SOLICITORS AND INSOLVENCY - Julian Dobson

Julian Dobson Solicitors – 2010 ©

SOLICITORS AND INSOLVENCY

1 Frederick Terrace, Frederick Place, Brighton, East Sussex, BN1 1AX Tel: 01273 766355 Fax: 01273 766350

E-mail: [email protected] Website: www.juliandobson.com

Julian Dobson Solicitors – 2010 © 2

INDEX Introduction 3 What is insolvency? 3 Identifying insolvency in practice 4 Different structures of law firms 5 Procedures applicable to each structure 5 - Sole practitioner 5 - Partnerships 7 - Limited Liability Partnerships – LLP’s 10

- Claw-back provisions 11 - Limited Company 12 Regulatory considerations 12 Appendix 1 – Solicitors Regulation Authority Practising Regulations 2009 14 - Solicitors Regulation Authority Guidance 17 - Solicitors Code of Conduct 2007 22 - Section 214A Insolvency Act 1986 23 Adjustment of withdrawals Appendix 2 – Recent case law covering solicitors’ practices 25 - Re DKLL Solicitors v HM Revenue & Customs [2007] BCC 908 25 - Clydesdale Financial Services v Smailes [2009] EWHC 1745 (Ch) 28 The contents of these notes are a summary of the relevant provisions. Legal advice should be taken in relation to specific enquiries. Any liability is disclaimed.


Introduction From the perspective of a sole practitioner or a group of partners/members of a solicitors’ firm, there will be differing views as to the seriousness of financial difficulties faced by solicitors’ practices. Some will regard it as the natural ebb and flow of the business cycle and that a determination to continue as before will see the firm through the dip. Others may appreciate that things cannot continue as they are, and that change is needed. Whatever view is taken, solicitors’ practices trade against a background of financial benchmarks and restraints. As a firm’s financial position deteriorates, the need to be aware of potential and actual insolvency and its implications becomes acute. One of the ways in which to measure the financial performance of a firm is to look at the question of whether or not it is insolvent, or likely to become insolvent. The existence of such circumstances will become the point at which detailed consideration will need to be given to the provisions of the Insolvency Act 1986 and their effect on the firm.

What is insolvency? Corporate In the case of a company Section 122(1)(f)of the Insolvency Act 1986 details one of the grounds under which a company may be wound up by the court. “(f) the company is unable to pay its debts”. The inability to pay debts is defined in Section 123(1) and includes the following:- (a) an unsatisfied statutory demand for £750 or more; (b) an unsatisfied execution (c) 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) “A company is also 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 contingent and prospective liabilities”.

Personal


In personal insolvency, the grounds on which a creditors’ petition may be presented include at Section 267(2)(c)

“the debt, or each of the debts, is a debt which the debtor appears either to be unable to pay or to have no reasonable prospect of being able to pay”.

Inability to pay is defined in Section 268(1) (a) as an unsatisfied statutory demand (b) an unsatisfied execution Section 271 provides that the court shall not make a bankruptcy order unless it is satisfied that the debt … (a) has neither been paid nor secured nor compounded for or

(b) it is a debt which the debtor has no reasonable prospect of being able to pay when it falls due.

These tests are often referred to as the “cash” and “asset” tests of insolvency. Understanding what is insolvency will be important when determining whether or not the claw-back provisions will apply.

Identifying insolvency in practice This usually manifests itself in 1. A deterioration in cash-flow 2. Correspondence from the bank/lenders concerning overdrafts and loans 3. A demand for further security from lenders 4. Requests for the provision of guarantees 5. Revised valuation of property assets held by the firm 6. Demands from HMRC 7. The negotiation of instalment payments with HMRC 8. Increase in the average number of days before payment of debts due to the firm 9. Increased professional indemnity premiums 10. Significant reduction in fee income 11. Reduction in number of new matters being opened 12. Looming retirement/cessation and run-off cover


In considering insolvency, regard must be had to both contingent and prospective liabilities. This includes taking into account liability under leases for both property and other assets. Consideration should be given to professional indemnity run off cover in the event that the practice were to cease trading in the absence of a successor practice taking over. Depending on the policy, the practitioner/partners/members will remain personally liable for both the run off premium and any excess due under the policy. These are contingent claims which must be taken into account when considering the question of insolvency.

Different structures of law firms 1. Sole practitioner. 2. Partnership. 3. LLP. 4. Limited Company.

Procedures applicable to each structure Sole Practitioner In the case of a sole practitioner, he or she will be the principal and the person primarily liable in respect of the obligations of the firm. In real terms there is no distinction between the personal private position of the practitioner and that of the firm’s finances. The options available to a sole practitioner in financial difficulties can be summarised as follows:- 1. Informal arrangement. As financial problems begin to mount and the pressure from creditors increases, the temptation is to deal with the creditors that shall shout the loudest. In such circumstances, it is often possible to obtain a substantial discount on the original debt in return for early payment. From the creditors’ perspective, this means getting some of their money back ahead of other creditors. From the individual’s point of view, it seems like a good idea too. Such a strategy can work in circumstances where there are a relatively small number of creditors who are prepared to deal on this basis and there are readily available resources to discharge all liabilities in full. The reality is often very different in that there is a finite amount of resources available to settle creditors’ claims and whilst some creditors are willing to do deals, there remain a stubborn few who insist on payment in full. The major risk in trying to reach an informal settlement is that the debtor runs out of money with which to reach agreements with creditors, and some creditors do not cooperate/participate. It only takes one creditor who remains unpaid to present a bankruptcy petition to defeat the objective of the informal arrangement. This may be because, inadvertently, they were left out.


