DATE: December Welcome to the FWJ INFORMER.

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1 DATE: December 2010 Welcome to the FWJ INFORMER. We are committed to excellence and aim to provide the highest possible quality of legal services to our clients. The FWJ INFORMER explains some of the recent legal developments that are relevant to the asset based lending industry and how they affect the conduct of your business. This edition of the FWJ INFORMER is a reminder of some of the notable legislative changes introduced and case law decisions made during 2010 and the practical implications of these for you. INSOLVENCY New Insolvency Rules The Insolvency (Amendment) Rules 2010 came into force 6 April 2010 and, with some exceptions that apply in all cases, apply to insolvency proceedings commenced after that date. These amendments are part of a protracted programme of modernisation of the rules and comprise a number of substantive changes to both the law and procedure relating to insolvency proceedings aimed at reducing the administrative burden and cost whilst increasing transparency and consistency with the Civil Procedure Rules. For insolvency practitioners and creditors the main changes are: Administrators pre-appointment fees and charges may be recoverable as administration expenses out of floating charge realisations. These costs must be included in the statement of proposals and approved by the creditors; Administrators remuneration can be calculated by reference to: a percentage of the asset value, time costs or a fixed fee or any combination of these bases; Provisions for the use of electronic communications and remote attendance at creditors meetings; A simplified procedure for disclaiming onerous contracts, including leases. The final modernisation stage presently proposed for 2012: the restructuring and reordering of the rules, is back under debate. The Insolvency Service has recently written to insolvency professionals inviting their views as to whether to continue with the full consolidation. A forceful argument is being made that the costs of the transition, including the replacement of prescribed forms, will outweigh any benefits. The conclusions from this consultation are expected in The Insolvency Service has indicated that if the final consolidation work is not done now, it may be a very long time before it is back on the agenda.

2 Pre-appointment costs Re Johnson Machine and Tool Company Limited [2010] EWHC 582 (Ch) In this case, which was heard before the New Insolvency Rules came into force, the court declined to make an order allowing the payment of pre-appointment costs, which included negotiating a proposed sale of the business, as an expense of the administration. Of significance to Insolvency Practitioners looking to recover pre-appointment fees under the New Insolvency Rules are the comments of the judge that pre-appointment costs, which the new rules refer to as costs incurred with a view to the administration of the company, were confined to the preparation of appointment documents only and not costs associated with a pre-pack sale. Administration expenses Bloom v The Pensions Regulator [2010] EWHC 3010 (Ch) This very recent decision on whether the cost of complying with an Financial Support Decision (FSD), or the monetary obligation imposed by a Contribution Notice issued by the Pensions Regulator pursuant to his powers under the Pensions Act 2004, ranks in the administration or liquidation of the company as a provable debt, or as an expense, or neither of those, will cause considerable concern for the administrator or liquidator of a company with a pension deficit. The court has held that as a general rule where statute has imposed a financial liability which is not a provable debt on a company in an insolvency process then, unless it constitutes an expense under any other sub-paragraph in the expenses regimes for liquidation and administration, it will constitute a necessary disbursement of the liquidator or administrator and be an expense in that insolvency process, with a super-priority as against the claims of any unsecured creditors and floating charge holders. The Judge noted an apparent inconsistency in the fact that liability arising under a FSD made after commencement of administration will rank as an expense, whereas if the FSD had been made even a day before, it would rank as an unsecured creditor. This, and the amounts involved in this case, brought by the administrators of the Nortel and Lehman Brothers groups of companies, means that an appeal is expected in 2011, but not yet confirmed. Form or substance? The importance of using the correct forms and complying precisely with the terms of the insolvency legislation has been emphasised. Successive notices of intention Re Corner Care Limited [2010] EWHC 893 The court confirmed that paragraph 28(2) Schedule B1 IA86 does not permit directors to appoint an administrator after the expiry of a notice of intention but, provided there are good reasons for an appointment not being made in that interim moratorium, there was no reason why a second notice of intention could not be filed. Insolvency Practitioners should note the court s warning that it would not allow the filing of a chain of notices by unscrupulous directors, merely as a way of protecting the company from creditor action without actually taking any substantive steps.

