Assignment of claims by officeholders – a future regulatory storm for insolvency practitioners

The recent decision by the Court of Appeal in Re Edengate Homes (Butley Hall) Limited (in Liquidation) 2022 has focused many practitioners’ minds on the issues and potential pitfalls concerning the assignment of causes of action by officeholders to litigation funders.

The role of an officeholder is to realise an estate’s assets for the benefit of all stakeholders, including in particular the general body of creditors. For several years now officeholders have been able to assign not only any causes of action that vest in the estate directly, but also officeholder claims.

At the same time we are also seeing an increasingly competitive market, with increasing numbers of entrants to the litigation funding marketplace.

Whilst there can be no doubt that litigation funding can be of invaluable use to insolvency practitioners, since often there are little or no funds within an estate to pursue or investigate causes of action, the concern is that too often situations arise where insolvency practitioners have assigned a cause of action for a relatively modest lump sum that is invariably used to meet fees.  This is often combined with an entitlement to a  limited share of any net recoveries, but often in the writer’s experience the insolvency practitioner’s file does not clearly record what other alternatives were considered, or what steps were taken to maximise returns for the general body of creditors.

The decision in Re Edengate concerned a challenge to the validity of an assignment of a cause of action by an officeholder. While the challenge in Edengate was unsuccessful, on the facts of that particular case certain findings of the Court of Appeal could be subject to further appeal. One also must consider from an insolvency practitioner’s perspective how a regulator would view actions taken by an insolvency practitioner when assigning a cause of action.

Re Edengate Homes (Butley Hall) Limited (in Liquidation)

On 28 April 2022 the Court of Appeal handed down a judgment in respect of Edengate. This concerned an appeal by Adele Lock (‘Mrs Lock’), a former creditor and former director of Edengate. The appeal concerned Edengate being placed into liquidation, and its only asset was a cause of action against Mrs Lock and members of her family.

Mrs Lock sought to challenge the validity of the assignment of the claim to a litigation funder, Manolete Partners plc (‘Manolete’), primarily on the basis that her and her family were not given an opportunity to purchase the cause of action.

Mrs Lock was unsuccessful both at first instance, before the Business & Property Courts in Manchester in November 2021, and before the Court of Appeal.

Mrs Lock sought to challenge the assignment of the cause of action, and it ought to be borne in mind the corresponding similar provisions in other types of insolvency appointment, pursuant to s168(5) Insolvency Act 1986 which provides that:

“If any person who is aggrieved by any act or decision of the Liquidator, that person may apply to the court, and the court may confirm, reverse or modify the act or decision complained of, and make such order in the case as it thinks just.”

In the correct circumstances s168 Insolvency Act 1986 provides the court with the ability to set aside an assignment to a litigation funder.

On 26 November 2015 Edengate was placed into creditors voluntary liquidation.  Whilst not revealed in the statement of affairs, there were monies owing to Edengate in respect of directors’ loans, and from connected debtors, estimated at approximately £2m. Mrs Lock was shown as a creditor in the statement of affairs for approximately £2m.

Although the company had been placed into creditors voluntary liquidation, a trade creditor petitioned for the compulsory winding-up of the company, and a winding-up order was made on 15 March 2016. The liquidator appointed following the making of the compulsory winding-up order was of the view that the company had substantial claims against Mrs Lock, her husband, her parents, and her parents’ company based upon transaction at an undervalue, preference and misfeasance. The value of those claims was estimated at £1.2m, and were disputed by Mrs Lock and her family. On 1 February 2018 solicitors instructed to act on behalf of the liquidator asserted claims against Mrs Lock’s parents, but not (for reasons unknown)  against Mrs Lock for the lesser sum of £1,198,222.

This resulted in discussions taking place between Mrs Lock and the liquidator in relation to threatened proceedings. Although disputed, Mrs Lock in evidence before the court suggested that on 8 February 2018 she discussed the possibility of taking an assignment of the cause of action from the liquidator, but accepted that no formal offer was made to take an assignment.

In the absence of a settlement being reached the liquidator had little or no funds within the appointment to pursue the claims. The liquidator considered alternative funding possibilities, and sought the views of the majority trade creditor who was not prepared to provide funding or to take an assignment of the cause of action.

The liquidator also considered instructing solicitors pursuant to a CFA agreement, combined with an ATE insurance policy (notwithstanding that the premium could be insured), but formed the view that this was unlikely to be practical.

As a result the liquidator sought to assign the cause of action to a litigation funding company, and an offer was received from Manolete in April 2019 for £20,000 together with a percentage of net recoveries.

