Supreme Court allows appeal finding banks not unfairly prejudiced by examiner's proposals due to lack of evidence.

THE SUPREME COURT

77 & 81/11

Fennelly, J.

Macken, J.

Finnegan, J.

O'Donnell, J.

McKechnie, J.

BETWEEN:

IN THE MATTER OF MCINERNEY HOMES LIMITED

AND IN THE MATTER OF MCINERNEY HOLDINGS LIMITED PUBLIC COMPANY, MCINERNEY CONSTRUCTION (HOLDINGS)

LIMITED,

MCINERNEY CONTRACTING LIMITED,

MCINERNEY CONTRACTING DUBLIN LIMITED,

(EACH A RELATED COMPANY),

AND IN THE MATTER OF THE COMPANIES (AMENDMENT) ACT 1990 (AS AMENDED)

MCINERNEY HOMES LIMITED

AND

MCINERNEY CONTRACTING LIMITED

APPLICANTS

JUDGMENT of Mr. Justice Fennelly delivered the 22nd day of July 2011.

1. O’Donnell J has delivered a thorough, not to say exhaustive judgment on the wide range of issues arising in this examinership.

Regrettably, I find myself unconvinced on a certain number of points. There are, however, powerful reasons for the delivery of a clear

judgment. O’Donnell J expresses the majority view. I will content myself with a brief expression of my reservations.

2. The focus of the present proceedings both in the High Court and in this Court has been on the question of whether the Banks

(Bank of Ireland, Anglo-Irish Bank and KBC) as creditors can be said to be unfairly prejudiced by the Examiner’s proposals. Section

24(4) of the Companies (Amendment) Act, 1990 provides that the High Court “shall not confirm any proposals…(c) unless the court is

satisfied that… (ii) the proposals are not unfairly prejudicial to the interests of any interested party.” The Examiner bears the burden

of establishing that his proposals are not “unfairly prejudicial.” Section 25(1) provides that at a hearing under section 24 “ a member

or creditor whose interest or claim would be impaired by the proposals may object in particular to their confirmation by the court…”

One of the grounds of objection is under paragraph (d) that the proposals unfairly prejudice the interests of the objector.” Other

possible grounds of objection are, for example, that “there was some material irregularity at or in relation to a meeting to which

section 23 applies,” [Paragraph (a)] or that (acceptance of the proposals by the meeting was obtained by improper means”

[paragraph (b)]. It may be that the burden of establishing such a ground of objection would fall on the party alleging it. That does

not, in my view, affect the burden of proof under section 24. The right to object on the ground of unfair prejudice was probably

included in section 25 ex abundante cautela. It does not affect the burden of proof. It is a burden on the balance of probabilities to

be discharged by the examiner.

3. How that burden is to be discharged is another matter. Most particularly, the meaning of “unfair prejudice” will need to be

considered, firstly, in the general context of the purposes of the system of examinership and, secondly, in the particular context that

the creditor of an insolvent company is necessarily prejudiced financially by the very fact that his debtor is no longer able to meet his

debts in full.

4. On the first point, it is useful to recall the remarks of McCarthy J in his judgment in In Re Atlantic Magnetics [1993] 2 I.R. 561 at

578:

“It is, I believe, of great importance to bear in mind in the application of the Act that its purpose is protection -

protection of the company and consequently of its shareholders, workforce and creditors. It is clear that parliament

intended that the fate of the company and those who depend upon it should not lie solely in the hands of one or more

large creditors who can, by appointing a receiver pursuant to a debenture, effectively terminate its operation and secure,

as best they may, the discharge of the monies due to them, to the inevitable disadvantage of those less protected.”

5. In the case of In Re Traffic Group Limited [2008] 3 I.R. 253 at 260, Clarke J made a number of observations concerning how this

burden would be discharged:

“5.5. It is clear that the principal focus of the legislation is to enable, in an appropriate case, an enterprise to continue in

existence for the benefit of the economy as a whole and, of equal, or indeed greater, importance to enable as many as

possible of the jobs which may be at stake in such enterprise to be maintained for the benefit of the community in which

the relevant employment is located. It is important both for the court and, indeed, for examiners, to keep in mind that

such is the focus of the legislation. It is not designed to help shareholders whose investment has proved to be

unsuccessful. It is to seek to save the enterprise and jobs.”

“5.7. It seems to me, therefore, that a court should lean in favour of approving a scheme where the enterprise, or a

significant portion of it, and the jobs or a significant portion of them, are likely to be saved.”

