UK Supreme Court Refuses Permission to Appeal in Preference Claim Arising From Liquidation of Comet: Key Takeaways for M&A Deals

Case: Darty Holdings SAS v Geoffrey Carton-Kelly (as additional liquidator of CGL Realisations Limited) [2023] EWCA Civ 1135

The UK Supreme Court recently refused an application by the liquidator of CGL Realisations Limited (formerly Comet Group Limited) (Comet) for permission to appeal a judgment of the English Court of Appeal handed down on October 9, 2023, in which Sidley successfully represented Darty Holdings SAS (Darty) and overturned what is believed to be the largest preference claim ever considered by the English courts by value. The Court of Appeal unanimously set aside the High Court’s judgment, in which the first instance Judge had found that the repayment by Comet of an intercompany loan at completion of the sale of the company by the Kesa Group (Kesa) in February 2012 was a voidable preference. The Court of Appeal’s decision resulted in £120 million being repayable to Darty along with costs.

The Court of Appeal’s judgment clarified that for the purposes of determining the relevant decision in a preference claim, a decision that is conditional on board approval or ratification does not amount to an operative decision for the purposes of that test.

Although the Court of Appeal set aside the High Court’s judgment, the first instance decision may provide an illustration of how the English courts could approach future preference claims brought in the context of distressed merger-and-acquisition (M&A) transactions. In this Sidley Update, we consider the key takeaways for parties to such transactions.

As a reminder, (broadly) a company gives a preference to a creditor if:

• The company does anything that has the effect of putting that creditor into a better position than it otherwise would have been in the event of the company’s going into insolvent liquidation
• The company was influenced in deciding to give the preference by a desire to prefer the creditor
• The company gave the preference six months before the onset of insolvency (or two years in the case of connected parties)
• At the time the company gave the preference, it was cash flow or balance sheet insolvent (or became insolvent as a result)

Background

Comet was one of the UK’s largest electrical retailers. Following the 2008 financial crisis, Comet began to experience financial difficulties due to increased competition and declining footfall, and by the financial year ending April 30, 2011, it made a retail loss of £16.5 million. Having considered various options for the company, Comet’s owner, Kesa, decided to sell the business and sought to achieve a “clean break” sale.

On November 9, 2011, Kesa entered into a sale and purchase agreement (SPA) to sell Comet to entities controlled by the private equity fund OpCapita. The core deal team on the Kesa side comprised Kesa’s General Counsel and Kesa’s CFO, both of whom were also directors of Comet. However, Comet was not a party to the SPA.

The terms of the SPA included an obligation on the buyers to procure that upon completion Comet would repay to Kesa International Limited (KIL) amounts outstanding under an intercompany loan (the KIL RCF). An OpCapita entity, Hailey Acquisitions Limited (HAL), was to advance a new intercompany loan to Comet (the HAL RCF), secured by a floating charge over all of Comet’s assets. The overall economic effect of the transaction was that in addition to Kesa assuming liability for the Comet pension scheme, KIL paid net £36.2 million to OpCapita. The existing directors of Comet, including the General Counsel and the CFO, resigned immediately before completion and were replaced with OpCapita nominees (the Post-Sale Board). Comet’s CEO remained in position.

On February 3, 2012, the Post-Sale Board approved the transaction, including the entry by Comet into a separate completion agreement in which Comet agreed to the arrangements required to discharge the amounts it owed to KIL under the KIL RCF.

In November 2012, OpCapita put Comet into administration. Comet appointed three insolvency practitioners as administrators and later liquidators of the company. Following an investigation by the Institute of Chartered Accountants in England and Wales into the conduct of the original liquidators, in June 2018 the English High Court appointed a conflict liquidator (Liquidator) to investigate potential claims arising out of the sale of Comet.

In late 2018, the Liquidator issued a claim against KIL’s legal successor, Darty, alleging that repayment by Comet of the KIL RCF at completion of the sale to OpCapita was a preference. The Liquidator also issued a claim against HAL challenging the validity of its security and served a separate claim on the Post-Sale Board for breach of directors’ duties. However, in November 2019, the Liquidator settled his claims against HAL for nominal amounts and his claim against the Post-Sale Board but continued to pursue his claim against Darty.

Decision of the High Court

The key questions before Mrs Justice Falk DBE (as she then was) at first instance were:

1. Desire to prefer: whether in repaying the KIL RCF, Comet was influenced by a desire to put KIL in a better position than it otherwise would have been in the event of Comet going into insolvent liquidation.
2. Preference in fact: whether the set-off of £73.1 million owed by Comet under the KIL RCF against amounts owed by KIL to its captive insurer, Triptych Insurance NV (Triptych), could constitute a preference given by Comet (given that KIL received nothing from Comet in return).
3. Solvency: whether Comet was insolvent at the time it repaid the KIL RCF or became insolvent as a result.
4. Remedy: if the Court considered that repayment by Comet of the KIL RCF was a preference, whether it would be appropriate for the Court to grant the remedy sought by the Liquidator (repayment of more than £83 million plus interest).

