The general principle, according to the Mellish LJ in Re Jeavons, ex parte Mackay[38] is that "a person cannot make it a part of his contract that, in the event of bankruptcy, he is then to get some additional advantage which prevents the property being distributed under the bankruptcy laws." So in that case, Jeavons made a contract to give Brown & Co an armour plates patent, and in return Jeavons would get royalties. Jeavons also got a loan from Brown & Co. They agreed half the royalties would pay off the loan, but if Jeavons went insolvent, Brown & Co would not have to pay any royalties. The Court of Appeal held half the royalties would still need to be paid, because this was a special right for Brown & Co that only arose upon insolvency.
In a case where a creditor is owed money by an insolvent company, but also the creditor itself owes a sum to the company, Forster v Wilson[39] held that the creditor may set-off the debt, and only needs to pay the difference. The creditor does not have to pay all its debts to the company, and then wait with other unsecured creditors for an unlikely repayment.
However, this depends on the sums for set-off actually being in the creditors' possession. In British Eagle International Air Lines Ltd v Compaigne Nationale Air France,[40] a group of airlines, through the International Air Transport Association had a netting system to deal with all the expenses they incurred to one another efficiently. All paid into a common fund, and then at the end of each month, the sums were settled at once. British Eagle went insolvent and was a debtor overall to the scheme, but Air France owed it money. Air France claimed it should not have to pay British Eagle, was bound to pay into the netting scheme, and have the sums cleared there. The House of Lords said this would have the effect of evading the insolvency regime. It did not matter that the dominant purpose of the IATA scheme was for good business reasons. It was nevertheless void.
Belmont Park Investments Pty Ltd v BNY Corporate Trustee Services Ltd and Lehman Brothers Special Financing Inc observed that the general principle consists of two subrules — the anti-deprivation rule (formerly known as "fraud upon the bankruptcy law") and the pari passu rule, which are addressed to different mischiefs — and held that, in borderline cases, a commercially sensible transaction entered into in good faith should not be held to infringe the first rule.
All these anti-avoidance rules are, however, subject to the very large exception that creditors remain able to jump up the priority queue, through the creation of a security interest.
See also: Netting and Set-off (law)
Secured lending
Main articles: UK banking law, Banking law, and Security interest
The Bank of England (est 1694) is the lender to all other banks, at an interest rate set by the Monetary Policy Committee under the Bank of England Act 1998. When lending on money to businesses at a higher interest rate, banks will contract for fixed and floating charges to decrease their risk and stabilise profits.
Kamis, 21 November 2013
The priority system is reinforced by a line
Sources: Insolvency Act 1986 and Companies Act 2006
Since the Bankruptcy Act 1542 a key principle of insolvency law has been that losses are shared among creditors proportionately. Creditors who fall into the same class will share proportionally in the losses (e.g. each creditor gets 50 pence for each £1 she is owed). However, this pari passu principle only operates among creditors within the strict categories of priority set by the law:[32]
The law permits creditors making contracts with a company before insolvency to take a security interest over a company's property. If the security is refers to some specific asset, the holder of this "fixed charge" may take the asset away free from anybody else's interest in order to satisfy the debt. If two charges are created over the same property, the charge holder with the first will have the first access.
The Insolvency Act 1986 section 176ZA gives special priority to all the fees and expenses of the insolvency practitioner, who carries out an administration or winding up. The practitioner's expenses will include the wages due on any employment contract that the practitioner chooses to adopt.[33] But controversially, the Court of Appeal in Krasner v McMath held this would not include the statutory requirement to pay compensation for a management's failure to consult upon collective redundancies.[34]
Even if they are not retained, employees' wages up to £800 and sums due into employees' pensions, are to be paid under section 175.
A certain amount of money must be set aside as a "ring fenced fund" for all creditors without security under section 176A. This is set by statutory instrument as a maximum of £600,000, or 20 per cent of the remaining value, or 50 per cent of the value of anything under £10,000. All these preferential categories (for insolvency practitioners, employees, and a limited amount for unsecured creditors) come in priority to the holder of a floating charge.
Floating charge holders come next. Like a fixed charge, a floating charge can be created by a contract with a company before insolvency. Like with a fixed charge, this is usually done in return for a loan from a bank. But unlike a fixed charge, a floating charge need not refer to a specific asset of the company. It can cover the entire business, including a fluctuating body of assets that is traded with day today, or assets that a company will receive in future. The preferential categories were created by statute to prevent secured creditors taking all assets away. This reflected the view that the power of freedom of contract should be limited to protect employees, small businesses or consumers who have unequal bargaining power.[35]
After funds are taken away to pay all preferential groups and the holder of a floating charge, the remaining money due to unsecured creditors. In 2001 recovery rates were found to be 53% of one's debt for secured lenders, 35% for preferential creditors but only 7% for unsecured creditors on average.[36]
Any money due for interest on debts proven in the winding up process.
Money due to company members under a share redemption contract.
Debts due to members who hold preferential rights.
