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Critically analyse how insolvency law systems endeavour to balance
Putting in a layman’s language insolvency law is generally concerned with individuals and corporate sector where debtors and creditors are the key players. Insolvency in general suggests that person/s or companies who cannot strive to repay their debts and become bankrupt1 or insolvent. Stating it in another way, bankruptcy is when all or most of the debtor’s remaining assets are distributed amongst his/her creditors.2 Insolvency law strives to balance the interests between the creditors and debtors. It ensures that all parties are treated fairly and equally and full justice is done while striking the balance. Since past recent 20 years, in a system where credit is increasing, insolvency law is a necessity.3 For instance, the downfall of various big giants like Northern Rock4, Rover, Lehman Brothers5,etc have not only economic crisis but also social crisis.
As per the statistics6 in number of insolvencies, there is a need of a system which helps the debtors to revive back from the situation and provides an opportunity to start a new beginning and help them in discharging off their liabilities in a fair and organized manner. In an era, where there is increase in credit flow, the law has to pilot itself to help preventing chaos and henceforth the breakdown of credit.
Bankruptcy and insolvency suggests same in terms of meaning as referred in various articles based on the American terminology.
Andrew Keay, ‘Balancing Interests in Bankruptcy Law’  Common Law World Review 206
Professor Andrew Keay and Dr Peter Walton, ‘Insolvency Law: Corporate and Personal’ Second Edition, (Jordan, 2008) 3
BBC News (Northern Rock shares plunge 32%, 14th September 2007, 14:49 GMT 15:49 UK) <http://www.news.bbc.co.uk/1/hi/business/6994328.stm> accessed 25th November 2010.
Lehman Brothers International Europe  EWHC 2545 (ch)
For statistics refer the escalation data in:-
Andrew Keay, ‘Balancing Interests in Bankruptcy Law’  Common Law World Review 206
Tests for Insolvency:-
There are two types of methods to test insolvency:-
Cash Flow Method – Wherein a debtor is unable to pay the debts owed as they fall due.7
Balance Sheet Method – When the debtor’s total liabilities are greater than the total value of assets.8
In my view, insolvency law aims to deal with the activities of the respective parties involved which prevents insolvencies from stirring in the first place. Balancing the interests of the various parties involved is rather a moral or social obligation than an economic obligation. There are various principles on which insolvency law is based and it reflects how the insolvency law attempts in striking the right balance with virtues of honesty, equality, righteousness.
The Principles of Corporate Insolvency Law9
The administrators should first take into consideration the scope under general law, then those rights affected by the winding-up and then lastly analyse the statutory provisions.10
There are mainly ten principles : -
Corporate insolvency law recognizes rights accrued under the general law prior to liquidation.11 – The general rule is, liquidation does not cease the contracts or the rights.12
Insolvency Act 1986, S. 123(1)(e)
Insolvency Act 1986, S.123(2)
Roy Goode, ‘Principles Of Corporate Insolvency Law’, student edn., (Thomson, Sweet & Maxwell, 2005) Ch 3, 69 (All the principles are referred from Chapter-3)
Only the assets of the debtor company are available for its creditors.13 - The liquidator under his power cannot sell the assets of the company which are beneficially owned by the company.14
Security interests and other real rights created prior to the insolvency proceeding are unaffected by the winding up.15
The liquidator takes the assets subject to all limitations and defences.16 – The liquidator holds the same position as the company itself and has all the rights to act in good faith on behalf of the company.17
The pursuit of personal rights against the company is converted into a right to prove for a dividend in the liquidation.18 – When the company is insolvent the creditor with the real rights in an asset can orifice from the general creditors whereas the creditors with purely personal rights is required to claim in proof of debt like other unsecured creditors and shall receive pari passu distributions of dividend.19
On liquidation the company ceases to be the beneficial owner of its assets.20 – When the winding up procedure starts the company ceases to be its beneficial owner. The assets cannot be realised by the company for its own use.21
No creditor has any interest in specie in the company’s assets or realizations.22
Ibid citing Re Albert Life Assurance Co, The Delhi Bank’s Case (1871) 15 Sol. Jo. 923
