Circuit Systems Ltd and Another v. Zuken-Redac (U.K) Ltd (Formerly Racal-Redac (UK) Ltd) [1997] UKHL 51 (27th November, 1997)

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	United Kingdom House of Lords Decisions
You are here: BAILII >> Databases >> United Kingdom House of Lords Decisions >> Circuit Systems Ltd and Another v. Zuken-Redac (U.K) Ltd (Formerly Racal-Redac (UK) Ltd) [1997] UKHL 51 (27th November, 1997) URL: http://www.bailii.org/uk/cases/UKHL/1997/51.html Cite as: [1998] 1 All ER 218, 87 BLR 1, [1997] 3 WLR 1177, [1998] BCC 44, [1997] UKHL 51, [1998] 1 BCLC 176, [1999] 2 AC 1

I have had the advantage of reading in draft the speech to be delivered by my noble and learned friend, Lord Hoffmann. For the reasons which he gives, I would dismiss both of these appeals.

I have had the advantage of reading in draft the speech prepared by my noble and learned friend, Lord Hoffmann. For the reasons he has given, I would dismiss these appeals.

I have had the advantage of reading in draft the speech prepared by my noble and learned friend, Lord Hoffmann. For the reasons he gives, I would dismiss these appeals.

The cost of obtaining justice in England, only too often prohibitive, is a current social problem which goes to the roots of civil society. The provision of a system of justice to resolve disputes between citizens is one of the most ancient and important duties of the state. But the cost of litigation is today so high that the majority of people are in practice unable to seek redress for the wrongs they have suffered. This applies not only to individuals but also to companies with modest resources. The position of a defendant, particularly when opposed by a legally aided or impecunious plaintiff, is equally unenviable. These two appeals both concern companies which went into insolvent liquidation while pursuing claims in legal proceedings and could not afford to continue. Individuals who lack means are in principle entitled to legal aid. But since its inception in 1949, the legal aid scheme has altogether excluded companies from its scope. Section 2 of the Legal Aid and Advice Act 1949 said that legal aid was to be available to "any person whose disposable income does not exceed four hundred and twenty pounds a year." (The limit is now set by regulations made under section 34 of the Legal Aid Act 1988.) But section 17(1) of the Act of 1949 provides:

Mr. and Mrs. Rodgers and Mrs. Rodgers's parents, Mr. and Mrs. Franks, acquired Norglen Ltd. as an off-the-shelf company in 1984. It was capitalised at £1,000, at first shared equally between the Rodgers and the Franks and later transferred to Mr. and Mrs. Rodgers in equal shares. The sole purpose of the company was to undertake a single speculation in property. It has not otherwise traded. With the aid of a loan from a bank it bought a large house near Manchester Airport called Heald Green House, together with some surrounding land, for £65,000. It then converted the property into 12 self-contained flats and sold them on long leases. The venture was not a great success. The cost of the land and conversion was about £783,000 and the sale of the flats brought in £726,000. This left the company owing some debts, including £80,000 to the Manchester City Council by way of repayment of building grants, but without any assets except the retained freehold of Heald Green House, subject to the leases, and about 1.8 acres of surrounding land which was surplus to needs.

Mr. Rodgers instructed Prudential Property Services ("Prudential") advise him on the prospects of obtaining planning permission for the development of the surplus land, a matter which was critical to its value, and to act as sole selling agents. The director of Prudential with whom he dealt was a Mr. Jonathan Sharp. Mr. Rodgers says that Mr. Sharp told him that the prospects of obtaining planning permission were remote and introduced him to a Mr. Richardson, who said he wanted to use the land to graze his children's ponies. Mr. Richardson offered £10,000 for the land with a covenant not to erect any structure on the land without the consent of Norglen, as owners of the freehold of Heald Green House, but subject to a right to the release of the covenant on payment of a third of the increased value if planning permission for development was obtained at any future date. Mr. Rodgers says that on the advice of Mr. Sharp he accepted this offer and sold the land to Mr. Richardson on 12 May 1988.