Following receipt of this offer the liquidator’s solicitors wrote to Mrs Lock’s parents putting them on notice that they were considering assigning the cause of action, and in the absence of settlement being reached within a period of time the cause of action would be assigned to the litigation funder.

This letter, it is accepted, was forwarded to Mrs Lock by her parents. In Edengate therefore Mrs Lock was aware that the cause of action would be assigned to Manolete, and that she had been put on notice of the proposed assignment.

No offer was made to settle the claims at that point in time, and the assignment to Manolete was ultimately progressed on 24 September 2019. The sum of £30,000 was paid on assignment, and an improved percentage of net recoveries was agreed with Manolete.

Up to and including the date of the assignment, whilst a cause of action had been intimated against Mrs Lock’s parents, no formal claim had been asserted against Mrs Lock or her husband. The definition of the ‘Claim’ in the assignment to Manolete was very broad, and included any causes of action against Mrs Lock and her husband.

Following the issue of a letter before action in early 2020, proceedings were issued on 19 January 2021. Proceedings were issued against Mrs Lock, her husband, her parents, and her parents’ company. Following preliminary steps, trial was listed to take place in December 2021. The claim was disputed.

On 18 February 2021 Mrs Lock issued an application to set aside the assignment of the cause of action to Manolete, which was heard on 28 October 2021. It is not clear why an application to set aside the assignment was not made prior to the issue of proceedings when Mrs Lock was on notice of the assignment.

Requirements of s168(5) Insolvency Act 1986

To succeed in a challenge pursuant to this section of the insolvency legislation an applicant must not only demonstrate whether it falls within the category of persons entitled to make such an application (i.e. any person aggrieved), but must also demonstrate that it has “an underlying legitimate interest in the relief sought“.

In this instance Mrs Lock was a creditor, although she would not be entitled to claim set-off in respect of the cause of action against her, and therefore prima facie she was a member of the class of persons entitled to seek to challenge the validity of the assignment.

The court held that Mrs Lock’s claim as a creditor however had to be aligned with the interests of the class of general body of creditors – namely with a view to maximising recoveries for the estate from the assigned claims.

In addition, adopting the criteria laid down by the court in Re Edennote Ltd, any applicant pursuant to s168 Insolvency Act 1986 would have to demonstrate that, in this instance, the liquidator’s decision to assign the cause of action was ‘perverse’.

In summary to succeed on a challenge the applicant must demonstrate that:

• They form part of the category of persons entitled to make the application under the relevant section – in this instance a creditor
• The liquidator’s decision was perverse, namely that it was “so utterly unreasonable and absurd that no reasonable man would have done it“.

Standing to make the application

A creditor, in order to form part of the class of applicant entitled to make an application, must be a ‘substantial creditor’ – i.e. a creditor who is owed more than a minimal amount. The fact that the creditor who issues the application is also a defendant does not mean that they cannot issue such an application.

In Re Edennote Ltd it was held that “any person aggrieved” as set out in s168(5) Insolvency Act 1986, by reference to s20 Bankruptcy Act 1869, included “any creditor, debtor or other person aggrieved”. Re Edennote Ltd confirmed that an outsider to a liquidation had no standing to make such an application, from which it follows that if for example another litigation funder had submitted an unsuccessful competing offer they could not bring an application.

The Court of Appeal in Edengate found that, in addition to being a creditor, the interests of the applicant had to be aligned with the interests of the class of the general body of creditors. The purpose of seeking a challenge to set aside must not be, for example, to ‘stifle a claim’. The applicant must demonstrate that the purpose of the application is to maximise realisations for the benefit of the general body of creditors.

Logically this involves an analysis of whether the applicant (or indeed potentially a third party if a regulatory complaint were to be made) would have offered a greater amount than ultimately a litigation funder had taken the assignment of the relevant cause of action for.

In Edengate Mrs Lock was notified of potential claims prior to assignment, and effectively given an opportunity to put forward an offer by way of settlement or to take an assignment of the cause of action.  She was notified of the proposed assignment of the causes of action before they were assigned to Manolete. That, however, is not the case in other instances where insolvency practitioners have simply assigned a cause of action to a litigation funder. In Edengate there was no suggestion that Mrs Lock would be willing, or had ever been willing, to match or beat the offer made by Manolete.

In circumstances, where claims have not been intimated at all, and where the proposed defendants are creditors for more than a minimal amount, simply assigning a cause of action without notification of any proposed claim, and/or putting the defendants on notice of the proposed assignment, it is submitted entails potential regulatory and financial risks for assignor office-holders.

