Court backs administrators in constructive trust claims over surplus funds

• Administrators successful in dispute concerning alleged trust monies
• Contract terms should be reviewed prior to potential insolvency if trust arguments are to be relied on
• Lowe and another (as joint administrators of Benedict Cole Ltd (in administration)) v Lloyds Bank Commercial Finance Ltd and another company [2020] EWHC 946 (Ch)

Lloyds Bank Commercial Finance Limited (Lloyds) provided an invoice discounting facility to Benedict Cole Ltd (Benedict) for invoices Benedict submitted to MUFG Bank Ltd (MUFG), to whom it provided staff. After invoices were rendered, Benedict would assign the debt to Lloyds, Lloyds would advance monies to Benedict and MUFG would have an obligation to pay Lloyds due to the assignment.

Benedict went into administration. However, shortly prior to the administration, MUFG paid a number of invoices which left a credit balance of £124,916.67 in Benedict's account at Lloyds.

The administrators sought directions from the court that funds held in the Lloyds account amounted to funds within Benedict's estate.

MUFG opposed the application arguing that the payments made to Lloyds were made by mistake. MUFG said it had a proprietary claim into these funds and that they were held for it under a constructive trust. If that was correct, the funds could not form part of the insolvent estate.

The core aspect that judge had to address was whether a constructive trust did in fact exist.

The judge stressed the importance of the terms of the contract between the parties, when the constructive trust is said to have been created, and whether a mistake can of itself give rise to a constructive trust.

The date of the existence of the trust is important in the context of insolvency. It must exist at the date of the insolvency so as not to fall foul of the 'parri passu' principle to treat all creditors fairly. Uniquely in this case, MUFG argued the trust was created after the company went into administration.

MUFG argued that the payments were a mistake because had they known Benedict was unable to perform its obligations under the contract, due to its pending insolvency, they would not have paid the outstanding invoices due.

The judge considered the contract between MUFG and Benedict and found it made no reference to any trust arrangement, nor did any trust exist at the date of insolvency. In this respect, the contract between MUFG and Benedict was one for services and there was no stipulation on how the payments Benedict received should be paid.

The judge did not agree with MUFG that the payments were a mistake capable of forming a constructive trust. He accepted that in this situation there may be a trust if Benedict had known that MUFG was operating under a mistake of fact. Instead, MUFG would have a breach of contract claim against Benedict for the non-performed services and the loss occasioned by that breach would be MUFG's unsecured claim in the administration. The judge said that absent anything further – for example, terms in their contract – MUFG should be in the same position as others creditors who had paid for services but had not received them.

The joint administrators' application was therefore successful. There was no constructive trust in favour of MUFG and the funds were capable of being utilised to pay administration expenses and the general body of creditors in accordance with the Insolvency Act 1986.

Lloyds raised an argument as to its ability to seek an indemnity from the funds held in respect of the costs it had incurred in having to participate in the application. That issue has been adjourned.

The decision has provided an up-to-date review of the principles concerning constructive trusts which arise in an insolvency context.  It clarified:

• the need to review the contract between the parties – is there a provision for funds to be held on trust?;
• if such a trust does exist, it must exist at the date of the insolvency; and
• payment by mistake does not of itself create a constructive trust.

The ruling is also a useful reminder that where a proprietary claim is asserted by way of a constructive trust, those claims will need to supported by strong evidence and that each case will turn on their own facts.

Vendors who know invoices are assigned to an invoice discounter and have concerns as to the supplier's financial position should try to negotiate an arrangement whereby the company is obliged to ensure that any payment conditions linked to the contract are made or, alternatively, that funds are held on trust.

Co-authored by Gemma Kaplan and Harry Clark, specialists in restructuring and insolvency law at Pinsent Masons, the law firm behind Out-Law.