[2002]	671
1 WLR

House of Lords

In re Toshoku Finance UK plc

[2002] UKHL 6

2001 Dec 10, 11; 2002 Feb 20

Lord Hoffmann, Lord Woolf CJ, Lord Hutton, Lord Hobhouse of Woodborough and Lord Rodger of Earlsferry

Insolvency - Winding up - Liquidator - Expenses incurred in winding up - Priority of payments - Corporation tax on interest not recoverable but deemed to have been received by company after commencement of winding up - Whether "necessary disbursement" - Insolvency Rules 1986 (SI 1986/1925), r 4.218(1)(m)

T plc, a company incorporated in the United Kingdom for the purposes of raising finance for overseas companies in the same group, went into creditors' voluntary liquidation, and joint liquidators were appointed. Its principal asset on liquidation was a debt of some US$156m owed to it by TE, a Lichtenstein company in the group. Thereafter the debt was discharged by an agreement under which the liquidators accepted payment of a sum equivalent to 54% of the funds available to TE that was stated to represent repayment of the principal only and not to include any amounts in respect of accrued but unpaid interest. Although T plc received no interest from TE after the liquidation date the legislation required it when computing its profits in respect of the accounting period which began on the commencement of the winding up to bring into account the amounts of interest payable by TE, and since T plc and TE were connected companies the computation was required to be made on the assumption that every amount payable would be or would have been paid in full as it became due. The liquidators applied for directions whether, notwithstanding that T plc had not and probably never would receive any of the interest due on the debt, it was nevertheless liable to pay corporation tax on it out of its assets as an expense of the winding up in priority to all other claims. The judge held that as a result of legislative changes effected by rule 4.218(1)(m) and (p) of the Insolvency Rules 1986¹ he was not bound by earlier authorities to require the liquidators to discharge tax out of T plc's assets in priority to the claims of unsecured creditors proving in the winding up. The Court of Appeal allowed the Crown's appeal and ruled that the tax liability on the interest that T plc had not received from TE was to be brought into account as a necessary disbursement payable out of the assets of T plc as an expense incurred in the winding up and in priority to the claims of creditors proving in the winding up.

On the liquidators' appeal—

Held, dismissing the appeal, that rule 4.218(1) of the 1986 Rules was mandatory and established what expenses were to be treated as the expenses of a winding up and also their priority inter se; that the heads of expenses listed in the rule could not be denied the status of an expense and were not subject to any qualification other than those expressly mentioned in the Rules; that, since it was expressly enacted by statute that a company was chargeable to corporation tax on profits or gains arising in the winding up, the tax was a post-liquidation liability which the liquidator was obliged to discharge and was therefore a necessary disbursement within the meaning of the rule; and that, accordingly, corporation tax was not only payable but was payable as a priority under paragraph (m) of the rule even though the tax was not related to any actual payment received or receivable for the benefit of the company (post paras 13-17, 41, 42, 46-51).

¹ Insolvency Rules 1986, r 4.218(1): see post, para 6.

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In re Mesco Properties Ltd [1980] 1 WLR 96, CA, In re MC Bacon Ltd [1991] Ch 127 and Lewis v Inland Revenue Comrs [2001] 3 All ER 499, CA approved.

In re Lundy Granite Co; Ex p Heavan (1871) LR 6 Ch App 462 and Atlantic Computer Systems plc [1992] Ch 505, CA considered.

In re Kentish Homes Ltd [1993] BCLC 1375 overruled.

Decision of the Court of Appeal [2000] 1 WLR 2478 affirmed.

The following cases are referred to in the opinion of Lord Hoffmann:

ABC Coupler and Engineering Co Ltd, In re (No 3) [1970] 1 WLR 702; [1970] 1 All ER 650

Atlantic Computer Systems plc, In re [1992] Ch 505; [1992] 2 WLR 367; [1992] 1 All ER 476, CA

Blazer Fire Lighter Ltd, In re [1895] 1 Ch 402

Downer Enterprises Ltd, In re [1974] 1 WLR 1460; [1974] 2 All ER 1074

Exhall Coal Mining Co Ltd, In re (1864) 4 De GJ & S 377

Hardy v Fothergill (1888) 13 App Cas 351, HL(E)

Kentish Homes Ltd, In re [1993] BCLC 1375

Lewis v Inland Revenue Comrs [2001] 3 All ER 499, CA

London Metallurgical Co, In re [1895] 1 Ch 758

Lundy Granite Co, In re; Ex p Heavan (1871) LR 6 Ch App 462

MC Bacon Ltd, In re [1991] Ch 127; [1990] 3 WLR 646

Mesco Properties Ltd, In re [1979] 1 WLR 558; [1979] 1 All ER 302; [1980] 1 WLR 96; [1980] 1 All ER 117, CA

