Scottish Court of Session Decisions

OUTER HOUSE, COURT OF SESSION [2013] CSOH 45
P58/13	OPINION OF LORD HODGE in the petition of PAUL HOWARD FINN and MICHAEL FIELD, JOINT LIQUIDATORS OF DIRECT SHAREDEAL LIMITED Petitioners; For DIRECTIONS ________________

Petitioners: Sellar, QC; Maclay Murray and Spens LLP

20 March 2013

[1] This is an application for directions by the joint liquidators ("the liquidators") of Direct Sharedeal Limited ("DSL") under section 112 of the Insolvency Act 1986 ("the 1986 Act"). From 12 April 2011 DSL was in administration. The liquidators were appointed in a creditors' voluntary liquidation with effect from 12 April 2012.

[2] DSL conducted investment business in the United Kingdom and was authorised by The Financial Services Authority (the "FSA") to do so. In accordance with that authorisation DSL was obliged to comply with rules that the FSA made under the Financial Services and Markets Act 2000 ("FSMA"). DSL failed to comply with the FSA's rules in the Client Assets Sourcebook ("CASS 7") in relation to the identification and segregation of client money.

[3] In the circumstances that I set out below, issues have arisen (i) as to how the liquidators should identify the clients who are entitled to claim a dividend from the funds which they hold and (ii) how the costs and fees incurred in carrying out that exercise are to be met. The liquidators ask the court to determine questions arising in the winding up in order to obtain directions on these matters.

Factual background

[4] DSL held clients' money and other assets as well as its own funds in two subsidiaries which acted as its nominees. They were DSL Nominees Limited and DSL Client Nominees Limited ("DSLCN"). Both companies are now in liquidation. DSL originally carried on its business in three parts. First, it bought and sold shares on behalf of clients. It placed client monies relating to this share-dealing business in Kas Bank NV ("Kas Bank") in the name of its nominee, DSLCN. DSL sold the share-dealing business to ODL Securities Limited ("ODL") in about August 2010 and transferred about £18 million to ODL before the start of the administration. The second part of the business was an automated facility for buying and selling contracts for differences ("CFDs"). The client money in connection with the CFD business was held by MF Global Holdings Limited ("MFG") in an omnibus account and sub-accounts. The third part of DSL's business included managing investment portfolios for clients.

[5] DSL carried on business in the United Kingdom and the Republic of Ireland and its clients resided in those countries. Most of the clients were private individuals and not institutional investors. DSL's creditors comprise its clients, who enjoy certain protections under CASS 7, and ordinary unsecured creditors, who do not.

[6] CASS 7 required DSL to identify client money and promptly to pay it into a segregated account for each client or to have systems that preserved the identity of client funds. On the insolvency of a "firm" such as DSL, the client money is to be pooled and held in trust for the clients pari passu in the event of any shortfall.

[7] As far as the liquidators have been able to determine, DSL complied with its obligations under CASS 7 in relation to its CFD business by segregating funds in the MFG accounts. Client money from the MFG accounts was transferred to the liquidators when they were acting in their former capacity as administrators.

[8] By contrast, DSL seriously failed to comply with its obligations under CASS 7 in relation to client money from its share-dealing business. It failed to pay the client money into a segregated account, as one approach requires, or to have adequate systems to identify client money in its own accounts, as the alternative approach requires. DSL operated a large number of bank accounts with Kas Bank. Those accounts fall into two categories, namely (i) a Kas Bank share account in the name of DSLCN and (ii) Kas Bank currency accounts. The bank accounts were not designated as client accounts but were used at least in part for the receipt and payment of dividends on the investments held on behalf of clients and for other transactions relating to the share-dealing business. DSL also withdrew funds from the Kas Bank accounts to pay itself fees and commissions. It also made significant unauthorised withdrawals of funds from the Kas Bank accounts before it went into administration. The liquidators, in their previous capacity as administrators, recovered £728.383.68 from the Kas Bank accounts in December 2011. They believe that £638,352.08 of that sum represents client money.

[9] The liquidators have recovered in aggregate £2,671,524 from MFG and Kas Bank. In their former capacity as administrators they have repaid £761,543 to clients who were entitled to the proceeds from CFDs to which the CASS 7 rules had been properly applied. DSL now holds net funds amounting to £1,909,981 and the liquidators estimate that about £1.8 million of that sum should be regarded as client money. The liquidators have received claims from clients of about £5.2 million. DSL owed other creditors about £1 million. There is a substantial shortfall of funds to pay creditors. As a result client creditors have claimed compensation from the Financial Services Compensation Scheme Limited (the "FSCS").