The Liquidator amended his claim multiple times including on the first day of trial to plead that:

• the General Counsel of Kesa, who was a director of Comet until he resigned at the completion meeting, had the relevant desire to prefer KIL.
• the Post-Sale Board’s resolution at completion “simply gave effect to a decision that had already been taken” on or around November 9, 2011 by Kesa when it decided to proceed with the sale and (on behalf of Comet) Kesa’s General Counsel.

Further, the Liquidator expressly disavowed the allegation that the Post-Sale Board of Comet had a desire to prefer KIL.

The Judge inferred that Kesa’s General Counsel and others on the Kesa side had a desire to prefer KIL and that Comet made the relevant decision to repay KIL at the time when the SPA was entered into on November 9, 2011. In reaching her decision, the Judge relied primarily on the terms of the SPA, which she considered were “prescriptive about what Comet would be required to do and no provision was made to cover the possibility that [Comet] would fail to take the actions contemplated.” She was not satisfied that Kesa’s General Counsel was acting solely in that capacity, given that he was also a Comet director and that he “did not see a conflict between that role and his role as Kesa’s General Counsel.” While the Judge acknowledged that the Post-Sale Board thought that it had a decision to make on February 3, 2012 (albeit a “binary one”), she considered that its approval of the transaction was simply a “formal, albeit necessary, step” to implement a decision that Comet had already made. However, none of this was put to the witnesses by the Liquidator’s counsel and, unusually, the Judge simply assumed that even if it had been, they would have denied it.

On solvency, the Judge applied the test laid down by the Supreme Court in BNY Corporate Trustee Services Ltd v Eurosail-UK 2007-3BL plc [2013] UKSC 28. In Eurosail, the Supreme Court concluded that the cash flow test requires the court to consider whether the company can pay its debts presently falling due as well as debts falling due “from time to time in the reasonably near future.” In contrast, the balance sheet test requires the court to compare “present assets with present and future liabilities (discounted for contingencies and deferment)” and to consider whether the company cannot reasonably be expected to meet those liabilities. The Judge decided that to apply the balance sheet test in a “commercially realistic manner” as required by Eurosail, she had to (among other things) consider the nature of Comet’s present assets and “in particular their future profit (or loss) generating potential.”

Applying the Eurosail test, the Judge found that Comet was balance sheet (but not cash flow) insolvent immediately before completion. Although the transaction led to an improvement in Comet’s balance sheet and one post-transaction balance sheet prepared on a generally accepted accounting principles (GAAP) basis showed that Comet had positive net assets, the Judge emphasized that the Liquidator’s expert’s calculations showed “balance sheet insolvency” prior to completion of the sale and that the majority of the post-transaction balance sheets in evidence showed negative assets. The Judge also declined to apply any significant discount to Comet’s long-term liabilities, including the KIL RCF, on the basis that “Kesa would continue to support Comet while it owned it, but only while it did so.” In her overall assessment on solvency, the Judge concluded that Comet’s outlook for profitability was “at best very uncertain” and there was “no clear evidence that the balance sheet was going to improve.”

The Judge decided the remaining key questions in favor of the Liquidator and ordered Darty to pay more than £110 million. However, she granted Darty permission to appeal to the Court of Appeal on grounds including the date of the relevant decision.

Decision of the Court of Appeal

The Court of Appeal held that the date on which the relevant decision is made for the purposes of a preference claim is a question of fact to be determined in the particular circumstances of the case. In this case, it found that there was “no basis in the evidence” for the Judge’s inferential finding that at the time the parties entered into the SPA, Kesa’s General Counsel made an operative decision on Comet’s behalf to repay the KIL RCF. In reaching its conclusion, the Court of Appeal relied on the fact that:

• Comet was not a party to the SPA and, while the SPA required Kesa to procure that Comet would do various things, it did not actually require Comet to do anything.
• Contrary to the Judge’s finding, the SPA did make provision for a failure by Comet to do what was expected of it (Kesa could terminate the agreement).
• The SPA envisaged that the Post-Sale Board would have to make a decision.
• The Judge concluded that the Post-Sale Board did make a decision on February 3, 2012, which was inconsistent with her finding that Comet had already made a decision.
• As a result of the late amendments to the Liquidator’s claim, it was not put to any witnesses that they made a decision on Comet’s behalf; although the Judge considered that did not matter because she thought Kesa’s General Counsel would have denied it, the Court of Appeal found that did not answer the question of what the General Counsel was doing on Comet’s behalf.
• It was not put to any witnesses, including Comet’s CEO, that Kesa’s General Counsel was authorized to make a decision on Comet’s behalf, such that there was an “evidential void” that could not support the Judge’s inferential finding that the Comet board was content to leave it to the General Counsel to decide to enter into the transaction.
• If Kesa’s General Counsel had made a decision on Comet’s behalf at the time the parties concluded the SPA, it was not a decision he communicated to anyone. It was therefore difficult to see how any earlier decision could have been an operative one.
• The Liquidator did not challenge the accuracy of the completion board meeting minutes, and the Judge had not found that the meeting was a sham or a charade.

