Companies Court applies strict pari passu principle to section 176A 1A86 (case of Courts plc)

Companies Court gives further guidance on the application of section 176A Insolvency Act 1986 in particular in connection with an application under section 176A (5) (case of Courts Plc (in liquidation) [2008] EWHC 2339 (Ch).

summary

The joint liquidators of Courts Plc (Courts) applied, among other matters, for an order pursuant to section 176A (5) of the Insolvency Act 1986 that section 176A (2) should be partially disapplied so that the distribution of the prescribed part would not take place to those unsecured creditors owed £28,000 or less. Those creditors were the majority of the unsecured creditors (by number) but were owed the minority of the overall debt owed to all unsecured creditors.

This case is the third case dealing with section 176A within a year. The other cases were Permacell Finesse Limited (in liquidation) (Permacell) where judgment was handed down on 30 November 2007 by His Honour Judge Purle QC sitting as a Judge of the High Court at Birmingham Civil Justice Centre and (1) Airbase (UK) Ltd and others -v- (1) HM Revenue and Customs and others.

In Permacell, the secured creditor held a floating charge and in Airbase the secured creditor held fixed and floating charges. In both cases the secured creditor was left with a shortfall after the relevant assets were realised. The issue in both cases was whether or not the secured creditor could participate in the prescribed part in respect of their unsecured shortfall. The decision in both cases was that the secured creditor had no right to participate in the prescribed part. The effect of both cases was that 'unsecured debts' in section 176A (2) does not include a debt which is secured in whole or in part whether under fixed or floating charges. In Airbase, Patten J made specific reference to section 248 of the Insolvency Act and was of the view that 'secured creditors', as defined in that section, were excluded from the prescribed part. The Permacell judgment was made available to Patten J after the hearing and the preparation of his judgment in the Airbase case but he did not add anything further to his judgment because it accorded with his own views.

the facts

Courts went into administration following a court order on 30 November 2004. Disposals took place until July 2007 and courts went into liquidation on 30 November 2007. There were 297 unsecured creditors' claims totalling approximately £94 million. Of the 297 unsecured creditors, 260 had claims of £28,000 or less leaving 37 owed more than that figure. HMRC and the pension scheme made up 86% by value of the £94 million. The only amount that would be payable to unsecured creditors would be in respect of preferential claims and the prescribed part. The amount of the prescribed part in this case was the maximum permitted namely, £600,000.

The liquidators had calculated that £50,000 would be the average overall cost of processing the unsecured creditors' claims and making distributions. As the costs came out of the prescribed part under Insolvency Rule 12.2(2), this would have left £550,000 available for distribution. On the assumption that the total value of the claims was £94 million this would result in a dividend from the prescribed part of about 0.6p in the pound. On the further assumption that the £50,000 'costs' were divided equally between all 297 unsecured claims, the average cost of dealing with each claim would be just over £168.00. The liquidators had worked out that a claim would have to be admitted in excess of £28,000 before the estimated costs of dealing with the claim were exceeded by the corresponding dividend. The liquidators believed that the costs of making a distribution to the 260 creditors whose claims were £28,000 or less would be disproportionate to the benefits for those creditors by making the distribution to them.

It was on this basis that the liquidators applied for an order under section 176A (5) that section 176(2) should not apply to those creditors.

Section 176A(2) provides:

"The liquidator, administrator or receiver:

1. shall make a prescribed part of the company's net property available for the satisfaction of unsecured debts, and
2. shall not distribute that part to the proprietor of a floating charge except in so far as it exceeds the amount required for the satisfaction of unsecured debts"

Section 176A (5) provides:

"Subsection (2) shall also not apply to a company if:

1. the liquidator, administrator or receiver applies to the court for an order under this subsection on the ground that the cost of making a distribution to unsecured creditors would be disproportionate to the benefits, and
2. the court orders that subsection (2) shall not apply"

the argument

The judge, Blackburne J, drew attention to the fact that the two conditions that have to be fulfilled if the power to disapply section 176A (2) is to be exercised, are that the 'defined' office-holder has to make an application to the court that subsection (2) shall not apply and the court has to be willing to make the required order.

