Setting Aside Transactions Defrauding Creditors
1. Obtaining judgment is not always the final battle in a litigation war. Latter battles may include enforcement, and it is not unknown to find that a judgment debtor has transferred assets to someone else to frustrate recovery (often a house to a spouse). Laws to address this problem have been around for centuries. Currently, one important provision is section 423 of the Insolvency Act 1986, titled “Transactions defrauding creditors” within a part of the Act headed “Provisions Against Debt Avoidance”.
2. Section 423 is concerned with transactions at an undervalue entered into for wrongful purposes and restoring the position to what it would have been if the transaction had not been entered into, as well as protecting the interests of persons who are victims of the wrongful transaction. “Persons must be just before they are generous and debts must be paid before gifts can be made.”
3. The section can be invoked whether or not the debtor has become insolvent, and it is available for use by a “victim of the transaction”, namely a person who is, or is capable of being, prejudiced by the transaction. The expression is not limited to those persons the debtor might have had in mind when entering into the transaction, and it may include a person the debtor was unaware of at the time of the transaction.
4. A court may make an order under section 423 if three conditions are satisfied.
(1) The debtor has entered into a “transaction” with third person.
(2) That transaction was “at an undervalue”, either because it was a gift or because its terms provide for the debtor to receive no or inadequate consideration.
(3) The debtor entered into the transaction with the requisite subjective intention, namely:
(a) of putting assets beyond the reach of a person who is making, or may at some time make, a claim against him, or
(b) of otherwise prejudicing the interests of such a person in relation to the claim which he is making or may make.
5. For the purposes of section 423, “transaction” is defined by section 436(1) as “a gift, agreement or arrangement” and it has been interpreted widely. While in many cases the transaction will involve a disposal of property belonging to the debtor, that is not a necessary requirement and the section extends to a transaction whereby a debtor agrees to procure a company which he owns to transfer a valuable asset for no consideration or at an undervalue, thereby reducing or eliminating the value of his shares in the company to the prejudice of his creditors.
6. As to “undervalue”, the voluntary waiver of a debt and the payment of a dividend by a company to its shareholders may be transactions for no consideration, and the fact that a transfer may have been expressed as a transfer not for money is not necessarily conclusive.
7. As to statutory purpose:
(1) The burden of proving that the debtor acted for this purpose is on a claimant.
(2) The test under is subjective, not objective: what did he/she aim to achieve?
(3) The wrongful purpose cannot be inferred from the bare fact of a transaction entered into at an undervalue because “purpose” is a separate statutory requirement.
(4) Whether the debtor had the wrongful purpose is a question of fact. Direct evidence of purposes is not common, and courts are often asked to draw inferences from factual circumstances surrounding the transaction to be impugned. A judge must make primary findings and then make a global evaluation of all the relevant facts.
(5) There is no rule of law to the effect that, if the debtor knew at the time of entering into the transaction that he was facing claims, the judge must find that the transaction was entered into for the wrongful purpose unless the debtor adduces evidence to show otherwise.
(6) Evidence that the debtor believed that the transaction would result in putting assets beyond the reach of creditors may support an inference that the transaction was entered into for the purpose of doing so, but the two things are not the same.
(7) The wrongful purpose need be only a purpose and not the sole or dominant purpose, even if the transaction was entered into for one or more other purposes.
(8) If the debtor did not believe that a claim would or might be made against him/her in the future, then it is unlikely that he/she had the wrongful purpose, because he/she is unlikely to have acted for the purpose of prejudicing a claim he/she did not see as a risk.
(9) If the debtor would have entered into the transaction in any event (i.e. even if it would have had no impact on creditors), a court should not too readily conclude that he/she also had the purpose of defeating his creditors.
(10) If the debtor has plenty of assets left with which to meet the claim, then however many additional assets are gifted to people, it is less likely that he/she had the relevant purpose in such a case.
(11) If prejudice to the claim or potential claim was only a consequence, and not a purpose, of the transaction, then section 423 is not satisfied, even if that consequence was foreseeable and actually foreseen by the debtor.
8. Helpfully for establishing the statutory purpose, professional privilege may be overridden in proceedings for declarations under section 423.
9. As to remedies on an application under section 423, the remedies are restitutionary in nature (rather than compensatory), and a court may make such order as it thinks fit for restoring the position to what it would have been and for protecting the interests of persons who are victims of the transaction.
10. The powers of the court are wide, and a non-exhaustive list of the types of orders which a court may make include:
(1) requiring any property transferred as part of the transaction to be vested in any person, either absolutely or for the benefit of all the persons on whose behalf the application for the order is treated as made;
(2) requiring any person to pay to any other person in respect of benefits received from the debtor such sums as the court may direct.
11. Orders made by a court under section 423 may not prejudice the interests of bona fide purchasers for value in respect of subsequent transactions from a person other than the debtor, or from a person who was not a party to the transaction with the debtor.
12. Finally, claims under section 423 are generally subject to a 12-year limitation period but a claim for payment of a sum is subject to a 6-year period.
