Informal Liquidation

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Informal Liquidation - Play Amongst Yourselves?

Letitia Crabb*

Copyright © 1997 Letitia Crabb.
First Published in Web Journal of Current Legal Issues in association with Blackstone Press Ltd.

* I would like to thank Professor Paul Jackson for commenting upon an earlier draft of this note. Any errors are my own.

Summary

The meaning of 'informal liquidation' is examined in relation to the facts of Neville v Wilson [1996] 3 All E R 171 CA. It is submitted that the procedure adopted in that case was no liquidation at all in the legal sense and therefore the distribution of property which occurred could not be legitimised by any of the statutory liquidation regimes. Use of the term 'informal liquidation' both hindered identification of other relevant company law concepts, in particular the unanimous consent rule and the rules relating to maintenance of capital, and confused the factual analysis resulting in the Court of Appeal applying section 53 of the Law of Property Act 1925 to the wrong transaction. The authority of the decision of the Court of Appeal that the formality requirements of section 53(1)(c) did not apply to a specifically enforceable contract to assign an equitable interest in shares may therefore be questioned.

Introduction

The liquidation of a company and its dissolution are separate events. Dissolution is a formal process (see Insolvency Act 1986 ss 201-205 & Companies Act 1985 s 652.) which extinguishes the legal entity which first arose on the similarly formal registration of the company (Companies Act 1986 Pt I). It is well known that liquidation is not necessarily a formal procedure - notwithstanding the menu of formal procedures (compulsory liquidation, members' or creditors' voluntary liquidation) embodied in the Insolvency Act 1986 Part IV. Sometimes the members simply divide the company's property between themselves leaving it an empty shell to be dissolved as a defunct company under s 652 of the Companies Act 1985.(1) Any property which the company still enjoys at the time of dissolution passes to the Crown as bona vacantia. Under s 653 a person aggrieved can apply within 20 years for the company to be restored to the register and, under s 655, for an order of recompense.

The Facts

In Neville v Wilson the 20 year period had been allowed to elapse but certain former shareholders sought to claim property which had been left undistributed; they could do this if they could establish that, prior to the dissolution, the company's title to that property had, by some means, become vested in them and thus not passed to the crown as bona vacantia. The company was J E Neville Ltd (JEN) and the property consisted of an equitable interest in 120 shares in Universal Engineering (Ellesmere Port) Ltd (UEC). JEN had held all the shares in UEC, the vast majority of them directly. However some 120 were vested, as to 60 each, in two individuals (the defendants in the action) as nominees of JEN, the purpose being to qualify those individuals to act as directors of UEC. At the outset, in 1958, UEC had accumulated losses, its prospects were poor and its shares had little value. In 1965 the directors of JEN resolved to distribute those UEC shares held directly by JEN (then worth around £1.50 each), for a consideration, to the shareholders of JEN in proportion to their share holdings and the transfers were duly executed by JEN and registered. It was argued before Morritt J that the nominee shares were also intended to be part of this arrangement and that from that time the nominees held the 120 UEC shares on trust, not for JEN, but for the shareholders of JEN. Had this argument succeeded, it would have provided a convenient way of treating the shareholders of a company as the owners of its property without doing violence to the doctrine of corporate personality (though the question of compliance with the Law of Property Act 1925, s 53(1)(c) would presumably have had to be addressed). However, Morritt J was not satisfied that the directors of JEN had any such intention, a finding accepted by Nourse LJ (who gave the judgment of the Court of Appeal).

Informal Liquidation

An alternative argument was successfully tried in the Court of Appeal, relying on circumstances which had arisen four years later, in 1969, and which amounted to an agreement between the shareholders of JEN to informally liquidate: "a process whereby its debts and liabilities (if any) were discharged and the balance of its assets, whether ascertained or not, were distributed to its shareholders rateably according to their share holdings, in specie or in cash" (at p 179). This agreement was found to extend to JEN's equitable interest in the UEC shares even though, at the time, the existence of that interest was not realised. Under the agreement JEN's equitable interest was to be divided between JEN shareholders in proportions corresponding to their existing share holdings. It is clear that the formal liquidation of a company (for example by a special resolution for a voluntary winding-up under the Insolvency Act 1986 s.84(1)(b)) has as its result the distribution of its surplus assets to its shareholders (see Insolvency Act 1986 ss 107, 165 & 166 & Schedule 4 Pt III): those assets cease to belong to the company. Compliance with the statutory procedure, involving the appointment of a liquidator to act within powers conferred by the Act, make such a divesting an act of the company. Here, there was no resolution, special or otherwise, no liquidator, no statutory procedure. There was a recommendation by one of the shareholder/directors to the other directors that JEN should be liquidated in the manner described above. There was no direct evidence that the recommendations were agreed to by the shareholders of JEN but Nourse L J concluded that as a matter of common sense "the only reasonable inference is that all the shareholders of JEN agreed" (at p 179). The question arises how an agreement between shareholders, outside the confines of a formal liquidation, can divest a company of its property? That this was the effect accorded to the agreement cannot be doubted:

