Judicial variation of CVA - The Insolvency Service Website

Published version in (2008) 1 Corporate Rescue and Insolvency 156Judicial Variation of CVAKEY POINTSA company voluntary arrangement (‘CVA’) under Part I of the Insolvency Act1986 (‘IA’) is a statutory contract into which terms may be implied onordinary contractual principles.Although some cases proclaim that the court has no power to vary the terms ofa CVA or authorise a breach of the CVA terms, they have overlooked Re TBLRealisations which suggests the opposite.Re Beloit Walmsley has recently injected more disorder and sets a dangerousprecedent for using CVAs to prefer a particular class of creditors.If due to the terms of a CVA or as a matter of law, a CVA does not cover certaincreditors, does the court have jurisdiction to vary the CVA terms so that it covers theerstwhile excluded creditors? If so, to what extent is the court’s jurisdiction curtailedby a trust created under the CVA over the company’s assets?A consistent judicial approach is wanting, as exemplified by the recent decision in ReBeloit Walmsley [2008] EWHC 1888 (Ch). These are the material facts. Prior toentering administration on 22 November 1999, the company was a manufacturer ofmachines and its employees were exposed to asbestos in the manufacturing process.While in administration, the company made a CVA to compromise its liabilities tothose unsecured creditors who could prove for their debts had the company gone intoliquidation on 22 November 1999 (‘cut-off date’). The result is that employees whomerely had a tort claim against the company but did not have any physical symptomsby the cut-off date (‘contingent tort claimants’) were excluded from the CVA (see ReT&N [2005] EWHC 2870 (Ch); [2006] 1 WLR 1728).The company’s insurer in respect of its liabilities to the employees also becameinsolvent. This led to a number of asbestos-related claims by the company’s formeremployees (or their estates) against the Financial Services Compensation Scheme(‘FSCS’), the statutory fund of last resort for customers of financial services firms.LCH

Published version in (2008) 1 Corporate Rescue and Insolvency 156After paying the claims, FSCS took an assignment of the rights of the employees (ortheir estates) against the company.The administrators of the company, who were also the CVA supervisors, applied forcourt directions in order to distribute funds in their hands, qua administrators orsupervisors, exclusively to creditors covered by the CVA, notwithstanding that therecould be contingent creditors (such as the contingent tort claimants) who were notcovered by the CVA. FSCS opposed the application and sought relief under s 6 of IAbecause the administrators’ position would preclude FSCS from recovering anythingin respect of claims assigned to it by the contingent tort claimants. FSCS requested adirection that the administrators or CVA supervisors reserve funds for the benefit ofthe contingent tort claimants.The court ruled against FSCS, reasoning thus:(a) as a matter of construction, the CVA excluded the contingent tort claimants;(b) the court had no power to vary the terms of the CVA, to sanction a course ofaction that involved a breach of the CVA terms, or to authorise the CVA supervisorsto proceed in a manner that had the effect of varying the CVA terms in a way thatinvolved a breach of trust created under the CVA;(c) as a matter of construction, all proceeds of realisations held by the administratorswere subject to a trust created under the CVA. Accordingly the court could not directthe administrators to breach the trust; and(d) FSCS’s application under s 6 of IA was time-barred and the court could not tollthe time bar. In any case, the court would be disinclined to grant any relief under s 6.Jurisdiction to vary CVA termsTo begin with, a CVA is a ‘statutory contract’ – a shorthand reference to the statutoryhypothesis whereby the arrangement is treated as if it were a consensual agreementbetween the debtor and all the relevant creditors such that dissenting creditors will bebound by the terms of the arrangement even if they have not agreed to its terms:Page 2