Ordinary shareholders, who have the right to residual assets.
Aside from pari passu or a priority scheme, historical insolvency laws used many methods for distributing losses. The Talmud (ca 200AD) envisaged that each remaining penny would be dealt out to each creditor in turn, until a creditor received all he was owed, or the money ran out. This meant the small creditors were more likely to be paid in full than large and powerful creditors.[37]
The priority system is reinforced by a line of case law, whose principle is to ensure that creditors cannot contract out of the statutory regime:
Since the Bankruptcy Act 1542 a key principle of insolvency law has been that losses are shared among creditors proportionately. Creditors who fall into the same class will share proportionally in the losses (e.g. each creditor gets 50 pence for each £1 she is owed). However, this pari passu principle only operates among creditors within the strict categories of priority set by the law:[32]
The law permits creditors making contracts with a company before insolvency to take a security interest over a company's property. If the security is refers to some specific asset, the holder of this "fixed charge" may take the asset away free from anybody else's interest in order to satisfy the debt. If two charges are created over the same property, the charge holder with the first will have the first access.
The Insolvency Act 1986 section 176ZA gives special priority to all the fees and expenses of the insolvency practitioner, who carries out an administration or winding up. The practitioner's expenses will include the wages due on any employment contract that the practitioner chooses to adopt.[33] But controversially, the Court of Appeal in Krasner v McMath held this would not include the statutory requirement to pay compensation for a management's failure to consult upon collective redundancies.[34]
Even if they are not retained, employees' wages up to £800 and sums due into employees' pensions, are to be paid under section 175.
A certain amount of money must be set aside as a "ring fenced fund" for all creditors without security under section 176A. This is set by statutory instrument as a maximum of £600,000, or 20 per cent of the remaining value, or 50 per cent of the value of anything under £10,000. All these preferential categories (for insolvency practitioners, employees, and a limited amount for unsecured creditors) come in priority to the holder of a floating charge.
Floating charge holders come next. Like a fixed charge, a floating charge can be created by a contract with a company before insolvency. Like with a fixed charge, this is usually done in return for a loan from a bank. But unlike a fixed charge, a floating charge need not refer to a specific asset of the company. It can cover the entire business, including a fluctuating body of assets that is traded with day today, or assets that a company will receive in future. The preferential categories were created by statute to prevent secured creditors taking all assets away. This reflected the view that the power of freedom of contract should be limited to protect employees, small businesses or consumers who have unequal bargaining power.[35]
After funds are taken away to pay all preferential groups and the holder of a floating charge, the remaining money due to unsecured creditors. In 2001 recovery rates were found to be 53% of one's debt for secured lenders, 35% for preferential creditors but only 7% for unsecured creditors on average.[36]
Any money due for interest on debts proven in the winding up process.
Money due to company members under a share redemption contract.
Debts due to members who hold preferential rights.
Ordinary shareholders, who have the right to residual assets.
Aside from pari passu or a priority scheme, historical insolvency laws used many methods for distributing losses. The Talmud (ca 200AD) envisaged that each remaining penny would be dealt out to each creditor in turn, until a creditor received all he was owed, or the money ran out. This meant the small creditors were more likely to be paid in full than large and powerful creditors.[37]
The priority system is reinforced by a line of case law, whose principle is to ensure that creditors cannot contract out of the statutory regime:
Fixed charge holders
The meaning of insolvency matters for the type of legal rule. In general terms insolvency has, since the earliest legislation, depended upon inability to pay debts.[24] The concept is embodied in the Insolvency Act 1986 section 122(1)(f) which states that a court may grant a petition for a company to be wound-up if "the company is unable to pay its debts". This general phrase is, however, given particular definitions depending on the rules for which insolvency is relevant. First, the "cash flow" test for insolvency represented under section 123(1)(e) is that a company is insolvent if "the company is unable to pay its debts as they fall due". This is the main test used for most rules. It guides a court in granting a winding-up order or appoints an administrator.[25] The cash flow test also guides a court in declaring transactions by a company to be avoided on the ground they were at an undervalue, were an unlawful preference or created a floating charge for insufficient consideration.[26] The cash flow test is said to be based on a "commercial view" of insolvency, as opposed to a rigid legalistic view. In Re Cheyne Finance plc,[27] involving a structured investment vehicle, Briggs J held that a court could take into account debts that would become payable in the near future, and perhaps further ahead, and whether paying those debts was likely. Creditors may, however, find it difficult to prove in the abstract that a company is unable to pay its debts as they fall due. Because of this, section 122(1)(a) contains a specific test for insolvency. If a company owes an undisputed debt to a creditor of more than £750, the creditor sends a written demand, but after three weeks the sum is not forthcoming, this is evidence that a company is insolvent. In Cornhill Insurance plc v Improvement Services Ltd[28] a small business was owed money, the debt undisputed, by Cornhil Insurance. The solicitors had repeatedly requested payment, but none had come. They presented a winding up petition in the Chancery Court for the company. Cornhill Insurance's solicitors rushed to get an injunction, arguing that there was no evidence at all that their multi-million business had any financial difficulties. Harman J refused to continue the injunction noting that, if the insurance company had "chosen" not to pay, a creditor was also entitled to choose to present a winding up petition when a debt is undisputed on substantial grounds.[29]
