A Review of Bankruptcy Annulment and Debtor Capacity
Under section 282(1) of the Insolvency Act 1986, the Court has discretion, on the application of a debtor, to annul a bankruptcy order, where the Court is satisfied that either:
- on any grounds existing at the time the order was made, the order ought not to have been made; or
- that the bankruptcy debts and expenses have, since making the order, been paid or secured to the satisfaction of the Court.
Applications for annulment relying on the first of these grounds, that the order ought not to have been made, usually arise where the proper procedures involved in obtaining the order were not followed.
Where an order is made annulling a bankruptcy order on the grounds that it ought not to have been made, the starting point (although this may be rebutted on the facts of each case) is that the petitioning creditor is liable for the bankruptcy costs, including the costs of the trustee in bankruptcy.
This is accordingly an issue of significance for local authorities which employ bankruptcy proceedings against their debtors. Where a bankruptcy order is subsequently annulled, the costs liability can often amount to far in excess of the underlying debt. Further, local authorities will wish to avoid the negative publicity attached with pursuing bankruptcy of debtors in these circumstances. In dealing with their debtors, Council must accordingly be mindful of these potential pitfalls, and have relevant policies in place to deal with these issues.
The decision in Haworth v Cartmel  EWHC 36 (Ch) confirmed that the issue of lack of capacity (as defined in the Mental Capacity Act 2005) can be raised on an application to annul, on the grounds that the order ought not to have been made. The Court also noted that lack of capacity could be raised at the earlier stage, as a defence to a bankruptcy petition.
Reviewing the medical and other evidence, the Court found that at all of the key stages of the proceedings, from the service of the statutory demand, to the time of the hearing of the petition, the debtor lacked the capacity to conduct the proceedings brought against her. Further, the petitioning creditor had been made aware of the debtor’s condition.
The Court noted that it retained discretion, and that an annulment would not necessarily be granted in every case concerning a lack of capacity. In the circumstances of that case however, the Court exercised its discretion to annul the bankruptcy order, noting that:
“If a bankruptcy order has been obtained by a creditor in circumstances where that creditor either knew or ought to have known that the person concerned lacked or may lack capacity, then the fact that there has been a delay in the making of the application to annul… and that costs have been incurred or increased as a result is almost certainly going to be outweighed by the inherent injustice in permitting a bankruptcy order to stand that has been obtained in such circumstances, at any rate when the problem could have been but was not drawn to the attention of the Court from which the order was sought”.
The Court held that the petitioning creditor was, in principle, liable to pay the trustee in bankruptcy’s costs, which were reported to be in excess of £360,000.
In Haworth, the Court also found that the petitioning creditor, HMRC, had breached its duties owed to the debtor under the Disability Discrimination Act 1995, which provided a further ground for annulment of the bankruptcy.
The Disability Discrimination Act 1995 has since been replaced by the Equality Act 2010, which is drafted in similar terms, including provisions that:
- a disabled person is discriminated against if they are treated less favourably because of something arising in consequence of their disability and the public authority cannot show that the treatment is a proportionate way of achieving a legitimate aim (section 15);
- indirect discrimination occurs when a policy that applies in the same way for everybody has an effect that particularly disadvantages disabled people (section 19); and
- Section 20(3) creates a duty “…where a provision, criterion or practice …puts a disabled person at a substantial disadvantage … in comparison with persons who are not disabled, to take such steps as it is reasonable to have to take to avoid the disadvantage.”
Councils must have regard to these duties when considering the use of any enforcement procedures.
Rules 7.43 and 7.44 of the Insolvency Rules 1986 provide that in insolvency proceedings, where it appears to the Court that a person lacks capacity within the meaning of the Mental Capacity Act 2005 to manage and administer their property and affairs, either due to a mental or physical affliction or disability, the Court may appoint a person to represent the incapacitated person.
Such an appointment may be made either on application of the representative, a relative or friend of the incapacitated person, the official receiver, the office holder, or by the Court of its own motion.
The Civil Procedure Rules also set out a parallel provision for the appointment of a litigation friend to act for a mentally incapacitated person.
Where a petitioning creditor has become aware that a debtor is mentally incapacitated, they should ensure that the Court has given full and proper consideration to the appointment of a representative or litigation friend to act for the debtor, prior to making any bankruptcy order. Failure to do so could provide the debtor further grounds for an annulment of a bankruptcy order.
Where a debtor is a disabled person, or lacks capacity, this will not necessarily preclude the use of bankruptcy proceedings. Each case must be considered with reference to the individual debtors’ circumstances. However, petitioning creditors will need to ensure that they can demonstrate their decision making process concerning recovery action, and that any action taken complies with their duties in relation to disabled people, or those lacking capacity.
Councils must ensure that, where a debtor is known to be suffering from any disability, that reasonable steps are made to avoid any disadvantage to the debtor. Complying with these obligations may necessitate such actions as:
- speaking to a family member before or after serving documents;
- not taking enforcement action pending the provision of a medical report from the debtor; and
- considering alternative methods of enforcement.
It is also essential that, should matters proceed to a hearing, councils ensure that any information concerning the debtor’s capacity or disability is brought to the court’s attention.
Councils should also ensure that they:
- Gather and consider information about an individual debtor’s circumstances;
- Implement a formal, published Debt Recovery Policy covering bankruptcy and other enforcement actions such as charging orders;
- Include in the Debt Recovery Policy, the steps officers must take before deciding on bankruptcy, or other enforcement action being taken, and clearly record that each of these steps has been taken prior to undertaking enforcement actions;
- Consider whether its recovery practice would particularly disadvantage a disabled person, and, if so, what steps can be taken to avoid the disadvantage;
- Include in the Debt Recovery Policy, a requirement to consider whether a debtor’s failure to pay and to respond to other recovery measures could arise from a disability (including a mental impairment with a long-term and substantial effect on normal day-to-day activities).
Visits to a debtor’s home to levy distress are an opportunity to gather information and a council’s expectations about what should be recorded by its own staff or bailiffs should be set out in its Debt Recovery Policy.