Mr. Richardson immediately transferred the land to Metier Property Holdings Ltd. ("Metier"), a company which he controlled and which was engaged in putting together a large-scale development on adjoining land later acquired from the Manchester City Council for £400,000 an acre. Mr. Rodgers says that Norglen was the victim of a fraud to which Mr. Sharp and Mr. Richardson were parties. He claims that they told him lies about the potential use and value of the land. He says that in fact, whether itself developed or not, it was valuable as giving access to the proposed development site. In November 1991 Norglen commenced proceedings against Prudential, Mr. Sharp, Mr. Richardson and Metier, claiming rescission of the sale of the land and damages for fraudulent misrepresentation and conspiracy. The allegations are strenuously denied but there is no suggestion that the action is not brought in good faith.

In May 1992 the defendants applied to for an order that Norglen give security for costs. On 9 October 1992 District Judge Fish held that the defendants were entitled to security under section 726 of the Companies Act 1985, but ordered that it should take the form of an undertaking by Mr. and Mrs. Rodgers to be personally liable for any costs of the defendants which the company might be ordered to pay. The defendants appealed, saying that the assets of Mr. and Mrs. Rodgers were insufficient to constitute adequate security. But before the appeal was heard, Norglen was compulsorily wound up on a creditor's petition. After a meeting of creditors, Norglen acting by its liquidator assigned to Mr. Rodgers the legal and beneficial interest in the company's cause of action against the defendants. The consideration was an undertaking to apply the proceeds of the action to paying the company's creditors and the costs of the liquidation and then accounting to the company for half the balance.

Mr. Rodgers applied for and was granted legal aid to apply to be substituted as plaintiff instead of Norglen and, if successful, to prosecute the action. His summons came before Morritt J. at the same time as the defendant's appeal against the order for security made by the District Judge. The judge held, following the decision of the Court of Appeal in Advanced Technology Structures Ltd. v. Cray Valley Products Ltd. [1993] B.C.L.C. 723, that the assignment of the cause of action should not be recognised or given effect because it was a "sham," on the ground that the sole or main purpose of the assignment was to enable the action to be carried on for the benefit of the company with the legal aid available to Mr. and Mrs. Rodgers as individuals. The application for substitution was therefore dismissed and the learned judge went on to allow the defendants' appeal against the security for costs order and ordered Norglen to provide security in a total sum of £74,000. The question of whether Norglen could provide this sum was complicated by the fact that on 7 June 1989 Norglen had purported to transfer its only asset, the freehold of Heald Green House with the benefit of the restrictive covenant over the land sold to Mr. Richardson, to Mrs. Rodgers. At the suggestion of the learned judge, Mrs. Rodgers executed a declaration that she held the property in trust for Norglen and Mr. Rodgers executed an assignment of the cause of action to himself and Mrs. Rodgers jointly. On the basis that Norglen was beneficial owner of the land and covenant, he found that it had substantial value (figures in the region of £200,000 had been mentioned) and that the order for security would not necessarily stifle the action.

Norglen appealed to the Court of Appeal (Sir Thomas Bingham M.R., Hobhouse and Aldous L.JJ) which allowed its appeal and made the order substituting Mr. and Mrs. Rodgers as plaintiffs. It distinguished the Advanced Technology Structures case on its facts and held that an assignment of a cause of action was not invalid solely on the ground that its purpose was to enable the action to be prosecuted on terms that the company would benefit from success. The court also held that there was no jurisdiction to make an order for security for costs against Mr. and Mrs. Rodgers and that it would not in the circumstances be right to make an order against Norglen, which was dropping out of the action. Against these orders the defendants appeal to your Lordships' House.

