Scottish Court of Session Decisions

OUTER HOUSE, COURT OF SESSION [2012] CSOH 191
P1796/08	OPINION OF LORD HODGE in the Liquidation of QUANTUM DISTRIBUTION (UK) LIMITED ________________

For the Former Liquidator: Sellar QC; DLA Piper Scotland LLP:

For Brodies LLP: D Thomson; Brodies LLP

18 December 2012

[1] I have prepared this opinion in the hope that its publication will discourage a repetition of the unacceptable events which occurred in the winding up of Quantum Distribution (UK) Ltd ("Quantum"). I am sending copies of this opinion to the Insolvency Practitioners' Association and the Law Society of Scotland to promote that result.

[2] The court only learned of the events after the Auditor of the Court of Session raised with me the concerns which he and the court reporter had about the way in which the liquidator had bypassed the court to obtain his remuneration for this winding up in the face of a very critical report from the court reporter. I had the case put out by order and counsel were asked to respond to questions which I raised. Their response and the documents which they provided gave rise to additional questions and I had a further by order hearing at which counsel addressed me on those questions.

[3] Counsel accepted that mistakes had been made and apologised on behalf of their clients. Both stated that lessons had been learned from their examination of the events in response to the court's challenge.

(i) The winding up

[4] On 18 December 2007 Irvine Estates Limited (IEL), which was the landlord of warehouse premises in Irvine that Quantum rented, presented a petition to wind up Quantum. On 16 January 2008 Lord Glennie pronounced the winding up order and appointed Kenneth W Pattullo of Begbies Traynor ("Mr Pattullo") as interim liquidator.

[5] On 15 February 2008 the court extended the time in which the interim liquidator could summon and hold a meeting of creditors. Thereafter, at the first meeting of creditors on 25 April 2008 Mr Pattullo was appointed liquidator of Quantum. A liquidation committee was established but it was disbanded on 1 May 2008 because a potential conflict of interest had been identified within the membership of the committee.

[6] Quantum was the subsidiary of Certance International ("CI"), a company registered in the Cayman Islands, and its ultimate parent corporation was Quantum Corporation ("QC") of San Jose, California. Mr Pattullo ascertained that Quantum had claims against both CI and QC. The first claim, which Mr Sellar described as unanswerable in law, related to the payment of an unlawful dividend to CI. The second, which was against both CI and QC, was based on a statement in the auditor's report dated 23 January 2007 in Quantum's audited accounts for the year to 31 March 2006. The auditors stated:

"The accounts have been prepared under the going concern concept because the parent company has agreed to provide adequate funds for the company to meet its liabilities as they fall due over the next twelve months from the date of the Auditors Report."

In addition QC had given an undertaking that it would satisfy the liabilities of CI. Thus there was the potential for a claim against QC. The third potential claim, which was against QC, related to a VAT repayment of £780,000 that had been made to Quantum's bank account after the winding up petition had been presented and then transferred to QC.

[7] Mr Sellar, who appeared on behalf of Mr Pattullo, explained that each claim faced practical difficulties. The first claim faced the difficulties that CI had been dissolved and its directors resided in the United States of America. It was perceived that litigation there would entail cost, delay and risk. The second claim was likely to be met with a claim for set off arising from an intra-group trading debt of £1,346,326.45 and faced the same problems of litigating in the United States. The third claim faced a defence that Quantum had been acting as the agent of QC in receipt of the funds and also the problems of set off and litigating in the United States. The claims therefore involved considerable risk.

[8] IEL, the petitioning creditor, was irritated by Quantum's insolvency because Quantum had paid the debts of some trade creditors but made no provision for its obligations under its lease from IEL. It was determined to obtain some money in the liquidation but Mr Pattullo had serious concerns about the viability of pursuing the claims. He sought advice from Brodies LLP ("Brodies") on the prospects of a claim against QC. Mr Thomson, who appeared for Brodies, informed me that it advised that it was "not likely that the claim would be available". Mr Pattullo and representatives of IEL negotiated with QC, which had initially suggested that it might make an ex gratia payment of £150,000 to the liquidation of Quantum. Neither Mr Sellar nor Mr Thomson was able to identify the legal basis on which IEL had a claim against QC, separate from that which the liquidator of Quantum had on behalf of all the company's creditors, that would entitle IEL to obtain funds and not make them available to the general body of creditors. Nonetheless, in the course of the negotiations IEL sought to obtain the whole sum which QC was prepared to pay, and Brodies did not advise either IEL or Mr Pattullo that that claim was illegitimate. QC reduced its offer to £100,000 on the stated ground that it had incurred legal expenses in the interim. The ultimate agreement was that QC would pay £50,000 directly to IEL and £50,000 to Mr Pattullo for the winding up of Quantum and that it would not pursue its claims in the liquidation.

