Return to Contents
The Jersey Law Review - June 2003
WINDING UP THE LIVING DEAD
Simon Howard
Introduction
1 A recent decision of the Royal Court has highlighted the practical problems which directors of a Jersey public company can face when trying formally to wind up the affairs of their company when it is deeply insolvent and has charged all its assets by way of security interests created under Jersey law in favour of a lending bank. It raises the interesting question as to who, in the absence of an official receiver in Jersey, can and should act as the liquidator of last resort of a Jersey public company.
Background to the Leveraged application
2 Leveraged Income Fund Limited ("Leveraged") was a Jersey incorporated public company which was regulated as a collective investment fund under the Collective Investment Funds (Jersey) Law 1988 (“the CIF Law"). Leveraged operated as a closed-ended split capital investment fund and had an issued share capital comprising income shares and zero dividend preference shares. It also had loan stock in issue. As its name indicated, an element of the investment strategy followed by Leveraged was seeking to enhance returns to its investors through bank borrowings which had the effect of gearing its investment portfolio. A lending bank in Jersey provided the gearing finance and held security interests over all the cash and investment custody accounts operated by the company. Unfortunately the vehicle was a casualty of the dramatic declines in stock valuations in the opening years of the new millennium which caused the value of the company's investment portfolio to plunge below the level of its borrowings. The lending bank was forced to exercise the security it held to mitigate its own losses which resulted in Leveraged being left as a shell with no assets and in problems for the directors as to how to wind up the company and to deal with angry and disappointed investors.
3 These problems were crystallised upon the enforcement of the bank's security and arose from the financial position of Leveraged and the nature of security which is currently available under Jersey law over intangible moveable assets. Jersey law does not recognise the concept of a floating charge. Security of the type in question created under the Security Interests (Jersey) Law 1983 is constituted in the form of fixed charges by the assignment of the title to the collateral to the secured party or its agent or the giving of control over the collateral to the secured party normally in tandem with a security power of attorney. Upon an event of default occurring there is no necessity for the secured party under such a security agreement to appoint a receiver or administrator to the debtor company in order to take charge of its undertaking and realise available assets. The secured party can proceed to enforce the security directly by appropriating cash collateral and/or exercising the statutory power of sale conferred by the statute and applying the proceeds towards the discharge of the secured obligation. Any surplus proceeds of the realisation will be subject to a statutory equity of redemption.
4 In the case in hand no surplus assets existed following enforcement of the security as the value of the collateral was insufficient to discharge the secured debt. The question which then faces the board of a company is how the residual affairs of the company can be wound up and its dissolution achieved. In the absence of any remaining monies available to the company the options are extremely limited.
Options for winding up and dissolution
5 The insolvent position of such a company precludes the possibility of a solvent summary winding up procedure being followed under Part XXI of the Companies (Jersey) Law 1991, as amended (“the Companies Law"). Nor is the alternative of a creditors' insolvent winding-up under the Companies Law a practical solution. Such a procedure envisages that the company does have remaining assets of some residual value out of which a dividend can be declared to creditors, or which can form the basis of a compromise arrangement between creditors and shareholders. The procedural requirements for a creditors' winding up also necessitate a certain level of expenditure with the appointment of a qualified liquidator and the convening of creditors’ meetings. In the case under review the company had no money to pay the costs of the procedure and there was nothing to share out amongst unsecured creditors.
6 One possibility is for the board to take no action and to allow the company to be struck off the register in due course for failure to submit its annual return and to pay the accompanying fee. Directors of a public company will not generally find this approach acceptable. They will wish to find some means of winding up the affairs of the company, preparing and presenting a final liquidation statement to any unpaid creditors and shareholders, and of arranging formally to dissolve the company.
