Vulnerable Transactions in Corporate Insolvency 9781472559364, 9781841133478

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Foreword Every system of insolvency law with any degree of sophistication contains provisions to enable antecedent transactions entered into by the debtor on the eve of insolvency to be set aside in favour of his creditors in prescribed circumstances. Roman law possessed the actio Pauliana, which is still alive and well and forms part of virtually all modem civilian legal systems. In England a statute of Elizabeth I in 1571 dealt with transactions in fraud of creditors. It remained in force for more than 400 years, though its archaic language increasingly caused problems as the years passed. It was finally replaced by section 423 of the Insolvency Act of 1986, drafted in more appropriate and contemporary English. The Statute of Elizabeth, like its successor, was not confined to insolvency, and its provisions could be invoked by any creditor who had been prejudiced by the transaction in question and whether or not the debtor had become insolvent. In this respect the Act and its successor are a sharp contrast with other statutory provisions which may be invoked only by the office holder in an insolvent liquidation. At first sight these form a variety of individual provisions possessing no common thread, applicable to different transactions and having different periods of vulnerability and different rationales, so far as these can be ascertained at all. This is, so far as I know, the first book in which a serious attempt has been made to gather these different provisions together and examine them in detail, explaining the policies which underlie them and their relationship to the basic principle of pari passu distribution in insolvency. This has enabled the contributors to bring out the fundamental distinction between those provisions such as Section 238 (transactions at an undervalue) which are designed to protect the overall size of the insolvent estate from depletion from those such as Section 239 (voidable preferences) which are designed to protect the statutory order of distribution. Although aimed primarily at insolvency practitioners and their legal advisers, the authors have not shrunk from discussing some of the more difficult and still unresolved questions in this field and which are of great practical importance. In considering what constitutes the insolvent estate available for distribution, for example, Michael Bridge contributes a valuable discussion of the controversial decision in Re Barleycorn Enterprises Ltd [1970] Ch 465 (priority as between the debt secured by a floating charge and the expenses of the liquidation). This is not lacking in courage, for the question is shortly to come before the House of Lords (leave to appeal has been given in Buchler v Talbot [2002] EWCA Civ 228, [2002] 1 BCLC 571). Other difficult issues which receive the same rigorous analysis are direct payment clauses in building contracts; the rule

vi Foreword which precludes contracting out of insolvency set-off, which is convincingly shown to have no rational purpose; and the destination of recoveries, in which context John Armour is surely right to warn against the over ready assumption that the same consequences follow whatever the particular ground of recovery. Sandra Frisby contributes a valuable paper on vulnerable transactions in crossborder insolvency, the area in which the most important battles are likely to be fought in the next few years. Simone Degeling argues that the statutory provisions which enable the office holder to set aside vulnerable transactions are restitutionary in nature and have as their object the reversal or prevention of unjust enrichment. This is not an academic question, but one of some practical importance, since it leads in to the question whether the change of position defence is available. The case is persuasively put, but the question remains open. The thesis is very difficult to sustain in relation to voidable preferences, where the payment does not diminish the net value of the insolvent estate, the recipient gives full value for the payment, and the statute aims to protect the statutory scheme of distribution rather than the integrity of the debtor’s estate. It is possibly easier to sustain in other cases, but even there the statutory purpose is to protect the debtor’s estate from depletion rather to reverse any enrichment of the recipient. These papers form a valuable contribution to a specialised subject of immense commercial importance. Where the law is established, it is explained with clarity and economy. Where the law is doubtful, the rival contentions are well analysed and thoughtfully presented. The book will provide welcome assistance to all those, practitioners and judges alike, who find themselves faced with what can be very difficult problems and are increasingly likely to find them arising in an international context. MILLETT House of Lords, London August 2002

Preface This book examines the powers and remedies available to the office-holder in liquidation or administration proceedings that adjust the company’s contractual or proprietary rights and obligations. These provisions become operable only once a company has entered liquidation or administration. Contracts or proprietary rights that may then be subject to attack are, therefore, said to become ‘vulnerable’ with the onset of insolvency proceedings. The book seeks to offer an exposition of the law that is both comprehensive and critical. The project has a long history. It was originally conceived in discussions between Patrick Goodall and Yogesh Rai in the summer of 1995. Regrettably, the original authors’ mounting professional commitments meant that it was not possible for them to see the book through to completion. John Armour was drafted in to assist in 1996, but little further progress was made until, at the suggestion of Howard Bennett, the project was taken forward as a collective effort by a team of academics most of whom were then members of the School of Law of the University of Nottingham. Although continuing professional commitments have prevented either of the original authors from participating in the final project, we should like to acknowledge our debt to them for kindly allowing us to proceed with their idea. We are also grateful to numerous colleagues and friends who have generously read drafts and offered comments. In this respect, we owe a particular debt to Richard Calnan of Norton Rose, who read nearly all the chapters. We should also like to offer particular thanks to David Brown (chapter 4), James Fawcett (chapter 10), Graham Ferris (chapter 8), Stuart Frith (chapter 8), Riz Mokal (chapter 2), Richard Nolan (chapter 7), and George Panagopoulos, Andrew Simester and Sarah Worthington (all chapter 9). For their valuable research assistance, we should also like to thank Alec Brown (chapter 1) and Dawn Collins (chapter 7). We should also like to express our gratitude to Lord Millett for graciously agreeing to contribute a foreword. A final note of thanks is due to our publisher, Richard Hart, who readily and enthusiastically took on our project and bore with us despite some delays. John Armour Cambridge July 2002 Howard Bennett Nottingham July 2002

About the Contributors John Armour is University Lecturer in Law and Fellow of Trinity Hall at the University of Cambridge. Howard Bennett is Hind Professor of Commercial Law at the University of Nottingham. Michael Bridge is Professor of Laws at University College, London and Director of Legal Research at Norton Rose. Simone Degeling is Senior Lecturer in Law at the University of New South Wales. Sandra Frisby is Norton Rose Lecturer in Corporate and Financial Law at the University of Nottingham. Adrian Walters is Reader in Law at Nottingham Trent University.

Table of Cases Abbey National Building Society v Cann [1991] 1 AC 56.....................................224–25 Abramson, In re 715 F 2d 934 (1983) ........................................................................146 Acatos & Hutcheson plc v Watson [1995] BCC 446 .................................................298 ACE Insurance SA-NV (Formerly Cigna Insurance of Europe SA-NV) v Zurich Insurance Co [2001] EWCA Civ 173, [2001] 1 Lloyd’s Rep 618 .............................436 Adelaide Truss & Frame Pty Ltd v Bianco Hiring Services Pty Ltd, (1992) 60 SASR 160 ........................................................................338, 369, 373, 380 AG Securities v Vaughan [1990] 1 AC 417..................................................................60 AG v Great Eastern Railway Co (1880) 5 App Cas 473 .............................................286 Agip (Africa) Ltd v Jackson [1991] Ch 547 ........................................................328, 357 Agnew v Commissioners of Inland Revenue [2001] UKPC 28, [2001] 2 AC 710........................................................8, 188–90, 192, 194–96, 228, 233 Agricultural Mortgage Corporation v Woodward [1995] 1 BCLC 1................................................55, 68–69, 74, 102, 394, 399, 404, 408 Agriplant Services Ltd, Re [1997] 2 BCLC 598 ..................150, 163–65, 177, 391–98, 404 Aiglon Ltd v Gau Shan Co Ltd [1993] BCLC 1321 ....................................................110 Air Conditioning Inc, Re see American Bank v Leasing Corp Airservices Australia v Ferrier (1996) 137 ALR 609 ......................................139, 155–57 Al Levy (Holdings) Ltd, Re [1964] Ch 19 ...................................................337, 369, 379 AL Underwood Ltd v Barclays Bank [1924] 1 KB 775 ...............................................348 Albemarle Supply Co v Hind [1928] 1 KB 307 ..........................................................230 Albion Reid (SA) Pty Ltd v Baron Holdings Pty Ltd (1973) 7 SASR 564 ........337, 379–80 Alderson v Temple (1768) 1 Black W 660............................................................128–29 Aldridge (G & M) Pty Ltd v Walsh [2001] HCA 27 ...........................................141, 153 All Benefit Pty Ltd v Registrar General (1993) 11 ACSR 578 .....................................340 Allied Carpets Group plc v Nethercott (unreported 28 January 2000).........301, 306, 327 Allobrogia Steamship Corporation, Re [1978] 3 All ER 423 ......................................441 Allsopp v Day (1861) 7 H & N 457 ..........................................................................246 Aluminium Industrie Vaassen BV v Romalpa Aluminium Ltd [1976] 1 WLR 676 ......236 Ambrose v Kerrison (1851) 10 CB 776 ......................................................................408 American Bank v Leasing Corp (In re Air Conditioning Inc) 845 F 2d 293 (1988).......153 Anchor Line (Henderson Bros) Ltd, Re [1937] Ch 483 ..............................................453 Angelakis (G & N) Shipping Co SA v Compagnie Nationale Algerianne de Navigation (The Attika Hope) [1988] 1 Lloyd’s Rep 439.........................................................233 Anglo-Oriental Carpet Manufacturing Co, Re [1903] 1 Ch 914 ....................................4 Annangel Glory Compania Naviera SA v M Golodetz Ltd (The Annangel Glory) [1988] 1 Lloyd’s Rep 45 ..................................................................226, 228, 233, 243 Annangel Glory, The see Annangel Glory Compania Naviera SA v M Golodetz Ltd ANZ Executors and Trustee Co Ltd v Qintex Ltd (1990) 8 ACLC 791 ................324–25 Arbuthnot Leasing International Ltd v Havelat Leasing Ltd (No 2) [1990] BCC 636 ..........................................45, 55, 61, 85, 109, 112, 115, 118, 176, 393

