Unauthorised collective investment schemes: reform needed

This article outlines:

• a typical scheme and more details of the failure stories, such as the Carlauren Group;
• the different legal statuses of the investors;what happens when the schemes go wrong; 
• the difficulties faced by insolvency office-holders when faced with such schemes (and the effect of the investors’ different rights); and
• suggestions for reform.

Failed Schemes

The Carlauren Group (the ‘Group’) bought hotels with plans to convert them into and run them as luxury care homes. Investors bought 125-year leases of individual rooms or suites, paying around £80,000. The Group promised investors a fixed annual return of 10% from the time of investment with a guaranteed buy back at 110% of the price after five years, rising to 125% after ten years.

In total, the Group granted 781 leases to investors, of which 687 were registered at HM Land Registry. Special purpose vehicles (SPVs) owned the hotels, but other group companies held the funds invested (around £79m in total). The Group used the funds for purposes other than those of the relevant SPV, leaving the SPVs unable to convert, refurbish and run the properties. The Group companies went into liquidation and administration. We discuss the difficulties faced by the office-holders in resolving the chaos below.

Aronex Developments Ltd (‘Aronex’) is another recent failure. Its first schemes developing accommodation and selling leasehold units of student accommodation were successful. Planning issues and rising professional costs, coupled with less overseas investment following Brexit meant its final project, based in Leicester suffered cash flow issues and eventually caused the decline into administration for the company.

Various companies in the Signature Living Group failed after the hotel owning company defaulted on its liabilities to the bedroom leaseholders of the prestigious Shankly Hotel, which other entities in the group had guaranteed.

Administrators to the rescue?

The courts have recognised that, where such a scheme fails and the property owning company is insolvent, an administrator, as office-holder, might in reality be the only party able to resolve the situation. Their unique status as officers of the court, and their powers deriving from the IA 1986 mean they can, among other things:

reconstruct the Company’s books and records, which may be incomplete and out-of-date at their appointment; use their powers under ss 234 to 236 IA 1986 to formally require the directors of the Company and the Company’s former solicitors or advisers to assist in that process; find all purchasers and investors, who may be based around the globe; remove restrictions registered at HM Land Registry to improve the prospects of a sale of the company’s assets and increasing the return to its creditors; preserve, protect and insure a company’s properties until sale; take advice on funding and completing a development where the valuation evidence and availability of funding supports this; market the company’s properties; ensure that all investors, wherever they might be in the world, can engage with the insolvency process and with the court’s involvement; take specialist legal advice and seek directions from the court on how to apportion sale proceeds; investigate why the company failed, the directors’ and advisers’ conduct and potential antecedent transactions the company has entered into.

Where suitable, the administrators can bring legal proceedings to increase the potential pot for creditors. 

For example, in the Carlauren case, the administrators got a £40m worldwide freezing order over the assets of its founder Sean Murray. They reported seizing or identifying various luxury assets (including a Rolls-Royce, a Bentley, a Ferrari and a Lamborghini, a yacht, a private jet and two lavish homes) with a view to selling them; prevent individual creditor action against the assets; and sell properties subject to security interests.

Obviously, an institutional secured creditor, such as a bank, may be able to exercise a power of sale of the whole of a development, depending on their security interests. But where there is no such creditor, or no creditor willing to do this, an administration seems the most obvious solution.

Where a development is unfinished, the investors themselves would have been in an impossible position seeking to sell their leases or secured interests (depending on their status) in empty plots of land or unmarketable units individually.

The only alternative to administrators exercising the rights and powers set out above to resolve the situation might be for the court to appoint receivers. Receivership is often a more expensive process, which reduces the amount available for creditors.
That said, the Carlauren case shows the task for office-holders is not a straightforward one. Insolvency practitioners need to examine carefully the basis for the insolvency process, the likely investor rights they face and where they will have recourse for their fees.

The office-holders’ valuation advice in this case was that the group’s properties might be worth £24.75m if sold ‘unencumbered’ by the investor leases; the implication being that as freehold reversions, with the investor leases in place, the value was much different. The office-holders unsuccessfully tried to persuade investors to surrender their leases.

The office-holders had incurred fees of over £2.6m, £1.3m in legal costs and had no obvious route to be paid or reimbursed. They incurred some of these costs directly, holding and selling the properties. Some were the general expenses of the insolvencies (including the litigation against the company’s founder). They applied to the court for directions to allow their fees and expenses to be paid from the sale of the freeholds. This assumed the investors’ leasehold interests could be dealt with without the consent of the leaseholders and the unencumbered valuation achieved.

The office-holders relied on the Berkeley Applegate principle, which was described in Re Sports Betting Media Ltd [2007] EWHC 2085 (Ch) at para 10 as being that:

‘the court has an inherent jurisdiction to require persons beneficially interested in property to subject their beneficial entitlements to a right of payment to persons who have come otherwise than by officious intermeddling into the position of fiduciaries in relation to the relevant fund and have incurred time and cost in realising the fund and identifying the entitlements of the beneficiaries and paying out to those beneficiaries their entitlements.’

They recognised the investors’ leasehold interests were legal interests in land. However, they could not identify a mechanism or jurisdiction for the court to ‘cancel’ these legal interests to allow them recourse to the funds that would be available on an unencumbered sale.

Their position changed at the hearing. They asked the court to declare the officeholders’ rights over the freehold reversions (without adjusting investors’ rights) and to apportion the group’s insolvency costs across the property owning companies.

ICC Judge Prentis decided the new directions reflected what would happen in the normal course and refused to make the order. The office-holders could sell the freehold reversions subject to the investor leases and then seek to charge their fees and expenses to the insolvent estates in the usual way and subject to the usual controls.

This is not the first attempt by office-holders to solve the problem created where unitised property ownership schemes fail. In Re Caer Rhun Hall Hotel Ltd [2019] EWHC 2617 administrators sought the court’s permission under para 71 Sch B1 IA 1986 to sell the freehold of a hotel, free of 57 long leases over individual rooms in the hotel. Again, this was flawed – para 71 allows the court to enable an administrator to sell assets free from security, not free from registered legal interests. They abandoned the application following criticism from the investors.

Thus far, the courts and office-holders have not found a legal solution to the problem from the officeholders’ perspective. Investors with leaseholds effectively hold the power to unlocking the value and cannot be forced into relinquishing their interests. From their perspective, leaseholders are often the biggest ‘victims’ of failed schemes and want to retain control over the outcome – the idea of giving up their leases for the greater good of all creditors will be resisted without adequate safeguards in place for the value they hold.

Currently, without legal reform, the only viable option is a consensual solution in an insolvency of the freehold owning company where investors hold leaseholds. In Australia, the courts have confirmed that a liquidator can disclaim a lease granted by the company to a tenant (Willmott Growers Group Inc v Willmott Forests Ltd (receivers and managers appointed) (in liquidation) [2013] HCA 51). The statutory protection in place for such tenants is that a challenge could be made to a disclaimer where the prejudice caused to the tenant by the loss of the leasehold interest in the land is ‘grossly out of proportion to the prejudice that setting aside the disclaimer would cause to the company’s creditors’ (s 568B of the Corporations Act 2001). The disclaimer provisions in Australia are different to those in the IA 1986, and it is generally accepted that the IA 1986 disclaimer provisions cannot deprive a party of their proprietary rights.

Whilst the administrators of Caer Rhun Hall Hotel Ltd were unsuccessful, we wonder whether para 71 of Sch B1 IA 1986 could be extended to encompass leasehold interests as well as security interests in limited situations. The valuation method to be ascribed to a ‘ransom’ leasehold is likely to be key if such an idea was pursued.