Section 236 Strikes Again As Liquidators’ Application Dismissed

This is the case of Webb & Anor v Eversholt Rail Ltd & Anor (Re Eversholt Rail (365) Ltd – Insolvency Act 1986) [2024] EWHC 2217 (Ch).

This application for the liquidators here highlights some of the difficulties with Section 236 applications that sparked our article a few years ago Reaching for the Section 236 pen; does the 234 one instead have more ink? and more recently How To Vault The Section 236 Investigation Hurdle.

The writer’s preference these days is to first and foremost deploy Section 234 powers to hoover up company records as property in preference to using Section 236 powers. Many reasons for doing so are rooted in issues that can arise in this judgment. The primary rationale for that is you do not usually need to descend into the merits and reasonableness of requests for property you are entitled to take possession of. You are required to do so if you seek information under Section 236. 

However, it is of course feasible the liquidators had no choice but to bypass Section 234 if they considered a trial over ownership of documents would have been more troublesome.

At the heart of this case was the matter of segregation of company records amongst group companies and the effect this had on the liquidator’s ability to assemble information on the company in liquidation’s transactions.

Background To The Section 236 Application

Whilst the writer was not present at the one day hearing of this application one might speculate about the advocates scintillating submissions.

Having a nosey at Companies House the writer managed to dig up a bit of information. Eversholt Rail (365) Limited (“E365”) went into creditors voluntary liquidation over five years ago on 19 August 2019.

Head over to the statement of affairs and you will see E365 was owed £10,817,698 by Eversholt Rail Limited (“ERL”). The statement of affairs suggests E365 ought to recover £10,817,698 of this sum ie. 100%. However, the statement affairs also showed a balance owed by E365 to ERL of £8,327,091 which the first creditor progress report said was made up of “intercompany maintenance charges, intercompany capex expenditure, management fees and storage costs”. The writer has assumed that this is the counter claim of £8,602,650 referred to in each of the progress reports. To date, ERL has paid over £2,221,074.

The judgment also refers to a board minute on 18 October 2018 that E365 was to repay £5 million loan to ERL before the end of 2018.

It is this counter claim which to an extent may have caused the Section 236 application to sprout.

Segregation Of Company Records

At the heart of the problem of the E365 company records was the following revelation from the judgment:

365Co’s directors corresponded on 365Co’s behalf using ERL email addresses. All of 365Co’s documents were held by ERL. 365Co’s documents were not separately filed, stored or segregated by ERL.

The question then perhaps is whose property are these documents if they have been created in some sort of dual capacity or if they are E365 information stored on ERL’s systems.

Information that would be company records of E365 created on ERL systems for convenience are presumably arguably, even if not the property E365, nevertheless disclosable by ERL due to the purpose and intention of their creation. However, the matter of course can become more complicated if E365 company records have become conflated and embedded within the documents of other companies in a group such as ERL.

Duty Of Directors To Keep Records Of Companies

Under Section 386 of the Companies Act 2006 and paragraph 21 of Schedule 18 of the Finance Act 1988 every company has a duty to keep company records. 

An overarching duty of a company director is to keep records so their fiduciary functions can be evidenced and held to account. 

The judge broadcast the usual rule on company records:

In circumstances where a company has properly maintained its books and records, following appointment, a liquidator would usually be given access to all of them. It would be a very rare case indeed where a liquidator would need to see everything, but they can pick and choose what they require, and some documents, particularly those that concern the period leading up to the company’s insolvency, are likely to help the liquidator to gain a better understanding of the company’s demise and whether any further investigation into its transactions is required.

This position means that when Section 234 is the power relied upon, the liquidator does not usually need to give reasons for the request because the usual position is the liquidator is entitled to the company’s property and the Walker Morris v Khalastchi [2001] 1 BCLC position can be triggered:

The starting point is that the files are the property of the Company, and the Liquidator is entitled to possession of them. The applicants have no right whatsoever to withhold them.

