Personal Bankruptcy and Alternatives — SQE1 FLK1 Business Law and Practice

Four months into a bankruptcy, a letter arrives from the Official Receiver. Her enquiries into the bankrupt's conduct are concluded. Nothing further is required of him. He reads that and hears one thing. It is over. There is work he cannot take while he is bankrupt, and he wants to take it. Is he discharged? No. He is discharged at the end of one year, and nothing in that letter moves the date.

This is Personal Bankruptcy and Alternatives, the last topic in Business Law and Practice. Almost every mark in it turns on a clock. How long a procedure lasts, and, harder, when the clock started running. Get those right and the rest is structure. Keep our man in mind. We are coming back for him.

Here is the route. Bankruptcy first: how you get in, what falls into the estate, and how you get out. Then the two formal alternatives, the individual voluntary arrangement and the debt relief order. Then the informal option, and what a creditor can do before any of it. And last, what all this does to a business and to a career.

Start with the shape. Three formal procedures: bankruptcy, the individual voluntary arrangement, and the debt relief order. One informal option beside them, the debt management plan, which is an agreement and nothing more. Each formal route has its own price, its own length and its own consequences.

Bankruptcy is an order declaring an individual unable to pay their debts. Assets are realised, creditors are paid a dividend. Two doors lead in. Since April 2016 a debtor who wants to be made bankrupt does not petition a court at all. The application goes online to an adjudicator. It costs £680: a £130 adjudicator's fee plus a £550 deposit for the Official Receiver.

There is no remission for a low income. It can be paid in instalments of at least £5, but nothing reaches the adjudicator until the whole £680 is there. So who makes the order on a debtor's own application, the court or the adjudicator? The adjudicator, usually within 28 days.

A creditor's petition is different. The creditor must be owed at least £5,000, and must show that the debtor cannot pay. There are two standard ways to show it.

The usual one is the statutory demand: a formal demand for a debt of at least £5,000, giving the debtor 21 days to pay or secure it. It is not a court document. Serve it, wait three weeks, and if nothing has been paid, secured or set aside, that unsatisfied demand is your evidence that he cannot pay. The other route is a judgment with execution returned unsatisfied.

The order is made, and the Official Receiver becomes trustee of the estate automatically. That is s.291A Insolvency Act 1986. A government official, not a private appointment. The Official Receiver investigates the debtor's affairs, realises the assets and distributes them, and may examine the bankrupt. An insolvency practitioner can be appointed trustee instead, and the creditors decide that through a decision procedure.

A secured creditor stands outside most of this. It realises its security and proves as an unsecured creditor for any shortfall. What it cannot do is keep the security and prove for the whole debt as well.

Now the estate, and this is where the marks live. It is all the property belonging to the debtor at the commencement of the bankruptcy. Section 283. Commencement, not discovery, not discharge. Excluded are the tools, books, vehicles and other equipment he needs personally for his work, and the clothing, bedding, furniture and household equipment needed for basic domestic needs.

But an exclusion is not a licence to keep a luxury. A joiner owns a fitted workshop van worth £25,000, and genuinely needs a van. Exempt? Yes. Safe? No. Under s.308 the trustee can claim an over-valuable exempt item by notice, sell it, buy an adequate second-hand van for about £6,000, and keep the difference for the creditors.

What about property that arrives later? He is made bankrupt in June. In September an aunt dies and leaves him £50,000. Does it fall into the estate? Not by itself. Property acquired after the order does not vest automatically. The trustee must claim it by written notice under s.307, and cannot serve that notice more than 42 days after learning of it.

Two contrasts worth holding. A registered pension sits outside the estate altogether, under s.11 of the Welfare Reform and Pensions Act 1999. And the court cannot make a bankrupt draw down a fund he has not touched. That is Horton v Henry. A cause of action is the opposite. It vests in the trustee, so a bankrupt suing for his own unpaid invoices loses the right to run the claim. Heath v Tang.

The family home is not excluded, and it is usually the largest asset there is. Any equity above the mortgage belongs to the estate. But a clock runs on it. Under s.283A the trustee has three years from the commencement of the bankruptcy to deal with the bankrupt's interest. Realise it, apply for an order for sale or possession, apply for a charging order, or agree terms with the bankrupt.

Miss all four, and the interest ceases to be part of the estate. It revests in the bankrupt automatically. Not on application. Not as a discretion. By expiry.

