England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
(From The Cardiff District Registry)

		Royal Courts of Justice Strand, London, WC2A 2LL
		27th February 2004

Mr Justice Hart :

1. This is a claim by Mrs Audrey Dyment ("Mrs Dyment") as a creditor and shareholder of an insolvent company ("the company") for orders and directions to be made under the Insolvency Act and Rules challenging proofs made in its liquidation by Mr Evan Bishop and his son Mr Paul Bishop.
2. Mrs Dyment is a state registered nurse with a separate qualification as a registered nurse for mental handicap. By the late 1980s she was employed by West Glamorgan County Council (WGCC) social services as a placement officer with the task of placing children with learning difficulties with new families on a long term basis and overseeing the resulting placements. In that capacity she met the Bishops who were at that time seeking local authority approval for a care home to be operated by them at Brynmill House Swansea.
3. The three of them decided to go into business together, the venture in question being to provide residential care to people with learning difficulties and associated behavioural problems. In broad outline the plan was that the Bishops would provide the capital for the venture and Mrs Dyment would then operate the business. Suitable premises were to hand in the form of a property known as The Mount, Mount Street, Gowerton, Swansea which Paul Bishop (by trade a building contractor) had purchased in 1986 and which enjoyed the necessary outline planning permissions.
4. Numerous difficulties had to be overcome before the venture could become operational. The detail of these does not matter. By March 1989 the difficulties had all been surmounted, the necessary improvements to The Mount had been completed and the first client took up residence at The Mount.
5. The legal structure of the operation was that the freehold of The Mount was treated as vested in the three co-venturers as partners in equal shares, but the actual business was to be operated through the vehicle of the company, the shares in which were issued as to 34 to Evan Bishop, 34 to Paul Bishop and 33 to Mrs Dyment. By March 1989 the partnership had incurred substantial liabilities to Midland Bank in connection with the refurbishment works, which were secured by charges over The Mount and over the houses of the co-venturers and their spouses. No formal arrangements for the company to pay rent existed, but in practice it paid into the partnership's overdrawn account monthly payments of £3,350.00 (i.e. £40,200 per annum) as from the time it first became fully operational.
6. Then disaster struck. In December 1989 Evan Bishop was charged with assault on one of the residents of Brynmill. In consequence, WGCC indicated that it proposed to take steps to cancel the company's registration under the Registered Homes Act 1984. There followed a period in which Mrs Dyment and Paul sought, through their solicitors James H Tonner, Johns & Co ("Tonners") a solution whereby Evan Bishop's interest in the venture (i.e. both in The Mount and in the company) would be bought out. Agreement could not, however, be reached on the price. Then it emerged that the WGCC was contemplating de-registration not only on the ground of the assault charge against Evan Bishop but also on the ground that each of the Bishops had failed to disclose in their original application for registration previous spent convictions. Thereafter Tonners acted solely for Mrs Dyment. The Bishops were represented by K. Lane, solicitors.
7. In April 1990 WGCC cancelled the registration. Mrs Dyment appealed. While the appeal was pending the business was able to continue. Over the next twelve months various proposals were made by Mrs Dyment to resolve matters on the basis of buying out the Bishops' interests but agreement on a price which Mrs Dyment could afford proved elusive. Throughout this period Midland Bank was increasingly concerned at the possibility that the going concern, following an unsuccessful appeal, would become a "gone" concern. All the parties appreciated that, unless an effective way could be found to separate the Bishops from the venture, permanent de-registration was inevitable.
8. The solution eventually arrived at was brokered through the good offices of the company's accountant Mr Harris, agreed in outline between the parties in July 1991, and ultimately enshrined in legal documentation executed by the parties in October and November 1991. The documentation consisted of (1) Heads of Agreement concluded between the Bishops and Mrs Dyment, (2) the lease mentioned below and (3) share transfers and registrations pursuant to the Heads of Agreement. Its effect was as follows: first Evan and Paul each gave up their interests in the company and transferred their shares to Mrs Dyment; secondly Mrs Dyment gave up her interest in The Mount to Evan and Paul; thirdly, Evan and Paul granted a 21 year lease of The Mount to the company at a rental of £66,000.00 per annum with 3 yearly upward only reviews; and, fourthly, Evan and Paul agreed to secure the unconditional release of Mr and Mrs Dyment's matrimonial home from the Midland Bank charge. This agreement was expressly conditional on WGCC approving these arrangements.
