Conquest v McGinnis & Anor

This is an application by Mr Andrew Conquest, the liquidator of Rusjon Limited (“the Company”), in which he seeks a direction pursuant to section 112 of the Insolvency Act 1986 as to whether or not the first and/or second respondents, Mr Patrick McGinnis and Mr Brian McGinnis, are subrogated or otherwise beneficially entitled to the surplus funds in the hands of the liquidator after realisation of a fixed charge dated 30 July 1985 in favour of Banco Bilbao Vizcaya Argentaria (“BBVA”) over the assets of the Company. If that question is answered in the affirmative, the liquidator also asks so far as necessary for an order for payment of his costs and remuneration out of the assets of the Company in accordance with the principles laid down in In Re Berkeley Applegate Limited [1989] Ch.32 (“Berkeley Applegate relief”).

Neither respondent has chosen to play any part in these proceedings, and no evidence has been filed on their behalf.

The first respondent, Mr Patrick McGinnis, said in a letter dated 25 October 2005 that he had never claimed a right to any surplus funds in the liquidation, and that he had no wish to do so. He asked not to be involved in the matter any further. Earlier this year he was asked to contact the applicant’s solicitors if his position had changed, but did not respond. He was also notified in writing of the present hearing before me, which took place on 31 October 2007, but again did not respond.

The second respondent, Mr Brian McGinnis, has proved very difficult to trace. He was eventually served with the application and supporting evidence on 13 March 2007 by delivery of the documents through the letterbox at an address in Colerain, County Derry, which is his last known address. By an Order of Registrar Rawson dated 21 May 2007 it was declared that he had been validly served. No response has been received from him. He was also notified in writing, at the same address, of the hearing before me in the Applications Court on 11 June, and of the present hearing, but again there has been no response.

The liquidator’s stance in the matter has throughout been one of neutrality. He wishes to have the issue resolved so that he can complete the liquidation of the Company. He has been represented before me by Miss Sally Barber of Counsel, to whom I am grateful for her clear and helpful submissions.

Although the application initially came before me in the Applications Court in June, there was insufficient time for it to be dealt with and on 19 June Rimer J directed that it should come on as an application by order with a time estimate of half a day.

The evidence before me consists of the witness statement of the liquidator dated 21 September 2005, together with a bundle of documents exhibited to it, and two witness statements dated 23 October 2007 by the former directors of the Company, Mr Venu Poduval and Mr Terence Banks. In his statement Mr Banks merely confirms that he is in full agreement with Mr Poduval’s statement.

The Company carried on business as building contractors. It was placed into administrative receivership by BBVA on 10 June 1999, and went into creditors voluntary liquidation on 6 September 1999. The applicant was appointed as joint liquidator by the court on 13 October 2000, in substitution for Mr Finbarr O’Connell. The other liquidator is Mr James Earp. The applicant is a member of Grant Thornton UK LLP. He is a member of the Institute of Chartered Accountants in England and Wales, and a Licensed Insolvency Practitioner.

BBVA was repaid in full from the Company’s assets, and a receivership surplus of £104,345.32 was paid over to the liquidators. The present application concerns the beneficial entitlement to that surplus.

The question arises in the following way. During the two years preceding the receivership, the directors of the Company, Mr Poduval and Mr Banks, were seeking interested parties, either to become partners in the business or to take over the Company. In October 1998 they were introduced to the second respondent, Mr Brian McGinnis, who was an outside investor looking for a major shareholding in a building company within the London area. According to a statement made by Mr Banks on 29 June 1999, shortly after the Company had gone into receivership, an agreement was reached between Mr McGinnis and the Company whereby Mr McGinnis would take full control of all the Company’s sites and would fast track progress on those contracts by employing sub-contractors known to him, locking in profits and completing the work over a period of six to eight weeks. In addition, Mr McGinnis agreed to provide financial guarantees to the Company’s bank in the sum of £200,000. Upon meeting those work and financial targets, he would then be allowed to acquire 50% of the shares in the Company. Mr Banks said that an agreement in these terms was made and began to take effect in November 1998 when Mr McGinnis laid off the Company’s staff and brought in his own sub-contractor, MGM Design & Build Limited.

