Transactions at undervalue – exercise of Court discretion not to set aside

In both corporate and personal insolvency matters, transactions which have been entered into in the period prior to the insolvency commencing may be set aside if it can be shown that the transfer of assets out of the ownership of the company or individual was made at an undervalue, thus reducing the amount available to creditors.

The recent High Court case of The Trustee in Bankruptcy of Claridge v Claridge considered whether a transaction had been made at undervalue. It was found that a transaction at undervalue had taken place. The judge however declined to make an order in favour of the Trustee in Bankruptcy as under the circumstances it would not be just to do so.

The first and second respondents, the husband and wife, had jointly obtained a loan secured against a property solely owned by the wife. The loan was used to pay off the existing mortgage and legal fees and the balance was used to repair and renovate the house. The husband was declared bankrupt shortly after and the Trustee in Bankruptcy applied to the Court under section 339 of the Insolvency Act 1986 for an order requiring the wife to repay half of the loan, as the transfer of the husband's part of the loan to the wife to repay her mortgage and renovate the house had been made for no consideration.

Although it was held that this did amount to a transaction at an undervalue the Court has a discretion in exceptional cases not to set the transaction aside, and in this case refused to make an order.

The factors the Court considered in exercising its discretion were:-

  • the recipient had in good faith altered her position by spending the money on home improvements,
  • the transaction could not be easily reversed,
  • the recipient remained liable to the mortgage lender for the full amount advanced to the husband and wife therefore she obtained limited benefit from the transaction, and
  • the late stage at which the Trustee introduced the claim for the transaction to be set aside.

The Removal of Administrators – Court reluctant to interfere

The Court has discretion to remove an administrator from office at any time under schedule B1 of the Insolvency Act 1986. However, there must be good and sufficient grounds for removal.

In the recent case of Finnerty v Clark, the Court of Appeal considered whether demonstrating that another administrator might have reached a different conclusion on a matter did not constitute 'good and sufficient' grounds for the Court to exercise its discretion to remove an administrator from office.

The appellants in this case wanted the respondent administrators to challenge a claim for default interest by applying to the Court under section 244 (extortionate credit transactions) of the 1986 Act. Under section 244, the Court can make various orders upon application of the office holder if it regards a transaction entered into within the last 3 years is extortionate. The appellants had offered to fund the cost of the challenge and had provided an unlimited undertaking in respect of an adverse costs order. A successful challenge would most likely save the company as a going concern. The administrators did not make the application.

The Court of Appeal dismissed the applicant's appeal against an order preventing them from removing the administrators on grounds that no good ground had been established for the removal from office. The fact that a new administrator may reach a different conclusion on the section 244 application was not a sufficient ground for the removal of the administrator.

This case highlights the Court's reluctance to interfere with the decisions of the officeholder unless some misconduct, personal unfitness or imputation on the integrity of the administrator can be proved. The Court will respect the decisions of the administrator, and the fact another administrator might reach a different decision is not a reason to remove the administrator.

Validity of extension of out of Court administration – importance of procedural compliance

Following changes to the Insolvency Act 1986 made by the Enterprise Act 2002, it is now possible for the holder of a floating charge, the Company or its directors to appoint an administrator out of Court. The appointment lasts for one year but can be extended out of Court with the consent of all creditors.

The recent High Court decision in Frontsouth (Witham) Limited (in Administration) looked at whether the failure to obtain written consent of one secured creditor to the extension of administrator's office could be waived under rule 7.55 of the (English) Insolvency Rules. Rule 7.55 provides that no insolvency proceedings shall be invalidated by any formal defect or irregularity unless substantial injustice has been caused and this cannot be remedied. A similar rule applies in Scotland under rule 7.32 of the Scottish Insolvency Rules.

In this case, the initial appointment of the administrators was made out of Court pursuant to paragraph 22(2) of schedule B1 of the 1986 Act. Such appointments cease to have effect after one year unless extended upon the written consent of the creditors. Written consent was not received from one of the secured creditors. Despite this, the administrators deemed the extension to have taken place and continued in office for a further 6 months. Towards the expiry of the period of extension, they applied to the Court to have their appointment extended for a further term of 1 year. This was granted.

When application to the court was made for a further extension, the original defect (failing to gain consent of the creditor at the first extension) was raised. The applicant administrators requested the Court to use its power under rule 7.55 to waive the defect.

After considering recent authority the Court found that rule 7.55 could not be used to cure the defect. The Court concluded that since the insolvency process had expired, there were no proceedings to which rule 7.55 could apply. The Court found it had jurisdiction to re-appoint the administrators, but a question then arose as to who could make this application. It was concluded that the former administrators were not able to apply to the Court as their appointment had now ceased; instead, the former directors, shareholder or creditors would be required to make the application.

'Anti-deprivation' principle upheld by the Supreme Court

The recent Supreme Court case of Belmont Park Investments PTY v BNY Corporate Trustee Services Ltd considered whether 'flip' clauses in finance agreements could be struck out under the English Law anti-deprivation principle.

It is contrary to public policy for parties to be able to contract out of insolvency legislation. The anti-deprivation rule provides that a person who possesses property cannot contract to pass the property to a third party in the event of his insolvency, thus denying his creditors the right to be paid out of the assets.

The documentation was highly complex but included provisions whereby the respective priorities of the Lehman Brothers Special Purpose Vehicle (LBSPV) over certain collateral and the holders of notes issued by LBSPV depended on whether there had been an 'Event of Default' under a swap agreement (generally an insolvency event). If there was no event of default, LBSPV had priority over collateral provided under the agreement – if there was, the note holders had priority.

The central question was the validity of these provisions altering priority.

The Court considered that it should not be quick to set aside arrangements and invalidate them when doubt might be cast over long standing commercial arrangements. The Court confirmed the continued existence of the anti-deprivation rule and the decision provides a useful summary of situations where it has been held to apply or not to apply. However it does not apply unless there is an intention to gain an advantage over creditors on insolvency. Good faith and the commercial sense of the transaction can prevent the anti-deprivation principle applying. It will also not apply if the deprivation is for reasons other than insolvency such as a provision for forfeiture on breach.

The arrangements in this case were not struck out by the anti-deprivation principle. The Court was particularly influenced by the fact the collateral was purchased from the money subscribed by note holders and the availability of the collateral reflected the risk the note holders had agreed to assume.

This case illustrates the willingness of the Court to give effect to contractual terms agreed by parties. The Court determined that the principle should be applied in a common sense manner and should not apply to bona fide commercial transactions where the deprivation of the property of one of the parties on bankruptcy was not the main purpose.

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.