Important Developments in Cross-Border Insolvency Law; Administration Expenses
Freshfields Bruckhaus Deringer; London
Also Written by:
Freshfields Bruckhaus Deringer; London
Web posted and Copyright © December/January 1, 2007, American Bankruptcy
Editor's Note: In this era of chapter 15, the EU Regulation on Insolvency Proceedings and Model Law, it is heartening to find that there is still life yet in the common law in cross-border cases. Bizarrely, given the levels of commerce between the United Kingdom and the United States, throughout the s.304 era there was no equivalent statutory means for cooperation and assistance to be requested and obtained in the United Kingdom in a bankruptcy case originating in the United States. One had the common law, and that was it. The Navigator case, discussed below, shows just how strong a tool the common law can be. The second case considered this month deals with the vexed topic of the priority to be given to the payment of particular types of expenses in a U.K. administration. The interest to a U.S. reader of this topic is most acute where there are parallel bankruptcy filings; what is one jurisdiction's priority expense may be another jurisdiction's unsecured claim. Practitioners beware!
The Privy Council has extended the common law approach to judicial assistance in cross-border insolvency cases. In Cambridge Gas Transport Corporation v The Official Committee of Unsecured Creditors,  UKPC 26, the court held that the Isle of Man court, having recognised a U.S. chapter 11 proceeding, had a broad discretion to assist in the implementation of that chapter 11 plan, notwithstanding that this involved the transfer of shares in an Isle of Man company.
In 2003, a group of deeply insolvent Isle of Man companies ("Navigator") went into voluntary chapter 11 proceedings in the United States. The chapter 11 reorganisation plan, approved by the U.S. court after lengthy and contentious proceedings, essentially called for Navigator's assets to be transferred to creditors (a debt-for-equity swap). As these assets were ultimately owned by a Manx company, the plan called for the shares in the top parent company to be transferred to a representative of creditors.
Through a Letter of Request, the U.S. court then formally asked for the assistance of the Manx High Court of Justice in giving effect to the chapter 11 plan. This was objected to by a shareholder of the Navigator parent, Cambridge Gas Transport Corp., on the basis that the U.S. court order could not affect its rights of property in Manx shares as Cambridge had itself never submitted to the personal jurisdiction of the U.S. court. Having succeeded in the Manx High Court and lost in the Manx Court of Appeal, Cambridge appealed to the Privy Council.
In unanimously rejecting the appeal, the Privy Council observed that the claim that Cambridge had not submitted to the jurisdiction of the U.S. courts was "technical in the highest degree" (the Cambridge directors and shareholders having actively participated in the U.S. bankruptcy proceedings in those capacities) and that the shares were in any event "completely and utterly useless."
But the case is of much wider significance. The court breathed new and welcome life into the principle of the universality of bankruptcy, the notion that, ideally, bankruptcy proceedings should have worldwide application. With this in mind, the court did not accept that the case required a decision on whether or not the U.S. confirmation order was a judgement of a type that could be enforced under traditional rules of law. Instead, the starting point was a refreshing description of the very nature of bankruptcy proceedings themselves:
the purpose of bankruptcy proceedings...is not to determine or establish the existence of rights, but to provide a mechanism of collective execution against the property of the debtor by creditors whose rights are admitted or established... The important point is that bankruptcy, whether personal or corporate, is a collective proceeding to enforce rights and not to establish them.
Applied to suit the context of a modern cross-border case, these principles were found to be sufficient to give the Isle of Man court jurisdiction to assist the U.S. court in the manner requested. Once the U.S. bankruptcy proceedings themselves had been recognised, a discretion to assist arose as a matter of common law to do whatever the Manx court could have done in the case of a domestic insolvency. This would include a transfer of shares in a Manx company to the representative of creditors without the need for any parallel Manx insolvency proceedings to do so.
Interestingly, the court also found that Cambridge, as shareholder, was bound by transactions entered into by the company in which Cambridge owned shares. When properly understood, this was one of the incidents of the ownership of shares and had to be accepted. Indeed, it was one of the reasons why the court can sanction a scheme of arrangement which leaves shareholders with nothing. The Navigator parent company having chosen the chapter 11 option, the shareholders were in effect bound into that process. Conversely, had the court been presented with a confirmed chapter 11 plan that treated the shareholders unfairly, there would have been discretion to refuse assistance notwithstanding recognition of the foreign bankruptcy proceedings themselves. This was not the case on the facts of this litigation.
There is much food for thought in the Navigator litigation. Although parallel proceedings may well remain the preferred approach to cross-border restructurings, this case gives advisors the opportunity to reflect on whether such proceedings are necessary in any given situation. On the facts before them, the Privy Council effectively concluded that parallel proceedings to give effect to the U.S. plan were not necessary. There could be many other situations where the same reasoning could apply.
Having found the common law of cross-border insolvency to be in a state of what they described as "arrested development," the Privy Council has left it a much fitter vehicle for dealing with future cross-border restructurings.
Administration Expenses: Courts and Policy
Freakley v Centre Reinsurance International Company1
The House of Lords has ruled that insurers are not entitled to reimbursement of claims-handling costs, incurred after the appointment of administrators, as administration expenses. Such costs will be treated as ordinary unsecured claims and will not have a statutory priority over other costs of the administration, the floating chargeholder or the unsecured creditors of the company. The judgment relies not only on interpretation of the relevant statutory provisions, but also on a helpful dose of policy.
While this may appear to be a rather narrow point of law, as we have previously written in this column (see the December/January 2006 edition and further below), whether or not certain liabilities have "super-priority" status as administration expenses is significant. It affects how administrations are conducted, the U.K. rescue culture in general and the extent to which U.S. practitioners may assume that administration resembles chapter 11.
