1 Lexis PSL Restructuring & Insolvency Practice Note Unwinding unlawful Stop Press: The Small Business, Enterprise and Employment Act 2015 (SBEEA 2015) received Royal Assent on 26 March 2015 and introduced a number of changes that have and will affect insolvency professionals. Specifically in relation to office-holder claims, SBEEA 2015 introduced the following changes: claims for fraudulent and wrongful trading will be able to be brought by administrators, as well as liquidators (currently only liquidators can bring such claims) administrators and liquidators will be able to assign to third parties rights of action in respect of claims concerning fraudulent trading, wrongful trading, transactions at an undervalue (TUVs), preferences and extortionate credit transactions, or the proceeds of such claims liquidators and trustees in bankruptcy will no longer need to obtain sanction of either the court or a creditors committee (or where there is none, the Secretary of State or (in the case of a liquidation) a meeting of creditors) The changes relating to office-holder claims (including allowing an administrator to bring fraudulent and wrongful trading claims) and the ability of office-holders to assign rights of action or the proceeds thereof will, pursuant to SBEEA 2015, s 164(1), come into force on such day as a Minister of the Crown may by regulations appoint. The abolition of the requirement to seek sanction came into force on 26 May 2015 pursuant to SBEEA 2015, s 164(3). General duties of the trustee in bankruptcy The main function and duty of a trustee in bankruptcy (trustee) is to get in, realise and distribute the bankrupt s estate in accordance with the applicable provisions of the Insolvency Act 1986 (IA 1986). As part of carrying out these functions-and in order to comply with their fundamental duties-trustees must look into any transactions or dealings concerning the disposition of property prior to the commencement of the bankruptcy which may have breached the IA 1986 and which should therefore be recovered for the benefit of creditors, possibly by obtaining a court order to that effect. This Practice Note looks at the kind of claims available to trustee in these circumstances, commonly known as antecedent claims or antecedent transaction claims. Transactions at an undervalue (TUVs) TUVs in bankruptcy can be challenged under IA 1986, s 339. The claim can only be brought by a trustee. For the court to declare that a transaction was at an undervalue and grant relief, the following conditions must be met: there must be a transaction which must be at an undervalue and which must have occurred within the relevant time Transactions TUVs under IA 1986, s 339 concern transactions where: the debtor (being the bankrupt prior to their bankruptcy) enters into a transaction with a person (or other entity)(the counterparty) on terms where the debtor receives no consideration on terms where the consideration given is marriage on terms where the consideration the debtor receives, in money or money s worth, is significantly less than the value, in money or money s worth, of the consideration provided by the counterparty A transaction is not exhaustively defined in the IA 1986, and can include a number of situations, including an agreement or arrangement. There is a requirement for the debtor to enter into the transaction, and the court is able to adopt a flexible approach to the transaction by looking at the whole course of dealings between the parties. There is no statutory definition of consideration. The courts will look at the consequences of the transaction and will assess the consideration in terms of its overall economic effect (see Pena v Coyne  2 BCLC 730,  All ER (D) 434 (Jul)).
2 There is also no statutory definition of what significantly less means. It is a concept that will be determined by reference to the circumstances of any given case, although it is widely considered that anything less than 70-80% of the consideration given by the debtor will be significant or at least indicative of that. TUV claims will normally concern the transfer of an asset by the debtor for less than the proper value of the asset, and the consideration given by the debtor will usually be the market value of that asset. Any attempt to dispose of an asset without testing the market may be indicative of a TUV-see Gil v Baygreen Properties (in liquidation  EWHC 1732 (Ch),  All ER (D) 105 (Aug)). However, it is clear that, for the court to make an order, the consideration given by the counterparty must be either significantly less, or no consideration is given at all. The granting of a charge or taking security over assets is not (of itself) a TUV, as the creation of security does not deplete the debtor s estate or diminish its value as a whole-see Re MC Bacon, although in some situations, the creation of security in favour of a creditor may be challenged as a preference under IA 1986, s 340. Doubts over the decision in Re MC Bacon were raised in Hill v Spread Trustee (both Re MC Bacon  BCLC 324 and Hill v Spread Trustee  1 BCLC 450 are corporate insolvency cases but the principles apply equally in personal insolvency cases). The relevant time The court can examine any transaction which took place five years before the day the bankruptcy petition was presented. However, it is important to establish when during that five year period the transaction occurred. If the transaction took place in the two years before the date the bankruptcy petition was presented, it does not matter whether the debtor was solvent or insolvent (or became insolvent as a result of the transaction). In these circumstances, the trustee only has to demonstrate that: the transaction took place and was at