In addition to the practical risk being unable to bind in all creditors, there is also the risk that payments made as a result of such negotiations could potentially be attacked as preferences under the provisions of the Insolvency Act 1986. As a general rule, preferences will only usually be open to attack where they are made to an associate within a relevant time period. Where a third party creditor places genuine commercial pressure on a debtor to pay, then the necessary intention/desire to place that creditor in a better position than they would otherwise be in bankruptcy is usually not present. The difficulties with an informal arrangement arise where the creditor has not made any demand for payment or applied any commercial pressure. On the contrary the pressure to reach an agreement emanates from the debtor. Even if the debtor’s course of action in paying a third party creditor in such circumstances does not constitute a preference, it may well be grounds for other action against the debtor, ie the making of a bankruptcy restriction order. As tempting as an informal arrangement might first appear, it is often a case of the debtor trying to perform the functions of a Trustee in Bankruptcy without the requisite skills or knowledge. Save in a few cases, informal arrangements should be treated with caution. 2. Individual voluntary arrangement. An individual voluntary arrangement is a contract between the debtor and his or her creditors to either usually pay income and/or assets to creditors under the terms of the arrangement for a defined period. It can be entered into either before or after a bankruptcy order has been made. It can be linked with an interim order application which provides a moratorium against creditor action whilst the proposal is presented to creditors for their consideration. The terms of the arrangement must contain certain key information but otherwise can contain a wide variety of proposals, subject to ensuring that such proposals are proposals in respect of which the nominee is willing to act. Consideration of the proposal will take place at a meeting of creditors at which 75% in value voting either in person or by proxy must vote in favour of the arrangement for it to be approved. The votes of secured creditors, ie banks etc will not be counted for the purposes of determining the requisite majority. The effect of the arrangement, if it is approved, is that it will bind all creditors irrespective of whether or not they had received notice of the meeting, provided that they were entitled to vote. This provision in particular avoids the difficult scenario of having missed a creditor who later threatens bankruptcy proceedings. If the arrangement is approved, then the nominee, who will be a licensed insolvency practitioner, will become supervisor of the arrangement. The assets belonging to the debtor will not vest in the supervisor as in the case of bankruptcy. If a bankruptcy order has previously been made, then following the approval of the voluntary arrangement, the bankruptcy order will be annulled. For solicitors in practice, the regulatory considerations, in the case of an individual voluntary arrangement, are less onerous than in bankruptcy but may lead to conditions being imposed in relation to their practising certificate. 3. Bankruptcy


The bankruptcy process is usually preceded by a series of warnings which should have been a trigger for the debtor to seek help concerning their financial affairs. In addition to the usual correspondence threatening bankruptcy, in some instances, creditors will serve a statutory demand. Finally, a bankruptcy petition will be issued. Once a bankruptcy petition has been issued, the insolvency process has in effect already started. Where a subsequent bankruptcy order is made, any dispositions of property by the debtor following the presentation of the petition are void except as approved by the Court. This can have serious implications for the running of a solicitor’s practice. Following presentation of a petition, entries are made at the Land Charges Registry and may be made over property owned by the debtor at HM Land Registry. The effect of bankruptcy order is to suspend a solicitor’s practicing certificate automatically. It may be possible to have the suspension of the practicing certificate avoided by applying in advance of the bankruptcy order being made. In such circumstances, the practising certificate may remain in force subject to conditions being attached. Examples of such conditions are as follows:-

- a restriction on employment, ie who the solicitor may work for during bankruptcy.

- the provision of more frequent accountants’ reports, ie 6 monthly. - conditions relating to the operation of client account. - conditions appropriate to the circumstances of the individual case. The making of a bankruptcy order may also lead to intervention. The effect of a bankruptcy order is that all assets belonging to the individual will vest in the Official Receiver/Trustee in Bankruptcy. Bank accounts will be frozen, which will also prevent access to any funds held in bank or building society accounts being used to discharge the bankruptcy debts. Bankruptcy also imposes restrictions which affect matters such as obtaining credit and trading. A bankruptcy order will also prevent creditors from taking separate action by means of charging orders and/or execution. Where a debtor is experiencing financial difficulties and a creditor has commenced proceedings for a charging order, advice should be sought immediately as to how such an application should be dealt with. A sole practitioner facing financial difficulties should consider the possibility of merger/amalgamation with another practice in order to avoid intervention. Interventions costs are recoverable from the solicitor/the firm’s assets. By merging/amalgamating with another practice, it is possible in certain circumstances for the solicitor to continue in practice by being employed in a new entity subject to conditions being imposed on his or her practising certificate. Bankruptcy will not automatically terminate contracts of employment, however, in the event that the practice ceases to trade, the employees will usually be made redundant.