The liquidators' argument was that the court should construe subsection (2) as if it could be disapplied in part. Their arguments in support of this were:

1. there is nothing in the wording of section 176A (5) which makes it clear that the court must disapply section 176A (2) in its entirety
2. the object behind the introduction of section 176A, (the setting aside of the prescribed part) was to benefit unsecured creditors of an insolvent company
3. section 176A should be interpreted purposively so as to give effect to its objective
4. the construction argued for by the liquidators enables the court to give effect to such objective
5. the contrary construction (namely, subsection (2) is either disapplied in its entirety or it is applied in its entirety) would frustrate Parliament's objective in introducing the section
6. in a situation as applied in this case, an all or nothing approach would not benefit the unsecured creditors of an insolvent company

the decision

The judge decided that section 176A (2) applies either in its entirety or not at all and that a literal reading of section 176A (5) is appropriate. The Judge pointed out that the wording in section 176A (5) was: "Subsection (2) shall also not apply …". In the judge's view that meant either subsection (2) applied or it did not. He did not believe it could apply in part.

Blackburne J based his view on two considerations. The first was his view of the principle of pari passu distribution among unsecured creditors in an insolvent liquidation. Other than in the case of preferential creditors, the debts of a company are to rank equally between themselves. He felt that either the Insolvency Act or the Insolvency Rules would have made it clear that another exception to the pari passu distribution rule would apply in the case of section 176A if Parliament intended it to, but they did not. He pointed out that if he were to grant the order asked for 37 creditors would take the prescribed part in its entirety and 260 creditors would receive nothing.

The other consideration was that the liquidators' affidavit, in support of their view that the cost of making a distribution to unsecured creditors would be disproportionate to the benefits, assumed that in assessing the benefits this should be by reference to what a particular creditor could expect by way of distribution having regard to the issue of the cost of processing that particular creditor's claim and making payment of the dividend with regard to it. The Judge took the view that the costs/benefit balance was to be approached by treating the creditors as a body and not by approaching it from a particular creditor's claim point of view. He referred to the fact that in the case of voluntary and compulsory liquidations the provisions in the Insolvency Act and the Rules provided that after the liquidator's expenses have been paid out, the balance is distributed among the company's unsecured creditors and, subject to preferential debts, is paid out on a rateable basis without any consideration as to whether or not the actual cost of processing a particular creditor's claim may exceed the distribution to that creditor.

The court therefore refused to make an order that section 176A (2) should not apply to unsecured creditors with claims of £28,000 or less.

implications for insolvency practitioners

• The Courts decision is clear cut in that an order under section 176A (5) to disapply section 176A(2) cannot apply to some rather than all unsecured creditors in the relevant matter.
• The case also gives helpful guidance as to how the court will look at the evidence that is submitted by the office-holder to show that the cost of making a distribution to unsecured creditors would be disproportionate to the benefits. According to the decision in Courts this has to be presented and looked at in the context of the benefit to the creditors as a whole rather than to any particular creditor or group of creditors.  This is the basis upon which other reported applications, and applications brought by Blake Lapthorn have been put.
• This is a first instance decision and it may be that the courts will have an opportunity to consider the application of section 176A (5) again in the future. Another judge might take a different view of the application of the pari passu rule in the context of the subsection as to how the evidence in respect of the costs of distribution should be approached.
• At least as far as fixed or floating charge holders are concerned, when faced with a shortfall, Permacell and Airbase make it quite clear that they will not be able to participate in the prescribed part.

If more information is required in respect of this matter then please do not hesitate to contact Paul Rippon or Mike Pavitt of Blake Lapthorn's Insolvency and Business Recovery team.