In the net! Court of Appeal rules on administration and liquidation expenses

Posted: 25/10/2013

The Court of Appeal’s ruling in Neumans LLP V Andrew Andronikou & Ors [2013] EWCA Civ 916 left no room for doubt: solicitors who advise a company defending a winding up petition cannot recover their fees as an expense in a subsequent out-of-court administration.  Instead, they should seek third party funding or indemnities from those behind the company or associated with it. The judgment also indicates that the courts will abide by the letter of the Insolvency Rules 1986 (the “Rules”), rather than by their spirit.

Pre-match warm up

Neumans were instructed by Portsmouth City Football Club Ltd (PCFC) in defending a winding up petition presented by HMRC on the basis that PCFC could not pay its debts, in particular a “massive liability for unpaid VAT”.   PCFC applied unsuccessfully to strike out the petition.  While the appeal was pending, PCFC’s new owner appointed administrators out of court.  The petition was automatically suspended under para 40(1)(b) Sch B1 of the Insolvency Act 1986 (the “1986 Act”). Neuman’s retainer was terminated, and they were given liberty to apply in respect of their costs.

PCFC’s unsecured creditors approved a Creditors Voluntary Arrangement in May 2010. Neumans did not claim to be unsecured creditors, their position being that their fees should be paid as an expense in PCFC’s administration, or, alternatively, liquidation. The administrators ran the football club until it was sold in September 2010.  Neumans applied to court for payment of their fees as an expense of the administration.  In February 2011, the court terminated the administration and ordered PCFC to be wound up on the original petition.

The administrators were paid very substantial sums in respect of the administration. Indeed, as Mummery LJ observed, the costs of the administration devoured PCFC’s assets.  The liquidators received no monies from which Neumans’ fees and disbursements (of around £267,000) could be paid.  Neumans applied to court for an order that PCFC’s costs in relation to the petition be paid by PCFC from its assets as an expense of the administration.

First half: claimants 0, defendants 1

Morgan J gave a detailed and meticulous ruling. First, he held that the court did not have jurisdiction under s51 Senior Courts Act 1981 (“SCA 1981”) to order the payment of Neumans’ fees from PCFC’s assets as an expense of the administration. Solicitors fees were not “costs” within the meaning of s51, or “necessary disbursements” under rule 2.67(1)(f) of the Rules: they were fees claimed against PCFC by Neumans.

If s51 applied at all, it could only be in relation to costs incurred by PCFC, and it made no sense to order a company to pay costs to itself.  An order under s51 would not result in Neumans being paid. Neumans were effectively seeking an order that their fees be given priority as an administration expense despite the fact that they were not included in the permissible class of administration expenses.  Section 51 did not give the court the power to make an order indirectly turning solicitors’ fees into administration expenses.

Secondly, the Rules did not provide for payment of solicitors fees as an expense in an out of court administration.  The court had no power to direct the administrators to treat them as administration expenses. Neumans had not been retained by the administrators for the administration, and payment of their fees would adversely impact unsecured creditors and other persons entitled to be paid administration expenses.

Thirdly, however, certain items of Neumans’ fees were payable as an expense of the liquidation (rather than of the administration) under rule 4.218(3)(h) of the Rules. This was because those directing PCFC’s affairs had considered that it was in PCFC’s best interests to oppose the petition and to apply to strike it out (even though that application had not been successful). The work Neumans had done on the petition had therefore been in PCFC’s best interests. Neither the administrators or liquidators opposed that result.

Second half: claimants 0, defendants 2

Neumans appealed Morgan J’s decision. Their main argument was that the judgment was contrary to public policy, as embodied in the statutory regime and the case law. They argued that it was not in the public interest that solicitors who had provided proper and often urgent advice and representation to a distressed company (thereby also benefiting its creditors) should be treated like an ordinary unsecured creditor.

Moreover, the Rules clearly provided that the costs of a winding up should be paid as an expense in the administration where the petition had been overtaken by an application for an administration order (see for example rule 4.128(1)(h), rule 2.12 and rule 2.67(1)(c)). Neumans argued that “on reason, principle and justice” the same should apply where the petition was overtaken by another type of insolvency process. The lack of express provision to that end in the Rules was “almost certainly an oversight”, which left an “obvious, unjustifiable and serious lacuna in the insolvency costs regime”.

