England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION

		Royal Courts of Justice Strand London WC2
		23rd April 2002

MR JARVIS QC:

Introduction

1. The Secretary of State for Trade and Industry petitions to wind up two companies, Alpha Club UK Limited (Alpha Club) and Marketing Services Worldwide United Kingdom Limited (Marketing Services), under section 124 of the Insolvency Act 1986.
2. The petitions are opposed by the directors and shareholders of Alpha Club who have been represented today by Miss Clare Hoffman. She opposes the petition against Alpha Club on the basis that the company is no longer carrying on business, that there is no need for any further investigations and that there is no benefit to be gained by a compulsory winding up Alpha Club.
3. So far as Marketing Services are concerned, the directors and shareholders of that company are controlled by a company incorporated in the Isle of Mann, International Company Services Limited. It wrote to the Treasury Solicitor by letter dated 17th April 2002 to the effect that it did not intend to appear at the hearing of the petition against Marketing Services, that it would give any assistance necessary to a liquidator and that it did not object to the winding up of Marketing Services.
4. The jurisdiction to wind up a company in these circumstances arises, as I have said, under section 124A of the Insolvency Act 1986. This provides that where it appears to the Secretary of State from information which he has obtained from investigations, that it is expedient in the public interest that a company should be wound up, the Secretary of State may present a petition for it to be wound up. If the court thinks it is just and equitable for it to do so, it may order the winding up of the company.
5. The circumstances in which the Court should exercise its discretion to wind up a company under section 124A of the Insolvency Act were considered by Megarry J in Re Lubin, Rosen and Associates Ltd [1975] 1 WLR 122, when he was dealing with the predecessor of section 124A, namely section 224 of the Companies Act 1967. In that case there had been a voluntary winding up of the company. Megarry J said that the fact of the voluntary winding up was one of the circumstances to be considered in deciding whether or not it was is just and equitable to make a compulsory winding up order, but said that it was no more than that. He also at page 127 said this:

"Furthermore, as Mr Morritt contended, where a petition is presented by a creditor seeking to exercise a class right, the view of the majority of his class has a potency which does not exist where the petition is presented not by a creditor but by the Secretary of State, after he has reached the conclusion that it is expedient in the public interest that the company should be wound up. It seems to me that the very fact that the Secretary of State has reached such a conclusion is a factor which, without being in any way decisive, ought to be given appropriate weight by the court."

6. I pause there to say that it is appropriate weight which should be given to it, which means it is one of the balancing factors which the Court takes into account. It is not to be given any special weight but it is a factor which must be taken into account.
7. Megarry J, at page 128 also considered the fact that under the 1948 Companies Act, although there was provision for a voluntary liquidator to report apparent offences, those provisions did not have the force of section 236 of that Act because, as with the Insolvency Act, the Official Receiver comes under a duty to submit a report to the court, in a compulsory winding up, setting out the state of the company and whether further enquiry is desirable. Megarry J went on to conclude that, in that case, where there were circumstances of suspicion, as there were in that case, that it was highly desirable that the winding up should be by the court, with all the safeguards that this provided, including the investigation of any suspected offences. He then said at page 128:

"Where the results of that investigation lead the Secretary of State to the conclusion that it is expedient in the public interest that the company should be wound up, and he accordingly presents a petition for a compulsory order, I do not think that the passing of a resolution for a voluntary winding up shortly before the Secretary of State presents his petition, and the subsequent confirmation of that resolution, ought to be allowed to put the voluntary winding up into an entrenched position, as it were, which can be demolished only if the Secretary of State can demonstrate that the process of voluntary winding up will be markedly inferior to a compulsory winding up. The Secretary of State may, of course, reach the conclusion that a voluntary winding up will suffice, and so not proceed with his petition; but if he does proceed, then in my judgment the question is essentially whether, in all the circumstances of the case (including, of course, the existence of a voluntary winding up and the views of the creditors), it is just and equitable for the company to be wound up compulsory. In addition to the suspicion of offences, the presence of foreign complications such as exist in this case, and the difference between the interests of the disappointed purchasers and those of any other creditors, seem to me to make it both just and equitable that this winding up should be conducted with the full authority and resources of the court."