[9] Mr Sellar sought to explain but not justify the arrangement. He stated that the liquidator was in a difficult position as the petitioning creditor was determined to receive money but the claims were risky. The deal provided £50,000 to the winding up. That sum would not otherwise have been obtained. IEL's claim amounted to 83% of the value of the creditors' claims and thus the bulk of further recoveries would have gone to it. Mr Sellar suggested that Mr Pattullo was attempting to do his best in difficult circumstances. He acknowledged that the liquidator had no power to compromise the claims without coming back to the court for authorisation. But he stated that Mr Pattullo had not been advised of the need for court approval of the compromise under section 167 of and Part I of Schedule 4 to the Insolvency Act 1986.

[10] It was not disputed that Brodies advised Mr Pattullo on the prospects of a case against QC in relation to the third of the liquidator's claims and it drafted the settlement agreements and discharges in favour of QC by the liquidator and IEL after a deal had been struck. Brodies did not take part in the negotiations and did not see itself as providing advice on the terms of the settlement. Mr Thomson explained that Brodies did not advise on the negotiation and terms of the settlements which the liquidator and IEL agreed with QC and probably said no more than that if was good that QC was paying something. But Mr Sellar informed me that Mr Pattullo had understood that Brodies was advising him in the context of the negotiations and that Brodies would alert him to relevant legal issues in what he proposed to do.

[11] It appears that Mr Pattullo thought that he was entitled to more advice than Brodies thought it was instructed to give. But it is noteworthy that Brodies did not ask any questions when it knew that the settlements involved the discharge of claims by both the liquidator and QC and the payment of money to both IEL and the liquidator. Brodies must also have known that the settlement which Mr Pattullo signed on 30 September 2008 involved the discharge of claims in his capacity as liquidator. But it did not advise him of the need to gain the approval of the court to that compromise. As I have said, I was given no explanation why the petitioning creditor, for whom Brodies acted, had a claim against QC that was separate from Quantum's claim.

(ii) The role of Brodies LLP in relation to the petitioning creditor's claim

[12] It is not unusual for a firm of solicitors to act for both the petitioning creditor and also the insolvency practitioner in a winding up or administration of a company. But where solicitors choose to do so they must be sedulous in guarding against conflicts of interest. In this case Brodies in my view failed to avoid a conflict of interest when it failed to spell out clearly to Mr Pattullo its inability to advise him and when it appeared to act as an adviser to both IEL and Mr Pattullo in relation to IEL's claim in the liquidation.

[13] Mr Bookless, the solicitor in Brodies who was dealing with the winding up, was aware of a potential for conflict as he declined Mr Pattullo's request that a lawyer from Brodies attend the meeting of creditors on 25 April 2008 to assist the liquidator on the admissibility and quantification of creditors' claims. He had initially been willing that a representative of Brodies attend the meeting on behalf of either the liquidator or IEL. But when Mr Pattullo suggested that Brodies could act at that meeting on behalf of both IEL and him as liquidator, Mr Bookless quite properly declined, stating in an email dated 24 April 2008,

"I must be honest and say that I am not comfortable with someone from our offices attending on behalf of both given the clear conflict of interest argument."

Unfortunately, Brodies appreciated the potential for conflict of interest that its position involved only intermittently and incompletely and that contributed to the misunderstanding between it and Mr Pattullo that has occurred as to the scope of its remit.

