Friday 13th: an Unlucky Day for Scottish Liquidators

by Reed Smith
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On 13 December 2013, the Court of Session ruled that the liquidators of The Scottish Coal Company Limited (SCC) were not able to disclaim ownership of certain open-cast mines and the environmental permits which were connected with the operation of those mines. This ruling followed an appeal by the Scottish Environmental Protection Agency (SEPA), and overturns the previous decision of 11 July 2013, in which it had been ruled that the liquidators were entitled to disclaim this property.

The liquidators had sought directions from the court as to whether they were entitled to disclaim the coal mines and the licences due to the cost of compliance with the statutory licences granted under the Water Environment (Controlled Activities) Regulations 2005 and 2011 (the "CARs") and permits issued under the Pollution Prevention and Control (Scotland) Regulations) 2000 and 2012 (the "PPCR").

The liquidators had submitted to the court that compliance with the environmental regimes cost around £500,000 per month and would exhaust the funds realised from the sale of SCC’s assets within 20 to 22 months. These obligations remain effective even though SCC’s operations have ceased. As such, the liquidators sought directions on whether they could disclaim the land and the associated environmental permits and licences.

Liquidators of companies being wound up in England and Wales may disclaim "onerous property" under section 178 of the Insolvency Act 1986. Onerous property includes property giving rise to a liability and has been held to extend to waste-management licences (now renamed "Environmental Permits") under English law. However, the power to disclaim under section 178 is not extended to liquidations in Scotland. Therefore, the court referred to the terms of the CARs and the licences themselves to ascertain whether the power to disclaim sought was permitted.

The CARs specifically state that a liquidator becomes the "responsible person" for the purposes of the environmental legislation. As such, by virtue of simply taking the appointment, a liquidator of a Scottish company with a CARs licence becomes responsible for ensuring the ongoing compliance with the environmental protection regime under the CARs.

The CARs also provide a specific manner by which licences may be surrendered by a responsible person (here, the liquidator). Such surrender may be granted subject to conditions imposed by SEPA to ensure the environmental protection of the land. Because of the operation of this prescribed surrender process, the court concluded that the licence could not simply be "disclaimed", and that the statutory procedure for surrender would have to be followed.

The court noted that "enforcing a statutory licence against a liquidator affords at best only temporary and imperfect environmental protection", as the company would eventually be wound up and could no longer be compelled to comply with the CARs. Nevertheless, the court held that its interpretation of the CARs, based on the intention of the regulations to implement the European Water Framework Directive (the purpose of which was to protect water and prevent and reduce water pollution) would achieve a better overall result as a matter of public policy than protecting the interests of "individual shareholders, creditors, debtors and liquidators of companies".

The court declined to determine whether (or where) SEPA could rank in the liquidation as a creditor in respect of liabilities arising from SCC’s breach of its obligations under the licences.

The Court of Session ruled that the costs of compliance with SCC’s environmental obligations could not be disclaimed and would be treated as liquidation expenses. As liquidation expenses rank after the payment of the claims of holders of fixed charges on insolvency, the burdensome cost of compliance has the potential to render the liquidation of SCC insolvent (i.e., there will be no funds remaining to pay the liquidator’s expenses, let alone the remaining, lower-ranking claims in the insolvency).

This case highlights the importance of licences and permits, which may at first seem to be ancillary to the operation of an insolvent business. The cost of compliance in this instance may render the liquidation itself insolvent, but regulatory and compliance costs can significantly impact distributions in many cases, even where sufficient funds are generated from realisations to meet these costs. Moreover, insolvency practitioners may be less than encouraged to take an appointment for which their fees are unlikely to be paid as the insolvent estate will be consumed by the costs of regulatory compliance.

The result in this case contrasts starkly with existing case law in England and Wales. In England and Wales, the power to disclaim such obligations is a significant tool in preserving value from the realisations of the insolvency.

In one of the leading English cases from 2000, two companies holding waste management licences (as they then were) had both gone into compulsory liquidation.1 The licences, under which the licence holders had remediation obligations, remained in force. On an application to disclaim, the Court of Appeal held that the licences were property that could be disclaimed as onerous under section 178 even though this had the effect of terminating the obligations. The court considered that the words of the then relevant legislation that "the licence shall continue in force until it is revoked…or its surrender is accepted" were not irreconcilable with section 178.

Subsequent English case law has gone even further. In the Hillridge case in 2004, the operator had made financial provision for its licence obligations via a trust fund. The operator went into liquidation, the liquidators disclaimed the licence and the court was concerned with the fate of the trust fund. The High Court ruled that the liquidators were not entitled to the fund, as their disclaimer of the licence operated so as to disclaim their interest in the fund as well. However, contrary to the Environment Agency’s arguments, the Agency was not entitled to the fund either (to use it to clean up the land) because the fund could only be used while the licence was in force. The fund therefore became bona vacantia and reverted to the Crown.2

The SCC case in Scotland serves as a reminder of the onerous obligations that insolvency practitioners may face in dealing with particular types of insolvent company, or environmental liabilities associated with land owned or occupied by that company. Insolvency practitioners should be mindful of these and should carry out as much due diligence as possible prior to the onset of any insolvency process. Contaminated land itself (as distinct from environmental licences and permits) may well fall within the definition of onerous property, although there is uncertainty around the ability to disclaim liabilities in respect of land that a company may have polluted but no longer owns or occupies.

The most pragmatic approach may well be to seek to disclaim onerous licences as soon as possible once the licences are no longer required, since many environmental licences will not be capable of immediate surrender or termination unless and until expensive clean-up works have been carried out.

1. Official Receiver (Celtic Extraction Ltd & Bluestone Chemicals Ltd) v Environment Agency.
2. Environment Agency v Hillridge

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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