Commercial Law - Insolvency Exam Questions with Complete Solutions.

Commercial Law - Insolvency Exam Questions with Complete Solutions What is insolvency? - Correct Answers: In the financial sense, insolvency is when the debtor cannot mean their liabilities to creditors. Various legal and practical consequences of insolvency in the financial sense require further clarification. Common element to these procedures is that an officially appointed third party has the responsibility of turning the property into liquid assets (if it is not already in such a form) and distributing such assets to creditors in a statutorily prescribed manner in an attempt to settle the debtor's debts. Note in Scots law there is a distinction between types of debtor: company debtors - corporate insolvency; and non-company debtors - sequestration (bankruptcy). Terminology - Correct Answers: (1) Personal insolvency (bankruptcy) and, (2) Corporate insolvency. What are the types of insolvency process? - Correct Answers: -Sequestration -Trust deed for behoof of creditors - Bankruptcy - Liquidation - Receivership - Administration - Company voluntary arrangements Sequestration - Correct Answers: Judicial process transferring whole assets of insolvent to trustee. This is done for the purposes of sale of the property by the trustee and distribution to the creditors of the insolvent. - Available for all insolvents except registered companies. That is, individual persons, partnerships, unregistered corporate bodies etc. The trustee in sequestration, to whom every asset belonging to the debtor (except the essential assets in the 2002 Act) is transferred to the T-in-S who becomes owner and can sell the assets to pay off the creditor Trust Deed for Behoof of Creditors - Correct Answers: Similar to sequestration except procedure is voluntary rather than judicial. This procedure can be less expensive than sequestration so leaving more funds for distribution to creditors. Not available to registered companies. -Trigger for apparent insolvency Bankruptcy - Correct Answers: This term is used indeterminately to refer to any of the above states of insolvency. Often it is used to refer to the process of sequestration or the granting of a trust deed. Bankruptcy is usually concerned with the affairs of individuals, partnerships and unincorporated bodies, rather than companies which are concerned with liquidation, receivership and administration. Liquidation - Correct Answers: Procedure for 'winding up' registered companies. Liquidator appointed with similar role to trustee in sequestration. At the end of liquidation, company is 'dissolved'. Available for solvent as well as insolvent companies. -Company ends up ceasing to exist - can be voluntary (initiated by shareholders, e.g. the books show that the company is screwed) or involuntary - if assets are bigger than liabilities, shareholders train control as any leftover money goes to them Receivership - Correct Answers: Used for enforcing 'old floating charges' (pre effect of Enterprise Act 2002). Receiver takes over the running of the company. Realises assets for benefit of chargeholder. NOT ON EXAM Administration - Correct Answers: Only available for companies. Administrator takes over management of company for benefit of all concerned. Rights of creditors suspended. -Company brought to an end by winding it up - Liquidator becomes manager, assets not transferred to them though - Can realise assets to get money into the company and pay off creditors - The administrator is appointed who takes over the company's management for a maximum duration of 1 year - Moratorium - no creditor can enforce a security or do diligence - If the company can't be saved, the adminisitrator can sell on the business or wind up the company and petition to go into liquidation What are the two objectives of the administration? - Correct Answers: ♣ First, can see if the company is a growing concern. They can cut costs (shut down shops, make someone redundant); there may be social impact but the company survives and creditors are happy b/c they get paid Second, administrator looks at company and sees that the company can't survive as an entity but bits of the business that the company has can be redeemed by selling them off separately to other businesses (e.g. these shops in these areas, can be sold to new established company, which brings money in; some other shops can't do anything) Company Voluntary Arrangements - Correct Answers: Deal approved by the majority of creditors for payment at less than 100% of debts due. - An agreement between the creditor/debtor whereby certain creditors take less than what is due, which requires the consent of the creditors BANKRUPTCY (SCOTLAND) ACT 2016 - Correct Answers: Together with certain common law provisions, the Bankruptcy (Scotland) Act 2016 governs insolvency of all insolvents in Scotland except registered companies (and certain other incorporated entities). The law for England and Wales is contained in the Second and Third Groups of Parts of the Insolvency Act 1986. Insolvency in a nutshell - Correct Answers: Failure to pay one's debts is the first step on the road to bankruptcy. However, before the provisions of the 2016 Act can be invoked by creditors in an attempt to have outstanding debts settled, the debtor must be 'insolvent'. There are three possible states of insolvency: Practical insolvency - CASH FLOW INSOLVENCY - debtor unable to pay debts as they fall due. Assets may be greater than liabilities. Absolute insolvency - BALANCE SHEET INSOLVENCY - total liabilities exceed total assets (affects gratuitous alienations and unfair preferences and can lead to disqualification of directors). Consequences: gratuitous alienations and fraudulent preferences may be challenged. Common with acceleration clauses. Unfair preference - gives a creditor preference to be paid off over other creditors Apparent insolvency - s 16 Bankruptcy (Scotland) Act 2016 arises automatically on occurrence of certain events. Eurostar case - absolute (balance sheet) insolvency - Correct Answers: o Company owns a tunnel which connects part of Europe with mainland Europe o Trains running through o 1 asset (a tunnel) o none of the creditors ever put the company into liquidation because if they had, the company had 1 asset to be sold (a tunnel) o the value of the debts was many thousands of times more than the value of the tunnel o therefore, the creditors and the debtor company reach an arrangement where the debtor company would give them money (convert debts to shares) wipe out some of debt in exchange for shares, but would NEVER put the company into liquidation b/c that would crystallise their