The Principle of Pari Passu in the Distribution of the Debtors Assets - Essay Example

Student details Professor’s name Law of Bankruptcy Submission date A trustee in bankruptcy is a person appointed for a bankrupt estate. A trustee is appointed in cases that involve individuals. On the other hand, a liquidator is appointed in companies where the company becomes insolvent. The two have the function of collecting debts and paying the creditors to the extent that the assets and the debts collected permits. The trustee and the liquidator are supposed to ensure equality in the distribution of what is recovered from the debtors to the creditors. The principle of pari passu applies in the distribution of the debtor’s assets. Pari passu means that the payments made to creditors are to be paid in accordance with the proportion of their claim (Goode 56). The principle is not only applied corporate insolvency but also in bankruptcy. There should be no preference of the creditors. The payments should be made from the funds collected from the recovered assets equally to all the creditors (Re-Home Loans Fund (NZ) Ltd (1983) 1 NZCLC 95). Equal in this case does not refer to the exact amount for each, but rather, an amount that is proportionate to the claim by each (Farrar 36). The principle has been cited as the most important and the main principle in bankruptcy (Keay 66). The principle is applied especially in unsecured debts to ensure that each creditor is able to at least recover a portion if not all of what they claim from the bankrupt individual or the insolvent company. Set-off, on the other hand, arises where a debtor owes the creditor and the creditor owes the debtor. It is a payment in some form (Wood 3). The right arises where a creditor is both a creditor and debtor to the insolvent company or a bankrupt individual, however, debtors must prove substantial claim (Glew v Harrowell, in the matter of Glew [2003] FCA 373). The amount to be paid in such a case is the difference if there is any in cases where there are mutual debts in bankruptcy (Bankruptcy Act, s.86). Set off allows the two parties that owe each other to apply their debts against one another (Ebert v Union Trustee Co of Australia Ltd [1960] HCA 50). The creditor instead of paying the money that they owe and then seeking to be paid for the amount the insolvent company or bankrupt individual, the creditor simply requests that the calculation is made and if a difference arises, the party to whom the difference is owed to be paid. This aspect avoids an absurdity of each party claiming their debt which may lead to increased costs of recovering debts from each other (Wood 15-005). The right of creditors to request for a set off is provided for in Bankruptcy Act. The Act accords the right to either party to claim set off where there is a mutual debt (Re Capsanis; Capsanis v The Owners – Strata Plan 11727 [2000] FCA 1262). Where is the mutual debt is equal, then no amount would be payable to either party and the debt would be treated as having been fully settled. Set off in insolvency and bankruptcy in Australia is therefore embedded in statute rather than in set off provided for in contracts (Wood, 15-004). The effect of having the right of set off has raised some concerns especially in relation to the pari passu principle. The question of whether set off breaches the principle of pari passu is critical, especially when considering the effects of providing for the right of set off by creditors. In any issue of bankruptcy or insolvency, the priorities of the debts is the first consideration. However, debts that have the same rank should be paid in consideration to equity. No preference should be given to any creditor (Corporations Act 2001, 588FC). The existing debts are classified as either secured or non-secured. The secured debts are paid from the assets providing the security for the debts. Secured debts rank highest in the hierarchy of debts. That means that they are to be paid first in bankruptcy or insolvency. For the rest of the debts which are not secured, the payments are made afterwards. The same may be outranked by other payments such as taxes. It, therefore, means that unsecured creditors may not be paid where the company or the individual does not have sufficient assets or debtors from whom the payments may be recovered. Unsecured creditors being of the same rank should be treated equally. Meaning that their payments should be done in proportion to the amount that each lay claim to (in pari passu). The issues of set off if brought in would bring a different approach. It means that the creditor will be asking to have what he or she owes the company or the individual, deducted from the amount that the company or the individual owes him or her. That would essentially serve to extinguish his or her claim or reduce it considerably. While looking at set off superficially, one may not see any issue with it. However, if analysed critically would give rise to a situation where a person having the right, has a superior claim that creditors in the same rank. This is because they will have an opportunity of reducing the amount they claim as a result of the mutual debts against each other. It, therefore, gives such creditors