It is a cornerstone of English insolvency law and practice that creditors of a company in financial difficulty should share rateably (“pari passu”) in that company's assets. Put at its simplest, creditors with security should be paid before creditors with no security and unsecured creditors should share rateably between each other. Where an unconnected and unsecured creditor is paid before another creditor in the same category, that payment risks being set aside as a "preference", should the company subsequently enter liquidation or administration. But when does a preference occur?
At its simplest, a preference payment is one that takes place within 6 months of liquidation or administration. Where the payee is "connected person" – for example the paying company’s wholly owned subsidiary – that 6 month period is increased to 2 years. However, the company making the payment must be "unable to pay its debts" or become unable to do so because of the payment in question. The company must also be "influenced by a desire" to put the creditor being paid in a better position than those creditors who are left unpaid. That "desire to prefer" must exist at the time the payment is made. Where the payment is made to a “connected person", there is a rebuttable presumption that the desire necessary to give a preference exists.
When must the desire to give a preference exist? This is an important issue, both for boards of directors managing a company through any period of financial difficulty and for that company's legal and financial advisors. If the company is to keep trading, it will need to pay key creditors, such as legal and financial advisors in the restructuring process and critical suppliers. Payments to other, non-essential, creditors should be deferred at least until the outcome of the company's financial problems has become clear.
In Darty Holdings SAS -v- Geoffrey Carton-Kelly, [2023] EWCA CIV 1135, (“Darty”) the Court of Appeal (“CA”) considered the question of "when" the desire to prefer must be found to exist. The CA’s judgment was given in relation to the long-running insolvency of the Comet electrical group. The CA had been asked to reverse an earlier ruling by Mrs Justice Falck (“Falck, J”) that the repayment by Comet Group plc ("Comet") of £115.4 million of unsecured intra group debt to Darty's predecessor, Kesa International Limited ("KIL") was a preference.
Summary
The CA allowed Darty’s appeal and overturned Falck J's decision that the repayment to KIL amounted to a preference. The CA found that the decision to authorise the repayment to KIL had been taken at a board meeting of Comet held on 3 February 2012. The CA went on to find that the board's decision that day was not influenced by any desire to improve KIL's position. To that extent, Darty does not make new law. It merely restates the well-established requirements for a preference. What is of interest to distressed companies and their advisors is the way in which the CA reached its conclusion as to the time at which the decision to repay KIL had been taken, doing so by closely reviewing who said what, where and when.
The CA’s analysis reiterated the fact based nature of the preference remedy. While that increases flexibility, it also reiterates the importance of companies, supported by their advisors, keeping careful minutes and summaries of the key stages in any restructuring process. That is particularly important where the restructuring process leads to some creditors being paid in circumstances where others remain unpaid.
The CA’s Analysis
The CA was asked to revisit whether the repayment by Comet of £115.4 million of unsecured intra group debt to KIL, on the occasion of the sale of Comet by the Kesa group, amounted to a preference. Repayment was made following a Comet board meeting held on 3 February 2012. The specific issue the CA was asked to revisit was whether the decision to make the repayment was taken at the board meeting on 3 February 2012 or at a different time. Comet had gone into administration on 2 November 2012, with the administration becoming a creditors' voluntary liquidation on 3 October 2013. Comet had been funded by a £300 million Revolving Credit Facility ("RCF") provided by the Kesa group.
KIL had decided to dispose of Comet and OpCapita became the preferred bidder. The target for completion was 3 February 2012. KIL was to retain Comet's defined benefit pension scheme and provide £50 million of share capital to the OpCapita purchasing vehicle.
Comet was not a party to the sale and purchase agreement ("SPA") which governed the terms of its disposal. The parties to that SPA included Kesa Holdings Ltd as the owner of Comet's shares and the OpCapita purchasing entities. The SPA provided for the appointment of OpCapita nominees as Comet directors in succession to the previous board of directors. The SPA also provided that the new Comet board would review Comet’s financial position in the light of an 18-month business plan.
Falck, J ruled that Comet's repayment of £115.4 million to KIL was a preference and should therefore be set aside. Her reasoning was first that Comet was unable to pay its debts immediately before its sale. She also found that representatives of the Kesa Group had desired to ensure that KIL received the £115.4 million payment. Falck, J also found that the decision for the repayment to be made was taken on Comet's behalf on 9 November 2011. In other words, the decision to repay KIL had been taken before the Comet board meeting on 3 February 2012.
The CA first observed that Falck, J had concluded that the decision for Comet to make the repayment had been taken on Comet's behalf by the Kesa Group's General Counsel, Mr Enoch. Falck, J had gone on to find that Mr Enoch had been influenced by the desire for KIL to be repaid ahead of other creditors. Falck, J had accepted that if the decision had in fact been taken at the board meeting on 3 February 2012, there was no desire to prefer KIL over Comet’s other unsecured creditors.
The CA stressed again that the timing of any decision to make a payment was a question of fact to be determined in the particular circumstances of the case. The CA observed that Comet was under no "enforceable contractual obligation" to make any repayment until it had entered into the various agreements that were approved by Comet’s board of directors on 3 February 2012. The CA went on to find that there was no reason, on the evidence, to conclude that the new Comet board of directors had perceived its hands to be tied in consequence of the discussions on 9 November 2011. The CA also saw no reason to doubt the accuracy of board minutes recording that Comet’s board had also considered other potential source of funds before deciding to enter into the completion arrangements that led to KIL's repayment.
Hence the CA accepted that there was "simply no evidence" to support Falck, J’s conclusion that the decision for Comet to repay KIL had been taken on 9 November 2011, some three months before the Comet board meeting on 3 February 2012. The CA accepted Darty's submission that there was "no contemporaneous evidence" to show that Comet had itself taken any decision to repay KIL before 3 February 2012. The CA placed particular weight on a provision in the SPA which gave the Kesa group the right to terminate the SPA if it failed to procure Comet’s holding a meeting of its board of directors that among other things led to Comet repaying £115 million to KIL. The result was that there was no "desire" on Comet's part to prefer KIL. Hence Darty's appeal succeeded, and it was permitted to retain the £115.4 million RCF repayment that Comet had made in February 2012.
Commentary
Successful management of a company's financial difficulties is invariably a complex process. It requires a combination of good commercial judgment and advice. Where a refinancing is successful, the factual bases for and the pressures inherent in making such judgments will invariably be forgotten as the company’s rescue recedes ever farther into the past and it trades from strength to strength. If the restructuring process fails, those involved in it will find their conduct scrutinised by administrators or liquidators who are almost certain to go with a fine toothcomb through every event and every payment leading to the company’s financial implosion.
In the worst cases, those investigations will inevitably lead towards at best censure and at worse disqualification of directors and others concerned in the management of the failing company. In every instance, however, those picking over the carcass of a failed company will possess one luxury denied to those burning the midnight oil seeking to conclude the ultimately unsuccessful rescue. That key, additional, attribute is, of course, the benefit of hindsight.
In our experience, there is only one counter to the application of "hindsight", however well-intentioned such "hindsight" may be. That counter is hard evidence. Such evidence should take the form of clear, substantiated, records of directors' decisions, along with the advice obtained on which such decisions were taken. Company directors must be able to demonstrate that they have each considered the financial health of their company closely and, indeed, done so on a regular basis. Darty, while a decision relating to preferences, is, no more no less, a further illustration of the importance of such evidence in any corporate restructuring that is implemented against a background of financial stress.