[10] On 29 March 2012 the FSA declared DSL to be in default, thereby entitling clients to claim that compensation. Clients who are eligible claimants will receive compensation up to a limit of £50,000. The liquidators estimate that as a result the FSCS will compensate in full about 90% of DSL's clients. The FSCS will then acquire an assignment of the rights of those clients against DSL. The FSCS will ultimately have the largest interest in the outcome of the liquidation and the liquidators have liaised closely with it and informed it of the terms of this application.

The need for directions

[11] The liquidators have searched DSL's archive records and have contacted individual financial advisers and fund managers, who had introduced clients to DSL, in order to identify DSL's clients. They have also liaised with the FSCS to identify clients who have made a claim directly to the FSCS. But because of the inadequate state of DSL's records the liquidators need to establish an authoritative method of bringing finality to the identification of clients who are entitled to claim as beneficiaries of a statutory trust under CASS 7 and the amount of their claims. The liquidators also seek a direction as to the payment of the expenses of this application and remuneration for their work in tracing client money, identifying clients, adjudicating on their claims and distributing the funds among the eligible claimants.

Discussion

(i) Ascertaining the claims on the pooled client money

[12] Mr Sellar QC for the liquidators submitted that there should be implied into CASS 7, which created a statutory trust in favour of a firm's clients, a mechanism to identify the beneficiaries of that trust. Alternatively, he submitted that the general law of trusts in Scotland supported the existence of such a mechanism and that the court had an inherent jurisdiction to supervise a Scottish private trust.

[13] Section 139(1) of FSMA seeks to create a fiduciary relationship between a firm and its client by providing that the FSA may make rules which result in client money being held by a firm on trust or in Scotland as an agent for a person who is entitled to call for it to be paid over to him or to be paid on his direction or to have it otherwise credited to him. Rule 7.7.2 of CASS 7 provides:

"A firm receives and holds client money as trustee (or in Scotland as agent) on the following terms:

(1) for the purposes of and on the terms of the client money rules and the
client money distribution rules;

(2) subject to (4) for the clients ... for whom that money is held, according
to their respective interests in it; ...

(4) on failure of the firm, for the payment of the costs properly
attributable to the distribution of the client money in accordance with (2); ..."

In Re Lehman Brothers International (Europe) (No 2) [2012] BCLC 487 (SC) the Supreme Court held that the statutory trust created by that rule arose on the receipt of funds by the firm before the segregation of funds and regardless of whether there was any segregation.

[14] I share Lord Drummond Young's doubts as to the reasons for the different wording in the section and the rule in relation to Scotland (which Lord Hope mentioned in paras 13 and 14 of his judgment). But it appears that nothing may turn on that in this case as the Supreme Court has construed the relevant provisions of CASS 7 as creating a statutory trust.

[15] Rule 7A 2.2R of CASS 7 provides that a primary pooling event occurs on the failure of the firm and Rule 7A 2.4R provides:

"If a primary pooling event occurs:

(1) client money held in each client money account of the firm is treated
as pooled; and

(2) the firm must distribute that client money in accordance with CASS
7.7.2R, so that each client receives a sum which is rateable to the client money entitlement calculated in accordance with CASS 7A 2.5R."

In Lehman Brothers (above) the majority of the Supreme Court interpreted CASS 7 in the light of the overriding intention of the MiFID Directives to achieve a high level of protection for investors' money. The majority of the court held that all clients whose money had been received by the firm were entitled to participate in the client money pool under CASS 7 in accordance with their respective money entitlements, regardless of whether their money had been segregated.

[16] As it is regrettably foreseeable that a failed firm may on occasion have inadequate records of its client money, a mechanism is needed to give effect to the statutory trust and to the rateable distribution of the client money pool.

[17] Mr Sellar's primary case is that the court should treat such a mechanism as implied in CASS 7. In Lehman Brothers (above), Lord Dyson (at para 131) approved a statement in the judgment of Briggs J at first instance (at [57]) that

"domestic legislation which is made for the purpose of fulfilling the requirements of EU law in a Directive must be interpreted in accordance with the following principles: (i) it is not constrained by conventional rules of construction; (ii) it does not require ambiguity in the legislative language; (iii) it is not an exercise of semantics or linguistics; (iv) it permits departure from the stricter and literal interpretation of the words which the legislature has elected to use; (v) it permits the implication of words necessary to comply with Community law; and (vi) the precise form of the words to be implied does not matter."

