#10442 - Vulnerable Transactions In Insolvency - BPC Corporate Insolvency

Vulnerable transactions in insolvency

The ‘clawback’/avoidance provisions of the Insolvency Act 1986

We will consider a series of executed transactions which are rendered ‘vulnerable’ on insolvency and which liquidator or administrator by virtue of statutory provisions, can attack and reverse. The effect of this is to return the company’s assets which were removed some time prior to insolvency.

These unravel transactions which are in some way objectionable e.g. contract law and inadequate consideration.

So this further blows apart idea that liquidator takes company’s assets as he finds them.

Why are these ‘avoidance’ provisions there?

• Upholding PariPassu? (avoidance upholds this retrospectively. Is a sense that law here is aimed at achieving PariPassu particularly re one provision)

• Preserving collectivity? (if you can gather in assets and deal with them collectively, that enhance not only realisations but also liquidation being a collective procedure where all creditors have to participate collectively. Again at least 1 provision ensures this)

• Reversing unjust enrichment? (Restitutionary principle)

• Prevention of fraud? (And if not at least prevention of mis-behaviour, particularly re those connected to company prior to insolvency)

Goode: Pointing to single rationale however is difficult, because e.g. ‘protecting general body of creditors’ rationale does not really explain why we should avoid transactions at an undervalue or unlawful preferences, but not unregistered charges, post-petition dispositions of assets for full value, etc. The paripassu rationale does not explain why it is ok to threaten or bully a company into making a payment, but not ok to receive a voluntary payment, even if in good faith.

Each ground of avoidance is evolved from earlier legislation and no attempt has been made to make all insolvency law coherent.

Types of avoidance provisions

• Transactions at an undervalue (s238 IA)

• Preferences (s239 IA)

• Floating charges for past value (s245 IA)

• Unregistered charges (effectively invalid as against creditors, liquidator or administrator)

• Post-petition dispositions of corporate assets without leave of ther court (s127 IA)

• Extortionate credit transactions (s244 IA)

• Transactions defrauding creditors (s423-5 IA)

Note also that certain executor contracted can be avoided if they contravene PariPassu.

How far do the considerations in relation to each transaction actually justify the reversal of transactions entered into prior to insolvency?

Transactions at an undervalue - s238 IA:

This is where company disposes of an asset for no consideration or not enough consideration as is equal to the consideration which they themselves provide.

This is linked to the common law anti-deprivation rule, but obviously operates differently to it because:

• S238 affects completed transactions, whereas anti-deprivation catches uncompleted transactions

• S238 operates retrospectively by providing for the reversal of transactions, whereas anti-deprivation is aimed at payments and transfers fixed to occur upon insolvency at a later date

• S238 transactions are valid but its effects are reversible in the discretion of the court upon application by the office-holder, but a provision which breaches anti-deprivation is necessarily void.

3 pre-requisites for operation of s238:

1. Company in liquidation or administration and application made by office-holder

S238(1) Company must be in(a)liquidation or (b)administration.

S238(2) Creditors of themselves cannot bring action under this section. Hence office-holder applies to court for order under this section at the relevant time.

Clearly must be the formal collective insolvency proceeding to bring together unsecured creditors and give them locus standi. Can’t let them interfere before insolvency because they’re unsecured.

Also right that office-holder only make application because the remedy is not automatic – it must be sought. Office-holder represents interests of creditors so no-one else should be allowed to apply since the whole point of the remedy is to protect those creditors.

2. Transaction entered into at the ‘relevant time’ with the company

S436 ‘Transaction’ is defined as including a gift, agreement or arrangement’

S240(1)Transaction ‘at the relevant time’ is--

(a) If transaction entered into within 2 years before ‘onset of insolvency’ (s238(3) tells us when this is) or

(b)Between presentation of petition of administration and the making of such an order.

