The roots of corporate insolvency law

Development and structure

The earliest insolvency laws in England and Wales were concerned with individual insolvency (bankruptcy) and date back to medieval times.3 Early common law offered no collective procedure for administering an insolvent’s estate but a creditor could seize either the body of a debtor or his effects – but not both. Creditors, moreover, had to act individually, there being no machinery for sharing expenses. When the person of the debtor was seized, detention in person at the creditor’s pleasure was provided for. Insolvency was thus seen as an offence little less criminal than a felony. From Tudor times onwards, insolvency has been driven by three distinct forces: impulsions to punish bankrupts; wishes to organise administration of their assets so that competing creditors are treated fairly and efficiently; and the hope that the bankrupt would be allowed to rehabilitate himself.4 Early insolvency law was dominated by punitive approaches and it was not until the early eighteenth century that notions of rehabilitation gained force. The idea that creditors might act collectively was recognised in 1542 with the enactment of the first English Bankruptcy Act which dealt with absconding debtors and empowered any aggrieved party to procure seizure of the debtor’s property, its sale and distribution to creditors ‘according to the quantity of their debts’.5 This statute did not, however, provide for rehabilitation in so far as it did not discharge the bankrupt’s liability for claims that were not fully paid.

Elizabethan legislation of 1570 then drew an important distinction between traders and others, including within the definition of a bankrupt only traders and merchants: those who earned their living by ‘buying and selling’.6 Non-traders could thus not be declared bankrupt. As for

3 On the history of insolvency law see Cork Report ch. 2, paras. 26–34; D. Milman, Personal Insolvency Law, Regulation and Policy (Ashgate, Aldershot, 2005) pp. 5–12; I. F. Fletcher,

Bankruptcy Law in England and the United States (Clarendon Press, Oxford, 1998); G. R. Rubin and D. Sugarman (eds.), Law, Economy and Society: Essays in the History of English Law (Professional Books, Abingdon, 1984) pp. 43–7; W. R. Cornish and G. de N. Clark, Law and Society in England 1750–1950 (Sweet & Maxwell, London, 1989) ch. 3, part II; V. M. Lester, Victorian Insolvency (Oxford University Press, Oxford, 1996).

4See Cornish and Clark, Law and Society, p. 231.

5Stat. 34 & 35 Hen. 8, c. 4, s. 1; see Fletcher, Law of Insolvency, p. 7; W. J. Jones, ‘The Foundations of English Bankruptcy: Statutes and Commissions in the Early Modern Period’ (1979) 69(3) Transactions of American Philosophical Society 69.

6J. Cohen, ‘History of Imprisonment for Debt and its Relation to the Development of Discharge in Bankruptcy’ (1982) 3 Journal of Legal History 153–6.

distribution, this statute again provided for equal distribution of assets among creditors.

Discharge of a bankrupt’s existing liabilities came into the law in the early eighteenth century when a 1705 statute relieved traders of liability for existing debts. This restriction of discharge to traders prompted a good deal of litigation throughout the eighteenth and early nineteenth centuries and an expansion of the definition of a trader. On why bankruptcy should have been restricted to the trader, contemporary and modern commentators7 have followed Blackstone8 in referring to the risks that traders run of becoming unable to pay debts without any fault of their own and to the trading necessity of allowing merchants to discharge debts. It can be pointed out that long before a general law of incorporation arrived (in the mid-nineteenth century), bankruptcy served as almost a surrogate form of limited liability which needed to be restricted to those undertaking mercantile endeavours and risks. The bankruptcy legislation, moreover, provided the only means by which eighteenthand early-nineteenth-century traders might limit their liabilities.

The state of the law was, however, deficient in many respects. Nontraders were still subject to the severities of common law enforcement procedures by means of seizures and impoundings of property and persons. These processes were non-collective and debtors might be imprisoned at the behest of single creditors without regard to the interests of others. An important difference between the bankruptcy laws available to traders and the insolvency schemes for non-traders was that whereas the bankrupt’s liabilities to creditors could be discharged on surrender of assets (even if these assets were insufficient to satisfy his entire debt), the insolvent non-trader was still obliged to repay the remainder of his judgment debt even though he had suffered seizure of his goods or served his term of imprisonment. Even traders could not apply of their own accord to be made bankrupt and, although discharge was possible after 1705, the law criminalised bankrupt traders and punished them severely, with the death penalty available in cases of

7Crompton, Practice Common-placed: Or, the Rules and Cases of the Practice in the Courts of King’s Bench and Common Pleas, LXVII (3rd edn, 1786); J. Dunscombe, ‘Bankruptcy: A Study in Comparative Legislation’ (1893) 2 Columbia University Studies in Political Science 17–18.