In that case the Court of Appeal also treated CASS 7 as a statutory code and recognised that gaps in the code could be filled in by the general law ([2011] 2 BCLC184, Arden LJ at paras 67 and 77 and Lord Neuberger MR at para 226).

[18] It seems to me that the decisions of the Court of Appeal and the majority of the Supreme Court point to a purposive approach to CASS 7 that would allow the implication of machinery to give effect to the policy that the regulatory document was designed to achieve. That is the entitlement of all clients who had given their funds to the firm to participate in the client money pool, regardless of the firm's failure to comply with its regulatory obligations in relation to the identification or segregation of the trust funds.

[19] In Attorney General of Belize v Belize Telecom Limited [2009] 2 All ER 1127 (PC) the Privy Council considered an argument that terms were to be implied into the articles of association of a company. In its judgment, which Lord Hoffmann delivered, the Privy Council stated (in para 21) that

"in every case in which it is said that some provision ought to be implied in an instrument, the question for the court is whether such a provision would spell out in express words what the instrument, read against the relevant background, would reasonably be understood to mean."

I am content to adopt that approach in relation to CASS 7 as it is consistent with what Lord Dyson stated (para [17] above).

[20] I am satisfied that the court can imply into CASS 7 a judicial power to give directions to achieve a means of identifying the clients of DSL and to give finality to the process of their ascertainment. I note by way of analogy that in Re W W Realisation 1 Ltd (in administration) [2012] 1 BCLC 405, David Richards J gave directions setting out a time limit by which claimants could lodge claims that would be expenses of an administration in order to allow the administrators to perform their statutory role.

[21] It is not strictly necessary for me to consider Mr Sellar's submission in support of other bases for such a power but I will state my views briefly. He submitted that our trust law imposed on a trustee a duty to take all reasonable steps to ascertain the identity and claims of creditors of the trust and also the equivalent duty to ascertain the identity and claims of beneficiaries of the trust. Interestingly, he could point to no express authority; but his submission must surely be correct. A trustee is under a duty to pay first the creditors of the trust and then the correct beneficiary or beneficiaries. He must therefore be under a prior duty to ascertain who those people are. In the absence of a more direct means of ascertainment, it seems to me that the trustee must do so by placing advertisements in appropriate newspapers and by setting a reasonable timetable within which people must give notice of their claims. Although there was no equivalent in Scots law to section 27 of the Trustee Act 1925, a similar regime provides a mechanism by which the trust can be implemented. It is appropriate therefore that the court should direct the liquidators to carry out defined steps to achieve that ascertainment.

[22] Mr Sellar also referred me to authorities on the power of the court to supervise a Scottish private trust. They appear to me to be somewhat removed from the circumstances of this case and I prefer to decide on other grounds that the court has power to issue such a direction to give effect to the regime set out in CASS 7 and also to enable the liquidators as statutory trustees to fulfil the obligations imposed on them by the statutory trust.

[23] In the petition the liquidators ask for a series of directions to establish, first whether it is appropriate in principle to ascertain the identity and claims of clients by reasonable advertisements in newspapers published in the United Kingdom and Ireland and setting a reasonable time limit of on the intimation in writing of such claims, secondly, the appropriate number of national newspapers in each country and the appropriate time limit and, thirdly, the more detailed application of those principles. While that disaggregation was useful to the presentation of the liquidator's submission, I see no need for so complex a series of directions as I consider that what the liquidators propose is reasonable.

[24] I propose therefore to direct that the liquidators, if they have not been able to their reasonable satisfaction to identify by other means the clients with rights against DSL in relation to the CASS 7 trust or their rights, are to ascertain those clients and/or their rights by (i) sending by first class post written notification to each of those clients who have been identified to the reasonable satisfaction of the liquidators and (ii) causing to be published advertisements in two national newspapers in the United Kingdom and one national newspaper in the Republic of Ireland, which notifications and advertisements are to state that any client must submit a written claim of his rights, with supporting vouching of his claim, within 28 days of the date on which the last of those notifications is given or the last of those advertisements is published, failing which that person will be excluded from any distribution which is made under the CASS 7 trust.