Partnerships Despite the rise of the LLP, there are still many firms which practice under the traditional form of a partnership structure. Partners should be aware of the financial position of the partnership and its continued trading. Where a partner reasonably ought to conclude that there is no prospect of the partnership avoiding insolvency, then there is a risk to the partners of wrongful trading if trading continues. Whilst the partners are in any event liable for the debts of the partnership, they must take steps with a view to minimising any potential loss to creditors once faced with insolvency. When partnerships get into financial difficulties, the options available to them include: 1. Partnership voluntary arrangement (with or without interlinked IVA’s). 2. Partnership administration order. 3. Liquidation as an unregistered company. 1. Partnership Voluntary Arrangement It is now possible for a partnership to put in place a voluntary arrangement similar to a company voluntary arrangement. A partnership voluntary arrangement will deal with the debts of the partnership including joint debts for which the partners are personally liable. It will not however cover individual personal creditors of the partners. For this reason, when considering putting forward a proposal for a partnership voluntary arrangement, regard must be had to the individual financial circumstances of each partner separately. Depending on the circumstances, it may be necessary to also have linked individual voluntary arrangements in addition to a partnership voluntary arrangement. The procedure for a partnership voluntary arrangement is similar to that of a company voluntary arrangement. The main creditors that will be asked to consider whether or not to approve a partnership voluntary arrangement will be the bank and HMRC in most cases. A partnership voluntary arrangement can be used as a structure to effect a sale of the practice. 2. Partnership Administration Order Partnerships may now seek the protection of an administration order. The procedure for obtaining a partnership administration order closely follows that which applies to companies. 3. Liquidation The position of a partnership is that, whilst it is not a separate legal entity, it will be wound up as an unregistered company. A creditor has the option of pursuing any of the following:- (a) The winding up of the partnership as an unregistered company without

any insolvency proceedings against the firm’s members;


(b) The winding up of the partnership as an unregistered company, together with the bankruptcy or liquidation of one of more of the firm’s members;

(c) The bankruptcy or liquidation of any one or more of the members of the

partnership without formal proceedings against the partnership itself.

A partnership will often be made up of several individual partners, whose financial position will be separate from that of the firm, but nevertheless, must be taken into account when looking at the overall picture. Partnerships are governed by the Insolvent Partnerships Order 1994.


Limited Liability Partnerships – LLP’s These originally came into existence in April 2001. They quickly became popular with solicitors as a vehicle through which to practice. They are principally governed by the Limited Liability Partnerships Act 2000 (LLPA 2000). They require two or more persons who agree to be associated for the purpose of carrying on business with a view to profit in order to establish an LLP. It is essentially a corporate vehicle, which comes into existence following incorporation at Companies House. Amongst its members there will be designated members who will be responsible for compliance with statutory duties. The minimum number of designated members required is two. Mutual rights and obligations between the members will be governed by an agreement and, in the absence of agreement on any matter, by regulation under the LLPA 2000. The LLP has an unlimited capacity and every member is the agent of the partnership. An LLP will not be bound by the act of a member when dealing with a third party if the member did not have authority and the third party was aware of that lack of such authority or did not know or believe them to be a member of the partnership. Whilst LLP’s have become popular for larger firms, smaller partnerships have not been able to avoid the giving of personal guarantees in order to convert to an LLP and, in many cases, the principal advantage of LLP status has been lost as a result. One of the advantages of an LLP is that banks can now take security in the form of a debenture over business assets. However, the effectiveness of such debentures is, in practical terms, often limited. One of the reasons for this is that only solicitors can practice as such and unless the business is disposed of immediately following an appointment, ie by means of a pre-pack, the value of the business and assets will be lost if the practice is unable to trade. In the case of outstanding work in progress and book debts, clients who are forced to transfer to another firm of solicitors will counter-claim for the additional costs that they have incurred effectively meaning that it will be extremely difficult to recover the value of the outstanding work in progress/book debts in such circumstances. Where an administration is put in place in order to allow continued trading of the practice, the administrator must also be qualified as a solicitor. 1. Voluntary arrangement An LLP may propose a voluntary arrangement. The designated members put forward a proposal on behalf of the LLP, which will have agreed to the proposal for the VA in accordance with its decision-making procedures. Unlike a corporate voluntary arrangement, there is no requirement to hold a meeting of members/shareholders and, therefore, there is only a meeting of creditors needed to be held to consider the proposal for a voluntary arrangement. Any modifications that are put forward at the creditors’ meeting must also be agreed by the LLP as a whole. 2. Administration An LLP may apply for an administration order to be made in respect of it. Presentation of a petition for an administration order will prevent the making of a winding up order the administration pending petition being heard.


The administration process can be used as a gateway in order to provide time in which either the practice may propose a voluntary arrangement and/or a disposal of the firm as a going concern. An administrator may continue to trade the practice if qualified as a solicitor. Alternatively, the administrator may propose a pre-pack arrangement whereby a sale of the practice is agreed to be entered into simultaneous with the LLP being placed into administration. The administration procedure will provide a moratorium which will protect the firm against the actions of creditors pending the proposal of a VA and/or a sale of the firm’s business. 3. Liquidation An LLP may be placed into compulsory or voluntary liquidation. In such cases the past and present members are liable to contribute to the assets of the LLP to such extent as had previously been agreed. In the case of a past member, the liability is dependent upon his agreement to continue contributing after ceasing to be a member, which will be determined by the terms of the LLP agreement. 4. Voluntary winding up This can be commenced by the determination of the LLP that it will be wound up voluntarily. A copy of the decision must have been forwarded to the Registrar of Companies within 15 days of being made. Any transfer of property to members after the company has gone into voluntary liquidation is void. It is possible to have a members voluntary winding up, provided that a declaration of solvency is made by the designated members. In any situation, other than a solvent members voluntary liquidation, members of the LLP will lose their capital. 5. Compulsory liquidation LLP’s may be wound up by the court, as in the case of a limited liability company. The most usual ground will be an inability to pay debts, for which the test is the same as in corporate insolvency. In compulsory liquidation the members of the LLP take the place of the general meeting of the company. Provisions relating to misfeasance, misappropriation, fraudulent and wrongful trading apply to the members of an LLP who may be required to contribute to the assets of the LLP on such terms as the court may order. Claw-back provisions The Limited Liability Partnerships Regulations 2001 created an additional provision enabling the court to order members of an LLP to make contributions to the assets available for creditors, now contained in Section 214A (see appendix 1). It applies to any member of an LLP who withdrew property from the LLP for his own benefit during the two years prior to the commencement of the winding up, whether in the form of a share of profits, salary, repayment of interest on a loan to an LLP or any other withdrawal of property.


