Evans v Jones [2016] EWCA Civ 660

Executive Summary

The Court of Appeal recently considered an appeal from the liquidators of a property development company which went into creditors’ voluntary liquidation. The company had made an unlawful dividend to its shareholders and the Court of Appeal considered whether the unlawful dividend should be treated as an asset of the company (being “something other than a dividend”) for the purposes of considering whether the company was insolvent at the “relevant time” subsequent preferences were given.

Background

Property development company, Rococo Developments Ltd, went into creditors’ voluntary liquidation on 21 April 2011 (the “Company”). The Company’s two directors, Mr and Mrs Jones were also its sole shareholders who had made various loans to the Company, and were the respondents in the case.

The Company had entered into a building contract with WJG Evans Ltd (“Evans”). As the development was completed and units sold the Company repaid the various loans to Mr and Mrs Jones. Four such payments were made between 3 June 2010 and 18 March 2011 (being just over a month before the Company went into liquidation). In addition, the Company paid a £75,000 dividend to Mr and Mrs Jones on 1 June 2010 i.e. before the loan repayments.

It was accepted that each of the loan repayments counted as a “preference” for the purposes of sections 239 to 241 of the Insolvency Act 1986 (the “Act”), and were made within the period of two years ending with the onset of the Company’s insolvency. However, the time a preference is made is not a “relevant time” for the purposes of those sections unless the company was unable to pay its debts within the meaning of section 123 of the Act or becomes unable to pay its debts within the meaning of that section in consequence of the preference.

In considering whether a company is insolvent, section 123 of the Act provides for a cash flow test of insolvency under section 123(1)(e), along with a balance sheet test under section 123(2). The balance sheet test 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.

On 28 May 2010 Evans presented the Company with a final account for sums due of approximately £191,487 which the Company disputed. The matter was referred to adjudication and Evans was successful in obtaining an adjudication award against the Company on 27 March 2011 for £66,881.80. The Company had not made any provision for this liability in its accounts and was unable to pay Evans. The Company’s Statement of Affairs showed that the Company had no funds to contest the adjudication and had a deficiency to unsecured creditors of £52,479, with only £3,939 outstanding for directors’ loans.

Unlawful dividend

During the course of their investigations into the Company the current liquidators became concerned that the dividend of £75,000 made on 1 June 2010 had been unlawful on the basis that:

  1. the Company’s statutory accounts only showed an available distributable profit of £57,934 as at 31 May 2010; and
  2. the Company’s accounts made no provision for the possible £191,487 liability to Evans.

Mr Jones initially argued that the dividend payment was lawful before accepting, shortly before trial on 6 March 2014, that it had been unlawful.

In the High Court, the expert appointed to consider the accounts of the Company noted that whether to make a provision in the accounts for the Evans debt was a matter of judgment but in order to comply with UK GAAP that judgment had to be on a reasonable basis. Having considered the evidence, the expert adduced that it was unreasonable for the Company not to have made any kind of provision. The level of provision would vary depending on the advice the Company received about the claim, but should not have been less than £20,000. In applying a constant sum of £20,000 to the Company’s historic accounts, the expert considered that the Company was balance sheet insolvent at three of the four dates the directors’ loans were repaid. On considering the dividend made on the 1 June 2010, the expert concluded that there were insufficient distributable reserves to justify the payment of the dividend. However, if the dividend had been treated as unlawful, for accounting purposes, it would have been treated as being void being categorised as something “other than a dividend and probably as a loan”. On this basis, the High Court concluded that the unlawful dividend was in fact an asset of the Company which was held on a constructive trust by Mr and Mrs Jones for the Company who were liable to repay it. By treating the unlawful dividend as an asset of the Company the net assets of the Company increased by £75,000 meaning that it was solvent at the “relevant time” the preferences were given.

Court of Appeal ruling

Giving the main judgment, Lord Justice Lewison referred to the authoritative guidance to section 123 in BNY Corporate Trustee Services Ltd v Eurosail-UK 2007-3BL plc that the proposition of law was that contingent or prospective assets are not taken into account for the purposes of section 123(2) which explicitly refers to contingent and prospective liabilities but not to contingent or prospective assets. If there is a present asset consisting of a chose in action (such as a claim in liquidation) it can be given a value, and what is obtained in a market is good evidence of that value.

How then to treat the unlawful dividend? Lord Justice Lewison considered the argument put forward by counsel for the appellants, that at the times the Company’s solvency was in question, Mr and Mrs Jones believed the dividend to be lawful and accordingly had no idea that there might be a contingent claim against them. Further, there would be no reason to investigate whether or not such a claim existed until the Company became insolvent and so the Company’s claim was a contingent claim, being contingent on it being discovered and then being pursued.

Paraphrasing Mr Donald Rumsfeld, Lord Justice Lewison distinguished the liability in respect of the Evans claim as a “known unknown” and the claim against Mr and Mrs Jones as being an “unknown unknown”. In allowing the appeal, he concluded that the claim for the unlawful dividend was not an asset of the Company but rather a contingent asset that should not have been taken into account by the judge in the High Court, and the Company was therefore insolvent at the “relevant time” for the purpose of reviewing the preferences.