Income is not an asset, and it is handled separately. A bankrupt earning more than his family reasonably needs can be made to hand over the surplus, under an income payments order or an agreement under s.310A. Earn £3,400 a month against reasonable needs of £2,900, and £500 a month goes to the trustee. It can run for up to three years, and it survives discharge.

The trustee also looks backwards, and three provisions do that work. First, s.284. Once a petition is presented, any disposition of property by the debtor is void unless the court consents or later ratifies it. Sell a van for a full £8,000 to a friend who knows about the petition, and the sale is still void. Full price is no answer.

Second, transactions at an undervalue. Section 339 catches a transfer for significantly less than the thing was worth, made in the five years ending with the petition. Insolvency must be proved only where the transfer was more than two years before. So a share worth £40,000 sold to a brother for £10,000, eighteen months before the petition, can be unwound.

Third, preferences. Section 340 catches putting a creditor into a better position than he would otherwise have been in. A man repays his brother's £10,000 loan in full three months before his petition, while the suppliers go unpaid. Recoverable? Yes. Six months is the ordinary period, two years for an associate, and for an associate the desire to prefer is presumed.

And credit provided by the bankrupt's spouse or civil partner is postponed under s.329, behind the ordinary creditors and behind the statutory interest on their debts. Commercial terms and a signed agreement change nothing.

Now the way out, and back to our man with the letter. Discharge is automatic one year after the bankruptcy commences. That is s.279. It happens whether or not the trustee has finished. His trustee expects to be paying dividends for another two years, and it changes nothing. There has been no early discharge since 1 October 2013.

Discharge releases him from most bankruptcy debts. Most. Student loans survive. Court fines survive. Child support arrears survive. So do debts arising from fraud, and confiscation orders. And the estate does not move: the house, the car, the legacy stay vested in the trustee. The period can be lengthened where he fails to cooperate. Never shortened.

One thing does make a bankruptcy disappear, and it is not discharge. Pay every bankruptcy debt and every expense, even with somebody else's money, and the court may annul the order under s.282. Annulment is retrospective. The order is treated as if it had never been made.

So to the alternatives. An individual voluntary arrangement is a formal agreement between debtor and creditors to repay over time, usually at a reduced amount, supervised by an insolvency practitioner. The debtor instructs a nominee, who prepares the proposal. If a creditor is about to petition, apply for an interim order under s.252. While it is in force, no bankruptcy petition may be presented or proceeded with.

Then the creditors decide, through a decision procedure. Physical meetings are no longer the default. Two tests, and here is the trap. Three-quarters or more in value of the creditors responding must vote in favour. And separately, the decision fails if more than half in value of the creditors who are not associates of the debtor vote against.

A woman owes £100,000. Her father lent her £70,000; four suppliers are owed the other £30,000. Her father votes in favour, suppliers owed £12,000 in favour, suppliers owed £18,000 against. That is 82 per cent in value in favour, clearing the first test. Approved? No. Her father is a relative, and so an associate. Strip him out, and £18,000 of the unconnected £30,000 voted against. 60 per cent. It fails.

Approved, it binds every creditor who was notified, including those who voted against. Unanimity has never been required. The debtor keeps his assets, usually including his home, and escapes the bankruptcy restrictions. The price is time. Five or six years, and an insolvency practitioner's fees.

Miss the payments and the supervisor, or anyone bound by the arrangement, can petition for his bankruptcy. On what ground? Not simply that it failed. Section 276 gives three. Failure to comply with the arrangement, false or misleading information given to the creditors, or failure to do what the supervisor reasonably required. And the bankruptcy commences on the day the order is made, not on the day of the failure.

The second alternative is the debt relief order, for people with almost nothing. Three hard limits. Qualifying debts no more than £50,000. Assets no more than £2,000, with a single domestic motor vehicle worth less than £4,000 left out of that total. And surplus income, after reasonable household expenses, no more than £75 a month.

Three more conditions. No bankruptcy and no debt relief order in the last six years. Not a homeowner with equity, because equity alone blows the £2,000 limit. And no bankruptcy petition pending unless the petitioning creditor consents, though a county court judgment is no bar. It goes through an approved intermediary, the Official Receiver makes the order, and since April 2024 there is no fee.

It lasts 12 months, and the included debts are then written off. Most consumer debts are in: credit cards, overdrafts, rent arrears, utility bills, council tax. Student loans, court fines, child support arrears and fraud debts are out, exactly as in bankruptcy. And in working out surplus income, deduct her outgoings, but not the payments to the creditors she wants written off.

