Privilege and insolvency

A recent Court of Appeal decision means insolvency practitioners should think twice before instructing solicitors. The case confirmed that whilst there is nothing wrong in principle with solicitors acting for both a trustee in bankruptcy or liquidator and a creditor of the bankrupt or insolvent company, conflicts can arise. Where they do, solicitors may be required to cease acting for the creditor.

The Court of Appeal has upheld a decision of the High Court ordering a law firm to cease acting for the main creditor of a bankrupt individual where the law firm also acted for the trustee in bankruptcy.

Facts

The facts of Avonwick Holdings v Shlosberg are complex, but in summary:

  • Mr Shlosberg was the owner of a company called Webinvest
  • Avonwick lent US$100m to Webinvest and Mr Shlosberg personally guaranteed the loan
  • Webinvest failed to repay the loan and Avonwick began legal proceedings against both Webinvest and Mr Shlosberg
  • Webinvest was placed into liquidation and a bankruptcy order was made against Mr Shlosberg
  • Liquidators and trustees in bankruptcy were appointed and both retained Avonwick's existing solicitors
  • Avonwick had commenced separate proceedings against another company linked to Mr Shlosberg's family (and other defendants), to which Mr Shlosberg was subsequently joined, for conspiracy related to the $100m loan to Webinvest
  • As part of the bankruptcy process, the trustees had obtained a large number of documents relevant to the conspiracy proceedings brought by Avonwick which were either privileged to Mr Shlosberg or privileged to Mr Shlosberg and Webinvest jointly, and which the law firm had reviewed.

The application and the judgment at first instance

Mr Shlosberg applied for an order directing that the law firm should cease acting for both Avonwick and the trustees. The application was made primarily in respect of the law firm's position as solicitors for Avonwick.

Avonwick, the trustees in bankruptcy and the law firm argued that privilege had transferred to the trustees and as a result the bankrupt could no longer assert privilege over the documents.

Arnold J held that privilege does not pass when title to property recording the privileged information is transferred to a trustee in bankruptcy. Privilege depends on the nature of the information recorded in the documents, not upon the status of the document as property constituting the bankruptcy estate.

Arnold J further held that where Mr Shlosberg and Webinvest had instructed solicitors jointly, privilege could only be waived jointly by all the parties entitled to it.

Arnold J, using the Court's discretion, granted an injunction requiring the law firm to cease acting for Avonwick.

Avonwick and the trustees (although not the law firm) appealed.

The appeal and the Court of Appeal's judgment

As the Court of Appeal's judgment explained, Avonwick's case was built on the provisions of the Insolvency Act 1986. Avonwick contended that the documents and any privilege attaching to the information contained in them are property forming part of Mr Shlosberg's estate. They therefore vested in the trustees on their appointment pursuant to sections 283 and 306 IA 1985.

It argued, in the alternative, that it is a necessary implication of section 311 Insolvency Act 1986 that the trustees are entitled to use the documents and the privilege for the purpose of their functions and powers. This included taking steps that would potentially reduce the claims on the estate, as would be the case if Avonwick succeeded in recovering damages in the conspiracy proceedings from any of the other defendants to those proceedings. That was because any such award of damages to Avonwick in the conspiracy proceedings would reduce Avonwick's claim as a creditor of Mr Shlosberg's estate by an equivalent amount.

The Court of Appeal held that, on the proper interpretation of the Insolvency Act 1986, privilege is not property that automatically vests in the trustee in bankruptcy. The Court held that the relevant provisions do not expressly treat privilege as property of the bankrupt which automatically transfers from the bankrupt to the trustee. Nor is that a necessary implication of the provisions.

The Court also rejected the argument in relation to section 311. The Court held that it is not necessarily implicit in that provision that the trustee can waive the bankrupt's privilege in taking steps for the benefit of the bankrupt's estate. The Court also rejected an argument that deployment of Mr Shlosberg's privilege to assist Avonwick in a claim against another party, if that would result in the reduction or elimination of a creditor's claims against the estate, would be for a purpose of getting in, realising or distributing the bankrupt's estate. The Court held such action would not be within the duty and ancillary powers of the trustees.

The Court of Appeal upheld the injunction restraining the law firm from continuing to act for Avonwick.

The Court of Appeal therefore upheld the decision of Arnold J in Mikhail Shlosberg v Avonwick Holdings Ltd & Ors [2016] EWHC 1001 (Ch), that privilege is not property of a bankrupt which automatically vests in a trustee in bankruptcy (Avonwick Holdings Ltd & Anor v Shlosberg [2016] EWCA Civ 1138).

The Court of Appeal confirmed that although bankruptcy trustees are entitled to the bankrupt's documents they are not entitled to the legal privilege of the bankrupt and therefore cannot waive that privilege. This can be contrasted with the position in relation to corporate insolvency where property is not automatically transferred from the company to the officeholder because, instead, the officeholder takes over control of the company and therefore takes the benefit of the privilege already belonging to the company.

However, this decision is relevant to all insolvency practitioners. As Arnold J said at first instance, there is nothing inherently objectionable about a solicitor acting for both a trustee in bankruptcy or liquidator and a major creditor of the bankrupt or insolvent company. Indeed, this is common. It is possible, however, that conflicts of interest can arise. For example, the officeholders could obtain documents or information during the course of the insolvency process which may be damaging to the bankrupt or company in liquidation and beneficial to the creditor.

Insolvency practitioners should, therefore, take care when instructing solicitors, particularly if they propose instructing a firm which already acts for a creditor. It would be prudent to consider whether separate teams within the law firm should represent each client (with appropriate information barriers established). This did not occur in this case and this was a factor which influenced the decision to grant an injunction restraining the law firm from acting for the creditor.