English High Court awards £90M to liquidator in landmark preference claim

In November 2022 the High Court in London awarded the liquidators of British electronics retailer, Comet Group Ltd (Comet), approximately £90 million following a successful preference claim.¹ This is understood to be the largest preference award in English legal history. The claim was vigorously contested, and the judgment contains a detailed analysis of the law relating to preferences in the context of a complex distressed M&A transaction.

Background

Comet was founded in 1993 and by 2011 it operated 249 stores and was one of the UK's largest electrical retailers. Comet was owned by the Kesa group (Kesa) and the members of Comet's board were senior Kesa executives, including Kesa's CEO, CFO and Group General Counsel.

Comet began experiencing financial difficulties in 2010, when it reported a loss of £3.8 million. The following year, the loss had increased to £31.8 million. Kesa sought to exit its investment in Comet and invited interested parties to submit bids. OpCapita, a private equity fund specialising in distressed retailers, agreed to buy Comet as a going concern through a share sale. Kesa was keen to sell Comet as a going concern for wider, reputational reasons and wanted a deal that involved a "clean break" to cap its downside risk. One of the pre-requisites for the deal was that Kesa required repayment by Comet of a £115 million intercompany unsecured revolving credit facility granted by Kesa International Limited (Kesa's group treasury company) (KIL) (the KIL RCF). The funds to repay KIL were to come from a new loan made by Hailey Acquisitions Limited (HAL) (the HAL RCF), which was to be the buyer of the Comet shares. The HAL RCF was to be fully secured against Comet's assets. These terms were documented in a SPA (to which Comet was not a party), which was entered into in November 2011.

The SPA provided that Comet was to enter into a completion agreement, prior to which all but one of Comet's directors would resign and be replaced by new board members made up of the purchaser's nominees (the New Board).

In February 2012, following a review of Comet's financial position, the New Board approved entry into the Completion Agreement and the HAL RCF and repayment of the KIL RCF.

Following the transfer, Comet continued to trade until November 2012, at which point it went into administration.

The elements of a preference claim under English law

Under English law, a company gives an unlawful preference where it does something (or suffers something to be done) which has the effect of putting a creditor in a position which, in the event of the company's subsequent insolvency, will be better than the position it would have been in had the thing not been done. Typically, a preference involves paying a particular creditor whilst others are left unpaid.

Once the basic premise of a preference has been established, further criteria must be satisfied.

First, the preference must have been given within six months of the commencement of administration or liquidation. However, this is extended to two years if the parties are connected (as was found to be the case with KIL and Comet in a preliminary hearing).

Secondly, at the time of the alleged preference, the company must have been insolvent or it must have become insolvent as a result of the preference.

Thirdly, and crucially, the company must have been influenced by a desire to put the recipient of the preference in a better position than would otherwise have been the case in the company's liquidation. Where the parties are connected (as was the case with Kesa and Comet), the desire to prefer is presumed, but this presumption may be rebutted by evidence to the contrary. Existing case law has clarified that a desire to prefer is subjective and need not be the dominant purpose of the transaction.

Timing is also important: the presence or otherwise of a desire to prefer must be assessed at the time of the decision to enter into the relevant transaction. This will not be necessarily when the transaction actually occurred.

The claim and Darty's defences

The repayment of the RCF was not initially challenged by Comet's administrators but in 2018 (by which time the administration had been converted into a liquidation) an independent conflict liquidator was appointed to investigate the transaction.

Proceedings were commenced in October 2018 against the French electricals company, Darty Holdings (Kesa's successor) (Darty). Darty submitted (amongst other things) that:

1. there was no desire to prefer KIL on the part of Comet. In particular, Darty argued that the directing mind of Comet was the New Board and the New Board, made up principally of the purchaser's nominees, had no desire to prefer KIL;
2. Comet was not insolvent at the relevant time; and
3. even if there was a preference, the court should exercise its discretion against making an order because there were 'exceptional circumstances', including the fact that the preference had been part of a larger transaction and there was now no simple way to restore the position to what it would have been if the preference had never been given.

The decision of the High Court

Addressing each of these arguments in turn, the High Court (Mrs. Justice Falk) held that:-

1. The disposal of Comet was deliberately structured to have the effect that the RCF was repaid, and Kesa "positively desired to achieve that result". One member of the core deal team for Kesa was a director of Kesa at group level and also a director of Comet: he acted on behalf of the Kesa Group as a whole, including Comet. The Judge found that "Kesa was driven entirely by the desire for a clean break, whilst meeting its objective of leaving Comet with a capital structure that could allow it to continue as a going concern. No separate interest of Comet was perceived to exist." In the circumstances, even though Comet had not been a party to the SPA, the Judge held that this did not prevent the key decision to repay the KIL RCF having effectively been made on behalf of Comet at the time of the SPA. Thus, by the time the New Board was put in place to approve completion, the decision to enter into the transaction (including the repayment of the KIL RCF) had already been made and what occurred at completion in February 2012 was "a formal, albeit necessary, step to allow that decision to be implemented." The Judge found that whilst, in theory, the New Board could have refused to approve the deal, "in substance the decision had already been taken": if the New Board had refused to implement that decision they "would have been sacked and replaced". In such circumstances, their role was merely "careful choreography", and the desire to prefer was to be assessed by reference to Comet's board at the time of the SPA.
2. Comet was insolvent on a balance sheet basis at the time of the repayment of the RCF. In particular, having heard expert witnesses for both parties, the Judge concluded that it was not appropriate in the circumstances to include a deferred tax asset of £44 million on the balance sheet, as Comet had done in statutory and management accounts. Without this "asset", Comet's balance sheet showed substantial negative net assets.
3. Just because the preference may have been part of a larger, complex transaction does not mean that the court should decline to make an order. The court must "do the best it can" and the appropriate award "is one that restores the position to what it would have been if a preference had not been given." In this case, this was the difference between the £115.4m repaid to Kesa and the dividend that Kesa would have received as an unsecured creditor in a hypothetical liquidation of Comet if the sale of Comet had never occurred.

Takeaways

Although concerned specifically with English law on unlawful preferences, this case is of broader import insofar as it provides a reminder that the interests of an insolvent company (and by extension its creditors) must be considered separately and independently from its wider group or the larger transaction when structuring any distressed M&A transaction or debt restructuring. Failure to do so will heighten the risk of challenge if the company were subsequently to fail. The High Court's focus on the underlying substance to determine when, and by whom, relevant decisions were made further illustrates that courts will be prepared to look through the form and any perceived corporate "choreography" when considering claw back claims.