9. On the basis of this documentation the WGCC on 21^st November 1991 approved Mrs Dyment's application for registration, and her appeal against de-registration was allowed by the Registered Homes Tribunal on the following day. Shortly afterwards, however, it transpired that Evan and Paul were going to be unable to comply with their obligation to secure the release of the Dyment matrimonial home from the Midland Bank charge : Paul's wife was refusing to sign the documentation in relation to their matrimonial home. There followed discussions between Evan Bishop and Mrs Dyment, and some correspondence between Tonners and K. Lane, as a result of which Mrs Dyment came to believe, or at least subsequently adopted the position, that there had been an agreement that so long as the charge remained over her home the rent payable under the lease would continue to be payable only at the existing rate of £3,350.00 per month.
10. There is some obscurity as to when the lease was in fact finalised. It had been executed in escrow shortly after 25^th October 1991 but subsequently came to be dated 6^th August 1992. From the contemporary correspondence it appears that the reason for the delay was the reluctance of Mrs Dyment to put Tonners in sufficient funds to pay both the stamp duty and K. Lane's costs. Mrs Dyment however appears eventually to have repaired this omission under pressure from Tonners' threat that unless the lease could be finalised the Registered Homes Tribunal would need to be informed that the conditions for its approval of the registration had not been fulfilled.
11. However that may be, the company continued to pay rent only at the £3,350.00 per month rate. Eventually, on 17^th February 1995, the Bishops issued proceedings in the Swansea District Registry for recovery of the arrears of rent ("the Rent Action"). The company sought to defend the Rent Action on the footing that the full rent was not payable as a result of the agreement allegedly reached between Mrs Dyment and the Bishops and on the further basis that the lease had only ever been executed in escrow.
12. In the autumn of 1996, while the Rent Action was still pending, Mr and Mrs Dyment took steps with a view to winding up the company's business. They acquired another property to which, in December 1995, the residents of The Mount were transferred. A new company formed by them (Pathways (Trebanos) Ltd) effectively took over the company's business. On 8^th January 1996 a resolution to wind up the company was passed and a Statement of Affairs signed by Mrs Dyment. At this stage the company was only some four days away from the hearing of the Bishops' summary judgment application in the Rent Action. The Bishops secured an adjournment of the s.98 meeting to 17^th January 1996 to await the outcome of that application.
13. On 12^th January 1996 the Bishops obtained judgment ("the judgment") against the company in the Rent Action for £140,017.63, the court taking the view that, despite Mrs Dyment's evidence and the arguments presented on its behalf by its counsel, the company had no real prospect of successfully defending the action. No appeal was brought against the judgment.
14. At the adjourned creditors' meeting on 17^th January 1996, the Bishops, armed with that judgment, were by far the largest creditors: the other creditors at that stage totalled only some £20,775.82. They were thus able to secure the appointment of liquidators of their choice ("the liquidator").
15. Thereafter Pathway (Trebanos) Ltd accounted to the liquidator for all the book debts of the company which it collected on its behalf and, after some negotiation, agreed to pay the liquidator £100,000 for the goodwill of the business which it had acquired.
16. The Bishops submitted a proof in the liquidation on 4^th March 1996 for the £140,017.63 ("the First Proof") which was accepted by the liquidator. In due course, in October 1999, they received an interim dividend of £52,506.61 in respect of this.
17. The Bishops sold The Mount with vacant possession on 5^th January 1998 for £140,000. This had the effect, at last, of releasing Mrs Dyment's home from the charge, and also of finally determining the lease. On 3^rd April 2000 the Bishops submitted a further Proof in the liquidation ("the Second Proof") of £197,728 plus interest in respect of the rent due under the lease from the commencement of the liquidation to the date of the sale of The Mount. The Second Proof has subsequently been revised.
18. In January 2001 the liquidator commenced misfeasance proceedings against Mrs Dyment and her husband. The latter died in October 2001, and on 7^th December 2001 the misfeasance proceedings were compromised on the basis that Mrs Dyment would pay the liquidator sufficient sums to pay and discharge all the debts of the company together with statutory interest from the commencement of the winding up and all the costs of the liquidation and that she would commence the present proceedings.

