Contingencies Post Nortel in the Supreme Court
1. Debts are such an integral part of the insolvency and restructuring system that it is easy to overlook the many complexities which lie concealed within such a disarmingly simple notion. X owes Y money; that is a debt. Of course, all practitioners will be aware that for the purposes of the Insolvency Act 1986 and the Insolvency Rules 1986, the term debt is intended to encompass near enough any form of liability imaginable, which, in the time-honoured phrase, is “present or future, certain or contingent, ascertained or sounding only in damages”. If X might (or might not) owe Y money, that is also a debt, albeit a different type of debt.
2. Contingent debts, which are the main focus of this paper and the talk which this paper supports, are an interesting (and difficult) sub-species of debts. The phrase “contingent debt” does not itself appear anywhere in the Insolvency Act 1986 or the Insolvency Rules 1986. The same is effectively true of the phrase “contingent liability”1. Notwithstanding that surprising state of affairs, insolvency litigation has given rise to numerous reported cases which all address, in some respect or other, the concept of a debt that is contingent. One of the reasons for which contingent liabilities are so fascinating is because they purport to cover a known (and therefore present) potential liability which may or may not be triggered and crystallise in the future (an unknown). The phrase recently made famous by a former
3. Happily, as a result of the co-joined appeals in the Lehman Brothers and Nortel Network insolvencies, which both arose in the context of the Pension Protection Fund’s efforts at plugging the monumental pension deficits hidden within those companies, the Supreme Court had the opportunity in 2013 to refresh the law in relation to contingent liabilities. This paper will consider the decision in that case: Re Nortel Companies  UKSC 52  BCC 624. Despite having been decided only comparatively recently, the Supreme Court’s decision has itself already been applied and interpreted in at least 3 later decisions of the High Court. In chronological order, those decisions are: Hellard and another (as Trustees in Bankruptcy for Mireskandari) v Chadwick (Trustee in Bankruptcy for Tehrani) and another  EWCH 2158 (Ch), Laverty and another v British Gas Trading Ltd  EWHC 2721 (Ch) and Secretary of State for Business Innovation and Skills v (1) Broomfield Developments Ltd (2) Lakeview Developments Ltd  EWHC 3925 (Ch). Those decisions will also be considered briefly in turn in due course.
4. The final part of this paper will build on the analysis of contingencies in Nortel and will focus on contingent assets in the context of the insolvency test set out in s.123 of the Insolvency Act 1986. That will necessarily also involve a short review of another major Supreme Court case which related to insolvency: BNY Corporate Trustee Services Ltd v Eurosail-UK 2007-3BL plc  UKSC 28,  1 WLR 1408.
5. First though, the inevitable and necessary starting point is the provisions in the Insolvency Rules and the Insolvency Act 1986.
6. It is necessary to start with a reminder of the various phrases that relate to debts in the Insolvency Rules 1986 and the Insolvency Act 1986; “provable debts” are defined as:
7. Of more central importance, however, is the definition of a “debt” and a “liability” which is contained in rule 13.12 of the Insolvency Rules 1986. That rule provides as follows:
8. Rule 13.12 applies explicitly to compulsory liquidations. That rule finds it equivalent in the bankruptcy context in s.382 of the Insolvency Act 1986, which provides as follows:
(4) In this Group of Parts, except in so far as the context otherwise requires, “liability” means (subject to subsection (3) above) a liability to pay money or money's worth, including any liability under an enactment, any liability for breach of trust, any liability in contract, tort or bailment and any liability arising out of an obligation to make restitution.
(5) Liability under the Child Support Act 1991 to pay child support maintenance to any person is not a debt or liability for the purposes of Part 8.
9. And finally it is necessary to set out the relevant provisions of the cash flow test and the balance sheet test. They are contained in s.123 of the Insolvency Act 1986. They provide as follows:
Nortel – what you need to know
10. The Supreme Court heard the appeals in Re Nortel Companies  UKSC 52  BCC 624 over 3 days in May 2013 and handed down its judgment on 24 July 2013. Lord Neuberger gave the lead judgment. Lord Sumption gave a short concurring judgment.
11. The appeals were made in the Lehman Brothers insolvency and the Nortel Networks insolvency. Those two insolvencies are amongst the largest insolvencies of the last 10 years and so need very little introduction. In order to understand the impact of the Supreme Court’s judgment it is however necessary to know a little in relation to the facts of both cases and the issue which the Supreme Court was considering. The cases concerned pension liabilities.
12. Each of the groups operated final salary pension schemes. By the time that the group companies entered a formal insolvency regime (in the main, this was administration), the relevant schemes had been in deficit for some time. As a result of the relevant companies going into administration, the liability owed by the relevant company to the pension scheme trustees crystallised pursuant to s.75 of the Pensions Act 1995; this is of course known as the s.75 debt. However, as a result of s.75(8), that debt was not preferential and fell to be paid pari passu with the unsecured creditors of the relevant company. In practical terms, that was of little utility to the pension scheme trustees.