T&N Ltd. went into administration in October 2001 when it appeared likely to become unable to pay its debts due to a large number of possible tort claims arising out of the use of asbestos in its products. Under the terms of the company's asbestos liability policy, the company was entitled to be indemnified against its "ultimate net loss" in excess of a "retained limit" of £690m and up to an insurance limit of £500m. "Ultimate net loss" included both established liabilities under asbestos claims and the costs of defending and handling such claims. The policy provided that the insurers had the exclusive right to handle and defend claims following the occurrence of an "insolvency event" (defined to include the presentation of an administration petition) or if the retained limit was reached.
It was accepted that in handling claims, instructing solicitors and so forth, the insurers acted as agents for the company and were entitled to reimbursement for their expenses. The insurers contended that their claim to reimbursement of claims-handling expenses fell within s19(5) of the Insolvency Act 1986 (the Act). They lost at first instance, but won in the Court of Appeal. The administrators appealed.
Relevant Statutory Provisions
Section 19(4) and (5) of the Act provide, in respect of an administrator, that:
(4) His remuneration and any expenses properly incurred by him shall be charged on and paid out of any property of the company which is in his custody or under his control at that time in priority to any security [under a floating charge].
(5) Any sums payable in respect of debts or liabilities incurred, while he was administrator, under contracts entered into...by him or a predecessor of his in the carrying out of his or the predecessor's functions shall be charged on and paid out of any such property as is mentioned in subsection (4) in priority to any charge arising under that subsection.
The House of Lords Decision
The leading judgment held that:
• the insurers' claims-handling expenses did not fall into either s19(4) or (5) of the Act; and
• there was no policy reason why the court should give such expenses priority over the company's debts.
The court did not accept that anyone with authority to act on behalf of the company must be deemed to have derived his authority from the administrator. Prior to the administration, the company may have authorised somebody to contract on its behalf. Such contracts, as in this case, are made on behalf of the company but not on behalf of the administrator.
The court was willing to assume that the Court of Appeal decision had been correct that the claims-handling expenses incurred by the insurers were necessary to the carrying out of the purposes for which the administration order was made. Yet this did not make them liabilities under contracts entered into by the administrator (as required under s19(5)).
The Importance of Policy
The most revealing part of the judgment is the statement that there is no reason of policy why the insurers' claim to reimbursement of claims-handling expenses (which might or might not be in the interests of the administration) should be given priority over the company's debts. The court analysed the general purpose behind the pre-Enterprise Act administration regime2—to impose a moratorium on claims to allow time to find a way of saving the business or to effect a realisation of the assets to better advantage than in a liquidation. It was not intended to alter substantive rights or priorities more than was necessary to enable this objective to be achieved.
The provisions of s19(4) and (5) entrusted to the administrator (subject to the supervision of the court) the power to decide what expenditure was necessary for the purposes of the administration and should therefore receive priority. There was no reason to extend that priority to expenditure that neither the administrator nor the court had specifically approved. Following the Atlantic Computers principle,3 the court had a broad discretion to authorise or direct the administrators to make payments or enter into contracts for the purposes of the administration. In the exercise of that power, the court could direct the administrator to authorise or ratify particular claims-handling expenditure by the insurers, with the result that their rights to reimbursement would have priority under s19(5). However, it would be unusual for the court to do so where the administrator had already determined that such expenditure was not necessary for the very limited purposes of the administration.
According to the House of Lords in Toshoku Finance,4 liabilities arising after the making of a winding-up order should be treated as liquidation expenses. It is interesting to consider how the result in this case might have been different had such logic been followed. This would have resulted in an unfortunate loss of control by administrators as to what are expenses of the estate. As such, the policy analysis underpinning the judgment is to be welcomed.
In some jurisdictions the powers of the directors do not cease upon filing (e.g., in debtor-in-possession jurisdictions such as the United States). In contrast, in other jurisdictions, the powers of the directors cease automatically unless the court orders otherwise (for example, in an English administration). Where there are parallel filings, there could be an issue as to whether expenses incurred by the directors of the debtor-in-possession could be expenses in the parallel insolvency proceeding, even though they are not incurred as a consequence of any active step of the officeholder in the parallel proceeding. While practitioners have generally developed control techniques to minimise this risk, authorities such as Toshoku Finance had caused concern that expenses might be deemed to arise automatically without intervention of the officeholder.
The case is helpful in alleviating such concerns since it steers the policy of the courts in this area back toward the need for some positive intervention of the officeholder that results in the expense falling within s19(4) or (5) of the Act or under the Atlantic Computers principle. The precise role of the relevant insolvency officeholder will, of course, be relevant (e.g., whether they merely oversee the decisions of the directors in the parallel proceeding or are actively engaged in authorising the directors there to incur expenses).
Recently, there have been a number of important cases involving administration expenses: In In Re Ferrotech Ltd., Re Granville Technology Group Ltd. and Re Huddersfield Fine Worsteds Ltd.,5 the Court of Appeal held that most payments in lieu of notice and protective award payments for the period of the adoption of a contract are not "wages or salary" for the purposes of paragraph 99 of Schedule B1 to the Insolvency Act 1986 (and so are not administration expenses). A decision is also expected in the next few months as to whether certain business rates are administration expenses. The House of Lords decision is a further clarification in a complicated area.
1  UKHL 45.
2 The Enterprise Act 2002 introduced significant changes to the administration regime with a view to streamline the procedure. Nevertheless, the general purpose behind the new regime remains broadly the same.
3 In re Atlantic Computer Systems plc,  Ch 505,  1 All ER 476,  BCLC 606.
4 Re Toshoku Finance UK Ltd plc,  UKHL 6,  1 WLR 671.
5  EWCA Civ 1072. This case was analysed in the European Update column in the December/January 2006 issue.