Insolvency Proceedings have never been treated in English law as an exclusively private matter between debtor and his creditors. The community itself has always been recognised as having an important interest in them.
There are two ways in which one could say that Insolvency Proceedings could be treated as a private matter between debtor and his creditors. The first would be that insolvency proceedings are solely concerned with protecting the interest of the particular creditor who initiated the proceedings, by ensuring he is paid the debt owed to him. The second would be that insolvency proceedings are concerned with protecting the interests of the creditors as a whole, disregarding the interests of other stakeholders in the company.
It will be argued in this essay that neither insolvency proceedings, nor Insolvency law more generally, treats them as a private matter in either of these two senses. The wider interests of the bankrupt individual/the members of the insolvent company and of the community at large are taken into account and protected. This has always been the case in English law; however, in the past, particularly before the reforms resulting from the report of the Cork Report in 1982, insolvency proceedings were more of a private matter between debtor and his creditors than they are today.
We shall begin my exploration of this question by considering corporate insolvency proceedings, then individual insolvency proceedings.
1. Corporate Insolvency Proceedings
a) The Proceedings themselves
A company is deemed to be insolvent when one of two conditions is fulfilled: either the company is unable to pay its debts as they fall due (in this case the company is deemed to be ‘cash flow insolvent’) or the company’s liabilities are greater than its assets (in this case the company is deemed to be ‘balance sheet insolvent’).
Once the company has been deemed to be ‘insolvent’, certain stakeholders in the company gain a statutory right to bring insolvency proceedings in relation to the company. The insolvency proceedings are commonly termed the ‘Insolvency regimes’ and are principally: administrative receivership, administration, arrangements with creditors and the winding up of the company. Which insolvency proceedings can be brought, and by whom, depends on the company and the stakeholder in question.
In Administrative Receivership, an Insolvency Practitioner takes over management of the company from the directors as agent of the company. The receiver is appointed by a creditor who is a
debenture holder, and the receiver’s purpose is to enforce the debenture holder’s security. The view of insolvency proceedings as a private matter between the debtor company and the creditor who initiated the proceedings clearly underlies Administrative Receivership. As Roy Goode states 1, the ability of the receiver to control the company to such a large extent prevents the unsecured creditors from effectively enforcing their debts.
The view of insolvency proceedings as a private matter between the debtor company and the creditors as a whole is also present here, for the receiver’s purpose is to enforce the creditor’s security, and is not to save the company, which could well be in the interests of the community as a whole. Gross2, although admitting that this is not always the case, states that often it is in the interests of a community that the businesses in financial difficulties survive as oppose to dissolving, and their assets being distributed to its creditors and its shareholders (if there is anything left for them at all).
Administrative Receivership as an insolvency proceeding was semi-abolished under the Enterprise Act 2002 by only allowing debenture holders with charges created before 15 September 2003 to appoint a receiver. This was done with the very purpose of making insolvency proceedings less of a private matter between the debtor company and its creditors, as was recommended by a review committee set up by the Treasury and the Department of Trade and Industry3.
Those with floating charges over the whole or substantially the whole of the company’s assets can initiate the insolvency proceeding of Administration. The effect of this is that an administrator, a qualified insolvency practitioner, takes over the management of the company. A vital difference between the administrator and the administrative receiver is that the administrator’s primary purpose is to rescue the company. The Insolvency Act 1986 sets out the objectives of the administrator4, which are arranged hierarchically with rescue at the top, then enforcing the debts of the creditors as below this.
This shows a marked move away from conception of insolvency proceedings as a private matter in both of the senses I previously mentioned. Firstly, the objective of the administrator is explicitly stated as to achieve a better result for the company’s ‘creditors as a whole’. And, secondly, the primary objective is to rescue the company, which may well be in the interests of the wider community. For example: rescuing the company could provide jobs and contribute to the economy. During the period of administration, there is a statutory moratorium in place which prevents the creditors from enforcing their debts against the company, and provides the company with vital breathing space so that the administrator can try to rescue it.
As for arrangements with creditors, this too is aimed at rescuing the company. The directors, or the administrator, will negotiate with the creditors in order to give the company some breathing space to try to trade out of its financial troubles. This may be by reducing the amount owed to the creditors, or by providing the company with more time to pay the debt. This, as with administration, is arguably underpinned by an appreciation of the more widespread benefits to the stakeholders more generally of keeping the company alive, rather than simply dissolving the company and distributing its assets to the creditors.