English law draws a distinction between a "debt", which is relevant for the cash flow test of insolvency under section 123(1)(e), and a "liability", which becomes relevant for the second "balance sheet" test of insolvency under section 123(2). A debt is a sum due, and its quantity is a monetary sum, easily ascertained by drawing up an account. By contrast a liability will need to be quantified, as for instance, with a claim for a breach of contract and unliquidated damages. The balance sheet test asks whether "the value of the company's assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities." This, whether total assets are less than liabilities, may also be taken into account for the purpose of the same rules as the cash flow test (a winding up order, administration, and voidable transactions). But it is also the only test used for the purpose of the wrongful trading rules, and director disqualification.[30] These rules impose potentially impose liability upon directors as a response to creditors being paid. This makes the balance sheet relevant, because if creditors are in fact all paid, the rationale for imposing liability on directors (assuming there is no fraud) drops away. Contingent and prospective liabilities refer to liability of a company that arise when an event takes place (e.g., defined as a contingency under a surety contract) or liabilities that may arise in future (e.g., probable claims by tort victims). The method for computing assets and liabilities depends on accountancy practice. These practices may legitimately vary. However, the law's general requirement is that accounting for assets and liabilities must represent a "true and fair view" of the company's finances.[31] The final approach to insolvency is found under the Employment Rights Act 1996 section 183(3), which gives employees a claim for unpaid wages from the National Insurance fund. Mainly for the purpose of certainty of an objectively observable event, for these claims to arise, a company must have entered winding up, a receiver or manager must be appointed, or a voluntary arrangement must have been approved. The main reason employees have access to the National Insurance fund is that they bear significant risk that their wages will not be paid, given their place in the statutory priority queue.
Priorities
See also: Pari passu, Seniority (financial), and Subordination (finance)
The Insolvency Act 1986 priority list
Fixed charge holders
Insolvency practitioner fees and expenses, s 176ZA
Preferential creditors, ss 40, 115, 175, 386 and Sch 6
Ring fenced fund for unsecured creditors, s 176A and SI 2003/2097
Floating charge holders
Unsecured creditors, s 74(2)(f)
Interest on debts proved in winding up, s 189
Money due to a member under a contract to redeem or repurchase shares not completed before winding up, CA 2006 s 735
Debts due to members under s 74(2)(f)
Repayment of residual interests to preference, and then ordinary shareholders.
English law draws a distinction between a "debt", which is relevant for the cash flow test of insolvency under section 123(1)(e), and a "liability", which becomes relevant for the second "balance sheet" test of insolvency under section 123(2). A debt is a sum due, and its quantity is a monetary sum, easily ascertained by drawing up an account. By contrast a liability will need to be quantified, as for instance, with a claim for a breach of contract and unliquidated damages. The balance sheet test asks whether "the value of the company's assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities." This, whether total assets are less than liabilities, may also be taken into account for the purpose of the same rules as the cash flow test (a winding up order, administration, and voidable transactions). But it is also the only test used for the purpose of the wrongful trading rules, and director disqualification.[30] These rules impose potentially impose liability upon directors as a response to creditors being paid. This makes the balance sheet relevant, because if creditors are in fact all paid, the rationale for imposing liability on directors (assuming there is no fraud) drops away. Contingent and prospective liabilities refer to liability of a company that arise when an event takes place (e.g., defined as a contingency under a surety contract) or liabilities that may arise in future (e.g., probable claims by tort victims). The method for computing assets and liabilities depends on accountancy practice. These practices may legitimately vary. However, the law's general requirement is that accounting for assets and liabilities must represent a "true and fair view" of the company's finances.[31] The final approach to insolvency is found under the Employment Rights Act 1996 section 183(3), which gives employees a claim for unpaid wages from the National Insurance fund. Mainly for the purpose of certainty of an objectively observable event, for these claims to arise, a company must have entered winding up, a receiver or manager must be appointed, or a voluntary arrangement must have been approved. The main reason employees have access to the National Insurance fund is that they bear significant risk that their wages will not be paid, given their place in the statutory priority queue.
Priorities
See also: Pari passu, Seniority (financial), and Subordination (finance)
The Insolvency Act 1986 priority list
Fixed charge holders
Insolvency practitioner fees and expenses, s 176ZA
Preferential creditors, ss 40, 115, 175, 386 and Sch 6
Ring fenced fund for unsecured creditors, s 176A and SI 2003/2097
Floating charge holders
Unsecured creditors, s 74(2)(f)
Interest on debts proved in winding up, s 189
Money due to a member under a contract to redeem or repurchase shares not completed before winding up, CA 2006 s 735
Debts due to members under s 74(2)(f)
Repayment of residual interests to preference, and then ordinary shareholders.
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