8W. Blackstone, Commentaries on the Laws of England (8th edn, Clarendon Press, Oxford, 1765–9) vol. II, no. 5: Cohen, ‘History of Imprisonment’, pp. 160–2; Cornish and Clark, Law and Society, p. 232; Cork Report, p. 33.

fraud.9 The bankruptcy system, moreover, was liable to manipulation by creditors and laid open to the ‘eighteenth century penchant for malign administration’.10 Nor was it the case that all traders were in practice brought within bankruptcy proceedings. The Erskine Commission of 1840 noted that the common law insolvency processes were frequently being used for small traders whose creditors were owed too little to justify bankruptcy proceedings (two-thirds of those before the Insolvent Debtors Court in 1839 were traders).11

Pressure for reform grew alongside dissatisfaction with the confinement of bankruptcy to traders. During the nineteenth century, attitudes towards trade credit and risk of default changed. A depersonalisation of business and credit was encouraged by Parliament’s enactment of the Joint Stock Companies Act 1844 together with notions that credit might be raised on an institutional basis and capital through stocks rather than both of these dealt with as matters of individual standing.12 Such changed attitudes rendered increasingly questionable Blackstone’s view that it was not justifiable for any person other than a trader to ‘encumber himself with debts of any considerable value’.13 The distinction between traders and non-traders was finally abolished in 1861 when bankruptcy proceedings became available for non-traders. Soon afterwards the Debtors Act 1869 abolished imprisonment for debt.

The origins of corporate insolvency law are to be found in the nineteenth-century development of the company. The key statute was the Joint Stock Companies Act 1844 which established the company as a distinct legal entity, although it retained unlimited liability for the shareholders. From 1844 onwards corporate insolvency was dealt with by means of special statutory provisions14 and the modern limited liability company emerged in 1855, to be followed seven years later by the first modern company law statute containing detailed winding-up provisions.15 Only from 1855 onwards, therefore, was the concept of the limited liability of members for the debts incurred by the company established in law. Members of incorporated companies could limit

9See Cork Report, paras. 37–8; Fletcher, Law of Insolvency, pp. 8–9.

10Cornish and Clark, Law and Society, p. 232. 11 Ibid., p. 234.

12On depersonalisation of business and credit in the USA see Rubin and Sugarman, Law, Economy and Society, pp. 43–4.

13Blackstone, vol. II, no. 5, p. 473.

14See e.g. Companies Winding Up Act 1844; Joint Stock Companies Act 1856; Companies Act 1862; Companies (Consolidation) Act 1908; Companies Acts of 1929, 1948 and 1985.

15Limited Liability Act 1855; Companies Act 1862.

their personal liability, thus creating a distinction between corporate and individual insolvency. The House of Lords in Salomon’s case16 confirmed that a duly formed company was a separate legal person from its members and that consequently even a one-man company’s debts were selfcontained and distinct. The growth of a specialised corpus of law and procedures dealing with corporate insolvency was manifest in the dedicated statutes already noted but it was also encouraged when issues relating to such matters became the exclusive jurisdiction of the Chancery Court in 1862.17

Thus the law dealing with company insolvencies developed independently from the law on the bankruptcy of individuals. By the late nineteenth century two separate bodies of law governed individual and corporate insolvency matters and these were dealt with by different courts, under different procedural rules18 and offering different substantive remedies. A degree of cross-influence between personal bankruptcy and corporate insolvency is discernible, however, and a number of principles and provisions of personal bankruptcy have been made applicable to company liquidation.19

Such a bifurcation of approaches produced, during the first half of the twentieth century, a confused tangle of insolvency laws that was both difficult to operate and prone to manipulation by the unscrupulous. Various committees were set up to look at particular aspects of the law dealing with credit, security and debt20 but it was the mid-1970s before the deficiencies in insolvency law were attended to at the governmental level. In 1975, Justice issued a report21 pointing to a number of serious deficiencies in the law of bankruptcy and making a number of reform proposals, some of which were adopted in the Insolvency Act of 1976, a short piece of legislation that was passed to remedy a number of the most serious defects pending broader review. Further pressure to reassess insolvency law flowed from the UK’s accession to membership of the EEC. This demanded that the UK negotiate with other Member States concerning a draft EEC Bankruptcy Convention. In order to secure advice for the Department of Trade, an advisory committee was

16Salomon v. A. Salomon & Co. Ltd [1897] AC 22.

17Companies Act 1862 s. 81. 18 See Fletcher, Law of Insolvency, p. 12.

19See H. Rajak, Insolvency Law: Theory and Practice (Sweet & Maxwell, London, 1993) p. 3 (citing as examples Companies Act 1985 ss. 612–13, 615).

20See the Crowther Committee (Cmnd 4596, 1968–71) and the Payne Committee (Cmnd 3909, 1965–9).

21Justice, Bankruptcy (London, 1975).

