The decision in March this year of Andrew Simmonds QC, sitting in the High Court, in the case of DKLL Solicitors -v- HM Revenue & Customs[1], provides assistance to insolvency practitioners wishing to apply for an administration appointment.

the facts

The case concerned an application for an administration order by the two equity partners of DKLL. It was accepted by all parties that DKLL was hopelessly insolvent and their liabilites exceeded £2.4 million, which included a debt to HMRC of £1.7 million. Clearly, therefore, HMRC was DKLL's majority creditor. The underlying purpose of the application was to preserve value by enabling the proposed administrators to effect a pre-pack sale of DKLL's business to a newly incorporated limited liability partnership for a total consideration of £400,000. The application was made urgently because HMRC had issued a winding up petition against DKLL about four months previously, which was due to be heard the day after the hearing of the application. HMRC opposed the application.

the statutory test

The judge identified the relevant test as being set out in paragraph 11 of Schedule B1[2], namely:

"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"

Paragraph 11 has two threshold conditions, namely that the partnership is unable to pay its debts and that the purpose of administration will be achieved. Provided that these conditions are satisfied, the court must then decide whether, in its discretion, an administration order should be made.

the first condition – is the partnership/ company unable to pay its debts?

That the first condition was satisfied was not in dispute.

the second condition – will the purpose of the administration be achieved?

In deciding whether the second condition is satisfied, the judge of course directed himself to paragraph 3 of Schedule B1:

"The administrator…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 secured or preferential creditors".

The grounds relied upon by the applicants was that an administration would achieve a better result for the partnership's creditors as a whole than a winding up. The applicant submitted that the total funds available for creditors on a forced sale of the business would be about £105,000 (and that a liquidation would result in additional preferential claims totalling £44,000 by employees for arrears of pay and holiday pay), whereas the proposed pre-pack sale of the business would preserve jobs and raise £400,000 for the creditors.

In response to the applicant's draft statement of affairs, HMRC rejected the suggestion that DKLL's assets – with a book value of £1.7 million – were worth only £100,000. In particular, HMRC queried why DKLL's work in progress – with a book value of £806,000 – was estimated to be worth nothing.

The proposed administrators (Malcolm Cohen and Anthony Nygate of BDO Stoy Hayward) prepared a report in reply to this challenge by HMRC. In that report, the proposed administrators set out in detail his experience of dealing with insolvent professional partnerships. The proposed administrators stated in the report that, in his opinion, "the proposed administration strategy…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". The proposed administrators went on to say:

"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, ie 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 partnership's only significant assets, namely debtors, work in progress and goodwill"

The judge pointed out that "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".

HMRC pointed out that it was the majority creditor of DKLL by a large margin and, if a meeting of creditors were held pursuant to paragraphs 50-55 of Schedule B1 to consider the proposed administrators' sale of the business, the Revenue would be able to defeat the proposal. In this case, there was to be no creditors' meeting because the pre-pack sale of the business immediately upon appointment of the proposed administrators did not require it. HMRC accepted that a creditors' meeting need not be called for the proposed administrators to carry out a pre-pack sale, but contended that the court ought not to make an administration order where it is known that the majority creditor opposes the sale. The judge considered the authorities and pointed out that even if a creditors' meeting were called, a majority creditor does not have complete power to veto an administrators' proposals: the court could, regardless of the majority creditor's opposition, authorise the proposals under paragraph 55(2) of Schedule B1.

The judge therefore rejected HMRC's submission that, if this case were not concerned with a pre-pack sale, HMRC's opposition to the proposed sale alone did not make it "reasonably likely" that the purpose of administration would be achieved. The judge saw no reason to put the applicants in a worse position or HMRC in a better position simply because this particular case involved a pre-pack sale; the principle, he said, was the same. Accordingly, the judge concluded that the second threshold condition had been satisfied.

the judge's discretion

Upon being satisfied that the statutory threshold conditions had been met, the judge was required to decide whether, in his discretion, the administration order should be made. The judge said that he was influenced against granting the application by reason of the opposition of HMRC. However, the judge was more heavily influenced by the fact that the proposed administrators' intended sale appeared to be the only way of saving the jobs of DKLL's employees (of whom there were approximately 50). Furthermore, the proposed sale was likely to result in the minimum possible disruption for DKLL's clients. The judge therefore decided to exercise his discretion in favour of the applicants, and the administration order was made.

implications for insolvency practitioners

This judgment offers further judicial support to the concept of pre-pack administration sales in appropriate circumstances. In addition, the following guidance can be taken from the judgment:

in establishing whether an administrator's proposals are reasonably likely to achieve the purposes of the administration, the court places great reliance on the professional opinion of the proposed administrator, but it also helps if the proposed administrator can draw upon sector-specific experience. Practitioners may therefore wish to ensure that their relevant credentials are prominent in any application for an administration order
the opposition by majority or significant creditors to a proposed administration and/or pre-pack sale is an important factor which the court will take into account when deciding whether to make an administration order. However, in an appropriate case, other factors can outweigh even a majority creditor’s wishes. The fact that the administrator is unlikely to be able to secure the approval of a majority of creditors is not, in itself, fatal to an administration order application
the judgment confirms the long-held understanding that the courts will take into account the position of other 'stakeholders' in the company/ partnership (such as employees or clients of the business). Practitioners may therefore wish to canvas and/or draw the court’s attention to the interests and desires of such stakeholders in any application for an administration order

For more information on this topic, please contact Dan Geddes or Mike Pavitt of Blake Lapthorn's Insolvency and Business Recovery team or Chris Boardman from 11 Stone Buildings.

[1] [2007] EWHC 2067 (Ch)

[2] In this case, the court was considering paragraph 11 as amended by article 6 and schedule 2 to the Insolvent Partnerships Order 1994. The effect of these provisions is simply to render paragraph 11 applicable to insolvent partnerships. There is no reason, in the writer's view, why the principles established in this case should not be equally applicable to administration applications in respect of limited companies.