Mineral Resources Ltd, In re [1999] 1 All ER 746

National Arms and Ammunition Co, In re (1885) 28 Ch D 474, CA

Oak Pits Colliery Co, In re (1882) 21 Ch D 322, CA

Progress Assurance Co, In re; Ex p Liverpool Exchange Co (1870) LR 9 Eq 370

Realisations (HH) Ltd, In re (1975) 31 P & CR 249

Watson Kipling & Co, In re (1883) 23 Ch D 500

The following additional cases were cited in argument:

Beni-Felkai Mining Co Ltd, In re [1934] Ch 406

Exchange Travel (Holdings) Ltd, In re (No 3) [1997] 2 BCLC 579, CA

Higginshaw Mills and Spinning Co, In re [1896] 2 Ch 544, CA

Lancashire Cotton Spinning Co, In re (1887) 35 Ch D 656, CA

Levi & Co Ltd, In re [1919] 1 Ch 416

Mond v Hammond Suddards [2000] Ch 40; [1999] 3 WLR 697, CA

Massey, In re (1870) LR 9 Eq 367

North Yorkshire Iron Co, In re (1878) 7 Ch D 661

APPEAL from the Court of Appeal

This was an appeal by leave of the House of Lords (Lord Bingham of Cornhill, Lord Hope of Craighead and Lord Clyde) granted on 6 December 2000, by the liquidators Neville Kahn and Nigel Vooght, from a decision of the Court of Appeal (Sir Richard Scott V-C, Chadwick and Buxton LJJ) on 23 March 2000, allowing an appeal by the Crown from a decision dated 30 July 1999 of Evans-Lombe J who held on an application by the liquidators pursuant to section 112(1) of the Insolvency Act 1986 that the liquidators were not required to discharge out of the company's assets as an expense of the winding up any liability to corporation tax on interest receivable after the commencement of the winding up from a connected company, Toshoku Europa Establishment, on a debt quantified at US$156.3m.

The facts are stated in the opinion of Lord Hoffmann.

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1 WLR	In re Toshoku Finace UK plc (HL(E))	Lord Hoffmann

Mark Phillips QC and Felicity Toube for the liquidators.

Michael Briggs QC and Philip Jones for the Crown.

Their Lordships took time for consideration.

20 February 2002. LORD HOFFMANN

1 My Lords, Toshoku Finance (UK) plc is in creditors' voluntary liquidation. It was a subsidiary of a Japanese corporation called Toshoku Ltd, which went into liquidation in December 1997. The resolution to wind up the company was passed on 26 January 1998. Two partners in PwC were appointed joint liquidators. The only substantial asset was a debt owing by another Toshuku subsidiary called Toshoku Europa Establishment ("TEE") under a loan facility agreement. TEE's indebtedness to the company on the liquidation date (including arrears of interest at the contractual rate) was US$156.3m. But TEE was itself heavily insolvent. It had realisable assets of only about US$43m and total liabilities (mainly to other group companies) of US$381.75m. Negotiations took place for the distribution of TEE's assets among its creditors. On 25 November 1998 the company agreed to accept about US$21.5m in full and final settlement of its claim. Nothing was paid in respect of interest which had accrued after the liquidation date.

2 Despite the fact that the company received no interest from TEE after the liquidation date, it is in principle liable to pay corporation tax as if it had. Section 8(2) of the Income and Corporation Taxes Act 1988 provides that a company is "chargeable to corporation tax on profits arising in the winding up of the company". It may be assessed in respect of an accounting period deemed to commence on the liquidation date (section 12(7)) and the liquidator is the proper officer liable to pay the tax (section 108(2) and (3) of the Taxes Management Act 1970). Chapter II of the Finance Act 1996 provides that, in the case of companies between which there is a "connection" as defined in section 87(3), profits from a "loan relationship" must be computed on an accruals basis: see section 87(2). In addition, the computation must be made on the assumption that "every amount payable under the relationship will be paid in full as it becomes due": see section 85(3)(c), read with section 85(5)(a) and paragraphs 5 and 6 of Schedule 9. No allowance may be made for bad debts.

3 There was at the relevant time a connection between the company and TEE because they had both been under the control of the Japanese holding company. In principle, therefore, the company was liable in respect of the accounting period after the liquidation date for corporation tax on profits computed on the assumption that it received all interest contractually payable by TEE. The liquidators do not admit liability to tax because they may wish to dispute whether TEE's obligation to pay interest continued after the liquidation date. But they applied to court for directions as to whether, assuming that there was such a liability, it was an expense "properly incurred in the winding up" which they were required by section 115 of the Insolvency Act 1986 to pay out of the company's assets in priority to other claims. The Inland Revenue was joined as a defendant to the application. Evans-Lombe J [1999] STC 922 held that the liability would not be an expense incurred in the winding up, but the Court of Appeal [2000] 1 WLR 2478 reversed his decision. The liquidators appeal to your Lordships' House.

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4 The case for the Crown is extremely simple. Section 115 provides that in a voluntary winding up such as this "All expenses properly incurred in the winding up, including the remuneration of the liquidator, are payable out of the company's assets in priority to all other claims".

