DKLL Solicitors v Revenue and Customs

THE DEPUTY JUDGE:

1. This is an application for an administration order in relation to DKLL Solicitors -- which I will refer to as the partnership - a firm of solicitors providing general legal services, whose principal place of business is in Epsom, Surrey. The application is made by Mr Anthony Lawson and Mr Stephen Lewis, who are the two equity partners. The partnership also employs four salaried partners, one of whom is a Mr Virash Patel. The partnership employs some 50 other staff in addition.

2. It is common ground that the partnership is hopelessly insolvent. It has liabilities exceeding £2.4m, including a debt owed to Her Majesty’s Revenue and Customs -- which I will call the Revenue -- of at least £1.7m in respect of unpaid VAT, PAYE and National Insurance contributions. There is an estimated deficiency as regard unsecured creditors of at least £2m, on any view of the realisable value of the partnership’s assets.

3. The purpose of the application is to enable the proposed administrators, who are Mr Malcolm Cohen and Mr Anthony Nygate, both of BDO Stoy Hayward, to effect an immediate sale of the partnership’s business to a newly incorporated limited liability partnership, known as Drummonds Kirkwood LLP -- and I will refer to that as the proposed purchaser -- for a total consideration of £400,000.

4. The application is opposed by the Revenue, which issued a winding up petition against the partnership in December of last year. The petition is due to be heard tomorrow, hence the urgency of this application. I was told that the Revenue have also issued bankruptcy petitions against the two equity partners in respect of the Crown debt. The application is supported by two witness statements of Mr Lawson, dated 15^th February and 2^nd March 2007. The Revenue’s grounds of opposition were set out in a witness statement of Mr James Sudds, dated 28^th February 2007.

5. Before considering the evidence and the Revenue’s grounds of opposition in more detail, I should set out the relevant statutory provisions governing the exercise of this jurisdiction. Under paragraph 11 of Schedule B(1) to the Insolvency Act 1986, as modified by the provisions of Article 6 of and Schedule 2 to the Insolvent Partnerships Order 1994, and I quote:

“The court may make an administration order in relation to a partnership only if satisfied that (a), the partnership is unable to pay its debts and (b), that the administration order is reasonably likely to achieve the purpose of administration.”

Thus, paragraph 11 imposes to two threshold conditions which must be satisfied before the court may make an administration order. If those threshold conditions are satisfied, the court has a discretion whether or not, and if so, on what terms to make such an order.

6. For the reasons I have mentioned, there is no dispute that condition (a) is satisfied, namely that the partnership is unable to pay its debts. The reference to the purpose of administration takes one to paragraph 3 of Schedule B(1), which provides relevantly as follows:

“The administrator of a company must perform his functions with the objective of (a), rescuing the company as a going concern or (b), achieving a better result for the company’s creditors as a whole than would be likely if the company were wound up without first being in administration or (c), realising property in order to make a distribution to one or more secure or preferential creditors.”

And then at paragraph 3(2):

“Subject to sub-paragraph 4, the administrator of a company must perform its functions in the interests of the company’s creditors as a whole.”

7. In the present context, references to the company in those extracts must, of course, be read as references to the partnership. It is not possible to rescue the partnership as a going concern, so the objective relied on is (b), namely achieving a better result for the partnership’s creditors as a whole than would be likely if the partnership were wound up without first being in administration. The applicant’s case is that the sale of the partnership’s business to the proposed purchaser for £400,000 will achieve that objective. In support of this contention Mr Lawson produced, as exhibit AJL5 to his first witness statement, an estimated statement of affairs as at 15^th February 2007, prepared by the applicants with the assistance and advice of the proposed administrators. According to the estimated state of affairs, total funds available for creditors on a forced sale in the event of liquidation, will be only about £105,000, compared to the £400,000 proceeds of the proposed sale, and the liquidation itself would create an additional £44,000 worth of preferential claims by employees for arrears of pay and holiday pay.

