What debts are provable on a debtor’s insolvency? Part One

Under English insolvency law, creditors “prove” for their debts against an insolvent debtor’s assets. They do this by submitting a ‘proof of debt’ form. Generally, submitting a proof of debt is necessary to allow the creditor to both receive a distribution from the assets (i.e. to get its money back) and to allow it to participate in creditor decision making procedures.

There are limited exceptions to the general rule on proving. Secured creditors need not prove in a liquidation and may simply enforce their security. However, they may choose to prove where there is a shortfall in the value of the security compared with the value of the debt, or where they surrender their security. At the other end of the spectrum, creditors with ‘small’ debts (under £1,000) are not required to submit a formal proof of debt.

The process of proving debts is usually relatively straightforward. A creditor will submit the proof of debt to the insolvency office-holder stating, amongst other things, its identity, the amount of its claim and how the debt was incurred. The office-holder then “adjudicates” the proof, i.e. assesses the claim – acting quasi-judicially – and determines whether to admit it in whole or in part, or to reject it.

Nevertheless, issues do arise from time to time and, in this first of a two-part post, we cover some of the more common queries we receive from creditors.

Can I claim for debts payable at a future time?  

Yes, such debts are capable of being proved. 

While most loans are structured so as to be repayable on a fixed future date, they will typically become present debts through the operation of the loan’s acceleration clause following an “event of default” triggered by the appointment of the insolvency office holder (or at some earlier stage).

Even if that is not the case, a creditor can still claim for the full value of its future debt. However, if, at the time when any dividend from the insolvent estate is declared, the debt is still not payable, its value for the purpose of the dividend is discounted by about 5% a year for each year between the date the company entered insolvency proceedings and the date on which the debt falls due.

An important exception to this principle are payments due periodically. These payments, which include rent, are not treated as future debts for which each periodic amount payable in future may be proved. Instead, only amounts due and unpaid at the date of entry into liquidation/administration may be proved (although for as long as the lease continues, the landlord may prove for each rental payment as it falls due).

Can a claim for debts arising after the initiation of the insolvency procedure?

Potentially. Certain debts are capable of being proved as being debts or liabilities to which the company may become subject after the beginning of the insolvency proceedings by reason of any obligation incurred before that date.

Where a debt becomes payable by the insolvent debtor on a certain event occurring (which may or may not happen), it is a contingent debt. The words in italics allow for a broad range of potential contingent debts to be proved.

Where the debt arises as a result of a contract entered into before the start of the insolvency proceeding, such a debt is capable of being proved and this should deal with the majority of queries on this point.

However, the answer is not quite so clear-cut in respect of debts arising other than under a contract, such as under statute or tort. The wording cannot possibly apply to bring every legal rule which may, on any contingency, have effect. No universal rule exists to determine which statutory debts fall within this scope. Nevertheless, case law[1] provides a useful test to be considered in “normal” circumstances which is worth quoting in full:

“in order for a company to have incurred a relevant ‘obligation’ under this rule, it must have taken, or been subjected to, some step or combination of steps which (a) had some legal effect (such as putting it under some legal duty or into some legal relationship), and which (b) resulted in it being vulnerable to the specific liability in question, such that there would be a real prospect of that liability being incurred. If these two requirements are satisfied, it is also, I think, relevant to consider (c) whether it would be consistent with the regime under which the liability is imposed to conclude that the step or combination of steps gave rise to an obligation under rule 13.12(1)(b).”

Applying this wide and flexible test, the courts have found that debts arising under pensions legislation moral hazard provisions and statutory “deemed” gas and utility contracts applicable during administration were both provable debts.

For liabilities arising in tort, a similar but separate rule provides that they are provable if the cause of action has accrued at the point of entry into insolvency proceedings or if all the elements necessary to establish the cause of action exist at that time except for actionable damage.

[1] In the matter of the Nortel Companies, UKSC 2011/0259, judgment of Lord Neuberger, paragraph 77.