Lord Justice Lewison:
The issue
- The legal issue raised in this appeal is: when is a company deemed to be unable to pay its debts, with the result that it is insolvent? The procedural issue is whether the intermediate appeal court was entitled to substitute its own evaluation of the facts upon which the answer to the legal question depends.
- The issue arises in the context of an application by the liquidator of Casa Estates (UK) Ltd ("Casa UK") to recover monies paid out by the company to Mrs Bucci under transactions which were transactions at an undervalue. Since Mrs Bucci was a person connected with the company, she had the burden of rebutting the statutory presumption that it was not insolvent at the time when the payments were made. HH Judge Purle QC decided that she had discharged that burden. But on appeal Warren J disagreed with HH Judge Purle QC and held that she had not. Warren J's judgment is at [2013] EWHC 2371 (Ch), and is available on BAILII.
- Mrs Bucci, represented by Mr John Randall QC and Mr James Morgan, appeals. The appeal is resisted by Mr Hermann Boeddinghaus and Mr Alexander Cook, appearing on behalf of the liquidator.
The legislation
- Section 123 of the Insolvency Act 1986 defines when a company is deemed to be unable to pay its debts. Section 123 (1)(e) says that a company is deemed to be unable to pay its debts:
"… if it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due."
- Section 123 (2) says that:
"A company is also deemed unable to pay its debts if it is proved to the satisfaction of the court that the value of the company's assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities."
- The test in section 123 (1) (e) is usually known as the test of cash-flow solvency; and the test in section 123 (2) as the test of balance sheet solvency, although these are no more than convenient shorthands.
- Section 238 enables an office holder, such as a liquidator, to apply to the court for an order reversing a transaction made at a significant undervalue by an insolvent company. In the case of a transaction with a person connected with the company this potentially applies to a transaction made in the two years preceding the onset of insolvency: section 240 (1). It will apply if, at the time of the transaction, the company is unable to pay its debts within the meaning of section 123. But in the case of a transaction made with a person connected with the company, the company is presumed to be unable to pay its debts, unless the contrary is shown: section 240 (2). Hence the burden lay on Mrs Bucci to rebut the presumption of insolvency.
HH Judge Purle QC's judgment
- Casa UK was incorporated on 23 February 2005. It was under the day to day management of Mr Bucci. His wife, Mrs Bucci, was the company secretary. The company's principal business was that of introducing investors to property in Dubai. It had an agent and intermediary in Dubai called Casa Dubai Real Estate Brokers LLC ("Casa Dubai"). By a written agreement dated 1 January 2007 Casa UK agreed to pay Casa Dubai a monthly sum in the nature of a retainer equivalent to £10,000. Casa Dubai, in turn, agreed to pay Casa UK commission on sales at an average rate of 6 per cent. That latter agreement does not appear to have been recorded in writing. In his first witness statement Mr Carman, Casa UK's liquidator, said that the precise relationship between Casa UK and Casa Dubai was unclear. I do not believe that it has since been materially clarified.
- Thus the business model is, to some extent, obscure but in the main it seems to have worked as follows. Casa UK would receive monies from an investor who wanted to invest in property in Dubai. In theory it would then transmit the monies to Casa Dubai in Dubai, for onward transmission to the developer. Arrangements between Casa UK and Casa Dubai were subject to a set-off arrangement. The details of the set-off are also obscure; and are also not contemporaneously recorded in writing. Casa UK was liable to pay the £10,000 a month retainer to Casa Dubai. Casa Dubai was, on the other hand obliged to pay commission to Casa UK. It was also to make payments to developers in Dubai on behalf of Casa UK's clients. The set-off apparently enabled Casa Dubai to withhold commission due to Casa UK by setting off those commissions against new client monies received by Casa UK. Casa Dubai would then pay over the withheld monies in its hands to the developers in Dubai. Casa UK would transmit to Casa Dubai any shortfall in payments due to the developers. None of the accounts of the set-off arrangement expressly refer to the payment by Casa UK of the monthly retainer to which Casa Dubai was contractually entitled. The key point about the set-off system (whatever its details were) was that, as Mr Bucci confirmed in his cross-examination, the flow of money was always from the UK to Dubai. No profits were in fact remitted from Dubai to the UK.
