Unreasonable Creditors

The Court cannot make an order for the bankruptcy of an individual or the winding up of a company if the debt on which the petition is founded has been paid or secured between the presentation of the petition and the first hearing. However, what happens when an offer to secure the debt has been made but such an offer has been refused?

The Court has discretion to consider whether a creditor’s refusal of a debtor’s offer to secure or compound the debt has been unreasonable. If it considers that the creditor’s refusal has been unreasonable the Court has the power to dismiss the petition.

It is often unclear as to what “unreasonably refused” means but the recent High Court case of Ross and Holmes v Commissioners for HM Revenue and Customs [2010] EWHC 13 (Ch) has provided some guidance.

The facts

Mr Ross and Mr Holmes (“the Debtors”), both of whom were solicitors, had incurred significant arrears in both partnership and individual tax liabilities amounting to £498k. HM Revenue and Customs (“HMRC”) initially served statutory demands and then presented bankruptcy petitions against both of the Debtors. The Debtors contested the petitions on three grounds one of which was that HMRC had unreasonably refused their offer to secure the debt. The Debtors intended to raise finance by way of charges on various properties, including a third charge on the partnership’s premises. An initial adjournment of three months was granted to allow them time to pay.

However, two months later, the Solicitors Regulation Authority intervened in the practice which meant it was impossible for the Debtors to continue and the practising certificates of the Debtors were suspended. The Debtors could not therefore arrange loans because they had no income with which to service such loans. In light of their inability to obtain loans secured against the properties, these properties could be offered as security to HMRC. In addition, the cessation of the practice was likely to generate substantial terminal losses which the debtors could carry back and set against previous profits.

The Debtors therefore made an offer to HMRC offering the various properties as security. The Debtors were told that it was not HMRC’s policy to accept security for unpaid tax and that discharge of the sums owed would have to be by way of payment in full.

At first instance before the Chief Registrar, HMRC gave five reasons for rejecting the offer:-

HMRC was not prepared to accept legal charges on properties as there was no guarantee as to when payment would be made;
Settlement of the debt was required to be by payment in full to maintain funds for the exchequer;
HMRC did not have the resources to monitor and administer property sales to pay tax and that it was not the role of the creditor to realise assets;
The Debtors had already had approximately eighteen months in which to have raised sufficient money to pay the petition debt; and
It would be unfair on other taxpayers who make provision to pay their taxes on time, if HMRC were to accept charges in the case of the Debtors.

The Registrar, on the issue of whether these reasons constituted an unreasonable refusal of an offer to secure the debt, held that it as not unreasonable for a creditor to reject an offer where previous promises had not been fulfilled and further sums had fallen due. The Registrar also referred to the fact that not all the charges would be first legal charges and that the ability to realise the security would be deferred for six months, both of which had also been factors in his decision.

The Debtors appealed to Mr Justice Henderson.

The Decision

The Debtors set out five reasons why HMRC’s rejection of their offer was unreasonable:

the security offered was ample to cover all of the petition debts plus all further liabilities that had accrued since the presentation of the petitions;
the offer had not been considered on its merits but was rejected out of hand in reliance on a rigid policy that in no circumstances would HMRC accept security over real property;
the security would more than cover the debt and would enable HMRC to be paid in full so that it was irrational to treat the previous history of non-payment and default as a good reason to reject the offer. Further, the offer of security was to provide certainty of payment that had previously been lacking;
that a sale after six months would in practice involve no more delay than a sale by a trustee in bankruptcy; and
the refusal of the offer was all the more unreasonable when the terminal losses were likely to eliminate or greatly reduce the debts owed to HMRC.

In the earlier case of HM Customs & Excise v Dougall [2001] BRIP 269, Lightman J held that the test is whether a reasonable creditor in the position of the petitioning creditor and in light of the actual history as disclosed to the Court would have reached the same conclusion. Two points arise from Lightman J’s judgment. Firstly, that this test is objective so that the Court is not limited to the consideration taken into account by the petitioning creditor; and secondly, that the debtor must be full frank and open and provide all the necessary information to enable an informed decision to be made by the creditor.

With this in mind, Mr Justice Henderson rejected the Debtors’ appeal. From his judgment the following is apparent:

a petitioning creditor is entitled to take into account a history of default, partial payments and broken promises and that such a creditor is “entitled to have regard to its own interests” and further that “acting reasonably is not the same as acting justly, fairly or kindly”;
he found it disturbing that the Debtors had been repeatedly told that it was HMRC’s policy not to accept security in the form of charges over land. He added that there was no indication that the security offered was ever considered on its merits;
in respect of rejecting the offer, Henderson J said:-

it was often the case that the prospects of obtaining payment in full are far less certain if security is refused and a bankruptcy order is made;
the issue is to maximise net recovery to public funds and not to maintain the flow to the exchequer as the Debtors have long since failed to pay the tax as it fell due;
he agreed that HMRC’s primary function was to collect tax and not to act as an institutional lender;
the fact that the Debtors had already had plenty of time was a material consideration and formed part of the history to which a petitioning creditor was entitled to take into account;
it seemed fanciful to Henderson J that the acceptance of the charges by HMRC would encourage other tax payers not to pay tax, when fairness to other tax payers would best be achieved, as he put it, “by adopting the policy which is best calculated to maximise the net recovery to public funds”; and
the “hypothetical petitioning creditor” must be regarded as one with the same characteristics as the actual petitioning creditor; in this case as a national revenue authority in the same position and subject to the same constraints.

To conclude, Henderson J rejected the appeal and held that HMRC had been within its rights to reject the offer because over a year had passed since the service of the statutory demand and 10 months since the presentation of the petition. The tax affairs of the Debtors were still in disarray- up to date accounts had not been prepared and filed and significant further liabilities had accrued. Further, two substantial cheques had been dishonoured.

Conclusions

The message from the Courts is two fold; debtors cannot expect to attract sympathy for HMRC applying a blanket policy refusal of their offers to secure debts if they have not helped themselves. They must have made payments in accordance with the terms of their offers, have put their tax affairs in order and dealt with things expeditiously. Creditors, however, cannot simply reject offers of security out of hand. Henderson J commented “that there is a real risk of institutional oppression if a rigid policy is unthinkingly applied and debtors are fobbed off with inadequate or generalised justifications for the policy.” An offer of security must be considered on its own merits.

Consistent with our policy when giving comment and advice on a non-specific basis, we cannot assume legal responsibility for the accuracy of any particular statement. In the case of specific problems we recommend that professional advice be sought.

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