3 Using the correct forms Re Kaupthing Capital Partners II Masters LP [2010] EWHC 836 (Ch) In this case, the court found that a Guernsey registered LP could not be categorised as a company for the purposes of Schedule B1 and therefore the notice of the administrators appointment had been given on the wrong form. As a consequence of using the wrong form, the judge held that the administration and all acts of the administrators were invalid. This was not a defect that could be remedied by the court: there were no insolvency proceedings that could be cured. Nor did the judge find it possible to make an order appointing the administrators back dated to the purported start of the administration, because such an order would expire automatically after a year and the administration had already been extended. It was not possible to make successive orders to extend the administration as an administration could not be extended after it had expired. This case highlights that the use of the correct forms is mandatory, although minor defects in completing the administration forms may not of themselves make the appointment invalid. A notable consequence of the administrators not being validly appointed was that there was no provision for the payment of their remuneration. Whose assets are they? Retention of title Sandhu v Jetstar Retail Limited [2010] EWHC B17 (Mercantile) Some useful guidance has been provided for dealing with ROT claims in trading administrations. The court distinguished between a clause for the supply of stock for resale from one where the goods supplied are intended to be used by the company in its business. In this case, the court found the ROT clause was not effective as it was inconsistent with the intention of the parties that the stock would be sold on to customers. The relevant contract contained provisions that clearly anticipated and allowed the purchaser to on-sell the stock it had purchased (without discharging its balance with the supplier), and to continue to do so even following the purchaser's insolvency. The court also declared that ROT clauses are only a right for a supplier to recover goods that are not paid for, not a security for a debt owed to the supplier. This means a creditor cannot, as is often the case, demand the value of the goods from the administrator as a priority debt in the insolvency. Check whose goods are being sold The New Northumbria Hotel Limited v Maymask (148) LLP [2010] EWHC 1273 (Ch) This case contains several reminders of best practice for Insolvency Practitioners negotiating pre-pack sales. Administrators must take care to ascertain the rights of third parties to goods on the premises occupied by a company in administration before they sell any goods and make provision in the sale agreement for any third party claims to the assets being sold. Administrators should also ensure that they do not enter into any agreements with regard to the assets of the company before they are appointed and that notice of their appointment is given to the company as soon as reasonably practical. The court noted that in certain circumstances this requirement can be satisfied by giving notice by . Challenges to office holders Where insolvency proceedings have become hostile, Insolvency Practitioners will be reassured to learn that the court does not readily admit applications to end their appointment.

4 Removal of administrators Clark and another v Finnerty and another [2010] EWHC 2538 (Ch) The High Court held that there are no general principles that a court should apply in determining an application for an administrator's removal whether to remove an administrator from office. Beyond the need for good cause to remove an administrator from office, it will depend on the facts of a particular case. The decision suggests that, in practice, a court is unlikely to remove an administrator from office without some element of unfair harm to a stakeholder from the administrator's conduct, or impropriety or misconduct on the part of the administrator. The court did not seem to consider that it held a distinct jurisdiction under which to review the conduct of an administration. Removal of liquidators Abbey Forwarding Ltd (in liquidation) v Hone [2010] EWHC 2029 (Ch) The shareholders and former directors of a company in liquidation brought an action under s 172 IA86 to remove the liquidator of the company and replace her with another liquidator. The court noted that s 172 does not specify any grounds for the removal of a liquidator, but that case law has determined that substantial grounds have to be established: in the absence of bad faith, the court will only interfere with the act of a liquidator if he has done something so unreasonable and absurd that no reasonable person would have done it. On the facts of this case the court held that the liquidator had not failed to take the only reasonable course of action, there were alternate courses of action open that were equally reasonable. LITIGATION AND DEBT RECOVERY Procedure Correct compliance with the procedural rules for any debt recovery action is essential to a successful action. Winding up petition HMRC v Green Eye Events [2010] EWHC 1403 (Ch) In this case HMRC served a petition on the defendant, but on the wrong address, which meant that the petition did not come to the attention of the company until the day before it was advertised and the company s bank account frozen leaving the company with no opportunity to pay the petition sum. This meant that the rule that a hostile petitioner must wait 7 days after service before advertising the petition and the advertisement must be at least 7 days before the petition is to be heard was not met This interval is to give the company either time to settle the debt or seek relief to restrain the advertisement where the debt is disputed. Given the serious consequences of the failure to serve the petition correctly and, the judge s view that the company would have paid the debt if it had had time to do so, the judge dismissed the petition. Financiers should note that whilst it was recognised that HMRC was not directly responsible for the service on the wrong address, as the correct address was on the documents, they were held to be responsible for the act of the process agent and were penalised for failing to check that service had been properly effected by the dismissal of the petition.

