Section 234 and 236 orders—who pays for the costs of complying?

Why did Mr Registrar Jones decide not to allow the respondents in Re Harvest Finance Ltd to charge for the time incurred in delivering documents and electronic files to the liquidators of Harvest Finance Ltd pursuant to an order made under the Insolvency Act 1986 (IA 1986), ss 234 and 236? Rory Brown, barrister at 9 Stone Buildings who acted for the liquidators, discusses the court's decision.

Original news

Re Harvest Finance Ltd (In Liquidation); Jackson and another v Cannons Law Practice LLP and others [2014] EWHC 4237 (Ch), [2014] All ER (D) 216 (Dec)

Following successful application for relief by liquidators under the IA 1986 , ss 234 and 236, the Companies Court considered whether it had jurisdiction to order payment of expenses incurred by the respondent solicitors in complying with an order for the delivery up of documents and electronic files. The court held that, in the circumstances, it should not, in the exercise of its discretion, allow the respondents to charge for the time incurred.

What was the background to the application?

The applicants were liquidators of a company suspected to have been used as a vehicle for a massive international fraud, relating to loans charged on securities with apparently artificially inflated values. The respondents were a solicitors' firm and its solicitors personally who had acted (or had in a previous incarnation acted) for many of the special purpose vehicles created in pursuance of the scheme under investigation. The application (made under the IA 1986, ss 234 and 236) was, broadly speaking, for identification and retrieval of documents under the respondents' control and required by the liquidators to investigate that suspected fraud.

It is important at the outset to note that it was not found by the court that the respondent solicitors had any knowledge of, or any hand in, any fraud.

What were the legal issues that the Registrar had to decide in this application?

The application threw up various issues, in particular:

  • whether the court should override any legal privilege attached to files sought by the applicants and controlled by the respondents
  • whether, once orders against the respondents were made pursuant to the court's powers under IA 1986, ss 234 and 236, the court had jurisdiction to order payment of the respondents' costs of identifying and retrieving files retained in their electronic archives (compliance costs), and if so
  • whether the court should order payment by the applicants of the respondents' considerable compliance costs
  • what orders should be made in respect of the parties' legal costs of the application

Why did these issues arise?

The question of waiving privilege arose because the respondents refused to produce client files without protective orders from the court in circumstances in which the contents were or might have been privileged.

After compulsory orders were made pursuant to IA 1986, ss 234 and 236, the dispute about compliance costs arose because there were conflicting or at least tricky-to-reconcile High Court authorities on whether the court had power to award such compliance costs (Re Aveling Barford [1988] 3 All ER 1019 (Hoffman J) and Re Cloverbay [1989] BCLC 724 (Vinelott J)). Furthermore, while the liquidators were content to pay the solicitors £500 to locate and deliver up relevant client files, they considered the sum of circa £40,500.00 (ex VAT) sought by the solicitors to be wildly disproportionate to the administrative task concerned. (In pre-action correspondence, the respondents had made an undertaking to pay these costs a pre-requisite of provision of the material sought.)

Finally, the litigation is ongoing—the incidence and amount of legal costs to be awarded (if any) remains finally to be determined. Both parties have made applications for the other to bear their legal costs of and incidental to the application.

What did the Registrar decide?

After surveying and applying the authorities to the insolvency context, the Registrar determined that, when considering displacing privilege, the court should ask whether the evidence plainly established a strong prima facie case for the investigation by the liquidators of criminal or fraudulent conduct. In respect of the particular legal privilege of the unrepresented clients or former clients of the respondents, he found the applicants' evidence established a strong prima facie case of criminal or fraudulent conduct. (It is noteworthy that the total security for the material loans had been valued at £161m and yet the properties had been sold for only circa £8m.) In the circumstances, any privilege that existed in the documents controlled by the respondents should be displaced.

As for the compliance costs, after hearing argument on the authorities and on the interpretation of the statute and relevant rules (see the Insolvency Rules 1986, r 9.6), the Registrar initially proceeded on the basis that he had jurisdiction to award the respondents their compliance costs.

However, he then stated that he may not need to choose whether or not there was jurisdiction, given that the practical effect for the application before him was the same. That is to say, even if he had such a power, he would not award the solicitors their time costs of complying with the order.

To what extent are the judgments helpful in clarifying the law in this area? Do they have wider practical application?

The judgments contain a detailed and careful treatment of both the facts and the authorities on:

  • the displacement of legal privilege in the context of fraud, and
  • the nature of the public duty to identify and produce (or allow access) to information and documents

The judgment on privilege advances the jurisprudence on the fraud exception to privilege in the context of the court's exercise of its compulsory powers under the insolvency regime. It does so by formulating a test for the court to apply when considering overriding privilege. The first trilogy of judgments is therefore required reading for practitioners in that field. More generally, the authority will be relevant wherever the court must consider whether to override the legal privilege of unrepresented parties.

As for the judgment on the court's jurisdiction to award compliance costs and the circumstances in which such costs will be awarded, in light of the deferential approach of the Registrar to the views of Vinelott and Hoffman LJJ, advocates may still argue the court has no jurisdiction to award such compliance costs. That said, the reasoning of the Registrar, elaborated in the exercise of the jurisdiction of the High Court, and based on a thorough survey of the authorities and painstaking analysis of the rules, is likely to command considerable respect in any superior tribunal. However, before placing reliance on the judgment on compliance costs, advisers will wish to check it has not been appealed by the respondents.

If so, what practical lessons can those advising take away from this case?

  • The court is eager to facilitate investigation into potential frauds and will readily set aside legal privilege to do so, where the test set out above is satisfied.
  • The public duty to assist those undertaking such an investigation is not to be taken lightly. Any failure to act in accordance with that duty will expose a respondent to such an application to adverse costs consequences. Furthermore, the public duty arising in respect of information needed by liquidators to carry out their statutory duties creates a strong reason per se for not awarding costs of compliance.
  • The quantum of compliance costs with such orders and the very jurisdiction of the court to award such costs can be expected to be a future battleground, not least given:
    • the Registrar's decision not to decide whether jurisdiction exists
    • the potentially stifling effects of such costs on liquidators' investigations into illegal use of company assets, and
    • the potential burdens both in terms of time and expense of the public duty to assist.

Interviewed by Diana Bentley.

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

Further Reading

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Basic principles—the delivery-up of information and property to the insolvency office-holder

Checklist and time-line for evidence and property collection

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First published on LexisPSL Restructuring and Insolvency

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