Grant Whatley and Neil Golding* of Freshfields Bruckhaus Deringer discuss the consequences of the recent court decisions on the HIH group of companies in Australia.

Recent court decisions mean that the paths have now been cleared for both the English Provisional Liquidators (EPLs) and the Australian Liquidators (ALs) to proceed with the administration of the HIH group companies.

On May 26th 2006, schemes of arrangement for eight of the HIH group companies were approved by the New South Wales Supreme Court (Australian Schemes). On June 12th 2006, the English Court sanctioned schemes of arrangement for four of the key English branch HIH group companies (English Schemes).

Until its collapse in March 2001, the HIH group of companies was the second largest insurance group in Australia and to date, it has been one of Australia’s largest ever corporate collapses. It has been estimated by the ALs that the total deficit for the HIH group as a whole at the time the companies went into provisional liquidation was between Aus$3.6 billion and Aus$5.3 billion.

The collapse of such a high profile group led to a lot of public and political interest in Australia. As a result, a Royal Commission was set up to investigate the failure of the group. Its findings were reported in April 2003.

The English Schemes and the Australian Schemes are combined run-off and estimation schemes dealing with the distribution of the assets. The Australian Schemes are intended to reflect Australian insolvency distribution priorities (which, in theory, will apply to all assets worldwide). The English Schemes are designed to reflect the distribution regime that would apply in England but are limited to the distribution of only the English assets.

As a result, the English Schemes and the Australian Schemes are distinct. They do however provide for a parallel mechanism for agreeing claims and allowing co-operation between both sets of schemes. Each of the English Schemes and the Australian Schemes are intended to reflect in practice what would occur if the companies were wound up in their respective jurisdictions (including the relevant distribution priorities).

It was the implementation of the relevant distribution priorities that gave certain creditors in Australia (referred to as Amaca) the impetus to challenge the application of the relevant English distribution priorities. In particular, it was argued that English assets should be remitted to the principal liquidation for distribution in accordance with certain Australian insolvency law provisions. The EPLs (and the ALs for the purposes of the schemes in their then present form) argued that the English assets should be distributed in accordance with the English insolvency regime (ie. a pari passu distribution) and not in accordance with the Australian insolvency law provisions.

While Australian insolvency law is similar in many respects to English insolvency law, this is not the case when it comes to the distribution of reinsurance assets upon the insolvency of insurance companies. There are two relevant Australian provisions. The first is section 116 of the Insurance Act 1973 (Section 116). Section 116 provides that assets in Australia must first be applied in satisfaction of liabilities in Australia, in other words an “Australia first” priority. The other provision is section 562A of the Corporations Act 2001 (Cth) (Section 562A). Section 562A provides that reinsurance proceeds collected by liquidators should be distributed to insureds in priority to all other creditors of the company (including normal preferred creditors such as those claiming employee entitlements). Section 562A also includes sub-section (4), which allows insurance creditors to apply to court to obtain the benefit of particular reinsurance assets on just and equitable grounds.

The implementation of the English Schemes and the Australian Schemes was put on hold pending the resolution of the question raised by Amaca – namely, whether the English assets were to be remitted to Australia for distribution in accordance with the Australian insolvency provisions. The matter was eventually brought to England in July 2005.

At first instance, the English Court (Re HIH Casualty and General Insurance Limited and Ors [2006] 2 All ER 671) found in favour of the EPLs and held that it would not order that the English assets be remitted to Australia for distribution in accordance with Australian law, notwithstanding a request (in the form of a Letter of Request) from the Australian Court. The English Court held that the Court had no power to direct the EPLs to transfer funds for distribution in the principal liquidation, if the scheme for pari passu distribution in that liquidation was not substantially the same as under English law. This same conclusion equally applied in relation to a request for remission by the ALs pursuant to section 426 of the Insolvency Act (Section 426). The purpose of Section 426 is to enable the English Court to assist courts of designated territories in relation to insolvency matters. In order for the English Court to grant assistance however, it must have the jurisdiction to do so and if so, consider whether it should properly accede to such a request. The English Court also held that the EU Regulation on Insolvency, the Insurers Winding up Directive and the (soon to be imposed at the time) UNCITRAL Model Law did not apply.

Both Amaca and the ALs appealed this decision but on June 9th 2006 the Court of Appeal unanimously found in favour of the EPLs and dismissed the appeals (Re HIH Casualty and General Insurance Limited & Ors [2006] EWCA Civ 732).

In the leading judgment by Lord Justice Morritt, he explained that the EU Regulation on Insolvency, the Insurers Winding up Directive or the UNCITRAL Model Law were not relevant on the facts. Where a Letter of Request was issued from a corresponding jurisdiction pursuant to Section 426, then the starting point was a consideration of that section.

In terms of jurisdiction to entertain a Section 426 request, the Court of Appeal provided different reasons than had been set out in the decision at first instance. The English Court at first instance held that the Court had no power to disapply any substantive rule forming part of the English statutory insolvency regime. However, the Court of Appeal held that Section 426, which is itself a part of the statutory scheme, can in fact authorise a transfer from the liquidators of an ancillary winding up to the liquidators in a principal liquidation. In some circumstances, it may be of benefit to the creditors that remission actually occurs (eg. costs savings and increased dividend and/or asset pool), even though, looking in isolation at the interests of English creditors, those rights may be adversely affected.

In terms of the exercise of the Court’s discretion, the Court of Appeal indicated that the Court should comply with a request if it was proper to do so (but as explained below it did not do so in this case). In examining whether it should do so, the Court will consider all the circumstances, including whether the transfer sought will prejudice the creditors or any class of them and whether there would be other advantages sufficient to counteract such prejudice.

The Court of Appeal held that because of the effect of Section 562A, it was clear in this case that (i) the transfer would prejudice all creditors except Australian insurance and reinsurance creditors; (ii) that the benefit of the advantaged creditors could not counteract the prejudice suffered by all other classes of creditors; and (iii) there were no advantages or any benefits obtained from avoiding duplication enabling the Court to conclude that a transfer would be in the best interests of the estate as a whole. The Court of Appeal also considered that the rules of private international law (referred to in Section 426) had no effect in this case.

The Court of Appeal finally considered whether it made any difference that the companies were not in “full” liquidation in England. In agreeing with the Court at first instance, the Court of Appeal indicated that it did not make any difference. Absent the schemes of arrangement (which were approved by the Australian Courts on May 26th 2006 and by the English Courts on June 12th 2006), there would be good reason for the Court in England to make winding up orders - namely, the justified concerns of all of those creditors other than the Australian insurance and reinsurance creditors who would be prejudiced by a remission of English assets to Australia for distribution.

The Court of Appeal refused leave to appeal to the House of Lords and awarded the EPLs their costs of the appeal.

As both the English Schemes and the Australian Schemes have been sanctioned by the Courts, the pathways are now clear for both sets of scheme administrators to seek to declare interim dividends for some of the larger of the companies within the HIH Group. Any appeal of the decision of the Court of Appeal will not prevent either of the schemes from proceeding as the English Schemes have an inbuilt mechanism dealing with any appeal result relating to the remission question.

*Neil Golding is a Partner and Grant Whatley is an Associate in the Dispute Resolution department of Freshfields Bruckhaus Deringer, which acted on behalf of the EPLs in relation to the application for remission (including the appeal) as well as jointly (with Australian lawyers) advising the parties regarding the implementation of the schemes of arrangement.

This Special item appeared in issue 107 of JTW News - July - August 2006

Author: Grant Whatley | Neil Golding - Freshfields Bruckhaus Deringer