Company

Winding up - Proof and ranking of claims

Re Kaupthing Singer and Friedlander Ltd (in administration): Supreme Court (Lord Hope DP, Lord Walker, Lady Hale, Lord Clarke and Lord Collins SCJJ): 19 October 2011

The first respondent, Kaupthing Singer & Friedlander Ltd (KSF), was a bank which went into administration during the financial crisis in October 2008. The second respondent company, Singer & Friedlander Funding plc (Funding), was a wholly-owned subsidiary of KSF and was also in administration (double insolvency). Funding’s sole function was to raise funds for use by KSF and other group companies.

In 2005, Funding issued £250m floating rate notes repayable in 2010. They were constituted under a trust deed dated 9 February 2005 made between Funding, KSF and HSBC Trustee (CI) Ltd (the trustee). By clause 7 of the trust deed, KSF guaranteed payment of principal and interest on the notes and performance of Funding’s other obligations under the trust deed. The net proceeds of the notes (approximately £249.5m) were advanced by Funding to KSF by way of unsecured loan. When KSF went into administration on 8 October 2008, it owed Funding approximately £242.6m.

When Funding went into administration on 15 October 2008 the amount of principal prospectively due on the notes was (following the buyback and cancellation of some of the notes during 2008) approximately £240.3m. On 23 March 2009, the trustee gave notice that an event of default had occurred in respect of the notes, with the result that the notes became immediately due and payable, and the obligations of Funding (as principal debtor) and KSF (as guarantor) came into immediate effect. On 28 April 2009, the trustee submitted to Funding’s administrators, and also to KSF’s administrators, proofs of debt for principal and interest in respect of the loan notes in the sum of approximately £248.1m in each case. Those proofs had been admitted.

On 8 May 2009, Funding submitted a proof in respect of its loan to KSF in the sum of approximately £242.6m. KSF’s administrators had indicated that, subject to the issues raised in the instant appeal, they intended to admit Funding's proof. On 20 May 2009, KSF’s administrators gave notice of their intention to make distributions in the administration, including distributions to ordinary unsecured creditors. That notice was given under rule 2.92 of the Insolvency Rules 1986 (SI 1986/1925) as amended, and with the permission of the court granted by an order made on 24 April 2009. KSF had numerous creditors who had already received dividends amounting to 58p in the pound (or in the case of Funding, had provision made for payment, subject to the instant appeal).

By contrast, Funding had only one creditor other than the trustee, namely the Revenue and Customs Commissioners, which had proved for the relatively trivial sum of £2,654.10. Funding had no assets other than its loan to KSF. It had an issued capital, fully paid up, of only £12,500. The administrators of KSF applied to the Chancery Division for directions. At that hearing, the trustee had recognised that the judge was bound by the decision of the Court of Appeal in SSSL Realisations, Re save Group plc (in liquidation) [2006] All ER (D) 98 (Jan) (SSSL), in which the Court of Appeal had in comparable circumstances applied the equitable principle known as the rule in Cherry v Boultbee (1839) 4 My & Cr 442.

That rule was basically a simple technique of netting-off reciprocal monetary obligations, even where there was no room for legal set-off, developed and used by masters in the Court of Chancery in giving directions for the administration of the estates of deceased persons. Complication arose only in a situation of insolvency, where the equitable rule produced a different outcome from that produced by statutory set-off. The rule provided that a person who owed an estate money, namely, who was bound to increase the general mass of the estate by a contribution of his own, could not claim an aliquot share given to him out of that mass without first making the contribution which completed it. The only issue argued before the judge was whether clause 7.7 of the trust deed excluded that rule.

Funding’s administrators were joined in the proceedings but were not represented. The judge's order of 18 December 2009 declared that the rule in Cherry v Boultbee was not excluded and directed that the administrators of KSF might rely on it unless and until KSF’s right to indemnity (as a surety) had been satisfied in full. He granted a certificate under section 12 of the Administration of Justice Act 1969 for a leapfrog appeal to the Supreme Court on the basis that there was a point of law of general public importance on which he was bound by a fully considered judgment of the Court of Appeal. The Supreme Court gave the trustee permission to appeal. Although both sets of administrators were respondents to the appeal, again, Funding’s administrators were not represented.

The rule against double proof provided that there was only to be one dividend in respect of what was in substance the same debt, although there might be two separate contracts. It prevented double proof of what was in substance the same debt being made against the same estate, leading to the payment of a double dividend out of one estate. Where the rule in Cherry v Boultbee applied, the rate of dividend was marginally higher for everyone, because the differential was made available for distribution across the board.