“5.10. Where there is a high level of likelihood that the company can survive with a consequent saving of a significant

enterprise and at least a significant proportion of the jobs at stake, the court should lean in favour of confirmation……”

6. It follows, in my view, that a court, in considering the discharge by the examiner of the burden of proof which lies upon him to

demonstrate that no interested party will be unfairly prejudiced, must bear these considerations in mind. The creditors’ right to have

their interests considered must be placed in context. The context is that the examiner’s function, he having been appointed by the

court, is to examine the feasibility of adopting proposals to enable the company to continue as a going concern. The creditors’

interests will necessarily be considered by comparison with the possibilities open to them in a liquidation or, as in this case, in a

receivership. Clarke J expressed the matter as follows, in a passage which includes a quotation from a different part of his own

judgment in Re Traffic Group Limited:

“Authorities which are concerned with unfairness as and between members of the same class are, at least in most cases,

of little assistance in assessing what should be considered fair or unfair where a scheme of arrangement deals separately

with members of different classes of creditors. Given that the backdrop to an examinership is that a company is insolvent,

it seems to me that very significant weight indeed needs to be attached to what would be likely to be the outcome of the

alternative to examinership, whether it be liquidation, receivership or a simple withering of the company without any

formal insolvency process. While it is clear from Re Antigen Holdings [2001] 4 I.R. 600, that the court retains a discretion

to approve a scheme of arrangement even though it may be that a party might do better under (say) liquidation than

under the proposed scheme, it nonetheless remains the case that, as I pointed out at para. 6.10 of Re Traffic Group

Ltd……a disproportionate disparity between the position of a creditor on winding up and under the scheme proposed

compared with the position of other creditors under both alternatives might be a factor to be properly taken into account

in ruling against confirmation of the scheme.”

7. The companies complain that, in the present case, Clarke J did not afford sufficient weight to either the principle that the purpose

of the legislation is the rescue of the company or to the proposition that, where it is apparent that the scheme of arrangement would

enable it to survive, deference should be shown to the views of the examiner. They say that the Examiner is not an advocate for any

party but is an independent officer of the Court. The Examiner has made it clear that he is of the view that his proposals represent

the best available outcome for all interested parties, including the Banks.

8. The companies stress that, in this case, 109 jobs may be saved and that so may be the livelihoods of subcontractors who have

been reliant on the companies for the survival of their own businesses. They say that the wider effects on the community and the

economy of the failure of a viable business, and investment funds committed by an outside investor were not sufficiently considered.

9. The companies complain that, although these arguments were advanced at the hearings, the learned judge made no reference to

them, or to the legislative purpose of the Act, in any of his five written judgments.

10. The principal and indeed the simplest issue which convinces me that the Banks will not be unfairly prejudiced is the issue of

treatment of “Work in Progress” (or WIP) in the receivership scheme put forward by the banks as their preferred alternative to the

examinership. Under the examiner’s proposals, the Banks would receive €25m in respect of their total debts of over €100m. Under their

receivership “controlled workout” they would realise €75m. over eleven years. After discounting, that figure would come back to

€50m.

11. Included in the cash flow sheet presented by the Banks is a figure of €22.4m. in respect of total “WIP release.” That is the total

figure for the full eleven years. It is the figure which, if the inclusion of the WIP is correct, the hypothetical receiver acting for the

Banks would receive.

12. According to the companies, it is simply wrong to include the WIP figure at all for the very simple reason that it does not and

cannot represent income to the receiver. The receiver, as I understand it, would take possession of the properties, i.e., sites and

incomplete houses. He would complete them, incurring costs for that, and then sell them. The WIP represents the value of the work

already incurred by the companies in bringing them to the state they are in or will be in at the date the receiver takes possession. On

each sale over the assumed eleven years, the receiver will sell the houses. The revenue will consist of the selling price received less

costs incurred by the receiver. The receiver would never receive any monies representing WIP. It is simply an accounting figure: it is

there to represent costs already incurred.

13. Insofar as the Banks, in objecting to the examiner’s proposals, claimed to have relied on the companies’ own plans derived from

the reports of the companies’ experts, it is important to note a fundamental distinction between the two exercises. The companies

were assessing what the future position might be for the Group as an ongoing entity. In such a situation, it is normal accounting

practice to include all the costs including all costs including costs already incurred. In the case of the Banks’ own workout proposal,

the objective is to estimate what revenue a receiver will be able to recover on behalf of the Banks. That will not include costs already

incurred by the companies.