7 A self-declaration en désastre by the company under the Bankruptcy (Désastre) (Jersey) Law 1990 (“the Bankruptcy Law") could be considered. However the directors may well be reluctant to follow this course unless the company is still operating and they are to avoid the prospect of wrongful trading claims. This reluctance will stem from the fact that many regulatory licensing procedures now require applicants to disclose as part of the licensing process whether they have ever been involved in the management of a company that has been the subject of bankruptcy/insolvency proceedings. Directors will fight shy of having to add a désastre application (albeit not a personal one) to their career profiles. It may also be argued that if there are no residual assets to be administered for the benefit of creditors there is no reason to invoke the bankruptcy process. The Viscount may in any event object to a self-declaration application by a company the assets of which are insufficient to cover the costs of administering the désastre. Where a désastre application is brought by a creditor the Court has the discretion to refuse to make the declaration unless the creditor indemnifies the Viscount against the costs to the extent that the Court thinks fit. This discretion to attach a costs’ indemnity only applies to creditor promoted désastres. Accordingly it would still be open to the Court to consider making a désastre order where the application is brought by the debtor notwithstanding that the costs of the procedure will have to be met out of the budget of the Viscount's Department.
8 This point appears not to have been considered in the proceedings relating to Leveraged where the Court was concerned to explore other procedures particularly if they might offer a better prospect of the company being able to investigate any rights of action which it might have arising from the failure of its investment portfolio. Representations were heard by the Court on behalf of the Viscount but the Court's conclusion was that the Viscount would not be in a position to pursue such matters because he was dependent upon the assets of the company to fund any litigation. The wording of article 5(2) of the Bankruptcy Law suggests that this conclusion may not be strictly correct. The real question (in the context of a corporate insolvency where there are no residual assets) is whether there is a sufficient public interest in the matter to require the public purse through the medium of the Viscount's Department to fund the désastre procedure and to carry out investigations to identify whether the debtor company has any claims which may be worth pursuing, and if so advised, to pursue them.
9 To this argument there are at least two responses: first the désastre procedure is intended to settle the claims of creditors who prove in the désastre. It is not a means to recoup asset value for shareholders of a failed company. In the case of Leveraged there were unsecured creditors holding loan stock issued by the Company but the loan stock holders were ranked behind holders of zero dividend preference shares; the loan stock therefore had the characteristic of quasi-equity capital. Secondly, the Viscount will tend to the view that, if a regulated financial services business in Jersey becomes insolvent and there are public interest factors to be weighed in terms of ensuring that the business is wound up properly and all relevant matters investigated, this is a task for the Jersey Financial Services Commission and not for the Viscount.
Just and equitable winding up
10 The Leveraged proceedings were concerned with an application brought by the directors of the insolvent company for an order under article 155 of the Companies Law that the company be wound up on the basis that it was just and equitable to do so. Just and equitable winding up remedies are options of last resort that are normally used where there has been a breakdown of trust and confidence in the management of the company or where the balance of power between disputing shareholders/directors causes deadlock. Winding up on just and equitable grounds breaks the impasse and enables the surplus assets of the company after creditors have been paid off to be released back to shareholders so that they can utilise their capital in other ventures. The interest being protected in a just and equitable winding up is the interest of shareholders in surplus capital. In the Leveraged case such an interest did not exist. The interest was that of the directors in bringing the affairs of the Company to a formal conclusion. In effect the Royal Court was asked to extend the scope of the just and equitable winding up jurisdiction so that it could be used as a summary winding up procedure for an insolvent Jersey company. But first of all the court had to be satisfied that the scenario of the Leveraged application was sufficiently similar to the circumstances of previous and successful winding up applications presented on a just and equitable basis to provide a foundation for the court's decision.
11 The jurisdiction of the Royal Court under article 155 of the Companies Law is similar to that conferred on the English courts under section 122 (1)(g) of the Insolvency Act 1986 and the Court referred to English law academic texts and cases to clarify the scope of the jurisdiction to order winding up on this basis. It was noted that the words "just and equitable" conferred a wide discretion which was not susceptible to exhaustive definition. One of the categories of case where the English court has exercised its jurisdiction on this basis is where the sub-stratum of the company in question has gone; in other words where the main object for which the company was formed has become impracticable. The mere fact that a company has suffered trading losses will not destroy its sub-stratum unless there is no reasonable prospect of making a profit in the future.
