Conditional Payments and Insolvency- The Quistclose Trust Gerard McCormack* It is axiomatic that assets which form the subject-matter of a trust do not constitute part of the property of an insolvent available for distribution among the insolvent's creditors. Persons responsible for administering the affairs of insolvents take the property of the insolvent subject to equities. One such equity that must be recognised and upheld is the interests of beneficiaries under a trust where the insolvent holds the bare legal title. In this article the applicability of the doctrine oftrusts in the realm of conditional payments will be considerd. If a lender lends money on condition that it is used for a particular purpose and/or paid back out of a particular fund, or if a purchaser pays in advance on condition that the money is used to provide something he wants, to what extent can the lender or payer enforce the conditional agreement?1 There is something of an analogy with prepayments in sale of goods situations. It is possible for a seller of goods to retain title to the goods notwithstanding delivery of the goods to the buyer until the goods have been paid for or some other condition has been fulfilled. Conditional loans or payments are usually discussed under the rubric of the Quistclose trust and it is perhaps convenient to continue this classification. 2 The Quistclose Trust The locus classicus is Barclays Bank Ltd. v. Quistclose Investments Ltd.3 This is a case where Quistclose lent a company, Rolls Razor Ltd., some £210,000 to allow Rolls Razor to pay a dividend it had already declared. Rolls Razor sent the money to its bank, asking it to pay it into a separate dividend account and stating that the •• School of Law, The University of Essex I. The link between reservation of title clauses in sales of goods and conditional loans or payments has not always been borne in mind when one or other of the two phenomena have been examined. However, the two are brought together in the excellent article by Goodhart and Jones, "The Infiltration of Equitable Doctrine into English Commercial Law" (1980) 43 M.L.R. 489. For a comprehensive examination of reservation of title clauses see McCormack, Reservation of Title (2nd. ed., 1995). See also Priestley, "The Romalpa Trust and the Quistclose Trust" in P.O. Finn ed., Equity in Commercial Relationships (1987); Milman and Durrant, Corporate Insolvency Law and Practice (2nd. ed., 1994), Chapter 8; M. Bridge, (1992) 12 O.J.L.S. 333 and C.E.F. Rickett, (1991) 107 L.Q.R. 608. 2. Some would argue however that the Re Kayford Ltd. [1975] 1 W.L.R. 279 line of authorities are not true examples of the Quistclose trust properly so called. 3. 11970]A.C. 567. 93 THE DENNING LAW JOURNAL money was to be used only to pay the dividend. But before the dividend could be paid Rolls Razor went into voluntary liquidation, leaving Quistclose and the bank to dispute ownership ofthe £210,000. The company's bank claimed the right to set off the £210,000 credit against a debit balance in another account. The claim failed. The money was held to be impressed with a trust in favour of Quistclose should the primary purpose of the payment fail. Lord Wilberforce said that the mutual intention of Quistclose and of Rolls Razor Ltd. and the essence of the bargain was that the sum advanced should not become part of the assets of Rolls Razor Ltd. but should be used exclusively for payment of a particular class of its creditors, namely, those entitled to the dividend. This entailed the necessary consequence that if, for any reason, the dividend could not be paid, the money was to be returned to Quistclose. The word "only" was not capable of bearing any other effect. 4 His Lordship was emphatic in his disavowal of the idea that a transaction giving rise to a legal action for debt could not also create a trust. He said: "There is surely no difficulty in recognising the co-existence in one transaction of legal and equitable rights and remedies; when the money is advanced, the lender acquires an equitable right to see that it is applied for the primary designated purpose ... : when the purpose has been carried out (i.e. the debt paid) the lender has his remedy against the borrower in debt; if the primary purpose cannot be carried out, the question arises if a secondary purpose (i.e. repayment to the lender) has been agreed, expressly or by implication: if it has, the remedies of equity may be invoked to give effect to it, if it has not (and the money) is intended to fall within the general fund of the debtor's assets) then there is the appropriate remedy for recovery of a loan. I can appreciate no reason why the flexible interplay of law and equity cannot let in these practical arrangements, and other variations if desired; it would be to the discredit of both systems if they could not."5 The early authorities In upholding the claim put forward by Quistclose, the House of Lords followed a long line of cases dating back to the beginning of the last century. According to Lord Wilberforce the fact that arrangements of this character for the payment of a person's creditors by a third person, give rise to a relationship of trust, in favour, as a primary trust, of the creditors, and secondarily, if the primary trust fails, of the third person, has been recognised in a series of cases over some 4. Ibid. at 580. 