At or about the same time, some draft Heads of Agreement were drawn up. Clause 1 recorded that the purpose of the agreement was to define heads of terms between Mr McGinnis as the prospective buyer and the Company as the prospective seller “for the sale/transfer of 50% of the shares in Rusjon Limited”. Clause 2 provided for a “proving period” of three months duration beginning on 1 November 1998 and ending on 1 February 1999. If, during that period, the performance criteria in Clause 3 and certain other conditions outlined in Clause 4 had been met, then the Company would transfer 50% of the shares in the Company to Mr McGinnis. I interpose that, although the Company is referred to as the seller, it must have been intended that the shares would be sold by Mr Poduval and Mr Banks, who were the only shareholders. Clause 3 then set out the performance criteria, by reference to various specified contracts, but with the figures and durations of the contracts evidently still to be agreed. Clause 3.4 also provided that new contracts “of a standalone, closed-ended, and self-financed nature” were to be secured with a gross value of between £5 million and £7 million, and that the fixed profit on those contracts was to be no less than £1.25 million.

Clause 4 then provided as follows:

“Rusjon Ltd financing requirements to be remanaged by [Mr McGinnis] to enable the achievement of the above targets, and also to meet all other outstanding commitments and liabilities. This will also be done so as to eliminate any personal guarantees currently provided by Rusjon’s directors. All refinancing initiatives, and the adoption of any policy on the handling of outstanding creditors must however be approved by Rusjon’s directors. To the extent that there remains a shortfall in meeting the working capital or cash flow requirements of Rusjon, [Mr McGinnis] will separately provide the balance of funds required up to a maximum of £200K, and will underwrite such provision through an irrevocable Solicitor to Solicitor undertaking, delivered prior to this agreement being signed.”

Finally, Clause 6 provided that if the performance criteria in Clause 3 were seen to be not met at the end of the proving period, then the proposed transfer of shares would not proceed.

“In this event, any monies already provided to underwrite Rusjon’s financing requirements will remain the property of Rusjon Ltd. At the same time any net profits from contracts during the period will be shared equally between Buyer and Seller based on the formula

Gross Contract Profits £(X + Y + Z) less Fixed Overheads

Failure to satisfy the condition outlined in 4 will separately constitute a basis for not proceeding with the proposed transaction, but will also be an immediately basis for cancelling this agreement.”

It will be noted that Clause 6 expressly provided that if the proposed share transfer did not proceed because of failure to satisfy the performance criteria, any money already provided by Mr McGinnis to underwrite the Company’s financing requirements would remain the property of the Company. Any net profits from contracts during the period would, however, be shared equally between Rusjon and Mr McGinnis. The gross profit figures of £X, Y and Z were evidently still to be agreed, but referred back to the figures so identified in sub-clauses 3.1, 3.2 and 3.3.

I should add that, according to Mr Poduval’s recent witness statement, the Heads of Agreement were drawn up and drafted by Mr Banks, Mr McGinnis and himself. They were admittedly incomplete, but no documentation was ever prepared to supplement them.

On 21 January 1999 a board meeting took place, attended by Mr Banks, Mr Poduval and Mr McGinnis. The minutes record that the meeting was called to discuss the future policies to be adopted by the Company. The trial period envisaged in the draft Heads of Agreement had commenced in November 1998, and was now agreed to be at an end. Although the contract dates had yet to be met, and no monies had yet been deposited by Mr McGinnis with the Company, Mr Banks and Mr Poduval thought “there was sufficient evidence that in general [Mr McGinnis] had/was keeping to the agreement”. For his part, Mr McGinnis “agreed to make available to the Company next week a sum of £150,000”. In recognition of that commitment, Mr Banks and Mr Poduval “agreed that the share transfer would take place”. A number of other matters were also discussed, including possible terms for Mr Banks’ retirement from the business.

According to the evidence of Mr Banks and Mr Poduval, the projected share transfer never took place because it soon became clear that Mr McGinnis was either unable or unwilling to meet the performance targets which had been agreed and to provide in full the financial support which he had promised. However, in early February 1999 a sum of £100,000 was deposited with BBVA as security for the Company’s overdraft facility in the same amount. The deposit was made pursuant to an irrevocable undertaking given to BBVA by a solicitor, Mr Colin S Patterson of the Alex Stewart Partnership of 3 Regent Street, Newtownards, County Down. The letter of undertaking dated 8 February said that the sum was to be held on deposit by the bank in the name of Mr Patterson until 30 April 1999. By a further letter dated 15 March, Mr Patterson authorised BBVA by way of continuing security to charge the monies standing to the credit of his account with the bank in respect of the Company’s liabilities, and authorised the bank without further notice to block the amount so charged from time to time in the account and to apply such monies as the bank might think fit in satisfaction of the Company’s liabilities. This authorisation was expressly stated to be irrevocable.

