John Tierney & Associates v European Pacific Banking Company Ltd [1992] CKCA 3; CA 3.1990 (22 July 1992)

This case commenced by way of interpleader proceedings in the High Court at Rarotonga, brought by Compass Hotels Ltd ("Compass"). Although that company commenced proceedings, in the event it had, as is often the case in such matters, no financial interest in the outcome. In the application the Inland Revenue Department was named first claimant, John Tierney & Associates ("Tierney") was the second claimant, and the European Pacific Banking Company Limited ("the Bank") was third claimant. As will emerge later, the Inland Revenue claim was disposed of in the High Court and the interests of the Bank prevailed over that of Tierney. Tierney, appealed nominally against Compass but, in effect, the appeal is a contest between Tierney and the Bank.

Compass was, at the beginning of 1988, insolvent and, pursuant to s 205 of the Companies Act 1970-71, had proposed to the High Court a scheme of compromise in an attempt to satisfy its creditors. There had been a meeting called by Tierney, acting as accountant on behalf of Compass, on 22 January. At that meeting the creditors had appointed Tierney to be supervisor of a compromise scheme if Court sanction was obtained. Detail of the resolutions passed at the initial and subsequent meetings will be set out later, but for present purposes it is sufficient to say that the creditors had agreed that the company's assets, namely its sublease of the Tamure Hotel and the associated hotel enterprise, should be sold for the benefit of creditors. Claims totalled between $350,000 and $400.000 against a hoped-for realisation of something between $250,000 and $400,000. And to avoid losses which could be anticipated from too hasty a disposition, the appellant on behalf of the company proposed that the company continue to trade. Tierney's role was to act as supervisor to the current management of the company and to negotiate a sale and subsequent distribution. Court sanction of the procedure was given on 29 January 1988.

As at the date of the first creditors meeting, the two creditors who had in law preferential claims were the Inland Revenue Department - by virtue of a legislatively created priority - and the Bank, which held a debenture over the undertaking. Initially the Inland Revenue was claiming approximately $33 000 as a priority and the amount owing under the Bank's debenture was something in excess of $150,000.

As already mentioned, the meeting approved the appointment of Tierney in a supervising capacity. Naturally, in view of the questionable nature of the proposed realisation, it would not have been willing to act unless it was also given priority for its fees. More detail of this will be set out below. In the event, the sale fell far short of original anticipation, realising but $60,000. After payment of costs, $57,000 remained. Compass conceded it had no beneficial claim to any part of this sum. It paid the amount into Court and issued the interpleader application, as already mentioned, naming the preference creditors - the IRD, Tierney and the Bank - as first, second and third claimants. Obviously, the claims of these three would more than consume the available funds.

The position of IRD can be easily disposed of. The trial Judge, Roper CJ, heard evidence and submissions from the three claimants. A substantial part of his judgment, delivered on 23 July 1990, was occupied in considering the degree of priority to be accorded to the first claimant pursuant to the Income Tax Act 1972 in contest with the Bank's debenture. He decided, in accordance with authority cited, that the IRD had priority only in respect of a sum of $2,881. The balance of the Department's claim was held to be an unsecured debt and, as with the others in that category, no balance of funds was available. No challenge has been made to that finding and no further consideration need be given to the Inland Revenue claim.

After deduction of the revenue amount, some $54,199 remained for the second and third claimants. It was conceded that priority had been accorded to Tierney for properly chargeable fees ahead of the Bank. Tierney's claim was $49,516, which would leave little available to the Bank. But that sum was contested as not a claimable priority in full. In accordance with negotiations prior to hearing, some $22,154 had been conceded as payable to Tierney's and paid, so the issue at trial was the division of the available balance.

The learned Chief Justice ruled that an amount of approximately half the Tierney claim had priority, namely $25,400. Once credit was given for the sum of $22,154 already acknowledged an additional $3,246 was awarded to Tierney, leaving $28,799 for the Bank's debenture claim.

