In a challenging economy bankruptcy increasingly stands accused of constituting a mechanism for debtors to escape their responsibilities at their creditors' expense. It understandably remains a live debate as to whether a bankrupt should be afforded the means of a protected pot of money for his future use while his creditors are left unrecompensed for their loss. The debate is not new, but the balance has perhaps shifted in a climate where creditor losses are felt particularly keenly. Should a bankrupt be permitted to retain his pension pot for whatever use he sees fit, or should it be utilised to soften the blow within the bankruptcy estate?
Once upon a time, only 15 years ago, pension rights were deemed sacred ground under statute and Jack the bankrupt was safe hiding with his pension fund at the top of his beanstalk. Recent case law on the reach of the trustee in bankruptcy by way of an income payments order relating to pensions begs the question not only where the top of the beanstalk now lies, but indeed whether the beanstalk is due to be imminently chopped down for firewood. Previously protected pension rights are now potentially obtainable by a trustee as an asset of the bankruptcy estate, and following two conflicting High Court cases on the subject in less than three years insolvency litigators have been left yearning for clarity. The appeal of the decision in Horton v Henry is due to be heard imminently. Given the increasing percentage of bankruptcy cases involving a debtor over the age of 55, the ramifications for pensioners in the face of bankruptcy are enormous. It is also interesting to see how the evolving case law will converge with the new flexible pension reforms introduced from 6 April 2015.
Once appointed the trustee in bankruptcy’s (TIB) function is to realise the assets within the bankruptcy estate and to distribute realisations to the bankrupt’s creditors in the prescribed order. Whilst most assets such as the bankrupt’s interest in his home are commonly known and accepted to form part of the bankruptcy estate, it remains in question whether a TIB should have to access to rights under a pension policy. The debate is finely balanced; to what extent should creditors in a bankruptcy benefit from the exhaustion of a bankrupt’s future financial support?
The court in the case of Re Landau held that rights under a pension policy did form part of the bankruptcy estate, entitling a trustee in bankruptcy to all income derived from that policy regardless of whether payments were actually being made under the pension scheme.
Concerns were voiced that the effect of Re Landau would be to leave bankrupts of retirement age unable to provide for themselves upon retirement. In response to those concerns the Welfare Reform and Pensions Act 1999 (WRPA) (together with the combined effect of the Pensions Acts 1993 and 1995 in relation to occupational pensions) reversed the decision in Re Landau and duly removed those pension rights from the bankruptcy estate.
Despite the pensions legislation removing the pension rights from the estate itself, they addressed the need for balance by way of consequential amendments to the Insolvency Act 1986 (IA). These provided that whilst pension rights in and of themselves did not fall within the bankruptcy estate, the actual pension payments received by the bankrupt could be accessed by the TIB for the benefit of creditors by way of an Income Payments Order (IPO).
The compromise seemed a plausible middle ground; uncrystallised future payments were protected from the reach of the creditors, but money received by the bankrupt was captured.
Additionally, amendments were made to section 342 of the IA which enabled a TIB to apply to court for an excessive pensions contributions order permitting the claw back of excessive pension contributions made by the bankrupt. This curtailed the bankrupt’s ability to direct funds into a pension policy, and so unfairly prejudice creditors. The amendments presented a safeguard against potential misuse of the protection granted by the WRPA. It should be noted, however, that in order to obtain an order under this provision, a TIB must show ‘on a balance of probabilities, the bankrupt was attempting to defraud creditors by making excessive pension contributions’ – an onerous evidential burden.
A TIB is able to apply to court for an IPO in the event that a bankrupt receives, or is entitled to receive an income in excess of what is necessary to meet the reasonable domestic needs of the bankrupt and their family. The IPO requires the bankrupt to pay the excess monies to the trustee in bankruptcy and can be ordered to endure for up to three years.
