4- Order of Distribution- New

Question 1

What is pari passu distribution?

Answer 1

PP is the most fundamental principle of insolvency law (British Eagle).

It means all creditors participle in the common pool in proportion to the size of their admitted claims, with creditors of the same status.

PP is based on the notion that losses caused by liquidation should be borne by unsecured creditors equally.

Question 2

What is the distinction between PP and the anti-deprivation rule?

Answer 2

1. Anti dep rule is concerned with cases where there is a contractual provision which states that on liquidation or bankruptcy the debtor should pay a non-creditor a sum or money or assets. This reduces the net assets of the co/individual.
2. If a co were to give money to a creditor on liquidation/an individual were to do this on bankruptcy, this would not be in breach of the anti-dep rule, since it does not reduce the co’s net asset value, since the co/individual is owed that money.
3. BUT it would be in breach of PP, because it would stop the equal distribution among the common pool of creditors (i.e. it would be a preference).
4. The two are commonly confused in case law.

Question 3

Barlow Clowes International Ltd v Vaughan [1992]

Answer 3

Explains fair basis for distribution of funds among competing claimants- not in the PP sense, but similar rationale.

Case: Concerned the distribution of assets among beneficiaries. Rule: In general the rule in Clayton’s Case (first-in first-out) applies to the distribution of trust funds, unless the application would be impractical or would result in injustice between the parties.

Reasoning: This is as first-in first-out rule is a convenient method of competing claims but would be contrary to the presumed intention of the beneficiaries.

Question 4

Cork on pari passu

Answer 4

PP is in theory fundamental and all-pervasive, but a rateable distribution among creditors is rarely achieved for 3 reasons:

1. PP is confined to assets of the co and does not affect creditors having rights in rem. These include: - secured creditors who can take security for present and future indebtedness over future and present assets; - suppliers of goods under contracts which reserve title until payment; - third parties for whom the co holds assets on trust or who have prop tracing rights in equity. These are not exceptions to the rule- these assets do not belong to the co.
2. Liquidator takes the assets subject to equities affecting them - E.g right to avoid a transaction for misrep.
3. Huge chunks of the assets that remain have to be applied to meet claims in ranking priority to those of the ordinary unsecured creditor.

Question 5

General order of distribution

Answer 5

1. Secured creditors with a charge over property.
2. Expenses of liquidation
3. Preferential creditors
4. Floating charge holders
5. unsecured creditors with provable debts
6. Statutory interest
7. Unsecured creditors with non-provable debts
8. Shareholders§

Question 6

Expenses of the liquidation- cases and provisions?

Answer 6

Bankruptcy: IR 6.22; s.324

Winding up: 4.218; s.115; s.156; s.176A, Re Lundy Granite, Re Nortel

Question 7

What is the position of expenses with regards to pari passu?

Answer 7

They enjoy a SUPER PRIORTY because they are not provable debts existing at the date of the winding up order, they are merely costs incurred later in the carrying out of liquidation. Because they are not provable, they do not engage pari passu

Question 8

IR 6.22/ IR 4.218

Answer 8

Order in which expenses are payable in bankruptcy/liquidation.

Question 9

s.324

Answer 9

Bankruptcy. Payment of dividends is subject to sufficient money to cover expenses.

Question 10

s.115

Answer 10

Expenses in liquidation are payable from the company’s assets in priority to all other claims.

Question 11

s.156

Answer 11

Liquidation- if the co’s assets are insufficient to satisfy its expenses, the court may make an order as to the payment of expenses out of those assets in the order that it thinks is just.

Question 12

s.176ZA

Answer 12

Where the assets available to the general pool of creditors are insufficient to cover the expenses of liquidation, they take priority over a floating charge.

Question 13

Principle in Re Lundy Granite Co (1871)

Answer 13

The principle enables creditors in respect of leases or other contracts entered into before the liquidation to recover debts in full, as expenses of the liquidation, where contracts have been continued by the liquidators for the benefit of the liquidation.

Question 14

Pension Fund Shortfalls

Answer 14

When an employer liable to make contributions to an occupational pension scheme suffers “an insolvency event” it becomes liable to pay to the trustees of the scheme the difference between the assets of the scheme and its liabilities.

In certain circumstances the Pensions Regulator (TPR) may issue a Financial Support Direction (FSD) against employer and associated companies or individuals- An FSD requires the target to put financial support in place for a scheme.

