RE MEEM SL LIMITED (IN ADMINISTRATION) [2017] EWHC 2688 (CH) – ATTEMPT TO CHALLENGE PRE-PACK DEFEATED

Summary

Where complaint is made about a pre-pack administration, more often than not it is the trade creditors who claim to have been left high and dry by the pre-arranged sale of the company’s business to the former management. The case of Re Meem SL Ltd (In Administration) [2017] EWHC 2688 (Ch) represented a variation to this theme, in that it was the founder and majority shareholder of the company that was seeking to challenge the sale of its business through a pre-pack.

Rather than attempt a direct attack on the validity of the administration itself, the applicant sought an order forcing the administrators to assign to him various claims which he said the company had against the directors who had engineered the pre-pack, and against the entity to which the company’s business had been transferred. The outcome of these alleged claims, were they to be upheld, would effectively be to reverse the sale of the business.

The applicant relied upon the power vested in the court under paragraph 74 of Schedule B1 to the Insolvency Act 1986 to intervene in an administration if it is being conducted in a manner that is unfairly harmful to a creditor or member of the company. The application was opposed by the administrators and one of the directors of the company, who was represented by Edward Davies QC.

The court refused to direct the administrators to sell the alleged claims to the applicant and the application was dismissed. It was held that the administrators’ proposed course of conduct, that of selling the alleged claims to the highest bidder by way of a public auction, could not be said to be unfairly harmful to the applicant. This was the case even though the likely winner of the auction was one of the putative defendants to the alleged claims, who would surely then stifle them.

This case illustrates the difficulties faced by creditors and members of companies who are unhappy with their treatment under a pre-pack administration in finding ways of challenging the process, at least in cases where there is no allegation of impropriety against the administrators themselves.

Background

The Meem cable is a product that backs up a phone’s memory during the charging process; it was the brainchild of Anil Goel. Meem SL Ltd was established to develop the Meem cable and bring it to market. Mr Goel enlisted Mr Kelly Sumner, an experienced businessman, to invest in the Meem business and to be its CEO.

Meem SL Ltd was incorporated on 11 February 2013. Mr Goel was the majority shareholder. Mr Sumner held a minority shareholding, and was the principal investor in the business; by the beginning of 2016 he had provided in excess of £1.1 million.

The establishment of the Meem business proved to be considerably more challenging than had been anticipated. Whereas at the outset Mr Goel had projected that the Meem cable could be developed and brought to market by the end of 2013 at a cost of about US$750,000, it was not until the first quarter of 2016 that the product was launched following the investment of sums in excess of US$2 million; even then, only 9,134 units were made, and this was at a cost that was not commercially viable.

Mr Goel was responsible for the development of the product, and, according to Mr Sumner, the principal problem was that his design was difficult and uneconomical to manufacture. In addition, Mr Sumner claimed that design flaws meant that there were problems with compatibility with both the iOS and the Android operating systems.

As both the timeframe and cost for the establishment of the business increased, Mr Sumner became frustrated with Mr Goel and indicated that he was not prepared to continue to provide finance on an open-ended basis. Attempts were made to raise funds from third parties, but these came to nothing, largely because potential investors were not willing to invest in circumstances where Mr Goel was not prepared to relinquish his majority shareholding.

Relations then broke down between Mr Sumner and Mr Goel with the business at a critical juncture. Additional substantial investment was urgently required in order to fund the development and manufacture of a re-designed Meem cable, but no one was prepared to provide the necessary funding whilst Mr Goel retained voting control.

It was in those circumstances that Mr Sumner, together with two other newly appointed directors, engaged an insolvency practitioner with a view to the sale of the Meem business. That business, the value of which was substantially comprised in its intellectual property, was independently valued at between £30,000 and £140,000 and then advertised for sale. There was only one serious bidder, a company established by Mr Sumner, Meem Memory Ltd.

