In England and Wales, where a bankruptcy petition (the 'Petition') has been presented against a debtor/defendant, one potential option the debtor/defendant ('Debtor') may seem to have available, in order to avoid a bankruptcy order, is to ask family, friend(s) or a colleague(s) etc. (a 'Third Party'), to pay off the Petition debt for the Debtor. If the Debtor is fortunate enough to have a Third Party willing to do this:

(a) will this amount to the Petition debt being properly satisfied, such that the Petition must be dismissed? 

(b) should the Third Party payment be made direct to the Petitioner (i.e. not to the Debtor for the Debtor to then forward it on to the Petitioner)?

(c) must the Third Party make a gift of the money, or can the payment be part of a loan arrangement with the Debtor?

Summary

The answer to (b) can be stated shortly. The Third Party payment ought be made direct to the Petitioner (i.e. not via the Debtor). This is to avoid the money ever becoming the 'property' of the Debtor. This is important to avoid section 284 of the Insolvency Act 1986 ('1986 Act') becoming engaged.

The answer to (a) and (c) came up for consideration in the case of Re Hood; Hood v JD Classics Ltd [2020] EWHC 3232 (Ch)('Re Hood'), a decision of Michael Green J on 27.11.20.

As a matter of insolvency law, provided: 

(1) The Third Party is paying the Third Party's own money (at least, the money paid is not the Debtor's money[0]); and 

(2) the Third Party pays the money: 

(i) direct to the Petitioner (i.e. not via the Debtor in any way[1]); and 

(ii) unconditionally (or at least, the conditions are satisfied[2]),

(c) the Third Party appropriates[2a] (allocates) it to the Petition Debt, 

the Petition Debt should be satisfied. 

It does not matter whether money provided is:

(a) a gift by the Third Party; or 

(b) part of a loan arrangement with the Debtor (with the Debtor agreeing to repay the loan to the Third Party in the future). 

Crucially, 

(a) the Third Party paying the money direct to the Petitioner, means the money is never the property of the Debtor. Never being the Debtor's property, means the money's transfer to the Petitioner is not a transfer vulnerable to later being rendered void under s.284 of the 1986 Act[2b]. It is treated as a true payment.

(b) the obligation the Debtor takes on to repay the loan is not 'property' which falls in the bankruptcy estate;

Whether the Petition must then be dismissed, depends on whether there is: (a) a Petition change of carriage, under r10.27 of the Insolvency (England and Wales) Rules 2016 ('2016 Rules'); or (b) a substitution of the Petitioner on the Petition, under r.10.29 of the 2016 Rules.

(a) a corollary of the Petition Debt being paid off as described above, is that there can be no change of carriage order made in favour of a supporting creditor under r.10.29 of the 2016 Rules. This is because, r.10.29(3) will prevent such an order being made. r.10.29(3) prevents any change of carriage order being made where the Petition Debt has been 'paid, secured or compounded by means of (a) a disposition of property made by some person other than the debtor' (r.10.29(3)(a)) - which is the case where the payment (the disposition of money) is made by a Third Party from the Third Party's own funds (whether as a gift or as part of a loan arrangement);

(b) for substitution - which was not considered in Re Hood - see a connected article, available here.

Short Point of Insolvency Law

Describing the appeal as resting on a '....short point of insolvency law' (paragraph 1), Michael Green J in Re Hood framed the short point of insolvency law before him, as following: 

'...whether a payment by a third party to the petitioning creditor that purports to discharge the petition debt so as to lead to the dismissal of the petition but where the debtor has agreed to repay or reimburse that third party is a void disposition or payment pursuant to section 284 of the Insolvency Act 1986 (“the Act”).' (paragraph 1)

To this, Michael Green J in Re Hood said '...it comes down to the meaning of the relevant statutory provisions and how they work together in this situation.' (paragraph 4)

Sections 284 and 271(1) of the 1986 Act, and r.10.29 of the 2016 Rules

Section 284

Section 284 of the 1986 Act is entitled 'Restrictions on dispositions of property' and reads (so far as presently material[3])

“(1) Where a person is made bankrupt, any disposition of property made by that person in the period to which this section applies is void except to the extent that it is or was made with the consent of the court, or is or was subsequently ratified by the court.

