England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION

		Royal Courts of Justice Strand, London, WC2A 2LL
		4 December 2003

Mr Justice Laddie:

1. This is the judgment in an application by Digital Equipment Company Limited, Compaq Computer Holdings Srl and seven other companies within the Compaq Computers Group (together referred to as "the Applicants") for payment of just over £60,000 held in the Insolvency Services Account of M.T. Realisations Ltd ("the Company"). The payment of that sum would discharge part of the total sum by way of costs due to the Applicants arising out of proceedings brought against them by the liquidators of the Company. The respondents to the present proceedings consist of the current and former liquidators of the Company and Withers, the solicitors who were instructed by the liquidators in that litigation. Withers is the only active respondent on this application.
2. This application is part of an attempt by the Applicants to recover costs. In fact there are two applications on foot. In the other one, in relation to which evidence is in the course of preparation, the Applicants are seeking the recovery of sums which they argue have been wrongly dissipated by the liquidators but which should have been used to pay sums due under various costs orders.
3. The costs orders arose as follows. The liquidators commenced proceedings against the Applicants alleging breaches of s 151 of the Companies Act 1985. Those proceedings were struck out by me on 31 July 2002. I made an order for costs against the Company. That judgment was upheld on appeal. A further order for costs was made against the Company by the Court of Appeal. In the meantime the liquidators had commenced a new set of proceedings against the Applicants covering, so I am told, much the same ground as in the first set of proceedings. In July of this year the liquidators discontinued the second set of proceedings. Master Moncaster made an order for costs against the Company, those costs to be assessed on an indemnity basis. I understand that somewhere in the region of £250,000 remains outstanding under these three orders.
4. The Applicants argue that they are entitled to be paid their costs pursuant to the orders referred to above out of the assets of the Company and that such payment should take priority over all the general costs and expenses of the liquidation. In particular the Applicants seek the payment of their costs in priority to the legal costs which the liquidators incurred in bringing their failed proceedings and the fees which they have charged in respect of such litigation.
5. The stance adopted by the liquidators is as follows. Insofar as the Company has £60,000 available to it in the Insolvency Services Account, they have no objection to that sum being paid to the Applicants. For that reason, they do not oppose this application. On the other hand they object to paying any sums to the Applicants which sums have already been paid away by them. Therefore they oppose the Applicants' claim in the other application. In the latter application the liquidators have been given until 21 November to serve their evidence. It is to be assumed that the substantive hearing will take place early next year.
6. Although the liquidators have no objection to the £60,000 being paid over, Withers do. By a letter dated 17 September 2003, the firm claimed that this money was held on trust for it. On 25 September the Court, of its own motion, joined it as a party to the proceedings. Since then the basis on which Withers has claimed to be entitled to this sum has changed or expanded.
7. Before turning to the live issues before me, there is one other matter which should be mentioned. The conduct of the original proceedings by the liquidators was facilitated in large part by funds made available to them by the Inland Revenue. At least part of the trust argument advanced on behalf of Withers is based on the assertion that those funds were solely and exclusively to be used to pay the costs incurred by the liquidators in pursuing the litigation and that they are, therefor, to be treated as held on trust and are outwith the general assets of the Company from which costs due to the Applicants can be paid. It is said that the trust is a purpose trust as discussed by the House of Lords in Barclays Bank v Quistclose Investments [1970] AC 567. Having discovered that the Inland Revenue had provided a significant part of the funding for the first set of proceedings, the Applicants applied successfully to the Court of Appeal for permission to seek an order under s 51 of the Supreme Court Act 1981 against the Inland Revenue. Although that permission has been granted, no proceedings under s 51 have been commenced yet. Mr Philip Marshall QC, who appears for the Applicants, has explained that his clients have not yet decided whether to start such proceedings. If they manage to recover all their outstanding costs in the current applications, they will have no need to pursue the Inland Revenue. It may be worth mentioning that none of the problems raised in this application would have existed had the Inland Revenue paid Withers' bills directly, but they did not.
8. Against this background, I can turn to consider the issues raised on this application. Mr Christopher Pymont QC, who appears for Withers, argues first that it is unfair to his client that this application should come on for hearing separately from (i) the balance of the claims in these proceedings against the other respondents, that is to say the current and former liquidators and (ii) the s 51 claim against the Inland Revenue and (iii) in any case, before the full factual picture has become clear. He points to the fact that the liquidators' evidence in relation to the claims made against them is not due until 21 November. The determination of the claims against Withers should not precede the consideration of that evidence. For these reasons he seeks an adjournment. Since the s 51 proceedings may never come into existence, I shall treat this as an application for an order that the current matter be adjourned to be determined at the same time as the other application some time next year. However, it is not possible to deal with the question of adjournment without having an understanding of the substantive points which Withers wish to run against the Applicants' claim to the £60,000 fund, not least because Mr Marshall argues that delaying this application will not improve Withers' position. For this reason it seems to me that the correct starting point is a consideration of the substantive issues between the parties.
9. My Pymont accepts that, in the normal course of events, any costs order made against liquidators in relation to civil proceedings undertaken by them has priority over the general expenses of the liquidation. This is a well established principle (see In Re London Metallurgical Company [1895] 1 Ch 758). However he says that this does not apply to assets held in a separate trust fund which do not form part of the assets of the Company. He suggests that there are two ways in which such a trust was set up here. The first arises out of an order made by Ferris J on 26 June 2001. The second involves the creation of a purpose trust, as mentioned above, into which funds from the Inland Revenue were placed, those funds being kept separate from the general assets of the Company and being held solely and exclusively for the purpose of paying the Company's legal fees incurred in pursuing the proceedings against the applicants. He also has what he calls a fall-back argument namely that I have a discretion pursuant to ss 112 and 156 of the Insolvency Act 1986 ("the Act") to alter the priority of payments out of the Company's assets and that, in the circumstances of this case, that discretion should be exercised to require the liquidators to pay the £60,000 to Withers in preference to the claims of others.
10. I shall deal with this fall-back argument first. It appears to me that ss 112 and 156 have no application here. As mentioned above, it is well established that costs awarded by a court to a successful litigant against a company in liquidation have priority over the general expenses of the liquidation. Ss 112 and 156 have no impact on that general rule.
11. S 156 reads as follows:

