A bird in hand – when to assign an insolvency claim
When a business hits the skids and is placed into administration or liquidation, an insolvency practitioner ("IP") is duty bound to preserve the tangible assets of the company and protect the interests of creditors. However, the IP should also be careful to consider whether there are any less tangible assets to be investigated and realised.
Aside from recovering debts owed to the company, there are a variety of opportunities available to a canny IP to maximise returns for creditors; such as the claims that arise on insolvency. They include: claims for wrongful trading (which involve picking points in time prior to the insolvency and carrying out an assessment of when the directors should have pulled the plug); transaction type claims (such as transactions at an undervalue or preferences, which concern the assets of the company being spirited away or the interests of connected parties being preferred) and claims against the former directors of the insolvent company for breach of duty.
The experienced office holder weighs up the potential cost to the estate of investigating and pursuing a claim with the likely benefit to the creditors of a recovery, which must be material in value to be justified. Unfortunately, this can lead to claims that could (and should) have been taken forward being shelved unnecessarily by a cautious office holder. This caution is not always a symptom of a lack of funds available to pay lawyers, experts or court fees to bring the claim and the risk of adverse costs if the claim goes wrong. Sometimes it is an unofficial policy.
IPs are generally not blind to the potential to shake out and maximise value for creditors by pursuing claims but they often hesitate as they must be careful to avoid wild goose chases, particularly those claims which could become difficult and defended, or which are against defendants without resources to meet any judgment. There must be a pot of gold, after all. However, does that mean that good claims are going to waste and that creditors are missing out and, perhaps more importantly to those in the profession, does that mean that IPs are in the firing line and open to action by creditors if they fail to take these opportunities? In this brave new world, the answer must be: yes.
One of the neatest ways in which an IP can achieve a recovery for creditors from what may appear to be a finely balanced claim (or even a nailed-on winner) is to assign the cause of action to a third party. There has long been a market in the buying and selling of claims which arise in the context of insolvency. Claims become assets to be traded at a discount and then pursued by a third party to recover the true value of what was originally at stake. This is a convenient arrangement for the office holder as a tricky liquidation can be drawn to a close and a discounted but certain recovery made for creditors, whilst the risk taker who purchased the claim can make a better recovery and derive a profit on exit. It's a win-win.
Since October 2015, the Small Business, Enterprise and Employment Act 2015 has made it possible for claims that would have been personal to office holders and which could not be assigned (such as wrongful trading) to be assigned to third parties. This produced a flutter of excitement in the market and some entrepreneurial private equity investors have seized this opportunity to build a business. However, IPs must be a cautious breed because many potentially good claims and recoveries are still being overlooked or abandoned because they seem to be problematic or difficult. For the purposes of balance, it is also fair to say that there is a view in the industry that the terms offered by some funders are sometimes less than generous.
So, where should you draw the line as a prudent but innovative IP and how do you demonstrate to creditors that you have squeezed the maximum value available out of a liquidation efficiently?
The circumstances in which an IP should consider assigning a claim have been examined in the context of administration by the High Court in the matter of LF2 Ltd –v- Supperstone and Another (Administrators of Pennyfeathers Ltd)  EWHC 1776 (Ch). In that case, the Court considered a challenge by an entrepreneur who was seeking the assignment of a claim by the administrators of Pennyfeathers Ltd. The Court decided as follows:
- A viable claim by a company against a third party is an asset of the company. A claim which is arguably viable is a potential asset of the company. In principle, an administrator ought to be ready to investigate whether such an asset should be preserved and pursued.
- If the administrator has no funds to investigate a possible claim against a third party and he receives an offer from a potential assignee of the claim to pay for an assignment, that offer will potentially constitute an asset of the company. The administrator should normally wish to preserve and pursue that asset.
- If it is clear to the administrator that the claim would be hopeless and that the potential assignee is bent on pursuing a hopeless claim in order to harass the third party, then the administrator should normally decline to assign the hopeless claim. The administrator is an officer of the court and the court expects him to behave honestly and fairly.
It seems clear therefore that an IP has a duty to investigate and pursue a viable claim or he must assign that claim: it is not enough for the IP to seek to justify failure to assign a claim on the basis that it seemed risky and he was being cautious and the decision in Pennyfeathers should be in the minds of every office holder. There will of course be plenty of situations in which there are good claims and a will to pursue them but insufficient funds available to take a litigation risk. That is where the funders come in and, provided that the market develops so that terms become more palatable to some in the profession (and of course to creditors) the best possible returns can be achieved in a cost efficient and timely manner.