What is the effect of bankruptcy on an individual’s financial responsibilities? Is there any legal alternative to bankruptcy proceedings?
The law of bankruptcy is now governed by the Insolvency Act 1986 (which also deals with the winding up of insolvent companies). Bankruptcy is therefore a form of individual insolvency, separate from company law. However, it should be noted that the insolvent winding up of a company may be followed by one or more individual insolvencies if the directors of the company have personally guaranteed the debts of the company or have otherwise incurred personal liability.
By contrast, the debts of an insolvent partnership will always fall upon the partners personally, and the joint and several liability of those partners may lead to one or more bankruptcies, with solvent partners having to carry the debts of the insolvent ones.
Voluntary arrangements
It is no longer the case that, when a person runs out of money or reaches the position where he can no longer pay his debts, he will inevitably be adjudged bankrupt. An alternative method of dealing with an insolvent individual was introduced in 1985 and is now to be found in Part VIII of the Insolvency Act 1986 under the title “individual voluntary arrangements”. This procedure allows the debtor to apply to the High Court (or, in some cases, the county court) for an “interim order”, pending a proposal to his creditors that they should enter into a legally binding compromise with him. The effect of an interim order is to impose a moratorium in respect of the legal remedies and processes which the debtor’s creditors may wish to commence or continue against him or his property.
If an interim order is made, it will give the debtor 14 days’ grace in which to draw up a statement of his affairs for the purpose of putting his proposal for an arrangement to his creditors. During that time, the court will not entertain a bankruptcy order and bailiffs cannot enforce existing judgment-debts. It is therefore important that, before the court grants an interim order, it satisfies itself that the debtor genuinely proposes to come to some arrangement with his creditors and that he is not seeking an interim order as a delaying tactic. For this reason a number of safeguards are built into the procedure.
The court will not grant an interim order unless it is satisfied that the debtor will indeed make the proposal to his creditors; that he has made no previous application in the last 12 months; that (on the day of making the application) he was already in a position to petition for his own bankruptcy (or was a bankrupt already); and that there is a person willing and qualified to implement and supervise the making of the proposal to the creditors. (This last person is known as a “nominee”, and — like a trustee-in-bankruptcy or the liquidator of a company — he must be qualified to act as an “insolvency practitioner” under Part XIII of the Act.)
Where an interim order is made, the nominee will submit a report to the court which will state whether, in his opinion, a meeting of the debtor’s creditors should be called to consider the debtor’s proposals. The purpose of this step is to require the nominee to satisfy himself that any proposed arrangement with the creditors is a feasible one. He must form a professional opinion based on his own appraisal of the debtor’s affairs and circumstances.
If it turns out that the voluntary arrangement would not be a practical solution, or that the proposals would clearly not be acceptable to the creditors, then the court — basing its decision on the nominee’s report — will discharge the interim order. If, however, the proposal is a feasible one, the court may extend the duration of the interim order to enable the nominee to summon a creditors’ meeting. The creditors’ meeting will decide whether or not to approve the voluntary arrangement — with or without modifications (but the debtor must himself agree to each modification). Voting at a creditors’ meeting is according to the value of each creditor’s interest, not according to a simple show of hands.
If the proposal is not approved (with or without modifications), the interim order will be discharged and bankruptcy proceedings will be likely to follow. If the proposal (or a modified proposal) is approved, it will be binding on every creditor with notice of the meeting who was entitled to vote, whether he attended the meeting or not. The meeting will appoint a “supervisor” to implement the voluntary arrangement: he also has to be a qualified insolvency practitioner and he may be the original nominee.
One disadvantage of a voluntary arrangement is that (in the absence of proven fraud) the supervisor and the creditors have no power to set aside previous improvident or suspicious transactions which have reduced the value of the debtor’s estate. By contrast, a trustee-in-bankruptcy has statutory powers to apply for certain transactions to be set aside (see below). If, therefore, the previous conduct of the debtor involves transactions which a trustee-in-bankruptcy could set aside, and could thereby increase the value of the estate, the creditors may well prefer to opt for bankruptcy proceedings rather than for a voluntary arrangement.
