties to distinct arrangements – so that they should have their own separate meetings – but also that those whose rights are sufficiently similar to the rights of others that they can properly consult together should be required to do so; lest by ordering separate meetings the court gives a veto to a minority group. The safeguard against majority oppression is that the court is not bound by the decision of the meeting. It is important that the test should not be applied in such a way that it becomes an instrument of oppression by a minority.

In the Hawk case itself, the question was whether policyholders who had contingent claims (i.e. IBNR claims) fell into the same class as those who had accrued claims. Chadwick LJ analysed closely the leading case of Sovereign Life Assurance Co v. Dodd [1892] 2 QB 573, and summarised his analysis as follows:

Chadwick LJ continued:

The Hawk case was a case of an insolvent company. So Chadwick LJ compared the rights that the contingent creditors had under the scheme, and the rights that they would have had in an insolvent liquidation. Having referred to the duty of a liquidator to get in and realise the company’s assets, and to distribute them, Chadwick LJ went on to explain that the rights of non-insurance creditors, insurance creditors with unsettled paid claims, insurance creditors with outstanding losses and insurance creditors with IBNR losses are the same in this respect: that in the context of a winding up of the company they will all be entitled to submit claims in the winding up and to have those claims admitted or rejected. The difference between the position of non-insurance creditors and insurance creditors with unsettled paid claims (on the one hand) and insurance creditors with outstanding losses or IBNR losses (on the other hand) is that, in the case of the latter, their claims are in respect of debts which by reason of their ‘being subject to any contingency or for any other reason’ do not bear a certain value and so must be the subject of an estimate. But that does not lead to the conclusion that the rights of, say, non-insurance creditors and insurance creditors with IBNR losses are different. Thus, he held, all the unsecured creditors fell into a single class for the purposes of the scheme under consideration. Chadwick LJ’s analysis of the Sovereign Life case is important; because it seems to me that in considering whether one type of creditor is in the same class as another type of creditor, Chadwick LJ recognised that rights of set-off can be taken into account. In other words, it is not simply a person’s rights as creditor of the company that are relevant, but also his obligations as debtor; at least if the one can be set off against the other.

In Re Telewest Telecommunications plc [2004] BCC 342, 351 David Richards J considered whether certain bondholders should form a separate class. Although the company was not then in liquidation, David Richards J said that “the reality is that they will not be able to enforce [their contractual] rights and that in the absence of the scheme or other arrangement their rights against the company will be those arising in an insolvent liquidation.” Thus the appropriate comparator was an insolvent liquidation, rather than the theoretical possibility that the company might remain solvent.

Mr Sheldon says that although the question of classes of creditors arises, logically, at the first stage, an opposing creditor can raise “class issues” at the third stage, even though he did not raise them at the first stage, if he has a good reason for doing so. Mr Moss agreed that there was no estoppel arising out of a failure to raise a class issue at the first stage. He said that although the court discourages the taking of technical points at the third stage, the opposing creditors are entitled to raise them since, potentially, they go to the court’s jurisdiction to approve a scheme.

In Re UDL Holdings Limited [2002] 1 HKC 172, 184 Lord Millett, sitting as a Judge of the Court of Final Appeal in Hong Kong, gave an overview of the court’s approach as follows:

Section 425 (1) requires the meeting to be summoned in such manner as the court directs. If, therefore, the meeting is summoned in the manner directed by the court, it would seem on the face of it, that section 425 (1) has been complied with. However, the conduct of and outcome of the meeting are still relevant at the third stage, as the passage I have quoted from Lord Millett demonstrates.

The opposing creditors criticise the conduct of the meeting; and in particular the valuation that the Chairman placed, for voting purposes, upon the IBNR claims of the direct insureds who voted against the scheme. This raises the question: on what grounds (if any) can the Chairman’s decision be impeached? Mr Moss accepts that the decision can be impeached if the Chairman did not act honestly; or if he acted perversely (that is, he reached a decision which no reasonable Chairman could have reached).

It also seems to me that if the Chairman did not conduct the meeting substantially in accordance with the procedure laid down by the court on the hearing at the first stage, that is an additional ground on which the vote can be impugned.

Mr Sheldon also submitted that if the claims of creditors could not be valued, the court could not be satisfied that the statutory majority of creditors by value had been attained. He relied on the judgment of James LJ in Re Albert Life Assurance Co (1871) 6 Ch App 381, in which the Lord Justice said:

The third stage does not arise unless the meeting has been held; and the statutory majority (in number and by value) of creditors have voted in favour of the scheme. So the starting point at this stage is that a majority of the company’s creditors want the scheme to be sanctioned. But even so, the cases emphasise that the court is not a rubber stamp. It has what has been described as an unfettered discretion to refuse to sanction the scheme. In Re BTR plc [2000] 1 BCLC 740 Chadwick LJ said:

In the Hawk case Chadwick LJ observed that the court should be careful not to allow a minority of creditors to frustrate the wishes of the majority, by an overzealous dissection of the creditors into classes. On the other hand in the Sovereign case, Bowen LJ said of the predecessor of section 425:

Mr Sheldon submitted that the court should not sanction a scheme if there is inherent unfairness in the scheme: Re Telewest Telecommunications (No 2) [2005] BCC 36. In determining whether a scheme is unfair, a comparison should be made between the contractual rights and reasonable expectations of the policyholders in the absence of the scheme and their rights and expectations if the scheme is sanctioned. In support of this submission he relied by analogy on the decision of Evans-Lombe J in Re Axa Equity and Law Life Assurance Society plc [2001] 2 BCLC 447, 468 (a case of transfer of business by an insurance company under the Financial Services and Markets Act 2000). Although this submission overlapped with his submissions on the identification of the relevant classes of creditors at the first stage, Mr Sheldon submitted that the same considerations could do double duty at both the first and third stages.

In Re English Scottish and Australian Chartered Bank [1893] 3 Ch 385, 406 Lindley LJ said:

In the same case at 409 Lindley LJ said:

The test that is stated in Buckley on the Companies Act (and which has been approved many times) is that the court should normally sanction a scheme if:

Thus stated, the test is not whether the opposing creditors have reasonable objections to the scheme. A creditor may be equally reasonable in voting for or against the scheme. In such a case Mr Moss submitted that creditor democracy should prevail. Where, as here, those who voted in favour of the scheme are large and sophisticated corporations, the rigid application of this test as the sole criterion would rarely, I think, enable the court to refuse to sanction a scheme. It is also not entirely clear to me how the rigid application of this test sits with statements that the court has an unfettered discretion.

