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You are here: BAILII >> Databases >> The Law Commission >> Third Parties –Rights Against Insurers [2001] EWLC 272(6) (July 2001) URL: http://www.bailii.org/ew/other/EWLC/2001/272(6).html Cite as: [2001] EWLC 272(6)

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PART 6

VOLUNTARY PROCEDURES

1 Introduction

6.1      An insolvent person (or company) may avoid or postpone a formal bankruptcy (or winding-up) by reaching an agreement with creditors. For example, a company may enter into a Company Voluntary Arrangement ("CVA") governed by Part I of IA 1986.^[1] There are a number of forms which such agreements may take, and they are governed by a number of different statutory regimes. We refer collectively to all of these different regimes as "voluntary procedures".

6.2      In this Part, we explain the implications for a third party under the 1930 Act if the insured enters into a voluntary procedure and identify problems with the existing regime. We then explain the way in which these deficiencies are overcome in the draft Bill. As the voluntary procedures available to individuals in England and Wales are not the same as those available in Scotland we deal first with the law in England and Wales, and conclude with an explanation of the way in which the position differs in Scotland.

6.3      We did not consult on these issues in the consultation paper, nor were they raised independently by any of our consultees. The need for reform was highlighted by case law reported since the publication of the consultation paper^[2] and we have consulted informally on our recommendations.

2 Types of voluntary procedure in England and Wales

3 Voluntary arrangements

6.4      Voluntary arrangements were introduced by IA 1986. They are procedures by which an insolvent person (the "debtor") can deal with his difficulties whilst avoiding a formal bankruptcy or winding-up by coming to a binding agreement with creditors. If the debtor is an individual this will be an Individual Voluntary Arrangement ("IVA") governed by Part VIII of IA 1986; if a company it will be a CVA governed by Part I.^[3]

6.5      Provided he abides by the terms of the agreement, a debtor who has entered into a voluntary arrangement is not required to pay his debts in full. Instead, he is only obliged to pay a proportion of them, often in instalments. A creditor bound by a voluntary arrangement is not entitled to enforce his original debt against the debtor (this will be a term, express or implied, of the voluntary arrangement).^[4]

6.6      Under IA 1986, a creditor will be bound by a voluntary arrangement as if he were a party to it, provided he was entitled to vote on it at the creditors' meeting and had actual notice of that meeting.^[5] Under the Insolvency Act 2000, a creditor will be bound by a voluntary arrangement as if he were a party to it, provided he was entitled to vote at the meeting, whether or not he had notice of the meeting.^[6]

4 Compromise or arrangement under section 425 of CA 1985

6.7      Section 425 of CA 1985 sets out a procedure whereby a company can compromise its obligations to creditors.^[7] This is similar in many ways to a voluntary arrangement under IA 1986. In particular, a creditor may be prevented by such an arrangement from receiving the full amount of his debt.

6.8      There are a number of differences between arrangements under section 425 and the IA 1986 procedures: there is no moratorium during the process leading up to the scheme or arrangement under section 425; the court is more actively involved in approving such arrangements; and the procedure for voting is determined by the court rather than set out in Rules. One advantage a section 425 arrangement possesses over a voluntary arrangement from the point of view of the debtor is that, once the agreement of three quarters of the creditors of a particular class has been obtained, the arrangement binds all members of that class, even if the debt arises after the arrangement has become binding.

5 Deeds of Arrangement Act 1914

6.9      An individual may also compromise his debts using the procedure in the Deeds of Arrangement Act 1914. The 1914 Act does not impose a moratorium on actions by debtors, and we understand that the procedure is little used today.^[8]

6 Treatment under the 1930 Act

7 Voluntary arrangements

6.10      If the third party has established the insured's liability, the 1930 Act effects a statutory transfer when the insured enters into a voluntary arrangement.^[9] It seems that the transfer occurs when the voluntary arrangement is approved by a creditors' meeting.^[10]

6.11      In Sea Voyager v Bielecki^[11] the court held that, if bound by an IVA, a third party who has not established liability against the insured may succeed on an application to court to have the IVA revoked or revised.^[12] The court found that the fact that the third party was prevented by the IVA from obtaining judgment against the insured for the full amount of his loss amounted to unfair prejudice, as, without such judgment, the third party was unable to proceed against the insurer under the 1930 Act for the full amount of his loss.^[13]