(2) Subsection (1) applies to a payment (whether in cash or otherwise) as it applies to a disposition of property and, accordingly, where any payment is void by virtue of that subsection, the person paid shall hold the sum paid for the bankrupt as part of his estate.

(3) This section applies to the period beginning with the day of ... the presentation of the bankruptcy petition and ending with the vesting, under Chapter IV of this Part, of the bankrupt's estate in a trustee.'

Section 271

Section 271 of the 1986 Act is entitled 'Proceedings on creditor’s petition' and reads (so far as presently material[4]):

'The court shall not make a bankruptcy order on a creditor’s petition unless it is satisfied that the debt, or one of the debts, in respect of which the petition was presented is either–

(a) a debt which, having been payable at the date of the petition or having since become payable, has been neither paid nor secured or compounded for, or

(b) a debt which the debtor has no reasonable prospect of being able to pay when it falls due.'

r.10.29

r.10.29 of the 2016 Rules is entitled 'Change of carriage of petition' and reads (so far as presently material[5]):

'(1) On the hearing of the petition, a person who has delivered notice under rule 10.19 of intention to appear at the hearing, may apply to the court for an order giving that person carriage of the petition in place of the petitioner, but without requiring any amendment of the petition.

(2) The court may, on such terms as it thinks just, make a change of carriage order if satisfied that(a) the applicant is an unpaid and unsecured creditor of the debtor; and

(b) the petitioner either–

(i) intends by any means to secure the postponement, adjournment, dismissal or withdrawal of the petition, or

(ii) does not intend to prosecute the petition, either diligently or at all.

(3) The court must not make such an order if satisfied that the petitioner’s debt has been paid, secured or compounded by means of(a) a disposition of property made by some person other than the debtor; or

(b) a disposition of the debtor’s own property made with the approval of, or ratified by, the court.'

The facts

In Re Hood, HMRC presented (15.5.19) a bankruptcy petition against Mr Hood (paragraph 1) for c.£990,000 (the 'Petition Debt'). There a supporting creditor (JD Classics), who gave (24.6.19) notice of it intention to appear on the petition as a supporting creditor (pursuant to r.10.19 of the 2016 Rules).

After the first bankruptcy petition hearing (26.6.19), Mr Hood applied for a validation order under s.284 of the 1986 Act, so that he could make payment from his own funds (of c.£1m), but this was refused as he was insolvent (paragraph 7; validation order judgment reported: In Re Hood; [2019] EWHC 2236 (Ch); [2019] BPIR 1425). Subsequently, Mr Hood organised for two third parties, his: (a) ex-wife; and (b) business associate (Mr Hill), to pay of the Petition Debt (paragraph 8). Both made their respective payments, importantly, direct to the Petitioner HMRC:
(1) the ex-wife (Mrs Hood) transferred her part (£470,000) to the Petitioner, as a gift to Mr Hood. There was no issue that this payment was somehow of Mr Hood's money; and
(2) business associate transferred his part (£530,000) as a loan This payment was made by a Mr Hill.

With the payments received, HMRC indicated that it intended to secure the dismissal of the petition (paragraph 8).

Prior to the next bankruptcy hearing, the supporting creditor, issued (19.9.19) an application for a change of carriage order under r.10.29 of the 2016 Rules, that is, an order granting the supporting creditor change of carriage of the Petition (paragraph 9) (the 'COC Application').

COC Application - first instance

On the COC Application at first instance, the first instance judge held (as summarised by Michael Green J at paragraph 11):

'(1) The payment of £470,000 by Mrs Hood was a gift by her for the benefit of her ex-husband “and, as third party funds, is not liable to be voided under section 284” (para 65).