- Casa UK's filed accounts for the periods to December 2005 and December 2006 showed modest profits of £2,695 and £53,794 respectively. Although Casa UK's entitlement was an entitlement to commission only, these accounts recorded the gross sales price as part of its turnover. No further accounts were filed for later periods.
- As HH Judge Purle QC pointed out, when Casa UK received customer deposits it had an obligation to account to the customer for those deposits, which was itself a liability to the customers until such time as the deposits had been correctly applied towards the purchase of property in Dubai by payment to the developers. Casa UK did not maintain a client account, but mixed depositors' monies with its own. Nor did its accounting systems enable depositors' monies to be accurately identified with any confidence. The combination of the lack of a client account, and the fact that depositors' monies were treated as part of Casa UK's own turnover led the liquidator's expert accountant, Mr Minshall, to comment in his report:
"The Company did not operate a client account. As a result, it processed many millions of pounds that passed through its accounts and treated them as its own."
- He adhered to that view in cross-examination.
- What is also puzzling is the existence of certain written agreements in the case papers. Casa UK introduced some investors (no more than four) to a scheme with a developer in Dubai called Al Barakah. These investors included a Mr Lees. The scheme promised investors a return on their investment of 40 per cent within 6 months. However, the case papers include a written agreement dated 25 September 2008. It is made between Casa UK itself and Mr Lees. Casa UK agreed to invest £200,000 "on behalf of" Mr Lees as part payment towards a property investment in Dubai. It also agreed to pay Mr Lees within 6 months a guaranteed return of 40 per cent on his investment and to repay the initial investment itself. Thus the overall effect of this agreement is that Casa UK had a liability to pay Mr Lees the equivalent of £280,000 (partly in sterling and partly in dirhams) within six months. Given that Casa UK's own entitlement to profit was its 6 per cent commission, it is wholly unclear where anyone thought that the money would come from to honour its commitment to Mr Lees; although Casa UK asserted that it would have had a matching claim against Al Barakah. In his first witness statement Mr Carman, Casa UK's liquidator, said that those investors whom Casa UK introduced to the Al Barakah scheme were provided with post-dated cheques drawn in Casa UK's own bank accounts. This arrangement was sometimes referred to as a guarantee. But in fact it was not a guarantee at all. It was a primary liability on the part of Casa UK to make the promised payments to Mr Lees.
- In the course of 2007 and 2008 Casa UK made payments to Mrs Bucci amounting to £103,988 in aggregate. It is no longer contested that these payments were made in connection with transactions at an undervalue.
- HH Judge Purle QC recorded that the experts were agreed that Casa UK was "marginally insolvent on a balance sheet basis" in March 2007. During the same period covered by the payments made to Mrs Bucci, Casa UK also made loans amounting to £474,259 to another company called Gianluca (UK) Ltd ("GUL"). GUL was another company owned and controlled by Mr and Mrs Bucci. It was in the drinks distribution business, but it was loss-making from the start. HH Judge Purle QC found that there was no real prospect of Casa UK ever recovering its loan from GUL; and that it therefore had no significant value as part of Casa UK's assets. The experts called before HH Judge Purle QC agreed that if the GUL loan were eliminated as an asset of value, then Casa UK was "balance sheet" insolvent at all material times from December 2007 onwards.
- HH Judge Purle QC said that there was a rapid expansion of Casa UK's business in 2007 and 2008. That, he said, "increased the apparent profits of the company up to July 2008 … but also resulted in additional liabilities to customers whose deposits had not reached the developer, either because the development had not reached the appropriate stage or because the developer could not hold deposits." He did not explain why he used the phrase "apparent profits" rather than "profits". Mr Randall suggested that what the judge must have meant was that if the market crashed, Casa UK would not be able to survive.
- In late 2008 the property market in Dubai did indeed collapse. HH Judge Purle QC found that the collapse was "sudden and not generally anticipated." It was that collapse that pushed Casa UK into insolvent liquidation. As he put it at [52]:
"As a result of the sudden collapse of the property market in Dubai, which post-dated the September 2008 collapse of Lehman Brothers by over two months, Casa Dubai failed and [Casa UK's] substantial liabilities to its customers crystallised, without the possibility of recovering any of those liabilities from Casa Dubai, or outstanding commissions. However, until that point, [Casa UK's] liabilities to customers were effectively contingent upon the failure of Casa Dubai or the developers."
