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'.

DISCLAIMER
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.

A Part 5 Subpart 2 proposal under the Insolvency Act 2006 gives a debtor an alternative to bankruptcy.  If the proposal succeeds, then the insolvent is bound by the proposal and does not have to comply with the usual provisions of a bankruptcy.  For example, the debtor may carry on in business and have more than one bank account, and is not prevented from leaving the country.

Proposals are called Part 5 proposals because they fall under Part 5 Subpart 2 of the Insolvency Act 2006.  The person who is subject to a proposal is called "the insolvent."

A proposal is in effect a contract between a debtor and his or her creditors.  The insolvent may put an offer to his or her creditors.  If the creditors agree to the offer with a requisite majority, and the Court approves the proposal, then so long as the debtor fulfills his or her obligations under the proposal that is the end of the matter.

During the course of the proposal no creditor may take any action against the debtor to make the debtor bankrupt, and at the end of the proposal residual debts, if any, are extinguished.

Legislation

The legislation applying is as follows:-

• Insolvency Act 2006
• The Insolvency (Personal Insolvency) Regulations 2007
• The High Court Rules, Part 24

What may be in a proposal

Section 326 of the Insolvency Act 2006 states as follows:-

An insolvent may make a proposal to creditors for the payment or satisfaction of the insolvent's debts

A proposal may include all or any of the following:

• an offer to assign all or any of the insolvent's property to a trustee for the benefit of the creditors
• an offer to pay the insolvent's debts by installments
• an offer to compromise the insolvent's debts at less than 100 cents in the dollar
• an offer to pay the insolvent's debts at some time in the future
• any other offer for an arrangement for the satisfaction of the insolvent's debts

The proposal may include any other conditions for the benefit of the creditors and may be accompanied by a charge or guarantee

The procedure

A proposal is drafted.  To this is attached a statement of assets, debts and liabilities of the insolvent and a background statement.  This statement is verified by affidavits.

• The proposal is signed by the insolvent and also by some person willing to act as trustee for the creditors
• The proposal is then filed in the High Court
• Upon the filing of the proposal, the trustee named in the proposal becomes the provisional trustee and has an obligation to forthwith call a meeting of creditors by posting to every known creditor, at their last known address;
  • Notice of date, time and place of meeting
  • Statement of the assets and liabilities of the insolvent
  • A copy of the proposal
  • A formal proof of debt
  • A voting letter in the prescribed form

Meeting of creditors

The next step is there is a meeting of creditors at which the provisional trustee is the chairperson, unless creditors elect their own chairperson.

The creditors have a right to examine the insolvent and may accept the proposal or may ask for modifications to the proposal.  Any such modifications have to be agreed to by the insolvent.

Voting at meeting

The resolution to approve the proposal is decided by a majority in number and 75% in value of those creditors who vote.  The same majority is required for any modifications to the proposal.

Approval of proposal by the High Court

Upon acceptance of the proposal by the creditors, the trustee completes detailed minutes and then applies to the Court for approval of the proposal.  It is the Court that approves the proposal - not the creditors.

The Court, however, has no power to approve the proposal unless the necessary threshold has been met.  A notice of the Court hearing is sent by the provisional trustee to the insolvent and to every known creditor.

The Court, before approving a proposal, will hear any objection that might be made by or on behalf of any creditor.  If the proposal is in order, the Court will usually approve the proposal.  An approved proposal is binding on all creditors listed in the proposal, not just those who voted.

The Court has no power to approve the proposal if the proper procedure has not been followed.  The Court also has discretion not to approve the proposal on various grounds.  The most common ground would be that the terms of the proposal are not reasonable or are not calculated to benefit the general body of creditors.

Variations from normal insolvency law

The law regarding the Part 5 proposal differs in many ways from the law applying to normal insolvency matters.  For example; in a Part 5 proposal preferential creditors are not entitled to vote.  In other insolvency procedures (liquidation or compromise), preferential creditors are entitled to vote.

Also, secured creditors are allowed to vote for the full amount owing to them.  Under normal insolvency law, secured creditors must first deduct the value of their security.

General comments

For a Part 5 proposal to succeed the following elements must be present:-

• There must be some goodwill between the debtor and his or her creditors
• The provisional trustee and the solicitor involved must be able to work effectively with each other
• Creditors must be convinced that the Part 5 proposal will give them a better result than if the insolvent were to be adjudicated bankrupt

Conclusion

Part 5 proposals can be very effective:-

• They can enable a person to continue to be self-employed
• They can enable creditors to get back more than would be achieved in a bankruptcy
• They can enable creditors to get continuing work from the debtor

In short, a good Part 5 proposal will benefit both the debtor and the creditor.

Please also see our further article on this topic 'An alternative to bankruptcy - Part 5 proposals'

DISCLAIMER
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.