C o m m i tt e e o n I n s o l v e n c y L a w a n d P r a c t

25Cork Report. In 1979 the Cork Committee issued an interim report to the Minister, published in July 1980 as Bankruptcy: Interim Report of the Insolvency Law Review

C om m i t te e (Cmnd 79 68, 198 0). T he G overnment also p ro du ced a Bankruptcy: A Consultative Document (Cmnd 7967, 1980). This contained proposals

for the privatisation of insolvency procedures which were attacked by commentators (see I. F. Fletcher (1981) 44 MLR 77) and subsequently dropped.

26The rate of failure increased by over 35 per cent: see D. Hare and D. Milman, ‘Corporate Insolvency: The Cork Committee Proposals I’ (1983) 127 Sol. Jo. 230.

with individual cases on their merits. On particular matters of substance concerning corporate insolvency, the Cork Committee’s key recommendations included steps to deal with abusive practices. These involved recommendations that private insolvency practitioners should be professionally regulated to ensure adequate standards of competence and integrity; that creditors be given a greater voice in the choice of the liquidator; and that new penalties and constraints be placed on errant directors. Cork also proposed reforms designed to increase the survival chances of firms in difficulties. He had informed the press, on the establishment of his committee, that many more companies could be saved if outside administrators could be brought into companies before the time when a bank would formally appoint a receiver and in circumstances when the company lacked a loan structure allowing the appointment of receivers.27 The Cork Report, in due course, introduced the concept of the ‘administrator’ into corporate insolvency procedures with the function of managing a company’s business during a period of grace in the hope of reorganising the company and restoring it to profit- ability. The report, furthermore, favoured a movement towards greater creditor participation with an increased role for creditor committees and strengthened access to information for such committees.

A special concern of Cork was the plight of the unsecured creditor, who generally received nothing at the end of the day. This concern was reflected in the recommendations that virtually all preferential claims28 be abolished and that funding representing 10 per cent of all net realisations of assets subject to a floating charge be made available for distribution among ordinary unsecured creditors.29 This fund was also designed to be utilised to provide liquidators with the financial resources to investigate company affairs and to take the actions that Cork proposed should be taken against delinquent directors.

The broad philosophy of Cork – as far as it related to corporate insolvency – represented a movement towards stricter control of errant directors but also in favour of an increasing emphasis on rehabilitation of the company. Cork might have thought that existing law dealt with individual bankrupts (perhaps sole traders) in an excessively punitive

27See K. Cork, Cork on Cork: Sir Kenneth Cork Takes Stock (Macmillan, London, 1988) ch. 10, pp. 184–203.

28See pp. 604–14 below.

29On the Enterprise Act 2002 reform implementing a similar ‘prescribed part’ see ch. 3 below.

and stigmatic manner,30 but the Committee was determined to remedy the law’s perceived leniency in dealing with directors who abused the privilege of limited liability. In doing so, Cork aimed to bolster standards of commercial morality and to encourage the fulfilment of financial obligations.

As for rehabilitation, the Cork Committee aimed to devise an insolvency regime that would facilitate rescues rather than just process failures.31 Sir Kenneth Cork was to reflect on this philosophy in the autobiography he published six years after his seminal report. He wrote:

through publication of the Cork Report, I have … put forward our principle that business is a national asset and, that being so, all insolvency schemes must be aimed at saving businesses. I have been at pains to stress that when a business becomes insolvent it provides an occasion for a change of ownership from incompetent hands to people who not only have the wherewithal but also hopefully the competence, the imagination and the energy to save the business. Before the 1985 Act every insolvent business went into liquidation or receivership automatically. It was the kiss of death for them and the creator of unemployment … [W]ith the concept of the administrator and voluntary arrangements taking its place in Britain’s insolvency law, the chances look bright for more and more businesses being saved in the years that lie ahead …32

The Cork Report thus not merely provided the most comprehensive and rational review of English company insolvency rules ever undertaken but also flagged a historic movement away from punitive towards rehabilitative objectives.

The Report was not, however, to be instantly transposed into legislative form. It was not even made the subject of a formal debate in either House of Parliament.33 Four years passed before legislation delivered the unified code of insolvency law that Cork had advocated. This came with the Insolvency Act 1986. That statute was preceded by a 1984 White Paper34 and the Insolvency Act 1985, which together dealt with a variety of important aspects of insolvency but neither implemented the main body of Cork nor brought together in one Act all the statutory provisions relating to bankruptcy and those dealing with corporate insolvency. The Insolvency Act 1986 offered such an aggregation of measures dealing with the bankruptcy

30 See Cork, Cork on Cork, ch. 10. 31 See Cork Report, para. 1502.

32Cork, Cork on Cork, ch. 10, pp. 202–3.

33For an account of governmental and legislative developments in the wake of the Cork Report, see Fletcher, Law of Insolvency, pp. 16–20.