claim and they would get a fraction of a penny When does apparent insolvency apply? - Correct Answers: a. sequestrated b. made bankrupt in UK c. debtor gives written notice to creditors that he has ceased to pay debts d. Becomes subject to insolvency in EU member state other than UK e. debtor grants trust deed to creditors f. charge for payment served on debtor and expires without payment g. decree of adjudication is granted h. debt payment programme under 2002 Act is revoked i. creditor is owed a prescribed amount £1,500 serves statutory demand for payment and denial of debt by debtor or no payment of debt within 3 weeks In the case of (f), (g), and (h), s 16(2) provides that apparent insolvency does not arise if the debtor was able and willing to pay debts as they fall due, or the debtor had a restraining order that made payment impossible. What is apparent insolvency? - Correct Answers: - Triggered by a diligence act in the first place - Often has a clause in the contract that if the debtor becomes apparently insolvent, they are in default which can trigger acceleration Insolvency Act 1986 s123 - Correct Answers: - a company can't pay its debts when: o statutory demands for payment o charge for payment expires o balance sheet insolvency o cash flow insolvency - key trigger for administration or liquidations What are the consequences of apparent insolvency? - Correct Answers: o contractual stipulations o equalisation of diligences o precursor to sequestration It is important to note that rules on gratuitous alienations and unfair preferences apply equally to individuals and registered companies. Also companies can be absolutely or apparently insolvent. EQUALISATION OF DILIGENCE - Correct Answers: Apparent insolvency has two important effects: (1) Precondition to Sequestration. (2) Equalisation of Arrestments and Attachments. As apparent insolvency is triggered by specific events, there might be multiple periods of apparent insolvency leading to overlaps Sch 7 para 1, Bankruptcy (Scotland) Act 2016 - Correct Answers: - All arrestments and attachments executed within 60 days prior to the apparent insolvency event or within 4 months after its constitution, rank pari passu as if executed on same date - Any arrestment which is executed on the dependence must be followed up without undue delay - A creditor judicially producing liquid grounds of debt/decree for payment within the 60 days/4 months period mentioned, is entitled to rank as if the creditor had executed an arrestment/attachment - Arrestments executed for attaching the same effects of the debtor after the 4 months period do not compete with those within the 60 days/4 months period, but may rank with each other on any reversion of the fund attached - The first/subsequent arresters obtain a decree of furthcoming and recover payment, then that arrester is accountable for the sum recovered to those who have pari passu ranking on the sum, and is liable in an action for payment to them proportionately. The same applies to an attaching creditor selling through an auction and receives payment for the attached article. Clark v Hinde Milne & Co (1884) - Correct Answers: A company registered under the Companies Acts may be made notour bankrupt (apparent insolvency), to the effect of equalising diligences, in terms of the 12th section of the Bankruptcy Act, 1856 - Creditors of a company registered under the CA charged them with a decree for payment, wasn't paid upon expiry; executed a poinding and obtained a warrant of sale - Company shareholders sought to wind up the company and appointed liquidators - Other creditors wanted to be preferentially ranked pari passu with the poinding credits on the proceeds of the poinding, lodged a minute with the court and produced liquid grounds for debt - COS ordered the winding up be continued subject to court's supervision - Even if the winding up commenced at date of shareholder's resolution, this was not struck by s163d of the CA 1862 so the compearers were entitled under s12 of the BA 1856 to rank pari passu with the poinding creditors Adjudication equalisation - Correct Answers: Adjudications within a year and a day are equalised Diligence Act 1661 60 day striking down rule - Correct Answers: Bankruptcy Act 2016 - s24 If the attachment/arrestment takes place in 60 days pre-sequestration, it is struck down (ceases to be effectual) - If you have an attachment in the 60 days before sequestration, you lose all priority - If you have an arrestment, likewise no priority - Same applies for inhibitions The 1986 Act s 185 provides that the 60-day rule in s24 ALSO applies to liquidation; if you have an arrestment/attachment/inhibition which takes place before liquidation, it's also struck down Multiple poinding - Correct Answers: Where there are two or more diligences, multiple poinding process can be initiated where the court decides who is paid first. They will usually apply priore tempore. CHALLENGES TO PRIOR TRANSACTIONS - Correct Answers: An area where a transaction entered into by the debtor prior to insolvency can be challenged either to (a) recover assets conveyed to third parties; or (b) strike down securities in favour of third parties. Note: treatment is harmonised for company and non-company insolvencies. The key for challengeable transactions at common law to differentiate them from challenges under statute is that there is no fixed time limit for challenge at common law. Instead the law of negative prescription applies. Fraudulent transactions @ common law - Correct Answers: Fraud has traditional common law meaning, not criminal definition. Based on actio Pauliana in Roman law. "What is included in the category of fraud at common law is very plain. When a man is insolvent, and knows it, he is barred by the first principles of justice from giving any preference to one of his creditors over another. That this is the law is well stated by Lord Corehouse in the case of McEwen & Miller v Doig, where his Lordship observed, "It is the duty of a person notoriously insolvent to abstain from every act which can affect the preferences of his creditors (6 S 889)."" Lord Neaves in Thomas v Thomson (1866) 5 M 198 at 201 What is needed for fraudulent transactions at common law (McBryde analysis) - Correct Answers: 1. prejudice to creditors by diminishing estate for creditors 2. absolutely insolvent or about to become so 3. other party to transaction (not debtor) need not know there is a problem, but if they do then, 4. collusion between transferee and debtor suggests fraud 5. fraud cannot be accidental - debtor must know insolvent 6. voluntary action - no legal compulsion so to act 7. ordinary acts of administration are not fraudulent transactions, extraordinary ones might be Who can raise an action at common law? - Correct Answers: Any creditor not a party to it (whenever the debt was incurred) or trustee in sequestration Remedy for fraud - Correct Answers: Reduction/redelivery GRATUITOUS ALIENATIONS - Correct Answers: Gratuitous alienations are simply gifts or part-gifts. Gifts made when a debtor is absolutely insolvent can be challenged by creditors and 'reduced'. The law is governed both by common law and statute. - at common law, it seems that it is not necessary to show that the debtor intended to defraud creditors of that act was done with a view to avoiding the effects of bankruptcy Gratuitous alienations at common law - Correct Answers: s 98 2016 Act, s 242 1986 Act More important than common law in practice but builds on the common law. Statutory regime 1. There must be an alienation by the debtor. 