When a company fails one of four things usually happens:-

• A receiver is appointed
• An administrator is appointed
• It enters into a compromise with its creditors
• It is put into liquidation (this will be covered in Part 2)

This article seeks to explain the rights that creditors have in each of the above insolvency proceedings. It is written from the perspective of the ordinary unsecured creditor.

1 - Receivership

The purpose of receivership is to repay the debt owed to the General Security Agreement ("GSA") holder.  GSA holders tend to be banks but can also be private lenders (including directors and family members). The receiver's obligations are primarily to the GSA holder who appointed them. If a receiver holds surplus funds after repaying the GSA holder these must be returned to the company or paid to a liquidator to distribute. Receivers have no powers to make distributions to unsecured creditors. There are also no meetings of creditors in a receivership.

The main option for unsecured creditors is therefore to apply to the Court for a liquidator to be appointed (assuming the shareholders are not willing to appoint a liquidator voluntarily). Although a liquidator cannot take control of charged assets until the GSA holder has been repaid, he/she can do the following:-

• Examine the validity of the GSA and of the receiver's appointment
• Examine the receiver's acts and ensure that he/she has obtained the best possible price for the assets
• Take actions not available to a receiver, the commonest being:-

- Insolvent transactions (previously known as voidable preferences), and insolvent setoffs
- Voidable charges
- Transactions for inadequate or excessive consideration with directors

However, legal action can cost many tens of thousands of dollars and if there are no surplus funds a liquidator may well need funding to bring such actions.

2 - Voluntary administration

The voluntary administration procedure was introduced in New Zealand in November 2007. Its stated aims are to either:-

1. maximise the chances of the company continuing in existence or;
2. achieve a better return for creditors than would be achieved in a liquidation

Appointment
An administrator can theoretically be appointed by the Court on a creditor's application. However, this is unlikely in practice given the amount of knowledge that is required for the court application. The administrator is much more likely to be appointed by the company.

The right to have a first meeting of creditors
The administrator must hold a meeting of creditors within eight working days of their appointment. Creditors can vote at this meeting on whether to appoint a creditors' committee or whether to replace the administrator. A vote is passed if approved by a majority in number, representing 75% in value, of the creditors or class of creditors voting in person or by proxy/postal vote. The creditors' committee has the right to consult with the administrator and to receive and consider reports by the administrator.

The right to have a 'watershed meeting'
This meeting must be convened within 20 working days of the administrator's appointment (unless the Court extends this period) and then held within a further five working days. Voting rules are as above. Creditors have the right to vote on the following:-

1. to resolve that the company execute a Deed of Company Arrangement ("DOCA") with creditors
2. to resolve that the administration should end
3. to appoint a liquidator (which also ends the administration)

The administrator will become the deed administrator (where a DOCA is approved) or the liquidator (where creditors vote to put the company into liquidation), unless creditors specifically nominate another person for this role.

The deed administrator can later be replaced by the Court on a creditor's application. A DOCA is binding on all creditors (excluding secured creditors), whether or not they voted in favour of its execution.

The right to request amendments to or termination of a DOCA
Creditors owed a total of at least 10% of the combined amount owing to all creditors can require the deed administrator to convene a meeting to either vary or terminate the DOCA.

The right to review the administrator's accounts
The administrator is required to file receipts and payment summaries at the Companies Office every six months. Any creditor can view these accounts online.

3 - Compromises with creditors
Compromises with creditors are the one situation where power is technically in the hands of the unsecured creditors. For a compromise to succeed it must be approved by a majority in number and 75% in value of each class of creditor voting for the proposal. The same rules apply for voting as to any proposed variations to the compromise terms.

One of the difficulties with compromises is that every compromise is different and there is less integrity in some compromises than others. This is where the power to ask for amendments is invaluable. Before voting, creditors need to be satisfied that the following questions have been answered satisfactorily:-

• Will the proposal give them a greater return than they would achieve in a liquidation? To give some degree of comfort on this issue it may be necessary for an independent accountant to examine the company's books and records
• Is there a professional Compromise Manager in charge of the process? It would seem to be relying on blind faith to assume that the director, who was the architect of the company's difficulties, can independently manage the compromise arrangement
• Is there a creditors' committee to work alongside the Compromise Manager? If creditors want to be involved with the process they must be represented
• What happens if the compromise does not work out? For instance, will the Compromise Manager hold a signed resolution by the shareholders to place the company into liquidation, to be exercised if the company does not fulfil its obligations under the compromise?

Our article 'Company creditor compromises - worthwhile or not?' covers this topic in greater detail.

Note: This is an expanded and updated version of an earlier article written by John Vague and was subsequently revised by Jonathan Barrett.

DISCLAIMER
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.