The Court of Appeal disagreed, holding that Morgan J’s order had been “dead on”.  The courts would not take a purposive approach to construction.  Morgan J had been correct to dismiss the argument that solicitors should not be treated as ordinary unsecured creditors if administrators were appointed out of court. Solicitors could protect their position by seeking indemnities or third party funding from those behind or associated with the company.

Any lacuna or anomaly in the Rules should be addressed by the legislature: there was “no case for judicial legislation dressed up as benevolent statutory interpretation”.

Impeccable refereeing

The Court of Appeal was fulsome in its praise for Morgan J’s “impeccable judgment”.  Mummery LJ concluded that no sensible purpose would be served by the Court of Appeal repeating in its judgments detailed discussions of every point raised in the appeal when they had already been dealt with correctly and in detail in the first instance judgment.

He further commented that the judiciary was not a bureaucracy, and neither was it in the business of “earning by churning”.  The proper administration of justice did not require another long and complicated judgment only to repeat what had already been fully explained in a sound judgment.  If the judgment below is correct, the Court of Appeal can legitimately adopt and affirm it without any obligation to say the same thing again in different words.  Mummery LJ therefore adopted Morgan J’s judgment without reservation and affirmed his order.

Match of the day

In order to aid practitioners and the courts in future cases, the Court of Appeal put together a brief summary of the main points by setting out legal propositions relevant to the case and the conclusions reached when they had been applied.  These are summarised below:

1. Fees owing to solicitors by a company in respect of an unsuccessful defence to a winding up petition may be payable as an expense of the subsequent liquidation.
2. There is no general principle of law or statutory provision making those fees payable where the company is administered out of court.
3. The Rules set out which liquidation and administration expenses may be paid in full ahead of ordinary unsecured creditors.
4. They expressly provide that where the court makes an administration order, the costs of the applicant and any person appearing that are allowed by the court are payable as an expense in the administration (rule 2.12(3)).
5. They do not provide that solicitors fees for opposing a winding up petition are payable as an expense in an out of court administration that may precede the company’s ultimate insolvent liquidation.  Those fees may be payable as an expense of the liquidation (rule 4.218(3)(h)).
6. The list contained in the Rules at 2.67 is a complete list of the expenses allowed in an out of court administration.  It does not include the fees at issue in this case.
7. The court has no power to direct the administrators to treat those fees as an administration expense. The fees were not incurred in connection with the performance of the administrators’ functions. Their payment would not be necessary or incidental to their performance of that duty under para 13 of Schedule 1 to the 1986 Act. Neither were they for the purpose of the administration under para 66 of Schedule 1, as they were directed at preventing a compulsory winding up.
8. The court has an inherent power to give the administrators directions but it would not be a correct exercise of that jurisdiction to make the order sought.  It would be inconsistent with the complete list of expenses set out in the Rules.
9. The court has no power under s51 SCA 1981 to make an order that would directly or indirectly result in the payment of Neumans’ fees as an expense of an out of court administration. The solicitors’ fees are not costs within s51; they are unpaid fees owed by the company.
10. In this case the firm’s retainer had been terminated before the administration; paying the fees would not benefit the administration, and would adversely affect the position of unsecured creditors and others with claims for expenses.
11. The court has power to allow certain solicitors fees as expenses of the liquidation (rule 4.218(3)(h)).
12. The court may exercise that power to allow payment of particular items as expenses of the liquidation, whether they were incurred by the company in unsuccessfully opposing a petition or in unsuccessfully seeking to strike it out.

Post-match analysis

Mummery LJ’s précis of the first instance judgment was intended to “stem the soaring costs of litigants when their advisers have to spend too long working out what the law is”.  The Court of Appeal is hoping to move away from the situation where lawyers and the public are faced with a plethora of separate, complex, discursive and sometimes cross-referential decisions. How successful the Court is in this undoubtedly laudable aim remains to be seen.

In the meantime, insolvency practitioners have been given some useful guidance on the courts’ approach to administration and liquidation expenses.  If they are not in the Rules, they will not be allowed.  Solicitors acting for distressed companies should heed the Court’s warning and seek to protect their costs position from the outset by seeking third party funding or negotiating indemnities with the directors of any potentially insolvent company.

This article was published in Insolvency Intelligence in October 2013.

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