In a subsequent letter dated 11 June 1999, after the Company had gone into receivership, Mr Patterson requested BBVA to return the deposit, but on 14 June BBVA informed him that they had already implemented the set off of the funds deposited with the bank in Mr Patterson’s name in accordance with his irrevocable instructions of 15 March.

No reference was made to Mr Brian McGinnis in the correspondence between Mr Patterson and BBVA, but there seems to be little doubt that it was Mr McGinnis for whom Mr Patterson was acting when he made the deposit. This certainly appears to have been the understanding of BBVA, as appears from a letter dated 23 July 1999 written by the bank to the administrative receiver of the Company, Mr Richard Long, in response to a request for an explanation of the £100,000 deposit. The letter referred to the correspondence which I have already mentioned, and explained the position as follows:

“In February this year the current account of [the Company] was overdrawn well in excess of its limit of £100,000. They asked the Bank to allow the excess to continue, and offered to secure it with a pledged deposit of £100,000. They explained that the depositor was a recent business associate who had joined them in order to oversee the work under their several contracts – the company had downsized and was going to sub-contract all or most of its work, rather than keeping a number of building workers on the payroll. Mr McGinnis, who had excellent credentials, would manage the sites to ensure that contracts were finished speedily. This would release Mr Banks to identify and secure future contracts.”

In the circumstances, I find that the deposit was indeed made by Mr Patterson on behalf of Mr Brian McGinnis, and that it was intended by Mr McGinnis to represent part of the financial commitment which he had undertaken at the board meeting on 21 January. Further confirmation of this conclusion is provided by Mr Poduval in his recent witness statement, where he says that Mr McGinnis told him and Mr Banks that the £100,000 represented the first tranche of the £150,000 which he had promised to make available to the Company in the week following the board meeting. Mr Poduval goes on to say that it was the understanding of Mr Banks and himself that the money would not at any time revert to Mr McGinnis, and there was no question of its being secured: Mr McGinnis was well aware of the risks involved, and at no time did he suggest that the payment was to be anything other than unsecured. The deposit was originally intended to remain with the bank until 30 April 1999, but this period was then extended to 31 May because, following further discussions with Mr McGinnis, they expected a total of £200,000 to be paid into the Company’s account by the latter date. It was not clear to them precisely how Mr McGinnis intended to honour this commitment, or whether he had borrowed the initial £100,000 from a third party, but their expectation was that he would ensure the Company was £200,000 better off by the end of May. Mr Poduval and Mr Banks regarded the £100,000 as part of Mr McGinnis’ agreed financial commitment to the Company, and as a non-refundable part payment for the acquisition of 50% of the shares. They did not consider at the time why the money had been provided by way of a guarantee rather than as a payment directly into the Company’s account, on the grounds that they were simply grateful for the payment as it helped stabilise the business at a very difficult time. In the event, however, Mr McGinnis never fulfilled his obligations under the revised agreement, so the shares were never transferred to him. Meanwhile, the Company renewed negotiations with another prospective purchaser of the business, Westco Plc, but by the end of May these negotiations too had broken down. On 2 June 1999, following discussions with the Company’s advisers, the directors made an application to the court to place the Company into administration. On 7 June they met BBVA, and gained the impression that BBVA would support the Company’s proposals. However, two days later, on 9 June, BBVA appointed Mr Long as administrative receiver without giving the Company any prior notification. Mr McGinnis had not yet parted company with the directors, but neither then nor at any subsequent stage did he demand repayment of the £100,000.

Following the termination of the receivership and the commencement of the voluntary liquidation, the solicitors for the joint liquidators tried to find out by whom the deposit of £100,000 had been given, and upon what terms. These enquiries led to a series of inconsistent assertions and responses from Mr Patterson, now practising as a partner in Patterson Donnelly in Newtownards, County Down. His first contention, in a letter dated 4 September 2000, was that the money was to be held as a form of security deposit on behalf of Patterson Donnelly and remained the property of the firm. At this stage Mr Patterson referred to his client as being Mr Brian McGinnis. The next contention, in a letter dated 17 October 2000, was that the money belonged to Mr Brian McGinnis’ brother Patrick, and that the balance not recovered from the Company would have to be repaid by Mr Brian McGinnis to his brother. Mr Patterson said that no proof of debt had yet been submitted to the liquidator, but he assumed that “the debt is clearly visible”. Again, at this stage Mr Patterson still described his client as Mr Brian McGinnis. On 23 October 2000, the liquidator’s solicitors wrote to Patterson Donnelly saying that if Mr Patrick McGinnis wished to make a claim in the liquidation, he should submit a proof of debt to the liquidator in accordance with Rule 4.73 of the Insolvency Rules 1986. No reply was received to this letter, and the matter then seems to have gone to sleep for some two and a half years.

