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Guildhall Chambers, Bristol
In the recent decision in HM Revenue & Customs v SED Essex Limited  EWHC 1583 (Ch) the High Court applied, for the first time, the principles set down by the Court of Appeal in Commissioners for Her Majesty's Revenue and Customs v Rochdale Drinks Distributors Limited  EWCA Civ 1116;  1 BCLC 748;  BPIR 1604;  BCC 419 in upholding the appointment of provisional liquidators in a case where there were allegations of involvement of VAT fraud.
The courts have repeatedly recognised that the appointment of a provisional liquidator is frequently terminal for the company. In Rochdale Drinks Rimer LJ said such an appointment was:
‘a most serious step for a court to take . . . is not an order to be made lightly and . . . requires the giving by the court of the most anxious consideration' 
In his judgment Lewison LJ said:
‘Not only is it an interim remedy, it is one of the most intrusive interim remedies in the court's armoury. In many, if not most, cases its effect will be to stop the company trading; and to cause the company's employees to lose their jobs. In deciding whether to grant or refuse an interim remedy the overriding principle is that the court should take whichever course seems likely to cause the least irremediable prejudice to one party or the other.'
Thus a court will be reluctant to appoint provisional liquidators except in the most obvious cases.
The appointment of provisional liquidators is provided for by s 135 of the Insolvency Act 1986 (‘IA 1986') and confers a discretion on the court to make such an appointment at any time after a winding-up petition has been presented.
Section 135(1) IA 1986 provides that:
‘Subject to the provisions of this section, the court may, at any time after the presentation of a winding-up petition, appoint a liquidator provisionally.'
Section 135(2) IA 1986provides that in England and Wales-
‘... the appointment of a provisional liquidator may be made at any time before the making of a winding-up order; and either the official receiver or any other fit person may be appointed.'
In Rochdale Drinks the Court of Appeal set out the test to be applied. It is that a judge dealing with such an application should consider it in 2 stages.
Firstly, the court has to consider whether the petitioning creditor and the applicant has demonstrated that it is likely to obtain a winding-up order. Such a view, will of course be provisional, because the petition itself is not being tried at the time of the application. If such likelihood is not demonstrated the court will not appoint a provisional liquidator. In this context the Court of Appeal modified the test previously formulated by Plowman J in Re Union Accident Assurance  1 All ER 1105 at 1110 that it was sufficient to establish good prima facie case for a winding-up at the hearing of the petition.
If the test is established the court moves onto the second stage to consider whether in the circumstances of the particular case, it is - as a matter of judicial discretion - right that a provisional liquidator should be appointed (or, where as here one has already been appointed, should be maintained in office) pending the hearing of the petition.
Factors to be considered in carrying out the second part of the test include (a) questions as to the integrity of the company's management and/or accounting and record keeping function; (b) whether there was any real risk of dissipation of the company's assets and/or any real need to take steps to preserve them; (c) whether there was any real risk that the company's books and records would be destroyed and/or any real need for steps to be taken to ensure that they were properly preserved and maintained; (d) whether there was any real need for steps to be taken to facilitate immediate inquiries into the conduct of the company's management and affairs and/or to investigate possible claims against directors for fraudulent or wrongful trading; (e) whether or not the company had a realistic prospect of obtaining a validation order under the Insolvency Act 1986 s 127, because if not, it might not be able to trade in any event; (f) generally, which course seemed likely to cause the least irremediable prejudice to one party or the other.
In this case each of SED's supply chains had been traced back to a trader involved in the VAT fraud. The judge found that SED, in the person of its sole director, either knew that its purchases were connected with the fraudulent evasion of VAT or should have known that the only reasonable explanation for the circumstances in which they took place was that they were so connected, or had ignored obvious inferences to that effect from the facts and circumstances in which it had been trading. On the evidence, HMRC was able to meet those requirements. SED and its suppliers' pattern of trading raised a powerful inference that fraudulent evasion of VAT had occurred in actual or purported supplies, which SED's director had been aware of. There was no realistic prospect that SED might succeed in explaining away all the indications of likely VAT fraud as a series of unfortunate coincidences. Further he found that there was a very real risk of funds held by the Provisional Liquidators being dissipated and therefore unavailable to creditors on the eventual making of a winding-up order.
In making the original application and on the application to set aside Her Majesty's Revenue and Customs (HMRC) recognised that it could not define the exact nature of the fraudulent evasion of VAT took in each of the Company's impugned chains of supply.
In Payless Cash & Carry Ltd v Patel  EWHC 2112 (Ch) (‘Payless') Mann J found that in many cases the proof of a fraud will, in practice, require it to be demonstrated what the actual fraud was - otherwise the fraud is less plausible - but it is not an absolute necessity to complete the actual trading picture where the evidence of fraud is sufficiently strong and it nonetheless possible for the court to draw the inference that fraud occurred.
John Randall QC (sitting as a High Court judge) in SED Essex noted that that where the applicant was unable to establish the exact nature of the fraud the Court must approach them with even more care than such allegations ordinarily attract.
He also held, relying upon the judgment of Rimer J in Rochdale Drinks, that where the party on whom the burden of proof initially lies adduces sufficient evidence that, were it to go wholly unanswered, the court would be satisfied that they had discharged that burden to the requisite standard the evidential burden shifts. It is then for the company to establish that it has a good arguable case. As with contested winding up proceedings in challenging the appointment an applicant must also descend to particularity and, in HMRC assessment cases, cannot simply rely upon the right to appeal or that an appeal has in fact been lodged.
This was a case where the evidence had been compiled by HMRC following a detailed investigation and subsequently a winding-up order was made; but it does demonstrate that in suitable cases a court will appoint provisional liquidators and uphold that appointment where there is evidence of complicity in fraud, even if the exact nature of the fraud is unknown at the time.
 At para 76,
 At para 84.
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