So, as a result of the agreement, JEN's equitable interest vested in its shareholders collectively. How is not explained. The shareholders, by individual agreements (at p 179j) between themselves, then adjusted their rights in accordance with their proportionate entitlements. The second stage of this process, the adjustment, is considered at length by Nourse LJ (see below). It is the first stage which is being addressed here. How, without any formal corporate act, did the company's property vest in its shareholders? It is submitted that it must relate to the idea that the shareholders, as proprietors of the company, can by unanimous consent bind the company to any act so long as it is within its capacity and honest (Salomon v Salomon [1897] AC 22 per Lord Davey at p 57; Parker & Cooper Ltd v Reading [1926] Ch 975 per Astbury J at p 982). The notion that corporate personality, and the constitutional structure which gives it expression, can be ignored if all the shareholders agree has often proved a useful means of side-tracking formalities associated with corporate entity. However, as Ross Grantham (1993, 245) has commented:

In the present case not only was the basis of the rule neglected, but there was no express acknowledgement that it existed and was being invoked. It was nowhere articulated what the unanimous consent of the shareholders was validating. It certainly did not validate any liquidation arising under the Insolvency Act 1986. No attempt was made to initiate a voluntary liquidation under s.84(1)(b) by passing a special resolution. As has been mentioned, there was no special resolution and none of the formalities consequent upon such a resolution. Had there been a such a resolution, but it had been passed on inadequate notice (In Re Bailey, Hay & Co Ltd [1971] 1 W L R 1357) or without a proper meeting (Re M J Shanley Contracting Ltd (1980) 124 Sol Jo 239) or without any meeting at all (Parker & Cooper Ltd v Reading [1926] Ch 975), the unanimous consent of the shareholders could have enabled the statutory procedure to operate notwithstanding these irregularities. Without a special resolution there is nothing out of which a de jure voluntary liquidation can arise: there is no resolution to be filed (s 84(3) and no date for the commencement of the winding-up, rendering the provisions relating to cessation of trading (s 87), avoidance of share transfers and alterations of members' status (s 88) and the statutory declaration of solvency (s 89), to name but a few, meaningless. Indeed, as in most of these cases, the avoidance of these formalities was the essence of the scheme. The truth of the matter is that "an informal liquidation" is no liquidation at all in the legal sense. The term is merely a factual summary of what has come to pass; a series of acts which, while they may fall outside the framework of a formal liquidation, still fall within the wider regulatory framework of company law. It is these acts which, in so far as they fail to comply with general company law formalities, may be susceptible to validation by unanimous consent.(2) Here the shareholders transferred company property to themselves and one would have expected the Court of Appeal to refer to the appropriate procedures for achieving that end, and the principles underlying them, before nodding the transfer through on an unanimous consent basis. If the transaction was a return of capital to the members as being in excess of the company's wants under the Companies Act 1985, s 135(2)(c) the court should surely, even if belatedly, have made reference to the existence, or more probably here, the non-existence of creditors. The existence of creditors would no doubt constitute a limit on the unanimous consent rule (Grantham 1993, 264-266). One would have thought that the need for confirmation by the court (Companies Act 1985, s 136) should also have been addressed. One assumes that the court would have been more than happy to confirm here (but with retroactive effect?) and one can accept that such a decision would have been sensible, but an opportunity to acknowledge and clarify the operation of the unanimous consent rule in the context of informal liquidation was lost.

Section 53 of the Law of Property Act 1925

Having, fortuitously, negotiated the company law hurdles to the transfer of JEN's equitable interest to its shareholders, one might have expected the Court of Appeal to turn its attention to the hurdle presented by the Law of Property Act 1925, s 53 to that transfer. Its effect was clearly to substitute the shareholders of JEN for JEN itself as the beneficiary under the trust binding on the defendant nominees. As such it would seem to constitute " a disposition of an equitable interest or trust subsisting at the time of the disposition" and should therefore have been in writing signed by the company or by its agent.(3) This was not however the transaction which the Court of Appeal subjected to the s 53 analysis. Rather, it was the network of individual agreements whereby each shareholder substituted for a collective entitlement an individual one:

If the effect of these agreements was to constitute each shareholder an implied or constructive trustee for the other shareholders, it could be argued, on the basis of views expressed in Oughtred v I R C ([1960] A C 206), that they fell within the s 53(2) exemption (which provides that s 53(1)(c) does not affect the creation or operation of resulting, implied or constructive trusts). In Oughtred shares in a private company were settled on a mother for life and then on her son absolutely. These two made an oral agreement whereby the son exchanged his reversionary interest in the settled shares for shares in the same company held by his mother as absolute owner. A few days later they executed a deed releasing the trustees accordingly and reciting that the settled shares were now held for the mother absolutely. Later on the same day the trustees transferred the settled shares to the mother for 10/-. The issue was whether that transfer was chargeable to ad valorem stamp duty as a conveyance on sale. The majority of the House of Lords (Lords Denning, Keith and Jenkins) held that it was so chargeable - regardless of whether the son's reversionary interest had previously passed under the oral agreement. However three of their lordships expressed a view upon the effect of the oral agreement. Lord Radcliffe considered that a specifically enforceable agreement to assign an equitable interest created a sub-trust and as the creation of that sub-trust came within s 53(2) no writing was required. He was then content to treat the creation of the sub-trust in the mother's favour as equivalent to an assignment of the reversionary interest to her:

Lords Cohen and Denning took the view that while the exception may apply to the creation of the sub-trust, that sub-trust did not have the effect of assigning the entire equitable interest to the mother: such an assignment had to comply with s 53(1)(c) (pp 230 & 233 - this view is fully developed in the submissions of Wilberforce Q C at p 220).

In the present case Nourse LJ accepted as "unquestionably correct" the view that a specifically enforceable contract to assign an interest in property creates an equitable interest in the assignee, and thus a constructive trust and he therefore held that" the effect of each individual agreement was to constitute the shareholder an implied or constructive trustee for other shareholders"(p 182). He also held that such a constructive trust was within s 53(2) and thus no writing was required to make the network of implied agreements effective.

This does not really clarify whether the creation of a sub-trust operates as an assignment so as to render compliance with s 53(1)(c) unnecessary. One may perhaps assume from the agreement Nourse LJ expresses with the views of Lord Radcliffe in Oughtred and from his disparaging reference to "fine distinctions" that he would have little sympathy with the view that a sub-trust was not an assignment - but a more explicit statement would have been welcome.

Decision

The outcome was that the agreements were valid, though oral, and JEN's equitable interest did not vest in the Crown as bona vacantia in 1970. That interest was validly dispersed between its shareholders prior to that date and its proceeds should therefore be divided between them in the ratio of 77.33 to the plaintiffs and 42.66 to the defendants.

Conclusion

Whatever the merits of the dispute about the effect of an oral agreement to assign an equitable interest in pure personalty (see Battersby 1979), it is respectfully submitted that the identification of this point as being in issue in Neville v Wilson is open to doubt. It was the transfer of the equitable interest by JEN to its shareholders which was crucial. If that was valid, JEN had disposed of the equitable interest to its shareholders prior to its dissolution; if their implied unwritten agreement did not suffice to divide the spoils between them, then, their entitlement being clear, the necessary writing could be conjured at leisure. If that transfer was not valid, the interest went to the crown as bona vacantia(4) and the shareholders had nothing to divide amongst themselves. Any discussion of s 53 should have been directed accordingly. It is respectfully submitted that when faced with something called an 'informal liquidation' the court should take care to further define the nature of the acts performed and the impact upon them of any formality requirements whether those requirements spring from a company law or a property law source.

Bibliography

Battersby, G (1979) 'Formalities for the Disposition of Equitable Interests under a Trust' Conveyancer 17.

Grantham, R (1993) 'The Unanimous Consent Rule in Company Law' Cambridge Law Journal 245.

(1) Where" the registrar has reasonable grounds to believe that a company is not carrying on business or in operation". In the circumstances set out in s 652B, a private company can now apply to the registrar for such dissolution: see s 652A Back to text..

(2) It has been suggested that it may depend on whether the statutory procedures are facilitative rather than constitutive: ie. whether it allows to be done by a special resolution what the shareholders could in any event do unanimously or whether it lays down the only way in which an end can be achieved: Farrar's Company Law ( 3rd ed., 1991 ), at p.338. Back to text..

(3) It could be argued that the circumstances fall within the s.53(2) exception - if it can be said that a company which has decided to pay back its assets to its shareholders becomes bound by a resulting, implied or constructive trust in their favour, sed quaere? Back to text..

(4) The Crown may disclaim such property under s.656 of the Companies Act 1985. The defendants, it appears, entertained hopes that this power would be exercised in their favour in the event of the plaintiffs claim failing, see p.183. Back to text..

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