2. The alienation must transfer the debtor's property or discharge or renounce a claim or right. 3. Sequestration, grant of trust deed or appointment of judicial factor. 4. Alienation within appropriate time period 5 years if to an associate 2 years in other cases. What is an associate of the debtor? - Correct Answers: s 229, 2016 Act (applied to liquidation by s 242 1986 Act) includes various relatives and business associates, employers and employees. And note the definition of associate in the Insolvency Act 1986, s 435, for companies. When can't the alienation be challenged? - Correct Answers: The alienation will not be capable of challenge if one of the defences can be upheld. The defences are: a. The debtor was not absolutely insolvent b. The alienation was for adequate consideration c. The alienation was a permitted gift (birthday present etc or for charitable purpose) if reasonable in circumstances Who can raise an action challenging a gratuitous alienation? - Correct Answers: Creditor; permanent trustee; trustee under trust deed, liquidator or administrator What remedy is granted? - Correct Answers: s98(5) of the 2016 Act: - Reduction or such other remedy as is appropriate. *Short's Trustee v Chung (No.1) 1991 - Correct Answers: - The Bankruptcy (Scotland) Act 1985 s.34 provides that where the estate of a debtor has been sequestrated an alienation by him to a third party within two years of the date of sequestration may be challenged by the permanent trustee, and that upon such challenge the court shall grant decree of reduction, or for such restoration of property to the debtor's estate or other redress as may be appropriate, unless the debtor can establish that the alienation was made for adequate consideration. - A debtor acquired two flats for GBP 1,500 each in spring 1986. He sold them for GBP 2,500 each in December 1986. The purchaser conveyed both flats to his wife in May 1987 "for love, favour and affection." - The debtor was sequestered in June 1987, and his trustee's valuer valued the flats in Oct. at GBP 7k and 6.5k - The trustees sought an action seeking reduction of the dispositions relating to both Oct and May transactions - Defender contended that the alienations were made for consideration - Lord Ordinary found that they were not and granted reduction - Defender reclaimed and said that the debtor's estate would benefit by more than the difference in value between the sum paid and the actual market value because of the rise in property prices - The appropriate remedy was therefore to grant decree for payment of GBP 8,500. The trustee contended that the court did not have a general equitable discretion in the matter, and therefore reduction was the appropriate remedy. - Held: (1) Purpose of s34 was to ensure any improperly alienated property is restored to the debtor's estate (2) 'other redress as appropriate' in s34(5) was not intended tog vie the court a general discretion to decide a case but was designed to enable them to make an appropriate remedy where reduction/restoration was not possible (3) B/c reduction is avail *Short's Trustee v Chung (No 2) 1998 SLT 200 - Correct Answers: - A trustee in sequestration sought an order under s 34 of the Bankruptcy (Scotland) Act 1985 for the delivery to him of a disposition by the widow of a gratuitous alienee of the bankrupt. - The trustee had previously been granted a reduction of the dispositions in favour of the alienee and in turn the widow, but had failed in further litigation - Pursued to the House of Lords, to challenge a subsequent refusal by the Keeper of the Registers to rectify the Land Register in his favour in light of the decree of reduction. - The defender pled res judicata, arguing that the action raised the same substantive issues as the proceedings for reduction and the remedy now sought had then been available and known to, but not sought by, the trustee. Held: (1) that a material change in circumstances might elide a plea of res judicata and that the question was one of fact and degree in every case (p 202E-F); (2) that although the present and previous actions dealt with the same subject matter, the subsequent decision that the remedy already obtained was of little or no practical worth constituted such a material change of circumstances as to differentiate the media concludendi of the two actions and elide the plea (p 202I-K); and decree de plano granted . MacFadyen's Tr v MacFadyen 1994 - Correct Answers: - The term consideration should be accorded its ordinary meaning as something of value given in return for something else. - Mother purchased a house for her son and paid all the costs, he transferred title to her gratuitously - This amounted to gratuitous alienation as her contribution of the price and payment could not be treated as consideration Accountant in Bankruptcy (Brown's Trustee) v Brown [2009] - Correct Answers: - Under s 98(2) of the 2016 Act, gratuitous alienations may be challenged in the cOS by a creditor, the trustee in sequestration, the trustee under a protected trust deed, or the judicial factor on a deceased's estate - A creditor may seek to reduce a gratuitous alienation even if the trustee in sequestration has taken steps to do so - Accountant in Bankruptcy v Orr 2005 - Correct Answers: The alienation is effectual, in relation to heritage, it is the date of the recording of the disposition (for corporeal moveables, it's the date of delivery) Johnston's Trustee v Baird [2012] - Correct Answers: - Trustee on the sequestered estate of the debtor J sought payment from B for a sum transferred by B to J, which T claimed was challengeable under s34 as a gratuitous alienation - s34 is compatible with Strasbourg jurisprudence Mahmood's Trustee v Mahmood [2016] - Correct Answers: The disposition of an interest in commercial property granted by a debtor to his son amounted to a gratuitous alienation under the Insolvency Act 1986 s.242 where the debtor had failed to demonstrate that payments from his son had been connected to the transfer, and thus there had been no consideration. - The disposition was to be of 'love favour and affection' but the value of this was diminished b/c two dispositions were executed, and only one suggested absence of consideration * Grampian MacLennan's Distribution Services Ltd v Carnbroe Estates Ltd [2017] - Correct Answers: - In July 2014, just a few months before it went into liquidation, Grampian sold property to Carnbroe for £550,000. - The owners of Grampian and Carnbroe had a close relationship. On the date of settlement, Grampian did not receive any payment. - Instead, Carnbroe paid £473,604.88 to the bank in order to discharge its security. - That was the precise amount of the debt under the Grampian's loan facility with the bank. - The balance of the purchase price was not paid to Grampian until well after it had gone into liquidation and, from the manner in which it is described in the decision, it was only paid following legal advice to Carnbroe to the effect that they had to pay it in order to avoid the decision going against them. - On 12 September 2017 Grampian went into liquidation on the petition of HMRC which was owed unpaid taxes of £550,000, the precise amount of the purchase price agreed between Grampian and Carnbroe. - The liquidator sought to challenge the property sale as an alienation and the action was defended on the basis that adequate consideration had been paid for it. - Lord Woolman considered a number of existing authorities and said this about the test: "The test is an objective one. The defender need not establish that the consideration was the best that could have been obtained. It must, however, be not less than would reasonably be expected in the circumstances if the parties were acting in good faith and at arm's length. Put short, the court enquires whether the transaction was a commercial one. If the answer is yes, then the consideration is presume to be adequate". - Lord Woolman heard from two experienced surveyors who gave evidence to the effect that the subjects were valued at £820,000 and £740,000 respectively. - However, despite these valuations, the surveyors also gave evidence to the eff UNFAIR PREFERENCES - Correct Answers: Unfair preferences occur when an absolutely insolvent debtor pays a creditor in certain circumstances which give the creditor an unfair preference or advantage over other creditors. It also covers situations where an unfair security is granted to a creditor. A creditor or trustee seeking to challenge an alleged preference must do so officially and have the transaction reduced. Common law rules on unfair preference - Correct Answers: The general rule is that a debtor must - at the time of insolvency - treat all creditors equally and according to their rights as then established. No preference can be given to a creditor after insolvency if such did not exist prior to insolvency. The grounds that the challenger must prove at common law are given above in the general material on fraudulent transactions. Wylie, Stewart & Marshall v Jervis 1913 - Correct Answers: - The question in this case is whether an ex facie absolute disposition by which an insolvent debtor conveyed certain heritable subjects to his father constituted an illegal preference at common law, and is reducible at the instance of one of the general creditors - Pursuers (creditors) entitled to decree What governs unfair preferences? - Correct Answers: s36 of BAD 1985 Act and s243 Insolvency Act 1986 s36 — this provides that 6 months before the date of sequestration a transaction entered into can be struck down, but it has to be a transaction which is to the prejudice of the general body of creditors. The classic examples of this are paying off one rather than the other creditors or giving a security to one existing creditor which will protect their position and ignoring other creditors. Non-challengeable payments - Correct Answers: Some transactions can't be challenged in the 6 months period Payment in cash Transactions in the ordinary course of business New debts Payments in cash - Correct Answers: An insolvent who has in his hands funds sufficient to meet a debt which is immediately due is, if he pays the debt in cash, doing no more than he is bound to do. This is not considered to be a voluntary act, and it is therefore necessarily exempt from challenge. A cheque is regarded as payment in cash in this regard. Whatmough's Trustee v British Linen Bank 1934 - Correct Answers: Transactions in the ordinary course of business - Correct Answers: Even if an insolvent is conscious of his insolvency, he remains free at common law to continue in business and so transactions which are in the ordinary course of that business are protected from challenge. If, however, financial difficulties cause him to depart from the ordinary course of business, the transactions are reducible. New debts - Correct Answers: There is no prohibition to an insolvent contracting new debts even once insolvent. Furthermore, there is no prohibition on him giving such a new creditor a preference compared to old creditors. The law on unfair preferences concerns the unfair treatment of existing creditors not new creditors. where debtor and another party have reciprocal obligations - there is therefore no diminution in value of the debtor's estate. A security for a new debt is fine, not a security for an old debt. However, not if collusive. Nova debita e.g. - Correct Answers: e.g if A owes £100k to B, 100K to C, 100k to D, and 100k to E. A has £200k worth of assets which includes a house worth £100k. F comes along and says to A I will lend you £100k but I want a security first over the house (£100k). The net effect is that A's assets have increased by 100k (loan by F) but they have decreased by 100k in that there is now a security over the house. The net impact on the assets is neutral, it has no been to the prejudice of all the other creditors. The creditors still have the entitlement to the amount as before. This is an example of a reciprocal obligation (grant of security is in return for something). Statute on unfair preferences - Correct Answers: s 99 2016 Act, s 243 1986 Act Statutory ground of challenge - Correct Answers: A preference created in favour of a creditor made within 6 months of sequestration or the grant of a trust deed or the commencement of winding up or the commencement of administration can be struck down. What is a