England and Wales Court of Appeal (Civil Division) Decisions

IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
His Honour Judge Mackie QC
HC10C02405

		Royal Courts of Justice Strand, London, WC2A 2LL
		6th September 2013

Lord Justice Patten :

1. This is an appeal by the third defendant, Mrs Mili Petrou Elia ("Mrs Elia"), against the order of HH Judge Mackie QC (sitting as a Deputy Judge of the Chancery Division) dated 25^th April 2012 in proceedings concerning the beneficial ownership of a flat at 29 Rutland Court, Rutland Gardens, London, SW7 ("the Flat"). The judge, on an application for summary judgment under CPR Pt 24, made a declaration that the claimant, E-Clear (UK) plc ("the Company"), is the beneficial owner of 35.5% of the Flat and ordered its sale. Mrs Elia appeals on the basis that the judge's order was made before disclosure and without the benefit of oral evidence and that she has at least a realistic prospect of defending the claim on the basis that no breach of fiduciary duty was involved in her son's purchase of the Flat with monies which had previously been paid to him by the Company
2. Before I come to the matters which are in issue and the way in which the judge resolved them I need to set out the details of the transactions leading up to the purchase of the Flat, most of which are no longer in dispute.
3. The Company was incorporated in August 2002 and has a share capital of £50,000. Most of the issued shares are held by a Cypriot company, E-Clear Global Limited ("ECG"), which was also one of the directors of the Company. The other director in the period material to these proceedings was the first defendant, Mr Elia. He is also the ultimate beneficial owner of ECG.
4. The Company carried on the business of processing electronic payments made by credit card customers to merchants in the travel sector. According to the particulars of claim, it acted as a middle-man between the cardholders and the credit card networks' acquiring banks, charging a fee to the merchant for each transaction which it processed. It used Pago eTransaction Services GmbH ("Pago"), a joint venture company between Deutche Bank AG and Beisheim Holding Schweiz AG, as its acquiring and payment processing provider. Pago authorised and paid each credit card transaction that the Company processed and it, in turn, was liable to indemnify Pago in respect of any chargeback liabilities which occurred when cardholders disputed the charges on their statements or the services which they had paid for were not provided.
5. The problem of chargebacks occurred in a particularly acute form in September 2008 when two of the Company's main customers, Zoom Airlines Inc (a Canadian company) and XL Leisure Limited, were placed into administration. Pago made chargebacks for the cancelled flights which had been paid for by credit card and, according to some evidence given by Mr Elia in Commercial Court proceedings in June 2009 (Red Seal Tours Inc v E-Clear (UK) plc), the Company was forced to pay the amount of the chargebacks because otherwise Pago would have stopped processing payments and retained all the monies which were due to the Company. This would have resulted in its liquidation. The losses incurred by the Company as a result of the failure of Zoom Airlines and XL Leisure Limited amounted to some £57m.
6. Until then the Company had been profitable. It made a gross profit for the year ended 29^th February 2008 of £17,436,735 on a turnover of £778,953,397 which translated into a profit on ordinary activities after taxation of £6,163,871. As at 29^th February 2008 its consolidated balance sheet showed a surplus of assets over liabilities of £16,701,670.
7. On 15^th January 2009 Mr Elia agreed to purchase the Flat for £4m. Two amounts of £200,000 and £225,000 were paid by a CHAPS transfer from the Company's business account with RBS in order to meet the 10% deposit required under the contract of sale. This occurred on 4^th February 2009. On 4^th March a further sum of £993,741.10 was transferred from the same account to complete the purchase. The balance due on completion was funded by a mortgage loan from Coutts Bank. The Flat was registered in Mr Elia's name.
8. On 23^rd December 2009 Globespan Airways Limited presented a winding-up petition against the Company and on 19^th January 2010 the Company was placed into administration. Mr and Mrs Elia claim that on 30^th July 2010 Mr Elia assigned his interest in the Flat to his mother, the appellant, for the sum of £25,000 subject to the charge in favour of Coutts Bank. The recitals to the deed of assignment relied on by Mrs Elia state that she has also lent her son some £785,000. The Flat remained, however, registered in the name of Mr Elia.
9. On 22^nd July 2010 the Company's administrators commenced these proceedings in the Chancery Division in which they allege that Mr Elia caused a number of payments to be made to or for his benefit out of funds belonging to the Company. These include the three payments in connection with the purchase of the Flat. The total amount paid from the Company is alleged to be some £4.206m. The payments are said to have been made in breach of Mr Elia's fiduciary duties to the Company as encapsulated in ss.170-177 of the Companies Act 2006 which include a duty to consider the interests of creditors particularly at a time of actual or impending insolvency: see West Mercia Safetywear Ltd v Dodd [1988] BCLC 250.
10. The Company now seeks to recover those payments and, where possible, to trace them into other assets. In relation to the Flat, the monies are said to be traceable into the purchase price via accounts in the name of Mr Elia with RBS and Coutts. It is therefore said that the Company was able to assert a proprietary claim to Mr Elia's interest in the property subject to the Coutts' charge and that he, having obtained and used the funds in breach of fiduciary duty, continued to hold his interest in the Flat on a constructive trust in the Company's favour. If this is right then the appellant, not having yet registered any legal title to the flat, cannot rely upon being a bona fide purchaser of the legal estate and will take subject to the Company's beneficial interest regardless of whether she had notice of it. The only possible defence therefore available to her in the action is that no breach of fiduciary duty was involved in the use of the monies which were paid to Mr Elia from Company funds. Ms Hilliard QC, who appears for Mrs Elia, has finessed this point by also arguing that it is not possible for the Company to assert an equity arising out of the use of monies to pay off one of its debts but I will come to this a little later when considering her submissions in more detail.
11. Mr Elia served a defence to the claim settled by Mr Jonathan Crystal of Counsel which does not admit that the Company became insolvent as a result of the losses suffered from the 2008 chargebacks I have described and asserts that the Sage Account no. 2246 which is relied on by the administrators in the particulars of claim as a record of the payments under challenge is in fact an account in the name of ECG, the other director of the Company. Mr Elia's principal defence as pleaded was that he had made two loans to the Company in 2007; one of €5m in October 2008 which he had borrowed from a Mr Michael Zolotas; and another amounting in total to €2.9m as a result of payments of €1.9m and €1m which he made to NF Bank on behalf of the Company in February 2008 and May 2009 respectively. He also relied on contingent liabilities of a further €10m arising under guarantees and share deposits he had given to NF Bank to secure loans made to the Company.
12. The Company served a reply in which it reserved its right to make an application under ss.238 and 239 of the Insolvency Act 1986 and challenged Mr Elia's right to set off the alleged liabilities against the contested payments because to do so would entrench a preference. The claim that the payments (if made to discharge debts due to Mr Elia) would fall to be treated as preferences was both anticipated and denied by Mr Elia in his defence. In paragraph 12 he pleaded:

"The Defendant will allege and aver that any payments to him or for his benefit were not made so as to put him in a better position than he would be in the event of the insolvent liquidation of the Company because he was confident at all times that insolvent liquidation would be avoided since he had reasonable grounds for believing that the Company would be refinanced by Marfin Bank or another bank with the assistance of Mr Zolotas."

13. On 27^th April 2011 a bankruptcy order was made against Mr Elia and his trustee (Mr Defty) was joined as the second defendant to the claim and served with the claim form and statements of case. At the same time Mrs Elia was given notice of the proceedings pursuant to CPR 19.8A. Mr Elia therefore ceased to take any active part in the claim and on 12^th October 2011 the trustee agreed to a consent order containing a declaration that the Company is the beneficial owner of 35.5% of the Flat and providing for its sale. By this time Mrs Elia had filed a defence through some Cypriot lawyers which simply repeats her son's claim to be entitled to a set-off. The Company then proceeded to issue an application against her for summary judgment under CPR Pt 24, in response to which Mrs Elia served a witness statement exhibiting a draft amended defence. In her witness statement she says that she relied, inter alia, on what is contained in the witness statement of her son. Her defence is that throughout 2008 and until late 2009 her son believed that the profitability of the business of the Company would improve and that administration could be avoided. The Sage account 2246 is incomplete and does not include the loans made by Mr Elia to the Company. Matters are further complicated by the fact that ECG never had its own bank account and that all payments related to its director's account recorded in the Sage account passed through Mr Elia's own bank accounts. But it is also pleaded that if (which is denied) the debits on the Sage account are debits to Mr Elia's loan account then it is necessary to set off the various loans he says that he made to the Company. These are set out in the amended defence in more and in different detail from the earlier accounts of the alleged loans and I will come to them later in more detail. This part of the defence concludes by asserting that the payment of the debts by the Company did not constitute preferences.
14. Ms Hilliard submits that there are on the evidence at least three triable issues:

(1) was the Flat purchased (as the judge accepted) using the Company's money or was the £1.418m transferred from the Company to Mr Elia paid in discharge of its debts to him or to ECG?;

(2) if the sums were paid in discharge of pre-existing debts, were they paid in breach of fiduciary duty? This largely turns on whether Mr Elia knew or ought to have known that the Company was insolvent at the relevant time; and

(3) is the use of the Company's money to pay the Company's debts (even if it does otherwise constitute a breach of fiduciary duty) capable of giving rise to a proprietary tracing remedy against the monies in the hands of Mr Elia as opposed to a purely personal remedy against him?