Bankruptcy petitions
The first stage in bankruptcy proceedings is the presentation of a petition of bankruptcy to the court. This may be presented by the debtor himself, or by one or more of his creditors, or by a supervisor or any other person bound by a voluntary arrangement.
The grounds on which a petition can be presented will depend upon who is presenting that petition. If it is a creditor who is presenting the petition, then the debt must be for a liquidated sum of at least £750 (unsecured) and it must be due either immediately or at some certain future date. The debt must be one which the debtor appears to be unable to pay or to have no reasonable prospect of paying. Individual debts of less than £750 may form the basis of a bankruptcy petition if, together, they total £750 or more.
Evidence that the debtor is, or will be, unable to pay a debt is supplied by showing that the creditor has served a statutory demand on the debtor, requiring him to pay the debt or to establish that he has no reasonable prospect of being able to pay it when it falls due. If three weeks have elapsed since the demand was served, and it has not been complied with, or execution of a judgment-debt in favour of the creditor has been returned unsatisfied (either in whole or in part), this will show to the court that the debtor is unable to pay his debt, as alleged in the petition (section 268).
The court may dismiss that petition if it is satisfied that the creditor has unreasonably refused an offer to secure or to compound for the debt: section 271(3).
A debtor has a right to petition for his own bankruptcy. The only requirement in such a case is that the debtor demonstrates an inability to pay his own debts. For this purpose, the petition must be accompanied by a statement of the debtor’s affairs.
Under section 276, a supervisor or any person bound by a voluntary arrangement may petition for a bankruptcy order if the debtor has failed to comply with his obligations under the voluntary arrangement, or has supplied false or misleading information to his creditors, or has failed to co-operate with the supervisor of the voluntary arrangement.
Finally, it should be noted that a person may be made bankrupt by an order of a criminal court (eg after being convicted of a large-scale theft): Powers of Criminal Courts Act 1973.
Duration and discharge of bankruptcy
If a person has been adjudicated bankrupt for the first time, he will obtain an automatic discharge after three years. (In certain cases, where the amounts involved are small, the period may be shortened to two years.) The short duration of a first bankruptcy reflects the modern conception that bankruptcy is not necessarily to be treated as a quasicriminal state of affairs and that the price of encouraging enterprise is a percentage of business failures.
If, however, a person has been adjudged bankrupt on a previous occasion and has had the status of an undischarged bankrupt at any time during the preceding 15 years, then an application for discharge from the new bankruptcy will not be entertained for at least five years. The court may then refuse to discharge the bankrupt, or may suspend an order of discharge, or may make such an order absolute or on conditional terms. Indeed, even the shorter periods of bankruptcy may be extended if the bankrupt fails to comply with his obligations under the bankruptcy order.
A discharge from bankruptcy releases the bankrupt from all of his bankruptcy debts. These are the debts to which the bankrupt was subject at the beginning of the bankruptcy or which arose after the commencement of the bankruptcy because of obligations incurred before it. There are, however, certain exceptional debts and obligations which are not affected by the discharge from bankruptcy, so that the debtor is not released from his liabilities in respect of them, nor are they reduced in any way. These exceptional debts and obligations are listed in section 281 and may be summarised as follows:
(1) debts incurred by fraud or fraudulent breach of trust;
(2) fines and recognisances;
(3) damages awarded in respect of personal injuries to any person;
(4) debts arising under court orders made in family or domestic proceedings.
It should also be noted that if a creditor is fraudulently induced by the debtor to release a debt (or to reduce a debt), the creditor will be entitled to enforce the debt, once he discovers the fraud. Moreover, the creditor will be able to do this, even after the bankruptcy order has been discharged, because the discharge will not release the debtor from that part of the debt which was the subject of a forbearance fraudulently secured from the creditor: section 281(3).
As to damages for personal injuries (and court orders in family or domestic proceedings), it should be noted that the court has a power to release (or to reduce) the debtor’s liability, conditionally or unconditionally. Similarly, the Treasury may release a debtor from any fine imposed under an enactment relating to the public revenue or from a recognisance. Finally, it should be noted that discharge from bankruptcy does not preclude a secured creditor (eg a mortgagee) from enforcing his security, nor does it affect the personal liability of any partner of the bankrupt, or any co-trustee of his, or any person who has acted as his guarantor or surety.