Be that as it may, none of the very experienced counsel in the case was able to show me a case in this jurisdiction in which the court, having decided that it had jurisdiction to sanction a scheme, nevertheless refused, as a matter of discretion, to do so. There is one possible exception in the shape of Re Canning Jarrah Timber Co (Western Australia) Ltd [1900] 1 Ch 708 where Cozens-Hardy J refused to sanction a scheme; but after the scheme had been amended it was ultimately sanctioned by the Court of Appeal.

The first-stage application is purely procedural, and regulates the manner in which the scheme is to be presented to creditors for approval. Although it is desirable for points about separate classes to be taken at that stage, it is not essential; since they can be (and are) taken at the third stage. It remains the Company’s responsibility to identify the classes correctly; and to show the court that the manner in which the meeting (or meetings) will be summoned and conducted is acceptable. It seems to me therefore, that whatever deficiencies there may be in notification of the first-stage hearing, they go neither to the jurisdiction of the court to sanction a scheme; nor, save in exceptional circumstances, will they be critical to the exercise of the court’s discretion at the third stage.

Nevertheless, I should deal briefly with Mr Sheldon’s criticisms of the notification of the first-stage hearing. First he said that the Company had not notified enough policyholders. There are, I think, two answers to this criticism. First, the policyholders whose details were in the Company’s records included details of all the policies it had ever issued. Many of these would have been hull cover for aircraft that had long since been scrapped, or insurance for cargo that had long since been shipped. Second, if the Company had no addresses for policyholders, what could it reasonably have been expected to do at that stage? In my judgment, no more than it did. Mr Sheldon’s second criticism was that the Company did not check that the addresses it had for policyholders were up to date. Some of the opposing creditors received notification of the application by roundabout means. Nor did the Company ascertain who was the relevant contact person to whom to send notification, unless this was already known. The reason given was that it would have been too time consuming. In the context of a first stage application, these complaints seem to me to be counsels of perfection. The sending of letters also has to be seen against the backdrop that the application was also advertised in national, international, and specialist press. I am not prepared to say that, in the absence of taking these steps, the Company failed to take reasonable steps, without good reason, to notify those who might be affected by the scheme.

Mr Sheldon’s third criticism was that the Company failed to advertise in newspapers circulating in the various countries in which known policyholders resided. However, it did advertise in national, international, and specialist press; and in my judgment that was enough at that stage.

Mr Sheldon’s final criticism was that the written notification of the first-stage hearing was sent out on 20 December 2004 (just before Christmas) and asked for responses by 11 January 2005; and it did not give a date for the first stage hearing. The timing of the letter was, I agree, tight, bearing in mind the holiday season; but even allowing for that there were at least 14 working days. At the date when the letter was sent, the date of the hearing was not known; and even if it were, it might have had to have been changed if any creditor had raised class objections.

I do not regard these criticisms as carrying any real weight.

Although Mr Sheldon did not quarrel with the formulation of the relevant questions in the Hawk case, he stressed that the Hawk case involved an insolvent company (a feature that Chadwick LJ said was “essential”). He submitted that the comparison that the court must make was a comparison between the rights that creditors would acquire under the scheme (if approved); and the rights that they would enjoy if it were not. In the latter case the court should consider (and consider only) realistic alternatives. If the company in question was insolvent, then the obvious realistic alternative was an insolvent liquidation. But if the company is solvent, then that is an inappropriate comparator. In some cases, an appropriate comparator might be a members’ voluntary liquidation. But that could only be appropriate if it was a realistic possibility. In the present case, a solvent liquidation has never been put forward as a realistic alternative, although the possibility was canvassed by Mr Moss in argument. Mr Sheldon pointed out that the scheme does not encompass the whole of the Company’s business; so that it will remain in being even if the scheme is approved. The business excluded from the scheme itself includes long-tail insurance written after 1990 but before 2002, so the Company will remain in solvent run-off for many years. He also submitted that, since the Company was a subsidiary of three well-known insurers, it was unlikely that, for reasons connected with their reputation and standing in the insurance market, they would put the company into liquidation, still less allow it to go into insolvent liquidation. Since a liquidation of the Company must be a liquidation of the Company as a whole, the rights of creditors in a liquidation is not an appropriate comparator.

Under the scheme, a policyholder with an accrued claim will have that claim paid in full. If the scheme is not approved, he will still have his claim paid in full. The measure of the claim will be the amount for which he is entitled to indemnity under the policy in respect of the known claim. By contrast, the position of a policyholder with an IBNR claim is different. Under the scheme he will be entitled to have his contingent claim valued. He will then be entitled to be paid the full amount of the valuation (less a discount for the time cost of money). Although a valuation of a future (and contingent claim) can be made, and may even be described as a fair valuation, it is only a valuation. It is not an indemnity. Indeed, whatever else one may be able to say about a valuation of a future contingent claim the one thing that one can say with near certainty is that, barring a miracle, the valuation will not be the same amount as the indemnity. If, on the other hand, the scheme is not approved, the Company will remain in run-off. It will pay claims as and when they arise; and the measure of the payment will be the full indemnity to which the policyholder is entitled. It may be that anticipated claims by some policyholders will never arise; in which case the Company will not have to pay. But that is what insurance is about. The policyholder bargains for the insurer to bear the risk of a contingency materialising. The insurer is in the risk business; and the policyholder is not. Unlike the policyholder with an accrued claim, who knows the extent of his exposure to that claim, the policyholder with an IBNR claim does not. The essence of the scheme is that it retransfers the risk from the insurer (who had contracted to bear it) to the policyholder (who did not). Thus the rights of a policyholder with an IBNR claim are fundamentally different under the scheme from the rights that he would have in the absence of the scheme.

Moreover, in Hawk Pill LJ (with whom Wright J agreed) said that even in the case of an insolvent insurance company, a creditor whose claims were limited to IBNR claims might be seen as falling into a separate class from creditors whose only claims were accrued claims. This reasoning, Mr Sheldon said, applied with greater force to the case of a solvent insurer. According to Mr Dempsey’s third witness statement, the Company itself divided claims into known claims on the one hand (both unsettled paid claims and outstanding losses) and IBNR claims on the other. This was the rational way to divide creditors, because the payment and estimation of known claims, even if contingent, was relatively straightforward, whereas the estimation of IBNR claims was far more speculative, and dependent on a large number of controversial variables. The two categories of creditor could not be regarded as a single class. Mr Sheldon’s submissions on this question were supported by Miss Nicholson.

