Trustees in bankruptcy and privilege—a spanner in the works? (Shlosberg v Avonwick Holdings)

Does a trustee in bankruptcy (TIB) acquire the benefit of the bankrupt’s legal professional privilege? Marcia Shekerdemian QC of Wilberforce Chambers considers the decision in Shlosberg v Avonwick Holidings Ltd.

Original news

Shlosberg v Avonwick Holdings Ltd and others [2016] EWHC 1001 (Ch), [2016] All ER (D) 76 (May)

The Chancery Division ruled that the claimant’s TIB had acquired the benefit of his legal professional privilege with respect to one of three categories of documents held by the second defendant solicitors, who were also acting for the claimant’s creditor (Avonwick). Both Avonwick and the claimant had been engaged in hostile litigation. In all the circumstances, no order was granted requiring the solicitors to cease acting for the trustees. However, an injunction was granted requiring the solicitors to cease acting for Avonwick.

Why does this case matter?

This case involved consideration of an important point of principle, namely whether and to what extent a TIB is entitled to obtain documents which were subject to legal professional privilege in favour of the bankrupt, prior to his bankruptcy.

Arnold J had to consider whether the TIBs of a bankrupt, Mr Shlosberg (S), could claim the benefit of the privilege attaching to three categories of document. It was common ground that prior to his bankruptcy, S would have been entitled to the benefit of any privilege attaching to those documents.

The issue arose within the framework of an application by S for an injunction restraining the solicitors from acting for his TIBs and for his major creditor (who had live proceedings pending against him).

Arnold J decided that in two out of the three categories, privilege remained with S.

Until Shlosberg, it had always been assumed that a TIB simply stepped into the shoes of the bankrupt and that accordingly, the TIB simply acquired the benefit of any privilege formerly exercisable by the bankrupt in relation to documents relating to his estate or affairs (see for example Re Murjani [1996] 1 All ER 65, Re Ouvaroff [1997] BPIR 712).

That assumption had never previously been questioned or tested or subjected to any detailed judicial analysis and scrutiny. This exercise was undertaken by Arnold J in Shlosberg. While strictly obiter, given the relative absence of any previous case law on point, it is likely that Arnold J’s judgment will be treated as providing powerful guidance on the question of what a TIB can and cannot lay his hands on.

In the judgment, Arnold J considered of the concept of ‘property’ under the Insolvency Act 1986 (IA 1986) and the operation of IA 1986, ss 283(4), 306(1), 311, and 436(1). He also carried out a review of the main authorities on privilege (including Three Rivers District Council v Governor and Company of the Bank of England [2004] UKHL 48, [2004] All ER (D) 176 (Nov)), on what is not property (including Heath v Tang; Stevens v Peacock [1993] 4 All ER 694 and Haig v Aitken [1999] All ER (D) 1001) and on the application of the Crescent Farm principle (see below) within bankruptcy proceedings (including Re Konigsberg [1989] 3 All ER 289 and Re Omar [1999] All ER (D) 560).

Arnold J’s conclusions on the question of privilege are surprising and troubling and are likely to have significant repercussions for TIBs and their investigative processes.

Permission to appeal has been granted, so watch this space.

What was the dispute about?

The application before the court was made by S, an undischarged bankrupt. He sought an order that his former solicitors, should cease to act both on behalf of his joint TIBs and on behalf of his major creditor (Avonwick).

The application was made principally on the grounds that having acted as his solicitors prior to his bankruptcy, the solicitors would come into possession of certain of his documents which were subject to legal professional privilege, in circumstances where that privilege was not vested in the TIBs and where the TIBs could not otherwise claim the benefit of it. The context was hostile post-bankruptcy litigation between Avonwick and S.

The application came before Arnold J for hearing on 25 March 2016 and 22 April 2016 and a reserved judgment was handed down on 5 May 2016. S substantially succeeded in persuading the court that with regard to two out of the three categories of documents in question, privilege remained with him. As a consequence, an injunction was granted, ordering the solicitors to stop acting for Avonwick.

The facts and procedural background are pretty complex and I recommend that the judgment is read in full. What follows is a summary of the essential factual background and the key issues arising.

What were the facts?

S was a Russian businessman domiciled in England. He was the beneficial owner of a company incorporated in St Vincent and the Grenadines (Webinvest Ltd). The first respondent, Avonwick, was a British Virgin Island company. Under a 2010 loan agreement, Avonwick lent $100m to Webinvest. S personally guaranteed that loan. Webinvest defaulted and Avonwick served statutory demands on Webinvest and S, for $100m, plus interest.

Separately, Avonwick also sued (by Part 7 claim form) for repayment of the sums due under the loan and guarantee (the original Avonwick proceedings). Avonwick was represented in those proceedings by the solicitors (the second respondent).