The bankrupt’s estate
The concept of the bankrupt’s “estate” is, of course, central to the law and practice of bankruptcy. Whatever is excluded from the definition of the bankrupt’s “estate” will reduce the funds available to pay his creditors. Assets which can be included within that definition will, of course, increase that fund. Under section 283, the definition of the bankrupt’s “estate” has two limbs:
(a) “all property belonging to or vested in the bankrupt at the commencement of the bankruptcy”, and
(b) “any property which by virtue of … [Part IX of the Act] is comprised in that estate…
There are three important classes of property which are excluded from the definition of the bankrupt’s “estate”. These are: (1) his tools, books, vehicles, and other items of equipment, which are “necessary” for his personal use in his employment, business, or vocation; (2) such bending, clothing, furniture, household equipment and provisions as are “necessary” for satisfying his “basic domestic needs” and those of his family; and (3) property which he holds as a trustee, not as a beneficial owner.
Conversely, Part IX of the Act gives the debtor’s trustee-in-bankruptcy certain powers to increase the size of the bankrupt’s estate. Thus he may make a claim to “after-acquired property” of the bankrupt (eg royalties, fees, legacies, prizes, gifts, and so on, paid or transferred to him after the commencement of the bankruptcy). Similarly, the trustee-in-bankruptcy may apply to the court for an “income payments order” (section 310). This permits the trustee to claim a proportion of the bankrupt’s income for the period during which the order is in force, and it may be made against the person paying the income; for example, the bankrupt’s employer, who will be obliged to make the payments directly to the trustee.
Section 310(2) provides a safeguard in that the court may not make an order which would reduce the income of the bankrupt below what appears to be necessary for meeting his “reasonable domestic needs” (and those of his family). To prevent the bankrupt from secretly receiving income and after-acquired property, or carrying out secret transactions, the court has a power to order the Post Office to redirect the bankrupt’s post to his trustee-in-bankruptcy (or, prior to his appointment, to the official receiver): section 371.
The trustee-in-bankruptcy also has a power to disclaim “onerous property” and to adjust previous transactions. “Onerous property” is defined by section 315 as being “any unprofitable contract” and “any other property comprised in the bankrupt’s estate which is unsaleable or not readily saleable, or is such that it may give rise to a liability to pay money or to perform any other onerous act”.
Once the trustee has disclaimed the onerous property, the other party to the transaction is entitled to prove for his financial loss in the bankruptcy proceedings, but he then ranks equally with other unsecured creditors, and loses any financial advantage which he previously had over them.
Section 317 refers to the disclaimer of leases (which, of course, may fall within the previous definition of “onerous property”). This section requires a copy of the notice of disclaimer to be served on every sublessee and every mortgagee. They then have 14 days in which to make an application to the court (under section 320) to have the lease vested in them (or such one of them as the court may choose), subject to the same liabilities and obligations as the bankrupt himself had under that lease, or (if the court thinks fit) subject to the same liabilities and obligations as would have passed to them on an assignment of that lease (section 321). A similar safeguard is provided in the case of the trustee’s disclaimer of a dwelling-house (should that come within the definition of “onerous property”).
Under section 318, a copy of the notice of disclaimer must be served (so far as the trustee is aware of their addresses) on every person in occupation of, or claiming a right to occupy, the dwelling-house. Each of these persons has a right to make an application under section 320 for the dwelling-house to be vested in him. Indeed, section 320 is not confined to leases and dwelling-houses — any person claiming an interest in any disclaimed property (or who is subject to a liability in respect of it which is not discharged by the disclaimer) has a right to make an application under section 320. However, in the case of leaseholds and dwelling-houses the trustee must first serve copies of his notice of disclaimer on sublessees, mortgagees, occupiers of the dwelling-house and so on, so that they are specifically forewarned of their right to apply to the court.
Section 308 gives the trustee-in-bankruptcy a power to claim property which is normally exempt from the bankrupt’s estate (tools of his trade, trade or business vehicles, household goods etc, but not trust property) if it appears to the trustee that any of these items are of excessive value. He may then sell these items, and buy reasonable replacements for the bankrupt, and retain the balance as part of the bankrupt’s estate.
