First published in Butterworths Journal of International Banking and Financial Law
Factual Background
Goldtrail was a leading tour operator, dealing in Turkish holidays. It traded for 15 years and had a turnover in excess of £50m. On 16 July 2010, it was put into administration by its sole director and shareholder, Mr Abdulkadir Aydin. The administration left thousands stranded abroad and resulted in the Air Travel Trust (ATT) incurring over £20m in repatriation costs, making it by far Goldtrail’s largest creditor. The events leading to Goldtrail’s insolvency were the subject of High Court litigation and were, as set out in the judgment, as follows.
In late 2009 Mr Aydin approached the second defendant, Black Pearl Investments Limited (BPI). BPI was a Hong Kong company, with an interest in Viking, a Swedish Airline. Goldtrail bought seat capacity from Viking. Mr Aydin invited BPI to buy 50% of Goldtrail’s shares for £2m. BPI, acting through the fourth-sixth defendants, Messrs Stephensen, Sigurdarson and Wyatt, (together with BPI “the BPI Defendants”), came up with a “tax-efficient” scheme to acquire the shares for a lesser price. The scheme involved BPI paying £500,000 to Mr Aydin directly and a further £1.4m to an off-shore entity to be set up by Mr Aydin with the assistance of a lawyer recommended by BPI. The £1.4m paid to the off-shore entity – Morning Light Limited (MLL) – was documented as commission for providing brokerage services for facilitating an agreement between Goldtrail and Viking. That agreement provided for Goldtrail entering into a five-year commitment to purchase a specified number of flight seats from Viking each year. Unbeknown to BPI, in early 2010 Mr Aydin also offered 50% of the shares in Goldtrail to Onur Air Tasimacilik AS (Onur), a Turkish Airline, from which Goldtrail also bought seat capacity. The terms of that share sale were similar to those involving the BPI Defendants but the price was higher and the flight seat commitment was for four rather than five years. In total Onur agreed to pay £4.64m to Mr Aydin: £1m directly and a further £3.64m off-shore to MLL. No services were in fact provided by MLL because:
- there were already pre-existing relationships between the companies and Goldtrail; and
- Mr Aydin was the sole director and shareholder of both MLL and Goldtrail.
The liquidators’ case was that Mr Aydin was in breach of s 175 of the Companies Act 2006, because the BPI and Onur deals put him in a position where his interest in obtaining the money for himself, via MLL, conflicted with Goldtrail’s interest in obtaining payment for its commitment to purchase seats from Viking and Onur. Goldtrail’s losses were the £1.4m under the BPI deal, and the £3.64m under the Onur deal.
It also appeared that £1.125m of the funds paid to MLL by Viking and £2.65m paid by Onur originated from Goldtrail itself. The liquidators argued that Mr Aydin had misapplied those funds in breach of his fiduciary duty to Goldtrail.
Preliminary Considerations
Funding
The potential length and complexity of cases of this nature will inevitably result in substantial costs being incurred by liquidators and their legal advisers – costs which an insolvent estate normally cannot afford. While there are ways of funding this type of litigation, including third party commercial funding, and many of these were either employed or explored in this case, the reality of a case like Goldtrail (with a quantum of under £10m) is that third party funding is likely to be difficult, if not impossible, to make work from a commercial perspective, because litigation funders typically look to recover their outlay plus 3-4 times that outlay. Unless a creditor is prepared to fund the case, the claimant needs to rely on a CFA or damages-based agreements with lawyers. In this case the liquidators entered into CFAs with both solicitors and counsel.
Historically, CFAs provided an effective means of conducting litigation of this nature, provided the liquidator could find lawyers willing to act on a CFA basis. However, success fees and ATE premiums now need to be deducted from the damages awarded, thereby minimising or completely consuming the damages available to creditors, who often, as in Goldtrail, are public bodies. In April 2016 R3, the Association of Business Recovery Professionals, published a report on insolvency litigation which showed that in 2014 claims with a value of over £1bn were conducted through CFAs, of these approximately £240m were owed to HMRC. Abolishing the recoverability of success fees in such cases leaves them as unattractive propositions. In Goldtrail the maximum quantum of damages recoverable was £5.04m. It is not hard to imagine that £5.04m could be consumed to a substantial degree or entirely by six years of litigation coupled with enforcement across several jurisdictions where lawyers are acting on CFAs and there are substantial ATE premiums.