Published version in (2008) 1 Corporate Rescue and Insolvency 156Johnson v Davies [1999] 1 Ch 117, 138; Re Hellard and Goldfarb [2007] BPIR 1322at [3].Re Alpa Lighting [1997] BPIR 341 and Beloit Walmsley maintain that the court has nostatutory power to amend the statutory contract. But this proposition seemingly leavesthe case of Re FMS Financial Management Services (1988) 5 BCC 191 hard tosquare. In FMS the debtor acting as a securities dealer induced its clients bymisrepresentation to purchase some worthless shares. After the debtor went intoadministration, due to disorderly records, the administrators managed to locate sharecertificates for some clients only. Clients who did not get their share certificates had aclaim for the return of their money, so a CVA was effected to cover these clients. Thisproduced an unfair result because, although all the clients bought the same worthlessshares in the same circumstances, only some clients could participate in the CVA.Participation in the CVA was thus purely fortuitous. In order to remedy thisunfairness, Hoffmann J directed the administrators to admit claims from clients whohad received share certificates as if they were subject to the CVA. However, the effectof this direction was that creditors who would otherwise have been outside the CVAwere brought into the CVA, causing the existing CVA creditors to recover much lessdividend from the CVA. As Evans-Lombe J said at first instance in Alpa Lighting,‘what the judge directed did involve what was in effect a variation of the [CVA]’([1997] BPIR 341, 343).Subsequent courts have tried different ways to compartmentalise FMS with politesse,including distinguishing it (e.g. Alpa Lighting), confining it to its own facts (e.g.Beloit Walmsley at [21]), questioning its precedential value because of its briefreasoning (e.g. Beloit Walmsley at [19]-[21]), and explaining it away in these terms:‘what is effectively a variation may be brought about, provided that it is not an actualvariation of the approved proposal’: Hellard and Goldfarb at [19]. One textbookboldly suggests that FMS has been impliedly overruled: E Bailey and H Groves,Corporate Insolvency: Law and Practice (3rd edn, 2007), p 316.All the above compartmentalisations of FMS are unconvincing. The court direction inFMS should be viewed as implying a term into the CVA on the basis of businessefficacy. The court may read terms into a CVA on normal contractual principles inPage 3

Published version in (2008) 1 Corporate Rescue and Insolvency 156order to give the CVA business efficacy: Johnson v Davies at 128; Re Broome [1999]1 BCLC 356, 362. There were ample business-efficacy grounds to justify theimplication of CVA terms in FMS. The fortuitous exclusion of certain creditors wasunquestionably unfair. As Hoffmann J pointed out, there was no moral divide betweenthe creditors with share certificates and those without. Furthermore, absent courtdirection, the administrators could not safely distribute the assets to the CVA creditorsbecause the excluded creditors had misrepresentation claims against the debtor. ‘Itwould be a matter of reproach if any [excluded creditor] were to make a claim only tofind that the court had authorised distribution of all the assets without leavinganything for him’ ((1988) 5 BCC 191, 193). Thus the actual direction given wasplainly sensible and amply justifiable.In sum, the above authorities proclaim that, while the court may imply terms into aCVA using normal contractual rules, it has no jurisdiction to vary the statutorycontract. How this proclamation sits with the Court of Appeal decision in Re TBLRealisations [2004] BCC 81 will be explored below.Jurisdiction to sanction a breach of CVA trustAccording to Beloit Walmsley, the court has no power to authorise a course of actionthat entails a breach of trust created under the CVA. But this appears to repudiate theCourt of Appeal decision in TBL Realisations. Extensive criticisms of TBLRealisations have been voiced elsewhere (see L C Ho and R J Mokal, ‘Interplay ofCVA, administration and liquidation: Part I’ (2004) 25 Company Lawyer 3; R JMokal, ‘Interplay of Administration, Liquidation, and CVA: Part II’ (2004) 25Company Lawyer 35).For present purposes, a short summary of the salient features in TBL Realisations isneeded. A bank, while facing a substantial tort claim by members of the Greenbergfamily (‘Greenbergs’), went into administration. Its administrators proposed a CVA.At the CVA meeting, the chairman rejected the Greenbergs’ claim for votingpurposes, thereby excluding the Greenbergs from the CVA. The Greenbergs thenobtained an injunction requiring the administrators to retain an amount up to the fullvalue of their claim outside of the CVA. Subsequently, the administrators soughtPage 4

