Adjustment of prior transactions
One of the advantages of bankruptcy over a voluntary arrangement is that it permits the trustee-in-bankruptcy to “call back yesterday” and to bid time return if the debtor has reduced his estate by improvident or suspicious transactions. This is one of the reasons why the law of bankruptcy permits the bankrupt to be examined in public about his affairs (although this procedure is no longer automatic). The trustee has three important powers in respect of antecedent transactions: (1) he may ask the court to set aside “transactions at an under-value”; (2) he may ask the court to set aside any “preference” given by the debtor to any other person; and (3) he may ask the court to set aside or vary an “extortionate credit transaction”.
“Transactions at an under-value” are defined by section 339(3) as being: gifts made by the debtor and other transactions in which he is to receive no consideration from any other person; transactions made in consideration of marriage; and transactions made for a consideration which, in money or money’s worth, is “significantly less” than the value, in money or money’s worth, which the debtor himself has to provide.
A “preference” is defined by section 340(3) as anything done by the debtor (or which he suffers to be done) which has the effect of putting one of his creditors, sureties or guarantors into a position which (in the event of his bankruptcy) would be “better” than the position the creditor, surety or guarantor would have been in had that thing not been done. The section is, of course, aimed at the natural tendency of debtors to pay their more pressing creditors or their friends and relatives before they pay the world at large.
An “extortionate credit transaction” is defined by section 343(3) as a credit transaction the terms of which require “grossly exorbitant payments” to be made, or where the “ordinary principles of fair dealing” have been “grossly contravened”.
In respect of all three concepts the law provides time-limits on the period of retrospection, since it is not the purpose of bankruptcy proceedings to make a debtor answer for his entire past life. The relevant period of retrospection for extortionate credit transactions is three years prior to the commencement of the bankruptcy: section 343(2). In the case of transactions at an under-value, the time-limit is five years, calculated back from the date on which the bankruptcy petition was presented: section 341(1)(a).
In the case of preferences given to creditors, sureties and guarantors, there are two time-limits. The general time-limit is six months, calculated back from the date of the presentation of the bankruptcy petition. If, however, the person to whom the preference was given was an “associate” of the debtor, then the period is two years. An “associate”, for these purposes, means the debtor’s husband or wife, or any of a wide class of “relatives” (including relatives of the husband or wife, and wives or husbands of relatives): section 435(8) lists an entire Forsyte Saga of relatives for the purposes of this definition.
A partner is also an “associate” and so is the wife or husband and the relatives of any partner: section 435(3). A beneficiary of a trust will usually be an “associate” of the trustees of that trust (section 435(5)), and a company will be treated as an “associate” of any person who controls it, and of the people who jointly control it if they are already “associates” to each other (section 435(7)). An employer is an “associate” of his employees, and (for these purposes) a company is treated as being the employer of its directors and officers (section 435(4) and (9)). For certain purposes (but not for the purposes of the two-year time-limit) an employee is treated as being an “associate” of his employer (section 435(4) and 341(1)(b)).
Even the above-mentioned time-limits are not absolute or inflexible. Bankruptcy may sometimes arise quite suddenly, without the debtor previously having had any reason to suppose that it would occur. In the case of transactions at an under-value, the period of two years before the bankruptcy is more significant than years three, four and five. In the absence of proven fraud, a transaction entered into in the third, fourth and fifth year prior to the bankruptcy will not be set aside (even if it was transacted at an under-value) unless it can be shown that the debtor was already insolvent at that time or became insolvent because of the transaction in question.
If, however, the other party to the transaction was an “associate” of the debtor (otherwise than by being his employee) the burden of proof is reversed. The debtor will have to prove that he was not insolvent at that time and that the transaction in question did not make him so: section 341(2). In the two-year period immediately before the bankruptcy, transactions at an under-value (whether with associates or not) can be set aside, without specific proof that the debtor was insolvent at that time or that he became so because of the transaction in question.
In the case of preferences given to creditors (etc), there is once again a distinction drawn between transactions with “associates” and transactions with strangers. If the preference was not given to an “associate”, the trustee-in-bankruptcy must show that the debtor was, nevertheless, influenced by a desire to put that other person in a better position than he would otherwise be in if a bankruptcy should afterwards occur (section 340(4)). But where the other party to the preference was an “associate” of the debtor (otherwise than by being his employee), the desire of the debtor to protect that “associate” from the consequences of a possible bankruptcy will be presumed against the debtor, unless he can prove the contrary (section 340(5)).
Likewise, a preference given to a stranger in the last six months before a bankruptcy will be set aside only if the trustee-in-bankruptcy can show that the debtor was insolvent at the time or became insolvent because of the preference (motivated as mentioned above). But where the preference was given to an “associate” (not being one of his employees) in the two-year period preceding the bankruptcy, the debtor will have the burden of disproving the insolvency, in the same way as he has the burden of disproving his bias towards that person (section 341(2)).