5. Ibid. at 581-582. 94 CONDITIONAL PAYMENTS AND INSOLVENCY - THE QUISTCLOSE TRUST 150 years. Toovey v. Milne marks the fons et origo of this stream of authority.6 Abbott C.J. said: "I thought at the trial, and still think, that the fair inference from the facts proved was that this money was advanced for a specific purpose, and that being so clothed with a specific trust, no property in it passed to the assignee of the bankrupt. Then the purpose having failed, there is an implied stipulation that the money shall be repaid."7 In Toovey v. Milne A advanced money to his brother-in-law, B, for the purpose of B settling with his creditors. 8 That purpose failed and B was declared bankrupt. What was left of the money was repaid to A by the bankrupt. The court held that this repayment was protected and that the assignees in bankruptcy could not recover the money so repaid. The principle enunciated in Toovey v. Milne was applied sub silentio as it were in Gibert v. Gonard since the case is nowhere cited.9 Gibert v. Gonard is a case where A lent money to B for the purchase of a particular business. B in fact paid the money into his general bank account and drew against it to the extent of several hundred pounds for the purpose of meeting certain of his own personal liabilities unconnected with the business to be purchased. B became bankrupt before the property acquisition could be completed and it was held that A was entitled to follow and recover the money in the bank account in the same manner as if it had been in terms a trust fund. According to North J. it was very well known law that if one person makes a payment to another for a certain purpose, and that person takes the money knowing that it is for that purpose, he must apply it to the purpose for which it was given. He may decline to take it if he likes but if he chooses to accept the money tendered for a particular purpose there was a legal obligation to apply it for that purpose. 10 In other words a duty was cast upon the borrower which placed him in the position of a trustee of the money advanced. Re Rogers is another authority, this time of the Court of Appeal, to the same effect. II This is a case where A, a money-lender, lent money to B to enable pressing creditors to be paid. Some of that money was applied by B towards meeting the claim of C, a judgment creditor. B was adjudicated bankrupt and the question arose whether the trustee-in-bankruptcy could sue C to recover the money. The Court of Appeal declined to answer in the affirmative. The holding was that since the advance to B 6. (1819) 2 B. & Ald. 683. See also Edwards v. Glynn (1859) 2 E. & E. 29; Giben v. Gonard (1885) 54 L.J. Ch. 439; Re Rogers (1891) 8 Morr. 243; Re Drucker [1920] 2. K.B. 237; Re Watson (1912) 107 L.T. 783; and Re Hooley [1915] 84 L.J.K.B. 181. See also the line of cases mentioned by Goode infra. n.59 at pp. 180-181 including Re Pal/itt [1893] 1 Q.B. 455; Re Mid-Kent Fruit Factory [1896] 1 Ch. 567; Re City Equitable Fire Insurance Co. Ltd (No.2) [1930] Ch. 293. 7. /bid. at p. 684. 8. Ibid. The early cases are well analysed by Milieu, (1985) 101 L. Q.R. 269 at 270-274. 9. Supra. n.6 10. Ibid. at 440. 11. 'Supra. n.6.' Millett supra. n.S, at 273 describes it as the decision of a strong Court of Appeal. The court consisted of Lindley, Bowen and Kay L.JJ. 95 THE DENNING LAW JOURNAL was for the special purpose of enabling his creditors to be paid, it was impressed with a trust for that purpose and never became the property ofB. Lindley L.J. observed: "I entertain no doubt that [A] could have obtained an injunction to restrain the bankrupt from using that money for any purpose except that of paying his pressing creditors. If this be so, the money never was the bankrupt's in any proper sense so as to vest in his trustee as part of his general assets. "12 Kay L.J. stated: , 'The desire and intent of [A] . . . was to prevent the bankruptcy of [B]. . . . The true result of the evidence seems to me to be that the advance by [A] was for this special purpose, and the money was impressed with a trust, so that [A] could have prevented its being otherwise used. "13 As one commentator has pointed out one striking characteristic of these 19th. century cases is the immediacy of the debtor's need for outside sources of funding. 