The purpose of this essay is briefly to examine the phenomenon of individual insolvency and bankruptcy in England, unknown in other mainstream and evolved jurisdictions. Modern English individual insolvency, in contrast to corporate and business insolvency, has its own law, carefully upheld by specialist courts. The first part of the essay is a brief legal history of the concept; the second part is a short analysis of the modern law of individual insolvency.
This essay concerns the law of England and Wales. It does not discuss the law of Scotland or that irritating, modern misnomer, “UK law”. The concept of insolvency is a commercial rather than a legal one, although used by lawmakers and lawyers. It describes a factual state of a debtor’s inability to pay his debts. How to identify insolvency is a matter of fact and is sometimes the matter of considerable argument. The traditional method is to ascertain whether the debtor’s assets exceed his liabilities. This is called the balance sheet test. Another test, called the cash flow test, is to ascertain, objectively, whether a debtor is able to meet his obligations at the time they fall due.
The concept of bankruptcy, however, is a legal one and the term can be traced in English statute to 1542. Bankruptcy is a legal state of being, brought about by a legal process. The modern definition of a bankrupt is “an individual who has been adjudged bankrupt…”. In England and Wales, it is only possible for a person to be bankrupt when a Court has made that adjudication in a Bankruptcy Order. As a matter of logic, a person may be (commercially) insolvent but not (legally) bankrupt because it is possible to be unable to meet financial obligations without a Court adjudicating bankruptcy. (Only individuals can be adjudicated bankrupt in England. The equivalent for companies is liquidation. There is no such thing as a “bankrupt company”).
Readers need not be reminded that English law emanates from three main sources: statutes, (passed by Parliament in its “Acts” and other related legislation), the common law and equity, which is the law developed by the Courts.
I shall refer to a bankrupt person as “he”. This is largely for convenience, although it is notable that for most of English legal history, women (unless they traded) were incapable of being adjudicated bankrupt. It was not until 1935 that married women could become bankrupt in England.
Brief History of English Bankruptcy Law
As Fletcher has observed, throughout Europe in the Middle Ages, the lex mercatoria influenced commercial practice. Deriving ultimately from Roman law, used and spread throughout Europe by Italian merchants, it was helpful, adaptive and trusted. Lex mercatoria possessed concepts such as cessio bonorum, distractio bonorum, remissio, dilatio and so on, presenting to its adherents what could loosely be called an “insolvency law”, protecting both debtors and creditors alike. It was a creature of commerce.
The inherently dynamic and developmental common law, introduced by Edward I (1239 – 1307) in his reforms of English law and justice, was initially resistant to lex mercatoria. However, from the fourteenth century, the English Courts Merchant and Courts Maritime, which administered lex mercatoria, were absorbed into the English common law. It would be naïve to think that commercial law and practice did not, in some way, influence the development of English law. The common law permitted creditors to seize debtors, as well as their goods. The goods could be sold to meet liabilities. The unwelcome notion of being physically restrained by creditors, as well as having to face the responsibilities of unpaid debts, doubtless led many debtors then, as now, to absconding.
Towards the end of the reign of Henry VIII (1491 – 1547), while that aging Tudor monarch was married to his fifth wife, the legal concept of individual bankruptcy emerged from the other source of English law – statute. The founding statute for individual insolvency law (still confined to traders) is Statute 1542, “An Act against such persons as to make bankrupts”. The statute was concerned with absconding commercial debtors and sought to protect creditors. Underpinning the statute was the belief that deliberately avoiding an obligation to pay a trade debt was irresponsible and unacceptable. Clearly creditor-oriented, the Act was passed in order to protect those injured by those tradesmen who, owing debts, tried to run away to avoid paying them. No protection of any kind was offered to the debtor. The Act allowed the seizure and sale of the absconding debtor’s possessions as well as their distribution among the creditors. Noticeable from that time was the perception, which survived in later centuries, that bankrupts were objects of opprobium, perceived as quasi-criminals. Two more statutes appeared in 1570, enabling the Lord Chancellor of England and Wales to order the seizure of the assets of an absconding trader and to arrange for them to be sold, the proceeds distributed to his creditors, pro rata in accordance with the size of the respective debts owed. Significantly, this power could only be invoked by a creditor; the debtor could not seek his own bankruptcy.
