“All cats are animals, but all animals are not cats”

17th September 2020 Corporate Recovery and Insolvency

Cory Bebb looks at a recent unsuccessful attempt by Administrators to block an £18.6M misfeasance claim by contributories.

“All cats are animals, but all animals are not cats” - former administrators’ attempt to stop £18.6M misfeasance claim based upon their CVA release clause, fails in a provisional ruling: Re Rhino Enterprise Properties Limited [2020] EWHC 2370 (Ch)

“All cats are animals, but all animals are not cats” was the way the Judge described the crux of this case: the fact that the established principles of construction of an instrument apply to a CVA, as they do a contract, does not lead to a conclusion that a CVA is a contract.

Brief Background Facts

Rhino (and one other associated company, ‘the Companies’) entered administration in August 2013 following the Bank appointing administrators at a time when the Companies had substantial claims against the Bank arising from the mis-selling of interest swap products (‘the Swaps’). The Companies held a substantial property portfolio. The appointment was made following the Companies issuing letters of claim against the Bank in May 2013.

The Companies had the benefit of advice from leading counsel, to the effect that there was a 60% chance of succeeding in a claim against the Bank based on LIBOR manipulation and mis-selling of the Swaps.

The Administrators took their own advice from solicitors, who put the prospects of success at just less than 50%, which was fatal to any prospect of litigation funding and insurance which led to the Administrators accepting the Barclays claim of £20.9M.

Despite protestations from the shareholders of the Companies (and intimation of personal claims against the Administrators for Paragraph 75 Misfeasance) the Administrators sold the property portfolio with a shortfall of £663,000 to the Bank.

The shareholders, the Claimants in this case, managed to persuade the Bank and Administrators to write off the £663,000 shortfall and exit the administrations through CVAs so that the Companies could proceed with the Swap Claims against the Bank.

The Administrators prepared the CVAs in June 2014, but included a clause by which all creditors (which included the Claimants) and the Companies undertook not to bring any claims arising from the Administrators’ acts, omissions or defaults, and further released the Administrators from such liabilities (‘the CVA Release Clause’). The Claimants approved the CVA in their capacity as creditors and the Companies were returned to the control of their directors in August 2014.  

The Companies issued proceedings against the Bank in 2015, which were settled that year.

In August 2019 the Claimants, as contributories of the Companies, issued proceedings challenging the Administrators’ conduct, seeking compensation of £18.6M.

The Complaint and Claim

The essence of the Claimants’ complaint and claim is that (1) the Administrators (a) should not have accepted the administration appointment because of a close relationship through which the Bank enjoyed the upper hand or “informal control” and/or (b) having accepted the appointment, acted in breach of duty because their close relationship with the Bank disabled them from exercising sufficient independence to properly investigate, pursue, and litigate the Swaps Claims against the Bank; and, (2) had the Swaps Claims been properly pursued, the Companies’ liabilities would have been extinguished or reduced to a level which could have been refinanced. The claim concerns allegations of breaches of fiduciary, common law, and statutory duties owed to and misfeasance against the Companies giving rise to an obligation to provide compensation under paragraph 75(4) of Schedule B1 to the assets of the Companies.

Given that the Administrators had been discharged under Paragraph 98, the Claimants required permission of the Court to bring the claims under Paragraph 75, which requirement  exists to weed out unmeritorious claims being brought against officeholders following their discharge and loss of indemnity from the company assets with which to deal with such claims.

The Administrators sought to stop the claim in its tracks by relying on the CVA Release Clause as preventing any claims being brought against them, also relying on the Contract (Rights of Third Parties) Act 1999 (‘the 1999 Act’) as a ‘third party’ entitled to enforce a term of a contract, being the CVA Release Clause.

The Issues  

Whilst the majority of the Court’s time and judgment was focused on whether or not a CVA was a ‘contract’ to which the 1999 Act could apply, it is worth pausing to note that the Judge agreed with the Claimants’ complaint that the CVA Release Clause was ineffective in equity as a provision intended by the Administrators to secure a personal benefit outside the scope and purpose of the CVA – the Administrators as officeholders were fiduciaries to whom the ‘proper purpose rule’ applied and it was improper for an administrator to use the machinery of a CVA to exclude a liability after the event which could not be excluded before or during the event. It did not benefit or affect the Companies’ creditors; its purpose was to benefit a fiduciary who was potentially a debtor. 

On the contract point, the court undertook a thorough review of the authorities which characterised CVAs by analogy to contracts variously describing them as having ‘contractual effect’; ‘subject to the ordinary principles of interpretation applying to contracts’; ‘hypothetical contracts’; ‘contractually based’; ‘contractual analysis to issues such as the true construction of the CVA’; ‘hypothetical bilateral contract’; ‘contractual mechanism’; ‘species of statutory contract’; ‘takes effect as a contract’ and ‘operating as a contract’.

Following the review of the authorities the Court found, for the purposes of the permission application, that a CVA is not a contract but this was only a provisional view when deciding whether the claim should proceed to a full trial. It may well be that the trial judge reaches a different conclusion.

Comment

Whilst practitioners have always considered CVAs to be analogous to contracts for the purposes of construction and interpretation, they have never really been viewed as contracts which are subject to the law of contract generally, and none of the cases on the point have suggested otherwise. Whilst this was a fairly novel defence, it is in the writer’s view unlikely to find any success at trial for the reasons in this extensive judgment. The Administrators also need to overcome the ‘proper purpose’ rule as the trial judge is unlikely to find the Administrators’ position on this very attractive as it could lead to routine exclusions of liability clauses being included in CVAs proposed by officeholders. Indeed, what would prevent directors including similar such releases for themselves?

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Cory Bebb is a Partner & Licensed Insolvency Practitioner located in Londonin our Corp. Recovery and Insolvency department

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