An alternative to bankruptcy - Part 5 proposals

When a person is faced with a bleak financial situation, bankruptcy may appear to be the only outcome. However, there are certain circumstances where this may not have to be the case. Part 5 of the Insolvency Act 2006 provides for alternatives for individuals facing bankruptcy - and the Subpart 2 proposal option can be very beneficial to affected parties.

Potential benefits of the Part 5 Subpart 2 proposal

As an insolvency practitioner with extensive experience in this area, I have acted as trustee for a large number of individuals and successfully negotiated terms with their creditors to the advantage of all concerned. I have found that the Part 5 Subpart 2 proposal option has become more popular for:

  • insolvent individuals who face significant personal guarantee obligations arising from the failure of an insolvent company, and
  • individuals who face bankruptcy proceedings and do not wish to face the restrictions involved in bankruptcies which include the inability to act as a director of a company, the loss of control of financial affairs, and restrictions to international travel let alone the stigma attached to bankruptcy.

Outcome of the proposal

The proposal must offer an outcome that would be better for creditors than that achieved in bankruptcy. The offer requires funding, which can be from any number of sources, including future earnings, third party lenders and existing assets. The formal proposal documentation is required to set out the offer to creditors, and provides for unsecured, preferential and secured creditors. The preferential creditors are required to be paid in priority to all other debts to the extent of such preference defined by the Insolvency Act 2006.

The proposal itself records a commitment to pay off a percentage of debt and can be either by way of an upfront lump sum payment shared pro-rata amongst creditors (after taking into consideration the priority provisions of the Insolvency Act 2006) within a short time period (usually timed within a fixed time period from date of High Court approval) or can be payable over time.

The proposal offer is a full and final settlement of all personal debts and obligations. It is a way for an insolvent person to reach a formal agreement that enables the individual to undertake business activities and have essentially the freedom to work without the consequences and restrictions of bankruptcy.

The procedure

The formal documentation includes the proposal offer and the individual's statement of affairs and affidavit which provides the details of the insolvent's assets, debts, and liabilities and provides a background statement with an explanation on how insolvency occurred and the benefits of the proposal and why creditors should support the proposal.

Voting at meetings

A proposal must be approved by requisite majorities in number and value and then sanctioned by the High Court to be valid. This requires 50% in number and 75% in value of creditors voting on the matter to pass a resolution agreeing to the proposal. Following the creditors' meeting, the provisional trustee seeks Court approval for the proposal.

Approval of proposal by the court

At the Court hearing, the Court considers the merits of the proposal and provides an opportunity for opposing creditors to be heard. The grounds for refusal of the proposal are set out in the Insolvency Act 2006. These include non-compliance with the Insolvency Act 2006, the terms of the proposal not being reasonable or not calculated to be for the benefit of the general body of creditors or that it is not expedient that the proposal be approved. Public interest and commercial considerations are also taken into account by the Court. There is no benefit in putting forward a proposal when the insolvent is aware that more than 25% by value of their creditors would oppose the proposal in any case.

The Court generally accepts the views of the majority of creditors. However, this is not a pre-determinant of the proposal. The wider public interest consideration is relevant and unless it is clear that the creditors are better off under the proposal than in bankruptcy, then the proposal can be rejected at the Court approval stage.

General comments

If bankruptcy proceedings have been lodged and are pending, a proposal can be presented to creditors at this late stage and an adjournment sought. It is, however better to be pro-active rather than reactive and to propose a Part 5 proposal to creditors prior to bankruptcy notices being served.

No enforcement or bankruptcy proceedings can be taken during the period from filing the proposal and the Court application for approval of the proposal. On the completion of the proposal the insolvent person is released from any liability whatsoever to the participating creditors whether personally as guarantor or otherwise.

McDonald Vague has assisted many insolvent people over the years with presenting Part 5 proposals under the Insolvency Act 2006 and prior to that, Part XV proposals under the Insolvency Act 1967.

We have provided advice to individuals and have completed many successful proposals. These proposals have been for a range of percentages in the dollar of the debt owing and have been over time periods of up to three years. We have found that creditors generally prefer proposals that offer lump sum payments up front or over short time periods. Often the percentage in the dollar is less relevant than the physical amount paid.

Insolvent persons with debts less than $40,000 can also consider No Asset Procedures as other alternatives to bankruptcy.

If you have a client who you think may benefit from a Part 5 proposal - particularly a client who has a vested interest in remaining in business and not being restricted from a director's position - please contact us to discuss their situation and we would be happy to advise further.

Please also see our more detailed article on this topic headed 'Personal insolvency - Part 5 proposals'.

This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.