The Issues

19. In these proceedings Mrs Dyment seeks to take a point under Section 151 of the Companies Act 1985 which it is claimed would, if taken, have provided a complete defence to the Rent Action. If it is a good point the consequence is said to be that the Liquidator's decision in relation to the First Proof should either be reversed (on Mrs Dyment's application under Rule 4.83(2) of the Insolvency Rules 1986) or that it should be expunged (on her application under Rule 4.85), and that the court, in exercise of its jurisdiction under Section 112 of the 1985 Act should direct the liquidator to reject the Second Proof.
20. The issues that arise on the Statements of Case in this matter are as follows:-

(1) Does Mrs Dyment have the necessary locus standi as a creditor to bring the present proceedings under Insolvency Rule 4.85(1)(b) and 4.83(2) and section 112 of the Insolvency Act 1986?

(2) Was the rent payable under the lease in excess of market rates ? The answer to this question has now been agreed between the parties. It is agreed that the initial market rental under the lease was £37,000 per annum, i.e. £29,000 p.a. less than that agreed to be paid.

(3) Did the Heads of Agreement and the lease contravene section 151 of the Companies Act 1985?

(4) What is the consequence of any breach of section 151 of the Companies Act 1985: is the consequence that the lease is void and unenforceable such that no rent was or is ever properly payable thereunder?

(5) Was and is the liquidator bound by the judgment (a) to admit the First Proof based upon the judgment (b) to admit the Second Proof (as revised) for further arrears of rent?

(6) Should the First Proof now be expunged and/or the liquidator's decision to admit the First Proof be reversed?

(7) If so, should the interim dividend in respect of the First Proof now be repaid?

(8) Should the Second Proof (as revised) now be rejected?

(9) If no rent was ever properly payable under the lease and the interim dividend paid in respect of the First Proof is recoverable by the Liquidator, are the Bishops entitled to prove in the liquidation for mesne profits for use and occupation or damages for trespass at the rate of an open market commercial rent?

21. Resolution of some of these issues depends to a certain degree on the exercise by the court of a discretion. Thus, for the application under Rule 4.83(2) to be made at all the court must first conclude that it would be right to extend (by a very considerable period) the 21 day period there laid down for its making. The jurisdiction to expunge a proof under Rule 4.85(1) is a discretionary one. An element of discretion also exists in the court's jurisdiction under Section 112. Since the merits of the underlying basis of the application (i.e. the section 151 point) may be relevant to the exercise of these discretions it is convenient to start by examining that point.

Section 151 of the Companies Act 1985

22. Sections 151 – 153 of the Companies Act 1985 provide (so far as presently material) that:

"151 Financial assistance generally prohibited

(1) Subject to the following provisions of this Chapter, where a person is acquiring or is proposing to acquire shares in a company, it is not lawful for the company or any of its subsidiaries to give financial assistance directly or indirectly for the purpose of that acquisition before or at the same time as the acquisition takes place.

(2) Subject to those provisions, where a person has acquired shares in a company and any liability has been incurred (by that or any other person), for the purpose of that acquisition, it is not lawful for the company or any of its subsidiaries to give financial assistance directly or indirectly for the purpose of reducing or discharging the liability so incurred.

(3) If a company acts in contravention of this section, it is liable to a fine, and every officer of it who is in default is liable to imprisonment or a fine, or both.

152 Definitions for this Chapter

(1) In this Chapter–

(a) 'financial assistance' means–

(i) financial assistance by way of gift,

(ii) financial assistance given by way of guarantee, security or indemnity, other than an indemnity in respect of the indemnifier's own neglect or default, or by way of release or waiver,

(iii) financial assistance given by way of a loan or any other agreement under which any of the obligations of the person giving the assistance are to be fulfilled at a time when in accordance with the agreement any obligation of another party to the agreement remains unfulfilled, or by way of the novation of, or the assignment of rights arising under, a loan or such other agreement, or

(iv) any other financial assistance given by a company the net assets of which are thereby reduced to a material extent or which has no net assets;

………………………………………..

(2) In subsection (1)(a)(iv), 'net assets' means the aggregate of the company's assets, less the aggregate of its liabilities ('liabilities' to include any provision for liabilities or charges within paragraph 89 of Schedule 4).

(3) In this Chapter–

(a) a reference to a person incurring a liability includes his changing his financial position by making an agreement or arrangement (whether enforceable or unenforceable, and whether made on his own account or with any other person) or by any other means, and

(b) a reference to a company giving financial assistance for the purpose of reducing or discharging a liability incurred by a person for the purpose of the acquisition of shares includes its giving such assistance for the purpose of wholly or partly restoring his financial position to what it was before the acquisition took place.

153 Transactions not prohibited by s 151

(1) Section 151(1) does not prohibit a company from giving financial assistance for the purpose of an acquisition of shares in it or its holding company if–

(a) the company's principal purpose in giving that assistance is not to give it for the purpose of any such acquisition, or the giving of the assistance for that purpose is but an incidental part of some larger purpose of the company, and

(b) the assistance is given in good faith in the interests of the company.

(2) . . ."