In order for the provision to be effective the liquidator must establish, to the court’s satisfaction, that at the time of the withdrawal the member knew or had reasonable grounds for believing that the LLP was unable to pay its debts as they fell due or was insolvent on a balance sheet basis, or would become insolvent as a result of the member’s withdrawal, either taken by himself or together with all other contemporaneous withdrawals by other members, or together with withdrawals in contemplation when that withdrawal was made. An order will not be made if the court is satisfied that after the relevant withdrawal there was a reasonable prospect that the LLP would avoid going into insolvent liquidation. Because of the claw-back provisions it is important to ensure that allocation of profits by means of drawings or other methods are clearly recorded and put into effect. The risk is that in the case of holding accounts containing funds such as tax reserves, those reserves on liquidation may be deemed not to have been properly allocated and may be vulnerable to being claimed as part of the general assets of the LLP in liquidation. The claw-back provisions are for LLP’s the equivalent of unlawful dividend claims. Liquidators may also attack transactions at an undervalue, preferences and credit transactions, as in the case of a normal liquidation. The claw-back provisions contained in section 214A of the Insolvency Act 1986 (see Appendix 1) are in addition to the wrongful and fraudulent trading provisions contained in sections 213 and 214 of the Insolvency Act 1986. Limited Company 1. Liquidation 2. Company Voluntary Arrangement 3. Administration

Regulatory considerations Under the Solicitors’ Code of Conduct 2007 (as amended), Rule 20.05 (2)(b), a solicitor must notify the Solicitors’ Regulatory Authority (Operations Unit) of the date on which the practice closes. Solicitors Regulation Authority Guidance sets out the implications of the making of a bankruptcy order as follows. Bankruptcy

• In the event of bankruptcy, a solicitor’s practising certificate will be automatically suspended.

• The solicitor must inform the SRA of the making of the bankruptcy order. • It is possible to apply to the SRA for suspension following the making of a

bankruptcy order to be lifted in advance of the bankruptcy order being made. • The SRA will usually impose conditions restricting practise to employment in an

approved firm. • The SRA can intervene in a practice following bankruptcy.


• The costs of intervention will be payable by the bankrupt. • Where faced with bankruptcy, consideration should be given to alternative

arrangements such as closing down or disposing of the practice or amalgamating with another firm.

Individual voluntary arrangements/partnership voluntary arrangements

• An individual voluntary arrangement or partnership voluntary arrangement will not suspend a solicitor’s practising certificate.

• Obligation to inform SRA of either an IVA or PVA. • SRA may impose conditions on a solicitor’s practising certificate. • Likely conditions include limiting employment to specified partnership. • Requirement to deliver more frequent accounts may be imposed. • An IVA or PVA is likely to involve the disclosure of confidential information to the

supervisor. The SRA guidance imposes an obligation to ensure that the supervisor is the practising solicitor.

• Either an IVA or PVA can be grounds for intervention.

Administrator, administrative receiver or liquidator The SRA guidance requires that, where a practice continues any of the above officeholders should also be qualified as a solicitor. There is also an obligation to inform insurers’ requirement to inform SRA immediately.


APPENDIX 1 Solicitors Regulation Authority Practising Regulations 2009 (as amended 1st July 2009) “Regulation 3 – Application following certain events 3.1 Regulation 3 applied (Subject to 3.3 below) to an initial application for a

practising certificate, an application for replacement of a practising certificate, an initial application for registration in the register of European lawyers and an application for renewal of registration in the register of European lawyers, in any of the following circumstances.

(a) The applicant has been: ……………………… (k) The applicant is an undischarged bankrupt. (i) has been adjudged bankrupt and discharged; (ii) has entered into an individual voluntary arrangement or a partnership voluntary arrangement under the Insolvency Act 1986; (iii) has been a manager of a recognised body which has entered into a voluntary arrangement under the Insolvency Act 1986; (iv) has been a director of a company or a member of an LLP which has been the subject of a winding up order, an administration order or administrative receivership; or has entered into a voluntary arrangement under the Insolvency Act 1986; or has been voluntarily wound up in circumstances of Insolvency……………………………… 3.2 If regulation 3 applies: (a) an application for replacement of a practising certificate or for

renewal of registration in the register of European lawyers must be commenced at least six weeks before the replacement or renewal date; and

(b) the SRA: (i) has no discretion under regulation 3 to grant the

application if the applicant does not meet the conditions in regulation 2.2 (a) to (c) or 2.3 (a)(i) to (vi);

(ii) has discretion to impose a condition or conditions in

accordance with regulation 6; and (iii) has discretion to refuse the application. 3.3 The provisions of 3.1 and 3.2 above are subject to the following exceptions. (a) Regulation 3 does not apply by virtue of 3.1(a), (b), (c), (d)(i), (e), (j),

(k), (m)(i), (n), (o), (p), (q), (r) or (s) if the applicant has previously


applied for and obtained a practising certificate or registration, provided that:

(i) the applicant’s practising certificate or registration is not

subject to a condition relating to any of those provisions; (ii) the SRA(or previously the Law Society) was aware, when

granting the application, of all the relevant facts; and (iii) no new circumstances have arisen which would bring the

application within any of those provisions.…………………” “Regulation 14 – Information requirements 14.1 In addition to any requirements under section 84 of the Solicitors Act 1974 or any

other rules application by virtue of that Act, a solicitor, registered European lawyer or registered foreign lawyer must inform the SRA within 14 days if he or she:

(a) is committed to prison in civil or criminal proceedings; (b) is charged with or convicted of an indictable offence; (c) is made the subject of bankruptcy proceedings; (d) makes a proposal for an individual voluntary arrangement or is a

manager of a firm which makes a proposal for a company voluntary arrangement or a partnership voluntary arrangement under the Insolvency Act 1986;

(e) is admitted as: (i) a member of a legal profession of a jurisdiction other than

England and Wales; (ii) a lawyer of England and Wales other than a solicitor; (f) is made subject to disciplinary proceedings as: (i) a member of a legal profession of a jurisdiction other than

England or Wales; or (ii) a lawyer of England and Wales other than a solicitor; (g) becomes a manager of or acquires an ownership interest in a firm which

is a recognised body or an authorised non-SRA firm; (h) sets up a sole practice as: (i) a member of a legal profession of a jurisdiction other than

England and Wales; or (ii) a lawyer of England and Wales other than a solicitor.


14.2 A solicitor, registered European lawyer or registered foreign lawyer who ceases to practice must inform the SRA within 14 days and supply the SRA with a contact address.”


Solicitors Regulation Authority Guidance “There are particular considerations to bear in mind if you personally, or your firm, are insolvent. Bankruptcy orders

• If you are declared bankrupt, your practising certificate will automatically be suspended by virtue of Section 15(1) of the Solicitors Act 1974.

• You must inform the SRA of the bankruptcy order in accordance with Rule

20.03(2)(b) of the Code. You can apply to the SRA for the suspension to be lifted in advance of the bankruptcy order being made. However, the SRA will usually impose a condition restricting you to practice in employment approved by the SRA.

• The SRA can intervene into your practice as a result of your bankruptcy. If this happens, the costs of intervention will be payable by you. To avoid this, if bankruptcy is a possibility, you should consider what arrangements can be made to avoid an intervention, such as

closing down or disposing of your practice before the bankruptcy

order(s) is made; or

amalgamating with another firm. For information on interventions and conditions on your practising certificate generally, see www.sra.org.uk/solicitors/enforcement.page. Individual voluntary arrangements and partnership voluntary arrangements An individual voluntary arrangement (“IVA”) or a partnership voluntary arrangement (“PVA”) does not suspend your practising certificate. The position is otherwise similar to bankruptcy, in that:

• You must inform the SRA of the IVA or PVA in accordance with rule 20.03(2)(b) of the Code.

• The SRA may impose conditions on your practising certificate. These commonly limit you to practising in approved employment or partnership, or require you to deliver more frequent accountants’ reports. If the IVA or PVA is likely to involve the disclosure of confidential information to the supervisor, you should ensure that the supervisor is a practising solicitor.

• Entering into an IVA or a PVA is a ground for intervention. However, this is unlikely if there is no evidence of any risk to clients’ money or the interests of the public or the profession.

Appointment of administrator, administrative receiver or liquidator To ensure that your duties to your clients continue to be met, (for example, in respect of confidentiality and independence), it is important to ensure that any appointment of an insolvency practitioner, whether as administrative receiver, administrator or liquidator, is a solicitor. This may not be necessary in the case of a pre-pack administration sale, which is unlikely to involve the disclosure of confidential information. You will need to continue to hold a practising certificate.


You must inform the SRA following such an appointment, and should also inform your insurers”. “Suspension of your practising certificate or registration Your practising certificate or registration (as an ERL) will be suspended automatically if

• you are adjudged bankrupt;

• the Solicitors Disciplinary Tribunal (SDT) suspends you; or

• we have intervened in your practice, due to “reasons to suspect dishonesty”, breaches of the account rules, the Code of Conduct, investment business rules, or your committal to prison.

How it affects you if you practising certificate or registration is suspended, you are prohibited from practising as a solicitor or REL. if this is because you are bankrupt, or we have intervened in your practice, you can apply to us to have the suspension lifted. Unless they have written permission from us, no other recognised sole practitioner or recognised body can employ or remunerate you if you have been

• suspended by the SDT, or

• your practising certificate or registration has been suspended because you are an undischarged bankrupt.

A prospective employer can apply to employ or remunerate you…………………… Employment or remuneration A recognised sole practitioner or recognised body is prohibited from employing or remunerating you if you are

• a struck off or suspended solicitor, or

• an un-discharged bankrupt with a suspended certificate. However, they may employ you if they have our written permission. A prospective employer can apply to us for permission to employ you.” “Bankruptcy What you need to know If you are entering into bankruptcy, your practising certificate will be suspended (unless you have successfully applied in advance to lift the suspension). You cannot then


practise or hold yourself out as a solicitor or registered European lawyer (REL) or registered foreign lawyer (RFL). If you are a solicitor or RFL, you can apply for the suspension of your practising certificate or registration to be lifted prior to being made bankrupt. If you are already bankrupt, you can apply for the suspension to be lifted provided the replacement date for your practising certificate or registration has not passed. There are steps you must take to protect your clients before your bankruptcy. If you are unable to make proper arrangements to protect your clients’ interests, we may need to intervene in your practice – this is a last resort. During bankruptcy, you cannot handle client account. You can ask another solicitor or registered European lawyer (REL) to assist you by authorising withdrawals and transfers. Client account does not form part of your estate in bankruptcy, and does not pass to the trustee. Steps you must take In all cases, you must

