A victory for the plain English school of interpretation

After the last Court of Appeal judgment in Smith (Administrator of Cosslett (Contractors) Ltd) v Bridgend County Council [2001] UKHL 58 in this long-running legal saga, the position was left that a creditor with an unregistered floating charge could, with cunning legal advice and a good sense of timing, manage to enforce its unregistered security against a company in administration. In other words, despite having security which ought to be void against an administrator pursuant to section 395 Companies Act 1985, and despite the moratorium created by the administration procedure which is meant to prevent secured creditors from enforcing their security for the duration of the administration, a creditor could successfully enforce its security. Whatever loopholes there might be in the legislation, this had to be wrong! The House of Lords thought so and has set the record straight in this important common sense judgment dealing with whether the power of sale contained in the standard Institution of Civil Engineers conditions constitutes a floating charge, and the effect of failing to register such a charge under section 395 Companies Act 1985.

Background

On 28th January 1991, Mid-Glamorgan County Council (which subsequently became Bridgend County Council) and Cosslett (Contractors) Ltd (referred to as the Company) entered into a contract which incorporated the Institution of Civil Engineers standard conditions (5th edition). Under the contract the Company agreed to undertake land reclamation works in Mid-Glamorgan. In order to carry out its obligations under the contract, the Company bought two coal washing plants with the use of finance provided by the Council.

Standard condition 63 provided that if the Company abandoned the contract, the Council would be entitled to complete the works, or to employ another contractor to do so, and to use the plant for that purpose. The condition also provided that the Council could sell the plant and apply the proceeds of sale in or towards satisfaction of any sums due from the Company to the Council under the contract.

The Company got into financial difficulties and abandoned the site in August 1993 and the Council entered into a contract with new contractors called Burrows in order to complete the works. It was a term of the Burrows contract that Burrows would remove the plant from the site after completion of the works at which time the plant would become Burrows’ property. The works were finally completed and the plant removed in mid-1997.

The Company went into administration in early September 1993. Early demands by the administrator to the Council for payment for continued use of the plant, or delivery up were refused.

First set of proceedings

The first action brought by the administrator in February 1994 was an application under section 234 Insolvency Act 1986 for an order for delivery up of the plant as property belonging to the Company. In case the reader is not familiar with it, section 234 allows an administrator to apply to court for an order for delivery up where “any person has in his possession or control any property…to which the company appears to be entitled”.

This first action went to the Court of Appeal, but ultimately failed. The Court of Appeal decided that clause 63 of the contract granted the Council two separate rights. The first was a contractual right to retain possession of the plant and to use it to complete the works. This was a possessory right not given by way of security and did not constitute a registrable charge and it therefore defeated the administrator’s right for delivery up under section 234 Insolvency Act 1986. The fact that the right to retain the plant to complete the works was categorised as possessory and not by way of security was important because if it was a security right (such as a floating charge), it would require registration at Companies House under section 395 Companies Act 1985, failing which the security right would be void against an administrator or liquidator.

The Court of Appeal found that the second right bestowed upon the Council by standard condition 63 was a right to sell the plant and apply the proceeds of sale towards discharge of sums due from the Company. The Court of Appeal held that this was a security right and constituted a floating charge, registrable under s395 Companies Act 1985. The failure to register this floating charge rendered the security created by the power of sale void as against the administrator, but this did not affect the Council’s right to retain possession of the plant under standard condition 63 to complete the works, which was not a security right and did not require registration. For this reason, the administrator’s first action failed.

Second set of proceedings

By the time the Court of Appeal reached a decision in the first set of proceedings, it was July 1997 and the land reclamation works in mid-Glamorgan had been completed and the plant removed from the site by Burrows. Notwithstanding this, and in reliance on the Court of Appeal’s earlier decision that the Council’s power of sale in clause 63 constituted a registrable charge which was void against him for want of registration, the administrator brought further proceedings against the Council. This time he claimed that as, after completion of the works, the administrator could have had an unanswerable s234 claim against the Council for delivery up of the plant, when the Council allowed Burrows to remove the plant from site it had converted the plant and the Council should therefore be liable in damages. For those not familiar with the legal tort of conversion, it is, broadly speaking, a claim for wrongfully selling another person’s goods.

The administrator obtained summary judgment against the Council and the Council appealed. The Court of Appeal allowed the appeal on the technical grounds that there was a mismatch of claims. The power of sale which amounted to a floating charge was void against the administrator (for non-registration), but not against the Company. But the right to sue for conversion vested in the Company and not the administrator. Putting it another way, it was the administrator who could bring an action under section 234 for delivery up because the power of sale was void against him, but as the plant was no longer in the Council’s possession, a section 234 application for delivery up was not appropriate. The appropriate action would be an application for damages under the tort of conversion. However, the right to sue for conversion vested in the Company, not the administrator and the power of sale remained valid against the Company and was an answer to the claim for conversion.

For technical reasons, therefore, the Court of Appeal arrived at a rather odd conclusion which allowed the Council to enforce its power of sale (which was in fact an unregistered floating charge) despite the fact that it was void against the administrator and despite the general moratorium against creditors enforcing security during an administration. In so doing, the Council managed to promote itself from being an unsecured creditor to a secured creditor to the detriment of other unsecured creditors.

Not surprisingly, the administrator appealed to the House of Lords and Lord Hoffmann and Lord Scott of Foscote gave the judgment.

First of all, Lord Hoffmann dealt with the effect of an unregistered registrable charge under section 395 Companies Act 1985, which the reader will remember renders the unregistered charge “void against a liquidator or administrator”. Lord Hoffmann said:

“The plain intention of the legislature was that property subject to a registrable but unregistered charge should be available to the general body of creditors (or a secured creditor ranking after the unregistered charge) as if no such charge existed.”

