A creditor whose debt is disputed can still apply for an administration order

Out-Law Legal Update | 09 Jul 2018 | 11:31 am | 2 min. read

LEGAL UPDATE: The High Court granted a creditor whose debt was disputed an administration order. The court ruled that, in contrast to the established practice in relation winding up petitions, the fact that a debt is disputed does not prevent a creditor from applying for an administration order, provided the creditor has a good and arguable case that the debt is owing. The court also confirmed that where that same debt is relied upon to prove that the company is insolvent, or is likely to become insolvent, as must be proved for an administration order to be granted, then that debt must be proved on the balance of probabilities. The court found the evidence relied on by the company to challenge the debt to be wholly insufficient and granted the administration order.

Newbury and Berkshire were related companies, sharing certain directors and shareholders. Berkshire ran a construction business. Liquidators were appointed to Newbury in 2016. The accounts of Newbury showed a debt owing by Berkshire to Newbury of £1.8m, and the liquidators' investigations revealed a further £3.2m of debt, bringing the total apparent debt to £5m. Berkshire acknowledged the existence of the debt showing in the accounts but claimed a number of set-offs, counterclaims and credits that expunged this and the debts revealed by the liquidators' investigations. Berkshire argued that taking into account these set-offs, counterclaims and credits as well as anticipated sales, not only was Newbury not a creditor, but the company was solvent.

Newbury had applied for an administration order under paragraph 12(1)(c) of Schedule B1 Insolvency Act 1986 (IA86) which allows "one or more creditors of the company" to make an administration application.

Given the debt was disputed the court had to first consider whether Newbury was a creditor of the company in order to bring the application. The court noted that in relation to winding up petitions, the courts had adopted a practice of dismissing petitions where there was a genuine and substantial dispute over the debt.

Following a line of recent authorities, notably Hammonds (a firm) v Pro-Fit USA Ltd [2007] EWHC 1998 (Ch), the court drew a "sharp distinction" against the usual practice relating to winding up petitions saying that the same practice doesn't apply to administration applications. The reasoning was that "a person is a creditor […] so long as he has a good and arguable case that a debt of sufficient amount is owing to him… Thus, even in the case of a disputed debt, such a person may make an application for an administration order. It is then a matter for the discretion of the court whether actually to make an administration order".

Paragraph 11 of Schedule B1 IA86 sets out the conditions which must be satisfied before the court "may" make an order. These are two-fold:

(a) that the company is or is likely to become unable to pay its debts (the insolvency hurdle); and

(b) that the administration order is reasonably likely to achieve the purpose of the administration (the purpose hurdle).

The court had to consider whether these two hurdles where satisfied, bearing in mind that the disputed debt was also relied on as evidence of the insolvency hurdle being met. The court decided that the mere fact that there was a dispute did not prevent the court from making an administration order, but where a disputed debt is relied upon to demonstrate the insolvency hurdle, then the debt must be proved on "the balance of probabilities". The court noted that proving the debt on the balance of probabilities does not necessarily involve disproving the dispute and/or any cross claim entirely.

The court then applied the balance sheet test for insolvency as set out in section 123(2) IA86. The court assessed that Berkshire had net assets of £332,589. The court confirmed that where a creditor has demonstrated the existence of a debt, the burden of proof is on the debtor to prove to the court that this debt does not exist. Berkshire had prepared some accounts but was unable to actually substantiate anything behind the figures. The court found that Berkshire had not met the burden of proof on it to show that its debt to Newbury was less than £332,589. Berkshire was therefore insolvent.

The court was also satisfied that the purpose hurdle would be met and therefore the administration order was granted.

While not ground breaking, the case is a good reminder of the approach the court will take in these circumstances, and is yet another example of where better accounting and legal practices – to properly document and record the arrangements between the companies – might have avoided the dispute arising.

Simon Gibbs is a restructuring expert at Pinsent Masons, the law firm behind Out-Law.com