I can deal more shortly with these proceedings, since the only point at issue is the validity of the assignment by the plaintiff company to its former managing director, Mr. Basten. The company was formed by Mr. Basten in 1983 to carry on the business of designing and supplying printed circuit boards. It used computer aided design hardware and software supplied by the defendant company, then known as Racal-Redac (U.K.) Ltd ("Racal"). After being modestly profitable until 1985, the company suffered heavy losses and in 1988 ceased to trade. Mr. Basten says that its failure was caused by deficiencies in the computer systems supplied by Racal and on 22 March 1988 the company commenced proceedings against Racal, alleging breach of contract and misrepresentation. Immediately afterwards it went into creditors's voluntary liquidation. For a while Mr. Basten funded the prosecution of the action by the liquidator but in 1989 he was unable to continue. On 12 April 1990 the company acting by the liquidator assigned to Mr. Basten the benefit of the company's contracts with Racal, together with its causes of action. The consideration was payment of £1 and the right to 40 per cent. of the proceeds of certain causes of action. Mr. Basten applied for and obtained legal aid to prosecute the causes of action which had been assigned to him. Racal consented to his joinder as an additional plaintiff but amended its defence to plead, in paragraph 21B, that the assignment was "void and of no effect" because it was "for the sole or dominant purpose" of enabling the action to be prosecuted with the benefit of legal aid and to avoid liability to give security for costs under section 726 of the Companies Act 1985. The question of the validity of the assignment was ordered to be tried as a preliminary issue. At the time of the trial of the issue before Judge Richard Havery Q.C., the Norglen case had been decided by Morritt J. but the appeal had not yet been heard. He found that the purposes of the assignment were twofold: first, "to enable the company to tap the resources of the Legal Aid Fund, which would not otherwise be available to it" and secondly, to give Mr. Basten a cause of action which reflected the fact that he was the sole beneficial shareholder in the company. Following the Advanced Technology Structures Ltd case, he held that the assignment was a "stratagem or device which the court would not countenance" and was invalid.

By the time the appeal from this decision was heard, the Norglen case had been before the Court of Appeal. A differently constituted court (Staughton, Simon Brown and Thorpe L.JJ) held that the Norglen court had been wrong to distinguish Advanced Technology Structures Ltd on its facts; the two cases were indistinguishable and in conflict. They elected to follow Norglen, held the assignment valid and allowed the appeal. Racal appeals against that decision.

The law is traditionally hostile to the assignment of causes of action in return for a share of the proceeds. Such transactions were described as champerty (division of the field) and regarded as illegal and unenforceable. It is unnecessary to examine the reasons: judges said that it would encourage malicious suits, but treating such arrangements as criminal was also, before the introduction of legal aid, an effective way of preventing poor people from obtaining legal redress. The position of liquidators and trustees in bankruptcy is however quite different. The courts have recognised that they often have no assets with which to fund litigation and that in such case the only practical way in which they can turn a cause of action into money is to sell it, either for a fixed sum or a share of the proceeds, to someone who is willing to take proceedings in his own name. In this respect they are of course no different from many other people. But because trustees and liquidators act on behalf of creditors, the courts have for the past century construed their statutory powers as placing them in a privileged position.

Nearly a century later, in Ramsey v. Hartley [1977] 1 W.L.R. 686, 698, Lawton L.J. said:

These cases both happened to have concerned trustees in bankruptcy, but the powers of liquidators have been given a similar construction and in Guy v. Churchill (1888) 40 Ch.D. 481 Chitty J. held that there could be no objection to an assignment in return for a share of the proceeds, which "apart from the bankruptcy law. . . is plainly void for champerty." In the face of this line of authority, counsel for both appellants accepted that apart from the impact of legal aid and the effect on the defendant's right to security for costs, the assignments could not be challenged.

The chief question in both appeals was therefore whether the assignments were void or unenforceable because they would enable a company to benefit indirectly from legal aid. This, as I have said, was the view of the Court of Appeal in Advanced Technology Structures Ltd. v. Cray Valley Products Ltd. [1993] B.C.L.C. 723.