5 Mr Briggs, who appeared for the Crown, submits that rule 4.218 of the Insolvency Rules 1986 determines both what counts as an expense in the winding up and the priorities of such expenses between themselves. The rule was made under both the general power in section 411 of the Insolvency Act 1986 (to make rules "for the purpose of giving effect to" the winding up provisions of the Act) and a specific power in paragraph 17 of Schedule 8 to make "Provision as to the fees, costs, charges and other expenses that may be treated as the expenses of a winding up".

6 Rule 4.218(1), with the omission of irrelevant items of expense, provides:

"The expenses of the liquidation are payable out of the assets in the following order of priority—(a) expenses properly chargeable or incurred by the official receiver or the liquidator in preserving, realising or getting in any of the assets of the company ... (m) any necessary disbursements by the liquidator in the course of his administration ( ... but not including any payment of corporation tax in circumstances referred to in sub-paragraph (p) below) ... (o) the remuneration of the liquidator, up to any amount not exceeding that which is payable to the official receiver under general regulations; (p) the amount of any capital gains tax on chargeable gains accruing on the realisation of any asset of the company (without regard to whether the realisation is effected by the liquidator, a secured creditor, or a receiver or manager appointed to deal with a security); (q) the balance, after payment of any sums due under sub-paragraph (o) above, of any remuneration due to the liquidator."

7 Mr Briggs says that the only question is whether the liability to corporation tax falls within one, and if so which, of these paragraphs. He submits that it plainly falls within (m). It is a sum which by statute is payable by a company in respect of profits or gains arising during a winding up. The liquidator is obliged to pay it. It is therefore a "necessary disbursement" which the liquidator has to make in the course of his administration. That is an end of the matter.

8 This approach is supported by high authority. In In re Mesco Properties Ltd [1979] 1 WLR 558 the question was also whether corporation tax had to be paid as an expense of the liquidation in priority to other claims. In that case it had arisen not on profits but on chargeable gains, on sales of the company's properties after the commencement of the winding up. Some of the properties had been sold by an administrative receiver appointed by a mortgagee, one by the mortgagee itself and the others by the liquidator. Under section 22(7) of the Finance Act 1965 a sale by a mortgagee or receiver was treated as if it had been a sale by a nominee for the mortgagor. The company was therefore assessed to corporation tax on chargeable gains realised on all the dispositions.

9 At that time the relevant rule was rule 195(1) of the Companies (Winding-up) Rules 1949 (SI 1949/330). It provided that the assets of a company in a winding-up which remained after "payment of the fees and expenses properly incurred in preserving, realising or getting in the assets"

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should "be liable to the following payments" and there followed an earlier version of the list of items which are now in rule 4.218. At that time, however, the rules did not specifically refer to corporation tax. The fifth paragraph, corresponding to paragraph (m) of the current rule, simply said "the necessary disbursements of any liquidator appointed in the winding up by the court ..." Brightman J said, at p 561:

"section 243(2) of the Income and Corporation Taxes Act 1970"—now section 8(2) of the 1988 Act—"expressly enacts that a company is chargeable to corporation tax on a capital gain arising in the winding up. It follows that the tax is a charge which the liquidator is bound to discharge by payment to the extent that assets are available. It is, therefore, to my mind, beyond argument that the payment of the tax is a 'necessary disbursement' of the liquidator and must come within the fifth paragraph of rule 195(1) ..."

10 This is a clear and uncompromising statement. When the case went to the Court of Appeal, Buckley LJ [1980] 1 WLR 96, 100, quoted it and said that he agreed. Bridge LJ, at p 101, said expressly that he agreed with the judgment of Brightman J and Templeman LJ also agreed. Mr Briggs says that it formed the basis upon which paragraphs (m) and (p) were drafted. Paragraph (m), in excepting corporation tax on chargeable gains, assumes that it would otherwise have fallen within the general description of a "necessary disbursement". It follows that corporation tax on profits remains within (m). Chadwick LJ suggested in the Court of Appeal [2000] 1 WLR 2478, 2496 that the reason for giving tax on chargeable gains a lower priority (below the first tranche of the liquidator's remuneration) was because it was thought unfair to give the higher priority to tax on gains which did not necessarily accrue during the liquidation period but may have been latent in the company's assets at the liquidation date. This seems a plausible explanation. The consequence is that, as a matter of construction, the corporation tax chargeable in this case falls within (m).

11 Both Evans-Lombe J and the Court of Appeal accepted the Crown's submission that whether the liability counted as an expense turned upon the construction of rule 4.218. But the judge thought that corporation tax did not come within (m). It was mentioned in (p) and so in his view could not come within another paragraph as well. The Court of Appeal disagreed and Mr Phillips, who appeared for the liquidators, did not support the construction adopted by the judge.