Perhaps it could be argued that company directors (in general terms) who cause the historic conflation of records of multiple companies (within a group) without segregation such that it fetters the transactions of each company from being readily and rapidly identified and determined, need on liquidation to reconstruct them. 

One might look to argue that position ought to trump Section 236 but as we shall see it did not do so. The reason it did not do so was because the well known thresholds the courts have developed under Section 236 are not the same as those under Section 234 of the Insolvency Act 1986. See the principles below.

Need For A Change In The Law?

Perhaps this is an area ripe for a change in the law in general terms. 

It appears concerning if directors of group companies (generally) who do not keep company records for each separate company, could conceivably avoid full reconstruction of them. This could leave one company in a group (that is insolvent) with a liquidator, unable to obtain what is typically available for individual companies. 

Once a director of a group has acknowledged company records were not separately kept or were not segregated, then perhaps a suitable change in the law would be for a statutory presumption of unfettered access of the liquidator either to all relevant records held by a group company or for there to be a duty of directors to reconstruct such relevant records. 

It could reasonably be argued perhaps that there ought to be some consequences that flow from unsegregated record keeping. 

Why should a liquidator have to justify full access to information so that they can reconstruct the information to the standard position of full company records? In such a situation a liquidator is not usually seeking to improve or move the company in liquidation’s position to a more advantageous position than what existed prior to liquidation. They would simply be seeking to put themselves into the position of the controlling minds of the company in liquidation and reconstitute their knowledge. 

The E365 Liquidators’ Application

The structure of the application lodged by the liquidators referred in paragraph 9 of the judgment appears to be an attempt to reconstruct E365’s company records.  

The judge highlighted that deployment of Section 236 is not available to help a liquidator determine the scope of documentation available to be obtained; it is to specify what you want and then apply for an order for it.

However, that said, the problem nevertheless is that specificity is difficult because the liquidators (unlike the directors) will not have seen or had prior access to the material. This might be at the heart of the potentially circular self-defeating nature of some Section 236 applications. 

The Section suggests a liquidator has to convince the court of the need for certain information. However, a liquidator enters office as a stranger. That means that requests under Section 236 in might be occasioned by speculation couched in general terms about the likely sort of documents they would hope ought to exist and be available. 

The Court’s View

The court said ERL cooperated with the E365 liquidators and it was when everything in relation to E365 was sought that matters went south.

An observation might be however that in seeking everything relating to E365, the liquidators were seeking to place themselves into the standard position of obtaining or reconstructing of E365’s records. If it is not offensive for liquidators to obtain all of E365’s records had they been segregated, then the question might be asked why it would be unreasonable to obtain them notwithstanding a lack of segregation.

However, the court said:

Thus the Liquidators persistently failed to apprehend that when exercising its powers pursuant to sections 235 and 236 of the Act, the court will only compel a third party to disclose information and deliver up documents that are reasonably required. The court would require compelling evidence to understand why a liquidator needs to reconstitute and thus see absolutely all of a company’s records. No temporal limitation is proposed in relation to any category of the documents sought and no explanation is given in the evidence as to why such a potentially enormous number of documents, so broadly described and covering such a long period of time are needed.

…

…blanket statements provide no assistance to enable the Court to move to the second stage of the exercise it is asked to perform, where it must weigh in the balance the Liquidators’ apparent need to see, in this case, pretty much everything held by ERL and NRF “relating to” 365Co since its incorporation, against any asserted inconvenience or oppression caused to the Respondents in providing it.

In my judgment, the application against ERL, as framed, is fundamentally misconceived. Mr Deacock’s submissions revealed the error. He asked rhetorically why the Liquidators should not be in the same position that they would have been in, if 365Co had held its own records.

The answer is straightforward: the Liquidators are not in the position they would like to be in, because that was not how the ERL Group operated. They must work within the confines of the circumstances of the company to which they have been appointed.

It is this position, that a liquidator must work within the confines of which the group operated which may have straitjacketed the liquidators.