This, said Hirst L.J., demonstrated that the assignment was "a sham." The give effect to the assignment would conflict with "the underlying policy of the Act," which was that "legal aid should not be available to corporate plaintiffs."

Mr. Rupert Jackson and Mr. Roger Henderson, counsel for the appellants in the Norglen and Circuit Systems appeals respectively, relied upon this reasoning but explained it somewhat differently. They both accepted, as Morritt J. had done in the Norglen case, that when Hirst L.J. described the assignment as a "sham," he could not have meant what is ordinarily meant by that expression, namely, a transaction which is not what it pretends to be: Snook v. London and West Riding Investments Ltd. [1967] 2 Q.B. 786. The transaction was intended to be exactly what it purported to be, namely a transfer to the assignee of the legal and beneficial interest in the cause of action in return for the right to a share in the proceeds. If it was unenforceable, it could only be because such a transaction was in some way illegal or contrary to public policy.

Mr. Jackson said that the introduction of legal aid for individuals in 1949 had the effect of restricting the power of liquidators and trustees to assign causes of action. They could no longer assign them to individuals on terms that the company or bankrupt's estate would receive part of the proceeds if it was intended that the action should be pursued with the benefit of legal aid. Such a restriction on the statutory power to sell the assets of the company or bankrupt had to be implied in order to make the insolvency legislation consistent with the Legal Aid and Advice Act 1949 and subsequent legislation to the same effect. Alternatively, the policy expressed in the Legal Aid and Advice Act 1949 had created a head a public policy which required such assignments to be treated as invalid.

Mr. Henderson said that the Legal Aid Act 1988 prohibited the grant of legal aid to a corporation and that it followed, upon the true construction of that Act, that a grant of legal aid to an assignee for the benefit of the company, as in a case like this, would also be unlawful. The assignment had therefore been executed for an unlawful purpose and was unenforceable under the principle that the courts would not lend their assistance to the achievement of an unlawful purpose.

My Lords, these two very different arguments advanced in support of the decision of the Court of Appeal in Advanced Technology Structures Ltd. v. Cray Valley Products Ltd. [1993] B.C.L.C. 723 illustrate the difficulties in analysing its reasoning. If the question is whether a given transaction is such as to attract a statutory benefit, such as a grant or assistance like legal aid, or a statutory burden, such as income tax, I do not think that it promotes clarity of thought to use terms like stratagem or device. The question is simply whether upon its true construction, the statute applies to the transaction. Tax avoidance schemes are perhaps the best example. They either work (Inland Revenue Commissioners v. Duke of Westminster [1936] AC 1) or they do not (Furniss v. Dawson [1984] A.C. 484.) If they do not work, the reason, as my noble and learned friend Lord Steyn pointed out in Inland Revenue Commissioners v. McGuckian [1997] 1 WLR 991, 1000, is simply that upon the true construction of the statute, the transaction which was designed to avoid the charge to tax actually comes within it. It is not that the statute has a penumbral spirit which strikes down devices or stratagems designed to avoid its terms or exploit its loopholes. There is no need for such spooky jurisprudence.

Wallersteiner v. Moir (No. 2) [1975] 1 Q.B. 373, upon which Mr. Henderson relied, is a good example of such straightforward construction applied to the legal aid legislation. The question was whether Mr. Moir would be entitled to legal aid to bring a derivative action on behalf of a company against its majority shareholder. The Court of Appeal held that as he was asserting the company's cause of action on the company's behalf, the effect of what is now section 2(10) of the Legal Aid Act 1988 prevented the grant of legal aid.

But the question of whether, upon the true construction of that subsection, the Legal Aid Board is entitled to make legal aid available to the assignees in these appeals, is not a matter which is before your Lordships for decision. In fact, Mr. Jackson and Mr. Henderson were not even agreed upon the answer. Mr. Jackson proceeded upon the assumption that if the assignment was valid, the Board could properly grant legal aid. Taking this position appeared to him to give better support to his argument that, in order to avoid such a result, the liquidator's power to assign should be restricted. Mr. Henderson, on the other hand, submitted that the grant of legal aid to the plaintiff in his appeal was unlawful and he mentioned that judicial review proceedings had been instituted against the Board to enforce this claim. This position appeared to him to support the argument that the assignment was an attempt to further an unlawful purpose.