5 Part 36 offers Gibbon v Manchester City Council; LG Blower Specialist Bricklayer Ltd v Reeve [2010] EWCA Civ 726 The Gibbon case is a useful reminder of the rules relating to offers to settle. The Court of Appeal confirmed that the common law rules of contract relating to offer and acceptance did not apply to Part 36 offers. A Part 36 offer remains open may be accepted at any time unless the offeror has withdrawn it by serving notice of withdrawal on the offeree. Parties therefore have an opportunity to settle matters by reviewing all previous existing offers in the light of changing circumstances. In this case, the defendant was able to accept the claimant s original offer after the claimant had rejected a subsequent offer made by the defendant. The Court of Appeal said that there was no reason why one party could make more than one offer that could be open concurrently and leave it to the other party to decide which to choose. Financiers may need to consider whether they should expressly withdraw any particular offer, if they no longer consider it advantageous to them to keep open, when making a subsequent offer to settle. Electronic disclosure October 2010 saw the implementation of a new Practice Direction (PD31B) relating to disclosure of electronic documents. This has significantly increased the extent of the obligations to disclose documents which only exist electronically and highlights the wide range of methods of electronically storing information. The language of the PD31B is mandatory. To avoid penalties for taking an unreasonable approach or being ordered to do more, more careful preparation of disclosure is now required. The new rules provide: There is an agenda that parties must discuss before the first case management conference or, in complex cases, even before proceedings commence. Parties need to exchange information about their electronically stored information, on what media and in what format it is stored, how it is organised, volumes and the likelihood of duplication. Assessments on how far to extend the reasonable search for electronic documents and which data storage locations are reasonably accessible must be taken. Opposing parties are encouraged to reach agreement on reasonable measures to get to key information in a case proportionately. Financiers pursuing creditors may have particular problems complying with disclosure requirements in respect of information they do not control. However, they should ensure that their own electronic documents are managed efficiently and effectively to minimise the cost of any disclosure exercise. Guarantees As challenging demands made to guarantors by financiers become more common, recent cases highlight the continued need for clarity and care when drafting guarantees.

6 Oral variation Investec Bank (UK) Ltd v Zulman [2010] EWCA Civ 536 In this case, the Court of Appeal was asked to consider whether there had been an effective oral agreement to amend the terms of a personal guarantee. The guarantor had indicated his agreement to a proposed amendment to his guarantee by telephone but an amended guarantee was never signed. When a demand was subsequently made the guarantor argued that he was not liable because the condition to the guarantee being payable contained in the original guarantee, had not occurred. The Court of Appeal concluded, considering the terms of the draft amendment to the guarantee, that it was not the intention of the parties that the amendment to the guarantee could take effect upon the oral agreement of the guarantor. Accordingly the personal guarantor was not bound by the amended guarantee as he had not signed it. This decision highlights once again the vulnerability of guarantees and the need for financiers to take particular care when drafting and documenting amendments to guarantees. Guarantee or performance bond? A recurring argument when seeking to claim against a guarantor is whether the guarantee is a primary or secondary obligation. Carey Value Added, S.L. v Grupo Urvasco, S.A. [2010] EWHC 1905 (Comm) In this case, the beneficiary of the guarantee was seeking to recover payment on demand and a certificate without first having to litigate defences under the primary documentation. The court confirmed that there is no standard wording which would make a deed a demand bond; it is not a matter of the label to be attached, but a question of the substance of the obligations. The mere incorporation of a principal debtor clause will not usually suffice in itself to determine the nature of the contract, nor will the use of words such as "on demand" in themselves have the effect of creating a demand bond. This case re-establishes the presumption that a market standard guarantee in a commercial transaction is a secondary obligation and financiers will need to follow the contractual conditions for successfully making a demand. Guarantees as a debt McGuinness v Norwich and Peterborough Building Society [2010] EWHC 2989 (Ch) A guarantee that requires a guarantor to discharge its obligations as a principal obligor, rather than simply as a surety, creates a debt in favour of the creditor with the benefit of the guarantee, rather than the right to sue the guarantor for damages. This decision endorses the standard practice of including an indemnity provision in the guarantee that makes the guarantor liable as a principal debtor. If drafted in this way a creditor owed a debt by a guarantor can pursue that debt by way of statutory demand and insolvency proceedings, without having to first obtain a judgment against the guarantor. Set off It is important that financiers can rebut the argument that a debt being claimed is reduced by a claim in set off.

