Declining to follow a 2012 decision, the High Court has ruled that a bankrupt’s unexercised rights to draw his pension did not represent income to which he was entitled within the meaning of the Insolvency Act 1986, and so did not form part of the bankruptcy estate.

Background

When an individual becomes bankrupt and a trustee in bankruptcy (TIB) is appointed, all assets to which the individual is beneficially entitled vest automatically in the TIB, and this is the bankruptcy estate. The TIB’s function is to realise the value of the assets in the bankruptcy estate and to effect distribution to the bankrupt’s creditors in settlement of his debts. If the bankrupt receives an income during his bankruptcy, the TIB may apply for a court order compelling the bankrupt to pay some or all of that income to the TIB for inclusion in the bankruptcy estate.

In our April 2012 Stop Press, we reported on the case of Raithatha v Williamson, in which the High Court ruled that an income payments order under section 310 of the Insolvency Act 1986 (an IPO) could be made where the bankrupt had an entitlement to elect to draw a pension but had not exercised it at the time of the application.

Before Raithatha, pension benefits were regarded as protected from creditors as, under the Welfare Reform and Pensions Act 1999, a bankrupt’s rights under an approved pension arrangement do not vest in the TIB. However, the Court held that as the respondent, Mr Williamson, had reached the scheme’s pension age, although he continued to work, the pension could be considered as income and therefore used to repay creditors.

The decision resulted in a successful application by Mr Raithatha, as Williamson’s trustee in bankruptcy, for a court order compelling Williamson, the bankrupt, to draw his pension and apply that income towards satisfying his bankruptcy creditors.

As a result of that decision, it appeared that a pension scheme was no longer a safe place in which an individual could seek to shelter funds from his creditors. The judgment was a warning to all those with substantial pension pots which had until then been considered beyond the reach of a TIB. A bankrupt of scheme pension age, even when is he is still employed and working, with no intention of taking his pension, may be forced to access pensions savings to pay off creditors where he is entitled to draw benefits but chooses not to.

Although leave was granted for Williamson to appeal, the appeal was not progressed, as the parties reached a confidential settlement. The full potential impact on occupational pension schemes therefore remained unclear.

The facts and decision in Horton v Henry [2014]

Mr Henry became bankrupt in December 2012. His assets included four personal pension policies which did not form part of the bankruptcy estate. Throughout his bankruptcy, he was entitled to draw his pension, but chose not to do so. On the day before his discharge from bankruptcy, his Mr Horton, as his TIB, applied for an IPO seeking a share of lump sum payments and income from the pensions.

Mr Henry opposed the application. He relied largely on the arguments advanced by the bankrupt inRaithatha, although he did not attempt to argue that a lump sum could never constitute a payment in the nature of income for the purposes of section 310(7) of the IA 1986 (an argument made unsuccessfully by the bankrupt in Raithatha).

The Court held that Mr Henry's undrawn pensions could not be subjected to an IPO. Although the circumstances of the application were acknowledged by the Court to be indistinguishable from Raithatha, it was held that Raithatha was wrongly decided and the Court declined to follow that decision.

The Court noted that, in order for Mr Henry to receive pension monies, he would have to make a number of decisions and elections. Unless and until these were made, the pension rights were uncrystallised and uncertain in value.

“Income” for the purpose of an IPO is defined in section 310(7) of the IA 1986 as:

payment in the nature of income which is from time to time made to [the bankrupt] or to which he becomes entitled ... [and includes] (despite anything in section 11 or 12 of the Welfare Reform and Pensions Act 1999) any payment under a pension scheme”.

The Court considered this section and, in particular, noted that payments under a pension in payment were plainly within its ambit. However, pensions not already in payment could not, in the Court's view, be said to be payments to which the bankrupt was “entitled” and so within the ambit of section 310(7). The word “entitled” suggested a reference to a pension in payment under which definite amounts had become contractually payable. Unless and until Mr Henry had made the necessary decisions and elections, payments were neither certain nor contractually payable. Further, the TIB had no right, on behalf of the bankrupt, to make decisions and elections relating to the pensions, as the pensions were not part of the bankruptcy estate.

Comment

As the judge noted in this case when he declined, albeit reluctantly, to follow Raithatha, it is hoped that the Court of Appeal will soon have an opportunity to rule on which of these cases is correct. Until such time, or statutory clarification, the contradictory decisions leave the law in an unsatisfactory state.

The anomaly pointed out by the court in Raithatha has some force: why should the mere issue of whether the bankrupt happened to have made an election to draw on his pension before or during the bankruptcy have such a fundamental impact upon the position of the bankrupt and his creditors? However, the decision inRaithatha is considered by many to be at odds with the legislative aim of protecting pensions from a bankruptcy estate.

As a result of the Budget 2014 and the pension flexibilities to be introduced from 6 April 2015, an individual with defined contribution pension savings will be able to access his fund in full once he reaches age 55, provided this is permitted under the scheme rules. The effect of the changes will mean that, for affected schemes, there will no longer be a distinction between the member’s pension and lump sums, making even a relatively small pension fund an attractive target for an IPO.

Although the various elections and decisions to be made by the bankrupt as referred to by the judge inHorton case will remain, the financial benefit of a successful IPO claim could make an application by a TIB, and potentially pursuit to the Court of Appeal, a worthwhile prospect.

The position for occupational pension schemes is further complicated, as the payment of lump sums on commencement may be subject not only to elections and decisions by the bankrupt but also to the discretion of the scheme’s trustees.