Published version in (2008) 1 Corporate Rescue and Insolvency 156court direction as to the basis upon which the Greenbergs ought to be paid, arguingthat the Greenbergs should be paid pari passu with the CVA creditors. TheGreenbergs argued that they should be paid the full amount of the judgment they hadobtained. But the court accepted the administrators’ contention.Recall the injunction the Greenbergs obtained requiring the administrators to keepmonies out of the CVA. The first instance court said it could grant the injunctionbecause the CVA created a trust only over assets already paid into the CVA account.Once paid into the CVA account, the assets could not be used to pay non-CVAcreditors and the court had no power to direct a distribution in breach of trust. Prior tobeing paid into the CVA account, the bank’s assets were not subject to any trust.Accordingly the court should grant the injunction in order to protect the non-CVAcreditors such as the Greenbergs ([2004] BCC 81, 88-89).However, on the subsequent substantive appeal, Chadwick LJ suggested in obiter that,despite the first instance court’s view, because the CVA required all the bank’s assetsto be realised by the administrators and paid to the CVA supervisors, all the bank’sassets were subject to a CVA trust. His Lordship went on to say it was unnecessary todecide this trust point ([2004] BCC 81, 105-106).Why was it unnecessary to decide the trust point? The answer is illuminating. If allthe bank’s assets were indeed subject to a CVA trust for the CVA creditors evenbefore they reached the CVA supervisors, two consequences would follow. First, theinjunction issued by the first instance judge would have amounted to a breach of trust.But the Court of Appeal did not question the propriety of the injunction. Second,ordering the Greenbergs to be paid out of funds retained outside the CVA would alsoamount to a breach of trust. Therefore, the logical reason for the Court of Appeal’srefusal to decide the trust point must be that, at any rate, the court could authorise abreach of the CVA trust. If the court could authorise a breach of the CVA trustanyhow, the scope of the CVA trust would not matter. Hence there was no need todecide the trust point.It follows from the Court of Appeal’s reasoning that the first instance judge’sreasoning about the court’s inability to authorise a breach of trust must be a mistake.Page 5

Published version in (2008) 1 Corporate Rescue and Insolvency 156However, in concluding that it could not direct the CVA supervisors to breach theCVA trust, the court in Beloit Walmsley expressly relied on the reasoning of the firstinstance judge in TBL Realisations that the court could not authorise a breach of trust([2008] EWHC 1888 (Ch) at [22]). The implications of Chadwick LJ’s refusal todecide the trust point appear to have been entirely overlooked.One has to conclude that the authorities are irreconcilable. This irreconcilability hasextensive ramifications beyond the trust issue. If the court does indeed have power tosanction a breach of trust whose terms are governed by the CVA, the court musttherefore have power to sanction a breach of other CVA terms. If the court mayauthorise a breach of the CVA terms, it will no longer make sense to say the courtmay not vary the CVA terms. The court’s failure in Beloit Walmsley to appreciate thefull implications of TBL Realisations only adds instability to uncertainty.Exclusion of creditors from CVAIf correct, Beloit Walmsley sets a disturbing precedent. CVAs may be drafted tosubject all the debtor’s assets to a trust for the benefit of certain creditors only, leavingall other creditors high and dry. Furthermore these excluded creditors would not havestanding to challenge the CVA under s 6 of IA. It cannot be right that CVAs could beused in such a discriminatory and expropriatory manner. But, as demonstrated inBeloit Walmsley, Part I of IA does not appear to provide any redress to theseexcluded, hapless creditors.It is suggested that there are a number of remedies potentially available to theexcluded creditors. First, if the discriminatory CVA is put in place without parallelinsolvency proceedings, the excluded creditors could seek to wind up the debtor.Upon liquidation, the CVA may be reversed as an unlawful preference under section239 of IA.Second, the court could interpret the CVA terms strictly against the preferred creditorsand liberally in favour of the excluded creditors.Page 6

