TRANSACTIONS DEFRAUDING CREDITORS

PART 7

February 2010

TRANSACTIONS DEFRAUDING CREDITORS

31.4B.137 Transactions defrauding creditors – scope of the provisions

Somewhat unusually, the provision in the Act [note 1] relating to transactions defrauding creditors applies equally to both companies and bankruptcies.  

 

31.4B.138 Transactions defrauding creditors - general

Essentially, the purpose of the provisions in the Act relating to transactions defrauding creditors are to enable the setting aside of transactions at an undervalue where the intention of the transaction was to put assets out of the reach of creditors.

On the face of it, the provisions relating to transactions defrauding creditors [note 2] are similar to the provisions relating to transactions at an undervalue [note 3] [note 4] (see Part 3 of Chapter 31.4A), in that both sets of provisions require that property (in the general sense of the word) has been transferred for less than its value.

When considered in more detail, however, there are some key differences between the two provisions.  Some of the differences make it easier for the official receiver, as liquidator or trustee, to challenge transactions; some make it more difficult; and others are of little consequence.

See paragraphs 31.4B.141 to 31.4B.142 for information relating to the differences between transactions defrauding creditors and transactions at undervalue.

 

31.4B.139 Realising transactions defrauding creditors

(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):

  • Any connection between the beneficiary and the insolvent.
  • The date of insolvency (as opposed to the date of the order)
  • Details of any assets transferred.
  • The date of the transfer
  • 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.
  • The circumstances of the transaction – the details and why it was undertaken.
  • Evidence of the asset position of the beneficiary.

31.4B.140 Deleted

 

31.4B.141 Transactions defrauding creditors versus transactions at an undervalue – differences consequential on the official receiver

The two differences between the provisions in the Act relating to transactions defrauding creditors and transactions at an undervalue that are most likely to have an impact on the official receiver when considering whether to challenge a transaction are:

  • There is no time limit during which a transaction must have occurred for it to be recoverable as a transaction defrauding creditors (see, though, paragraph 31.4B.24 regarding the statute of limitation), whereas there are time limits applying to recoveries as transactions at an undervalue (see paragraph 31.4A.67).
  • For a successful recovery of a transaction defrauding creditors it will be necessary to show that the transaction was entered into with the intention of putting asset(s) beyond the reach of creditors or a creditor.  It is not sufficient just to show that this was the consequence of the transaction; it must have been the intention of the person entering into it [note 5].

Where the transaction has taken place within the time limits to open it to challenge as a transaction at an undervalue (see Part 3 of Chapter 31.4A), it is better to go down this route due to the lower burden of proof.  Otherwise, the official receiver, as officeholder, will need to consider a challenge of the transaction as a transaction defrauding creditors.

 

31.4B.142 Transactions defrauding creditors versus transactions at an undervalue – differences with no direct consequence on the official receiver

In addition to the differences outlined in paragraph 31.4B.141, there are other differences  between the provisions relating to transactions defrauding creditors and those relating to transactions at an undervalue that are less likely to have a direct impact on the official receiver:

  • Unlike the provisions relating to transactions at an undervalue, a recovery action under the provisions relating to transactions defrauding creditors need not take place within a formal insolvency proceeding and does not require that the transferee was insolvent at the time of the transaction.
  • A recovery action under the provisions relating to transactions at an undervalue may only be brought by the relevant office holder, whereas a recovery under the provisions relating to transactions defrauding creditors may be brought, additionally, by any “victim” of the transaction [note 6] (see paragraph 31.4B.143).

 

31.4B.143 Who may apply for an order under the provisions relating to transactions defrauding creditors?

Unlike the similar provisions relating to transactions at an undervalue, the ability to bring actions to have a transaction defrauding creditors set aside is not limited to office-holders see point above.  Nor is it limited to bringing actions against companies or individuals in some form of formal insolvency proceeding – in fact, the company or individual need not even be, or have been, insolvent for an action to be brought [note 7].  An action can be brought by any “victim” of the transaction, whether or not that victim was the creditor who the transferor had in mind when entering into the transaction [note 8].

In circumstances, however, where the company or individual is in liquidation or bankruptcy (as the case may be), any “victim” of the transaction must first obtain leave of court before bringing an action [note 9].

Where the action is brought by one “victim” of the transaction, the action is treated as having been brought by all victims of the transaction [note 10] and any sums awarded in the action should be awarded to all those prejudiced.  Generally speaking, the court will achieve this by re-vesting the property in the company/individual and allowing individual creditors to pursue claims against the company/individual [note 11].

 

31.4B.144 Undervalue transactions

A key component of the provisions relating to transactions defrauding creditors is that, for a successful recovery, it will be necessary to show that the asset was transferred at an undervalue [note 12].

The following transactions are identified in the Act as being those that are undervalue [note 13]

A gift or transaction to a person on terms that provide for the company/individual to receive no consideration.

  • A transaction for a consideration the value of which, in money or money’s worth, is significantly less that the value, in money or money’s worth, of the consideration provided to the company/individual.
  • A transaction with a person in consideration of marriage or the formation of a civil partnership (bankruptcy only).