Administrators were appointed by notice filed by the directors of the Company under paragraph 22 of Schedule B1 to the Insolvency Act on 6 April 2016. The sale of the Meem business to Meem Memory Ltd was completed the same day, for the sum of £1,449,643, of which £140,000 was paid for the intellectual property and the balance was paid by way of the assumption of Meem SL Ltd’s existing liabilities.

Mr Goel, together with one other shareholder, subsequently complained about the sale of Meem SL Ltd’s business. He argued that the funding had been available to enable Meem SL Ltd to survive and claimed that, instead of acting in the company’s best interests, Mr Sumner had deliberately sought to engineer the sale of its business via a pre-pack administration to his own company at a massive undervalue. This had been achieved, it was said, by the directors providing misleading information for the purposes of the company’s valuation. Mr Goel asserted that the true value of Meem SL Ltd’s business was at least £10 million.

On that basis, Mr Goel claimed that Mr Sumner, together with Meem SL Ltd’s other directors, had breached their directors’ duties and had, together with the company’s solicitors, Fox Williams LLP, conspired by unlawful means to harm Meem SL Ltd.

Mr Goel approached the administrators with these allegations. The administrators were not in funds to pursue the alleged claims themselves, and there was some dialogue about the prospect of the alleged claims instead being assigned to Mr Goel. Mr Sumner then informed the administrators that he too would be interested in acquiring the alleged claims, and it was in those circumstances that the administrators proposed a sale to the highest bidder by means of a public auction.
Mr Goel sought to prevent the administrators from proceeding with the proposed auction by applying to the court for an order requiring the administrators instead to assign the alleged causes of action to him in return for the payment of a nominal sum (£1) and a share in the proceeds of such claims in the event that they were pursued to a successful conclusion.

As indicated above, Mr Goel’s application was brought under paragraph 74 of Schedule B1 to the Insolvency Act 1986, under which the court has broad powers to intervene in the conduct of an administration if it is established that the administrator is acting, or has acted, or is proposing to act in a way which would unfairly harm the interests of the applicant.

Mr Goel argued that he would be unfairly harmed by the proposed auction on two main grounds:

•    First, he claimed that the administrators had entered a binding contract to sell the alleged claims to him for a fixed amount of £5,750;

•    Second, he argued that the proposed auction would necessarily be unfairly harmful to him because Mr Sumner had the deepest pockets, and would be able to win the auction and therefore stifle the alleged claims by paying a price that would substantially undervalue them.

The contractual argument

Mr Goel’s argument that the administrators were contractually bound to sell the claim to him was dismissed.

The Judge, David Halpern QC (sitting as a Deputy Judge of the High Court), held that although it was true that the prospect of assigning the alleged claims to Mr Goel had been canvassed, the correspondence was always merely exploratory and impliedly subject to contract. In the result, and on the basis of the principles governing the formation of contracts articulated by the Supreme Court in RTS Flexible Systems Ltd v Molkerei Alois Muller GmbH & Co KG [2010] 1 WLR 753, the idea never morphed into an offer capable of acceptance.

Although this aspect of the case turned on the facts, the Judge helpfully confirmed (at [20]) that an administrator does, in principle, have the power to sell a bare cause of action, by way of exception to the rule against champerty. The Judge stated that it was well-established that liquidators had such a power, referring to Norglen Ltd v. Reed Rains Prudential Ltd [1996] 1 WLR 864 at 875 and [1999] 2 AC 1 at 11E-12E, and pointed out that the power conferred on administrators under paragraph 60 of Schedule B1, and paragraph 2 of Schedule 1 to the Insolvency Act 1986, “to sell or otherwise dispose of the property of the company by public auction or private contract”, was in substantially the same terms as the provision conferring powers of sale on liquidators, i.e. paragraph 2 of Schedule 4 to the Insolvency Act 1986.