For reasons which I shall give in a moment, I do not think that it is necessary for your Lordships to decide whether Mr. Jackson or Mr. Henderson is right. The Legal Aid Act 1988 appears on its face to be concerned with whether the party to whom aid is provided is an individual or a corporation and not with how he got his cause of action or what he is going to do with the proceeds. The Lord Chancellor is given power in section 34(1) to make regulations "for preventing abuses" of the Act and the Board has power under section 15(3)(a) to refuse representation for the purpose of proceedings if in all the circumstances it appears to the Board "unreasonable" that the applicant should be granted representation. In Reg. v. The Law Society, Ex parte Nicholson, (unreported), 22 February 1985, Hodgson J. decided that a legal aid committee could not refuse legal aid under this provision solely on the ground that the applicant had acquired the cause of action by assignment from an insolvent company, without having regard to the other circumstances of the case. But there is no doubt that such an assignment is a matter which the Legal Aid Board is entitled to take into account. Furthermore, since the grant of legal aid in these appeals, the Lord Chancellor has pursuant to section 34(1) of the Legal Aid Act 1988, made the Civil Legal Aid (General)(Amendment)(No. 2) Regulations 1996 (S.I. 1996 No. 1257) which insert a new Regulation 33A into the Civil Legal Aid (General) Regulations 1989:

This regulation might appear to reverse Reg. v. The Law Society, Ex parte Nicholson and permit a refusal on the specified ground irrespective of the other circumstances of the case. But your Lordships' Appellate Committee invited the comments of the Legal Aid Board on the issues in these appeals and received a helpful letter, which was made available to the parties, from the Board's legal adviser Mr. Colin Stutt. He said that the powers to make regulations conferred upon the Lord Chancellor by section 34(1) did not entitle him altogether to proscribe legal aid in the circumstances stated in the new regulation 33A. It followed that in his view the Board would still have to have regard to all the circumstances of the case. If the Board had to take a general view of the merits of the application, the answer was by no means obvious. One view was that an assignment by an insolvent company was "simply an abuse of the legal aid scheme:" people who chose to take the advantages of limited liability had to accept the disadvantages, including the absence of state benefits such as legal aid. On the other hand, another view was that this was a harsh and unrealistic judgment. Few people who decided to incorporate their businesses would realise that the result could be a form of outlawry, excluding them from access to justice. In most of the assignment cases which came before the Board, the individual was a shareholder who had an overwhelming interest in the outcome of the proceedings and a claim which had strong merits. Considerations of this kind frequently persuaded Area Committees to grant legal aid to assignees despite the discretion to refuse conferred by rule 33A. Mr. Stutt said that the discretion entrusted to the Board by the new rule was "problematic" and any guidance from your Lordships by way of clarification of the law would be welcome.

Looking at the matter in a wider perspective, Mr. Stutt also drew your Lordships' attention to the proposals for reform of civil legal aid announced by the Lord Chancellor on 18 October 1997. These include the abolition of civil legal aid for money claims and the substitution of a right to enter into conditional fee agreements with solicitors. Such agreements would be open to companies as well as individuals and would remove the difference in treatment which has given rise to these appeals.

