UK: Restraint Orders: Payments To Third Party Creditors

Introduction

A problem frequently encountered in the context of restraint orders arises where a defendant subject to a restraint order owes a debt to a third party. The third party may seek advice whether the restraint order can be varied to allow the defendant to repay him. The correct advice will depend on a number of factors, including: (i) under which statutory regime the restraint order was obtained; (ii) whether the third party is a 'secured' or 'unsecured' creditor; (iii) whether the third party is a victim of the defendant's criminal conduct.

Identifying the Appropriate Statute

For offences committed before 24 March 2003, the applicable regime for restraint and confiscation is the Criminal Justice Act 1988 or (for drug trafficking offences) the Drug Trafficking Act 1994. Offences committed on or after that date are governed by the Proceeds of Crime Act 2002. Each of these legislative schemes contains a section providing guidance about how the court should exercise its power to make and vary restraint orders (section 82 of the 1988 Act, section 31 of the 1994 Act and section 69 of the 2002 Act). Contained within each of these sections is a provision giving the court a 'legislative steer' (as it has come to be known). Thus, under the earlier legislation the legislative steer states that the power to make and vary restraint orders should be exercised 'with a view to making available for the purpose of satisfying... any confiscation order that may be made... the value... of realisable property held by any person'. A similar, albeit differently drafted, provision is found in section 69(2) of the 2002 Act.

The statutory provisions governing the making and varying of restraint orders have been interpreted differently by the courts depending on the statutory regime under consideration. Before looking at these differing interpretations we will first consider another important matter, namely the distinction between secured and unsecured creditors.

Unsecured vs. Secured Creditors

It is, generally speaking, much easier to get a restraint order varied to permit the payment of a secured creditor as opposed to an unsecured creditor. But what is a secured creditor?

A 'secured' creditor (in the context of restraint orders) means a creditor who has an 'interest' in the restrained assets. 'Interest' is widely defined under the legislation and includes both legal and equitable interests. The following examples illustrate persons treated as 'secured' creditors.

A person who has an interest (legal or equitable) in property held by the defendant. An example would be the interest held by the spouse of the defendant in the marital home.

A victim of the defendant's conduct who can show that he has an interest in the restrained assets. The simplest example is where a defendant steals property which is subsequently restrained. The victim plainly has an 'interest' in the stolen property.

Where the defendant steals money which is then used to buy other property which is later subject to a restraint order, it may be possible to rely on equitable principles of tracing to show that the victim has an interest in the restrained property.

An unsecured creditor is any creditor who does not have an 'interest' in the restrained assets.

Secured creditors are given a favoured status by the various regimes for confiscation. Thus, at the confiscation stage, when calculating the value of the defendant's realisable assets, the value of third party interests is deducted from the value of the property held by the defendant. This makes good practical and common sense: the defendant cannot be expected to satisfy a confiscation order from assets which are not his to sell. Consistent with this, at the restraint stage, the statutory provisions suggest that, upon application by a third party, the restraint order should be varied to allow him to recover the value of any restrained property in which he has an interest (section 82(4) of the 1988 Act, section 31(4) of the 1994 Act and section 69(3) of the 2002 Act). Again, this accords with common sense: it would serve no useful purpose to restrain an asset which will not form part of the defendant's realisable assets at the confiscation hearing.

It is important to note that a person who obtains judgment in a sum of money against a defendant (a judgment creditor) does not necessarily gain any advantage over other creditors. Whether or not a judgment creditor is treated as a secured or unsecured creditor will depend, just as it does in relation to other creditors, on whether he has an interest in the restrained assets.

Unsecured Creditors: Proceeds of Crime Act 2002

As noted above, the courts should vary restraint orders to permit payments to secured creditors, but what is the position in relation to unsecured creditors? Under the Proceeds of Crime Act 2002 the Court of Appeal has said that restraint orders should ordinarily not be varied to permit payments to unsecured creditors. Thus in Director of the Serious Fraud Office v Lexi Holdings plc (in administration) and another [2009] 2 WLR 905 it was said (at paragraph 81) that:

The key phrase is 'unless there is no conflict with the object of satisfying any confiscation order'. What is required of the court at the time of the application to vary a restraint order is to 'look ahead' to see what confiscation order may be made. This involves an assessment of the value of both the defendant's proceeds of crime and his realisable property. If granting the variation would leave sufficient assets to meet the likely confiscation order, the variation can be made. Otherwise, the variation should not be made.

