Costs are the price that creditors pay for an insolvency practitioner’s (“IP”) expertise and time in dealing with a trading bankrupt or insolvent business. However, where the assets are insufficient to meet the existing debts, the imposition of a practitioner’s fees and expenses being paid out in priority can send some “over the edge” and all practitioners have the scars to prove it. This article explores the developing general principles and major pitfalls and how to avoid them.
For the purposes of this article, we will focus on remuneration in the context of a liquidation. However, the principles are broadly similar for other trading insolvencies.
Fees and disbursements incurred prior to a formal insolvency procedure (“FIP”)
IPs are often instructed prior to a FIP, whether to provide advice to directors or assess whether a company is trading whilst insolvent. It may seem like an obvious point, but it is vital that before starting work an IP should seek an indemnity or some means of payment as an alternative to being paid by the company in question.
If the work undertaken subsequently results in an application for an FIP then (subject to the indemnity) the IP is likely to want to apply for their costs for that work to be treated as an expense of the FIP. For work which is not referable to this FIP, or if the application for an FIP is refused then payment of fees is simply a matter between the company and the IP. Any fees outstanding will simply rank as an unsecured claim in the FIP.
Practitioners should beware the fast moving pace of FIPs or the difficulties of changing between two different FIPs (i.e. moving from an administration into a liquidation). The case of Neumans LLP v Androndikou and others  EWCA Civ 916 provides a stark warning of the danger of being caught out without an indemnity. In this case, a firm of solicitors were unsuccessful in striking out a winding up petition against Portsmouth City Football Club Ltd (“PCFC”). While the appeal was pending, PCFC’s new owner appointed administrators out of court. After the administrator’s costs had devoured all of PCFC’s assets, PCFC was wound up on the original petition, leaving the firm of solicitors ranked as an unsecured creditor and facing the prospect of recovering none of its fees and disbursements of around £267,000.
Unsurprisingly, the solicitor’s position attracted scant sympathy. There is of course nothing more ingenious or focused than a solicitor seeking to recover his costs. They sought to claim that their fees should be treated as an expense in a subsequent out-of-court administration. The court rejected this and (with the benefit of hindsight) suggested that the solicitors should have sought third party funding or indemnities from the company directors.
PRACTICE POINT: Think about costs from the beginning and get an indemnity or third party funding.
Fees and disbursements incurred following an FIP:
- General principles: The Insolvency Rules 1986 (“IR 86”)
Unfortunately, IPs cannot fix their own remuneration and have no right to retain remuneration out of the assets if they are insufficient to pay other expenses of the FIP.
IR 86 provides for the remuneration of IPs (“office-holders”) and further important guidance is provided to the court by Practice Direction: Insolvency Proceedings  B.C.C. 265 (the “Practice Direction”).
Historically, remuneration had often been determined as a percentage of realisations and distributions. This changed with IR 86 which provided for an office-holder’s remuneration to be determined:
- by reference to the time properly given by the insolvency professional; or
- as a percentage of realisations and distributions; or
- to be fixed (1).
The decision as to which basis of remuneration to apply is made by the creditors' committee or by a resolution of the meeting of the creditors. In making their decision, the committee shall have regard to the following matters:
- the complexity (or otherwise) of the case;
- any respects in which, in connection with the winding up, there falls on the IP any responsibility of an exceptional kind or degree;
- the effectiveness with which the IP appears to be carrying out, or has carried out, his duties as liquidator; and
- the value and nature of the assets with which the liquidator has to deal (2).
In the event of no determination, the office-holder will be entitled to remuneration on the “official receiver’s scale” both for realisations and distributions.
In the event that the office-holder considers that the basis of the remuneration fixed by the committee or by resolution of the creditors is insufficient or inappropriate, the office-holder may apply to court for an order changing it (3). Recent case law, such as the Neuman case, suggests that the courts are adhering to the letter of the IR 86 and the Practice Direction (see below). Therefore, an office-holder will maximise their chances of increasing their remuneration if they think about costs and apply the principles in the Practice Direction from the outset and have evidence to justify this, over and above basic time entries.
PRACTICE POINT: Consider whether your existing time recording systems comply with IR 86 and the general principles set out in the Practice Direction to ensure that you can have easily accessible evidence to justify your remuneration.
