Transactions defrauding creditors

Insolvency professionals are well-aware of section 423 of the Insolvency Act 1986 covering claims under Part XVI Provisions against debt-avoidance, referred to as ‘transactions defrauding creditors.’ A recent case has put a spotlight on the practicalities of bringing a claim under this section which is worthy of note.

On the application of the office-holder, or a ‘victim’ of a specific transaction, the court may make an order setting aside a transaction and restoring the position to what it would have been if the transaction had not been entered into.

For these purposes the Act says that a ‘victim’ is anyone capable of being prejudiced by the transaction. Section 424 of the Insolvency Act 1986 provides a distinction between claims by office-holders and claims by creditors who are victims, as where the debtor has entered insolvency, a victim seeking to make an application must first obtain leave of the court (unless their debt is compromised in a company voluntary arrangement).

As a potential downside for a victim/creditor, section 424 makes clear that any claim is brought for the benefit of every victim of the transaction and not just the applicant. However, this ought not detract entirely from the utility of the section for non-office-holders; it is a right of action which remains in force against a wrongful recipient of assets after the transferor has entered insolvency.

It should also be noted that there is no requirement that an insolvency process is underway under section 424, which means that the victim does not need leave of the court to bring a claim.

Another aspect of the section’s usefulness is that, strictly speaking, there is no time restriction on the lookback period, as there is for transactions at an undervalue in section 238/339 of the Insolvency Act. Subject to the above qualification that insolvency is not a prerequisite, in principle, the trustee in bankruptcy, liquidator/administrator or ‘victim’ of the transaction can seek to challenge a transaction entered into at any time before insolvency of the bankrupt individual or company.

The key components of an application under section 423 are that:

• i) the transaction was at an undervalue, so that the insolvent person/company received either no consideration or significantly less money (or money’s worth) than the value of the asset/transaction transferred by it to the third party.
• ii) There is no need to demonstrate insolvency at the time of the transaction, as the second key ingredient that must be present is a desire on the part of the transferor to put assets beyond the reach of someone who may make a claim against them, or otherwise prejudice the interests of such a person in relation to a claim he may make.

As case law has developed, it has established that the above motive does not need to be the sole or even dominant reason for the debtor entering into the transaction, but it must be a reason.

So it was within the debtor’s contemplation, rather than simply an effect of a transaction designed or entered into for some other purpose – one can immediately see the potential for difficulties here for officeholders/victims, if for example a transaction was entered into for tax planning but had an inadvertent impact of prejudicing creditors’ interests – as was the case in Re Robin Farrell Tate and another v Farrell and others [2019] EWHC 119 (Ch).

One could therefore envisage insolvency of the transferor at the time of the transaction might be evidence of such an intention, but evidence of insolvency alone will not prove that the intention was to put assets out of reach or prejudice the debtor’s creditors. There must be compelling evidence of actual intention and it is the job of the applicant to prove that.
Where such a transaction is found to have taken place, the court may make an order, if it thinks fit, restoring the position to the pre-transaction position and to protect the position of persons who are victims of the transaction.

This necessarily gives broad discretion as to the form of order and relief the court may grant. Section 425 of the Insolvency Act 1986 adds a little detail to this, but essentially the court can:

• transfer or vest property in another person
• discharge security obligations
• release guarantor obligations
• order that money be paid, including against parties who were not the original recipient in the transaction, provided that the third party was not acting in good faith or without notice of the relevant circumstances.

The recent case of Manolete Partners Plc v Hayward and Barrett Holdings Ltd [2021] EWHC 1481 (Ch) had wider application than just section 423, and also directly concerned a litigation funder who had taken assignment of company claims as well as a section 423 claim. It highlighted that section 423 of the Insolvency Act 1986 is to be found on its own in Part 16, separate to other antecedent transaction claims, and is not to be treated as an insolvency claim.

Accordingly, the mechanism for any party seeking to bring a section 423 claim is a Part 7 Claim Form under the CPR 1998 and not an Insolvency Act application form. The corollary of that is that different parts of the civil and family court fees schedule applies; Part 7 issue fees are determined by the value of the claim generally being around 5% of the value of the claim, up to a maximum of £10,000 if the claim exceeds £200,000. In comparison, the issue fee for a new insolvency application is currently £280 (or less if a different fee is specified).

There are also significant procedural differences concerning, for example, mandatory costs budgeting and case timetabling in terms of the initial cost and case management conference (CCMC) or direction hearing which may have an impact on costs of bringing claims. The Part 7 procedure is geared towards commercial disputes – in a significant number of claims by insolvency practitioners they, and their lawyers, will be acting under a full or partial conditional fee agreement. A fuller case timetable undoubtedly places a greater burden of costs risk on them compared to the more streamlined insolvency application procedure.

The court’s findings in Manolete Partners Plc v Hayward also confirmed that, where an office holder wished to bring a section 423 claim as well as office holder/company claims, whilst the company claims and the insolvency claims may be brought together under one insolvency application (a good example being section 212 misfeasance and breach of duties claims under the Companies Act 2006), the section 423 claim may not.

It should be issued by way of a separate Part 7 Claim Form (in spite of what might have been a fairly common practice for insolvency practitioners and lawyers before this case). It is open to debate whether this is a reasonably sensible outcome in an insolvent context, where monies in the officeholder’s hands are often in short supply and ability to launch claims might be hindered by a higher issue fee, but that is nevertheless the current position.

Key take-aways

There must be a transaction at an undervalue designed to prejudice a creditor or potential creditor.

It is important to make a full investigation into all the circumstances surrounding the alleged wrongful transaction(s) to establish any alternative reasons for it, albeit it is not necessary that the intention to prejudice or defraud creditors was the only or predominant or ‘substantial’ purpose of the transaction.

It is not relevant as to what the intentions of the recipient party to the transaction(s) were; all that matters is the intention of the transferor.

Office holders must currently bring a claim under section 423 as a Part 7 claim, even if there are co-existent Insolvency Act claims.

Normal rules on limitation for bringing claims applies to victims (six years for a sum of money and 12 years for specialty claims/deeds). Officeholders benefit from limitation beginning on the date of the bankruptcy or winding up order (Rubin v Dweck [2012] B.P.I.R. 854). Concealment or fraud may result in a later limitation date (JSC BTA Bank v Ablyazov and Another [2018] EWCA Civ 1176).