On 2 May 2003 one of the liquidators, Mr Earp, wrote again to Mr Patterson asking him to formulate any claim he had against the Company. In response, Mr Patterson wrote on 8 July 2003 to say that he had no instructions in the matter. On 3 November 2003 the liquidators’ solicitors wrote to Mr Patterson asking for contact details for the two McGinnis brothers, with a view to establishing their position in regard to the £100,000. On 17 November 2003 Mr Patterson replied, saying:

“We have had an opportunity to discuss this matter with our clients.

The £100,000 was paid by Mr Patrick McGinnis to the bank as extra and liquid security for the bank loan. The bank held other security in the form of land and buildings but was reluctant to advance further overdraft funds without this extra security. The £100,000 was not a loan to the Company.

We are now instructed to act.”

It will be noted that Patterson Donnelly now purported to act on behalf of both the McGinnis brothers, and said that the deposit was paid by Mr Patrick McGinnis by way of security only, and not as a loan to the Company.

In March 2004 the liquidators’ solicitors sought clarification from the directors of the Company, and were told by them that they had always regarded Mr Patterson as acting for Mr Brian McGinnis, who had advanced the £100,000 pursuant to the Heads of Agreement in part payment for the transfer of shares. They said that there was no question of the Company being expected to repay the money. On 16 April 2004 the liquidators’ solicitors wrote again to Patterson Donnelly, enclosing copies of the directors’ letters and saying that unless they received confirmation within seven days that the McGinnis brothers agreed with the position as set out by the directors it would be necessary for the liquidator to apply to the court for a declaration as to the status of the funds. The letter continued:

“… in particular we will be seeking the Court’s confirmation that neither Patrick McGinnis nor Brian McGinnis are subrogated to the Bank’s security.”

This letter elicited a reply dated 28 April 2004, in which Mr Patterson said he had now taken further instructions from Mr Brian McGinnis. His instructions were that the money had been forwarded to the bank “as extra liquid security only”, and that the balance of funds “after payment of the bank’s liabilities in excess of their security still belong to Mr Brian McGinnis”. I have to say that I find this contention largely unintelligible, but it does appear to assert that Mr McGinnis had some form of continuing beneficial interest in the money. The letter also rejected the directors’ assertion that the money had been paid for shares, on the basis that no shares had ever been issued to Mr Brian McGinnis and he was not consulted prior to the Company being put into voluntary liquidation. The letter concluded:

“We await the return of our client’s funds.”

It will be noted that there was no indication in this letter that Patterson Donnelly acted for anybody other than Mr Brian McGinnis.

Finally, on 22 September 2004 Patterson Donnelly wrote again to say that they now had no instructions to act for either of the McGinnis brothers.

Against this confused background, it is obviously impossible to be sure what the parties intended. However, I find on the balance of probabilities:

It is impossible to spell out the precise terms of the agreement, but I am satisfied on balance that it went beyond a mere agreement to agree, and that the performance targets which Mr Brian McGinnis had to satisfy were sufficiently understood between the parties to be contractually binding, even though they had not been finalised when the draft Heads of Agreement were prepared. I also find that it was always understood and agreed that Mr McGinnis’ financial contributions were not loans, and would not be repayable, although they would be treated as a part-payment on account of the purchase price of the shares if that transaction was ever completed. If the transaction fell through, because Mr McGinnis was unable to meet the performance criteria, or to provide all the money which he promised, he accepted the commercial risk that the money would be lost, and his only entitlement would be to a share of profits as envisaged in Clause 6 of the Heads of Agreement. It may seem surprising that Mr McGinnis was prepared to invest his money upon such a precarious basis, but any surprise is tempered by the fact that he did not demand repayment when the Company went into receivership, although he was still in contact with the directors, and by the fact that he has apparently elected not to advance any claim in the present proceedings.

