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Trust deeds, and protecting them

Trust deeds

2.1 Trust deeds for creditors have a long history. They grew up as a way for people to sort out debt problems by agreement with their creditors.

2.2 The debtor makes an offer to put everything they own towards paying as much of their debts as is possible, and each creditor who accepts the offer agrees that they will not enforce payment of the rest of what they are due. If the creditors all agree then the debtor hands over everything they have to a trustee for the creditors, whose job it is to make sure that the creditors are paid as much as is possible. If the debtor defaults then the trustee can sequestrate ¹ them.

2.3 Trust deeds developed because both debtors and creditors had good reasons for preferring agreement to the alternatives. Creditors had a better chance of getting something back than by using the court system as it then was, or by letting the debtor go to prison leaving them unable to work or carry on business. Debtors avoided the shame of public sequestration, and the shame and hardship of debtors' prison.

2.4 Sir Walter Scott, perhaps Scotland's most famous 'bankrupt', signed a trust deed for his creditors. His sense of obligation for his debts was so strong that he repaid the whole amount he was due, although it took him many years.

Protected trust deeds

1985 Act

2.5 The main disadvantage of the historical trust deed is that any creditor who won't accept part payment can still enforce their debt, and may be able to bankrupt the debtor. One dissenting (or technically, 'non-acceding') creditor could spoil an arrangement that would have worked well for the debtor and the consenting creditors.

2.6 As a result the Bankruptcy (Scotland Act) 1985 ("the 1985 Act") created the protected trust deed, administered by a qualified insolvency practitioner (a specialised accountant) on behalf of the creditors. A trust deed becomes protected if enough creditors accept the offer to satisfy the test set out in Schedule 5 to the 1985 Act. When a trust deed is protected non-acceding creditors are barred from enforcing their debt by sequestration or diligence, although they can of course claim a payment from the trustee for the creditors.

2.7 The test for protection set out in the 1985 Act was:

• Notice of the trust deed to be published in the Edinburgh Gazette, which publishes official announcements; and
• Within 5 weeks of the date of the notice the trust deed must be accepted by:
• A majority in number; and
• Two thirds in value,of the creditors.

It is thought that very few trust deeds do not become protected, although statistics are not available as trust deeds do not have to be registered in the Register of Insolvencies.

2.8 The numbers of trust deeds that became protected after the 1985 Act came into force started low, and then fell away. The numbers of protected trust deeds between 1987 and 1993 are set out in table 1.

Table 1

2.9 The numbers of sequestrations in the period 1987 to 1993 grew strongly, as shown in table 2. Ordinary trust deeds were in fact common in this period, but nearly all of them were converted into sequestrations by the trustee. At that time debtors could not sequestrate themselves without the agreement of at least one creditor. Table 3 shows the numbers of 'converted' trust deeds in that period.

Table 2

Table 3

2.10 It will be seen that the number of bankruptcies increased, broadly speaking, in line with an increase in the number of converted trust deeds.

1993 Act

2.11 The Scottish Office reviewed the administration of insolvency under the 1985 Act. For example, in the period 1987 to 1993 insolvency practitioners ( IPs) were paid by the public purse to administer small asset sequestrations. Table 4 shows the net cost of payments from the public purse to trustees in that period as fees and outlays (in millions of pounds).

Table 4

2.12 As a result of that review the Bankruptcy (Scotland Act) 1993 ("the 1993 Act") was passed. It was commenced on 1 April 1993, and the amendments it made to the 1985 Act remain current law.

2.13 Direct public funding of trustees in sequestration came to an end and trust deeds have never been funded by the public purse. An IP is a self employed professional, and as a result will therefore only administer a trust deed if confident that the fees and outlays will be paid from the assets or income of the debtor.

2.14 The 1993 Act also amended the test for protection of trust deeds. It struck a new balance intended on one hand to make it easier for creditors to make an informed choice on whether to accept the trust deed, and on the other hand to make it harder for creditors to block the deed by (for example) not making a choice at all.

2.15 The current test for protection as set out in the 1993 Act is therefore:

• Notice of the trust deed to be published in the Edinburgh Gazette;
• Within one week of the date of the notice each creditor known to the trustee is sent:
• A copy of the trust deed;
• A copy of the notice; and
• Such information as has been prescribed;
• Within 5 weeks of the date of the notice the deed must not be rejected by more than:
• A majority in number; or
• One third in value, of the creditors.

2.16 The changes in the 1993 Act have had an effect on the numbers of bankruptcies that proceed as sequestrations or protected trust deeds respectively. The numbers of sequestrations, the numbers of protected trust deeds, and the numbers of protected trust deeds converted to sequestrations between 1987 and 1993 are set out in tables 5 to 7 respectively.

Table 5

Table 6

Table 7

2.17 Figures are not published for the year from 6 April 2005 to date, but preliminary returns show that sequestrations and protected trust deeds have increased by 54% and 11% respectively compared to the same period in 2004/05.

2.18 It will be seen that the number of sequestrations remained broadly the same from 1999 to 2004, and therefore that the overall increase in the numbers of bankruptcies in that period is linked most strongly to the increase in the numbers of protected trust deeds.

2.19 The rate of increase in the numbers of protected trust deeds in the current year is broadly similar to the 8% increase in 2004. The situation for the current year however is quite different for sequestrations, where there has been a significant rise in the number of awards equating increase of 58% over the same period in 2004.

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