an undervalue However, if the transaction took place in the two to five-year period before the bankruptcy petition was presented, it will be necessary to demonstrate that the debtor-at the time of the transaction-was insolvent, or became insolvent as a consequence it. Accordingly, if the debtor was solvent at the time of the transaction, it cannot be challenged as a TUV. If the counterparty to the transaction was an associate of the debtor (as defined in IA 1986, s 435, which will include the bankrupt s husband, wife, civil partner or relative), there is a presumption that the debtor was insolvent at the time of the transaction-or became insolvent as a result of it-but this presumption is rebuttable by the associate. If, however, the counterparty to the transaction was not an associate of the debtor, the burden will be on the trustee to prove the debtor s insolvency. Rules 1986, SI 1986/1925 (IR 1986) by an application notice in Form 7.1A containing the information required by IR 1986, SI 1986/1925, r 7.3. It should seek a declaration that the transaction concerned was at an undervalue and seek an order restoring the position to what it would have been had the transaction not occurred. The respondent to the application will be the counterparty to the transaction, with the trustee as the applicant. notice should also be accompanied by a witness statement in support, which should (broadly speaking), state the following: full details of the trustee and the details of his appointment whether the respondent was connected to the debtor at the time of the transaction or, at that time, the debtor was insolvent or became insolvent as a result of the transaction If the court is satisfied that the transaction was at an undervalue, it has wide discretion to make any order it thinks fit for restoring the position to what it would have been but for the transaction. This includes reversing the transaction (ie transferring property back to the bankrupt, which will then vest in the trustee), or ordering the respondent to pay to the trustee a sum compensating the bankruptcy estate for the transaction. The court could order no relief, although situations in which that may happen are rare. Preferences Preferential are governed by IA 1986, ss 340. A preference claim can only be brought by a trustee. The court will make an order setting aside a preferential transaction where: there is a debt due from the debtor to the creditor, surety or guarantor the debtor does any act (ie entering into a transaction such as making a payment), which has the effect of putting the creditorin the event of the debtor s bankruptcy-into a better position than they would have been had that transaction not occurred there is desire (actual or presumed) on the debtor s part to put that creditor into a better position the transaction took place within the relevant time Better position The key component of a preference claim is that the creditor was put into a better position as a result of the transaction in question. This goes beyond just merely entering into a simple transaction or making a payment-it also requires suffering something to be done. Although there is no judicial definition of what constitutes suffering something to be done, the proper approach would include permitting something to be done.
3 Another core component to a preference claim is improvement in the position of the creditor, which is assessed by the court objectively (ie the court will look on the face of it whether the position of the creditor is actually bettered, ie making a simple payment). Examples of where a creditor s position has been improved include: the right to obtain property, which the creditor would be unable to claim otherwise (see Goel v Pick  EWHC 833 (Ch),  All ER (D) 180 (Apr)) returning goods which have not been paid for but where title has passed to the debtor One area which has been subject to judicial consideration is the effect that entering into a charge has on bettering the position of the creditor, surety, or guarantor. Entering into a charge can be considered putting the creditor into a better position and therefore could be susceptible to challenge (whereas it may not be a TUV). This will particularly be the case where the creditor has lent the debtor money and the creditor s position was subsequently secured (ie the security was based on old money ). Desire Another key component to a preference claim is there must be desire on the debtor s part to better the creditor s position. The desire is based on wanting to improve the creditor s position and not just merely entering into the transaction. Merely entering into a transaction because it was necessary on the debtor s part (ie paying off a key trade creditor-also known as the commercial expediency defence) will not be enough. There must be evidence to show the positive wish to improve the creditor s position (see Re MC Bacon and Re Fairway Magazines  BCLC 643). If the creditor is an associate of the debtor (as defined in IA 1986, s 435, which will include the bankrupt s husband, wife, civil partner or relative), there is a presumption that the debtor intended to better the creditor s position. This presumption is rebuttable by the creditor. If the creditor was not an associate of the debtor, the burden will be on the trustee to prove that the debtor desired to put the creditor into a better position. IA 1986, s 340(6) also provides that the fact a preferential transaction is made in accordance with a court order does not prevent that transaction from being challenged by a trustee. This effectively rules out payments being made following a simple judgment for a debt, unless there are commercial reasons for making that payment (ie the debtor has