12 The Royal Court was left in no doubt that the sub-stratum of Leveraged had gone. The company no longer had any money to invest for its shareholders; in fact it was grossly insolvent. The company was without doubt moribund and there was no prospect of its being able to recommence its activities. A key factor to the viability to the winding-up application brought by the directors of Leveraged was that the secured lending bank had agreed to put up a fund to cover the costs of the liquidation process. There was no legal obligation on the lending bank to do this, and there is no reason to suspect that the bank agreed to put up this fund other than as a bona fide gesture towards the shareholder investors. The bank itself had suffered a very significant shortfall on the amount that it had realised under its security as against the amount of the secured indebtedness. The amount of the liquidation provision reflected a reasonable estimate of the likely costs of the two professional liquidators who were to be appointed for the purpose of preparing liquidation statements for the creditors and members. Certain shareholder investors were however concerned that these funding arrangements would not allow the liquidators to undertake a full investigation so as to evaluate whether the company had any claims against any persons which might be worth pursuing. The Court appreciated the great concern of investors but concluded that it saw no way of assisting them. It accordingly ordered that the nominated liquidators be appointed and that the company be wound up on the ground that it was just and equitable to do so.
Independence of the liquidator
13 The Court had little alternative but to make the order which it did in the circumstances and on the information presented to it. But whether the outcome was satisfactory is open to debate particularly from the point of view of shareholder investors. They could be expected to question the apparent conflict of interest that the joint liquidators were placed in by reason of funding for the liquidation being put up by the sole secured creditor of the company. The risk of prejudice was in fact probably negligible. Shareholder investors, including those holding loan stock issued by the company, ranked behind all other creditors. The lending bank as the only material creditor of Leveraged would have received all its realisable assets either as sole secured creditor or, if its security was capable of being challenged, as principal unsecured creditor.
14 Hotel Beau Rivage Co. Ltd. v Careves Investments Ltd. (No. 2) is an example of a case where there were acknowledged conflicts of interest affecting a liquidator which made his position untenable. In that case a liquidator was invited to take up appointment in respect of a company which was insolvent and without assets to pay the liquidator's fees. Assurances were given that the liquidator's fees would be paid by the group of companies with which the company in liquidation was associated. The group was in fact allegedly a substantial debtor of the company and consideration was being given to actions against group directors personally to recover funds. Faced with the distinct possibility that his paymasters might well be contributories needing to be pursued in the liquidation the Court ordered that the liquidator's appointment should be rescinded and the company declared en désastre so that the Viscount would be responsible for conducting the liquidation. Here is an example of the Viscount being appointed effectively as liquidator of last resort. However it must be recognised that this case was decided in 1985 (prior to the enactment both of the Companies Law and the Bankruptcy Law) and the Royal Court was operating within its customary and common law jurisdiction. It could thus more easily move between its inherent power to appoint liquidators to a Jersey company and its extensive customary law désastre jurisdiction. The advent of statutory winding up and bankruptcy procedures in Jersey has not entirely closed off this freedom of manoeuvre for the Court. The Viscount is by virtue of his office qualified to act as liquidator of a Jersey company under any of the winding up procedures set out in the Companies Law where a liquidator is needed. Accordingly it would have been open to the Court in the Leveraged proceedings, had it so wished, to grant the winding up order and to substitute the Viscount in place of the nominated liquidators.