an upper hand since the money collected from debtors should be used to pay all the creditors according to the proportion of their claim. However, the creditor, in this case, gets the advantage of collecting all the amounts from a debtor to the satisfaction of his own debt against the company or the individual. The creation of a superior claim is one of the issues that raise critical questions on equality. The proper approach would be for him or her to pay up his or her debt. The debt would then go to the settlement of the claims by the creditors while adhering to equity. The practice may even override other interests that may have been discussed in creditors meetings. The meetings are important in protecting the rights of each creditor as well as ensuring that the assets of the company or the bankrupt person are not misapplied (Tomasic 3). Having one creditor or several creditors receive ‘payments’ otherwise than with the approval of the creditors in the creditors’ meeting will serve to violate their rights. The principle of pari passu is breached as against the other creditors since they get ranked lower compared to a creditor with a right of set off. They do not get a chance to share in the amount recovered the specific creditor at all, an aspect that would place an unsecured creditor on the same level as a secured creditor. The existence of the right of set off, therefore, means that the creditor has a secured claim to the extent of the right to set off. The effects do not only extend to a rise in the hierarchy. The effect of the right of set off is that the creditor will end up recovering more amounts than fellow creditors. In an instance where the total amount recovered by the liquidator or the trustee in bankruptcy is not sufficient to settle all the debts, the creditor with a set off will have a huge advantage. Instead of collecting small amounts that the rest of the creditors in the same rank are likely to receive, the creditor might have an opportunity of recovering all their claim or a substantial part of the claim. The effects indicate a clear breach of the pari passu principle since equality is not upheld among creditors with claims that are equal in rank. It is further disadvantageous since creditors in this rank mostly end up with very little or no payments at all. The initial actions by the liquidator or the trustee in bankruptcy include getting a list of all the debtors and creditors and the amounts owed or due to each. Actions of dealing with any creditor which includes making some form of arrangement besides following the list of creditors and their respective claims may amount to preferential treatment which is prohibited. However, the granting of the creditor the right to set off amounts to some form of preference. The debt that he or she holds is dealt with in a manner that he or she wishes. The same amounts to the application of the assets of the company or the individual to the settlement of a claim by a single creditor. The right of set off serves to deprive the other creditors of assets that would have, if not for the set off, been available to them for distribution. This is equivalent to a great extent, with the transfer of property to a creditor preferentially. The Act provides that the transfer of money also amounts to the transfer of property. A debt, therefore, should receive the same treatment since the effects of both set off and transfer of property preferentially to a creditor have the very same effects. The right of the rest of the creditors to receive equal treatment or equal proportion of the amounts or the assets recovered is therefore infringed. The action, therefore, amounts to an outright preference which is against the pari passu principle. When viewed from the different angles discussed above, it is without a doubt that the right of set off breaches the pari passu principle. The effects when carefully analysed indicate a huge similarity to some of the actions that are already prohibited by Statute. The right gives a creditor an undue advantage over the other creditors and to a great extent, deprive the other creditors of the assets would otherwise be available to them for distribution. The fact that it also raises the rank of an unsecured creditor to equal that of a secured creditor is also an issue of concern. Works cited Bankruptcy Act 1966(Cth) Corporations Act 2001(Cth) Ebert v Union Trustee Co of Australia Ltd [1960] HCA 50 Goode, R, Principles of Corporate Insolvency Law: Student Edition, London, Thompson–Sweet & Maxwell, 2005 Glew v Harrowell, in the matter of Glew [2003] FCA 373 Farrar, John. "Piercing the corporate veil in favour of creditors and pooling of groups-a comparative study." Bond Law Review 25.2 (2014): 6. Keay, Andrew. "In Pursuit of the Rationale Behind the Avoidance of Pre-Liquidation Transactions." Sydney Law Review. 18 (1996): 55. Re Capsanis; Capsanis v The Owners – Strata Plan 11727 [2000] FCA 1262 Re Home Loans Fund (NZ) Ltd (1983) 1 NZCLC 95 Tomasic, Roman. "Creditor participation in insolvency proceedings.", OECD, 2006. Wood, Philip R. Set-off and netting, derivatives, clearing systems. Vol. 4. Sweet & Maxwell, 2007. Wood, Philip R. Principles of international insolvency. Sweet & Maxwell, 2007. Read More