(2) The payment of £530,000 by Mr Hill was from his own funds and the [Debtor] had no interest in such funds. The payment was made unconditionally by Mr Hill, in the sense that it was not conditional on the petition being dismissed. Mr Hill did not assert that there was any trust of the monies and it was simply a transfer of funds by him.

(3) The payment by Mr Hill was however to be treated as a loan by him to the [Debtor] “to be repaid or reimbursed” (para 73).'

Consequently, the first instance judge held:

'...that the payment by Mrs Hood was not caught by section 284 of the Act, but the payment by Mr Hill, as a loan to Mr Hood, was so caught and there was therefore jurisdiction under rule 10.29(3) of the Rules to make a change of carriage order. Furthermore, as Mr Hill's payment was void under section 284, the petition debt was not discharged and there was no bar under section 271(1)(a) to the making of a bankruptcy order.'

In essence therefore, the first instance judge:

(a) granted the change of carriage order sought by the supporting creditor, on the basis that the transfer of loan monies directly from a third party to the Petitioner was the equivalent of a disposition of the debtor's own property and, so rule 10.29(3)(a) did not preclude the making of the order (given there was no validation order, r.10.29 did not preclude the Court from making the change of carriage order); and

(b) held Mr Hill's payment was void under section 284 of the 1986 Act, section 271(1)(a) of the 1986 Act did not present a bar to the making of a bankruptcy order;

(c) held that she was able to make the bankruptcy order (paragraph 79).

The Debtor appealed, contending that:

(a) '....the Judge came to the wrong conclusion on the law and she should have held that: (i) the payment of monies by the third party to the petitioner was an application of the third party's own monies, not the debtor's; (ii) the making of a loan by the third party to the debtor did not amount to and was not the equivalent of a disposition or payment of the debtor's own funds within section 284; and (iii) the petition debt was thereby discharged by the third party's payment and the court was unable to make a bankruptcy order because of the operation of section 271(1) of the Act.' (paragraph 2)[6]

(b) '...even if the payment by Mr Hill is characterised as a loan from Mr Hill to Mr Hood, there was no disposition of the [Debtor's] property within section 284 because the monies never came into his possession and were at no time his “property”.' (paragraph 13)

COC Application - on appeal

On appeal, Michael Green J allowed the appeal:

[1] It was common ground between the parties that a Third Party not paying direct to the Petitioner, but routing the money through the Debtor's bank account, would be a disposition of the Debtor's own property, to the Petitioner. Michael Green J recorded, at paragraph 31:

'Both parties are agreed that if the payment is routed through the debtor's bank account and then the petitioner is paid from funds within that bank account, then that is a disposition of property by the debtor and outside of rule 10.29(3).'

[2] Michael Green J held that, loan monies paid direct by a third party to the petitioner, never became the 'property' of the debtor, such that they never became subject to s.284 of the 1986 Act. At paragraph 63, Michael Green J said:

‘In my judgment ... the monies paid by Mr Hill direct to [the Petitioner], together with the [Debtor] obligation to repay Mr Hill the same amount, never became the “property” of the [Debtor] such as to engage section 284 of the Act.'

At paragraph 74, he said:

'...I do not think that Parliament intended to invalidate or prevent third parties from making payments direct to creditors even where those third parties are contractually or otherwise entitled to be repaid by the debtor. In fact, I think that the wording of rule 10.29 indicates that such payments were being encouraged and I do not believe that this was considered only to enable those payments to be by way of gifts.'

In support of this conclusion, Michael Green J had found that:

(a) the relevant statutory definition of 'property' for these purposes, as that contained in section 436 of the 1986 Act, namely, '...as including: “money, goods, things in action, land and every description of property wherever situated and also obligations and every description of interest, whether present or future or vested or contingent, arising out of, or incidental to, property.' (paragraph 21). He said that the '...statutory words...clearly cover only dispositions of a debtor's property, meaning property which the debtor owns beneficially or in which he or she has a beneficial interest.' (paragraph 73)

(b) to be 'property' of the Debtor, the money would have to have been beneficially owned by the Debtor at some point in the Third Party payment process[7], and that '...the money paid by Mr Hill was never beneficially owned by the [Debtors].' (paragraph 25)[7a]. 