Mr Moss submitted that the appropriate comparator was the rights that the policyholders would enjoy in a solvent liquidation. In such a liquidation, they would be entitled to have their contingent claims valued and payment of the valuation in full. Under the scheme they would have the same entitlement. Indeed, they will do better under the scheme because the discount rate that will be adopted to represent the time cost of money will be more generous to the policyholders than that which would be adopted in a solvent liquidation.

Mr Moss submitted that, for the following reasons, the Scheme Creditors were correctly grouped into a single class:

All the Scheme Creditors are creditors under contracts of insurance and reinsurance entered into by the Company.

It follows that they all have similar rights against the Company arising out of claims in respect of the insurance and reinsurance policies.

All Scheme Creditors are to be treated equally under the terms of the Scheme.

Whilst it is true to say that the impact of the early valuation and payment process will vary depending upon the number and quality of the contingencies that exist in relation to each claim and that the largest number and most speculative of contingencies will arise in relation to IBNR claims, the variations in impact as between all Scheme Creditors will be infinite and impossible to quantify in advance of the claims actually arising.

Moreover, depending on whether the estimated contingencies ever arise, the impact of the early valuation process on a particular creditor may be either beneficial or detrimental. It is again impossible to know in advance of the contingencies actually arising which it will be.

The vast majority of Scheme Creditors, given that the policies all relate to long tail business that has been in run-off, will have (at least potentially) IBNR claims. Mr Dempsey’s evidence is that there are approximately 400 policyholders who have “actual or pending” claims against the Company. (I was told that the phrase “actual or pending” claims included IBNR claims, although this is not immediately apparent from the language. It contrasts with Mr Cracknell’s evidence that there are 459 policyholders with “current” claims. It seems to me that Mr Dempsey has understated the number of claims by 59, and must have been referring to the same claims that Mr Cracknell described as “current”. Moreover, the very nature of an IBNR claim, as Mr Sheldon pointed out, is that it has not yet been reported to insurers.) Mr Dempsey also says that of: “all the Scheme Creditors whose votes were taken into account at the Scheme Meeting by the Chairman, I believe that all such Scheme Creditors have or could have IBNR claims”. The nature of the policies written is such that, on any view, many of the Scheme Creditors will have both IBNR claims and non-IBNR claims. The mere fact that a Scheme Creditor has submitted one or more claims already is no indicator that it will not submit claims in the future. This substantial overlap between Scheme Creditors with actual and potential claims makes it impossible, in practice, to identify cleanly a separate “class” of Scheme Creditors with potential claims from those with actual claims. Further, the fact that most Scheme Creditors fall into both categories emphasises the fact that they are capable of consulting together in their common interest.

Accordingly, notwithstanding the different impact the early valuation process might have on different types of Scheme Claim, this is insufficient to render the Scheme Creditors unable to consult together with a view to their common interest, given the features of the Scheme Claims and the treatment of them, that are shared by all Scheme Creditors.

Mr Moss accepted that if the scheme is sanctioned, Scheme Creditors would have different rights under the scheme from the rights that they would have had in a “no scheme world”. But although their rights would be different, it would be the same difference for all of them. Accordingly, there was no need to separate them into different classes.

In my judgment the starting point is to identify the appropriate comparator. This is critical to deciding whether all the policyholders form a single class. In Hawk the appropriate comparator was an insolvent liquidation because the company was insolvent. In Telewest it was also an insolvent liquidation because that was the real alternative to the scheme. On that basis, the rights to which policyholders with IBNR claims would be entitled are the right to have their claims valued; and the right to a dividend based on the value of the claim. Those with accrued claims would be entitled to the same dividend. The same may well be true in a solvent liquidation, although Mr Sheldon said that in a solvent liquidation there is no compulsion on a liquidator to make an early distribution. But this is not, in my judgment, a case in which a realistic alternative to the scheme is a voluntary (solvent) liquidation. The only realistic alternative to the scheme, as things stand, is a continuing solvent run-off. In my judgment that is the appropriate comparator.

In a solvent run-off, policyholders with unsettled paid claims will be entitled to have their claims paid in full. They will have exactly the same right under the scheme. The risk against which they insured has materialised and the extent of the liability has been quantified; and all they have to do is to collect the insurance proceeds. They incur no further risk. So the scheme does not disadvantage them in any way. For them the so-called compromise is not much of a compromise if it is a compromise at all. Policyholders with outstanding losses are in a slightly different position. There is no need to estimate the probability of a claim arising; that is already known. Their right in a solvent run-off is to wait until the quantum of the claim had been determined; and then to claim indemnity from the insurers. Under the scheme they will have to accept an estimate of that quantum instead; but they will not have to accept any estimate of the likelihood of a claim being made at all. This removes one of the greatest of the uncertainties from the process of estimation. There is some risk that an estimate will prove to be inaccurate; but it is a small one.

So far as policyholders with IBNR claims are concerned, their right in a solvent run-off is to wait and see whether a claim materialises, and if it does, to have a full indemnity against the claim. They have already paid their premiums for the insurance cover, so they are at risk of no further expenditure in relation to a valid claim. Under the scheme they will receive cash up front. It may be an amount that is greater than or smaller than the liabilities that eventually materialise, but it will not be the same. The risk of inadequate resources to meet such liabilities is retransferred from the insurers to them. So the scheme may well disadvantage them.

I do not consider that the fact (if it is a fact) that policyholders may have both accrued claims and IBNR claims is of any great moment. The evidence is directed only at those policyholders who actually voted at the meeting. Mr Dempsey’s evidence goes no further than to say that all those who voted “could have” both accrued claims and IBNR claims. At least one of the direct insureds who voted in favour of the scheme (United Airlines) had substantial accrued claims, but no IBNR claims. An examination of the votes allowed also shows that some creditors had very modest accrued claims but substantial IBNR claims. So although they may be as important numerically when considering the statutory majority of creditors by number, whether there is one meeting or two; they may have greater influence when considering the majority of creditors by value, if separate meetings of policyholders with accrued claims and creditors with IBNR claims are held. Moreover, an analysis of the votes cast at the meeting by some 15 per cent of policyholders with known claims is not an adequate basis for safely concluding that there are no creditors who only have IBNR claims. A known claim is, after all, a reported claim, whereas an IBNR claim is not. The fact that a creditor may fall into more than one than one class does not, in my judgment, mean that separate classes are inappropriate.