- I do not understand the last sentence of that extract. The judge had already held at [50] that the receipt of money from customers created an obligation on the part of Casa UK towards the depositors. That is plainly correct, because Casa UK, as agent for the depositors, had an obligation to account. But that obligation was not contingent: it was an immediate liability. Nor could Casa UK's liability towards its depositors have been contingent on failure by the developers. If the money paid by depositors had actually reached the developers, Casa UK would have correctly applied the depositors' money and its own obligation would have been discharged. Whether the developer subsequently failed was the client's risk: not Casa UK's. Mr Randall accepted that this part of the judge's judgment was a muddle.
- Until late December 2088 HH Judge Purle QC considered that Casa UK had been cash-flow solvent. He explained his reasons for that conclusion at [44]. They were as follows. There was no suggestion that any creditor had served a statutory demand or obtained a judgment against Casa UK. There was no creditor pressure and Casa UK was in fact paying its debts as they fell due. It had no cash flow problem at the time of any of the payments to Mrs Bucci. The cash flow problems arose only after the collapse of the Dubai property market in late 2008; and when the problems materialised Casa UK reached the point of no return very suddenly and ceased business. At [57] the judge said that at the end of December 2007:
"Business was increasing, and there was no likelihood of [Casa UK] being called upon to refund the customer deposits."
- This is a puzzling observation for two reasons. First, since the business consisted of paying customers' deposits to developers, the question of refunding them would not normally arise. Second, the way the judge has phrased his observation suggests that if there had been a likelihood of Casa UK being called upon to refund deposits (i.e. to comply with its obligation to account) it would not have been able to do so. That ties in with Mr Randall's suggested explanation of the judge's use of the phrase "apparent profits" earlier in his judgment.
- Casa UK went into insolvent liquidation in March 2009 with a deficiency as regards creditors of some £1.2 million. The deficiency as regards investors has been variously estimated. It is between £488,000 at its lowest, and £1.05 million at its highest. The liquidator and Mr Minshall arrived at figures of £630,000 and £648,000 respectively.
- As I have said HH Judge Purle QC held that Casa UK had been paying its debts as they fell due up to the end of 2008 when the Dubai property market collapsed suddenly. He held, therefore that at the time of the payments to Mrs Bucci it was not cash-flow insolvent. He further held that its liabilities to depositors were contingent and that, taking into account those contingent liabilities, Casa UK had not reached the point of no return until the end of 2008.
- The phrase "the point of no return" was one that had been coined by Prof Sir Roy Goode QC and applied by the Court of Appeal in BNY Corporate Trustee Services Ltd v Eurosail-UK-2007-3BL plc [2011] EWCA Civ 227; [2011] 1 WLR 2524 ("Eurosail"). It is abundantly clear that that was the test that HH Judge Purle QC applied: not least because he used the phrase throughout his discussion of Casa UK's solvency: see [47], [52], [56], [57], [58] and [59].
The judgment of Warren J
- By the time that the appeal in this case reached Warren J the Supreme Court had considered the appeal in Eurosail and had said that the "point of no return" test was not the appropriate test: [2013] UKSC 28; [2013] 1 WLR 1408. It is not easy to distil Warren J's judgment, but I think that the key points are these:
i) The test that HH Judge Purle QC applied, namely the "point of no return" test, had been shown by the Supreme Court's decision in Eurosail not to be the right test: see [36], [66] (iii) and [122].
ii) Thus the question for Warren J was whether, applying the right test, he was in a position to decide whether Casa UK was unable to pay its debts: see [66] (iii).
iii) In reaching his conclusion on cash-flow solvency HH Judge Purle QC had not dealt with some of the important evidence. In particular (a) there were at least four creditors who had expressed concern about the non-transfer of their deposits to the developer; (b) there was a table of creditors which showed an increase in the amount of aged creditors, thus indicating that debts were accruing and not being paid; (c) Mr Bucci had himself stated that there were 34 clients exposed to losses of over £488,000 for goods and services that had not been supplied, and that that list of clients had been compiled by collating complaints from investors who had said that their funds had not been properly invested: see [107] to [110].
iv) HH Judge Purle QC had also not considered how it was that debts continued to be paid. In Warren J's view the continued payment of debts was only possible because new deposits from investors were used to pay old debts: see [48], [62] and [117].
v) There was no material on which it could be said that, if no significant value was attributed to the GUL loan, Casa UK would ever be able to meet its liabilities, including contingent liabilities. Those liabilities included directors' loans, but they could not be excluded. Casa UK was balance sheet insolvent as at 31 March 2007 and thereafter: see [118] to [120].