[14] IEL, on Brodies' advice, submitted a claim for £1,490,120.80 in the liquidation. Mr Pattullo adjudicated on the claim and accepted it. The claim was for damages for breach of the contract of lease and included future rental payments (£720,000) and future rates liability (£420,000) until the expiry of the lease in November 2012. As the claim was one for damages, questions of mitigation of loss were likely to arise. One such issue was the liability for rates, which required someone to consider whether the landlord would be able to obtain rates relief for unoccupied buildings. While it appears that IEL might not have qualified for that relief in early 2008 when Quantum still retained the keys to the warehouse, it would not have been difficult for IEL to obtain control of the warehouse and submit a claim to the rating authority for such relief.

[15] Mr Bookless was aware that there was an entitlement to claim rates relief and mentioned it in an email to Mr Pattullo dated 21 February 2008. But he thought that the premises did not then qualify for that relief as the tenant still held the keys. Mr Thomson submitted that there was therefore a proper basis on which Brodies submitted IEL's claim in April 2008. After the court reporter had raised concerns over the adjudication of IEL's claim, Mr Pattullo's staff asked Brodies for advice in August 2009 and again in January 2010. Brodies confirmed that the relief was available and asserted that it was not aware of IEL's position in relation to the relief when it submitted IEL's claim in 2008. Mr Pattullo asked Brodies if he should have accepted IEL's claim fully in his adjudication but Brodies did not answer his enquiry.

[16] Whether or not Mr Pattullo asked Brodies for advice on the rates element of IEL's damages claim before he adjudicated on that claim in November 2008, I am satisfied that Brodies placed itself in a position where there was a potential conflict of interest by submitting a substantial damages claim on behalf of IEL while it remained the legal adviser of the liquidator.

[17] It is clear that by 19 January 2010 employees of Brodies had become aware of the potential conflict. On that date Mr Bookless and Mr Nisbet of Brodies discussed a request by Mr Thomas Mackay, who was Mr Pattullo's insolvency administrator in the liquidation, to demand repayment from IEL of an overpayment of its dividend because it had received rates relief. They agreed that Brodies could not make that request because of a conflict of interest. Mr Bookless telephoned Mr Mackay and told him that Brodies could not act because of an "obvious conflict" of interest.

[18] A potential conflict of interest arose when IEL sought to re-let the premises which Quantum had leased. As IEL's claim for damages included loss of future rental income, its signing up of a new tenant in late 2008 would have materially reduced its claim in Quantum's winding up. But Brodies did not inform Mr Pattullo of IEL's intention to do so. It seems that Brodies took the view that Mr Pattullo as an experienced insolvency practitioner would know to get legal advice from another firm on matters relating to IEL's claim. Beyond Mr Bookless' refusal to act for both IEL and the liquidator at the creditors' meeting in April 2008 and his refusal to demand repayment from IEL in January 2010, Brodies never advised Mr Pattullo of its inability to advise him.

(ii) A further conflict of interest

[19] A further conflict of interest emerged when IEL sought to obtain the whole of a sum which QC offered to the creditors of Quantum. In late July 2008 QC offered to pay £100,000 into the liquidation. IEL wished to receive that sum itself. On 28 July 2008 Mr Bookless of Brodies emailed Mr Thomas McKay to state that IEL wanted the funds to go to it rather than into the pot and that Mr Martin Rawstron, who was instructing Brodies on behalf of IEL, had instructions to accept QC's offer only on the basis that IEL received the full £100,000. Nobody appears to have recognised that there was a clear conflict between IEL's interest and that of Quantum's other creditors. Nobody considered what was the legal basis of IEL's claim against QC. The fact that IEL was the largest creditor and that its claim was 83% in value of the creditors' claims does not remove that conflict.

[20] Brodies, in response to my challenge, obtained a memorandum from Mr Bruce Ritchie of the Law Society of Scotland on whether it had complied with the then current Solicitors (Scotland) Practice Rules. He gave an opinion that there had been no actual conflict in relation to the presentation of IEL's claim in the winding up and only a potential conflict in relation to the reduction of that claim through IEL's entitlement to rates relief. He also expressed the view that there was no actual conflict of interest in relation to the settlement agreement with QC in which QC's ex gratia payment was shared equally between Mr Pattullo and IEL, because (a) both clients were aware of the facts and (b) Brodies' role was confined to preparing the documents to vouch the settlement agreement.