Published version in (2008) 1 Corporate Rescue and Insolvency 156Third, the court could imply terms into the CVA on usual contractual principles. Asmentioned above, FMS should be seen as a case of implied terms with a view toavoiding injustice and promoting business efficacy.Fourth, if the discriminatory CVA is conducted within the administration framework,the excluded creditors could challenge the administrators’ conduct on the basis that itconstituted misfeasance (para 75 of Schedule B1 to IA) or unfairly harmed theexcluded creditors’ interests (para 74 of Schedule B1). In Beloit Walmsley, thepropriety of the administrators’ conduct was probably not an issue because thecontingent tort claimants were excluded from the CVA only by virtue of a legislativequirk which was probably unknown at the time of the CVA.Fifth, since the administrators’ statutory powers to promote a CVA are for the benefitof all creditors, promoting a discriminatory CVA is an unauthorised use of theirpowers. Any purported exercise of a power beyond the scope of the power isexcessive and void: Geraint Thomas, Thomas on Powers (1998), ch 8. Thus adiscriminatory CVA may be held to be void.Sixth, whenever possible, the court could issue an injunction to prevent the debtor’sassets from being caught by the CVA trust. Although this possibility does not appearto have been canvassed in Beloit Walmsley, this case in fact provides an apt factpatternto explore this remedy. Let us assume the court was correct as a matter ofconstruction that, as soon as the company’s assets were realised by the administrators,the proceeds of realisations would be immediately subject to a trust. The CVA alsoprovided that all unrealised assets were excluded from the CVA, although theadministrators were under a duty to realise the unrealised assets. Conceivably thecourt could issue an injunction to prevent the administrators from realising theunrealised assets, thereby keeping those assets out of the CVA trust. In granting suchan injunction in TBL Realisations, the first instance judge said this:‘If a non-CVA Creditor is to be paid, it will be necessary to retain sufficientmonies outside the CVA. In principle, it seems … right that the court shouldgrant an injunction to ensure that this is done: otherwise the claims of acreditor excluded from the CVA would be rendered worthless. This mayPage 7

Published version in (2008) 1 Corporate Rescue and Insolvency 156arguably require the [administrators] to breach … the CVA under which theyagreed to pass realized funds … to the CVA Account. However … if thatagreement is not on its true construction subject to a right of retention to meetthe legitimate claims of non-CVA creditors, it should not have been givenwithout such a qualification, and in consequence does not of itself provide areason why the court should not impose the retention by prohibitive order’([2004] BCC 81, 88-89).Once kept out of the CVA trust, the unrealised assets could be distributed to thecontingent tort claimants represented by FSCS. The actual outcome in TBLRealisations demonstrates that assets retained outside a CVA can be distributed tocreditors outside the CVA.ConclusionThe disarrayed state of the authorities does not lend itself to easy extraction of legalpropositions. One may say with confidence only that a CVA is a statutory contractthat is susceptible to implication of terms on ordinary contractual principles.Attempting unqualified legal propositions beyond that will attract discordance.The discordant hodgepodge of authorities find their embodiment in Beloit Walmsley.It says the court has no power to sanction a breach of CVA trust, but it relies on thereasoning of the first instance judgment in TBL Realisations that has been doubted onappeal. It says the court cannot authorise a breach of the CVA agreement, but theinjunction in TBL Realisations did just that. It says the court is unable to vary theCVA terms, but this makes no sense as long as TBL Realisations stands.On another front, Beloit Walmsley embodies a disturbing precedent enabling aninsolvent debtor’s assets to be used to prefer a particular class of creditors at theexpense of all other creditors. CVAs may be drafted to subject all the debtor’s assetsto a trust for the benefit of certain creditors only, leaving behind everyone else.Should such CVAs come to pass, the court should strive hard to arrest the injustice ofexpropriation.Page 8

Published version in (2008) 1 Corporate Rescue and Insolvency 156Look Chan Ho, MA, BCL (Oxon), LLM (Cantab), LLM (NYU), Attorney-at-Law andSolicitor, is a member of the Restructuring and Insolvency Group at FreshfieldsBruckhaus Deringer LLP, based in London. Email: lookchan.ho@freshfields.com. Ihave benefited from discussions with Professor Riz Mokal and am most grateful toJackie Donner for her helpful comments. All views expressed herein are my soleresponsibility.Page 9