(d) the other aspect to the loan arrangement, namely, the obligation to repay the loan was not itself, '...“property” within the meaning of section 436 of the Act' (paragraph 49).

(e) 'the allowance of direct payments by third parties to the petitioning creditor itself' (paragraph 75) did not contravene '...the policy behind this Part of the Act or the pari passu principle.' (paragraph 75)[8]

[3] Michael Green J also rejected, as wrong, that the notion that section 271(1)(a) of the 1986 Act and rule 10.29(3) of the 2016 Rules were confined to Third Party gifts and did not apply if there was a loan arrangement[9]. This was because Michael Green J found that there was:

'...nothing within those sections, or rule 10.29, that indicate that Parliament intended so to confine their operation to pure gifts; nor is there anything within the judgments of the Court of Appeal in Smith v Simpson that indicate that it considered the sections and rule to be limited to gifts from a third party.’ (paragraph 63) (Smith v Simpson is a reference to Smith v Ian Simpson & Co [2001] Ch 239; [2000] 3 WLR 495; [2000] 3 All ER 434, CA)

In short, this was a rejection of the Petitioner's argument, that '...to come within rule 10.29(3)(a), the “disposition of property” by the third party must be by way of gift with no concomitant obligations on the debtor to reimburse the third party.' (paragraph 31)

[4] 'In the circumstances of this case, the payment by Mr Hill direct to HMRC did not amount to a disposition of the [Debtor's] own property; it was a disposition of Mr Hill's property which brought it within rule 10.29(3)(a) and meant change of carriage to the [supporting creditor, JD Classic] could not be ordered.' (paragraph 78)[10]

Reasoning
Most readers probably need not read any further. For those interested however, Michael Green J reasoning can be considered. Under the heading 'Is the loan from Mr Hill the [Debtor's] “property”?', Michael Green J said, from paragraph 48 to 58:

'48. In order to determine the answer to this question, it is necessary to explore whether an outstanding loan repayment obligation can sensibly be considered to be “property” within section 284.

49. I do not think it was seriously disputed that an obligation to repay a loan is not “property” within the meaning of section 436 of the Act. Even though section 436 refers to an “obligation”, as Arnold J pointed out in Shlosberg v Avonwick Holdings Ltd [2017] Ch 210, paras 135–140 that can only mean an “obligation” owed to, not by, the debtor. This was also made clear by Lightman J in Coutts & Co v Stock [2000] 1 WLR 906 in which he set out certain “principles” as to the operation of section 127 of the Act including in relation to an increase in a company's bank overdraft: “the loan by the bank to the company is not a disposition of the company's money (it is a disposition of the bank's money to the company) and is therefore outside section 127” (p 910G).

50. Even though [counsel for the supporting creditor JD Classic] accepted that the obligation to repay a loan or overdraft is not “property” within the meaning of section 284 and section 436, she did not accept that it was necessary to show that the money used to pay the petitioner came into the debtor's beneficial ownership. She argued that one should look at the substance of the transaction which shows that the loan monies that went direct from the third party to the petitioning creditor were in reality and effectively a disposition of the debtor's own property within section 284. There are no authorities dealing with the position under the Act, including the operation of the change of carriage rules. But [counsel for the supporting creditor JD Classic] particularly relied on In re Salaman and I was also referred to a number of earlier authorities, all of which were based on the original Bankruptcy Acts.

