Contingent Provable Debts in Bankruptcies

What happens if a debtor is made bankrupt after a creditor has issued debt recovery proceedings?

A bankruptcy debt is any debt that the bankrupt owed to the relevant creditor at the date of the bankruptcy order, or a debt which arises under an obligation incurred by the debtor before the bankruptcy order, but one which falls due after the date of the bankruptcy order (known as contingent debts).

Broadly speaking, a creditor may prove (that is, submit a claim and receive a share of the assets available for distribution to creditors) in the bankruptcy if the creditor is owed a debt by the bankrupt even if the debt has not fallen due for payment at the time the debtor goes bankrupt.

A debt in this context, therefore, includes a liability that arises from an obligation to which the debtor was subject when he became bankrupt. But at what point does his obligation arise?

Historically, it was accepted that orders for costs made after the commencement of bankruptcy were not provable debts even if the litigation in which the costs order was made was underway before the debtor’s bankruptcy. This was accepted because the obligation to pay costs did not arise until the Court made the costs order.

Welcomingly, this position was overturned by the Supreme Court in the case of Re Nortel Companies. Not only has the Supreme Court widened the scope of contingent debts in the context of bankruptcies, it has also set out a universal approach which helpfully clarifies what represents a provable debt.

It has held that the key factor in determining whether a debtor is under an obligation is whether there is some form of legal relationship or duty that carries with it a real prospect of a payment liability arising in due course.

The practical implication following this is that, in the majority of cases, orders for costs made after the commencement of bankruptcy will represent a provable debt.