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should hold the money on trust or that the money be put aside pending transmutation from collected money to goods or vouchers.119 The relationship between Farepak and its customers was, thus, a contractual one and there was no Quistclose trust.120

Consumer prepayments

When consumers make payments in advance to companies for goods or services – for example, by sending money to mail order firms – they run considerable risks. If the company becomes insolvent before the goods or services are supplied (as in Farepak) the consumers have no remedies except as unsecured creditors, a position in which they are unlikely to receive even a substantial portion of their money back. The Cork Report121 noted that a good deal of public and media concern attended this state of the law and in 1984 an Office of Fair Trading (OFT) survey suggested that there were at least 15 million prepayments per year, that

2 per cent of these involved a loss of money and that total losses exceeded £18 million.122

Such difficulties have been responded to in a variety of ways. A number of trade associations have established voluntary compensation schemes123 and certain statutes deal with prepayments in particular sectors. The Estate Agents Act 1979 section 13 thus requires a client’s

119Mann J stated that a failure to keep the received money separate from other money was not fatal to a Quistclose-type resulting trust but that what was crucial in the Farepak situation was the lack of any suggestion that the money had to be put on one side by Farepak pending transmutation from credited money to goods or vouchers. If there were a Quistclose trust then that obligation would have been inherent in it.

120Nor was Mann J prepared to hold that money received after the company had ceased trading was held on constructive trust: see p. 651 above. He was sympathetic to this possibility, following Neste Oy v. Barclays Bank [1983] 2 Lloyds Rep 658, but the limited evidence available did not provide a sufficient basis for such a decision.

121Cork Report, paras. 1048–9.

122OFT, The Protection of Consumer Prepayments: A Discussion Paper (1984) (‘OFT’). See also Moffat, Trusts Law, ch. 15.

123Moffat, Trusts Law, p. 765, notes those of the Newspaper Proprietors Association, the Mail Order Protection Scheme and the Direct Marketing Association. See also T. Sears, ‘Turbulence in the Travel Trade’ (2008) Recovery (Spring) 28, describing the operation of protection schemes run by tour operators and travel agencies (e.g. the ABTA bonding arrangement, the ATOL Bonding Protection Scheme, the IATA travel agents’ agency for IATA member airlines). ‘The practical result of this protection for passengers will be that they will not form the bulk of unsecured creditors in a travel insolvency; but rather the bulk will be trade creditors and those who provide the bonding protection for the organisations referred to above’ (at p. 28).

money to be held in trust in a separate bank account.124 General legislation also plays a part here in so far as the Sale of Goods (Amendment) Act 1995 provides that pre-paying buyers of part of a bulk will obtain undivided proprietary rights in the bulk.125 This amending legislation went some way in helping with problems of identifying the subject of the trust (though the bulk of goods may itself present difficulties of identi- fication) but such legislative responses have not solved all the problems and uncertainties left by judicial decisions in this area.

Customer interests may, however, be protected where it is decided that funds are held in trust for their benefit. A key decision on such trusts is Re Kayford.126 This case concerned a company (K) that ran a mail order business. K had loaned its main supplier considerable sums of money but the supplier entered financial difficulties. This, in turn, threatened K’s solvency. K was advised by an accountant to open a separate ‘Customers’ Trust Deposit Account’, to pay into it any money received from customers for the purchase of goods which had not yet been delivered and to withdraw money only on delivery of the goods. K accepted the device but, in the first instance, paid money into a dormant deposit account in the company’s name, only at a later stage altering the name of the account. After K had entered involuntary liquidation Megarry J found sufficient evidence of an intention to create a trust. This was contained in the discussions of K’s managing director, the accountant and the bank manager. Megarry J found that the three certainties of a trust were established and commented:

No doubt the general rule is that if you send money to a company for goods which are not delivered you are merely a creditor of the company unless a trust has been created. The sender may create a trust by using appropriate words when he sends the money … or the company may do it by taking suitable steps on or before receiving the money. If either is done the obligations in respect of the money are transformed from contract to property, from debt to trust.127

Megarry J suggested, further, that it was entirely ‘proper and honourable’ for a company to use such a trust account as soon as there were doubts about the firm’s ability to fulfil its obligations. He, indeed, welcomed the taking of such steps.