However, Thomas Jackson still would say that this shift towards collective insolvency proceedings is due to the fact that such proceedings are more likely to benefit the creditors in the grand scheme of things, as opposed to individual insolvency proceedings. Jackson gives the example of a situation where there are four creditors owed $25,000 from the same debtor5. Jackson states that in a non- collective insolvency system, based on a ‘first come first served’ basis, the first two creditors would receive the full $25,000. But the last two creditors would receive nothing. Jackson’s point is that the reason to have such a ‘rescue culture’ as recommended by the Cork Committee in 19826 and enshrined in the subsequent reforms is that it is better for all of the creditors to be guaranteed to receive half of the debt owed to them than to have a 50% chance of receiving none of it.
Jackson would therefore accept that after the 1986 reforms, English law no longer viewed corporate insolvency law as a private matter in the first sense I mentioned, in the sense that it now saw insolvency proceedings as a collective matter. However, he would deny that the reforms meant that English law viewed corporate insolvency law as a private matter in the second sense I mentioned, in the sense that it is taking into account interests beyond those of the creditors and the members of the company.
We can therefore see that in the past Insolvency Proceedings were more geared towards the enforcement of an individual creditor’s debt. The reason for this change, as noted above, can be attributed to a significant extent to the aforementioned ‘Cork Report’.
b) Insolvency Law more generally
A general principle of English insolvency law is that, when the assets of a company which is wound up are distributed to the creditors, this distribution occurs ‘pari passu’. This means that each of the creditors will receive a portion of the available funds in proportion to the amount of their debt. What underlies this principle is a view of Insolvency as a collective proceeding, as opposed to being a proceeding being initiated by one creditor with a view to enforcing that particular debt.
However, creditors undermine this principle by gaining security for their debt. This means that the creditor can be paid the money owed to them outside of the Insolvency regime, and outside of the pari passu distribution. English law restricts creditors from doing this by ‘carving’ out of the assets of the company funds which will be distributed to unsecured creditors before the secured creditors. For example, ‘preferential creditors’ (employees of the company) will be paid before those creditors with a floating charge7. And those creditors who entered into contracts with the Liquidator will receive payment before those creditors with a fixed charge over the company’s assets8. 1986 marked yet another step towards community interests being considered and protected in insolvency proceedings when punishments for directors who caused the insolvency of the company were introduced. In sections 213 and 214 of the Insolvency Act 1986, there contain the offences of fraudulent and wrongful trading respectfully.
Although a consequence of being found guilty of these offences is that the creditors of the company will be compensated (indirectly, by the directors compensating the company), these provisions serve as a deterrent on directors from causing loss to creditors, and from causing companies which are valuable to the economy to fail. This is particularly the case for section 213 which is also a criminal offence.
Moreover, the Directors Disqualification Act came into force in 1986 as a result of the recommendations of the Cork Committee. One effect of this Act is that a director who has been at fault in causing the insolvency of a company is disqualified from being a director for other companies for a certain amount of time. This Act is a clear example of English Insolvency Law taking into account the interests of the community, rather than simply the company in question’s creditors.
The aforementioned ‘carving out’ of the available funds was first introduced in 1986, and so again this reflects a change around this time in favour of seeing insolvency proceedings less as a private matter between the debtor company and the individual creditors.
And, as noted above, the sophisticated regime of punishment for directors who have been at fault for the insolvency of their companies was introduced in 1986. Thus, again, this time can be seen as a key turning point in relation to the nature of insolvency proceedings.
2. Bankruptcy proceedings for individuals:
a) The Proceedings themselves
Bankruptcy is the equivalent of insolvency for an individual. There are three statutory bankruptcy proceedings: a bankruptcy order, an informal voluntary arrangement and a debt relief order.
A bankruptcy order can be petitioned for by the individual, or by a creditor. Its effect is that the assets of the bankrupt individual are distributed pari passu to the individual’s creditors. The liabilities of the individual are thereafter extinguished.
An individual voluntary agreement is an agreement between the debtor and his creditors under which the debtor will pay the creditors less or over a longer period of time in order that the individual can avoid bankruptcy. The effect of a debt relief order is that the debtor will pay a certain amount to his debtors over a twelve month period, after which his liabilities are extinguished.
As mentioned in relation to corporate insolvency proceedings, what underlies the pari passu principle of distribution is a view of insolvency proceedings as a collective proceeding as opposed to one solely concerned with protecting the interests of individual creditors.
As noted earlier in this essay, over time English law’s view of insolvency proceedings changed from seeing it as proceedings concerned primarily with distributing the insolvent company’ assets, to seeing it as primarily concerned with rescuing the company. Likewise, English law’s view of personal insolvency proceedings changed to see it as less about distributing the bankrupt individual’s assets to his creditors and discharging his debts, and more about aiding the individual to renegotiate with his creditors in order that he can remain solvent.
