CJ and RA Eade LLP, Re

The liquidator succeeded in part. The court held that the LLP had, by agreement between the members, assumed liability for the Lloyds Bank loan and that drawings paid to the two designated members were withdrawals on account of anticipated profits and therefore treated as loans unless and until allocated as profits. The judge rejected the liquidator's case that the Lloyds loan had been capitalised. The designated members owed fiduciary duties to have regard to creditors once insolvency was probable; those duties were triggered during the LLP’s trading and, applying section 214A and section 212 of the Insolvency Act 1986, the court ordered repayment of all drawings and repayment of Lloyds Bank payments from May 2011 to liquidation inclusive. The court held there was no right of set-off by reference to members’ capital (section 107 Insolvency Act), the limitation defence under the Limitation Act 1980 did not bar the claims, and neither ex parte James nor s.1157 Companies Act 2006 provided relief.

This was a first-instance insolvency claim brought by the liquidator, Andrew McTear, against the two designated members, Christopher and Richard Eade, of CJ & RA Eade LLP (in liquidation). The liquidator sought recovery of (i) drawings paid to the members on account of anticipated profits between incorporation and liquidation, (ii) payments made by the LLP in respect of a loan originally advanced to the members by Lloyds Bank, and relied on misfeasance (section 212 Insolvency Act 1986), transactions at undervalue (section 238), preference (section 239) and the withdrawal provision for LLPs (section 214A).

Background and parties:

• The LLP was formed in July 2009 after Mr C. Eade purchased his partner’s share, financed by a joint Lloyds loan taken out by father and son and paid into their bank account which was thereafter used for LLP trading.
• The LLP entered creditors’ voluntary liquidation on 24 August 2011.

Nature of the application: Recovery of drawings and Lloyds loan payments as breaches of fiduciary duty / misfeasance and under statutory avoidance and withdrawal provisions.

Issues the court framed:

• Whether the LLP had assumed and capitalised liability for the Lloyds loan or whether payments to Lloyds were payments of debt pursuant to an agreement between the members.
• Whether drawings were unlawful remuneration or withdrawals on account of profits and thus recoverable.
• Whether the designated members breached duties to creditors once insolvency was probable and whether section 214A applied to withdrawals within two years of winding up.
• Whether set-off, limitation, preference, ex parte James or s.1157 Companies Act 2006 provided a defence or relief.

Court’s reasoning (concise):

• The court found an agreement by conduct that the LLP would assume the Lloyds loan and that the loan proceeds funded purchase of the business and working capital. Payments to Lloyds therefore fulfilled that contractual obligation.
• The filed accounts did not establish capitalisation of the Lloyds loan on the balance of probabilities: the accounts were opaque and failed to distinguish equity from debt, but surrounding evidence (agreement and subsequent payments) supported treatment of the amounts as debt.
• Drawings were withdrawals on account of anticipated profits, recorded as such in the books, and not permissible remuneration under the default rule in Regulation 7 of the LLP Regulations 2001; they were therefore loans subject to recovery absent a lawful set-off. The court held there was no set-off because members’ capital cannot be set off against creditors’ claims (section 107 Insolvency Act).
• The designated members’ duty to have regard to creditors was triggered once insolvency was known or should have been known (the judge applied the Eurosail and Sequana principles). That duty was engaged from early trading and certainly by January–September 2010 onwards. Some continued trading and payments were justified up to April 2011 to pursue a realistic rescue or sale, but after May 2011 continued payments to Lloyds and continued drawings were not in creditors’ interests and therefore constituted breaches of duty/misfeasance.
• Accordingly, the liquidator was entitled to equitable compensation under section 212 and to make a section 214A contribution for withdrawals in the two-year window; the court exercised its discretion not to order repayment of Lloyds payments before May 2011 but did order repayment of drawings and Lloyds payments from May 2011 to liquidation inclusive. The presumption of preference was rebutted as to earlier payments; limitation defences failed by reason of fiduciary breach principles (Limitation Act s.21(1)(b)). Ex parte James and s.1157 relief were unavailable.

The court therefore allowed the liquidator’s application in part and dismissed other aspects.

The application was allowed in part. The court found that the LLP had assumed liability for the Lloyds Bank loan by agreement and that the members’ regular payments of drawings were withdrawals on account of anticipated profits. The court rejected the capitalisation argument. Applying the duties owed by designated members to creditors once insolvency was probable, the court held payments and drawings after May 2011 were made in breach of duty and ordered the members to repay (by way of equitable compensation under section 212 and contribution under section 214A) all drawings and the LLP’s payments to Lloyds Bank from May 2011 to liquidation inclusive; payments before that date in respect of the Lloyds loan were not ordered repaid. The court also held there was no lawful set-off, no limitation defence, and no relief under ex parte James or s.1157 Companies Act 2006.