34A Revised Framework for Insolvency Law (Cmnd 9175, 1984).

of individuals and the insolvency of companies. It consolidated the Insolvency Act 1985 and the insolvency provisions of the Companies Act 1985 (except in relation to the disqualification of directors).35

The Cork Report recommendations produced a sea change in English corporate insolvency and, as noted, can be seen as the foundations of modern corporate insolvency regimes. The Cork Committee had been established by a Labour Government but its recommendations were given legislative effect by Margaret Thatcher’s Conservative administration. The membership of the committee was, however, characterised by strong professional and practitioner rather than political representation.36 The Cork Report set out to be systematic, pragmatic and balanced: as seen in its efforts to recognise the interests of secured creditors (especially banks) and those of unsecured, trade creditors. The Cork approach to floating charges, for instance, was to acknowledge their effect in prejudicing weaker creditors’ interests but to stop short of alienating the banks by proposing abolition of such charges.37 As for the Insolvency Act 1986, this can be seen as strongly shaped by both professional and political factors. As Carruthers and Halliday put it:

[I]t is inconceivable that the [1986 Act] can be understood without comprehension of the powerful ideological undercurrents that variously sought to champion reorganisation, privatise bankruptcy administration, professionalise insolvency practice and discipline company directors. While professionals and their technical interests were persuasive in the English reforms, the particular cost of the insolvency reforms, and the very fact of the parliamentary passage, testified to the affinity between professional agendas and wider party ideology.38

As will be seen in subsequent chapters, however, the Cork Report was not implemented to the letter by the 1986 Act and, although the different branches of insolvency law were harmonised to a degree, the longestablished distinction between corporate insolvency and personal bankruptcy law and procedures survived the passing of the Act. Sir Kenneth, moreover, was to be deeply concerned that the Government was selective in its approach to his recommendations, saying in his autobiography: ‘They

35See Company Directors’ Disqualification Act 1986. A few provisions of the Companies Act 2006 are relevant to insolvency and survive the Insolvency Act 1986: CA 2006 ss. 754, 895–900, 993 (see chs. 11 and 16 below).

36 See Carruthers and Halliday, Rescuing Business, pp. 124–5. 37 See chs. 3 and 15 below.

38Carruthers and Halliday, Rescuing Business, p. 148. On the politics of Cork and the committee’s membership see ibid., pp. 124–49.

ended up by doing the very thing we asked them not to. They picked bits and pieces out of it so that they finished with a mish-mash of old and new.’39 What was reflected in the 1986 Act, however, was the (already noted) aim of Cork to produce a set of rules capable of practical implementation. Thus, in the Act there can be seen two strong threads of concern: to establish formal legal procedures for business rescue and the orderly realisation and distribution of assets and to erect a regulatory framework that would prevent commercial malpractice and abuse of the insolvency

procedures themselves.

The operation of the Insolvency Act 1986 is a central concern of the chapters that follow. This piece of legislation has been through the fire of the 1989–93 economic recession and has been subject to review in a number of respects.40 The Enterprise Act 2002 effected a number of highly significant changes – most notably in largely replacing administrative receivership with the more inclusive arrangements of a revised administration process; in providing a ‘prescribed part’ fund for unsecured creditors; and in ending the Crown’s status as preferential creditor. The courts have also played their role in effecting change – with cases such as Spectrum Plus and Leyland DAF that have served either to change incentives to use different financing arrangements or to prompt the Government to make a legislative response on an issue.

In recent years, moreover, a number of dramatic changes have altered the landscape of corporate insolvency law and have transformed the assumptions that underpin the law and key processes of insolvency beyond those obtaining during the passing of the 1986 Act. Commercially and politically, there has, for instance, been a consolidation of the rescue culture within the UK and a new emphasis on managing insolvency risks proactively rather than after troubles have become crises. In comparison with the seventies and eighties, much more work on corporate problems is now carried out before any insolvency procedure is entered into. The ‘pre-packaged’

39Cork, Cork on Cork, p. 197; White Paper, A Revised Framework for Insolvency Law (1984).

40See DTI/Insolvency Service, Company Voluntary Arrangements and Administration Orders: A Consultative Document (October 1993). See also DTI/IS, Revised Proposals for a New Company Voluntary Arrangement Procedure (April 1995); DTI/IS, A Review of Company Rescue and Business Reconstruction Mechanisms (1999); DTI/IS, A Review of Company Rescue and Business Reconstruction Mechanisms: Report by the Review Group

(2000); Justice, Insolvency Law: An Agenda for Reform (London, 1994); DTI/IS,

Productivity and Enterprise: Insolvency – A Second Chance (Cm 5234, 2001); Company Law Review Steering Group, Modern Company Law for a Competitive Economy: Final Report (DTI, London, 2001). Key amending legislation since 1986 has included the Insolvency Acts of 1994 and 2000, the Enterprise Act 2002 and the Companies Act 2006.