"The court may, in the event of the assets being insufficient to satisfy the liabilities, make an order as to the payment out of the assets of the expenses incurred in the winding up in such order of priority as the court thinks just."

12. This section is in Chapter VI of the Act, that is to say the part concerned with compulsory winding up. Since the Company was put into voluntary liquidation, s 156 has no direct application here. However s 112 provides:

"(1) The liquidator or any contributory or creditor may apply to the court to determine any question arising in the winding up of a company, or to exercise, as respects the enforcing of calls or any other matter, all or any of the powers which the court might exercise if the company were being would up by the court."

13. That section applies here. Mr Marshall accepts for the purpose of this application that the section gives the court powers in a voluntary winding up which are equivalent to those given by s 156.
14. The real issue is what is meant by the words "expenses incurred in the winding up of the company" in s 156. In other words, to what types of expenses does the statutory power to alter priorities apply? Although the Act contains no definition of these words, r 4.218 of the Insolvency Rules 1986 contains a list of expenses and specifies their order of priority. Costs ordered to be paid by the company in respect of its participation in civil litigation are not included in this list.
15. Mr Marshall argues that the type of expenses covered by s 156 and, by extension, s 112 are the expenses listed in r 4.218. The power given by the sections therefore only allow the court to alter the order of priority within the rule. It does not give the court power to displace the well established rule that a court order for costs takes precedence over all of these expenses. He draws my attention to two authorities. The first is In Re M C Bacon Ltd [1991] Ch 127 in which Millett J was concerned with the meaning of s 115 of the Act. In the course of his judgment he said:

"An order authorising the payment of costs "out of the company" means "out of the assets available for distribution to the general body of creditors," and does not have the effect of making the costs in question "expenses of the liquidation" or bring them within any paragraph of rule 4.218(1) so as to make them payable out of the floating charge assets. The liquidator recovers the costs by virtue of the order, not the statute, and the statutory rules of priority take effect, subject to the order: see In re London Metallurgical Co …" (p 140)

16. The second authority is Re Toshoku Finance UK plc [2002] 3 All E R 961 in which the House of Lords had to consider, among other things, the effect of r 4.220. The latter is in the following terms:

"Saving for powers of court

(1) In a winding up by the court, the priorities laid down by Rules 4.218 and 4.219 are subject to the power of the court to make orders under section 156, where the assets are insufficient to satisfy the liabilities.

