Restructuring & Insolvency analysis: How should a court deal with conflicts between contemporaneous documents and the evidence of witnesses who have not been cross-examined? Nick Oliver, director and head of the insolvency and business turnaround team at Verisona Law, considers the Chancery Division’s approach in Fielding and another v Hunt, when hearing an appeal against a liquidator’s rejection of a proof of debt.
Fielding and another v Hunt (acting as liquidator of the Burnden Group Ltd)  EWHC 247 (Ch),  All ER (D) 169 (Feb)
The Chancery Division allowed an appeal against the respondent liquidator’s rejection of the appellants’ proof of debt in which they claimed that the company in liquidation, which they effectively owned and controlled, owed them nearly £3.6m.
What was the background to this case?
This was an appeal, pursuant to rule 4.83 of the Insolvency Rules 1986, SI 1986/1925 (IR 1986), against the respondent’s decision to reject the appellants’ proof of debt. The case involved a large volume of evidence, both documents and witness statements, and was vigorously contested by the parties.
The appellants, who were a married couple, were challenging the respondent’s decision not in the hope of being paid a creditors’ dividend if successful, but because the outcome was highly relevant to misfeasance claims brought against them and the former administrators of the company by the respondent. The misfea-sance proceedings were stayed pending determination of the appeal in relation to the proof of debt.
The original proof of debt submitted by the appellants was in the sum of £3,249,083. This proof of debt was rejected by the respondent. After the appeal was lodged, however, the quantum and make up of the debt claimed by the appellants was significantly amended in the evidence that they submitted. Some elements were dropped and new elements introduced.
One of the new elements of the proof of debt which fell to be considered by the court was a rollover debt claim in the sum of £3,150,000 which the appellants said represented monies loaned by the appellant wife to the company to finance the acquisition of the assets and business of three companies as part of a pre-pack sale in October 2008.
It was common ground between the appellants and the respondent that the function of the court on such an appeal following the rejection of a proof of debt was to decide the case on the basis of all the evidence before it (ie to establish the true value, if any, of a creditor’s claim), not simply to decide whether the liquidator was right or wrong in rejecting the proof on the evidence that was before him or her (see Re Kentwood Constructions Ltd  2 All ER 655n). It was also common ground that the burden of proof was on the appellants to establish their claim to the civil standard, not on the respondent to disprove the claim or justify his rejection of it.
What issues arose for the court’s consideration?
At the heart of this case was the dilemma faced by the court as to how to deal with a conflict in the evidence between contemporaneous documents relied upon by the respondent, and witness statements submitted by the appellants and the former finance director of the company in circumstances where there had been no order for cross-examination of witnesses.
The respondent disputed certain significant assertions of fact in the witness evidence filed by the appellants. He alleged that this evidence was inconsistent with the contemporaneous documentary evidence and with the inherent probabilities.
This issue was of particular importance in relation to the rollover debt claim, where the respondent’s case was that it had been agreed that the appellant wife’s original loan would be converted to loan capital. The appellants and their witnesses, however, filed evidence asserting that there was no such agreement. Their evidence was that the contemporaneous documents had been generated as a result of a misunderstanding on the part of the finance director, which the appellants had not noted.
The court had to consider whether it was open to it to reject the witness evidence without the appellants and their witnesses being cross-examined on it.
The appellants submitted that the court was not entitled to reject the evidence of their witnesses without cross-examination where that evidence was apparently credible and neither inherently improbable nor con-tradicted by incontestable extraneous evidence.
The respondent, however, submitted that the court was entitled not to accept the evidence of the appellants or their witnesses where that evidence was inconsistent with the contemporaneous documentary evidence and the inherent probabilities. As the court noted, this was a lower hurdle than that contended for by the ap-pellants.
What did the court decide and why?
After careful consideration of the authorities regarding the correct test, the court accepted the approach pro-posed by the appellants. It cited with approval the summary of the principle given by Rimmer J in Long v Farrer & Co and another  EWHC 1774 (Ch),  All ER (D) 415 (Jul) and went on to note:
‘It is the loss of this opportunity to explain his or her evidence in a way which the judge regards as credible which arises if the witness is not cross-examined or at least offered the opportunity to explain any particular matters upon which the other party intends to rely in inviting the court to disbelieve his or her evidence on that point. If follows, it seems to me, that although the matter is always highly fact-sensitive and no hard-and-fast rule can be laid down, in general the benefit of the doubt must be given to the witness in such cases, and his or her evidence should only be disbelieved if it can properly be regarded as incredible.’
Applying that test to the evidence before him, the court went on to accept most of the elements of the claim submitted by the appellants.