From the mid-sixteenth century, English bankruptcy law continued to develop but it still only applied to those who made, bought and sold goods (traders). Non-traders were subject to the brutal common law for proving and enforcing debts, which included seizure of a debtor and his goods and even the imprisonment of the debtor until he repaid his debts, as well as the sale of his possessions. It was not until the nineteenth century that non-traders were able to become bankrupt.
At the beginning of the eighteenth century, with the introduction of the Act of 1705, the notion of bankruptcy as a legal condition capable of being brought to an end (now called “discharge”), was introduced. This was a clear softening of the law towards a debtor, although a fraudulent trader who became bankrupt could still be sentenced to death. In earlier times, a bankrupt remained so for life and was always tainted with the stigma associated with that. However, even at the end of the eighteenth century, the perception that bankrupts were quasi-criminals was still maintained, with bankrupts still called “offenders” (a legal term normally associated with criminals).
The nineteenth century (when Great Britain grew to be a global commercial power, with sophisticated legal and commercial concepts of credit) witnessed significant developments in the law of individual insolvency. Parliaments of that century passed over fifty statutes concerned with insolvency, reflecting rapid development of commercial, social and economic change. As remarked upon by twentieth century jurists: “This concern followed a pattern which had been going on for many generations. Each new wave of legislation had usually been precipitated by some economic crisis or grave business scandal (such as the South Sea Bubble in the early part of the Eighteenth Century, and the railway company and banking failures in the Nineteenth Century) or by a desire to mitigate some of the harsher features of the law”.
The development of individual insolvency law in this period is better understood in the light of similar, parallel, developments in company law and the development of the concept of limited liability companies. The nineteenth century was a period of dramatic change for England and Wales. Armed with the powerful economic weaponry of the industrial revolution but wounded by the economic upheavals of the Napoleonic wars (as well as other corporate disasters) the English progressed through the early part of the century with a mixture of economic optimism and realism, and a real sense of the fragility of gaining and retaining wealth.
In 1813, the Court of Relief of Insolvent Debtors was established. Life was improving for bankrupts, although not by much: while they could still be imprisoned for being bankrupt, at least they could be released from prison after fourteen days, provided their assets did not exceed £20 and their creditors did not object.
The first attempts to reform English bankruptcy law began, therefore, shortly after the end of the Napoleonic wars. The Act of 1825 allowed, very significantly, a person to make himself bankrupt, with the consent of his creditors. Before 1831, the power to administer the insolvent’s estate was left to the creditors, with inevitable abuse (such as creditors selling property to each other, selling at an undervalue, and so on). After 1831, officers known as Official Assignees, attached to the London bankruptcy courts, were appointed to administer the estates. Still often corrupt and imperfect (and eventually abolished in 1869), that embryonic system nevertheless demonstrated the recognition that justice needs to be meted out both to the debtor and the creditor by the imposition of a neutral, accountable, administrator. It was an important step and its vestiges remain today in purer form. Reforms continued as the nineteenth century wore on. As public concern grew over how a bankrupt’s estate was administered, (both on the creditors’ and the debtor’s behalf,) Parliament passed the Bankruptcy Act 1883 to address those concerns. As Joseph Chamberlain, who was President of the Board of Trade, told Parliament when the prospective law was being considered:
“Every good bankruptcy law must have in view two main, and at the same time, distinct objects. First, the honest administration of bankrupt estates, with a view to the fair and speedy distribution of the assets among the creditors whose property they were; secondly, following the idea that prevention was better than cure, to do something to improve the general tone of commercial morality, to promote honest trading, and to lessen the number of failures. In other words, Parliament had to endeavour, as far as possible, to protect the salvage and also to diminish the number of wrecks”.
