Dividends and loan repayments in a construction insolvency—Evans v Jones

What is the status of dividends and loan repayments in the context of insolvency following the decision in Evans v Jones? Simon Passfield of Guildhall Chambers, who represented the respondents in this case, says when considering the balance sheet position of a company for the purposes of a claim under section 238 or section 239 of the Insolvency Act 1986 (IA 1986), it is necessary to consider the commercial reality of the position.

Original news

Evans and another v Jones and another [2016] EWCA Civ 660, [2016] All ER (D) 36 (Jul)

The Court of Appeal, Civil Division, allowed the joint liquidators’ appeal against a judgment that had ruled on their application under IA 1986, s 239. The judge had erred in having taken into account, in assessing the solvency of the company, a dividend that had been paid to the defendant director/shareholders which had been shown during the course of the liquidation to have been an unlawful dividend.

What was the background to the appeal?

The respondents were the directors and shareholders of Rococo Developments Ltd (the company), a property development company. On 1 June 2010, the company paid a dividend of £75,000 to the respondents. Between 3 June 2010 and 18 March 2011, the company repaid various loans made by the respondents. On 21 April 2011, the company was placed into creditors’ voluntary liquidation.

Subsequently, the liquidator issued a claim:

  • to challenge the dividend as being unlawful pursuant to section 847 of the Companies Act 1986, and
  • to challenge the loan repayments as preferences pursuant to IA 1986, s 239

The parties instructed a single joint expert to prepare a report on the following issues:

  • whether the company had sufficient distributable reserves to justify the dividend, and
  • the solvency of the company at the time of each of the loan repayments

As regards (i), the expert held that the company’s accounts should have made provision for a claim which had been made against the company by a contractor and which subsequently resulted in an adjudication award. If that provision was included, the company would not have had sufficient distributable reserves to justify the dividend.

As regards (ii), the expert concluded that the company was balance sheet insolvent when four of the five payments were made. However, he noted that if the dividend was treated as an asset of the company (on the basis that it was unlawfully paid and therefore void) the balance sheet would be returned to solvency.

After receiving the expert’s report, the respondents accepted that the dividend had been unlawful and agreed to repay it. At the trial of the preference claim, HHJ Jarman QC held that the loan repayments constituted preferences. As to the question of solvency, he accepted that it was necessary to include a provision in respect of the contractor’s claim. However, he also held that the dividend should be treated as an asset of the company for the purpose of assessing its company’s balance sheet position. In consequence, he held that the company was solvent at the time of each of the loan repayments and therefore dismissed the preference claim. The liquidator appealed against that decision.

What were the legal issues the Court of Appeal had to decide?

It was common ground that the balance sheet test in IA 1986, s 123(2) requires the court to compare a company’s present assets with its present and future liabilities (discounted for contingencies and deferment) and that contingent assets are left out of the assessment.

The issue which the Court of Appeal had to decide was whether HHJ Jarman QC was right to treat the dividend as a present asset to be included at full value in the assessment.

What were the main legal arguments put forward?

The appellants argued that the dividend was a contingent asset at the date of the loan repayments because at the time of payment the respondents (the sole directors and shareholders of the company) had believed that it was lawful, and therefore the company’s claim for repayment was unknown until the company subsequently entered liquidation.

They further argued that the judge’s treatment of the dividend was inconsistent with his treatment of the company’s liability to the contractor—he had used the benefit of hindsight in determining the appropriate value to place on the former but had expressly disavowed hindsight in valuing the latter.

The respondents argued that the fact that the dividend was believed to be lawful at the time of payment was irrelevant. As a matter of law, the dividend was unlawful. In consequence, the monies paid to the respondents were held by them on constructive trust for the company and therefore the dividend remained an asset of the company. In the circumstances, the dividend was a present asset of the company.

They accepted that the judge was entitled to use hindsight in valuing both the dividend and the liability to the contractor but noted that the appellants had not sought to appeal the judge’s finding in relation to the value of the latter.

What did the Court of Appeal decide, and why?

The Court of Appeal held that at the date of the loan repayments the company’s entitlement to repayment of the dividend was contingent on the claim against the respondents being discovered and pursued. It was therefore a contingent asset which should not have been taken into account in assessing the company’s balance sheet position.

HHJ Jarman QC was wrong to treat the company as having a present asset of £75,000 because that required the court to make the following (incorrect) assumptions:

  • the unlawfulness of the dividend was known
  • someone on behalf of the company would have pursued the claim before it went into liquidation
  • the respondents would not have disputed the claim
  • the monies would have been recovered from the respondents without cost, and
  • the company had the funds to pursue the claim—that approach failed to accord with commercial reality

As a result, the court held that the company was insolvent at the time of the loan repayments and thus that those payments were made at a relevant time for the purposes of IA 1986, s 239.

To what extent is the judgment helpful in clarifying the law in this area?

Lewison LJ acknowledged that the facts of the present case were ‘very peculiar’. Nevertheless, the judgment reaffirms the commercial approach to the assessment of insolvency adopted by the Supreme Court in BNY Corporate Trustee Services Ltd v Eurosail-UK 2007-3BL plc [2013] UKSC 28, [2013] 3 All ER 271.

What practical lessons can those advising take away from this case?

When considering the balance sheet position of a company for the purposes of a claim under IA 1986, ss 238 or 239, it is not sufficient to adopt a mechanistic approach to the valuation of its assets and liabilities. Rather, it is necessary to consider the commercial reality of the position.

Interviewed by Nicola Laver.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

Further Reading

If you are a LexisPSL subscriber, click the links below for further information:

Cashflow and balance sheet tests for insolvency

Can a liquidator or an administrator challenge or unwind transactions entered into by the company before it was wound up or entered into administration?

Not a subscriber? Find out more about how LexisPSL can help you and click here for a free trial of LexisPSL Restructuring and Insolvency.

First published on LexisPSL Restructuring and Insolvency

 

Relevant Articles
Area of Interest