In reaching its conclusion the Court of Appeal was particularly swayed by the fact that unsecured debts owed by the defendant are ignored at the confiscation stage: the value of the defendant's realisable assets is the sum of his assets, ignoring any liabilities. The Court said that payments to third party creditors at the restraint order stage would be inconsistent with the position at the confiscation order stage. Moreover, the potential 'harshness' to innocent third parties was 'to some extent softened' by two mitigating features of the legislation. First, a restraint order is a temporary measure (paragraph 84). Secondly, third party creditors who are also victims of the defendant's conduct are protected by the legislation in that they should ultimately recover the debt owed to them, either by way of a compensation order or, if they issue a civil claim against the defendant, via the mechanism of section 6(6) which permits the court to reduce the amount of the confiscation order in order to preserve sufficient assets to meet the civil claim.

Unsecured Creditors: Criminal Justice Act 1988 and Drug Trafficking Act 1994

The position in relation to unsecured creditors under the earlier legislation is less clear: there are conflicting decisions of the High Court: Re W, The Times, 15 November 1990 and In Re X [2004] 3 WLR 906.

In Re W a mother obtained judgment against her son in the sum of £50,000. The son was subject to a restraint order. The mother applied to the High Court for a variation to permit her son to satisfy the judgment debt. The High Court refused to make the variation, holding that there was no power to vary a restraint order made under the 1988 Act to enable the payment of an unsecured creditor. Buckley J. reasoned that to allow the variation would undermine the purpose of a restraint order, which was 'to make available the value of realisable property to satisfy the confiscation order'.

The High Court in In Re X (Restraint Order: Variation) [2004] 3 WLR 906 reached the opposite conclusion. The essential facts were similar: an unsecured creditor sought the variation of a restraint order to permit payment of the debt. Davis J. considered the reasoning in Re W but rejected it. He concluded (on the basis of a close analysis of the statutory provisions which deserves careful reading) that the court does have a discretion to vary a restraint order to permit a payment to be made in favour of an unsecured creditor. He nevertheless declined to vary the order in the case before him. He provided little, if any, guidance about how the discretion should be exercised. This is perhaps understandable, since it is difficult to see what the principled approach to the exercise of the discretion should be. Aside from refusing variations which are in fact shams (e.g. where the variation sought is a dishonest mechanism to enable the defendant to recover his assets) how should the discretion be exercised? Is a company on the verge of bankruptcy a deserving candidate? Would a charity have a greater entitlement? Would one charity find greater favour with the court than another? Such moral questions seem out of place in the wider statutory scheme and would be difficult to answer.

Re W or In Re X?

The question remains which of the two conflicting decisions of the High Court should be followed. It may be that the answer lies in the decision of Director of the Serious Fraud Office v Lexi Holdings plc (in administration) and another, supra. Although that decision concerned the 2002 Act, the reasoning of the Court of Appeal (even accounting for the differences in the statutory language) is equally applicable to the earlier legislation. Thus, under the 1988 Act and 1994 Act it is illogical to permit payments to unsecured creditors at the restraint stage when at the confiscation stage the confiscation order takes priority over unsecured creditors. Moreover, the features said to mitigate the harshness of the Court's conclusion are equally present in the earlier legislation.

If this analysis is correct, it follows that Re W should be followed in favour of In Re X. This conclusion also avoids the difficult question of how the discretion would be exercised.

Victims: a Special Status?

The strict rule found in Director of the Serious Fraud Office v Lexi Holdings plc (in administration) and another and Re W is that restraint orders should not be varied to permit payments to unsecured creditors. Arguably, this strict rule would not apply to judgment creditors who are also victims of the defendant's criminal conduct. The argument is developed in the following way. Faced with an application by a victim to vary a restraint order, the court will 'look ahead' to assess the impact on any confiscation order if the application were granted. It is reasonable to anticipate that the court would reduce the size of the confiscation order to ensure there are sufficient assets available to meet the civil claim. Accordingly, permitting payment of the victim at the restraint stage would not conflict with the object of satisfying the confiscation order: doing so merely ensures the victim is compensated as early as possible.

This analysis has a number of practical implications. First, to be categorised as a 'victim' has its advantages. There may be considerable scope to argue that a person is a victim of the defendant's conduct, particularly where the defendant has a criminal lifestyle such that 'conduct' means all of the defendant's criminal conduct, whenever committed, and not just the criminal conduct alleged in the indictment. Secondly, a victim anxious to recover his money as soon as possible may be well advised (depending on the precise circumstances) to commence civil proceedings at the restraint stage, rather than await the outcome of potentially protracted criminal proceedings.

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.