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Important legal principles

INTRODUCTION

In this topic, you will learn about some of the legal concepts that are relevant
to financial services.

LEARNING OBJECTIVES

By the end of this topic, you will be able to:

„ describe the role of ‘legal persons’;

„ describe power of attorney and the responsibilities and powers conferred

by it;

„ explain the basic law of contract and agency;

„ describe ownership of property;

„ explain the impact of insolvency and bankruptcy.

THINK ...

Before we start this topic, consider how much you know about
legal concepts associated with financial services.

For instance:

„ Do you know what is meant by the term legal person and who
or what it relates to?

„ If you, or people close to you, own a property, do you know the

implications of the way ownership is arranged?

4.1 Legal persons

In the context of financial services, the term legal person(s) (or legal entity)
refers to those who have a separate legal existence and can enter into contracts
or be sued in a court of law. These entities include natural persons, companies
limited by shares or guarantee, public limited companies, sole traders,

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partnerships, limited liability partnerships and unincorporated associations.
Executors and trustees are also included as legal persons because they have
powers to enter into contracts on others’ behalf and can be sued.

You learned about sole traders, partnerships, limited liability partnerships

and limited companies in Topic 3, section 3.3. In this section, you will learn
about the legal implications that apply to each entity.

4.1.1 Sole traders

Sole trader is the technical term for self-employed people working on their
own. Although they might operate under a business name rather than their
own name, the business is not a separate legal entity from the owner – in effect,
they are the business. The owner is personally responsible for all elements of
the business, including any borrowing by the business and any business debts
incurred, including taxes.

4.1.2 Companies
Companies are legal entities, separate from their shareholders or individual
employees. Shareholders of a limited liability company are not personally
responsible for the debts of the company, with their liability being limited to
the amount that they have already invested in company shares, hence the title
‘limited companies’. This is the most they could lose if the company became
insolvent with large debts.

Companies must be registered with Companies House and make annual

returns, listing the shareholders and their shareholdings, as well as other
organisational information.

The nature of the company, and the rules about what it can and cannot do,
are set out in its memorandum and articles of association. The memorandum
normally includes the power to borrow, but may place limits or restrictions on
the amounts or purpose. This will be significant if the company wishes to take
out a mortgage or other form of loan.

It is essential to check that the people entering into a borrowing commitment

for the company are authorised and empowered to do so.

Public limited companies, known as ‘PLCs’ are those listed on the stock
market, which allows the company to raise capital through the issue of shares
to the general public and institutions, and provides a secondary market for
those shares. This means the company is effectively owned by the public. In
order to be listed the company must follow certain capital and governance
requirements.

Private limited companies, usually referred to by the abbreviation ‘Ltd’, are

limited companies owned by a small number of private shareholders. The
shares cannot be listed on the stock market and cannot be offered to the
general public, although they can be sold privately.

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4.1.3 Partnerships
A partnership is an arrangement between self-employed people who are
carrying on a business together. A partnership is not a separate legal entity
from its partners, who jointly own the assets of the partnership and are
personally responsible for its debts and liabilities.

Each partner acts as a principal of the business and the agent for the other
partners. This means that each partner is able to bind the other partners in all
matters within their authority. Each partner is jointly and severally liable with
every other partner for all the debts and other obligations of the firm. That
means one partner could be liable for all debts if the other partners cannot or
will not pay.

Partnerships should have a written partnership agreement that sets out in

detail the relationship between the partners, including authority to make
decisions for the partnership, profit sharing proportions and what will happen
when a partner leaves, retires or dies.

Each partner’s share of the profit is taxable as self‑employed income.

4.1.4 Limited liability partnerships (LLP)

An LLP is a partnership, but the firm is a separate legal entity that can borrow
money in its own right – as with a limited company. If the businesses collapsed,
the partners’ liability is limited to the amount that they have invested in the
partnership, together with any personal guarantees they have given for loans
to the business.

LLPs must be registered with Companies House. There must be at least two
partners in the business, each partner is self-employed and there should
be a written partnership agreement, as with a normal partnership. At least
two partners must be ‘designated’ partners, with responsibilities for the
partnership including maintaining accounts and meeting the statutory
reporting requirements for which they are legally liable.

LLPs are taxed in the same way as other partnerships.

