Fraudulent Preferences and Conveyances under the Bermuda Companies Act 1981

Creditors should exercise caution when negotiating payment terms, asset transfers or securitisation transactions with companies which are in the zone of insolvency. Such transactions are vulnerable to being set aside by liquidators or by other creditors in the event of the insolvency of the company. The purpose of Bermuda's reviewable transactions law is to uphold the pari passu basis for the distribution of a company's assets amongst its unsecured creditors in an insolvency context.

Zone of Insolvency

In normal circumstances, when a company is in good financial health, a director's primary duty is to act in the best interests of the company by promoting shareholder value in the company. However, when a company is insolvent, or is in the "zone of insolvency", this duty shifts such that a director is obliged to instead have primary regard to the interests of the creditors. This is because in an insolvency context, it is the creditors who have an economic interest in the company, rather than the shareholders.

So how does one determine when a company is in the "zone of insolvency"? There is no simple answer to this question and there is no bright line test which can be applied to ascertain whether a company is or is not in the zone of insolvency. As a general proposition, the "zone of insolvency" can be thought of as the period where there has been a serious deterioration of a company's financial position, to the point where there is a reasonable expectation that insolvency has become imminent.

What does "insolvency" really mean?

In Bermuda, section 161(e) of the Companies Act 1981 (the "Act") provides that a company may be wound up by the Court if it is "unable to pay its debts". Section 162 of the Act provides that when considering whether a company is unable to pay its debts, the Court can take into account both the cash flow and balance sheet tests for insolvency

Fraudulent Preferences

Transactions involving payments to a certain creditor or creditors made within six months of a company's winding up are susceptible to being set aside as a fraudulent preference of its creditors if it can be established that:

  1. the transaction was undertaken with the intention to fraudulently prefer one or more of the company's creditors; and
  2. at the time of the transaction, the company was unable to pay its debts as they fell due.

Practitioners of other common law jurisdictions may be more familiar with the other terms used to describe what is known in Bermuda as a fraudulent preference, i.e. an unfair preference, a voidable preference, a reviewable transaction or an antecedent transaction.

Because the transaction must have been undertaken with the intention to fraudulently prefer one of the company's creditors over its general body of creditors, the liquidator of the debtor company must establish the mental state of the debtor company (i.e. the mental state of its directors) at the time it decided to enter into the transaction. This is a notoriously difficult undertaking. The commentary of Lord Justice Smith in New, Prace & Gerrard's Trustees v Hunting and Others [1897] 2 QB 19 is instructive:

"I have always understood that to ascertain whether there has been a fraudulent preference, it is necessary to consider what the dominant or real motive of the person making the preference was, whether it was to defraud some creditors by preferring others, or for some other motive".

The Privy Council has also recently considered the 'intention to fraudulently prefer' point, noting that a dominant intention to prefer can be inferred from the fact that one creditor was paid in circumstances where it was well known that other creditors were likely to not be (Skandinavska Enskilda Banken AB v Conway and another (as Joint Official Liquidators of Weavering Macro Fixed Income Fund Limited) [2019] UKPC 36). Given that this was an appeal from the Courts of the Cayman Islands, it is not strictly binding on the Courts of Bermuda, however, it would be considered to be strongly persuasive in Bermuda. View Walkers' summary of the case here.

While the debtor company's intentions are critical, the mental state of the allegedly preferred creditor is irrelevant. This means that a completely innocent third-party creditor can nevertheless find themselves subject to clawback (see Re Stealth Construction Ltd [2011] EWHC 1305).

When a transaction runs afoul of section 237 as a fraudulent preference, that transaction is voidable at the instance of the liquidator. Upon a fraudulent preference being proven to the satisfaction of the Court, orders will typically be made setting aside the transaction as a nullity, and unwinding the transaction so as to restore the company to the position it would have been in had it not given the preference. It should also be remembered that a director who causes a company to give an unfair preference may be liable for breaches of his fiduciary duties owed to the company pursuant to section 97(1) of the Act and at common law.

The primary defence to a fraudulent preference action is to seek to establish that the transaction was not undertaken by the company with the intention of defrauding its creditors by preferring some over others. This is a question of fact. It is also potentially open to the creditor to assert a set-off defence, if it can be proven that there were "mutual dealings" between the insolvent debtor company and the creditor and, additionally, that the creditor did not have notice that the debtor company was insolvent. The issue of mutuality of dealings will be determined in accordance with section 235 of the Act, which imports substantively section 37 of the Bermuda Bankruptcy Act 1989.

Fraudulent Conveyances

Part IV A of the Bermuda Conveyancing Act 1983 (the "Conveyancing Act") deals with fraudulent conveyances, that is to say, dispositions which are made with the dominant intention of putting property beyond the reach of creditors, where such disposition is at an undervalue.

Part IV A of the Conveyancing Act is Bermuda's take on a long line of legislate enactments in the common law world dealing with fraudulent conveyances which dates back to the Statute of Elizabeth of 1571. Although it is a somewhat dense statutory instrument, its broad scope means that it is often relied upon by creditors of Bermuda companies to seek to have a transaction set aside. By way of example:

  1. The scope of "disposition" is exceptionally broad, applying to "any disposition...of property of any nature whatsoever and however effected". This would include assignments or compromises of debt or other rights, gifts, transfers or any other forms of conveyance.
  2. The definition of property is equally wide: "money, goods, things in action, land and every description of property wherever situated and every description of interest, whether present or future or vested or contingent, arising out of, or incidental to, property".

For the purposes of the Conveyancing Act, a "creditor" is a person who is owed an obligation as at the date of the impugned conveyance, or to whom it is reasonably foreseeable an obligation will be owed within two years of the date of the transfer, or to whom an obligation is owed pursuant to a cause of action which accrued before, or within, two years after the date of the transfer.

The Conveyancing Act imposes clear limitation periods for bringing actions to recover an allegedly fraudulent conveyance. Those limitation periods differ depending on whether the eligible creditor was a current creditor, a contingent creditor or a contingent creditor whose cause of action accrued within two years after the date of the disposition of the property. Depending on the class of eligible creditor, the limitation period can range from six to eight years from the date of the allegedly fraudulent conveyance.

Floating Charges

Section 239 of the Act provides that in the event of a company's winding up, any floating charges on the undertaking or property of the company created within twelve months of the commencement of the winding up shall, unless it is proved that the company immediately after the creation of the charge was solvent, be invalid, except for the amount of cash paid to the company in consideration for the charge, together with interest thereon.


Creditors of Bermuda companies should exercise caution and take advice before entering into transactions with companies which are in the zone of insolvency, as such transactions can be vulnerable to attack in the event of a company's insolvency or liquidation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.