First refusal

When considering if a bankruptcy order should be made under section 271 (3) of the Insolvency Act 1986, the court may consider whether a creditor's refusal of an offer to secure the debt has been unreasonable. If it considers that the refusal has been unreasonable the petition may be dismissed.

The test arising from the case law is that the debtor must establish before the court that no reasonable hypothetical creditor would have rejected the offer. Other cases have suggested that offers must be clear and satisfactory, also going so far as to say that the proposal of an IVA by a debtor is not an offer because it requires more than just the petitioning creditor's approval of the proposal.

The recent High Court case of Ross and Holmes v Commissioners for HM Revenue and Customs [2010] EWHC 13 (Ch) has provided further guidance on the issue, which may prove helpful to debtors in light of the current 'Time to Pay' arrangements being tightened up.

The debtors had incurred significant arrears for tax liabilities amounting to £498k. HM Revenue & Customs (HMRC) presented bankruptcy petitions against both of the debtors which were contested on three grounds, one of which was that HMRC had unreasonably refused their offer to secure the debt. Various properties had been offered as security to HMRC while the debtors also claimed that the cessation of their practice was likely to generate substantial terminal losses which the debtors could carry back and set against previous profits.

HMRC gave five reasons for rejecting the offer:

1. HMRC was not prepared to accept legal charges as there was no guarantee as to when payment would be made.

2. Settlement of the debt was required by payment in full to maintain funds for the exchequer.

3. 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.

4. The debtors had already had approximately 18 months in which to have raised sufficient money to pay the petition debt.

5. 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.

Unreasonable rejection?

At first instance before the chief registrar, it was held that it was not unreasonable for a creditor to reject an offer where previous promises had not been fulfilled and further sums had fallen due. The chief 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.

On appeal and before Mr Justice Henderson, the debtors set out five reasons why HMRC's rejection of their offer was unreasonable:

1. 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.

2. The offer had not been considered on its merits but was rejected for policy reasons.

3. 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.

4. That a sale after six months would involve no more delay than a sale by a trustee in bankruptcy.

5. 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. First, that this test is objective so that the court is not limited to the factors actually considered by the petitioning creditor; and also that the debtor must be full, frank and open with the information provided to the creditor to enable an informed decision to be made.

With this in mind, Henderson J rejected the debtors' appeal for the following reasons:

1. 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'.

2. He criticised HMRC for failing to let the debtors have the proper reasons for its rigid policy of not accepting security in the form of charges over land. He added that there was no indication that the security offered by the debtors was ever considered on its own merits.

3. In respect of rejecting the offer, Henderson J said:

3.1. 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.

3.2. 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.

3.3. He agreed that HMRC's primary function was to collect tax and not to act as an institutional lender.

3.4. The fact that the debtors had already had plenty of time was a material consideration and formed part of the history, which a petitioning creditor was entitled to take into account.

3.5. It seemed fanciful to Henderson J that the acceptance of the charges by HMRC would encourage other taxpayers 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'.

3.6. 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.

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 ten 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.

A clear message

Henderson J found it 'disturbing' that the debtors were repeatedly told that it was a policy of HMRC not to accept security in the form of legal charges over land. He noted that there had no been indication that the security by the debtors had ever been considered on its merits. While counsel for HMRC told the court that each offer of security is considered on its own merits, Mr Justice Henderson disagreed, finding no evidence of such a policy. He added that 'there was 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'.

This is a warning to creditors that petitions may be dismissed if they fail to give clear and specific reasons for the rejection of the offer. Once HMRC had given detailed reasons for the policy, the debtors were able to raise counterarguments, which the court could consider. However, the debtors could not get past the history of non-compliance, in the context of which the bankruptcy petitions were presented.

Such a history of non-compliance included an initial offer being made some 13 months before the bankruptcy order was made, which included an offer to pay £20,000 each calendar month for six months and a property to be sold immediately. At the time of this offer, annual returns for both debtors were still outstanding. HMRC was prepared to accept this offer subject to further conditions being agreed, including annual returns being filed. None of these conditions were fulfilled; no monthly payments were made and the property to be sold remained unsold at the time the bankruptcy order was made. In addition, further and substantial tax liabilities had been incurred after the presentation of the petition.

The message from the courts therefore is two fold; debtors cannot expect to attract sympathy for a creditor 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.