Against this decision Tierney appealed. The issue turns upon the nature of the fee priority authorisation given by the creditors to Tierney as supervisors of the compromise scheme. It is necessary to examine in some detail the history of events and the composition of the claims made by Tierney to a total of $49,516. There are a number of notices, minutes and reports which referred to the basis of the fee payment claim and extracts from these will need consideration.

The first relevant document was the notice of creditors outlining the scheme and that notice was the basis of the application made to the High Court in January 1988. The suggested programme was set out thus:

"1. the appointment of John Tierney & Associates to supervise this arrangement and approve all actions of the Company, including the sale of the property, the lease negotiations, reporting to and the final settlement of creditors.

2. the company be permitted to continue to trade on a cash basis under supervision. Our supervision is to include the control of cash, issuing of orders, and distribution of any trading surplus to creditors on an equitable basis.

3. the supervision of John Tierney & Associates is to include a review of costs and operating procedures and the matching of same against occupancy fluctuation.

5. the company enter into negotiations with the landlord to review lease terms and conditions.

6. the property be marketed more actively in an effort to improve the occupancy and the revenues.

8. the fees and disbursements of John Tierney & Associates as supervisers to and Clarkes as Solicitors to this compromise shall be preferential payments of the company."

At the meeting on 22 January the scheme outlined in Tierney's letter was approved and particular note needs to be made of the scope of authority in paragraphs 1, 2 and 3 and of the preferential status of fees and disbursements in paragraph 8. In addition, at the initial creditors meeting a further resolution was added, as follows:

"That any unpaid creditors arising out (of) this statutory management be treated as special creditors ahead of the unsecured creditors and that a creditors committee of three be appointed to assist the statutory managers."

It should be noted that at the time this meeting was held the expectation was for a favourable sale, which could be anticipated to cover the Bank, the IRD, and Tierney's fees, with funds available for those special creditors whose services would be required for functions incidental to the sale proceeds. Although Tierney's letter had originally spoken of "supervision", the phrase "statutory management" was introduced in this additional resolution. A term not previously suggested and having, as far as one can see, no defined legal meaning in the Companies Act. More of this later.

The pivotal issue is to determine whether all fees and expenses subsequently earned or incurred by Tierney ranked as preferential, or some merely as special unsecured claims. The recommended period for compromise was three months, but no resolution of the matter had been achieved within that period and further retrospective Court approvals of time extensions were granted on 13 May 1988 and 11 August 1988. In each case further meetings of creditors were held and at these "for the avoidance of doubt" the preferential status of Tierney's "reasonable fees and disbursements as supervisors to the management of the company" was confirmed for the extended periods. It may be noted that the word "reasonable" had been added to the January resolution.

At these meetings reports were made to the creditors to the effect that trading had continued with, generally, diminishing returns and that attempts to sell were continuing. At a May meeting "nibbles" were reported. In August it was said that interest from prospective purchasers was "currently high". On both occasions a Mr Wright, a member of the creditors committee, spoke pessimistically of any funds being available for unsecured creditors. This view was in marked contrast to the earlier estimates of a realisation of anything upwards of $400,000, which would have provided a sum even after preferential and special payments had been made.

A crucial issue in the claim relates to the role played by Tierney immediately before and during the proposed period. Attention must be given to the nature of the role suggested for itself by the firm. At the time of the initial approval in January 1988, as the letter discloses, it was to act as "supervisors to the management of the company" and an estimate of fees was given at $600 per week. There has been some dispute as to whether this was to include turnover tax or whether that was to be additional, and whether or not disbursements were included. No firm conclusion can be reached either way but this round figure, put forward as an estimate, does seem to suggest that turnover tax (10%) would be additional and similarly with disbursements which would be odd, unrounded, amounts.

In the conduct of what one is sure was conceived as its original role, Tierney called itself "statutory manager". A phrase which, as we have said, does not appear in the legislation or in the initial letter and seems to have derived from the wording of the supplementary resolution at the meeting of 22 January; but it was certainly adopted thereafter. It is this phrase which has given rise to some debate, for management is by no means coextensive with supervision - and confusion of terminology, not least by Tierney, may have been the cause of all the trouble. It is unfortunate that the limits of the "supervisor's" activities were not more specifically defined ad initio. However, the phrase must be taken as an attempt to define the original function. Some limitation on that phrase seems to have been contemplated, for in the reports to the creditors' committee there were frequent references to the engagement of managers and similar functionaries as part of the continuing company staff, and comment was made that this would reduce the costs of Tierney's fees. Even so, such engagements were essential for the purposes of sale.