4.1.5 Trustees
A trust allows the owner of an asset (the settlor) to distribute or use that asset
for the benefit of another person or persons (the beneficiaries) without allowing
them control over the asset while it remains in trust. Depending on the nature
of the trust, the beneficiaries may eventually take absolute ownership of the
asset. We will look in detail at the types of trust and how they are created,
together with the parties to a trust and their specific responsibilities in Topic
5; for now, we will look at an overview.

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KEY TERMS

TRUST DEED

The document that sets up the trust, appoints the parties to the trust and
dictates how the trust should operate.

SETTLOR

The person setting up the trust and settling assets into it.

TRUSTEES

People aged 18 or over and of sound mind, who are appointed by the
settlor to look after the trust assets and administer them in accordance
with the trust deed. In some cases, trustees are given powers to borrow
money, buy property on behalf of the trust or a beneficiary, and make
loans to beneficiaries.

BENEFICIARY

The person(s) intended to benefit from the trust.

4.1.6 Personal representatives

A deceased person’s estate is distributed by personal representatives. The
exact procedure to be carried out in order to distribute a deceased person’s
estate depends on whether or not there is a valid will. The following information
applies to the law of England and Wales (Scottish law differs both in the
procedures and the terminology used).

Testator – the person making a will.

Executor – the person named in a valid will to be responsible for sorting out
the estate is the executor; they can also be a beneficiary. The executor will
seek a grant of probate, which gives them legal authority to carry out the
testator’s instructions, as set out in the will. The duties of an executor can
be time‑consuming and onerous, and it is not uncommon for executors to
appoint a solicitor to carry out all or part of their duties.

Intestate – the term used to describe someone who dies without a valid will. In
this case, the laws of intestacy apply to the distribution of the estate.

Administrator – an appropriate person who takes on the role of distributing

the estate where there is no valid will. This will often be the surviving spouse
or another close relative. The administrator will seek a grant of letters of
administration, which provides similar legal authority to distribute the estate
in accordance with the laws of intestacy.

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We will look in more detail at wills and intestacy in Topic 5.

4.2 Powers of attorney

An attorney is a person who is given the legal responsibility to act on behalf of
another person in certain matters. The person who makes a power of attorney
is called the donor and the person who acts for them is called the donee, or
simply the attorney.

Anyone aged 18 or over and has the mental capacity to understand what they
are doing can grant powers of attorney to someone else.

The attorney must also be aged 18 or over, must have mental capacity to
undertake the role and must not be bankrupt.

Ordinary power of attorney

An ordinary power of attorney gives the attorney the authority to carry out a
number of important activities on behalf of the donor while the donor still has
mental capacity. The powers are given to the attorney through a document
called a power of attorney (PoA). Typical powers include the right to:

„ sign documents on behalf of the donor of the PoA;

„ handle the donor’s financial affairs – for example buying and selling
investments, signing cheques and making bank transfers;

„ make purchases on the donor’s behalf; and

„ dispose of the donor’s property, including by making ‘usual’ gifts to third

parties.

A power of attorney may be implemented for a number of reasons, such as:

„ someone who could be abroad for long periods may arrange a power
of attorney for a trusted person to handle their financial affairs in their
absence; or

„ someone in poor health may delegate powers so that another person can
look after matters while they are recuperating.

A power of attorney will not enable the donee to make non‑financial decisions
for the donor – for example about personal care or medical arrangements – or
to make very large or ‘unusual’ gifts, unless the courts specifically approve
such a gift.

A power of attorney can be given only by someone who is aged 18 or over and
has the mental capacity to do so, and the power ceases if that individual loses
mental capacity later on.

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A power of attorney must be signed as a deed by the donor or, if not signed
by them, signed at their direction and in their presence, and in the presence
of two witnesses.

The power can be revoked (cancelled) by the donor while they have the mental
capacity, and it is automatically ended if:

„ the donor dies;

„ the donor becomes bankrupt; or

„ any specified time limit expires.

4.2.1 Enduring power of attorney (EPA)

An ordinary power of attorney expires on the donor’s loss of mental capacity
and this can create problems, because it may be the point when support and
assistance is most needed. Because of this, a special form of power of attorney
arose: the enduring power of attorney.

Enduring powers of attorney (EPAs) could be set up until 30 September 2007,

at which point they were replaced by lasting powers of attorney. Where an EPA
was set up on or before 30 September 2007, it can still be registered, and the
attorney can assume all the powers in the arrangement.