preference? - Correct Answers: Security for a debt. Assisting creditor to execute diligence. Arranging for another debtor to pay the creditor. Sham sales for existing debts (possession retained). An unfair preference is voidable at the instance of creditors, the trustee, or the liquidator or administrator Some transactions cannot be challenged: Actions to reduce certain floating charges - Correct Answers: S 245, 1986 Act Floating charges created within certain time periods will be voidable. If the charge is created in favour of a person connected with the company the time period is within 2 years of the commencement of winding up or administration ("connected with" means directors and others (associates): see ss 249 and 435 of the 1986 Act). Otherwise the time period is 12 months provided that the company was unable to pay its debts at the time the charge was created: see s 123, 1986 Act. However, not if the floating charge is for nova debita. SEQUESTRATION - Correct Answers: Sequestration is the term used to refer to the procedures available to apply to the courts to recover debts from an insolvent debtor. The procedures involve the court taking control of all of the property of the debtor (with a few exceptions) which is passed to a duly qualified and authorised third party for realisation and distribution to creditors according to clearly defined rules. The name of the third party is the trustee in sequestration. The estates of individuals, partnerships, unincorporated bodies/associations and trusts can all be sequestrated. The notable exception is registered companies. Sequestration Procedure: If the debtor intends to apply for sequestration - Correct Answers: A debtor can give notice to the Accountant in Bankruptcy of his intention to make a debtor application and on receipt of that notice the Accountant must enter the debtor's name in the Register of Insolvencies. This results in a moratorium on diligence which lasts for 6 weeks or when award of sequestration is registered (see below) - s 195 of the 2016 Act. How does one commence a sequestration and who can do so? - Correct Answers: (a) petition for sequestration (b) debtor application (a) Petitions for sequestration - Correct Answers: A sequestration can be commenced by a petition to the Sheriff Court. Such a petition can be presented by the following (see s 2(1)(b) 2016 Act): - a qualified creditor (a creditor owed not less than £3,000 - see s 7 of the 2016 Act) if the debtor is apparently insolvent; or - a trustee acting under a trust deed (complying with s 2(7) of the 2016 Act) Note in particular, the apparent insolvency for a creditor's petition must be within 4 months before the presentation of the petition; s 13(2) and the need for the creditor to serve the debtor with a debt information and advice package (s 3 of the 2016 Act). All petitions must be notified to the Accountant in Bankruptcy. (a) Debtor Application - Correct Answers: If the debtor seeks his own sequestration he must make a debtor's application to the Accountant in Bankruptcy (s 2(2) or (8) and s 8 of the 2016 Act). (i) Low income low asset debtors The debtor will only be able to seek his sequestration under s 2(2) if the debt is between £1,500 and £17,000, the debtor's assets are worth less than £2,000 and the debtor has a certificate of sequestration under s 9 (a certificate by a money adviser that the debtor is unable to pay debts), and the debtor has not been sequestrated in the preceding 5 years (or 10 years if the original application was under s 2(2)). (ii) Other debtor applications Under s 2(8) the application can proceed if the debtor owes at least £3,000 and has had money advice on the debtor's financial circumstances and the effect of sequestration (under s 4) and is apparently insolvent and has a certificate of sequestration under s 9. What happens after the petition fro the debtor's sequestration? - Correct Answers: Where the creditor or trustee petitions for the debtor's sequestration the debtor must be given the chance to defend. There is a warrant to cite the debtor. The date of this warrant is critical. It is the "date of sequestration" if sequestration is later awarded (s 22(7)(b)). On a debtor's application the Accountant in Bankruptcy must award sequestration forthwith if satisfied that the application has been made in accordance with the 2016 Act; that the conditions for making a debtor application are satisfied: see s 22 of the 2016 Act. See, also, s 26, 2016 Act, which is very important. The warrant to cite or the award of sequestration by the Accountant in Bankruptcy must be sent forthwith to the Register of Inhibitions. Why do you think registration of the court order or the Accountant in Bankruptcy's determination is important? Failure to register: Fortune's Trustee v Medwin 2016 - Correct Answers: Trustees? - Correct Answers: In limited cases the court will appoint an interim trustee (under s 54 where the debtor agrees the appointment in a creditor or trustee-initiated application or the creditor or trustee shows good grounds). Typically, however, a trustee in sequestration will be appointed. The trustee is to be given a statement of assets and liabilities (s 41). If there is an interim trustee s/he has duties to preserve the estate under s 39 and s 53. A trustee may or may not choose to call a statutory meeting of creditors under s 44 of the 2016 Act, with notice given to creditors within 60 days of the decision whether or not to call the meeting. A creditor may within 7 days of notice choose to call a meeting. Statutory meetings - Correct Answers: If there is no statutory meeting s 45 applies and a report must be made to the Accountant in Bankruptcy. If there is a statutory meeting then s 48 applies and creditors can vote whether to keep the trustee. Section 49 governs voting and s 60 governs the appointment of the replacement trustee. The sheriff is to approve the appointment. Decree of appointment - Correct Answers: Where the trustee is appointed there is a decree of appointment which has effect in accordance with ss 78, 79, 85 - 88, 90 - 97, 112 and 113 of the 2016 Act. They tell us what assets can be dealt with by the trustee. What property can the trustee's appointment effect? - Correct Answers: 1. Heritable property: see Burnett's Trustee v Grainger 2004 SLT 591 (but note the trustee is not be able to register title for 28 days beginning with the date of registration of the s 26 notice - s 78(3) and (4)). Additionally, s 87 gives some protection to a purchaser who acquired from a party that was already bankrupt and consequently unable to deal with the property. 