With regard to the rollover debt claim, the respondent had put in evidence a number of contemporaneous documents which he said showed an agreement to convert the initial loan to share capital. These included entries on the company’s own financial software system that, from an internal accounting perspective, had the effect of recording an increase in the company’s share capital by about £3m and an email from the com-pany’s auditors in December 2008 attaching a document which referred to the company’s accountant having made reference to the appellant wife’s investment of £3.15m ‘via the issue of shares’. The respondent also exhibited management accounts which showed an increase in share capital of circa £3m from September 2008 and a report prepared by accountants, PwC in 2009 which also referred to share capital of around £3m. The respondent pointed to the fact that the alleged outstanding loan was, conversely, not shown in the same management accounts. Nor was it referred to in the signed statement of affairs when the company went into administration or in the first proof of debt which the appellants had submitted.
The witness evidence tendered by the appellants sought to explain why these documents did not reflect the true position. The company’s finance director, who was an accountant, said in his evidence that he and the auditors were confused by the nature of the specific transactions. He said that he did not discuss the treat-ment of the £3m with either of the appellants, explaining that they would have trusted him to deal with these internal financial arrangements without asking him for details. The appellants’ evidence was that they never authorised or consented to the £3m loan being converted into or treated as share capital.
The respondent contended that the accountant’s explanation was simply not credible. He submitted that it was inconceivable that the accountant would have taken it upon himself to allocate such a substantial amount to share capital without having first discussed it with, and had it approved by, the appellants. But they contended that the explanations given by them and their witnesses were not incredible.
Ultimately, applying the above test, the court, ‘not without some hesitation’, accepted the appellants’ evi-dence. With regard to the accountant, the judge noted that:
‘Whilst it is a surprising mistake for an experienced accountant to make, I find it difficult to say that it is an incredible explanation which defies rational belief.’
To what extent is the judgment helpful in clarifying the law in this area?
The role that the court has to undertake in establishing the true value of a creditor’s claim on such an appeal from the decision of a liquidator was largely common ground. The aspect that was clarified by this case, however, was how the court should address conflicts between witness evidence, where there has been no cross-examination, and contemporaneous documents.
What are the practical lessons that those advising can take away from this case?
For insolvency practitioner office-holders, it is a reminder that there may be other explanations for what, on the face of it, appear to be a set of facts supported by a number of contemporaneous documents. As the judge in this case pointed out, much of the appellants’ claim only came out after the respondent’s initial rejection of their proof:
‘I am satisfied that the liquidator did not act unreasonably as regard his initial response to the individual claims based on the material before him and that in many cases it was not until the Fieldings had served evidence in reply to the liquidator’s evidence in response that the strength of their claim became reasonably clear.’
The judge also noted the expectation that, in relation to complex proofs of debt, there should normally be a ‘dialogue and exchange of views and information’ between the creditor and the liquidator before a decision is made by a liquidator.
Perhaps more importantly, the case is a reminder that in any applications under the Insolvency Act 1986 and the IR 1986, very careful consideration should be given as to whether an order for cross-examination of key witnesses should be sought. As the judge noted in relation to one of the issues that he dealt with:
‘Had I heard the Fieldings cross-examined in the course of a traditional trial, it is possible that I might have reached a different conclusion. That would, however, be pure speculation.’
Are there any other related issues that arise from this case?
Potentially—yes. A further judgment regarding how the considerable costs of this appeal should be dealt with is expected to be handed down next week. This may, ultimately, be of more and wider interest to insolvency/restructuring lawyers advising insolvency practitioners and creditors as it may clarify how the costs of such appeals should be dealt with.
This article was first published on Lexis®PSL Restructuring & Insolvency on 24 February 2017.
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Exploring how best to secure payment of the Court award
The Defendant was the sole owner of his property and we discovered there was one mortgage registered against it. Mortgage enquiries and a valuation showed there was over £300,000 of equity in the property.
Taking Court action to settle the debt
First we obtained a Final Charging Order. This means that the Judgment debt is registered and secured against the property as an equitable charge.
We then applied to the Court for an Order for Sale whereby the property would be sold and the proceeds of sale, following the discharge of the mortgage and other costs, would be used to settle the client’s claim.
Although the Defendant strenuously opposed the application, the Court granted an Order for Sale and ordered the Defendant to vacate the property. They refused to leave.
Full repayment of the debt
At this point the Bailiff was instructed to take possession of the property and the Defendant was evicted. It was then sold and we recovered full settlement of the debt and payment of legal costs for our client.
The balance of the proceeds of sale was paid to the Defendant.
Orders for Sale are granted at the discretion of the Court and the Court may be unwilling to make an Order for Sale if there are young children, elderly or disabled occupiers living in the property.
A building company