INTRODUCTION

Bankruptcy proceedings may not be used or threatened for the purpose of obtaining some collateral advantage. This is known as 'the Rule in Bankruptcy'.

The Rule in Bankruptcy ('RIB') applies to both: (1) statutory demands; and (2) bankruptcy petitions.

Violation of RIB may mean that:

(1) the (personal insolvency) statutory demand is liable to be set aside (on an application by the debtor/statutory demandee under r.10.5(5)(d)[1] of the Insolvency (England and Wales) Rules 2016 ('2016 Rules'), for an order setting aside the statutory demand);  or, (as the case may be),

(2) the bankruptcy petition should be dismissed (as a exercise of discretion by the Court, pursuant to section 266(3) of the Insolvency Act 1986 ('1986 Act')[2])

Proper Advantages

Legal proceedings should be used to obtain the advantages (remedies/relief) they are designed to bestow/provide. Bankruptcy proceedings are designed to bestow/provide (if the applicable critieria is met) a bankruptcy order (with all that flows from that order). The proper (or lawful) purpose of bankruptcy proceedings is to obtain a bankruptcy order. The proper purpose for obtaining a bankruptcy order, for a creditor, is so that the creditor might receive his due dividend[3] for the debt he holds, from the bankrupt estate. These are the 'proper advantages' from the bankruptcy process.

Collateral Advantages

The 'proper advantages' from the bankruptcy process are not the only 'advantages' that can arise from threatening or using (both before and after the bankruptcy order) the bankruptcy process. Other, collateral advantages, can be gained. Creditors of the debtor may realise this, and be tempted to threaten or use the bankruptcy process, not to obtain any proper advantage(s) (or at least, not exclusively), but to (also) obtain the collateral advantage(s) too. Threatening or using the bankruptcy process with the purpose of obtaining a collateral advantage will render that purpose, an 'improper purpose' - which can (though might not) render the threatened use/use of the bankruptcy process, an abuse of process/violation of RIB.

Nomenclature

Various words are used to describe the impermissible purpose of seeking to gain some collateral advantage(s) from the threat of, or use of, the bankruptcy process. This impermissible purpose is sometimes called the 'improper purpose', 'ulterior purpose', 'extraneous purpose', 'collateral purpose', 'illegitimate purpose' or 'unlawful purpose'. And sometimes it is the person's 'reason', 'motivation' etc. for using the bankruptcy process. So it might be said that the petitioner has an 'illegitimate motive' or 'ulterior motive', or a 'extraneous reason', for seeking the bankruptcy order. In one early case (re Majory [1955] Ch 600), referred to below, the word 'extortion' as used. For consistency and brevity, in this article, unless quoting from a case, the label 'improper purpose' will be used.

Improper Purpose - 2 Main Areas

A creditor might seek to gain some collateral advantage at various stages of the bankruptcy process. In Re Swindon Town Football Co Ltd [2022] EWHC 2071 (Ch) ('Swindon Town'), Deputy ICC Judge Baister said, at paragraph 35:

'...the presentation of a petition by a person who has an undisputed debt will only be an abuse in two situations:

"The first is where the petitioner does not really want to obtain the liquidation or bankruptcy of the company or individual at all, but issues or threatens to issue the proceedings to put pressure on the target to take some other action which the target is otherwise unwilling to take. The second is where the petitioner does want to achieve the relief sought but he is not acting in the interests of the class of creditors of which he is one or where the success of his petition will operate to the disadvantage of the body of creditors" (Maud v Aabar Block Sarl (supra)).' The reference to here is to Maud v Aaber Block Sarl [2015] BPIR 819.

Though referring to 'the presentation of a petition' stage, this would seem to have wider resonance.