 

31.4B.145 Identifying and assessing transactions at an undervalue

As outlined in paragraph 31.4B.144, it is necessary to show that a transaction was entered into for no consideration or for consideration that was significantly less than the true value of the property transferred.  There is no statutory definition of “significantly less” and courts have tended to decide each case on the particular facts.  In one case [note 14] a difference of 10% between the consideration and true value was held to be the result of a genuine difference of opinion.  In another case, a difference of 20% was held to be a transaction at an undervalue [note 15].

See paragraphs 31.4A.72 to 31.4A.80 of Part 3 of Chapter 31.4A for information on matters to take into account when considering whether property has been transferred at an undervalue.  

 

31.4B.146 Purpose behind the transaction

In addition to the need to show that the transaction was at an undervalue (see paragraph 31.4B.144), a successful recovery would also require that it be shown that the transaction was entered into for the purpose [note 16]:

  • of putting assets beyond the reach of a person who is making, or may at some time make, a claim against him/her, or
  • of otherwise prejudicing the interests of such a person in relation to the claim which he/she is making or may make.

Despite the title of the provision relating to transactions defrauding creditors, it is not necessary to show fraud in any technical or criminal sense on the part of the person transferring the property [note 17]. 

 

31.4B.147 Necessary to prove intention

For a successful recovery under the provisions relating to transactions defrauding creditors, it is necessary to show that one of the purposes detailed in paragraph 31.4B.146 was the actual intended purpose of the transaction. 

The intention behind the transaction may, ideally, be proved by evidence provided by those involved in the transaction but, in the more likely scenario where this is not possible, it is possible to draw inferences from the timing and circumstances of the transaction [note 18].  It should be noted that  just because the consequence of the transaction was to put assets beyond the reach, does not mean that this was the intention [note 19] [note 20].

 

31.4B.148 More than one purpose behind the transaction

Of course, an intention to put assets beyond the reach of creditors may not have been the only purpose behind a transaction.  It is possible that a person may have had more than one reason for entering into the transaction.  In these cases the court would look to see that the intention to put assets beyond the reach of creditors was a “substantial purpose” behind the decision to enter into the transaction [note 21] [note 22].

There may be a good reason for entering into the transaction (for example, to save a business or the family home) but this does not mean that the purpose was not to put assets beyond the reach of creditors [note 23].

 

31.4B.149 Deciding a purpose – companies

A company itself cannot be said to be able to have a purpose in mind and any purpose in the “mind” of the company must, of course, be formed in the mind(s) of those human beings controlling the company [note 24].  In order to successfully challenge a transaction defrauding creditors, the official receiver, as office holder, would need to show that the decision to enter into the transaction arose from a proper decision by those controlling the company – i.e., those with the controlling “mind” of the company. 

Commonly, in cases dealt with by the official receiver the company has one director and, in these cases, identifying the controlling mind would be a simple matter.  For the vast majority of these and the other cases dealt with by the official receiver, the person(s) causing the company to undertake the transaction will be the sole director or directors as a group and, therefore, there will be no difficulty in showing that they were acting on behalf of the company, and had authority to do so.

Where an employee, other than a director, took the decision to effect the transaction it will be necessary to show that he/she had appropriate direct authority (a “blanket” authority, as it were) to act on behalf of the company – to be the “mind” of the company.  The motivation of the person with authority needs to be considered [note 25].

 

31.4B.150 Professional advice

Assuming all relevant features to suggest that a transaction defrauding creditors has taken place are present, then the fact that the decision to enter into the transaction was taken based on professional advice will not save it from challenge [note 26].

 

31.4B.151 Remedies

Having found that a transaction is a transaction defrauding creditors under the provisions of the Act, the court may make such order as it thinks fit for [note 27]:

  • restoring the position to what it would have been if the transaction had not been entered into; and
  • protecting the interests of persons who are victims of the transaction.

The Act provides a “menu” of possible forms of relief that it is in the power of the court to order [note 28] but the power of the court is not restricted to this list.

The court has discretion to set aside the whole or any part of the transaction [note 29].

 

31.4B.152 Discretion of court not to make order

It has been held that the court has discretion to decline to make an order setting aside the transaction (see paragraph 31.4B.151) where, for example, to do so would result in a hardship to the recipient [note 30] but it is envisaged that this discretion would be exercised only rarely [note 31].

 

31.4B.153 Effect of remedy on third parties

When deciding on the appropriate remedy to be ordered to set aside the transaction, the court may also make an order providing for the extent to which the interests of third parties (who may have had dealings in the property since it was transferred) are to be protected [note 32].

An order made setting aside a transaction defrauding creditors may affect the property of, or impose any obligation on, any person whether or not he/she is the person with whom the debtor entered into the transaction.  In this respect, however,  the Act gives protection to those who acquired the property in good faith, for value and without notice of the relevant circumstances [note 33].

 

31.4B.154 Misfeasance – companies only

The entering into a transaction defrauding creditors may constitute a misfeasance and breach of duty on the part of the director(s) and, therefore, the liquidator may consider bringing an action for misfeasance [note 34].

The advantage of this over an action to recover a transaction defrauding creditors is that an order can be made against the director(s) to repay the sums personally.

An action for misfeasance may be brought alongside an action to recover a transaction defrauding creditors, though the loss may only be recovered once, and any sums recovered must not exceed the amount originally lost to the company.

Please see Part 4 for more information on misfeasance and civil recoveries in respect of misfeasance.

 

 

[Back to Part 6 – Extortionate credit transactions] [On to Part 8 – Avoidance of general assignment of book debts]