Three recent decisions clarify issues around personal bankruptcy proceedings.
procedures for substitution of creditors, and
vesting of property disclaimed by the Official Assignee.
Debtors' compromises in bankruptcy proceedings
A bankruptcy notice under the Insolvency Act requires the debtor to pay the debt or compromise the amount owing on terms that satisfy the Court or the creditor.
But if the creditor rejects a proposed compromise, can the Court override that rejection? This was the question in Commissioner of Inland Revenue v Wilson  NZCA 100.
The Commissioner of Inland Revenue served a bankruptcy notice on the debtor and rejected the debtor's proposal to satisfy the debt. The debtor applied to the High Court for orders approving his proposed compromise and setting aside the bankruptcy notice.
The High Court obliged, citing its inherent jurisdiction to do so (as opposed to approving the compromise under the proposal scheme in the Insolvency Act). The Commissioner appealed.
The Court of Appeal held that:
- the Court does not have inherent jurisdiction to approve a compromise rejected by the creditor or creditors, and
- the Court cannot approve a compromise outside the proposal scheme in the Insolvency Act but a debtor can without needing the Court's approval. Such a compromise would satisfy the bankruptcy notice and would prevent adjudication of bankruptcy, and
- debtors seeking a compromise with the Commissioner of Inland Revenue should first seek financial relief under the Tax Administration Act which imposes policy considerations not directly addressed by the proposal scheme in the Insolvency Act.
Creditors or debtors considering compromise should keep in mind that:
- the issuer of the bankruptcy notice and the debtor may, by agreement, compromise the debt without seeking the Court's approval. The compromise will be binding on the creditor but, importantly, will not bind any other creditors
- a debtor may propose a compromise to creditors pursuant to the proposal scheme in the Insolvency Act. The proposal, if approved by the creditors and the Court, will bind all creditors who are affected by the proposal. The Court has no jurisdiction outside this scheme to approve compromises of personal debts.
Creditors must be owed provable debt to be substituted
The High Court decision in Muollo v Garnham  NZHC 622 confirms when substitution may be used in bankruptcy proceedings.
Generally, a creditor may apply for a debtor to be adjudicated bankrupt if:
- the debtor owes more than $1,000, and
- has committed an act of bankruptcy, and
- the debt is for a certain or liquidated amount, and
- is payable immediately or at a particular point in the future.
If the original creditor fails to progress an application, another qualifying creditor (i.e. owed $1,000 or more by the debtor) may be substituted. The benefit of substitution is that the substituted creditor can rely on the existing act of bankruptcy.
In this case, a second creditor was successfully substituted for the original creditor despite the debtor's objection. The debtor sought a review of that decision.
The High Court found that the second creditor did not have standing to be substituted because the alleged debt owed to her was not a qualifying debt under the Insolvency Act:
- there was no creditor/debtor relationship between the parties to the proceeding
- the alleged debt was not immediately payable or payable at a certain date in the future
- was not a liquidated sum, but a security interest in property, enforceable against another individual and unenforceable against the judgment debtor, and
- was not for a certain amount as there was conflicting evidence about the value of the property in which the security interest was held.
To commence bankruptcy proceedings, the debt providing the foundation for the application or the grounds for substitution must comply with the requirements of section 13 of the Insolvency Act. Particularly, the debt must be a liquidated sum.
The Court can and will inquire into the factual basis for substitution.
The fact that notice or evidence is not always required in support of substitution applications in the bankruptcy regime does not mean that it is never required.
Chapman Tripp comments
The decision is another step away from the New Zealand practice of not requiring evidence of the debt on substitution. Now, it seems that it will be required in all but the clearest of cases.
Creditors should also notify the debtor of the substitution application and the evidential foundation for it.
Vesting of property disclaimed by the Official Assignee
In Re Hanara ex parte the Official Assignee  NZHC 902, the Court had to consider whether property disclaimed by the Official Assignee (OA) could be subsequently vested in the OA.
A party who has suffered loss or damage as a result of a disclaimer may apply to the Court for an order that the disclaimed property be vested in that party.
A husband and wife each owned a half share in a property. The wife was adjudicated bankrupt and the OA decided to disclaim her half share because there was no equity in the property. By the time the husband was adjudicated bankrupt two years later, the OA considered that there was now equity in the property and that it could be sold for the benefit of the creditors if both half-shares were vested in the OA.
The OA made the application in her capacity as Assignee of both the husband's and the wife's estate. The Court decided that the OA had standing to make the application in respect of both estates.
The Court did not accept that the wife's estate had suffered a loss by the disclaimer as, at the time it was made, there was no value in the property. The fact that it grew in value later was irrelevant. The Court also considered that Parliament could not have intended to give the OA a “second bite at the cherry" in these circumstances.
However, the Court accepted that the husband's estate had suffered a loss. The husband's half share in the property would be hard to sell on its own. Had the wife's interest not been disclaimed, the OA could have sold both half-shares at the same time.
The Court found it was fair to make an order vesting the wife's half-share in the OA for the benefit of the husband's creditors. The new equity in the property was largely due to the husband making mortgage payments following the wife's bankruptcy. The Court therefore concluded it was not unfair to the wife's creditors that the order be made.
The Court's reasoning is likely to apply to liquidators as well as to the OA. Liquidators should therefore carefully consider the potential consequences before disclaiming any perceived onerous property. However, where it is clear that circumstances have changed and there are practical benefits to doing so, the Court will consider making orders vesting the property with the OA or with the company, as the case may be.