However, as time went by, it is apparent that Tierney, perhaps of necessity, engaged more and more in day to day management - even as far down as choosing wine lists and printing menus. This, of course, involved very substantial expenditure of time and the incurring of disbursements which ordinarily would have been company expenses. It may be questioned whether the creditors contemplated such expenditure as within the priority of preferential payments. Indeed, day to day debts for various administrative expenses performed by third parties would doubtless have been thought of as special unsecured. On the other hand, Tierney could well say that these functions had to be discharged by someone or, the whole operation would collapse. In a small community such as Rarotonga, the financial difficulties would be common knowledge and labour and outside services would be difficult to secure; hence the need for Tierney to expand its sphere of operations.

That is all understandable, but the question is not the need to incur such accounts but what degree of priority the creditors intended.

Two interesting and relevant features emerge: First, no report was made to the creditors' meetings of the dual role being undertaken, nor of the scale of increasing costs above the original estimate. On the contrary, the continuation of preferential status was accorded in the same terms as in the original resolution - "fees and disbursements as supervisors" - even though unbeknown to the creditors, the scale and type of expenses had more than doubled from the original estimates. That Tierney recognised that its services were covering several functions seems apparent from various documents. For example, in the report to the committee of inspection on 22 April 1988 mention was made of the employment by the company of a lady with experience in cost control and this, it was said, would "reduce our involvement on the day to day administration" and would "reduce both statutory manager's and accounting fees". It seems clear, however, that in those early months, when a favourable sale was anticipated, there was no great concern over the payment for accounting work, as distinct from supervision, and surplus funds to pay these as special creditors seemed likely. Colour to this thought is lent by a second feature which emerges from an examination of the way in which Tierney rendered its monthly accounts - both in the classification of the items and the addressee to whom the accounts were sent. It may be noted that Tierney's postal address was Box 67, Rarotonga, and Compass Hotels Limited was Box 17. Some accounts were sent to one address, some to the other. Some were addressed to the statutory manager, some to the manager of Compass Hotel. Separate services were separately charged for in the accounts for March and April; from May onwards they were merged with no particular logical sequence. An analysis of the accounts forwarded can be summarised as follows:

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"Date	A/c to	Address	Service Description	...
22/3/88	22/1/88	Statutory Manager Box 67	Proposed preparation	$6,354.28
24/3/88	24/3/88	Statutory Manager Box 67	Statutory Management (at $600 per week)	$6,641.28
6/4/88	31/3/88	Statutory Manager Box 17	Accounting Services	$2,189.06
6/4/88	"to date'	Statutory Manager Box 17	Statutory Management	$4,953.22
6/4/88	31/3/88	Statutory Manager Box 17	Specific services:- menus wine lists stock sheets etc	$1,630.24
6/5/88	April 88	Manager Compass Hotel Box 17	Accounting Managerial Secretarial Taxation services	$7,365.67 (Statutory Management itemised at $2,480)
21/6/88	May 88	Manager Compass Hotel Box 17	ditto	$4,468.41 (Statutory Management itemised at $1,550.70)
31/8/88	June & July 88	Manager Compass Hotel Ltd Box 17	ditto	$8,074.05 (Statutory Management itemised at $2,411.00)
29/9/88	August 88	Manager Compass Hotel Ltd Box 17	ditto	$4,637.01 (Statutory Management itemised at $1,615)
30/11/88	Sept. Oct. November 1988	Manager Compass Hotel Ltd Box 17	ditto	$5,764.17 (Statutory Management itemised at $1,147.50)"

On 10 February 1989 there was a reverse credit in respect of the last account for $2,558.89 in respect of "fees, turnover, tax and disbursements". The total of statutory management items so charged can be divided by the 34 weeks which were allegedly occupied to produce an average which is just a fraction over the original estimate of $600 per week. The management total from the accounts is $20,798 divided by 34 equals $612. However, there are in the accounts a number of other items which would justifiably have fitted into the supervisory category, e.g, attendance at management meetings, review of monthly accounting, cheque signing, and others. Particularisation of these might not be easy, but they were obviously legitimate supervision from which there could be an inference that something in excess of $600 might be reasonable.