Enduring power of attorney is effectively an ordinary power of attorney, but

with the additional provision that it can carry on if the donor becomes mentally
incapable, allowing the attorney to continue dealing with the donor’s financial
property and affairs. By default, once signed, an EPA allowed the attorney to
deal with the donor’s property and affairs, meaning that both the donor and
the attorney have equal powers to make decisions and deal with the donor’s
financial matters from that point, in the same way as an ordinary power of
attorney. However, the donor could specify that it should only come into force
if they became mentally incapable, or on a specified date. In either case, if
the donor does become mentally incapable, the EPA must be registered with
the Office of the Public Guardian (OPG) in order for the attorney to continue
with the powers conferred. An unregistered EPA can be revoked, providing the
donor has mental capacity. A registered EPA may be revoked, but only after
confirmation from the Court of Protection that the donor fully understands
the implications of doing so.

When an application is made to register an EPA with the OPG, the donor and at
least three of the donor’s relatives aged at least 18 and mentally capable must
be informed in a set order of priority.

The purpose of this requirement is to ensure that the interests of the donor
are protected, as they and any of the relatives can object to registration.

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4.2.2 Lasting powers of attorney (LPA)

The Mental Capacity Act 2005 replaced EPAs with the lasting power of attorney
(LPA) from 1 October 2007. From that date no new EPAs could be set up,
although an EPA included in a document written before 1 October 2007 is still
valid and can be registered on the donor’s incapacity.

LPAs are similar in most respects to EPAs but can be arranged in two forms.

This allows the donor to appoint

Personal one or more people to make
decisions regarding their
welfare personal health care and welfare.
This is not available with an EPA.

This allows the donor to appoint

Property one or more people to make
decisions regarding their
and affairs property and personal affairs and
is similar to an EPA.

The donor has the option to choose up to five people they wish to be told if an
application for registration of an LPA to the OPG is made. They have the right
to object to registration on the donor’s behalf.

An LPA only comes into operation when it is registered with the Office of the
Public Guardian.

„ A property and affairs LPA must be registered before the attorney can
assume any powers. It can be registered with the OPG at any time after it is
set up. From this point, both the donor and the attorney can make decisions
until the donor is mentally incapacitated, unless the arrangement includes
a condition that the LPA should not be used until the donor has lost the
capacity to make decisions.

„ A personal welfare LPA can be registered at any time but, unlike a property
and affairs LPA, the attorney can only make decisions once the donor has
lost mental capacity. From that point the donor cannot make decisions for
themselves.

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FACTFIND

The Office of the Public Guardian (OPG) is responsible for the

registration of powers of attorney.

The Court of Protection has powers to make decisions about

whether someone lacks capacity, make orders regarding their
situation, or appoint deputies to act and make decisions on
behalf of someone who lacks capacity.

Read more about the OPG and the Court of Protection at:

https://www.gov.uk/government/organisations/office-of-
the-public-guardian

https://www.gov.uk/courts-tribunals/court-of-protection

CHECK YOUR UNDERSTANDING 1

What are the main differences between a partnership and a limited

3 liability partnership?

Explain the difference between an enduring power of attorney

(EPA) and a lasting power of attorney (LPA).

4.3 The laws of contract and agency

Contract law and the law of agency are relevant to financial services, where
most products are based on a contract.

4.3.1 Contract law

Most business agreements are established as legally binding contracts. Most
are made in writing, some are made by deed. It is possible to make a verbal
contract, provided all the normal contract requirements are met, although
there could be difficulties in enforcing it without strong evidence, such as
credible witnesses. A verbal contract cannot be made for certain more complex
contracts such as property purchase, tenancy agreements and consumer
credit. Also, any contracts including a guarantee must be in writing to be
legally binding.

Key requirements for a valid contract

Contracts are generally subject to certain basic requirements in order for them
to be binding, as follows.

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„ Offer and acceptance – there must be an offer made by one party (the
offeror) and there must be an unqualified acceptance by the other.

„ Consideration – the subject of the contract (often a promise to do something

or supply something) must be matched by a consideration (which is
usually, but not always, the payment of money). The consideration is given
by one of the parties (the promisee) to the person making the promise (the
promisor). A promise to pay is valid consideration.

„ Capacity to contract – parties to the contract must have the legal capacity,
or power, to enter into the contract. For finance related contracts they must
be 18 or over (16 in Scotland) and of ‘sound mind’ when the contract is
entered into. Those aged 16 to 18 in Scotland can enter into a financial
contract, but they are protected by being able to void a contract if it can
be shown that a ‘prudent adult’ would not have entered into it, and it is
prejudicial to the teenaged party.

„ The terms of the contract – must be certain, complete and free from doubt.