The main thrust of this legislation was to improve the quality of the administration of the bankrupt’s estate by placing it into the hands of independents who could act fairly both towards the creditors and the debtor. Public and transparent examination of the estate was encouraged, as well as fair, accountable and clear distribution of funds to creditors. Significantly, Parliament also recognised (as a matter of public policy) the need to “diminish the number of wrecks” and saw making legislation as way to prevent bankruptcy if possible, as well as make it fairer when it was not. This statute is the basis of modern insolvency law as we know it today.
Before we leave this quick review of the nineteenth century, it is suggested that developments in bankruptcy law at that time can be better understood in the bright light of parallel developments in English company law, and particularly the limitation of personal liability of those individuals who own such companies.
Originally, English corporations were only able to be created by Royal Charter. The Joint Stock Companies Act 1844 (the precursor to the later Companies Acts) dispensed with that. The important notion that a company was a distinct, legal entity was introduced. Moreover, owners of a company were personally liable for the company’s debts. Specific statutory provisions were introduced to deal with corporate insolvency with the Joint Stock Companies Winding Up Act 1844. The Limited Liability Act 1855 limited the liability of the shareholders of a company and protected them from angry creditors and possible bankruptcy.
By the end of the nineteenth century, the notion of corporations being separate legal persons, distinct from their shareholders, reached its high-water mark. In the leading case of Salomon v Salomon & Co  AC22, the House of Lords, interpreting the Companies Act 1862, held that a company was a distinct legal person, separate from its shareholders, even if it only had one main shareholder. As such, it could own property and it could owe money. The debts of a company thus belong to the company, not to the shareholders.
Throughout the nineteenth century it is possible to see a trend emerging towards the protection of individual debtors or potential debtors who engage in business; limited liability companies were, in deference to the individuals who own them, given the legal liability for debts, which previously would have been the personal responsibility of those owners. Owners are only liable to the extent of their shareholding. At the same time, individuals who do not enjoy such protection, were given ever widening rights by statute, as we have seen.
Passing reluctantly (through lack of time) over developments during the first seventy years or so of the twentieth century, we arrive at a era of considerable economic crisis for Great Britain; but we also pick up in a real sense where the 1883 Act, with its notion of being fair and “diminishing wrecks”, left off. In January 1977, the British Government commissioned a “comprehensive review of the law of insolvency” in England & Wales. A review committee was established under the Chairmanship of Kenneth Cork, which published a Report in April 1981.
The Cork Report (as it became quickly known), was published amid widespread praise. Expressing a need for reform of British insolvency law, it made a number of recommendations. Specifically on the subject of individual insolvency, it recommended that: (a) the emphasis on “selling up” the individual debtor (in effect, reducing him to ruin and poverty) should be diminished, and instead, attention should be increased on the possibility of meeting the claims of creditors out of the debtor’s future wages or income. The rehabilitation of the debtor was encouraged; (b) the excessive severity of the law towards the individual insolvent should be relaxed, particularly when the insolvent is incompetent rather than dishonest.
The Government’s response to the Cork Report was a White Paper in 1984 called A Revised Framework for Insolvency Law. The Insolvency Act 1985 followed shortly thereafter, and then the Insolvency Act 1986 (which largely repealed the 1985 Act) and the accompanying Insolvency Rules.
The Insolvency Act of 1986 was and remains the most significant expression of modern individual insolvency law for a century. It has been complimented by the Insolvency Act 2000 and the Enterprise Act 2002. The EU Regulation on Insolvency Proceedings came into force in England in 2002.