Swindon Town therefore identifies two instances of creditors/petitioners seeking to take a collateral advantage, namely, where:

(1) '...the petitioner does not really want to obtain the liquidation or bankruptcy of the company or individual at all, but issues or threatens to issue the proceedings to put pressure on the target to take some other action which the target is otherwise unwilling to take'. The question this invokes, for determination is: does the petitioner genuinely wish to put the debtor into bankruptcy; and

(2) '...the petitioner does want to achieve the relief sought but he is not acting in the interests of the class of creditors of which he is one or where the success of his petition will operate to the disadvantage of the body of creditors' . The question this invokes, for determination is: for what purpose does the petitioner wish to put the debtor into bankruptcy?[4]

KING

This area was recently considered in the case of King v Bar Mutual Indemnity Fund [2023] EWHC 1408 (Ch) ('King'), a decision of HHJ Kelly sitting as a Judge of the High Court, on whether statutory demands should be set aside for violating the RIB.

The Facts

In King, the Kings (3 people) were ordered to make a payment on account of costs, at the same time as a detailed assessment of costs was ordered (following the Kings claim for unlawful means conspiracy being struck out). The beneficiary of the interim payment on account of costs ('IPOAOC') order, a barrister, assigned the benefits of that IPOAOC order, to the Bar Mutual Indemnity Fund ('BMIF') (which is the insurer for all barristers). BMIF served statutory demands on the Kings, each statutory demand founded upon non-payment of the IPOAOC order. The Kings applied for an order, setting aside the statutory demands. Among the various grounds upon which the Kings sought to have the statutory demands set aside (one of which, they were successful on), was that the statutory demand had been issued/served for an improper purpose - that RIB had been/was being violated. The collateral advantage BMIF were alleged to be seeking to gain (and so had an 'improper purpose' in seeking to gain), was the 'stifling'[5] of a (professional negligence claim) claim the Kings said they had against one of BMIF's insured.

Applicable Legal Principles

Under the subheading 'Applicable legal principles', the Judge in King helpfully went through some of the authorities in this area, from paragraphs 126 to to 134:

'126. Bankruptcy proceedings may not be used or threatened for the purpose of obtaining some collateral advantage ("the Rule in Bankruptcy"). In re Majory [1955] Ch 600, a creditor agreed that a debtor could pay off his debt in instalments if the latter also paid his costs. The debtor later contended that this was an extortion. In a crucial passage the court said:

"(1) There is no such hard and fast rule as Mr. Duveen suggested, namely, that any arrangement or agreement made by a petitioning creditor with his debtor, after the institution or under the shadow of bankruptcy proceedings, whereby the creditor is able to get more than that "to which he was legally entitled" (that is, more than he could have recovered at law at the time of the bankruptcy proceedings being started or threatened) amounts to extortion in bankruptcy law notwithstanding the absence of any mala fides or anything amounting to oppression in fact. In our judgment, the decision in In re Bebro involves necessarily the rejection of such proposition.

"(2) There is equally no rule that extortion has in bankruptcy law a special and artificial significance divorced altogether from the ordinary implication of the word.

"(3) The so-called "rule" in bankruptcy is, in truth, no more than an application of a more general rule that court proceedings may not be used or threatened for the purpose of obtaining for the person so using or threatening them some collateral advantage to himself, and not for the purpose for which such proceedings are properly designed and exist; and a party so using or threatening proceedings will be liable to be held guilty of abusing the process of the court and therefore disqualified from invoking the powers of the court by proceedings he has abused.

"(4) On the other hand, having regard to what Jenkins LJ called "the potent instrument of oppression" which bankruptcy proceedings (with their potential consequences upon property and status) provide, the court will always look strictly at the conduct of a creditor using or threatening such proceedings; and if it concludes that the creditor has used or threatened the proceedings at all oppressively, for example, in order to obtain some payment or promise from the debtor or some other collateral advantage to himself properly attributable to the use of the threat, the court will not hesitate to declare the creditor's conduct extortionate and will not allow him to make use of the process which he has abused.

"(5) In every case it is a question of fact in all the circumstances of the case whether there has been, in truth, extortion."