UK insolvency service
15 In England and Wales the broad rule is that the proper expenses of liquidation are payable out of the assets of the company which is being wound up. A major difference however in terms of infrastructure and resource between the UK and Jersey is the existence and role played by official receivers in compulsory liquidations in England and Wales, including those ordered by the court on a just and equitable ground under section 122 of the Insolvency Act 1986. Official receivers are officers of the Insolvency Service, an Executive Agency of the Department for Trade and Industry in the UK, attached to courts having bankruptcy jurisdiction. On the making of a winding up order, the official receiver automatically becomes liquidator by virtue of his office and will remain so unless and until another liquidator is appointed. Liquidation expenses will be recovered out of the assets of the company in liquidation, or will be borne by the general public through the government funding of the Insolvency Service where, for example, there has been a public interest petition for winding up and there is an insufficiency of assets. Specific costs’ orders may however be obtained to transfer the burden of the expenses of a winding up petition and liquidation to former officers of the company who are guilty of misfeasance.
The Jersey regulator’s powers
16 Leveraged was a regulated entity in Jersey and it is worth considering what other winding up remedies were available to the regulator to organise its funerary rites.
17 The Jersey Financial Services Commission has a number of powers which it can exercise to wind up the affairs of regulated financial services businesses in Jersey. A number of them are set out in the CIF Law under which Leveraged was regulated. The Commission has an interest and a responsibility to see that insolvent investment funds which are regulated by it are wound up properly in the interests of investors in such funds and indeed of protecting the reputation of the Island as a finance centre.
18 Under article 155 of the Companies Law the Commission is able to bring winding up petitions before the Royal Court in respect of companies which hold a permit under, inter alia, the CIF Law on the basis that it is just and equitable that the company be wound up. This is the same provision which the directors of Leveraged used in their application to the Court. If the Commission were to bring an application under this provision it would have to nominate a person as proposed liquidator and to seek the Court's approval. The persons who are able to act as liquidator for the purpose of article 155 are prescribed, and the Commission would need to nominate one or more accountancy professional to act as liquidator or liquidators. No doubt as part of this exercise the Commission would have to agree with the proposed liquidators that the Commission would underwrite their fees and expenses should the assets of the company in question be insufficient to discharge them.
19 The Commission could also pursue the winding up of a collective investment fund under article 20(3) of the CIF Law which allows the Commission to apply to the court for the removal of a functionary holding a permit under the CIF Law (typically this would be the Jersey-based management company appointed to the collective investment fund) and its replacement with a person nominated by the Commission. As part of this procedure the Commission may also apply for an order that the person nominated by the Commission procure the winding up of the collective investment fund. There are two pre-conditions to be satisfied by the Commission in this context. It is not clear on the wording of article 20(3) whether both of these pre-conditions must be satisfied or whether they are alternatives. The former seems the better interpretation on a reading of the provision as a whole.
20 Under these provisions the Commission has to be satisfied that an application of this type is in the interests of the participants or potential participants in the collective investment fund; and that the functionary who is to be removed has breached the CIF Law or subordinate legislation or contravened the terms of its permit, failed to comply with a direction issued by the Commission or has furnished false, inaccurate or misleading information. Accordingly there needs to be evidence of misfeasance on the part of the functionary before the Commission can bring the application for removal and winding up. Under the article 20(3) procedure the Commission will need to identify a person as replacement functionary.
21 This may prove a difficult task. Unlike the procedure under article 155 of the Companies Law, where the role of the person nominated as liquidator is limited to that of winding up the affairs of the company, there is no such limitation in the role of the replacement functionary appointed under article 20(3) of the CIF Law. If, as would likely be the case, it is the current manager to the collective investment fund which is to be replaced, the replacement manager will take over the full role and responsibilities of the former manager (subject to the additional duty to procure a winding up of the fund). The replacement manager will presumably need to be issued with a permit under the CIF Law as there appears to be no relaxation of the licensing and qualification requirements for a Commission-sponsored manager. No doubt the Commission would also have to underwrite the fees and expenses incurred by such a replacement manager.
