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Provisional Liquidation - Rochdale Drinks Distributors Limited Technical Bulletin No: 372

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Provisional Liquidation - Rochdale Drinks Distributors Limited Technical Bulletin No: 372 Provisional liquidation - Rochdale Drinks Distributors Limited Technical Bulletin No: 372 Case: HM Revenue & Customs Commissioners v Rochdale Drinks Distributors Ltd [2011] EWCA (Civ) 1116; Rimer, Pill & Lewison LJJ (13 October 2011) Synopsis: Following the discharge of a provisional liquidator initially appointed without notice, the CA restored his appointment, and provided useful guidance in respect of such applications and the evidence required to support them. Topics covered: Compulsory winding up; s.135 IA86; provisional liquidators; VAT; missing trader fraud The Facts Rochdale (“RDD”) was a wholesale trader of alcoholic drinks. HMRC claimed that RDD had been run for the purpose of fraudulent evasion of VAT where it had falsely claimed input tax on invoices for supplies by six counterparties, five of whom were described as ‘missing traders’ and the sixth as a ‘buffer trader’. HMRC doubted the authenticity of the supplies to RDD by the missing traders and asserted that the invoices were invalid. It also claimed that RDD had inflated its input tax claims, and had under-declared the amount of output VAT due on its sales. HMRC presented a creditor’s winding-up petition on 24 February 2011, and on the same day successfully applied (without notice) for the appointment of a provisional liquidator in respect of RDD on the basis that, without one, there was a real risk of dissipation of the RDD’s assets pending the making of a winding-up order. Peter Smith J made the appointment. On the next day HMRC served a VAT assessment for over £2m on RDD. RDD applied to discharge the provisional liquidator's appointment and succeeded before Floyd J, who held that the risk of dissipation was not sufficiently great and that, although HMRC had an arguable case of fraud and forgery, the proper venue to try that issue was in the tax tribunal on an appeal against the VAT assessment. The judge concluded that, because the debts appeared to be disputed, HMRC had not shown that it was likely to obtain a winding-up order on the hearing of the petition, and even though there was an undisputed sum owing to the Commissioners, RDD had a substantial counterclaim exceeding that amount. HMRC appealed against Floyd J’s order discharging the provisional liquidator’s appointment. The Issue As set out in [75], the court’s power to appoint a provisional liquidator is found in s.135 IA86. It is an interim measure between presentation of a winding up petition and the winding up order, albeit a most intrusive one, but is otherwise a broad and general power. The Decision The CA recognised that the appointment of a provisional liquidator to a trading company was a most serious step for the court to take ([76] and [109]). It was likely in many cases to cause the company to cease to trade, and was frequently terminal for it. Given the potential seriousness of appointing a provisional liquidator, the petitioning creditor seeking such an appointment had first to show that it was likely to obtain a winding-up order on the hearing of the petition. If that was shown, it was then necessary for the court to consider whether to make the appointment as a matter of discretion. In contrast to the judge, the CA found that HMRC was likely to obtain a winding-up order on the hearing of Law Debenture sponsor of the Insolvency Lawyers’ Association 1 the petition. That RDD had a statutory right of appeal against the assessment was not sufficient without more, and the court had to consider whether any such appeal would have merit. It was open to HMRC to petition against RDD on the basis that the debt claimed, or at least a substantial part of it, was not capable of serious dispute and so could properly found the basis for a winding-up order ([85],[86] & [96]). The evidence raised serious questions as to the genuineness of the invoices. Much of the judgment of Rimer LJ is characterised by a deep scepticism of RDD’s claims, even if expressed in judiciously restrained terms. If RDD wanted to challenge the petition and the appointment of the provisional liquidator, the burden of proof shifted to RDD to show that it had at least a good arguable case that its trading was genuine. RDD's evidence on this point was breathtakingly inadequate and lamentable. The judge should have found that the court hearing the petition would find that a material part of the disputed supplies had not taken place. There was also an undisputed debt of at least about £340,000. In failing to discharge the burden of proof, RDD had failed to make good any case that it had a counterclaim exceeding that admitted debt. The judge should also have concluded that RDD was insolvent, or was likely to be shown to be insolvent on the hearing of the petition. The circumstances justifying the appointment of a provisional liquidator were not confined to jeopardy to the company's assets prior to a winding-up order. That was too narrow an approach, even if usual ([97], [99] & [100]). RDD's corporate governance was inadequate and raised doubts about the integrity and competence of its management and records. There were ample grounds for the provisional liquidator's appointment, and it would be restored. Comment This case clarifies the test for the appointment of a provisional liquidator. Prior to this judgment, the test had been whether there was a prima facie case that a winding-up order would be made. The formulation for the threshold base test is now that a petitioner should prove ‘nothing less’ than it was likely to be successful, and was meant to be a high hurdle given the seriousness of a winding-up petition. It also looked at how the burden of proof shifts once the petitioner raises serious questions sufficient to justify the making of an order. Where a company wishes to oppose an application on the basis that the there is a dispute as to the petitioner’s claims, it must do more than merely raise an argument, and needs to show a good arguable case. The CA also pointed out that dissipation of assets in the context of a provisional liquidation application is not the same as the criteria applied on an application for a freezing order ([99] & [113]). In a s.135 IA application, the court is entitled to take more into account, such as the need to preserve books and records, or to investigate claims for wrongful or fraudulent trading. That said, evidence of an actual risk of dissipation of assets remains highly relevant, and perhaps more so when the creditor is not an involuntary one such as HMRC was in this case. The decision is a timely reminder that the court proceeds on the basis of the evidence, and is entitled to require the evidence to be both sufficient and credible. About 10 months prior to this decision, the New Zealand High Court also considered the test for appointment of an interim liquidator in NZ Mail Ltd v EXNZOL Ltd [2010] NZHC 1530. The petitioning creditor was a trade creditor (not a tax collector), and was concerned enough about issues of phoenixism and potential asset dissipation to seek the appointment of an interim liquidator. In NZ, the applicant was required to show (as its initial legal test) a good prima facie case for liquidation (which has since been set at a higher threshold by the English CA in the RDD case), and urgency, with real reasons for an interim appointment, such as jeopardy to the company’s assets or to maintain their value, and to preserve the status quo and safeguard creditor interests. The NZ High Court, in common with the CA, recognised that appointing an interim liquidator is a very intrusive step to take, so that a without notice application for the appointment of an interim liquidator will not be successful unless “special circumstances” can be shown, which lends some support to Lewison LJ’s obiter comments about the absence of notice to RDD (at [111]), and again emphasises the requirement for evidential sufficiency. The RDD case was no doubt something of a test case. The effect of the several orders is that there has been a provisional liquidator in place from 24 February 2011 until 5 April 2011, then none until restored by the CA on 13 October 2011. In the intervening period, trading activity continued but without any order Law Debenture sponsor of the Insolvency Lawyers’ Association 2 validating dispositions of RDD’s property under s.127 IA86. This feature attracted judicial disapproval as just the sort of thing that the appointment of a provisional liquidator would have prevented ([105]). It remains to be seen what happens on the hearing of HMRC’s petition. Law Debenture sponsor of the Insolvency Lawyers’ Association 3 .
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