AVOIDANCE OF DISPOSITIONS PROPERTY

PART 5

February 2010

AVOIDANCE OF DISPOSITIONS PROPERTY

31.4B.89 Avoidance of dispositions – general

The purpose of the provisions relating to avoidance of dispositions of property are to ensure that the estate is preserved in the period between the service of the petition and the making of the order.  Without the relevant provisions, there would be a risk that the directors of the company or the bankrupt may seek to dissipate assets in advance of the making of the order and consequent appointment of a liquidator or trustee.  Additionally, the provisions seek to maintain the principle that the assets of a company or bankrupt are distributed in an ordered manner, to avoid any one creditor or person benefiting unfairly.

 

31.4B.90 Avoidance of dispositions – general rules

So far as companies are concerned, the general rule is that any disposition of property entered into by the company after the commencement of a winding-up (see paragraph 31.4B.26) is void unless the disposition is authorised or validated by the court (see paragraph 31.4B.114) [note 1].  All dispositions are void – even those that benefit the company [note 2].

For bankruptcies, dispositions of property or payments made after the date of the presentation of the petition and up to the vesting of the estate in the trustee are void unless approved by the court (see paragraph 31.4B.114) [note 3].

 

31.4B.91 Identifying voidable transactions

Transactions from or to the bank account can be identified from the accounting records or bank statements.  Information about the transfer of other assets may be obtained in the interview with the company director or bankrupt.  Information may also come from suppliers and/or creditors, such as copies of statements of account which may reveal transactions after the presentation of the petition.

 

31.4B.92 Recovery of void dispositions

Whilst the Act is quite clear that dispositions after the commencement of the winding-up  or presentation of a bankruptcy petition are void (unless the court orders otherwise), it gives no guidance on the consequences of avoiding the disposition, or what should be done about it.  It has been held that the invalidation of a disposition of the insolvent’s property and the recovery of the property disposed of are two separate matters, and that the remedy is a matter to be decided by general law [note 4].

In most cases, the liquidator or trustee will simply apply to court for an order that the disposition be declared void and the property disposed of be returned, or the position restored to what it was prior to the disposition. 

 

31.4B.93 Realising voidable transactions

(Amended August 2014)

As explained in detail in Part 1 of this chapter, all antecedent recoveries are handled by The Service’s antecedent recovery contractor (see paragraph 31.4B.5). 

The following are the areas on which the official receiver should, ideally, obtain information before instructing the contractor and include on the ‘details of conduct/transaction’ section of the ARIA form (see paragraph 31.4B.9):

  • The date of winding-up or presentation of bankruptcy petition
  • The date of the property transferred
  • The valuation of the assets transferred, and details of the basis for this valuation
  • Details of any consideration given for the asset.
  • Any explanations given by the bankrupt or the insolvent for the transaction.
  • Evidence of the asset position of the beneficiary.
  • Details of the disponee

 

31.4B.94 Deleted

 

31.4B.95 Costs in contested proceedings

A person that has received property as a result of a voidable transaction may seek to challenge the liquidator’s  or trustee’s application for an order that the disposition be declared void and the property disposed of be returned, or the position restored to what it was prior to the disposition (see paragraph 31.4B.92).

The liquidator or trustee will generally be entitled to an order for costs where contested proceedings are successful (from the point of view of the liquidator or trustee).  Where the liquidator or trustee is unable to recover his/her costs, they will be treated as an expense in the liquidation [note 5] [note 6]. 

Where proceedings are unsuccessful, the costs are not automatically treated as an expense in the liquidation or bankruptcy [note 7] but the court may exercise its discretion to allow this [note 8].

 

31.4B.96 Property

Property is specifically defined in the Act to include “money, goods, things in action, land and every description of property wherever situated and also obligations and every description of interest, whether present or future or vested or contingent, arising out of, or incidental to, property” [note 9].

 

31.4B.97 Disposition

The Act gives no definition of the word “disposition”.  The dictionary definition is given as “a bestowal by deed or gift” [note 10].  A disposition may be viewed as having occurred where there has been a transaction involving the transfer of ownership rights in assets of the company or bankrupt.

 

31.4B.98 Examples of relevant dispositions

The following areas have been held to have been dispositions of a company’s property within the meaning of the relevant provision of the Act:

  • An outright transfer of company assets, by gift, sale or exchange [note 11] [note 12] [note 13].
  • The grant of a mortgage, charge or lease over the assets [note 14] [note 15] [note 16].
  • The grant of a declaration of trust, or other form of interest, in the assets [note 17].
  • A payment made with company money (including payments made against debts) [note 18] [note 19] [note 20] [note 21].