Therefore, “where section 395 says that the charge shall be ‘void against the liquidator’, it means void against a company acting by its liquidator, that is to say, a company in liquidation.........Once a company is in liquidation and can only act by its liquidator, there seems to me little value in a distinction between whether the charge is void against the liquidator or void against the company. It is void against the company in liquidation”.

It follows that where section 395 is applied to a company in administration, it means that an unregistered charge is void against the company in administration.

Second, their Lordships considered section 234 Insolvency Act 1986, and found that the Court of Appeal had erred in finding that in order for the administrator to take advantage of the effect of section 395 Companies Act 1985 in relation to the Council’s void power of sale, he could only bring the action under section 234 Insolvency Act 1986 in his own name. In fact, as the plant was by that time no longer in the Council’s possession, section 234 was largely irrelevant. The administrator had power under section 14(1) and schedule 1 of the Insolvency Act 1986 to bring an action in the name of the Company against the Council for converting the plant. As Lord Scott of Foscote said, under the Burrows contract, “the Council purported to dispose of the coal washing plants to Burrows. But since Cosslett was the owner of the plants and the Council’s power of sale under clause 63(1) was void as against Cosslett in administration, the disposal was, in my opinion, a clear act of conversion”.

Their Lordships rejected the Council’s argument that it was not the Council that converted the plant, but Burrows. This argument was based on the fact that conversion is a tort against a person entitled to possession. When the Council entered into the Burrows contract which purported to allow Burrows to remove the plant from the site, the Company had no right to possession because standard condition 63 allowed the Council to retain the plant to complete the works. By the time the works were completed and the Company became entitled to possession, the Council did not do anything to interfere with that right, Burrows simply removed the plant. The House of Lords found that the Council did consent to the removal of the plant by Burrows in violation of the Company’s right to possession. The fact that the consent was given earlier at a time when the Company was not entitled to possession made no difference. The Council did convert the plant.

The House of Lords also dealt with the set-off argument. The Court of Appeal considered that even if the security was void against the Company, any claim for damages for conversion would have been met by a set-off either in equity or under rule 4.90 of the Insolvency Rules 1986. However, their Lordships held that this reasoning was misconceived. They ruled that no set-off would be allowed. Under rule 4.90 there would be no set-off because conversion of the Company’s property did not amount to a “mutual dealing” between the Council and the Company capable of set-off under the rule. Equally, there could be no set-off in equity because a defendant could not, in the absence of a lien or other security, claim to retain an asset belonging to a claimant by way of set-off against a monetary cross-claim. In other words, he could not improve his security in equity by wrongfully converting the debtor’s property. To allow an equitable set-off would be to allow the Council to exercise the very right which it could have exercised if the charge had been registered, which section 395 was intended to avoid.

Having lost the arguments raised in the second proceedings before the Court of Appeal, the Council tried a last-ditch attempt to reverse the Court of Appeal’s original finding in the first set of proceedings that the Council’s power of sale pursuant to standard condition 63 of the contract was not a floating charge, but a fixed one and therefore not registrable under section 395 Companies Act 1985. Lord Hoffmann rejected this argument too. The right to sell an asset belonging to a debtor and to appropriate the proceeds to payment of the debt is clearly a charge. In this case, the property subject to the power of sale in clause 63 was a fluctuating body of assets (constructional plant, temporary works, goods and materials on the site) which could be consumed or (subject to the approval of the engineer) removed from the site in the ordinary course of the contractor’s business. It was therefore a floating charge. Lord Hoffmann approved Agnew v Commissioner of Inland Revenue [2001] 3 WLR 454 (also known as Re Brumark) in this respect.

Lord Hoffmann felt that in reaching its over-technical decision, the Court of Appeal was wrongly influenced by what it considered to be the merits of the case. The Council had originally provided the finance for the plant, but this in itself was not sufficient reason to contort the plain meaning of the legislation.

In summary therefore, the House of Lords held that:

1. Condition 63 of the ICE standard conditions created a floating charge because the property subject to the charge was a fluctuating body of assets subject to change in the ordinary course of the contractor’s business. The floating charge was registrable at Companies House under section 395 Companies Act 1985.
2. When section 395 Companies Act 1985 says that a charge is void against a liquidator or administrator, it means that the charge is void against the company acting by its liquidator or administrator, or in other words, void against the company in liquidation or administration.
3. There was a conversion when the Council agreed to the removal of the plant by Burrows even though at the time the Council gave its consent, the Company did not have an immediate right to possession. The consent given in advance by the Council was effective until the plant was removed and amounted to a conversion.
4. Finally, the Council could not rely on its own conversion to raise a set-off against the debts owed by the Company. There was no set-off under rule 4.90 Insolvency Rules 1986 because conversion of the Company’s property was not a mutual dealing between the Council and the Company. There was no set-off in equity because the a defendant could not, in the absence of a lien or other security, claim to retain an asset belonging to a claimant by way of set-off against a monetary cross-claim. A creditor cannot improve his security by wrongfully converting the debtor’s property.

Comment

This is a useful judgment because it prefers the plain common sense meaning of the legislation over an overly technical interpretation and provides a user-friendly interpretation of section 395 Companies Act 1985. It is often the case that where a complicated interpretation of the legislation is preferred in a particular case in order to reach a certain result, it is not good law and provides a difficult precedent to follow. The House of Lords’ judgment is therefore to be welcomed.

It has now been confirmed that condition 63 of the ICE standard conditions creates a floating charge. Prudent employers should therefore register this charge at Companies House. Otherwise, in the event of a liquidation or administration of the contractor, the security created by the standard conditions will be void against the Company.