xiv Table of Cases Argentum Reductions (UK) Ltd, Re [1975] 1 WLR 186.............................................369 Armagh Shoes, Re [1984] BCLC 405 ........................................................................194 Armorduct Manufacturing Co Ltd v General Incandescent Co Ltd [1911] 1 KB 143....35 Armour v Thyssen Edelstahlwerke AG [1991] 2 AC 339...............................222, 237–38 Arnold (RM) & Co Ltd, Re (1984) 128 Sol Jo 659 ....................................................263 Art Reproduction Co Ltd, Re [1952] Ch 89 ..............................................................317 Arthur D Little Ltd v Ableco Finance plc [2002] EWHC 701 (Ch), [2002] 3 WLR 1387 ......................................188–89, 192, 196, 218, 245, 253, 269, 273 Arthur Sanders Ltd, Re (1981) 17 Build LR 125 ..........................................................30 Ashbury Railway Carriage and Iron Co Ltd v Riche (1875) LR 7 HL 653...........285, 288 Ashby Warner v Simmons [1936] WN 212 ...............................................................242 Ashpurton Estates Ltd, Re [1983] Ch 110 ...........................................260, 263, 265, 274 ASRS Establishment Ltd, Re [2000] 1 BCLC 727, [2000] 2 BCLC 631........................191 Associated British Engineering Ltd v IRC [1941] 1 KB 15..........................................307 Atlantic Computer Systems plc (No 1), Re [1992] Ch 505 ..............................19, 196–97 Atlantic Medical Ltd, Re [1992] BCC 653.................................................................197 Atlas Truck Service Pty Ltd, Re (1974) 24 FLR 220 ...........334, 338, 367–70, 373, 378–79 Atlas Wright (Europe) Ltd v Wright [1999] 2 BCLC 301 ...........................................311 Attika Hope, The see Angelakis (G & N) Shipping Co SA v Compagnie Nationale Algerianne de Navigation Attorney General for Canada v Standard Trust & Co of New York [1911] AC 498 ..............................................................................................316, 324 Attorney General for Hong Kong v Reid [1994] 1 AC 324 ...............................8, 18, 410 Attorney-General v McMillan & Lockwood Ltd [1991] 1 NZLR 53....................28, 154 Australian Securities Commission v AS Nominees Ltd (1995) 133 ALR 1....................53 Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame [1906] 2 Ch 34 ......311 Automobile Association (Canterbury) Incorp v Australasian Secured Deposits Ltd [1973] 1 NZLR 417 ..............................................................................................245 Aveling Barford Ltd v Perion Ltd (1989) 5 BCC 677.......................282, 284, 296–98, 302 Ayala Holdings, Re [1993] BCLC 256.................................................102, 276, 360, 403 Ayerst (Inspector of Taxes) Ltd v C&K Construction Ltd [1976] AC 167 ........4, 37, 274 Azoff-Don Commercial Bank, Re [1954] Ch 315 .................................................440–41 Babcock v Lawson (1880) 5 QBD 284.......................................................................231 Bairstow v Queens Moat Houses plc [2001] EWCA Civ 712, [2001] 2 BCLC 531; [2000] 1 BCLC 549 ...........................................................................296, 301, 304–05 Baker (GL) Pty Ltd v Medway Building and Supplies Ltd [1958] 2 All ER 532 ...........406 Baltic Shipping v Dillon (1993) 175 CLR 344 ............................................................417 Banca Carriage SPA Cassa di Risparmio di Genova e Imperia v Banco Nacional de Cuba [2001] 2 Lloyd’s Rep 147 ................................................................100–01, 110 Banco Nacional de Cuba v Cosmos Trading Corp [2000] BCC 910 .....................443–44 Bank of Credit and Commerce International SA (No 2), Re [1992] BCLC 570....430, 450 Bank of Credit and Commerce International SA (No 8), Re [1996] Ch 245 .....7, 229, 251 Bank of Credit and Commerce International SA (No 10), Re [1997] Ch 213..........................................................................................450–51, 460 Bank of Credit and Commerce International v Akindale [2001] Ch 437 .............306, 328 Bank of East Asia Ltd v Rogerio Sou Fung Lam [1988] 1 HKLR 181....................362–65 Bank of Marin v England 87 S Ct 274 (1966) ............................................................364 Banque des Marchands de Moscou v Kindersley [1951] Ch 112 ...........................439–40

Table of Cases xv Banque Financière de la Cité v Parc (Battersea) Ltd [1999] 1 AC 221.........................415 Barclays Bank Ltd v Astley Industrial Trust Ltd [1970] 2 QB 527 ..............................350 Barclays Bank Ltd v Homan [1993] BCLC 680 .........................................................462 Barclays Bank Ltd v Quistclose Investments Ltd [1970] AC 567 .......................8, 18, 242 Barclays Bank Ltd v TOSG Trust Fund Ltd [1984] BCLC 1 ......................................344 Barclays Bank Ltd v WJ Simms Son & Cooke (Southern) Ltd [1980] QB 677 .....365, 415 Barclays Bank plc v British & Commonwealth Holdings plc [1995] BCC 19..................................................................................293–97, 299–300 Barclays Bank plc v Estates & Commercial Ltd [1997] 1 WLR 415............................232 Barclays Bank plc v Eustice [1995] 1 WLR 1238 ........................74, 102–03, 108, 111–13, 394, 399, 408–09 Barclays Bank plc v Stuart Landon Ltd [2001] EWCA Civ 140, [2001] 2 BCLC 316 ...266 Barclays Mercantile Business Finance Ltd v Sibec Developments Ltd [1992] 1 WLR 1253 ................................................................................................92 Barleycorn Enterprises Ltd, Re [1970] Ch 465 ........................................v, 6, 14, 88, 227 Barlow Clowes International Ltd v Vaughan [1992] 4 All ER 22...................................2 Barn Crown Ltd, Re [1995] 1 WLR 147..................................................343–44, 347–48 Barned’s Banking Co, Re (1867) LR 3 Ch App 105 ...................................................342 Barrett (RA) & Co Ltd v Livesey (1981) 131 NLJ 1213 .............................................231 Barrow Borough Transport Ltd, Re[1990] Ch 227....................................................268 Barton Manufacturing Ltd, Re [1999] BCC 827 ..................................57, 78, 87, 391–98 Bassett v Nosworthy (1673) Finch 102 ................................................................39, 106 BAT Industries plc, Re (unreported 18 June 1999) ....................................................301 Bayley v National Australia Bank Limited (1995) 16 ACSR 38 ..................................360 Bayspoole v Collins (1871) LR 6 Ch 228 .............................................................39, 106 Beacon Leisure Ltd, Re [1992] BCLC 565 ....................................................139, 169–70 Bell Houses Ltd v City Wall Properties Ltd [1966] 2 QB 656................................288–89 Belmont Finance Corp v Williams Furniture Ltd (No 2) [1980] 1 All ER 393 ..........................................................................306, 327–28, 406 Bennett & White (Calgary) Ltd v Municipal District of Sugar City No 5 [1951] AC 786......................................................................................................234 Berkeley Applegate, In re [1989] Ch 32.....................................................................408 Berton v Alliance Economic Investment Co [1922] 1 KB 742 .....................................144 Biggerstaff v Rowatt’s Wharf Ltd [1996] 2 Ch 93 .......................................................24 Birmingham, Re [1959] Ch 523 ................................................................................232 Bishopsgate Investment Management Ltd v Maxwell [1993] BCC 120 .................314–15 Bluston & Bramley Ltd v Leigh [1950] 2 KB 548.........................................................35 Boardman v Phipps [1967] 2 AC 46 ..........................................................................424 Bolton Engineering v TJ Graham & Sons [1957] 1 QB 159 .......................................163 Bombay Official Assignee v Shroff (1932) 48 TLR 443 (PC)........................................33 Bond Worth Ltd, Re [1980] Ch 288...............................143, 188, 222, 225, 232, 236, 243 Borden (UK) Ltd v Scottish Timber Products Ltd [1981] Ch 25 ....................236–37, 288 Borland’s Trustee v Steele Bros & Co Ltd [1901] 1 Ch 279 .........................................33 Boulevard Music Pty Ltd v Birch (1996) 21 ACSR 367 ..........................359, 373–74, 379 BP Exploration Co (Libya) Ltd v Hunt (No 2) [1979] 1 WLR 783 .............................391 Brabon, Re [2001] 1 BCLC 11..................................................44, 55, 59, 72–73, 91, 109 Brady v Brady [1989] AC 755; [1988] BCLC 20 ...................................108, 112, 294, 320 Braemar Investments Ltd, Re [1988] BCC 366...................................5, 259, 264–65, 318