22 The replacement manager could also face problems in implementing the order of the Court to procure the winding up of the collective investment fund. Assuming that the fund in question is corporate in form, no order of the Court will exist addressed to the corporate fund requiring it to go into winding up. The order is addressed to the replacement manager only, and requires it to procure the winding up of the corporate fund. There is room for disputes to arise if the directors of the corporate fund and/or its shareholders are not in agreement that the fund should be wound up. For these reasons the article 20(3) procedure is unlikely to be the preferred option of the Commission unless there are serious concerns about the conduct of a functionary and there is a pressing need to intervene and remove it from office.
23 A better approach for the regulator, which avoids the Commission having to identify a successor functionary and to underwrite its costs, is to use its power to issue directions to functionaries under article 12 of the CIF Law. Without the need to demonstrate grounds for the immediate replacement of a manager or other functionary, the Commission can issue a direction requiring a functionary to wind up the affairs of the collective investment fund in accordance with such procedures and directions as the Commission may specify. The Commission merely needs to be of the view that such a winding up is in the best interests of creditors of the fund or that it is desirable to protect the reputation and integrity of the Island in financial and commercial affairs. A corporate investment fund is itself a functionary for the purposes of the CIF Law and the direction to wind up can be issued to the fund company itself. Provision can also be made by direction that a person, acting in a role akin to that of a receiver, should take possession and control of the fund assets and records. Injunctive relief can be obtained by the Commission to back up any directions which are issued in order to ensure compliance with them.
Remedial powers of the regulator
24 Turning back to the scenario of a Jersey regulated collective investment fund which has lost all its asset value, the key question is whether there is anything which can be salvaged for investors. It is clear that it is this question which was exercising the mind of the court in the Leveraged application. The fund might have had claims against its investment advisers and other functionaries which ought to be evaluated. The fund might have had rights of action against its board of directors. A liquidator appointed to such a corporate fund under the Companies Law is likely to find his position compromised if he has insufficient funding to discharge his role, or is reliant for funding on parties whose relationship with the fund may need to be investigated.
25 Furthermore his role does not really permit him to concentrate his time and efforts on shareholder concerns and interests if these go beyond the limits of creditor interests. In his capacity as an officer of the company in question he may owe certain duties to the company and its shareholders, but his primary duty is to get in the company's assets for the benefit of creditors. Any investigation that he may launch in connection with claims which the company may have against third parties will be influenced by this primary duty towards creditors. Clearly, if the liquidator is appointed by the Court under article 155 of the Companies Law there is greater scope for the Court to require the liquidator to investigate the wider history and operation of the company and to report back his findings. But in the absence of adequate funding neither the liquidator nor the Court will be able to do more to further the interests of the shareholders.
26 In the Leveraged proceedings the Court heard from a representative of the Jersey Financial Services Commission and was informed that the Commission was considering launching a formal investigation into whether there had been any breaches of regulatory requirements in relation to the company. The Court stated that the Commission's jurisdiction was confined to breaches of the regulatory regime and that it had no jurisdiction to bring an action for negligence in the performance of duties by directors or advisers of a regulated entity. In making this observation the Court was no doubt relying upon the representations which had been made to it. But the role of the Commission and the scope of its powers are far wider. While its primary focus may be on the promotion of good regulation and the investigation and prosecution of regulatory breaches, the Commission has at its disposal a range of statutory procedures to effect investor compensation or restitution in appropriate cases.
27 Shareholder investors in a regulated financial services business in Jersey ultimately depend upon the Jersey Financial Services Commission to pursue their interests if there is a business failure and there are grounds to attribute blame to one or more parties. This is particularly the case if the investment product in question is retail in nature, and there are a large number of members of the public who have suffered financial loss. The history of the Leveraged winding up application and the subsequent turn of events bear witness to the fact that while the courts have the ability to order winding up, the Commission is the proper party to convene the inquest.
Simon Howard is an advocate of the Royal Court and a partner in Bedell Cristin, P.O. Box 75, 26 New Street, St. Helier, Jersey, JE4 8PP.
Return to Contents