Update: insolvency

The last six months have been a turbulent time in the insolvency world as the economy continues to feel the squeeze. There has been a marked increase in the number of cases being brought by creditors who believe they have been unfairly treated by administrators with courts having to justify their reluctance to interfere with their commercial judgments.

Employment issues in insolvency have come to the forefront once again, with the courts seemingly being no closer to clarifying recurring problems. The fallout from the decline of Lehman Brothers continues to cause problems for creditors in more ways than one and the issue of costs, which has always been rife in insolvency, has now been catapulted to the top of the agenda with Jackson LJ's recent report.

As expected, the number of insolvencies has continued to rise over the last 12 months. According to recent data published by the Insolvency Service, corporate insolvencies in the third quarter of 2009 showed an increase of just over nine per cent compared with the same period a year ago. A similar comparison shows an increase of one third in personal insolvencies in the same quarter.

Administrator's conduct and unfair harm

Zegna III Holdings Inc [2009] EWHC 2994 (Ch) considered the extent of an administrator's duty to creditors. Z was a British Virgin Island registered company which was incorporated as a special purpose vehicle to undertake the redevelopment of a property. The project fell behind schedule and was over budget. The bank applied to court for the appointment of administrators to Z. Following their appointment, the administrators terminated the contract with the builder (B) after they received evidence that B was not competent to complete the redevelopment on time and to budget.

B applied to the court asserting that the wrongful termination of the contract by the administrators caused unfair harm to its interests and amounted to a breach of the duty by the administrators to act in the interests of the 'creditors as a whole'. B sought the removal of the administrators.

B's application was dismissed on all grounds. However, Norris J considered whether B had been treated differently from other creditors in having its contract terminated. The obligation on administrators to perform their functions in the interests of the 'creditors as a whole' did not require them to treat each and every creditor in an identical way. The court accepted there may be good commercial reasons for treating individual creditors differently and for terminating particular contracts (even wrongfully).

Similarly, unequal or differential treatment of B compared with other creditors did not necessarily result in 'unfair harm'. Norris J explained that if there is a cogent and rational explanation for the differential treatment of a particular creditor, then the harm caused will not be 'unfair'. This is a commercial judgment for the administrators, and the courts will not interfere with such decisions unless it is based on an incorrect appreciation of the law or is conspicuously unfair to a particular creditor.

The case is consistent with Four Private Investments Funds v Lomas [2008] EWHC 2869, where the court has maintained its reluctance to interfere with the commercial judgment of administrators on applications by creditors objecting to their conduct.

TUPE and bankruptcy

Under regulation 8(7) of TUPE 2006, employees will not automatically transfer to a buyer and their dismissal by the seller will not be automatically unfair if the seller is the subject of 'bankruptcy proceedings' or any analogous insolvency proceedings which have been instituted with a view to the liquidation of the assets of the seller under the supervision of an insolvency practitioner.

Parliament did not specify which of the formal insolvency procedures satisfy the regulation 8(7) definition of 'bankruptcy proceedings'. In its guidance, BIS takes the view that administration would not fall within regulation 8(7) because its primary purpose is always to rescue the company as a going concern, and not a liquidation of the assets. However, this guidance is not binding, and the Employment Appeal Tribunal (EAT) in Oakland v Wellswood (Yorkshire) Ltd [2009] UKEAT/0395/08; [2009] EWCA Civ 1094 took a different view.

Here, administrators were appointed to a fruit and vegetable wholesaler. The administrators concluded that the first objective of the administration (rescuing the company as a going concern) was not achievable. They therefore concentrated on achieving the secondary purpose of administration, namely a better result for creditors than would be likely if the company were wound up without first being in administration. The administrators concluded that any period of administration trading would probably have resulted in further losses, which dictated the need for a pre-packaged sale. On the same day as the administrators were appointed, a buyer purchased the company's assets, including its trading premises, fridges, and vans from the administrators. The purchaser also took on five of the seven employees, including the claimant.