(ii) The remuneration of the liquidators

[25] The liquidators will need to spend time and money on this process of ascertainment and in tracing client money in the Kas Bank accounts and other bank accounts. They do not have sufficient funds in the liquidation of DSL from which to fund this application or for their remuneration for work in this application and giving effect to the direction. They therefore seek a direction (a) that the expenses of this application will be expenses in the liquidation and (ii) that the liquidators are to be paid, out of client money, remuneration for (a) their work in making this application, (b) their future work in giving effect to the direction and (c) their future work in tracing client money .

[26] It seems to me that this is a novel application in this jurisdiction. In England the courts have such entertained applications and used an equitable principle to achieve a similar result (Re Berkeley Applegate (Investment Consultants) Ltd [1989] Ch 32). The English courts have asserted an inherent jurisdiction over trusts and, using the principle of salvage, have authorised the reimbursement of trustees. See, for example, Re Staffordshire Gas and Coke Co [1893] 3 Ch 523, In re Downshire Settled Estates [1953] Ch 218, and Merry v Pownall [1898] 1 Ch 306.

[27] Mr Sellar submitted that a similar approach applied in Scottish trust law in part because Menzies on Trustees (at sections 1186 and 1214) cited two of those cases. But, as is well known, Menzies frequently cited English cases because there was no reported Scottish authority. I would be reluctant to develop a new doctrine based on such citation. Nonetheless, I have no doubt that a trustee has a right to be reimbursed out of the trust estate. I am also satisfied that Boardman v Phipps [1967] AC 46 provides authoritative guidance in Scots trust law. In that case, as is well known, fiduciaries were not allowed to retain a profit from a share purchase which was an opportunity which arose when they were acting in a fiduciary capacity. But because they had acted openly although mistakenly, they were allowed to retain in the accounting their expenditure and a liberal allowance for their skill and work in generating the profit for the trust.

[28] I observe also that this application is concerned with the directions that the court may give to a liquidator under section 112 of the 1986 Act. The liquidators as officers of the court are tasked with the winding up of DSL and find themselves responsible for the administration of a statutory trust. St Clair and Drummond Young suggested in Corporate Insolvency in Scotland (4^th ed.) at para 12.25 that Scots law would achieve a similar result to Berkeley Applegate. I agree. It seems to me that the liquidators could advance a claim in the general law for their expenses and outlays on the basis of negotiorum gestio. I consider also that they are entitled to reasonable remuneration for their work in relation to the statutory trust. I think that entitlement is consistent with the approach of the House of Lords in Boardman v Phipps and it is more specifically consistent with Rule 7.7.2 (4) of CASS 7 (paragraph [13] above) which provides that the client money may be used to pay the costs properly attributable to its distribution.

[29] At the first hearing of this application I asked who was to approve the liquidators' remuneration. Solicitors for the liquidators then discussed the issue with the FSCS. At the later hearing Mr Sellar proposed that the FSCS should perform that role as it will have compensated the clients and obtained an assignation of their rights. The FSCS has by letter agreed to undertake that role. It has (as it cautiously stated) a "significant" interest in the trust estate. Mr Sellar pointed out that under rule 7.2 of the FSA Handbook (as it was on 11 April 2011) the FSCS would, by virtue of the assignation, have the only interest in relation to claims which it compensated except where it recovered more than the sum paid in compensation of a claim (Rule 7.2.4). The liquidators do not expect that there will be such a surplus.

[30] I am prepared to direct that:

(a) the expenses of this application are to be expenses of the liquidation and be paid out of the client money;

(b) the liquidators are to be paid, out of the client money, reasonable remuneration for their work in making this application and for their future work in giving effect to the direction in paragraph [24] above;

(c) the liquidators are also to be paid, out of client money, reasonable remuneration for their future work in tracing the client money which is, or was, held in the bank accounts which DSL held through its nominee DSLCN with the Kas Bank; and

(d) the liquidators are to present their accounts and claims for remuneration and reimbursement of expenses to the FSCS for approval and to obtain its approval before debiting the client money therefor.

[31] The direction should enable the liquidators to perform the statutory trust. But if any difficulties arise in relation to the approval of remuneration and reimbursement of expenses, they may make a further application to the court for directions.

Conclusion

[32] I therefore make the directions set out in paragraphs [24] and [30] above.