Insolvency: To be or not to be
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Eversheds has secured a major victory for Amway (UK) in defending a petition from the Department for Business, Enterprise and Regulatory Reform (DBERR) to wind the company up following a major overhaul of its business model. In this case, the court also dismissed allegations that Amway was operating an unlawful lottery or an unlawful trading scheme.
Winding up of a company
A company is usually ‘wound up’ on insolvency-related grounds. However, in exceptional circumstances the Secretary of State may also apply to wind up a company on public interest grounds pursuant to Section 124A of the Insolvency Act 1986. The court may make such an order if it believes it is just and equitable to do so on the evidence presented to it.
The Secretary of State typically takes action to wind up companies in the public interest where it believes the company is acting unlawfully or its business is inherently objectionable. The leading authority in this area is Re Walter L Jacob & Co (1989). In that case the company had misled the public by giving the impression that it was providing impartial advice in relation to buying shares in US companies, when in fact the company was the vendor of the shares. The shares were of dubious value and could not be traded freely. The company ceased trading the day before the petition was served.
The petition was dismissed by the High Court, but the Court of Appeal later overturned the decision and made an order to wind up the company. In the Court of Appeal Lord Justice Nicholls stated that individuals and companies that deal in securities “should maintain at least the generally accepted minimum standards of commercial behaviour”.
It made no difference that the company had ceased trading the day before the petition was presented, as it would “offend ordinary notions of what is just and equitable” to allow a company to avoid being wound up despite its previous misconduct by simply taking action to cease the offending business once the Secretary of State had intervened, according to Nicholls LJ.
However, in some cases the court will dismiss a petition if it is satisfied that a company is capable of operating in the public interest or if the company gives undertakings to this effect.
A company that seeks to address the petition in this way needs to demonstrate to the court that it can be trusted to ensure that the future conduct of its business is not objectionable. This requires a proactive approach in reviewing the business at the time the petition is presented and identifying the offending elements. It is for the company to develop the new business model. It is not the duty of the Secretary of State to help to construct a legitimate business. As Mr Justice Norris stated in Re Amway (UK) Limited (2008), any revised business plan should be “fully formulated, comprehensive, open and transparent
and capable of effective and ongoing implementation without the supervision of either the Secretary of State or the court”.
If it is necessary for the Secretary of State to monitor the due performance of the undertakings, then it is unlikely that the court will accept them in preference to winding up the company. However, the option to dismiss a petition on undertakings even if the Secretary of State is not willing to accept them remains open to the court and this approach was followed in both Re Adcom Limited (2002) and Amway.
In Amway, a new business model was developed and presented to the court and the DBERR. The company also offered undertakings confirming that it would operate within the realms of the new business model. The court accepted the undertakings and dismissed the petition, despite the Secretary of State’s opposition (the DBERR is now in the process of appealing this decision).
It is interesting to compare Walter L Jacob with the situation that arose in the recent case of Square Mile Securities (2008). Square Mile was the subject of investigation by the Financial Services Authority (FSA). The approach of the FSA in this case provides an interesting comparison with the reaction of the Secretary of State in Walter L Jacob, which was decided prior to the establishment of the FSA.
Square Mile had acted recklessly in using high-pressure sales tactics to encourage customers to make investment decisions about higher-risk securities based on misleading and inaccurate information. The approach of the FSA was to impose a penalty of £250,000 on Square Mile. The FSA took into account the fact that the company had mitigated its failings by engaging an independent consultant to review its operations and by making improvements to its systems and controls.
The FSA determined that Square Mile’s conduct had fallen below the “accepted minimum standards of commercial behaviour”. In other words, it was not operating in the public interest. Nevertheless, the FSA decided that the imposition of financial penalties was the appropriate response.
While the FSA’s reaction in Square Mile might be regarded as appropriate, the comparison with the response in Walter L Jacob does highlight the fact that there needs to be consistency in the approach adopted by different regulatory bodies when addressing public interest issues that fall within their remits.
As the above cases demonstrate, a winding-up petition brought by the DBERR is not necessarily fatal to a company. While it certainly will not be an answer in every case, a comprehensive and effective review of how it conducts business may enable it to continue to operate.
Jonathon Crook is a partner and Sarah Naylor a solicitor in the financial services regulation and litigation practice group at Eversheds