The claimant was subsequently dismissed by the buyer, and brought a claim for unfair dismissal against him. A preliminary point arose as to whether regulation 8(7) of TUPE 2006 applied to the transfer (if it did not, he would not have the one year's service needed to bring an unfair dismissal claim of the kind alleged). The Employment Tribunal concluded that regulation 8(7) did apply to the administration process, so that the claimant was not automatically transferred under TUPE 2006. The claimant appealed.

The EAT judge (sitting alone) relied on the fact that the seller did not trade in the administration before the relevant transfer and concluded that the Employment Tribunal had correctly decided that the appointment of administrators 'was with a view to the eventual liquidation of the assets of [the seller], by way of CVL'. Consequently, regulation 8(7) operated to take the sale outside the scope of TUPE and the claimant did not automatically transfer.

The case subsequently came before the Court of Appeal. It held that, pursuant to section 218(2) of the Employment Rights Act 1996, the employee's continuity of employment was not broken by the transfer and therefore a claim for unfair dismissal was permissible. Although the Court of Appeal did not focus on TUPE in coming to its decision, it did indicate that it considered that it was unlikely that regulation 8(7) would apply in relation to pre-pack administration sales. This, however, may not prevent such an argument being used by purchasers in the future and we shall have to wait for a future case to give a definite ruling on the issue.

Cash held by administrators subject to a trust

When do administrators hold money on trust for secured creditors rather than for creditors as a whole?

In Lehman Brothers International (Europe) (in administration) v RAB Market Cycles (Master) Fund Limited [2009] EWHC 2545 (Ch), the administrators of Lehman Brothers International (Europe) (LBIE) sought directions as to how they should treat US$1.8bn cash received by LBIE after having entered administration. The money was held by LBIE as custodian under its standard form international prime brokerage agreement. The key question considered by the court was whether the cash should be treated as trust money, and therefore paid to the beneficial owners of the securities from which it derived, or, alternatively, added to the assets of LBIE and be made available for unsecured creditors.

It was held that the relevant brokerage agreement language showed a clear intention to create a trust and therefore that the fund counterparties retained and continued to retain a beneficial interest in those securities. LBIE's contractual rights to mix the property of multiple counterparties and to swap one counterparty's securities for the equivalent securities of another counterparty were found not to be incompatible with a trust relationship.

The judgment is only relevant to cash received post-administration by LBIE. It does not extend to title transfer agreements, or to cash received by LBIE's sub-custodians or by any other Lehman entities which may be subject to insolvency proceedings in other jurisdictions. Indeed, in the case of RAB, the securities were held by Lehman Brothers Inc, and, although the judgment favours RAB's claim as a matter of English law, RAB still faces the practical hurdle of recovering those securities or their cash equivalent from the US.

Fixed costs for insolvency proceedings?

In his review of civil litigation costs, Jackson LJ has recommended that a scheme of benchmark costs should be implemented for bankruptcy and winding-up petitions. There is currently a system of benchmark costs in bankruptcy proceedings under which HMRC costs are summarily assessed in the Royal Courts of Justice. A Working Group has recommended that the current scheme could and should be extended to all 'routine' bankruptcy and winding-up petitions. The Working Group concluded that most bankruptcy and winding-up petitions should be considered routine.

The Working Group recommended a procedure for recovering costs on a fixed costs or benchmark basis as an option for a party who obtains a costs order in his or her favour, without requiring those costs to be assessed. If a party exercised its option of seeking to recover costs by application of the fixed or benchmarked amount for the particular step in the proceedings, such an amount would be awarded to that party '“ usually without further inquiry. This should lead to cost assessments being dealt with swiftly and ideally by the agreement of the parties. Nevertheless, a party could seek to recover its costs without reference to the fixed or benchmarked amount, but, if it failed to recover significantly more than the fixed or benchmarked amount, appropriate cost sanctions could be applied against that party due to it having caused a greater amount of party and court time to be consumed to no useful purpose.

But as this is still only a proposal it remains to be seen whether it can be implemented and whether insolvency proceedings can be categorised under a 'routine' system.