23. As noted above, it is common ground that the initial rent under the lease (£66,000.00 per annum) was £29,000.00 in excess of the market rental. It was also accepted by Mr Bamford on behalf of the Bishops that the consequence of this was to reduce the net assets of the company to a material extent. On that basis it was possible for Mr Hantusch on behalf of Mrs Dyment to assert that the company had given "financial assistance": see the definition in section 152(1)(a)(iv). He submitted further that, since it had been given in relation to a transaction which involved the acquisition by Mrs Dyment of the Bishops' shares in the company, it could and should be seen as having been given "directly or indirectly for the purposes of that acquisition".
24. His primary case was that this was a case which fell under section 151(1) on the footing that the company's liability for rent under the lease had been incurred at the same time as, or prior, to the acquisition of the shares. A difficulty about that way of putting the matter results from the contents and chronology of the legal documentation to which I have referred in paragraph 8 above. The Heads of Agreement appear to have been signed by the parties on or about 25^th October 1991. The only parties to the Heads of Agreement were the Bishops and Mrs Dyment. As already indicated, by the terms of that document the Bishops (by Clauses 1 and 2) agreed to give up their interests in the business carried on at The Mount "under the style or title of Pathways Residential and Training Centres Limited", Mrs Dyment (by Clause 3) agreed to give up her share and interest in The Mount, and the Bishops (by Clause 4) agreed to grant the lease. Clauses 5 and 6 dealt with future responsibilities in relation to the liabilities in relation to, respectively, the company and The Mount. Clause 7 provided:

"Mrs Dyment Mr Evan and Mr Paul acknowledge that the said agreement is conditional upon approval and acceptance by West Glamorgan County Council and that such agreement is null and void if such approval is not granted PROVIDED THAT Mrs Dyment shall have used her best endeavours to appeal against any refusal of approval."

25. Clauses 8 and 9 provided for each of the Bishops "forthwith" to sign a form of resignation as a director and an irrevocable stock transfer form in respect of his shares in the company. This was duly done at a directors' meeting on 5^th November 1991 attended by Mr Harris who produced the relevant documentation at the meeting and whose minute records the proceedings.
26. Three points should be noted. First the resignations and share transfers which were executed at that meeting were not treated by those present, either then or subsequently, as being subject to any sort of condition. They were to have immediate effect. That probably accorded with the Heads of Agreement, although it is not absolutely clear how widely the words "the said agreement" in Clause 7 are to be read. Secondly, there is no reference in the minutes of the meeting of 5^th November to the company having been granted, or having agreed to take, the lease. The Bishops had executed the lease and delivered it in escrow to Tonners under cover of K. Lane's letter of 24^th October. It seems unlikely, however, that the company itself had by this stage done anything to bind itself, conditionally or otherwise to take the lease. The counterpart lease was, it seems, executed by the company some time after this meeting and before 19^th November 1991: Tonners' letter to Mrs Dyment of that date refers to the counterpart and their letter of 26^th November refers to it as having been executed by Mr and Mrs Dyment. Mr Dyment only became company secretary at some point after 5^th November 1991. Thirdly, the share transfers stated the consideration in each case to be the par value of the shares. This reflected Mr Harris' advice that the company was insolvent on a balance sheet basis.
27. The conclusion must be that as at the date of Mrs Dyment's acquisition of the Bishops' shares the company had not become liable, conditionally or otherwise, under the lease and was not bound by any legal obligation to enter into it. It follows, in my judgment, that Mrs Dyment's case under section 151(1) must fail.
28. Mr Hantusch put his case alternatively under section 151(2). The argument here was that it was an implied term of the Heads of Agreement that Mrs Dyment should procure the company to enter into the lease, that that liability had been incurred for the purpose of Mrs Dyment's acquisition of the shares, and that the company, by subsequently entering into the lease, had discharged her liability.
29. In my judgment had Mrs Dyment not caused the company to enter into the lease she would have been in breach of the obligation undertaken by her in clause 7 of the Heads of Agreement, to use her best endeavours to obtain the WGCC approval. Entry into some 21 year lease was necessary to obtain that approval, and the only one which she could insist be granted was that referred to in the Heads of Agreement. It follows, in my judgment, that if it can be shown that she undertook that obligation for the purposes of acquiring the shares, the claim that there was an infringement of section 151(2) is in principle a good one.
30. I have not, however, been persuaded that as a matter of commercial reality it can properly be said that the obligation to procure the company's acceptance of the lease was undertaken for that purpose. So to describe the situation seems to me to be contradicted both by the history of the parties' negotiations, by the form which the legal documentation took and by their accounts of their subjective intentions.
31. The history of the negotiations which led to the solution finally adopted begins with a meeting between the parties at the offices of Mr Harris on 6^th May 1991. The position arrived at in this respect at that meeting was recorded as follows:

"The only possible alternative to a capital buy-out was then discussed at length, this being a two part exercise. Firstly, Messrs E. and P. Bishop accepted that there could not be a future for them in [the company] either as shareholders or directors Secondly, both could remain as owners, albeit in part of the Mount. It was, therefore, conceivable to consider a formal lease document being drawn up between Bishop, Bishop and Dyment, t/a Mount Properties, Landlord, to [the company], Mrs Dyment (and/or her nominees) being directors and shareholders."

32. Mr Harris followed up that suggestion in correspondence with Evan Bishop in which he suggested that the way forward was to instruct a Valuer to advise on the appropriate rental. Evan Bishop was not interested in that suggestion. He eventually replied, by a letter dated 11^th June 1991, that the "rental would have to show not only the valuation of the property but to consider the loss of earnings that would have been enjoyed." Evan Bishop subsequently calculated that the sum for which he would be prepared to settle as the initial rent under the lease was £5,500 per month. This was calculated partly by reference to his desire to be receiving sufficient to pay down the bank borrowings and partly to give him an element of profit from the venture into which he saw himself as having invested so much time and money, and which was still potentially profitable. He was concerned to see what he could squeeze out of Mrs Dyment/the company as the price of her being able to continue alone. His proposal was in due course presented to her on a take it or leave it basis, Evan Bishop stating at some point in the discussions to Mrs Dyment that "If I am going to go down I am going to take you with me".
33. Mrs Dyment perceived herself as having no commercial alternative but to agree to Evan Bishop's hard-nosed proposal: both she and her husband had given up their salaried jobs in order to operate the company, they had charged their matrimonial home, and the company had no possibility of obtaining any alternative premises from which to trade. The bank was pressing, and WGCC was insisting that the Bishops be separated from the premises by a lease of at least 21 years. Her purpose therefore in agreeing to the company taking this onerous lease was to obtain the premises for the company. In cross-examination she readily accepted that entry into the lease at the rental of £5,500 per month was for this purpose and was not linked to her acquisition of the shares. She also accepted that she had not known at the time whether or not the proposed rental exceeded the market rental.
34. The fact that Evan Bishop's letter of 11^th June 1991 had referred to the rent as being compensation for loss of earnings he would otherwise have enjoyed was, naturally, relied on by Mr Hantusch as showing a link between the amount of the rent and the fact that the Bishops were giving up their shares. However, in my judgment this overlooks the fact that the Bishops giving up of their shares was a premise of the negotiation and not one of the elements over which there was, or could be, any negotiation. This was simply the effect of the requirements of the WGCC if the company was to continue to operate the business. To put the point in a different way, if the Bishops had at the outset transferred their shares at par, their ability to drive the hard bargain which they eventually did over the lease would not have been one whit impaired. It was their ownership of a 2/3 interest in the Mount, the company's need to take a 21-year lease if it was to continue in business, and the Dyments' desire to keep that business going which gave the Bishops the negotiating position which they exploited. Accordingly I have come to the conclusion that, while the company's entering into the lease can be said to have been "in connection with" (in the words of the old section 54) the acquisition of the shares, it cannot fairly be said to have been "for the purpose" of that acquisition. It entered into the lease in order to obtain the premises, and agreed to pay what is now known to be an excessive rent because the owners of the freehold were in a position to exact that ransom.
35. In the course of his submissions Mr Hantusch took me to three recent decisions of the Court of Appeal: Macpherson and another v. European Strategic Bureau Ltd [2000] BCLC 683, Chaston v. SWP Group plc [2002] EWCA Civ 1999, [2003] 1 BCLC 676, and MT Realisations Ltd (in Liquidation) v Digital Equipment Co [2003] EWCA Civ 494, [2003] 2 BCLC 117. Apart from the emphasis given in the last two cases to the importance of applying a test of commercial substance and reality in the application of section 151, and apart from noting that the mere fact that the shares transferred may themselves have had no value cannot be decisive of the question whether financial assistance has been given for the purposes of the share acquisition (see the observations of Chadwick LJ at paragraph 54 of Macpherson and of Arden LJ in Chaston at paragraph 41, differing from the approach of Laddie J at first instance in MT Realisations) I do not think that anything in those cases, which involved very different facts, is inconsistent with the analysis which I have adopted.
36. Having reached that conclusion it is unnecessary for me to decide any of the other issues.