Government rejects to protect payments into Christmas Saving Clubs
As the holiday season has ended, the Government’s rejection of Law Commission proposals to give pre-paid consumers more protection when a retailer goes bust is timely, particularly for those consumers who pay into Christmas saving club style schemes (Savings Clubs).
This article looks at some cases that address whether or not pre-paid consumer can claim a trust over their prepayments if their Savings Club goes insolvent.
The Key question: Is there a trust?
Organisations offering Saving Clubs are not regulated under the Financial Services and Markets Act 2000 and, unlike depositing money at a bank, consumers who pay into them are not protected under the Financial Services Compensation Scheme.
As a result voluntary trade association compensation schemes have been set up, including the Christmas Prepayment Association (CPA), to try and protect payments into Savings Clubs by setting up a trust to keep them safe until the Savings Club has delivered its goods. Despite this, a gap still exists - leaving consumer’s prepayments vulnerable in insolvency situations if the Savings Club is not a part of the CPA. Not all Savings Clubs are.
In the event of a Savings Club going bust, the distribution of its assets is pre-determined by law, and the consumers sit low down that order of distribution. This means they often get nothing back. This is particularly unfair when those consumers paying into such schemes are often the most financially vulnerable. One exception to the pre-determined order of distribution is where the payments are held in a trust. The difficult question is - can a trust arise outside of the CPA arrangement?
The Case Law
A leading trust case, Barclays Bank Ltd v Quistclose Investments Ltd, Quistclose loaned money to Rolls Razor to be used for a specific purpose. The money loaned was held in a separate account with Barclays, and the bank was aware of the arrangement. Barclay’s later attempted to set off amounts owed to it by Rolls Razor using the funds loaned by Quistclose and held by the bank.
While parts of the Court’s rationale in this case have been criticised subsequently, the key principle established has not. In a simplified form, the principle is that where money is paid for a specific purpose, and it is not used for that purpose, a trust catches the money for the benefit of the party who paid it - provided the money can still be clearly identified. This is called a ‘Quistclose trust’. Whether a Quistclose trust applies will depend on the specific facts of each case.
The next leading case is Re Kayford. This involved a company, Kayford, carrying on a mail order business. Kayford provided loans to its main supplier, who subsequently got into financial trouble - which also affected Kayford’s solvency. Kayford opened a separate bank account which it labelled as a ‘trust account’ to put money received from its customers whose orders had not yet been delivered. Kayford went into liquidation.
The Court decided that because there had been a clear intention by Kayford to keep the money separate pending completion of the order, this created a trust in favour of the customers’, which kept it separate from the insolvency money and meant it could be returned to the customers who had not received their orders. Namely, there was a clear intention to create a trust.
A Kayford trust differs from a Quistclose trust, because the money was not originally held in a separate account, but Kayford was aware of its potential solvency problems and therefore clearly transferred those monies into a separate account and segregated them from its general funds.
Holiday Promotions and OTC Computers
Holiday Promotions (Europe) Ltd reinforces the principles above - the Court held that because consumer deposits were not in a separate account – they were mixed with the company’s general funds (and the company was free to use them for general purposes) - there was no intention to create a trust. Therefore the customer deposits formed part of the company’s general assets, and would follow the general order of insolvency distribution (i.e. no special status for the customers).
In OT Computes Ltd (in administration) v First national Tricity Finance the Court decided that although customer money was paid into the company’s general account, this did not prevent a trust arising when they were later transferred to a separate account after the company realised it could not avoid insolvency.
Farepak Food and Gifts Ltd is probably the most infamous case involving Savings Club insolvency. Farepak owed £37 million to approximately 100,000 consumers - who waited 6 years to be repaid only 50% of the pre-payments they had made (and for which they received no goods) - most of which was contributed by hardship compensation funds. There was no trust found to exist here.
Farepak had attempted to ring-fence customer money by creating a trust days before entering administration. However, the Court found that there was no Quistclose trust because the money was originally paid by consumers to local agents of Farepak who then paid the money on to Farepak. These agents did not intend, nor have any obligation, to hold the money on trust or keep it separate and safe. Customer payments were mixed with the company’s general funds and the corporate group’s.
The Courts will clearly not make special exception just because consumer pre-payments are involved, it will make its decision based upon establish principles. They include (but are not limited to) the money being clearly identifiable and segregated from general funds, and there being a clear intention to create a trust. While judges can empathise with consumers that lose their money, they are still bound by the law.
The Government has rejected the Law Commission’s proposals, but indicated its intention to provide consumer protection through other means. Like many things at this current time, we shall see. In the interim, while there is no guarantee that a trust will exist in every case where a Savings Club goes bust, attempts to create one at an early stage can lower the risk to consumers (and potentially the risk of subsequent wrong doing allegations against the directors) if the worst happens.