• stop practising until the suspension is lifted, and

• inform us of your bankruptcy immediately. If you are a manager, you must also

• tell your partners, directors or members, and

• make arrangements to step down as a manager. If you are a recognised sole practitioner, you could

• arrange for clients to go to another firm,

• merge with another firm and apply for permission to work there, or

• dispose of your firm and go to work elsewhere. If you are an assistant you must tell your employers. How to apply for suspension to be lifted To apply for the suspension of your practising certificate or registration to be lifted, write to us or email us. Please tell us what your plans are for after you are bankrupt, so we can take these into account. What we will do when you apply We will deal with your application as quickly as possible. It is probable that we will lift the suspension but impose conditions on how you practise. Conditions are likely to require you to work


• as an assistant or a consult,

• for an approved employer, and

• without handling client money.

As a bankrupt, you are unlikely to be allowed to become a recognised sole practitioner, owner or manager of a recognised body. You can appeal a decision to refuse to terminate the suspension or any conditions imposed. Appealing a decision If you disagree with the decision you can either

• lodge an appeal with us within 28 days of the decision’s date, or

• appeal to the High Court. Your appeal must fully state the reasons for your disagreement with our decision. if you appeal to us, you can lodge your appeal by emailing us or writing to us. What can happen on appeal We can vary the first instance decision. The decision on appeal might improve or worsen the outcome from your point of view. Involuntary individual arrangement (IVA) – what you need to do If you enter into an IVA, your practising certificate or registration will not be suspended. If you are considering entering into an IVA, or have done so, you should notify us, explaining when you are likely to enter into the IVA/PVA. What we will do We will consider whether to impose conditions on how you may practise once you enter into an IVA/PVA. Conditions may involve you being able to work

• as an assistant,

• as a consultant,

• as a manager of somewhere we have approved,

• while having to deliver accountant’s reports twice a year,

• with restrictions on handling clients’ money. How to notify us you are entering an IVA


You must notify us by writing to us. If you are currently working as a solicitor, REL or RFL tell us what your plans are, as we can take them into account. Send us a copy of your IVA/PVA when you have it. Once you have notified us, we will consider whether to impose conditions in respect of your practising certificate or registration.”


The Solicitors Code of Conduct 2007 (as amended) contains the following:- “20.05 Duty to co-operate with the Solicitors Regulation Authority and the Legal Complaints Service. (1) You must deal with the Solicitors Regulation Authority and the Legal Complaints

Service un an open, prompt and co-operative way. (2) You must:

(a) provide the Solicitors Regulation Authority with information necessary in order to issue you with a practising certificate, or deal with renewal of registration or renewal of recognition, as appropriate; and

(b) during the period your practising certificate, registration or recognition is in

force, notify the Authority of any changes to relevant information about you, or your firm or in-house practice.

20.06 Reporting serious misconduct and serious financial difficulty. You must (subject, where necessary, to your client’s consent) report to the Solicitors Regulation Authority if:

(a) you become aware of serious misconduct by a solicitor, an REL, an RFL, a recognised body, a manager of a recognised body, or an employee of a recognised body or recognised sole practitioner;

(b) you have reason to doubt the integrity of a solicitor, an REL or an RFL, a

manager of a recognised body or an employee of a recognised body or recognised sole practitioner; or

(c) you have reason to believe that a solicitor, an REL, an RFL, a recognised

body, a manager of a recognised body, or a firm is in serious difficulty which could put the public at risk”.


Section 214A Insolvency Act 1986 “214A Adjustment of withdrawals (1) This section has effect in relation to a person who is or has been a member of a limited liability partnership where, in the course of the winding up of that limited liability partnership, it appears that subsection (2) of this section applies in relation to that person. (2) This subsection applies in relation to a person if –

(a) within the period of two years ending with the commencement of the winding up, he was a member of the limited liability partnership who withdrew property of the limited liability partnership, whether in the form of a share of profits, salary, repayment of or payment of interest on a loan to the limited liability partnership or any other withdrawal of property, and

(b) it is proved by the liquidator to the satisfaction of the court that at the

time of the withdrawal he knew or had reasonable ground for believing that the limited liability partnership –

(i) was at the time of the withdrawal unable to pay its debts within

the meaning of section 123 or

(ii) would become so unable to pay its debts after the assets of the limited liability partnership had been depleted by that withdrawal taken together with all other withdrawals (if any) made by any members contemporaneously with that withdrawal or in contemplation when that withdrawal was made.

(3) Where this section has effect in relation to any person the court, on the application of the liquidator, may declare that that person is to be liable to make such contribution (if any) to the limited liability partnership’s assets as the court thinks proper. (4) The court shall not make a declaration in relation to any person the amount of

which exceeds the aggregate of the amounts or values of all the withdrawals referred to in subsection (2) made by that person within the period to two years referred to in that subsection.

(5) The court shall not make a declaration under this section with respect to any person unless that person knew or ought to have concluded that after each withdrawal referred to in subsection (2) there was no reasonable prospect that the limited liability partnership would avoid going into insolvent liquidation.

(6) For the purposes of subsection (5) the facts which a member ought to know or ascertain and the conclusions which he ought to reach are those which would be known, ascertained, or reached by a reasonably diligent person having both:

(a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that member in relation to the limited liability partnership, and

(b) the general knowledge, skill and experience that that member has.