15. Ms Hilliard accepts that the foundation for all these arguments has to be a realistically arguable case that the monies were paid in satisfaction of existing debts. The schedule annexed to the particulars of claim was compiled by the administrators from the Sage Account no. 2246 which appears to be a running account between the Company and Mr Elia/ECG which was maintained by the Company's accounts department. But the schedule in the pleading includes only debits to the account after 13^th October 2006. The evidence of Mr Elia was that if one includes all relevant credits to the account then it was in credit in the sum of £2,081,209.01 at the date of the administration order and was also in credit (in the sum of £1.843m) in February and March 2009 when the relevant payments to Mr Elia were made.
16. One of the credits shown on the Sage account with a date of 2^nd October 2008 is the sum of £3,932,703.50 with a reference to Anemi Investments Inc. The judge had a witness statement from a Mr Michael Zolotas who said that he had known Mr Elia for many years and had received a request from him in September 2008 for a €5m loan. Mr Zolotas said that he agreed to make the loan to Mr Elia personally through one of his companies, Anemi Investments Inc. There were proposals that the loan should be secured by a transfer from the Company of shares which it owned in NF Bank AG but, due to problems about obtaining German regulatory approval, this was not possible and Mr Zolotas says that he went ahead and advanced the money as a personal loan to Mr Elia which, at Mr Elia's request, was credited to the Company's account at RBS. No claim was made to recover the monies in the liquidation of the Company but a claim was made and accepted in Mr Elia's IVA.
17. On the face of the Sage account the sterling equivalent of the €5m was treated as a loan from Mr Elia to the Company. But the judge did not accept this. He makes the point in his judgment that the personal loan is undocumented apart from the entry in the Sage account and that there are questions about the reliability of the Sage accounts. But, as Ms Hilliard submits, the NF Bank agreement exhibited to the witness statement is explained and the existence of questions, as the judge put it, about the reliability of the Sage account might be thought to require to be resolved at a trial rather than on an application for summary judgment.
18. The judge was equally dismissive about the next entry on the Sage account which is a "loan from D. Tullett" in the sum of £886,359.81. The evidence about this is confusing. The same ledger entry appears twice in the Sage account. The evidence includes a witness statement made by Mr Tullett in proceedings brought by him against Mr Elia in which he describes his involvement in assisting the Company in acquiring NF Bank. As part of those arrangements he says that he agreed to pay €1.9m to NF Bank in return for a guarantee from Mr Elia for its repayment. The Company, he says, exercised its option to acquire the shares but did not meet all the instalments of the price that became due. The vendors have sued him under a personal guarantee which he gave and he then proceeded to sue Mr Elia for the repayment of the €1.9m.
19. Mr Elia's evidence in his first witness statement in these proceedings is that the €1.9m (£1.433m) which Mr Tullett transferred to NF Bank was treated as a loan to or repayable by Mr Elia. The payment was necessary to cover losses by NF Bank and Mr Elia says that he arranged the payment on the Company's behalf. He should therefore be given credit for this sum in the Sage account. The difficulty, however, is that Mr Elia seeks to rely on the entire €1.9m being a debt due to him from the Company whereas the only reference to any credit relating to the NF Bank transaction is a loan from Mr Tullett in the sum of £886,359.81 which post-dates the purchase of the Flat in terms of its ledger entry.
20. Judge Mackie said that the commercial rationale for what is suggested by Mr Elia to be Mr Tullett's involvement is improbable and that there is "no real prospect of these loans being established". But although the ledger entries about the alleged loan of €1.9m do not support Mr Elia's evidence, there is little real disparity between his evidence and that of Mr Tullett on whether the €1.9m was paid to NF Bank as part of its acquisition by the Company and whether Mr Elia assumed a personal liability to Mr Tullett for the money which he advanced for the benefit of the Company. I therefore agree with Aikens LJ (who gave permission for this appeal) that there was sufficient evidence before the judge to raise a seriously triable issue that the Company was indebted to Mr Elia in the sums of €6.9m and that it was not open to the judge to resolve that issue on a Part 24 application. The real issues therefore are whether the use of Company money to repay its debts to Mr Elia amounted, in the circumstances of this case, to a breach of fiduciary duty and whether such a breach is capable of giving rise to the proprietary claim on which the Company now relies.