124See OFT, paras. 3.1–3.13; G. Howells and S. Weatherill, Consumer Protection Law (Dartmouth, Aldershot, 1995).

125See Ulph, ‘Equitable Proprietary Rights in Insolvency’.

126[1975] 1 All ER 604, [1975] 1 WLR 279. 127 [1975] 1 WLR 279 at 282.

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There was, however, no trust of customer deposits in Holiday Promotions (Europe) Ltd128 where the court held that the payment of customer deposits created a purely contractual relationship of debtor and creditor. In Holiday Promotions, deposits were not segregated in a separate account but were mixed with company money and, importantly, the company was free to use the deposits for its general purposes. There was nothing in the terms of any contract, nor in the general circumstances, to indicate any intention or agreement that the funds should not form part of the general assets available to creditors.

It would now appear, though, that initial payment into the company’s general account is not necessarily fatal to the existence of a trust. In the Tiny Computers case,129 a trust was expressly and successfully set up for sums forthcoming from customers. These sums constituted deposits and, in anticipation of insolvency, were deposited with the company’s bank with instructions that the bank should hold the funds on trust for customers in a customer trust account. The complication was that the deposits were paid into the company’s general account from which transfers were periodically made into the customer trust account. The court stated, however, that there was no difficulty regarding certainty of intention or subject matter and that there was certainty of objects since (though difficult) it was possible to determine the relative interests of the depositing customers by referring to the customer lists held by the company.130 Where, moreover, there is an intention to establish a trust for listed beneficiaries and there is a shortfall in the trust account, it has been held that beneficiaries’ entitlements should be assessed with reference to the sums owed to them in the trust period rather than by looking at the quantum of funds that had actually been placed in trust for them. Thus in Sendo International Ltd131 a schedule set out the debts owed to each beneficiary and it was stated that there was a clear intention to release sums equal to the scheduled debts from the security that would otherwise cover those funds. It was the scheduled amounts, accordingly, that were said to define each creditor’s interest.

128[1996] 2 BCLC 618.

129OT Computers Ltd (in administration) v. First National Tricity Finance [2003] EWHC 1010.

130A parallel trust for suppliers failed since its object (‘payments due to urgent suppliers’) was uncertain in the absence of any listing of such suppliers and because the term ‘urgent’ was too vague to define any class of beneficiary.

131Sendo International Ltd (in administration) [2007] BCC 491.

Efficiency

Do trust devices offer an efficient way for parties to protect themselves when advancing funds or making prepayments? What is clear is that trusts are often set up to ring-fence moneys received in the twilight period prior to an anticipated insolvency since this serves to protect customers and suppliers and it also suggests to the outside world that business is being carried on as usual. This is particularly useful in sustaining a position while a pre-pack or other turnaround strategy is being brought into effect.132 ‘Twilight trusts’ can thus be seen as useful in allowing the directors to continue trading in the hope of attracting investors and maximising returns to creditors. The counter view is that such trusts are often used to protect the directors from liabilities for wrongful trading and that the time-consuming and expensive process of setting up such ‘fireproofing’ trusts tends to distract the management of the company away from the needs of a business in crisis.133 A significant difficulty in using such trusts is that they often have to be set up rapidly and they are, in legal terms, notoriously fragile.134

In relation to express trusts and resulting trusts, as encountered in Quistclose, there are also issues of uncertainty. As commentators have pointed out,135 the precise nature of the equitable right to see that the loan is applied ‘for the primary designated purpose’ is unclear and it is not always apparent when the primary purpose is fulfilled, the ‘trust’ spent and the equitable right extinguished. Moffat also notes: ‘Similar uncertainty surrounds the status of the particular class of creditors for whose benefit the primary trust in Quistclose was created, i.e. the shareholders post-declaration of a dividend. Are they beneficiaries under a private express trust with associated rights of enforcement? If not, are we presented with an example of a “purpose trust” infringing the beneficiary principle?’136

Questions also arise as to the characterisation of the assets to be placed in trust. This area of uncertainty is encountered in the Carreras

132See D. Redstone, ‘Customer Deposits (in the Twilight Zone)’ (2008) Recovery (Spring) 17; M. Ellis and L. Verrill, ‘Twilight Trusts’ (2007) 20 Insolvency Intelligence 151; Sidle, ‘Whose Money is it Anyway?’ On pre-packs see ch. 10 above.

