The question of who should and should not be included in a class of creditors or members for the purposes of a scheme of arrangement under section 425 of the Companies Act 1985 (section 425 scheme) has always been an anxious one, especially when the court can give no conclusive guidance on the initial application and the penalty for making a wrong choice is to deprive the court of jurisdiction to sanction the scheme (Practice Note [1934] WN 142).

Recent decisions, in particular, re BTR plc, had shown that when deciding what constitutes different classes of creditors or members a relatively clear test had emerged (whether the creditors have different rights rather than different interests) and that, on the whole, this question did not require a statutory definition of class, for which the Company Law Review might otherwise have presented an opportunity ([1999] BCLC 675; [2000] BCLC 740).

However, a recent Court of Appeal decision in re Hawk Insurance Company Limited, reversing the High Court decision, has muddied the waters (23rd February, 2001). (PLC, 2000, XI(4), 77)

In this case most of the creditors of the company, Hawk, were insurance companies that had reinsured with Hawk. The company went into provisional liquidation and the provisional liquidators proposed that the company enter into a section 425 scheme as, without a scheme, the ultimate level of claims against the company was unlikely to be known for some time due to the nature of the company's business.

Chadwick LJ (who gave the leading judgment) first analysed what is the correct test for ascertaining the appropriate classes and confirmed that a class "must be confined to those persons whose rights are not so dissimilar as to make it impossible for them to consult together with a view to their common interest"(Sovereign Life Assurance Company v Dodd [1892] 2 QB 573). He then stated that the answer to the question depended on analysis of:

The court then seems:

The court therefore held that all insurance creditors should be treated as one class. The court's application of the test to the facts of the case seems to have stood the test (as previously understood) on its head: the court appears to be saying that unless you can identify enormous dissimilarities in rights, all creditors are capable of consulting together.

The view generally accepted has been that creditors or members cannot consult together where, in order to reach a conclusion, there is a material feature of the new rights under the scheme which one group must consider but which to another group is of no consequence.

There were at least three categories of creditors included in the single class, of which a meeting was convened, in Hawk:

A possible fourth category was non-insurance creditors (such as a provider of goods or services to Hawk). It is not clear from the facts whether there were any.

It appears to be clear that many, but not all, insurance company creditors had claims in all those insurance categories. Some reliance seems to have been placed on this feature by the court and counsel as amicus curiae (friend of the court), though it is not clear to what extent creditors with claims in all three categories might have differed in the proportions in which their claims fell in one category rather than another.

Pill LJ suggested that different considerations might have applied if some creditors have only unsettled paid claims and others only IBNR claims. Presumably the same would be the case if some creditors have claims made up of 90% of the former but 10% of the latter and other creditors have claims made up the other way round; and the extent of such divergence required for separate classes would be a question of degree.

Pill LJ's reservations, with which Wright J agreed, appear to have gone to jurisdiction, as the question for the court was whether separate classes were required. On this basis a scheme on similar lines might well require separate classes, as held by the High Court despite the Court of Appeal decision, unless this particular feature of the facts in Hawk is repeated.

There were two elements of the scheme that affected the rights of different creditors in a way which required the constitution of separate classes:

At one end of the spectrum, a creditor with a non-insurance debt or a creditor with only an unsettled paid claim would have no interest in the debt ascertainment machinery since there could be no real scope for argument about the amount of his claim. The only matter of concern to him would be whether he would receive a higher dividend under the scheme than in a winding up.

At the other end of the spectrum, an IBNR creditor has to consider firstly whether he is prepared to accept binding expert determination of his claim and second, even if that procedure can be equated with "a just estimate", whether he is prepared to accept payment of only 50% of his claim as so established. No such discount would be applied in a winding up; and, if it is suggested that the 50% discount is part of the "just estimate", it cannot be suggested that it is other than a completely arbitrary figure: a "just estimate" must require consideration of the facts and surrounding circumstances of each individual claim.

Most people who have had contact with insolvent general insurance companies would be happy to see a simple, practical and inexpensive way of resolving matters and achieving finality for the creditors. A compromise under Schedule 4 of the Insolvency Act 1986 is a possible alternative; but that is only available in a liquidation with all the disadvantages that liquidation entails.

The question of what are the appropriate classes for the purpose of section 425 schemes has ramifications far beyond insolvent insurance companies. It may be that the reservations of Pill LJ will confine the effect of Hawk to unusual facts which will rarely be repeated. But if the decision were held radically to change the meaning of the words "whose rights are not so dissimilar as to make it impossible to consult together", then the protections which have been enjoyed by minority shareholders and creditors in section 425 schemes over a century will be seriously eroded.

A question must then arise whether it is necessary to override Hawk by legislation.