(7) For the purposes of this section a limited liability partnership goes into insolvent liquidation if it goes into liquidation at a time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of the winding up. (8) In this section “member” includes a shadow member. (9) This section is without prejudice to section 214.” Section 214A inserted by SI2001/1090 Schedule 3


APPENDIX 2

Recent case law concerning solicitors’ practices Re DKLL Solicitors v HM Revenue & Customs [2007] BCC 908 Court approves “pre-pack” of Solicitors practice Facts This was an application by two partners in an insolvent firm of Solicitors trading as a limited liability partnership for an Administration Order. The proposal was that an Administration Order be granted and that the practice of the firm of Solicitors be subject to a “pre-pack” arrangement disposing of the business to a newly incorporated limited liability partnership known as Drummonds Kirkwood LLP. The partnership was hopelessly insolvent, with liabilities in excess of £2.4 million. HM Revenue & Customs were owed £1.7 million and were the largest creditors. The deficiency as regards unsecured creditors was in excess of £2 million. Under the terms of the “pre-pack”, the business was to be sold to the newly formed LLP for a total consideration of £400,000. The Inland Revenue opposed the application and had previously presented a Winding Up Petition against the partnership, which was due to be heard the following day. In considering the application, the Court had regard to the following statutory provisions. Paragraph 11 of Schedule B1 to the Insolvency Act 1986, as modified by Insolvent Partnerships Order 1994:-

“ The Court may make an administration order in relation to a partnership only if satisfied –

(a) that the partnership is unable to pay its debts, and (b) that the administration order is reasonably likely to achieve the

purpose of administration.” The Court noted that if the conditions set out in paragraph 11are satisfied, then the Court has a discretion as to whether or not to make the Order. The Court also had regard to paragraph 3(1) of Schedule B1, which provides:-

“ The administrator of a company must perform his functions with the objective of –

(a) rescuing the company as a going concern, or (b) achieving a better result for the company’s creditors as a whole

than would be likely if the company were wound up without first being in administration, or

(c) realising property in order to make a distribution to one or more secure or preferential creditors.”

And then at paragraph 3(2):-


“ Subject to sub-paragraph 4, the administrator of a company must perform his

functions in the interests of the company’s creditors as a whole.” It was apparent that it was not possible to rescue the partnership as a going concern and, therefore, the purpose would be to achieve the objective in paragraph (b), namely achieving a better result for the company’s creditors as whole than would be likely if the company were wound up without first being in administration. The applicants arguing that the pre-pack sale of the business would achieve that objective. In considering whether or not that objective would be achieved, the Court had regard to the statement of affairs prepared by the proposed administrators in conjunction with the partners. It showed that in the event of liquidation there would only be the sum of £105,000 available to creditors compared with £400,000 under a pre-pack. It was also noted that liquidation would create a further £44,000 worth of preferential claims by employees. In considering the application, the Court stated that it would place great reliance on the expertise and experience of impartial insolvency practitioners. Whilst the Inland Revenue objected, there was no evidence produced to indicate that the assets, the subject of the sale under the pre-pack, could realise a greater purchase price. However, the principal ground of opposition advanced by the Revenue was that as the majority creditor, they could defeat the proposals in the event that they were put before a creditor’s meeting. However, since it was intended to pre-pack the sale of the business, there would be no creditors’ meeting to consider the proposed sale and that as such the Revenue would be disenfranchised. Following decisions in re T&D Industries Plc [2000] BCC 9056 and re Transbus International Ltd (In Liq) [2004] BCC 401, the administrators would have a power to complete the proposed sale without the sanction of a creditors’ meeting or a direction of the Court. For the Revenue it was argued that whilst this was accepted, the Court ought not to make an Order where the majority creditor opposes the sale. In examining that argument the Court considered the decision in re Structures & Computers Ltd [1998] BBC 348. Although based on pre Enterprise Act 2002 provisions, it concerned an application for an Administration Order, which was opposed by the majority creditor. The Court noted that even if the majority of creditors opposed the proposals, it would still be open to the administrator to apply to Court for the proposals to be implemented, even if the majority of creditors were against it. In the current case the Court considered that that decision demonstrated the important point that even a majority creditor does not have a veto on the implementation of the administrator’s proposals. On this point the Court examined paragraph 55(2) of Schedule B1, which provides:-

“ 55(1) This paragraph applies where an administrator reports to the Court that –

(a) an initial creditors’ meeting has failed to approve the

administrator’s proposals presented to it, or


(b) a creditor’s meeting has failed to approve a revision of the administrator’s proposals presented to it.

55(2) The court may – (a) provide that the appointment of an administrator shall

cease to have effect from a specified time; (b) adjourn the hearing conditionally or unconditionally; (c) make an interim order; (d) make an order on a petition for winding up suspended by

virtue of paragraph 40(1)(b); (e) make any other order (including an order making

consequential provision) that the court thinks appropriate.”

Even where the creditors’ meeting has failed to approve the administrator’s proposals, the Court may implement the proposals under paragraph 55(2). Decision Andrew Simmons QC considered the authorities and, in particular, the Revenue’s opposition as the majority creditor. The Court was not willing to accept that the Revenue’s opposition meant that it “was not” reasonably likely, as referred to in paragraph 11, Schedule B1, that the statutory objective would be achieved. The Court noted that “reasonably likely” means that the Court considers there is a real prospect that the objective will be achieved. In considering a “real prospect”, the Court held that this did not equate to more than a 50% probability (see re AA Mutual International Insurance Co [2004] EWHC 2430). Accordingly, it was held that the second condition contained in paragraph 11(b) at Schedule B1 was satisfied. In exercising its discretion, the Revenue’s opposition should be taken into account, as should the interests of other stakeholders, not merely those of partnership creditors. In particular, the Court was influenced by the fact that the jobs of 50 odd employees in the partnership would be saved. Comment

• This is one of the first opportunities the Courts have had to consider the legality or otherwise of pre-packs.

