Re Rococo Developments Ltd

The Court of Appeal allowed the liquidators' appeal against the first instance judge's treatment of an unlawful dividend when assessing the company's balance-sheet insolvency for the purposes of the Insolvency Act 1986. The court held that a claim by the company against directors to recover an unlawful dividend was a contingent asset, contingent on discovery and pursuit, and therefore should not have been treated as a present asset in determining whether the company was unable to pay its debts under section 123. The court applied the principle in Eurosail that contingent assets are not to be taken into account when assessing balance-sheet insolvency and emphasised that hindsight must not be used to rewrite commercial reality.

Background and parties. Rococo Developments Ltd, a property development company controlled by Mr and Mrs Jones, entered creditors' voluntary liquidation on 21 April 2011. The appellants are the company's liquidators; the respondents are Mr and Mrs Jones. The company had repaid directors' loans and paid an apparently unlawful dividend of £75,000 to the Joneses on 1 June 2010. The company also faced claims by its contractor WJG Evans Ltd and adjudication awards in March and May 2011.

Nature of claim and procedural posture. The liquidators sought recovery of five payments made by the company to Mr and Mrs Jones within two years of insolvency as preferences under sections 239–241 of the Insolvency Act 1986 and challenged the lawfulness of the dividend. The case was heard at first instance in the Chancery Division (Cardiff) and came on appeal to the Court of Appeal.

Issues framed by the court.

• Whether the unlawful dividend paid to the directors constituted a present asset of the company for the purposes of assessing balance-sheet insolvency under section 123 of the Insolvency Act 1986.
• Whether it was permissible to apply hindsight in valuing contingent assets or liabilities when determining insolvency at the relevant historic dates, and whether the adjudicator's subsequent award to Evans could be taken into account.

Court’s reasoning and conclusions. The court accepted that the dividend was unlawful and that the Joneses held it on constructive trust for the company, but concluded that the company's claim to recover the dividend was a contingent asset because it depended on discovery and pursuit (both unlikely while the Joneses controlled the company). Relying on the Eurosail authorities, the court held that contingent assets should not be counted as present assets when assessing balance-sheet insolvency. The Court of Appeal found that treating the dividend as a present asset involved impermissible hindsight and counterfactual assumptions (that the unlawfulness was known, that the claim would have been pursued and recovered without cost, and that funds to pursue the claim existed). It therefore allowed the appeal, holding that the company was insolvent on the balance-sheet basis at the dates in question and that the first instance judge had erred in his approach to the unlawful dividend. The court declined an unforeshadowed amendment to argue that the Evans adjudication award should be taken fully into account.

Appeal allowed. The Court of Appeal held that the judge erred in treating the unlawful dividend as a present asset of the company when assessing balance-sheet insolvency under section 123 of the Insolvency Act 1986. The dividend recovery claim was a contingent asset dependent on discovery and pursuit, and it was impermissible to use hindsight and counterfactual assumptions to treat it as available to meet the company's liabilities.

Appeal from the High Court of Justice, Chancery Division (Cardiff District Registry), His Honour Judge Milwyn Jarman QC (first instance reference 392OF2012). The appeal was heard in the Court of Appeal (Civil Division) culminating in judgment [2016] EWCA Civ 660.