12 Instead, Mr Phillips put forward a more radical argument. He said that the terms of rule 4.218(1) did not in themselves determine whether a liability counted as an expense of the liquidation. The rule was made, as I have said, under a power to make provision as to the expenses which "may be treated as the expenses of a winding up". Mr Phillips laid stress upon the word "may". He said that the rule created only an outer envelope within which expenses were contained. If they could not be brought within one of the paragraphs of the rule, they could not count as expenses. But the reverse was not necessarily true. In order to be treated as liquidation expenses, they also had to pass a judge-made test which Nicholls LJ in In re Atlantic Computer Systems plc[1992] Ch 505, 520 called the "liquidation expenses" principle. That principle was one of fairness. If a liability was incurred as a result of a step taken for the benefit of the insolvent estate, it was fair that

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the burden should be borne by the persons for whose benefit the estate was being administered. So Mr Phillips said that a liability falling within rule 4.218(1) was payable as an expense only if it arose as a result of a step taken with a view to, or for the purposes of, obtaining a benefit for the estate. If the corporation tax had been chargeable on profits arising from carrying on the business of the company in liquidation, it would have satisfied the liquidation expenses principle. In the present case, however, the liquidator had neither received interest nor taken any steps to recover it. It was therefore not fair that the creditors should have to bear the burden of corporation tax on fictitious credits.

13 My Lords, I do not think that, as a matter of statutory construction, rule 4.218(1) is capable of being given the gloss for which Mr Phillips contends. It was in my opinion intended to be (subject to certain express qualifications and a well established rule of construction to which I shall later return) a definitive statement of what counted as an expense of the liquidation. Until 1890, this question was answered by reference to the practice of the Companies Court. But the practice was codified by the Companies (Winding-up) Rules 1890. Rule 31 was the lineal ancestor of rule 4.218(1). It provided:

"The assets of a company which is being wound up, remaining after payment of the fees, and actual expenses incurred in realising or getting in the assets, shall, subject to any order of the court ... be liable to the following payments, which shall be made in the following order of priority ..."

14 There followed a list of items. My Lords, the language of the rule is mandatory. The assets "shall" be liable to the payments listed. There may have been room for an argument (which I shall touch upon later) over whether the list was exhaustive. But the language is inconsistent with there being any ground upon which an item expressly mentioned in the rule can be denied the status of an expense. Similar language was used in the successive Rules which were in force until 1986. Rule 4.218(1) uses slightly different language. It says "The expenses of the liquidation are payable out of the assets in the following order of priority" and then sets out the list. But I do not think that any change of meaning was intended.

15 The courts have treated the rule as a complete statement of liquidation expenses, subject only to the qualifications contained in the Rules themselves. In In re MC Bacon Ltd [1991] Ch 127, 136 Millett J said: "The expenses of the winding up and the order on which they are payable out of the assets are listed in rule 4.218." Giving the judgment of the Court of Appeal in Lewis v Inland Revenue Comrs [2001] 3 All ER 499, 510 Peter Gibson LJ said: "Rule 4.218 tells one both what are the expenses to be treated as the expenses of a winding up and what priority they have inter se." In In re London Metallurgical Co [1895] 1 Ch 758, decided soon after the first Rules had been made, it was noted that the list said nothing about the costs of litigation incurred by the liquidator or awarded against him. Under the pre-1890 practice, costs awarded to a successful litigant had been recoverable in priority to the general costs of the liquidation. Vaughan Williams J said that rule 31 of the 1890 Rules did not change this practice. But he did not say that this was because the rule was not intended to be a complete statement of the law. He said that the practice on costs was

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preserved by the words "subject to any order of the court". When the 1890 Rules were replaced by the Companies (Winding-up) Rules 1903 (SR & O 1903/1103), it was specifically provided in rule 170(3) that:

"Nothing contained in this rule shall apply to or affect costs which, in the course of legal proceedings by or against a company which is being wound up by the court, are ordered by the court in which such proceedings are pending or a judge thereof to be paid by the company or the liquidator, or the rights of the person to whom such costs are payable."

16 This provision is now rule 4.220(2) of the 1986 Rules. No head of liquidation expense not mentioned in the rules has been discovered since the London Metallurgical Co case [1895] 1 Ch 758. And the general provision that the rules are "subject to any order of the court" has gone. The only power reserved to the court is that conferred by section 156 of the 1986 Act, which gives it a discretion to rearrange the priorities of the listed expenses inter se. This power is expressly reserved by rule 4.220(1).

17 In my opinion, therefore, both as a matter of construction and on authority, the heads of expense listed in rule 4.218(1) are not subject to any implied qualification. And I do not think that the use of the word "may" in the power in paragraph 17 of Schedule 8 to make provision for expenses which "may be treated as the expenses of a winding up", will bear the weight which Mr Phillips wants to put upon it. I think that the word "may" does no more than indicate that the liquidator has a right to reimburse himself out of the assets in respect of his liabilities which fall within the rule. Whether they fall within the rule is a question of construction and no more.