The introduction of individual voluntary arrangements and debt relief orders reflect this. Moreover, in certain circumstances, the law positively requires that an individual voluntary arrangement be considered rather than a bankruptcy order being granted. This is the case where a debtor petitions for his own bankruptcy, under IA 1986, s 273(1), and the debts are relatively small; in such circumstances, the court must consider using an IVA.
Again, as Gross9 emphasises, the question is just what this ‘rescue’ culture is seeking to protect. It is arguable that it is furthering some notion of the ‘community interest’. It may well be that having a culture where renegotiation and persevering as opposed to giving up and discharging the debts, is more beneficial to the economy as a whole. In this way, the ‘rescue culture’ in personal insolvency proceedings could serve the community interest in a similar way to how it may do in corporate insolvency proceedings.
One could argue that the ‘rescue’ culture in individual insolvency proceedings is furthering the community interest in a very different way. It could be argued that what is being protected here is the well being of the debtor; the law encourages the debtor and his creditors to reach an agreement by which the debtor can avoid bankruptcy as bankruptcy can be a traumatic experience to the debtor. This would be an example of paternalism in the law.
However, again, Jackson10 would strongly dispute this. He would argue that, as with corporate insolvency, the encouragement of renegotiation with the creditors as a whole is because this process will ultimately lead to the creditors receiving the largest proportion of the money they are owed from the debtor.
b) Bankruptcy law more generally
English law imposes a number of restrictions on the individual subject to a bankruptcy order. These relate to the business and employment of the bankrupt.
Section 11 of the Company Directors Disqualification Act 1986 states that a bankrupt individual is prohibited from acting as a director of a company and from being involved in the promotion, formation or management of a company, without the court’s permission. Section 11 of this Act makes the breach of this prohibition a criminal offence.
Section 360(1)(b) of the Insolvency Act 1986 states that a bankrupt individual may not trade under a different name from the one in which the bankruptcy order was made, without informing all those who trade with him that he is a bankrupt. Again, breach of this provision is a criminal offence.
Section 33(1) of the Partnership Act 1890 states that, unless there is an agreement to the contrary between the partners, the bankruptcy of a partner shall cause the dissolution of the partnership.
There are also various restrictions on the bankrupt’s professional activities, amongst these being a prohibition from acting as a trustee of a pension trust (section 29 of the Pensions Act 1995) and being prohibited from practising as a solicitor without the leave of the Solicitors Regulation Authority (Section 15 of the Solicitors Act 1974).
As with the disqualification of directors who have been at fault for the insolvency of a company, these restrictions are firm evidence of how English insolvency law does not view insolvency as a private matter between the debtor and his creditors. The community interest is being protected by preventing individuals who have been guilty of causing losses to creditors by financial mismanagement from being in positions of financial responsibility. This has the effect of protecting creditors and the community at large and of acting as a deterrent to individuals from being financially reckless in the first place.
As Goode notes11, even since medieval times, the bankrupt individual has been subject to punishment for becoming bankrupt. This is because becoming bankrupt has seen to be akin to committing theft. Thus the principle of punishment in insolvency law is not a new one. However, again, it was around the time of 1986, after the Cork Report, that a sophisticated regime was introduced. This is arguably because such a principle of punishment supports the view of bankruptcy proceedings as protecting the interests of the community interest, a view which underpinned the Cork Report of 1982.
In conclusion, insolvency proceedings under English law is not a private matter between the debtor and his creditors. It is a collective proceeding to protect the interests of the creditors as a whole, but it also takes into account and protects the interests of the community as a whole. Insolvency proceedings have always been this way to an extent, but insolvency law developed further in this direction after the Cork Report of 1982.
1 Roy Goode, Good on Commercial Law (Edited and fully revised by Ewan McKendrick, 4th edn, Penguin Group,
2 Karen Gross, Taking Community Interests into Account in Bankruptcy: An Essay, 72 Wash. U. L. Q. 1031 (1994).
3 Review of Company and Business Reconstruction Mechanisms (May 2000).
4 Insolvency Act 1986, Sch B1, Para 3.
5 Thomas H Jackson, The Logic and Limits of Bankruptcy Law (Beard Books, 2001).
6 Report of the Review Committee, Insolvency Law and Practice. (Cmnd 8558, 1982) 7 Insolvency Act 1986, ch 6.
8 Insolvency Act 1986, s115.
9 Karen Gross, Taking Community Interests into Account in Bankruptcy: An Essay, 72 Wash. U. L. Q. 1031 (1994).
10 Thomas H Jackson, Bankruptcy, Non-Bankruptcy Entitlements, and The Creditors' Bargain (1982) 91 Yale Law Journal 857.
11 Roy Goode, Good on Commercial Law (Edited and fully revised by Ewan McKendrick, 4th edn, Penguin Group, 2010).