(2) Nothing in those Rules applies to or affects the power of any court, in proceedings by or against the company, to order costs to be paid by the company, or the liquidator; nor do they affect the rights of any person to whom such costs are ordered to be paid."

17. In Toshoku Lord Hoffmann said:

"The courts have treated the rule [i.e. the rules which lead to r. 4.218] as a complete statement of liquidation expenses, subject only to the qualifications contained in the rules themselves. In Re MC Bacon Ltd [1991] Ch 217 at 136, [1990] 3 WLR 646 at 650 Millett J said: 'The expenses of winding up and the order in which they are payable out of the assets are listed in rule 4.218 …' Giving the judgment of the Court of Appeal in Re Floor Fourteen Ltd, Lewis v IRC [2001] 3 All ER 499 at 510 (para 32) Peter Gibson LJ said: 'Rule 4.218 tells one both what are the expenses to be treated as the expenses of a winding up and what priority they have inter se.' In Re London Metallurgical Co [1895] 1 Ch 758, decided soon after the first rules had been made, it was noted that the list said nothing about the costs of litigation incurred by the liquidator or awarded against him. Under the pre-1980 practice, costs awarded to a successful litigant had been recoverable in priority to the general costs of the liquidation. Vaughan Williams J said that r 31 of the 1890 rules did not change this practice. But he did not say that this was because the rule was not intended to be a complete statement of the law. He said that the practice on costs was preserved by the words 'subject to any order of the court'. When the 1890 rules were replaced by the Companies (Winding-up) Rules 1903, SR & O 1903/1103, it was specifically provided in r 170(3):

'Nothing contained in this rule shall apply to or affect costs which, in the course of legal proceedings by or against a company which is being wound up by the court, are ordered by the court in which such proceedings are pending or a judge thereof to be paid by the company or the liquidator, or the rights of the person to whom such costs are payable.'

This provision is now r 4.220(2) of the 1986 rules. No head of liquidation expense not mentioned in the rules has been discovered since the London Metallurgical Co case. And the general provision that the rules are 'subject to any order of the court' has gone. The only power reserved to the court is that conferred by s 156 of the 1986 Act, which gives it a discretion to rearrange the priorities of the listed expenses inter se. This is expressly reserved by r 4.220(1)." (p 966 – 7, emphasis added)

18. Mr Pymont argues that Lord Hoffmann did not expressly state that the powers granted to the court under ss 156 and 112 was limited to rearranging the priority of the expenses listed in r 4.218. He says that the section could be construed as giving the court power to rearrange the priorities both of the expenses there listed and any costs which are the subject of a court order made in litigation in which the company has been involved.
19. I do not accept these submissions. As Lord Hoffmann pointed out, the primacy of a court order as to costs was set out in London Metallurgical Co and preserved by r 4.220(2). S 156 is concerned with re-ordering the priorities of expenses in the liquidation, meaning the definitive list of expenses contained in r 4.218(1). That view is also consistent with the view expressed by the Court of Appeal in Lewis v Commissioner of Inland Revenue [2001] 3 All ER 499 paragraph 41. Costs which are payable as a result of a court order made against liquidators who engage in litigation are not "expenses incurred in the winding up". It follows that, even if minded to do so, it would not be open to me to use ss 112 and 156 to change the normal precedence afforded to costs made payable by court order.
20. It may be that when a court makes an order for costs against a company in liquidation it has the power to make it subject to a condition that the order cannot be enforced until some other event has occurred, just as it stays execution of orders for costs made against litigants who are in receipt of public funding. But even if that power exists, it was not exercised by the Court of Appeal, Master Moncaster or me when we made our respective orders for costs against the Company nor were we asked to impose any such stay.
21. It follows that I do not have power to alter the priorities as suggested by Mr Pymont. Furthermore this argument does not justify adjournment of this application. Further time and evidence will not improve it.
22. In these circumstances, it is not necessary to consider how I would have exercised the discretion argued for by Mr Pymont had I had it. Suffice to say, that I am not aware of any pressing reason why I should have overturned the long established priority referred to in London Metallurgical Co particularly where, as here, it might be construed as an attempt to qualify an unqualified order for costs made by the Court of Appeal. Therefore I can concentrate on the trust issues.
23. There is no dispute that the Inland Revenue partly funded the Company's litigation against the Applicants. It is also clear that not all the funds came from that source. The most important document relating to this funding consists of a letter dated 22 August 2002. It is from the Inland Revenue to the first and second respondents. It reads as follows:

"Dear Messrs Hore & Bower

M T REALISATIONS LIMITED – IN VOLUNTARY LIQUIDATION INLAND REVENUE GUARANTEE OF COSTS

Further to recent correspondence I am pleased to confirm that the Inland Revenue is prepared to offer you a further guarantee of costs in this case. This guarantee is in addition to that in the sum of £35,000 + VAT already offered.

The further guarantee is in the sum of £36,734 including VAT. This gross amount has been calculated as follows:

Solicitor's fees £25,721.00

Counsel's fees £26,438.00

Total: £52,159.00

Less balance of earlier guarantee £15,425.00

Total: £36,734.00

The maximum estimated amounts of future solicitors and Counsels fees have been incorporated in the guarantee. This should allow sufficient leeway for legal disbursements. I am also aware that a VAT refund claim is being pursued. In the circumstances I believe that this guarantee should be sufficient for the present purpose.

I am also pleased to confirm that the Inland Revenue offers you an Adverse Costs Indemnity in relation to the anticipated appeal proceedings against the Summary Judgment in the sum of £20,000.

The further guarantee of costs is subject to the following conditions:

1. Sums advanced under the terms of this guarantee will relate to expenditure directly related to the Liquidator's current proceedings involving breaches of S 151 CA 85 in the High Court

2. Any sums advanced under the terms of this guarantee will constitute, along with any other outstanding advances, a first Charge over recoveries into the liquidation.

3. The Liquidator will make regular reports of progress in the proceedings, as requested by the Inland Revenue.

I trust that it will now be possible to issue immediate instructions to your solicitors concerning the appeal proceedings. If you have any queries, please do not hesitate to contact me."

24. For convenience I will refer to the Inland Revenue's funding agreement referred to in this letter as the August Guarantee.
25. It will be seen that the fifth paragraph of the letter refers to a VAT reclaim being pursued. This is of significance. The reclaim was successful.
26. The way in which funds came from and were repaid to the Inland Revenue, and the interrelationship between those payments and the VAT refunds, can be gleaned from some of the documents produced on this application, particularly the liquidators' statement of receipts and payments made under s 192 of the Act ("the s 192 Statement").
27. The letter from the Inland Revenue refers in its first paragraph to a prior guarantee in the sum of £35,000. It appears that this was intended to cover, and was used to cover an order for an interim payment to the Applicants of £25,000 in respect of their costs. That order was made by me on 31 July 2002 and was paid shortly thereafter by Robson Rhodes, the firm of which the current liquidators are partners. Those sums have been reimbursed to Robson Rhodes by the Inland Revenue through Withers. The payment of £25,000 to Withers for this purpose and the provision of that sum by the Inland Revenue are recorded in the s 192 Statement, albeit on incorrect dates. Nothing turns on the payment in and out of this sum and it can be ignored. The s 192 Statement discloses that on 21 February 2003, a sum of £47,041.66 was provided by the Inland Revenue as funding. That must have been paid pursuant to the August Guarantee. It can also be seen from the s 192 Statement that a few days later, £46,000 was paid to Withers. Nothing is said to turn on the small discrepancy between these two figures. Thus, at the end of February of this year, such sums as the Inland Revenue had paid to the liquidators under the August Guarantee had been paid on to Withers. It is important to note that, as of this date, none of the funds in the liquidators' hands were derived from the Inland Revenue. At that time the Inland Revenue was entitled to be reimbursed in the sum of £72,041.66 (i.e. the sums of £25,000 and £47,041.66).
28. The s 192 Statement shows that on 10 March 2003, the liquidators received a VAT refund, described as "VAT refund (administration)" in the sum of just over £88,000. In early April a further refund, referred to as "VAT refund (liquidation)" was received by the liquidators. The s 192 Statement is not clear, but the sum recovered appears to have been just over £3,250. On 8 April, the Inland Revenue wrote to the liquidators. They noted that £92,000 in VAT refunds had been recovered, that the Inland Revenue had advanced a total of £72,041.66 (see above) and asked for reimbursement of the latter figure. That sum was reimbursed to the Inland Revenue on the next day. It appears, therefore, that as of early April 2003, the liquidators had no indebtedness to the Inland Revenue although there is nothing to suggest that the August Guarantee was terminated.
29. On 16 May 2003, the Inland Revenue wrote to the liquidators. The letter contains the following paragraph:

"We discussed the cost position on Tuesday and I understand that the liquidators have sought specialist advice concerning the priority for payment of their expenses and costs relating to the action. As you are aware, Inland Revenue is not now seeking reimbursement of the sums advanced by it under the Guarantee of costs given in relation to this action."

30. At about this time – the date is difficult to discern from the poor copy of the s 192 Statement in the court papers – just over £72,000 was sent by the Inland Revenue to the liquidators. In other words, the Inland Revenue reversed its position in relation to reimbursement out of the funds which the liquidators had recovered on their VAT reclaims and, consequent on that, sent back the money which had been sent to them by the liquidators on 9 April.
31. There is only one other letter to which I should refer. It is dated 19 June 2003 and is from the Inland Revenue to Withers. It contains the following paragraph:

"Quite clearly the liquidators of the company have responsibility for the legal fees incurred on its behalf. The Inland Revenue has not instructed your firm as you are appointed and instructed by the liquidators. However, the department, as a major preferential creditor, has been closely involved in consultations and has offered certain guarantees of costs to the liquidators in limited sums for specific purposes. The amounts guaranteed have been agreed based on the liquidator's estimates of likely costs. These took into account your own estimates of fees …"

32. I can now consider the arguments concerning the trusts asserted on behalf of Withers. It is convenient to consider the arguments relating to the order of Ferris J first. This appears to have been raised very recently.
33. Before going into liquidation, the Company was in administration. On 26 June 2001 the administrators applied to Ferris J to discharge the administration. Among other things he ordered as follows:

"1. The administration order made on 19 March 1997 be discharged pursuant to section 18 of the Insolvency Act 1986 with effect from 12 o'clock noon on 27 June 2001

2. The joint administrators be authorised and directed to pay the balance of any funds available to them as joint administrators of the Company (after provision for their remuneration, costs and expenses) into a designated trust account for the benefit of those creditors who are or would have been preferential creditors of the Company in the event that an order for the compulsory winding up of the Company had been made immediately on discharge of the administration order."