127. In In Re Maud [2015] EWHC 1626 (Ch) Rose J said that the Rule in Bankruptcy was triggered in two situations:

"In the light of these authorities I conclude that the pursuit of insolvency proceedings in respect of a debt which is otherwise undisputed will amount to an abuse in two situations. The first is where the petitioner does not really want to obtain the liquidation or bankruptcy of the company or individual at all, but issues or threatens to issue the proceedings to put pressure on the target to take some other action which the target is otherwise unwilling to take. The second is where the petitioner does want to achieve the relief sought but he is not acting in the interests of the class of creditors of which he is one or where the success of his petition will operate to the disadvantage of the body of creditors. It is also clear from those authorities, and as a matter of common sense, that the jurisdiction of the court to dismiss a petition based on an undisputed debt on the grounds of collateral purpose must be exercised sparingly. Bankruptcy proceedings cannot be allowed to become the forum for a detailed investigation into past and present relationships or an exploration of what the petitioner hopes to gain from the insolvency of the company or individual, in financial or personal terms and a consideration of whether those hopes are legitimate or not."

128. The facts of Maud are complicated. For present purposes it suffices to note that Rose J dismissed the argument on the bases that: (1) the respondents did want to bankrupt the applicant because it was the applicant's bankruptcy that triggered the 'collateral' advantage; and (2) "it has not been suggested that the bankruptcy would damage the prospects of Mr Maud's other creditors. There is no reason to suppose Mr Maud's Ramblas shares will be sold under the pre-emption provisions of the Ramblas articles of association at less than their proper price. Those monies will then be available for the general body of Mr Maud's creditors".

129. The standard of proof to show a breach of the Rule in Bankruptcy is high. In In re Amalgamated Properties of Rhodesia (1913) Ltd [1917] 2 Ch 115 Sargant J said:

"the petitioners, as judgment creditors for this very large sum, are prima facie entitled ex debito justitiae to a winding up order, and it seems to me to be impossible to displace that prima facie position without the very strongest proof that the petition is being improperly made use of for some ulterior motive".

130. A mixed motive on behalf of the petitioner does not amount to abuse of process. In Hicks v Gulliver [2002] BPIR 518, H sought to have the bankruptcy petition filed by G dismissed because she said it was designed to stifle her claim against another party in related litigation. HHJ Weeks QC rejected the argument, holding that even though stifling may have been the effect of the petition, it was plain that G just wanted to be paid the costs or some part of them. He said:

"…The sole argument presented to me on behalf of Mrs Hicks on this appeal is that under subs (3) of s 266, which I have read, the application should have been dismissed as an abuse of the court's process because the intention of the petitioners was to stifle the proceedings against Mr Gosland and that that is not a legitimate purpose…

"…if the presenter of a petition has two purposes, one of which is the lawful purpose of seeking to obtain a dividend in the bankruptcy, a second purpose, however important that might seem to the presenter, is insufficient to justify stigmatising the petition as an abuse of the court's process. […] I think I am bound to hold that if at least one genuine purpose of the petitioner is to obtain a dividend in the bankruptcy if one is forthcoming, that is sufficient to justify the presentation of a petition …

"Furthermore, I am not entirely satisfied that the stifling of an action in itself is an illegitimate purpose. It may well be legitimate for a creditor to take the view that the debtor ought not to be spending his money – or what is his money until the bankruptcy order is obtained – on an action which has no prospect of success and which may result in an entirely unjustified increase of the liabilities which will compete with the petitioning creditor eventually when the bankruptcy petition is presented" (emphasis added).

131. That said BMIF fairly took me to the decision of Snowden J in re Maud [2016] EWHC 2175 (Ch) which made it clear that a court must be realistic about what the petitioning party actually wanted:

"It also appears that a petitioner who has more than one objective or purpose in presenting and pursuing a petition may be able to avoid a finding of abuse of process if one of his purposes is legitimate, even though that is not his principal purpose. However, as regards the decision in Hicks v Gulliver, I would observe in passing that I do not think that it can be the law that just because a petitioner can say that one of its purposes is to obtain a dividend (however small) on its debt in the bankruptcy, its petition cannot be an abuse of process, no matter what its other purposes might be. As I observed in argument, and none of the counsel who appeared before me disagreed, the effect of a petitioner who is seeking a winding-up or bankruptcy order with the illegitimate purpose of obtaining a benefit for himself at the expense of the other creditors may well be merely to reduce, rather than eliminate altogether, the dividend payable on the unsecured debts in the bankruptcy. Such a case may be no less an abuse of the collective process because the petitioner can say that he would (in addition to obtaining the singular benefit for himself at the expense of the other members of the class) also wish to receive the (reduced) dividend on his debt" (emphasis added).