13. The Pensions Act 2004 created a new regulator: the Pension Regulator. It also created the Pension Protection Fund (PPF). The PPF is financed by levies on all pension schemes. However, in order to avoid an incentive for groups of companies to arrange their affairs in such a way that the PPF would always be left to pick up the tab in an insolvency, the 2004 Act created a financial support direction (FSD) regime. An FSD is addressed to a fellow group company of the under-funded pension company and imposes an obligation on that target to provide reasonable financial support to the under-funded pension scheme. If the FSD is not complied with, it is open to the Pensions Regulator to serve on the target a “contribution notice” which creates a monetary liability.
14. Inevitably, whether or not the Pensions Regulator will issue an FSD or a CN depends on a large number of variables. For example, it is necessary for the Pensions Regulator to determine that the “employer” company in the group is insufficiently resourced. Next, it is necessary to identify a connected company which has sufficient assets. Those determinations are made on the basis of a “rich man / poor man” test. They are made as at a “look back date” which is selected by the regulator. There is also a “reasonableness” requirement which must be met. As Lord Neuberger said in Nortel, the pensions legislation lays down an “elaborate procedural code” for the implementation of the Regulator’s functions. The standard procedure involves six stages as follows:
15. The entire issue in Nortel was where a liability to pay an FSD / CN which was issued after the insolvency event sat in the insolvency distribution waterfall. It was common ground that a CN issued in respect of an FSD which was served before an insolvency event would be a provable debt. In the course of his judgment in Nortel, Lord Neuberger helpfully summarised the waterfall at paragraph 39 as follows:
16. It was common ground in Nortel that if a liability under the pensions regulation arose during administration and a winding-up were to follow later, that liability can be the subject of a proof of debt in the winding-up. In the case of Lehman Brothers, the s.75 debt which crystallised when the group companies went into administration on 15 September 2008 was approximately £120 million. Warning notices were issued to Lehman group companies on 24 May 2010. Those were followed by an oral hearing in September
17. At first instance, and in the Court of Appeal, it was held that a liability to pay an FSD and a CN would qualify as an expense of the insolvency proceedings. As Lord Neuberger pointed out, however, both lower courts felt constrained to reach that conclusion as a result of the decision of the Court of Appeal in R (Steele) v Birmingham City Council  1 WLR 2380. The alternatives which were argued in the Supreme Court were whether the liabilities created by an FSD and a CN were (i) expenses, (ii) unsecured provable debts, or (iii) non-provable liabilities, and (iv) if (iii) applied, whether the Supreme Court should make a direction requiring the officeholder to apply a more favourable ranking to the liabilities.
18. It seems that the “common sense” reaction of the Supreme Court was to plump for debt over expense. Indeed, Lord Neuberger said this:
"BPIR is an excellent series, of interest to both corporate and personal insolvency lawyers,...
20. His detailed analysis proceeded as follows:
20.3 The PPF argued, in the alternative, that the liability fell within both rule 13.12(1)(a) and 13.12(1)(b). Its argument on the first ground was that a liability under an FSD was a “contingent liability” coming within rule 13.12(3) to which the company was subject at the date of the insolvency event, and so therefore it came within rule 13.12(1)(a). Lord Neuberger did not accept that argument. He did so by reference to rule 13.12(1)(b). He considered that that rule imposed a limitation on what could constitute a future debt: “by reason of any obligation incurred before that date”. If the PPF’s construction of sub-rule (a) was right, it would effectively over-ride the limitation contained in sub-rule (b).
20.4 In reaching that view, he expressly concurred with the decision of David Richard J in In re T & N Ltd  1 WLR 1728 which had held that: “para (a) is concerned with liabilities to which the company ‘is subject’ at the date of the insolvency event, whereas para (b) is directed to those liabilities to which it ‘may become subject’ subsequent to that date, and that there is no overlap between these two categories.”
20.5 If the liability didn’t fall within (a), could it fall within (b)? Was it a liability arising “by reason of any obligation incurred before that date”. He considered that the meaning of the word ‘obligation’ in that phrase was crucial. He described it as a word which could have a number of different meanings, or nuances. He did not think that it was a simple as equating a liability with an obligation:
20.8 Lord Neuberger made the obvious point that, “the mere fact that a company could become under a liability pursuant to a provision in a statute which was in force before the insolvency event, cannot mean that, where the liability arises after the insolvency event, it falls within rule 13.12(1)(b)...” because if not, every liability would fall within the rule. Something more was needed.