 

31.4B.99 Examples of transactions that are not dispositions

The following have been held to be transactions that are not dispositions of a company’s property within the meaning of the relevant provision of the Act:

  • A transfer of property held by the insolvent as trustee [note 22] [note 23].
  • A transfer of property under a contract entered into prior to the commencement of winding up or bankruptcy [note 24]
  • The incurring of liabilities by the company or bankrupt
  • The use or consumption of the company’s assets by itself or bankrupt by his/herself.

 

31.4B.100 Payment to the petitioning creditor

Where the debtor pays the petition debt in advance of the order being made (thereby causing the petition to be withdrawn), this would not be a voidable transaction as a post-petition transaction only becomes voidable once the order is made (see paragraph 31.4B.111).  Where, however, the petitioning creditor is substituted by another [note 25] [note 26] and an order is subsequently made, that payment to the original petitioner would be recoverable as a voidable transaction [note 27].

 

31.4B.101 Disposition of charged property

A disposition in favour of a chargeholder of an asset subject to security would be a voidable transaction in a bankruptcy (unless the disposition was made by the chargeholder), but not in a liquidation [note 28].  This is because the company provision [note 29] states that only a disposition of property owned by the company would be voidable, whereas the bankruptcy provision [note 30] merely refers to property transferred by the bankrupt, apart from property held on trust [note 31].  

 

31.4B.102 Disposition avoided where floating charge in operation - company only

Where a disposition is declared void and property is recovered as a result, it is considered that the property should be treated as though it had never left the company.  Therefore, the property would fall within the scope of a floating charge, and it would be open to an administrative receiver to lay claim to the property [note 32] where the charge was created before 15 September 2003 [note 33].

 

31.4B.103 Disposition of property by Trustee where subsequent petition presented

Where the official receiver, as trustee, is dealing with a bankruptcy case and a bankruptcy petition is presented against the same person, the provisions of the Act relating to voidable transactions [note 34] would not apply to dispositions made by the official receiver, as those provisions apply only to the bankrupt.

There are, though, provisions in the Act [note 35] that have the same effect on the trustee as those relating to voidable transactions do on the bankrupt.  These provide that any disposition of property, or monies that are the fruits of the sale of property, of the bankrupt is void unless it was made with the consent of the court [note 36].  This includes monies from IPA/IPOs [note 37] and property claimed as after-acquired property [note 38].   

 

31.4B.104 Payments into an insolvent’s bank account – account in credit

Where an insolvent’s bank account is in credit, any payments into the account after the commencement of the winding up (see paragraph 31.4B.26), or the presentation of the petition for bankruptcy, are considered to be invalid dispositions, which may be recovered from the bank.  When a company or individual pays monies into an account (whether by cheque or cash), the monies are technically exchanged for a claim against the bank – and this transaction counts as a disposition [note 39].

Assuming that the bank is solvent, the fact that the deposits are considered to be invalid transactions is, in effect, academic as the bank will, in any case, be required to remit the balance on the account to the liquidator or trustee in bankruptcy.

 

31.4B.105 Payments into an insolvent’s bank account – account overdrawn

Where the account is overdrawn, any monies paid into the account during the relevant period (see paragraph 31.4B.90) will result in the company’s or individual’s indebtedness to the bank being cleared in part or in full.  It is clear that such a transaction would count as a disposition, which would be void under the relevant provisions of the Act, and may be recovered from the bank.

 

31.4B.106 Payments out of an insolvent’s bank account – account in credit

Where the insolvent’s bank account is in credit, any payments out of the account are considered to be in favour of the payee, rather than the bank, and recovery action would, accordingly, be against the payee and not the bank [note 40].

 

31.4B.107 Payments out of an insolvent’s bank account – account overdrawn

When a bank authorises a payment from an overdrawn account, this is effectively a (further) loan from the bank to the company or individual.  The honouring of the payment by the bank cannot, therefore, be a disposition of the insolvent’s property.  When the bank as agent for the company consequently passes this “loan” money on to the payee, it becomes a disposition of company property as, by then, the “loan” money has become company property.  The monies are recoverable by the liquidator or trustee from the payee [note 41].

 

31.4B.108 Transfer of shares

The transfer of shares in a company and alterations in the status of its members made after the commencement of the winding-up are void under the relevant provisions, unless validated by the court.

 

31.4B.109 Disposition pursuant to an order of court

Where a disposition made during the relevant period (see paragraph 31.4B.90) is made in compliance with a (general) court order, it will still be void  unless ratified by the (insolvency) court [note 42].  Where the party who benefitted from the order has incurred costs in enforcing the order and that order has resulted in a benefit to the estate (such as tracing assets), the court may allow those costs to be recovered from the estate [note 43].  A court order ordering a transfer of property would not constitute a disposition but steps taken in compliance with it would [note 44].