My Lords, I think that the way in which this matter comes before your Lordships makes it undesirable for the House to express any opinion on the way in which the Legal Aid Board should deal with cases such as the present under the existing scheme. The Board has not been a party to these proceedings and although your Lordships will, I am sure, have been assisted by Mr. Stutt's letter, the legality of the Board's exercise of its public powers and discretions is not an issue in either of these appeals. It is concerned solely with the validity, as a matter of private law, of the assignments by the two companies to Mr. and Mrs. Rodgers and Mr. Basten respectively. For this purpose, the question of how the Board should have exercised its discretion in granting them legal aid or whether, as a matter of construction of the Legal Aid Act 1988, it had such a discretion, is not relevant. For the Board either had such a power or it did not. If Parliament conferred such a power, there seems to me no ground for saying that it must be taken impliedly to have prohibited such assignments or that the Act requires this to be done as a matter of public policy. The Act recognises in general terms the possibility of abuse but leaves it to the rule-making power of the Lord Chancellor and the discretion of the Board to identify such abuses and deal with them. The legal aid scheme can look after itself and does not require the courts to strike down private transactions which would otherwise be valid. On the other hand, if upon the true construction of the Act there is, as Mr. Henderson argues, no power to grant legal aid to assignees in the position of Mr. and Mrs. Rodgers or Mr. Basten, then there is by definition no possibility of abuse. The foundation for an argument that the assignments are for an illegal purpose disappears. They are valid as a matter of insolvency law and give the assignees a cause of action but there is no mischief in them because they do not enable the companies to derive benefits from legal aid. Mr. Henderson said that although this might in theory be true, it was in practice very difficult to challenge the exercise of discretion by the Legal Aid Board. The fact was that legal aid had been granted and his clients had the disadvantage of being faced by a legally aided plaintiff. But this argument seems to me fallacious, because to say that the Legal Aid Board has a discretion in the matter means that there are circumstances in which it could properly grant legal aid. In that case, as I have said, the question of whether such a grant would be an abuse of the scheme is a matter for the Lord Chancellor's regulations and the Board. For these reasons, Advanced Technology Structures Ltd v. Cray Valley Products Ltd [1993] B.C.L.C. 723 was in my view wrong to hold that the assignment was invalid.

Like the Court of Appeal in the Norglen case, I also think that there is nothing in the point that the assignment is invalid because it deprives the defendants of the right to apply for security for costs under section 726 of the Companies Act 1985. For better or worse, the law entitles a defendant to be protected against incurring irrecoverable costs in litigation brought against him by an impecunious company but not by an impecunious individual. But that cannot prevent companies from assigning property to individuals.

It follows that the Circuit Systems appeal, in which the only issue is the validity of the assignment, must in my opinion be dismissed.

Mr. Peter Smith advanced an alternative argument for the appellants in the Norglen appeal based on what he said was misconduct on the part of the liquidator in assigning the company's cause of action to Mr. and Mrs. Rodgers. He said that until the hearing before Morritt J. the liquidator took no steps to set aside the purported transfer of the company's property to Mrs. Rodgers, he gave Mr. and Mrs. Rodgers uncontrolled conduct of the litigation which deprived the company of the value of the restrictive covenant and forced through the assignment in the face of opposition from creditors. My Lords, I make no comment upon the factual basis of any of these allegations because, even if true, they have no present relevance. The liquidator had a statutory power to assign the company's cause of action and has exercised that power. If his exercise of the power was a breach of duty to the company and its creditors, that is a matter of which the creditors may complain in the Companies Court. It does not affect the validity of the assignment.

There are two further points which arise only in the Norglen appeal. Both concern the exercise of the discretion to substitute Mr. and Mrs. Rodgers as plaintiffs pursuant to R.S.C. Ord. 15, r. 7(2). The rule reads:

Mr. Jackson accepted that if, as I think, the assignment was effective to transfer the cause of action from the company to Mr. and Mrs. Rodgers, their joinder as parties was necessary. They were the only people who could prosecute the action. But Mr. Jackson submitted that the rule gives the court a discretion and that the Court of Appeal failed to consider the exercise of that discretion in two ways. First, he says that it should simply have refused to make an order on the ground that the prosecution of the action by the Rodgers would be an abuse of legal aid. Alternatively, he says that the order should have been subject to a condition that Norglen provide security for costs in the amount ordered by Morritt J.

