United Kingdom House of Lords Decisions

HOUSE OF LORDS

OPINIONS OF THE LORDS OF APPEAL FOR JUDGMENT

IN THE CAUSE

Freakley and others (Appellants) v. Centre Reinsurance International Company and others (Respondents) and one other action

[2006] UKHL 45

LORD HOFFMANN

My Lords,

1.   This appeal arises out of a number of questions on which the administrators of T & N Ltd sought the directions of the court. On all but one of these questions the answers given by Blackburne J ([2004] 2 All ER (Comm) 28) were not appealed or affirmed by the Court of Appeal ([2005] 2 All ER (Comm) 65) and there is no further appeal. On the remaining question his decision was reversed and the administrators appeal.
2.   The relevant facts may be shortly stated. In 2001 T & N appeared likely to become unable to pay its debts because it was faced with a large number of tort claims arising out of the use of asbestos in its products. On 1 October 2001 Hart J, on the company's petition, appointed administrators for purposes including the approval of a corporate voluntary arrangement or scheme of arrangement under section 425 of the Companies Act 1985.
3.   The company had the benefit of an asbestos liability policy under which it was entitled to be indemnified against its "ultimate net loss" (defined to include both established liabilities under asbestos claims and the costs of defending and handling such claims) in excess of a "retained limit" of £690m and up to an insurance limit of £500m. It was a condition of the policy that after the occurrence of an "insolvency event" (defined to include the presentation of an administration petition) or the reaching of the retained limit the insurers should have the exclusive right to handle and defend claims.
4.   It is accepted that in handling claims, instructing solicitors and so forth, the insurers act as agents for the company and are entitled to reimbursement for their expenses: Groom v Crocker [1939] 1 KB 94; Cox v Bankside Members' Agency Ltd [1995] 2 Lloyd's Rep 437. The question which is the subject-matter of the appeal is whether the right to reimbursement of such expenses incurred after the appointment of the administrators has a statutory priority over other costs of the administration, the floating charge and the unsecured creditors of the company.
5.   The question is not asked in respect of any particular expenses. Your Lordships know nothing of the amount claimed or the reason why the expenses were incurred. The policy requires that the insurers exercise their rights "in a businesslike manner in the spirit of good faith and fair dealing, having regard to the legitimate interests of the parties to the policy". It may therefore be assumed that the insurers complied with this requirement, otherwise there would be no claim to reimbursement at all. The question is whether any legitimate claim to reimbursement under the policy would have priority.
6.   Before looking at the specific statutory provisions under which priority is claimed, I should say something about the general scheme and purpose of administration as it existed under the Insolvency Act 1986. Changes have since been made by the Enterprise Act 2002 but I say nothing about these because they were not in force at the relevant time. The background to the 1986 Act is explained by Lord Browne-Wilkinson in Powdrill v Watson [1995] 2 AC 394, 441-442. It was introduced to enable a court to give insolvent companies a moratorium on the enforcement of debts and securities while the possibility of some form of rescue or arrangement with creditors was explored. Unlike Chapter 11 of the US Bankruptcy Code, with which it is sometimes compared, administration did not involve a reconstruction of the company. It usually looked forward to some kind of reconstruction, but that took place under different statutory provisions such as Part I of the 1986 Act (corporate voluntary arrangement) or section 425 of the Companies Act 1985.
7.   In essence, an administration order did two things. First, it placed a procedural bar on the enforcement of security over the company's property or the commencement or continuance of any legal proceedings or execution against the company. Secondly, it substituted for the existing management a court-appointed administrator with power, under the control of the court, to manage the company's business and property. It did not alter substantive rights under contracts into which the company had entered or security which it had given. It did not affect the company's capacity, under its new management, to continue to trade and incur liabilities. It did not, save to the extent which I shall explain, affect the priorities which creditors would have if the company was wound up. That was left to any future reconstruction or liquidation.
8.   It was obviously necessary for the administrator, if he was to carry out his function of preserving the business of a company as a going concern, to be able to pay for necessary goods and services and give suppliers the assurance that they would be paid in full even if the administration ended in a liquidation or a reconstruction under which the unsecured creditors received only a small dividend. This latter object was achieved by section 19(3) to (10) of the Act. Subsections (6) to (10) deal with contracts of employment and it is necessary only to refer to subsections (3) to (5):
(3)  Where at any time a person ceases to be administrator, the following subsections apply.