A Brief Description of Modern English Personal Insolvency Procedures
The process for making someone bankrupt begins by presenting a legal document, called a petition, to the Court. No person can be adjudicated bankrupt in England or Wales unless, at the time that the petition for his bankruptcy was presented: (i) he was domiciled in England or Wales; (b) was personally present in England and Wales on the date that the petition was presented to the Court; or (c) within three years before that had ordinarily resided or had a residence in England or Wales, or was carrying on business in England or Wales either personally, in partnership or by an agent or manager. This qualification for who can, and cannot, be made bankrupt, is subject to EC Regulation on Insolvency Proceedings 2000 where the debtor has his main interest in an EU member state.
However, bankruptcy in modern Britain is a last resort. There are ways in which people in serious debt may avoid bankruptcy. The 1986 legislation introduced the concept of the Individual Voluntary Arrangement, commonly called an IVA, which is available to individuals and not to companies. It is intended to prevent a person becoming bankrupt, while enabling creditors to recover realistic sums of money. It is a statutory creature, but relies on the old common law concepts of agreement and complying with the terms of an agreement, to be workable and effective.
An IVA is a legally binding agreement between the debtor and his creditors whereby the creditors are repaid an agreed amount, in an agreed period of time. Often, the IVA comprises the debts of unsecured creditors, leaving secured creditors to pursue their own rights. IVAs are attractive to individuals who may own significant assets but, for whatever reason, cannot manage repayment of their debts at a particular time. Once a creditor has agreed to be bound by an IVA, he cannot then sue the debtor and, for example, seize those assets to recover the debt. The creditors receive repayment of what they agree is reasonable and realistic and the debtor avoids bankruptcy and its related constraints and social stigma. He is also protected from legal action by other creditors. An IVA can be of any length of time.
From April 2009, another method that a (modest) debtor can obtain legal relief without becoming bankrupt is by obtaining a Debt Relief Order from the Official Receiver. They are only available if the debtor owes less than £15,000, has less than £50 spare income per month and does not own his own home. They are very helpful in that creditors cannot recover money without permission from the Court (which includes suing for it) and any unpaid debts are discharged after twelve months.
Debtors who have entered into either and IVA or Debt Relief Order must have their names placed on the Individual Insolvency Register, which is a public record.
Creditors and debtors are not obliged voluntarily to seek such relief under statute. It is possible for the to reach agreement under common law contract as well as negotiate informal moratoria, under which debts can repaid and the debtor is free to find the money to do so without the fear of being sued. These techniques of course, rely entirely on the ability of the parties to agree and to honour them. Furthermore, if a debtor does not take steps, then a creditor can do so instead.
IVAs or common law contracts will not be suitable where a debtor has debts he cannot realistically pay, or pay within a sensible period of time. A Debt Relief Order, of course, is unavailable for debts exceeding £15,000. In those circumstances, pure, Court adjudicated bankruptcy is the most likely option.
As we have seen, both a debtor and a creditor may now petition for bankruptcy. In a real sense, each seeks a type of forensic protection by doing so. Bankruptcy has real advantages for the debtor. First, unmanageable debt is put under immediate control. A bankrupt is only obliged to repay “provable” debts, which excludes unproved or speculative claims, and includes only debts which have been approved by the trustee in bankruptcy with responsibility for managing the bankruptcy. Interest payments are frozen. Litigation is halted and cannot begin (or restart) without the Court’s permission. Personal and commercial pressure under which the bankrupt may have been living will be relieved when responsibility for his debts passes to the official responsible for administering his estate. There will come a time when his bankruptcy will be lifted (normally one year) and he will have no more debts to pay. He will be given a new financial life. Of course, the social and commercial stigma which society can attach to bankruptcy will remain, and his credit rating will be poor or even non-existent. He may also have little or no property of his own. His name will be placed on the public Individual Insolvency Register.