I do not think it escaped the attention of the Court of Appeal that the rule confers a discretion. But the discretion must be exercised judicially and in my view, once it is accepted that, in spite of the finding that the assignment was a "stratagem or device" to obtain legal aid, it is nevertheless valid, there are no grounds upon which joinder can properly be refused. If the question of whether the assignment is an abuse of legal aid is a matter for the discretion of the Legal Aid Board, it must follow that it should not be a ground for the court refusing to join a plaintiff who has a good title to sue. Otherwise one could have a situation in which the Board decided that in all the circumstances there was no abuse and that legal aid should be granted while the court refused joinder on the ground that the prosecution of the action with legal aid would be an abuse. Sir Thomas Bingham M.R. dealt with the matter shortly and in my respectful opinion correctly when he said:

Mr. Jackson's alternative argument was that the Court of Appeal should have imposed a condition that Norglen give security for costs. He also submitted that although the basis upon which Morritt J. made his order for security against Norglen, namely, that it would continue as sole plaintiff, was no longer valid, the Court of Appeal should have reimposed the order before ordering substitution and left it to take effect against Mr. and Mrs. Rodgers by virtue of R.S.C. Ord. 15, r. 8(4), which provides:

On the other hand, Mr. Purle, who appeared for Mr. and Mrs. Rodgers, said that the rule could not have the effect of making an order for security, based upon an assessment of the means of a corporate plaintiff, effective against a new individual plaintiff. "All things done" meant steps in the action and no more. I do not think that it is necessary to decide this question because in my view, if it would not be right to make an order for security as a condition of substitution, it would not be right to achieve the same effect in the highly artificial manner suggested by Mr. Jackson.

The Court of Appeal said that it would not be right to make such an order for the following reasons:

The Court of Appeal must have had in mind an order with which the original plaintiff had to comply before substitution would be ordered, that is to say, as a condition of substitution. Otherwise there would be no sanction for non-compliance; the normal sanction, namely a stay of the action, could not be enforced against someone who was no longer a party. It therefore assumed that there was a power to impose such a condition but decided as a matter of discretion not to exercise it.

Mr. Purle submitted that in fact there was no such discretion. He contrasted R.S.C. Ord 15, r. 6(2), which is the general rule dealing with adding parties and says expressly that the court may make such an order "upon such terms as it thinks just," with rule 7(2), which makes no reference to terms or conditions. It is however unusual to confer a discretionary power in such all-or-nothing terms that it cannot be exercised subject to conditions and I do not think that a great deal of weight can be put upon the absence of express language. Mr. Stern also referred us to Freightex Ltd. v. International Express Co. Ltd. (unreported), 15 April 1980; Court of Appeal (Civil Division) Transcript No. of 1980 in which Dunn L.J. said categorically:

On the other hand, the other two members of the court (Stephenson L.J. and Sir Stanley Rees) merely thought that it was inappropriate to impose such a condition in that particular case.

The exercise of the discretion was considered by the Court of Appeal in Eurocross Sales Ltd. v. Cornhill Insurance Plc. [1995] 1 W.L.R. 1517. In that case a company in financial difficulties but not yet in liquidation sold its assets, including a claim against the defendant insurance company, to its principal shareholder Mr. Sood. The company's action against the defendant was proceeding in the county court and it had been ordered by the district judge to give security for costs. Mr. Sood applied under the County Court equivalent of R.S.C. Ord. 15, r. 6 to be joined as an additional plaintiff. The learned judge granted the order subject to a condition that Mr. Sood give security for costs in the sum of £5,000. The reason he gave was that:

On appeal, the Court of Appeal (Sir Thomas Bingham M.R., Auld and Ward L.JJ.) discharged the order. The question was whether it was appropriate for the judge to have exercised his discretion so that the defendant:

Sir Thomas Bingham M.R. thought that this was not a proper ground upon which to exercise the discretion. He said:

It is therefore a proper exercise of the discretion to impose conditions to ensure that the joinder does not put the defendant in a worse position as to costs than he would have been if the new party had been in the action from the beginning. He may be ordered to pay or give security for additional costs caused by or thrown away as a result of the joinder. But the discretion cannot be used to ensure that joinder does not put the defendants at a greater risk as to costs than they would have been if no joinder had taken place. Having to litigate against an impecunious individual plaintiff is a risk of litigation which has to be accepted.