xvi Table of Cases Brall ex p Norton, Re [1893] 2 QB 381 .....................................................................355 Brandon v Robinson (1817) 18 Ves 428 ......................................................................34 Branston & Gothard Ltd, Re [1999] BPIR 466..........................................................166 Brewin Dolphin see Phillips v Brewin Dolphin Bell Lawrie Ltd Brian D Pierson (Contractors) Ltd, Re [2001] 1 BCLC 275 ...................138, 140, 167–68, 391–92, 396–98 Brightlife Ltd, Re [1987] Ch 200 ..............................................................8, 14, 190, 250 Bristol & West Building Society v Mothew [1998] Ch 1..............................................78 Bristol Airport v Powdrill [1990] Ch 744 ....................................................................92 British & Commonwealth Holdings plc (No 3), Re [1992] 1 WLR 672 .......................21 British Bank of the Middle East v Sun Life Assurance of Canada Ltd [1983] 2 Lloyd’s Rep 9 .........................................................................................311 British Eagle International Airlines Ltd v Cie Nationale Air France [1975] 2 All ER 390 .............................................................2, 9, 11, 13, 26–28, 33, 44 British South Africa Co v de Beers Consolidated Mines Ltd [1910] 1 Ch 353 .............453 Brown v Bateman (1872) LR 2 CP 272 ..................................................................31, 32 Brunton v Electrical Engineering Corp [1892] 1 Ch 434 ............................................230 Brush Aggregates Ltd, Re [1983] BCLC 320 .............................................................249 Buchanan Enterprises Pty Ltd, Re (1982) 7 ACLR 407 ..............................................344 Buchler v Talbot [2002] EWCA Civ 228, [2002] 1 BCLC 571 .............................6, 14, 88 Buckingham International plc (No 2), Re [1998] BCC 943 ..........................................35 Burdick v Sewell (1883) 10 QBD 363 ........................................................................231 Burns v Stapleton (1959) 102 CLR 97 ................................................................139, 142 Burston Finance v Speirway Ltd [1974] 1 WLR 1648.................................................232 Burton & Deakin Ltd, Re [1977] 1 WLR 390 .............................................369, 372, 381 Burton v Burton [1986] 2 FLR 419............................................................................338 Business Computers Ltd v Anglo-African Leasing Ltd [1977] 1 WLR 578....................24 Butcher v Stead (1875) LR 7 HL 839.........................................................................130 Butterworth, Re (1882) 18 Ch D 588 ........................................................................110 Byblos Bank SAL v Al-Khudairy (1986) 2 BCC 99 ......................................................50 Cadogan v Kennett (1776) 2 Cowp 432.................................................................38, 96 Cairney v Back [1906] 2 KB 746 ...............................................................................263 Campbell v Michael Mount PPB (1995) 65 SASR 334 ........................................360, 383 Capital Finance Co Ltd v Stokes [1969] 1 Ch 261......................................................232 Carden v The Albert Place Association (1886) 56 LJ 166...........................................369 Cardiff Workmen’s Cottage Co Ltd, Re [1906] 2 Ch 627 ...................................261, 275 Caribbean Products (Yam Importers) Ltd, Re [1966] Ch 331...............................36, 124 Carl-Zeiss Stiftung v Herbert Smith & Co (No 2) [1969] 2 Ch 276............................406 Carreras Rothmans Ltd v Freeman Mathews Treasure Ltd [1985] Ch 207 ....220–01, 243 Carson, Re (1924) 55 OLR 649 ................................................................................162 Carter v Wake (1877) 4 Ch D 605.............................................................................220 Case of the Bankrupts (1584) 76 ER 441; (1592) 2 Co Rep 25; 76 ER 441 ........2, 127, 334 Cases of Taffs Well Ltd, Re [1992] Ch 179 ...............................................................317 Cassell & Co Ltd v Broome [1972] AC 1027.............................................................192 CCG International Enterprises Ltd, Re [1993] BCC 580............................................191 Cebu, The see Itex Itagrani Export SA v Care Shipping Corp Centros Ltd v Erhvervs-og Selskabsstyrelsen (Case C–212/97) [1999] ECR I–1459.....434 Chaigley Farms Ltd v Crawford Kaye & Grayshire Ltd [1996] BCC 957..............236–37

