Fairness v Contractual Rights – the Court’s Control over Administrators, Court-Appointed Liquidators and other Officers of the Court

Emily Gillett

The Court of Appeal in England has decided that administrators, as officers of the court, may not be entitled to rely upon rights under a contract freely entered into by both parties if reliance upon those rights would be unfair in the circumstances. Basing its decision on the principle in Ex parte James, Re Condon (1874) LR 9 Ch App 609 and on paragraph 74 of Schedule B1 to the English Insolvency Act 1986 (Paragraph 74), the Court of Appeal held that administrators were not entitled to rely upon the terms of a claims determination deed (CDD) which, by common mistake of the administrators and the relevant creditor, understated that creditor’s claim by £1.67 million.  Accordingly, the administrators were directed to increase the creditor’s agreed proof of debt by £1.67 million to just over £25 million.

Background

Part of the worldwide Lehman Brothers group, the Applicant-creditor, Lehman Brothers Australia Ltd (LBA), entered liquidation in Australia in October 2009.  About a year earlier, Lehman Brothers International (Europe) (LBIE) had entered administration in England.  There had been intra-group dealings between LBA and LBIE resulting in LBIE submitting a proof of debt in LBA’s liquidation and LBA submitting a proof of debt in LBIE’s administration. As part of a claims determination process operated by the LBIE administrators, by the CDD, LBA and LBIE agreed an irrevocable and unconditional mutual release of all claims between them apart from the ‘Agreed Claim’, i.e. the amount agreed to be owing to LBA and which was to be accepted by LBIE’s administrators as an admitted claim.  Thus, under the CDD, LBA’s claim as an unsecured creditor in LBIE’s administration was limited to, and was admitted to proof for, the sum of just under £23.4 million.

Over 2 years after the CDD was executed, and after LBA had been paid £23.4 million, an error in the calculation of the amount of the ‘Agreed Claim’ surfaced. By common mistake of both parties, the Agreed Claim had been understated by £1.67 million.  LBA asked the LBIE administrators to increase the amount of LBA’s provable claim. Whilst the LBIE administrators agreed that the error had been made, they refused to vary the proof of debt because of the release in the CDD. As a consequence, LBA applied to court for directions that its proof of debt be increased either (a) on the basis of the principle in Ex parte James that it would be unfair for the administrators to stand on their legal rights under the CDD or (b) under Paragraph 74 because the administrators’ conduct had unfairly harmed LBA.  LBA did not argue that the CDD should be rectified.

At first instance, LBA’s application was dismissed. The judge rejected LBA’s arguments under both Ex parte James and Paragraph 74 on the basis that the court was not entitled to interfere with contractual rights and obligations of the parties.

LBA appealed and continued to advance its case primarily on Ex parte James. It did not alter its case to rely on rectification of the CDD but it did continue to rely on Paragraph 74. LBA’s appeal was successful.

The Court of Appeal’s Decision

Ex parte James stands for the principle that the court will not permit its officers to act in a way which, although lawful and in accordance with enforceable rights, does not accord with the standards which society would think should govern the conduct of the court or its officers. As David Richards LJ explained (at [35]): “As a public authority and given its role in society, the court is expected to apply standards to its own conduct which may go beyond bare legal rights and duties… Trustees in bankruptcy, liquidators in compulsory liquidations and administrators are all officers of the court… In the case of administrators, this is expressly provided by paragraph 5 of schedule B1.  As such, they are acting on behalf of the court and they will accordingly be held to these standards by the court.”

Earlier authorities had created some confusion as to the proper test for applying the Ex parte James principle. Previous judges had used a variety of terms when describing the relevant threshold: was it only unfairness that needed to be established or did the officeholder’s conduct need to be unconscionable?

Having reviewed the authorities, David Richards LJ (with whom the other members of the Court agreed) concluded as follows:

  1. The Ex parte James principle will apply where the circumstances generate unfairness. It is not necessary to establish unconscionability on the part of the administrator, court-appointed liquidator or other officeholder.
  2. The fact that the administrator is relying on rights under contract freely entered into by both parties is not an absolute bar to relief under the Ex parte James It will be a highly material factor against relief but such a bar is not implicit in the underlying rationale of the principle: “In all cases the rule in Ex parte James…will be invoked to restrain an officeholder from relying on his strict legal rights. Those rights may arise at common law or in equity or under statute, and, in my judgment, there are no grounds for excluding contractual rights from the scope of…the rule in Ex parte James…” (at [87]).
  3. The fundamental principle underlying the jurisdiction lies in the idea that the court will not permit its officers to act in a way in which it would be clearly wrong for the court itself to act. It is not acceptable for the court to act unfairly. Therefore, a test of unfairness as the threshold to apply the Ex parte James principle is manifestly appropriate.
  4. There is no inherent difficulty in the court using a test of unfairness to apply the principle in Ex parte James on a case by case basis. The courts are very familiar with applying a standard of fairness in many contexts, including in insolvency matters.
  5. The court applies the unfairness test on an objective basis. The court does not enquire into whether the officeholder is consciously proposing to adopt a course which falls foul of the appropriate standard of an officer of the court.  

As for Paragraph 74, this empowers the court to grant relief if the administrator has acted in a way which has “unfairly harmed”, or would “unfairly harm”, the interests of the applicant. Whilst an administrator would not be causing unfair harm if he was acting in accordance with his statutory obligations, the situation is different if the administrator is exercising a discretion. In the latter circumstance, the Court of Appeal held that Paragraph 74 could apply to offer relief to an applicant if it resulted in unfair harm.

The Court also held that there was no basis on which to limit Paragraph 74 to cases of discrimination. Therefore, conduct which meets an objective test of unfairness will fall foul of Paragraph 74 even if other creditors in the same position have been treated in the same way.

Further, the Court confirmed that Paragraph 74 can offer relief even when an administrator relies on his/her strict contractual rights. Consequently, Paragraph 74 is capable of limiting the strict legal rights of administrators under a contract. The Court noted that there was no remedy equivalent to Paragraph 74 on which an administrator could rely against a creditor but held that that was of no consequence.  That was a choice made by Parliament when crafting the statutory framework for administrations with that inherent imbalance.

When applying these findings to the facts of the case, the Court emphasised that LBA was not seeking to renegotiate the deal embodied in the CDD. Rather, it was seeking to correct a common mistake of a clerical nature. That was an error for which, as they accepted, the LBIE administrators were as much at fault as LBA. As a consequence, there would be no windfall to LBA and no true detriment to LBIE’s estate if the error were now corrected. The appeal was allowed and LBIE’s administrators were directed to increase LBA’s proof of debt.

Comment

This decision highlights a tension between the common law’s respect for freedom and sanctity of contract on the one hand, and the higher standards expected of officers of the court, on the other.  With the Court of Appeal’s confirmation that the principle in Ex parte James does not require unconscionability and with its application in this case in circumstances where rectification of the contract was not sought, the potency of the rule in Ex parte James has been made clear and we may now see creditors relying on Ex parte James with renewed vigour. Officeholders will need to reconsider their ability to enforce their rights even those arising from freely negotiated agreements.  It is now plain that fairness reigns supreme and has the potential to re-write a bargain.

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