8. In paragraphs 14 and 15 of his witness statement, Mr Sudds says this.

“At this point I should add that in the respondent’s opinion, the estimated realisations in compulsory liquidation are substantially lower than they would expect. Furthermore, no explanation has been given to justify such a substantial variation from what is listed, at approximately £1.7m worth of assets, to a realisable sum of only marginally over £100,000. The Revenue does not accept the valuations or contentions put forward on the, for sale scenarios, and the whole financial position is very short on detail.”

He then goes on to say:

“In the respondent’s opinion the firm’s assets could be realised for a sum more in line with the purchase price.”

Echoing this, in the course of her submissions on behalf of the Revenue, Miss Williamson said it was surprising that work in progress with a book value of £806,000 was estimated to realise, “Probably zero.”

9. In response, Mr Cohen has produced a report, dated 2^nd March 2007. The material parts are as follows: he says that he is a Fellow of the Institute of Chartered Accountants of England and Wales; a licensed insolvency practitioner and a partner in the firm of BDO Stoy Hayward, with over 25 years of experience in the field of corporate recovery.

He says that he has previously acted as supervisor to various professional practices, including Loxleys, Lewis Old King and the FHP Partnership, which at the time was the largest insolvent partnership, involving interlocking individual voluntary arrangements, and that he is currently the joint liquidator of Merricks LLP.

He says that he has provided advice and assistance to many partnerships in relation to their financial affairs, brokering deals with landlords and banks, and negotiating informal rescue arrangements. He is a member of BDO’s professional practices focus group, and is also the co-author of Insolvent Partnerships published by Jordan. He continues:

“I have consented to act in this matter, as I am of the opinion that the proposed administration strategy i.e. an immediate sale of the partnership business will achieve a better result for the partnership’s creditors as a whole than would be likely if the partnership were to be wound up without first being in administration. All stakeholders, i.e. creditors, employees and partners would be better off. I assisted the partners in preparing a statement of assets as at 15^th February 2007. The book value is shown as £1.27m for the assets, as being extracted from the partnership’s latest available financial information, but is simply a book value based on historical costs, and bears no resemblance whatsoever to realisable values, which is all important when considering the alternative of liquidation.

Based on my experiences in dealing with other solicitors’ practices in distressed circumstances, and where a winding up order is about to be made, the potential to realise value of major assets, i.e. debtors and work in progress is put severely at risk. With the winding up order only three business days away should a sale not be concluded, it is inevitable that either, the Law Society will intervene, the partnership will be forced to try and hand over existing files to other practices to avoid litigation for non-pursuance of matters on which they have been instructed, all fee earners will walk away. In any of these eventualities my experience tells me that it is extremely unlikely that any value can be realised for what are the partnerships only significant assets, namely debtors, work in progress and good will.”

He then refers to the costs of an intervention by the Law Society, and continues under the heading Fixed Assets:

“Agents instructed by me to value the fixed assets of the partnership have concluded that a forced sale of such assets which are represented by fixtures, fittings and computer equipment will achieve negligible realisations. The leases have no value at all.”

Then under the heading, Debtors:

“It is difficult to estimate a realisable value for debtors. However, the ledger comprises some 300 balances, some of which are three years old. A 30 per cent provision has been made on book value, which given the looming winding up order, is probably now not prudent enough.”

And under the heading of Work in progress:

“Time recording of work in progress is virtually non-existent; records are poor; old work in progress is not provided for or written off, and errors occur in the manual recording of the work in progress. Therefore, the likely realisation for work in progress is at best, uncertain. Without the continuity provided by the existing practice, again, this work in progress would be lost.”

He then says:

“I am advised by the partners that informal discussions have been had in the last few weeks with a few other local practices with a view to selling the business of DKLL. Indeed, one formal offer was subsequently received for only part of the business -- the rest was not wanted -- which proposed that nothing would be paid up front for any of the assets, but that should any profit costs be recovered that were attributable to the work done by DKLL, this could be paid over to any appointed administrator as deferred consideration. Effectively, accepting such an offer would give no certainty regarding any recovery whatsoever. Therefore, based on the information available to me, achieving a realisation of £400,000 for these assets represents a better outcome for creditors and stakeholders than would be achieved in liquidation.”