Two smaller options. An administration order has the debtor pay the court, which distributes to creditors, but it is limited to debts under £5,000 and is now rarely used. A debt management plan is informal. No court, no register, not binding, and creditors can still enforce.

Last, what all this does to a working life. An undischarged bankrupt cannot act as a director, or take part in the management of a company, without the leave of the court. That is s.11 Company Directors Disqualification Act 1986. It bites automatically on the order, and breach is a criminal offence. A solicitor needs the SRA's permission to practise.

And the business itself? A sole trader is his business. Trade debts and family credit cards fall into the same bankruptcy, because there is nothing to separate. A partner is no safer. Under s.9 Partnership Act 1890 partners are liable jointly for the firm's debts, and joint liability is liability for the whole. A supplier owed £90,000 can pursue each solvent partner for all of it.

What about the firm itself? Section 33(1) dissolves a partnership on the bankruptcy of any partner, subject to any agreement between them. Dissolution is the default. A well-drafted agreement displaces it. Read the agreement first.

A word on how SQE1 tests this. You are not asked to recall section numbers, and there is barely a case name in the topic. You get a scenario, five answers, and one instruction: pick the best. Learn the rules. Treat the numbers as pegs.

If you keep only three pegs, keep three clocks. Section 279: discharge one year after the bankruptcy commences, automatic, whatever the trustee is still doing. Section 283A: three years to deal with the home, or the interest revests in the bankrupt. And Schedule 4A: a bankruptcy restrictions order runs from the date it is made, not from discharge, which is why it bites long after the bankrupt is free.

Four traps. One: a statutory demand can be fought. The debtor has 18 days from service to apply to set it aside, and applying in time stops the 21-day clock. The grounds include a counterclaim or set-off equalling or exceeding the debt, a debt disputed on substantial grounds, and security worth the whole debt.

Two: discharge does not end a bankruptcy restrictions order. Gambling, rash speculation, or debt incurred with no reasonable prospect of paying will do it. The court may make one for between two and fifteen years, beginning with the date the order is made. Not from discharge. This is the distinction the paper loves.

Three: the register and the credit file run on different clocks. The Individual Insolvency Register entry goes three months after discharge or completion. The credit file entry lasts six years from the date the procedure began, not from discharge, and not from the final payment.

Four: obtaining credit of £500 or more without disclosing the bankruptcy is an offence under s.360, and the duty is a positive one. A trade account for goods is credit. It is no defence that the form never asked, and that every answer given was true. Silence is the offence.

Quick check. A man is made bankrupt on a creditor's petition. Within weeks he tells the Official Receiver that he owns a half share of the house he lives in with his wife. After the mortgage, his share is worth about £30,000. Three years and two months have now passed. The trustee has never applied for sale or possession, never sought a charging order, and has made no agreement with him. The trustee now wants the house sold. Is the half share still available to the trustee?

Three candidate answers. One: yes, because the trustee remains in office and the share is still part of the estate. Two: no, because the trustee took no qualifying step within three years and the share has revested. Three: no, because the share revested on his automatic discharge, twelve months after the order. Pause here if you want a moment.

The answer is two. Section 283A gave the trustee three years from the commencement of the bankruptcy to deal with the interest. Realise it, apply for an order for sale or possession, apply for a charging order, or agree terms with the bankrupt. None of that was done. So the interest ceased to form part of the estate, and revested in him automatically.

Why the others fail. Option one assumes the trustee's continuing office keeps the share alive. It does not. Revesting happens on expiry, whatever the trustee's position. Option three is right for the wrong reason. Discharge released his debts. It left the estate, house and all, with the trustee.

Five things to take away. One: bankruptcy lasts one year and discharge is automatic, but the estate stays with the trustee, and a restrictions order can run for years past it. Two: the estate is what he owned at commencement, plus what the trustee claims by notice, less a short list of necessities and his pension.

Three: the home has its own clock. Three years to act, or the interest revests in the bankrupt. Four: an arrangement needs three-quarters in value of those responding, and still fails if more than half in value of the non-associate creditors vote against. Five: a debt relief order means £50,000 of debts, £2,000 of assets, £75 a month, and no home.

And our man with the letter? Nine months in, he is still bankrupt. The Official Receiver's enquiries being over is not a discharge. Only the calendar discharges him, at one year. That is the end of Business Law and Practice. Next time, a new subject: Dispute Resolution.

Practise this topic with exam-style questions at sqe1prep.co.uk. This episode is for education and exam revision only, not legal advice, and we are not affiliated with or endorsed by the SRA or Kaplan.