(4)  His remuneration and any expenses properly incurred by him shall be charged on and paid out of any property of the company which is in his custody or under his control at that time in priority to any security [under a floating charge].

(5)  Any sums payable in respect of debts or liabilities incurred, while he was administrator, under contracts entered into or contracts of employment adopted by him or a predecessor of his in the carrying out of his or the predecessor's functions shall be charged on and paid out of any such property as is mentioned in subsection (4) in priority to any charge arising under that subsection.

9.   Thus subsection (4) deals with claims against the company by the administrator himself and subsection (5) deals with claims against the company by third parties. Claims by the administrator may be either for remuneration or for expenses, that is to say, for goods and services supplied to the company for which the administrator has paid or chosen to make himself liable but for which he has not yet reimbursed himself out of the company's assets. Subsection (5) deals with debts and liabilities incurred by the administrator which have not been discharged and which were incurred under contracts entered into by the administrator "in the carrying out of his … functions". But the supplier will have the benefit of section 14(6), which provides that a person dealing with the administrator in good faith and for value "is not concerned to inquire whether the administrator is acting within his powers."
10.   The administrator's remuneration and expenses under subsection (4) have priority over a floating charge and of course over unsecured creditors if there is a liquidation. The outside creditors' debts under subsection (5) have "super-priority" over the administrator as well.
11.   The insurers say that their claim to reimbursement of claims-handling expenses falls within subsection (5). Blackburne J rejected this submission on the short ground that the payments to claims handlers by the insurers had not been pursuant to or in discharge of any contract entered into by the administrators. It was true that the contracts with the claims handlers had been made on behalf of the company but they had not been made on behalf of the administrators. It was the policy, entered into before the appointment of the administrators, which gave the insurers authority to incur expenses on behalf of the company.
12.   In the Court of Appeal, Chadwick LJ said, ([2005] 2 All ER (Comm) 65, para 125) in my view correctly, that —
"The relevant question…is whether liabilities for claims handling expenses incurred on the instructions of the insurer - acting under the rights conferred by the policy … are properly to be treated as liabilities incurred by the administrator in carrying out his functions …"

13.   Chadwick LJ then proceeded to examine the duties of the administrators and came to the conclusion that, given the objects for which they had been appointed, it would have been proper for the administrators to have incurred the claims handling expenses which had been incurred by the insurers. It followed that such expenses were "necessary to the carrying out of the purposes for which the administration order was made": para 130. I think that Chadwick LJ may have stated these purposes a little widely and I would certainly have wished to have some evidence about exactly what the expenses were before expressing an opinion about their necessity. The administrators say that, given the existence of a stay, there is very little in the way of claims handling that needs to be done. Sometimes the administrator may be asked to give his consent to the issue of proceedings to stop the limitation period from running, but this requires no more than writing a letter and in any case it involves the exercise of a statutory discretion vested in the administrator himself. But for the sake of the argument I am willing to assume that Chadwick LJ was right.
14.   Even so, I do not see how that makes the claims handling expenses liabilities under contracts entered into by the administrator. The administrator had nothing to do with either the contracts under which the liabilities were incurred or the contract which gave the insurers authority to incur them on behalf of the company.
15.   Mr Vos QC, who appeared for the insurers, submitted that, as a company in administration could act only by its administrator, any liabilities incurred on behalf of a company in administration must have been incurred on behalf of the administrator. But that does not in my opinion follow. It is true that once an administrator has been appointed, only he can act or confer authority to act on behalf of the company. I say "confer authority to act" because I do not suggest that an administrator is obliged always to contract personally. He may employ agents. But that does not mean that anyone with authority to act on behalf of the company must be deemed to have derived his authority from the administrator. The company may, before the appointment of the administrator, have conferred on someone an authority to contract on its behalf which, in law or in practice, the administrator cannot revoke. This is such a case. Such contracts are made on behalf of the company but not on behalf of the administrator.
16.   There seems to me no reason of policy why such obligations (which may or may not be in the interests of the administration) should be given priority over the company's other debts. As I have said, the purpose of administration under the 1986 Act was simply to impose a moratorium to allow time to find a way of saving the business or realising it to better advantage than in a liquidation. It was not intended to alter substantive rights or priorities more than was necessary to enable this objective to be achieved. The provisions of section 19(4) and (5) entrust to the administrator (subject to the supervision of the court) the power to decide what expenditure is necessary for the purposes of the administration and should therefore receive priority. But there is no reason to extend that priority to expenditure which neither the administrator nor the court has specifically approved.
17.   The Court of Appeal in In re Atlantic Computer Systems plc [1992] Ch 505 said that the court, exercising its supervisory powers over an administration, has a broad discretion to authorise or direct the administrator to make payments or enter into contracts for the purposes of the administration. In the exercise of this power, the court can in my opinion direct the administrator to authorise or ratify particular claims handling expenditure by the insurers, with the result that their right to reimbursement would have priority under section 19(5). It would however be unusual for the court to make such a decision, involving questions of business judgment, contrary to the opinion of the administrator that such expenditure, while no doubt in the interests of the insurers, was not necessary for the very limited purposes of the administration. It would also require much more evidence of the particular expenditure than is available to your Lordships. Blackburne J refused to make a blanket order authorising claims handling expenditure by the insurers in general terms, saying ([2004] 2 All ER (Comm) 28, paras 110-111) —
"[110]  While…it may be true that the reinsurers' exercise of claims handling may be of benefit to T&N's creditors, the reinsurers' prime concern is to protect their own interests. The transfer of claims handling rights to the reinsurers is not something which the administrators desire. On the contrary, they are anxious to have control themselves of claims handling in what they see as the best interests of T&N and its creditors. The reinsurers have power to give back control of claims handling to T&N (in effect to the administrators) but the issue assumes that they decline to do so.

