It is common for insolvency and fraud to come to light at the same time. The process tends to follow a familiar pattern, with the liquidator or other insolvency office-holder needing to gather in information and documentation swiftly, but at the same time to take action quickly to preserve assets that potentially belong to the insolvent estate.
Often time does not permit all inquiries to be completed before proceedings need to be brought and protective measures obtained. The fact that proceedings are necessary in such circumstances arguably should have no impact on the continuing investigations that are still required. In practice, however, achieving this is not always easy.
The Insolvency Act 1986 provides various powerful weapons for the office-holder to investigate, none more so than the provisions for private examination in the act. In practice they provide a good illustration of the interplay between fraud claims and insolvency procedures.
Practice and procedure
Section 236 of the act contains powerful provisions for investigation of an insolvent company’s affairs.
It provides that, upon the application of an office-holder, the court may order to appear before it to be examined on oath:
a) any officer of the company,
b) any person known or suspected to have in their possession any property of the company or supposed to be indebted to the company, and
c) any person whom the office-holder thinks capable of giving information concerning the promotion, formation, business dealings, affairs or property of the company.
To obtain a Section 236 order an office-holder must issue an application with unsworn detailed grounds in support. Whether the application is made ex parte or inter partes will depend upon the circumstances of a particular case.
Where Section 236 orders are sought against third parties (eg trust advisers, banks and solicitors), and where, in particular, officers suspected of wrongdoing are unaware of any ongoing investigation, ‘gagging’ orders may also be obtained to restrain the third party from communicating the fact of the examination or its content.
The court’s discretion to grant an order under Section 236 is unfettered. However, the principles applicable to an application under Section 236 are well established, as summarised in the judgment of Lord Slynn in Re British and Commonwealth Holdings (1993): “… the applicant must satisfy the court that, after balancing all relevant factors, there is a proper case for such an order to be made.
“The proper case is one where the administrator reasonably requires to see the documents to carry out his functions and the production does not impose an unnecessary or unreasonable burden on the person required to produce them in light of the administrators’ requirements.
“An application is not necessarily unreasonable because it is inconvenient for the addressee of the application or causes him a lot of work or may make him vulnerable to future claims, or is addressed to a person who is not an officer or employee of or a contractor with the company in administration, but all these will be relevant factors, together no doubt with many others.”
The scope of any Section 236 examination will be dictated by the terms of the court’s order. However, typically an office-holder will wish to ensure that the order is in broad terms so that they may conduct the examination having regard to all matters relating to the company’s business and affairs, as expressly envisaged by the statutory wording.
Where civil proceedings are pending
Historically, the decision of an office-holder to commence litigation against the proposed respondent was treated as almost an absolute bar to the office-holder obtaining any order under Section 236.
However, as explained in Cloverbay (Joint Administrators) v Bank of Credit and Commerce International (1991), this ‘rule’ proved unsatisfactory, as it often required the court to reach a view as to whether and when the office-holder had subjectively decided to bring a relevant claim.
While there is now no rule preventing a Section 236 order being made once litigation is underway, the willingness of the court to grant such an order is subject to certain limitations. Principally:
– It remains the case that an order under Section 236 will only be made where the information sought is reasonably required to enable the office-holder to meet their professional duties and where the order is not oppressive. The view of the office-holder that such examination is required is usually afforded substantial weight.
– A Section 236 application will still not be granted where solely intended by an office-holder to secure an advantage in ongoing litigation (see Re RBG Resources (2002) and Re Sasea Finance (1998).
– The scope of any Section 236 examination will necessarily be limited to matters relevant to the company’s affairs and assets.
– The court may also consider whether an alternative source is available from which the office-holder might obtain the relevant information; where there is not, the court will be more likely to grant the order sought (see Daltel Europe (In Liquidation) and others v Makki (2005).
These safeguards are necessary to balance the interests of the office-holder against those of an intended examinee.
However, where the company appears to have become insolvent by reason of a respondent’s fraudulent conduct, there are arguments for reducing the significance of the factor that there is intended or actual litigation, at least when that respondent is one of the officers of the company in the following circumstances:
– In cases of fraudulent conduct, records are often missing or concealed and the need for urgent and early information from former officers is consequently greater.
– The extent of litigation advantage obtained by the Section 236 process is arguably more limited than in other cases. The extent of disclosure an officer-holder could provide if there was mutual disclosure may well be limited and already known to the relevant officer anyway. Indeed, early disclosure under Section 236 might redress the balance between the officer, who at all times has complete knowledge of the relevant fraud, and the office-holder, from whom such knowledge has been purposely withheld.
– An office will be likely to have information on areas unrelated to the precise matter that is the subject of litigation. There will be scope for still conducting a Section 236 examination on the non-litigious areas. Thus, in Daltel, a liquidator was permitted to examine a defendant to proceedings involving very serious allegations of fraud, where such examination was necessary to enable the liquidator to engage in his primary function of collecting in the company’s assets.
– Where an examination does take place pursuant to Section 236 where litigation is ongoing, the court will be particularly astute to ensure that the scope of the examination is appropriate. A request can be made, if appropriate, for the examination to take place before a judge.
A positive outcome
It can be seen that Section 236 examinations do provide an extremely powerful investigative tool in the hands of an insolvency office-holder.
They can very important in the context of investigations into fraud and, if used carefully, can even be obtained when litigation is underway.
They provide a method by which incomplete investigations can be pursued while necessary action is taken to preserve assets that may have been misappropriated or to take other steps to ensure the insolvent estate is protected properly.
Philip Marshall is a barrister at Serle Court