„ There must be an intention to create a legal relationship, as distinct from

a merely informal arrangement.

„ Legality of object – contracts cannot be made for illegal or immoral

purposes.

„ The contract must not have been entered into as a result of misrepresentation,
or under duress or undue influence.

REFLECT

Why is the term ‘contract killing’ a contradiction in terms?

Answer at the end of this book.

4.3.1.1 Consumer Insurance (Disclosure and Representations)

Act 2012
Historically there were many cases of insurance companies declining seemingly
valid claims because the policyholder failed to disclose information about
previous illnesses or medical consultations, even though the ‘fact’ would have
had no bearing on the reason for the claim. One of the major factors in many
cases was the reliance on the applicant to decide what was relevant to disclose.
Typical questions on the application form would be along the lines of: “Have
you ever visited a doctor or suffered from a medical condition requiring
treatment?” This required the applicant to remember all such occasions and
decide which, if any, to include. In some cases, the insurer rejected claims on

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the basis that the policyholder failed to disclose information that they should
have realised was relevant and important, even though no direct question
asked for the information. For example, some critical illness policy cancer
claims were rejected because the policyholder failed to declare a doctor’s
consultation about a rash some time before the application was made, which
the doctor had diagnosed as a minor, harmless skin complaint.

In many cases, the Financial Ombudsman determined that the insurance

company’s rejection was unreasonable and found in favour of the policyholder.

The situation caused regulators and legislators much concern, and led to
the Consumer Insurance (Disclosure and Representations) Act 2012, which
came into force on 6 April 2013. In simple terms, the Act clearly defines the
responsibilities of insurance customers, and abolishes the duty of consumers
to volunteer material facts they think might be relevant when applying for
insurance. Instead, it requires them to take reasonable care to answer the
insurer’s questions fully and accurately, and not give misleading information.

„ If the consumer has taken reasonable care, and the misrepresentation was
honest and reasonable, the insurer has no right to refuse a later claim.

„ In the case of misrepresentation due to carelessness, detailed rules allow

the insurer to apply a ‘compensatory remedy’ to the claim, based on what
the insurer would have done had the applicant answered all questions
completely and accurately. In other words, whether the insurer would
have refused cover completely (which means the claim would be rejected),
excluded certain illnesses (which means claims for such an exclusion would
not be met), or offered a reduced benefit or an increased premium. If the
claim is rejected then the insurer must refund the premiums paid.

„ If careless misrepresentation is identified in situations other than a claim,

the insurer and the policyholder have the right to terminate the contract
with reasonable notice. However, the insurer cannot cancel a life insurance
policy in this situation.

„ In the case of deliberate or reckless misrepresentation, the insurer may

reject the claim completely as if the contract never existed and is not
required to refund premiums paid unless there is a good reason to do so.

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IN
BRIEF Breach of contract occurs when a party fails to perform their
side of the contract and does not have a legal excuse for doing
so; several court remedies are available in these circumstances.
The main remedies are to seek damages, an order for specific
performance or an injunction. Of these, by far the most
frequently sought is damages, whereby the injured party
seeks to obtain financial compensation for their loss. The
intention is to put them in the position they would have been
in had the contract not been breached by the other party, as
far as possible to do so with money. In certain circumstances,
an order for specific performance can be obtained to compel
the other party to complete the contract. Alternatively, an
injunction can be sought – this is a court order preventing
someone from doing something.

4.3.2 Law of agency

An agent is a person who acts on behalf of another (the principal) and can
conclude contracts on their behalf. In law, the acts of the agent are treated as
being those of the principal.

In any kind of agent–principal relationship, it is important to determine how

much power and authority is given to the agent. Some agents are given very
wide authority while some are severely restricted in what they can do.

An agent should only act within the authority given to them by their principal.
This should be strictly observed, because, if an agent exceeds their power,
it could result in their principal being liable for the consequences. This can
happen when they act within what is known as their apparent authority.
Apparent authority is where something either done or said by the principal
gives the impression that they have authorised the agent’s actions.

In some circumstances where an agent exceeds their authority, they may be

held personally liable. This protects the third party, who would have entered
into the contract in good faith only to find themselves without recourse to
either the principal (if there is no apparent authority) or to the agent.

If the agent exceeds their authority, the principal can, if they choose, agree
after the event to what the agent has done. This is called ratification.

This very brief introduction to agency cannot cover all the detail of agency law
but it illustrates how important it is for advisers to know, understand and act
within the extent of their authority.