2. Corporeal moveables - s 78(8); 3. Incorporeal moveables (those which require registration and those which do not) - s 78(8); 4. Pensions; 5. Acquirenda i.e. estate acquired by the debtor after the date of sequestration and within 4 years following the date of sequestration - see s 86(4), (5) and 79(5); 6. Assets outside Scotland; 7. Property exempt from diligence (in accordance with Debt Arrangement and Attachment (Scotland) Act 2002, s 11 and Part 3) - s 88; 8. Income of the debtor s 85 but note that Debtor Contribution Orders must be made in respect of a debtor - ss 90 - 97; 9. Property held in trust - s 88(1)(c); 10. Family home (s 113). What are the duties of the Trustee? - Correct Answers: These are essentially two-fold: To recover, manage and realise the debtor's estate. To distribute the estate among the debtor's creditors according to their respective entitlements. The duties of the trustee are set out throughout the 2016 Act (see especially s 50 (on functions), 109 (on management and realisation of assets) and 126-7 (on adjudication of claims). What are the 'respective entitlements' of creditors? - Correct Answers: • Secured creditors - effective in sequestration to recoup debt. Preference over all other creditors (including expenses of the trustee). What happens if the security is not enough to satisfy the debt? • Diligence - see s 24 of the 2016 Act. Note: the striking down rules, and the rule in Stewart v Jarvie 1938 SC 309 • Other creditors - s 129 of the 1985 Act o Outlays and remuneration for interim trustee o Outlays and remuneration for trustee o Expenses of creditor who petitioned for sequestration o "Preferred" debts o "Ordinary unsecured debts" o Interest on debts between sequestration date and payment date o "Postponed" debts If inadequate, note pari passu ranking for certain groups of creditors - all rank equally. What happens if an attachment or arrestment has been carried out but not completed before sequestration? - Correct Answers: s 24(6). Stewart v Jarvie 1938 - Correct Answers: [arrestment shortly before bankruptcy and sequestration]. - - 16/10/1936 = arrestment - 27/11/1936 = apparent insolvency - 4.1.1937 = sequestration - sequestration is a deemed arrestment; it is a deemed arrestment over every piece of incorporeal moveable property; sequestration is also a deemed attachment of corporeal moveables; adjudication over land - go back 60 days from 1 Jan: looks like arrestment is safe b/c more than 60 days in advance - BUT: b/c sequestration is a deemed arrestment, from the 27th Nov you go back 60 days, and then 4 months forward; what you have, is the Oct. arrestment equalised with the sequestration in January - S24: if in 60 days before, it's struck down: not SO: Sch. 7 creates a mechanical set of rules when you have 2 or more diligences over the same assets; s24 provides that sequestration (s185, 1986 act), are diligences over entire asset base of the debtor individual; this means that because sequestration is an arrestment, attachment, and adjudication, it plugs into the equalisation rule s24 2016 act (very important) - Correct Answers: a sequestration is (has the effect of) an attachment of corporeal moveables; arrestment of incorporeal property; and adjudication of land equalisation rules thus apply to sequestrations and liquidation, based on the Stewart v Jarvie case 60 day rule - Correct Answers: - arrestments and attachments within 60 days of sequestration struck down - not effectual diligence if struck down by s24, so FC takes priority over that creditor - if not struck down, the diligence prevails over the FC Inhibitions - Correct Answers: s 24(3). An inhibition against a debtor does not affect the trustee's right over the property for sequestration purposes, unless obtained 60 days prior to sequestration. Bankruptcy and Diligence etc (Scotland) Act 2007, s 154, regarding inhibition not conferring a preference in ranking processes. Bankruptcy and Diligence etc (Scotland) Act 2007, s 154 implications - Correct Answers: Baird & Brown v Stirrat's Trustee (1872) - Correct Answers: Debtor Discharged - Correct Answers: At end of procedures, the debtor is 'discharged' - i.e. deemed to be free from continuing liability. This can be so even if creditors have not received 100% of their debt or the sequestration continues and the permanent trustee has not been discharged. The debtor may be discharged one year after date of sequestration. Where the Accountant in Bankruptcy is not the trustee in sequestration discharge can only be made on application to the Accountant in Bankruptcy - s 137. Such application can only take place 12 months after sequestration. The debtor can request an application. Applications have to be accompanied by statements as to the debtor's affairs and conduct. The trustee is to provide a report to the AiB. The AiB makes the decision taking into account the trustee's report and any representations made by the debtor and any creditor. Where the trustee is the Accountant in Bankruptcy the AiB has to decide whether to apply for discharge - s 138. Where there is a decision to refuse discharge notification has to be given to those interested with reasons why. The decision can be reviewed by application. if the debtor cannot be traced discharge will be deferred. What if the debtor has minimal assets? - Correct Answers: Where the debtor has minimal assets (and makes a low income low asset application under s 2(2) of the 2016 Act) the discharge period may be reduced to 6 months, but there is a 12 month restriction order that will apply, which limits the obtaining of credit. Does discharge of the debtor reinvest the debtor in property vested in the permanent trustee? - Correct Answers: Discharge of the debtor does not reinvest the debtor in property vested in the permanent trustee Section 145(7) - Correct Answers: makes clear that student loans are not discharged on bankruptcy. Section 145 also provides that debts secured by a right in security are not discharged. Is the debtor then free from liability once discharged? - Correct Answers: Once 'discharged' the debtor is deemed to be free from continuing liability for debts due at the time he was sequestrated. But it is possible that the debtor will have to make a regular Debtor Contribution Order which can last for 48 months from the first date of payment - see ss 90 - 97) and vesting of assets in the trustee for 4 years from the date of sequestration - s 86(4) and (5). Bankruptcy restriction orders - ss 155 - 161. - Correct Answers: These impose a regime to punish certain bankrupts. The regime is for bankruptcy restriction orders and undertakings which can last to a maximum of 15 years and will impose restrictions on credit facilities and certain offices