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17 March, 2016

What can Adjudication amount to in practice?

David Sellar QC assesses the implications of recent Court of Session decisions and how an administrator may approach adjudication of creditor claims.

The recent Court of Session decision of Lord Doherty in the application named Nimmo and Friar Noters [2015] CSOH 165 raises a very practical matter for an administrator, namely what he has to do to adjudicate on claims.

The matter arose in the context of an application by the joint administrators of a company for an order under section 176A (5) of the Insolvency Act 1986 (‘Section 176A (5)’) to disapply the ‘prescribed part’ which would otherwise be available to satisfy the company’s unsecured creditors.

The express requirement for such an order, which is set out in Section 176A (5), is that the cost of making a distribution to the unsecured creditors would be disproportionate to the benefits of the distribution to the creditors. That is a requirement which is so imprecise that it gives little guidance to practitioners. In any case, the application was made on the basis that that express requirement was satisfied.

Lord Doherty refused the application, doing so on the short ground that, on the final information before him, the express requirement was, in his view, not satisfied.

In refusing the application, Lord Doherty largely followed the overall approach to Section 176A(5), which Lord Glennie had adopted, again in the Court of Session, in the application by Stephen & Hill Noters [2012] BCC 794. However, Lord Doherty went further in holding, following Re International Sections Ltd [2009]1 BCLC 580, that Section 176A(5) also gave the court a discretion whether to make the order, even if the express requirement was satisfied.

On any view, Lord Doherty’s decision confirms that it is rather less easy to obtain an order under Section 176A (5) than may have been thought. There might be a judicial suspicion that administrators, who are so often appointed by the banks and other holders of qualifying floating charges, may favour them by seeking such orders too readily.

However, it is not the purpose of this article to consider the meaning of Section 176A(5) and, in particular, whether the provision does include some discretion in addition to the express requirement. Rather, this article considers what the process of adjudication may amount to in practice.

 Judicial comment

In that context, the opinion of Lord Doherty included the following final paragraph:

“Second, I respectfully agree with the observations of Lord Glennie in paragraphs 4 and 5 of Stephen & Hill. Administrators ought to act in a proportionate way when carrying out their statutory duty to adjudicate upon claims. In the present case the breakdown of the Noters’ estimated time and costs allocates to the lowest value claims a very large part of the time to be expended and the cost to be incurred. That seems disproportionate given the relatively small dividend payments likely to be made in relation to those claims. Serious consideration should be given to a more rough and ready (and less time consuming and costly) adjudication being carried out in respect of at least those claims.”

It was simply accepted by Lord Doherty, again following Re International Sections Ltd (above), that the ‘cost’, to which Section 176A(5) refers, was that of adjudication and not simply those of sending out the cheques.

The paragraphs in the opinion of Lord Glennie in Stephen & Hill (above), to which Lord Doherty referred, includes the following passage which is in very similar terms:

“Although, of course, administrators and liquidators are under a statutory duty to adjudicate upon claims, it seems to me that this duty had to be carried out in a proportionate way. Each case will no doubt turn on its own facts. It may be necessary for some rough and ready adjudication to be carried out. There may be questions as to the validity of large claims which, in fairness to other unsecured creditors, require more detailed attention. But the need for proportionality must be borne in mind, as must the potential prejudice to unsecured creditors with good claims if the investigations take up too much time and expense.”

As well as refusing the order under Section 176A(5), Lord Glennie went on to direct the administrator to pay the claims “without carrying out further investigations into the merits of the claims”. That direction was not mentioned by Lord Doherty and seems to have been rather overlooked by practitioners, although it may give more authoritative guidance than a SIP. Ironically, the direction is noted in the essentially English textbook, Fletcher The Law of Insolvency (second supplement to the 4th ed.) at paragraph 24.039.1.

Beyond that direction, neither Lord Glennie nor Lord Doherty gave any general guidance about how an administrator should in practice adjudicate claims of a small value. Nor does there appear to be any textbook discussion. An article by R.E. Aird, Advocate, at [1997]42 JLSS 229 discusses adjudication but not this matter.

 Adjudication in practice

In the absence of any guidance, this article makes some suggestions, if only tentatively and in order to stimulate further thought among practitioners.

It seems useful to start with the law. Rule 2.26C of the Insolvency (Scotland) Rules 1986 (“Rule 2.26C”), which was introduced only in 2010, deals with a creditor’s entitlement to vote and draw a “dividend, the latter term being simply a synonym for a “distribution” which Section 176A (5) uses. When making the suggestions which are quoted above, neither judge referred to that Rule as a possible basis for achieving the desired savings.