On 6 November 2014, Sales J awarded judgment against S and Webinvest in the High Court, in the principal sum of $195,159 plus interest.

On 19 November 2014, Avonwick (once more retaining the same solicitors) commenced proceedings against Castle Investment Fund Ltd (a trust vehicle for S’s family) seeking damages and other relief for conspiracy (the Avonwick conspiracy proceedings).

In due course, statutory demands were served both on S and on Webinvest, both of whom applied to restrain any further insolvency proceedings based on those demands.

They failed. In January and February 2015, bankruptcy and winding-up orders were made against S and Webinvest respectively. The third respondents were appointed as S’s TIBs and they subsequently retained the solicitors. The liquidators of Webinvest also retained the same firm as their solicitors.

Through their solicitors, the TIBs sought to exercise their statutory powers, under IA 1986 s 311(1), to require S to provide them with information about his affairs.

S objected to the solicitors acting both for Avonwick and for the TIBs (notwithstanding that information barriers had been put in place to protect S).

The application was issued on 4 December 2015.

In the meantime, Avonwick sought permission to join S as an additional respondent to the Avonwick conspiracy proceedings, pursuant to IA 1986, s 258(3). That permission was granted on 15 December 2015 (Avonwick Holdings Ltd v Castle Investment Fund Ltd [2015] EWHC 3832 (Ch), [2015] All ER (D) 270 (Dec)).

S applied for an order that the solicitors should cease to act for the TIBS and for Avonwick, on the grounds that they would come into possession of a significant quantity of documents which he contended—in the case of category (a), (b) and (c) documents—were subject to legal professional privilege (to which he was entitled either solely or jointly with Webinvest) and/or were confidential.

The category (a) documents concerned some county court proceedings in which S (as claimant) had obtained judgment prior to his bankruptcy.

The category (b) documents related to the statutory demands served on S and Webinvest by Avonwick and to the subsequent attempts to restrain bankruptcy and winding up petitions.

The category (c) documents related to the original Avonwick proceedings.

There was no dispute that many of the documents were privileged and confidential. However, the respondents all contended that the benefit of that privilege had passed to the TIBs and that there was no real risk that the solicitors would misuse confidential information that was confidential to S.

What were the main legal arguments arising?

It was common ground that:

  • the starting point is that a party is entitled to be represented by the solicitor of his choice unless there are solid grounds for interfering with that entitlement, and
  • there is nothing inherently objectionable about a solicitor acting for both a TIB and a major creditor of the estate, and
  • S had been entitled to the benefit of the privilege in the documents prior to his bankruptcy

The arguments focused on the question of whether the benefit of S’s privilege now vested in the TIB as part of the bankruptcy estate.

Given that it was accepted that S had been entitled to the privilege prior to his bankruptcy, the application was argued on the footing that it was for the respondents to prove that the benefit of that privilege had passed to them—in other words that S could not launch an objection based on privilege.

The respondents argued that there could be no objection on the grounds of privilege, essentially for four different reasons:

  • in relation to the category (b) and (c) documents, as a consequence of the statutory vesting under IA 1986, s 306(1) and having regard to the definition of property under IA 1986, s 436(1), the TIBs were the successors in title to the pieces of paper on which the privileged information was contained. They relied on the Crescent Farm principle (namely that the legal professional privilege of a predecessor in title endured to the benefit of his successor) (see Crescent Farm (Sidcup) Sports Ltd v Sterling Offices Ltd [1971] 3 All ER 1192)
  • in relation to the category (b) and (c) documents, privilege was itself ‘property’ within the meaning of IA 1986, s 436(1) and therefore it vested in the TIBs, along with the power exercisable in respect of it, as contained in IA 1986, s 283(4)
  • in relation to the category (a) documents, the benefit of the county court judgment awarded in S’s favour pre-bankruptcy vested in the TIBs. Since the category (a) documents concerned that judgment, applying the Crescent Farm principle, the privilege in those documents also vested TIBs
  • in relation to the category (b) and (c) documents, the TIBs were the successors in title to the High Court judgment obtained against S before his bankruptcy pursuant to Sales J’s order in the original Avonwick proceedings and that S had an obligation under that judgment which could be characterised as property within the meaning of IA 1986, s 436(1), applying IA 1986, s 315 (a TIB’s power to disclaim onerous property) as an aid to construction

The third argument was conceded/not resisted. Accordingly, the matters in contention were the first, second and fourth arguments.

What did Arnold J decide?

He held that privilege in the category (a) documents had passed to the TIBs (as was effectively common ground), but that the privilege in the category (b) and (c) documents remained with S.