10. In applications of this nature the court places great reliance on the expertise and experience of impartial insolvency practitioners, even though, of course, it is ultimately for the court to decide if the threshold conditions are satisfied. Moreover, there is no evidence to support Mr Sudds’ assertion that the firm’s assets could be realised for a sum more in line with the purchase price. It is also perhaps significant that there is no suggestion that those assets could be realised for more than the purchase price. I therefore see no reason not to proceed on the basis that the estimated statement of affairs produced by the applicants is reasonably likely to prove accurate.

11. Certain other arguments were canvassed by Miss Williamson, which I did not find persuasive. First, it was said that even though BDO Stoy Haywood had been involved since November 2006, very little hard evidence had been produced in connection with the proposed sale. In particular, there was no written sale agreement. It is fair to say that negotiations in respect of the sale have been continuing, and consequently the proposed terms have varied from time to time. However, the current position is summarised by Mr Cohen as follows: “under the proposed sale £250,000 will be realised on day 1, and three further instalments of £50,000 will be received at three monthly intervals. These instalments are secured by a first charge over the assets of the purchaser. In addition, Nigel Shepherd -- who is now to take a 50 per cent equity stake in the new business -- has confirmed that he will assist in providing any necessary funding to settle any deferred consideration should the purchaser not be in a position to do so. I have seen a statement of assets of Mr Shepherd which, albeit not verified in any way by me, demonstrates his ability to fund these deferred instalments should it be necessary”.

12. Mr Lawson adds, in paragraph 2.8 of his second witness statement that “an Escrow arrangement is presently in place whereby in the event that an administration order is granted, the completion funds held by the LLP solicitors, Cripps Harris Hall, will be immediately released to the administrators, and the sale will complete immediately upon the appointment of the administrators”.

13. Mr Boardman for the applicants, assures me that a written sale agreement is in existence, and could have been produced if this point had been taken earlier.

14. Secondly, the Revenue contended that Mr Virash Patel, one of the four salaried partners, is personally liable for the petition debt, and that his ability to meet that obligation would be reduced by his involvement in the proposed purchase.

15. Miss Williamson accepted that, in the light of the decision of Patten J, in Revenue and Customs Commissions v. Pal [2006] EWHC 2016, the Revenue could not succeed on the basis that Mr Patel was held out as a true partner. She said that the Revenue did not, however, concede that Mr Patel was not personally liable, and suggested that there might be a claim based upon estoppel, by which I assume she meant a different form of estoppel to the alleged holding out. There are a number of potential answers to this point, but for present purposes I need only say that I have seen no evidence to support such an alternative claim against Mr Patel.

16. Thirdly, it was said that there had been no adequate explanation of how Crown debt of over £1.7m had been allowed to mount up, and the Revenue would want the conduct of those previously managing the partnership business to be investigated. In point of fact, Mr Lawson’s explanation at paragraph 2.16 of his second witness statement is as follows:

“The majority of the debt arose during a period when I was unable to attend to the partnership’s affairs through illness, and a subsequent severe heart attack. Without my support it fell to Stephen Lewis to take sole responsibility for the administration of the business. He became overwhelmed. Largely, as a result of that the partnership has regrettably failed.”

I do not pass any comment on whether or not this explanation is adequate, but the answer to Miss Williamson’s point seems to me to be that, any necessary investigation can be conducted either by the administrators, or in the subsequent liquidation of the partnership. Mr Lawson makes it clear that he has no difficulty with that prospect.