18 Mr Phillips accepts that, with the exception of In re Kentish Homes Ltd [1993] BCLC 1375, there is no case which supports a qualification of the statutory language. But that case has the authority of being a decision of Sir Donald Nicholls V-C and is based upon his own dicta when sitting as Nicholls LJ in In re Atlantic Computer Systems plc[1992] Ch 505. For that reason, and in deference to the able argument of Mr Phillips, I must examine the true scope of what Nicholls LJ called the "liquidation expenses" principle.

19 The rule has somewhat obscure origins in In re Exhall Coal Mining Co Ltd (1864) 4 De GJ & S 377, a briefly reported case in the Chancery Court of Appeal. Section 163 of the Companies Act 1862 (25 & 26 Vict c 89) provided: "any ... distress or execution put in force against the estate or effects of the company after the commencement of the winding up shall be void to all intents." After the presentation of a petition (which is deemed to be the commencement of a compulsory winding up) but before the winding up order, the lessor of land of which the company was the beneficial tenant levied a distress upon the company's goods for arrears of rent. The liquidator claimed that the distress was void under the statute. The court nevertheless said that it had a discretionary power to validate the distress. It derived this power from section 87, which provided that after a winding up order, no "suit action or other proceeding" should be proceeded with or commenced against the company without the leave of the court. The judgment of Turner LJ, at p 379, has usually been cited in later cases. It reads (in its entirety) as follows:

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"I also concur in the decision of the Master of the Rolls. I think the 163rd section of the Act must be construed as only avoiding attachments, sequestrations, distresses or executions when leave to put them in force has not been given under the 87th section."

20 Thus was created a discretion to allow a creditor to use a process of execution to recover in full a debt for which he would otherwise have had to prove in the liquidation. In subsequent years a body of precedent on the exercise of the discretion developed. In In re Progress Assurance Co; Ex p Liverpool Exchange Co (1870) LR 9 Eq 370 the lessors of a company in liquidation levied a distress for unpaid rent upon its office furniture three months after the winding up order. Lord Romilly MR said, at pp 372-373, that a distress after the winding up order would be allowed to proceed only where the company "has retained, not merely formal, but actual possession of the property for the purpose of carrying on the business of the liquidation ..."

21 This principle was restated in the influential case of In re Lundy Granite Co; Ex p Heavan (1871) LR 6 Ch App 462. The landlord of Lundy Island, which was let to a third party, distrained upon goods of the company which had been left upon the tenant's property. The distraint was for rent which had fallen due more than a year after the winding up order. The tenant had agreed to assign the lease to the company but had not actually done so. He had however allowed the company into possession and the company had brought its goods upon the land. After the winding up order the liquidator retained possession with a view to a sale of the company's assets on the land.

22 The Lords Justices gave two reasons for allowing the distress to proceed. The first was that the distress was not in respect of a claim for rent against the company, for which the landlord could have proved in the liquidation. The company was not his tenant. The landlord was exercising his ancient right to distrain upon any goods on the land, whether they belonged to his tenant or not. It should not make a difference that the third party to whom the goods belonged happened to be a company in liquidation.

23 The second and, for present purposes, more important reason, was that even if the rent had been owing by the company, the liquidator had retained possession of the land for the purposes of the liquidation. Following the Progress Assurance Co case LR 9 Eq 370, James LJ said, at p 466:

"if the company for its own purposes, and with a view to the realisation of the property to better advantage, remains in possession of the estate, which the lessor is therefore not able to obtain possession of, common sense and ordinary justice require the court to see that the landlord receives the full value of the property."

24 Although these principles were evolved in relation to a statutory discretion to allow a process of execution to proceed, it was obvious to everyone that there could be no practical difference between allowing a landlord to levy a distress for rent falling due after the winding up and directing the liquidator that he should be paid in full. It is important to bear in mind that the rent was a future debt for which the landlord could have

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proved in the liquidation: see Hardy v Fothergill(1888) 13 App Cas 351. Under rule 12.3(1) of the 1986 Rules, all claims by creditors are provable as debts against the company "whether they are present or future, certain or contingent, ascertained or sounding only in damages". But a "debt" is defined by rule 13.12(1) as:

"(a) any debt or liability to which the company is subject at the date on which it goes into liquidation; [and] (b) any debt or liability to which the company may become subject after that date by reason of any obligation incurred before that date ..."

25 Thus debts arising out of pre-liquidation contracts such as leases, whether they accrue before or after the liquidation, can and prima facie should be proved in the liquidation. In this respect they are crucially different from normal liquidation expenses, which are incurred after the liquidation date and cannot be proved for. In the Lundy Granite Cocase LR 6 Ch App 462 the court was therefore exercising the discretion conferred by section 87 of the 1862 Act to decide that, contrary to the normal pari passu rule, a creditor who had a debt which was capable of proof at the date of liquidation should be paid in priority to other creditors. What was the justification for the exercise of such a discretion?