133See Ellis and Verrill, ‘Twilight Trusts’, who question (p. 115) whether it is right for directors to pursue self-protection rather than safeguarding business value.

134Redstone, ‘Customer Deposits (in the Twilight Zone)’.

135Ibid.; J. Heydon, W. Gummow and R. Austin, Cases and Materials on Equity and Trusts (4th edn, Butterworths, Sydney, 1993) p. 476; Swadling, Quistclose Trust.

136Moffat, Trusts Law, p. 775.

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Rothmans137 case. Rothmans owed an advertising agency money for services and renegotiated an agreement so that the sums involved were paid by the agency into a special account for the purpose of paying these expenses. The agency went into liquidation and Rothmans contested their claim to the funds with the liquidator. The case was decided on Quistclose lines and the funds were said never to have belonged to the agency and to be repayable to Rothmans. Such an approach is, however, questionable since the agency had effectively made an existing asset (the Rothmans’ debt) available exclusively to one class of creditor, and this should probably now be seen as a preference or contrary to the principle established in British Eagle.138

Quistclose, it should also be noted, involved an attempted corporate rescue, and the extent to which Quistclose principles are liable to be extended by the courts to cover more routine advances of corporate finance is a further area of uncertainty.139 The courts may well act consistently with the advice of commentators and be less inclined to recognise trusts where rescues are not involved and where the language used does not evidence the intention to establish a trust in rigorous terms.140 Here, again, the philosophical underpinnings of Quistclose are unclear and further cases raise the questions whether the Quistclose trust is to be seen as an express trust or a constructive trust and whether it is to be viewed in pure trusts law terms or remedially.141

Such uncertainties reduce the present value of the Quistclose type of trust as an effective and efficient means of protecting investors but there is no necessary reason why the courts or the legislature could not bring new clarity into this area of the law. If it is asked whether such trusts hold out the promise of effective and efficient protection in routine cases of lending, other considerations have to be taken into account. First, a creditor may demand that a debtor company should place the funds at issue into a special account to be used for a specific purpose but the company may resist such a request for a number of reasons. Administrative costs will be

137Carreras Rothmans Ltd v. Freeman Mathews Treasure Ltd [1985] 1 Ch 207, [1984] 3 WLR 1016.

138On preferences see Insolvency Act 1986 ss. 239, 240 and ch. 13 above; British Eagle International Airlines Ltd v. Compagnie Nationale Air France [1975] 1 WLR 758, [1975] 2 All ER 390 and ch. 14 above.

139See Belcher and Beglan, ‘Jumping the Queue’, p. 7; Moffat, Trusts Law, ch. 15.

140See Bridge, ‘Quistclose Trust’.

141See Belcher and Beglan, ‘Jumping the Queue’, p. 8; C. Rickett, ‘Different Views on the Scope of the Quistclose Analysis: English and Antipodean Insights’ (1991) 107 LQR 608; Moffat, Trusts Law, ch. 15; Chambers, ‘Restrictions on the Use of Money’.

incurred by the company and these may be seen as excessive and unnecessary. Other creditors may insist on similar separate accounts and there may be fears of a deluge of such requests that, overall, would impose tight and inconvenient restraints on the uses to which money can be put. The company, moreover, may consider that it is not possible to designate specific purposes for its borrowings without giving up the flexibility of financing that it needs to compete in the marketplace. In the face of such company resistance to the use of a Quistclose trust, the small supplier of funds or the infrequent/one-off supplier may be ill-positioned to insist on the arrangement and may be ill-equipped to calculate the advantages, disadvantages and ways of arranging such a trust.

