Out-Law Analysis 6 min. read
20 Jun 2023, 1:20 pm
A recent ruling of the English High Court found that a genuine attempt to restructure a company did not amount to an ‘informal winding-up’ in contradiction of insolvency laws on the distribution of assets to creditors.
The ruling will be welcomed by lenders and professional advisers. If it had gone the other way it would have had negative implications for business and would have changed the landscape for advice and lending services.
Henderson & Jones, a litigation funder, brought a series of claims concerning the restructure of The Hospital Medical Group Limited (THMG) in November 2012. The funder argued that the restructure was an attempt to defraud creditors by putting assets beyond their reach as part of an ’informal winding-up’. It alleged that the restructure came about as a result of a series of negative events, which would eventually lead to THMG’s insolvency.
Those negative events were the likelihood of claims against THMG in relation to a sector-wide Poly Implant Prothèse company (PIP) breast implant scandal and the possibility of HMRC levying additional backdated VAT on cosmetic procedures. According to the funder, foreseeing the collapse of THMG, the directors attempted to remove value from the company.
The funder told the court that the restructure amounted to an unlawful distribution under Part 23 of the 2006 Companies Act and was an ‘informal winding-up’ and a fraud on creditors. It argued that THMG’s directors, including one de facto director, were in breach of their duties under the Companies Act by engaging in the restructure, and that THMG’s bank Barclays and its solicitors The Wilkes Partnership had dishonestly assisted the directors in respect of the restructure.
The funder alleged that the substance and true purpose of the restructure was THMG’s ‘informal winding-up’, including the cessation of its trade and return of capital to its members, in effect side-stepping the legal requirements to make proper provisions for creditors.
The court noted that, in the lead-up to the restructure, THMG was aware of increasing litigation risk as a result of PIP claims. However, at the time the restructure was contemplated, the litigation exposure for THMG was not inevitable and impossible to quantify in the absence of any regulatory or legal input to inform their position. This conclusion was supported by the fact that THMG instructed legal counsel, who expressed the view that their exposure would be limited and manageable.
The court’s finding was further supported by evidence produced by THMG that the early discussions in respect of restructuring efforts were introduced in 2009, three years prior to the eventual restructure taking place and the crystallisation of the PIP scandal. Due to the uncertainty in respect of THMG’s litigation exposure, the court refused to make a finding that the restructure was principally motivated by the rising number of PIP claims.
In relation to the VAT position, THMG’s view was that new VAT might be introduced on cosmetic surgery but that hospital services would continue to be exempt. The position was being tested through litigation at the time of the restructure. However, HMRC’s engagement with the group concerning the VAT treatment of cosmetic surgeries did not commence until 2014, well after the restructure.
The funder also argued that THMG was “cash flow insolvent” at the time of the restructure. THMG eventually went into liquidation in 2016 due to issues unconnected to the restructure. Neither THMG nor Barclays identified any significant cash flow issues at the time of the restructure. THMG’s relationship with the bank was an important consideration for the court in concluding that the cash flow condition of THMG was actively managed and THMG’s financial health was better than alleged by the funder.
For example, Barclays' decision to move the company out of its business support unit, where it was determined that no further professional support was needed, was seen as positive evidence in the active management of the cash flow position of THMG. The court was satisfied with the financial position of THMG at the time of the restructure, despite the fact that THMG later renegotiated the loan facilities with Barclays due to ongoing cash flow issues.
However, the financial health of the company improved again in 2013, and THMG was released from Barclay’s business support unit altogether. The court concluded that in spite of the eventual demise of THMG and some of the group’s other entities, THMG was not insolvent at the time of the Restructure, and neither did it become insolvent as a result of the restructure.
The general rule under Part 23 of the Companies Act states that a limited company may distribute profits to members by way of a dividend if calculated in accordance with the rules set out in the Act. The focal point of the funder’s argument was that there were insufficient distributable profits to declare the dividend of £1.5 million as part of the restructure. The court ruled that the dividend was properly declared in accordance with the Companies Act and was not intended to extract value from THMG.
Breaches of directors’ duties were alleged against two directors in office at the time of the restructure and one de facto director, who took on a consultancy role. The argument in respect of the de facto director was rejected, and none of the remaining directors were held to be in contravention of the duties owed to THMG.
The court clarified that the directors were entitled to consider the position of the group, alongside THMG’s own interests. The benefit of the group was undoubtedly one of the elements considered by the directors, as one of the motives of the restructure was to shift value to other group entities to limit claims to the trading subsidiaries.
The restructure effectively led to a separation of trading activities. However, the court was not convinced that rising PIP claims were the determining factor for the separation, rather the viability of the group in light of general patient claims was held to be the true and valid consideration.
Reorganisation of the group in accordance with its trading activities was ruled to be for the benefit of the group. Further, the directors ensured that the restructure was honestly and reasonably in THMG’s best interests, including the receipt of full value for its assets, complying with their duties.
As the court found that THMG’s directors had not breached their duties, the question of accessory liability in dishonest assistance on the part of Barclays and Wilkes was of limited importance. However, given the seriousness of the allegations made against Barclays and Wilkes, the court considered their duties, if any, and the witness evidence put forward on behalf of Barclays.
The funder argued that Barclays had “turned a blind eye” to the restructure and its alleged detriment to THMG and its creditors, and failed to ask questions expected of a reasonably honest person. It alleged that the security net of Barclays was cast widely enough across the group so that they were not concerned about exposure and wanted to complete a refinancing as soon as possible.
The court noted, however, that Barclays took a significant interest in THMG, providing support to turn the business around. In addition, where potential negative impact was identified, Barclays took legal advice to assess the impact on THMG’s facilities and determine steps forward in line with the aim for THMG to continue to operate as a running concern.
The court pointed out that THMG and Barclays took proactive steps in the management of the PIP claims, providing non-commercial fees to affected patients, in an attempt to devise a long-term strategy for THMG. The court determined that Barclays acted honestly, making the enquiries that a reasonable person would have in the same position. The same conclusion was arrived at for Wilkes. The court also rejected the claim in unlawful means conspiracy.
The court dismissed all the claims, ruling that the was a genuine attempt to reorganise for the benefit of THMG. This case is an important test not only in respect of genuine restructurings which may nevertheless end in an insolvency, but also in clarifying the role of third parties, such as banks and legal advisers on the discharge of their duties in the process of devising restructurings.
Lenders and professional advisers, in particular, will welcome the judgment. There would have been horrendous implications for business if the court were to find that lenders or advisors have liability for approving the movement of assets and would have dramatically change the landscape for advice and lending services.
With a lot of attention paid at the moment to difficulties in the healthcare sector and the way they treat contingent liabilities, this case is a good example of the provisions taking by the company and its advisors and lender in ensuring that appropriate strategies were put in place to manage future trading. It is a good reminder of the importance of taking notes of key decisions that can be referred to when often these claims are brought many years down the line.
The case is also an example of the types of fraud claims which might be pursued against lenders and professional advisers, and therefore highlights the importance of taking steps to mitigate and protect against such claims being brought in the future. In this case, the court did not need to consider liability for fraud because the directors had not breached their duties. However, it was clear in any event that the reasonable enquiries had been made and there was no dishonesty on the part of the defendant bank.
Co-written by Katerina Mrhacova of Pinsent Masons.