Table of Cases xvii Chantry House Developments plc, Re [1990] BCLC 813...........................................266 Chappell & Co Ltd v Nestlé Co Ltd [1960] AC 87......................................................70 Charge Card Services Ltd, Re [1987] Ch 150 .......................................................228–29 Charles (LH) & Co Ltd, Re [1935] WN 15 ...............................................................265 Charlesworth v Mills [1892] AC 231 ........................................................................246 Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] Ch 62 .................79, 286, 295, 310, 326, 328 Chase Manhattan Bank NA v Israel-British Bank (London) Ltd [1981] Ch 105........8, 18 Chelsea Cloisters Ltd, Re (1980) 41 P&CR 98 .................................................2, 17, 143 Chillingworth v Chambers [1896] 1 Ch 685..............................................................305 China Pacific SA v Food Corporation of India [1982] AC 939 ...................................408 Chohan v Saggar [1992] BCC 306; [1994] 1 BCLC 706 ......................83, 108–09, 112–18 Chow Yoong Hong v Choong Fah Rubber Manufactory [1962] AC 209 ...................241 Christonette International Ltd, Re [1982] 1 WLR 1245, [1982] 3 All ER 225 ..........6, 227 Cimex Tissues Ltd, Re [1995] 1 BCLC 409 ...............................................................187 City Life Assurance Co Ltd, Re [1926] Ch 191 ...........................................................25 Civil Service and General Store Ltd, Re (1887) 57 LJ Ch 119 ......................................13 Clark (Inspector of Taxes) v Oceanic Contractors Inc [1983] 2 AC 130..............452, 456 Clark v Balm Hill & Co [1908] 1 KB 667..................................................................245 Clarkson v Clarkson [1994] BCC 921 ...................................................................56–57 Claspar Group Services Ltd, Re (1988) 4 BCC 673 .....................................139, 163, 180 Claytons Case (1816) 1 Mer 572 ..................................................................205, 210–11 Cleaver v Delta American Reinsurance Co [2001]UKPC 6, [2001] 2 AC 328................14 Cleveland Museum of Art v Capricorn Art International SA [1990] BCLC 546 .........270 Cleveland Trust plc, Re [1991] BCLC 424 ................................................................301 Clifton Place Garage Ltd, Re [1970] Ch 477 ....................................12, 338, 369, 374–78 Clough Mill Ltd v Martin [1985] 1 WLR 111 ......................................................235–37 Clydebank Football Club Ltd v Steedman (2002) SLT 109 ...........................296–97, 302 Coakley v Argent Credit Corp Ltd (1998) unreported ..................................242, 248–49 Cohen, In re [1924] 2 Ch 515....................................................................................130 Coleman v Harvey [1989] 1 NZLR 723 ....................................................................238 Columbian Fireproofing Co Ltd, Re [1910] 2 Ch 120 ............................200, 206–09, 226 Combe v Combe [1951] 2 KB 215 .......................................................................69, 199 Commercial Bank of South Australia, Re (1886) 33 Ch D 174............................448, 463 Commercial Bank of India, Re (1868) LR 6 Eq 517..............................................439–40 Commissioner of State Revenue (Victoria ) v Royal Insurance Ltd (1994) 182 CLR 51 ...............................................................................................403 Compania Merabello San Nicholas SA, In re [1973] Ch 75 ................................441, 445 Company (No 007523 of 1986), Re a [1987] BCLC 200.............................................381 Company (No 00359 of 1987), Re a see International Westminster Bank plc v Okeanos Maritime Corp Company (No 005009 of 1987) ex p Copp, Re a [1989] BCLC 13.........................194–95 Company (No 00687 of 1991), Re a [1991] BCC 210.................................................381 Company (No 003192 of 1991) ex p Nykeln Finance, Re a [1991] BCLC 539 .......440–47 Company (No 006685 of 1996) [1997] 1 BCLC 639 ...................................................335 Compaq Computers Ltd v Abercorn Group Ltd [1991] BCC 484 .......................237, 277 Compton Corp, In re see Kellogg v Blue Quail Energy Inc Condon ex p James, Re (1874) 9 Ch App 609 ....................................................142, 373

xviii Table of Cases Connolly Bros Ltd (No 2), Re [1912] 2 Ch25 ............................................................224 Contemporary Cottages (NZ) Ltd v Margin Traders Ltd [1981] 2 NZLR 114......248–49 Continental Assurance Co of London plc, Re [2001] BPIR 733 .................................180 Copis v Middleton (1818) 2 Mad 410..................................................................39, 106 Cornhill Insurance plc v Improvement Services Ltd [1986] BCLC 26...........................50 Cosslett (Contractors) Ltd, Re [1998] Ch 495 .......................................31, 188, 230, 234 Cotman v Brougham [1918] AC 514.........................................................................286 Country Stores Pty Ltd, Re [1987] 2 Qd R 318..........................................................340 Countrywide Banking Corporation Ltd v Dean [1998] AC 338 .................................421 Coutts & Co v Stock [2000] 1 WLR 906 ....................................9, 332, 342, 357, 366–67 Coventry Permanent Economic Building Society v Jones [1951] 1 All ER 901 ............224 Cowan de Groot Properties Ltd v Eagle Trust plc [1992] 4 All ER 700 ......................306 Crabtree-Vickers Pty Ltd v Australian Direct Mail Advertising & Addressing Co Pty Ltd (1975) 133 CLR 72 .........................................................................................311 Creasey v Breachwood Motors [1993] BCLC 480 .......................................................45 Credit Managers Association v Federal Co 629 F Supp 175 (CD Cal 1985) ............65–66 Crédit Suisse Fides Trust SA v Cuoghi [1998] QB 818...............................................449 Crédit Suisse v Allerdale Borough Council [1997] QB 306.........................................284 Criterion Properties plc v Stratford UK Properties llc [2002] EWHC 496 (Ch), [2002] 2 BCLC 151 ................................................................................................79 Crowthers McCall Pattern Inc v Lewis 129 BR 992 (SDNY 1991)..........................65–66 CTN Cash and Carry Ltd v Gallaher [1994] 4 All ER 714.........................................407 Cuckmere Brick Co Ltd v Mutual Finance Ltd [1971] Ch 949 ...................................339 Cunard v Hopwood [1908] 2 Ch 564........................................................................226 Curtain Dream plc v Churchill Merchanting Ltd [1990] BCLC 925 .....................239–40 Customs & Excise Commissioners v Broomco (1984) Ltd (Formerly Anchor Foods Ltd) 2000 WL 1084449 (unreported 30 March 2000), [2000] BTC 8035 ....................50, 104 Cutts, Re [1956] 1 WLR 728 ....................................................................................130 Dallhold Estates (UK) Pty Ltd, Re [1992] BCLC 621.................................................437 Dansk Syndicat v Snell [1908] 2 Ch 127 ....................................................................232 Davey & Co v Williamson & Sons [1898] 2 QB 194 .................................................263 David Allester, Re [1922] 1 Ch 211 ...................................................................231, 246 David Payne & Co Ltd, Re [1904] 2 Ch 608 .............................................................288 David Securities Pty Ltd v Commonwealth Bank of Australia (1992) 175 CLR 353....415 Davies Chemists Ltd, Re [1992] BCC 697 .................................................................361 Davis v Johnson [1979] AC 264 ...............................................................................192 Dawson v Isle [1906] 1 Ch 633............................................................................250–51 De Medina v Grove (1846) 10 QB 152 ......................................................................415 Dearle v Hall (1828) 3 Russ 1............................................................................277, 341 Debtor, Re A [1927] 1 Ch 410.............................................................................86, 175 Demite Ltd v Protec Health Ltd [1998] BCC 638 ........................................................59 Denney v John Hudson & Co Ltd [1992] BCLC 901...............................13, 333, 369–83 Dennis (A Bankrupt), Re [1996] Ch 80 .....................................................................336 Dennison v Krasner [2001] Ch 76.............................................................................358 Department for the Environment Food and Rural Affairs v Feakins & Hawkins (unreported 10 December 2001) .............................................................................59 Destone Fabrics Ltd, Re [1941] Ch 319 ........................................................201–02, 205 Deverall v Grant Advertising Inc [1955] Ch 111........................................................271

