The Supreme Court recently issued an interesting ruling in an insolvency case where receivables that had been validly pledged to a bank were unlawfully collected by a bankruptcy trustee. The question was whether the damages claim of the bank against the bankrupt estate would take priority over the foreclosure and settlement costs, including the bankruptcy trustee's salary. The Supreme Court ruled that in this situation – where the estate also consists of unlawfully collected monies that were pledged to the bank – the general rule still applies: if there are insufficient funds in the estate to pay all estate creditors, their claims must be paid in accordance with the applicable priority rules. This means that the bankruptcy trustee still comes first, which could create a 'perverse incentive' for bankruptcy trustees to commit tort. And the injured party – the bank in this case – might only receive partial payment of its claim for damages, or none at all.

What remains as a remedy for the injured party is to hold the bankruptcy trustee personally liable for his unlawful action if the bankruptcy trustee realised or ought to have realised his mistake at the time of that action.

In this case, a company had pledged receivables to a bank. When the company went bankrupt, the bank wanted to collect the receivables, but the bankruptcy trustee claimed that the receivables had not been validly pledged and collected the receivables. The bank then took legal action against the bankrupt estate, alleging that the bankruptcy trustee had unlawfully collected the receivables. The bank also claimed that the bankruptcy trustee had to pay back the funds collected – which had benefited the bankrupt estate – without deducting any bankruptcy costs. Those costs, notably, include the bankruptcy trustee's salary. The bank argued that the unlawful collection by the trustee had cost the bank its special preferential position as pledgee; based on this position the bank would not have had to contribute to the bankruptcy costs.

The Court of Appeal acknowledged that the bank had been wrongly ordered by a lower court to share in the general costs of the bankruptcy, as well as in specific costs of collecting the receivables. The claim of the bank itself, for damages caused by the bankruptcy trustee, is an estate claim and therefore part of the general costs of the bankruptcy. But the Court of Appeal did consider that when there are insufficient funds to pay back all of the estate creditors, the costs of foreclosure and settlement have to be paid first, before the estate claims. This includes the salary and certain disbursements of the bankruptcy trustee.

The bank appealed to the Supreme Court, which held that all estate creditors have an equal right to be satisfied in proportion to the value of their claims, except for preferential rights recognised by law, and only after the costs of foreclosure and settlement have been paid. Contrary to what the bank had argued, this main rule should also be applied in cases where the assets of the bankrupt estate include the proceeds of pledged receivables which where unlawfully collected by the trustee. The Supreme Court acknowledged that this might lead to undesirable situations. A bankruptcy trustee could cover his costs at the expense of creditors by unlawfully collecting receivables. But the Supreme Court considered that there were no grounds for disregarding the legal system of creditor ranking.

There is one last option for the bank to recover the shortfall caused by the bank being prevented from collecting the receivables and having to share in the costs. The Supreme Court pointed out that, as is well established in case law, a trustee may be personally liable for incorrect performance of his duties in certain cases. For personal liability to exist, the trustee must have acted despite the fact that he realised or reasonably ought to have realised his mistake. Certain rules for collection by the bankruptcy trustee of pledged receivables are also well established in case law. If the trustee acts contrary to those rules, in a case where the rules leave him no freedom, the test for personal liability is met, the Supreme Court mentioned in the ruling. The bank did also claim personal liability at an earlier stage in the case, but the court in the first instance rejected this, while the bank did not appeal against that aspect of the judgement.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.