The facts of this case were somewhat unusual although it serves as a reminder of the principles involved in the trading of a business by a trustee in bankruptcy.

Background

On bankruptcy in October 2014, the debtor ran a cleaning business employing approximately ten staff, having operated the business successfully for over 20 years until he ran into difficulties as a consequence of overstating his profits (by including VAT in turnover) and therefore the tax due to HMRC. Following bankruptcy, the debtor was very keen to ensure the continuation of the business and so the Official Receiver arranged the urgent appointment of a trustee on 20 October 2014. The Trustee immediately applied to the Secretary of State for urgent sanction to continue to trade and to use a local bank account, which was granted a few days later.

Thereafter, the debtor continued to operate the business on a day to day basis under the Trustee’s supervision, accounting to the Trustee for all trading income. The Trustee paid the wages and other bills of the business, including ongoing tax, from the trading income and the debtor received an agreed monthly allowance for his assistance in running the business.

By 2017, the Trustee was required to issue an application for possession and sale of the debtor’s family home pursuant to the “use it or lose it” provisions of the Insolvency Act 1986. At the same time the Trustee also sought to persuade the debtor to purchase the business with a view to the Trustee extracting himself from trading and progressing the administration of the bankruptcy estate. The Trustee and debtor met to discuss these matters in August 2017, nearly three years after the bankruptcy order had been made.

Following this meeting the debtor sought his own legal advice and having co-operated with the Trustee in the operation of the business over a 3 year period, then asserted that the business “was his”, on the basis that he continued to be self-employed following bankruptcy albeit using some bankruptcy estate assets for which he was under an obligation to account to the Trustee. The debtor set up a limited company with a similar name to that in which he had been trading which triggered an application by the Trustee for injunctive relief based on a concern that the debtor was planning to move the business to the new company. The Trustee applied to the court for declarations as to entitlement to the business and trading income.

The Issues

The main issues to be determined by the Judge were as follows:

1. Which business assets vested in the Trustee on bankruptcy and which assets were excluded as tools of the trade, and remained owned by the debtor?
2. Who in fact traded the business from the date of the Trustee’s appointment?
3. What did the Trustee have power to do under the Insolvency Act 1986 and/or the Secretary of State sanction? Did the Trustee act outside of his powers and if so what were the consequences?
4. Did the Trustee act in breach of the rule in ex parte James by taking the benefit of trading?

The crux of the debtor’s position was that at all material times he was carrying on business in his own right and not on behalf of the bankruptcy estate, in effect continuing as self-employed but utilising some of the assets that fell within the bankruptcy estate for which he should account (or had accounted) to the Trustee. All net post-bankruptcy income was the debtor’s for which the Trustee had to account to him.

In terms of the main issues that the Court had to determine, it considered as follows:

• To qualify as exempt, tools of the trade must be both “necessary” and “personal”. Items to be used not only by the bankrupt but also by anyone employed in his business are not personal to the bankrupt and not within the definition. “Necessary” does not mean convenient or desirable. The tools of the trade must be physical property.
• In relation to goodwill, it was common ground that this vested in the bankruptcy estate but due to the nature of the business, and the role played by the debtor, there was a dispute as to whether it had any value. The Court found that the business plainly had realisable value; it had been established for over twenty years, had numerous customers (including local authorities) and importantly, repeat business. Its reach extended beyond the debtor’s locality and whilst profits may have been overstated in the run up to bankruptcy, it was nonetheless a profitable business as at the date of bankruptcy. The debtor himself clearly considered the reputation of the business to be of some value by using the name for the limited company which reflected that of the business. The Judge found that whilst there may have been a relatively limited market for the business, she was satisfied that there was one and if anything the goodwill value of the business was higher in bankruptcy because it could be sold free of prior liabilities, most likely back to the debtor.
• The Court examined the powers of a trustee to trade a business in particular to appoint the bankrupt to assist. Paragraph 1 of Schedule 5 to the Insolvency Act 1986 conferred upon the Trustee the “power to carry on the business of the bankrupt so far as may be necessary for winding it up beneficially and so far as the trustee is able to do so without contravening any requirement imposed by or under any enactment”.

The Court considered the phrase “winding it up beneficially” finding that the term “it” means the business and not the estate, whilst “beneficially” must be “for the benefit of the creditors as a whole”.

The Court examined the case law (such as it was) on the concept of “winding it up…” concluding that the authorities stressed the temporary nature of the power to carry on trading. The Court found that Schedule 5 does not authorise the trustee to carry on a bankrupt’s business, with or without the assistance of the bankrupt, indefinitely. The carrying on of the bankrupt’s business is only authorised “so far as may be necessary for winding it up beneficially”.