[21] It is not for me to comment on whether Brodies complied with the relevant Practice Rules. But I am satisfied that, by acting for the petitioning creditor in submitting its claim for damages and by facilitating the settlement agreement without advising Mr Pattullo that he should obtain separate legal advice, Brodies found itself in a position of conflict of interest and failed to act to remove that conflict.

(iii) The audit of the accounts and the reporter's concerns

[22] In November 2008 Mr Pattullo applied to the court for the appointment of a reporter to examine and audit the account of his intromissions as liquidator from 16 January 2008 until the end of the liquidation and for the fixing of his remuneration. By order dated 6 November I appointed Mr Gerard Crampsey of Stirling Toner & Co, CA, as the court reporter. In accordance with established practice I remitted to the Auditor of Court to report his opinion on suitable remuneration and appointed the reporter and the Auditor of Court to confer before issuing their respective reports.

[23] Mr Pattullo's accounts showed realisations of £101,005 which comprised principally cash in the company's bank account (£46,712.34) and QC's payment of £50,038. Mr Crampsey raised various concerns with Mr Pattullo. In his report to the court Mr Crampsey suggested that the petitioning creditor had been allowed to exert undue influence over the liquidation, especially in the negotiation of the compromise with QC, and that it was never intended to disclose QC's payment of £50,000 to IEL to the other creditors. He criticised the liquidator for brokering the deal and charging the time for so doing to the general creditors. He criticised Mr Pattullo's adjudication of IEL's claim for failing to allow for the payment from QC and for accepting the whole of the claim of £420,000 for future rates liability. He also suggested that Brodies appeared to have a clear conflict of interest in its position as adviser of IEL in respect of this claim and as Mr Pattullo's adviser. He criticised Mr Pattullo for not pursuing QC in relation to the parent company undertaking to which I referred in paragraph [5] above and both QC and CI's directors for the unlawful dividend which Quantum had paid. He suggested that the agreement with QC which was not disclosed to the general creditors was not an appropriate agreement for the liquidator to have entered into.

[24] Mr Crampsey explained in his report that because of his concerns about what he had discovered in his audit, he was not able to express an opinion on what was suitable remuneration for the liquidator but that Mr Pattullo was seeking £38,500 as his remuneration. The Auditor of Court, with whom Mr Crampsey conferred, produced a most unusual report dated 23 December 2010, which concluded thus:

"In the light of the concerns identified by the Reporter, the Auditor is respectfully unable to report what, in his opinion, would be suitable remuneration for the Liquidator for the period from 16 January to the close of the Liquidation."

[25] The Auditor arranged for his report to be lodged in court and sent to Brodies in accordance with normal practice on 24 December 2010. By doing so, the Auditor did not bring his report to the court's attention. Again, this is normal practice. It was the task of the liquidator's agents to do so by applying to the court either for approval of the court reporter's report and the Auditor's report or to mount a challenge to those reports. This did not happen. Mr Crampsey did not send a copy of his report to Mr Pattullo. I was told that the normal practice was for reporters to send copies of their reports to the insolvency practitioner. But Mr Crampsey's omission in this case is no excuse for the liquidator. Mr Pattullo would have been aware of the likely content of the report from his prior correspondence with Mr Crampsey.

(iv) The bypassing of the Court

[26] As the Auditor's report was issued in the festive period it was not until 30 December 2010 that Brodies sent a copy of it to Mr Pattullo. Mr Bookless was on holiday. In his absence Lisa Kelly, a senior solicitor, emailed Mr Pattullo and copied to Mr Bookless the following message:

"Please find attached a copy of the Auditor's Report dated 23 December 2010. You'll note that the Auditor was unable to report what would be suitable remuneration of the Liquidator for the period 16 Jan 2008 to the end of the liquidation.

Jamie [Bookless] is back in the office on 5 January and I'm sure will pick this up with you then."

Mr Pattullo replied on the same day and copied his message to Mr Bookless. He stated:

"I am not back till the 6^th or 7^th & can discuss things with Jamie then. However my initial thoughts are that, if the auditor will not set a fee for us, we probably will have no option other than to convene another creditors meeting solely for the purpose of electing a liquidation committee."