In the financial services sector, there are two important distinctions.

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„ Financial advisers who operate as company representatives of a product
provider (tied agents) are acting as agents of that product provider.

„ Independent financial advisers, on the other hand, act as agents of the

customer who seeks their advice.

4.4 Property ownership

In legal terms, property falls into two broad categories.

„ Real property (realty): real property is property that is fixed or immovable,

in other words land or buildings. Successful action for loss would result
in the physical property being restored to their possession, rather than a
compensation payment.

„ Personal property (personalty or chattels): refers to movable assets,

including animals. In fact, the term ‘chattel’ derives from the word ‘cattle’
which, in ancient times, were considered a good measure of an individual’s
wealth. If the owner lost possession of the property illegally or improperly,
successful action could result in compensation rather than return of the
asset because it could have been sold on, destroyed or even eaten!

Types of ownership
Property of all types can be owned in the following three ways – single
ownership, joint tenancy and tenants in common.

4.4.1 Single ownership

The asset is owned by one person, who is solely entitled to the asset and any
benefit derived from it. The owner is entitled to do as they wish with the asset
without considering anybody else.

4.4.2 Joint ownership – general

There are two forms of joint ownership – joint tenancy and tenancy in common.
Before we move on to look at the different forms of joint ownership, we need
to be clear that law regards joint legal owners as one single owner. Therefore,
in law, joint legal owners do not have a defined share of the property and, on
the death of one co‑owner, legal title passes automatically to the survivor,
regardless of any will or the laws of intestacy.

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KEY TERMS

LEGAL OWNER

The legal owner is the person or persons registered as the legal owner(s).
In the case of bank and investment accounts the legal owners are usually
the people named on the account, although this may not always be true.
An example of an exception is where an elderly person adds a relative’s
name to the account so that there is a fallback option if they become
ill or unable to deal with things. In the case of any subsequent dispute
over ownership, a court will have to consider the intention behind the
inclusion of the second person.

EQUITABLE (BENEFICIAL) OWNER

Has an economic interest in the property (an entitlement to a share

of the value of the property) but are not necessarily the owners of the
legal title. In most cases, the legal and equitable owners are the same,
although this is not always the case. Equitable owners do not have the
right to transfer legal ownership.

REGISTERED LAND

In the case of realty (houses, land, etc) it has been possible to register
ownership of land on a voluntary basis since 1925. In 1990, it became
compulsory to register previously unregistered land when a new
mortgage was arranged or the property was sold or transferred to a new
owner. Registration means all relevant information about the property
and its ownership is held in one central place, and provides proof of
ownership.

It is possible for up to four people to be registered as joint legal owners

of realty at the Land Registry. If more than four people own a property,
four will be registered as joint legal owners; the rest will be equitable
(beneficial) owners but will not be registered at the Land Registry. Legal
owners have the power to transfer legal ownership of the land or to
mortgage it as they wish.

UNREGISTERED LAND

Land that has not yet been registered at the Land Registry because it
has not changed hands since 1990 and had not been registered prior
to that date. The person holding the deeds is regarded as the legal
owner, although ownership could be challenged if certain documents
are missing.

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TRUST IN LAND

When two or more people own land jointly, a trust in land is created
automatically, with the legal owners as trustees. The trustees must hold
the property in trust for all the legal and beneficial owners.

4.4.2.1 Joint tenancy

In the case of joint tenancy, none of the joint tenants owns a specific legal or
beneficial share of the property. Technically they each own the whole of the
property, and on the death of any joint tenant, the surviving joint tenants take
over legal ownership under the law of survivorship. The transfer under this
principle is automatic and cannot be overridden by any provisions made by a
joint tenant in a will or the laws of intestacy.

We tend to focus on joint tenancy in relation to realty (houses, etc), but it

also applies to joint ownership of financial assets such as bank and deposit
accounts, investments and so on. If the asset produces income, the income is
treated as being received on an equal split basis for tax purposes, although it
is possible in some cases to agree on a different distribution.

4.4.2.2 Tenancy in common

‘Tenants in common’ is another, less common, way of owning property jointly,
which relates in most cases to realty but can also apply to other assets. In
this case, each joint owner has a defined equitable (beneficial) share of the
property as set out in an agreement between them; it will not necessarily be an
equal share. We will consider a simplified explanation of tenancy in common
as it applies to realty, because the legal position is quite complicated.

