Compositions and Schemes of Arrangements are an underused mechanism for getting out of bankruptcy before the statutory three year period expires. This may be due to these provisions being little understood.
It is a common misconception that once a person is bankrupt; there is nothing more they can do about their financial lives until they have been discharged.
But there is an alternative that could be used by many bankrupts. Compositions (the payment of money over some time period) and Schemes of Arrangements (any other form of legal arrangement) – collectively section 73 Arrangements – can be used at any time during the bankruptcy period, and have been used occasionally by bankrupts after discharge.
The actual mechanism is fairly straight forward. The bankrupt sets out his or her proposal in writing and the trustee in the bankruptcy examines it, calls a meeting of the bankrupt’s creditors and recommends whether it should be accepted or not when compared against the likely return from a continued bankruptcy. At the end of the day it is up to the creditors to decide whether to accept the proposal or not. Acceptance must be made by special resolution – more than 75% of the creditors voting in value and 50% of the creditors in number – meaning that the proposal has to have general support before it will be accepted.
73(4) The creditors may, by special resolution, accept the proposal.
A great benefit of a successful section 73 proposal to the bankrupt is that it annuls the bankruptcy. Annulment is an effective undoing of the bankruptcy. An annulment is different (and better for the bankrupt) than discharge from bankruptcy at the end of the three year statutory period, which is just an ending of the legal process and the restrictions placed on the bankrupt.
The debtors under a section 73 agreement (the ex-bankrupts) are still subject to the provisions of the proposal accepted by the creditors and can be re-bankrupted if they breach the agreement, but many of the restrictions placed upon bankrupts will no longer apply. Also, in most circumstances, they will not be an ex-bankrupt in the eyes of the law.
74(5) Upon the passing of a special resolution at a meeting of creditors of a bankrupt under subsection 73(4), the bankruptcy is annulled, by force of this subsection, on the date on which the special resolution was passed.
Because the bankruptcy has ended as if it never occurred, the actions of the trustee during the bankruptcy could potentially be void, or at least be under some legal question, without some other protection. To clarify this position, the Bankruptcy Act provides that the acts of the previous trustee are deemed to have been validly performed.
Because the bankruptcy is ending and a new arrangement is being proposed, the creditors are not stuck with having the same trustee. If for some reason they wish the 73 arrangement to be administered by another registered trustee, they can make that change of person part of the proposal. There is no logical reason why the trustees have to be the same.
74(6) Where a bankruptcy is annulled under this section, all sales and dispositions of property and payments duly made, and all acts done, by the trustee or any person acting under the authority of the trustee or the Court before the annulment shall be deemed to have been validly made or done but, subject to subsection (7), the property of the bankrupt still vested in the trustee vests in such person as the Court appoints or, in default of such an appointment, reverts to the bankrupt for all his or her estate or interest in it, on such terms and subject to such conditions (if any) as the Court orders.
The other reason that bankrupts propose section 73 arrangements is to be released from their debts. Interestingly the Act does not automatically release debtors from their debts under 73 arrangements, and because the bankruptcy has been annulled there will be no discharge process to trigger the release of debts after the bankruptcy. Without special provisions being included in the proposal, the debtor (ex-bankrupt) would once again be liable for those debts once the 73 arrangement has ended, or that part of the debts not paid under the arrangement.
It is important that these provisions are included and made known to creditors.
Why would creditors entertain such a proposal from a bankrupt? Money is usually the answer. Specifically creditors will want a larger dividend through the 73 arrangement than through the continuation of the bankruptcy. On most occasions these proposals are made some way into the bankruptcy period, so the trustee and the creditors have a pretty good idea whether any or any more assets will become available to distribute as dividends. They are likely then to be able to make a decision on whether the proposal makes commercial sense to them or not.
The provisions are meant to give both the bankrupt and their creditors a win. One gets released from bankruptcy and the other gets more money. Given that both sides are benefitting, we are a little surprised that these provisions are not used more often.