Table of Cases xix Deveze, ex p Barnett, Re (1874) 9 Ch App 293............................................................25 Devon and Somerset Farmers Ltd, Re [1994] Ch 57 ..................................................437 Dewrun Ltd v Royal Bank of Scotland [2002] BCC 57 ...................355–57, 367, 375, 381 Dextra Bank and Trust Company Limited v Bank of Jamaica [2002] 1 All ER (Comm) 193 ...................................................................................................417–20 DGA (UK) Ltd, Re (2001) WL 482928 (unreported 15 February 2001) ........................73 Dimskal Shipping Co SA v International Transport Workers Federation (The Evia Luck) [1992] 2 AC 152..........................................................................407 Diplock, Re [1948] Ch 465.......................................................................................406 DKG Contractors Ltd, Re [1990] BCC 903 ...............140, 167–68, 172, 283, 324, 391–92, 396–98, 404 Doe d Grimsby v Ball (1843) 11 Mees & Wel 531 .....................................................101 Doe d Watson v Routledge (1777) 2 Cowp 705 .................................39, 99, 106–07, 115 Dora v Simper [2000] 2 BCLC 561 .........................................................59, 101–02, 405 Dronfield Silkstone Coal Co (188) 17 Ch D 76..........................................................291 Dublin City Distillery Ltd v Doherty [1914] AC 814 .................................................246 Dublin Corporation v Building and Allied Trade Union [1996] 1 IR 468 ...................415 Dunkley, Re [1905] 2 KB 683 ...................................................................................334 Duomatic Ltd, Re [1969] 2 Ch 365 ...........................................................................311 Ebbw Vale Steel Iron & Coal Co, Re (1877) 4 Ch D 327 ...........................................291 Edmunds v Edmunds [1904] P 362 .............................................................................45 Edmunds v Blaina Furnaces Co (1887) 36 Ch D 215..................................................244 Ehrmann Bros Ltd, Re [1906] 2 Ch 697...............................................261, 263, 274, 278 Eichholz, Re [1959] Ch 708........................................................................................97 El Ajou v Dollar Land Holdings plc [1994] 2 All ER 685 ................163, 306–07, 328, 406 Eloc Electro-Optieck and Communicatie BV [1982] Ch 43 ..................................442–44 England v Smith [2001] Ch 419 ................................................................................449 English & Scottish Mercantile Investment Co v Brunton [1898] 2 QB 700...................92 English Scottish and Australian Chartered Bank [1893] 3 Ch 385 ..............................451 Engstrom v Benzel 191 F 2d 689 (1951).....................................................................138 Engstrom v Wiley 191 F 2d 684 (1951)......................................................................138 Equiticorp Finance Ltd v Bank of New Zealand (1993) 32 NSWLR 50 ................79, 322 Eric Holmes (Property) Ltd, Re [1965] Ch 1052 ..................................................257–58 Erlanger v New Sombrero Phosphate Company (1878) 3 App Cas 1218 ....................424 Esberger & Son Ltd v Capital and Counties Bank [1913] 2 Ch 366............................225 Eurostem Maritime Ltd, Re [1987] PCC 190 ..............................................................51 Evans v Din (unreported 17 March 1995) .................................................................110 Evans v Rival Granite Quarries Ltd [1910] 2 KB 979 ..................................187, 228, 275 Evia Luck, The see Dimskal Shipping Co SA v International Transport Workers Federation Ex p Blaine; In re Sawers (1879) 12 Ch D 522 ....................................................452, 456 Ex p Chalmers (1873) 8 Ch App 289 ..........................................................................31 Ex p Cooper (1875) LR 10 Ch 510..............................................................................89 Ex p De Villiers, Carbon Developments (Pty) Ltd 1993 (1) SA 493 ..............................21 Ex p Griffith (1883) 23 Ch D 69 ........................................................................130, 159 Ex p Hill (1883) 23 Ch D 695 ............................................................................130, 159 Ex p Mackay (1873) 8 Ch App 643...........................................................................154 Ex p Mercer, Re Wise (1886) 17 QBD 290..................................................................39

xx Table of Cases Ex p Stubbins (1880) 17 Ch D 58..............................................................................130 Ex p Williams (1872) 7 Ch D 314 ........................................................................35, 262 Exchange Travel (Holdings) Ltd , Re [1999] BCC 291 (CA); [1996] 2 BCLC 524....................................................................140, 152, 163, 167–68 Exchange Travel (Holdings) Ltd (No 3), Re [1997] 2 BCLC 579 ................................88 Exchange Banking Co, Flitcroft’s Case, Re (1882) 21 Ch D 518 ....................290–91, 304 Exeter Trust v Screenways Ltd [1991] BCLC 888...............................................265, 267 F (Mental Patient: Sterilisation), In re [1990] 2 AC 1.................................................408 Fablehill Ltd, Re [1991] BCLC 830...........................................................................264 Facia Footwear Ltd v Hinchcliffe [1998] 1 BCLC 218 ...............................................323 Fairway Graphics Ltd, Re [1991] BCLC 468.............................................................372 Fairway Magazines Ltd, Re [1993] BCLC 643...................151, 153, 168–69, 202–05, 208 Falcon Sportswear, Re (1983) 1 ACLC 690...............................................................248 Farnol Eades Irvine & Co [1915] 1 Ch 22 .................................................................220 Federal Commerce & Navigation Co Ltd v Molena Alpha Inc [1979] AC 757...........233 Felixstowe Dock and Railway Co v US Lines Inc [1989] QB 360 ...............................437 First Energy (UK) v Hungarian International Bank [1993] BCC 533 ..........................311 Flakiner Chains Pty Ltd, Re (1981) 5 ACLR 94..................................................337, 379 FLE Holdings Ltd, Re [1967] 1 WLR 1409 ........................................................130, 159 Flint, Re [1993] Ch 319 ............................................................................................338 Foley v Hill (1848) 2 HLC Cas 28 .....................................................................345, 363 Forest of Dean Coal Mining Co, Re (1878) 10 Ch D 450...........................................288 Forth v Simpson (1849) 13 QB 680 ...........................................................................230 Foskett v McKeown [2001] 1 AC 102 ................................................................353, 400 Fostoria-Fannon (Aust) Pty Ltd, Re (1979) ACLC 40................................................351 Four-Maids Ltd v Dudley Marshall (Properties) Ltd [1957] Ch 317...........................221 Franks v Midland Bank plc (unreported 31 October 1995) .........................293, 295, 303 Freeman & Lockyer v Buckhurt Park Properties (Mangal) Ltd [1964] 1 QB 480 ........311 Freeman v Pope (1869) 9 LR Eq 206; (1870) LR 5 Ch 538..........................39, 99, 107–10 French’s (Wine Bar) Ltd, Re [1987] BCLC 499..........................................................340 Galbraith v Grimshaw [1910] AC 508 ......................................................................464 Garrud ex p Newitt, Re (1881) 16 Ch D 552 .........................................................32, 33 General Rolling Stock Co, Re (1872) LR 7 Ch App 644 ............................................317 George Inglefield Ltd, Re [1933] Ch 1 ......................................................................241 George Newman & Co, Re [1895] 1 Ch 674 ..............................................291, 293, 303 German Date Coffee Co, Re (1882) 20 Ch D 169 ......................................................286 Gertsch v Atsas [1999] NSWSC 898 ....................................................................418–19 Glegg v Bromley [1912] 3 KB 474 ..................................................................39, 45, 106 Glencore International AG v Metro Trading International plc [2001] 1 Lloyd’s Rep 284 ......................................................................................239 Gleneagles see US v Gleneagles Inv Co Glow Heating Ltd v Eastern Health Board (1988) 6 ILT 237 ..........................28–29, 154 Gold Hill Mines, Re (1883) 23 Ch D 210 ..................................................................335 Goldcorp Exchange Ltd, Re [1995] 1 AC 74 ......................................................144, 342 Gorringe v Irwell India Rubber and Gutta Percha Works (1887) 34 Ch D 128 ...........341 Goss v Chilcott [1996] AC 788 .................................................................................417 Government of Newfoundland v Newfoundland Railway Co (1888) 13 App Cas 199 ...........................................................................................24

