England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION

		Royal courts of Justice Strand, London, WC2A 2LL
		21/07/2004

Mr Justice Hart:

1. By an application dated 19^th January 2004, the liquidator of Rosshill Properties Limited ("Rosshill") seeks relief inter alia against the first respondent ("Sinai") under section 238 of the Insolvency Act 1986 ("the 1986 Act") in relation to an agreement dated 20^th December 2000, whereby Rosshill covenanted to pay £6m to Sinai and granted a charge to Sinai to secure that covenant. Alternatively the liquidator seeks relief under section 239 of the 1986 Act on the ground that that covenant and its associated charge constituted a preference.
2. The application before me is an application by Sinai dated 12^th February 2004 whereby it seeks to have the liquidator's application dismissed as having no real prospect of success. The actual form of Sinai's application invites the court to approach it on a number of alternative bases, directions to the liquidator under section 167(3) and/or section 168(5) of the 1986 Act, striking out under CPR 3.4 or judgment under CPR part 24. Nothing of substance turns on which of these jurisdictions is being invoked.
3. Rosshill is a company incorporated as an international business corporation under the laws of the British Virgin Islands. It owns 300 acres of land at Hayle Harbour in Cornwall which has development potential but which does not currently have and has not at any material time had any planning permission relevant to that potential. In order to realise that potential it needed, in addition to a suitable planning permission, the cooperation of Hayle Harbour Company Limited ("HHCL"), a harbour company incorporated by the Hayle Harbour Act 1989.
4. The agreement dated 20^th December 2000 ("the 2000 compromise") was an agreement to which both Rosshill and the eleven respondents to the liquidator's application were parties. It was entered into in order to compromise litigation which had been brought by Mr Ronald Smith ("Mr Smith") against ten defendants (i.e. the parties to the present application with the exception of Sinai). The underlying dispute was a dispute between Mr Smith and one Philip Carruthers ("Mr Carruthers") as to who was the true beneficial owner of the issued share capital of Rosshill. Mr Carruthers had a controlling interest in HHCL. Stripped to essentials, Mr Smith's claims were that he was the beneficial owner of the issued share capital of Rosshill, but that Mr Carruthers had so manipulated matters that he, Mr Carruthers, was able to control the shareholding via the trustee of his family trust (Spread Trustee Company Limited – "Spread") and that, purporting to act on behalf of Rosshill, Mr Carruthers had fraudulently incurred liabilities on behalf of Rosshill to a number of parties, including a substantial liability to a Mr Sacki in respect of which Mr Sacki had obtained both a judgment and a charging order against the Hayle Harbour land. Mr Carruthers' position by contrast was that Mr Smith had sold his beneficial interest in the land and in the shares in Rosshill to Rosshill and Mr Carruthers respectively for a sum which was agreed on 3^rd April 1998 to be £1.4m (payable as to £1.3m by Rosshill and £100k by Mr Carruthers) which sum was subsequently agreed to have been increased to £1.805m on 23^rd September 1999. Mr Carruthers accordingly claimed that Mr Smith was a creditor of himself and Rosshill in that sum (it is not clear how much of the increased sum is alleged to have been Rosshill's as opposed to Mr Carruthers' liability), and claimed that Mr Smith held the land certificates to the Hayle Harbour land as security for that liability.
5. The prize at stake in the proceedings was, in the final analysis, the Hayle Harbour land owned by Rosshill. On the valuation material currently before the court, the existing use value was at the date of the 2000 compromise perhaps some £750,000. On the other hand a valuation in 1988 making assumptions that appropriate planning permissions would be available had put the value of the land at £23m. There was evidence that Mr Carruthers was, in December 2000, hoping to achieve for Rosshill a price of some £16-17m under a joint venture agreement being proposed to a company called London & Amsterdam. That was on the assumption that planning permission would be obtained. Receivers appointed by Sinai under its charge have recently negotiated a sale of the land to an associated company of London & Amsterdam for £7.5m without the benefit of planning permission.