„ The property is registered with the Land Registry as a joint tenancy; it is

not possible to register a property on a tenancy in common basis. However,
the arrangement will be noted at the Land Registry and a restriction will be
added to the register. The restriction means that, in the event of the death
of a joint owner, the property cannot be sold if there is only one surviving
legal owner.

„ On the death of one legal owner, the surviving legal owner(s) will become
the sole or joint legal owner(s). They will continue to be trustee(s) of the
‘trust in land’ and must look after the interests of all legal and beneficial
owners. In this case the beneficial owner will be whoever was entitled to
benefit in the deceased owner’s will or through intestacy.

„ The restriction at the Land Registry means that if there is only one legal
owner (trustee) they cannot sell the property – they must appoint another

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trustee and register them as a joint legal owner before the property can
be sold. If there are more than two surviving legal owners, the restriction
would not apply and the property can be sold.

„ The value of the deceased owner’s share (known as the equitable share) goes
into their estate and will be distributed according to their will or the laws of
intestacy once the property is sold. However, the beneficial owners cannot
force the legal owner(s) to sell although, as trustees, the legal owners must
look after the beneficial owners’ interests at all times.

„ When the property is sold, the beneficial owners would be entitled to their
share of the property proceeds. If the surviving owner died, the heirs of
each original owner would receive their equitable share, which represents
50 per cent (or the specified share) of the property equity.

Tenancy in common can be useful if the intention is to leave one’s share of

the property to someone other than the joint owner, in most cases as part
of an inheritance tax (IHT) mitigation plan or where the owners are not in a
relationship and want their share to pass to their own heirs. It is also useful in
cases of a second or subsequent marriage where each partner wants to leave
their share of joint assets to their own family.

CHECK YOUR UNDERSTANDING 2

James and Cathy have just married; both have been married before

3 and have adult children. They have just bought their first house
together with the proceeds of the sale of their previous properties.
What type of property ownership would allow them to each leave
their share of the house to their own children?

4.5 Insolvency and bankruptcy

Insolvency arises when:

„ a person’s liabilities exceed their assets; or

„ a person cannot meet their financial obligations within a reasonable time

of them falling due.

Insolvency is often a temporary state, and the debtor may be in a position to

pay the debts in the relatively near future.

Bankruptcy is the term used for insolvency in England, Wales and Northern
Ireland, while Scottish law refers to it as ‘sequestration’. Scottish sequestration
law is different from bankruptcy laws in the rest of the UK. This text will focus
on bankruptcy laws that apply to England, Wales and Northern Ireland.

Bankruptcy arises when a person is insolvent and has no prospect of being

able to meet their liabilities. The primary legislation on insolvency is the

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Insolvency Act 1986, which has been subject to amendments over the years.
Under the legislation, a bankrupt is any person who has been made subject to
a petition for bankruptcy by the county court. From 6 April 2016, bankruptcy
applications went online and out of the courts.

There is no minimum debt for a person to petition for their own bankruptcy,
but a creditor must be owed £5,000 to petition to have someone else declared
bankrupt.

In Scotland, bankruptcy administration is carried out by the Accountant in

Bankruptcy, which is the Scottish equivalent of the Insolvency Service. The
minimum debt for a creditor to trigger a sequestration is £3,000, and for
individuals applying for their own bankruptcy the minimum level of debt is
£1,500.

4.5.1 The Enterprise Act (2002)

The Enterprise Act became law across the UK in November 2002 and dealt
with a wide range of issues, one of which was the approach to bankruptcy.
From the individual’s perspective, the Act reduced the amount of restrictions
placed on an undischarged bankrupt at the discretion of the court.

The standard discharge period is 12 months for all individuals declared

bankrupt. Those who have been declared bankrupt in the past may be subject
to a longer discharge period if the court feels it is appropriate, and if a bankrupt
does not keep to the terms of the order, the court can suspend the discharge
for a specified period, in other words extend the bankruptcy period. At the
end of the discharge period the bankrupt is released from all obligations and
restrictions imposed by the court.

Prior to discharge, the person subject to the order is said to be an undischarged

bankrupt.

4.5.2 Bankruptcy in practice

Bankruptcy has serious implications. While a bankruptcy order is in place, the
undischarged bankrupt’s possessions are, in effect, surrendered to an official
receiver or an insolvency practitioner, referred to as the trustee in bankruptcy,
who can dispose of them and use the cash to pay off the creditors. The only
exceptions are clothing, household items and items the bankrupt would need
to carry on working – tools, vans and so on. Although bankruptcy cancels most
kinds of debt and allows people to make a fresh financial start, it comes at a
price: it normally makes it more difficult to obtain credit in the future and it
can affect employment prospects.