In my judgment in the particular circumstances of a solvent scheme, where a solvent liquidation is not a realistic alternative, those with accrued claims and those with IBNR claims have interests which are sufficiently different as not to make it possible for them sensibly to consult together “in their common interest”. In truth, they do not have a common interest at all.

As I have said the Company’s insurance contracts were both contracts of insurance and contracts of reinsurance. But Mr Sheldon said that some of the reinsureds are also reinsurers of the Company. As reinsurers, they have a clear interest to cap their own liabilities to the Company under their own reinsurance contracts. Thus they are in a position of conflict (or at least neutrality, since the cap on their entitlement as reinsured will be matched by a cap on their liability as reinsurers); whereas a direct insured who caps his entitlement against the Company will remain exposed to uncapped liability at the suit of one who makes a claim for personal injury. So also will a reinsured who is not also a reinsurer. Moreover any payment made under the scheme will be made after taking into account set-off. Thus it is not just a question of different economic interests; it is a case of direct impact on legal rights. Those reinsureds who were also reinsurers ought to have been constituted as a separate class. Miss Nicholson did not support Mr Sheldon’s submission on this point.

Mr Moss submitted that, legally, both direct insureds and reinsureds constituted a single class of unsecured creditors, each of whom had the same right of indemnity against the Company in respect of insured risks. It is true that set off will be applied to those reinsured who are also reinsurers; but it is only those reinsureds who, after the application of set-off, were adjudged to be net creditors of the Company at the time of the scheme meeting who were admitted to vote. As net creditors of the Company, it did not matter how the net position arose. They also had the same economic balance to make as the direct insureds. In each case it was a question of choice between certain cash now and uncertain cash later. If the reinsureds choose cash now (as overwhelmingly they did), they will recognise that they are losing their reinsurance cover.

I have found this a difficult question, but in the end I have been persuaded by Mr Moss that a separate class for reinsurers could not be justified, for the reasons that he gave. But the fact that some members of a class have personal or special interests in supporting the proposals may be relevant at the third stage, when the court exercises its discretion in sanctioning (or refusing to sanction) the scheme.

Mr Sheldon also submitted that the exclusion of the scheme of certain parts of the Company’s business was arbitrary and irrational; and for that reason also the scheme meeting had not been properly convened. However, it is for the Company to choose the creditors with whom it wishes to enter into a compromise or arrangement; and the evidence shows that they had rational reasons for selecting the categories of business to include within the scheme. The Company’s evidence has not been challenged; and in those circumstances, this criticism fails.

I conclude nevertheless that the single scheme meeting was not properly constituted. It follows, therefore, that I must hold that I have no jurisdiction to sanction the scheme. However, in case I am wrong, I must go on to consider the other grounds of objection.

As I have said the requirement of the Act is that the meeting be summoned in such manner as the court may direct. It was. It follows, in my judgment, that no criticism of the steps taken to publicise the meeting can deprive the court of jurisdiction to sanction a scheme. However, any perceived deficiencies in the publicising of the meeting can, I think, be taken into account at the third stage. If, for example, creditors are to be notified by post; and there is a lengthy postal strike, that must be something that the court can take into account in considering whether to sanction the scheme.

Mr Sheldon directed his initial criticisms at the circular letter of 20 December 2004 announcing the proposal for the scheme. This criticism seems to me to be misplaced. The requirement to send an explanatory memorandum arises under section 426 (2) of the Act. That applies to the notice summoning the meeting for which the court has given directions at stage one. It does not apply to an advance notification before stage one is even reached. I think that Mr Sheldon ultimately agreed with this.

So far as the explanatory statement itself is concerned, Mr Sheldon submitted that it was flawed. He said that although it stated that one of the advantages of the Proposed Scheme for Scheme Creditors would be “certainty and finality” that was wrong. The scheme gives the Company a right, to be exercised at the Company’s “absolute discretion” to opt out of the scheme, bring the scheme to an end and to continue with the run-off. Thus whether the sanction of the Scheme ends the run-off for all time depends on what the Company unilaterally decides to do in the future. However, the Explanatory Statement does, in my judgment, state clearly that the Company may decide to terminate the scheme and revert to run off. The creditors are assumed to be intelligent, when it comes to the third stage of sanctioning the scheme; and I think that they may be assumed to have had the same intelligence at the preceding stages. Although it may be too much to expect creditors to read the small print of the scheme itself, they can I think be expected to read the Explanatory Statement as a whole. Had they done so, they would have seen the Company’s right to terminate the scheme clearly explained.

Mr Sheldon also criticised the statement that creditors would be paid in full. It is accepted on all sides that there is uncertainty in estimating the present value of future contingent claims. The Explanatory Memorandum itself recognises that a creditor who is bound by the scheme and submits a claim which is valued could ultimately receive a greater or smaller amount in respect of its Scheme Liabilities than would have been the case had the Scheme Business been run-off in the traditional way. This is highlighted as one of the possible disadvantages of the scheme. There are therefore, in my judgment, two answers to Mr Sheldon’s point. First, as I have said, creditors can be expected to read the Explanatory Statement as a whole. If they had done so, they would have seen that they might not receive as much as they would be entitled to in traditional run-off. Second, what is being paid in full is not the indemnity to which the creditors would be entitled in traditional run-off, but the estimate (or valuation) of the present value of the future contingent indemnity. As Mr Moss submitted, future claims will be estimated and payment in full will be made of the value of the claim as estimated. That this is so would be clear to the Scheme Creditors and it is difficult to see how the statement could be misunderstood. In addition, creditors with accrued claims would, indeed, be paid in full.

The opposing creditors’ principal complaint under this head was that their IBNR claims were unfairly valued at nominal amounts. Allied to this is a separate complaint that the Company gave favourable treatment to those creditors who were prepared to vote in favour of the scheme.