no choice but to make the payment). Again, as is the case with a TUV claim, an essential requirement of a preference claim is that the debtor was insolvent at the time of the transaction in question, or became insolvent as a result of it. However, the significant difference is that there is no presumption of insolvency where the preference was given to a creditor who was an associate of the debtor. Accordingly, the burden will always be on the trustee to establish this insolvency requirement as part of any court application he makes challenging a preference. Rules 1986, SI 1986/1925 (IR 1986) by an application notice in Form 7.1A containing the information required by IR 1986, SI 1986/1925, r 7.3. It should seek a declaration that the transaction concerned was a preference and seek an order restoring the position to what it would have been had the preference not been given. The respondent to the application will be the person to whom the preference was given, with the trustee as the applicant. notice should also be accompanied by a witness statement in support, which should (broadly speaking), state the following: full details of the trustee and the details of his appointment that the respondent was a creditor, surety or guarantor of the debtor and the details of the debt or guarantee whether the respondent was connected to the debtor at the time of the transaction that, at that time of the transaction, the debtor was insolvent or became insolvent as a result of the transaction, and provide evidence If the court is satisfied that the respondent has been preferred, it has wide discretion to make any order it thinks fit for restoring the position to what it would have been but for the transaction. This includes reversing the transaction (ie transferring property back to the bankrupt, which will then vest in the trustee), or ordering the respondent to pay to the trustee a sum compensating the bankruptcy estate for the transaction. The court could order no relief, although situations in which that may happen are rare. Relevant time As is the case with a TUV claim, a preference must have taken place within a certain period of time prior to the presentation of the bankruptcy petition for the court to set it aside: for preferences given to creditors who were associates of the debtor, the court can look back up to two years ending with the day on which the bankruptcy petition was presented at court for preferences given to creditors who were not associates of the debtor, the court can look back up to six months from the day on which the bankruptcy petition was presented Transactions defrauding creditors Transactions defrauding creditors are dealt with under IA 1986, ss They differ to the other antecedent claims (TUVs and preferences) in that a claim can be commenced not only by a trustee, but also by a victim of the transaction (ie any creditor who has been harmed by it). Further, a claim may be brought outside of an insolvency process-for example, if a party conducting litigation has evidence that the other party is
4 intentionally disposing of assets at an undervalue to defeat any future liability. This Practice Note only considers transactions defrauding creditors from a trustee s perspective. In order for the court to grant relief under IA 1986, s 423, the following conditions must be satisfied: the transaction which is being challenged must have been a TUV within the meaning of IA 1986, s 339 the transaction was entered into for the purpose of putting assets beyond the reach of a person who is making a claim (or may make a claim at some point in time), or was entered into for otherwise prejudicing the interests of such a person in relation to the claim(s) which they are making, or may make Despite its title, there is in fact no requirement for any fraud to have occurred. There are a number of key differences between IA 1986, s 339 claims and IA 1986, s 423 claims. These are: the purpose of the transaction is key under IA 1986, s 423, whereas the purpose of the transaction under IA 1986, s 339 (a TUV) is not relevant. The current case law provides that the dominant or substantial purpose of the transaction needs to be putting assets beyond the reach of creditors. It may be that the purpose of the transaction had mixed motives, some of which were perfectly appropriate (see Inland Revenue Commissioners v Hashmi  2 BCLC 489). The court will look at and assess what the dominant purpose of the transaction was under IA 1986, s 423, there is no requirement for the debtor to be insolvent at the time of the transaction or as a consequence of it. In addition, there is no requirement for the debtor to have any creditors at the time of the transaction. In the case of Sands v Clitheroe  BPIR 1000, the fact that the respondent was about to engage in risky or hazardous business-which gave rise to the transaction, even though there were (at the time of the transaction) no creditors-still gave rise to the transaction being held as a transaction to defraud creditors there is no specified time limit (unlike for TUVs and preferences) in which the transaction must have taken place before the onset of the insolvency process for it to be challengeable the debtor does not need to be bankrupt for a claim to be made. Any victim of the transaction can make a claim, but if they do and the debtor is bankrupt, the claim is made on behalf of every victim of the transaction (ie the creditors) and not just the applicant creditor There is an exception by way of a limitation to making orders against parties (other than the debtor) who entered into the transaction in good faith, for value and without notice of the relevant circumstances. Rules 1986, SI 1986/1925 (IR 1986) by an application