Overview Of Can I Pick And Choose Which Creditors To Pay When Going Into Liquidation?
The answer to the question Can I pick and choose which creditors to pay when going into Liquidation? is, and here it comes again – it depends on the facts of the case. Generally, you cannot. It is not to be recommended without taking professional advice. If it were to be ordinarily permissible it could drive coach and horses through the cardinal pari passu principle
If the Court is assessing facts that need to be proved it invokes a binary system of determination ie. either the fact happened or it did not happen. There is no scope for maybe. Lord Hoffmann said in B (Children), Re [2008] UKHL 35
If a legal rule requires a fact to be proved (a “fact in issue”), a judge or jury must decide whether or not it happened. There is no room for a finding that it might have happened. The law operates a binary system in which the only values are 0 and 1. The fact either happened or it did not. If the tribunal is left in doubt, the doubt is resolved by a rule that one party or the other carries the burden of proof. If the party who bears the burden of proof fails to discharge it, a value of 0 is returned and the fact is treated as not having happened. If he does discharge it, a value of 1 is returned and the fact is treated as having happened.
However, this question Can I pick and choose which creditors to pay when going into Liquidation? is a matter of legal interpretation of the facts, not whether or not a fact happened.
How the assets are shared and who gets paid first in Liquidation depends on concepts like the pari passu principle.
What Is The Pari Passu Principle?
The pari passu principle is introduced expressly in Section 107 of the Insolvency Act 1986 which means unsecured creditors who are not deemed to be preferential creditors (such as employees and HMRC for example) should rank equally in any distribution of a company in Liquidation’s assets.
The Court in the case of Re Fastfit Station Ltd) [2023] EWHC 496 (Ch) examined the pari passu principle in some detail:
The pari passu principle is described in Goode on Principles of Corporate Insolvency Law (5th edition) at paragraph 3-07 as follows:
“As mentioned earlier, the pari passu principle is one of the most fundamental principles of corporate insolvency law. All unsecured creditors are required to share and share alike in a common pool of assets and realisations. This principle, formerly confined to winding-up, now applies also to administrations in which a distribution is made. Arrangements that would have the effect of distributing an asset of a company in liquidation (or in a distributing administration) other than in accordance with the statutory provisions for rateable distribution are to that extent to be treated as ineffective. This is the common law pari passu rule, which as stated above, is distinct from the anti-deprivation rule. As we shall see, the pari passu rule applies irrespective of whether insolvency proceedings are the trigger for the operation of the impugned provision, and the fact that the arrangement was a commercially sensible one entered into in good faith will not insulate it from the invalidating effect of the rule.”
Once a company cannot be saved as a going concern and will enter an insolvency procedure the pari passu principle cannot be swept to one side. That does not mean payment to creditors in such instances will never be permissible. However, for such payments to survive challenge may be full of difficulty and might amount to an impermissible insolvency Preference.
Fastfit Station Limited
The company Fastfit Station Limited (“the Company”) was insolvent and went into Administration on 15 April 2014 with a deficiency of around £942,284.40. The Statement of Affairs dated 30 May 2014 showed trade and expense creditors of £884,953.40.
Between 1 April 2014 and the date of Administration, payments were made in the sum £110,345.09 (“the Payments”) to a connected company Fastfit Station MK Limited (“Newco”) which had been incorporated on 3 March 2014. The notice of intention to appoint an Administrator had been filed on 2 April 2014.
On 8 August 2014 the Company went into Creditors Voluntary Liquidation.
On 20 March 2020 shortly prior to the limitation period kicking into effect the Liquidators issued the application that the Payments were Transactions At Undervalue and a Breach of Duty. The Liquidators said the Payments were not made for the benefit of the Company but for the benefit of Newco and its shareholders.
The claim was brought against a former Director (Mr Barker) and Newco. They said the Payments were not transactions at undervalue as they were not undertaken by the Company and were used to discharge creditors of the Company in the sum £20,174.64 to trade creditors and £67,320.73 to discharge certain employee liabilities.
