Case Re Demaglass Ltd; Lewis V Dempster (10Th July 2002, Ch D, Unreported)

Recovering costs of litigation as an expense - further developments Technical Bulletin No: 9 Case Re Demaglass Ltd; Lewis v Dempster (10th July 2002, Ch D, unreported) Synopsis The spate of cases dealing with the question of whether an office holder can treat the costs of any litigation that s/he initiates or pursues as an expense payable in priority to other creditors shows no sign of abating. This is perhaps no surprise given that a number of issues were left unresolved by the Court of Appeal decision in Lewis v Inland Revenue Commissioners; Re Floor Fourteen Ltd [2001] 3 All ER 499. One such case, Re Demaglass Ltd; Lewis v Dempster (10th July 2002, Ch D, unreported) is the subject of this update. Topics covered: Liquidation expenses, litigation funding The Facts In Demaglass the liquidators of two companies which were in administrative receivership and liquidation applied for an order requiring the receivers to pay over specified sums out of floating charge realisations in their hands to enable the liquidators to fund investigations leading to possible litigation. For the purposes of the application, it was taken as read that floating charge assets have to be made available to pay liquidation expenses and liquidation preferential creditors. In other words, the correctness of the Court of Appeal's decision in Re Leyland Daf Ltd; Buchler v Talbot [2002] EWCA Civ 228, [2002] 1 BCLC 571 (see Technical Update 7/May 2002) was assumed (although it should be noted that the decision in Leyland Daf is currently under appeal to the House of Lords). The main question therefore was whether the liquidators were entitled to call for the establishment of what amounted to a "fighting fund" to cover anticipated future expenditure. The Decision In the light of the House of Lords decision in Re Toshoku Finance (UK) plc; Kahn v Inland Revenue Commissioners [2002] UKHL 6, [2002] 1 WLR 671, it was common ground that rule 4.218 amounts to "a complete statement of liquidation expenses, subject only to the qualifications contained in the Rules themselves". Logically, the first question requiring determination was whether prospective expenditure, as opposed to expenditure already incurred, could be recovered in principle under rule 4.218. The liquidators contended that their claim fell within all or any of paragraphs (a), (m) and (n) of rule 4.218(1). The deputy judge rejected this contention for the following reasons: The heads of expense set out in rule 4.218(1) are all couched in the past tense suggesting that an item of expenditure can only be treated as a liquidation expense if it has already been paid or incurred. The word "expenses" denotes sums of money that have been expended. It would also extend to liabilities that have actually been incurred but not yet paid. The references to "disbursements" in paragraph (m) and "remuneration and emoluments" in paragraph (n) are clearly references to sums already expended. This is reinforced in the case of paragraph (n) by the use of the past tense in the phrase "any person who has been employed". Similarly, rule 4.218(1)(a) could not be construed as entitling a liquidator to call on floating charge realisations held by a receiver in order to fund future activities. It was beyond doubt that the phrase "expenses... incurred" could not possibly refer to prospective expenditure or liabilities that have not yet arisen. The phrase "expenses... chargeable... by the... liquidator" is probably a reference to expenses or liabilities that have been incurred but not yet paid. It should not be Law Debenture sponsor of the Insolvency Lawyers’ Association 1 construed as having a forward-looking effect. Moreover, the expenses within paragraph (a) have to be "properly" chargeable or incurred and it is difficult to see how a judgment can be made about that unless a liability to make payment has arisen. In principle, a fiduciary is not normally entitled to withdraw money from funds under his control until a positive event has arisen entitling him to make the withdrawal. In the light of this reasoning, it was strictly unnecessary for the deputy judge to decide whether the prospective expenditure was of a type falling within the substantive heads of rule 4.218(1). However, as all the expenditure related to the investigation and pursuit of possible claims against various parties he held that it could not have been treated as a liquidation expense in any event following the line of authority commencing with Re MC Bacon Ltd[1991] Ch 127 and culminating in Lewis v Inland Revenue Commissioners; Re Floor Fourteen Ltd [2001] 3 All ER 499. The second question was whether the liquidators could claim to have the costs of proceedings payable in priority out of the assets of the company under the court's inherent jurisdiction. It will be recalled that in Floor Fourteen Peter Gibson LJ refused to speculate about the precise source and scope of the court's discretion under the inherent jurisdiction (see also Re Romar Engineering Co Ltd [2002] BPIR 409). The position was clarified in Re Toshoku Finance (UK) plc; Kahn v Inland Revenue Commissioners [2002] UKHL 6, [2002] 1 WLR 671 where Lord Hoffmann identified Re London Metallurgical Co [1895] 1 Ch 758 as the source of the discretion, adding that it had been preserved in what is now rule 4.220(2). Thus, the inability of a liquidator to claim his costs out of the assets under rule 4.218 is not necessarily the end of the matter. However, the deputy judge held that rule 4.220(2) did not assist the liquidators in Demaglass because it had not been invoked and, in any event, could only be invoked with regard to costs already incurred. The third question was whether, in an appropriate case, a liquidator can seek some form of declaratory relief in advance as to whether prospective expenditure would fall within the established categories of liquidation expense when incurred. The deputy judge saw no reason in principle why a liquidator should not be able to make such an application (indeed, he thought that Floor Fourteen involved this kind of application) but there would need to be sufficient detail for the court to assess whether the expenditure would be properly incurred. Comment The Demaglass decision provides further confirmation, if any were needed, that rule 4.218 is, by and large, an exhaustive code. Generally speaking, an item of expenditure can only be treated as a liquidation expense if (i) it is of a type falling within the categories in rule 4.218(1) and (ii) it has already been expended or incurred. The effect of rule 4.220(2) is that the court has a discretion to order costs incurred "in the course of legal proceedings by or against the company" to be paid out of the assets. In this respect, Demaglass builds on Lord Hoffmann's observations in Toshoku and holds out the possibility that liquidators may in future be able to seek some form of anticipatory relief perhaps by way of analogy to that which has evolved for trustees in the wake of Re Beddoe [1893] 1 Ch 547. Despite the welcome clarification of some of the issues left unresolved by Floor Fourteen, a number of questions still remain concerning the scope of the jurisdiction preserved by rule 4.220(2). In particular, it appears that the jurisdiction can only be triggered in relation to the costs of proceedings brought "by or against the company". This suggests that the costs of proceedings brought exclusively by the office holder, for example, proceedings under Insolvency Act 1986, ss 213-214, 238-239 and 245 would fall outside rule 4.220(2) as well as falling outside rule 4.218(1). Postscript Members might also like to note the decision in Re Ciro Citterio Menswear plc [2002] EWHC 897. The question arising here was whether the prospective costs of an appeal brought on the company's behalf by its administrators could be treated as "expenses properly incurred" by them that were payable out of the assets in priority to the holder of a floating charge by virtue of section 19(4) of the Act. It was held following Re MC Bacon Ltd [1991] Ch 127 and Mond v Hammond Suddards (No 2) [2000] Ch 40 that an administrator does not have an unqualified right to recoup his costs "by virtue of an order made a priori upon a partial assessment of the merits of the proposed litigation." It should be noted that the decision is probably 2 explicable on policy grounds as if the court had ruled in their favour, it would have entitled the administrators to subordinate a secured creditor to the costs of unsuccessful proceedings against him. Further information: Technical Update 5/March 2002: Liquidation expenses - Re Toshoku Finance (UK) plc. Technical Update 7/May 2002 - Receivers and liquidation expenses/Quistclose - further developments. 3.

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