Alternatives to pari passu

is well placed and can spread default risks across taxpayers who, in turn, are likely to be able to cope with marginal increases in tax rates without suffering catastrophic consequences. Resilient traders tend to be those

whose businesses are not totally dependent on the viability of one particular debtor170 and who are involved in the supply of goods or services to a large

number of customers. If one of their customers becomes insolvent they are less exposed to disaster than those trade creditors who deal with only one main customer. Most trade creditors are relatively protected in this respect, as are many tort victims. Employees, on the other hand, are seldom able to spread default risks and so are highly vulnerable.171 Tort creditors and consumer creditors, as has been seen, will tend to be lower-cost risk bearers than employees since they will usually have other sources of income, funds and products, and risks will be spread by such diversification.

Bearing in mind such issues of fairness to the vulnerable and effi- ciency, it is almost time to consider particular alternatives to pari passu but before doing so we should map out the limitations of the role that pari passu plays in the insolvency process.172

The first such limitation is in the breadth of that role. It can be argued that by the time the pari passu principle comes into play many of the difficult insolvency law questions have been posed and answered.173 There is force in this point. The role of pari passu is defined and limited by the shape of exceptions and bypassing arrangements that insolvency law allows. As has been indicated, those exceptions and bypassing devices raise, in themselves, numerous issues of efficiency and fairness (not to mention expertise and accountability). To allow the use of such devices is not merely to reduce the role of pari passu, it introduces principles and priorities to override pari passu. When teachers say ‘The sweets will be distributed equally to all children in the class’ we see a single, clear principle of fairness. When they say ‘All red-haired children’s appetites will, however, be satisfied first and then equal distribution will take place’, the fairness of Animal Farm comes to mind.

Limitations of scope do not in themselves, however, constitute reasons for abandoning pari passu. Questions arise as to the acceptability of the overriding principles that qualify pari passu but it could still be argued

170 Ibid. 171 Ibid.

172For arguments that pari passu is less important than it is generally held out to be, see F. Oditah, ‘Assets and the Treatment of Claims in Insolvency’ (1992) 108 LQR 459 at 468–76; Mokal, ‘Priority as Pathology’; L. C. Ho, ‘Goode’s Swan Song to Corporate Insolvency Law’ (2006) 17 EBLR 1727; see also ch. 14 above.

173See Mokal, ‘Priority as Pathology’, esp. pp. 587–8.

668 gathering and distributing the assets

that pari passu is the most appropriate method of redistributing residual assets and that other principles would, even in relation to the residual assets, produce significantly different (perhaps less acceptable) results for residual claimants.

If, however, the role of pari passu is seen in terms of ensuring that unsecured creditors are dealt with in an efficient and fair way, it should be noted that there are approaches to this issue that go beyond asking how the residual assets should be distributed and that these can be seen as further limitations on the importance of pari passu. Five such approaches can be noted. These look to protect unsecured creditors through:

*rethinking how the estate is constructed (for example, by considering priorities and deferrals);174

*procedural protections (for example, improving transparency and disclosure through insolvency regimes);

*substantive protections (for example, augmenting the residual estate with the section 176A prescribed part fund or directors’ contribution through personal liability);

*reducing insolvency risks (for example, through training of directors, corporate governance improvements, educating traders in reasons for corporate collapse, encouraging banks and secured creditors to monitor);

*spreading insolvency risks: either across groups of companies;175 or through compensation schemes;176 or through insurance mechanisms.177

If these alternatives are borne in mind it can be concluded that the role of pari passu is modest, given that issues concerning pari passu are linked to, and surrounded by, a host of not inconsiderable questions. This does not, however, mean that pari passu is of insignificant importance.

A second limitation of pari passu’s role is that it is not wholly clear. The principle can be said to be weak because it operates in a confused manner due to the multiplicity of potential exceptions and bypassing arrangements encountered in law and practice. The above discussion

174A class of creditor that might be dealt with specifically by statute is the company director: see ch. 14 above, pp. 613–14.

175On insolvency issues raised by corporate groups see ch. 13 above.

176As in the travel industry via ABTA: see p. 654 above.

177On insurance limitations and availability see S. Shavell, ‘On Liability and Insurance’ (1982) 13 Bell Journal of Economics 120; V. Finch, ‘Personal Accountability and Corporate Control: The Role of Directors’ and Officers’ Liability Insurance’ (1994) 57 MLR 880 at 887–92.

suggests that there is scope for clarifying the rules governing exceptions and bypasses. Such clarification might be expected to reduce the costs incurred by parties seeking to protect themselves from insolvency risks but distributional consequences may flow: ordinary creditors who are still ill-placed to secure protections may be faced with a yet smaller residual estate as other parties take greater advantage of newly facilitated protections.

A number of questions are raised. A first issue is whether particular exceptions and bypasses are justifiable in themselves. This chapter and the last have explored a number of issues that arise on that front. A further matter, however, is whether, as a collectivity, the array of exceptions and bypasses involves too great a degree of confusion and too large a mass of uncertainty to offer efficiency and fairness. Viewed collectively, the question is whether a simpler, more rational and legally certain array of devices might be devised. If it is accepted that wellresourced, well-informed creditors will take any steps they think rational to protect themselves against the risks of insolvency, the challenge is to allow them to do this at lowest cost consistent with the fair treatment of other unsecured creditors: to achieve an acceptable balance of efficiencyserving and distributionally fair ends. At present, it could be argued, the worst of two worlds is achieved: the well-resourced expend too much money and time on protection and the poorly-resourced are left with too small a fund to draw from. Such reasoning suggests that a statutory clarification of the law relating to exceptions and bypasses would have much to offer provided that this reduced legal uncertainties and the costs of achieving protections while, at the same time, it provided adequate protections for those who cannot reasonably be expected to negotiate themselves into protected positions.

The final question for consideration in this chapter is whether the residual ordinary creditors who are left with a collectively ‘fair’ fund should be allocated shares in it pari passu or by other principles of distribution. To return to the children in our Orwellian classroom, distribution to the pupils might be governed by a principle of evenness but alternatives could be argued for. Larger shares could, for instance, be given to well-behaved children; to those who lodge confectionery claims first; to those who shout loudest; to those who need sugar most; to those who fared badly in prior distributions; or to those who would create most trouble if not favoured.

Let us now turn to consider the main alternatives to pari passu distribution of the residual estate.