The public auction

In support of his argument that a public auction of the alleged claims would be unfairly harmful, Mr Goel argued the outright sale of the alleged claims to the highest bidder would necessarily result in a sale at an undervalue. This was because:

•   The assets in question, being causes of action in respect of which there was no recognised market, were only likely to be of value to Mr Goel (because he was the only person with the requisite knowledge to bring the claims) or Mr Sumner (who would be interested in paying an amount to acquire, and thereby stifle, the claims): and

•   Mr Sumner, who was the bidder with the deepest pockets, would not have to pay anything like the true value of the claims (which exceeded £10 million according to Mr Goel) in order to win the auction.

Mr Goel argued that since only he was in a position to realise the alleged claims at their true value, because only he had the necessary knowledge and motivation to pursue them to a successful conclusion, the court should stop the proposed auction and direct the administrators to assign the alleged claims to him.

In rejecting this argument, the Judge first sought to clarify the law governing the jurisdiction under paragraph 74 of Schedule B1 to the Insolvency Act 1986 and the application of the unfair harm test, holding as follows:

•    The paradigm case under paragraph 74 arises where the administrator treats the applicant (either alone or together with further creditors) less favourably than another creditor or creditors: see Re Coniston Hotel (Kent) LLP [2013] 2 BCLC 405. This constitutes harm, but it is not necessarily unfair harm. In order to be unfair, the applicant has to show that the decision cannot be justified by reference to the interests of the creditors as a whole or to achieving the objective of the administration.

•   That said, the concept of unfair harm in paragraph 74 is not limited to differential treatment but can include a decision of the administrator to sell an asset at an undervalue, thereby causing harm to all creditors: see Hockin v. Marsden [2014] 2 BCLC 531. However, in a case where there is no differential treatment of creditors, the court will not interfere with the administrator’s decision to sell an asset unless the decision does not withstand logical analysis; i.e. it is perverse.

•    A cause of action is a difficult asset to value. If it appeared to have a substantial value, no reasonable administrator would sell it for a fixed price without properly considering its value, usually with expert assistance, or finding a sensible alternative: see Faryab (A Bankrupt) v Smith (Trustee in Bankruptcy) [2001] B.P.I.R. 246.

•    However, it does not follow that the administrator is necessarily acting unreasonably if he sells a cause of action by auction. Whether or not this is unreasonable will depend on an analysis of the facts in each case. In an appropriate case, the process of testing the market by holding an auction may make it reasonable to proceed without seeking valuation advice, particularly where the claim is a difficult one to value.

•    The argument that there was a public interest in preventing claims from being bought by defendants in order to stifle them was at best a marginal factor. The Judge referred to Whitehouse v. Wilson [2007] BCC 595, where the Court of Appeal had upheld a decision to sell a cause of action to a putative defendant, and Hopkins v. TL Dallas Group Ltd [2005] 1 BCLC 54, where Lightman J had actively encouraged the practice of seeking bids from putative defendants.

Applying these principles to the present case, the Judge held that the proposed auction of the alleged claims would not cause unfair harm to Mr Goel within the meaning of paragraph 74 of Schedule B1 to the Insolvency Act 1986.

There was ample and cogent justification for the administrators seeking to proceed by way of an auction instead of selling to Mr Goel on his terms. A sale to Mr Goel in return for a share of the proceeds would lead to considerable uncertainty, since there was no certainty (a) that the applicants would have the means to pursue the litigation, (b) that it would succeed, or (c) that it would result in substantial recovery. It would also lead to considerable delay, because it could take many years for the claim, if successful, to result in any recovery. By contrast, the proposed auction would result in the certainty of a fixed price without delay.

Although the Judge was careful to avoid making any findings or adverse comments regarding the merits of Mr Goel’s alleged claims, it should be noted that both the administrators and Mr Sumner had made detailed submissions at the hearing to the effect that the alleged claims were entirely misconceived. A particular weakness in Mr Goel’s case that was highlighted was that no allegation of impropriety was made against the administrators; i.e. the people who were actually responsible for the sale of Meem SL Ltd’s business. In those circumstances, the idea that the pre-pack was the manifestation of an unlawful means conspiracy was implausible.

Barristers
Edward Davies QC