That is arguably perhaps where a change in the law might be beneficial to avoid a situation whereby a group operates in a way that may hamper subsequent review due to inadequate segregation of information. 

The Court concluded as follows:

If a reasonable requirement is identified, then the question of the burden on the respondent in complying must be viewed in the light of that requirement. Having concluded that the evidence fails to explain why all or any of the documentation sought by the widely-drawn application is reasonably required, there is no cause for me even to start to consider any alleged inconvenience or oppression on the part of ERL.

Counsel For The Liquidators Section 236 Principles

Counsel for the liquidators set out the following section 236 principles:

” 54. The authorities show that it is entirely in the Court’s general and unfettered discretion whether an order under s. 236 IA 1986 is made: Shierson v Rastogi [2003] 1 WLR 586 per Mance LJ at [52]. However, that discretion has typically been exercised having regard to the following principles:

54.1. The power is conferred to enable an office-holder to discover the true facts concerning the affairs of the insolvent so that they may be able as quickly, effectively and with as little expense as possible to complete their duties: Picard v Fim Advisers LLP [2010] EWHC 1299 (Ch) per Kitchen J at [28] ;

54.2. The exercise of the discretion involves balancing the reasonable requirement of the office-holder to obtain information against the possible oppression to the person sought to be examined: Cloverbay Ltd (Joint Administrators) v Bank of Credit and Commerce International SA [1991] Ch. 90 per Sir Nicholas Browne-Wilkinson V-C at p. 99C ; British and Commonwealth Holdings per Lord Slynn at p. 439D;

54.3. That balancing depends on the relationship between the importance to the office-holder of obtaining the information, and the degree of oppression to the person sought to be examined.

54.4. The views of office-holders should be afforded great weight by the Court, but they are not decisive: Cloverbay at pp. 101D, 104C;

54.5. The case for making an order against individuals who have a statutory duty to cooperate with office-holders under s.235, is usually stronger than the case for making an order against a third party: Cloverbay at pp. 102H-103C;

54.6. an order for the production of documents is less likely to be oppressive than one for an oral examination: ibid at p. 103C;

54.7. An application is not necessarily unreasonable because it is inconvenient for the addressee of the application or causes him a lot of work or may make him vulnerable to future claims, or is addressed to a person who is not an officer or employee or contractor with the company but all these will be relevant factors, together no doubt with many others British and Commonwealth Holdings at 439-440.”

The judge here said the liquidators did not get past the base to get them into the realms of consideration of matters of oppression in Section 236. On that basis, it is to be taken that the point raised below did not feature in the judgment at all but nevertheless, it might have meant the liquidators’ application might not have succeeded for other reasons even if they met the reasonable requirement threshold.

The matter at the heart of much of this could be inferred to involve matters of debt collection. In other words, the liquidators appeared to be investigating the counterclaim of ERL which was a considerable sum.

Section 236 is not a power that can usually be deployed to obtain a litigation advantage. It is also not a power to investigate a proof of debt of a creditor.

It therefore cannot be deployed as an alternative to discovery which means we go to the well known broadcast in Re Bank of Credit and Commerce International SA (in liq) (No 12),; Morris and others v Bank of America National Trust and Savings Association and others [1997] 1 BCLC 526 in which the following statement was made by the Court:

…there is (as Mr Sheldon submitted and as I accept) a basic and important distinction between the procedures which the court may order under s 236, on the one hand, and discovery on the other hand. Discovery (like other procedures to which accusations of ‘fishing’ may be pertinent, such as interrogatories and writs of subpoena duces tecum) is naturally constrained by and limited to issues which have, by then, been raised and pleaded in adversarial proceedings. The same is not true of applications under s 236, whose whole object (as Sir George Jessel MR said in Re Gold Co (1879) 12 ChD 77 at 85) is to enable the office-holders to find out facts before they bring an action (and, it may be, to discover that an action would not succeed).