6.12      A third party who has already established liability against the insured might find his claim against the insurer reduced by the IVA. This would depend on the wording of the IVA and the insurance contract.^[14] If, on the facts of a particular case, an insurer would only be liable for the reduced amount, this might well be an additional ground on which the third party could succeed on an application to revoke the IVA / CVA.^[15]

6.13      It is in the interests of both the third party and other creditors that third parties should be able to proceed against the insurer without the need to challenge voluntary arrangements. It may therefore be that under an unamended 1930 Act, IVAs / CVAs will come to be drafted so that the rights of a third party to proceed under the 1930 Act against the insurer for the full amount of the claim will be expressly preserved.^[16]

8 Compromise or arrangement under section 425 of CA 1985

6.14      We have not found any reported authority under the 1930 Act in which a third party was faced with an insured which had entered into an arrangement with its creditors under section 425 of CA 1985. It is not entirely clear whether this would trigger a statutory transfer under section 1 of the 1930 Act.^[17] If it does, however, the third party will face similar difficulties to those of third parties involved in a voluntary arrangement.

6.15      Although there is no express statutory basis of unfair prejudice for challenging a scheme or arrangement, as there is in the case of voluntary arrangements, the courts can reject (and have rejected) applications for the confirmation of a scheme or arrangement under section 425.^[18]

9 Deeds of Arrangement Act 1914

6.16      We have not found any reported cases in which the 1930 Act effected a statutory transfer as a result of the insured entering into a deed of arrangement under the 1914 Act.^[19] Were such a transfer to occur, however, the third party would face similar difficulties to those of third parties involved in a voluntary arrangement.

10 The rationale for reform

6.17      It seems to us to be anomalous that third parties may receive a statutory transfer when the insured enters into some voluntary procedures but not others. In addition, in cases in which the 1930 Act does effect a statutory transfer, the case law discussed above indicates that this may cause significant problems to the third party. Whilst it is possible that voluntary procedures may in future be drafted so as not to bind a third party (see paragraph 6.13 above), there is no guarantee that this will be the case. In our view it is likely that at least some will not do so. In such cases a third party may be bound.^[20]

6.18      Were the draft Bill to remain silent on this issue then a third party would face similar difficulties to those he faces under the 1930 Act. In particular, the third party might^[21] only be able to recover from the insurer the lower amount as determined by the voluntary procedure.

6.19      A third party bound by a voluntary arrangement might apply to court to have it revoked.^[22] In our view it would not be satisfactory to require the third party to do so for the following reasons:-

(1) A third party may not be aware that he has a claim against the insurer under transferred rights until it is too late to challenge the arrangement.^[23] This may occur, for example, in a long tail personal injury claim in which the facts giving rise to the debt occur long before the manifestation of the disease. In such a case, a third party might find that he was only able to recover from the insurer the debt as reduced by the arrangement.

(2) The procedure may involve the insured and the insured's other creditors in additional work, expense and delay as they renegotiate the reopened voluntary arrangement.^[24]

(3) The requirement that the third party apply to court in order to pursue his claim against the insurer seems to us to serve no useful function.

11 Reform recommendations for England and Wales

12 Statutory transfer if the insured enters into a voluntary procedure

6.20      Under the draft Bill, a third party may receive a statutory transfer as a result of the insured's voluntary arrangement,^[25] or arrangement under CA 1985, section 425,^[26] or deed of arrangement under the Deeds of Arrangement Act 1914.^[27] The draft Bill also provides that, if a transfer does take place for one of these reasons, the third party will not be bound by the procedure to the extent that he is able to recover from the insurer.^[28] The effect is that the third party's claim against the insurer will be the same as if the procedure had not been initiated. The third party will be entitled to claim from the insurer the full amount of his insured debt.

6.21      Although the third party will not be bound by any moratorium imposed by the voluntary procedure to the extent of his (recoverable) insured debt, it is important to note that he will not, as a result, be in a position to bring down the voluntary agreement, for example, by bringing a bankruptcy / winding-up petition against the insured.^[29]

6.22      It is also important to note that the draft Bill does not prevent the third party from being bound by the agreement to the extent that his debt is uninsured (for example, if there is an excess in the policy) or is not recoverable from the insurer (for example, because the insurer is insolvent).^[30]

13 Third party's right to vote on a voluntary arrangement

6.23      One consequence of this reform will be that the third party will be entitled to vote on an IVA / CVA proposal which he knows (or strongly suspects) will not bind him to the extent of his insured debt. Prima facie this appears objectionable. We have, therefore, considered recommending that the third party should be prevented from voting on the proposal for a voluntary arrangement.