6. The compromise of the Chancery proceedings took a complex form. Its essence, however, so far as Mr Smith was concerned, lay in his abandonment of his claims to the share capital of Rosshill, leaving Mr Carruthers (through Spread) in control of Rosshill and thereby the Hayle Harbour land. In return, Rosshill agreed to pay Sinai (to whom Mr Smith appears to have assigned the benefit of his claims) £6m secured by a charge on the land which also secured Mr Sacki. There was also a provision whereby Mr Carruthers, albeit subordinated to the claims of Mr Sacki and Sinai, became a secured creditor of Rosshill for up to £3m. Rosshill's liability to Mr Sacki and to Sinai was not however to be enforceable for a period of two years from the date of the agreement. Mr Sacki was entitled to demand repayment of the Sacki Debt on 1^st November 2001 and was entitled to interest thereon at 3% over base from 1^st November 2000. Sinai was entitled to interest on the Sinai Debt at a fixed rate of 8% per annum from 1^st May 2002.
7. I should emphasise that the foregoing is an extremely compressed summary of the essential features only of what was a much more elaborate agreement.
8. The liquidator's claim under section 238 of the 1986 Act is based on the proposition that Rosshill either received no consideration for its agreement to pay Sinai £6m (on that footing relying on section 238(4)(a)), alternatively that the consideration received by Rosshill had a value "which, in money or money's worth, [was] significantly less than the value, in money or money's worth, of the consideration provided by [Rosshill]" (within section 238(4)(b)). The claim is put in these alternative ways on the premise that either Mr Smith was right and he was entitled to the Rosshill shares (in which case Rosshill owed him nothing), or Mr Carruthers was right and Rosshill owed him at least £1.3m.
9. Sinai's case is that the liquidator's application is bound to fail at this stage of the argument. It is submitted that reliance on section 238(4)(a) cannot be in point since on any view Rosshill received some consideration for its covenant: the abandonment by Mr Smith of all his claims removed the possibility of it being held in the proceedings that Mr Smith was a creditor of Rosshill; furthermore, although Mr Smith had not made any claim to the Hayle Harbour land in the proceedings, the 2000 compromise required him to give up any claims he might have as well to surrender the land certificates; it also gave Rosshill a two-year period of grace in which to seek to realise the development potential of the land, and by stilling the disputes over the constitution of the Board of Rosshill and its ownership, freed Rosshill from the corporate paralysis from which it otherwise suffered and which, so long as it continued, prevented it from exploiting the business opportunity represented by the deal with London & Amsterdam. As at present advised I am inclined to agree with Sinai's submission that section 238(4)(a) can have no role to play in this case.
10. The more difficult issue lies in the application of section 238(4)(b). That sub-paragraph requires a comparison to be made between (a) the consideration provided by Rosshill and (b) the consideration which was given for it, the onus being on the liquidator to show that (b) was significantly less than (a). It was submitted on behalf of Sinai that there was no real prospect of the liquidator discharging that onus. That submission depended on the proposition that Rosshill's agreement to pay £6m was valueless at the time it was made. The argument was that since the only evidence before the court of the value of the land was that it was worth £750,000, and since Rosshill had creditors (including Mr Sacki) in excess of that sum, the covenant cannot have been worth anything. In support of that proposition, reliance was placed on the analysis of the value of a covenant to pay money contained in a speech of Lord Scott in Phillips –v- Brewin Dolphin Bell Lawrie Limited [2001] 1 WLR 143 particularly at paragraphs 22 and 26. Rosshill's covenant was simply not bankable.
11. As an argument for dismissing the liquidator's application at this interlocutory stage, this proposition does not in my judgment work. It is open to the liquidator to establish by evidence that the covenant to pay £6m did have a substantial value. Given the fact that a sale of property without the benefit of planning permission has in fact been negotiated at a price of £7.5m, it cannot be said that the liquidator has no prospect of establishing that the land had some similar value in December 2000. It seems to me that the greater difficulty is likely to be suffered by Sinai in putting a value on the consideration which it alleges that Rosshill received. On one possible view the hotchpotch of benefits alleged to have been obtained by Rosshill under the 2000 compromise are not capable of being measured in money or money's worth, and for that reason are arguably not consideration which can be put in the scales against the measurable consideration given by Rosshill (compare Millett J in Re MC Bacon Limited [1990] BCLC 324 at page 340g-h).
12. Mr Driscoll's second submission on behalf of Sinai was that even if the court were satisfied that there had been a transaction at an undervalue, there was no real prospect that the court would make any order against Sinai as a result. Section 238(3) provides that where an application has been made by a liquidator in respect of a transaction at an undervalue:

"…the court shall, on such an application, make such order as it thinks fit for restoring the position to what it would have been if the company had not entered into that transaction."

13. It was common ground that this provision does not mandate the making of an order once the transaction has been established to have been at an undervalue (and assuming the non-availability of a defence under sub-section (5)). As Sir Donald Nicholls V-C pointed out in Re Paramount Airways Limited (in administration) [1993] Ch 223 at 239G-H, the discretion given by the sub-section is "wide enough to enable the court, if justice so requires, to make no order against the other party to the transaction…". The argument here was that the impossibility of putting Mr Smith (or Sinai) back into the position which he (or it) would have been in but for the transaction meant that there was no real prospect of the liquidator persuading the court to make any order at all under the section. Mr Smith had claims against Mr Carruthers (and Spread) to the shares in Rosshill and claims against purported creditors of Rosshill (including Mr Sacki) that Rosshill was not indebted to them. Mr Carruthers is now however bankrupt and Rosshill has in the period since December 2000 apparently incurred further debts (allegedly in the millions) and is now of course in liquidation. Mr Sacki continues to enjoy the benefit of his charge and will continue to do so because the liquidator has taken the view that there are no grounds for applying to set it aside. Accordingly, it is submitted that it is simply impossible to conceive of any form of order which the court might make which could restore Mr Smith to the position which he previously enjoyed.
14. One possible answer to this submission was suggested by Mr Ashworth on behalf of the liquidator. He observed that if at the hearing of the application it were established that Mr Smith had never been anything other than an unsecured creditor of Rosshill (as had been Mr Carruthers' case in the Chancery proceedings) there would be no difficulty in restoring him to that position. In my judgment there are two difficulties with that argument. First, it does not appear from the liquidator's application as currently formulated that he is proposing on this part of his case to prove that Mr Smith was no more than an unsecured creditor. The case is put in alternative, conditional, form: either Mr Smith was a shareholder or he was a creditor, and on either hypothesis the transaction was at an undervalue. If I am right about section 238(4)(a) this way of putting the case will have to be re-thought. Secondly, the argument overlooks the fact that what Mr Smith was compromising was his claim to be the shareholder beneficially, and his claim that Rosshill did not have an indebtedness in respect of the liabilities purportedly incurred on its behalf by Mr Carruthers. That claim must have been perceived as worth more to Mr Smith than his position as an unsecured creditor of Rosshill encumbered by those liabilities. Putting Mr Smith back in that position is now impossible.
15. In my judgment the answer to Mr Driscoll's submission is that the court will not necessarily be deterred from making an order by the fact that Mr Smith cannot be put back into the position he was in immediately prior to the 2000 compromise. Suppose A owes B a debt of £1,000 which B agrees to release in exchange for A procuring C Ltd to sell to B land worth £1,100 for a consideration of £100. The transaction is completed, and thereafter A goes bankrupt and C Ltd into liquidation. It is possible to say that an order requiring the land to be re-vested in the company on payment of £100 to B will "restore the position to what it would have been if [C Ltd] had not entered into [the] transaction", even though the result is to leave B worse off than he would have been as against A. There are two reasons why this is so. First, the relevant transaction for section 238 purposes is not the tri-partite arrangement between A, B and C Ltd, but simply the sale by C Ltd to B. Secondly, it is at least arguable that the court's primary, and possibly only, concern under section 238(3) is the restoration of the company's position: the position of the counter-party needs to be considered by the court as a general matter of discretion, but the court is not obliged to ensure that his position is restored in every particular to the status quo ante the transaction. There will be many cases where that is simply impossible.
16. I have accordingly concluded that it cannot be said on this ground that the liquidator has no real prospect of obtaining an order. I turn therefore to Mr Driscoll's third submission based on section 238(5).
17. Section 238(5) provides that:

"The court shall not make an order under this section in respect of a transaction at an undervalue if it is satisfied-

(a) that the company which entered into the transaction did so in good faith and for the purpose of carrying on its business, and

(b) that at the time it did so there were reasonable grounds for believing that the transaction would benefit the company."

18. Rosshill's entry into the 2000 compromise was specifically approved by its board at a meeting on 17^th November 2000. The board then comprised Mr Carruthers, Mr McHugh, an associate of Mr Carruthers, and Mr Sampson who had been nominated to the board by Mr Smith. The proceedings of the meeting were recorded in what was obviously a carefully crafted minute, which, after appropriate disclosures had been made of the directors' personal financial interests, recorded as follows:

"The Directors having taken into account the inability of the Company to control and manage its affairs for so long as the litigation continued, the imminence and likelihood of outline planning permission being granted for the development of part of the Company's land, the interest expressed by prospective purchasers or joint venture partners in the development project, the very substantial gain in the value of the Company that would result in the present solvency of the Company, it was resolved that it would be in the best interests of the Company for a settlement of the proceedings to be achieved. It was noted that the consequences of not achieving such a settlement would almost certainly be the collapse of the Company and the failure to realise the substantial gain which would result from a successful sale of the land or a joint venture partnership and that this would not be in the interests of the Company its shareholders or creditors."

