Court rules on validity of administrators' appointment after notice failure

Out-Law Legal Update | 30 Oct 2020 | 4:05 pm | 4 min. read

The Insolvency and Companies Court (ICC) has ruled that an out-of-court administration appointment, which took place without the applicants having given the requisite five business days' prior written notice to the qualifying floating charge holders (QFCH)is not automatically void.

However, it said it is instead an irregularity for which an affected party can apply for discretionary relief, which may include the appointment of replacement administrators proposed by the QFCH.

Facts of the case

Paragraph 26(1) of Schedule B1 of the Insolvency Act 1986 (the Act), makes it a requirement to give notice of intention to appoint administrators in the prescribed form to any person who is or may be entitled to appoint an administrative receiver or an administrator or has appointed an administrative receiver of the company, and any prescribed person.

The applicant, a holder of a qualifying floating charge (QFCH), requested a court order declaring the appointment of the joint administrators to Tokenhouse VB Limited by its directors was void because a notice of intention to appoint the joint administrators was not given to the applicant. The applicant submitted that the failure to deliver the notice deprived the applicant of the opportunity to intervene in the appointment process and in particular, the opportunity to appoint their own administrators. Therefore, the applicant also submitted that in the event the appointment was held to be valid, the opportunity to appoint their own administrators should be restored.

Primary issue – validity of appointment

The main issue the court had to consider was whether or not the appointment was valid despite a breach of the notice requirements under paragraph 26(1) of Schedule B1 of the Act. As a QFCH, the applicant was entitled to five business days’ notice of the intention to appoint. ICC Judge Jones reviewed case law and found that it directed him to decide the first issue by focusing on the consequences of non-compliance and deciding whether or not the intention of Parliament was that a failure to give the required notice be considered a fundamental breach, or rather an irregularity that has caused substantial injustice or not.

Judge Jones said that classifying such a breach as a fundamental breach would be to mis-rank the importance of receiving notice above the importance of the overall goal of the administration, highlighting, in particular, that administrators are independent insolvency practitioners required to act in the interests of the creditors as a whole. Balancing the severity of the potential prejudice of the applicant as against the potential severe impact on the effectiveness of the administration should the appointment be found void, the judge decided that the intention of Parliament could not have been that a failure to give notice should result in automatic invalidity. 

Instead, the judge said that a breach of paragraph 26(1) of Schedule B1 of the Act should be treated as an irregularity for which the QFCH could apply for directions to remedy the breach or, if the QFCH was content with the appointment, allow them to decide that no such application would be necessary.

The finding is consistent with the Act’s approach to not invalidating the actions taken following a defective appointment and the court’s general power to rectify errors of procedure under the Civil Procedure Rules. The approach also accords with the general goal of out-of-court appointments to streamline the appointment process.

The ruling that the failure to give notice of appointment did not render an appointment of the joint administrators by the directors as void supersedes the decision of His Honour Judge David Cooke in the case of Re Eco Link Resources Ltd (In CVL) [2012] B.C.C. 731.

Secondary issue – restoring the opportunity to intervene

The applicants further submitted that by not having received notice of the proposed administration, they had lost the opportunity to intervene in the process and had they received proper notice they would have appointed their own administrators. Judge Jones highlighted that the court should always address the commercial rationale for the relief requested and consider the potential outcome. The example cited was: will a replacement of administrators be conducive to the proper operation of the administration and will it achieve justice between all those interested in the process? The judge said this is a matter to be decided on the facts of each case.

In this instance, the court remedied the original breach of paragraph 26(1) of Schedule B1 of the Act by appointing the applicants’ nominated insolvency practitioners as joint administrators. Weight was given to the fact that the application for relief was made promptly and at an early stage of administration. Considerable consideration was also given to the report given by the proposed joint administrators and the circumstances as reported by them that any appointment would be "seamless".

The implications of the ruling

This decision is concerning for secured lenders who have previously relied upon the fact that paragraph 26(1) of Schedule B1 gives them sufficient protection as QFCH from borrowers appointing their own choice of administrator. As any breach will not render the administration appointment automatically void, it will be for the QFCH to make an application to court to remedy the position, if appropriate.

Whilst in this case the administrators were ultimately replaced with the QFCH's preferred administrators, each case will be assessed on its own merits. The evidential burden will be on the QFCH to show any prejudice suffered and the commercial rationale to support any application to replace administrators

It is also clear from the ruling that the court will take into account the timing of any application, which should be made at an early stage in the administration. This may prove difficult if the lender is not aware of the administration appointment until the administration has been substantially progressed. If replaced, the costs of any prior administrators may also have a detrimental impact upon any floating charge realisations, if permitted as an expense of the administration. 

This particular issue has been the subject of much conflicting case law. Judge Jones did state that whilst this decision is binding on judges sitting below High Court level, he suggested that any future cases to resolve this conflict should be listed at the High Court.

Until such time as this issue is overturned by a High Court decision, it is advisable for lenders to protect their position by carrying out regular insolvency searches of borrowers experiencing financial difficulties to ensure they receive immediate notice of any administration.

This decision does not prevent an application for a retrospective solution by the QFCH to order the current appointment to cease and to appoint new administrators backdated to the original date of administration, if that was deemed appropriate to cure any prejudice.