S238(3) For the purposes of subsection (1), the onset of insolvency is--

(a)in a case where section 238 or 239 applies by reason of an administrator of a company being appointed by administration order, the date on which the administration application is made,

(b) in a case where section 238 or 239 applies by reason of an administrator of a company being appointed under paragraph 14 or 22 of Schedule B1 following filing with the court of a copy of a notice of intention to appoint under that paragraph, the date on which the copy of the notice is filed,

(c) in a case where section 238 or 239 applies by reason of an administrator of a company being appointed otherwise than as mentioned in paragraph (a) or (b), the date on which the appointment takes effect…

(e) in a case where section 238 or 239 applies by reason of a company going into liquidation at any other time, the date of the commencement of the winding up.

It is right to set a period for relevant transaction like this because would be unfair to expose a party indefinitely to a liability to restore that which he lawfully received. Plus the impact of the transaction on creditors becomes more tenuous with the passage of time.

3. Company Insolvent at Time of Transaction or as a Consequence of Entering into it

S240(2) Where a company enters into a transaction at an undervalue … at a time mentioned in subsection (1)(a) or (b), that time is not a relevant time for the purpose of section 238 or 239 unless the company--

(a) Is at that time unable to pay its debts within the meaning of section 123 in Chapter VI of Part IV, or

(b) Becomes unable to pay its debts within the meaning of that section in consequence of the transaction…

But the requirements of this subsection are presumed to be satisfied, unless the contrary is shown, in relation to any transaction at an undervalue which is entered into by a company with a person who is connected with the company.

(So where the transaction is entered into with a person connected with the company, it is presumed that the company was insolvent at that time, or became insolvent by virtue of entry into the transaction).

It’s right that company should be unable to pay debts at time of transaction or as a result because if after the transaction they can still pay debts etc then no creditors are disadvantaged as a result.

S249 For the purposes of any provision in this Group of Parts, a person is ‘connected’ with a company if--

(a) He is a director or shadow director of the company or an associate of such a director or shadow director, or

(b) He is an associate of the company; and “associate” has the meaning given by section 435 in Part XVIII of this Act.

(This is because someone connected with company getting transaction at undervalue is treated even more harshly).

Meaning of transaction at an undervalue (i.e. attackable transaction):

This is almost an anti-deprivation principle – company given something up and received less or nothing in return. ‘Equivalent consideration’ is at the heart of this – depletes assets otherwise:

S238(4) For the purposes of this section and section 241, a company enters into a transaction with a person ‘at an undervalue’ if--

(a) The company makes a gift to that person or otherwise enters into a transaction with that person on terms that provide for the company to receive no consideration, or

(b) The company enters into a transaction with that person for a consideration the value of which, in money or money’s worth, is significantly less than the value, in money or money’s worth, of the consideration provided by the company.

• What about bonuses to employees?

• Charitable donations?

These would fall within s238(4)(a) which seems unfair. But note s238 only applies when company is insolvent when arguably it shouldn’t be so free with its money. Moreover bonuses might be justifiable under s238(5) as bona fide payments for purposes of carrying on business e.g. positive encouragement to workforce. Also, court has discretion over what order to make so can take into account the circumstances.

M C Bacon –

“To come within S238(4)(b) the transaction must be:

(1) entered into by the company;

(2) for a consideration;

(3) the value of which measured in money or money’s worth;

(4) is significantly less than the value;

(5) also measured in money or money’s worth;

(6) of the consideration provided by the company.

It requires a comparison to be made between the value obtained by the company for the transaction and the value of consideration provided by the company. Both values must be measurable in money or money’s worth and both must be considered from the company’s point of view.” – Lord Millett.

Stanley v TMK Finance – Example of how courts proceed here generally: Company N commenced action through liquidator against TMK who was associate of N. Action tried to cover 1.5 mill. In 2005 N had sold property, price received was 2.25 mill. Liquidator alleged that at that time, that 2.25 mill was roughly 1 mill less than property was actually worth – evidence being T (purchaser of property) paid dividend of 1.5 mill to holding company and that...