20.9 At this point, it is necessary to cite directly from the judgment of Lord Neuberger:
20.11 Lord Neuberger’s conclusion in respect of each one of the requirements which he described as (a), (b), and (c) in para. 77 is encapsulated in the following paragraphs:
“84. As to the first requirement, on the date they went into administration, each of the Target companies had become a member of a group of companies, and had been such a member for the whole of the preceding two years – the crucial look-back period under the 2004 Act. Membership of a group of companies is undoubtedly a significant relationship in terms of law: it carries with it many legal rights and obligations in revenue, company and common law.
85. As to the second requirement, by the date they went into administration, the group concerned included either a service company with a pension scheme, or an insufficiently resourced company with a pension scheme, and that had been the position for more than two years. Accordingly, the Target companies were precisely the type of entities who were intended to be rendered liable under the FSD regime. Given that the group in each case was in very serious financial difficulties at the time the Target companies went into administration, this point is particularly telling. In other words, the Target companies were not in the sunlight, free of the FSD regime, but were well inside the penumbra of the regime, even though they were not in the full shadow of the receipt of a FSD, let alone in the darkness of the receipt of a CN.”
20.12 His conclusion meant that it necessarily followed that several earlier decisions of the courts in cases involving costs orders imposed on an entity after the commencement of insolvency proceedings, but in relation to litigation started before the insolvency proceedings were not provable debts, were wrongly decided: In re Bluck, Ex p Bluck (1887) 57 LT
“whether the liability would be within the expression “charges and other expenses incurred in the course of the … administration” within rule 12.2, and, more particularly, within the expression “any necessary disbursements by the administrator in the course of the administration”, within rule 2.67(1)(f) - the equivalent provision in a liquidation being rule 4.218(3)(m).”
20.14 He expressed a “rule of thumb” on this issue as follows:
“100. While it would be dangerous to treat any formulation as an absolute rule, it seems to me, at any rate subject to closer examination of the authorities and counter-arguments, a disbursement falls within rule 2.67(1)(f) if it arises out of something done in the administration (normally by the administrator or on the administrator’s behalf), or if it is imposed by a statute whose terms render it clear that the liability to make the disbursement falls on an administrator as part of the administration – either because of the nature of the liability or because of the terms of the statute.”
20.15 Lord Neuberger mentioned some examples: if an administrator enters into a transaction which would give rise to a liability to tax, or starts or adopts proceedings potentially giving rise to a liability for costs, those would be necessary disbursements. The same is true in the now notorious case of business or domestic rates following the decision in
20.17 Lord Neuberger held that the “balance of anomalies” favoured a liability under an FSD not being an expense of an insolvency. He said this: “... if the liability in these cases did not rank as a provable debt, it would not count as an expense of the administration.”
21. Nortel has been considered in three cases since it was decided: Hellard and another (as Trustees in Bankruptcy for Mireskandari) v Chadwick (Trustee in Bankruptcy for Tehrani) and another  EWCH 2158 (Ch), Laverty and another v British Gas Trading Ltd  EWHC 2721 (Ch) and Secretary of State for Business Innovation and Skills v (1) Broomfield Developments Ltd (2) Lakeview Developments Ltd  EWHC 3925 (Ch).
Hellard and another (as Trustees in Bankruptcy for Mireskandari) v Chadwick (Trustee in Bankruptcy for Tehrani) and another  EWCH 2158 (Ch)
22. Misreskandari is a decision of Charles Hollander QC. This was a case concerning a legal partnership trading as Dean & Dean. The partners were Messrs Mireskandari and Mr Tehrani. The latter retired from the partnership and was due to receive future fees from the partnership. By way of discharge of that liability, Mr Mireskandari assigned to Mr Tehrani the benefit of a loan agreement he had with a company of which he was the shareholder: Azadian Property Limited. In turn, Mr Tehrani assigned that right to Mrs Tehrani. After that, on 5 November 2009, Mr Tehrani was made bankrupt. A few months later, on 15 January
23. The matter reached the courts as a result of a claim made by the trustees in bankruptcy of Mr Mireskandari under s.339 / s.340 of the Insolvency Act 1986 seeking to challenge the Mr Mireskandari assignment of his loan account. That prompted Mr Tehrani’s trustees to take mirror action against Mrs Tehrani. On the first hearing of the claim, Registrar Barber raised an issue in relation to whether Mr Mireskandari’s trustees’ claim should be stayed as a result of s.285 of the Insolvency Act 1986. She concluded that the claim against Mr Tehrani’s estate was a provable debt, and she also decided, in the exercise of her discretion, to stay the claim against Mrs Tehrani.
24. The issue on appeal was whether the claim by the Misrekandari trustees against the Tehrani estate was a “bankruptcy debt” within s.382 of the Insolvency Act 1986. The terms of s.382 are similar to rule 13.12. The issue was whether a claim under s.339/s.340 could give rise to an “obligation”.
