Restructuring & Insolvency

Deconstructing 423 Claims – Part 1

This is the first of three linked law bites that seek to illustrate the wide application of section 423 Insolvency Act 1986 and dispel some of the widely held misconceptions regarding the successful prosecution of claims using that provision.

The “honest” 423 claim

Section 423 is described in the legislation as relating to “transactions defrauding creditors”. This is somewhat of a misdescription as no references to ‘fraud’ or ‘dishonesty’ appear within the wording of the section. It may be that reference to fraud in the heading to the section is a legacy of the fact that section 423 was drafted as a replacement for section 172 of the Law of Property Act 1925 (subject to the new section being extended to apply to money and other assets), which specifically applied to conveyances made “with intent to defraud creditors”. However, section 423 has clearly been drafted with a different test in mind.

Although section 423 is often used to unwind transactions at an undervalue arguably entered into for fraudulent or dishonest purposes, it is a disservice to the wide application of the provision to describe it as relating to “transactions defrauding creditors”. The word “defrauding” raises the unnecessary concern that, to successfully prosecute, it is necessary to satisfy a court of fraudulent or dishonest intent. Many are thus discouraged from such claims because of the difficulties in proving a state of mind and because they believe that allegations of dishonesty require a higher standard of proof than is the case with other civil claims.

The key operative provision is contained in section 423(3):

423(3) [Conditions for court order] In the case of a person entering into [a transaction that is at an undervalue] an order shall only be made if the court is satisfied that it was entered into by him for the purpose (our emphasis):

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

The requirement to evidence a purpose is the price for not having to satisfy the insolvency and time limit requirements to pursue a transaction at undervalue claim. However, it is not necessary to prove a dishonest purpose, as demonstrating that a purpose of the transaction was to avoid creditors or future creditors will be sufficient to establish liability. In Arbuthnot Leasing International Limited v Havelet Leasing Limited (No 2) the court held that the fact that the debtor had acted on legal advice and therefore believed that the undervalue transaction entered into was lawful did not exclude the debtor having the requisite purpose specified in section 423(3)(a). Scott J commented that the director’s “motive of saving Leasing’s business was not necessarily a dishonest motive, but is consistent with an intention to put Leasing’s assets out of the reach of Arbuthnott”.

This decision was specifically referred to by Jonathan Parker J in 2000 in Treharne v Brabon and Others and he conceded in his judgment; “notwithstanding that section 423 is entitled “Transactions defrauding creditors”, it is not necessary to establish dishonesty”.

Given such clear guidance by the courts, it is surprising that there remains a widespread belief that, to pursue a 423 claim, it remains necessary to establish a dishonest or fraudulent purpose.

On this interpretation of purpose, transfers of assets at an undervalue to avoid creditors such as the tax authorities, by relying on schemes devised and promoted by professional advisers that ultimately do not operate as envisaged, may well be liable to successful challenge under section 423.

It is also now well established that the requisite purpose does not have to be a dominant one. This element of the section will be satisfied provided that the purpose to avoid creditors or future creditors was one of the substantial purposes behind the impugned transaction.