The first argument failed:

  • the TIB’s didn’t acquire S’s privilege as a consequence of acquiring title to the documents (through the statutory vesting under IA 1986, s 306)
  • the right to exercise privilege could not depend on ownership of the paper on which the privileged information was recorded—a client can claim privilege even if the paper is owned by the solicitor, even if that paper is given away, that privilege is not lost
  • the Crescent Farm principle did not depend on acquisition by the successor in title of property in the documents recording the privileged information, but on acquisition by the successor in title of some other property to which the legal advice or litigation related
  • it was not ownership of the paper which mattered, but the right to control the dissemination and use of the information recorded on the paper—that right remained with the client, including where the information is recorded electronically

The second argument also failed:

  • privilege is not an ‘interest’ within the meaning of IA 1986, s 436(1), nor is it a power exercisable over, or in respect of, property within the meaning of IA 1986, s 283(4)
  • although a right to privilege is enforceable in law, it is not a marketable right and has no commercial value (and cannot be realised or distributed to creditors)
  • the only effect of a right to privilege is to enable the beneficiary of the privilege to resist compulsory disclosure of information in proceedings—‘It is a purely negative right’ (para [62])
  • privilege does not arise out of and is not incidental to the property in the documents containing the privileged information, it is a right in respect of information which arises out of the confidential relationship between the client and the lawyer—that has nothing to do with the documents themselves (which are just chattels)

The fourth argument also failed:

  • a judgment against a bankrupt is not ‘property’ or an ‘obligation’ within the meaning of IA 1986, s 436(1)—judgment debts cannot be realised for the benefit of the estate and the statutory purpose of IA 1986, ss 306(1) and 436(1) would not be served by construing them as extending the meaning of property and the statutory vesting to judgment debts against a bankrupt
  • IA 1986, s 315 does not assist as an aid to the construction of IA 1986, s 436(1)

To what extent is the judgment helpful?

As I said at the beginning of this paper, it had always been assumed that a TIB would be able to assert privilege in any circumstances in which, prior to his bankruptcy, a bankrupt would have been able to do so—provided that the documents in question concerned property within the bankruptcy estate or otherwise related to his estate or financial affairs.

That assumption had not previously been challenged or tested, nor had the genesis of that assumption previously been analysed.

This judgment ticks both of those boxes. Along the way, it provides useful clarification on the meaning of ‘property’, on the nature of the right to assert privilege and on the extent to which (if at all) a negative right or indeed a positive obligation can be characterised as property, having regard to the purpose of IA 1986, ss 306, 436(1) and 283(4), especially if that right/obligation cannot be monetised.

To what extent is the judgment unhelpful and what practical lessons are there to be learned?

The practical consequence of this judgment is that it is now highly unlikely that a TIB will easily be able to get his hands on documents over which the bankrupt could have asserted privilege prior to the bankruptcy, unless those documents relate to or arise directly out of property which has vested in the TIB.

In Shlosberg, this was manifestly the case in relation to the category (a) documents. The benefit of county court judgment given in the proceedings in which S had obtained judgment plainly was property within the meaning of IA 1986, s 436(1), having regard in particular to the purpose of the legislation, not least because it could be realised and distributed. The TIBs had therefore acquired the benefit of that privilege as successors in title to the property (the judgment) itself.

Beyond this, plainly, the mere ownership of a document is, of itself—quite literally—not worth the paper it is written on and there is no correlation between the document and the information contained on it. In other words, privilege attaching to documents which do not arise out of vested property, but which are nonetheless directly relevant to the bankrupt’s financial affairs or other property will remain with the bankrupt, even though ownership of the piece of paper will vest in the TIB.

The touchstone is therefore the nature of the ‘thing’ (for want of a better expression) that underlies the document. If that ‘thing’ is property within the meaning of IA 1986, s 436(1) (something realisable or a marketable right), then the TIB will be able to claim the benefit of any privilege in any document relating to that property, but not otherwise.

IA 1986, s 333 (a bankrupt’s absolute duty to provide such information to his TIB as the latter may reasonably require) and IA 1986, s 366 (a TIB’s right to apply for an order for the provision of documents and information (including in court and on oath)) are not considered in the judgment. Whether the operation of these sections will prove to have been modified or tempered as a consequence of this judgment remains to be seen.

If asked by his TIB (informally, or on oath in the context of a IA 1986, s 366 examination) what his solicitors advised with regard to (say) a transaction, would the bankrupt be entitled to refuse to answer that question on the grounds of privilege, whether or not that advice was contained in a document? I suggest not.

Would it make any difference if that advice was contained in a document?

Discuss…

Marcia is a leading practitioner in insolvency, company and partnership law as well as commercial litigation. Her work encompasses both domestic and international matters. She has appeared in the Grand Court of the Cayman Islands and in the Isle of Man.

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:

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

Inquiry into a bankrupt's dealings and property (including by way of private examination) under section 366 of the Insolvency Act 1986

What assets vest in the trustee in bankruptcy and what steps does the official receiver or trustee in bankruptcy need to take?

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First published on LexisPSL Restructuring and Insolvency

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