Whilst historically an IPO has been applied to income in the traditional sense of the word, the definition of income for the purposes of an IPO is now stated in section 310(7) of the IA to ’comprise every payment in the nature of income which is from time to time made to him or to which he from time to time becomes entitled, including…(despite anything in section 11 or 12 of the Welfare Reform and Pensions Act 1999) any payment under a pension scheme.’
This definition expanded the traditional interpretation of ’income’ to enact the changes brought about by the WRPA. However the words ’becomes entitled’ have provided an additional opportunity for the definition to be widened more than the statute perhaps anticipated. This definition of income is the subject of the current conflict of cases, and has given rise to a debate fuelled further by the recently enforced flexible pension reforms.
The definition of income was expanded to a controversial bean-stalk-grabbing level by Bernard Livesey QC in the case of Raithatha v Williamson (a bankrupt). The bankrupt, Mr Williamson, had reached his pension scheme’s pensionable age although he continued to work. The bankrupt had no intention to draw down on his pension in the foreseeable future. Had the bankrupt elected to draw down on his pension, he was entitled to an income of between £23,000 and £43,000 per year together with a lump sum nearing £250,000.
The TIB, unsurprisingly given the value involved, made an application for an IPO, and sought the maximum period of three years of income and the lump sum, notwithstanding the fact that the bankrupt had not elected to receive either.
Despite the bankrupt advancing the anticipated argument of unjustifiable interference with his human rights, it was held that the definition of income in section 310(7) not only applied to payments which a bankrupt has elected to receive from a pension, but extended to payments which the bankrupt was entitled to receive but in respect of which the bankrupt had not made an election. Thus, whilst Mr Williamson was receiving no actual payments under his pension, they did constitute income that he could obtain if he so chose and he was compelled by the court to draw his pension for the benefit of his creditors (including in particular the 25% tax free lump sum). It should be noted that the court accepted that the right to elect did not pass automatically to the TIB, but that the TIB could instead compel such an election.
The court considered the following question: ’whether the intention of the legislature was to preserve the technical difference so that a person whose election had preceded his bankruptcy would be brought into the s 310 regime, whereas the person who had not yet elected to take his pension, would not.’
Livesey J considered that to preserve such a difference would produce an unacceptable anomaly which would inadvertently discriminate against the class of bankrupts who had not made an election.
The avoidance of such discrimination is not without irony. The Raithatha decision, it is suggested by some within the profession, may be argued instead to discriminate against a different class of bankrupts – those members of society who have reached pensionable age. Further, the unprecedented extension to the definition in Raithatha dispels the balance that the WRPA and associated amendments to the IA sought to achieve. Not only does it creep perilously close to the territory of Re Landau, leaving little space between the Re Landau position and the monies that could be accessed by way of an IPO post-Raithatha, but it potentially removes the bankrupt’s freedom of choice as to his elections in respect of an uncrystallised pension.
Given the controversy of the Raithatha decision, audible relief could be heard when permission to appeal the first instance decision was granted. However, that relief was short lived. The parties reached a settlement prior to the appeal on terms that remain confidential, and the appeal hearing was vacated. The vacation of the appeal left a controversial decision in its wake and its full impact on occupational pension schemes unclear.
In Horton v Henry less than three years later, Robert Englehart QC, reached the opposite conclusion, despite the two cases being virtually indistinguishable on the facts. Mr Henry was adjudged bankrupt in 2012 and his assets included four pension policies. During his bankruptcy he was able to draw on his pensions, but decided not to do so and so they remained uncrystallised. The bankrupt did not wish to draw down on the policies and instead wished to preserve the pension funds for as long as possible. The TIB sought an IPO in respect of a share of both lump sum payments and income from the pensions. The bankrupt sought to oppose the application by utilising the arguments made by the bankrupt in Raithatha.