• To issue an FSD we must consider that the scheme’s employer was either a service company or ‘insufficiently resourced’ at a time that we choose (known as the ‘relevant time’).
• We must also consider that it is reasonable to require the target to provide financial support. We consider any relevant issues, which may include similar issues to those we consider for CNs.

Or may issue a contribution notice, requiring the target to pay money to a scheme. The individual must have been part to an act to prevent the recovery of all or part of a debt due to the scheme under section 75 of the Pensions Act 1995 (i.e. the insolvency).

Question 15

*Re Nortel GmbH [2014] SC

Answer 15

The Supreme Court considered whether the liability that would arise on a financial support direction (FSD) being served by the Pensions Regulator on a company in administration ranked as an expense of the administration or a provable debt.

Decision: the company’s liability under the FSD regime ranked as a provable debt of the company and not an expense of the administration.

The Supreme Court called the answer ‘sensible and fair’ even though their decision overrules a number of cases dating back to 1887.

Question 16

Implications of Nortel?

Answer 16

1. Creates certainty for office holders, companies and pension schemes?
2. Widens category of provable debts and narrows the category of expenses.
   - The definition of expense has been narrowed to arising out of the ‘doing’ of the administrators, or from a statute whose terms make clear that the liability falls on the administrator as part of the administration.
   - This may also affect the issue relating to rent as an expense in administration (Lundy Granite).

Question 17

Preferential creditors- cases and provisions?

Answer 17

s. 328/s.175
s. 368/s.387

Sch 6, paras 8-11 and 15A-15B;

s.40;

Re Unit 2 Windows (1985)

Question 18

s.175(1) (liquidation), s.328(1) (bankruptcy)

Answer 18

In a winding up/bankruptcy the company’s preferential debts (within meaning of s.386 such 6) shall be paid in priority to all other debts.

Question 19

s.386

Answer 19

Preferential debts are: - contributions to occupational pension schemes; -remuneration of employees; - levies on coal and steel. All defined in Sch 6.

Question 20

Sch 6

Answer 20

PAGE 198. Defines each of the categories of preferential debt.

Question 21

s.387

Answer 21

Use to determine the relevant date when it is referred to in Sch 6.

Question 22

Sch 6 Para 8

Answer 22

Contributions to occupational and state pension schemes are preferential debts

Question 23

NB: Pension Schemes Act 1993 s.123-127

Answer 23

Where an employer is insolvent requires the secretary of state to pay any unpaid contributions to occupational and personal pension schemes where employer is insolvent in the place of the employer paying it.

Question 24

Sch 6 Para 9, 10, 11

Answer 24

Remuneration of employees is preferential debt (i) maximum per employee £800 or 4 months (ii) accrued holiday remuneration (para 10) (iii) subrogation to employees’ preferential status for lender of money advanced to pay wages which has been so used (para 11)

Question 25

NB: Employment Rights Act 1996

Answer 25

where employer insolvent (s 183) arrears of up to 8 weeks pay (s 184) not exceeding £489 per week (s 186) are payable by Secretary of State (s 182); Secretary of State is then subrogated to employee’s claim against employer (s189)

This is against the Cork Report recommendation.

BUT the reasons they gave, that ‘it is desirable for more funds to be left for the unsecured creditors’ is unconvincing, because there is no reason why the general body of creditors who would have been subordinated to claims of the employees themselves should find themselves in a better position because such claims have been met by the Crown.

Question 26

Cork Report- Employees preferential claims

Answer 26

1. Rejected the idea that all debts due to employees for wages or salaries should be preferential without any limit in amount or extent.
2. There have been substantial improvements in the position of wage earners through the introduction of unemployment pay, redundancy payments and other social security benefits, coupled with the ability, under the Employment Protection Acts, to obtain immediate payment of claims out of what was then the Redundancy Fund.
3. Recommended that
   the financial hardship of employees through their employer’s insolvency should be dealt with under the Employment Acts. There is no need for an overlapping insolvency code.

This recommendation was not adopted.

Question 27

Why was the Cork recommendation about the employment redundancy fund rejected?

Answer 27

Because employees deserve preferential status.

1. Their wages or salaries are often their sole source of income and its loss can be devastating for their families. This would be exacerbated by their employer’s non-payment of their entitlements.
2. The employer-employee relationship requires mutual trust.
3. Without the work of employees the employer’s business could not function and then the creditor would not get paid.

Question 28

Sch 6 Para 15A

Answer 28

Levies on coal and steel production preferential debt

Question 29

s.175(2)(a) and s.328(2)

Answer 29

Preferential debts rank pari passu inter se, and shall be paid in full unless the estate/assets are insufficient to meet them, in which case they abate in equal proportions.