- General principles: The Practice Direction
The Practice Direction has been designed as a one stop shop for the principles, procedure and practice relevant to the fixing of an office-holder’s remuneration by the court, including the information required.
The Practice Direction states that its objective is “to ensure that the remuneration of an appointee [office-holder] is fair, reasonable and commensurate with the nature and extent of the work properly undertaken by the appointee in any given case and is fixed and approved by a process which is consistent and predictable” (paragraph 20.2.1).
Under IR 86 a creditor may apply to the court for an order that an office-holder’s remuneration be reduced on the basis that, in all the circumstances, the remuneration is too high (4). Ordinarily all such applications will be heard at first instance by a registrar sitting alone. However, where it is sufficiently complex the court may direct that the application be heard by a registrar or district judge sitting with an assessor or a costs judge. In addition the court may direct that a report in respect of the remuneration be prepared by an assessor or a costs judge as an aid for the registrar.
As well as setting out the procedure for a remuneration application, the Practice Direction also sets out the court’s guiding principles when fixing and approving remuneration:
- justification –the office-holder must justify his claim and be prepared to provide full particulars of the basis for and the nature of his claim for remuneration;
- the benefit of the doubt – if there is any doubt as to the appropriateness, fairness or reasonableness of the amount sought, such doubt should be resolved by the court against the office-holder;
- professional integrity – the court should give weight to the fact that office-holders are members of a regulated profession;
- the value of the service rendered – remuneration should reflect so as to reward the value of service rendered, not merely reimburse time expended and cost incurred;
- fair and reasonable – remuneration should be fair and reasonable and represent fair and reasonable remuneration for the work properly undertaken;
- proportionality (both of information and remuneration) – this relates to the information to be provided by the office-holder in relation to his remuneration and to the remuneration itself. It takes into account the nature, complexity and extent of the work, the value and nature of the assets and liabilities involved. Consideration will also be given to the nature and degree of responsibility of the office-holder, and the nature and extent of risk to and the efficiency of the office-holder;
- professional guidance – regard can be taken of relevant and current statements of practice by relevant regulatory and professional bodies in relation to remuneration; and
- timing of application – remuneration should reflect whether any application should have been made earlier and the reasons for any delay in doing so.
The actual costs of and occasioned by an application for the fixing and/or approval of the remuneration of an office-holder are paid out of the assets of the estate unless ordered otherwise by the court.
PRACTICE POINT: Think about how you can justify costs to the creditors and court by reference to the general principles, and record this in a contemporaneous note (ideally accessible to the creditors).
Solicitors and experts' fees should be treated as disbursements and not as part of an office-holder’s remuneration. As such costs met by and reimbursed to the office-holder should be properly chargeable, i.e. appropriate and reasonable.
Where there is litigation, solicitors and experts’ fees may be recovered (in part, at least) from the other side. However, where this is not the case and they are properly chargeable or incurred by the office-holder, disbursements are counted as an expense of the liquidation. As such, disbursements are paid out of the assets in the order of priority set out in r.4.218 IR 86, resulting in the payment of expenses prior to the payment of an office-holder’s fees.
If prior sanction for actions such as litigation over antecedent transactions is not obtained from the committee/creditors, then those disbursements will not be treated as properly chargeable and therefore are not payable as an expense of the FIP. An office-holder may be left footing the bill personally.
PRACTICE POINT: Think carefully about whether disbursements are necessary and obtain prior sanction where appropriate.
Before accepting an appointment, an office-holder should consider carefully whether the company’s assets will be sufficient to discharge the expenses of the FIP, including his remuneration, to avoid being out of pocket.
Given the dire consequences of failing to recover costs, IPs should consider costs and their recovery at the outset and keep them in mind throughout. IPs should consider whether third party funding might be available, or seek to negotiate indemnities from the directors of any potentially insolvent company. While these practice points may not be rocket science, these simple steps should save a lot of problems when it comes to remuneration from a limited pot.
The situations are myriad and the tactics sometime Machiavellian, but a clear approach to costs and transparent records (together with clear and quick legal advice) will go a long way to prevent an IP from working without remuneration and at their own expense.
This article was published in Recovery Journal in February 2014 .