This reasoning seems to me to apply equally to a condition imposed on an application for substitution under R.S.C. Ord. 15, r. 7. Nor does it matter that the condition is imposed upon the original plaintiff company rather than the individual plaintiff seeking to be substituted. The latter cannot require the company to comply with the condition and, unless it chooses to do so, he will either have to put up the security himself or be unable to prosecute the action.

The decision in the Eurocross case therefore suggests that it would be wrong to impose the condition sought by the defendants. It is not however necessary for your Lordships to express a final view on whether this reasoning is correct because, in refusing to order security, the Court of Appeal in Norglen did not rely upon it. As appears from the passage in the judgment which I have quoted, the court exercised its discretion on the ground that Norglen had sufficient assets to be able to meet all the costs for which it could be made liable.

Mr. Jackson criticised this reasoning on a number of grounds. He said that the court had not taken proper account of the defendant's valuation evidence which said that the covenant was worth a great deal less and, in any case, there was no knowing what it might be worth when costs had to be paid. In my opinion, this was a matter on which the Court of Appeal had to take a broad view and there is nothing to show any basic error.

Mr. Jackson also said that the Court of Appeal were wrong in assuming that the defendant's claim under an order for costs would rank in priority to the company's other creditors. If it did not, the defendants would receive no more than a dividend. It is in my view clear that the costs ordered to be paid by a company in liquidation to a successful defendant are payable out of the net assets in the hands of the liquidator, in priority to other claims, including that of the liquidator for his own costs: see In re Pacific Cost Syndicate Ltd. [1913] 2 Ch 26 and In re Movitex Ltd. [1990] B.C.L.C. 785. In re M.C. Bacon (No.2) (unreported) upon which Mr. Jackson relied, deals with a different question, namely whether costs incurred by a liquidator (either directly or in consequence of being ordered to pay the costs of another party) are "expenses. . . incurred by the. . . liquidator in preserving, realising or getting in any of the assets of the company" within the meaning of rule 4.218(1)(a) of the Insolvency Rules 1986 (S.I. 1986 No. 1925). Millett J. held (rightly or wrongly) that costs incurred in litigation which realised no assets did not qualify for priority under this head. But the right of a successful defendant to an action brought or adopted by a company in liquidation to be paid out of the assets in the hands of the liquidator is not parasitic on the liquidator's right to recover such costs. It is enforceable directly against the company by virtue of the order for costs. I therefore think that the Court of Appeal were correct in assuming that the defendants, if successful, would not have to compete with pre-liquidation creditors for payment of their costs.

Finally, Mr. Jackson said that such priority would attach only to costs incurred after the date of liquidation. Pre-liquidation costs would be ordinary pre-liquidation debts. I do not think that this is right. If the company in liquidation is liable for any costs at all, as is accepted by the liquidator, it is because it adopted the action: it resisted the order for security for costs, applied for substitution and appeared both in the Court of Appeal and your Lordships' House. And if it adopted the action, there is clear authority, including a decision of your Lordships' House (Boynton v. Boynton (1879) 4 App.Cas. 733 and; In re London Drapery Stores (1898) 2 Ch 684) for the proposition that the company adopts the action as a whole and makes itself liable for all costs previously incurred.

I have had the advantage of reading in draft the speech to be delivered by my noble and learned friend, Lord Hoffmann. For the reasons which he gives, I would dismiss both of these appeals.

United Kingdom House of Lords Decisions

Circuit Systems Ltd and Another v. Zuken-Redac (U.K) Ltd (Formerly Racal-Redac (UK) Ltd) [1997] UKHL 51 (27th November, 1997)