In the long-running litigation concerning Mr Gertner’s debt position, IVA’s and ultimate bankruptcy, the High Court in an appeal decision has concluded that the decision on whether or not an IVA should be approved is one for the creditors. In reaching that conclusion, the court had to consider the application of the good faith principle, its ambit and whether the assignee of a debt was tainted by the assignor’s irregular conduct which had caused a previously approved IVA to be set aside as a material irregularity had occurred.
The litigation connected with Mr Gertner’s insolvency already has a long history (see the reports at  EWHC 111 (Ch),  EWCA Civ 1781 and  EWHC 1839 (Ch)). The latest contribution comes in the form of a dense judgment of Marcus Smith J, Gertner & Anor v CFL Finance Ltd  EWHC 1241 (Ch), allowing an appeal from the decision of Chief ICC Judge Briggs to make a bankruptcy order (see the last of the three cases cited above).
The facts are convoluted. In a nutshell, in 2015 CFL presented a bankruptcy petition against Mr Gertner, but he managed to see it off by securing the approval of an IVA providing a modest return to creditors on the basis of approval from a creditor, Kaupthing hf, holding over 90% of the votes. Two creditors voted to reject, one being CFL, a creditor for £12m odd, but that amounted to under 2% of total creditor claims.
The approval of the IVA was challenged and ultimately overturned by the Court of Appeal on the basis that, unknown to the general body of creditors, Kaupthing had entered into a settlement agreement with a number of parties: Mr Gertner, his brother, and Laser Trust, a creditor connected to a Mr Levison who was the source of the third party injection of funds on which the IVA was based. The Court of Appeal accepted that there had been a material irregularity because the agreement benefitted Kaupthing but not the other creditors.
CFL then sought to restore its bankruptcy petition, but Mr Gertner proposed a second IVA in terms similar to his first. In the meantime, Kaupthing had assigned its debt to Laser Trust.
Chief ICC Judge Briggs found, inter alia, that the proposed second IVA was unsatisfactory by reason of the settlement agreement: “[T]he need for transparency goes hand-in-hand with the good faith principle. Without transparency there can be no good faith”. He decided to make a bankruptcy order so that Mr Gertner’s affairs could be investigated.
Laser Trust, as an opposing creditor, appealed on two grounds, first that the judge had erred in his interpretation of the good faith rule; secondly, that the judge had erred in rejecting, without cross-examination, evidence adduced by Laser Trust. Mr Gertner appealed on six grounds:
(1) That the judge had erred in his interpretation of the good faith rule.
(2) That the judge was wrong to hold that the “independence” of a creditor from a debtor was relevant to the question whether “that creditor ought to be allowed to vote in an Individual Voluntary Arrangement and/or whether its views as an opposing creditor ought to be discounted”.
(3) That the judge had erred in holding that allowing Laser Trust to vote in relation to the second proposal would be unfairly prejudicial to CFL.
(4) That the judge had erred in rejecting Mr Gertner’s and Laser Trust’s evidence.
(5) That the judge had erred in holding that the settlement agreement did not fall within the Consumer Credit Act.
(6) That the judge ought to have held that a provision of the settlement agreement amounted to a penalty.
Whilst agreeing with the first instance judgment on many points, on the “independent creditor” issue Marcus Smith J decided that Laser Trust was not an associate of the debtor within the meaning of section 435 Insolvency Act 1986, rule 15.34(6)(b) Insolvency (England and Wales) Rules 2016 had not been infringed, so the second proposal could be lawfully approved.
It is, however, the judge’s detailed analysis of the so called good faith rule that makes this judgment significant. The law is set out in detail in paragraphs 34-38 of his judgment.
