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Client money and poor records: Guidance for administrators

 

02 February 2016

How to identify and distribute client money is a vexed question for insolvency practitioners, especially where a company’s records are incomplete. Against the background of recent decisions in the administrations of Lehman Brothers International (Europe), MF Global UK Ltd, and Worldspread Ltd, this case (Allanfield Property Insurance Services Ltd & ors v Aviva Insurance Ltd & anr [2015] EWHC 3721 (Ch), 17 December 2015) provides further reassurance that, when administrators are faced with complex arrangements involving trust property and imperfect information, the English Court will offer practical solutions. 

The judgment does, however, also contain a strong warning from the Court that the officeholders are expected to carry out their work efficiently and proportionately if they are to be paid in full. If they are in any doubt they should seek guidance from the Court at an early stage.

Introduction

Administrators of two insurance intermediaries, Allanfield Property Insurance Services Ltd (APIS) and Industrial & Commercial Property Insurance Consultants Ltd (ICP), applied to the court for directions on how to distribute money held in certain client accounts. The money represented insurance premiums received but not yet passed on to insurers or other intermediaries but neither company kept proper records of the entitlement to the money in its client accounts.

Jurisdiction

His Honour Judge Keyser QC held that the court had jurisdiction to give directions to the administrators under paragraph 63 of Schedule B1 to the Insolvency Act 1986, even though the funds did not belong to the companies in administration but rather were trust monies which sat outside the estates. This applied even where the gaps in the administrators’ knowledge meant that the proposed distributions might involve a breach of trust on the basis that the court has an inherent equitable jurisdiction to supervise and administer trusts.

Application of CASS 5

Chapter 5 of the FCA’s Client Asset Sourcebook (CASS 5) lays down rules, pursuant to the Financial Services and Markets Act 2000 (and implementing Article 4.4 of the Insurance Mediation Directive (2002/92/EC)), as to how regulated insurance intermediaries should receive or hold money for a client. This includes premiums received from customers that are to be passed on to an insurer and funds received from an insurer that are to be distributed to a policyholder.

The rules provide for two main mechanisms to protect policyholders: either for the intermediary to act as agent of the insurer such that the risk of the intermediary’s default is transferred to the insurer; or for such money to be treated as “client money” in which case it must be segregated from the intermediary’s assets and held on statutory trust. In this case the court gave directions as to how the administrators should apply CASS 5 to the companies’ client accounts despite the lack of information available.

The administrators were directed to proceed on the basis that:

− The client accounts were subject to a statutory trust under CASS 5.3.2R and the money in each account had been pooled following each company’s administration.

− No deductions from the client accounts should be made by the companies’ estates for amounts not within the statutory trusts, ie (i) remittances that had a non-client-money element, (ii) commissions or payments due to the companies, (iii) interest, (iii) a payment made from APIS’ office account, and/or (iv) premiums received as agent for the insurer where no risk-transfer agreement was in place (and hence the insurer has no claim to it). Since the accounts were now in shortfall, no deductions would have been possible under rule CASS 5.5.63R and none should be possible after insolvency.

− All clients whose money had been received on the statutory trust should be eligible for distribution and not just those whose specific contributions could now be identified (following Lehman Brothers International (Europe) (in administration) v CRC Credit Fund Ltd [2012] UKSC 6, which considered the substantially similar provisions in CASS 7).

− Where business was conducted on risk-transfer terms (ie the intermediary acted as the insurer’s agent and insurance was effective from when the payment was received by the intermediary) the policyholder has no entitlement to the client money unless there is reason to believe that the relevant insurer had failed to put the insurance in place.

− Where the insurer may have gratuitously provided insurance cover (where it could otherwise have withdrawn cover or required payment from the policyholder) this should not prevent the policyholder from having a claim against the trust.

 − For non-risk-transfer transactions the administrators should proceed on the basis that claims were for the benefit of the policyholder and not any intermediary (although if this was disputed the administrators should determine the issue, subject to an appeal to the court).

− When calculating the amount of a claim, the administrators should not deduct any commission relating to a premium being claimed back by a policyholder client. However, they should deduct commission relating to a premium that was to be forwarded to an insurer, provided that it had become contractually due to the intermediary company.