Mr Sheldon’s main attack in relation to preferential treatment of supporting creditors was on the treatment of Honeywell (which voted an unsplit claim of £11 million in favour of the scheme). There is nothing inherently objectionable about a company promoting a scheme from reaching agreement with some of its creditors under which they undertake to vote in favour of the scheme. But Mr Sheldon submitted that the treatment of Honeywell’s claims was different from that of other creditors who were required to provide a breakdown of the claims between accrued claims and IBNR claims; and whose claims were closely scrutinised. Honeywell was not required to provide the kind of information in support of its claim that the Company required others to provide. The evidence shows that the Company agreed Honeywell’s claim on 10 March 2005, five days in advance of the meeting. It appears from the evidence that the Company gave detailed consideration to the information provided by Honeywell before it informed Honeywell that it considered that Honeywell’s claim was “reasonable”. Much the same process applied to Viacom, which was allowed to vote an IBNR claim of $9 million.

Mr Sheldon contrasts the treatment of Honeywell and Viacom with the treatment of other insureds who voted against the scheme. He submits that of the 27 insureds that voted against the Proposed Scheme, 20 were admitted to vote their claims for $1 and/or had their IBNR claims valued at nil. This is factually correct, but it appears that many of these creditors did not claim more that $1. However Mr Sheldon goes on to say that of the eight insureds who voted against the proposed scheme and who did put a value on their IBNR claims, only one claim was accepted by the Chairman (Sabreliner at $10,000). The remaining seven claims were significantly reduced, in particular the claims made by Goodrich and Goodyear. This is also factually correct. Mr Sheldon’s ultimate complaint was, I think, that opposing creditors were not given the same opportunity to have pre-meeting discussions with the Company in order to arrive at mutually agreed values for their claims. Instead, they were required to submit claims which the Company (and ultimately the Chairman) considered and rejected, or substantially reduced, without further dialogue.

The reasons given by the Company for reducing the opposing creditors’ IBNR claims have varied; but have included:

The allocation period over which claims were spread was unreasonable. The opposing creditors say that under the law of Ohio, which governs the policies, the insured is entitled to an “all sums” basis of allocation. This principle holds that each policy in effect from the time of the allegedly harmful occurrence until the manifestation of the illness covers the entirety of the insured’s loss. The decision not to apply this principle to the IBNR claims meant that it was assumed that the opposing creditors would receive contribution from multiple insurers, whereas the “all sums” doctrine places that burden on insurers. It seems that the Company’s current position is that the “all sums” doctrine only applies to liability that has been determined by a court, and does not govern a settlement or its analogue, namely a payment under a scheme of arrangement. I confess that I do not follow the logic of the Company’s position, since the object of the scheme is to determine the Company’s legal liability to each policyholder, and that must involve an attempt to predict what would happen if disputes ended up in court. But even if the Company’s position is correct, it does not follow that the opposing creditors’ claim was unreasonable: merely that it was wrong. The legal opinion exhibited in support of the Company’s position does not go so far as to say that the opposing creditors’ view is untenable.

Some of the opposing creditors, having no claims history of their own, relied on the claims history and estimates for associated companies in estimating IBNR claims. The Company rejected these claims as being unreliable. However, although the Company rejected these claims for voting purposes, and in most cases (although not all) placed a nominal value on them, it says that claims based on precisely the same material may be admitted in order to support a claim under the scheme. This is Catch-22. One of the opposing creditors’ complaints about the scheme is that the estimation of IBNR claims is uncertain and unreliable. When they wish to deploy their IBNR claims in voting against the scheme, the Company and the Chairman reject their claims on the ground that they are uncertain and unreliable. Yet if the scheme is sanctioned, they will be permitted to present their IBNR claims on the basis of the self-same or similar material, which has already been castigated as uncertain and unreliable.

Mr Moss submitted that the admission of the claim was only for voting purposes, and did not mean that when the claim ultimately came to be valued under the scheme, it would be found to have a nominal value. But this only compounds the problem. Assuming, as I do, that the admission of the claim for voting purposes does not in any way bind the Company (or for that matter the creditor) when the claim ultimately comes to be valued under the scheme; still the purpose of the statutory requirement that a large majority in value of the creditors must support the scheme must be to ensure that there is a reasonable relationship between the size of the claims admitted for voting purposes and the size of the claims that will ultimately be allowed under the scheme. Mr Moss accepted that in an ideal world, this would be so; but said that in the real world it was an impractical aspiration.

In the case of a disputed claim the Chairman was required by the terms of the order to place a value on the claim. The notion of the Chairman valuing a claim means, to my mind, that the Chairman was required to ascribe a genuine value to the claim. Under the procedure embodied in the court’s order he was not given the luxury of saying that he did not know what its value was and placing an arbitrary $1 on the claim. Effectively to disallow IBNR claims (by valuing them at a nominal $1) on the basis that they were uncertain or unreliable is not, to my mind, valuing them at all.

Mr Moss says that if the IBNR claims of creditors were rejected for lack of reliable information, the creditors have only themselves to blame. They have the relevant data within their knowledge (e.g. the kind of products they made, and whether they included asbestos; the number of employees they had and so on). Some creditors may legitimately, and for commercial reasons, choose not to go to the trouble and expense of submitting an IBNR claim at the voting stage, whereas they will no doubt do so when there is hard cash available. The difficulty I have with this submission is that the opposing creditors did ask for more time to formulate their claims and for the scheme meeting to be adjourned; but the Company refused their request.

Mr Moss also submitted that the valuation of an unliquidated or uncertain claim at a nominal amount is common practice in schemes of this kind; and is specifically required in cases of voluntary arrangements by the Insolvency Rules. In the context of a scheme of arrangement this practice is beneficial to a creditor because it allows his vote to be counted in assessing whether the numerical majority of creditors has been reached, even though his vote may count for little in assessing the majority of creditors by value. In many cases, this may well be true. But in the context of the present scheme it is common ground that the “big numbers” relate to IBNR claims. These “big numbers” do not seem to me to have been reflected in the amounts for which opposing creditors were admitted to vote. The Company’s own estimates of its liabilities include amounts allocated on account of IBNR claims. They appear to have been used in agreeing the claims of Honeywell and Viacom, who supported the scheme. If an actual claim by a disease-ridden mechanic materialises against any of the policyholders who claim to have IBNR claims, it is inconceivable that such a claim would only be worth $1. The attribution of $1 to IBNR claims effectively means that the Company has treated the probability of an actual claim arising as being virtually nil. I have a very uneasy feeling that these IBNR claims were simply brushed aside.

Mr Moss stressed, throughout his submissions, the importance of creditor democracy. I see the force of this point; but the corollary of a fully functioning democracy is a fair and free election, where all electors are treated equally. I emphasise that this is not the normal case of creditors with ascertained debts owing by the company. Nor is it a case of creditors with known but contingent claims. The real problem is that the votes of the policyholders with IBNR claims have to be estimated using sophisticated and controversial actuarial techniques. In such a case it seems to me that the court must be especially wary of simply waving through a vote in which so many of the dissentients have had a nominal value placed on their claims.