26 A reason, or at any rate a rationalisation, was put forward by Lindley LJ, giving the judgment of the Court of Appeal in In re Oak Pits Colliery Co(1882) 21 Ch D 322, 330:

"When the liquidator retains property for the purpose of advantageously disposing of it, or when he continues to use it, the rent of it ought to be regarded as a debt contracted for the purposes of winding up the company, and ought to be paid in full like any other debt or expense properly incurred by the liquidator for the same purpose ..."

27 My Lords, it is important to notice Lindley LJ was not saying that the liability to pay rent had been incurred as an expense of the winding up. It plainly had not. The liability had been incurred by the company before the winding up for the whole term of the lease. Lindley LJ was saying that it would be just and equitable, in the circumstances to which he refers, to treat the rent liability as if it were an expense of the winding up and to accord it the same priority. The conditions under which a pre-liquidation creditor would be allowed to be paid in full were cautiously stated. Lindley LJ said, at p 329, that the landlord "must show why he should have such an advantage over the other creditors". It was not sufficient that the liquidator retained possession for the benefit of the estate if it was also for the benefit of the landlord. Not offering to surrender or simply doing nothing was not regarded as retaining possession for the benefit of the estate.

28 I give two modern examples which illustrate this restrictive application of the principle. In In re ABC Coupler and Engineering Co Ltd (No 3)[1970] 1 WLR 702, the liquidator on appointment closed down the business which had been conducted on the premises, had the company's plant and machinery valued and thought about what he should do. It was only from the time he decided to put the lease on the market that Plowman J held that he was retaining the premises for the benefit of the winding up and was liable to pay the rent in full. In In re HH Realisations Ltd (1975) 31 P & CR 249 Templeman J held that a company ceased to be

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liable to pay the rent in full from the time it gave notice to the landlord that it was seeking authority to disclaim the lease, even though it remained in occupation for nearly two months longer. (See also In re Downer Enterprises Ltd [1974] 1 WLR 1460.)

29 The principle evolved from Exhall Coal Mining Co Ltd 4 De GJ & S 377 and Lundy Granite Co LR 6 Ch App 462 is thus one which permits, on equitable grounds, the concept of a liability incurred as an expense of the liquidation to be expanded to include liabilities incurred before the liquidation in respect of property afterwards retained by the liquidator for the benefit of the insolvent estate. Although in was originally based upon a statutory discretion to allow a distress or execution against the company's assets, the courts quickly recognised that its effect could be to promote a creditor from merely having a claim in the liquidation to having a prior right to payment in full. As in the case of other equitable doctrines, the discretion hardened into principle. By the end of the 19th century, the scope of the Lundy Granite Co principle was well settled.

30 It was not, however, a general test for deciding what counted as an expense of the liquidation. Expenses incurred after the liquidation date need no further equitable reason why they should be paid. Of course it will generally be true that such expenses will have been incurred by the liquidator for the purposes of the liquidation. It is not the business of the liquidator to incur expenses for any other purpose. But this is not at all the same thing as saying that the expenses will necessarily be for the benefit of estate. They may simply be liabilities which, as liquidator, he has to pay. For example, there will be the fees payable to fund the Insolvency Service, ranking as paragraph (c) in rule 4.218(1), where the benefit to the estate may seem somewhat remote. There would be little point in a statute which specifically imposed liabilities upon a company in liquidation if they were payable only in the rare case in which it emerged with all other creditors having been paid.

31 The difference between the treatment of pre-liquidation debts under the Lundy Granite Coprinciple and the treatment of post-liquidation liabilities emerges clearly from the 19th century cases on rates. In In re Watson Kipling & Co (1883) 23 Ch D 500, which concerned an assessment for rates made after the liquidation upon property occupied by the company, Kay J rejected the submission of counsel for the rating authority, at p 506, that "where a liability is incurred during the winding up, that liability ought to be paid in full, and therefore these rates ought to be paid in full because they were made during the winding up".

32 He applied instead the Lundy Granite Co principle and said that it was not enough that the company was in rateable occupation. It must have retained occupation for the benefit of the estate. But in In re National Arms and Ammunition Co (1885) 28 Ch D 474 Bowen and Fry LJJ said that this was wrong. Bowen LJ said, at pp 480, 482:

"If the company retains the possession of property which would be rateable in the hands of anyone else, it is only reasonable that it should be rateable in the hands of the company ... the true test is whether there has been a beneficial occupation within the ordinary meaning of those words in cases as to rating ..."

33 This test was applied by Vaughan-Williams J in In re Blazer Fire Lighter Ltd[1895] 1 Ch 402. The liquidator had closed the business and

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done nothing on the premises except to install a caretaker to protect them from vandalism. That was sufficient to continue the company in rateable occupation. So the rates were an expense of the liquidation.

