Bankruptcy annulment and divorce (Lin v Gudmundsson (a bankrupt) and others)

April 20, 2021

This article was first published by Lexis®PSL on 8 April 2021.

Steven Fennell

Restructuring and Insolvency analysis: The courts recognise the possibility of party to divorce proceedings attempting to use the protection of a bankruptcy order as a shield against the claims of the spouse for ancillary relief. Where a solvent spouse does this, the court has the power to annul the bankruptcy order under section 282(1)(a) of the Insolvency Act 1986.

Those advising a spouse looking to challenge the other spouse’s bankruptcy need to focus very clearly on the liquidity of the bankrupt spouse on the date of the order. Simply showing that the bankrupt spouse had assets far beyond their liabilities is not enough. The question is whether those assets were sufficiently liquid to allow the petition debt and the other debts to be paid in full as at the petition date or very shortly afterwards.

The directions in this case required the trustees to file a report setting out their conclusions on the debtor’s assets, liabilities and liquidity. The trustees may have access to material which the applicant spouse does not have. The applicant’s advisors should explain at the outset that the view of the merits of the application will have to be reconsidered and possibly withdrawn on receipt of the trustees’ report.

The case also illustrates the risks of over—reliance on past misconduct by the bankrupt spouse. In Lin v Gudmundsson, the husband had a history of addiction and some years before the bankruptcy he forged a drug test certificate in order to obtain access to his children. The wife’s representatives invited the judge in the bankruptcy proceedings to find that the bankrupt’s past dishonesty should affect how the court views his evidence about his finances. The judge refused to do that. He noted that the bankrupt accepted in cross—examination that he should not have forged the certificate and concluded that the bankrupt was an honest witness. Again, managing the expectations of a client whose spouse has lied to them and to the court can be very difficult, but failing to do so could lead to an expensive and unsuccessful outcome.

Finally, if collusion between the bankrupt and the petitioning creditor is alleged, the applicant needs to consider very carefully whether to join the petitioning creditor as a respondent. Failure to do so may make the allegation of collusion very difficult to prove.

What was the background?

The husband had enjoyed a successful career in banking and finance. His marriage to the applicant broke down leading to very acrimonious proceedings in the family court. The wife’s case in the ancillary relief proceedings was that the husband was in reality the beneficial owner of assets in offshore trusts. The husband denied beneficial ownership. The wife’s case was that it would be fair to the husband for her to be given the equity in the matrimonial home with the husband keeping his other assets, including any interest he might have in the trusts.

Shortly before judgment was given in the family court, the husband was made bankrupt on a petition presented by a business associate who had (among other things) assisted him in the family proceedings after the husband ran out of money to pay his solicitors.

The annulment application was initially made on the basis that there was collusion between the husband and the petitioner and that the petition debt was not owed. That allegation was not pursued after the trustees’ investigation showed that the petitioner had made loans to the husband which had not been repaid. At trial, the application was pursued on the basis that the husband was not insolvent because he could call upon the trust assets to pay his debts.

What did the court decide?

The court reviewed all of the principal authorities and summarised the law as being that if a bankruptcy order is made against a spouse who cannot pay their debts when they fall due, prima facie that order is rightly made. The position is different if the statements supporting the petition or application are false, if there are no debts, or if the bankrupt could pay their debts as they fell due (see para [48] of the judgment).

The judgment goes on to say that the warning that a party to financial relief proceedings may attempt to use the protection of a bankruptcy to avoid a spouse’s claim is not directed at cases where a genuine creditor petitions and the debtor cannot pay the debt (para [50]).

In Paulin v Paulin [2009] BPIR 572, the Court of Appeal held that where the bankruptcy follows a debtor’s application, if the spouse shows an excess of assets over liabilities, the evidential burden shifts to the debtor to show a lack of liquidity. In Lin v Gudmundsson the court held that this applies only to debtors’ applications—it does not apply where there has been a creditor’s petition.

Even if the applicant can show that the debtor was able to pay their debts at the date of the order, it does not follow that the court has to annul the bankruptcy. The court has a discretion (see para [44]). In Lin v Gudmundsson the court did not get as far as considering the exercise of its discretion.

In a number of cases, the courts have declined to annul bankruptcies where the process was tainted by serious procedural irregularities, including on one occasion apparent dishonesty as to service on the debtor, where the court concludes that the debtor is insolvent and a further bankruptcy order is inevitable (Artman v Artman [1996] BPIR 511; Askew v Peter Dominic

Ltd [1997] BPIR 163; Omokwe v HFC Bank Ltd [2007] BPIR 1157 at [38]–[39]; Lambert v Forest of Dean District Council [2019] EWHC 1763 (Ch) at [50]–[52]). A further factor in Artman v Artman was the desirability of a thorough investigation of the bankrupt husband’s conduct and affairs.

Conversely, if a debtor makes a dishonest statement of affairs understating their assets and/or overstating their liabilities, the court is more likely to exercise its discretion to annul (Paulin v Paulin at [50]; Re Eichler (No 2) [2011] BPIR 1293 at [175]–[176]).

Case details:

• Court: Business and Property Courts of England and Wales, Insolvency and Companies Court (ChD)
• Judge: Chief Insolvency and Companies Court Judge Briggs
• Date of judgment: 6 April 2021