The bankrupt is likely to find that banks will not provide normal current
account facilities, offering (if at all) only a basic account that does not offer
overdraft or normal debit card facilities. Once discharged, the bankrupt may
be able to open a normal account but is still likely to find it difficult to find a
bank that will be prepared to offer the full range of facilities.

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Once declared bankrupt, the bankrupt’s interest in a property (their share of

any equity) will be included in their assets, providing the interest is more than
£1,000. This could result in the property being sold to pay the debts, or a joint
owner or spouse buying out the bankrupt to ensure continuing ownership. If
the property cannot be sold immediately, the trustee can place a charge on
the property, to be settled on the eventual sale of the property, although any
existing mortgage will remain as the first charge.

If the debtor’s family is living with them, sale of the property can be delayed
for 12 months, so that alternative housing can be arranged. If the trustee has
not sold the property, obtained a charge over it, or sought a possession or
charging order within three years from the bankruptcy order, the property will
revert to the bankrupt. This means that the future of the property could be
uncertain for two years after discharge.

The trustee can also claim any property gained by the bankrupt until they are
discharged – this includes past and future inheritances and other windfalls.

The trustee can ‘attack’ transactions in the years prior to bankruptcy if they
are considered to have been a deliberate attempt to move assets out of the
estate. Known as ‘prior transactions’, they are generally occasions where
the assets were gifted or sold at less than their true value in the two years
before bankruptcy. The attack period can be extended to five years if a prior
transaction took place in the five years before bankruptcy, and the individual
was insolvent at the time of the transaction (or the transaction caused them to
become insolvent).

The value of a registered pension fund cannot be claimed by the trustee

because it does not form part of the bankrupt’s estate. However, the court
could apply an income payments order, which requires some of the bankrupt’s
income, including pensions in payment during the bankruptcy period, to be
paid to the trustee.

The following are criminal offences that specifically apply to undischarged

bankrupts:

„ obtaining credit of £500 or more, either alone or jointly with any other
person, without disclosing the bankruptcy (in this context credit includes
borrowing, credit cards and ordering goods on credit);

„ carrying on business (directly or indirectly) in a different name from that

under which they were made bankrupt, without telling all those they do
business with the name under which the bankruptcy was registered;

„ being directly or indirectly involved in promoting, forming or managing

a limited company, or acting as a company director, without the court’s
permission.

An undischarged bankrupt cannot hold certain public offices, and they cannot
hold office as a trustee of a charity or a pension fund.

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Once discharged from bankruptcy, the person is perfectly entitled to borrow,
although they are likely to have difficulty in finding a lender prepared to lend.
By law, a prospective borrower must declare a previous bankruptcy when
applying – failure to do so can render the person guilty of fraud.

4.5.3 Individual voluntary arrangements

An individual voluntary arrangement (IVA) is an alternative to bankruptcy,
under which the debtor arranges with the creditors to reschedule the
repayment of part of the debts over a specified period. A creditors’ meeting
is called, and the creditors vote whether to accept the IVA. An IVA can be set
up only if creditors who are owed at least 75 per cent of the value of the total
debt represented at the meeting agree to the arrangement. Note that, as this
is 75 per cent of the total debt represented at the meeting, not 75 per cent of
the creditors in attendance, a creditor holding a large debt can push an IVA
through against the wishes of ‘smaller’ creditors.

The scheme must be supervised by an insolvency practitioner.

Insolvency practitioners are often able to arrange for interest to be frozen, for
a reduction in the amount of the debt, and for creditors to write off part of the
debt in exchange for a reasonable guarantee of receiving partial repayment. In
many cases this is better for the creditor than simply writing off the debt or
selling it to a debt recovery firm.

There is no legal reason why an individual with an IVA cannot borrow or

arrange a mortgage; however, they will find it difficult to obtain credit while
the IVA is in place, and creditworthiness is likely to be impaired even after the
end of the arrangement. A record of the IVA will remain on the individual’s
credit record for six years after the start date. Lenders are also likely to ask
about previous IVAs in an application form, and the applicant must provide
truthful answers.

4.5.4 Debt relief orders

Debt relief orders (DROs) are intended to give relief to those living in England
and Wales who are struggling to pay their debt, and have limited disposable
income, no assets, and no prospects of their situation improving.