R3 has opposed the ban on the recoverability of success fees in insolvency cases. While time-limited exemption for insolvency cases was previously granted, it ended in April 2016. Liquidators in future cases will therefore face the challenge of coming up with effective funding strategies (probably via creditors) or simply not bringing meritorious claims.
Security for costs
To succeed in an application for security for costs a defendant needs to show that there is reason to believe that the claimant will be unable to pay the defendant’s costs if ordered to do so. In the case of Goldtrail, the applications were made despite notifications from Goldtrail that it was in the process of obtaining ATE insurance which would cover any adverse costs orders.
Goldtrail applied for the ATE insurance in early 2013. At the time imminent changes to the rules on recoverability of costs resulted in an influx of applications causing Goldtrail’s application, while ultimately successful, to be delayed. Even after ATE was in place, as a forerunner to some of the arguments later heard in the Premier Motors Auctions Ltd v PWC & Lloyds [2017] EWCA Civ 1872 case, the defendants argued that the ATE policy did not offer sufficient security. To address that argument, the liquidators obtained backup indemnity from the ATT. The court found that the combination of ATE insurance and ATT indemnity was sufficient. However, because of the length of time it had taken to put the ATE insurance and the indemnity in place, the judge made an adverse costs order against Goldtrail, depleting the funds in the liquidation estate. Liquidators should consider this risk at an early stage, particularly in light of the decision in Premier Motors.
First Instance Judgment
Mrs Justice Rose found ample evidence to support the misapplication claims and a breach of s 175 of the Companies Act 2006. In addition, she also determined an argument raised by the defendants in relation to the misapplication claim that the liquidators were no longer entitled to rely on common law fiduciary duty and instead had to frame their case as a breach of ss 171-177 of the Companies Act. This is because s 170(3) of the Act provides that:
“The general duties [in sections 171-177 of the Act] are based on certain common law rules and equitable principles as they apply in relation to directors and have effect in place of those rules and principles as regards the duties owed to a company by a director.” (Emphasis added)
Rose J rejected the argument relying on the Supreme Court judgment in Re Paycheck Service 3 Ltd, HMRC v Holland [2010] UKSC 51, which held that a claimant was entitled to bring a claim for misapplication without reference to ss 171-177. Claimants in future cases would be well advised to keep in mind the ability to rely on the common law duties in addition to ss 171-177 of the Act.
Another issue arose regarding whether or not Mr Aydin as the sole shareholder of Goldtrail was capable of ratifying his decisions as its director. The defendants relied on the Duomatic principle which provides that shareholders can, if acting unanimously, ratify the actions of directors where those actions would otherwise amount to a breach of duty. Rose J, however, held that the Duomatic principle did not apply in this case. She laid out the following reasons for her conclusion that fraudulent actions which do not take into account the interests of creditors are incapable of ratification:
- There was evidence that by March 2010 (four months before the administration) Goldtrail was already insolvent. Relying on the decision in Vivendi SA v Richards [2013] EWHC 3006 (Ch), Rose J held that once a company has become insolvent the director owes duties not just to its shareholders but also to the creditors. Consequently, in deciding to ratify any breach qua shareholder, Mr Aydin should have also taken into account the interests of the creditors and he clearly had not done so.
- Relying on the decision of the Court of Appeal in Bilta (UK) Ltd (in liquidation) and others v Nazir and others (No 2) [2013] EWCA Civ 968, Rose J confirmed that a sole director/ shareholder “cannot use his control of the company to ratify his fraudulent acts against the company particularly where the interests of creditors would be prejudiced”. This conclusion was supported by s 239 (7) of the Companies Act and was not alleviated by the Duomatic principle (Ultraframe (UK) Ltd v Fielding [2004] RPC 479).
In relation to the other defendants’ conduct, the issues were:
- whether there was assistance;
- if so, whether it was dishonest; and
- whether the fact that the defendants believed Mr Aydin capable as the sole shareholder of ratifying his decisions as a director meant that they were not acting dishonestly.
Rose J confirmed that although historically dishonest assistance was associated with breaches of duties by trustees, there was no reason why it should not apply to other fiduciary relationships, in particular directorships (Baden v Societe Generale pour Favoriser le Developpement du Commerce at de l’Industrie en France SA (1983) [1993] 1 W.L.R. 509). She then proceeded to discuss the conduct of the defendants which amounted to assistance, namely, coming up with the dishonest scheme and then diverting funds from Goldtrail in favour of MLL. The judge concluded that there could be no doubt that the defendants' "conduct crossed the line into assisting Mr Aydin to misapply Goldtrail’s money and to divert the opportunity to earn consideration for entering into a long term seat purchase commitment from Goldtrail”.
