Insolvency calls time on pursuing claims
Claims remain frequent in the construction industry, and so do insolvencies. In the wake of main contractor Carillion’s entry into liquidation, and rumours of forthcoming interest rate rises, it is worth looking at what effect different types of insolvency have on the ability to prosecute claims.
It is a familiar scenario: a party to a construction contract goes into an insolvency process such as administration or liquidation. Most standard forms of construction contract already have a wide definition of what constitutes insolvency, and provide that the employer is not obliged to make any further payment to the contractor until the works are complete, and may terminate the contract. Typically, creditors are then requested to ‘prove’ the debts they contend they are owed, by returning completed proof of debt forms to the relevant Insolvency Practitioner. They then determine all claims by creditors and, if accepted and there are sums to distribute, declare dividend(s). Which claims can still be progressed will depend on a combination of the insolvency process and dispute resolution method invoked.
Why make or sustain claims at all?
Isn’t litigating against an insolvent company futile? Generally, yes, because unsecured claims will rank equally, so no debt can be recovered ahead of other unsecured creditors, and all creditors frequently face receiving only a few pence in the pound, if anything. The Association of Business Recovery Professionals suggest that unsecured creditors, on average, receive 1% of the debt due to them from a company in administration that undertakes a pre-pack sale and 3% in cases in which a going concern sale is achieved.
However, there may be good reason for commencing or continuing a claim in some circumstances. The remedy sought may be more than simply monetary, such as a declaration which establishes certain rights, or an order for specific performance concerning items you contend are not part of the insolvent estate, or the subject-matter could be security over land you hold. In such circumstances, seeking permission to bring or continue a claim may make sense. In ‘run of the mill’ claims for a debt or damages however, there is often little to no cost-benefit justification for an unsecured creditor to commence or continue a claim in many insolvency situations.
Scope of moratoria
The Insolvency Act 1986 (‘IA86’) provides for moratoria to apply when most insolvency processes begin. They mean that no claims can be begun, and existing legal proceedings are automatically stayed (i.e. suspended), unless the relevant insolvency officer (liquidator, administrator etc.) consents or the court permits it (following an application for that by a creditor). In the insolvency world, ‘legal proceedings’ is very broad and as well as action in court, this will include arbitration (Re Paramount Airways Ltd [1990] Ch 744), adjudication (A Straume (UK) Ltd v Bradlor Developments Ltd [2000] BCC 333 where, following the test in Bristol Airport Plc v Powdrill [1990] Ch. 744, adjudication was judged to be a "quasi-legal proceeding"), the presentation of a winding up petition (Re Arucana Ltd [2009] EWHC 3838 (Ch)) and even serving a statutory demand (Fulton and another v AIB Group (UK) plc [2014] NICh 8). Certain regulatory proceedings are covered too, so the moratoria are quite comprehensive. The upshot is that come the end of a formal insolvency process then, except as explained otherwise below, any liability or debt that was owed at the beginning of the process is extinguished (limited exceptions apply to fraud and personal injury claims).
It may seem one sided, but the insolvency practitioner charged with handling an insolvent company’s affairs – particularly the realisation of assets (including debts due) in the hope of declaring dividend(s) to creditors – can elect to commence or continue the insolvent company’s claims, without the court’s permission. Therefore, where a claimant is insolvent, or evidence suggests that it is insolvent, a defendant should consider seeking security for costs so that its financial position is protected – at least in part – should it successfully defend itself. If the insolvent claimant cannot put up the security ordered, its claim is likely to be struck out.
Moratoria in corporate insolvencies
In Compulsory liquidation, the presentation of a winding up petition at court results in no interim moratorium unless the company or a creditor applies for it (IA86 s.126(1)). Litigation therefore continues pending the hearing of the petition. On the court making a winding up order, a moratorium applies for the duration of the subsequent liquidation (IA86 s130).