Mr Barker’s defence suggested there was no loss. It is not unusual for a breach of duty claim to require the Liquidator to show there has been a loss following the rationale in the case of Re E D Games Limited [2009] EWHC 223 (Ch). However when the Court went through £87,498.37 of payments made by Newco that related to the Payments it was unable to accept they were made for the Company’s benefit:
Here I accept that the Company received no value from the transaction – that is to say that payments to Fastfit MK were gratuitous. What was done with them thereafter was entirely in the gift of Fastfit MK and included payments to lawyers and accountants instructed on the sale of the business. Rightly, no attempt has been made to contend that these payments were applied for the benefit of the Company. It is quite clear that these monies were applied, not for the benefit of the Company but for the benefit of Fastfit MK, Mr Barker as its shareholder and Mr Richardson as the personal guarantor of the Company’s liability to Boost Capital. It is impossible to regard the payments of liabilities of the Company, which incidentally benefited the Company, as forming part of the consideration for the April Payments.
…
The value of the benefits given and received has to be assessed at the time of the transaction, albeit hindsight can be used to assess the value of the consideration given. The Company had caused the April Payments to be made to Fastfit MK with no corresponding guarantee of a benefit being conferred on it or its creditors. The fact that the directors of Fastfit MK chose to make payments which primarily benefited that company but incidentally discharged some liabilities of the Company does not mean that that those payments are to be regarded as forming part of a composite transaction with the April Payments. The decision to make those payments was entirely within the gift of Fastfit MK. That is so despite the conversations with Mr Dickinson as to how to deal with payments and liabilities following the filing of the notice of intention to appoint administrators. Mr Dickinson’s advice to pay creditors as they fell due was, on Mr Barker’s own account, qualified by the statement that suppliers should be paid sufficiently to maintain essential supplies. On any footing the payments made were not in respect of essential supplies.
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The obvious point here is that liabilities of the Company have been discharged. It is, on a purely mathematical basis, no worse off insofar as the payments discharged the proper liabilities of the Company. Nonetheless the effect of these payments has been to subvert the insolvency regime and the pari passu principle. The proper order is to require the repayment of the monies and allow Fastfit to prove in the liquidation for the liabilities of the Company that it has discharged.
There is no evidence that Mr Barker considered the interests of the Company, or the interests of creditors as a class, at a time when the Company was irretrievably insolvent. Indeed, I am satisfied that he did not. As I have explained, it is plain that Mr Barker’s focus was to acquire the business of the Company and to pay those creditors that would be of advantage to Fastfit MK in carrying on the business once acquired. There is no evidence of essential suppliers being paid so as preserve the value of the Company’s business for the benefit of its creditors, as opposed to that to be carried on by Fastfit MK. In my judgment that amounts to a breach of the duty set out in section 172 CA 2006 and he personally benefited by the company of which he was shareholder having the benefit of the April Payments. Had he properly considered the interests of the Company or its creditors, the payments would not have been made. Instead, he preferred his own interests.
While the balance sheet position of the Company might not be altered to the extent that the Company’s debts were discharged, and it is thus no worse off, it seems to me that Mr Barker is liable to account and must reconstitute the fund that he, as a fiduciary, caused to be misapplied without regard for the interests of creditors, so that those monies are returned to the Company and dealt with as part of the liquidation. Given that I intend to direct pursuant to section 238(3) IA 1986 that Fastfit MK repay the monies received and stand subrogated to the rights of creditors that it discharged, it seems to me that Mr Barker’s liability to reconstitute the fund should be secondary to that of Fastfit MK, so that he should be liable to do so only to the extent that Fastfit MK does not within a reasonable period and similarly be subrogated to the discharged creditors’ claims.
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It appears to me that Mr Colclough is right that it cannot be correct that the insolvency regime can be subverted by monies being paid to a third party, which then has a free hand as to which creditors of the insolvent company are then paid. A preference claim under section 239 IA 1986 would not be open to the office-holder because the preferences themselves would not have been made by the insolvent company. It would make no difference if the third party was a company with identical directors to the insolvent company (see Klempka v Miller [2008] EWHC 3554 (Ch) at paragraph 61, per Mr Anthony Elleray QC, sitting as a deputy judge of the High Court).
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