Insolvency

Case Alert - Court oversight of unfairness in insolvencies

Lehman Bros Australia Ltd v MacNamara

Overview

In this Lehman Bros decision, the UK Court of Appeal[1] examined the scope of the court's inherent jurisdiction to control the conduct of its officers.  Under the principles in Ex p James, Re Condon,[2] the Court applied a test of unfairness and required the administrator to correct a clerical error in calculating the settlement sum in a "Claims Determination Deed".  Strict reliance on clear contractual rights (including comprehensive release and full and final settlement clauses) would have been regarded as unfair by right-thinking people.  It was unnecessary to show that the administrator was acting unconscionably.

Facts

The respondent, LBIE (in administration), had followed a process calling for the proof of debts and quantification of claims in order to make a distribution. Given the scale of LBIE's business, a special regime was put in place to deal with the estimated 3,490 "street creditors" with claims aggregating some £4.8 billion. The administrators ran an optional claims determination process, designed to provide advantages of finality and early certainty through the use of an in-house valuation methodology culminating in the execution of standard form "Claims Determination Deeds" (CDDs).  

The applicant, LBA (in liquidation), elected to use that pathway. However, the figure arrived at was wrong as a result of a clerical error first made by the administrators' staff and then not subsequently noticed by LBA. Although initial spreadsheets exchanged between the parties listed the components of the claim correctly, a subsequent version of the spreadsheet incorrectly denominated one of the bonds in the wrong currency (Australian dollars instead of Euros), resulting in LBA's claim being undervalued by £1.67 million.

Following execution of the CDD (containing comprehensive release and full and final settlement clauses), the administrators paid LBA the agreed figure of £23.35 million.  The error was noticed 2.5 years later by a prospective purchaser of LBA's residual claims.  The LBIE administrators declined LBA's request to vary the amount of LBA's provable claim to the correct amount, on the basis of the release clause in the CDD.

Legal analysis

Relief was sought:

(1) under the court's inherent jurisdiction to control the conduct of its officers; and

(2) under paragraph 74 of Schedule B1 to the Insolvency Act 1986.[3]

Rectification was not sought, but LBA's right to seek it was reserved.[4]

The High Court declined the application. Hillyard J considered that the correct test under the inherent jurisdiction was one of "unconscionability". In any event, the judge's view was that there was no room for the application of either the principle in Ex p James or paragraph 74 (with a test of "unfairness") so as to direct an officeholder not to give effect to “contractual obligations freely entered into”. Assuming that the contract cannot be reformed or rectified, there is no unfairness in enforcing a full and final settlement agreement in accordance with its terms.

The Court of Appeal overturned that decision. It examined the correct threshold test for invoking the principle in Ex p James. Numerous terms have been used to describe the relevant standard over the past 165 years, including "dishonest", "dishonourable", "unworthy", "unfair" and "shabby". However, the Court did not regard any instances as providing binding authority for an unconscionability test. Rather, there was a proper basis in the authorities for a test of unfairness. Going back to the fundamental principle underlying the jurisdiction, the court will not permit its officers to act in a way which, although lawful and in accordance with enforceable rights, does not accord with the standards which right-thinking people or society would think should govern the conduct of the court or its officers. A challenge should not be regarded as an attack on an insolvency practitioner's personal integrity. Fairness is an objective standard, calling for judgment or evaluation in its application to particular facts. It is of course the case that different judges might reach different views, but that is true of any standard falling short of dishonesty.

In terms of paragraph 74 of Schedule B1 to the Insolvency Act 1986, it is expressed in wide terms, and it adopts the objective standard of fairness. It does not require discrimination, bad faith or improper purpose. Where an administrator is acting in accordance with his or her obligations under Schedule B1, there can be no question of causing unfair harm. Where, however, the administrator is exercising a discretion, but does so in a manner which unfairly harms a creditor, the court may grant relief in an appropriate case. In judging whether any conduct can be said to have caused unfair harm, it is a factor of great importance that the administrator is carrying out statutory functions and is or should be doing so in the interests of creditors as a whole, but that may still involve unfair harm to a particular creditor.