14. I believe the figures as presented on behalf of the Banks are consistent with that simple analysis. It is sufficient, for the purpose

of this discussion, to cite only the total figures from the “Summary Analysis of Prospective Recovery on a Controlled Work Out of the

Portfolio,” (which I will call the “workout proposal”) presented on behalf of the banks as part of their case of unfair prejudice. Total

Revenue is estimated at €327,061m. To be deducted is the total figure of what is significantly described as “Construction Cost to be

incurred.” (emphasis added) After other deductions, which are not significant for this point, the net profit figure is €53,086m. There

then occurs the crucial addition of the total figure for “WIP Release” at €22,353m. That gives the total of €75m. If it were not for the

WIP figure, the return from the hypothetical receivership would be sufficiently close to the offered figure of €25m. to show that the

Banks would not be unfairly prejudiced and that there would not be a “disproportionate disparity,” to use the phrase from the

judgment of Clarke J in Re Traffic Group Limited.

15. The “Summary Analysis,” so far as costs are concerned was supported by a report from DTZ Sherry Fitzgerald designed to provide

“inputs to a controlled workout business plan model being considered for the McInerney Homes business.” The “specific inputs

provided” included market value of completed housing and “approximate costs of construction and other related costs.” The report

was based on an inspection of all the properties. “We have prepared estimates of costs of various costs remaining on a site by site

basis……” A table in that report is headed: “Remaining Average Cost per Site…” (emphasis added)

16. The Examiner examined these figures in a report which was before the court. Having explained the method of computing gross

profit, he continued:

“The model then includes a section entitled “cash flow statement” which takes the net profit as computed above and

adds an amount for “WIP Release” totalling €22.4m. It is unclear as to what house sales or revenue generation technique

will lead to these cash flows, as the model described above encompasses the sales and cost of sales for all plots……With

the increased unit construction, the WIP investment increases with the corresponding cash requirement in each year. We

cannot, therefore, understand the “WIP Release” line in the model, which is positive and growing year on year.”

17. On 16th December 2010, (the Thursday before the hearing due to take place on Monday, 20th December) the solicitors for the

Banks wrote to the solicitors for the Examiner stating that the line, quoted above from the workout proposal which read “Construction

Cost to be incurred,” should have read “Construction costs incurred/to be incurred.” This apparently was intended to convey that the

WIP figure was to be treated as included in the costs to be deducted from the selling price. If so, it was far from clear in conveying

that. The letter made no reference to WIP at all. Most importantly, it was not the subject of any affidavit for the purpose of the High

Court hearing.

18. One of the principal matters of which counsel for the companies complained at the hearing of the appeal was that the learned trial

judge, at a very late stage of the hearing on 21st December 2010, nonetheless permitted counsel for the banks to “speak from his

instructions” and to explain that “a further sum…………ought to be included in work in progress as it currently stands to reflect the

enhanced value of various sites on which significant construction work had not yet occurred, but where money had been expended on

planning, infrastructure or the like.” The learned judge indeed permitted further explanation to be given in this form without any

evidence. This included a statement that “the figures given in the Banking Syndicate’s cash flows for construction costs were based

on estimates compiled by DTZ Sherry Fitzgerald which related to the total cost of construction whether that cost had already been

partly incurred or not.” As the learned judge explained, he was left in the position that “the only basis [he] had for the precise manner

in which the work in progress figure had been included in the Banking Syndicate’s cash flows was a detailed explanation given by

counsel speaking from his instructions.” This is necessarily a most unsatisfactory way in which to reach a conclusion on an issue of

fact.

19. In the course of these passages, the learned judge made repeated reference to the absence of any cross-examination of the

experts on their reports. Insofar as that implied criticism of the companies, I regret to say that it does not appear to be justified. It

was the Banks which sought, through counsel’s statements made at the hearing, but without any affidavit, effectively to contradict

the written record. In this state of the evidence, the learned judge, nonetheless, reached the following conclusion:

“there is a realistic and credible basis for the contention put forward on behalf of the Banking Syndicate that the sum of

€22,000,000 under the heading “release of work in progress” ought to be included in the cash flows.”

20. In his later judgment of 17th February 2011, the learned judge explained why he had been unable to reach a conclusion about the

expert reports in his judgment of 10th January. He said that “the reason why it was not possible to choose between the expert

evidence tendered on [on behalf of the respective parties] was the absence of both cross-examination and any obvious flaws in the

respective experts’ views.” For the reason already given, I do not think the companies can be criticised for failure to cross-examine.