Table of Cases xxi Gray’s Inn Construction Co Ltd, Re [1980] 1 WLR 711 ...................4, 6, 9, 13, 333, 347, 350, 358, 364–83 Great Eastern Railway Co v Lord’s Trustee [1909] AC 109.......................................230 Great Northern Railway v Swaffield (1874) LR 9 Ex 132 ..........................................408 Green v Wilden Pty Ltd [1998] WASC 399 ...............................................................318 Green, Re [1979] 1 WLR 1211..................................................................................334 Greenwood v Bennett [1973] QB 195 ................................................................359, 415 Gregory Love & Co, Re [1916] 1 Ch 203..................................................................227 Griffin Hotel Ltd, Re [1941] Ch 129 .........................................................................227 Grosvenor Metal Co Ltd, Re [1950] 1 Ch 63 ..............................................................35 Grove v Advantage Healthcare (T10) Ltd [2000] 1 BCLC 661 ...................................255 Haigh v Brooks (1840) 10 A & E 309 .........................................................................70 Halesowen Presswork and Assemblies Ltd v National Westminster Bank Ltd [1971] 1 QB 1 ...............................................................................................345, 349 Halliday v Holgate (1868) LR 3 Ex 299 ....................................................................231 Halt Garage (1964) Ltd, Re [1982] 3 All ER 1016 ..........282, 291, 303, 310, 316, 324, 326 Hamblin v Field [2000] BPIR 621 .............................................................................181 Hamilton v National Bank of Australia (1996) 66 FCR 12 ........................................179 Hamilton Young & Co v Ex p Carter, Re [1905] 2 KB 772 .......................................247 Hamlet International plc, Re [1999] 2 BCLC 506......................................................230 Hampson v Price’s Patent Candle Co (1876) 45 LJ (Ch) 437......................................310 Hardwick ex p Hubbard, Re (1886) 17 QBD 690......................................................246 Harman v Fishar (1774) 1 Cowp 117.................................................................128, 129 Harman v Richards (1852) 10 Hare 81..................................................................55, 61 Harrison ex p Jay, Re (1880) 14 Ch D 19.......................................................32, 33, 343 Harrods (Buenos Aires) Ltd, Re [1992] Ch 72 .......................................436–37, 447, 474 Harrods Ltd v Stanton [1994] BCLC 706..................................................................117 Harrogate Estates Ltd, Re [1903] 1 Ch 498 ...............................................................225 Harrold v Plenty [1901] 2 Ch 314 .............................................................................232 Hart, Re [1912] 3 KB 6 ............................................................................................355 Hayman Christy & Lilly Ltd [1917] 1 Ch 283 ...........................................................201 Heathcote v Paignon (1787) 2 Bro CC 167 ..........................................................39, 106 Heathstar Properties Ltd (No 2), Re [1966] 1 All ER 1000.........................................259 Heinl v Jyske Bank (Gibraltar) Ltd [1999] Lloyd’s Rep Bank 511 ........288, 306, 315, 327 Hely-Hutchinson v Brayhead Ltd [1968] 1 QB 549 ...................................................312 Henderson v Bank of Australasia (1888) 40 Ch D 170........................................286, 310 Hendy Lennox Ltd v Grahame Puttick Ltd [1984] 1 WLR 485 ..................................238 Herne v Meeres (1687) 1 Vern CC 465 ................................................................39, 106 Higinbotham v Holme (1812) 19 Ves 88 ...............................................................34, 44 Hill v Mullis & Peake [1999] BCC 325.......................................................................72 Hilton International Ltd v Hilton (1988) 4 NZCLC 64 721 .......................................303 Hindle v John Cotton Ltd (1919) 56 Sc LR 625 .........................................................315 Hogg v Cramphorn [1967] Ch 254 ...........................................................................315 Holbird v Anderson (1793) 5 TR 235 .........................................................................45 Holden, Re (1887) 20 QBD 43..................................................................................355 Holidair Ltd, Re [1994] 1 IR 416 ..............................................................................194 Hollicourt (Contracts) Ltd v Bank of Ireland [2001] Ch 555 ......9, 337, 345, 349, 352–67, 370–73, 380–83

xxii Table of Cases Holroyd v Marshall (1862) 10 HLC 191 ...................................................................226 Hone, Re [1951] Ch 85 ............................................................................................366 Horne v Chester and Fein Property Developments Pty Ltd [1987] VR 913...................21 Horsley & Weight Ltd, Re [1982] Ch 442 ....................................286, 310, 316, 318, 324 Houghton v Northard Lowe & Wills Ltd [1927] 1 KB 246........................................311 Howard Holdings Inc, Re [1998] BCC 549 ...............................................................461 Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821 ................................205, 315 Howard v Patent Ivory Manufacturing Co (1888) 38 Ch D 156.................................312 Hudson v Benallack [1976] 2 SCR 168......................................................................132 Hughes v Hannover Ruckversicherungs-Aktiengesellschaft [1997] 1 BCLC 497........................................................................................449, 463 Hutton v West Cork Railway Co (1883) 23 Ch D 654...............................................310 Hydrodan (Corby) Ltd, Re [1994] BCC 161..........................................................51–53 Ian Chisholm Textiles Ltd v Griffiths [1994] 2 BCLC 291.............................236–37, 247 Illingworth v Houldsworth [1904] AC 355 ........................................................187, 228 Independent Automatic Sales Ltd v Knowles & Foster [1962] 1 WLR 974 .................................................225, 226, 244, 248–49, 272–73, 279 Indian Oil Corp Greenstone Co SA (The Ypatianna) [1988] QB 345 .........................238 Inland Revenue Commissioners v Hashmi (unreported 3 May 2002) ...100, 109, 111, 113 Inland Revenue Commissioners v Heaver Ltd [1949] 2 All ER 367..............................51 International Bulk Commodities Ltd, Re [1993] Ch 77 .............................................437 International Life Assurance Society, Gibbs & West’s Case, Re (1870) LR 10 Eq 312 .........................................................................71, 337, 370, 378 International Sales and Agencies Ltd v Marcus [1982] 3 All ER 551 ............306, 316, 328 International Tin Council, Re [1987] Ch 419............................................................450 International Westminster Bank plc v Okeanos Maritime Corp [1988] Ch 210 ....442–46 Introductions Ltd v National Provincial Bank Ltd [1970] Ch 199.........................287–88 Itex Itagrani Export SA v Care Shipping Corp (The Cebu) (No 2) [1990] 2 Lloyd’s Rep 316 ......................................................................................233 Jackson & Basford Ltd, Re [1906] 2 Ch 467 .............................................................218 Jackson v Bowley (1840) Car & M 97.................................................................99, 107 James Bibby Ltd v Woods [1949] 2 KB 449...............................................................230 James v Commonwealth Bank of Australia (1995) 13 ACLC 1604 ............................153 James v United Kingdom (1986) 8 EHRR 123...........................................................358 Janeash Ltd, Re [1990] BCC 250 ..............................................................................335 Jardio Holdings Pty Ltd v Dorcon Construction Pty Ltd (1984) 3 FCR 311...337, 373–79 Jartay Developments Ltd, Re (1982) 22 Build LR 134 .................................................30 Jeavons, ex p Mackay, Re (1873) 8 Ch App 643 ...........................................932–33, 228 Jenkins v Tucker (1788) 1 H Bl 90............................................................................408 Joachimson v Swiss Bank Corporation [1921] 3 KB 110 .............................345, 348, 363 Johnson v Diprose [1893] 1 QB 512..........................................................................246 Johnson v Gore-Wood & Co [2002] 2 AC 1 .............................................................103 Johnson, Re (1881) 20 Ch D 389.........................................................................39, 106 Johnson (IC) & Co Ltd, Re [1902] 1 Ch 101.............................................................264 Jon Beauforte, Re [1953] Ch 131.........................................................................288–89 Jones, ex p Nichols, Re (1883) 22 Ch D 782 ...............................................................10 Jones (FC) & Sons (Trustee of Bankruptcy) v Jones [1997] Ch 159 ....................353, 358 Joplin Brewery Co Ltd, Re [1902] 1 Ch 79................................................................261