34. Based on this, Mr Pymont argues as follows. The company never had any funds from which to pay the costs due to the Applicants. It is for the Applicants to prove that they were entitled to be paid any sums held by the liquidators. The reason they cannot do that is that the Ferris J order creates a trust fund into which sums due to preferential creditors must be paid. One of, if not the only, preferential creditors was the Inland Revenue. The VAT refund in the sum of £88,000 is described as "VAT refund (administration)". It is reasonable to infer from this that it was a refund attributable to the period during which the Company was in administration. It should therefore be treated as funds available to the joint administrators and should, for that reason, be treated as being included in the trust fund created for the benefit of the Inland Revenue. When, on 8 April of this year, the Inland Revenue asked for just over £72,000 to be paid to it, it was money from the trust fund. It did not come from funds of the Company. When the Inland Revenue repaid that sum in mid-May it was not returning the Company's money to the Company. It was paying its own money to the Company for onward transmission to Withers to meet their bills. He draws my attention to Re Mark One (Oxford Street) plc [2000] 1 BCLC 462 and In re UCT Ltd [2001] 1 WLR 436 to emphasise the point that the making of an order like that made by Ferris J was designed to protect the assets of the preferential creditors. If, as Mr Pymont suggests, the major VAT refund was in respect of VAT paid during the administration, it should be treated as within the trust created by the Ferris J order.
35. I am not persuaded by these arguments. The order made by Ferris J did not purport to create a trust in the hands of the liquidators. As its first paragraph makes clear, the order was made under the provisions of s 18 of the Act. As is confirmed by In re UCT Ltd, an order under that section must be directed to administrators. It cannot be used to give directions to liquidators, require them to create a trust fund or require them to put any assets in any such fund. Thus this order could not, and does not purport to, create a trust fund of which the liquidators were trustees. The VAT refund was made some two years after the discharge of the administration order and was paid to the liquidators. By that time the administrators were long gone. Ferris J's order did not purport to bind the liquidators who, at the time it was made, had not been appointed. In those circumstances it not relevant how the refund would have been treated had it been received during the administration. The sum was received by the liquidators and put into funds controlled by them as part of the assets of the Company.
36. It is worth noting that the beneficiary of this alleged trust, namely the Inland Revenue, has not asserted that the VAT refund was held by the liquidators on trust for it. It treated it as part of the assets of the Company to pay to it to reimburse it for sums made available to support the litigation. If Mr Pymont were correct, the Inland Revenue was asking the liquidators to use the Inland Revenue's money to pay off a debt to the Inland Revenue.
37. Again, I do not see how any adjournment could alter this outcome. The argument based on the Ferris J order fails.
38. I therefore turn to the alternative trust argument advanced on behalf of Withers. This is Mr Pymont's primary argument. It may be summarised as follows. The £60,000 held in the Insolvency Services Account was derived from payments made by the Inland Revenue solely and exclusively for the purpose of paying Withers' bills. As a result, a purpose trust was created into which all the Inland Revenue moneys were paid. The funds in the trust were not assets of the Company which could be used to meet the cost orders made against it. Mr Pymont argues that the creation of the trust is evidenced by the two letters of 22 August 2002 and 19 June 2003 referred to above. In particular the first of these set out the conditions on which Inland Revenue funding was to be made available. He says it is clear that they are intended to ensure that the funds are ring-fenced and used solely and exclusively for paying Withers' fees and disbursements incurred in conducting the litigation.
39. Mr Marshall has three answers to this. First he says that the correspondence above gets nowhere near establishing the existence of a purpose trust and the onus must be on Withers to prove there was one. Second, even if there was a purpose trust, it has no bearing on the £60,000 in issue since that money was never within the trust. Third, even if both of these arguments are incorrect, the beneficiary of the trust is the Inland Revenue. Only it can ask for payment of the £60,000, not Withers.
40. It is convenient to consider the second of these arguments first. For this purpose it should be assumed that a purpose trust was created into which funds from the Inland Revenue were to be placed to be used solely and exclusively to meet the liquidators' lawyers' fees in the litigation against the Applicants. It is clear that the VAT refund was not money paid into any such trust. It did not come from the Inland Revenue nor was there any restriction placed on its use by the liquidators. As explained above, just over £72,000 from the refund was used to reimburse the Inland Revenue. That sum was subsequently returned. The basis of that return is set out in the paragraph from the letter of 16 May 2003 set out in paragraph 29 above. The Inland Revenue did not say then, nor has it or the liquidators asserted at any stage, that the £72,000 was to be held in trust for payment of the liquidators' lawyers' fees. On the contrary, the Inland Revenue's stance was that it was no longer seeking reimbursement of the moneys advanced under the August Guarantee. In other words, it was reversing its earlier decision to ask for part of the VAT refund to be paid to it. The £72,000 was therefore returned to the liquidators. It was no more impressed with a trust when it was returned than when it had been received from H. M. Customs & Excise. It is from this refund that the remaining £60,000 is derived. All moneys supplied by the Inland Revenue under the August Guarantee were spent before the refund was received (see para 27 above).
41. In these circumstances, whether a purpose trust was created or not has no relevance to this sum which remained under the liquidators' control to distribute in accordance with the normal priorities. In the light of this it is not necessary to consider Mr Marshall's other arguments, nor would any purpose be served by adjourning this application to come on later.
42. For these reasons, the Applicants succeed in this application.