Overcoming real world problems with preference claims

Insolvency investigators, lawyers and IPs prefer to find nice straightforward claims where the various elements required by the Insolvency Act are readily identifiable, like watching Nigella Lawson or Rick Stein create a perfect bouillabaisse. Each ingredient is neatly placed in a bowl beside the hob before they start, but cooking a bouillabaisse is not that easy and real-life claims tend to have awkward facts to be navigated.

Directors and those who advise them when their companies are in the “twilight zone” are, unsurprisingly after nearly 40 years, very aware of the transactions which are likely to be scrutinised and challenged by a liquidator when the honeymoon period of the liquidation has evaporated. They do their best to disguise the steps they take to extract funds from the insolvent company in this period.

This guile applies equally to payments made to directors or connected companies where the insolvent company was genuinely indebted to the recipient but where the intention of the payment was to prefer a particular creditor over the general body of creditors. Such payments are very common when the failing company is one of a group and the director is planning to save the associated companies.

What you need to prove

S239 requires the liquidator to prove the company has done “anything or suffers anything to be done which …has the effect of putting that person into a position which, in the event the company goes into insolvent liquidation, will be better than the position he would have been in if that thing had not been done”.

And second that the company “which gave the preference was influenced in deciding to give it by a desire to produce…” the preference (“the desire to prefer”).

Then there is the timing of the transaction.

S240 requires that the ‘thing’ (usually but not always a payment) must also be done at a relevant time, i.e. within six months of the date of an administration order being made or if it goes into liquidation of the commencement of the winding up. This means, if compulsory, the date of presentation of the petition and if voluntary the date it went into CVL extended to two years if the recipient is a person “connected with the company”.

Last but not least, there is a second limb to the relevant date test. In addition to the look-back period the transaction will only be a preference if the company was insolvent at the date of the transaction, or became insolvent “in consequence of the transaction”.  The potential complexity of proving insolvency is fresh in our minds following the Sequana judgment and is always a potential problem with making out these claims but not the subject of this article.

What happens when the directors muddy the water by disguising the purpose of the payments?

In Kelmanson v Gallagher & De Weyer [2022] EWHC 395 (CH) the court had to consider two interesting complications in what was otherwise a textbook preference or misfeasance claim.

DeWeyer Limited acquired a franchise to sell Mobalpa kitchens (appropriate for my analogy at the top of the article) but the business did not take off. The director, Mr Gallagher, caused the company, De Weyer Limited, to pay £315,750 to a connected company a month or so before he placed the company into liquidation following the sale of its only significant asset, the leasehold of a shop in Fulham. The first complication was the company did not pay the £315,000 directly to the director and to Ms De Weyer, who had resigned as a director a few months before. Instead, the payment was made to DeWeyer Design Limited (“DeWeyer Design”) a company of which Mr Gallagher and Ms De Weyer were shareholders and directors, and which immediately passed on the payments to the respondents.

There was no evidence DeWeyer Design was a creditor of the company at the date of the payment, but the liquidator understandably did not want a remedy (an order that the payment to DeWeyer Design was a transaction at an undervalue) which would require him to wind up this company to pursue a remedy against the respondents. It is relevant that Ms DeWeyer was not a director at the date of the transaction and so could not be pursued on the ground the payment was misfeasant.

Considering the first question the Deputy ICC Judge Curl QC asked:

“Did the company do anything or suffer anything to be done which had the effect of putting the respondents into a position which, in the event of the company going into insolvent liquidation, would be better than the position they would have been in if that thing had not been done?”

Counsel for the liquidators argued that the payment by the company to DeWeyer Design was an active disposition to Design and was  entered into “specifically for the purpose of repaying the respondents.”

He argued that the payments from the company to Design and from Design to the respondents were “in substance a single composite transaction undertaken without derogation or delay” and relied on the well-known House of Lords authority, Phillips v Brewin Dolphin Bell Lawrie [2001], a case concerning a transaction at an undervalue and Damon v Widney [2002] a preference case in which the Court followed Brewin Dolphin in taking the view that “as a matter of commercial common sense, it was unreal to divide up any part of the overall transaction.”

The court decided that since it was not disputed that the payment to Design was made:

“so that the company’s cash would be used to repay the Respondents the debts the company owed to them….the company made a payment to Design that was … part of a single co-ordinated scheme or composite transaction, which was effected in order to discharge the debts owed by the company to the Respondents”.

Deputy ICC Judge Curl continued, saying: “it was inevitable, because that was the nature of the composite transaction…that the money would then be paid to the respondents.” As a result, the Company did “something that had the necessary effect of improving the respondents’ position on liquidation” and met the test in S239 (4) (b).

The Court also accepted that in addition to the company doing something to improve the respondents’ position it had also suffered something to be done – the alternative formulation in s239 (4) in so far as it allowed Design to use company funds to pay the respondents.

Deputy ICC Judge Curl was influenced in reaching this view by the fact “there was no suggestion by the respondents…Design had set up any beneficial title of its own to the money that used to pay the respondents” nor was there any evidence Design had title to the money. He also said that “Design knew it was handling the company’s money and so necessarily also knew that it needed the company’s permission to pay the company’s money to the respondents”.

The judge was willing to see through the interposition of another company to disguise the purpose of the payments to the director and ex-director and gave a clear judgment in favour of the liquidators.

Although the respondents had interposed another company the facts were unambiguous, particularly the absence of a debt owed by the company to Design and the immediate payment on of all of the funds to the respondents.

What if the director genuinely misunderstood the regime, is it still a preference?

Did Mr Gallagher have the required ‘desire to prefer’ because he may have wrongly believed at the date of the transaction that he and Ms DeWeyer were secured creditors and so would not be placed in a better position by the payment to DeWeyer Design as they were entitled to the money on liquidation anyway?

The applicants had the benefit of the statutory presumption that Mr Gallagher was so influenced to the extent the recipient of the preference was a person “connected” to the company, Mr Gallagher, but not to the extent the recipient was Ms De Weyer as she was not a connected person.

The court accepted that “if the debtor can be shown to have a belief that flatly contradicted the possible influence of the statutory desire, then that is likely to go a long way towards showing that the statutory desire was absent” notwithstanding, if this belief was wholly irrational, i.e. the short answer to my question is “no”.

Although at trial Mr Gallagher accepted that he and Ms DeWeyer were not and had not been secured creditors at the relevant date the judge felt it incumbent upon him to consider Mr Gallagher’s belief at the time of the payment.

Having reviewed the evidence the court concluded that Mr Gallagher did not believe the respondents were secured when the payment to Design was made and so he failed to rebut the statutory presumption that the company was influenced by the necessary desire to prefer.

Conclusion

DeWeyer was a claim which at first blush looked open and shut; all the funds extracted within weeks of liquidation and paid to a company controlled by its sole director and his partner. On closer inspection, however, it had numerous potential factual issues which had to be explored and proven before it could be made out at trial. It is to that extent typical of antecedent transaction claims in the £250,000-£1m bracket where the complexity understandably deters some Ips from pursuing a good claim. HCR and Andrew Brown of Radcliffe Chambers acted for the liquidators.