Mr Sheldon had two further criticisms of the conduct of the meeting:

Two companies (Eagle Star Insurance Company and Dowa Fire and Marine) submitted claims; but the chairman considered that, taking set-off into account, they were likely to be net debtors of the Company; and not creditors at all. Nevertheless the Chairman admitted them to vote, although he placed a nil value on their claims. Both voted in favour of the scheme. The effect of this is that these two companies counted in the numerical majority of creditors, but not in the majority by value. Mr Sheldon submitted that once the chairman had formed the view that they were not Scheme Creditors at all, he should not have admitted their votes. However, Mr Moss retorted that the Chairman’s report went no further than to say that after the application of future set-off these two companies were likely to be net debtors of the Company. At the date of the scheme meeting, they were (or at least were potentially) net creditors of the company. One of the Chairman’s functions was to determine whether a person who claimed to be a Scheme Creditor should be allowed to vote at all. The Chairman decided that these two companies should be allowed to vote; but with a value of $1 attributed to their claims. This was not a perverse decision and was within the Chairman’s remit. I agree.

Two other companies (Royal Indemnity Company and Sea Insurance Company) were admitted to vote with claims of $25,000 and $79,696 respectively. Both these companies are subsidiaries of Royal & Sun Alliance Insurance Group plc, which is the majority shareholder of the company. Mr Sheldon submitted that although these two companies did not form a separate class of creditor, nevertheless since their parent stood to receive a substantial return of capital in the event of the outcome of the scheme conforming to expectations, their votes should be discounted. I agree that the special interest of these companies is something that I can and should take into account.

For the above reasons, I am not satisfied that the manner in which the IBNR claims of opposing creditors were treated was truly representative of their interests.

As the cases make clear, the court may, at the third stage, refuse to endorse the majority vote if it is satisfied that the meeting is unrepresentative; or that those voting at the meeting have done so with a special interest to promote which differs from the interest of the ordinary independent and objective creditor.

Mr Sheldon submitted that I should not endorse the majority vote for two main reasons. First, because the number of creditors who voted was “a minuscule proportion” of the total number of policyholders. Second, because some creditors, particularly those who were both reinsureds and reinsurers, had special interests of their own; and were not representative of the general class of creditors, in whose name they were permitted to vote.

Statistically, the number of creditors who voted can be calculated, by extrapolation, to have been approximately 0.44 per cent of policyholders (72 out of about 50,000). The number of creditors voting in favour was, on the same basis about 0.25 per cent. However, I think I must have in mind the Duke of Wellington’s warning about statistics. The figure of 50,000 is, I think, the number of policies that the Company had issued over its trading life. It may be the number of policyholders to whom the Company has issued policies, but the point is the same. The point is that not all policyholders are Scheme Creditors. Many of them will have taken out, say, hull insurance or personal accident insurance. I have already made this point when dealing with notification of the meeting. So in my judgment this statistical extrapolation is not a sound basis for impugning the meeting. It is partly demonstrated by the fact that out of 9,300 Canadian policyholders, only two are Scheme Creditors. The Company’s evidence is, as I have said, that there are about 459 policyholders or so who have “actual or pending” claims. Viewed in this way, the turnout of creditors was some 15 per cent in number; and the aggregate in value of their claims represents just over 50 per cent of the total “actual and pending” claims against the Company.

Mr Moss emphasised that voting was not compulsory. In a creditor democracy, the majority of those voting may bind the minority; and even if the majority of those voting are a minority of those entitled to vote, the result is the same. Even though a British politician might be disappointed at a turnout of 15 per cent, it was not unusual by the standards of schemes of arrangement.

I am not persuaded that the low turnout, in itself, is a valid reason for refusing to endorse the majority vote. However, the size of the turnout is relevant in considering whether the result of the vote could have been affected by collateral factors affecting some members of the class (see Re Equitable Life Assurance Society [2002] BCC 319, at 337 and 344). Consequently, the size of the turnout must be viewed in the context of Mr Sheldon’s submissions about special interests; to which I now turn.

I have already concluded that there ought to have been two meetings: one of creditors with accrued claims; and one of creditors with IBNR claims. I must assume that I was wrong in so concluding. I have also concluded that the fact that some reinsureds were also reinsurers does not make them a separate class of creditors; but may provide a reason for caution in endorsing the vote. Mr Moss emphasised that if I ignored or discounted votes of creditors, I would be effectively disenfranchising them; and that would be unfair. I agree that I should not pick on individual creditors and discount their votes. But the question posed by the cases is a more general one. The third stage of the procedure (the sanction hearing) cannot arise unless the statutory majority of votes has been cast in favour of the scheme. This also presupposes that the class (or classes) of creditors has been correctly identified. Yet the cases emphasise that the court is not required simply to endorse the majority vote; if it considers that the meeting is unrepresentative, or that those voting at the meeting have done so with a special interest to promote which differs from the interest of the ordinary independent and objective creditor. For as long as the court retains this power (and some might say duty), the votes of the majority are not conclusive. Still less are they conclusive where the value attributed to the votes is dependent on controversial methods of estimating future probabilities.

Sixteen of the voting creditors were reinsurers of the Company. So far as they are concerned, Mr Sheldon submitted that the interests of these reinsured creditors (as reinsurers) are directly opposed to the insured creditors. They have a vested interest in commuting their reinsurance obligations to the Company, because such commutations typically cap the exposure that they would otherwise have under their treaties and facultative reinsurance certificates if the Company were to continue to run-off its long-tail claims in the normal course. They have a vested interest in ascribing a low or nil value to future claims because this limits their exposure as reinsurers. While an identity of economic interest exists between the Company and its reinsurers on this point, this interest cannot be reconciled with the very different interest of the Company’s direct insureds, including the opposing creditors, who purchased decades worth of “occurrence” coverage to obtain protection against asbestos and other long-tail claims as they emerge over time. The court should attach little or no weight to these votes.

Mr Moss’ response was that these creditors were net creditors of the Company; otherwise they would not have been admitted to vote at all. He concluded from this that their interests are allied with those of the direct insureds. This was, in effect, the same submission that Mr Moss made (and which I accepted) in relation to class issues.