Question 30

s.175(2)(b) (liquidation), s.40 (receivership)

Answer 30

Preferential debts rank ahead of FT.

Question 31

Re Unit 2 Windows Ltd [1985]

Answer 31

In a voluntary liquidation, if a creditor would, but for the existence of set off, bring a claim against the co that would be partly preferential and partly non-preferntial, he must exercise any right of set-off (i.e. set off money the co owed him against money his is owed by the co) proportionately against each class of debt (i.e must not mix them).

Question 32

Floating charge- cases and provisions?

Answer 32

s.176A; Re Airbase Services (2008)

Question 33

s.176A

Answer 33

Where a co has gone into liquidation or administration or there is a provisional liquidator or receiver appointment, the liquidator or receiver shall make a prescribed part of the co’s net property available for the satisfaction of unsecured debts and shall not distribute that part to the FT holder.

Question 34

Re Airbase Services (2008)

Answer 34

Case: After the administrators calculated the prescribed part of the property for the satisfaction of unsecured debts under s.176A, there was a large shortfall in what was owed under the FT and the fixed charge. I

Issue: Could the holder of the charges share pari passu in receiving the prescribed part for the shortfall on his charges, which became unsecured debt due to the prescribed part?

Decision: The provisions of the IA prevented the FT holder from participating as an unsecured creditor in a claim for part of the prescribed part.

Question 35

McCormack (2003)- is the priority of secured creditors justified? (about prescribed part.

Answer 35

Two conflicting views on the “carve-out” (prescribed part) provision contained in the Enterprise Act.

1. It redresses the balance in favour of the unsecured creditor and is valuable as it may forestall the domino effect of a chain of insolvencies resulting from the failure of one business that leaves its trade creditors and suppliers unpaid.
2. BUT it can also be seen as interfering with contractual freedom and property rights of banks, and as making banks more reluctant to lend money, or to lend on harsher terms. So the proposal, which is designed to help small business, may actually be damaging them.
3. BUT banks are in the business of lending money and are unlikely to stop doing so simply due to a partial loss of priority rights (banks often hold FTs), so this may be exaggerated.
4. However, there are fears by banks that the size of the prescribed part could increase over time, so these things may begin to happen in the attack on security continues.
5. So, the provision should be kept under review, it order to ensure bank lending strategies are not affected.
6. PLUS the provision is not avoidance proof. Banks can make better use of fixed charges and using a range of ‘artificial’ security devices.
7. These tactics may completely deprive the provision of force, so courts and Parliament should be alert to this possibility and change the rule if necessary.

Question 36

Unsecured creditors with provable debts-provisions?

Answer 36

s.328(3), s.107, IR4.12

Question 37

s.328(3), s.107 (voluntary winding up), IR4.12 (compulsory winding up and administration)

Answer 37

Debts which are not preferential (i.e. ordinary debts) rank equally among themselves, and after preferential debts. Shall be paid in full after preferential debts, unless estate/assets are insufficient to meet them, in which case they rank in equal proportions pp.

Question 38

Interest- provisions?

Answer 38

s.328(4)(5), s.189(2)(3)

Question 39

s.328(4)(5), s.189(2)(3)

Answer 39

After ordinary debts satisfied interest is payable on all proved debts during insolvency, which also rank pari passu inter se, at the rate in (5).

Question 40

Unsecured creditors with unprovable claims (i.e debts which are deferred to this status by statute)- provisions and cases?

Answer 40

1. Loans by a partner to the partnership- Partnership Act 1890 s.44(b) rule 2, Re Longorian, e p Sheil
2. Loans by a non-partner for use in a business for a rate of interest varying with profits, Partnership Act 1890 s.3, Re Beale, Re Meade
3. Debts due to bankrupt’s spouse- s.329
4. Debts due to members of the co in their capacity as members- .74(2)(f), Re L B Holliday & Co Ltd [1986], Cork, s.215(4)
5. Loans at a rate of interest varying with profits- IR 14.2(4)(b)

Re Maxwell Communications Corp plc (no.3) [1993]

Question 41

Partnership Act 1890 s.44(b) rule 2

Answer 41

Deferred debts- Loans by a partner to the partnership- bankruptcy

“In settling accounts between the partners after a dissolution of partnership, the following rules shall, subject to agreement, be observed: ….

