Insolvency Practitioners deserve huge pat on the back from creditors?
Insolvency Practitioners deserve huge pat on the back from creditors?Certainly not, I fear some of you might say!
Let’s have a look at the Insolvency Practitioner who puts his neck on the line seeking to improve the realisations by pursuing contentious recoveries for creditors. Before we do that however we need to consider litigation generally.
At the heart of this matter is the irony that a litigant usually must present a positive case when asking the Court to order compensation. This person has the burden of proving their case. How is this possible for an Insolvency Practitioner who enters office as a stranger to the Insolvency and who is often hampered by an absence of information to go to Court to enhance recoveries for creditors?
What do creditors want?
What do most creditors want out of insolvency. No surprise here, that they want their money back and some more. Interest on a debt might be a poor substitute for the time and trouble involved in what creditors endure after having supplied something to someone who has not paid for it.
What creditors may not always appreciate is their long path to recovery has only just started when the insolvency arose. It does not matter if that took years to get to insolvency because what matters is that the process starts afresh at insolvency, when creditors who had been focusing on their own debt are thrust into the ‘pot’ when insolvency sprouts, along with all the other creditors who are in the same boat. Insolvency is a new process, a class action, of creditors coming together to share the spoils of what might be left over if any at all.
Once insolvency has come along creditors cannot any longer obtain a recovery ahead of one another unless they are secured or preferential. There can be no Preference provided to individual creditors. Few creditors are preferential any longer. However, what it means is that recoveries for creditors is a matter no longer in their hands. One of the most arguably frustrating aspects of insolvency for creditors is that a creditor is no longer master of their own destiny. The Insolvency Practitioner has in effect taken over who acts for all creditors. It does not matter if as a creditor your introduction led to my appointment as Liquidator, you are not financially better off from that.
Recovery of a debt can be a long, expensive and frustrating experience.
The Insolvency Practitioner needs to understand the business to then see what if any records should be available and or exist to recover the assets. Whilst doing this the Insolvency Practitioner has to realise the disclosed assets, report regularly to creditors and are expected (certainly by creditors) to recover assets misapplied with court action undertaken promptly. Those are Liquidator (or Administrator) duties.
Catch 22 for the Insolvency Practitioner
One of the biggest problems for any Liquidator is incomplete records. Records that are incomplete hamper every single aspect of an insolvency procedure from potential asset recoveries of book debts through to litigation compensation claims such as Wrongful Trading, Misfeasance, transactions at an undervalue, preferences and fraudulent trading. It also will hamper the Insolvency Practitioner’s compliance functions as well.
Legally there is an incentive for Directors to hand over the books and records. A failure to do so is a criminal offence by virtue of Section 387 of the Companies Act 2006. Unfortunately, the risk of committing a criminal offence might not in itself be sufficient to ensure this problem does not arise. In fact, it arises all too often. One reason is because it is a poorly enforced provision by the authorities. Another problem is that records might have been poorly kept or even badly recorded.
An approach which can assist overcoming this is to reconstruct the records. This is time consuming and expensive. It is time consuming because arguments over entitlement to documents often arise and even when resolved you then still have to wait for someone to hand them over and evaluate what if anything for instance might be still missing. For reasons unclear to me concepts of reasonable time extend to weeks and months as far as the Courts seem to be concerned. When something is a matter of mere production of documents (frequently stored electronically) hours and days seems reasonable to me but I do not make these rules!
However, one of the ultimate Catch 22’s for an Insolvency Practitioner is the question of dealing with transactions that Directors cannot adequately explain. This is the most common feature of insolvency litigation when contentious recoveries are brought by Insolvency Practitioners for the ultimate benefit of creditors.
The starting point is to ask the Directors to explain the transactions. However when dealing with large numbers of transactions this might not be possible, particularly when the detail cannot be reconstructed. All too often Directors will say the answer is in the records. However, that sort of response is often unsatisfactory, particularly if it would be the start of a fruitless search for something that does not even exist. It has been recognised that such an approach where an HMRC tax enquiry is concerned is unreasonable. In the matter of Nicholson v Morris Reported (Ch.D.)  STC 269; (C.A.)  STC 162 the Court said:
“It is the taxpayer who knows and the taxpayer who is in a position (or, if not in a position, who certainly should be in a position) to provide the right answer, and chapter and verse for the right answer, and it is idle for any taxpayer to say to the Revenue, “Hidden somewhere in your vaults are the right answers: go thou and dig them out of the vaults.””
It is simply not good enough for a Director to send HMRC off searching for a needle in a haystack. The same applies to adopting the same approach when dealing with questions from Insolvency Practitioners about unexplained transactions it seems to me.