The court declined to direct that all claims by other intermediaries for commissions or fees should fail on the basis that only one such claim currently existed and it could be determined at reasonable cost.
 

Scheme for distribution

The court sanctioned the proposed schemes to distribute the funds held on the statutory trusts based on the schemes that were approved in Re MF Global UK Ltd (No 3) [2013] EWHC 1655 (Ch), [2013] 1 WLR 3874 and Re Worldspread Ltd [2015] EWHC 1719 (Ch). Under the sanctioned schemes claimants will be required to submit claims by a bar date; the administrators will then accept or reject these claims, subject to a right of appeal to the court. Any surplus will then be available to the creditors of the companies (rather than being retained in case further beneficiaries of the trust come forward).

In order to elicit claims for the APIS trust, HHJ Keyser considered that an advertisement in the London Gazette and a national newspaper modelled on s27(1) of the Trustee Act 1925 would be sufficient. This was in light of the tiny number of claims received following a previous mailshot and the fact that most of the company’s business was conducted on risk-transfer terms. The situation as regards ICP was simpler as the administrators had sufficient records to allow a preliminary calculation of entitlement and the notification of interested parties.

Remuneration

The administrators also requested that the court sanction the payment out of the statutory trusts of their costs of investigating, seeking the court’s directions, and implementing the scheme for distributing the trust money. The court agreed that administrators can, in principle, recover their costs from trust monies on the basis that these are “costs properly attributable to the distribution of client money” and so recoverable under CASS 5.3.2R(4) (or alternatively under the court’s general equitable jurisdiction following In re Berkeley Applegate (Investment Consultants) Ltd [1989] 1 Ch. 32).

However, HHJ Keyser was concerned by the amounts claimed by the administrators in this case, which already amounted to over 57% of the value of the trusts. He noted that officeholders should “devise at the outset a strategy for carrying out the work efficiently and with regard to the size of the trust fund so that expenditure is planned and controlled. Although an early application to the Court for directions is not itself a condition of the recovery of costs and disbursements, without such an application the office-holders run the risk that the work they have done will be regarded as unreasonable or disproportionate and of being unremunerated for significant parts of it”. The issue of how much the administrators should recover was referred to the Registrar of the Companies Court for determination.

Tracing

Two unexplained payments (totalling GBP 370,000) had been made from the APIS client account to the ICP client account shortly before the administration commenced in December 2012. The administrators suspected that these payments may have been made in breach of trust, giving rise to a tracing claim by the APIS trust.

HHJ Keyser agreed that in principle there was no reason that one statutory trust could not trace into another. Although it had been held in Lehman Brothers that statutory trusts under the Client Asset Sourcebook had to be understood in terms of their regulatory scheme, this did not mean that the usual tools of equity were not available where they did not contradict the statutory scheme.

The administrators proposed a mechanism to settle whether there had in fact been a breach of trust and whether a tracing claim was available. The proposal was that one of the administrators should be authorised to act on behalf of each of the trusts. They would seek, with separate legal advice, to negotiate a settlement. The court ultimately agreed with this suggestion, subject to a cap on the administrators’ costs.

COMMENT

This case shows that the court is prepared to accept jurisdiction and give directions to assist administrators, even where the assets do not strictly form part of the insolvent estates. Administrators and creditors should be comforted that the court will allow a commercial approach to be taken when practical difficulties make a strict application of the client money rules impossible, provided that the interests of customers are adequately protected.

Insolvency practitioners, particularly when managing relatively small estates, should take heed of the costs advice. This may be difficult for officeholders who encounter a complex fact pattern and gaps in the company’s documentation. They will be conscious that applying to court is an expensive exercise in itself and that the court is likely to want the officeholders to have a reasonable grasp of the task required and the likely associated costs, before sanctioning a particular course of action. Nevertheless the message to officeholders here appears to be: if in doubt, err on the side of seeking directions sooner rather than later if you want to maximise your chances of getting paid.

This article first appeared on Practical Law and is published with the permission of the publishers.

Further information

This case summary is part of the Allen & Overy Litigation and Dispute Resolution Review, a monthly publication.  For more information please contact Sarah Garvey sarah.garvey@allenovery.com, or tel +44 20 3088 3710.

 

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