Fehily & Fehily v Atkinson & Mummery



Judge: High Court (Chancery Division) (Stephen Jourdan QC sitting as a Deputy High Court Judge))

Citation: [2016] EWHC 3069 (Ch)

Summary

This was an appeal against a district judge’s refusal to annul a bankruptcy order. The grounds of appeal centered on whether the appellant had the mental capacity to enter into an Individual Voluntary Arrangement (IVA) breach of which had led to the bankruptcy order being made.

The chronology was that in November 2011 HMRC presented a bankruptcy petition against the appellant, her husband and two others based on unpaid partnership tax. All four proposed an IVA, the court made an interim order (staying the petition and other execution until the IVA proposal could be put to creditors) and subsequently the IVA was approved by creditors in February 2012 and the petition dismissed.

The two others complied with the terms of the IVA but Mr and Mrs Fehily did not. Thus, in June 2013 the IVA’s supervisors petitioned for the bankruptcy of Mr and Mrs Fehily on that ground. On 2 August 2013 the court made bankruptcy orders against both. On 6 August 2013 they applied for the bankruptcy orders to be annulled. The application was eventually dismissed in November 2014. Mrs Fehily obtained permission to appeal and Mr Fehily did not.

Initially the application to annul was pursued on the basis that the bankruptcy orders were unfair. In early 2014 it was first suggested that Mrs Fehily lacked mental capacity to enter into the IVA and to litigate and that on those grounds the bankruptcy order should be annulled.

In August 2014 the court appointed Mrs Fehily’s daughter to represent her pursuant to Insolvency Rule 7.44. In November 2014, however, the court held that Mrs Fehily had capacity to enter into the IVA in February 2012 and to litigate in August 2013. The court, therefore, refused to annul the bankruptcy order.

Mrs Fehily’s appeal, which was again brought on her behalf by her daughter, argued that the lower court had applied the wrong test of capacity in relation to the IVA and was wrong on the evidence as well. There was no appeal against the finding of capacity to litigate in August 2013.

As regards the issue of evidence of capacity, the court did not have a formal capacity assessment. There were letters from the appellant’s GP but they did not address the specific issue. The appellant sought to adduce fresh evidence on the appeal but it was not admitted, partly because it could have been made available to the lower court but also because it took the matter no further.

That lack of formal medical evidence of want of capacity was sufficient to persuade the lower court to reject allegations of incapacity and the appeal court to reject the appeal.

Of more interest is the question of the correct approach to issues of capacity in relation to IVAs. The argument on appeal proceed on the basis that the test was the common law test of capacity applicable to contracts and other voluntary transactions such as gifts or wills and there was no reference to the test of capacity in the MCA (indeed there was no mention of the MCA at all).

The lower court had applied the test as set out in Chitty on Contracts as follows.

At common law, the understanding and competence required to uphold the validity of a transaction depend on the nature of the transaction. There is no fixed standard of mental capacity which is requisite for all transactions. What is required in relation to each particular matter or piece of business transacted, is that the party in question should have an understanding of the general nature of what he is doing.

The appellant criticised that formulation and said that the judge had not applied it properly anyway. The appeal court rejected the latter argument and after a long review of authorities held in relation to the former at paras 101-103 as follows:

  1. In my view, there is a distinction between the key features of a transaction, and ancillary, incidental or procedural aspects of it. I think that the requisite capacity is to understand the key features. It is not necessary that a person has capacity to understand every detail of the proposed transaction. In Banks v Goodfellow, at 567, Cockburn CJ, delivering the judgment of the court, quoted with approval from an American judgment: “It is not necessary that he should view his will with the eye of a lawyer, and comprehend its provisions in their legal form. It is sufficient if he has such a mind and memory as will enable him to understand the elements of which it is composed, and the disposition of his property in its simple forms.” Hoffmann J said in Re K, “… one cannot expect that the donor should have been able to pass an examination on the provisions of the Act”. In Masterman-Lister, Chadwick LJ said at [79]:

‘a person should not be held unable to understand the information relevant to a decision if he can understand an explanation of that information in broad terms and simple language’.

  1. In conclusion, I think that the law is as stated by the High Court of Australia in Gibbons v Wright. The summary of the law in Chitty, taken from that case, is accurate, although it would be possible to misinterpret it as only requiring the capacity to form a general impression of the nature of a contract, rather than the capacity to absorb, retain, understand, process and weigh information about the key features and effects of the contract, and the alternatives to it, if explained in broad terms and simple language.

Although it would be possible for someone not familiar with this branch of the law to misinterpret the test stated in Chitty¸ if they did no more than read the relevant paragraph in the textbook, I do not think that DJ Parnell did that. DJ Parnell referred earlier in his judgment, when considering litigation capacity to Masterman-Lister, so it is clear that he had that decision in mind. That is the leading modern case on the test for deciding if a person has mental capacity. He identified in his judgment the key features of the IVA and I think, reading his judgment as a whole, that he did have in mind the need to assess whether Mrs Fehily had the mental capacity to understand and weigh those features, and the alternative to the IVA, namely that the bankruptcy petition would proceed to a hearing. I therefore reject the argument that DJ Parnell failed to apply the right test for assessing Mrs Fehily’s mental capacity to enter into the IVA. I am satisfied that he applied the right test. “

The judge then went on to consider whether the IVA was necessarily void if the appellant had, in fact, lacked capacity to enter into it. He held that an IVA is analogous to a contract with creditors and, therefore, if the creditors had no reason to know of the incapacity, then the IVA was not void. He further held that the creditors and the IVA supervisors did not know of the alleged incapacity: see paras 116-127.

Comment

The appellant’s difficulty in this case arose mainly from the fact that there was no formal mental capacity assessment. This underlines the necessity that anyone asserting want of capacity whether at common law or under the MCA must have such evidence save in the clearest of cases.

The appeal court did not have to deal with the issue of litigation capacity but had it done so, it would have had to apply MCA principles because both the CPR and the Insolvency Rules define incapacity with reference to the MCA.

It is worth noting that the Insolvency Rules make somewhat different provision with regard to incapacity enabling the court to appoint a representative where a party lacks capacity to administer his property and affairs. There is no provision that proceedings are void if this is not done (See rr 7.43 and 7.44). This contrasts with the situation under CPR 21.3(4).

That said, in De Toucy v Bonhams 1793 Ltd [2011] EWHC 3809 (Ch); [2012] B.P.I.R. 793, the court held that the CPR must also be applied in these circumstances so that if the court has reason to believe that a party lacks capacity, it must make sure that the party is properly represented. That case states, however, that if bankruptcy is inevitable, there may be no need for a representative or litigation friend or to annul a bankruptcy order in the absence of such (as the case may be).

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