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. This meant the bankrupt’s pension could be applied towards paying his debts, and was a controversial decision as, previously, pensions funds were beyond the reach of a bankrupt’s creditors. The parties settled on confidential terms before the case was due to be heard in the Court of Appeal.
In our January 2015 update, we reported on the contradictory decision in Horton v Henry , where the High Court declined to follow the Raithatha ruling and held 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. The bankrupt could not therefore be compelled to draw his pension and apply that income towards satisfying his bankruptcy creditors.
In the most recent case to consider whether a bankrupt’s pension fund should be part of his bankruptcy estate, Hinton v Wotherspoon, the High Court preferred the decision in Horton v Henry. However, these are all first instance decisions and are not binding authority for future cases which may come before the High Court. Until such time as the Court of Appeal has an opportunity to rule on which approach is correct, or alternatively there is further statutory clarification, the contradictory decisions leave the law in an unsatisfactory state.
We will look in depth at the subject of pensions and bankruptcy in detail in a future briefing.
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 (IPO) compelling the bankrupt to pay some or all of that income to the TIB for inclusion in the bankruptcy estate.
The conflicting case law
In Raithatha, the High Court ruled that 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 bankrupt, 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 TIB, for a court order compelling Williamson 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.
In Horton v Henry , the bankrupt (Henry) had assets including 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, Horton, as his TIB, applied for an IPO seeking a share of lump sum payments and income from the pensions.
Henry opposed the application. He relied largely on the arguments advanced by the bankrupt in Raithatha. The Court held that his 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 the bankrupt 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.
In Hinton v Wotherspoon, (in which the Court did actually decide to make an IPO), the Court considered the point at which a bankrupt would become entitled to pension income. The judge noted that if the bankrupt had made an election to enter drawdown but had neither actually withdrawn a lump sum, purchased an annuity, nor started to receive an income from the fund, the entitlement to income had not arisen and thus no IPO could be made. It was possible, for example, for a pension fund to be subjected to an election to draw down, without any instructions as to payment (or annuity purchase) having been given: only once such instructions had been made was there an entitlement which could found the basis of an IPO.
The Court’s comments on this aspect of the case were obiter, as the bankrupt in this case had actually selected and had started to receive specific and quantified payments.
The decision in Raithatha 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 introduced from 6 April 2015, an individual with defined contribution pension savings is 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 means 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.
The various elections and decisions to be made by the bankrupt before a pension benefit crystallises (as referred to in Horton and Hinton cases) will continue to apply. However, the financial benefit of a successful IPO claim could make an application by a TIB, and potential pursuit of the bankrupt 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.