Perversity

The Court of Appeal confirmed in Re Edennote Ltd that the court would only interfere with the act of an officeholder where the officeholder had “done something so utterly unreasonable and absurd that no reasonable man would have done it“. The Court of Appeal held that whilst it may be sensible, or good practice, to give a defendant an opportunity to submit an offer to acquire or settle a cause of action prior to assignment, failure to do so was not necessarily perverse.

Whether an assignment is perverse will depend upon a scrutiny of all the facts of any particular case. Re Edennote Ltd contains several important features that were not present in Edengate, namely:

• In Re Edennote Ltd (the dispute concerned Terry Venables, Lord Alan Sugar, and Tottenham Hotspur plc) the liquidator had incorrectly believed that he could not assign a cause of action to a proposed defendant (such assignment can take place as confirmed in both Re Edennote Ltd and Re GMEL).
• The liquidator failed to take advice as to the effects of assignment regarding security for costs.
• The judgment in Edengate cites the following passage from the judgement of Lord Justice Nourse in Re Edennote Ltd:

“It is certainly possible for the liquidator to do something so utterly and unreasonably absurd that no reasonable man would have done it … simply by selling an asset … without taking into account the possibility that a third party may well have made a far better offer to whom it was sold …“.

• At first instance in Edengate the judge criticised the liquidator for not advising Mrs Lock directly that the cause of action was to be assigned to Manolete, but did not go as far as to suggest that that failure was ‘perverse’.

The test as to whether an assignment is perverse is objective. The Court of Appeal in Edengate ruled that the decision was not perverse because Mrs Lock never followed up her suggestion made at a meeting with the liquidator in late February 2018 that she might be interested in buying the claims i.e. She did not make an offer, and her parents did not respond to the letters advising that the claims were to be assigned. The court was not satisfied that Mrs Lock would have made an offer, she had an opportunity to do so, and the court was not satisfied that a third party would offer a greater amount of the cause of action.

Discretion

The relief following inter alia s168 Insolvency Act 1986 is discretionary. In a situation where an application to set aside the cause of action is made late in the day, the court will not readily assign a cause of action and delay trial.

Is an assignment of a cause of action to a litigation funder capable of assignment?

Notwithstanding that the appeal in Edengate was unsuccessful, the writer’s view is that an assignment of a cause of action to a litigation funder is capable of being set aside subject to being able to demonstrate that:

• the applicant would have submitted a greater bid for the cause of action
• The applicant was in a position financially to submit a greater bid than that accepted upon assignment
• The applicant had not been given notice of a potential claim, or at the very least put on notice of the intention to assign the cause of action to a third party, prior to the assignment taking place
• The offer accepted for the cause of action was ‘perverse’.

The definition of what constitutes perverse is capable of challenge.

The concern is that there have been instances where insolvency practitioners have simply assigned causes of action for a modest amount, together with perhaps a percentage of recoveries, and yet the market has not been tested, and there is no suitable file note as to why the assignment has taken place.

The lump sum payment received on completion is often used to meet the insolvency practitioner’s fees, and does not result in a return for the general body of creditors. In cases that involve a percentage of net recoveries, there may also be realisations for the estate in the final analysis. However, what if there isn’t, and how can a licensed insolvency practitioner say that the assignment is in the best interests of the general body of creditors if the market has not been tested?

Misfeasance and paragraphs 73 & 74 Schedule B1 Insolvency Act 1986

There is a risk that if an insolvency practitioner assigns a cause of action without taking the appropriate steps, and preparing a suitable file note to explain the rationale for any assignment, they could be subject to scrutiny from inter alia creditors and their regulatory body.

Creditors could progress proceedings by misfeasance in a liquidation, challenge the administrator’s conduct pursuant to paragraphs 73 & 74 Schedule B1 of the Insolvency Act 1986, or in bankruptcy an application pursuant to ss303 & 304 Insolvency Act 1986. The aforementioned involve a claim for financial redress against the officeholder.

Why should the general body of creditors suffer financially if an officeholder has not taken the correct steps prior to assigning a cause of action? As the litigation funding market continues to develop, invariably there will be greater scrutiny on insolvency practitioners arising due to the assignment of causes of action.

Regulatory implications

In addition to the risk of a challenge pursuant to inter alia s212 Insolvency Act 1986, there is significant concern that going forwards regulators will be asked to scrutinise an officeholder’s conduct when assigning a cause of action.