A Creditors Voluntary Liquidation (‘CVL’) involves the shareholders of a company passing a special resolution to liquidate their insolvent company and appoint a liquidator to distribute the proceeds to the company's creditors. Within 14 days of that resolution the company must seek its creditors’ approval of its nomination of the liquidator, giving at least 3 business days’ notice of the decision date. Within 7 days of that resolution its directors must prepare and serve a statement of affairs on the creditors no later than the business day before the decision date. Conversely, a Members Voluntary Liquidation (‘MVL’) involves the shareholders of a company passing a special resolution to liquidate their solvent company and appoint a liquidator to distribute the proceeds to the company's creditors and members so that both are paid in full. An MVL is only permissible if the company is solvent, so the company’s solvent position has to be certified by a director’s statutory declaration of solvency (IA86 s.89). At the end of either type of voluntary liquidation, the company is dissolved. Unlike compulsory liquidation, there is no automatic moratorium in either scenario, although a court may order that particular proceedings are stayed under its general, discretionary power, on a liquidator’s application (IA86 s.112(1)). Because an MVL is a solvent liquidation, the liquidator will not always require a proof of debt to be submitted, but he should do so in a CVL. Liquidation is terminal, so limitation periods cease to run and claims will not be time barred and remain possible until the company is dissolved (and sometimes thereafter, but that’s a different ball game).
In Administration, an interim moratorium applies as soon as an application for an Administration Order is made at court or, where a company’s members or board resolve to go into administration, a notice of intention to appoint an administrator is then filed at court (IA86, Sched B1, para 43(6)). The moratorium becomes permanent once the administrator accepts his appointment and lasts until the administration is concluded. However, note that in administration, the moratorium only suspends rights to bring claims and does not extinguish them. If the company comes out of administration and resumes normal trading then bringing a claim remains an option. However, the applicable limitation period will continue to run. Agreements with administrators to ‘stop the limitation clock’, by means of a ‘stand-still agreement’ are not uncommon. However, if no overall commercial settlement or stand-still can be agreed, and there is a risk that a claim will become time-barred during the currency of the administration, claimants should seriously consider seeking the administrator's consent or the court's permission to issue a claim during the administration.
Where a company proposes to enter into a Company Voluntary Administration (‘CVA’), the directors of certain smaller companies have the option of applying to court for a 28 day moratorium during which the creditors can consider that proposal (IA86 s.1A). When a proposal is accepted by 75% of creditors by value, the CVA binds both known and unknown creditors in relation to debts which the terms and scope of the proposal encompasses (IA86 s.5(2)(b)). Essentially, the creditors’ majority decision to accept a proposal creates a statutory contract between the company and all the company’s creditors, even those which opposed the proposal but were outvoted, or those which had no notice of the meeting when they ought to have done. This statutory contract supersedes any preliminary moratorium. However, the resulting moratorium is weaker than that which applies to other insolvency regimes, because its scope depends on how the proposal is drafted. An aggrieved creditor can challenge the validity of the CVA on limited grounds (a) up to 28 days from the date on which the proposal was approved or (b), in the case of failure to deliver notice of it to a creditor who is entitled to receive it, 28 days from their actual notice of the proposal (IA86 s.6). Even if such a challenge is successful though, there is every possibility that the correctly constituted body of creditors may re-approve the proposal or a variation of it, such that a brake remains on the aggrieved creditor’s ability to bring claims. Companies often go into administration with the benefit of a full moratorium and propose a CVA within it while they trade back into the black.
Schemes of arrangement are a statutory procedure under Part 26 of the Companies Act 2006 (‘CA06’) which enables a company to enter into a binding compromise or arrangement with creditors (or any class of them). If the Scheme is approved, then like a CVA, the scheme will bind all of the relevant class of creditors, including those who voted against it. A Scheme requires sanction by the court before it can be implemented. Although neither CA06 nor IA86 contain provision for a moratorium pending approval of the Scheme, the court may stay court proceedings against a debtor pending the creditors’ approval of the proposed Scheme under rule 3.1(2)(f) of the Civil Procedure Rules (CPR). The jurisdiction should only be exercised in exceptional circumstances (see Bluecrest Mercantile BV and another v Vietnam Shipbuilding Industry Group (‘Vinashin’) and others [2013] EWHC 1146 (Comm)). In Vinashin, the court recognised that without a de facto moratorium using the CPR, other non-Scheme creditors would bring proceedings, prejudicing the position of those claimants whose claims were subject to a stay.
Moratoria in individual insolvencies
Where the Bankruptcy of an individual is concerned, no automatic moratorium applies on the presentation of a bankruptcy petition at court, but the court can impose one or only allow proceedings to continue on certain terms. On the court making a bankruptcy order, a moratorium applies to pre-order claims until the bankrupt is discharged (IA86 s.285).