8. So that is the jurisdiction.
9. There are three ways in which the public interest can be said to be affected in this case:

1. Suspected offences under the Fair Trading Act 1973.

2. Offences under the Lotteries and Amusements Act 1976.

3. If the business carried out by the companies is inherently objectionable.

Background

10. I will turn, in due course, to each of those heads but I need to set out the background of the business carried out by Alpha Club. Alpha Club operated a scheme from the beginning of 1999 until it changed the scheme in August 2000. Under the original scheme Alpha Club sold 10 year memberships of Alpha Club for a cost of £2,650. Respective members were told that membership attracted benefits in six stated categories, namely travel, business, household, leisure, motoring and personal. The benefits were, for example, discounts through a travel agent, Shires Travels Bureau Limited, which company has now been subject to a compulsory winding up order. The discounts were, in reality, as the evidence discloses, of minimal value, if any. Either the benefits were never taken up by members or they would have been available to members without having to be a member of Alpha Club. Indeed, in some cases, the evidence shows that a greater discount was available to members of the public than Alpha Club purported to offer.
11. The scheme worked shortly in this way. Respective members of Alpha Club were invited by sales agents to presentations. The agents paid a commission fee of £20 for themselves and each guest that accompanied them. Agents were then appointed as silver agents and they received a commission on the sale of the first two memberships. Then, on the sale of a third membership, a silver agent received an increased commission and was promoted to a gold agent. Gold agents then received an increased rate of commission on every direct sale of a membership and a reduced rate of commission on the first two direct sales made by silver agents who were considered to be part of the gold agent structure or sales team. When a silver agent made any two membership sales and those two new members made their first two sales, the gold/silver member then would become a platinum agent. The rates of commission were calculated as a percentage of the net sum of the membership fee of £2,650 less VAT.
12. The rates of return for agents were potentially attractive and large sums could be earned. For example, a Mr Stephen Sweeney earned some £45,547 and Mr Andrew Martin earned some £31,110 by way of commission. As the evidence disclosed, there were relatively small numbers who benefited financially from becoming an agent for Alpha Club.
13. The presentations which were given by Alpha Club and Marketing Services focused primarily upon the potential return to be made by joining the organisation and choosing to become an agent so as to sell Alpha Club membership to others. The discounts which I have indicated above were merely an ancillary part of the presentation. The whole focus and emphasise was to induce the individuals to become members on the basis of the profits that they would make as a result of further introductions.
14. As I have said, the original scheme in this form ceased in August 2000. It may well be that the directors of Alpha Club took legal advice and decided that the scheme should be operated in a different way. It operated in the new form until November 2000, when investigations were then undertaken by the Secretary of State.
15. On 29th June 2001, the Secretary of State was informed by Alpha Club that it was preparing to re launch its operations. It was that which led to the presentation of the petition.
16. I return to the revised scheme. This provided for 1 year memberships of Alpha Club to be sold for £200 including VAT. The distinct element of this scheme was that it was said that it was no longer necessary to become a member of Alpha Club in order to become an agent of the company and have the right to recruit other members. In order to become an agent under the new scheme, persons were required to make application to become an agent of Marketing Services, an Isle of Man company. The legal representative of Alpha Club, Mr Botrass, a barrister, said that Marketing Services was an independent contractor who employed members in Alpha Club on the Internet, effective from 25th August 2000.
17. Agents of Marketing Services were, it is said, required to sell a minimum of two memberships of Alpha Club per month and the agents were paid a commission for sale of memberships for Alpha Club. No commission significantly was payable to agents for recruiting new non member agents. The agents were again categorised as silver or gold. Newly recruited agents were referred to as silver agents and received a commission for the first two members that they recruited to Alpha Club. The gold agent responsible for recruiting a silver agent also received an increased commission for the first two new recruits for the silver agent. Following the sale of two memberships a silver agent then became a gold agent and received both a silver and gold commission for each further member recruited by him. The gold agent also continued to receive a commission on the first two members recruited by the agents in the gold agent's training group. Once an agent in a training group had recruited two new members to Alpha Club that agent then left the training group and established his own group, leaving that agent's first two groups in the gold agent's training group.
18. An application to become a member of Alpha Club could only be made after a person had attended a sales presentation. There were presentation across the country and attendees were encouraged to consider becoming members of Alpha Club. The commissions that could be earned were emphasised. The whole focus, again, of the presentations was on the selling of memberships of Alpha Club, rather than on the discounts and other discounts available to Alpha Club members.
19. The evidence shows that the distinction which was sought to be drawn between the old and new scheme was in practice not carried out. The reality was that Marketing Services was a company which had no appointed directors other than those who were appointed when the company was incorporated. It carried on business, and indeed, it did not appoint any agents. In reality, the two schemes operated on a similar basis. Each scheme depends on the continued recruitment of new members. The reality is, as with all pyramid selling schemes of which this is a classic example, a time comes when there is a saturation point and the members who joined later have no real prospect of ever making profits, or ever recovering their investment, let alone making profits. Those at the beginning do well; those in the middle may just be all right and those at the end are likely to suffer losses. That is the vice of pyramid selling and the scheme, in my view, clearly fell into that kind of class.
20. The public interest issue
21. I turn to consider the public interest issue by considering the three heads which Mr Moverley Smith QC, counsel for the Secretary of State, invites me to consider:
22. (1. Section 118 of the Fair Trading Act 1973.) I do not intend to burden this judgment by setting out the terms of the Fair Trading Act 1973. They are set out by Neuberger J in his judgment in Re Delphin International Special Adjudicator Limited [2001] Butterworth Company Law Cases 71 at pages 78 and 79. Neurberger J at page 79D - F identifies three hurdles which the Secretary of State has to clear in order to demonstrate to the Court that a business falls foul of section 118 combined with section 119, and the offence under section 120(3) of the 1973 Act. The three hurdles are:

"First he has to establish the Delphin business constitutes a trading scheme. Secondly he has to establish that a person who applies or has recruited to become a distributor makes a payment falling within section 120(3)(a) of the 1970 Act. Thirdly he has to establish that such an applicant make a payment in circumstances which fall within section 120(3)(b) of the 1973 Act."

23. I take each of these hurdles in turn.
24. First, I have no doubt that the scheme under both its original and subsequent form was one where services were provided by Alpha Club to recruits introduced to it by agents participating in the scheme. As I have said, the evidence shows clearly that the prospect was held out for recruits that they would receive payments both from the introduction of other persons into the scheme and, in addition, by the continued participation of agents in the scheme, selling further memberships to others. I have no doubt, therefore, that this is a scheme within part 11 of the Fair Trading Act 1973.
25. Second, I am quite satisfied that when a new recruit makes payment under the scheme, the payment is for the benefit of the company and that he makes that payment by reason of the prospect being held out to him of receiving payments or other benefits in respect of the introduction of other persons who are to become participants in the trading scheme. It seems to me plain that, in the circumstances that pertained here, this was the nature of the payment.
26. Third, this has to be a payment that falls within section 120(3)(b) and I am satisfied that this is such a payment. I only need to be satisfied, for the purposes of this hearing, on the balance of probabilities, that such an offence has been committed and, on the evidence before me, I am quite satisfied that the scheme necessarily involved the commission of an offence under section 120 of the 1973 Act.
27. 2. Section 1 of the Lottery and Amusement Act 1976, I have to consider whether this was a legal lottery under the Lotteries and Amusements Act 1976. Section 1 of that Act provides:

"All lotteries which do not constitute gaming are unlawful except as provided by this Act."

28. Those somewhat unilluminating words need to be analysed in the light of the judgments which the Courts have given over the years in relation to what constitutes a lottery. In the unreported decision of Rattee J (13th February 1998) in the matter of Vanilla Services BV, Rattee J set out, in considerable detail, the history of the analysis of what is a lottery. I do not propose to do that in this judgment.
29. There is also very helpful analysis of this area of the law In Re Senator Hanseatische Ver Waltungsgesellschaft mbh & Anr [1997] 1 WLR 515. That case involved what was known as the Titan scheme. For obvious reasons, the case is generally referred to as the Titan case. In his judgment, Millett LJ summarised the background of the law of lotteries and said that Parliament had left it to the courts to decide what constitutes a lottery by references to the general underlying idea. The courts have consistently said that what lies at the heart of the concept is the distribution of prizes by a lot or chance. There is no magic, in the words used, because any reward or commission is sufficient. Part of the analysis of Millett LJ concerned whether the way in which the Titan scheme operated was such that, because of the need to persuade people to join and become new recruits for the Titan scheme, this was a scheme whereby the benefits, the rewards, were obtained as a result of the skill and effort expended by the recruiter.
30. The scheme itself in Titan consisted entirely of the sale of participations. Recruits were induced to part with substantial sums, by the prospect of easy money and very large gains. As Millett LJ said, at page 524 E-G:

"In order to achieve the spectacular rewards which are held out to them, they depend on commissions from the sale of participations by their recruits and by those whom their recruits have recruited in their turn, and so on down the line apparently ad infinitum. Whether any commission on such indirect sales will ever be earned, and if so how much, is due to factors which are completely beyond the control of the original participant and are wholly unpredictable."