The perennial problem therefore commonly arises for the Insolvency Practitioner when seeking to address contentious recoveries for creditors. The Director has to account for the assets of the company and may have personally benefited from unexplained transactions. In such circumstances many creditors might say that in those circumstances in view of the Director’s duties, the Director ought to compensate the company and push for the Insolvency Practitioner to take action by bringing legal proceedings against the Director. If the unexplained transactions are sufficient and material, they may have caused the insolvency themselves.
The Insolvency Practitioner then however has to consider if they are prepared to issue legal proceedings to produce contentious recoveries for creditors without being able to put forward a positive case but instead bringing a case on the basis of the inability of the Director to prove that transactions were proper and for the company’s benefit. The starting point here is that the case to be brought cannot overcome the underlying problem ie. the Insolvency Practitioner needs to prove that unexplained transactions amount to improperly dissipated company money. The case can only be determined however by the absence of the ability of the Director to prove their propriety.
I certainly used to take the view that if a Director has a duty to account for and safeguard the property of the insolvent entity, cannot show that they have deployed such property for the benefit of the company, then they should compensate it accordingly. I still hold that view, but it seems that not all Judges necessarily do.
This sort of problem was perhaps demonstrated in the case of Toone v Robbins  EWHC 569 (Ch) when Mr Toone brought proceedings to produce contentious recoveries for creditors. On appeal Mr Justice Norris said that the former Chief Registrar got the law wrong when the matter went to court in the first instance. Mr Justice Norris acknowledged that the transactions in question were not adequately explained by the Directors and rejected the former Chief Registrar’s position that the burden was with the liquidator to displace those explanations, notwithstanding that the inadequate company records. He notably said:
“We have received company money: but our record keeping is so bad that the basis upon which we received it is unclear. So by reason of our defaults we ask you to assume in our favour that we took the money lawfully”.
However, the concern is if the courts can get the law wrong, then creditors need to be alert to that fact when insisting that Insolvency Practitioners set about producing contentious recoveries for creditors. In such circumstances given an Insolvency Practitioner’s unique role, to then bring legal proceedings about unexplained transactions without funding from creditors is conduct when faced with such risks in litigation, that is arguably deserving of a pat on the back.
Criticism of Insolvency Practitioners
The risks however do not end there for the Insolvency Practitioner looking to pursue contentious recoveries for creditors by recovering money from Directors who cannot explain transactions that arose on their watch. If the Insolvency Practitioner loses the court case, they have to decide if they could get an appeal off the ground. Appeals are by their nature an uphill struggle.
An appeal involves going before the Court with a losing banner plastered on your forehead and saying the first judge got it wrong, but you are still right.
It is beyond the scope of this post to consider the limited grounds that any litigant can appeal over. Only it is understood that findings of fact are harder to appeal. Points of law are usually better grounds to appeal.
An appeal can of course be lost and creditors could end up worse off, particularly if the case is funded by the insolvency’s assets already realised.
However, if losing a court case is not bad enough how about losing it badly. What do I mean by that? I mean for example the judge being very critical as well. As we shall see this happens not infrequently.
An Insolvency Practitioner who brings legal proceedings anticipating better returns for creditors will do so typically after seeking independent legal advice from solicitors and a barrister. Relying on such advice the Insolvency Practitioner will bring the case and they are responsible for it. In all likelihood the Insolvency Practitioner might be a sophisticated litigant but it is unlikely that they have the knowledge to bring the legal case themselves. They use Lawyers for that purpose. However, notwithstanding that in recent judgments involving Insolvency Practitioners where criticism was dished out by Judges, the Insolvency Practitioner has been the focus not their Lawyers. That could be considered unfair as the Insolvency Practitioners bringing these legal claims are usually not qualified Lawyers. Litigation is a reserved legal activity that only lawyers can provide legal assistance pursuant to Section 12 of the Legal Services Act 2007.
It is therefore of note to read judgments that can be somewhat critical of the Insolvency Practitioner over matters of law and how a case is brought.
The following extracts in judgments are examples of Insolvency Practitioners attempting to provide a better outcome for creditors but then being criticised for some aspect of the way that they conducted litigation.
In the matter of Hosking & Anor v Apax Partners LLP & Ors  EWHC 2732 (Ch) the Court was unsympathetic to Liquidators who suddenly discontinued an action.
In the mater of Hellard & Anor v Graiseley Investments Ltd & Ors  EWHC 2664 (Ch) the Court said:
“In conclusion, I must express my concerns as to the manner in which the Applicants have prepared and pursued this case. A liquidator conducting an investigation into a contentious issue arising in a company’s affairs should strive to gather and review all readily available evidence on that issue on an impartial basis. He should be alive to the possibility of conjecture and unsubstantiated opinion. He should re-evaluate evidence as the investigation progresses.