34 It therefore did not follow that because a liquidator might in certain circumstances retain possession of leased property without having to pay the rent as an expense of the liquidation, he did not the same circumstances have to pay the rates. In In re ABC Coupler and Engineering Co Ltd (No 3)[1970] 1 WLR 702, for example, the rent did not become a liquidation expense until some time after the winding up order, notwithstanding that the company remained in occupation. And in In re HH Realisations Ltd 31 P & CR 249 the company remained in occupation for some time after the rent had ceased to be a liquidation expense. But in both cases the company would in my opinion have been liable to pay rates on the simple ground that it was in rateable occupation. The rates would have been an obligation incurred after the liquidation which (unlike the rent) was not provable and was therefore payable in full.

35 My Lords, I have spent some time examining the origins and scope of the "liquidation expenses" principle because it formed the basis of the two recent authorities upon which Mr Phillips particularly relied. In In re Atlantic Computer Systems plc [1992] Ch 505 was about whether rental due under hire purchaser agreements should be treated as an expense of administration. But the judgment of Nicholls LJ contains a discussion of the principles upon which obligations based upon pre-liquidation agreements should be treated as expenses in a liquidation. He said, at p 522, that a creditor could ordinarily be given leave to execute against the company's assets for a "new debt incurred by the liquidator for the purposes of the liquidation": "it is just and equitable that the burden of the debt should be borne by those for whose benefit the insolvent estate is being administered." It was, he said, a corollary of this principle that a debt incurred for the purposes of the liquidation ought to be paid in full as an expense of the liquidation.

36 Nicholls LJ then went on to say:

"This latter principle is not confined to new debts incurred by the liquidator. It applies also to continuing obligations under existing contracts such as leases which the liquidator chooses to continue for the benefit of the winding up."

In this connection he discussed the Lundy Granite Cocase LR 6 Ch App 462, the Oak Pits Colliery case 21 Ch D 322 and others in the same line of authority. He then said, at p 523:

"It is important to keep in mind that this principle, relating to outgoings on property retained by a liquidator for the purposes of the winding up, is no more than a principle applied by the court when exercising its discretion in a winding up. The principle, which it will be convenient to call the 'liquidation expenses' principle, is a statement of how, in general, the court will exercise its discretion in a common form set of circumstances. The liquidator himself has power, in a suitable case, to pay the relevant outgoings. But the court retains an overriding discretion, to give leave under section 130(2) [of the 1986 Act] or to give

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directions to a liquidator that the relevant outgoings shall be paid by him as an expense of the liquidation."

37 Two points arise out of these passages. First, Mr Phillips is entitled to say that Nicholls LJ assimilates the grounds upon which post-liquidation debts count as expenses with the grounds upon which a continuing obligation which has arisen under a pre-liquidation contract may be treated as a liquidation expense. This certainly provides support for his submission that post-liquidation expenses must satisfy the "liquidation expenses" principle. But in my respectful opinion the two categories of expenses cannot be assimilated in this way. The considerations which determine whether they should count as expenses are different. Assimilation is inconsistent with the authorities to which I have referred and with the statutory regime which has existed since 1890.

38 The second point is the proposition that whether debts should count as expenses of the liquidation is a matter for the discretion of the court. In my opinion there is no such discretion. Rule 4.218 determines what counts as expenses, subject only to the limited discretion under section 156 of the 1986 Act to re-arrange the priorities of expenses inter se. The court will of course interpret rule 4.218 to include debts which, under the Lundy Granite Co principle, are deemed to be expenses of the liquidation. Ordinarily this means that debts such as rents under a lease will be treated as coming within paragraph (a), but the principle may possibly enlarge the scope of other paragraphs as well. But the application of that principle does not involve an exercise of discretion any more than the application of any other legal principle to the particular facts of the case. I should say that Mr Phillips made it clear that he also did not suggest that the court was able to exercise what would ordinarily be called a discretion.

39 There is of course no question that section 130(2) of the 1986 Act (the lineal descendant of section 87 of the 1862 Act upon which the Lundy Granite Coprinciple was originally constructed) confers a statutory discretion. But the discretion is as to the remedy which the creditor should be allowed to exercise; whether he should be able to bring proceedings, levy distress or execution or should have to wait for the distribution of the assets in due course of liquidation. The fact that a debt counts as an expense of the liquidation does not necessarily mean that the creditor should be allowed immediately to bring proceedings or levy execution. The order of priorities under rule 4.218(1) may mean that if he is paid at once, the assets to satisfy prior expense claims may be insufficient. So the question of remedy is entirely a matter of discretion. But the discretion does not determine whether a claim is a liquidation expense or not. It is rather the other way round; the claim must be a liquidation expense before the court can have any discretion to grant a remedy which will enable the creditor to obtain payment in priority to other claims.