The issue of cross-examination could not arise in the light of the fact that the crucial information was conveyed by counsel for the

Banks at the hearing. I have to say that, since the crucial matter conveyed by counsel involved a radical change to the terms of the

workout proposal with consequent change in the significance and even meaning of WIP, there was, it seems to me, an obvious flaw in

the report if it was not amended.

21. The issue of WIP was one of a number of points, four in all, considered by the learned trial judge in relation to the workout

proposal. Having suggested a test for unfair prejudice by reference to his own judgment in Re Traffic Group, i.e., disproportionate

disparity from the possible alternatives, he does not appear to have applied that test. His ultimate conclusion was that “the scheme is

unfairly prejudicial to the Banking Syndicate.” However, in dealing with the various headings, including WIP, he said either that the

Banks had produced a “realistic and credible” or merely a “credible” basis for their contentions. I have already indicated that I am not

satisfied that he had a sufficient basis in the evidence to reach that conclusion in respect of WIP. In other cases, he said: “it is just

not possible to reach a conclusion” or “it is just not possible to say.”

22. For these reasons, I am not convinced that the learned trial judge correctly applied the principles of the burden of proof in his

first judgment of 10th January 2011.

23. I am, on the other hand, satisfied that the learned judge was correct in deciding to reopen that matter following the conclusion of

his first judgment. It is unnecessary to consider the reasons in any detail. The Banks had put forward their workout proposal, which

necessarily implied a receivership and not a takeover by NAMA. The companies were criticised for not raising the possibility of the

Banks’ loans being taken into NAMA. Whichever party is the more deserving of criticism, the fact is that the Court had considered the

matter in its first judgment on a basis which would be totally undermined if NAMA were to take over the loans. Crucially, in my view,

no order had been made up following the first judgment. The matter, once raised, was fundamental. The learned judge was quite right

to reopen the hearing. I do not find it necessary to consider the English authority, Paulin v Paulin [2010] 1 WLR 1057.

24. This brings me to the second significant area in which I find myself unconvinced by the conclusions reached by Clarke J. That was

his treatment of the hypothesis of the loans of Bank of Ireland and Anglo being taken into NAMA. There were two stages to the

analysis. In the first stage, the learned judge considered the likelihood that the two banks (Bank of Ireland and Anglo) would recover

more, if their McInerney loans were acquired by NAMA, than under the scheme of arrangement. In effect, he found that they would

not and, therefore, that those two banks, on that assumption, would not be unfairly prejudiced if the scheme of arrangement were

approved. The second stage of his analysis was a consideration of the position of KBC, which, of course, was not exposed to the

possibility of being taken into NAMA. He concluded that, by reference to the original receivership model, KBC would remain prejudiced.

I will summarise the approach of the learned judge briefly.

25. Firstly, Clarke J came to the view that there was “a significant degree of likelihood…that the relevant loans will be acquired by

NAMA.” Thus, he held that their position was dependant on the amount which NAMA would pay for the loans, assuming NAMA

acquired them.

26. He noted that, to date, NAMA appeared to have adopted 30th November 2009 as its valuation date, though property prices had

continued to fall thereafter. The question was whether the “long-term economic value,” the basis on which NAMA would pay for

loans, could be established. He noted that, although long-term economic value was significantly above current market value,

allowance had to be made for the deduction of significant amounts relating both to due diligence costs of investigation and future

costs of enforcement. These could result in long-term economic value being either greater or less than current market value. Overall,

it was, as he put it “impossible to tell.”

27. Moreover, the learned judge laboured under the dual handicap that NAMA, not being a party, had declined to make any

information available and that the banks, though likely to have been in a position to have a real and expert view on the likely values,

tendered no evidence. Throughout this part of his analysis the learned judge repeatedly acknowledged that he was in the realms of

“speculation” or “pure speculation. The result was that he was “satisfied that it was not possible to conclude that B of I and Anglo

Irish would do significantly better in a NAMA valuation today than they would under the scheme of arrangement.” It was all “so

speculative as to provide little basis for a real assessment of prejudice.”

28. This left him with the task of deciding whether, assuming the other two banks’ loans were to be acquired by NAMA so that they

would not be unfairly prejudiced, KBC would, nonetheless, be so prejudiced. It is important that KBC’s prejudice was to be assessed

by reference to the receivership model. In the NAMA context, however, there were questions concerning the legal effect of the terms

of the inter-lender documentation between B of I and Anglo, on the one hand and KBC on the other. There was also the question of

whether NAMA would or could be compelled to participate in the receivership workout model.