17. I come now to what appeared to me to be the principal ground of opposition advanced by the Revenue. Miss Williamson pointed out that the Revenue was, by some way, the majority creditor of the partnership by value, and accordingly, if a meeting of creditors were held pursuant to paragraphs 50 to 55 of Schedule B(1) to consider the administrator’s proposal to sell to the proposed purchaser, the Revenue would be in a position to defeat those proposals. In the present case there will be no creditors’ meeting to consider the proposed sale, because it is what is described in the jargon as a pre-pack. In other words, the sale has been arranged to complete immediately after the appointment of the administrators, in circumstances where the administrators could not carry on the partnership’s business in administration without further funding, which is not available.

18. Miss Williamson accepts, in the light of the decisions of Neuberger J -- as he then was -- in Re T & D Industries Plc [2000] 1WLR 646 and Lawrence Collins J -- as he then was -- in Re Transbus International Limited [2004] 1WLR 2654, that the administrators would have power to complete the proposed sale without the sanction of a creditors’ meeting or a direction of the court. However, she contends that the court ought not to make an administration order in circumstances where it is known that the majority creditor opposed the proposed sale, and would, in effect, be disenfranchised -- as she puts it -- by a pre-pack sale without a creditors’ meeting taking place. In this connection I was referred to another decision of Neuberger J, namely Re Structures & Computers Limited [1998] 1 Butterworths Company Law Cases 292, where an application for an administration order based on the pre-Enterprise Act equivalent of paragraph 3(1)(b) of Schedule B(1) was opposed by the majority creditor, which was called Ansys Inc. Neuberger J said:

“Ansys’s second argument is that it is owed more than 50 per cent of the outstanding unsecured debts of the company, and that therefore, it would be in a position to defeat any proposal put forward by the administrators by virtue of the provisions of Rules 1.17 and 1.19 of the Insolvency Rules 1986. Through its counsel, Ansys says that it anticipates voting against any proposals which the administrators would make.”

He then referred to three earlier authorities, and continued:

“If the administrator were to come forward with proposals under s.8(3)(a) and/or (d), and a substantial number of creditors supported those proposals, but the majority, namely at least principally, Ansys, opposed those proposals, it would still be open to the administrator to apply to the court for those proposals to be implemented, even if the majority of the creditors were against it.”

This passage demonstrates the important point that even a majority creditor does not have a veto on the implementation of the administrator’s proposals. The court could, exercising its powers under paragraph 55.2 of Schedule B(1), authorise the implementation of those proposals, notwithstanding the opposition of the majority creditor. Accordingly, if the present case were not concerned with a pre-pack sale, and a creditors’ meeting prior to the implementation of proposals were envisaged, I would not accept that the Revenue’s opposition meant that it was not “reasonably likely” that the statutory objective would be achieved. In this regard it is to be noted that reasonably likely, means that the court considers there is a real prospect that the objective will be achieved. A real prospect does not equate to more than a 50 per cent probability; see Lewison J in Re AA Mutual International Insurance Company Ltd [2005] 2BCLC 8.

19. In the light of my conclusions in respect of the Revenue’s other grounds of opposition, I consider that there would be a real prospect of the court authorising the proposed sale, notwithstanding the Revenue’s opposition. I do not see why the applicants should be in a worse position or the Revenue in a better position because this case involves a pre-pack. I therefore conclude that the second threshold condition in paragraph 11 of Schedule B(1) is satisfied.

20. That leaves the question of the court’s discretion. Clearly, the Revenue’s opposition ought to be taken into account at this stage of the process also. I was told that the views of the other creditors are not currently known. However, I accept Mr Boardman’s submission that in exercising its discretion, the court can take into account the interests of what he described as other stakeholders, not merely those of the partnership’s creditors. I am particularly influenced by the fact that the proposed sale appears to be the only way of saving the jobs of the 50 odd employees of the partnership. The proposed sale is also likely to result in the affairs of the partnership’s clients being dealt with, with the minimum of disruption. If I refuse to make an administration order, it is accepted that the partnership will have to be wound up, and that will result in an intervention by the Law Society, and the distribution of the partnership’s work in progress to other firms of solicitors.

21. In all of the circumstances I consider it to be appropriate to make the order sought by the applicants.

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