Since Chester Street Insurance Holdings went into provisional liquidation on 9 January, gossipmongers have had a field day.

It has been alleged Chester Street undersold its subsidiary Iron Trades Insurance Company by £47.5m, wrongly paid former Chester Street chief executive Robert Hardy a bonus of almost £440,000 on completion of the sale and that assets were moved between subsidiaries in a dubious manner.

Provisional liquidator and scheme administrator Dan Schwarzmann of Pricewaterhouse-Coopers (PWC) promised he would conduct an investigation into the conduct of Chester Street's directors prior to its insolvency. He revealed his findings at a public meeting on 8 November. His team included senior PWC manager Sarah Redgers, Clifford Chance partner David Steinberg and senior solicitor Philip Hertz. They investigated transactions back to December 1996, as well as the cessation of business in 1990. Their work was reviewed by two insolvency practitioners on the creditors' committee. All are adamant that nothing untoward occurred.

Legal options
Steinberg explained the legal avenues open to PWC under the Insolvency Act 1986. He said it could act on transactions at an undervalue (section 238), preference (s 239), transactions defrauding creditors (s 423) or wrongful trading (s 214).

To prove transaction at an undervalue, the team needed evidence that Chester Street received either no money or significantly less money than it should have for the sale of Iron Trades.

To prove preference, a transaction needed to put a creditor or class of creditors in a better position in the event of liquidation than would otherwise have been the case. It would also have to be proved that Chester Street showed a "desire" for the transaction to have had that effect.

To prove transactions defrauding creditors, there needed to be a trans-action at an undervalue, with the purpose of putting assets beyond the reach of creditors or otherwise prejudicing their interests.

To prove wrongful trading, the directors had or ought to have known earlier than they did that there was no reasonable prospect of avoiding insolvency. They would also had to have failed to take every step to minimise loss to creditors.

The history behind it
Chester Street's history goes some way to explaining why these avenues were unavailable to PWC.

A shipbuilders' mutual called Iron Trades Employers Insurance Association was set up in 1898.

It wrote employers' liability until 1990, when it transferred the goodwill of its future business to its subsidiary Iron Trades Mutual Insurance Company, which it renamed Iron Trades Insurance Company. In 1997, the association transferred its assets and liabilities to a new intermediate holding company called Iron Trades Holdings. The changes were partly designed to get better tax benefits from a non-mutual status. Finally, in February 2000, the association changed its name to Chester Street Employers' Association and the holdings company changed to Chester Street Insurance Holdings.

Schwarzmann said the Inland Revenue confirmed all the changes would have the beneficial effect sought. They were made with the knowledge of the Department of Trade and Industry (DTI) and the permission of the company's policyholders and main reinsurers.

"There was no loss of value, indeed, there was an enhancement of value because of the favourable tax treatment," he said. "I can only see the transaction as increasing the value of Iron Trades Holdings."

Schwarzmann said the sale of Iron Trades Insurance Company to Australian company QBE International Insurance for £175m, comprising £148m cash and £27m in an escrow account to be reviewed in March 2003, was above-board. According to its filed accounts, the company's assets were valued at £220m, but Schwarzmann said its accounts also contained a contingent deferred tax liability of £54m, which took its value down to £166m. Chester Street's advisers on the sale Donaldson Lufkin & Jenrette (DLJ) said the minimum acceptable sale price was £160m. Some 24 groups showed interest in buying Iron Trades, six put in proposals and two (one being QBE), made offers of £175m. DLJ advised Chester Street's directors to give QBE a period of exclusivity because it had more potential of success than the other buyer. The sale was given added momentum when Standard & Poors announced it might reduce Iron Trades' ratings to reflect Chester Street's lower rating.

Any rating's drop would have severely affected the firm's value. QBE also had concerns that the company's claims record would deteriorate, which led to the establishment of the escrow account. DLJ advised Chester Street to accept QBE's offer.

"The directors were being properly advised. They had good reasons for going ahead with the sale and for entering into the deal," Schwarz-mann said. "I do not believe this was a transaction of undervalue."

Schwarzmann told the meeting bonuses were paid to 12 staff who worked on the sale, some of whom knew a sale meant inevitable redundancy. Two of the 12 received more than £150,000, three received between £100,000 and £150,000, and seven received up to £100,000, costing a total of £1.3m.

"It's very sensible," he said. "In this type of company, staff are a valuable asset and they wanted to lock them in. In our view, you have to have management and staff on board to maintain the value of the subsidiary."

Steinberg said wrongful trading was notoriously difficult to prove against insurance company directors. Schwarzmann said the only evidence that could be used to prove wrongful trading was Chester Street's "optimistic" setting and discounting of reserves.

"The directors went for the lower range of reserves and were slightly high at 6% or 6.5% discounting," he said. "But it was mentioned in its accounts that there was huge uncertainty in relation to reserves."

Hindsight doesn't apply
Schwarzmann stressed that asbestos claims were among the hardest to accurately reserve against and that Chester Street's directors should not be judged with the benefit of hindsight. The directors took legal advice before signing off reserves for asbestos-related liabilities in April 1998. Lawyers concluded the problem had been properly recognised and addressed. The directors also adopted legal recommendations to improve their analysis of information and to acknowledge in financial statements the difficulties in setting reserves. Chester Street's attempts to improve its data included commissioning exposure reviews by Ernst & Young, which worked as Chester Street's external auditor.

Watson Wyatt was Chester Street's external actuary. It told the company all of its reserve scenarios were equally plausible and that it was possible for the ultimate outcome to be significantly above or below the lower or upper scenarios provided. Overall, the investigators found the directors were in a situation where a broad range of outcomes was possible; they took detailed advice from a variety of experts and made decisions which were, with hindsight, optimistic, but not unreasonable at the time.

Schwarzmann said: "Our view, supported by Clifford Chance and the creditors' sub-committee, is that there isn't an action we want to pursue." He added a court recently refused to find the directors of Continental Assurance Company of London guilty of wrongful trading, in a case brought by the firm's liquidator.

In his judgment, Justice Park said of the directors' actions: "It was not the only possible decision, but it was a possible decision and I'm not prepared to say that, when it was the decision which the directors took, it was wrong."