40 Sir Donald Nicholls V-C applied the two propositions in the Atlantic Computer Systemscase [1992] Ch 505 to arrive at his decision in In re Kentish Homes Ltd [1993] BCLC 1375. The question there was whether a post-liquidation liability to community charge on empty flats was an expense of the liquidation. He recorded, at p 1380, that it was common ground that "the company is the chargeable person in respect of the flats for the relevant periods". But he said that the liability was nevertheless not a

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liquidation expense. In his opinion, it would rank as such only if the court, as a matter of discretion, directed the liquidators to discharge the obligation out of the assets in their hands. And in his view there was no ground upon which the court should do so. The case did not fall within the Lundy Granite Co principle because the liquidators had not retained possession of the flats for the purpose of the winding up. An administrative receiver had taken possession. Nor was there any other equitable ground upon which the liquidators should pay.

41 The Court of Appeal said that they were driven to the conclusion that this case was wrongly decided. I respectfully agree. In the first place, the question of whether the community charge should count as an expense of the liquidation was not a matter for the judge's discretion. It depended upon whether it came within one of the paragraphs of rule 4.218. In my opinion if, as was common ground, the company was the chargeable person, it was a necessary expense which came within (m). If, therefore, the liquidator had sufficient assets after satisfying the liabilities coming within paragraphs (a) to (l), he was obliged to pay it. Secondly, the Lundy Granite Co principle had no relevance. The liability did not arise out of a pre-liquidation obligation. If it came within the language of paragraph (m), it was a liquidation expense.

42 I therefore respectfully adopt the simple approach of Brightman J in In re Mesco Properties Ltd [1979] 1 WLR 558, 561. The statute expressly enacts that a company is chargeable to corporation tax on profits or gains arising in the winding up. It follows that the tax is a post-liquidation liability which the liquidator is bound to discharge and it is therefore a "necessary disbursement" within the meaning of the Insolvency Rules.

43 My Lords, I accept that it may be possible to characterise the liquidator's "retention" of the debt from TEE as an act for the benefit of the estate which could be brought within an attenuated version of Mr Phillips's liquidation expenses principle. But I think that such an exercise, suggesting a gloss on the language of rule 4.218 in respect of post-liquidation liabilities, could only cast doubt upon law which has been perfectly clear since the Mesco Properties case. It should in my opinion be left that way.

44 Everyone agrees that this is a hard case for the company's creditors. The provisions of the 1996 Act which exclude bad debt relief in loan relationships between connected companies are to prevent groups of companies from manipulating their tax liabilities. But it does not seem fair to visit the consequences upon creditors in a winding up. The present case was specifically considered in "Corporate Debt, Financial Instruments and Foreign Exchange Gains and Losses", a consultative document issued by the Inland Revenue on 26 July 2001. The Government said that it proposed to introduce legislation to make an exception to the bad debt rule where a creditor goes into liquidation.

45 Mr Phillips said that the problem was not specific to this particular form of tax liability but existed in every case in which a liability might be imposed upon a company in liquidation. The answer, he said, was the adoption of a general liquidation expenses rule. I do not agree. The injustice, if any, does not arise because liabilities imposed upon a company in liquidation have priority as expenses of the liquidation, but because it may be unjust to impose certain liabilities upon companies in liquidation. Mr Phillips mentioned liabilities under environmental legislation which

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might also take precedence over other claims if there were no liquidation expenses principle. But in In re Mineral Resources Ltd [1999] 1 All ER 746 Neuberger J carefully considered the consequences for creditors of his decision that a company in liquidation could not disclaim a waste management licence. He recognised that this might result in post-liquidation liabilities which would rank ahead of other creditors. But he decided that the legislation, on grounds of public interest, required that the claims of the environment should be preferred.

46 In my opinion, the question of whether such liabilities should be imposed upon companies in liquidation is a legislative decision which will depend upon the particular liability in question. It should not be ruled out by an illegitimate extension of the liquidation expenses principle, which was devised more than a century ago for an altogether different purpose.

47 I would therefore dismiss the appeal.

LORD WOOLF CJ

48 My Lords, I have had the advantage of reading in draft the speech prepared by my noble and learned friend, Lord Hoffmann. I agree with him and for the reasons, which he has given, I too, would dismiss this appeal.

LORD HUTTON

49 My Lords, I have had the advantage of reading in draft the speech of my noble and learned friend, Lord Hoffmann. I agree with it, and for the reasons which he gives I too would dismiss the appeal.

LORD HOBHOUSE OF WOODBOROUGH

50 My Lords, with some reluctance, both for reasons given by my noble and learned friend, Lord Hoffmann, towards the end of his opinion and because I found the arguments of Mr Phillips and judgments of Nicholls LJ and V-C more persuasive than have your Lordships and would not have accepted that the authorities are incapable of reconciliation, but, in deference to the unanimity of your Lordships' opinions, I concur in the order proposed.

LORD RODGER OF EARLSFERRY

51 My Lords, I have had the privilege of studying the speech of my noble and learned friend, Lord Hoffmann, in draft. I agree with it and, for the reasons which he gives, I too would dismiss the appeal.

Appeal dismissed with costs.

S H

Solicitors: Linklaters; Solicitor of Inland Revenue.

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