Liquidation accelerates creditors’ rights to payment.23 – The creditor has an immediate right of proof not only for debts already due to him but also for those payable in the future or on a contingency.24
Unsecured creditors rank pari passu.25 – It is the most fundamental principle of corporate insolvency law.26 All the unsecured creditors shall get equal and rateable amount of share when the debtor’s assets are realized. However, preferential creditors are an exceptional to this rule.27
Members of the company are not as such liable. – It is a well-established principle in English Law, that the members of the corporate body are not liable personally. Any contracts contracted are with that body and not its members.28
Striking a balance:
The pari passu principle – According to the Pari Passu principle of distribution, all the claims against the company rank equally amongst themselves and are abated pro-rata in so far as the company are insufficient to satisfy them all.29 As per S.133 of the Companies Act, 1862, the assets of a company which is being wound up must be applied in satisfaction pari passu of the liabilities of the company as they exist at the commencement of the winding-up.30
Insolvency rules 1986, rr.4.94, 12.3(1)
Roy Goode, ‘Principles Of Corporate Insolvency Law’, student edn., (Thomson, Sweet & Maxwell, 2005) Ch 3, 77 (All the principles are referred from Chapter-3)
Insolvency Act 1986, S.107(provisions applying to both kinds of voluntary winding up)
Roy Goode, ‘Principles Of Corporate Insolvency Law’, student edn., (Thomson, Sweet & Maxwell, 2005) Ch 3, 78 (All the principles are referred from Chapter-3)
Michael G Bridge, ‘Collectivity, Management of Estates and the Pari Passu Rule in Winding Up’ in John Armour and Howard Bennett (eds), Vulnerable Transactions in Corporate Insolvency (Hart Publishing, Oxford and Portland, Oregon 2003)
Re Smith, Knight, & Co. (1868) L. R. 5 Eq. 223
it was held - that there being no question of fraudulent preference, those who had not received any dividend were not entitled to a dividend under the winding-up in priority to those who had.
Between Debtors and Creditors - Insolvency law helps the debtors from facing various moral issues. It prevents the creditors from going overboard and try maintaining the balance between debtors and creditors by preventing conflicts through administration process. The liquidators play an important role in balancing the interests of the various parties affected in insolvency. Insolvency law provides voluntary winding-up as well as compulsory winding-up.
Between liquidation and reorganization – It needs to balance the advantages of near-term debt collection through liquidation against preserving the value of the debtor’s business through reorganization.31 It strives to uplifts the value of a debtor in the society by reorganizing as an alternative to liquidation.32 It has social repercussion like protecting employment and encouraging development of an entrepreneurship.33
Balancing Non-Debtor Interests34 - Bankruptcy has multi-fold effects. When a debtor becomes bankrupt there are various parties like family35, spouses36, business associate37, state38, professionals39 etc are affected. When a debtor becomes insolvent the families are also affected with them. The family of the bankrupt40 has to face lot of social and economic problems. The family may benefitted from a curtailment of credit pressure as they are the ones affected from bankruptcy.41
UNCITRAL (United Nations Commission On International Trade Law) United Nations New York 2005, (Legislative Guide On Insolvency Law) <http://www.uncitral.org/pdf/english/texts/insolven/05-80722_Ebook.pdf> Accessed 25th November 2010.
David Milman, ‘Personal Insolvency Kaw, Regulation and Policy’ (Ashgate Publishing Co. 2005) Ch 6, 99
Andrew Keay, ‘Balancing Interests in Bankruptcy Law’  Common Law World Review 218
Andrew Keay Ibid 218
Insolvency law systems are attempting to balance the interests between the debtors and the creditos and as well as the non-debtors. However the system has not been fully successful in protecting the interests of all parties.42 Insolvency
laws achieve that balance by reapportioning the risks of insolvency in a way
that suits a State’s economic, social and political goals. 43
UNCITRAL (United Nations Commission On International Trade Law) United Nations New York 2005, (Legislative Guide On Insolvency Law) <http://www.uncitral.org/pdf/english/texts/insolven/05-80722_Ebook.pdf> Accessed 26th November 2010.
Armour J and Bennett H (eds), Vulnerable Transactions in Corporate Insolvency (Hart Publishing, Oxford and Portland, Oregon 2003)
Goode R, ‘Principles Of Corporate Insolvency Law’, student edn., (Thomson, Sweet & Maxwell, 2005)
Keay A and Walton P, ‘Insolvency Law: Corporate and Personal’ Second Edition, (Jordan, 2008)
Milman D, ‘Personal Insolvency Kaw, Regulation and Policy’ (Ashgate Publishing Co. 2005)
Keay A, ‘Balancing Interests in Bankruptcy Law’  CLW Rev 206