- Warren J therefore concluded, contrary to HH Judge Purle QC's decision, that Mrs Bucci had not rebutted the presumption that Casa UK was insolvent at the times that it made the disputed payments to her. He reached this conclusion largely on the basis that Casa UK was unable to pay its debts as they fell due: see [123]. As he put it:
"It could not be suggested that, had the Company stopped trading on any particular date after 31 March 2007, that it would have been able to meet all of its liabilities: its balance sheet shows (valuing the GUL loan at nil) an excess of liabilities over assets. It would not then have been able to pay its debts as they fell due. Its ability to do so depended on having sufficient cash flow which in turn depended on receiving further deposits and/or instalment payments. However, the further income received by the Company would have given rise to a further immediate debt, or one due in a very few days, so that, in my view, it could not be said that the Company was able to pay its debts as they fell due. The new monies received would not, properly, have been available to pay the old debts at all."
The main arguments
- Mrs Bucci's argument is that if a company is cash-flow solvent, there is no need to consider whether it is also balance sheet solvent, unless it has contingent or prospective liabilities. The trial judge found that the company was cash-flow solvent; and so there was no warrant for examining whether it was balance sheet insolvent. If it is necessary to examine whether a company is balance sheet insolvent, then a judgment has to be made whether it really is balance sheet insolvent. It is not simply a mechanical exercise of comparing assets and liabilities.
Eurosail
- In my judgment the following points emerge from the decision of the Supreme Court in Eurosail (and in particular the judgment of Lord Walker):
i) The tests of insolvency in section 123 (1) (e) and 123 (2) were not intended to make a significant change in the law as it existed before the Insolvency Act 1986: para [37].
ii) The cash-flow test looks to the future as well as to the present: para [25]. The future in question is the reasonably near future; and what is the reasonably near future will depend on all the circumstances, especially the nature of the company's business: para [37]. The test is flexible and fact-sensitive: para [34].
iii) The cash-flow test and the balance sheet test stand side by side: para [35]. The balance sheet test, especially when applied to contingent and prospective liabilities is not a mechanical test: para [30]. The express reference to assets and liabilities is a practical recognition that once the court has to move beyond the reasonably near future any attempt to apply a cash-flow test will become completely speculative and a comparison of present assets with present and future liabilities (discounted for contingencies and deferment) becomes the only sensible test: para [37].
iv) But it is very far from an exact test: para [37]. Whether the balance sheet test is satisfied depends on the available evidence as to the circumstances of the particular case: para [38]. It requires the court to make a judgment whether it has been established that, looking at the company's assets and making proper allowance for its prospective and contingent liabilities, it cannot reasonably be expected to meet those liabilities. If so, it will be deemed insolvent even though it is currently able to pay its debts as they fall due: para [42].
- In the course of his judgment in Eurosail Lord Walker approved what he described as the "perceptive judgment" of Briggs J in Re Cheyne Finance plc (No 2) [2007] EWHC 2402 (Ch); [2007] 2 All ER 987. Two of the points that Briggs J made bear on our case:
i) Cash-flow solvency or insolvency is not to be ascertained by a blinkered focus on debts due at the relevant date. Such an approach will in some cases fail to see that a momentary inability to pay is only the result of temporary illiquidity. In other cases it will fail to see that an endemic shortage of working capital means that a company is on any commercial view insolvent, even though it may continue to pay its debts for the next few days, weeks, or even months: para [51].
ii) Even if a company is not cash-flow insolvent, the alternative balance-sheet test will afford a petitioner for winding up a convenient alternative means of proof of a deemed insolvency: para [57].