Table of Cases xxiii JSF Finance Ltd v Akma Solutions Inc [2001] 2 BCLC 307........................................335 Jyske Bank (Gibraltar) Ltd v Spjeldnaes [1999] 2 BCLC 101, [2000] BCC 16 ..........................................................................102, 105, 113, 465–66 Kahn v Inland Revenue Commissioners see Toshoku Finance UK plc, Re Kaiser Steel Corp v Pearl Brewing Co 952 F 2d 12330 (10th Cir 1991) .........................65 Katz v First National Bank of Glen Head 568 F 2d 964 (2nd Cir 1977).......................347 Kayford Ltd, Re [1975] 1 WLR 279 ...............................................................17–18, 143 Kaytech International plc, Re [1999] BCC 390 ......................................................52–53 Keen & Keen ex p Collins, Re [1902] 1 KB 555.........................................................234 Keenan Bros Ltd, Re [1986] BCLC 242.............................................................191, 195 Keith v Burrows (1876) 1 CPD 722...........................................................................220 Kellogg v Blue Quail Energy Inc (In re Compton Corp) 831 F 2d 586 (1987)..............153 Kelly v Solari (1841) 9 M & W 54 ............................................................................416 Kennedy (CA) Co Ltd and Stibbe-Monk Ltd, Re (1976) 74 DLR (3d) 87 ...................453 Kent & Sussex Sawmills Ltd, Re [1947] 1 Ch 177 .....................................................242 King v Greig [1931] VLR 413 ...................................................................................247 Kingsley v Sterling Industrial Securities Ltd [1967] 2 QB 747 ....................................240 Kingston Cotton Mill Co (No 2), Re [1895] 1 Ch 331 ...............................................304 Kinsela v Russell Kinsela [1986] 4 NSWLR 722............................................320–22, 327 Kleinwort Benson Ltd v Lincoln City Council [1999] 2 AC 349.................................415 Kleinwort Benson Ltd v South Tyneside Metropolitan Borough Council [1994] 4 All ER 972 ..............................................................................................403 Kleinwort Benson v Birmingham City Council [1997] QB 380 ..................................403 Knight v Frost [1999] 1 BCLC 364............................................................................180 Kratzmann (NA) Pty Ltd v Tucker (No 2) (1968) 123 CLR 295...................................91 Kreditbank Cassel GmbH v Schenkers Ltd [1927] 1 KB 826 ......................................311 Kris Cruisers Ltd, Re [1949] 1 Ch 138 ...............................................................259, 261 Kumer, Re [1993] BCLC 548 ................................................................................81, 83 Kupetz v Wolf 845 F 2d 842 (9th Cir 1988)............................................................65–66 Kuwait Asia Bank EC v National Mutual Life Nominees Ltd [1991] 1 AC 187...316, 318 Landau v Purvis (unreported 15 June 1999)................................................................35 Lands Allotment Co, Re [1894] 1 Ch 616 ...................................................288, 306, 328 Law Car and General Insurance Corp Ltd, Re [1911] WN 91 ...................................249 Law Society v Southall [2002] BPIR 336; [2001] BPIR 303...........................105, 111, 120 Ledingham-Smith, Re [1993] BCLC 635 ......................................123, 137, 145, 158, 163 Lee Behrens & Co Ltd, Re [1932] 1 Ch 46 .....................................288, 299, 309, 325–26 Leslie (J) Engineers Co Ltd, Re [1976] 1 WLR 292.................13, 336, 338, 342, 352, 356, 360, 372, 379 Levit v Ingersoll Rand Financial Corporation 874 F 2d 1186 (1989) .....134, 138, 151, 178 Levy v Abercorris Slate & Slab Co (1887) 37 Ch D 260......................................226, 243 Lewis v Commissioner of Inland Revenue [2001] 3 All ER 499 ...4, 7, 88–90, 179, 360–61 Lewis v Cook [2000] NSWSC 191 ........................................................................72, 75 Lewis v Hyde [1998] 1 WLR 94.........................................................................146, 148 Lewis’s of Leicester Ltd, Re [1995] BCC 514 ...................................16–18, 143, 166, 404 Leyland DAF Ltd, Re see Buchler v Talbot Ligget (B) (Liverpool) Ltd v Barclays Bank Ltd [1928] 1 KB 48..................................311 Lind, Re [1915] 2 Ch 345 .........................................................................................226 Lipkin Gorman v Karpnale Ltd [1991] AC 548................307, 356, 401, 406, 418–20, 423

xxiv Table of Cases Liverpool Civil Service Association ex p Greenwood, Re (1874) 9 Ch App 511 ..............................................................................333, 338, 378 Liverpool Marine Credit Co v Hunter (1867) LR 4 Eq 62..........................................454 Lloyd Generale Italiano, Re (1885) 29 Ch D 219 .......................................................440 Lloyd’s Bank Ltd v Marcan [1973] 1 WLR 1388 (CA); [1973] 2 All ER 359 ............................................................................97, 98, 106, 109 Lloyds & Scottish Finance Ltd v Cyril Lord Carpet Sales Ltd [1992] BCLC 609 ........241 Lloyds Bank Ltd v Chartered Bank of India Australia and China [1929] 1 KB 40.......363 Lo-Line Electric Motors Ltd, Re [1988] Ch 477.....................................................51–52 London & Cheshire Insurance Co Ltd v Laplagrene Property Co Ltd [1971] Ch 499 ......................................................................................................232 London Hamburg and Continental Exchange Banking, Re (1866) LR 2 Eq 231 .......................................................................................349, 351 London Wine Co (Shippers) Ltd, Re [1986] PCC 121................................................144 Lord Advocate v Huron and Erie Loan and Savings Co 1911 SC 612.........................270 Loteka Pty Ltd, Re [1990] 1 Qd R 322 ...........................................333, 337, 347, 363–64 Lovell Construction Ltd v Independent Estates plc [1994] 1 BCLC 31 .......................221 Lowndes ex p Trustee, Re (1887) 18 QBD 677............................................................40 Luckins v Highway (Carnavon) Pty Ltd (1975) 7 ALR 413........................................454 Lundy Granite Co, Re (1871) LR 6 Ch App 462 .........................................................19 Lunn v Thornton (1845) 1 CB 379............................................................................225 Lyford v Commonwealth Bank of Australia (1995) 130 ALR 267 ..............................339 Lyn Securities, Re [1988] 2 MLJ 137 ........................................................................192 Mace Builders (Glasgow) Ltd v Lunn [1987] Ch 191 (CA); [1985] BCLC 154.............212 Mac-Jordan Construction Ltd v Brookmount Erostin Ltd [1991] BCLC 333; [1992] BCLC 350 ............................................................................................30, 144 Mackay v Douglas (1872) 14 Eq 106.........................................................................110 MacKinlay v Arthur Young [1989] STC 898 .....................................................109, 112 Macmillan Inc v Bishopsgate Investment Trust plc (No3) [1996] 1 WLR 387 (CA); [1995] 1 WLR 978 ............................................................................306–07, 328, 432 MacPherson v European Strategic Bureau Ltd [2000] 2 BCLC 683 ....284, 296–302, 324–26 Mahoney v Purnell [1996] 3 All ER 61......................................................................424 Mal Bower’s Macquarie Electrical Centre Pty Ltd, Re [1974] 1 NSWLR 254......................................................................337, 342, 364, 368 Mallalieu v Drummond [1983] 2 AC 861..................................................................109 Manchester Sheffield & Lincolnshire Railway Co v North Central Wagon Co (1888) 13 App Cas 554 .........................................................................................245 Manilla, The see Proctor & Gamble Phillipine Manufacturing Corporation v Peter Cremer GmbH Mann v Goldstein [1968] 1 WLR 1091 .....................................................................335 Manson v Smith [1997] 2 BCLC 161 ..........................................................................24 Margart (Pty) Ltd, Re [1985] BCLC 314 (CA); (1984) 79 FLR 330 ...........71, 338–39, 350 Mark One (Oxford Street) plc, Re [1999] 1 WLR 1445 ...............................................20 Maronis Holdings Ltd v Nippon Credit Australia Pty Ltd (2001) 38 ACSR 404 ................................................................................79, 322, 328 Marston Construction Co Ltd v Kiglass Ltd [1989] 46 Build LR 109 .........................413 Marwalt Ltd, Re [1992] BCC 32 .......................................................................194, 242 Matheson Bros Ltd, Re (1884) 27 Ch D 225 ........................................................439–40