31. The result, as Millett LJ found, was that the unpredictability led to this being a commission that would be achieved as a result of chance and, therefore, it was a lottery. In the Vanilla case, Rattee J said that, at the end of the day, although given that a member might be able by the exercise of his own skill, to select and persuade others to attend a recruitment meeting and induce them to become a member, that that by itself was not sufficient because the scheme in Vanilla did not stop there because, once a member became a senior partner there was then the chance of other and potentially more glittering prizes which could be achieved further down the family tree. As Rattee J said at page 18:

"Whether or not they do so depends on the success or failure of others down the line. The fact that those down the line might themselves exercise skill in persuading others to join is, to my mind, irrelevant since whether they can do and indeed whether further members joined for whatever reason is, so far as any particular senior participant is concerned, entirely a matter of chance.

It seems to me a scheme can be lottery even if some of the rewards can be said to be gained by the application of an element of skill on the part of the participant provided the scheme is to substantial extent offers other rewards dependent entirely on chance."

32. It seems to me that the scheme operated by Alpha Club depends in the same way on the success of others down the line. It is the multiplication of the reward, by the skill or ingenuity of others which brings the ultimate rewards to those who come in early on the scheme. It is therefore, in my judgment, a lottery. In those circumstances, it is carried on illegally, in breach of section 1 of the Lotteries and Amusements Act 1976.
33. Inherent objectionability
34. Mr Moverley Smith submits that the scheme is itself inherently objectionable, in that it lacks commercial propriety and, on that basis, the continuation of it will be contrary to the public interest. As I have already indicated, pyramid selling schemes put at risk those who join later on. They have been described as pernicious by Millett LJ in the Titan case. It has that description because members of the public are induced by the prospect of easy money being earned by others, and believing that it will fall into their laps with little effort. In order to buy that prospect, they must themselves put up substantial sums of money. The reality is that, as the scheme goes on, that money goes to the benefit of those earlier on, at the real expense and loss of those who come later.
35. In the Titan case Millett LJ said this at page 525H - 526D, after quoting from the unreported decision of Megarry J in Re Kascot Interplanetary Ltd:

"That is strong language, but in my opinion such language is amply warranted by any scheme which must be sold to the public on an implicitly false basis or which cannot be sold at all. Like any lottery, it holds out the promise of spectacular rewards for the few at the expense of many. Unlike the ordinary lottery, however, it does not charge nominal sums to enter to people who knowingly and for their own amusement risk a small sum in the remote hope of a great prize. If the Secretary of State's allegations are to be believed, the Titan scheme pretends to be a commercial operation in which the public are encouraged to 'invest' substantial moneys, often borrowed, in what, from the point of view of the 'investors' as a wholly, is cynically set up as a loss-making venture.

If the Secretary of State makes good his allegations, he is plainly entitled to the view that it is expedient in the public interest that the company be wound up in order to protect the public by bringing the scheme to an end. I reject Mr Bannister's submission that the Secretary of State has no business to intervene in a case where no illegal activity is being carried on. The expression 'expedient in the public interest' is of the widest import; it means what it says. The Secretary of State has a right, and some would say a duty, to apply to the court to protect members of the public who deal with the company from suffering inevitable loss, whether this derives from illegal activity or not. A common case in which he intervenes is where an insolvent company continues to trade by paying its debts as they fall due out of money obtained from new creditors. The insolvency is the cause of the eventual loss, but it is the need to protect the public, not the insolvency, which grounds the Secretary of State application for a winding up order in such cases. The analogy with his allegations in the present case, while not exact, is close."