Discussion
- It is in my judgment clear from Eurosail and its approval of Cheyne Finance that the balance sheet test in section 123 (2) is not excluded merely because a company is for the time being in fact paying its debts as they fall due. In the case of Eurosail that is clear from Lord Walker's approval at [42] of what Toulson LJ had said in the Court of Appeal, and his description of the two tests as standing side by side. In the case of Cheyne Finance it is clear from Briggs J's description of the balance sheet test as an alternative test. Thus I agree with Warren J at [34] that the two tests feature as part of a single exercise, namely to determine whether a company is unable to pay its debts. In addition, even when applying the cash-flow test it is not enough merely to ask (as HH Judge Purle QC did) whether the company is for the time being paying its debts as they fall due. As Briggs J said in Cheyne Finance a realistic examination may reveal that a company is on any commercial view insolvent, even though it may continue to pay its debts for the time being.
- Warren J was at pains to point out that he was not (and we are not) dealing with a Ponzi scheme. But a hypothetical corporate Ponzi scheme will test the point. In the early stages of a Ponzi scheme money flows in from investors promised high returns. Money from new investors is used to pay the promised returns to existing investors. On the face of it therefore the company is managing to pay its debts as they fall due. But the underlying reality is that, sooner or later, the whole house of cards will collapse. The accumulating liabilities to new investors cannot hope to be matched by any real investments: they are dependent on the continued inflow of new money. When that dries up, the game is up. In any commercial sense the company is insolvent from the beginning. What a commercial approach requires the court to do is not to stop automatically at the answer to the question: is the company for the time being paying its debts as they fall due? In an appropriate case it must go on to inquire: how is it managing to do so?
- It certainly seems counter-intuitive (to me at least) that a company that manages to stave off cash-flow insolvency by going deeper and deeper into long-term debt is not insolvent. It may be able to trade its way out of insolvency, and thus avoid going into insolvent liquidation, but that is a different matter. Equally if (as Warren J held) Casa UK was only able to continue to pay its debts as they fell due by taking new deposits, and using them to pay off old debts, in any commercial sense the company was insolvent, whether on a cash flow basis or a balance sheet basis.
- So the question is twofold: was Warren J entitled to go behind HH Judge Purle QC's conclusion that Casa UK was cash-flow solvent up to December 2008; and, if he was, did he find (on a sustainable basis) that Casa UK was using new deposits to pay old debts?
Cash-flow solvency
- HH Judge Purle QC's conclusion was expressed at [44] and repeated at [49]. But that, in my judgment, is all it is: a conclusion.
- It was not in dispute that Casa UK had been paying debts when creditors required to be paid. But the liquidator did not accept that that meant that Casa UK was cash-flow solvent. In their letter of 16 March 2010 the liquidator's solicitors wrote:
"The fact that the Company made its other payment obligations on time does not rebut the presumption that the company intended to prefer Mrs Bucci. On a cash-flow basis the Company was regularly receiving substantial sums of money but those monies belonged to investors: they were not sums that the Company was entitled to use to discharge its own liabilities. They should therefore be ignored when calculating whether or not the Company was cash-flow insolvent. If they are left in then its is unsurprising that the Company was able to meet cash-flow obligations at those points, through the misuse of investors' money."
- In his first witness statement Mr Carman had said at [47] that the company "was … able to remain cash flow solvent by taking substantial deposits from investors wishing to purchase properties in [Dubai]." In the same witness statement he said at [52] that Casa UK's cash reserves were "restricted largely to money received by investors which was meant to be remitted to [Casa Dubai]". He amplified this in his third witness statement by referring to instances where the monies had not been remitted to Casa Dubai. He repeated that evidence in cross-examination. His evidence was supported by that of Mr Minshall. Thus the liquidator's case was clear and consistent. Casa UK was able to meet its debts by the misuse of investors' money. The mere fact, therefore, that there were no statutory demands or judgments, and no creditor pressure proved nothing. Remarkably neither Mr nor Mrs Bucci, nor their expert witness Mr Vigar, answered the liquidator's case in their written material. That silence is eloquent. Mr Bucci, in cross-examination, denied the suggestion but he had no detailed figures to work with.
- HH Judge Purle QC did not comment on any of the liquidator's evidence on this part of the case. He simply failed to deal with the liquidator's case as put. Accordingly, in my judgment HH Judge Purle QC stopped his inquiry too early. Superficially Casa UK may have been managing to pay its debts as they fell due; but HH Judge Purle QC did not ask himself how it managed to do that.