that may be held. The legislation is reticent as to how they could be used (a general discretion is given to the court to grant a BRO and various types of conduct are then listed - see s 56B(2)). No guidance is given as to how the duration of the BRO is to be fixed. Being subject to a BRO can affect ability to hold various elected offices, to become a receiver, and the accessibility of credit. The BRO legislation is largely lifted from equivalent provisions in England in the Enterprise Act 2002 applicable to English bankruptcies. INSOLVENCY ACT 1986 - Correct Answers: Companies can be apparently insolvent. If the company is an unregistered body, it can be sequestrated. If it is registered and becomes insolvent, it may be liquidated. Liquidation (also called winding up) is a very similar process to sequestration. Note, however, two important differences: Liquidation culminates in the extinction of the insolvent (cf - sequestration) Sequestration implies insolvency. Liquidation does not. A solvent company can be 'wound up' by members seeking voluntary liquidation. There can be winding up on "just and equitable" grounds and some other grounds (see below). What are the 3 kinds of liquidation? - Correct Answers: a. The company may be solvent or insolvent. b. The company is solvent. c. The company is or may be insolvent. Voluntary and compulsory liquidation - Correct Answers: Liquidation - Correct Answers: Liquidation has, in itself, no property consequences. The liquidator replaces the board of directors, and can thus do juridical acts in the name of the company. The company continues to exist as a juristic person, until the end of the liquidation. Normally no vesting in liquidator (but note s 25, Titles to Land Consolidation (Scotland) Act 1868 (as amended by the Abolition of Feudal Tenure etc (Scotland) Act 2000)). By contrast, in a sequestration ownership of the assets of the debtor is conveyed, by the order of the court, to the trustee in sequestration. Winding up is carried out by the Liquidator. S/he replaces the company directors. If company chooses to wind itself up the liquidator is appointed by company - no need for court intervention. If, however, creditors of the company wish to have it wound up they must apply to court for Compulsory Liquidation. Grounds for petition (some examples from s 122 of the 1986 Act): - Correct Answers: • Company unable to pay its debts. • Company has by special resolution resolved that company be wound up by court. • Company does not commence business within one year of incorporation or suspends business for a whole year. • Court is of the opinion that it is just and equitable to wind up the company - minority shareholder protection. • In Scotland, a company over which the Court of Session has jurisdiction, can be wound up by the Court if there is subsisting a floating charge over property comprised in the company's property and undertakings and the court is satisfied that the security of the creditor entitled to the benefit is in jeopardy. Provisional liquidator - Correct Answers: A provisional liquidator may be appointed initially by the court to be replaced later by an interim liquidator and then a liquidator proper. Commencement of winding up - Correct Answers: When winding up commences the company must cease trading unless trading is required for the purposes of the winding up itself. Contracts entered into by the company are not terminated by liquidation. Liquidator can either adopt the contract or terminate it and allow the other party to rank for damages. Winding up is a sign to employees that they are constructively dismissed and they can walk away from their employment and sue for damages. If they do not do so, the liquidator will take either the step of adopting their contract or giving them actual notice of dismissal. Functions of the Liquidator - Correct Answers: Administer the assets of the company and manage matters during winding up distribute assets to creditors according to their rights as creditors. The Liquidation Committee supervises the liquidator (equivalent of commissioners in bankruptcy). How does the liquidator distribute assets? - Correct Answers: Insolvency (Scotland) Rules 1986/1915 r 4.66 Secured creditors (including those doing diligence) (for special ranking rules for floating charges, see below) Expenses of liquidator Preferred creditors Unsecured creditors Postponed creditors Shareholders - only receive payment when the creditors have been paid in full Pari passu ranking. What about unfair preferences and gratuitous alienations? - Correct Answers: Both unfair preferences and gratuitous alienations can be challenged on the same basis as for sequestration. As discussed previously. What happens if diligences have been done on company property prior to liquidation? - Correct Answers: This is governed by s 185 of the 1986 Act. The rules which are there laid down follow those for sequestration under s 24 of the Bankruptcy (Scotland) Act 2016. As discussed previously. ADMINISTRATION PROCEDURE - Correct Answers: Liquidation deals with winding up, i.e. the company, its trade, its jobs, disappear. An alternative approach to insolvency is to try to "rescue" the company, or part of it. Governed by ss 8 to 27 of the Insolvency Act 1986 and especially by Sch B1 of the same Act. The 2002 Act introduced out of court administration. So we can have court administration as well as out of court administration. An administrator appointed by a floating charge creditor must administer in the interests of the creditors as a whole and try to "rescue" the company. Administration is a mode of company rescue involving a moratorium procedure. Appointment by Court? - Correct Answers: Sch B1, paras 10 - 13 When? • Unable to pay its debts (defined s 123 IA) - but see para 35 if application by FC holder • Order will achieve purpose of administration (for purpose see para 3) What is the "purpose of administration"? - Correct Answers: Para 111 refers to para 3 objectives (a) Rescue company as going concern or (b) Achieve better result for company creditors than likely if wound up immediately or (c) Realise property for secured/preferential creditors Para 3(3) and (4) suggest (a) takes priority, then (b), then (c). Who can petition the court? - Correct Answers: Company Directors (not individual director) Creditor(s) Court has discretion Out of court procedures - Correct Answers: Much more common Appointment by the holder of a floating charge (para 14) after giving notice to any prior FC holder (or obtaining their consent to application) - grounds to appoint: Or appointment by company or directors (para 22) -Grounds are unclear - para 27 which identifies