Part 5 of the Insolvency Act 2006 enables a debtor to enter into an arrangement with creditors. Part 5 may be a good alternative for insolvent individuals who are facing bankruptcy proceedings and would like to avoid the formal restrictions that are associated with a bankruptcy.

Compositions

In the event that a debtor can put in place a composition, the arrangement will be binding on all creditors. Including dissenting creditors. The composition must be accepted by the prescribed majority (currently three quarters) of creditors and approved by the court, then a debtor is entitled to have their bankruptcy annulled. This process requires the debtor to formulate a scheme that offers creditors more than what they would receive in a formal bankruptcy.

The process for compositions can be complex, it involves the following:

  1. Two meetings of creditors
  • The first meeting will settle the terms of the composition and hold a vote, a special resolution is required (currently three quarter majority)
  • The second meeting will confirm the preliminary resolution and as with the first meeting a special resolution is again required; and
  1. An application must be made to the court for approval:
  • There are four prescribed grounds in section 315(3) which if any are made out the application can be refused.
  • If it is approved, all creditors are bound.
  1. If accepted the bankrupt and Assignee must prepare a deed of composition; and
  2. Apply to the court for approval of the deed.

This procedure is not commonly used, as it seems to offer little advantage over obtaining a discharge. However, a debtor may be persuaded to enter a composition if there is an ability to trade again immediately upon approval.

Proposals

Proposals have a similar process as to compositions. However a proposal occurs prior to adjudication and essentially provides that if a proposal is brought about and approved, unsecured creditors cannot pursue a formal bankruptcy process against the debtor. The difference between proposals and compositions is that under a proposal the debtor is able to avoid bankruptcy completely and the procedure is much less complex.

The proposal procedure has two basic requirements:

  1. That the debtor has an interest in “being saved” from the consequences of the bankruptcy; and

  2. That the creditors receive (the potential of) something more than they would receive in either a bankruptcy, or through normal execution methods.

In terms of the latter, a debtor can provide more to a creditor than would be received in a formal bankruptcy if they fund the scheme through earning income, through assets that cannot be taken by the Assignee or through a third party.

The process for a proposal involves the following steps:

  1. The insolvent must formulate and make a proposal to their creditors which is filed at the nearest court to where the insolvent lives; and

  2. A meeting of creditors is then held, creditors must submit a claim form and then it is up to the trustee to decide whether the claim is accepted or not. In order for the proposal to be accepted it must obtain support of the majority (three quarters majority) and;

  3. If accepted the trustee must as soon as possible:

  4. Apply to the court for approval of the proposal; and

  5. Send notice of hearing to insolvent and each creditor

  6. The court may reject the proposal under section 33 if one of the three prescribed grounds is made out.

Once approved the proposal is binding upon all creditors whose debts were provable. During the proposal the insolvent must do everything that is necessary to put the proposal into effect.

Summary

These procedures enable a debtor to either avoid bankruptcy or to be removed from the process by formal compromise with creditors. There may be advantages to creditors as in some cases they may receive more than they otherwise would in a bankruptcy.

The creditors are not in any way required to accept either procedure so it is at the wider pool of creditors’ discretion as to whether or not either process will be successful.