19. Mr Driscoll submitted that there were no grounds whatsoever for doubting the veracity of that passage or the good faith of those who participated in the meeting. Accordingly, he submitted, it was plain that, unless the liquidator were able to suggest some foundation for a suggestion to the contrary, the requirements of section 238(5)(a) and (b) were satisfied.
20. In response to that submission, Mr Ashworth pointed to some evidence of Mr Carruthers which sought to suggest that his motivation in entering into the 2000 compromise was physical intimidation by Mr Smith. I agree with Mr Driscoll that this evidence has to be taken with a very liberal pinch of salt. If Mr Carruthers had grounds for upsetting the 2000 compromise on such grounds it is astonishing that he never relied on them, but instead sought to escape its consequences by the device of putting Rosshill into administration on the very eve of the expiration of the two year period of grace which Rosshill enjoyed as a result of the 2000 compromise. I would therefore be prepared to discount entirely the prospect of the liquidator being able to establish this as the "real" reason for Rosshill having been caused to enter into the 2000 compromise.
21. If that is right then Sinai will be able to establish "good faith" in the sense that the minute accurately and honestly reflects the thought processes involved. That does not however by itself establish that the court will be satisfied either that the decision was taken "for the purpose of carrying on [the company's] business" within section 238(5)(a) or that there were "reasonable grounds for believing that the transaction would benefit the company" within section 238(5)(b). The first of those requirements involves both subjective and objective elements; the second is expressed in entirely objective terms. The liquidator is in my judgment entitled to maintain a case that the transaction was not necessary for the purpose of carrying on the company's business and/or that there were not objectively reasonable grounds for believing that it would benefit the company.
22. The difficulty which, as it seems to me, Sinai faces under section 238(5) is that the principal advantage to Rosshill from the transaction lay in its being freed from the corporate paralysis from which it suffered. To obtain a release from that paralysis it was prepared to pay a price which (ex hypothesi) exceeded the value to it of what it was to receive. Prima facie that could only be justified if there was no other (or cheaper) means of removing the paralysis. It is not immediately apparent to me that such means did not exist. In the final analysis the dispute which was producing the paralysis was a dispute between Mr Carruthers and Mr Smith over who was entitled to control Rosshill. On the face of it the adoption of some procedure designed to allow Rosshill to continue in business notwithstanding the irresolution of that dispute would be a better course for Rosshill to have taken than the one it did take, namely the deployment of a substantial chunk of its assets on Mr Carruthers' behalf in buying out Mr Smith's claim to be the beneficial owner of the share capital. The course ultimately taken by Mr Carruthers of obtaining an administration order was ostensibly one of those courses. An alternative might have been the appointment of a receiver, or provisional liquidators. Unless and until it be shown that some such solution was impossible the liquidator has some prospect in my judgment of being able to show that the requirements of section 238(5) are not satisfied.
23. Accordingly, I do not consider that the liquidator should be shut out at this stage from pursuing his case against Sinai under section 238.
24. The liquidator's case under section 239 has, however, to surmount a different obstacle. Under section 238, the transaction at an undervalue is impugnable if made within the period of 2 years ending with the onset of insolvency: see section 240(1)(a). That is satisfied in this case. The same period applies in the case of a preference which is given to a person who is "connected with" the company. In the case of a preference which is not a transaction at an undervalue and not given to a connected person the relevant period is, however, only 6 months: see section 240(1)(b).
25. In this case the preference (if it was one) was given outside this 6 month period. It is necessary therefore for the liquidator to show that it was given to a connected person. He faces three potential obstacles. First, he has to show that the person to whom it was given was a "creditor". To the extent that he here relies on Mr Smith as having been a creditor before the 2000 compromise itself, he has set himself the task of showing that Mr Carruthers' version of events was the correct one. It is not clear that the liquidator's application fully recognises this as currently formulated. Secondly, he has to deal with the fact that the putative preference was given to Sinai rather than to Mr Smith. This possibly presents a difficulty more apparent than real. Thirdly, he has to show either that Sinai or Mr Smith was a connected person. It is not suggested that Sinai fits this bill.
26. In argument various solutions were proposed to the first and second of these difficulties. Each of them depend on asserting, by one means or another, that Mr Smith/Sinai was a creditor of Rosshill. Each of them therefore has to eschew the allegation that Mr Smith was a shareholder of Rosshill. Accordingly, the liquidator accepts that the only basis on which Mr Smith can be alleged to have been "connected with" Rosshill is as a "shadow director" of Rosshill: see section 249(a). The expression "shadow director" is defined by section 251 as:

"a person in accordance with whose directions or instructions the directors of the company are accustomed to act (but so that a person is not deemed a shadow director by reason only that the directors act on advice given by him in a professional capacity)."

27. On the face of those words it is not enough to constitute Mr Smith a shadow director that one member of the board, Mr Sampson, was his nominee. It would have to be shown that all the directors, or at least a consistent majority of them, had been accustomed to act on Mr Smith's directions. Mr Ashworth submitted that this could not be the proper construction of the provision, since it would expose an obviously unintentional lacuna in the legislation. I agree that the construction does leave a lacuna: it is difficult to see why a director should be connected but a person who controls a director is not. I am, however, unable to read section 251 as having the meaning contended for by Mr Ashworth, and, as he recognised, there are two first instance authorities which are against him on the point: see per Millett J. in Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180 at 183 and (on the identical wording in section 741(2) of the Companies Act 1985) Harman J. in Re Unisoft Group Ltd (No. 2) [1994] BCC 766 at 775.
28. The only means of escape for the liquidator from this conclusion was to seek to argue that the whole board had been "accustomed" to act on Mr Smith's directions, that custom having begun and ended on the day of the board meeting itself when a resolution compliant with Mr Smith's wishes was passed. This seems to me a hopeless argument.
29. Accordingly, the liquidator's application under section 239 is in my judgment doomed to fail and ought not to be allowed to proceed to trial.
30. I will hear further argument as to the form of order and further directions which are appropriate in the light of this judgment on the occasion of its formal delivery.