Restructuring & Insolvency

Deconstructing 423 Claims – Part 3

This is the third 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.

How far will the court go in restoring the position as if the transaction had not taken place?

If the court accepts that a transaction satisfies the relevant tests contained in section 423, the court may make such order as it thinks fit for “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”. That is generally a straight forward exercise when the original transferee retains the fruits of the undervalue transaction. Most reported cases on section 423 are against the original transferee and the provision has been used generally because the time limits that would apply if the transaction could be challenged under sections 238 or 339 have expired. However, the orders available to the court to restore the position are much wider than has perhaps been fully realised to date.

The Insolvency Act, by sections 241 (Companies), 342 (Individuals) and 425 (Transactions Defrauding Creditors), sets out almost identical reliefs to claimants who establish liability. These include requiring repayment, property to be restored to the insolvency estate or the payment of the equivalent value. Most claims will involve relief of this sort.

To restore the position to what it would have been, the relevant sections cited above include the ability to:

  • release or discharge any security given by the company or individual; and
  • revive the obligation of a surety or guarantor whose obligations have been released or to require security to be provided for the discharge of any obligation arising from the order.

None of the above present any particular conceptual difficulties but they do appear to be primarily aimed at the immediate beneficiary of the impugned transaction.

Issues in recovery arise when the party benefiting from the transaction is one or more steps beyond the initial beneficiary. Planned asset stripping exercises will often result in assets or money being quickly moved beyond the initial beneficiary. Given that the initial beneficiary is left as an empty shell, the strategy is designed to protect the fruits of the asset strip and to render future litigation to recover the assets unattractive, if not pointless.

Restoring the position to what it would have been if the transaction had not been entered into may not be possible if the immediate beneficiary has already denuded itself of the asset in issue or any other meaningful assets that might be used to discharge a monetary order.

Sub sections (1)(d) to each of the above relief provisions provide that a court may require any person (our emphasis) to pay, in respect of benefits received by him from the company/individual, such sums to the office holder as the court may direct.

The intended wide application of this relief is confirmed in subsections (2) to each of the relief provisions although those provisions also include important protections for innocent parties:

425(2) [Limit to order] An order under section 423 may affect the property of, or impose any obligation on, any person whether or not he is the person with whom the debtor entered into the transaction; but such an order –

  • shall not prejudice any interest in property which was acquired from a person other than the debtor and was acquired in good faith, for value and without notice of the relevant circumstances, or prejudice any interest deriving from such an interest.

This, on the face of it, provides a remedy to the challenges presented by schemes involving multiple transactions, but there has been very little case law interpreting the extent to which the courts will use these provisions to compel third party recipients to reimburse the insolvent estate.

The Court of Appeal decision in CI Ltd v The Joint Liquidators of Sonatacus Ltd [2007] is one example of the courts applying the wider provisions regarding relief. The case concerned a preference but the reasoning on the subject of relief is equally applicable to transfers at an undervalue.

The facts of the case concerned the repayment, by the soon to be insolvent company, of a debt owed by its director to a third party (“the Payee”). The director had borrowed the money to inject into the company and wanted to ensure that his liability was discharged. Although the court at first instance held such payment was a straightforward undervalue, for reasons which are unnecessary to elicit here, the Court of Appeal decided the case on the basis of the payment being a preference.

As the Payee was in fact a creditor of the director and not a creditor of the company, the only way the Payee could be held liable to repay the money was pursuant to section 241 (1)(d) of the Insolvency Act 1986 as “any person…in respect of benefits received by him from the company”.

It was the director who was “preferred” in this instance because his liability to the Payee was discharged by the company. However, the Payee clearly received a benefit from the preference, because his position was improved, and the Payee could therefore be required by the court to repay the money. The Payee knew of the company’s precarious financial state at the time he advanced the money to the director and the court found that he would not have loaned the money direct to the company in light of that knowledge. It could not therefore be argued that the Payee received repayment in good faith without knowledge of the underlying facts and without knowing that repayment by the company was improper.

There has been more recent consideration of the ability to make orders affecting third parties. In his judgment in Re Oxford Pharmaceuticals; Wilson v Masters International Limited [2009], Mark Cawson QC, sitting as a deputy of the High Court stated:

“it is correct that section 241(2) does specifically envisage the making of orders against third parties (i.e. parties that were not in fact preferred themselves). However, as I see it, the court could only properly exercise its discretion against such a third party if the order was required as part of the process of restoring the position of the company to what it would otherwise have been, and the third party was in possession of assets applied in making the preference or, at least, had otherwise personally benefited in monetary terms from the payment in some direct and tangible way…”

Neither of these cases deal specifically with parties to whom assets have been transferred from the initial recipient of the undervalue transaction but they do demonstrate that, subject to the usual protection of the bona fide purchaser for value without notice of the relevant circumstances, the courts are willing to apply the legislation to order relief against third parties.

One section 423 case where there is express judicial acceptance of the principle can be found in the decision of Brittain v Courtway Estates [2008] BPIR at 1246. The judge was unable to grant the relief sought against the respondents on the grounds relied upon in the application, but went on to consider whether the claim should have been brought against a different party. The judge concluded that there was “a simple remedy available to the trustee, but one which requires YR and probably MW [third party recipients of the funds being pursued] to be parties, namely, a claim that the transaction by which the property was purchased by the company with money provided from a fund whose origin was the Bankrupt can be set aside as a transaction in fraud of creditors pursuant to s423 of the Insolvency Act 1986”

No doubt the concept of making orders against third parties is one that is likely to be explored further in future cases. Businessmen and individuals do not generally dispose of assets at significantly less than their true value to strangers. Most undervalue transactions, particularly where the requisite purpose exists, are entered into for the benefit of connected parties at the expense of present or future creditors. Where this is established, the court will be inclined to find a way to justify restoration of the position to what it should have been had the transaction not taken place and sections 423 and 425 mean that this is will be possible even where third party entities, often domiciled off-shore, have been used to impose a further layer of difficulty in pursuing the asset.

For further information, please contact Martin Askew.