Turning to consumer prepayments and the Kayford type of trust, this also possesses limitations.142 In the first instance, it requires that the consumer, on forwarding money, should use appropriate words to manifest the intention to establish a trust, or the company supplying the goods must itself take actions demonstrating such an intention.143 Most consumers will not be aware of the possibilities offered by Kayford trusts and are unlikely to use the required forms of words when making purchases. They may not occupy bargaining positions that allow them to insist on such arrangements and the trading companies themselves will have weak incentives to establish Kayford trusts. A second difficulty arises from the need to identify the funds at issue. The law provides rules to trace assets in mixed accounts but these rules are complex and do not allow involved parties to predict legal effects clearly. Legal uncertainties also infect the process of establishing a Kayford type of trust. Thus, the courts may refuse to recognise such trusts where they are deemed to infringe the pari passu principle of residual insolvency distribution and when such infringements will be declared is a matter of some uncertainty.144

Pursuing the issue of efficiency prompts the question whether it is desirable to offer consumer pre-payers the protections of Kayford trusts and to place them ahead of other unsecured creditors in whose body they would take their place in the absence of a trust. Practical considerations may undermine the efficiency case for consumer protections through

142See W. Goodhart and G. Jones, ‘The Infiltration of Equitable Doctrine into English Commercial Law’ (1980) 43 MLR 489; Moffat, Trusts Law, pp. 768–70; A. Ogus and C. Rowley, Prepayments and Insolvency (OFT Occasional Paper, 1984).

143See Ogus and Rowley, Prepayments and Insolvency, p. 6.

144See Cork Report, para. 1068; British Eagle International Airlines Ltd v. Compagnie Nationale Air France [1975] 2 All ER 390.

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trusts so that, even if the case for consumer protection was accepted, it could be argued that trusts do not provide the best route to such protection. The OFT recognised in 1984 that administrative costs for firms might be high if separate accounts and trusts were routinely employed.145 These costs would have a disproportionate effect on small new companies. Public policing of such practices might prove expensive since firms would possess incentives to transfer funds from special to general accounts before contracts were fulfilled. Prepayments also provide, in many cases, an ‘essential part of the trader’s working capital’.146 Ogus and Rowley suggest that in general terms there is no efficiency presumption that such financing is better provided by commercial rather than customer creditors (though they qualify this comment by stating that if poorly informed consumers falsely maintain uneconomic market operations, there may be efficiency losses to society). A danger that can be pointed to with more confidence, however, is that if superior protections were given to consumer creditors, the effect would be to increase the incentives of other parties to take security and to leave fewer assets available for unsecured creditors. A further danger is that funds to replace those currently provided by prepayment might be hard to come by. Ogus and Rowley caution: ‘Given capital market imperfections, it is by no means clear that alternative finance would be available, save at loaded rates of interest, even where the trader was essentially solvent, especially in the case of new enterprise.’147 The risk is that gains for consumers would be achieved at the price of significant increases in legal and administrative costs.

Other means of consumer protection have been suggested.148 In rejecting preferred status for consumer creditors and compulsory trust accounts, the Cork Committee relied on more general measures to discourage irresponsible corporate behaviour or limit its effects. These came in the form of tighter disqualification rules for errant directors and the introduction of the wrongful trading concept together with the proposed 10 per cent fund which would be available for consumer as well as other unsecured creditors. Ogus and Rowley pointed out that a number of protective arrangements had already been introduced (most

145Ogus and Rowley, Prepayments and Insolvency, paras. 6.9–6.24.

146Cork Report, para. 1050.

147Ogus and Rowley, Prepayments and Insolvency, p. 28; cf. P. Richardson, ‘Consumer Protection and the Trust’ [1985] JBL 456.