• It is notable that in challenging the application for an Administration Order and

the proposed pre-pack, the Revenue were unable to produce any evidence that the consideration payable under the pre-pack could be bettered.

• The fact that a majority creditor is opposed to the making of an Administration Order and the proposed pre-pack does not in itself allow them a veto.

• It will be relevant also to consider the motive of the majority creditor in their opposition to the administrator’s proposals.

• The decision also indicates that the Court will take into account the interests of other stakeholders and not just creditors. In this particular case it was the interests


of the employees and the saving of their jobs.

• Whilst this case represents clear judicial support for pre-packs, careful consideration should be given in each case as to whether or not it is appropriate.

• A compelling factor in this case was that in the event that a pre-pack was not achieved, the Law Society would have intervened in the practice in any event, effectively closing it down permanently.

Clydesdale Financial Services v Smailes [2009] EWHC 1745 (Ch) The Court removes Administrator on application by creditors Facts This case involved an insolvent firm of Solicitors, who had originally been formed as a limited liability partnership. The practice dealt with personal injury claims arising out of road traffic accidents and employer liability actions. The business was funded and backed by various creditors. Early in 2009 it became apparent that the LLP was in serious financial difficulty and was in breach of its obligations to lenders. The firm consulted S, a licensed insolvency practitioner, in March 2009. The initial advice was that there was little prospect of saving the LLP and that the best course of action was to negotiate a sale of the firm’s work in progress to another practice. S attended meetings with his own Solicitor and began negotiations for the sale of the practice to another firm. S obtained a valuation of the firm, which ranged between £810,000 to £1 million. S was intimately involved in the negotiations for the sale of the practice, which was concluded on 2 April 2009 to another firm of Solicitors for £1.9 million (approx). Whilst the total consideration was considerably more than the valuation obtained by S, the consideration was payable in instalments of £150,000 payable immediately, with 30 equal monthly instalments of £58,330 thereafter. The sale was conducted as part of the pre-pack, with completion immediately following the appointment of S as Administrator. The terms of the contract were such that the sale would be null and void if no appointment was made. The appointment was made on 2 April 2009. Two of the firm’s funders and its ATE insurers, applied at 7.45 am on Monday 6 April 2009 for interim relief in respect of the sale. The creditors concerned objected to the terms of the sale, alleging that the terms of the contract and valuation had not been properly arrived at. It was also asserted that the terms of the contract and the circumstances in which it was made required an independent review that necessitated the removal of the administrator. The application included such a claim under paragraph 88 of Schedule B1. Paragraph 88, Schedule B1, Insolvency Act 1986 “The Court may by order remove an Administrator from office”. The claimants also alleged that S had colluded in the sale at a gross under-value without consulting with creditors. Further that there had been a breach of SIP 16 and that the Administrators had failed subsequently to conduct the administration with transparency or with independence.


In addition, the creditors applied against S for equitable compensation and/or damages arising out of S’s role as administrator. Decision The matter came before David Richards J in which he referred to the considerations when assessing whether or not to remove an administrator, as set out in the Judgment of Warren J in Sisu Capital Fund Limited v Tucker [2006] BCC 463. In that decision Warren J reviewed the issues to be considered by the Court in deciding whether or not to remove an office-holder. In particular, the Court noted that regard should be had to the wishes of the majority of creditors, although this will not of itself be sufficient grounds to remove an office-holder. In considering such applications, the Court is mindful of the risk of opening the flood-gates to creditor applications for the removal of office-holders, in the event that they are too readily granted. David Richards J held that on the evidence S had been very closely involved in the negotiations prior to his appointment and the sale and that, taken as a whole, it would be difficult for S to conduct an independent review of matters. In view of the fact that the majority of the firm’s creditors supported the creditors application to remove the Administrators, the Court granted the application. In giving his Judgment, he commented that alleged breaches of SIP 16 are not of themselves sufficient grounds for the removal of an Administrator. Similarly, the delay by the administrators in providing to creditors a copy of the sale agreement and valuation did not provide grounds for removal. As to the claims for equitable compensation against the administrators, these claims were struck out on the grounds that the alleged breach of duties of skill and care were duties owed to the firm and could not be pursued by the claimants in their capacity as creditors. Comment

• This case demonstrates the importance of consulting with the majority of creditors with regard to a pre-pack administration sale.

• The grounds on which the Administrators were removed emanate in part from the Insolvency Ethical Code, which came into force on 1 January 2009.

• The valuation in this particular case, although it was alleged that the business was sold at an under-value, the consideration paid was significantly more than the valuation that had been provided. However, it was noted that the quality of the valuation was questionable, as it was based on a “desk top review” based entirely on information by the vendor without any examination of the files. Reliance on such valuations the Court noted was a risky strategy, particularly where there was no ready market for such assets.

• Although concern had been expressed in earlier cases concerning the removal of office-holders and the need to avoid a rush of applications from creditors, this particular case will probably serve as encouragement to creditors to challenge the administrators on the grounds of their inability to conduct an independent review following their appointment as administrators.

SOLICITORS AND INSOLVENCY - Julian Dobson

Documents

Transcript of SOLICITORS AND INSOLVENCY - Julian Dobson