132. Jones v Sky Wheels Group [2020] EWHC 1112 (Ch) is another decision of Snowden J. A statutory demand was set aside by a judge on the basis that "the situation has been manipulated to enable [the creditor] to obtain a bankruptcy order which would avoid him potentially facing the unfair prejudice proceedings from [the debtor]". Counsel criticised this as being too general and vague a concern but Snowden J upheld the decision on appeal.

133. The creditors had earlier stated a clear intention to pursue damages for the non-payment of debt. At some point they then chose "instead to go down the path of bankruptcy proceedings", and there was "no credible explanation" for this other than the fact that it became apparent to them that the debtor was serious about bringing an unfair prejudice claim. Snowden J concluded:

"In the absence of any other coherent explanation, I am driven to the same conclusion which Judge Watkin reached, namely that Company's decision to change tack and commence bankruptcy proceedings was driven by a desire to bankrupt Mr. Jones in order to forestall his threatened Section 994 Petition against Mr. Schofield. Consistent with the approach of Nicholls LJ in Re a Debtor , Judge Watkin concluded - and I believe she had ample basis for concluding - that this rendered it unjust for Mr. Jones to face the consequences of bankruptcy proceedings before his Petition could be heard, so that it was appropriate for her to exercise her discretion under IR 10.5(5)(d)".

134. Snowden J also made it clear that the Rule in Bankruptcy can be considered in a rule 10.5(5)(d) set aside application:

"I also consider that Judge Watkin's conclusion could have been justified by analogy to the principles which apply when the Court is considering, under its inherent jurisdiction, whether a bankruptcy petition is an abuse of process. Bankruptcy proceedings are a class remedy, and even if a statutory demand is served in respect of a debt that is otherwise undisputed, if the bankruptcy process is being used to enable the petitioner to achieve an illegitimate purpose to the detriment of the class of creditors, this will constitute an abuse of the process of the court"

Other Authorities

Though not referred to King, it is helpful to also quote from two other Re Maud judgments of Snowden J:

(1) In Re Maud [2020] EWHC 974 (Ch), the 'April Judgment', Snowden J said, at paragraphs 137 to 141:

‘137. As I held in the First Judgment, the basic principles of law which apply to the question of whether a bankruptcy petition is an abuse of process are those set out by Rose J in paragraph [29] of her judgment refusing to set aside Edgeworth's statutory demand,

"29. In the light of these authorities I conclude that the pursuit of insolvency proceedings in respect of a debt which is otherwise undisputed will amount to an abuse in two situations. The first is where the petitioner does not really want to obtain the liquidation or bankruptcy of the company or individual at all, but issues or threatens to issue the proceedings to put pressure on the target to take some other action which the target is otherwise unwilling to take. The second is where the petitioner does want to achieve the relief sought but he is not acting in the interests of the class of creditors of which he is one or where the success of his petition will operate to the disadvantage of the body of creditors."

…

139. As I indicated in my First Judgment, however, Rose J's statement of the second situation requires two points of further explanation. The first is that it will be an abuse of process if, even though the petitioner wants a bankruptcy order to be made, recovering its debt through the bankruptcy process is no part of its purpose. The example of that type of abuse in the authorities is the Irish case of McGinn v Beagan [1962] IR 364 which concerned the long-running personal feud between the town clerk of the Castleblayney Urban District Council and a town councillor. The town clerk took an assignment of debts owed by the councillor, and petitioned for his bankruptcy. The judge found, as a fact, that the town clerk did not have the purpose of recovering any money, but was motivated by the sole purpose of making the councillor bankrupt and unseating him from the town council.

140. As I indicated in my First Judgment, however, McGinn v Beagan was highly unusual because there was an express finding that the petitioner was not using the bankruptcy process to find assets which could be made available for creditors or to get payment. I expressed the view that in a commercial setting it is likely to be difficult to establish on the facts that a petitioner is not seeking to receive some payment on the debt which he is owed.