21. I should perhaps make it clear at this stage that although put forward as part of the defence on the Part 24 application, it is no longer contended that debts due to Mr Elia from the Company can now form a set-off against any liability on his part for breach of fiduciary duty. The judge rejected this argument in [46] of his judgment and was right to do so. Ms Hilliard also accepts that, in principle, the use of Company money to pay a debt (even if not a preference) can amount to a breach of fiduciary duty, although not one which justifies a proprietary remedy. Her case is that there is a serious issue to be tried as to whether there was a breach of fiduciary duty in this case by Mr Elia and that the subsidiary issue of whether the repayment of the Company's debts to him or to ECG amounted to a preference is irrelevant because monies used to repay debts (even as a preference) are not impressed with a trust and can only be preserved in specie by the Court making an order under s.239 of the Insolvency Act. To justify such an order the Court would have to be satisfied that the conditions in s.239(5) were made out and Mrs Elia could resist any order to vest beneficial ownership of the Flat in the Company by showing that she acquired her interest in the property for value and in good faith: see s.241(2). The liquidators, she submits, have sought to avoid these complications by relying on a proprietary claim arising out of Mr Elia's alleged breach of fiduciary duty and Mrs Elia has a suitably arguable defence to both parts of that claim.
22. Before I come to those issues it is convenient to mention an objection taken by Mr Russen QC, on behalf of the Company, as to whether Mrs Elia has locus to raise these points at all. He relies on the fact that Mr Elia's trustee-in-bankruptcy has agreed to the relief sought in the consent order and has therefore accepted that the Flat (of which he as Mr Elia's trustee is or is about to become the registered legal owner) is impressed with a trust in the Company's favour. That, he says, is conclusive against all third parties including Mrs Elia because she (for the reasons explained earlier) can have no better title to the Flat than her son.
23. I am not persuaded by this. Although Mrs Elia cannot assert a better title in equity than her son because she is not a bona fide purchaser for value of the legal estate, his admission (through his trustee) of the Company's claim is not binding on her and cannot estop her from seeking a judicial determination of that issue based on the evidence rather than the trustee's admission of liability. On any view she acquired an equitable title to the Flat under the deed of assignment which pre-dates the consent order and the issue of whether that is subject to a trust in favour of the Company remains an issue to be decided in the action as against her.
24. The question whether Mr Elia committed a breach of fiduciary duty against the Company by causing it to re-pay its debts to him in February and March 2009 is inextricably linked to the solvency or otherwise of the Company and his knowledge of its financial position. Absent actual or imminent insolvency, the repayment of the debts would be unobjectionable.
25. We know that the Company continued to trade until the end of 2009. Mr Elia in his evidence contends that it remained financially viable until it was brought down by the collapse of Globespan Airways at the end of that year. What is clear is that it managed to survive the £56m losses it suffered from the 2008 failure of Zoom Airlines and XL Leisure Limited but the claimant says that it was effectively insolvent throughout 2009 and that Mr Elia's purchase of the Flat amounted to an attempt by him to take money out of the Company before it collapsed.
26. The judge was very much influenced by the witness statement which Mr Elia made in the Commercial Court proceedings I referred to earlier. As part of that statement dated 26^th June 2009, he produced some management accounts for the Company for the year to 28^th February 2009. There are no audited accounts for this period but the management accounts show an operating loss after tax of £44.528m and a net deficit of liabilities over assets of some £28.691m. These accounts were drawn up by the Company's accountant, Mr Vanezis, in June 2009, some months after the purchase of the Flat, and this timing is, of course, relied on by Ms Hilliard to rebut the inference that Mr Elia must have known back in February that the Company was in a parlous financial position.
27. In his witness statement Mr Elia says:

"The business is profitable going forward and it is for this reason that I sought refinancing. I was introduced to someone who has available to her a substantial bond which could be used as security for a very substantial loan to the Company from which the amount due to the Claimant could be discharged. I have spent most of the last two months in Greece trying to assist in the implementation of these arrangements."

28. There is also a witness statement from Mr Antonis Shiammoutis of KPMG Limited in Cyprus, the Company's auditors, who is also Mr Elia's brother-in-law. He says:

"In 2009 both E-Clear Global Ltd and E-Clear (UK) PLC had very good prospects as new banking partners were signed and a good flow of clients in the pipeline as demonstrated in the Business Plan dated January 2009. I was also involved with the discussions with Mr Michael Zolotas in investing in E.Elias Capital Ltd and thereafter increase the capital in both E-Clear Global Ltd and E-Clear (UK) Plc; a meeting was held in my presence together with Mr Zolotas in Cyprus".

29. A submission was made to the judge that the 2009 management accounts understated the Company's asset position by not including all its assets and investments but the judge was understandably sceptical about that and was justified in being so. The Company also relied on an e-mail from Mr Vanezis dated 20^th December 2009 which stated that the Company had not paid certain taxes and NIC for 2 years. Against this there is no evidence of any attempt by HMRC to press for payment (if it was due) and suggestions have been made that the e-mail was an attempt by Mr Vanezis to cause difficulties following a dispute he had with Mr Elia.
30. These are not issues which are capable of any sensible resolution on this appeal. We are only concerned with whether the judge could be sufficiently certain that the Company was either insolvent or on the brink of insolvency in February and March 2009 and that Mr Elia should be taken to have been aware of this. The management accounts provide strong evidence that the Company was at least balance sheet insolvent at that time. But an excess of liabilities over assets is not a bar to a company continuing to trade provided that it can meet its liabilities as they fall due. Although there was undoubtedly a considerable amount of firefighting to be done after September 2008, I think that Ms Hilliard is entitled to rely on the fact of the Company's survival for another year as evidence which suggests that it had the necessary financial support to enable it to continue to run its business and which may have justified Mr Elia in taking the optimistic view of the future contained in his and Mr Shiammoutis's evidence. In my judgment, these are issues for a trial and not for a Part 24 application. The judge was, in my view, wrong to say that the Company's insolvency was beyond reasonable doubt.
31. In these circumstances it is unnecessary for us to express any further view about whether Mr Elia knew or should have known about the Company's financial position in February and March 2009 and whether any belief he may have had about the Company's future prospects was realistic. Whether he acted in breach of fiduciary duty is tied up with the question of the Company's solvency and will have to be investigated at a trial when the evidence contained in the witness statements can be subjected to cross-examination in the usual way. Issues about the payments being a preference are also for another day.
32. Of much more moment is the appellant's submission that the use of the Company's money to pay its own debts cannot give rise to a proprietary claim even where that payment constituted a breach of fiduciary duty on the part of the director responsible and, in this case, involved a payment of debts due to him.
33. Mr Russen QC drew our attention to the decision of this Court in Re Washington Diamond Mining Co [1893] 3 Ch 95 as confirmation that the payment of a debt owed to directors can be both a fraudulent preference and a misappropriation of company property for which the directors are accountable. But the decision provides no guidance as to the type of remedy which can be granted. I accept that the use of the Company's money to repay its debts does not ipso facto negative any possibility of the payments being made in breach of fiduciary duty. But that leaves open whether the Company can assert a proprietary claim to trace into the payee's account where the monies have been used to discharge a pre-existing liability of its own. The answer to that question has, I think, to be found in the general rules governing tracing claims.
34. Where trust money is used to pay debts the right to trace it will usually be lost because the creditor can claim to be a purchaser without notice. But that has no application in the present case given the identity of the creditor. If the issue is whether the payment by the Company of its debts is inconsistent with it retaining a beneficial interest in the sums paid then I can see much force in the argument that a proprietary claim may not be available. But the correct focus is more likely to be on the actions of the defaulting fiduciary and whether, on this hypothesis, Mr Elia who had control of the assets of the Company effectively as trustee would be entitled to take the Flat which he had purchased with the increase in funds caused by the repayment of the debts free from any claim by the Company to that asset or a share in that asset. As the decision of this Court in Sinclair Investments (UK) Ltd v Versailles Trade Finance Ltd [2012] Ch 453 demonstrates, these are difficult questions which are best answered in the light of the judge's findings of fact. Since that lies in the future and no Part 24 determination of this point was sought by Mrs Elia, I propose to say nothing further about the continuing availability of a proprietary claim.
35. For the reasons already given, I would allow the appeal and set aside the judgment against Mrs Elia. I see no reason why this matter should not proceed to a speedy hearing in the Chancery Division and would invite the parties to agree directions to that end which can be included in the order.

Lord Justice Fulford :

36. I agree.