Kaupthing Singer and Friedlander Ltd, Re

The Court of Appeal determined the proper construction of Insolvency Rules 1986 (IR) rules governing set-off in administration, in particular IR 2.85(7) (which incorporates IR 2.105) and IR 2.85(8). The court held that the discounting formula in IR 2.105(2) operates "for the purpose of dividend (and no other purpose)" and therefore is confined to quantifying amounts for the purpose of calculating distributions.

As a result, only so much of a future debt as is required to match and extinguish the creditor's claim for distribution is to be discounted and treated as extinguished by set-off; any remainder of the loan not required for that statutory set-off remains a contractual debt of the creditor to the company and is not reduced by the IR 2.105 discounting process. The court allowed the administrators' appeal on that point and concluded that the Rules should not be read to release or reduce indebtedness beyond what is necessary to achieve the set-off and dividend purpose.

Background and parties: Kaupthing Singer & Friedlander Limited (a bank) was placed in administration on 8 October 2008. The joint administrators sought directions about how to calculate and set off mutual dealings between the bank and certain depositors who themselves owed large, often unmatured, loans to the bank (total figures for those depositors' deposits and loans are given in the judgment).

Procedural posture: The administrators applied for directions (application dated 24 June 2009). Norris J gave directions and an order on 2 October 2009. The administrators appealed to the Court of Appeal (hearing on 15 April 2010) on a single issue concerning the treatment of the balance of a loan after set-off under the Insolvency Rules.

Nature of the application / relief sought: Directions were sought on calculation and set-off of cross-claims in an administration and on the treatment of the company's right to payment of the balance of any loans. The appeal concerned whether, after future debts are discounted to present value for set-off under IR 2.105, any balance remaining in the company's favour is payable in the discounted amount or in the original (undiscounted) contractual amount payable at maturity.

Issues framed:

• Whether IR 2.105(2)'s statutory discounting applies only "for the purpose of dividend (and no other purpose)" so that discounting affects only the quantum for distribution/set-off and not the residual contractual debt;
• Whether post-administration contractual interest on loans should be included in the amount to be discounted for set-off;
• How IR 2.85(7) (incorporating IR 2.105) and IR 2.85(8) inter-relate in determining what is provable and what is payable after set-off.

Court’s reasoning and decision: The Court of Appeal allowed the administrators' appeal on the central point. The court emphasised statutory construction and insolvency policy: the discounting mechanism in IR 2.105 is expressly limited to the purpose of dividend and should therefore be read as confined to quantifying proofs and calculating the set-off necessary to determine distributions. It is not to be read as operating so as to extinguish or reduce contractual indebtedness to the company further than is necessary to effect the set-off and dividend. The court rejected the view that the discount should be applied to the whole of an unmatured loan such that the company would thereafter hold only a discounted liability; instead, only that portion of the loan necessary to match the depositor's present-value claim is treated as extinguished, and the remaining loan continues on its contractual terms to maturity. The court accepted that Norris J’s unappealed conclusion on interest was problematic but did not vary it because it was not appealed.

Wider context: The court noted the potentially anomalous and prejudicial consequences of reading the Rules as releasing creditors from substantial parts of their indebtedness without clear statutory direction, and it preferred an interpretation consistent with the objectives of administration and equal treatment of creditors.

Appeal allowed. The Court of Appeal held that the discounting formula in IR 2.105(2) operates only for the purpose of quantifying proofs/dividends and that, when applied via IR 2.85(7), only so much of a future debt as is required to calculate and effect the insolvency set-off is to be discounted and extinguished. Any remainder of the loan not needed for set-off remains a contractual debt payable at its contractual date and is not reduced by the IR 2.105 discounting mechanism. The court allowed the administrators' appeal on that construction and reversed the narrower interpretation given by Norris J on this point.

Appeal from the Chancery Division (Companies Court) before Norris J (order dated 2 October 2009). Appeal heard in the Court of Appeal (Civil Division) 15 April 2010; judgment allowing the appeal delivered 11 May 2010 [2010] EWCA Civ 518.