Where an individual proposes to enter into an Individual Voluntary Administration (‘IVA’), they have the option of applying to court for a moratorium during while the creditors consider that proposal (IA86 s.252), and the moratorium applies from the date of that application (IA86 s.254). If the proposal is accepted by 75% of creditors by value then the IVA binds both known and unknown creditors in relation to debts which the IVA is drafted to encompass (IA86 s.260), and this supersedes the interim order for a moratorium. The IVA moratorium is therefore weaker than that which applies in bankruptcy since, like the CVA, its scope depends on how the proposal is drafted. As with a CVA, creditors can challenge the validity of the IVA on limited grounds and within a limited period (IA86 s.262) but, again, the original proposal or a variation of it may be re-approved, and commercially the aggrieved creditor’s position may be no better.
Debt Relief Orders also carry a moratorium on pursuing qualifying debts (IA86 s.251G). That moratorium lasts one year, and on its expiry the obligation to pay qualifying debts ceases.
Immediate impact of actual or pending insolvency on dispute resolution processes
In such situations, the parties will be obliged to follow court orders designed to progress, say, their litigation (e.g. disclosure, witness statements etc.), but as explained above, such costly activity will be quickly rendered futile if a formal insolvency process begins. So what should a claimant do if ‘its’ defendant has a Winding Up petition presented against it, which does not automatically result in a moratorium? A claimant’s first step should be to notify the court of the defendant’s insolvency (if the defendant has not already done so) and remind it of the relevant provisions quoted above. The court will normally stay the proceedings pending the outcome of the petition. In compulsory liquidation and bankruptcy situations, if the claim which is being litigated concerns a debt, the claimant may capitalise on the situation and serve a ‘Notice of intention to appear’, so that it may support the relevant petition as a creditor, and take over carriage of it (‘piggyback’) if the petitioning creditor is paid off and seeks to withdraw. If the petition is nevertheless dismissed or withdrawn then the litigation can continue.
The position is more difficult where no formal insolvency process is engaged but the defendant is dying a lingering financial death and is likely to enter into a formal insolvency process in the medium term. Warning signs include the defendant being unable to get credit for materials, requirements, sporadic payment of debts and creditors serving statutory demands, director-level resignations, defaulting on Companies House filing and possibly missed court deadlines, or it may cease trading altogether. There may be no value in pursuing the litigation much longer, but a claimant which discontinues is expected to pay the defendant’s costs, which will be unpalatable (and provide an undeserved lifeline for an ailing defendant to boot). Under CPR Part 25, Security for costs is only available for defendants against claimants, so unless security can be sought in respect of an insolvent defendant’s counterclaim, no ‘knock out’ blow is available by that tactic. Settling the claim may become more attractive to the claimant, but this carries a risk that any settlement sums paid could be clawed back by the defendant’s future insolvency office-holder if such payments can be challenged as a preferential payment which offends the pari-passu rule. Seek ‘unless orders’ in the proceedings when the defendant is in default of court deadlines, and consider whether certain issues are suitable for summary judgment, resulting in immediately enforceable costs orders and, therefore, the right to obtain more information about the defendant’s financial standing. If the insolvent defendant is represented by solicitors, this raises the question of where the funds to pay their fees come from. If the source is a third party, it may be possible to recover at least costs from them, and the ability join that third party in to the litigation may be a strong rationale for continuing with the claim. Where compliance with court orders is concerned, it may pay to postpone the need for that by agreeing extensions of time, which a court will usually not object to.
Effect of Insolvency on Judgments and Awards
It is disappointing when a meritorious claim is effectively killed off by the defendant’s insolvency, but it is more galling still that a judgment or arbitrator’s award generally only results in a claimant still being an ordinary unsecured creditor. Ultimately, a judgment is only worth the paper it is written on if there are assets against which to enforce and recover the judgment debt. Moreover, the same moratoria applicable to dispute resolution processes also apply to the enforcement of judgments, so timely completion of the enforcement method, before formal insolvency processes kick-in, is key to capitalising on any judgment obtained. A creditor is entitled to retain any proceeds of an enforcement method which has completed before the commencement of an insolvency process, including Final Charging Orders elevating them to secured creditors (see for example IA86 s.278 concerning bankruptcy). For judgment creditors who cannot achieve that, the best gloss that can be put on this is that at least a liquidator, administrator or trustee cannot question the judgment or award and will be obliged to admit the claim. Any enforcement process which is underway when a corporate insolvency commences must cease so that the judgment debtors assets are available to the general body of creditors. The same is true of bankruptcy, and although the court can use its discretion to allow an enforcement process against a bankrupt to continue, that jurisdiction is only likely to be exercised in exceptional circumstances (IA86 s. 346(6)).
