Gemma Lampert and Will Anderson look at whether a lump sum can be extracted from a pension and treated as income to pay creditors in bankruptcy proceedings.

A major consideration for any Claimant in an action seeking monetary damages is whether the Defendant to an action has the assets to meet a judgment, whether that be a claim against an individual or a limited company backed by the personal guarantee of an individual. That consideration should extend to a scenario where the Defendant has a judgment made against them and then either refuses to pay or cannot pay on time. The Claimant may have to seek their bankruptcy to achieve some payment. One question when looking at the Defendant’s assets and the possible recovery has in the recent past been the extent of the Defendant’s pension and whether the Defendant is at an age whereby a lump sum can be taken from the pension which might then become income of the Defendant and so be subject to an Income Payment Order so that the sum can be used as an asset in the bankruptcy to pay creditors.

Recent Case Law

In the recent appeal in the case of Horton v Henry the Court of Appeal has clarified the law in relation to a trustee in bankruptcy’s ability to treat as income a bankrupt’s pension when the bankrupt has not yet exercised a right to draw down a lump sum.

The first instance decision reached by Mr. Robert Englehart QC, sitting as a deputy judge of the High Court, was that the trustee could not compel the draw down of such a lump sum when the bankrupt had not exercised the right. This contrasted with previous judgments from the High Court (for example Raithatha v Williamson (a bankrupt) EWHC 909 (Ch) and Hinton v Wotherspoon EWHC 623 (Ch)) and so there has been an element of uncertainty as to a trustee’s rights in this area. The law has now been clarified by the Court of Appeal.

Facts

The Court of Appeal set out the following headline facts and matters in its judgment which were common ground:

• the respondent was made bankrupt on his own petition;

• the respondent had the present right to compel his pension provider to make payments under the policy in the future;

• because of the generosity of his wife and family, he had no current need for that income;

• he wished and intended to preserve the entirety of his pensions for his children after his death;

• therefore, he did not wish to exercise the right to take income now.

The Pension Policies

The assets of the respondent on the date of the bankruptcy were detailed by the Court of Appeal to include four pension policies:

a) Self-Invested Pension Policy (“SIPP”) which as at October 2014 had a value of £848,022.76. The terms of the SIPP entitled the holder to “crystallise” some or all of the separate units and to take up to 25% of the amount crystallised (subject to the lifetime allowance) as a pension commencement lump sum without incurring a tax charge.

As such there was potentially a maximum of approximately £212,005 available, plus recurring drawdown and/or annuity payments in accordance with elections made.

The investments in the underlying fund did not all consist of readily realisable shares, so there was a measure of uncertainty as to what would in fact be available if the SIPP were crystallised; and

b) Three personal pension policies, taken out under the National Provident Association Retirement Plan which had been transferred to Phoenix Life Limited under which the bankrupt could elect to receive a lump sum, “not exceeding three times the annual amount of the part of that annuity which is not commuted”. These policies had no fund value, simply a guaranteed annuity income of £2,450.68 for each policy at the age of 70.

First Instance Decision

The judge held that the bankrupt’s uncrystallised pension rights did not fall to be assessed as part of his “income” for the purposes of section 310 of the Insolvency Act. As a result the trustee was unable to require draw down on the funds and for them to be subject to an Income Payment Order.

The trustee appealed this judgment.

Appeal court issues identified

Lady Justice Gloster set out the issues which the Court of Appeal felt arose:

“i) whether section 333(1), read in conjunction with section 310, of the Insolvency Act enables a trustee in bankruptcy to require a bankrupt, who has reached the age at which he is contractually entitled to draw down or “crystallise” his pension (but has not done so), to elect to do so, so that the trustee may apply for an IPO under section 310 in relation to the funds drawn, or to be drawn, down;

ii) if so, what criteria apply to determine the manner in which, and the extent to which, the bankrupt may be required by the trustee to draw down his pension;

iii) how, if such a power exists, it should be exercised in the present case, having regard to the appellant’s reasonable domestic needs.”

Judgment

The Court of Appeal’s unanimous judgment, Sir Stanley Burton and Lord Justice MacFarlane agreeing with Lady Justice Gloster without any dissenting remarks, was that:

“As a matter of construction of section 310 of the Insolvency Act, there is no basis for concluding that a bankrupt’s contractual rights to draw down or “crystallise” his pension come within the definition of “income of the bankrupt” within section 310(7).” Going on to say it “simply does not support a construction which characterises a pension holder’s contractual rights under his pension to elect, after reaching a certain age, to draw down, or “crystallise” his pension, in the form of a lump sum or income payments”.

“The language of section 310 is addressed to capturing income; there is no suggestion in the language that it is conferring a power on the court to require the bankrupt to exercise a power - in relation to property expressly excluded from the bankruptcy estate - to generate income”.

The appeal of the trustee was dismissed. Where a bankrupt has a right to draw down on a certain amount of his pension but at that time has not done so, the trustee cannot require the bankrupt to drawn down such lump sum and for it to be treated as income for the purposes of an IPO.

Lady Justice Gloster did go on to say: “In my judgment, Parliament has decided to draw the balance between, on the one hand, the interests of the State in encouraging people to save through the medium of private pensions (so that in old age or infirmity they will not be a burden on the resources of the State), and, on the other, the interests of creditors in receiving payment of their debts, by the mechanism of sections 342A to 342C of the Insolvency Act which enable a trustee to claw back excessive pension contributions made by the bankrupt where such contributions have unfairly prejudiced the bankrupt’s creditors.”

It does though appear that the Court of Appeal was conscious to point out that the appeal judges’ decision in this case did not affect a trustee’s ability to clawback excessive pension contributions. This may open the door for more litigation in the future relating to pensions as to what sums are reasonable for retirement planning and will remain ring fenced from creditors. Whether the Court of Appeal will have to clarify in the future what is reasonable remains to be seen.