In the present case, there appears to have been a wholesale failure on the part of the Applicants properly to analyse, interrogate and vouch the journal entries which formed the bedrock of their case. As Mr Davies put it in closing: ‘Plainly the liquidators didn’t understand the journals or they could not have pleaded [their application] in the way that they did.'”
In the matter of Stewart & Ors v Watkin  EWHC 1311 (Ch) the Court said:
“I have some reservations as to the accuracy and fairness of Mr Wood’s written evidence. I have highlighted at paragraph 4 of this judgment some key documents which were not exhibited to his statements. I set out other examples of the selective and at times inaccurate presentation of the case in Mr Wood’s statements during the course of this judgment. The description of Mr Quinn as simply a ‘business colleague’ of Karl Watkin (Wood (1) paragraph 18) is one such example; the assertion that net rental receipts from all three properties were paid into Karl and Jill’s joint account (Wood (1) paragraph 35.4) is another.
In oral evidence, whilst for the most part Mr Wood did his best to engage with the questions put to him, he was prone to moments of obduracy. When it was put to him by Mr Moss QC that the trustees had ‘chosen’ not to exhibit material bank statements, for example, he avoided the question by stating: ‘they are not exhibited’. The question was put to him three or four times. On each occasion, he responded in the same way, each time avoiding the issue whether the failure to exhibit bank statements was deliberate or an oversight. When he was asked to accept that it was wrong of him not to have disclosed the Official Receiver’s questionnaire and the transcript of Grant Thornton’s interview with Karl Watkin of 4 November 2013, he simply looked down in the witness box and ignored the question, apparently hoping that no one would notice that he was not answering. It was only when I intervened that he gave an answer, stating that he had not deliberately failed to comply with his professional obligations.
There were also material gaps in his knowledge. When asked what had happened to the detailed ‘bespoke’ questionnaire, prepared by Grant Thornton for Karl and completed by him ahead of the interview of 4 November 2013, for example, he stated that that had been ‘Mr Standish’s duty’, that he hadn’t been able to track it down overnight, that he hadn’t read it, and that he did not even know if it existed. Yet it was obvious from reading the transcript of the Karl Watkin interview of 4 November 2013 that the interview itself mostly comprised ‘follow up’ questions to those answered by Karl in the questionnaire; a questionnaire which was never produced.”
In the case of Johnson v Arden  EWHC 1624 (Ch) the Court said:
“First, the Applicant has not produced any direct evidence of the agreement that he alleges was made. Whilst I accept that as a liquidator of the Company, the Applicant will not have any direct knowledge of what occurred, in this case, he has had over 8 years to investigate the matter, including interviewing various parties, and has had available to him the powers in sections 234, 235 and 236 of the Insolvency Act.
70. Secondly, the agreement alleged should not be lightly inferred as the allegation made is a serious one, relating as it does to the honesty of the Directors. I do not accept that it can be properly inferred from the matters set out in paragraph 52 above…”
I observe that many of the aforesaid criticisms raised concerns about the way a case was brought or presented and how matters were evaluated and disclosed. Lawyers are usually responsible for such aspects of cases and judges will know this, yet the Insolvency Practitioner appears to be suffering the criticism.
It is all too easy with the benefit of hindsight after a trial to say a case should not have been brought. A trial really focuses people’s minds and information can suddenly sprout late in the day that was not made available earlier.
This sort of criticism may be justified but if the Court is going to criticise one of its own officers then it seems to me that there is a case for identifying the party who is really responsible.
Recent published cases such as Khan v ICAEW  EWHC 1378 (Ch) referred to in the post on Comet, Confidentiality & Conflict and Lambert Carton-Kelly v Edwards  EWHC 131 (Ch) in the post Comet, Confidentiality and Regulatory Intervention may also highlight and give yet further insight into the difficult and challenging job of Insolvency Practitioners. And how careful an Insolvency Practitioner has to be in the execution of his or her duties.
I frequently look to serve the interests of creditors by bringing legal proceedings and contentious recoveries as Liquidator against misfeasant Directors. It is a huge challenge and one fraught with danger. However, if by virtue of the matters detailed above Insolvency Practitioners stop bringing these actions for the ultimate benefit of creditors then the system risks encouraging misfeasant Directors to continue acting improperly and no signal will go out to change this behaviour enabling the dark forces to prevail. Directors who act improperly must be held to account for the sake of the business community as a whole. As with the Director who fails to keep records to justify transactions, it also cannot be right that a Director can misappropriate money from a company and avoid meaningful challenge and investigation because they leave nothing behind to fund the necessary investigations into their conduct.
So do Insolvency Practitioners deserve huge pat on the back from creditors? Let me know what you think.