High Court releases landmark preference decision

Carton-Kelly v Darty [2022] EWHC 2873 (Ch)What is the test for a preference under the Insolvency Act 1986?

Overview

This decision considers various elements of the statutory cause of action under the preference provisions (s.239) of the Insolvency Act 1986, including what constitutes a desire to prefer (s.239(5)), how balance sheet insolvency is determined (s.123(2)), and more.

Background

On 2 November 2012, Comet Group plc, now known as CGL Realisations Limited (“Comet”), entered administration. The administration was converted to a creditors’ voluntary liquidation on 3 October 2013.

On 3 February 2012, around nine months before it collapsed, Comet had been sold by a listed group headed by Kesa Electricals plc (the “Kesa” group) to vehicles established by OpCapita LLP, a private investment partnership specialising in distressed retail sector opportunities (the “Disposal”). Comet then repaid approximately £115.4m of intra-group debt to Kesa International Limited, a predecessor to Darty Holdings SAS (for simplicity, Kesa International Limited will be referred to as “Darty“) as part of the completion arrangements for the Disposal.

The issue was whether the repayment of the loan to Darty constituted a preference. Darty raised an initial defence, arguing that it was not connected with Comet at the time of the Disposal. This point was concluded in favour of the Liquidator by Deputy ICC Judge Agnello, whose decision was upheld by Miles J on appeal in 2021.

On this application, Darty disputed all other aspects of the claim, namely:

1. whether there was a preference in fact, and if so its extent;

2. whether there was the necessary desire for the purposes of s.239(5);

3. whether Comet was insolvent at the time the preference was given, or in consequence of it; and

4. whether, even if all the requirements for s.239 to apply were satisfied, the court should exercise its discretion to make no order to restore the position.

Balance Sheet Insolvency

Mrs Justice Falk dealt first with the question of whether Comet was in fact insolvent at the relevant time. Her overall assessment of the evidence was that Comet was balance sheet insolvent within s.123(2) immediately before the Disposal.

By far the most significant debate between the experts in relation to balance sheet solvency related to whether Comet’s assets should include a material deferred tax asset (“DTA”) that had been included in the FY2011 statutory accounts. Mrs Justice Falk concluded that the DTA should not be taken into account. The DTA represented tax benefits in the form of carried forward losses and unclaimed capital allowances that were available to offset future taxable profits of Comet’s trade. Such tax benefits were of value only if and to the extent that future taxable profits actually arose, such that a tax saving could be made. Mrs. Justice Falk agreed with the Liquidator’s expert that this amount should have been written off because it did not meet the test of it being probable that Comet would have sufficient taxable profits available in future periods to allow it to be used.

Although certain of the long-term liabilities, in particular in respect of lease-related items, should be discounted to some extent for delay in crystallisation, Mrs Justice Falk was satisfied that it was more likely than not that any discounting would have been insufficient to have resulted in positive net assets.

Mrs Justice Falk was similarly not persuaded by the board’s conclusion that Comet was solvent on 3 February 2021, finding that there was no evidence of a detailed scrutiny of that position by the board, and that they likely focused on cash flow solvency rather than balance sheet solvency.

Preference In Fact

As to the existence of a preference, the Liquidator’s argued that Darty received £115.4m, equating to a return of 89p/£, whereas it would have received less in a hypothetical liquidation. For its part, Darty argued that an amount paid to Triptych Insurance NV (“Triptych”), another entity connected with Comet, should be ignored in determining the extent of the factual preference, characterising the relevant arrangement as Triptych, rather than Comet, giving up value.

Mrs Justice Falk disagreed, finding that what was done in relation to the Triptych amount (where payments were made without cash actually moving out of the bank account of the solicitors for the purchasers) was no different than the other payments made pursuant to the Disposal. All of these payments were in effect no different to a series of cash payments, set offs being equivalent to cash. In order to repay the amount owing by Darty to Triptych, Comet had to take on the burden of a secured borrowing from Hailey Acquisitions Limited (“HAL“, one of the purchaser entities), just as if cash had moved from HAL to Comet and been used by it to repay Darty.