However, the question at the third stage is not the same. Unlike the direct insureds, the reinsurers are in the risk business. Given the uncertainties of the extent of potential exposure to asbestos and other long-tail claims, it makes perfect sense for them to be keen to cap their liabilities. If the Company’s liabilities are capped, so are their liabilities as reinsurers. Their mutual liabilities are to be set off under the scheme. This does not apply to the direct insureds, who remain liable to those who contract asbestos-related diseases. Although, in their capacity as reinsured creditors, they have the same legal rights against the Company as direct insureds, they have very different economic interests. I also take into account that although the overwhelming majority of reinsureds voted in favour of the scheme, they account for only 8 per cent of the Company’s estimated liabilities in respect of Scheme Business. I cannot regard them as representative of the class of policyholders as a whole.

I also take into account the fact that two of the votes were cast by subsidiaries of Royal & Sun Alliance Group.

Mr Sheldon next points to five of the reinsureds who are in insolvency proceedings of one kind or another. He submits that each of these companies will want the cash to pay their own creditors and finalise their own liquidations or schemes. The court should therefore attach little or no weight to these votes. He points also to one creditor (GRC International) which is an arbitrageur of claims; and which therefore has every incentive to “make a turn” on the claims. This creditor too will have had reasons of its own for voting in favour of the scheme. I do not consider that at the third stage the court should scrutinise the individual financial circumstances of creditors. Faced with a choice between certain cash now and uncertain cash later, a creditor may have all sorts of reasons for preferring the former to the latter. Involvement in insolvency proceedings may be one of them. But so also may be the desire to invest in new corporate headquarters, or to commit funds to R & D. I do not accept Mr Sheldon’s criticism on this score.

I have already expressed considerable misgivings about the way in which the opposing creditors’ IBNR claims were devalued. I am not satisfied that their voices have been adequately represented, as compared with the supporting creditors, because of the devaluation of their claims.

For these reasons I am not satisfied that the votes cast adequately represented the views of the creditors.

Mr Sheldon had a number of criticisms of the detailed terms of the scheme.

Allied to Mr Sheldon’s complaint that there had been inadequate notification of the Scheme Meeting, he said that the Bar Date (120 days after the scheme came into operation) was too short. A potential creditor who missed the deadline would find that his claim had been extinguished. This might result in creditors losing perfectly valid claims despite being unaware that a scheme had been sanctioned. Mr Moss accepted that if I took the view that the Bar Date was too early, I could extend time (by a period measured in weeks or months, rather than years) and I could direct more extensive advertising of the existence of the scheme. If I were to sanction the scheme, I would have extended the Bar Date to one year after the scheme became operative and I would have directed more extensive advertising than proposed.

The “Estimation Liability” is set out in Appendix D of the Explanatory Statement. Mr Sheldon submits that it is not an estimation methodology at all. It simply sets out the kind of evidence that a Scheme Creditor is expected to supply in support of his claim. To some extent, the Company agrees. Mr Powell, the “principal architect” of the scheme says that Appendix D would be better described as “How to Support Your Claim.” Mr Moss submits that the flexible approach which it facilitates is necessary given the nature of the Scheme Business and it affords the Scheme Creditors the freedom to support their Scheme Claims in the manner which they perceive to be most sensible. In fact, he says, this flexibility is in the interests of the creditors, rather than the Company. Mr Sheldon’s objection is that if the methodology is as flexible as Mr Moss says it is, there is a real danger that the claims of different creditors will be estimated on different bases; and that, following on from this, there is a real danger that creditors will be unequally treated. I see the force of this. However, if a scheme is to work at all, and given the extreme difficulty of estimating IBNR claims, it seems to me that there must be a good measure of flexibility built into the process. If, therefore, the scheme is to be sanctioned at all, the Estimation Methodology is probably the best that can be achieved. But the dangers to which Mr Sheldon points are, in my judgment, factors that I must bear in mind in deciding whether to sanction the scheme.

A number of points arise under this head. First, Mr Sheldon objects to the identity of the Scheme Adjudicator, Mr Matthews. Mr Matthews is, as Mr Moss said the “top man” in his field, and has considerable experience of schemes such as this (even though, as I understand it, they have resulted in only four contested adjudications). Mr Sheldon does not (quite rightly) impugn Mr Matthews’ integrity or competence. What he says is that if Mr Matthews is the Scheme Adjudicator, there will be an appearance of bias. However, this seems to be based on his contacts with the insurance industry; and the Company’s refusal to appoint a Scheme Adjudicator selected by the Company and the creditors jointly. I do not consider that this gives rise to any suspicion of bias.

Mr Sheldon’s next complaint is that the adjudication procedure purports to lay down a procedure applicable to a determination by an expert, whereas in fact, on examination, what is proposed is an arbitration. He relies on the following features of the procedure which, he says, show that the process is arbitral:

The Scheme Adjudicator’s function is to determine a formulated dispute between a Scheme Creditor and the Scheme Manager, rather than to arrive at his own independent estimation of the value of a claim;

Matters within the remit of the Scheme Adjudicator include matters of construction of documents and other legal issues, including issues of pure law (e.g. the application of the Ohio “all sums” doctrine), which are properly the subject of an arbitration, but which cannot be the subject of a binding expert determination;

The scheme envisages that the Scheme Adjudicator will receive evidence and legal submissions, which is the hallmark of an arbitration;

The terms of the scheme appear to preclude any action against the Scheme Adjudicator for negligence and, he submits, preclude any such action even if the Scheme Adjudicator acts dishonestly.

Mr Sheldon also submitted that the scheme’s comprehensive attempt to make the Scheme Adjudicator’s decision immune from challenge in the courts “so far as the law allows” was contrary to public policy (if the Scheme Adjudicator was an expert); contrary to the Arbitration Act 1996 (if the Scheme Adjudicator was an arbitrator); and in any event represented a breach of the creditors’ right of access to the courts, as guaranteed by article 6 of the European Convention on Human Rights.

I agree with Mr Sheldon that some of the procedures envisaged by the scheme are more akin to an arbitration than to a determination by an expert. But the substance of the complaint, in my judgment, is that which fastens on the lack of access to the courts in order to correct alleged errors by the Scheme Adjudicator. The scheme does not purport to bar access to the courts completely. It does so only “as far as the law allows”. In the case of an arbitration, the law does not allow parties to bar access to the courts before a dispute has arisen. In the case of an expert determination there are also grounds on which the court can overturn an expert’s decision (although these are limited). I very much doubt whether a clause that bars actions against the Scheme Adjudicator would bar an action for fraud (and the clause in the present scheme does not expressly purport to do so). Indeed clause 7.4.1 of the scheme seems to me to envisage that the Scheme Adjudicator’s immunity from suit applies only where he acts both in good faith and with due care and diligence.