(b) the assets of the firm… shall be applied in the following manner and order:
2. in paying to each partner rateably what is due from the firm to him for advances as distinguished from capital.

Question 42

Partnership Act 1890 s 3

Answer 42

Deferred debts- Loans by a non-partner for use in a business for a rate of interest varying with profits- bankruptcy- i.e. whether or not you are paid back is dependent on the profits of the co.

Where money is lent to a person who is engaged in business or about to engage in business by way of a loan in consideration for a share in the profits, and the person engaged in business become bankrupt, the lender is not entitled to recover the loan until claims of other creditors have bene satisfied (i.e. it is not a provable debt).

Question 43

Re Lonergan ex p Sheil (1877)

Answer 43

Case: A loan was made to a trader at a rate of interest in consideration of a share in the profit, the amount of the loan and interest being secured by a mortgage to the lender of the lease of the house where the business was carried on, and of the goodwill of the business.

The trader became bankrupt.

Held: the rights of the mortgagee under his mortgage were in now way affected by [s.3]

i.e he was entitled to the mortgage property because he had a charge. It did not matter that the interest rate varied, because it was not an unsecured debt.

Question 44

Re Beale (1876)

Answer 44

Loans by a non-partner for use in a business in consideration of a share in the profit.

Case: B, a trader, in 1857 went through the ceremony of marriage with M, a sister of his deceased wife, and henceforth lived with her as his wife.

In 1858 she inherited a sum of £2000. She directed that it be paid to B, to be employed by him in his business. They also agreed that B should be a trustee of the £2000 for M.
and that a settlement should be executed to carry out the agreement.

In 1876 B filed a liquidation petition. No settlement of the £2000 had been executed:

Held: M was not entitled to prove in the liquidation for the £2000 in competition with the creditors of the business, because her repayment was dependent on the profits of the business.

Question 45

Re Meade [1951]

Answer 45

Loans by a non-partner for use in a business in consideration of a share in the profit.

Case: Miss H lived with Major M and lent him £7,218 to set up a riding academy, described in brochures as being run by Major and Mrs M. Major M went bankrupt and Miss H submitted proof for £7,218.

Held: Claim to repayment ranked last as Miss H’s repayment was based on shares in the profit.

Rule: A person who authorizes the use of his money for the purpose of a business cannot subsequently, on the failure of the business, prove in competition with the creditors of the business for the money so lent.

Question 46

Insolvency Act 1986, s.329

Answer 46

Debts due to bankrupt’s spouse rank after interest paid during bankruptcy, therefore are postponed (i.e. to deferred debts)

Question 47

Insolvency Act 1986, s.74(2)(f)

Answer 47

Debts due to members (i.e shareholders) of the company in their capacity as members are postponed deferred debts.

Question 48

Re L B Holliday and Co Ltd [1986]

Answer 48

Case: Wholly owned subsidiary declared dividends to its parent company between 1974-1981. They were never actually paid but instead retained by subsidiary, who was in insolvent liquidation.

The parent company claimed unpaid dividends had been lent back to subsidiary and it could therefore prove as a creditor

Decision: In order to prove for the debt not in the capacity as a member (i.e to avoid a postponed claim), the burden was on the parent company to prove that the retention of the funds by the subsidiary was due to some kind of express/implied agreement.

On the facts there was no evidence of this.

Question 49

Cork paras 1958-65

Answer 49

“We recommend that, on a winding up of a company, those of its liabilities whether secured or unsecured which are owed to connected persons or companies, and which appear to the Court to represent all or part of the long-term capital structure of the company, shall be deferred to the claims of other creditors and be paid only after all such claims have been met in full.” (not enacted)- secured debts are not deferred.

Question 50

Insolvency Act 1986, s.215(4)

Answer 50

“Where the court makes a declaration under either section (wrongful or fraudulent trading) in relation to a person who is a creditor of the company, it may direct that the whole or any part of any debt owed by the company to that person and any interest shall rank in priority after all other debts owed by the company and after any interest on those debts.

Question 51

Insolvency Rules 1986, 14.2(4)(b)

Answer 51

Any claim which by virtue of the IA or another enactment is in postponed is not payable until after interest in bankruptcy/liquidation or administration.

Question 52

Re Maxwell Communications Corp plc (no.3) [1993]

Answer 52

No policy reasons not to allow a creditor to agree to defer its claim to those of other creditors. 2 creditors can agree that one of them who would otherwise rank higher than or PP with the other shall be subordinated to the other. The subordination may be of secured or unsecured debt