Adjudicator’s awards are a strange species. They, like court judgments and arbitrator’s awards, are arrived at after much effort and specialist deliberation, but they are not final and binding and therefore do not have the same status, and this complicates their enforcement. This is especially true where the risk of payee insolvency is concerned, and. I will look at the complex interaction between insolvency and enforcement of adjudicator's awards in the next article.
What does this mean for you or your business?
A claimant in existing proceedings, when faced with a potential insolvent defendant, should seek to stem its litigation expenditure and/or take tactical steps which may lead to the defence being struck out. When a formal insolvency process commences, either party should inform the court and ask for the proceedings stayed. Creditors can then expect to be invited to submit proof of debt forms, but can also submit them if they have notice of the process but their claim has been overlooked. The relevant insolvency practitioner should assess every claim set out in a proof of debt form, and he may either accept it in whole or part, or reject it. Dissatisfied creditors should not simply accept, say, a liquidator’s verdict on their claim, and their rights to challenge that decision and the mechanisms will be covered in a separate article.
What do you need to be doing now?
Prevention is better than cure, and (perhaps with the exception of administration), most insolvency situations are, in financial terms, terminal. When contracting, seek payment security by means of parent company guarantees and performance bonds, which should confer some comfort that the contractor’s parent will ensure the main contract is performed, or you are compensated by the contractor’s bank. Alternatively, use a project bank account, from which agreed payments are made to the contractor, key sub-contractors and suppliers who are a party to that arrangement. All parties agree that the contents of that account will create a trust in the event of insolvency, so the project costs do not fall into an insolvent party’s estate.
Exercise robust credit control so when an invoice falls due and goes unpaid, chase for payment. The longer it lingers, the higher your debt will become and, thus, the higher your exposure in the event that the other party enters into insolvency.
Prior to and during contract, and in the build up to and during any dispute resolution process, and prior to enforcement of any judgment or award, regular checks on the ‘target’ at the following organisations are recommended:
The Registry Trust for England and Wales county and high court judgments, tribunal awards, administration orders, child support agency orders and magistrates courts defaulted fines. Judgments are also held from courts in Northern Ireland, Jersey, Isle of Man, and decrees from Scottish sheriffs’ courts.
Companies House, for much company information, including insolvency processes underway, dissolutions, strike offs and director disqualifications.
The London Gazette, which publishes all public notices relating to corporate and personal insolvency in England and Wales daily, and includes links to the Edinburgh and Belfast Gazettes.
The Individual Insolvency Register (‘IIR’), which includes bankruptcies, debt relief orders, IVAs, bankruptcy restrictions orders or undertakings (BROs/BRUs), and debt relief restrictions orders or undertakings (DRROs/DRRUs).
The Central Registry of Winding Up petitions, which includes all winding-up petitions issued in England and Wales and is maintained by the Insolvency and Companies list of the High Court’s Business and Property Courts division. It can be used by calling 0906 754 0043 or by sending an agent to the Business and Property Courts at the Rolls Building in London.
There is no equivalent central register of administration applications or notices of intention to appoint administrators, and there is often a time lag before such information is posted on Companies House’ website. Unfortunately there is no requirement to file administration documents in the district registry nearest to the insolvent company, which some companies take advantage of to avoid publicity.
Enforce any judgment you obtain quickly, before any insolvency process kicks in. If your claim concerns such things as professional negligence, such that the insolvent judgment debtor has insurance covering his liability to you, instead of enforcing against him, you may be able to claim against the insurers under the Third Parties (Rights against Insurers) Act 2010.
These notes have been prepared for the purpose of articles only. They should not be regarded as a substitute for taking legal advice.