Rule 2.26C(1) says:

  • A creditor, in order to obtain an adjudication as to his entitlement –
    • (a) to vote at any meeting of creditors in the administration; or
    • (b) to a dividend (so far as funds are available) out of the assets of the company in respect of any accounting period, may submit a claim to the administrator.

Rule 2.26C(2) deals with the timing of a claim.

Rule 2.26C (3) says

  • A creditor’s claim must –
    • (a) be made out by, or under the direction of, the creditor;
    • (b) have attached an account or voucher (according to the nature of the debt claimed) which constitutes prima facie evidence of the debt..Rule 2.26C (3)(c) specifies what the claim must complain, most obviously the “creditor’s” name and address and the amount claimed.

Rule 2.26C(4) says:

  • The administrator may dispense with any requirements in paragraph (2)(b) in respect of any debt or class of debt.

It is curious that the equivalent provision of the Insolvency (Scotland) Rules, which applies in a liquidation and which was in effect applied before 2010 to an administration, Rule 4.15(2), is in different terms. Rule 4.15(2) requires the creditor to use the statutory form but gives a liquidator power to dispense also with the form of claim.

It is difficult to see any policy reason why the provision which applies to an administration should be narrower than that which applies in a liquidation. One is left with the strong impression that the present Rule 2.26C(4) is the result of a drafting oversight, albeit one which cannot be corrected as a matter of statutory interpretation.

In any case, what are the practical implications of Rule 2.26C, as it is drafted, and, in particular, the implications of the power under Rule 2.26C(4)?

Those implications can be seen first by taking the straightforward example of a local shopkeeper, who has supplied papers and milk to the company and remains unpaid when it goes into administration.

The company’s accounting records may include the debt to the shopkeeper and it may, therefore, be included in the statement of affairs. More probably, the accounting records will not be up to date but one could expect the unpaid shopkeeper to contact the administrator.

If the shopkeeper sends an email, it is suggested that that will comply with the requirements of Rule 2.26C (1). There is nothing in that Rule which says that a claim cannot be made by email and indeed by more than one email.

In addition, the content of the email may comply also with the requirements of Rule 2.26C (3)(c), which, as just said, specifies what a claim has to contain. If, however, the email does not comply with those requirements, the administrator’s staff can easily inform the shopkeeper of what further information is required in a further email.

If one assumes then that the shopkeeper does comply with Rules 2.26C (1) and (3)(c), it would seem to be an entirely proper exercise of the administrator’s power under Rule 2.26C (4) for him to adjudicate the shopkeeper’s claim by accepting it. In other words, it is unnecessary, as well as unrealistic, to ask the shopkeeper to produce a written order from the company for the goodssupplied or some other written evidence of the claim.

It is of course implicit in that scenario that the administrator has no reason to suspect that the sum claimed by the shopkeeper might not be due.

By contrast, the administrator may well have such a reason where, for example, one of the company’s directors, or a close relative of a director, claims that he had lent money to the company.

It seems appropriate to generalise from the scenario of the shopkeeper. Assuming the absence of any reason to suspect that the sum claimed might not be due, it would appear a proper exercise of an administrator’s power under Rule 2.26C (4) to pay a dividend to a person, who puts in a claim, which complies with the requirements of Rules 2.26C(1) and (3). That must be all the more so, where the company’s accounting records show some debt being owed to the person making the claim.

The suggested approach seems to give practical content to the suggestions which Lords Doherty and Glennie made in the passages cited above. In particular, the approach is consistent with the direction which Lord Glennie made in in Stephen & Hill (above) and which, as said, seems to have been rather overlooked.

Caution to be exercised

Having said all of that, prudence suggests that, even in the absence of any reason for suspicion, the approach should be subject to some financial limit and that claims above that limit should be vouched. Such a limit would again be consistent with the suggestions of the two Court of Session judges.

A reasonable limit for the suggested approach might be £10,000. Whether the suggested approach, including whatever limit is thought appropriate, would lead to the significant savings which the two judges sought is a question for practitioners.

A final thought is that the insolvency regulators would have to be content with the adoption of the suggested rough and ready approach, and the reasonable limit. Some of the present caution of IPs, and the resulting costs, reflect understandable concerns that they are complying fully with the regulators’ requirements.

This article first appeared on the ICAS website on 17th March 2016.

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