14. The party advancing the money is doing so on an emergency or rescue basis while the debtor serves merely as a conduit pipe through whom the money is channelled to the outside creditor. It can fairly be said that the debtor's possession of the money does not mislead. Nobody is induced into further dealings with him on the basis of a false assumption as to creditworthiness. Any benefit that might accrue to general creditors if the conduit pipe broke down would be pure windfall. Moreover the payer is not receiving any special premium consequent on the transaction being characterised as a mere loan. Thus it does not seem unfair to general creditors if the payer is allowed to return or recover the money as the case may be. Doctrinal criticisms of Quistclose The notion of the Quistclose trust has engendered some discussion and disquiet insofar as the finer points of the law of trusts are concerned. IS Issues for debate include whether the trust is properly constituted, questions of enforcement, revocability and the identity of the beneficiary. Consideration of these questions will be postponed until later in the article but one might legitimately inquire here about why the primary purpose was deemed to have failed in Quistclose. Some observers have no doubts. For instance in Re Northern Developments (Holdings) Ltd. Sir Robert Megarry V.C. said: "[I] n the Quistclose case, the primary purpose was clear, simple and definite, both in its ambit and frustration. The purpose was to pay a particular debt due to particular creditors upon a particular date; and once the company [B] had 12. Ibid. at 248. 13. Ibid. at 249. 14. See Bridge supra. n.!. IS. See in particular Millett ·supra. n.S·, and Rickett supra. n.!.2 96 CONDITIONAL PAYMENTS AND INSOLVENCY-THE QUISTCLOSE TRUST decided to go into liquidation, that primary purpose plainly could never be accomplished. Once the voluntary winding up had commenced, the dividend could not be paid in competition with other creditors . . . and so in the circumstances no trust for the payment of the dividend could be carried out. "16 There are some difficulties with this analysis however. 17 For a start the dividends had actually been declared before the loan was obtained. Case-law establishes that the declaration of a dividend by resolution of the shareholders brings into being an immediate debt in their favour unless a later date for payment has been expressly specified. The argument therefore is that the trust to pay the dividends was complete. Subsequent liquidation of the company could not unravel that trust. 18 In his exploitation Megarry V.C. relied on what is now section 74(2)(f) of the Insolvency Act 1986 which relegates shareholder claims for unpaid dividends behind debts due to external creditors. Clearly the statutory provision precludes debts based upon unpaid dividends being proved in competition with the claims of outside creditors. The legislative statement would not seem though to catch trusts of dividends. 19 As one judge writing extra-curially put the matter: "It does not prevent a trustee from paying trust money, which ex hypothesis does not belong to the company, to the persons beneficially entitled thereto. "20 The better view may be that the underlying purpose behind the conditional loan arrangements in Quistclose was not merely the payment of a dividend to shareholders but also the preservation of the company as a going concern. 21 In other words, the case is explicable with reference to a corporate salvage rationale.22 A similar explanation may be prof erred in respect of Re E. V. T.R. Ltd. 23 This is a case where the appellant, B, had the good fortune to win a big prize on the premium bonds. He was not in the business of lending money but was persuaded to lend £60,000 to a company, EVTR Ltd., that was experiencing financial difficulties. The company was run by a friend of his. B was advised by his accountant, in no uncertain terms, that he would be wasting his money if he simply lent it unconditionally to the company. What happened therefore, was that B advanced to solicitors acting for EVTR Ltd., 16. Unreported, October 6, 1978. Despite its unreported status the case has been referred to extensively by academic commentators and was also the subject of lengthy discussion in Carreras RaThmans Lid v. Freeman MaThews Lid. [1985] Ch. 207. 