The High Court recently re-affirmed the discretionary nature of its right to grant an administration order. In this case, the court refused to grant an administration order even when it determined that the companies were insolvent and the statutory purpose of administration would likely be achieved if the order was granted. On reviewing the evidence before it, the court exercised its commercial judgment and considered it to be pre-mature to grant an administration order.
The two companies which were the subject of the application for an administration order, were Oak Property Partners Ltd (“Oak Property”) and Oak Forest Partnership Ltd (“Oak Forest”) which each owned a hotel (together, the “Companies”). The business of the Companies was to sell off individual rooms in the hotels on long leases. The Companies were essentially operating as property developers. The applicants in the proceedings were two companies which had acquired leases from the Companies on terms entitling them in certain circumstances to serve notice on the owner to repurchase the lease. The applicants had served notice to repurchase on the Companies and have made their application for an administration order as prospective creditors of the Companies.
In considering their application, Judge Purle noted that before granting an administration order the two pre-conditions set out in paragraph 11 of Schedule B1 of the Insolvency Act 1986 must be satisfied, namely, that the court may make an order only if it is satisfied:
(a) that the company is or is likely to become unable to pay its debts (either on a balance sheet or cash flow test); and
(b) the order is reasonably likely to achieve its statutory purpose of either:
(i) rescuing the company as a going concern;
(ii) achieving a better result for creditor’s than would be likely if the company were wound up; or
(iii) realising property to make a distribution to secured or preferential creditors.
With regard to the first pre-condition, the respondent companies produced financial projections to demonstrate the likelihood, or at least a realistic possibility, of survival to contradict the inference of insolvency put forward by the applicants. While the judge accepted that there was “ostensible” balance sheet solvency in respect of Oak Property, he considered that much of this was dependent on the recoverability of a very large debt from a company undergoing a CVA for which the likelihood of any recovery seemed unlikely. While Oak Forest was considered to be balance sheet solvent (at least presently), the cashflow projections produced in respect of Oak Forest and Oak Property were considered by Judge Purle to be ‘highly optimistic’ given the number of leases due for repurchase in the coming years and accordingly he did not have any confidence that the Companies would be able to pay their debts as they fell due.
With regard to the second pre-condition, the argument put forward by the applicants, was that an administration would likely a achieve a better result for creditors than a winding up, if for no other reason than the avoidance of the ad valorem fees which would be incurred in a compulsory liquidation on any realisations. On this point however, Judge Purle considered that compulsory liquidation was not the only alternative to administration. The other option was to simply give the Companies more time to bring their businesses round without being subject to any kind of insolvency procedure. Judge Purle noted that, at least in respect of Oak Property, the program of repurchases did not start for several years and it seemed pre-mature to put the Companies into administration, particularly given the associated costs with such a procedure. So while the judge considered the two pre-conditions to administration to be “technically satisfied”, using his commercial judgment, he exercised his discretion not to grant an administration order, as the option of not entering into any insolvency procedure would be better for creditors.
In his closing remarks, Judge Purle did however state that if firm evidence, as opposed to a suspicion, of past fraud or potential fraud had been properly presented to him, he would not have reached the same conclusion on the exercise of his discretion.
The judgment is particularly interesting as the courts have traditionally refrained from exercising independent commercial judgment in such matters. It does however raise some potential concerns for directors of companies which have been found by the court to be insolvent but are allowed to continue trading. Should the companies in this case ultimately fail, it will be interesting how any insolvency practitioner approaches the question of wrongful trading during the period the Companies continued to trade.