[27] On 5 January 2011 Mr Bookless emailed Mr Pattullo and asked him to let him know when he returned to work so that they could "pick up things then." On 10 January emails passed between Mr Pattullo and Mr Bookless as they attempted in vain to find a time to speak together. There is no evidence of any further communication until 1 February 2011 when Mr Bookless sent Mr Pattullo this email message:

"I'm assuming as I didn't hear back from you that you are going down the liquidation committee route. We have some WIP on file which I am happy to get written off. However, we have now received the Auditor's fee which stands at £1,443.75. Will you be able to arrange to put us in funds in respect of this?"

[28] It is not disputed that Mr Pattullo and Mr Bookless both saw the Auditor's very unusual report, which referred to Mr Crampsey's concerns. Neither sought to investigate what Mr Crampsey had said in his report, although both would have been aware that it would be critical of Mr Pattullo's conduct of the winding up. As I have said, Mr Pattullo must have known the details of those concerns from his prior correspondence. They ignored the existence of the report. Indeed, I was informed that neither saw Mr Cramspey's report until August 2012 after I raised my concerns in July 2012. I find that very surprising. Instead, Mr Pattullo sought to obtain his remuneration by other means. Had it not been for the oversight to pay Mr Crampsey his reporter's fee, the court might never have known of the irregularities in the winding up and the improper bypassing of its procedures.

[29] Subsequent correspondence between Brodies and Mr Pattullo in February 2011 related to the payment of the Auditor's fees. Mr Pattullo, mistakenly thinking that the claim was for Mr Crampsey's fee, expressed frustration (in an email dated 18 February 2011) at the court reporter's "constant queries which have caused a massive increase in the amount of our time costs to the extent that there is now no possibility of a dividend to creditors & in fact there will now be a considerable shortfall on our own costs." Mr Bookless replied, expressing his understanding of Mr Pattullo's annoyance.

(v) The authorisation by creditors of the liquidator's fees

[30] Mr Pattullo convened a meeting of creditors on 26 July 2011. The creditors appointed three creditors to be a liquidation committee. Those creditors were Campbell Dallas, British Telecommunications plc and G4S Secure Solutions Ltd, whose claims were for £9,846, £1,069 and £24,803 respectively.

[31] On 29 August 2011 Mr Pattullo wrote to the members of the liquidation committee enclosing a presentation of his intromissions between the start of the liquidation and 8 August 2011, a SIP 9 report on his time costs, and notes of guidance for members of liquidation committees. In his letter he explained that QC were creditors of Quantum in the sum of $2 million but that QC had agreed to waive that sum and make a contribution of £50,000 to the costs and expenses of the liquidation as a goodwill gesture. While he referred to meetings and conference calls and an ex gratia settlement, Mr Pattullo did not tell creditors about Quantum's claims against CI and QC, which he had compromised, or of the £50,000 that QC had paid directly to IEL as part of the deal to which he was a party.

[32] Mr Pattullo explained in his letter that his time costs to 8 August 2011 amounted to £78,695 but that only £67,113.27 remained as available funds. He asked the members of the liquidation committee to approve his fees in the former sum but restricted to the latter amount and sent them a docket to sign which gave that approval. Two members of the liquidation committee thereafter returned signed dockets giving the needed approval.

[33] Mr Pattullo paid an interim dividend of £49,034.41 (3p in the pound) to creditors on 21 November 2008. He thereafter worked to obtain the payment of a surplus of £44,254.46 from Quantum's pension fund and that involved costs in relation to, among other things, the appointment of an independent pension trustee. I was also informed that fees of about £12,000 were attributed to responding to Mr Crampsey's enquiries. Nonetheless there is a contrast between the £45,763.25, which were the total time costs to 1 December 2008 which Mr Mackay intimated to Mr Crampsey and which covered the bulk of the work in the winding up, and the £78,695, which he presented to the liquidation committee in 2011. It is not clear to me that the creditors should have paid the whole of the costs of his responding to Mr Crampsey's enquiries when they included some matters which the liquidator could not justify.

Discussion

[34] In this opinion I am critical of both Mr Pattullo and Brodies. In fairness to both I record that there is no evidence that in the end the general body of creditors suffered a significant loss as a result of their failings as Mr Pattullo sought to recover overpayments in the dividend to IEL. Nonetheless, the events show an unacceptable attitude by the liquidator and by Brodies both in relation to their obligations to the court and to their professional responsibilities.