6.24      We concluded that this was not the correct approach. A third party is likely to be bound by the proposed arrangement to the extent of his uninsured debt, and it is right that he should retain the right to vote on it at least to this extent. Nor did it seem to us to be satisfactory to limit the weight attached to the third party's vote to the value of the uninsured portion of the debt. The chairman of the creditors' meeting,^[31] at which the proposal for the voluntary arrangement is considered, is already obliged to put a value on the third party's unliquidated debt for voting purposes.^[32] At the time of the creditors' meeting the insurance position may also not be clear. Had we recommended that the third party be entitled to vote at the meeting only to the extent of his uninsured debt, we would also have had to impose on the chairman the additional, possibly onerous, duty of putting a value on the insurance cover (over both liquidated and unliquidated debts) for voting purposes.

14 Insurer with a right of recourse - effect on voluntary arrangement

6.25      An insurer may be entitled to recover from the insured some of the money it has paid out to a third party claiming under transferred rights.^[33] If the statutory transfer (either under the 1930 Act or under the draft Bill) comes about as a result of a voluntary arrangement, the voluntary arrangement will not bind an insurer who has such a right of recourse.^[34] As a result, the insurer would be in a position to disturb the voluntary arrangement, for example, by issuing a bankruptcy petition at a later date.

6.26      One consultee identified this as a problem and suggested that the draft Bill should provide that, in the above circumstances, the insurer is bound by the voluntary arrangement. On reflection, we did not agree. A similar issue will arise whenever the insured becomes subject to a debt after a voluntary arrangement is approved. In other words, it is an issue relating to voluntary arrangements generally and is, accordingly, not something it would be appropriate to alter in the context of this project.

15 Voluntary procedures in Scotland

6.27      Individual Voluntary Arrangements governed by Part VIII of IA 1986 and deeds of arrangement under the Deeds of Arrangement Act 1914 do not apply to Scotland. On the other hand, CVAs governed by Part I of IA 1986 and compromises or arrangements under section 425 of CA 1985 do apply to Scotland and, under the proposed new Act, will be treated in the same way in Scotland as they are in England and Wales.

6.28      In addition, voluntary procedures in Scotland may be regulated by way of a trust deed or composition contract. In the case of a trust deed, the debtor executes a unilateral deed containing a conveyance of the whole of his property to a trustee for the benefit of his creditors in general. A major failing of the trust deed was that a non-acceding creditor could still supersede the arrangement by simply sequestrating the debtor. To avoid such a situation, the trust deed was given statutory protection and the debtor now has an option to create a protected trust deed as described in Schedule 5 to the Bankruptcy (Scotland) Act 1985.

6.29      A composition contract can take the form of an extra-judicial or judicial composition contract. The terms of an extra-judicial composition contract are a matter for the debtor and creditor so that each agreement will differ. In contrast to the trust deed, under the composition contract the debtor is not divested of his entire estate. For the debtor, this is seen as the main advantage of entering into such an arrangement. The extra-judicial composition contract is to be distinguished from the judicial composition contract, or discharge on composition, which was introduced by the Bankruptcy (Scotland) Act 1985. Unlike an extra-judicial composition, the judicial composition is a means of discharge from a sequestration^[35] and the procedure to be followed is set out in Schedule 4 to the 1985 Act.

6.30      Should the voluntary procedures fail or be unsuitable, the appropriate procedure would be to petition for sequestration.^[36] In the case of a judicial composition contract, in certain circumstances, the order approving the composition may be recalled or the order discharging the debtor may be reduced.^[37] In such instances, the sequestration will revive.

6.31      Under the proposed new Act, a transfer will take place only in the case of a protected trust deed or judicial composition contract for the reasons set out in paragraphs 2.47 to 2.49 above.

16 Reform recommendations in Scotland

6.32      In line with the recommendations for England and Wales,^[38] in Scotland, we recommend that a third party who receives a statutory transfer of rights as a consequence of the insured's protected trust deed will not be bound by the arrangement to the extent that he is able to recover from the insurer.^[39] Similarly, a third party who receives a transfer by virtue of the insured's sequestration will not be bound by any subsequent judicial composition contract to the extent that he is able to recover from the insurer.^[40]

Note 1    See para 6.4 below.    [Back]

Note 2    In particular Jackson v Greenfield [1998] BPIR 699 and Sea Voyager v Bielecki [1999] 1 All ER 628.    [Back]

Note 3    These statutory provisions have been amended by the Insolvency Act 2000.    [Back]