His starting point is the rule in its modern form as stated in Cadbury Schweppes plc v. Somji. In Somji, the deputy judge “appeared to regard the rule as a residual discretion at common law that policed the fairness or otherwise of the individual voluntary arrangement as between the debtor and his creditors, and operated outside the scope of the Insolvency Act and the Insolvency Rules.” Its essential elements were identified by Marcus Smith J as being:
(1) Any secret deal made in connection with a composition or other similar arrangement for the settlement of debts, whereby a creditor was to receive more than the other creditors in return for supporting (or not opposing) the composition or arrangement, was illegal and void;
(2) the existence of such a deal rendered the composition or arrangement voidable at the instance of an aggrieved creditor;
(3) such a deal was unenforceable as between the parties to it;
(4) the principle was of general application, and covered all forms of composition and arrangement, whether statutory or otherwise;
(5) the principle was based on the fundamental rule that there must be equality between creditors in the distribution of the debtor’s assets, and on the equally fundamental rule that there should be complete good faith between the debtor and his creditors inter se. It was therefore irrelevant that any inducement to a creditor came from a third party, and not out of the debtor’s estate;
(6) if the secret deal was not made by the debtor himself, all that was required was that it should have been made to his knowledge, and therefore with his concurrence, since concurrence must obviously be inferred where the debtor knows of the deal and does nothing to stop it, or to inform his other creditors of it.
Marcus Smith J noted that the decision of the first instance deputy judge in Somji was affirmed and the appeal dismissed, but that the self-standing common law basis of the good faith principle had been doubted. Thus, Robert Walker LJ considered that Somji placed too much weight on the old law of bankruptcy. He had said:
“If a proposed IVA has apparently been approved by a creditors’ meeting, the only routes to challenge or circumvent it are in my judgment a direct challenge under section 262(1) or an indirect challenge by means of a bankruptcy petition under section 276(1).”
Marcus Smith J was of the view that “[I]t appeared to be Robert Walker LJ’s conclusion that the principles articulated by [the deputy judge] lived on, in some form, but as part of the IA1986”. He was strengthened in that view by dicta of Staughton LJ.
Marcus Smith J then considered the examination of the good faith rule by the Court of Appeal in Kapoor v. National Westminster Bank plc and in Mr Gertner’s own case (see the second citation above). He noted, however, that both of those decisions concerned an attack by a creditor of an individual voluntary arrangement which had - on the face of it - been approved by the creditors by the requisite majority. “That is in contrast to the present case, where the question is not whether the Second Proposal was properly approved, but whether the Second Proposal should be seen and considered by creditors at all”; furthermore, in both of the earlier cases, the Court of Appeal had seen the good faith principle as arising out of the IA1986 itself, and not as some separate self-standing principle”.
Applying his analysis to the facts of the case before him, Marcus Smith J concluded that the judge below had erred in his statement of the scope of the principle “and that, as a result, he took into account as relevant factors that are in fact immaterial to the application of the rule.” Following a detailed analysis, he summarised the position as follows:
“In short […] I do not consider that the fact that Laser Trust was an assignee of an earlier creditor who breached the good faith rule nor the fact that Laser Trust has […] an alternative means of satisfying the debt that is owed to it to be sufficient, whether in themselves or in combination to bring Laser Trust within the ambit of the good faith rule. The other factors considered [by ICC Judge Briggs] – the level of the dividend, the benefits of a more detailed investigation of the debtor’s affairs, and the fact that that creditor has given an unsatisfactory account of its circumstances - clearly cannot do so. I have considered whether the fact that Laser Trust has given an unsatisfactory account of its circumstances justifies an inference that some other, illicit, collateral benefit exists, sufficient to trigger the good faith rule: I can see no sufficient evidence to justify such an inference, and the Judge did not himself draw this inference.”
There is much to be learned from this case. First, the court’s strict approach to the definition of “associate” is to be welcomed for its clarity. Secondly, the judgment reinforces the primacy of the decision-making power of the creditors when it comes to whether or not to accept an IVA. Thirdly, it clarifies the limits of the good faith rule: creditors remain subject to the obligation not to engage in behind the scenes deals that give them an advantage, but an assignee taking an assignment of a debt will not necessarily be tainted by the impropriety of the assignor.
Whilst the rationale for the decision is understandable, the conclusion that Laser Trust were not tainted by Kaupthing’s prior conduct would seem to many to be surprising. This can be explained, perhaps, by the fact that it is possible to assign rights but not liabilities. It could be thought that the assignment of a debt in this manner could be seen to be artificial and a device to allow the assignee to be distanced from the prior conduct of the assignor. However, were that the case and there is evidence of collusion, it is likely that the good faith principle will be offended. As always, these cases turn on the evidence of the parties’ dealings and motivations and not suspicions or assumptions.