Freakley and Others v Centre Reinsurance International Company and Others

This appeal arises out of a number of questions on which the administrators of T & N Ltd sought the directions of the court. On all but one of these questions the answers given by Blackburne J ( [2004] 2 All ER (Comm) 28) were not appealed or affirmed by the Court of Appeal ( [2005] 2 All ER (Comm) 65) and there is no further appeal. On the remaining question his decision was reversed and the administrators appeal.

The relevant facts may be shortly stated. In 2001 T & N appeared likely to become unable to pay its debts because it was faced with a large number of tort claims arising out of the use of asbestos in its products. On 1 October 2001 Hart J, on the company's petition, appointed administrators for purposes including the approval of a corporate voluntary arrangement or scheme of arrangement under section 425 of the Companies Act 1985.

The company had the benefit of an asbestos liability policy under which it was entitled to be indemnified against its "ultimate net loss" (defined to include both established liabilities under asbestos claims and the costs of defending and handling such claims) in excess of a "retained limit" of £690m and up to an insurance limit of £500m. It was a condition of the policy that after the occurrence of an "insolvency event" (defined to include the presentation of an administration petition) or the reaching of the retained limit the insurers should have the exclusive right to handle and defend claims.

It is accepted that in handling claims, instructing solicitors and so forth, the insurers act as agents for the company and are entitled to reimbursement for their expenses: Groom v Crocker [1939]1 KB 94; Cox v Bankside Members' AgencyLtd [1995]2 Lloyd's Rep 437. The question which is the subject-matter of the appeal is whether the right to reimbursement of such expenses incurred after the appointment of the administrators has a statutory priority over other costs of the administration, the floating charge and the unsecured creditors of the company.

The question is not asked in respect of any particular expenses. Your Lordships know nothing of the amount claimed or the reason why the expenses were incurred. The policy requires that the insurers exercise their rights "in a businesslike manner in the spirit of good faith and fair dealing, having regard to the legitimate interests of the parties to the policy". It may therefore be assumed that the insurers complied with this requirement, otherwise there would be no claim to reimbursement at all. The question is whether any legitimate claim to reimbursement under the policy would have priority.

Before looking at the specific statutory provisions under which priority is claimed, I should say something about the general scheme and purpose of administration as it existed under the Insolvency Act 1986. Changes have since been made by the Enterprise Act 2002 but I say nothing about these because they were not in force at the relevant time. The background to the 1986 Act is explained by Lord Browne-Wilkinson in Powdrill v Watson [1995]2 AC 394, 441-442. It was introduced to enable a court to give insolvent companies a moratorium on the enforcement of debts and securities while the possibility of some form of rescue or arrangement with creditors was explored. Unlike Chapter 11 of the US Bankruptcy Code, with which it is sometimes compared, administration did not involve a reconstruction of the company. It usually looked forward to some kind of reconstruction, but that took place under different statutory provisions such as Part I of the 1986 Act (corporate voluntary arrangement) or section 425 of the Companies Act 1985.

In essence, an administration order did two things. First, it placed a procedural bar on the enforcement of security over the company's property or the commencement or continuance of any legal proceedings or execution against the company. Secondly, it substituted for the existing management a court-appointed administrator with power, under the control of the court, to manage the company's business and property. It did not alter substantive rights under contracts into which the company had entered or security which it had given. It did not affect the company's capacity, under its new management, to continue to trade and incur liabilities. It did not, save to the extent which I shall explain, affect the priorities which creditors would have if the company was wound up. That was left to any future reconstruction or liquidation.

It was obviously necessary for the administrator, if he was to carry out his function of preserving the business of a company as a going concern, to be able to pay for necessary goods and services and give suppliers the assurance that they would be paid in full even if the administration ended in a liquidation or a reconstruction under which the unsecured creditors received only a small dividend. This latter object was achieved by section 19(3) to (10) of the Act. Subsections (6) to (10) deal with contracts of employment and it is necessary only to refer to subsections (3) to (5):

(3) Where at any time a person ceases to be administrator, the following subsections apply.

(4) His remuneration and any expenses properly incurred by him shall be charged on and paid out of any property of the company which is in his custody or under his control at that time in priority to any security [under a floating charge].

(5) Any sums payable in respect of debts or liabilities incurred, while he was administrator, under contracts entered into or contracts of employment adopted by him or a predecessor of his in the carrying out of his or the predecessor's functions shall be charged on and paid out of any such property as is mentioned in subsection (4) in priority to any charge arising under that subsection.

Thus subsection (4) deals with claims against the company by the administrator himself and subsection (5) deals with claims against the company by third parties. Claims by the administrator may be either for remuneration or for expenses, that is to say, for goods and services supplied to the company for which the administrator...