requirements of notice of intention to appoint including: unable to pay debts; not in liquidation; and not in CVA. Effect of administration - Correct Answers: Applicable either if appointed by court or informally (paras 42 and 43) No liquidation No enforcement of security or other debts No irritancy (in lease) Powers of administrator - Correct Answers: See paras 59 and 60 and Sch 1 (which you must read) Manage company affairs Duties Custody of property Notify appointment Can dispose of property where security over it To set out (para 48) objectives to meet purpose of administration End of administration - Correct Answers: 1 year (para 76) (can be extended by application of the administrator/creditor to court) or Winding up RECEIVERSHIP - Correct Answers: A company can go 'into receivership' as well as 'into liquidation'. Indeed, a company can be in both states at the same time. Receivership is concerned with the use of floating charges. As the name suggests, a floating charge 'floats' over the general property of a company and when there is default on the debt it 'attaches' to the property, freezing the latter and ensuring that the creditor gets paid. Since the relevant parts of the Enterprise Act 2002 came into force from 15th September 2003, a receiver may only be appointed in respect of a floating charge granted prior to the relevant date (although there are many exceptions where receivers are permitted). For "new" floating charges there may be an administrator. Receivership is a curious institution in that it is a hybrid between: (a) an insolvency process, and (b) the enforcement by a single creditor of his security. Receivership represents the enforcement of a "floating charge". Receiver has power to sell - but is not secured creditor. Chargeholder is secured creditor but cannot sell. floating charge - Correct Answers: A floating charge, which is available only if the debtor is a company (or certain other type of corporate entity), affects the debtor's entire patrimony, movable and immoveable, corporeal and incorporeal, real and personal, present and future. It must be publicly registered (see earlier handout on rights in security). So long as the company is solvent, the effect of the charge is suspended. At this stage, the charge is not a real right. That does not arise until attachment. What happens on attachment by receivership? - Correct Answers: S 53(7) attaches "as if" a fixed security S 57 - receivers are deemed agents of the company National Commercial Bank v Telford Grier 1969 - Correct Answers: Procedure of recievership - Correct Answers: "Receivership" is thus a method of enforcing a floating charge. Receivership may be judicial or extra-judicial: in practice it is usually the latter. The receiver takes control of the company's assets, and has power to do juridical acts for the company. He or she can thus sell individual assets or - and this is common - the whole active side of the patrimony. In other words, the receiver can sell the business as a going concern. The receiver must pay creditors who have priority over the chargeholder, but has no duty to pay other creditors. A receiver is appointed to enforce the floating charge. Unlike a liquidator, the receiver acts in the interest of the holder of the floating charge and only has very general duties to the company. However, the receiver is an agent of the company. The primary duty of the receiver is to realise the frozen assets to pay the debts secured by the floating charge. The receiver is empowered to act in accordance with the powers found in 1986 Act, Sch 2 and the powers include that to sell the business. The timing of receivership - Correct Answers: The holder of a floating charge can appoint a receiver at any time after default on a debt. The appointment of a receiver means that the company is 'in receivership', but this does not prevent the company trading nor does it mean that the directors are removed from their office. The extent of their remaining powers depends on the scope of the floating charge. Contracts of the company are not affected. A floating charge will attach immediately if the company goes into liquidation (s 463, Companies Act 1985). A receiver can be appointed even after the company has gone into liquidation, and a company can go into liquidation even after it has gone into receivership. See Manley Petitioner 1985 SLT 42. Distribution of moneys - Correct Answers: The order of priority of distribution of moneys by the receiver is in IA 1986 s 60. It is: 1. Fixed securities ranking prior to or equally with the floating charge (see below); 2. those who have "effectually executed diligence" on property subject to the charge; see MacMillan v T Leith Developments Ltd [2017] CSIH 17; 2017 SC 642 (a five judge decision); 3. debts incurred by the receiver; 4. the receiver's outlays and fees; 5. preferential creditors; 6. the floating charge holder; 7. another receiver or holder of fixed security or a liquidator or the company. Ranking - Correct Answers: Floating charge on attachment ranks above other claims including (a) ordinary unsecured creditors (except the "prescribed part" - as introduced by Enterprise Act 2002, see s 176A of the Insolvency Act 1986) (b) later floating charges: s 464(4) (c) later rights in security that are made real rights after the creation of the floating charge (if there is a negative pledge clause: s 464(1) and (1A) of the Companies Act 1985: AIB Finance Ltd v Bank of Scotland 1995 SLT 2) The floating charge ranks after: Prior floating charge; Prior real security (and a later real security which is made a real right prior to the floating charge's attachment, if the floating charge has no negative pledge); Prior and posterior tacit security (cf Cumbernauld Development Corporation v Mustone 1983 SLT (Sh Ct) 55 with Grampian Regional Council v Drill Stem 1994 SCLR 36); Preferential creditors (a curious regime - amended substantially by Enterprise Act 2002); (e) "Effectually executed diligence" (see MacMillan v T Leith Developments Ltd [2017] CSIH 17; 2017 SC 642 (a five judge decision)); (f) The prescribed part; (g) Quasi-securities, eg trusts Circles of priority: eg the preferential creditors circle. COMPANY VOLUNTARY ARRANGEMENTS - Correct Answers: Under Insolvency Act 1986 ss 1 to 7, directors of company may make a proposal to creditors for a composition of debts. Insolvency practitioner nominated as trustee to administer scheme. Meetings of company and creditors consider proposals. (There can also be Schemes of Arrangement under Part 26 of the Companies Act 2006). Although statistics are not available, CVAs and Schemes of Arrangement are not very common in Scotland.