[111]  In these circumstances, it is difficult to see why the court should direct, in exercise of its power to regulate the conduct of an administration, that the cost to the insurers of conducting claims handling in pursuit of their own interests (in circumstances where, as the issue assumes, the cost of so doing is one which, under the policy, is recoverable in any event from T&N) should enjoy an elevated status as against the claims of others against T&N by treating it as an expense of the administration ahead of T&N's other pre-administration creditors. There is no injustice in this. If the reinsurers wish to avoid the risk of non-recovery of their claims handling expenses (a circumstance which can only occur if the ultimate net loss never exceeds the retained limit, since, once the retained limit is attained, it will be open to the reinsurers to set-off any un-recovered claims handling costs against the £500m limit of insurance), they can return claims handling to T&N."

18.   It seems to me that Blackburne J correctly identified what, in commercial terms, is the issue in this case. The insurers want to handle the claims to ensure that the ultimate net loss, if it exceeds the retained limit, will do so by as little as possible. If the ultimate net loss does exceed the retained limit, they will recover any current expenditure by set-off against their liability to indemnify T & N. But they want both to handle the claims and to bring themselves within section 19(5) to ensure that they do not have to wait to exercise a right of set-off or take the risk that the claims will not exceed the retained limit and no set-off will be possible. These are sensible business objectives for the insurers but they have little to do with the purposes of the administration.
19.   In my opinion the decision of Blackburne J was entirely right and the appeal should be allowed and his judgment on this point restored.

LORD HOPE OF CRAIGHEAD

My Lords,

20.   I have had the advantage of reading in draft the speech of my noble and learned friend Lord Hoffmann. I agree with it, and for the reasons he gives I too would allow the appeal and restore the judgment of Blackburne J.

LORD PHILLIPS OF WORTH MATRAVERS

My Lords,

21.   For the reasons given by my noble and learned friend Lord Hoffmann I would allow this appeal and restore the judgment of Blackburne J.

LORD WALKER OF GESTINGTHORPE

My Lords,

22.   I have had the advantage of reading in draft the speech of my noble and learned friend Lord Hoffmann. I agree with it, and for the reasons which he gives I too would allow the appeal.

LORD BROWN OF EATON-UNDER-HEYWOOD

My Lords,

23.   I have had the advantage of reading in draft the speech of my noble and learned friend Lord Hoffmann. I agree with it, and for the reasons which he gives I too would allow the appeal and restore the judgment of Blackburne J.