51. In re Snyder, Ex p Pixley (1891) 8 Morr 127 concerned a third party company, albeit associated with the debtor, lending money to the debtor to pay his petitioning creditor so as to have the petition adjourned. Amongst the security taken by the company was a charge over the debtor's assets. It is clear from the facts as recited in the submissions of counsel that the money from the company was paid to the debtor's solicitors and they then paid a cheque, drawn on the firm's account, to the petitioner. After the debtor had subsequently been made bankrupt, Cave J held that the monies paid to the petitioner were the property of the bankrupt and therefore had to be repaid. In his short judgment he said as follows:

“It is clear to me that this was the money of the bankrupt, and that it was paid by the solicitor as his money for the purpose of obtaining a delay of the bankruptcy proceedings … They [the lending company] never meant to lend without looking to somebody to repay them. The money was lent to Snyder and was not lent to the five gentlemen, and the consequence of that is that the trustee is entitled to succeed in this application.”

52. I do not see that this case assists, for a number of reasons. Cave J clearly found the money to have gone to the debtor's solicitors. It was at that stage the debtor's property as recorded in the judgment. The granting of the charge would also itself be a disposition of the debtor's property. It is not akin to the [the Debtor's] position of a third party payment direct to the petitioner without security for the loan.

53. In re Rogers; Ex p Holland and Hannen (1891) 8 Morr 243 concerned a debtor who borrowed from a moneylender in order to pay a number of creditors after an act of bankruptcy had been committed. The money was paid into the debtor's bank account, then to his solicitors’ bank account and from there the solicitors paid the creditors. After the debtor was made bankrupt, his trustee sought to recover the payment to one of the creditors. Cave J, following his decision in In re Snyder, held that this was a payment of the debtor's money and so recoverable. However, the Court of Appeal allowed the appeal on the basis that the money never became the debtor's property. Lindley LJ said:

“In my opinion the true result of the evidence is not that the money paid to Bromley [the creditor] was the bankrupt's money, but that the bankrupt through his solicitors paid his debt with money lent him for the purpose by Mozley [the moneylender] … The payment cannot be impeached by the trustee if the above conclusion is correct in fact. The trustee is endeavouring to affirm the transaction in part and to repudiate it in part. He wants to claim the money as the bankrupt's because it came to his hands and at the same time to reject the terms and conditions on which alone the bankrupt procured it. This is manifestly unjust and contrary to principle … I entertain no doubt that Mozley could have obtained an injunction to restrain the bankrupt from using that money for any purpose except that of paying his pressing creditors. If this be so, the money never was the bankrupt's in any proper sense so as to vest in his trustee as part of his general assets.”

54. The other two members of the Court of Appeal, Bowen and Kay LJJ, also considered that the payments from the moneylender were impressed with a trust and could not be used by the debtor for any other purpose than to pay the creditors. In re Rogers was one of the cases relied upon by Lord Wilberforce in establishing the concept of the Quistclose trust for a purpose — Barclays Bank Ltd v Quistclose Investments Ltd [1970] AC 567. [counsel for the supporting creditor JD Classic] says that In re Rogers and the next case in the series, In re Drucker(No 1); Ex p Basden [1902] 2 KB 55, need to be re-analysed in the light of Quistclose and Twinsectra Ltd v Yardley [2002] 2 AC 164, but I am not so sure that they do in this context.

55. In In re Drucker the debtor's own solicitors agreed to lend him money so that he could pay off the petitioning creditor. The solicitors paid the petitioning creditor directly. The debtor was later adjudicated bankrupt and the trustee sought to recover the money as property of the bankrupt. At first instance Wright J held as follows:

“All that I have to consider is, whether this money, which was paid to the bank, was the money of the debtor or not … if the 300l ever became the debtor's money, it is plain that he had the right to spend it, or to speculate with it, or do whatever he pleased with it. But what I find is, that it never came into debtor's hands at all; and I am of opinion that it never was intended to come into his hands. It is quite clear that [the solicitors] would never have consented to that money going out of their hands into the debtor's hands, or being applied for any purpose whatever other than the dismissal of the petition by the bank … I cannot help thinking that this money was never free, and never became part of the general assets of the debtor at all. He never had any right to receive it, or use it, or apply it to any purpose except this one particular purpose. Under these circumstances it seems to me it was impressed with a trust—not in the strict sense of the word—but in substance with a quasi-trust that it should be applied by [the solicitors] out of their own money for the discharge pro tanto of the claim of the bank.”