The lower the expected rate of dividend, the greater would be the disparity between the two computations. The trustee submitted that payment-off in full of the trustee as creditor was a condition precedent to the admission of any proof against Funding by KSF as surety. The trustee, on behalf of the noteholders, further submitted that it would be irrational and unfair to apply the rule in Cherry v Boultbee in circumstances in which there was clear House of Lords authority (West End Networks In liquidation), Re; Secretary of State for Trade and Industry v Frid [2004] All ER (D) 180 (May) that statutory set-off did not apply.

The administrators of KSF, submitted that its application was required by two decisions of the Court of Appeal, Melton, Re, Milk v Towers [1916-17] All ER rep 672 and SSSL and that they had been rightly decided. The appeal ultimately turned on what function, if any, the equitable rule in Cherry v Boultbee had to perform in the operation of the rule against double proof as it applied in suretyship situations. The basic question to be asked was: 'If the policy of the law underlying the rule against double proof is powerful enough to oust statutory set-off, is there any good reason why it should not have the same effect on the equitable rule?' The appeal would be allowed.

The situation in the instant line of authority was that a shareholder was a creditor of an insolvent company, but his shares were not fully paid up, so that he was liable as a contributory. If he sought to prove in the liquidation, the liquidator could rely on the equitable rule as it applied in the instant case, namely, he could receive nothing until he had paid everything that he owed as a contributory. Payment of the call was a condition precedent to the shareholder’s participation in any distribution, and again the shareholder was to that extent disadvantaged.

Accordingly, the rule in Cherry v Boultbee might be said to fill the gap left by disapplication of setoff, but it did not work in opposition to set-off. It produced a similar netting-off effect except where some cogent principle of law required one claim to be given strict priority over another. The principle that a company’s contributories had to stand in the queue behind its creditors was one such principle. The rule against double proof was another (see [52] of the judgment).

It would be technical, artificial and wrong to treat the rule against double proof as trumping set-off (as it undoubtedly did) but as not trumping the equitable rule. Paragraph 96 of the SSSL judgment suggested that in a double insolvency the equitable rule and the rule against double proof could and should both apply, and that that would strike a fair balance between the competing interests of creditors. That approach would lead to many doubts and difficulties, and whether the end result would strike a fair balance would depend very much on the facts of the particular case (see [50], [52] of the judgment). The judge's direction would be set aside (see [54] of the judgment).

SSSL Realisations (2002) Ltd (in liq), Re; Re Save Group plc (in liq) [2006] All ER (D) 98 (Jan) doubted; Jeffs v Wood (1723) 4 ER 668 considered; Cherry v Boultbee (1839) 4 My & Cr 442 considered; Willes v Greenhill (1860) 29 Beav 376 considered; Midland Banking Co v Chambers (1869) 4 Ch App 398 considered; Akerman, Re, Akerman v Akerman [1891-4] All ER Rep 196 considered; Binns, Re, Lee v Binns [1896] 2 Ch 584 considered; Auriferous Properties Ltd (No 2), Re [1898] 2 Ch 428 considered; Melton, Re, Milk v Towers [1916-17] All ER Rep 672 considered; West Coast Gold Fields Ltd, Re, Rowe's Trustee's Claim [1905] 1 Ch 597 considered; Rhodesia Goldfields Ltd, Re, Partridge v Rhodesia Goldfields Ltd [1910] 1 Ch 239 considered; Peruvian Railway Construction Co Ltd, Re [1914-15] All ER Rep Ext 1397 considered; Fenton, Re, ex p Fenton Textile Association Ltd [1930] All ER Rep 15 considered; Fenton (No 2), Re, ex p Fenton Textile Association Ltd [1930] All ER Rep 27 considered; Polly Peck International plc (in administration), Re [1996] 2 All ER 433 considered; Glen Express Ltd, Re [2000] BPIR 456 considered; West End Networks Ltd (in liq), Re; Secretary of State for Trade and Industry v Frid [2004] All ER (D) 180 (May) considered; SSSL Realisations (2002) Ltd (in liq), Re; Re Save Group plc (in liq) [2004] All ER (D) 470 (Jul) considered.

Decision of Sir Andrew Morritt C [2009] All ER (D) 237 (Dec) Reversed.

Gabriel Moss QC and Richard Fisher (instructed by Allen & Overy LLP) for the trustee; Robin Dicker QC and Tom Smith (instructed by FreshfieldsBruckhaus Deringer LLP) for KSF.