While a bankruptcy order is in force (normally twelve months), the bankrupt must comply with “bankruptcy restrictions”. These include not: (i) borrowing more than £500 without informing creditors; (ii) acting as a director of a limited liability company; (iii) creating, managing or promoting a company without the permission of the Court; (iv) managing a business under a different name without disclosing that he is a bankrupt. A breach of these restrictions is a criminal offence. The restrictions can be extended if the bankrupt conducts himself carelessly or dishonestly while they are in force.
In the second quarter of 2013, there were 25,717 individual insolvencies in England & Wales. Of that number, 6,469 were bankruptcies, 7,132 Debt Relief Orders and 12,116 IVAs. According to the Insolvency Service, the introduction of Debt Relief Orders in April 2009 has (with other factors) impacted on the number of bankruptcies.
The legal concept of individual bankruptcy has its very distant ancestor in mediaeval England, where perhaps its proto-ancestors came ultimately from Roman law. It was a child from the world of trade and commerce, although that changed over time. Gaining traction in the sixteenth century with Henry VIII, but still set aside for traders, the law gained more sophistication in the eighteenth century.
The intentions behind English personal insolvency legislation, which began timidly in the eighteenth century, grew in confidence throughout the nineteenth and matured in the twentieth, were justly and fairly to balance the rights of the creditors to recover their lawful entitlements with suitable protection for the bankrupt (and, by extension his dependents).
Fletcher observes that the Act of 1542 evidenced two of the basic concepts of English insolvency law: the collectively (where the creditors act as one) and the distribution of the insolvent estate for the benefit of all the creditors, pari passu. These seminal concepts, expressly crudely in the sixteenth century, remain today, refined and purer. The eighteenth century legislation saw the introduction of bankruptcy as limited in time to protect debtors, and the nineteenth century introduced measures to protect those in debt (who were not only traders) by filing for their own bankruptcy as well as making the administration of the estate fairer and more transparent by placing greater Court control over those affairs.
It is submitted, however, that for the very brief reasons given above, one of the most significant steps to protect the individual from insolvency was the parallel development of the law of limited liability companies. That development overtly protected the personal wealth of individual shareholders from the creditors of a company which they owned, by limiting liability and developing the concept of individual corporate identity.
By the end of the nineteenth century, the foundation of modern insolvency law had been laid down. In 1986, English and Welsh insolvency law, as it is largely recognised and applied today, was put in place. EU law does not have a significant impact upon it. That legislation, with its numerous procedures designed to tackle problems connected insolvent individuals, endeavours to rehabilitate debtors, rather than punish them, seeks to place the administration and distribution of bankrupt estates in the hands of independent and accountable third parties, under the jurisdiction of the Courts, to ensure fairness to all and, wherever possible, endeavours minimise the personal, social and economic effects on bankruptcy both on the individual and wider social and commercial community.
1. I am conscious that this subject could be the subject of a book, let alone a very short paper, and I am endeavouring to cover it for the benefit of those with little or no previous knowledge of the subject in only a few pages. Omissions and elisions are regrettably inevitable, but I am responsible for any errors.↑
2. I have relied upon, and refer readers to, the excellent chapter on this subject in The Law of Insolvency by Ian Fletcher 4th edition 2009. I am also indebted to the excellent Historical Background to late twentieth century insolvency law contained in Chapter Two of the Cork Report (see below). ↑
12. Imprisonment for debt (let alone bankruptcy) was abolished in England in 1869, although a debtor who could pay but wouldn’t pay may still be imprisoned for up to six weeks, thereafter. A famous imprisoned debtor was the father of Charles Dickens, whose humiliating imprisonment for debt inspired his son to write bitterly on the subject in Pickwick Papers and elsewhere. ↑
23. This is the trustee in bankruptcy. Normally, it is an official of the Office Receiver’s Office. That Office is part of the Insolvency Service, an Executive Agency of the British Government’s Department of Business Innovation and Skills. It is possible for a privately funded trustee to be put in place, who is suitably independent and qualified. See: www.bis.gov.uk/insolvency ↑