In the light of these findings of fact, I must now consider whether any right of subrogation arose in favour of Mr Brian McGinnis. The deposit of £100,000 was charged by him, through Mr Patterson, to BBVA as a collateral security for the Company’s overdraft facility, and was then applied by BBVA in part discharge of the Company’s indebtedness. BBVA also held an existing security for the Company’s debt in the form of the fixed charge over the Company’s assets. Mr McGinnis was therefore in the position of a surety who has discharged part of the secured debt of the principal debtor. In such a situation I have no doubt that the doctrine of subrogation is prima facie engaged. Indeed, suretyship is probably the paradigm relationship in which subrogation has historically been held to arise, and this is reflected in section 5 of the Mercantile Law Amendment Act 1856 which provides so far as material as follows:

“Every person who, being surety for the debt … of another, … shall pay such debt …, shall be entitled to have assigned to him, or to a trustee for him, every … security which shall be held by the creditor in respect of such debt … and such person shall be entitled to stand in the place of the creditor, and to use all the remedies, and, if need be, and upon a proper indemnity, to use the name of the creditor, in any action or other proceeding, at law or in equity, in order to obtain from the principal debtor … indemnification for the advances made and loss sustained by the person who shall have so paid such debt … ”

However, a right of subrogation can always be excluded by agreement between the surety and the principal debtor, and there is also no reason in principle why a surety’s statutory right of subrogation under section 5 of the 1856 Act may not also be bargained away, although clear and explicit language will normally be required if the court is to conclude that this has happened: see Andrews & Millett, Law of Guarantees, 4^th edition, para 11-028, and O’Donovan & Phillips, The Modern Contract of Guarantee, 2003 edition, paras 12-260 and 261.

In the present case, two critical features of the agreement between Mr McGinnis, Mr Poduval and Mr Banks were:

I should add that a right of subrogation would in my judgment still be excluded even if I am wrong in my view that it was never intended that the £100,000 would be repayable to Mr McGinnis in any circumstances. I can see that there may arguably be room for implication of an obligation to repay the sum in the event that the share sale did not proceed, and particularly if the profit-sharing formula in Clause 6 of the draft Heads of Agreement was never finalised. However, any such implied obligation could not in my view have gone further than an obligation to repay the money as a simple unsecured loan. It is well established that there is no room for the doctrine of subrogation to apply where the intention of the parties was merely to create an unsecured loan: see Paul v Speirway Limited [1976] Ch 220 at 232B-D per Oliver J, cited with approval by Lord Hoffmann in Banque Financiere de la Cite v Parc (Battersea) Ltd [1999] 1 AC 221 at 233B-E and 234D-E.

In the course of his valuable and illuminating review of the doctrine of subrogation in Banque Financiere, Lord Hoffmann pointed out that the term is used not only in contractual contexts, where it is founded upon the common intention of the parties, but also to describe an equitable remedy to reverse or prevent unjust enrichment, where it is not based upon any agreement or common intention of the party enriched and the party deprived. He continued at 231H:

“The fact that contractual subrogation and subrogation to prevent unjust enrichment both involve transfers of rights or something resembling transfers of rights should not be allowed to obscure the fact that one is dealing with radically different institutions. One is part of the law of contract and the other part of the law of restitution. Unless this distinction is borne clearly in mind, there is a danger that the contractual requirement of mutual consent will be imported into the conditions for the grant of the restitutionary remedy or that the absence of such a requirement will be disguised by references to a presumed intention which is wholly fictitious.”

Later on, at 234C, he said that the appropriate questions to ask in a resitutionary context are, first, whether the defendant would be enriched at the plaintiff’s expense; secondly, whether such enrichment would be unjust; and thirdly, whether there are nevertheless reasons of policy for denying a remedy. He also observed that questions of intention may still be highly relevant to the question of whether or not enrichment has been unjust.

I have so far considered the question of subrogation in the context of the contractual arrangements between the parties, but in my view the same conclusion is reached if one approaches the question from the standpoint of the law of restitution. The Company was indeed enriched at the expense of Mr McGinnis, unless a term for repayment of the money is to be implied; but the enrichment was not unjust, because this was what the parties always intended to happen if the performance and financial targets were not met, and if the share sale did not go ahead.

In the light of the conclusion which I have reached, it is unnecessary for me to consider Miss Barber’s alternative submission that, if Mr McGinnis did have a right of subrogation, he has subsequently lost it by acquiescence. The question of Berkeley Applegate relief also does not arise.

For these reasons I will declare that neither of the respondents has any beneficial entitlement to the surplus of funds in the hands of the liquidator, whether by subrogation or otherwise.