Rose J found that the defendants acted dishonestly in assisting Mr Aydin in full knowledge that the transactions in which they were participating were “unorthodox”; that MLL in fact provided no brokerage services and that information was being concealed from the regulator (the UK CAA). She relied on the test in Twinsectra Ltd v Yardley and others [2002] UKHL 12, that a defendant’s conduct is dishonest by the standards of ordinary people and that the defendant realises that he is dishonest, and the decision in Barlow Clowes International Ltd v Eurotrust International Ltd [2005] UKPC 37, that as long as it could be shown that the defendant’s knowledge of the transaction rendered his participation contrary to the normal standards, the defendant need not have had reflections about what the normal standards were. Rose J held that the fact that the defendants believed Mr Aydin capable of ratifying his decisions was irrelevant because “if they should be assumed to know enough about English company law to know that a director’s conduct can be approved by the shareholders or directors then they should be assumed also to know that in this case, that was not legally possible”.
Remedy
This question was determined by Rose J by reference to the decision in Ultraframe (UK) Ltd v Guy Fielding & Ors [2005] EWHC 1638 (Ch). The defendant should compensate the claimant for any loss suffered and disgorge any profit made but not compensate the claimant for any profit that it failed to make. The defendants sought to rely on the Appeal Court decision in Target Holdings Ltd v Redgerns (a firm) and another [1996] 1 AC 421 to argue that Goldtrail did not suffer loss as a result of Mr Aydin’s breaches. Rose J rejected this argument saying that the benefit of hindsight precluded her from making a conclusion that “the breach of duty did not ultimately cause Goldtrail any loss”.
Rose J awarded the full amount of the misapplied funds as damages in the misapplication claim and the full value of the contracts with MLL as damages for the breach of s 175. She rejected the defendants’ argument that because some of the payments made by Mr Aydin to Viking and Onur were subsequently recouped as flights provided by those two companies to Goldtrail, those payments should be set off. Relying on the decision in Manson v Smith (liquidator of Thomas Christy Ltd) [1997] 2 BCLC 161 Rose J concluded that because payments by Mr Aydin were made in breach of duty, they could not be regarded as dealings for the purposes of r 4.90 of the Insolvency Rules and could not be eligible for set off against the benefit received by Goldtrail. It was irrelevant whether or not the purported set off had already occurred, Viking and Onur could only prove for these amounts in liquidation.
Appeals
The BPI Defendants
The grounds of the BPI Defendants’ appeal were largely factual. For this reason and because the Court of Appeal was generally supportive of Rose J’s findings and reasoning, it is not proposed to discuss all of them here. The only point on which the court differed from Rose J was in relation to the set off argument above. Distinguishing the present case from Manson, the Court of Appeal held that the judge addressed herself to the wrong question. The correct question was whether or not Goldtrail had in fact recovered the payment made by Mr Aydin as flights provided by Viking before it was put into administration meaning that it did not suffer loss of the recovered funds. The Appeal Court found that Goldtrail had recovered a proportion of the funds in this way. The award of damages against the BPI Defendants for dishonest assistance in the misapplication of Goldtrail’s funds was reduced in that proportion.
This made no practical difference to the financial outcome for Goldtrail because the Court of Appeal upheld the award of £1.4m with respect to the breach of s 175. The BPI Defendants’ argument that they would not have paid for the seat commitment in the absence of the share deal was dismissed because whether the company could take advantage of the opportunity was irrelevant under s 175 (2) of the Act.
The BPI Defendants’ permission to appeal to the Supreme Court was refused on 28 November 2016.
Onur
The grounds of Onur’s appeal were the same as those of the BPI Defendants. The substantive appeal did not come before the court because in October 2014 Onur ceased flying to the UK. That led to concerns about the possibility of enforcing the judgment against Onur in Turkey. Goldtrail successfully applied under CPR 52.18(1) (c) (then CPR 52.91(1)(c)) for security for costs and an order that Onur should pay both outstanding costs orders and the judgment sum into court as a condition of the continuation of its appeal. Onur paid the costs orders and security but did not pay the judgment debt.