A regulator would consider not primarily consider whether an assignment is capable of being challenged, which is a matter for the court, but primarily whether the office-holder’s actions meet the requisite duties of care and standards expected.

Well-advised persons aggrieved by an assignment of a cause of action it is submitted would in the first instance complain to the regulator through the gateway, as opposed to simply challenging an assignment at court, as this would not place them at risk on costs.

Suggested steps to be taken by an insolvency practitioner prior to assigning a cause of action

Insolvency practitioners ought to consider the Official Receiver’s guidance in relation to assigning causes of action, which is useful. The summary of the steps to be taken by the Official Receiver before considering an assignment of a cause of action are as follows:

• Identify the cause of action that is capable of assignment, and the extent to which it falls within the estate and is capable of assignment either as a legal estate claim or as an officeholder claim;
• Identify the merits of the cause of action, and whether the same is frivolous or vexatious;
• If the claim is frivolous or vexatious it ought not to be assigned;
• If a claim is not frivolous or vexatious, and assignment is not barred by (for example) contractual conditions, an assignment ought not to be made without testing the market;
• When testing the market, the cause of action to be assigned ought to be offered inter alia to the defendant in accordance with the principles established in Re GMEL and Re Pennyfeathers. All potentially interested parties, including the defendant, should be given an opportunity to submit an offer for the cause of action that is offered for assignment; &
• A cause of action ought not to be assigned if any offer received is derisory.

The Official Receiver’s technical manual contains  ‘good guidance’ that ought to be considered by all officeholders. The writer however would go further and suggest the following steps that it is submitted ought to be taken prior to assigning a cause of action. The suggested steps below ought to be recorded in a full file note that is maintained on file prior to assigning any cause of action:

1. With the assistance of solicitors if appropriate, identify what causes of action the company or the officeholders have, and as against whom;
2. Discount any causes of action that are frivolous or vexatious, which ought not to be assigned;
3. Consider how any potential claim can be investigated further, and funded;
4. A full file note to be prepared setting out that the insolvency practitioner has considered the following prior to assignment:
   • Instructing solicitors pursuant to a CFA or DBA agreement;
   • Seek funding from majority creditors;
   • How to meet the costs of putting in place ATE insurance if appropriate, to include the self-insuring option; &
   • The risk of a successful application for security for costs, considering the principles established inter alia in D’Jan of London
5. Once a cause of action has been identified, write to the proposed defendants putting them on notice of the potential cause of action, attaching core documentation, and inviting them to put forward proposals. This need not necessarily be, in the first instance, a pre-action protocol letter before action;
6. To explore all avenues of funding the claim, to establish which is likely to achieve the greatest return for the general body of creditors, and which are not capable of being progressed.
7. If appropriate, invite offers from litigation funders. We would suggest inviting offers from at least two or three litigation funders, so that offers received can be compared and the best offer accepted in principle;
8. At the same time invite offers from all interested parties (to include proposed defendants, and majority creditors) to take an assignment of the causes of action;
9. Compare all offers received. In the event that the best offer is received from a litigation funder, who will be in a position to fully fund proceedings, notify the proposed defendants that an offer has been received from a litigation funder and afford them a final opportunity of (say) 21 days to put forward offers of settlement or to take an assignment of the cause of action, failing which the proposed defendants are expressly put on notice that the claim will be assigned without further notice;
10. In respect of any assignment to be entered into with a litigation funder, which is often on the litigation funder’s standard terms, we would suggest that insolvency practitioners consider the following:
    • Limiting the definition of “the Claim” to be assigned – the definition in most assignments is so wide that it encompasses any potential claim that may exist and vest in the estate or that can be progressed by the insolvency practitioners. To avoid future criticism, limit the definition of the cause of action to be assigned to specifically the claims identified, and no others.
    • Increase the scope of the indemnity – when negotiating with a litigation funder always seek to increase the standard indemnity in any assignment so that it includes not only the matters usually covered, but also specifically an indemnity in respect of a challenge to the assignment, any misfeasance claim, and any claim pursuant to paragraph 74 Schedule B1 Insolvency Act 1986.

Summary

Whilst there is nothing perverse in assigning causes of action to litigation funders, and the emphasis must always be on maximising recoveries for the general body of creditors, it is suggested that the steps suggested above ought to be taken so as not to expose assignor office-holders to financial and regulatory risk. A full file note should be kept in order to explain the rationale for any assignment. In the writer’s opinion offering causes of action to proposed defendants is key, since it could generate greater returns for the general body of creditors as a well-advised defendant may be advised to submit a higher offer than a third party whose objective is to generate a profit.