Opening the floodgates: Will the current increase in insolvencies result in more claims against Insolvency Practitioners?

Published 14 diciembre 2022

The Autumn budget will have done little to ease the concerns of companies facing significant trading pressures as the country tries to get back on its feet following the pandemic, the ongoing effects of Brexit, the Ukraine conflict and the current cost of living crisis.  Inflation has now topped its forecasted peak at 11.1%; there are soaring energy prices and the UK is now officially in recession.

The UK is not alone. The global economy faces huge challenges as the Ukraine conflict wears on and China’s zero Covid policy continues; at least for now. Against that turbulent and uncertain back drop, it is unsurprising that global insolvencies are predicted to rise throughout the rest of 2022 and into 2023.  

UK insolvencies are now at their highest level since 2012. The UK is forecast to be the first major European economy to face levels of business restructuring and insolvency activity last seen in the aftermath of the 2008 financial crisis.  While current high levels of energy prices and inflation more generally are obvious factors in this assessment, UK businesses have also seen a greater reduction in COVID era subsidies than has so far been the case in some other European jurisdictions

UK incorporated companies are being squeezed from all directions. Problems with slow and late payments are pushing many struggling businesses towards serious cashflow issues and potentially liquidation. In addition,  many of those companies which took loans from the government during the pandemic are unable to pay back what they owe. The figures speak for themselves. For October 2022, the number of company insolvencies was 1,948.  This was 38% higher than in the same month in 2021. Of the 1,948 registered company insolvencies some 242 went into compulsory liquidation, in the same month, Creditors’ Voluntary Liquidations (“CVL’s) increased in number by 28% and 53% higher than in October 2019[1]. We expect these figures, particularly the number of to  CVL’s to continue increasing. 

On any basis, these numbers demonstrate that many smaller companies are reaching the end of the road but larger companies are also likely to face the prospect of administration with cash balances being depleted, an increase in interest rates and a shrinking economy. Amongst those companies believed to be most at risk are likely to be property companies who lost out when shops closed during the pandemic and have not recovered, as well as the retail sector as cash strapped companies and individuals seek to retain at all costs their hard earned cash. Insolvency Practitioners (“IP’s”) are therefore gearing themselves up for busy times.

There is no doubt that in discharging their functions under the relevant provisions of the Insolvency Act,  IP’s are frequently confronted with challenging situations and exposed to latent and unquantified risks immediately upon their appointment  Individual IP’s agree to take appointment as administrators liquidators or receivers  of a company (or in the case of receivers, certain of its assets).  Often they know little of the company’s affairs and have to make quick judgment calls under pressure about the future of a company, and indirectly, its directors and shareholders. There is always a risk that a mistake will occur, especially in relation to the crucial but intractable question of where value may break in any given case. It is these decisions which are often played out in court some years later when those involved consider they have been prejudiced by the decisions made, considerations reached more often than not with the ostensible benefit of hindsight.

For a claim to be made against an IP,  it must satisfy three components, (a) a duty of care must be owed, (b) there must have been a breach of that duty; and (c) the breach of duty must have resulted in a loss to the claimant.

The four most common sources of claims made against IP’s, are that:

• the IP failed to sell assets for the best possible price and instead sold them at an undervalue. Such claims may be made by a former director, who is also a guarantor, where lenders are seeking to enforce a personal liability. On occasion a claim may be made directly by shareholders or assignees of the claim;

• the IP unlawfully colluded with a secured creditor-often a bank but increasingly a credit fund, to place the company into an insolvency process with a view to generating work and fees;

• the IP acted outside his or her statutory powers; and

• realising value from causes of action.

The most frequently bought claims are those for a sale of assets at an undervalue-see AM Holdings V Batten & Le Page [2018] EWHC 934, Davey V Money & Another [2018] EWHC 766 (Ch) and Fitzroy v Manning and Another [2022] EWHC 1495 (Ch); see this article.  None of the above cases has led to a successful outcome for the claimants. It remains to be seen what effect these cases have on the funders and if they dissuade funders from investing  in similar litigation in the future. 

The primary reason for the increase in claims against IP’s can largely be attributed to the growth in litigation funding and “After the Event “ Insurance. Most IP’s will be familiar with these tools, having themselves used them to pursue claims against (for instance) former directors in order to bolster the assets of the insolvent estate. Litigation funding for IP’s has therefore now turned into a double-edged sword.

The litigation funding market has experienced extreme growth in recent years.  It was recently reported that the top 15 UK litigation funders had £2.2bn of assets on their balance sheets in 2020/2021 an 11% increase on the previous year. The amount of available capital means that litigation funders will have to cast the net wider when funding claims and deploy ever larger sums in the hope of achieving a significant return for their investors. In doing so, they know that the relevant IP’s will have relatively deep pockets by virtue of their compulsory insurance cover in relation to each assignment and it is that cover which has become the target of many claims.

Claims which involve allegations of a sale of assets at an undervalue are inevitably complex and are likely to require detailed factual and expert valuation evidence concerning the relevant assets, the sale process and the conduct of the insolvency holder.  

These claims are difficult to strike out as a court will frequently want the benefit of hearing oral evidence as evidence given on behalf of the IP’s is likely to be contested. This leaves an IP with the prospect of incurring significant costs in defending their name through litigation. In the Fitzroy case referred to above, the proceedings against the Administrators were commenced after the conclusion of the administration and only shortly before the expiry of the limitation period. By the time the action came on for trial, some 9 years had elapsed since the start of the administration. Memories inevitably begin to dim over time and it is therefore vital that the IP’s and their teams keep careful records of the various steps in the insolvency process with reasons for decisions made and professional advice given and received so that if a claim is made in due course, the IP is in a position to respond to it.

Given the anticipated increase in both workouts and insolvencies, and what appears to be a voracious appetite by litigation funders to pursue this avenue of funding, it seems likely that the sheer volume of new cases will result in an increase in allegations against IP’s, although these may well not translate into actual claims which are pursued through the courts. Much will depend on how banks and other funders deal with distressed businesses during this difficult period. There is however an increased appetite for litigation against large institutions.   That in turn may well have created significant impetus for those parties who may be interested in pursuing claims against banks, other financial institutions and professionals to take those claims forward. 

[1] Monthly Insolvency Service Statistics: October 2022