36. It seems to me that the scheme operated by Alpha Club, and the extent to which Marketing Services played a part in that, was pernicious and inherently objectionable. It seems to me that it clearly put at risk those who came later into the scheme and therefore it is something of which this Court should disapprove, and against which the public are entitled to be protected. It was no doubt for that reason that the Secretary of State concluded that it was in the public interest that these companies should be wound up.
37. Miss Hoffman has rightly submitted that whether I make the order in this case is in the discretion of the Court, and that it must be just and equitable for me to do so. She says, again, rightly, that one of the matters that I have to consider is whether the fact that the company has now gone into creditor's voluntary liquidation on 12th April 2002, means that it is no longer necessary for a compulsory winding up order to be made.
38. She rightly says that a compulsory winding up order will be made where there appear to be matters that require investigation and there are reasons to suppose that the liquidator, on a voluntary winding up, is not or may not give the appearance of being sufficiently independent. She submits that neither of those matters arise here. She says the company is no longer trading and indeed has not traded since November 2000. There is, therefore, she says, no further risk to the public. She says that I must be satisfied that it is in the public interest that this company is wound up.
39. The Secretary of State submits that it is right to wind up these companies, in particular, Alpha Club, because the court should mark its disapproval of a scheme such as this and that the court should send out a message to the public that schemes such as this will not be tolerated. Against that, Miss Hoffman says that it is no function of the Companies Court to make winding up orders as a mark of disapproval. In that she is undoubtedly right. This Court is not in that sense a court of morals, but it is carrying out a statutory function under the Companies Act. Part of the public interest, it seems to me, is that where a company has operated in the way which I have described, it is right that the public should see that the Secretary of State has investigated and has concluded that it would be in a public interest for it to be wound up, and that the court agrees with that conclusion.
40. It is right, in those circumstances, that rather than leaving the matter in the hands of a liquidator appointed by creditors, the creditor of which I should say is an associated company, the matters should be in the hands of a court appointed liquidator. The public can then feel that the matter is properly investigated, and, at the same time, it does send out the message that this kind of business cannot be carried out by limited companies. The more that message is sent out, the less the public will be at risk in the future. It seems to me to be a message that needs to be sent out again and again because these schemes appear with increasing repetition.
41. I, therefore, consider it is in the public interest that Alpha Club should be the subject of a compulsory winding up rather than merely a creditor's voluntary winding up.
42. Mr Movenly Smith says in addition that it is necessary to carry out an investigation. As against that, Miss Hoffman submits that a provisional liquidator, was appointed on the application of the Official Receiver by an order of Neuberger J, made on 23rd July 2001. She says that, although that order was discharged on 22nd August 2001, by an order of Blackburne J, there had been an investigation by the Official Receiver. Indeed, a report, dated 15th August 2001, was prepared by the Official receiver on both Alpha Club and Marketing Services. She asks rhetorically what further investigation is needed. Those reports are in the barest detail and merely outline the assets and liabilities as discovered at that stage by the Official Receiver. It is also the case that the Official Receiver, in the light of the application to discharge his appointment as provisional liquidator gave undertakings that he would not have direct contact with the scheme and letters of enquiry, although approved by the Official Receiver were sent out directly by the company. On the face of it, there is no real investigation that has been carried out by the Official Receiver whilst acting as provisional liquidator.
43. Miss Hoffman also says that there has been a full investigation by the Secretary of State, pursuant to its powers, in which there has been co-operation. She says there has been co-operation from the outset because it was as a result of a letter from a Director of Alpha Club that the Secretary of State started his investigations.
44. To some extent that needs to be put in context. There was some campaigning journalism by the Sunday Express in its newspaper in which it drew attention to the risks which were being run by Everton Football Club in engaging with Alpha. It was highly critical of Alpha's scheme. There is no doubt in order to protect itself against those accusations that the company thought it right to contact the Secretary of State.
45. In the event it is quite right that extensive investigations have been carried out, and it is right that it has not been identified precisely what further investigations are necessary. Mr Moverley Smith said that one thing that is apparent is that at 15th August 2001 the Official Receiver had identified assets of some £2,490.80, whereas the statement of affairs filed by the directors, in the creditor's voluntary winding up, showed no assets. Miss Hoffman says to me that that is due entirely to the fact that those were monies in a bank account which were frozen when the provisional liquidator was appointed and they simply do not appear in the statement of affairs. There is no doubt they should have appeared in the statement of affairs whether frozen or not. It is undoubtedly a matter that should be investigated in any event: the fact that even a small sum of money, it appears, on the face of it, not to have been accounted for by the directors in filing that statement of affairs.
46. Finally, Mr Moverley Smith says that there have been suspected offences that have been committed here, and it is those matters that must be subject of investigation by a liquidator, appointed by the Court, with the full powers which he has to investigate those matters and to make a report to the Secretary of State.
47. It seems to me that, where this kind of selling has taken place, and this activity has been carried out, it is extremely important that it is properly investigated and a report is sent to the Secretary of State, so that he can then consider whether criminal prosecutions should take place or not. That is something, in my view, that is fundamentally in the public interest. It is linked to the need to stop these schemes. If criminal offences have been committed, then it is right that they are the subject of the report and investigation.
48. It seems me to me, therefore, that despite Miss Hoffman's telling submissions that it is vital to achieve results consequential on a liquidation, I find that there will be results as a result of a compulsory liquidation compared with a creditor's voluntary winding up. I do not believe the fact that the company is no longer trading is in itself a sufficient reason for refusing to make the order.
49. There are circumstances such as this where it seems to me it is in the public interest that such an order should be made. In all the circumstances, having weighed up all the considerations, I will make compulsory winding up orders on the grounds that it is in the public interest and it is just and equitable to wind up Alpha Club and Marketing Services.