Priorities under pressure: what can (and cannot) be paid in distressed private schools

Posted: 05/06/2025

Independent schools are increasingly operating within a tightening financial and regulatory environment. Alongside sector specific challenges – such as rising operating costs, demographic shifts, and reputational and regulatory risks – broader government policy is beginning to bite. Changes such as VAT exemptions on school fees have contributed to casting long shadows over medium and long-term planning – as seen in other articles in our spring campaign.

The emerging policy backdrop has coincided with an uptick in distress, particularly among small and medium-sized private schools that already operate on tight margins and try not to pass through all increasing costs, for fear of impacting pupil numbers. For insolvency practitioners engaged either in contingency planning or formal processes, this raises important legal questions: in light of the Sussex decision, how should regulatory fines be treated? Are prepayments by parents considered general company monies, or might they give rise to trust obligations? What risks arise from payment prioritisation during periods of financial distress?

This article explores some of the legal subtleties that may not sit squarely within the traditional insolvency playbook – but which can materially affect value preservation, fairness and process defensibility.

Directors’ duties and the regulatory pressure to pay

In periods of distress, school governors — often unpaid and untrained in corporate governance — may feel compelled to pay regulatory penalties, settle claims, or maintain reputational expenditures. However, the legal framework shifts as financial distress deepens.

Following the popular case of BTI 2014 LLC v Sequana SA [2022] UKSC 25, it is clear that the duty to consider creditor interests arises when insolvency is probable, and becomes paramount once it is inevitable. At that stage, payments made with other motives — including reputational preservation or perceived regulatory obligations — may expose decision-makers to personal risk or create clawback issues under the Insolvency Act 1986.

Regulatory penalties: when not paying is potentially the right call

The recent £585,000 fine levied against the University of Sussex by the Office for Students (OfS) serves as a pertinent example. The OfS found that the university failed to uphold freedom of speech and academic freedom, particularly in connection with the resignation of Professor Kathleen Stock following protests over her views on gender identity. The regulator criticised the university’s trans and non-binary equality policy, alleging it created a 'chilling effect' on free speech, leading to self-censorship among staff and students. The university has challenged the ruling, claiming it represents regulatory overreach and sets a dangerous precedent.

While Sussex was not itself insolvent, the case highlights how regulators may frame penalties as immediate obligations, even where the underlying liability is more complex. For insolvency practitioners, this underscores the importance of scrutinising the nature and enforceability of such fines, especially when financial distress is imminent.

Regulatory fines as provable debts: Re Paperback Collection and Recycling Ltd

In Re Paperback Collection and Recycling Ltd [2020] EWHC 1601 (Ch), the court held that a criminal fine imposed prior to the commencement of liquidation constituted a provable debt. The case clarified that such fines are not excluded from proof and therefore should be treated like any other unsecured liability when distributing assets in a winding-up.

The timing of payment is key. If a school nearing insolvency settles a regulatory fine — such as one imposed by the Office for Students — ahead of others, that payment may:

• be scrutinised as a potential preference (section 239 IA 1986);
• give rise to a claim in misfeasance (section 212 IA 1986);
• raise questions around directors’ adherence to the creditor duty if not properly considered and documented.

In short: not all demands are made equal, and not all penalties are payable — at least, not ahead of proper creditor process.

What can be paid — subject to structure and justification 

1.    Operational essentials

Where the school is still functioning — even in a minimal capacity — essential expenses may continue to be paid, including:

• salaries due for completed work;
• insurance premiums (especially public liability and D&O);
• utilities and minimal maintenance to protect property.

However, these payments should be scrutinised on a case-by-case basis and halted if they no longer serve the interests of creditors as a whole.

2.    Professional fees for restructuring or compliance  

Fees for legal, insolvency, and financial advice may be justified where they are:

• incurred for value-preserving purposes (eg contingency planning or employee communications);
• reasonably incurred in the company’s best interests; and
• not excessive or self-serving.

Care must be taken, however, where legal fees relate to defending reputational claims or challenging regulatory findings — unless a tangible benefit to creditors can be demonstrated.

3.    Trust monies and ring-fenced funds

Certain categories of payment may fall outside the estate because they are not the company’s property. The most relevant example in this context are deposits and prepaid school fees.

Prepaid fees: may well be held on trust

While sometimes treated as general company monies, in the context of private schools, prepaid tuition fees are increasingly likely to be characterised as trust property, particularly where:

• payment terms specify that funds are 'held' pending future performance;
• the school’s policies or contracts refer to deposits being refundable or earmarked for specific use;
• there is a pattern of placing such funds in segregated accounts or designated income streams.

In these cases, prepaid fees are often not part of the general estate and should therefore not be used to fund other liabilities. The devil, as with all things 'trust' related, is always in the detail. The implication is twofold:

• these monies should be returned (to the extent unearned);
• they must not be used to pay creditors or regulatory obligations — doing so may amount to misapplication of trust property.

This treatment can materially affect the asset pool — and challenges may arise if such monies have already been used to pay other debts shortly before formal insolvency.

What should not be paid (absent legal advice)

1.    Regulatory fines and enforcement penalties

Unless clearly enforceable and supported by statutory authority, and the consequence of non-payment well explored and advised on, regulatory fines should be treated as unsecured claims. Payment may give rise to challenge — and in many cases, regulators do not have enforcement priority in insolvency.

2.    Voluntary settlements (parents, staff or reputational claims)

Ad hoc settlements, especially those that include compensation for distress or reputational harm, are risky:

• they may fall outside the class of provable debts;
• they often lack an enforceable obligation;
• payments made on this basis may be challenged as preferential or under section 212 misfeasance.

Where litigation is ongoing, and settlement demonstrably avoids cost or preserves value, different considerations may apply — but clear documentation and justification will be needed.

3.    Discretionary or promotional spend

Payments for marketing, refurbishment, promotional events, or even strategic planning projects should usually be halted immediately. These are not essential to realising value and may be viewed as mismanagement of funds where those activities no longer have good prospects of helping the school survive.

Practical guidance for IPs

When engaged by a financially distressed school — whether pre- or post-appointment — top suggestions for assessing payments include:

• Assess the legal basis: is the payment an enforceable obligation, a trust disbursement, or discretionary?
• Classify by risk: use a working matrix to flag payments as (i) mandatory, (ii) permissible with justification, or (iii) challenge prone.
• As always, encourage the school to document everything: especially when payments are made close to a known insolvency event. Notes of decision-making and rationale may later serve as the governors' best defence.
• Treat regulators and reputation with caution: pressure to 'do the right thing' – is not a legal obligation — and reputational motivations rarely justify estate depletion.

Conclusion

In distressed private schools, where regulation, public interest and creditor fairness collide, payment decisions carry risk. Knowing what not to pay is as important as collecting in what’s owed. The structure of liabilities — whether regulatory, contractual, or trust-based — must be tested rigorously.

Ultimately, every payment must be justifiable not only to stakeholders but in law. The appearance of doing the right thing is not a defence — but acting in accordance with the Insolvency Act is.

This article was co-written by Priscilla Oronsaye, associate in the commercial dispute resolution team.

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