If a DRO is granted, the creditors listed in the order will be subject to a

‘moratorium’ on debts owed to them, usually lasting for 12 months. This means
that they cannot seek repayment or enforcement of debts owed to them. At
the end of the moratorium, assuming that the debtor has met the terms of the
DRO, the debts are written off and they are discharged.

DROs are organised through a partnership between the Insolvency Service and
experienced debt advisers, known as ‘approved intermediaries’. A debtor can
only apply for a DRO through an approved intermediary.

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In order to apply for a DRO, certain conditions must be met. The main
provisions are that the debtor:

„ is unable to pay their debts;

„ owes a maximum of £30,000 in unsecured debts;

„ has total gross assets of no more than £2,000 – one vehicle valued below
£2,000 can be excluded;

„ has disposable monthly income (after tax, NICs and normal household
expenses) of no more than £75;

„ must not have been subject to a DRO in the previous six years, or be the
subject of any other formal insolvency orders, such as bankruptcy or IVAs;

„ may not be able to gain approval for a DRO if they gave away or sold any
property for less than its real value in the two years before the application;

„ must pay a fee of £90.

4.5.5 Company voluntary arrangements

The company voluntary arrangement (CVA) is the company equivalent of an
IVA, where a company that is in temporary financial difficulties (but which its
directors believe has a viable long‑term future) can make a binding agreement
with its creditors – including the tax authorities – about how its debt and
liabilities will be dealt with.

In this way, the directors retain control of the company and it can continue
to trade. A CVA can be proposed by the directors of the company, or by a
liquidator but not by the creditors. As with IVAs, creditors representing 75 per
cent of the company’s debt must agree to the CVA being set up.

Conclusion
A number of ‘legal persons’ may require financial services and products. They
include individuals (natural persons), companies, partnerships, trustees,
personal representatives and attorneys. It is important that the adviser
understands the legal nature of the ‘person’ they are dealing with and the role
they are taking.

The laws of contract and agency also have an important impact on financial
services in that the majority of products are contract based and the adviser
may well be acting in the role of agent or dealing with agents of the client.

Insolvency and bankruptcy can also affect both the nature and scope of the
advice given because it will limit what the client can and cannot do and may
result in forfeiture of certain assets.

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THINK AGAIN . . .

Now that you have completed this topic, how has your knowledge
and understanding improved?

For instance, can you:

„ describe the various legal entities that are relevant to financial

services?

„ explain the difference between a power of attorney, an enduring

power of attorney and a lasting power of attorney?

„ explain the purpose of the Consumer Insurance (Disclosure and

Representations) Act 2012, and describe its key terms?

„ list the requirements for a contract to be legally binding?

„ outline the consequences of someone being declared bankrupt

or arranging an individual voluntary arrangement?

Further reading
Reynolds, P.G. and Watts, F.M.B. (2009) Bowstead and Reynolds on agency. 18th edn. London: Sweet & Maxwell.

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Test your knowledge

?
Use these questions to assess your learning for Topic 4. Review the
text if necessary.

Answers can be found at the end of this book.

1) In terms of liability for business debts, what is the difference

between a partnership and shareholders in a limited company?

2) In what ways does a public limited company (PLC) differ from

a private limited company?

3) Applications to register an enduring or lasting power of

attorney must be made to the Court of Protection. True or
false?

4) Explain the terms ‘apparent authority’ and ‘ratification’ in

relation to the law of agency.

5) Adrian died as a result of a crash while flying his private plane.

His representatives have made a claim on his life insurance
policy, but the insurer has stated that Adrian did not disclose
his flying hobby and the insurer would have excluded flying
as a policy condition had it been disclosed. After negotiation,
the insurer has accepted that the non-disclosure was due to
carelessness rather than a deliberate act, but has refused the
claim. What must the insurer do?

a) Pay the claim on a proportionate basis.

b) Pay the claim in full.

c) Refund the premiums paid up to Adrian’s death.

6) What is ‘realty’?

7) In what circumstances must unregistered land be registered?

8) David and Victoria own their house on a joint tenancy basis,

while Nisha and Sam own theirs as tenants in common. Explain
how these two arrangements differ.

9) Martin is subject to a bankruptcy order. Three years before

the order, while his business was booming and his personal
finances were solid, he sold his holiday cottage to his son
Logan for 50 per cent of its market value. What is the trustee
in bankruptcy’s position regarding this transfer?

10) Creditors representing what percentage of a person’s debts

must agree to an application for an individual voluntary
arrangement (IVA)?

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