- In my judgment, given that he did not pursue the inquiry as far as he should have done, it was open to Warren J to do so himself on the basis of the evidence before him. I do not accept Mr Randall's submission that Warren J was required to answer the question: what would HH Judge Purle QC have decided if he had applied the correct test? Nor do I accept his submission that if the answer to that question was unclear then the case should have been remitted to HH Judge Purle QC. In my judgment if an appeal court comes to the conclusion that the lower court has applied the wrong legal test, it is entitled to apply the correct legal test itself. I have already summarised Warren J's relevant findings of fact. In my judgment we should not interfere with those findings. Warren J was in my judgment entitled to find that Mrs Bucci had not rebutted the presumption that Casa UK was cash-flow insolvent at the time that it made the payments to her. He did not need to go any further.
Balance sheet solvency
- Warren J noted a tension between HH Judge Purle QC's finding that the GUL loan had no "significant" value, and his inclination to find that it had "no" value. I do not think that this matters. If the GUL loan had no significant value, then whatever value it did have cannot have made any difference. The experts agreed that if the GUL loan was given no value then Casa UK was balance sheet insolvent at all relevant times. While that, in itself, may not be a conclusive answer to the question whether Casa UK was insolvent within the meaning of section 123 (2), it is difficult to see how it could not lead to that conclusion in the case of a trading company unless there was credible evidence that the balance sheet would improve in the near future. HH Judge Purle QC did not refer to any such evidence.
- HH Judge Purle QC recognised that every time that Casa UK took a deposit from an investor it incurred a liability to that investor. But I do not consider that he ever asked himself the question: how were those liabilities to be satisfied? HH Judge Purle QC said at [60]:
"The result of the Dubai crash is that [Casa UK's] liabilities towards depositors, which would but for the crash have been dealt with in the ordinary course of business, have come to fruition, without any possibility of recoupment from Casa Dubai, which seems to have evaporated."
- Again, this is a puzzling observation. In the ordinary course of business depositors' money would have been paid over to developers, thus discharging Casa UK's obligation to account. If the amount that Casa UK owed depositors after the crash had been matched by monies held by Casa Dubai under the set-off arrangement which became irrecoverable, then one might conclude that nothing had gone wrong with the accounting. But if the amount owed to depositors exceeded the amount in the hands of Casa Dubai, then the inference must be that Casa UK had used depositors' monies for its own purposes. The claims made by investors were of the order of £650,000. Although the monies in the hands of Casa Dubai were said to be of the order of £1.6 million, the experts agreed that there was no underlying material to substantiate that claim. HH Judge Purle QC did not analyse the evidence about that.
- Mr Randall fastened on a passage at [47] of HH Judge Purle QC's judgment in which he said that if a company was dependent on loans from its directors, then if the directors have no intention of calling in the loans, the company might not have reached the point of no return even if its current liabilities exceeded its current assets. I do not consider that this passage supports the conclusion that Casa UK was not balance sheet insolvent. In the first place, HH Judge Purle QC's observations was illustrative only. It was not accompanied by a finding of fact that Casa UK was such a company. Second, in fact Casa UK repaid all directors' loans (almost in full) very shortly before it went into insolvent liquidation. So this was not a case in which the directors left their money in the company. Third, in the passage in question HH Judge Purle QC was applying the wrong test.
- Again in my judgment Warren J was entitled to make the findings for himself. Again I do not consider that we should interfere with those findings.
The presumption
- Finally, Mr Randall criticised Warren J for having said that he was not in a position to make findings of fact on some of the matters debated before him. But this overlooks the statutory presumption that the company was insolvent when the payments were made. A presumption is a provisional conclusion that must be displaced by contrary evidence. It is not the same as a trial at which the court starts, so to speak, with a blank sheet of paper. If the judge is not in a position to make a finding of solvency, the presumption prevails. Equally, if he is not in a position to make one or more findings about the building blocks in the case that the company was solvent, then the presumption is not displaced. I do not, therefore, consider that this criticism undermines Warren J's overall conclusion.
Result
- I would dismiss the appeal.
Lord Justice McFarlane:
- I agree.
Lord Justice Sullivan:
- I also agree.