(i) Their obligations to the court

[35] I am concerned by the failure of Mr Pattullo and his staff and also the employees of Brodies to bring the concerns of the court reporter to the attention of the court. Both Mr Pattullo as liquidator and the staff in Brodies were acting as officers of the court in the winding up.

[36] I accept the submission by counsel that Mr Pattullo and his staff and Brodies did not set out to conceal information from the court. I accept also that Mr Pattullo did not tell Brodies details of the concerns that Mr Crampsey had expressed. Nonetheless, it is a matter of serious concern that neither Mr Pattullo and his staff nor the lawyers in Brodies were alerted by the most unusual report by the Auditor to question what had caused his inability to recommend a fee. It is clear from the email exchanges that Brodies knew at least that there had been problems in obtaining Mr Crampsey's approval of the liquidator's accounts. In my opinion it was not acceptable behaviour for Mr Pattullo or Brodies to seek to bypass the court by turning to the creditors to obtain approval of the liquidator's accounts and remuneration. It was also not acceptable for Mr Pattullo to fail to disclose to those creditors the circumstances of the settlement of the claims against QC.

[37] Accepting as I do that there was no bad faith, I am nonetheless very concerned that the response by Mr Pattullo and by Brodies to the Auditor's report shows a striking disregard of their obligations to the court. It appears that nobody applied his mind to why the Auditor said what he did or showed any curiosity as to what the court reporter had said in his report. The concern, as the emails show, was simply how to get the liquidator his remuneration.

[38] It appears from Mr Sellar's submissions that the liquidator had satisfactory answers to several of Mr Crampsey's criticisms, which did not take account of the difficulties of pursing the claims against CI's directors and QC. But Mr Crampsey was correct to call into question both the deal which was reached with QC and Mr Pattullo's failure to disclose the full terms of the settlement to the creditors which eventually approved his accounts and remuneration. He was also justified in raising the problem of Brodies' actual or potential conflicts of interest.

[39] It was the duty of both Mr Pattullo and Brodies to bring to the attention of the court the concerns which the reporter had raised so that it could debate whether and to what extent those concerns were valid and what the consequences should be.

(ii) Conflicts of interest

[40] I also consider that solicitors who act in an insolvency for both the petitioning creditor and the insolvency practitioner need to be much more alert to the dangers of conflict of interest than Brodies was in this case. It may be acceptable for a firm of solicitors so to act when the petitioning creditor's claim is straightforward and not open to dispute. But where the claim is complex and is open to question, the potential for conflict of interest should bar the solicitor from so acting. In my opinion claims for damages for breach of contract often are of that nature, particularly where, as here, they entail a claim for loss in future years. Such claims generally have the potential to be contested.

[41] In this case Mr Pattullo thinks that Brodies gave him advice on matters in which it faced a conflict of interest and Brodies considers that its correspondence did not amount to advice. I do not need to go into the details of that disagreement. It is sufficient to state that I think that Brodies was in a position of potential and actual conflict of interest and that it did not make clear to the liquidator his need to take separate legal advice.

[42] There also appears to have been a failure both within Brodies and among Mr Pattullo's staff to distinguish between the interests of petitioning creditor and the interests of creditors as a whole. It is essential to the probity of insolvency processes that officers of the court focus on their duties to the general body of creditors. Had they done so in this case, they might have (i) called into question the basis on which IEL received half of the sum that otherwise QC would have paid to the liquidator, (ii) recognised the need to obtain the court's approval of the compromise of Quantum's and QC's mutual claims and (iii) questioned the quantification of IEL's claim in the winding up.

(iii) General comments

[43] As I have said, it is only by chance that I was alerted to what occurred in this insolvency. The successful operation of our insolvency procedures depends on the integrity and the professionalism of insolvency practitioners and those who advise them. I ask the professional bodies to see that the relevant members of their professions learn from this case.

Postscript

[44] I am grateful to Mr Crampsey for expressing his worries about the conduct of this winding up in his report and for drawing to the attention of the Auditor of Court the bypassing of the court's supervisory procedures. While I am persuaded that the liquidator had answers to some of his more serious concerns about the decision not to raise legal proceedings against QC, this investigation has shown that there was substance in several of the points which he raised.