Another limitation to the principle argued, is that it is operates in an uncertain manner due to the multiplicity of potential exceptions and bypassing devices, as there is a lack of statutory clarification on the law relating to the exceptions and bypasses i.e. claims by tort victims, providers of professional services who might be able to benefit form common law liens which arise by operation of the law.
Looking at the question of fairness, it has been argued that parri-passu has nothing to do with fairness, as fairness may not always result from treating two types of creditors equally i.e. a creditor who is able to diversify its risk such as a bank, in comparison to a creditor who is unable to do so, such as an employee.
It has nevertheless been accepted that the principle retains some practical importance, in the sense that it lies very much in the heart of the rationale behind the insolvency avoidance provisions for pre-liquidation transactions.
Notwithstanding the limitations to the scope of the rule, they do not in themselves constitute reasons for abandoning the principle, as the principle can still be argued to be the most appropriate method of redistributing residual assets in comparison to other alternative principles.
A first alternative would be to rank the debts in a chronological order, whereby those debts established at an earlier date would accordingly be paid first. However such a regime does not address the exceptions and bypassing issues, in addition to the fact that it may dissuade potential creditors from lending, if they know they will rank low in the distributional order. It however has the advantage of enabling creditors assess their position before advancing funds.
Another possible alternative would be to rank the debts ethically, so that unsecured creditors would be paid according to their or the society’s needs. A disadvantage of this is the high level of creditor uncertainty, as predicting positions in the payment queue will be nearly impossible. The effect of this would be to bring about huge inefficiencies.
A further alternative is to rank the debts according to their size; therefore small creditors should be paid at a higher rate of returns than those other unsecured creditors who loaned larger amounts to the company. The rationale for this alternative was to protect vulnerable small creditors. A criticism of this option is that it is difficult to correlate the size of the loan with the vulnerability of the creditor i.e. some small creditors may be more risk reliant that the larger creditor.
Looking at all of the above alternatives, one clear thing is that, to take on board any of them in place of the collective approach offered by the parri-passu principle would create so much uncertainty, that it would be impossible to provide efficient and fair processes. This therefore strengthens the case for the collective approach provided for by the parri-passu principle.
Moving on to the second part of this discussion, I shall consider whether the exceptions make the principle unduly complex and uncertain or whether the exceptions are consistent with the ‘efficiency’ and ‘fairness’ justification of the principle.
The exceptions to the principle are based on a combination of history, policy and pragmatism, and reflect a wide range of considerations. For the purpose of this discussion I shall start by considering the bypassing devices otherwise known as the false exceptions, before moving on to the true exceptions.
Starting with the so called ‘false exceptions’, it has been said that the principle does not apply to secured creditors; suppliers of goods under agreements reserving title; or creditors for whom the company holds assets on trust because such assets do not belong to the company.
In relation to security given to a creditor which may involve fixed or floating charges, the institution of security has always been supported on broad efficiency grounds. Arising issues relate generally to questions of fairness, where it has been argued as being fair, based on a ‘bargain’ justification theory, whereby the parties freely bargained the arrangement. Another fairness justification is that relevant parties are given due notice of the security arrangement, and so are unable to complain, in addition to a further justification namely, that it does not deprive the company of any value. Each of theses arguments however, can be countered in the sense that inequality of bargaining powers, information asymmetries, and enforcement biases undermine the free-bargaining rationale. After-acquired property clauses and weak preference rules counter the value argument, while inadequacies of the registration process counter the assertion that notice is adequate.
Looking at agreements reserving title, efficiency-wise, it increases the uncertainties associated with lending, coupled with the legal uncertainties surrounding ROTs. In terms of fairness a key issue is that such arrangements i.e. ROT clauses, are not registrable, thereby misleading unsecured creditors on the insolvency risk they are running. A following uncertainty of the concept is the use of its ‘all-monies’ form, which is used to secure debts beyond the immediate transaction. This is a significant issue especially when assets of escalating value are involved. The effect of the above is that the device shifts insolvency risk to the newest and weakest players in the market.