Accordingly, the Court of Appeal held that the only operative decision was the Post-Sale Board’s decision on February 3, 2012, to approve repayment of the KIL RCF. Given that the Liquidator accepted that the Post-Sale Board did not have a desire to prefer KIL as at that date, the Court of Appeal set aside the High Court’s judgment in its entirety.

Key Takeaways

Factual issues were key to the Court of Appeal’s judgment as to when Comet made the relevant decision to repay the KIL RCF. However, the Court of Appeal did clarify (obiter) that while an operative decision for the purposes of a preference claim can in certain circumstances be conditional (such as an agreement to purchase property subject to the grant of planning permission), a decision subject to board approval or ratification is not an operative decision. This should provide some certainty for parties negotiating distressed sales in that, absent any evidence of a board meeting being a “sham” or a “charade”, it is unlikely that the courts will look behind a formal board resolution approving a transaction when determining when the relevant decision was taken. Accordingly, parties should ensure that they produce detailed and accurate board minutes that fully reflect everything that has been considered and done, when those steps were taken, and by whom.

The Court of Appeal also reiterated (as it has done on a number of occasions recently) that the circumstances in which it will review findings of fact at first instance, and any inferences drawn from such findings, are very limited.

Given that the Court of Appeal “found it hard to discern any clear-cut points of law on which it [could be] said that [the Judge] went wrong”, the High Court’s judgment may provide an illustration of how the courts might in the future approach preference claims in the context of complex distressed M&A transactions. Accordingly, there are several key points arising from its judgment of which parties to such transactions should be aware and on which they should ensure they seek appropriate advice:

• Types of transactions that may be challenged: The courts will consider preference claims that seek to unwind only an individual payment that is part of the wider mechanics of a M&A transaction (however complex), even if the rest of the transaction cannot easily be unwound. In these circumstances, the Court is likely to remain focused on the question of whether the principle of pari passu distribution among unsecured creditors in a liquidation has been subverted by the payment in question.
• Contributions by sellers to the target’s ongoing finances: Claimants may still seek to challenge individual repayments to sellers even if the recipient of the payment has made a significant investment in the buyer’s structure or contribution to the target’s ongoing finances in order to help ensure that the target can continue as a going concern. In this case, KIL made a capital contribution of £78.5 million into the buyer’s structure and made an overall net payment to OpCapita of £36.2 million. However, on the question of the appropriate remedy, the High Court did not give any “credit” for the amount contributed by KIL because this “did nothing to increase Comet’s assets available to unsecured creditors.
  
  Similarly, despite the fact that Kesa Electricals Plc (KEP) assumed liability for the Comet pension scheme (which had a very significant deficit), the High Court took this into account on the question of remedy only to the extent that it reduced the total amount owed to unsecured creditors in a hypothetical liquidation of Comet (on the particular facts this led to a small reduction in the amount of the preference).

• Potential conflicts of interest: The High Court emphasized that Comet’s interests might have diverged from KIL’s regarding repayment of the KIL RCF. Parties should therefore remain alert to any potential conflicts of interest (even where there is no actual conflict), including where core members of the seller’s deal team are also directors of the target. In those circumstances, parties should consider carefully whether any of those individuals should recuse themselves from decision-making and ensure that any such deliberations are fully documented. Sellers of distressed targets should also consider whether and at what stage it may be appropriate for the target to obtain independent legal advice.
• Solvency: The High Court found that Comet was balance sheet insolvent immediately before completion, despite the fact that (as mentioned above) the transaction led to an improvement in its balance sheet and that one post-transaction balance sheet prepared on a GAAP basis showed that Comet had positive net assets. Accordingly, where there are concerns regarding balance sheet solvency or the buyer’s long-term commitment to supporting the target financially, sellers should ensure that (i) the target has prepared a robust business plan and long-term cash flow forecasts that show a credible return to profitability; (ii) the parties retain evidence that those documents were produced to any board meeting at which the transaction was approved; and (iii) those approving the transaction consider the documents carefully, and their deliberations are fully documented.