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Breaking news for astrophysicists: Black holes can collapse

Litigation costs after insolvency

OK, so the title perhaps implies that what follows is more interesting than it is. However, the most recent decision of the Supreme Court in the Nortel/Lehman litigation is of considerable importance for all of us, particularly in the current economic climate.

Some of you may have read my article, Costs, expenses and provable debts of February 2012 where I considered the broad issues of the costs of ordinary litigation in the context of insolvency.  One of the issues considered was the "black hole" that arose for many litigation costs following insolvency.  It is this issue that we now need to revisit. 

For those of you who don’t deal with insolvency day in day out (and in an effort to show you why this is very relevant), take the following scenario:

  • You act for the landlord.
  • There have been proceedings ongoing against the tenant for various breaches of the lease.
  • Trial is but two weeks away.
  • Costs are substantial but you had good reason to believe that the tenant was financially sound and would be able to pay when you were successful at trial.
  • However, as is increasingly common, then lands on your desk the bankruptcy order, the administration order or the winding up order. One way or another the proceedings are no longer opposed and an order is obtained whereby, amongst other relief, the landlord gets an order for his costs to be paid by the now insolvent Defendant. 

The rules

The question then is, what is the status of that costs order?  The difficulty has always been the interplay of rules 12.3 and 13.12 of the Insolvency Rules 1986.  Rule 12.3 defines the term "provable debts" and states:

"Subject as follows, in administration, winding up and bankruptcy all claims by creditors are provable as debts against the company, or as the case may be the bankrupt, whether they are present or future, certain or contingent, ascertained or sounding only in damages."

Rule 13.12 sets out the definition of "debt" for the purposes of winding up, albeit the same definition applies for the purposes of bankruptcy.  Relevantly it states:

"Debt" in relation to the winding up of a company, means…

Any of the following

(a)    any debt or liability to which the company is subject… at the date on which the company went into liquidation.
(b)    any debt or liability to which the company may become subject after that date by reason of any obligation incurred before that date.

Rule 13.12(b), when taken together with rule 12.3 therefore conceives of contingent liabilities being provable debts. As a provable debt it will rank with the remainder of the unsecured creditors when any distribution is made. 

The issue

What then is a contingent debt? It was never particularly clear as to how one would define what was or wasn’t a contingent debt. However returning to the example above, the authorities said that the possible liability to pay costs that arose by virtue of the fact that the parties were involved in litigation before the insolvency event was not a contingent debt. Equally though it could not be said that the liability under the costs order should be paid as an expense of the bankruptcy, liquidation or administration because the liability hadn’t arisen in the course of the winding up, the administration or the bankruptcy. These conclusions arose from authorities as far back as In re Bluck, Ex p Bluck (1887) 57 LT 419 and In re British Gold Fields of West Africa [1899] 2 Ch 7 and has been recently approved in cases such as Glenister v Rowe [2000] Ch 76 and R (Steele) v Birmingham City Council [2006] 1 WLR 2380. 

By this analysis, the landlord in our example was left without redress – he cannot prove for the costs incurred and he cannot claim them as an expense of the insolvency – the order fell into the "black hole".  Whilst in bankruptcy he could pursue the individual later, in the case of limited entities there is almost never anything that survives the insolvency process to later pursue.

Black holes can collapse

However, as indicated in the title, black holes can collapse. This one just has.  By the decision of Lord Neuberger and Lord Sumption in Bloom v Pensions Regulator (In the matters of the Nortel and Lehman Group of Companies) [2013] 3 WLR 504 the scope of contingent liabilities (and therefore debts which count as provable) has been significantly clarified and extended.

The contingent liabilities in that case were contribution notices served by the Pensions Regulator. Summarising hugely, Nortel and Lehman had both organised their affairs so that separate companies in the group held and operated the pension funds and schemes for employees in other group companies. Due to the various changes in the pensions’ landscape, that service company and the scheme frequently had and has a shortfall against the pensions’ liability. The Pensions Regulator therefore has the ability, ultimately by contribution notice, to require other group companies to contribute to the group pension scheme held in the service company.  In both instances the relevant contribution notices were served on the group companies after administration. 

The administrators therefore originally applied for directions as to how this liability should be treated, the Pensions Regulator contending that they should be payable as an expense. In the High Court and the Court of Appeal, both of whom felt constrained by authority, the liability was held to be payable as an expense.  However in the Supreme Court, these decisions were overturned and the liability under the contribution notice is now to be treated as a provable and therefore an unsecured debt.

The underlying rationale as expressed by Lord Neuberger is that the purpose of the insolvency regime must be to deal with as many of the insolvent’s issues as possible that exist at the date of the insolvency.  Leaving matters to fall into "black holes" is undesirable. The specific reasoning in regard to costs orders is that by entering into litigation you become subject to the statutory scheme governing that litigation. In so doing a contingent liability arises to pay costs to the other side in the event that you are unsuccessful. That contingency, Lord Neuberger held, is sufficient for the purposes of rule 13.12(b).

In reaching these conclusions the long running line of authority on costs orders has been set aside, Lord Neuberger determining that they had been wrongly decided. The way has been left firmly open for an extension of categories of debts which constitute contingent debts for the purposes of proving in a liquidation, administration or bankruptcy. Lord Sumption for instance at paragraphs 132 and onwards sets out a number of other contingent debts that are provable.

So we can now finally return to the example above. Following the judgment of the Supreme Court, our Landlord can prove for the costs that he incurred in the litigation which started before the event of insolvency. Whilst in many instances this will remain cold comfort where there are no funds available for pari passu distribution to unsecured creditors, there will be a number of instances where this gives the landlord at least some redress for the costs expended.