29. One clause of the inter-lender agreement provided that unanimity between the three banks was required for the discharge of any

security. The learned judge thought it would be wrong to decide that issue “especially in circumstances where NAMA is not a party

and was not heard on the question.” However, the agreement was between the three banks, all of whom were, in fact, represented.

The learned judge thought that there were significant arguments either way.

30. On the other hand, the learned judge reached a clear conclusion that, insofar as enforcement actions might be concerned, the

two principal banks, Bank of Ireland and Anglo, because they represented more than 66% of the lending, would constitute “an

instructing group” for the purposes of Clause 9.1 of the Interlender Agreement and would be in a position to direct that certain

enforcement actions be taken. NAMA would, accordingly, step in to their shoes and become the “instructing group.”

31. He then addressed himself to the question of what NAMA was likely to want to do, but thought, in the first instance, that what

NAMA would actually wish to do was “a question of speculation.” Nonetheless, the learned judge proceeded to consider that question

and concluded that “there [was] at least a prima facie basis for believing that NAMA might regard the potential gain under the long

term receivership model as more attractive than an immediate or medium sale.” This is perhaps more positive than “speculation,” but

falls far short of a finding of probability. The learned judge, however, next proceeded to conclude as follows:

“Given the findings in the confirmation judgment [10th January 2011] (which, for reasons which I have set out, I do not

propose revisiting) it follows that this is a likely scenario. It is possible that NAMA may take a different view…..On the

basis of the assessment contained in my confirmation judgment and in the absence of any view from NAMA, it seems to

me that NAMA is likely to take the view that the long term receivership model as being more economically valuable than a

short term sale (unless a price well above €25,000,000 can be achieved.” (emphasis added)

32. The companies submit that that the preponderance of the evidence before the High Court was to the effect that NAMA would be

most unlikely to adopt a receivership workout model over an eleven-year period. NAMA plans to reach the end of its life within 7 to 10

years of its establishment, which was at the end of 2009. Its horizon does not extend beyond 2019. The receivership workout plan

requires a full 11 years to be completed, and, it could not commence before the second half of 2011, taking its conclusion well into

2022. NAMA’s current business plan sets debt reduction targets such that 40% of debts are planned to be repaid by 2015, 80% by

2017 and 95% by 2018, whereas the receivership workout model envisages the debts of the vehicle operating the model to be repaid

as to 19% by 2015, 33% by 2017 and 42% by 2018. The model expects only 51% of debts to be repaid by 2019, when NAMA’s

operations are due to end.

33. The companies complain that the banks provided no evidence to counter these propositions. This is a valid criticism for a number

of reasons. There was no evidence whatsoever before the High Court from NAMA. NAMA, although not a party to the proceedings,

could have provided assistance to the High Court, through the bank objectors. Secondly, and perhaps of greater significance, is the

approach of the Banks themselves to the provision of evidence. Under the NAMA legislation, it is the Banks, and not the companies to

which they have made loans, who have the relationship with NAMA. The banks decide whether or not to participate in the NAMA

scheme for recapitalisation of their undertakings, and who furnish to NAMA all appropriate information on the borrowing companies’

loans. Two of the three banks in the syndicate are participating banks pursuant to the NAMA legislation. It is they who know or are

most likely to have evidence about (a) how NAMA has approached the valuation of properties; (b) whether in every case it uses 2009

as its reference date; (c) NAMA’s business plan; (d) how NAMA has handled syndicated loans, where some lenders are outside NAMA;

and (e) whether NAMA has to date either agreed or even considered any long term arrangements akin to or analogous to those

envisaged by the banking syndicate in the present appeal. Instead the banks have been singularly silent on this vital aspect of the

matter, leaving the High Court in the position of classifying the possible approach of NAMA as being “entirely speculative.” Against

that background, the High Court would normally have given considerable weight to the opinion of the Examiner.

34. It seems to me that these submissions carry very significant weight. In the passage quoted above, in which he dealt with the

issue, the learned judge commenced with the observation that what NAMA would propose would be a matter of speculation. After

reflection, he considers that there was “at least a prima facie basis for believing that NAMA might” see merit in the receivership

model. It is difficult to see how these statements provide the basis for his ultimate conclusion that NAMA would be “likely” to adopt

the receivership model. If it was merely a matter of “speculation,” and certainly there was no evidence whatever that NAMA would

adopt a receivership model and such evidence as there was suggested the contrary, it could not be considered likely.

35. In all of these circumstances, I am not convinced that the learned judge was correct to find that the banks and, in particular,

KBC in the NAMA context, would be unfairly prejudiced. I would allow the appeal. Given that this is a dissenting judgment, I do not

need to propose any other form of order.