Settlement agreements and the application of the Insolvency Act 1986

A recent High Court decision can potentially profoundly affect the actions of liquidators in their dealings with former directors and/or employees once a winding-up petition has been presented and before a winding-up order is made. John Churchill, barrister at Guildhall Chambers, examines this decision and says it reaffirms section 127 of the Insolvency Act 1986 (IA 1986) as a powerful tool to protect assets for creditors.

Original news

Officeserve Technologies Ltd (in compulsory liquidation) and another v CAM [2017] EWHC 1920 (Ch), [2017] All ER (D) 37 (Aug)

The settlement agreement entered into by the first applicant company and the respondent, governing certain claims or potential claims by each against the other, did not release the respondent from his obligations to the company in his capacity as a director. The Chancery Division held that the agreement released the respondent from claims connected with or arising out of his employment and not connected with or arising out of his holding an office.

What was the background to the case?

HHJ Matthews gave judgment on preliminary issues in an application that the respondent founder and former shareholder (the respondent) of the applicant company (the company, subsequently in liquidation) had misapplied monies belonging to the company.

Following the presentation of the winding-up petition against the company (but before the winding-up order was made), the respondent and the company concluded a settlement agreement. By this ‘settlement agreement’ the company agreed it would waive any claims against the respondent. On the part of the respondent, his shares in the company, other benefits, and rights including all ‘employment claims’ were given as ‘consideration’ to the company (to facilitate an agreement with one of the company’s largest creditors). The legal effect of this settlement agreement, which was concluded as a deed of release was the question which the court had to consider (as the ‘agreement’ was concluded as a deed the term ‘consideration’ above is used as a label of convenience rather than denoting the legal characterisation of the obligations created).

What were the legal issues the court had to decide?

The legal issues between the parties were:

  • whether any or all of the claims brought by the company (acting by its liquidators) against the respondent were to be barred pursuant to the terms of the settlement agreement (the construction issue)
  • whether (if the settlement agreement did bar any claims made by the company against the respondent) the settlement agreement was rendered void by section 127 of the Insolvency Act 1986 (IA 1986)

What did the court decide, and why?

The court found for the company on both issues, deciding the settlement agreement did not, on its true construction, release the respondent from his obligations to the company and that even if the agreement did have that effect IA 1986, s 127 would render such releases of the respondent’s obligations void. In the event that any such dispositions were void under IA 1986, s 127 the court would not validate any such releases.

The construction issue

HHJ Matthews considered at length recent appellate decisions on the interpretation of contracts, dwelling in particular on the summary given in Globe Motors Inc v TRW Lucas Varity Electric Steering Ltd [2016] EWCA Civ 396, [2016] All ER (D) 171 (Apr), by Beatson LJ (at paras [56]–[62]) and that of Lord Hodge in Wood v Capita Insurance Services Limited [2017] UKSC 24, [2017] All ER (D) 182 (Mar) at paras [9]–[14].

The analysis given by HHJ Matthews provides a detailed assessment of the factual matrix in which this particular agreement was concluded, including looking at:

  • what the parties were seeking from the agreement and their commercial objectives
  • the time limits imposed by the winding-up petition, and
  • the presence on both sides of legal advice (paras [48]–[49])

Two conclusions of HHJ Matthews bear particular note:

  • first, the court paid attention to the asymmetrical rights and obligations between the company and the respondent in respect of future claims. The wider release clause granted by the respondent to the company had to have some significance in construing the seemingly narrower release clause granted by the company to the respondent, even if both releases appeared to be widely drafted (para [50])
  • second, the absence of certain words in the release of claims by the company against the respondent (even if there was evidence of the parties entering the negotiations to achieve the result that those words would produce), could be an indication that the negotiations had shifted the agreement between the parties to a different contract to that envisaged at the outset of those negotiations (paras [50]–[54])

The IA 1986, s 127 issue

Although unnecessary given its conclusion on the construction issue, the court turned to whether the settlement agreement could be viewed as a disposition of the company’s property to fall within IA 1986, s 127, the key part of which states that:

‘[…] in a winding up by the court, any disposition of the company’s property, and any transfer of shares, or alteration in the status of the company’s members, made after the commencement of the winding up is, unless the court otherwise orders, void’.

This required analysis of the Supreme Court’s decision in Akers v Samba Financial Group [2017] UKSC 6, [2017] All ER (D) 06 (Feb).

In Officeserve, the company argued that the proposed claims by the company against the respondent constituted ‘property’ (under IA 1986, s 436) which was ‘disposed of’ by the settlement agreement and which rendered the settlement agreement void.

In contrast, the respondent argued that:

  • the extinguishment of claims was not caught by IA 1986, s 127
  • it would pose wider practical difficulties for liquidators in future were the court to hold that settlement agreements with employees were to be caught by the section, and
  • the purpose of IA 1986, s 127 was to invalidate dispositions and not contracts/transactions themselves (this was why the word ‘dispositions’ had been chosen)

The respondent’s further argument was that the company was estopped (if the dispositions were void under IA 1986, s 127) from bringing any claims and that accordingly the court should validate any dispositions it felt were caught by IA 1986, s 127.

