The Court said that it will look behind the judgment debt to the terms of the underlying contract in deciding to set aside a statutory demand. This has important implications for the initiation of insolvency proceedings, particularly where the underlying contract prohibits one party from using bankruptcy proceedings to enforce the contract.
In the case, Pearse v Revenue and Customs Commissioners  EWHC 3422 (Ch), a firm of solicitors owed HMRC around £1.2m in tax. The firm entered into a time to pay arrangement (TTPA) with HMRC, agreeing to pay £25,000 per month for 24 months.
The TTPA was supported by a personal guarantee granted by two partners limited to £600,000 which was defined in the agreement as the "Part Debt". One of the partners was Martin John Pearse. The guarantee included a clause which stated that HMRC could not enforce the Part Debt by way of bankruptcy proceedings against the partners.
The firm only made one payment of £25,000 under the TTPA then defaulted. The firm was then wound up by the court in an insolvent liquidation.
HMRC issued court proceedings against Pearse for £575,000, plus interest. No interest was payable under the terms of the guarantee, so statutory interest was sought by HMRC. HMRC obtained default judgment against Pearse for the sum of around £589,000. Pearse unsuccessfully sought to dismiss the default judgment. HMRC then served a statutory demand on Pearse for the judgment debt, costs and interest which by this time total almost £717,000. Pearse applied to court to set aside the statutory demand.
At the first hearing, the judge dismissed Pearse's application, he appealed to the High Court.
The High Court judge made three decisions. The first was that guarantee was clear that HMRC was prohibited from starting bankruptcy proceedings against Pearse in respect of the Part Debt under the guarantee, but the guarantee did not prevent HMRC from starting bankruptcy proceedings against Pearse in respect of the judgment debt.
Pearse accepted that the debt under the guarantee and the debt under the judgment were different debts. However, he argued that HMRC was aware that the reason bankruptcy proceedings had been prohibited in the guarantee is that he would lose his practicing certificate to act as a lawyer which would threaten his livelihood. Therefore, based on the parties' understanding, Pearse argued, HMRC should also be prohibited from enforcing the guarantee debt by way of bankruptcy proceedings indirectly under a judgment debt.
The judge rejected this argument ruling that the natural and ordinary meaning of the words under the guarantee was that it was only the debt under the guarantee which could not be enforced by way of bankruptcy proceedings. Further, both parties were legally advised and could have include a prohibition on enforcement under a judgment debt if they so wished.
The second decision was that, even if HMRC was prohibited from enforcing the judgment debt by way of bankruptcy proceedings, interest and costs, totalling over £125,000, were separate debts and therefore HMRC would not be prohibited from pursuing bankruptcy proceedings in respect of these debts. The reason for this is that the judge adopted a plain reading of the guarantee which only prohibited bankruptcy proceedings in respect of the Part Debt, meaning the principal debt of £600,000, but not costs or interest.
The third decision related to Pearse's final argument that, if he failed in respect of the first two decisions, commercial sense and business efficacy required that a term be implied into the guarantee extending the prohibition to stop HMRC pursing the judgment debt by means of a statutory demand. Again, the judge rejected Pearse's argument. The judge decided that there was no basis for including an implied term to this end in the guarantee. The contract was clear and placed an additional burden on HMRC of obtaining a judgment before pursuing bankruptcy proceedings. On the point that Pearse may lose his practicing certificate and, therefore, repayment to HMRC would be more difficult, this was a decision for HMRC to make to protect its interests without needing to be contractually prevented from doing so.
Matt Ford is a restructuring expert at Pinsent Masons, the law firm behind Out-Law.com