Applying those principles to the facts, the starting point was that a common mistake had been made, and no legitimate reason existed for the administrators not to correct it.[5]  Granting relief would not undermine the objectives of certainty and finality of the CDDs.  Correcting a common mistake was not akin to reopening negotiations with a view to obtaining a better deal, nor would it open any floodgates. There was nothing unfair in administrators being subject to court oversight, but not counter-parties if the mistake had gone the other way. The Court of Appeal concluded that no right-thinking person would think it fair for the administrators to stand on their strict contractual rights and refuse to correct a shared mistake. LBA were accordingly entitled to the relief under both grounds.

Conclusion

The principles in Ex p James, Re Condon are directly relevant for liquidators in New Zealand who are subject to the Court's inherent supervisory jurisdiction.[6] Similar principles would logically also apply to administrators and deed administrators, who are subject to the court's supervisory powers under Part 15A, subpart 17 of the Companies Act 1993.[7] In the New Zealand cases involving liquidators, unfairness has already been recognised as potentially sufficient for the threshold requirement. As this Lehman Bros decision demonstrates (with the Court of Appeal taking a view different from the High Court), it is not always easy to predict the view that a court might take on a question of "fairness". For administrators and liquidators exercising a discretion, it is not simply a matter of assessing legal rights and then relying on those when it would be in the interests of the creditors as a whole. The specific factual context is important.[8] A mistake causing an unexpected windfall is a common trigger for relief of this type.

[1] Lehman Bros Australia Ltd (in liq) MacNamara and others [2020] EWCA Civ 321, [2020] 3 WLR 147 (CA).

[2] Ex p James; In re Condon (1874) LR 9 Ch App 609; [1874-80] All ER Rep 388; (1874) 30 LT 773; (1874) 22 WR 937 (CA).

[3] "(1) A creditor or member of a company in administration may apply to the court claiming that (a) the administrator is acting or has acted so as unfairly to harm the interests of the applicant (whether alone or in common with some or all other members or creditors), or (b) the administrator proposes to act in a way which would unfairly harm the interests of the applicant (whether alone or in common with some or all other members or creditors) . . . (3) The court may (a) grant relief; (b) dismiss the application; (c) adjourn the hearing conditionally or unconditionally; (d) make an interim order; (e) make any other order it thinks appropriate. (4) In particular, an order under this paragraph may (a) regulate the administrators exercise of his functions; (b) require the administrator to do or not do a specified thing; (c) require a decision of the company's creditors to be sought on a matter; (d) provide for the appointment of an administrator to cease to have effect; (e) make consequential provision. (5) An order may be made on a claim under sub-paragraph (1) whether or not the action complained of (a) is within the administrator's powers under this Schedule; (b) was taken in reliance on an order under paragraph 71 or 72."

[4] Lehman Bros Australia Ltd (in liq) v MacNamara and others [2020] EWCA Civ 321, [2020] 3 WLR 147 (CA) at [26], referring to FSHC Group Holdings Ltd v GLAS Trust Corpn Ltd [2019] EWCA Civ 1362; [2020] Ch 365; [2020 2 WLR 429]; [2020] 1 All ER 505 (CA). 

[5] Although it is not explicit in the judgment, it seems that this did not create a shortfall or require disturbing any distributions already made - see Lehman Bros Australia Ltd v MacNamara and others [2020] EWCA Civ 321, [2020] 3 WLR 147 (CA) at [94].

[6] CIR v Livingspace Properties Ltd (in rec and in liquidation) [2020] NZHC 1434 at [168]; CIR v Robertson [2018] NZHC 696 at [52]; Strategic Finance Ltd (in rec & in liq) v Bridgman [2013] NZCA 357; [2013] 3 NZLR 650 at [108] to [120]; Henderson v Walker [2019] NZHC 2184 at [288] and ANZ National Bank Ltd v Sheahan [2012] NZHC 3037, [2013] 1 NZLR 674 at [137].

[7]  See the general power under s 239ADO, and the court's specific supervisory power under s 239ADS to make "any order it thinks just" if it is satisfied that the administrators or the deed administrator's conduct (or proposed conduct), or management of the company's business, property, or affairs, is "prejudicial to the interest of some or all of the company's creditors or shareholders".

[8] For example, in assessing whether a Deed of Company Arrangement ("DOCA") is unfairly prejudicial to a creditor, differential treatment of itself is insufficient to amount to unfairness, where: (1) the outcome under the DOCA is better than what the creditor would have obtained under a liquidation; and (2) differential treatment is necessary to preserve the going concern value of the underlying business: Cargill International (CA) v Solid Energy New Zealand Ltd [2016] NZHC 1817 at [95]-[97] and [114].