The Court of Appeal dismissed the trustee's appeal. Romer LJ said [1902] 2 KB 237, 238–239: “In my view there never was a moment of time at which this money could have been used for any other purpose than that of paying the bank.”

56. It seems fairly clear that the Court of Appeal in both In re Rogers and In re Drucker held that money would only be regarded as part of the bankrupt's estate if it was beneficially owned at a relevant point of time by the bankrupt. This is confirmed by section 283(3)(a) of the Act which excludes from the bankrupt's estate any property held on trust for another person. The corollary must be that the bankrupt's estate is confined to assets which are beneficially owned by the bankrupt or in which the bankrupt has a beneficial interest.

57. As I said above, [counsel for the supporting creditor JD Classic] sought to distinguish these cases on the basis that they needed to be reinterpreted in the light of the modern juridical basis for Quistclose trust cases, as explained by Lord Millett in Twinsectra (see particularly paras 68, 69, 7981 and 100). That explanation is, however, that at no point does the borrower have a beneficial interest in the monies advanced; the beneficial interest remains with the lender (the borrower holding on resulting trust for the lender) until those monies are applied in accordance with the agreed purpose. When they are so applied, there remains the simple debtor/creditor relationship between the lender and borrower. In her oral submissions, [counsel for the supporting creditor JD Classic] said that at the moment that the purpose was about to be fulfilled, the beneficial interest became vested in the borrower (for a “scintilla temporis”) but I do not understand Lord Millett to have been saying that in Twinsectra. Rather, in accordance with In re Rogers and In re Drucker, the beneficial interest never became vested in the borrower/debtor, as it either remained with the lender or transferred to the payee/creditor.

58. In this case, one of the issues that the Judge had to consider was whether the monies paid by Mr Hill were subject to a Quistclose type trust, such as in In re Rogers (1891) 8 Morr 243, and she decided that there was no such trust. Even though this was a point of defence raised by the [the Debtor], I do not see why the question of a trust ever arose because the money never in any sense, legal or beneficial, came into the [Debtor's] hands. It was perhaps because of the case of In re Salaman that this became a live issue and I now turn to that case.'

After analysing In re Salaman, Michael Green J continued, at paragraphs 62 and 63:

62. While the Judge understandably relied on In re Salaman I do not find it of persuasive authority. It is a decision under the Bankruptcy Act 1914, under which there were no change of carriage rules, and contains no analysis of the legal status of loaned monies nor why the payment by a third party direct to the petitioning creditor should be treated as the “property” of the bankrupt and as having come within his estate.

63. In my judgment therefore, the monies paid by Mr Hill direct to HMRC, together with the [Debtor's] obligation to repay Mr Hill the same amount, never became the “property” of the [Debtor] such as to engage section 284 of the Act. It follows that I reject [counsel for the Petitioner's] contention that the notion of third party payments within section 271(1)(a) and rule 10.29(3) following Smith v Simpson is confined to gifts from third parties and does not extend to loans from them. There is nothing within those sections, or rule 10.29, that indicate that Parliament intended so to confine their operation to pure gifts; nor is there anything within the judgments of the Court of Appeal in Smith v Simpson that indicate that it considered the sections and rule to be limited to gifts from a third party.'

Repaying the Loan

It can be added that, after the Petition is dismissed, though the Petition will have been dismissed, a Debtor will need to consider whether, depending on the circumstances, preferentially prioritising the repayment of the loan, would amount to an (unlawful) preference under s.340 of the 1986, should there be a subsequent bankruptcy petition and bankruptcy order.

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