Goldtrail applied to have the appeal dismissed for failure to comply with the condition. Despite not previously advancing this argument, Onur argued that the condition was stifling the appeal. In January 2016 Patten LJ relying on the ratio in Societe Generale SA v Saad Trading, Contracting and Financial Services Company & Anor [2012] EWCA Civ 695 concluded that although Onur itself may not have been able to fulfil the condition, its majority owner, Mr Cankut Bagana, could provide the funds and the circumstances of this case were exceptional enough to justify looking to Mr Bagana as a potential source of funding for the company given his close connection to it and the past history of dealing with the company.
Onur appealed to the Supreme Court. In a judgment in August 2017 the Supreme Court having reviewed the two leading cases in this area – Societe Generale (above) and Hammond Suddard Solicitors v Argrichem International Holdings Ltd [2001] EWCA Civ 2065 – found that the leading cases erred in concluding that the issue was whether or not a wealthy owner could pay on behalf of a company. Instead the court should consider the financial position of the company and whether or not the company was able to raise the necessary funding. The question therefore was not whether Mr Bagana could but rather whether he would provide the funds to Onur. The Supreme Court remitted the case to Patten LJ.
Patten LJ, applying the Supreme Court’s clarified test, found in November 2017 that Mr Bagana would provide the funds to Onur and the condition was not stifling Onur’s appeal. After the second dismissal of its appeal Onur applied again to the Supreme Court for permission to appeal on the ground that the condition was contrary to its Art 6 right to a fair trial. Permission was refused in March 2017.
Enforcement
The BPI Defendants
There were two limbs to enforcement against the BPI Defendants: first, liquidation proceedings were initiated against BPI in Hong Kong. Those proceedings and investigations are ongoing. Second, steps were taken to enforce the judgment against the individual defendants in the UK, including charging orders, a writ of control and an application for an order for sale of a valuable property.
Onur
Enforcement against Onur, a non-EEA company with no presence in the UK and which was no longer flying into the UK (which meant it no longer had assets in the jurisdiction), was expected to be challenging. The liquidators started exploring various avenues for enforcing the judgment even before the final rejection of Onur’s appeal. These included enforcement against lease payments from a Saudi airline and obtaining assistance from the Turkish CAA. For various reasons, both routes were rejected.
In the end the liquidators pursued a solution under the Brussels Judgments Regulation. Through its investigations Goldtrail became aware that Onur used a German company to process its electronic payments and that it also had a German subsidiary. The judgments claimed against Onur were registered in Germany and the electronic payments and the shares in the subsidiary were frozen. The subsidiary was an essential part of Onur’s compliance with German regulations surrounding payment of airport taxes and charges, without it Onur was at risk of losing the ability to fly to Germany. Onur’s attempts to challenge the enforcement proved futile and Onur eventually settled with the liquidators.
Lessons Learned
The liquidators were from the outset open to settlement discussions. There was mediation with both the BPI Defendants and Onur during the early stages of the case. The defendants’ objective appeared to be to prolong the litigation first by trying to stifle the case and then by preventing enforcement. Perhaps they thought the liquidator would run out of money or patience. They were wrong.
The first lesson is that cases like Goldtrail with multiple defendants may well be lengthy battles. The liquidators and their legal team need to work closely together to consider all options. Cases of this nature present an intricate web of interconnected events; careful ongoing analysis of the factual background is essential to their success. Particularly where both liquidators and the legal team are working on a contingent basis, there is a need for a very straightforward and close relationship between the whole team throughout the claim.
Goldtrail’s long and complicated enforcement journey also demonstrates the need for claimants to look beyond the obvious routes to enforcement. Important assets may not be immediately obvious and there may well be a need to enforce judgments abroad, likely in more than one jurisdiction. The inclusion of investigator and foreign lawyer costs are not always first entries in a litigation budget but may be essential in contingent cases.
The last lesson is that success in cases of this nature will often depend on the availability of resources to pursue a plethora of different measures which when combined together lead to a successful outcome. With CFAs now becoming a less attractive option, it remains to be seen what, if any, solutions will be adopted to fund cases of similar complexity and quantum. At the time of writing the Ministry of Justice is undertaking a review into the implementation of Pt 2 of the Legal Aid, Sentencing and Punishment of Offenders Act 2012, and in particular into the ban on the recoverability of success fees and ATE insurance premiums. The findings are yet to be published; however, it is possible that without the reversal of the rules on recoverability we may have to wait a long time before the success of Goldtrail is repeated. Public bodies may (as they would have done in this case) be unable to make significant recoveries from those engaging in dishonest conduct, because meritorious cases are simply no longer commercially viable.