7 Geldof Metaalconstructie NV v Simon Carves Limited [2010] EWCA Civ 667 The Court of Appeal has confirmed that equitable set off will apply where: cross claims [are] so closely connected with [the plaintiff s] demands that it would be manifestly unjust to allow him to enforce payment without taking into account the cross claim. The Court emphasised that the test was based on legal principle rather than judicial discretion. The legal principle involves the application of a test which has two elements: the requirement for a close connection between the claim and the counterclaim (the formal element) and secondly, the requirement whereby it needs to be unjust to enforce the claim without taking into account the counterclaim (the functional element). The formal and the functional elements cannot be divorced from one another. Where the claim and counterclaim both arise from the same contract, it is likely that both elements of the test will be satisfied, although this may not always be the case. Where the claim and counterclaim arise from different contracts, satisfying the test may prove more difficult. In any situation, it will be necessary to apply this test to the facts in order to determine whether a financier s claim may be successfully reduced by a debtor s cross claim against a customer. COMMERCIAL FINANCE Bribery Act 2010 preparing your defences The Bribery Act 2010 received Royal Assent in April 2010 and is presently expected to come into force in April The delay is while the Secretary of State publishes guidelines for commercial organisations on what measures they can put in place to constitute an adequate defence to the new offence of failure by commercial organisations to prevent bribery. It is particularly important that financiers and insolvency practitioners are prepared for the introduction of an offence that they can commit if any person associated with them bribes another person with the intention of obtaining or retaining business or any business advantage for the commercial organisation. A commercial organisation will not commit an offence if it can show that it has in place adequate procedures designed to prevent any of its associates from committing bribery offences. A consultation seeking views on draft guidance and proposing six general principles that are designed to be applicable across all sectors and for all types and size of business has recently closed and draft guidance is expected in early For financiers wishing to make an early start on establishing the necessary procedures, steps to consider include: assessing the likely risks; establishing a clear internal policy and code of conduct for dealing with clients; training staff and developing a management system for monitoring compliance. Registration of Security In December 2010, the government published its outline proposals for changes to the law relating to the registration of charges created by companies, unregistered companies and limited liability

8 partnerships. The draft regulations implementing these changes are expected to be published in early 2011 with a view to the changes coming into force in 2012 or The headline changes are: The requirement to register should apply to every mortgage or charge created by a company registered in the UK over any of its property (wherever situated), unless expressly excluded by regulation. It will not be necessary to register the crystallisation of a floating charge. It will be possible to register a charge electronically. The filed particulars are to include whether there is an automatic crystallisation clause and a negative pledge. The criminal sanction for failure to register a charge will be abolished. The new regime will not apply to overseas companies. Disclaimer: This newsletter is a short selection of items which may be of interest and is only a summary of the relevant law. Further specific advice on any matter referred to must be taken at all times. No part of this publication may be reproduced without the prior permission of Francis Wilks and Jones LLP. The information is given for general guidance only and publication is without responsibility for loss occasioned to any person acting or refraining from acting as a result of the information given. Sally Bradshaw Senior Associate Tel: Mobile: Sally.bradshaw@franciswilksandjones.co.uk Copyright Francis Wilks & Jones LLP 2010.