141. The second point which I explained in my First Judgment is that a petition will not be an abuse of process if, in addition to wishing to receive a dividend on his debt in the bankruptcy together with other creditors, the petitioner has a collateral purpose which is not shared with the other creditors, but which will not cause them any detriment if achieved. In essence that is the position which Rose J reached at the hearing before her when she concluded that Mr. Maud had not established that triggering the preemption provisions in relation to Mr. Maud's Ramblas shares would result in loss to his creditors, because a fair price would be paid for them under the mechanism in Ramblas' Articles of Association.’

(2) In Re Maud [2020] EWHC 1469 (Ch), Snowden J considered whether he should reconsider the analysis in his April Judgment ‘…in light of the new materials placed before me relating to the Interest Claim’ ( paragraph 27), at paragraphs 30-31 (subparagraph numbers are (1) 2. 2. 2. in original - oddly) (June 2018 judgment is unavailable).

‘...[the debtor's barrister's] ... submitted that the correct approach in law was as follows,

“(1) a petitioner abuses “the process of the court in seeking a bankruptcy order or a winding-up order for a purpose which is contrary or alien to the nature of the class remedy that he is purporting to invoke” (para 115 of the Appeal Judgment);

2. a petition will not be an abuse of process, however, if in addition to wishing to receive a dividend on his debt in the bankruptcy together with other creditors, the petitioner has a collateral purpose which is not shared with the other creditors but which will not cause them any detriment if achieved (see para 82 of the June 2018 Judgment);

2. however, if a creditor has such a collateral purpose which would operate to the detriment of the class, he cannot save his petition by protesting that he would still wish to receive a dividend upon his debt in the bankruptcy, because the effect of his achieving his collateral purpose would be to reduce that dividend for all creditors (see para 83 of the June 2018 Judgment); and

2. a petition would be an abuse of process if it was being pursued, not to recover the petition debt at all, but solely for an extraneous purpose, even though that did not harm the interests of creditors (see para 84 of the June 2018 Judgment).”

31. That approach was consistent with the analysis of the authorities by Rose J when refusing to set aside Edgeworth’s statutory demand (for which Mr. Maud was refused permission to appeal by Gloster LJ). It was also essentially the test that I applied in my [April Judgment]: see paragraphs 137-141.’

Snowden J concluded, at paragraph 39, that there was no ‘...realistic prospect of a successful appeal on the basis that I applied the wrong legal test in determining whether the Edgeworth Petition was an abuse of process.’

Spectrum

What Snowden J said in Re Maud [2020] EWHC 1469 (Ch) is particularly illuminating about mixed purposes - the middle ground, so to speak on the spectrum of purposes (motivations). To elaborate, clearly, there is spectrum as to what is motivating, what is driving, the statutory demander / would-be petitioner / petitioner to seek a bankruptcy order. At one end will be a 'sole proper purpose' (for which use of the bankruptcy process cannot be impugned), and at the other end, 'sole improper purpose' (which will render use of the bankruptcy process, an abuse of process, even though achieving that 'improper purpose' would not harm the interests of the general body of creditors of the debtor; e.g. McGinn v Beagan [1962] IR 364). The middle ground is the part between these two extremes. In this middle ground, there is a varied mix of 'proper purpose(s)' and 'improper purpose(s)'. What mix will render use of the bankruptcy process an abuse of process. What mix will not, is addressed by Snowden J in Re Maud [2020] EWHC 1469 (Ch)

Where there are mixed purposes for use of the bankruptcy process, the key seems to be about whether (any of) the improper purpose(s) will, or will not, cause them any detriment to the general body of unsecured creditors of the debtor, if that improper purpose is achieved. Where there would be detriment from (any of) the improper purpose(s), this will taint everything, and render use of the bankruptcy process, an abuse of process. Conversely, where there would not be detriment from (any of) the improper purpose(s), the improper purposes will not taint everything, and so use of the bankruptcy process, will not be rendered an abuse of process.

SIMON HILL © 2023*

BARRISTER

33 BEDFORD ROW

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