The most obvious examples of continued trading of a business for the purpose of winding it up beneficially are (1) where there is outstanding work in progress and the most effective way of collecting in book debts is to complete the same, and (2) where continued trading is with a view to the sale of the goodwill at the best price reasonably obtainable.

In justifying the prolonged trading period the Trustee submitted that the Court should take a wider view of such powers in light of the “rescue culture” but this was rejected as a means of ignoring the clear wording of Schedule 5. Where long term or indefinite trading of a bankrupt’s business is envisaged, which is not for the purpose of winding it up beneficially, this should be achieved either by the bankrupt exiting the bankruptcy via a trading IVA, or by a sale of the goodwill of the business to the bankrupt or a third party, on deferred consideration terms if appropriate. 

• In relation to who was trading, the Court had no trouble finding that, notwithstanding the debtor’s assertion, the Trustee was trading the business. The suggestion that the debtor was trading in his own right after the bankruptcy order made no sense, given the extensive involvement in the business of the Trustee. In particular, at no time prior to instructing solicitors in 2017 did the debtor suggest that he was trading the business in his own right.
• The Court had to consider whether the Trustee was trading the business “for authorised purposes” and whilst the Judge was satisfied that the Trustee did not intentionally misrepresent the purpose of continued trading in his application for sanction, she found that he had lost sight of the purpose and pursued others instead. The initial sanction application had indicated that his aim was to maximise realisations by trading on to (1) realise the book debts and (2) achieve a sale back to the debtor. A reasonable period of trading in the context of this sort of business would be up to twelve months. The Judge found that on the date of the sanction of 24 October 2014 until 10 October 2015 (date of discharge), the Trustee continued trading the business with a view to the debtor achieving either a payment in full annulment or an IVA. From the date of the debtor’s automatic discharge on 10 October 2015 until June 2017, the Trustee continued trading the business initially with a view to the debtor achieving either an “informal IVA” or payment in full annulment. The Trustee did not trade with a view to achieving a sale back to the debtor until June 2017.

The Judge found that the earlier strategies prior to June 2017 did not fall within the purposes permitted by Schedule 5: it is no part of a trustee’s function to carry on the trading of the business of a bankrupt in the hope that it will assist the bankrupt in achieving an IVA or payment in full annulment. Whilst the Trustee acted honestly, in good faith and with the very best intentions, in trading the business with a view to the debtor achieving an IVA or payment in full annulment, he acted for a purpose other than that permitted by Schedule 5.

• The Court then had to determine what the consequence of that was. The Court found that this did not render the Trustee’s actions void as being ultra vires.
• The debtor alleged that the Trustee had acted in breach of the rule in ex parte James, which is the principle that an officeholder as officer of the Court should act fairly in his dealings generally, notwithstanding strict legal rights.

The application of that principle in this case was relevant to the windfall the bankruptcy estate was said to have received from the trading business as compared to an Income Payments Order or Income Payments Agreement.

An IPO could have commenced at any time up to 9 October 2015 (being the date of discharge) and therefore could have run for a three year period. The issue was whether to apply the rule in ex parte James in relation to trading income from 10 October 2017 (being 3 years from the date of bankruptcy, and during which an IPO could have been in force) and require the Trustee to account to the debtor for the net benefit to the estate.

The Court considered that this did not turn on whether the Trustee had been guilty of conscious or deliberate wrongdoing and to the contrary, whilst the Trustee was guilty of errors in his handling of the bankruptcy, he acted honestly, with integrity and with the best intentions. The key here was how the trading income from the business for the period from 10 October 2017 should be approached in circumstances where, on strict legal analysis, that income belonged to the estate.

The Court found that it would be unfair for the Trustee to treat the entirety of the trading income from the business from 10 October 2017 as an asset of the estate, because the trading arrangements which took place in 2015 should not have continued for such a length of time. By October 2015 (a year after the bankruptcy) the Trustee should have insisted on the sale of the business or cessation of trading.

Whilst the Trustee was directed by the Court not to insist on the strict legal rights in relation to the trading income generated by the business from 10 October 2017, and to account for such income to the debtor, certain caveats were applied: (a) accountancy fees incurred by the Trustee must be deducted from the account; (b) reasonable and proper time costs incurred by the Trustee in relation to the business must be deducted from the account; and (c) most importantly, the debtor must account to the Trustee for a sum representing the value of the business.

Comments 

Whilst this case is an interesting reminder of the principles relating to the trading of a business by a trustee in bankruptcy, and a warning not to do so for too long, some may think the more important point is the use of ex parte James to control the trustee which has seen a resurgence in recent times. The courts seem to be ready to regulate the conduct of an officeholder where it is perceived to be unfair, see in particular Bucknall –v- Wilson [2020] EWHC 1200 (Ch).