HHJ Matthews referred to the Australian case of Re Mal Bower’s Macquarie Electrical Centre Pty Ltd [1974] 1 NSWLR 254 where Street J held that the paying of the company’s cheques by a bank from the company’s account to the strangers who presented the cheques did not involve a disposition. The grounds upon which this decision was based included the absence of a sufficient link between the proposed disponee (the recipient stranger) and the disponor (the company) which was not affected by the actions of the disponor’s agent (the bank).

Another ground of Street J’s decision was the etymology of ‘disposition’ in Scots law (but as HHJ Matthews noted no direct reference was made to the existing English cases on the term at the time). HHJ Matthews questioned elements of the Re Mal Bower’s decision. Why for example did the payment out of the cheques of the company by the bank not involve a disposition by the company to the bank (para [77])?

HHJ Matthews then moved on to Akers and cited extracts from the judgments of Lord Mance (paras [52]–[55]), Lord Neuberger (paras [62]–[76]) and Lord Sumption (paras [89]–[90]). In all three judgments there was passing comment on whether the destruction, extinguishment or surrender of a right could amount to a disposition (see Lord Mance at para [55], Lord Neuberger at para [66] following his reference to Re Mal Bower’s and Lord Sumption at para [89]).

Their Lordships spoke of the need for a wide application to be given to IA 1986, s 127 and ‘disposition’. Many of the remarks (see, for example, Lord Sumption at para [89]) touched upon the case of a transfer to equity’s darling, rather than somebody whose conscience may have been affected by the transfer/extinguishment of whatever property was being discussed. Lord Neuberger explicitly distinguished the purchase by equity’s darling from the situation of a surrender (para [74]) due to the qualitatively different status of knowledge of the person acting as against the company which enabled the former to escape IA 1986, s 127 but not the latter.

In light of the comments made in Akers, HHJ Matthews held the release of contractual rights by a creditor company in favour of a debtor could constitute a disposition for IA 1986, s 127. There was no requirement in IA 1986, s 127 that identifiable property should pass from the company’s ownership to become the identifiable property of another, although the deliberate consumption or waste by the company of its assets or the mere effluxion of time on a wasting asset would not be covered. HHJ Matthews held:

…it is sufficient that identifiable property by some act having legal consequences (so excluding mere effluxion of time) ceases to be in the ownership of the company, so that it is no longer available to the liquidator of the company for statutory purposes, and the value accrues to some other person (so excluding consumption or waste), even though that other person cannot necessarily be said to become the owner of the same property’ (para [98]).

Accordingly, the court held the release by the company of any claims against the respondent as director was caught by IA 1986, s 127, and therefore any purported release was void, subject to the court’s validation.

On the question of estoppel by the company’s promise not to sue, HHJ Matthews emphasised the importance of analysing the substance of the transaction rather than the form, and that in either event the settlement agreement (by causing the company’s enforcement of any debt against the respondent to fail) would destroy the substantive obligation of the respondent. For the purposes of IA 1986, s 127, the court did not therefore look to how the obligation’s destruction was to be framed in law (in equity by estoppel or by the deed at common law) in deciding whether the disposition was void, rather it asked whether the mischief (the destruction of the company’s property) had occurred and whether the section applied on that basis.

On the question of validation, the court asked itself whether the validation of the settlement agreement extending to the rights of the director and the company was to the benefit of the interests of the general body of creditors (particular reference was made to Sales LJ’s decision in Express Electrical Distributors Ltd v Beavis and others [2016] EWCA Civ 765, [2016] All ER (D) 118 (Jul)). The respondent argued in any event that the company had insufficient resources to take proceedings against the respondent and/or that the pursuit of the claim was not viable on a commercial basis. The court declined to validate the transaction on that basis. Since the settlement agreement which had been invalidated sought to deprive the company of its property it was not appropriate for the court to take decisions for the liquidators on what they should do with their property unless the liquidators had sought directions to that effect (paras [113]–[117]).

To what extent is the judgment helpful in clarifying the law? What practical lessons can those advising take away from this judgment?

In terms of the contractual issue, this decision again highlights the useful clarity that Beatson LJ’s judgment in Globe Motors has given following a tumultuous period in contractual interpretation in the highest appellate courts. It also makes clear that an analysis of the factual matrix leaves few elements of the contract’s conclusion unturned. The analysis of a court can be broad. Moreover, the presence of lawyers at a negotiation can be a double-edged sword. If those lawyers explain what their objectives were beforehand, they can risk the court asking whether the agreement extended to those objectives if the subsequent contract does not explicitly cover them in terms.

This decision has the potential to profoundly affect the actions of liquidators in their dealings with former directors and/or employees once a winding-up petition has been presented and before a winding-up order is made. In stepping into the ground prepared in Akers but not expressly trodden by their Lordships in the Supreme Court, this case has reconfirmed the practical efficacy of IA 1986, s 127 as a tool to protect assets for creditors. Those seeking to rely upon a company’s release from obligations owed to it should be wary. The terms used by HHJ Matthews at para [98] are broad and ‘identifiable property’, ‘legal consequences’, ‘available’ and ‘value’ are capable of application in a wide variety of contexts. As a consequence of this judgment it appears IA 1986, s 127 is hyper-sensitive to the valuable reduction in the company’s property and its accretion to another, but relatively blind as to the form that these steps can take.

Interviewed by Lucy Trevelyan. First published on Lexis PSL Restructuring and Insolvency.

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

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