Note 4    The cross-heading to IA 1986, Part VIII (on IVAs) is “moratorium for insolvent debtor”. Whether the moratorium prevents a creditor from issuing or pursuing proceedings against the debtor or simply prevents him from enforcing a judgment appears to depend on the true construction of the IVA (Sea Voyager v Bielecki [1999] 1 All ER 628 at p 644). In the case of an IVA, a creditor may be prevented from enforcing his debt against the debtor even before he becomes bound by the voluntary arrangement, if the debtor obtains an “interim order” under IA 1986, s 252. In the case of a CVA, no such moratorium was included in the original scheme, so that directors of a company in difficulties who initiated the CVA procedure often found themselves facing a winding-up petition before the CVA was in place. This drawback of the CVA system is rectified by the Insolvency Act 2000 under which the directors of a company may obtain a moratorium, a reform which is likely to increase the use of CVAs.    [Back]

Note 5    IA 1986, s 5(2)(b) (CVA) and IA 1986, s 260(2)(b) (IVA). For authority that constructive notice is not sufficient see Re A Debtor (64 of 1992) [1994] 1 WLR 264 and Beverley Group plc v McLue [1995] 2 BCLC 407.    [Back]

Note 6    Insolvency Act 2000, para 6, Sched 2 and para 9, Sched 3.    [Back]

Note 7    Agreements under s 425 of CA 1985 may also be made with members. These are used to reorganise the share capital of a company. Such a reorganisation may take place in the context of a take-over, or may be undertaken within a group for financial, particularly tax, reasons. Such arrangements are not relevant to the third party and do not trigger a transfer under the draft Bill.    [Back]

Note 8    See I F Fletcher, The Law of Insolvency (2nd ed 1996) p 59. TheCork Report , which recommended the voluntary arrangement procedure, suggested that the consequential repeal of the old procedure in the 1914 Act (paras 363-399). This recommendation has not been acted upon, and the 1914 Act remains on the statute book.    [Back]

Note 9    Section 1(1)(a) (IVAs) and s1(1)(b) (CVAs)    [Back]

Note 10    IA 1986, s 5(2)(a) (CVA) and IA 1986, s 260(2)(a) (IVA).    [Back]

Note 11    [1999] 1 All ER 628.    [Back]

Note 12    The application was under IA 1986, s 262(1)(a) (the equivalent application in the case of a CVA is under IA 1986, s 6) under which the applicant is required to show that the IVA unfairly prejudices his interests as a creditor. A similar application will be possible under the amendments proposed by the Insolvency Act 2000. It was pointed out by Lord McIntosh of Haringey at the Committee stage of the Insolvency Bill 2000 (Hansard (HL) 15 June 2000 CWH 43) that such an application would be available to a third party. Lord Sharman in response withdrew his proposed amendment to the Insolvency Bill 2000, which would have excluded from the proposed CVA moratorium third parties who wished to obtain judgment against the insured only in order to obtain a transfer of rights under the 1930 Act. In our view, however, for the reasons which follow in the text, legislative reform is necessary.    [Back]

Note 13    [1999]1 All ER 628 at p 647.    [Back]

Note 14    In Johnson v Davies [1999] Ch 117 the Court of Appeal confirmed that someone liable for the insolvent’s debts may obtain the benefit of the IVA if, on its true construction, the IVA had that effect. The insurer’s liability would also depend on the wording of the insurance contract in question and, in particular, how it defined the insured loss.    [Back]

Note 15    The judge in Sea Voyager rejected (at p 645) an argument on the facts of that case that the insurer would only be liable to indemnify the third party in the IVA amount, though the reasoning, based on s 1(4) of the 1930 Act, is not entirely clear. For an example of a case in which a third party was arguably bound by a voluntary arrangement, see Jackson v Greenfield [1998] BPIR 699.    [Back]

Note 16    The judge in Sea Voyager clearly envisaged that this should normally be the case. He observed at p 637: “The strange position, therefore, is that neither party wished to prevent SVM having whatever rights it may have under the 1930 Act, and neither side has any desire to see Mr Bielecki go into bankruptcy. One’s first reaction, therefore, is that the common intention in this regard ought to be capable of resolution by suitable drafting of the arrangement, or modifications thereto to make the position entirely clear.” However, the point is a marginal one which may escape the attention of the person drafting the voluntary arrangement . We understand that the Association of Business Recovery Professionals (formerly the Society of Practitioners of Insolvency) is currently working on standard terms for IVAs (though not CVAs) which preserve a third party’s right to proceed against an insured, and obtain a money judgment against him, in order to use direct rights against the insurer under the 1930 Act.    [Back]