It was held that an IPO cannot be made in respect of an uncrystallised pension. Englehart J held that the definition of income in section 310(7) is applicable only to ’a pension in payment under which definite amounts have become contractually payable’. The key theme to the judgment is that there could be no receipt of payments under the pensions without the bankrupt making a number of positive decisions and elections. Without those decisions or elections having been made, the pension rights were both uncertain in value and uncrystallised. The court considered the use of the word ’entitled’ in section 310(7) and concluded that the word inferred a reference to pension payments that had been contractually payable and therefore definite in amount, and as a result a bankrupt cannot be ’entitled’ to an uncrystallised pension.
Englehart J acknowledged the ’formidable problem’ that the wording of section 310(7) does not empower the court to make a bankrupt’s decision for him as to how to exercise the available options under an as yet uncrystallised pension, and therefore effect the metamorphosis of an uncrystallised pension right into a definite and contractual payment. The distinction between the historical position in Re Landau and the current position following the WRPA reforms must be highlighted; pension rights of themselves do not form part of the bankruptcy estate. The TIB has no right to step into the shoes of the bankrupt and make decisions on his behalf relating to pensions. To do so would be irreconcilable with the clear intention of the WRPA.
Despite Englehart J being clearly troubled in reaching a conclusion in opposition to Raithatha, the judgment is illuminating in its balanced application less at odds with the intended legislative aims as to pension protection. It remains to be seen whether the Court of Appeal reaches a different conclusion.
Even if the Court of Appeal concludes that the Raithatha approach is preferable, this raises a further question in relation to IPOs. An IPO shall not be ordered by the court if to do so would reduce the bankrupt’s income below what the court considers to be necessary to meet the reasonable domestic needs of the bankrupt and his family (section 310(2) IA). If the subject matter of the IPO application is pension monies, against what timescale are those reasonable domestic needs to be assessed? Legislative answer comes there none.
This was the specific question addressed by the court in Re X (Application for Income Payments Order) which involved a personal pension valued in the region of £100,000. The available annual income for the bankrupt varied between £5,474 and £4,103 depending upon whether the bankrupt took the 25% tax free lump sum. This income, when taken alongside the bankrupt’s other income (being state pension and housing benefit) resulted in a significant shortfall below the reasonable domestic needs. The court declined to make the IPO on the premise that to do so would reduce the bankrupt’s annual income below her living requirements indefinitely, not just for the maximum three year duration of an IPO.
This further consideration merely serves to indicate that the interaction between bankruptcy and personal pensions is inherently complex.
From 6 April 2015 the Government has introduced significant changes relating to pension flexibility. Any individual with defined contribution savings will be entitled to access their full pension fund upon reaching the age of 55 (conditional on scheme rules permission). For schemes that do permit such flexibility, the distinction between an individual’s lump sum payments and pension income will be removed. This potentially puts at risk the pension funds of those who are either bankrupt or at risk of being declared so, and will undoubtedly cause even a modest pension fund to embody an attraction for a TIB. For both TIBs and bankrupts finding themselves in this position, the outcome of the Horton v Henry appeal will resonate widely – either for the benefit of creditors or to the detriment of the bankrupt’s retirement plans. A decision in favour of Raithatha would undoubtedly engender a blissful marriage for the TIB and a bankrupt’s creditors, but would simultaneously carve a chasm into the pension protection aims of the current legislation.
It is hoped that the appeal of the Horton v Henry decision will bring much needed clarity to a complex relationship. The reality however is less defined; even once the case law is settled on this point there will remain many tangential issues to resolve. Not least whether the reach of the TIB is to be curtailed before it impacts upon the newly available flexible pension access for individuals in bankruptcy attaining pensionable age. Whether Jack the bankrupt remains safe at the top of the beanstalk remains to be seen. Lest we forget after all, the TIB has more than one magic bean - even if a bankrupt escapes the reach of the TIB’s IPO, he may still find the TIB close on his tail with a claim for after-acquired assets in the event that he uses his pension pot to go on a shopping spree.
This article was published in Commercial Litigation Journal in June 2015.