148See the Customer Prepayment (Protection) Bill 1982: C. M. Schmitthoff, ‘A Consumers’ Prepayment (Protection) Bill?’ [1984] JBL 105. See also the Insolvency Act 1986 s. 176A – the ‘prescribed part’ or ‘ring-fenced’ fund.

following negotiations with the OFT) so as to protect consumers in relation to certain types of transaction. Thus, certain statutes such as the Estate Agents Act 1979 demand that clients’ money must be held in trust in a separate account.149 Some trade associations, moreover, had voluntarily established compensation schemes to reimburse disappointed consumers: these, as noted above, were encountered, for instance, in the newspaper, periodical, travel agency, vehicle building and glazing installation sectors. As for further responses to the predicament of consumer pre-payers, these commentators backed Cork on wrongful trading controls as a way forward, and viewed as promising the institution of steps to educate traders on the causes of collapse (where possible involving the banks and expert creditors); the wider dissemination of corporate accounting information; ‘the linking of bank guarantees to the obtaining of secured creditor status – thereby inducing self-interested monitoring of trading company performance’; and the encouraging of voluntary trust funds and insurance bonds. There was, they added, no clearly established public interest case for the compulsory introduction of any of the above solutions.

Before leaving the question of efficiency in relation to trusts, the special case for ‘rescue fund trusts’ should be considered.150 The argument for regularising arrangements whereby finances are supplied to a troubled company for the purposes of assisting in its survival is that it may be in the economic interest of the community to encourage the supply of funds (by consumers, bankers or traders) in circumstances that facilitate rescues and increase corporate survival rates.151 This type of arrangement could operate on a regularised Quistclose basis when a purchaser of goods offers prepayment expressly on the basis that this funding is to assist in a rescue and is given for a specific purpose to be held on trust. Recognition of the trust would thus keep the fund out of the insolvency estate and encourage rescue funding by traders as well as banks.

The possible problem with the trust-based regime, as described, is that it may be open to the same criticisms as were made of the statutory superpriority (SSP) as proposed by the DTI/Insolvency Service in 1993,

149Section 13.

150On the general issues attending ‘twilight’ trusts that are established at times of corporate stress and are ‘becoming an integral part of the rescue culture’ see Ellis and Verrill, ‘Twilight Trusts’; Redstone, ‘Customer Deposits (in the Twilight Zone)’; and p. 657 above.

151See R. Austin, ‘Commerce and Equity: Fiduciary Duty and Constructive Trust’ (1986) 6 OJLS 444 at 455.

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dropped in 1995 after consultation152 and mooted again in 1999.153 SSP would give providers of funding during a moratorium a statutory superpriority over all existing creditors. (Such lenders would be at the head of the queue for the insolvency estate, not placed outside the queue as would be the case in a trust-based system.) The proposal was dropped in 1995 on the grounds that it might militate against the proper consideration of the viability of the business by a lender: it would lead to inefficiently large incentives to lend and to unjustifiable financing.154 In such a scenario, the supposed danger is that the highly protected investor encourages the company to continue trading beyond the point where this is justified and this results in greater damage to existing creditors than would otherwise be the case.

Such reasoning, however, is open to question. In a Quistclose type of arrangement where the lender to the troubled company places funds on trust and is well informed, there is no excessive incentive to invest because the investor is not free-riding on the security of other parties but is able to calculate the relevant investment risks and to agree a price or interest rate accordingly. The use of a separate trust account, in this regard, keeps the affairs of the new finance supplier separate from those of the creditors of the company. (It is, of course, the requirements of specific purpose and separate accounting that, as noted, restrict the potential role of the Quistclose trust as a general form of flexible corporate financing.) Inefficiencies might arise where such new trust-based finance suppliers are ill-informed (a position likely where consumer prepayments are involved) or where the company’s creditors have no information on the trust-based funding. More generally, indeed, it can be argued that recognition of the Quistclose-type of trust contributes to a lack of transparency since this is a device that ‘by its very nature will misrepresent to the world, and in particular to prospective creditors, the true financial state of a company’155 (an argument to be returned to below in looking at questions of fairness). From the point of view of a company’s existing creditors, there is a balance to be considered in

152DTI Consultative Documents: Company Voluntary Arrangements and Administration Orders (1993), Revised Proposals for a New Company Voluntary Arrangement Procedure

(1995).

153See Insolvency Service, A Review of Company Rescue and Business Reconstruction Mechanisms (1999). See ch. 9 above.

154DTI, Revised Proposals, para. 2.2.

155See J. Penner, The Law of Trusts (5th edn, Oxford University Press, Oxford, 2006) ch. 9, pp. 242 ff.