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Costs, expenses and provable debts

October last year saw the decision of the Court of Appeal in litigation arising from the administrations of Nortel and Lehman Brothers (Re Nortel GMBH [2011] EWCA Civ 1124).  The case concerned the treatment of contribution notices from the Pensions Regulator by the administrators.   However, for those who ventured beyond mention of the Pensions Regulator, the decision contains a useful review of the law pertaining to whether liabilities fall as provable debts or expenses of the insolvency process.

This is a question that seems to be cropping up more frequently particularly in circumstances where the insolvency practitioner inherits litigation started before the insolvency process.  A common issue is what to do with litigation that is afoot when the insolvency practitioner is appointed, particularly if the merits are unclear.

There are a number of well established principles relating to the costs of litigation during insolvency proceedings and it is perhaps worth briefly revisiting them first, particularly as neither the Act nor the rules contains a self contained code. 

The first scenario is where the office holder brings proceedings.  Although trite, there is no protection for an office holder bringing proceedings in his or her own name or in the name of the company.  The office holder is liable (personally) for the costs of the proceedings in the usual way and the provisions of the CPR will apply when a final determination is made in those proceedings (Re Wilson Lovatt & Sons Ltd [1977] 1 All ER 274).  Thereafter it is usually the case that the office holder will be entitled to recover the costs that he has been ordered to pay (and indeed his own costs) from the assets in the estate.

However, a word of caution in regard to the last point.  The Courts appear to be increasingly willing (or creditors more willing to bring the point before the Courts) to make orders that costs incurred should not be paid from the assets of the estate.  Coyne and Hardy v DRC Distribution [2008] EWCA Civ 488 was a case in point where the major creditor applied for the removal of the administrators as a consequence of a failure to recover assets from an errant director.  Although that application wasn’t ultimately heard (the company being placed into liquidation beforehand), the administrators were ordered to pay the creditor’s costs of the application and were not entitled to recover those from the assets of the company.

Another was the case of Re Capitol Films Limited [2010] EWHC 3223 (Ch) in which the administrators were ordered to pay the costs of the successful applicants, and the claims for recoupment of those costs from the assets of the company were deferred until repayment of the unsecured creditors in full.

The second scenario is where the practitioner is the Defendant to proceedings.  The starting point is rule 7.39 of the Insolvency Rules 1986.  This enacted the long standing practice of the Courts and provides that unless the Court orders otherwise the practitioner shall not, when made a party to proceedings, be personally liable for the Applicant’s costs.  The same shall be paid from the assets of the estate as an expense.  However the prohibition is not absolute and the Court retains a discretion to order otherwise in appropriate cases.  DRC Distribution and Re Capitol Films are both examples of the Court ordering otherwise.

These are standard situations with which we are familiar.  However where litigation is inherited the position gets more complicated.  Again it is perhaps instructive to go back to some first principles.  Provable debts are determined primarily at the date of the inception of the insolvency.  Theoretically the distribution to creditors will take place at the date of the inception of the process albeit practically this is of course never possible.  Rule 13.12(b) (and 382(1)(b)) extends this position in regard to contingent debts arising from liabilities in existence at the date of insolvency.  Consequently debts which arise after that date can only be paid if they satisfy the criteria for being an expense of the insolvency process.

It is not difficult to see that there will be some debts that can fall between these two stools and fall into what has been described as the "black hole" (see Re Nortel GMBH). 

There is no technical difference here between bankruptcy, liquidation and administration.  However there is a significant practical difference.  If debts fall into the ‘black hole’ in a bankruptcy, the creditor will retain his right to pursue the bankrupt post discharge, the individual surviving the bankruptcy process.  Almost without exception though a company does not survive the insolvency process and for debts falling into the "black hole" there will be no redress.  It is worth noting though at this stage that, whilst the Courts accept that the hole exists there seems a reluctance to find that debts fall into it, particularly in the corporate sphere where various ways have been found to ensure that the debt is resolved in the insolvency process. (A review of the relevant cases is in the Re Nortel GMBH  decision at paragraphs 55 and onwards).

It seems now settled that costs in proceedings not complete at the date of insolvency and in which no order for costs is made until after the date of insolvency form one type of liability that falls into the "black hole".  In Glenister v Rowe [2000] Ch 76 the debtor obtained a strike out of the creditor’s claim.  The creditor appealed but the debtor was made bankrupt.  It seems that the trustee took no steps to resolve the litigation in the bankruptcy and shortly after the debtor’s discharge the appeal was successful.  The debtor was ordered to pay the creditor’s costs and it was held that that debt, not existing or contingent at the date of bankruptcy, survived the insolvency and could be pursued against the debtor post bankruptcy. 

Where the practitioner adopts proceedings in the insolvency process, that is takes the proceedings afoot at the date of the inception of the insolvency procedure and continues the claim or defends them on behalf of the individual or the company, it seems that the usual cost consequences set out above will flow - Re Movitex [1991] 1 WLR 303.

However, this leaves one important issue unanswered.  Assume that the litigation started by the company or being defended is hopeless.  Upon appointment the practitioner should, for the purposes of properly winding up the affairs of the company (or completing his duties for a company in administration), deal in some way with the litigation to ensure that provable debts are properly identified for the purposes of distribution.  In circumstances where the company is Claimant the liquidator may well decide to issue a notice of discontinuance.  The usual rules of CPR 38.6 apply and the company will be prima facie liable for the costs. 

How then are those costs to be dealt with?  From the authorities it seems unlikely that the costs simply fall into the "black hole".  Equally though, if by serving the notice of discontinuance the liquidator is to be treated as having adopted the proceedings, the party upon whom the notice of discontinuance is served will be afforded priority status, the costs being an expense of the litigation.  This is something they would not have enjoyed if the notice had been served the day before insolvency.

There are no decided cases on this point as yet but it seems likely in these turbulent economic times that the point will fall to be considered in the near future.  It is the author’s view that the most likely outcome is that the liquidator will, in such a scenario, be regarded as having adopted the proceedings and the costs will be dealt with as an expense.  However, the Court retains the power to vary the priorities of payment of costs and can, as we have seen, go as far as to order that expenses be paid subject to payment of the unsecured creditors (Re Capitol Films).  It seems likely that the Court would order that the costs incurred should rank alongside the unsecured creditors.