Beware of solvent liquidations
A Court of Appeal decision illustrates how contingent liabilities may be avoided by a company going into members' voluntary liquidation
The poor state of the economy in recent years has heralded a busy time for insolvency practitioners. Now a decision of the Court of Appeal in England has opened the door to further activity, with the potential for limited companies using the members’ voluntary liquidation (“MVL”) procedure as a means of avoiding full payment of contingent liabilities.
MVLs can be a tax-efficient way of distributing the assets or restructuring the business of a solvent limited company. Following a declaration of solvency by a majority of the directors and the passing by members of a resolution to wind up, a liquidator is appointed. The liquidator will either simply return assets to the members of the company, or where there are creditors, distributions must be made to them first. The liquidator will declare the intention to make a final distribution to creditors and set a deadline for submission of claims. When faced with a contingent claim, the liquidator estimates its value, and that becomes the value for the purpose of receiving a distribution of assets under the Insolvency Rules 1986.
Share purchase risks
Share purchase agreements often include indemnities to protect the buyer for a period after completion, where a liability is anticipated that it has not been possible to quantify at the time of the sale of the shares and which will impact on the company’s value.
Buyers are usually well aware of the risks posed by the seller’s insolvency before the period of indemnity expires, and will perhaps try to negotiate a reduction in price instead of relying on an indemnity.
However, thought is less often given to the possibility of the MVL procedure being used by a solvent corporate seller as a means of defeating an indemnity claim.
The risk of the liquidator taking a different view on the value of a contingent liability was highlighted by the Court of Appeal decision in Ricoh Europe Holdings BV v Spratt  EWCA Civ 92. The effect of the decision was that following an MVL, the selling company’s shareholders walked away with cash which might have been payable to the buyer had the indemnity period been allowed to expire.
Ricoh and proper valuation
The Ricoh group purchased the Infotec group from Danka Business Systems plc in 2006. Under the agreement, Danka fully indemnified certain Ricoh companies against Infotec’s tax liabilities in various European jurisdictions. The valuation of Ricoh’s claim under the indemnity was contingent on the outcome of an audit process in numerous European tax authorities.
Danka went into MVL in 2009. Ricoh submitted a claim to Danka’s liquidators which they valued at nearly €12 million, partly based on the tax indemnity. The liquidators took advice and estimated the final value of Ricoh’s claim to be €268,961.
Ricoh applied to court for an order directing the liquidators to retain a fund of £11 million to meet Danka’s liability under the tax indemnity, as they had been granted a full indemnity. Ricoh argued that Danka should not be able to limit that liability by entering into a MVL. The court rejected that proposition both at first instance and on appeal, on the basis that:
- So long as a liquidator carried out a proper valuation of the contingent part of a creditor’s claim, there was no basis for the court to interfere with the distribution process.
- Although Ricoh did not get the full benefit of the tax indemnity, the purpose of the insolvency legislation was not to achieve a fair result for each creditor, but to allow a liquidation to proceed as efficiently as possible. The reason for allowing a contingent creditor to claim in a liquidation was to prevent the liquidation process being held up waiting for a liability to crystallise.
- The liquidator’s obligation to estimate Ricoh’s claim was an independent one. The liquidator could not simply allow Ricoh’s estimates to stand, so as to prevent Ricoh from suffering the loss of the full tax indemnity. The nature of the indemnity was irrelevant to the liquidator’s assessment of the value of the claim.
Lessons to be learned
The case emphasises the need for corporate lawyers negotiating share purchase agreements on behalf of buyers to have considered the possibility of an MVL by a corporate seller in the future.
An MVL will not always be a possibility, depending on the corporate structure of the business. It will usually also be clear to a solicitor acting for a buyer under a share purchase agreement if a company will not have a purpose after a share sale.
However, if there is any possibility that an MVL could be used and there are contingent claims, careful thought should be given as to what buyer protections could be built in when drafting the share purchase agreement.
Pamela Abbott, solicitor, CCW LLP