It has not been suggested that Tierney's conduct was done other than in good faith for the benefit of the creditors. Its primary concern had been for the hotel to be kept running on as normal an operational scale as could be. A compromise scheme of this sort has many of the hallmarks of the operation of a receivership, where the appointing creditor instructs that the property should be sold for the primary benefit of the security holder and, if possible, for other creditors. The receiver's duty is to trade as best he can until realisation and all monies properly expended to that end are preferential charges. In addition, some regard must be had to two aspects of commercial life in the Cook Islands. First, those engaged in trade there are perhaps not as commercially sophisticated nor have ready access to expert advice as in larger communities. Secondly, news of financial fragility travels rapidly. It is not a community with extensive commercial facilities, either by way of accounting or business management talents or a broad base of office work facilities. An examination of the Tierney accounts show that many routine office work activities were carried out by the firm and we have no doubt it would have been difficult, if not impossible in the circumstances, to engage outside personnel for this work without guaranteed payment. Alternatively, additional staff for the same functions could have been put on the company's payroll with a consequential decrease in returns while it continued to trade. Tierney apparently decided there was no option but to do the work themselves. Although there were only two meetings of the body of creditors after the original Court sanction, there are in the record a number of reports to the Committee of Inspection (sometimes called Committee of Creditors) which had been appointed by the general body. It seems clear that these reports detailed the extensive work being done and those gentlemen must have been aware how much time - doubtless in excess of original expectation - was being expended by Tierney, both principals and staff. Indeed, it may be noted that one of the members, Mr Wright, who had been paying close attention to the affair, said in evidence that Tierney's job was "to run the pub". He was cross-examined by counsel for the Bank as follows:

Mr Clarke: "In the terms of the letter (January 88) Tierney's were only to supervise?"

Mr Wright: "I believe it went beyond that. We were to pay $600 per week. We believed they had to run it as well as could be.'

Despite the confusion of terminology and the use by Tierney of the equivocal phrase "statutory manager", we believe they were acting within the terms of the creditors' interests and intended authorisation – although ambiguous terms have been used. This is reinforced by the view earlier expressed, namely that the creditors would have initially believed that the realisation would cover all expenses necessary to achieve sale, and it was essential that these be incurred and met. It is true that Mr Wright repeated the $600 figure in his evidence, but the minute shows that that was an estimate only. In his judgment the learned Chief Justice analysed the costs charged as being of the order of $1,400 per week or $1,200, depending upon the incidence of the pre 22 January charges. But Mr Kenney produced a schedule showing that much of this was turnover tax or unexpectedly heavy disbursements for causes we have referred to. Shorn of these additions, the fees' average is of the order of $850 per week. Although somewhat on the high side, we accept that it is a legitimate inference from the factual material before the Court that payment of this order was within, the broad authorisation. Had the increasing costs been pointed out to the creditors during the sale negotiation period, it seems obvious that approval would have to have been given.

Accordingly, the appeal will be allowed and the matter referred back to the High Court for an order in favour of Tierney for the payment out of sums up to Tierney's total of $49,516. However, there are not sufficient funds for them to receive their account in full. Costs must be paid as a priority. Counsel for the applicant Compass and for the IRD are entitled to costs in the High Court. Tierney is entitled to costs in both Courts. We also take the view that the Bank was obliged and entitled to stake its claim in the High Court and should require some consideration. Accordingly, the matter is remitted to the High Court for fixing of appropriate costs and payment out to Tierney of the available balance.

Court of Appeal of the Cook Islands

John Tierney & Associates v European Pacific Banking Company Ltd [1992] CKCA 3; CA 3.1990 (22 July 1992)