Another way of looking at this was to say that Comet permitted Darty to satisfy the debt that Darty owed to Triptych (which Darty had been directed to pay successively to HAL) by set off against an amount that Comet owed Darty, but this was at the cost of incurring a secured debt to HAL. This is because HAL gave a further direction to Darty to pay Comet, so permitting a set off, only in exchange for Comet agreeing to incur that debt. It was not correct to characterise the arrangement as Triptych rather than Comet giving up value.

Accordingly, it was appropriate to consider the Triptych amount in determining the extent of the factual preference. Mrs Justice Falk ultimately accepted the Liquidator’s argument that Darty received more than it would have in a hypothetical liquidation, and determined that there was a preference in fact.

Desire to Prefer

With respect to this element of the test, Mrs Justice Falk found that a desire to make a payment was not enough – what was required was a desire to improve Darty’s position in the event of an insolvent liquidation of Comet. Mrs Justice Falk did not accept that Kesa did not contemplate the possibility of an insolvent liquidation. Whether or not individuals at Kesa had formed the view that Comet was solvent at the point of Disposal, they undoubtedly knew that there was a risk of an insolvency process and had discussed such a possibility with the purchaser and another potential bidder.

Mrs Justice Falk accepted that no one at Kesa seriously contemplated an insolvent liquidation of Comet while it remained part of the Kesa group, but did not consider this fatal. If this submission were correct, then that would materially undermine the effectiveness of s.239. It would amount to saying that it cannot apply in any situation where a debtor is prepared to do whatever it takes to immunise a particular creditor from an insolvency process, by paying them off before there is a real risk of any such process commencing. It makes no difference to this that paying the debt off may be part of a broader transaction in which shares are also transferred.

With respect to the imputation of intent from an employee to the company, Mrs Justice Falk held that a desire to prefer must have been held by a person or persons involved in the debtor’s decision making process, such that it was capable of being a factor which “operated on the mind” of the decision maker or makers. Of the five directors Comet had at the time, two were heavily involved in the process of agreeing the terms of the Disposal. The others were clearly content, either consciously or by leaving the details to the relevant directors, to enter into a transaction which contemplated Comet taking actions that, left to its own devices, might well be perceived as not being in its own interest. Accordingly, it could be concluded that the directors, and Comet itself, had the requisite desire to put Darty in a better position.

Discretion

Finally, Darty took the position that, even if a preference within s.239 was found to exist, no order should be made to restore the position on the basis that exceptional circumstances existed. It argued that the real issue related to the grant of the debenture to HAL at the conclusion of the Disposal, and pointed out that the Liquidator had not only jettisoned any claim challenging the debenture, but had not objected to a proof of debt by HAL that made it by far the largest unsecured creditor, and therefore the largest beneficiary of any recoveries made by the Liquidator in these proceedings.

Mrs Justice Falk found that it would not be right to refuse to make an order because the Liquidator might have had a claim against HAL, or because he did not object to HAL proving as an unsecured creditor. Either approach would amount to accepting an indirect challenge to the Liquidator’s actions. No such challenge was before the court.

There was no dispute that the purpose of s.239 is to prevent a company defeating or undermining the pari passu principle, namely that creditors should be entitled to participate on a pari passu basis in assets held at the date of the insolvency, and that this should extend to assets that ought to have been held but for ill-motivated transactions putting them out of the liquidator’s reach.

In order to repay the debt owing to Darty, Comet drew down £115.4m of secured debt. The effect was to deprive other unsecured creditors of access to assets that became available only to the secured creditor. This was not a case where “exceptional circumstances” existed to justify no order being made. Instead, it was appropriate to order the relief sought by the Liquidator, namely the difference between the £115.4m repaid and the counterfactual dividend in a hypothetical liquidation.

Judge: Mrs Justice Falk

Counsel: Andreas Gledhill KC & Tiran Nersessian of 4 Stone Buildings (instructed by Jones Day) for the Applicant; Tom Smith KC & Henry Phillips of South Square (instructed by Sidley Austin LLP) for the Respondent