25. The judge applied Nortel. He concluded that the claim was a “provable debt”. He expressed his conclusion as follows:
Laverty and another v British Gas Trading Ltd  EWHC 2721 (Ch)
26. Laverty is a decision of the Chancellor. It arises out of the liquidation of three companies: PGL Realisations plc, PStores Realisations Ltd and Dorsman Estates Ltd. The companies were first in administration: 19 January 2012. They entered compulsory liquidation on 19 July 2013. They were notorious because they operated the Peacock chain of clothing stores. British Gas supplied gas and electricity to stores operated by Peacock. That supply was pursuant to the terms of a contract which was for a fixed term from 1 April 2011 to 31 March 2012. It will be observed that the fixed term of the contracts ended after the start of the administration of the companies. As a result British Gas served notices terminating the contracts on 20 and 23 January 2012. However, British Gas continued to supply gas and electricity to the stores pursuant to contracts deemed to arise under the Gas Act 1986 and the Electricity Act 1989.
27. A large number of stores were sold by the administrators on 22 February 2012. Between February and March 2012, the administrators closed the other remaining stores. After the companies entered liquidation in July 2013, any leases which hadn’t been surrendered were disclaimed. The administrators accepted that the price of gas and electricity supplied to the Stores during the administration while the Companies continued to trade from them was an expense of the administration. An agreed amount of £1,384,607.45 (excluding VAT) was paid in respect of that liability. There was a dispute, however, between the administrators and British Gas as regards the supply of gas and electricity to closed stores under the deemed contracts. British Gas claimed the sum of £1.2 million. A preliminary issue as to the priority of that liability was ordered. Was it an expense? Was it an unsecured debt? This was classic Nortel territory.
28. The Chancellor undertook a detailed analysis of Nortel and Toshuku. He expressed his conclusion as follows. He agreed
Secretary of State for Business Innovation and Skills v (1) Broomfield Developments Ltd (2) Lakeview Developments Ltd  EWHC 3925 (Ch)
30. The question of contingent or prospective assets does not ordinarily arise in the context of the cash flow insolvency test: such assets are unlikely to be material to the question of whether or not a company is unable to pay its debts “as they fall due”. However, when considering the balance sheet insolvency test, even post BNY Corporate Trustee Services Ltd v Eurosail-UK 2007-3BL plc  UKSC 28,  1 WLR 1408 (“Eurosail”) which encourages some blurring of the edges between the two tests, the question may arise as to whether or not assets which might be viewed as being contingent or prospective assets can be taken into account.
31. The balance sheet test is stated in s. 123(2) IA 86 and provides that a company is deemed unable to pay its debts “if it is proved to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities”.
32. The question is, do “assets” include “contingent or prospective assets”, as is provided for in relation to liabilities? The short answer is they probably (at least ordinarily) cannot. The reason for that is two-fold:
33. This approach can be reconciled with the decision in Eurosail to the effect that the balance sheet test is to be viewed as an extension of the cash flow insolvency test by allowing the court to look further ahead than the present or near present, as the cash flow test encourages.
34. That said there are some qualifications to this approach which need to be considered, both legal and practical.
35. The first is that it is necessary to distinguish stand alone contingent or prospective assets and those which are in some way interlinked with the assessment of a contingent liability. The example given by Goode in Principles of Corporate Insolvency Law (4th Edn) is the contingent liability of a surety, who should be entitled to take into account the value of the any assets which may be acquired by way of subrogation. It may be said however that in reality what this is doing is setting a net figure for the liability as opposed to taking into account a future asset. However the point is worth having in mind: contingent liabilities should not be taken into account blind, or without netting off any benefits which might reasonably be said to acquire with such liabilities, so as to reduce their effect.
36. The second is simply because a company may not have in its hands an asset, or its current directors are not cognisant of its true value, should not result in its being ignored and treated as a future asset out of the balance sheet equation.
37. Practical issues relating to evaluation of assets, and assessing whether they are future in whole or in part, can and does arise in many claw back claims without either the claimant or defendant giving it full or due consideration. It is intended to consider some of those issues in the context of a case example during the seminar.
38. So to take a classic example of a claim brought by an insolvency practitioner: Co A enters into administration on 1 March 2010. Dividends totalling £500k were paid out by the directors in the period from 1 March 2008 to 1 March 2010. £250k of those dividends were paid in the period to 1 March 2009. The directors also paid out £500k on 1 March 2009 to themselves to repay loans they had made to the company when it started out in life, and following what they described as a very successful period of trading. The IP decides to bring two claims:
39. Can the IP bring both those claims to a successful conclusion?
40. If not, why not?
41. Would there be a better way of formulating the claims?
42. It is intended to consider those questions further during the seminar.