 

31.4B.110 Increase in value of disposed property

Where the disposed property increases in value by the operation of market forces, the liquidator or trustee should reclaim the original property and any increase in value arising since the disposition.  Where, on the other hand, the property has increased in value due to actions on the part of the person who acquired the property (perhaps, due to sensible investment or improvements made) the liquidator or trustee may be required to compensate the disponee for an amount equal to the increase in value caused by their actions [note 45].

 

31.4B.111 Effectiveness of avoidance of disposition provisions

The relevant provisions of the Act have no effect until the winding-up commences (see paragraph 31.4B.26), or the bankruptcy order is made.  All dispositions entered into after the date of the presentation of the petition are valid at the time that they are carried out, but will become void (subject to court approval – see paragraph 31.4B.114) if a winding-up order or bankruptcy order is subsequently made.  Once a winding up order or bankruptcy order is made, then an earlier post-petition disposition will become retrospectively void and its validity will be dependent on whether the court is minded to validate it.

Post winding-up dispositions would also be caught by the provisions of the Act, though this does not affect the liquidator’s or trustee’s ability to dispose of the company’s or bankrupt’s property [note 46] [note 47].

 

31.4B.112 Moratorium in advance of a CVA

Where directors of an eligible company obtain a moratorium to enable them to put forward proposals for a CVA, the operation of the relevant provision of the Act [note 48] is suspended for the duration of the moratorium [note 49].

 

31.4B.113 No effect on administrator while petition suspended

The relevant provisions of the Act have no effect in respect of anything done by an administrator of a company while a winding-up petition is suspended [note 50].

 

31.4B.114 Validation of post-petition dispositions

The Act sets no guidelines or statutory guidance as to the principles that should be applied when a court is deciding an application for the validation of a post-petition disposition.  Courts have viewed that the exercise of discretion in this respect has been left to the same general principles which apply to every kind of judicial discretion [note 51]. 

Provided a person has some discernable interest in the matter, he/she has standing to make application for the validation of a post-petition disposition.  This might include, for example, shareholders or creditors of the company [note 52].

The following paragraphs (31.4B.115 to 31.4B.120) outline the matters that may be taken into consideration by courts when deciding this type of application.

 

31.4B.115 Validation before or after the order

An application for validation may be made before or after the transaction becomes void (on the making of the winding-up or bankruptcy order – see paragraph 31.4B.111).  The application can also be made in advance of the transaction, to gain the court’s approval of a particular disposition, or a general continuation of trading [note 53].

 

31.4B.116 Validation – benefit to creditors

The court’s primary concern is to establish whether the proposed/past transaction will/did benefit the general body of creditors [note 54].  The court will not normally allow a transaction that benefits a sole creditor, or group of creditors or another person, unless there are special reasons - for example, if the transaction is necessary for continued trading that will/has the benefit of improving the position of the business – see paragraph 31.4B.117 for further information on validations of continued trading [note 55].  

Approval will tend to be given where assets are sold at a fair market value, as this would not change the overall position of the insolvent [note 56].

 

31.4B.117 Validation – continuance of trading

The court may give a general validation to the continuation of trading, where that continuation would lead to the business being preserved to allow it to be sold as a going concern [note 57].  In deciding whether to allow continued trading, the court will need to consider whether the interests of unsecured creditors are being met [note 58] and, also, the financial position of the company.  Where the company is considered to be irretrievably insolvent, it is unlikely that validation will be given [note 59].

It may be beneficial to the general body of creditors for the court to validate the completion of a contract that the insolvent is engaged in.

 

31.4B.118 Validation – disposition in good faith and in ignorance of the petition

Courts have tended to give validation where dispositions were made in good faith, in the ordinary course of business and where the parties were unaware that the petition had been presented, unless the transaction appeared to involve an attempt to prefer the recipient [note 60].

For a party to successfully argue that they were without notice of the service of the petition, it will normally be necessary to show that the transaction took place before the advertisement of the petition [note 61].  The advertisement of the petition is considered to constitute notice to the whole world [note 62].

 

31.4B.119 Validation - disposition entirely post-petition

Where the disposition is due to an entirely post-petition event (i.e. where both the supply of goods and payment for those goods were made after the petition), the court will normally validate the transaction as there would be no dissipation of the insolvent’s property – so long as equivalent value is being given and received [note 63].  Where, on the other hand, the transaction is at an undervalue (from the point of view of the insolvent), then validation is unlikely to be given.

 

31.4B.120 Validation – payment in respect of pre-petition debts

Normally, the court will not validate a transaction which involves the payment of a creditor, or a group of creditors or another person, to the detriment of the general body of creditors (see paragraph 31.4B.116).  Where, however, such a payment would have the result in benefiting the general body of creditors – such as a business paying arrears in respect of a lease to allow that lease to be sold where it would have become forfeit in bankruptcy – then validation may be given [note 64] 

 

 

[Back to Part 4 – Civil recoveries following the misconduct of directors] [On to  Part 6 – Extortionate credit transactions]