In both the Hawk case (at first instance) and in Re Pan Atlantic Insurance Co Ltd [2003] 2 BCLC 678 similar adjudication schemes have been sanctioned by the courts. In both cases it was held that the scheme adjudication process did not involve any breach of article 6. I do not consider that the differences between this case and those should lead to any different conclusion.

The scheme appears to give the Company the right to revert to a conventional solvent run-off at any time before it has made a general settlement with all its Scheme Creditors if it considers that the scheme is no longer a benefit to it. I say “appears” because the drafting is not entirely easy to follow. In that event any payment under the scheme to an individual creditor remains binding on that creditor; and he is not entitled to participate in the run-off.

In addition one possible reading of the scheme is that any former creditor whose claims were barred as a result of a failure to submit them by the Bar Date remains barred. The Company disputed this reading; and said that it was not intended. Had it stood alone, this particular point could, in my judgment, have been clarified by a drafting amendment.

The Company’s justification for the power to revert to run-off is that it is designed to cater for the possibility that, having estimated its liabilities to Scheme Creditors, the Company is not able to accelerate its reinsurance claims which apply to Scheme Business and as a result cannot pay claims valued under the Scheme in full at that time. This is said to be a most unlikely contingency but one that has to be provided for. I see the force of this point, but it is not what the scheme says. The power to revert to run-off is exercisable at the “absolute discretion” of the Company and the sole criterion is that the Company believes that the scheme is “no longer beneficial to it”. The power is not, therefore, exercisable simply in the event that the Company is unable to pay the Scheme Liabilities as they fall due. In that event, the Company might be insolvent anyway; and might not be able simply to revert to run-off. The Company is under no obligation to consult its creditors; and has no obligation to consider their interests at all. If, for example, the Scheme Adjudicator were to award a creditor more than the Company thought was proper, the Company could avoid similar results arising in relation to other creditors simply by terminating the scheme. The essence of a compromise is that it is binding on both sides; whereas this clause gives the Company power to bring the compromise to an end more or less at will.

Mr Moss submitted that although it was possible to construct scenarios under which the Company could terminate the scheme, these were fanciful. I should not assume that the Company would operate the right to terminate the scheme except in extremis; and that in any event the creditors had voted in favour of the scheme. As to the first of these submissions, it seems to me that I must look at the legal rights that the scheme, if sanctioned, would give the Company. Those legal rights are exercisable by it in its own interest alone. The Company could not be criticised if, having a right to act in its own interest, it exercised that right. But that, as it seems to me, is a reason for not sanctioning the conferring of that right, rather than leaving it to the Company to decide not to exercise it unless the exercise is in the interest of creditors as well. As to the second submission, I have already said that I am not satisfied that the votes cast were a fair reflection of the views of creditors.

Mr Sheldon’s remaining criticisms of the scheme were, in my judgment, of less substance. All other things being equal, they are the sort of points where creditor democracy ought to be allowed to prevail.

I have already held that I have no jurisdiction to sanction the scheme. So the question of discretion does not really arise. I will therefore express my view shortly.

Mr Moss submitted that there were the following advantages to the scheme, such that I should sanction it, if I had jurisdiction to do so:

The run-off of the Company’s business would, apart from the scheme, not be expected to be completed for many years.

The Scheme will save the very substantial costs which would be incurred by continuing to run off the business over many years.

Under the Scheme all Scheme Creditors will be paid earlier than would otherwise be the case.

Scheme Creditors will have the benefit of a simple independent out of court dispute resolution mechanism.

Scheme Creditors will not run the risk of future insolvency if the run-off turns out to be disastrous.

I comment on these supposed advantages as follows:

The benefit of an early conclusion of the run-off seems to me to be a benefit which enures largely to the Company. A creditor who wishes to compound the Company’s liabilities to him is free to do so in the absence of the scheme. A creditor who wishes to receive the indemnity which he was promised gains no advantage from the early conclusion of run-off;

The saving in costs is a benefit that enures entirely to the Company. There is no suggestion that its assets are insufficient both to meet its liabilities and to pay the administrative costs of run-off;

Early payment is, I accept, a benefit to creditors, but it has to be balanced against the fact that they will not be indemnified but will be paid an estimate of liability;

The availability of the dispute resolution procedure is largely necessitated by the scheme itself. If the scheme is not sanctioned, the dispute resolution procedure becomes largely unnecessary;

The prospect of these shareholders allowing their subsidiary to go into insolvent liquidation is, on the evidence, no more than a remote and theoretical possibility.

I appreciate that the court must be slow to differ from the statutory majority of creditors who have voted in favour of the scheme. But if I had had jurisdiction I would not have sanctioned the scheme. I have already listed a number of reasons why not. To summarise:

The votes allowed to be cast at the scheme meeting did not fairly represent the creditors (and in particular the direct insureds) with substantial IBNR claims;

The Estimation Methodology does not provide a clear basis for treating all creditors alike, and results in uncertainty;

The Company’s power to revert to run-off is not circumscribed;

The supposed benefits of the scheme are largely benefits to the Company and its shareholders; or are brought into existence by the exigencies of the scheme itself.

In the end, though, the most powerful consideration is that it seems to me to be unfair to require the manufacturers who have bought insurance policies designed to cast the risk of exposure to asbestos claims on insurers to have that risk compulsorily retransferred to them. The Company is in the risk business; and they are not. This is not a case of an insolvent company to which quite different considerations apply. On the evidence presented to me the Company is able to meet its liabilities under such policies as and when they fall due. The purpose of the scheme is to allow surplus funds to be returned to shareholders in preference to satisfying the legitimate claims of creditors. No matter how usable and reasonable an estimate may be, the very fact that it is an estimate is likely to make in an inaccurate forecast of the actual liabilities of policyholders. If individual policyholders wish to compound the Company’s contingent liabilities to them, and to accept payment in full of an estimate of their claims, there is nothing to stop them doing so. But to compel dissentients to do so would, in the words of Bowen LJ, require them to do that which it is unreasonable to require them to do.

I will therefore dismiss the petition.