Moving on to arrangements whereby the company holds assets on trust for creditors, in terms of fairness consistency with the principle, the fact that certain trust i.e. ‘Quistclose type’ trusts, are not subject to the registration and disclosure requirements associated with security, it conflicts with the principle. Looking at another type of trust namely the ‘Kayford-type’ trust, it has been argued that such trusts should constitute a preference because money is taken from a general account and paid into a trust account for the benefit of certain creditors, which is in direct conflict with the parri-passu principle.
Summing up the position of the above bypassing devices or so-called false exceptions, there is a lot of strength in the argument that they are not consistent with the rationale behind the principle, and no doubt make it very uncertain due to informational and resourcing disparities.
Moving ahead to the true exceptions, they can be broadly broken down into 4 categories namely claims analogous to security; super-priority claims; preferential claims and deferred claims.
Starting with claims analogous to security i.e. insolvency set-off claims, the justification argument for this exception is that it protects legitimate expectations. On the other hand, it has been argued that this exception represents a major incursion into the parri-passu principle since to the extent that there are mutual credits /debits or dealings, the creditor can assert set-off rights and gain priority over others. The confusion however seems to evolve from the fact that this priority is mandated by virtue of r.4.90 Insolvency Rules 1986 as highlighted in National Westminster Bank v Halesowen. The overall effect of this, it has been argued is that parties are compelled to breach the parri-passu principle.
In relation to the super priority claims, these would include liquidations expenses; post-liquidation creditor’s claim arising under new contracts. It may also include post liquidation claims arising under pre-liquidation contracts, and even pre-liquidation claims of creditors who are able to inflict certain types of harm on the insolvent estate. These debts are payable and not provable; they do not rank parri-passu amongst themselves and have to be met in full following the priority ranking in r.4.218 IR 1986, subject to the courts discretion under section 156 IA 1986.
The issue that however, brings difficulty is whether the liquidator has adopted the contract for the purpose of winding up, this issue seems to strengthen the point that the exceptions bring about uncertainty and complexity because the liquidator is left with the discretion of whether or not to e.g. adopt pre-liquidation contracts, or add cost of environmental clean up liability; therefore creating a thin line between payable and provable. The process of an exception bringing about another exception is arguably a major source of complexity surrounding the principle.
The third category is that of preferential claims, which originally used to include Crown claims, and employee claims, but which after September 15th 2003 constituted only employee claims. The rationale for this exception is the desire to provide safeguards for those that have not voluntarily assumed a risk and are unable to do anything to provide for the risk. This particular category has a peculiar feature, which is that all preferential claims abate rateably amongst themselves. This has been argued by some commentators as being an application of the parri-passu principle. The problem here is that if preferential creditors are supposed to be an exception to the rule, how can the principle still apply to it?
The rationale for the last category, deferred claims, is that it serves as a way to punish those that are guilty of improper conduct i.e. delinquent directors guilty under sections 213 and 214; and to subordinate those who are expected to bear the greater risk i.e. shareholders. Efficiency and fairness-wise there is not much of an argument against it.
In conclusion it can be seen that though the parri-passu principle is not in itself without limitations, if the objective of insolvency law is to be concerned with distributional and public interest aspects; and the stated objective of efficiency and fairness is to be met, then the principle is the most appropriate for allocating the insolvency estate in comparison to other approaches. However when considering the effect of the exceptions on the principle, it will not suffice to say that a few of the arguments against them are theoretical; one must consider statistics and figures from empirical studies that show that most creditor claims (75%) in practise either are exempted or can be exempted from the application of the parri-passu principle, the effect of this is that distribution in accordance with this principle is virtually non-existent. There is a lot of complexity with the priority rules, which have a penchant for leaving absolutely nothing for the general body of unsecured creditor in practise, all which leads me to agree with a description of the principle as a ‘rule of non distribution’, which undeniably is as a result of the exceptions.
Ex Parte Mackay (1873) 8 Ch App 643
Section 107 Insolvency Act 1986, for voluntary winding up; r.4.181 (1) Insolvency Rules 1986, for compulsory winding up.