Insolvency misuse case study

We look at a case concerning insolvency misuse and business rates avoidance and what it means for local authorities.

The Case

In the recent decision of Secretary of State for Business, Energy and Industrial Strategy v PAG Asset Preservation Ltd [2019] EWHC 2890 (Ch) HHJ Davies in the High Court divisively ruled against the Claimant, the Secretary of State (“SOS”) who had petitioned to wind up two companies; PAG Asset Preservation Limited and MB Vacant Property Solutions Limited, the Respondent’s and collectively “the companies”. The SOS cited the companies’ manipulation of a business rates avoidance scheme as a breach of section 12a of the Insolvency Act 1986 and contended that the companies ought to be wound up on public interest grounds.

Background

The companies devised and operated a scheme, which enabled landlords to avoid paying empty property premium business rates by leasing the property for a fixed term of 3 years to a special purpose vehicle company (“SPV”) incorporated by the companies. The SPV was then placed into members voluntary liquidation (“MVL”).

The effect of the SPV is that it took the place of the landlord and in doing so, became liable for the properties business rates. When placed into MVL the SPV then benefitted from the relief of liability for payment of business rates as an automatic exemption afforded to companies being wound up. The consequence was that the lease continued until the expiry of the 3 year period or until an interested tenant came along who was to occupy the premises.

The Legal Arguments Surrounding Insolvency Misuse

The argument posed by the SOS was that this amounted to insolvency misuse although in the absence of being able to rely upon a particular provision of the insolvency act or other statutory provision, the SOS instead relied heavily upon government policy and questioned the morality behind benefitting from a tax avoidance scheme. Paul Chaisty QC, Counsel for the SOS contended that the use of the scheme was a “contrived creation of assets solely for the purpose of a planned, inevitable and intended liquidation”.

In defence, the companies took a surprisingly transparent approach at trial, acknowledging that the scheme was designed purely as a tax mitigation method and that it was an artificial scheme. However, David Chivers QC, Counsel for the companies argued that using such a scheme was not insolvency misuse nor was it in contravention to the Insolvency Act and therefore the arguments presented by the SOS were ultimately flawed.

The Scheme

The scheme itself was actually the third revised version (“scheme 3”) following a previous decision of Vice Chancellor Norris J given on 09 August 2015 [EWCH 2404] (Ch) whereby the SOS succeeded in their petition to wind up PAG Management Services Limited (“PAGMS”) for use of a similar scheme (“scheme 2”) on public interest and Insolvency misuse grounds.

Following this decision, the companies openly detailed how they sat down and considered how scheme 2, which lacked “commercial probity” could be revised to meet the criticisms of Norris J whilst remaining an effective tool to avoid business rates. Ultimately, they succeeded in making “sufficiently substantial” changes to the scheme.

HHJ Davies commented in his judgment that for him the key difference between scheme 2 and scheme 3 was the introduction of the determination premium in scheme 3, which altered the nature and effect of this type of the avoidance scheme making the use of it, valid in his judgment. The companies conceded that the determination premium was artificial but that its purpose was to create something of value to the SPV.

The intended consequence of the determination premium was that the liquidator must maintain the MVL for the duration of the lease so as not to lose the opportunity to receive a crystallised contingent asset namely that of the determination premium in the event the landlord exercised his right of determination.

Further changes incorporated by the companies included a 7-day time lapse between the granting of the lease and going into MVL whereas in scheme 2 these two steps happened simultaneously. These changes according to HHJ Davies were significantly different to those in scheme 2 and therefore justified a different conclusion to Norris J’s decision in the PAGMS case. In scheme 2 there was never any asset which had any realisable value and therefore it could not be said that the MVLs were for the purpose of collecting, realising and distributing assets in contrast to scheme 3.

It was accepted by the SOS that the leases and legal contracts were genuine (despite being artificial) but it was her contention that the Companies lacked commercial probity in their operation of Scheme 3 which misused/ abused and / or subverted the insolvency legislation and process.

HHJ Davies considered that the Court ought not to be concerned with the motives of those involved where a company is placed into MVL so long as it can be demonstrated by reference to objective evidence that the purpose of the MVL is indeed the collection, realisation and distribution of genuine assets.

HHJ Davies did not determine that the artificial nature of the scheme or its motive to avoid business rates undermined the validity of the scheme as the liquidation was a genuine process whose purpose it was to collect, realise and distribute assets. He commented that he was not satisfied that the SOS made her case for a public interest winding up order against either of the two companies and noted that it is not possible to say there was a lack of commercial probity which resulted in public harm.

Whilst HHJ Davies ultimately adjudged that there had not been a contravention to the policy behind insolvency legislation, local authorities may question the relevance and suitability of current legislation. HHJ Davies even acknowledged that there would be legitimate scope to disagree with his decision and that many would strongly believe that rates avoidance is contrary to the public interest. This potentially lends credence to the SOS’ argument should she consider appealing the judgment, it remains to be seen if this is something the SOS may pursue.

Impact on Local Authorities and next steps

The Court were clear in this case that they ought not to be concerned with the motives behind the use of the schemes nor to form judgment based on moral arguments or policy. One might suggest that this is a naïve approach because law and morality should arguably go hand in hand and fairness and public interest should sit as the basis behind all legal decisions.

There are an increasing number of similar decisions such as the recent Court of Appeal case of Rossendale Borough Council and Wigan Council v Hurstwood Properties Ltd and Property Alliance Group Ltd (2019) EWCA Civ 364 where the local authorities also lost test cases against schemes utilised to avoid the payment of business rates. These cases are extremely expensive to fund up to the High Court or Court of Appeal and is a further strain on local authority and government spending. When presented with such a scheme, given the current tenor of decisions, Local Authorities and City Councils should review and consider their position very carefully. Our dedicated team, experts in the recovery of council tax and national non-domestic rates would be delighted to assist.

If you need expert advice around insolvency misuse or the Insolvency Act, contact our experts.