The Electronic Money Regulations 2011 and the Insolvency Act 1986: Statutory Trusts, the Asset Pool, and the waterfall provision



In the recent case of Baker v Financial Conduct Authority (Re Ipagoo LLP) [2022] EWCA Civ 302 the Court of Appeal has given useful guidance on the interaction of the Electronic Money Regulations 2011 (EMRs), which implemented the EU Electronic Money Directive (EMD), with the Insolvency Act 1986 (the 1986 Act), in respect of the status and basis of the Asset Pool, and the waterfall of payments where there is a distribution from an insolvent estate.

Whilst much focus of the case was on the argument whether the EMRs created a statutory trust over funds received by an electronic money institution (EMI), the court also considered the competing interests of the Asset Pool under the EMRs and an insolvent estate under the Insolvency Act.

The Electronic Money Regulations and Statutory Trust argument

The EU Electronic Money Directive was introduced to safeguard customer funds that are received by an EMI in exchange for electronic money that has been issued.  Article 10 of the Directive, implemented by regulations 20 – 22 of the EMRs, required EMIs to take one of two steps to safeguard customer funds.  Either they must: (a) segregate them, or (b) obtain insurance or a guarantee in respect of them.

On appeal the FCA argued that the requirement under the EMRs created a statutory trust in respect of any such funds for the benefit of the EMI’s customers.  If that was right, such funds would be safeguarded in the event of an EMI’s insolvency.

This argument, however, was rejected by the Court of Appeal.  In rejecting the argument four considerations supporting this conclusion were identified.  Firstly, the funds which are required to be segregated under option (a) are a “fluctuating pool”.  Secondly, option (b) does not require any funds to be segregated at all, and it does not imply that customers have any continuing beneficial interest in the funds.  Thirdly, there would be other consequences, in particular, “a trust would apply in circumstances other than insolvency and would have wider ramifications. Furthermore, it would create rights and remedies against third parties other than the creditors of the EMI.”  Fourthly, there were identifiable features of the drafting of the EMRs which militated against the trust interpretation.

This judgment brings useful finality to this issue given the first instance decision conflicted with a well-reasoned judgment of ICC Judge Burton in Re Allied Wallet Ltd [2022] EWHC 402 (Ch).  Unusually, ICC Judge Burton had prepared her judgment prior to the first instance decision in Baker, but handed it down afterwards.  This meant that despite coming to the opposite conclusion, she had considered herself bound by the first instance decision in Baker, and had to change her decision in light of it.

Interaction between the EMR Asset Pool and the insolvent estate in an insolvency

The Extent of the Asset Pool

The court also considered whether the customers’ Asset Pool in the EMRs could be increased by drawing from the EMI’s general insolvent estate where the EMI had not taken the steps required under regulations 20 – 22.

In support of its argument that the EMRs created a statutory trust, the FCA had argued that extending the Asset Pool in such a way would override insolvency and property law, and to do so would require an amendment of the 1986 Act which the EMRs did not purport to make.

Having rejected the statutory trust argument, the Court of Appeal also rejected this argument. It held that the EMR provisions regarding insolvency are distinct from the usual provisions of the 1986 Act, and that the 1986 Act provision begin to apply only after the requirements of the EMRs have been fulfilled.  It held:

the EMD requires all funds received by EMIs from electronic money holders to be safeguarded…  not merely those which have been safeguarded….. It follows, therefore, that in order to fulfil the requirements of the EMD and in order to interpret the EMRs in conformity with the Directives, “Asset Pool” in regulation 24 must be given a wider meaning than merely such funds as have been so safeguarded.”

The Court then endorsed the first instance judge’s statement that the Asset Pool must therefore include a sum equal to such funds which ought to have been safeguarded in accordance with the regulations, but had not been.

The Order of Priorities

Finally, the court considered the EMRs in the context of the order of priorities under the 1986 Act.  This question arose in the context of considering Regulation 24 which states that where there is an insolvency event, claims of electronic money holders are to be paid in priority to all other creditors.  This provision clearly had the potential to make a significance difference to funds available to customers of EMIs, since it would determine whether they were paid in priority to the costs of the insolvency.

The FCA argued that Regulation 24 should be considered as an administrative provision in support of the statutory trust it had argued for, and that it could not effect the order of priorities under the 1986 Act, as this would be to amend the 1986 Act.

The Court rejected this argument, holding clearly that the EMRs and Asset Pool under them were prior to, and outside of, the 1986 Act.  The Court stated that EMI’s customers’ right to the Asset Pool:

applies before the waterfall under section 175 of the 1986 Act and stands outside it. There was no need to amend the 1986 Act, therefore, or for the EMRs to make express reference to it. The statutory regime under the 1986 Act applies after distribution has taken place under regulation 24”.

In emphasising its conclusion, the court stated that “the Asset Pool [under the EMR’s] is intended to stand apart from the normal insolvency regime and should only bear the costs associated with distributing it…. The electronic money holders’ claims are not to be subject to the priority of expenses of an insolvency proceeding.

The Court also added, obiter, that in any event were it necessary, it considered that the EMRs were capable of overriding the 1986 Act, pursuant to section 2 of the European Communities Act 1972.

This decision will be welcomed by customers of EMIs that have suffered losses in the course of an EMI’s insolvency.  This will not be the case for other unsecured creditors of EMIs who may consider the insolvent estate in which they had a pari-passu interest to have been diminished, or for the Office Holder whose fees will not be payable out of funds held in the Asset Pool.

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