Court does not clear up confusion over 'deficient' legislation, says expert

Alastair Lomax of Pinsent Masons, the law firm behind Out-Law.com, said that far from coming as a "welcome relief" to the restructuring and insolvency sector, as claimed by the firm involved in the case, the High Court's decision did not answer "fundamental questions". He said that it remains uncertain whether, in cases where a company has not granted any qualified floating charges (QFCs) over its assets, the directors of that company must serve a formal notice of their intention to appoint administrators on the company or other "prescribed persons " before administrators can be validly appointed.

"The legislation in this area and the prescribed appointment paperwork are deficient," he said. "Some judges are leaving it to Parliament to solve the problem, and others are turning cartwheels to solve it themselves. In the meantime confusion reigns, which is counter-productive to the rescue culture which underpins the insolvency regime."

In its ruling the High Court concluded, after considering conflicting previous decisions, that it was "now settled law" that a failure to notify the insolvent company itself of its directors' intention to make an out-of-court administration appointment did not automatically invalidate that appointment. The case concerned Birmingham-based education charity BXL Services, which was forced into administration as a result of an unmanageable pension deficit.

Insolvency law allows the directors of an insolvent company to appoint administrators without a court order, providing that they file a prescribed set of forms at court. In order to do so, the rules state that where the company has granted one or more QFCs - a type of security which 'floats' over the assets of a company until this right 'crystallises' on an insolvency event – the directors must notify the holders of those QFCs as well as a number of other parties, including the company itself, of their intention to appoint administrators.

Over the past few years conflicting cases have considered whether the way in which the rules are phrased means that the directors do not need to notify the company and other prescribed parties where no QFCs have been issued. They have also considered whether the appointment of administrators is inherently invalid or must be ratified by the courts in cases where directors should give notice. The consequences of an invalid appointment can be very serious, not just for the administrators but also for the insolvent company and anyone dealing with it.

According to the outcome of two cases involving the companies Minmar and Msaada Group , failure to give notice renders any purported appointment inherently invalid and incapable of remedy by the court. However in a case involving professional services company Virtualpurple, decided on the same day as the Msaada case last year, the High Court said that there was no obligation on the directors to give notice where no QFCs had been issued. In addition, the court said, even if notice was necessary the failure to give it could be remedied at the discretion of the court.

No QFCs had been issued over the assets of BXL, so the directors gave no formal notice of their intention to appoint administrators before doing so; they simply consented to short notice on behalf of the company in the board resolution which approved the appointment. They then applied to the court for an order declaring that the appointment was valid, which the High Court granted.

Lomax said that it was clear from the judges' reasoning in this and other recent cases that a "substantial section" of Chancery judges is in favour of adopting a 'purposive' approach to such cases, which would allow them to declare the appointment valid even if there were 'minor irregularities' in the notification process followed. However he said that the decision in the BXL case, although "helpful", did not provide the required level of certainty.

"Everyone involved in a proposed administration needs to know, before the button is pressed, that the appointment will be valid and can be put into effect quickly and smoothly," he said. "The ability to rescue the failing business and save the jobs of its employees will often depend on this. It is not enough to know after the event that a court is likely to declare the appointment valid. Until this issue is properly resolved by the Court of Appeal or Parliament we are likely to see more applications of this sort – particularly in cases where suitable additional steps have not been taken to notify all persons prescribed in the existing legislation."

"The best argument for the purposive approach is the stated aim of legislation to rescue failing businesses," he added. "The courts have yet to reconcile this objective with the wording of the legislation and the prescribed appointment forms. Practitioners understand the desire to adopt a purposive approach but they need to know what will actually work in practice. Any solution must also take into account the need to prevent a slick appointment process which is focussed on speed of delivery from prejudicing the likes of dissident directors or shareholders and, ultimately, creditors. That is undoubtedly why Parliament put notification requirement into law as a pre-requisite to the appointment going through."