The family home
Special provisions apply where the bankrupt’s estate includes an interest in a dwelling-house which either he or his spouse (or former spouse) occupies. If the trustee-in-bankruptcy is unable to realise this property (for example, because the bankrupt is bringing up young children in the home) the trustee may apply to the court for an order imposing a charge on the property for the benefit of the bankrupt’s estate (section 313).
Where the bankrupt and his spouse are trustees-for-sale of a dwelling-house and either or both of them refuse to sell the house, the trustee-in-bankruptcy may apply to the court under section 30 of the Law of Property Act 1925 for an order of sale. The court, in deciding whether or not to grant such an order, will have regard to the following factors: (1) the interests of the creditors; (2) the conduct of the spouse (or former spouse) as far as it may have contributed to the bankruptcy; (3) the needs and financial resources of the spouse or former spouse; (4) the needs of any children; and (5) all the circumstances of the case other than the needs of the bankrupt himself: section 336(4). However, after the lapse of one year from the date on which the bankrupt’s estate vested in the trustee-in-bankruptcy, the court is to assume that (unless the circumstances of the case are exceptional) “the interests of the bankrupt’s creditors outweigh all other considerations”. This is an illustration of the maxim that “a man is presumed to intend to be just, before he affects to be generous”.
The above rule also operates in the special case where the bankrupt has no spouse with occupational rights (or no spouse at all) but nevertheless has children to bring up who are under the age of 18. Section 337 gives the bankrupt the right not to be evicted without leave of the court. But, again, after one year the interests of the creditors are given priority over all other considerations, unless the circumstances of the case are exceptional.
It should be emphasised that the bankruptcy of a person does not mean the bankruptcy of his wife or her husband. Upon a sale of the family home, the trustee-in-bankruptcy is entitled to claim only the bankrupt’s financial share in that property — unless, of course, it (or some share in it) has been transferred to the spouse at an under-value in the recent past (see “Adjustment of prior transactions”, above). In this respect, it should be noted that any transaction at an under-value (whether between husband and wife or not) can be set aside by the court, no matter how long ago that transaction took place, if it was effected with the specific intent of defrauding creditors (sections 423-425).
Priority of debts
Secured creditors (eg mortgagees) are unaffected by a bankruptcy provided their security exceeds the value of their debt. They are entitled to realise their security and to recover their costs and expenses and interest (if any) out of the secured property. Any surplus must be paid into the bankrupt’s estate. If, for any reason, the security is inadequate to meet the debt, the creditor in question will have to prove for the balance of the debt as an unsecured creditor.
Also prior to the unsecured creditors will be placed the claim of the trustee-in-bankruptcy to his own remuneration and expenses. Thereafter will rank the debts of “preferential creditors”, most notably the Inland Revenue, the Commissioners of Customs and Excise, the Department of Health and Social Security, and employees of the bankrupt claiming arrears of wages. These preferential creditors rank equally, so that they will be paid an equal percentage in the pound if the estate is not large enough to meet all the preferential debts. If, after these preferential debts have been paid, anything else remains in the bankrupt’s estate, it will be divided among the unsecured creditors at an equal percentage in the pound. (Interim distributions are possible.) Any debts owed to the bankrupt’s spouse can be paid only after the other unsecured creditors have been paid in full (including interest).
Although imprisonment for debt has been largely abolished in the United Kingdom, the law of bankruptcy does create certain bankruptcy offences for which the bankrupt can be sentenced to imprisonment (he is, after all, unlikely to be able to pay a fine). These offences relate to various forms of failing to co-operate with the trustee-in-bankruptcy; failing to keep proper accounts of his business; concealing, destroying, or falsifying books or records; engaging in business, or obtaining credit, under a different name without disclosing that he is an undischarged bankrupt; absconding with property; increasing his insolvency by gambling or by rash and hazardous speculations; and disposing of property obtained on credit without first paying for it.
The register of undischarged bankruptcies can be searched in the same way as the Land Charges Register (that is to say, by post, using the appropriate search form and paying the Registry fee by means of a Land Registry stamp).
Finally, it may be observed that the precarious position of unsecured creditors in any bankruptcy has led suppliers (and their legal advisers) to use much ingenuity in framing “retention of title clauses” in contracts. Such clauses attempt to reserve for the supplier (or manufacturer) of goods his legal ownership of those goods until he has been paid in full. In their simplest form, these clauses are often highly successful in preventing the goods forming part of the bankrupt’s “estate” when he ceases to trade. However, complexities arise if the contract attempts to create ownership over finished products which have incorporated the goods or if it attempts to create a trust over the proceeds of sale. In particular, it should be noted that a retention of title clause will not be effective if the goods are incorporated into a building because (once they form part of the “land”) they will lose their essential nature as goods.
Retention of title clauses are sometimes known as “Romalpa” clauses, because of the reported case which made them famous: Aluminium Industrie Vaasen BV v Romalpa Aluminium Ltd [6] 1 WLR 676.