17. See generally H.A.J. Ford and W.A. Lee, Principles afThe Law afTrusTs (1990) at p.31; Millett 'supra. n.8', at 275-276; Rickett supra. n.1.2; Oditah (1992) 108 L. Q.R. 459 at 475. 18. Millett ibid. at p. 276 argues that there is not good reason why the rights of the shareholders to the money should be affected by the subsequent liquidation of the company, B. The desire of B's liquidator to repay the loan to A rather than to pay the dividend is understandable though as the effect of paying the dividend would be to substitute A, an ordinary creditor, for C, a deferred creditor, to the detriment of the general body of creditors. 19. See Oditah, supra. n.17 at 475. 20. See Millett, supra. n.8, 269 at 276. 21. It might also be the case that there was a further condition attached to the payment to the effect that the money should be utilised for paying dividends only if Rolls Razor obtained further finance by a named date. On this point see [1968] Ch. 504 at 549-551. 22. See R.P. Austin, (1986) 6 O.l.L.S. 444 at 455. 23. [1987]B.C.L.C. 646. 97 THE DENNING LAW JOURNAL the sum of £60,000 "forthe sole purpose of buying new equipment". Unfortunately, EVTR Ltd. did not have the balance necessary to buy the equipment outright and so a more complicated scheme was embarked upon with two other companies. The first company was the manufacturer of the equipment. EVTR Ltd. contracted with this company for the supply of new equipment to be delivered within 7 months and in the meantime to supply the company with temporary equipment. EVTR Ltd. also entered into a contract with another company under which the second company agreed to take over EVTR Ltd.'s obligations under the contract with the manufacturer by buying the new equipment and then leasing it to EVTR Ltd. The contract involved EVTR Ltd. paying a deposit of £60,000 plus 36 monthly instalments. The bank who had financed EVTR Ltd. appointed receivers to the company before the new equipment arrived and the two supplier companies returned the £60,000 less various agreed deductions. The question arose whether the refunded sum formed part of the general assets of EVTR Ltd. available for distribution to its secured creditors or whether it was impressed with a trust in favour of B. This involved consideration of the point whether the original purpose of the transaction had been accomplished. In other words, had B been disappointed in his aim of making himself an unsecured creditor of EVTR Ltd?24 The Court of Appeal answered in the affirmative. Dillon L.J. suggested that the purpose of B from which any trust was to be implied was, realistically, the purpose of EVTR Ltd, acquiring new equipment and not the purpose of EVTR Ltd entering into an abortive contract for the lease/purchase of new equipment. Bingham L.J. opined that it would strike most people as very hard if B were in this situation to be confined to a claim as an unsecured creditor of the company.25 Moreoever, it must be pointed out that B was not a trade creditor conversant with credit risk and the bank's debenture had been granted some time before the injection of credit by B. As one commentator perceptively observes: "The bank would have been a windfall creditor if the Quistclose trust, and its failure of achievement, had not been recognised. "26 Application of the conditional payment principle - some controversial cases If the primary purpose of the payment had been carried out in Quistclose then the result achieved is one of credit substitution.27 A, the payer, becomes a creditor of B, the person to whom payment is made, instead ofC, the third party creditors who are the ultimate intended recipients of the payment. Before the payment was made, there was no pre-existing relationship of debt between A and B. 24. To borrow the felicitous expression of Michael Bridge supra. n.1 at 354.' 25. Supra. n.23 at 652. The judge added that while it was literally true that the fund which the appellant, B, provided was applied to the stipulated purpose, the object of the payment was not achieved and that was why the balance was repaid. 26. See Bridge supra. n.1 at 356. 27. See Priestley, supra. n.1 at p.230 who points out that the attitude of other sources of finance might change if the credit substitution were known, but this is unlikely in the case of unsecured credit. 98 CONDITIONAL PAYMENTS AND INSOLVENCY-THE QUISTCLOSE TRUST Carreras Rothmans Ltd. v. Freeman Mathews Treasure Ltd. involves an extension of the Quistclose principle in that A stood in a relationship of debt to B prior to the time of making the payment. 28 The plaintiff tobacco manufacturer arranged that the defendant advertising agency would place advertisements for it in newspapers, periodicals and by means of posters. The services of an agency were availe