Note 17    On the one hand it might be said that such an arrangement amounted to “the insured ... making a composition or arrangement with ... creditors” under s 1(1)(a). On the other hand, it could be argued that s 1(1)(b), which does not mention CA 1985, s 425, exhaustively sets out the circumstances in which a company will be subject to a statutory transfer. This is supported by the observation that, when voluntary arrangements were added to the circumstances in which a statutory transfer is effected (by IA 1986), Company Voluntary Arrangements were added to the list in s 1(1)(b), whereas no amendment was felt to be necessary in order to bring in Individual Voluntary Arrangements within the terms of s 1(1)(a). We prefer the latter view.    [Back]

Note 18    For example, Re Hellenic & General Trust Ltd [1976] 1 WLR 123.    [Back]

Note 19    The transfer would be effected under s 1(1)(a).    [Back]

Note 20    Indeed, under the Insolvency Act 2000, third parties may become bound by voluntary arrangements more often than under the current law, as they will not need to have had notice of the creditor’s meeting at which the voluntary arrangement was approved before they are bound (see para 6.6 above).    [Back]

Note 21    This would depend on the wording of the IVA / CVA, and on the wording of the insurance policy. See para 6.12 above.    [Back]

Note 22    As he currently must under the 1930 Act and as was done in Sea Voyager. See Para 6.11 above. If the court has already sanctioned an arrangement under CA 1985, s 425, the third party would appear to have no recourse.    [Back]

Note 23    Under IA 1986, s 262 the third party must apply within 28 days of the creditors’ meeting. Under the Insolvency Act 2000 the third party has 28 days from becoming aware that a meeting has taken place.    [Back]

Note 24    The orders available to the court on a successful application in the case of an IVA are to: “(a) revoke or suspend any approval given by the meeting; (b) give a direction to any person for the summoning of a further meeting of the debtors’ creditors ...” (IA 1986, s 262(4)). The equivalent section for CVAs is s 6. Paragraph 36 of Sched A1 of IA 1986, to be inserted by the Insolvency Act 2000, is in similar terms.    [Back]

Note 25    Clause 1(2)(b) (IVAs); clause 1(3)(a) (CVAs).    [Back]

Note 26    Clause 1(3)(g). If, as part of the compromise under s 425, the court orders the assets and liabilities of the insured to be transferred to another company (under CA 1985, s 427(3)(a)) then the third party’s claim is against the transferee company and no statutory transfer will take place (clause 1(5)).    [Back]

Note 27    Clause 1(2)(a).    [Back]

Note 28    Clause 14(2).    [Back]

Note 29    The draft Bill prohibits the third party from enforcing any part of his debt against the insured which he can recover from the insurer (clause 14(1)). See paras 7.5-7.8 below.    [Back]

Note 30    It is probable that those who draft voluntary arrangements will wish to take advantage of this feature of the draft Bill and ensure that a third party’s residual claim against the insured is subject to the voluntary arrangement. This would prevent the third party from presenting a bankruptcy petition during the currency of the voluntary arrangement.    [Back]

Note 31    Called under IA 1986, s 257 (in the case of IVAs) or under IA 1986, s 3 (in the case of CVAs).    [Back]

Note 32    Insolvency Rules r 5.17 (in the case of IVAs) or Insolvency Rules r 1.17 (in the case of CVAs).    [Back]

Note 33    For example, a “claw back” clause in the insurance contract may allow an insurer to claim back from the insured employer some (or all) of the money it has paid to a third party employee under the terms of the employers’ liability insurance policy. See paras 5.23-5.27 above.    [Back]

Note 34    The insurer’s debt will not have arisen at the time of the creditors’ meeting. Consequently, the insurer will not be bound, either under the rule in IA 1986 or the rule in the Insolvency Act 2000. Cf the position under an arrangement under CA 1985, s 425. See para 6.6 above.    [Back]

Note 35    The sequestration ceases once the composition is in force and the debtor has been discharged in terms of Sched 4, para 13.    [Back]

Note 36    Bankruptcy (Scotland) Act 1985, s 12.    [Back]

Note 37    Bankruptcy (Scotland) Act 1985, Sched 4, paras 17 and 18.    [Back]

Note 38    See paras 6.20-6.26 above.    [Back]

Note 39    Clause 14(2).    [Back]

Note 40    Clause 14(3).    [Back]