notice in Form 7.1A containing the information required by IR 1986, SI 1986/1925, r 7.3. It should seek a declaration that the transaction concerned was a transaction defrauding creditors and seek an order restoring the position to what it would have been had the transaction not been given. The respondent to the application will be the counterparty to the transaction, with the trustee as the applicant. notice should also be accompanied by a witness statement in support, which should (broadly speaking), state the following: full details of the trustee and details of his appointment full details of the asset(s) transferred, including why it constitutes a TUV the purpose behind the transaction the details of the intention of the debtor at the time of the transaction the fact that any order made will not prejudice any third parties, who acquired the assets for value and without notice the court will usually grant (particularly where the application is made by the trustee) is similar to the relief as set out in IA 1986, s 342 for TUVs and preferences. However, the key distinction is that IA 1986, s 425 provides for an order that the property may be vested in a person other than the debtor (which is at odds with the derivative nature of the claim). Restrictions on dispositions of property Under IA 1986, s 284, any disposition of the bankrupt s property in the period between the presentation of the bankruptcy petition and the vesting of the bankruptcy estate in a trustee (which can be some time after the bankruptcy order is made) is void unless ratified by the court. When section 133 of the Small Business, Enterprise and Employment Act 2015 comes into force, the official receiver (or the supervisor of an individual voluntary arrangement) will become trustee immediately upon the making of a bankruptcy order, and so IA 1986, s 284 will essentially cover the period from the presentation of a bankruptcy petition through to the making of the bankruptcy order.
5 The consequences of IA 1986, s 284 take effect when a bankruptcy order has been made by the court, but in essence have retrospective effect going back to when the bankruptcy petition was presented. Accordingly, if there is a disposition of the bankrupt s property after the presentation of a bankruptcy petition-but no bankruptcy order is made on that bankruptcy petition-then the disposition cannot be challenged under IA 1986, s 284 in the event that a new bankruptcy petition is presented. It may, however, still be challengeable as a TUV, preference, or transaction defrauding creditors if the requisite conditions for any of those claims are met. IA 1986, s 284 is only effective against the bankrupt s property, or assets of the bankrupt which would vest in the trustee on his appointment. Although simple payments in cash by the debtor or transfers of real property (ie a house) by the debtor will clearly be caught under IA 1986, s 284, other transfers and dispositions are not so clear. One area which has been subject to judicial consideration is that of property adjustment orders (ie financial orders made by the family court during divorce proceedings). Should the family court make a property adjustment order-which has the effect of transferring property-in the period between the bankruptcy petition and the bankruptcy order, then (and assuming there has been a disposition of the bankrupt s property) IA 1986, s 284 will render that order and transfer void. In these circumstances, an application will need to be made setting out why the order should be ratified by the court (see Treharne v Forrester  All ER (D) 36 (Nov)). Another common problem relates to payments made to settle the bankruptcy petition debt, which will come within the scope of IA 1986, s 284 in the event that a bankruptcy order is made on that bankruptcy petition (ie another creditor continues with the bankruptcy petition). Therefore, unless the payment has been ratified by the court, the petitioning creditor should always seek payment from funds which do not belong to the debtor, ie from a third party. There is some protection for purchasers acting in good faith under IA 1986, s 284(4). No remedy can arise against any person in respect of any property or payment that was received before the bankruptcy proceedings commenced in good faith, for value and without notice of the bankruptcy petition. Circumstances when the court will ratify any dispositions The circumstances when the court will ratify a disposition of the bankrupt s property are limited, as the court s ultimate objective is to ensure that the debtor s creditors are not prejudiced in any way. The court will sanction dispositions where (i) the debtor is solvent, able to pay their debts and the petition was somehow presented, or (ii) where the disposition will not prejudice the interests of the debtor s creditors. Challenges Unless the disposition is ratified by the court, it will be void and will not bind the trustee. However, in most cases, the trustee will make an application to court seeking a declaration that the disposition is void and for the property to be transferred back/ repaid. The process for this will follow a similar pattern to an application to a TUV or a preference (set out above). For more details about Lexis PSL Restructuring and Insolvency or to have a free trial, please see Reed Elsevier (UK) Limited trading as LexisNexis. Registered office 1-3 Strand London WC2N 5JR Registered in England number VAT Registered No. GB LexisNexis and the Knowledge Burst logo are trademarks of Reed Elsevier Properties Inc. LexisNexis The information in this document is current as of July 2015 and is subject to change without notice.
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