Table of Cases xxv Matheson v Smiley [1932] 2 DLR 787.......................................................................408 Matthew Ellis Ltd, Re [1933] 1 Ch 458 ...............................................................201–02 Matthews v Geraghty (1986) 11 ACLR 229 ..............................................................152 Matthews (FP and CH) Ltd, Re [1982] Ch 257 .........................................................178 Maudsley Sons & Field [1900] 1 Ch 612............................................................454, 464 Maxwell Communications Corp plc, Re 93 F3d 1036; 1996 US App; 29 Bankr Ct Dec 788 ............................................................................................463 Maxwell Communications Corp plc (No 2), Re [1993] 1 WLR 1402 ...........................21 MC Bacon Ltd, Re [1990] BCLC 324, [1990] BCC 78 ...16–18, 44–45, 68, 70–71, 90, 109, 132, 135, 141, 160–66, 168–69, 179, 404, 406–07 MC Bacon Ltd (No 2), Re [1991] Ch 127 ........................4, 88–89, 179, 214–15, 360, 405 McDonald & Anor v Hanselmann (1998) 28 ACSR 49 ....................................68, 73–74 McEntire v Crossley Bros [1895] AC 457 .....................................................60, 235, 240 McGunness Bros (UK) Ltd, Re (1987) 3 BCC 571................................347, 373, 376, 383 McLaughlin & Harvey plc, Re [1996] NI 618.............................................................28 Mechanisations (Eaglescliffe) Ltd, Re [1966] 1 Ch 20................................................257 Mellon Bank NA v Metro Communications Inc 945 F 2d (3d Cir 1991) ......................65 Mellor’s Trustees v Maas & Co [1902] 1 KB 137......................................................239 Mercantile Bank of India Ltd v Chartered Bank of India Australia and China [1937] 1 All ER 231 ..............................................................................................279 Mercer ex p Wise, Re (1886) 17 QBD 280.................................................................107 Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 2 AC 500 ........................................................................78, 163, 310, 316, 324 Mersey Steel and Iron Co v Naylor Benzon & Co (1884) 9 App Cas 434 ............337, 365 Mid East Trading Ltd, Re [1998] 1 All ER 577 (CA); [1997] 3 All ER 481 ...440, 446, 462 Middleton v Pollock (1876) 2 Ch D 104 .....................................................................45 Midland Bank plc v Wyatt [1997] 1 BCLC 242 ................103, 109, 111, 113, 404, 408–09 MIG Trust, Re [1933] Ch 542 ..................................................................................259 Milestone (JA) & Sons Ltd v Yates Castle Brewery Ltd [1938] 2 All ER 439 ...............28 Minister of Transport v Joint Liquidators of Civcon Pty Ltd [2000] WASCA 149......138 Ministry of Defence v Ashman (1993) 66 P & CR 195, [1993] 2 EGLR 102.........390, 395 Mistral Finance Ltd, Re [2001] BCC 27....................................44, 71, 132, 141, 152, 172 Modelboard Ltd v Outer Box Ltd [1993] BCLC 623 .................................................237 Modern Terrazo Ltd, Re [1998] 1 NZLR 160....................................................132, 134 Molton Ltd, Re [1968] 1 Ch 325...............................................................................277 Mond v Hammond Suddards [1996] 2 BCLC 470 ........................................360–61, 383 Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd [2001] 2 BCLC 347 ....................................................................................33–34, 343 Monkhouse (CG) Pty Ltd, Re (1968) 69 SR (NSW) 429 ............................................154 Monolithic Building Co [1915] 1 Ch 643 ..................................................................278 Montagu’s Settlement Trusts, Re [1987] Ch 264................................................306, 406 Moody v Security Pacific Business Credit Inc 127 BR 958 (WD Pa 1991)................65–66 Moon v Franklin [1996] BPIR 196.................................................104, 108–09, 113, 115 Moore v Fulham Vestry [1895] 1 QB 399..................................................................415 Morgan v Bain (1874) LR 10 CP 15............................................................................31 Morris v Kanssen [1946] AC 459..............................................................................312 Mosaic Oil NL v Angari Pty Ltd (No 2) [1990] 20 NSWLR 280 ................................342 Moxham v Grant [1900] 1 QB 88 .............................................................................305

xxvi Table of Cases MS Fashions Ltd v Bank of Credit and Commerce International SA (No 2) [1993] Ch 425 ........................................................................................................25 Mullan (B) & Sons (Contractors) Ltd v Ross (unreported 7 December 1995) ..............28 Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical Services Co Ltd [1983] Ch 258.......................................................................316, 324 Murphy v Meritor Savings Bank 126 BR 370 (Bankr D Mass 1991).............................65 National Acceptance Corporation Pty Ltd v Benson (1988) 12 NSWLR 213 ..............................................................333–35, 351, 354, 383 National Australia Bank Ltd v KDS Construction Services Ltd (1987) 163 CLR 668 ......................................................................................147, 350 National Bank of Kuwait v Menzies [1994] 2 BCLC 306...........................55, 67–68, 102 National Benefit Assurance Co, Re [1927] 3 DLR 289...............................................450 National Commercial Banking Corporation of Australia Ltd v Batty (1986) 160 CLR 251 .............................................................................................348 National Funds Assurance Co, Re (1878) 10 Ch D 118 .............................................291 National Provincial & Union Bank of England v Charnley [1924] 1 KB 431..254, 257–58 National Westminster Bank Ltd v Halesowen Presswork and Assemblies Ltd [1972] AC 785 .........................................................................................5, 14, 25, 44 National Westminster Bank plc v Jones [2001] EWCA Civ 1541, [2002] 1 BCLC 55; [2001] 1 BCLC 98................................................60, 64, 68, 74–75, 394, 399, 402, 404 Neath Harbour Smelting and Rolling Works, Re [1887] WN 87 ...............................353 New Bullas Trading Ltd, Re [1994] 1 BCLC 485 (CA); [1993] BCLC 1389, [1993] BCC 251 .........................................................190, 195–96 New Hampshire Insurance Co Ltd v Rush & Tomkins Group plc [1998] 2 BCLC 471...............................................................................................447 New London and Suburban Omnibus Co, Re [1908] 1 Ch 621..................................225 New Prance & Garrard’s Trustee v Hunting [1897] 2 QB 19 .............................159, 161 NIAA Corporation Ltd, Re (1993) 12 ACSR 141 (SC(NSW)) ................................21–23 Nicholson v Permakraft [1985] 1 NZLR 242 ..............................................318, 321, 327 Nilant v Plexipack Packaging Services Pty Ltd (1996) 21 ACSR 428 ...............56, 64, 153 Nitschke ex p Official Receiver, Re (1930) 2 ABC 36 ................................................142 Noakes & Co Ltd v Rice [1902] AC 24.....................................................................220 Norburg v Ryan 193 F 2d 407 (1951) ........................................................................144 Norditrack (UK) Ltd, Re [2000] 1 WLR 343........................................................48, 172 North Australia Territory Co Ltd v Goldsborough Mort & Co Ltd (1889) 61 LT 716..................................................................................................436 North Central Wagon Finance Co Ltd v Brailsford [1962] 1 WLR 1288 ..............................................................................................239 North Wales Produce & Supply Society Ltd, Re [1922] 2 Ch 340 ..............................243 North Western Bank v Poynter [1895] AC 56 ...........................................................231 Northern Bank Ltd v Ross [1991] BCLC 504 ............................................................251 Northern Engineering Ltd, Re [1994] BCC 618.........................................................290 Northside Developments Pty Ltd v Registrar-General (1990) 170 CLR 146 .311, 312, 328 Norton v Yates [1906] 1 KB 112...............................................................................263 Nurdin & Peacock plc v DB Ramsden & Co Ltd [1999] 1 WLR 1249 .......................415 Nye (CL) Ltd, Re [1971] Ch 442 .........................................................................257–58 O’Sullivan v Management Agency and Music Ltd [1985] QB 428..............................424 Oak Pits Colliery Co, Re (1882) 21 Ch D 322 .............................................................19

Table of Cases xxvii Oasis Merchandising, Re [1998] Ch 170 ......................88–90, 179, 213, 280, 360, 403–05 Obaray v Gateway (London) Ltd [2001] L&TR 223..........................................243, 251 Official Receiver v Stern (No 2) [2001] EWCA Civ 1787, [2002] 1 BCLC 119.............317 Official Receiver v Tailby (1886) 18 QBD 25 ............................................................248 Olympia and York Developments Ltd, Re (1996) 29 OR (3d) 626 .............................448 Omnico Ltd, Re (1976) 1 ACLR 381 ............................................................337, 376–78 Onward Building Society, Re [1891] 2 QB 463..........................................................351 Opera, Re [1891] 3 Ch 260.......................................................................................263 Operator Control Cabs Ltd, Re [1970] 3 All ER 657..........................................369, 380 Oriel Ltd, Re [1986] 1 WLR 180 (CA); [1984] BCLC 24..............................269, 271, 279 Oriental Bank Corporation ex p Guillemin, Re (1885) 28 Ch D 634............334, 336, 354 Orion Finance Ltd v Crown Financial Management Ltd [1996] 2 BCLC 78 .....240–42, 278 Orion Sound Ltd, Re [1979] 2 NZLR 574...................................................................21 Orleans Motor Co Ltd, Re [1911] 2 Ch 41 ..........................................................201–05 Overseas Aviation Engineering (GB) Ltd, Re [1963] Ch 24........................................233 Owners of Harvey Oil Center, Re (1982) 25 BR 979 .................................................338 Palk v Mortgage Services Funding plc [1993] Ch 330 ................................................339 Palmer Clay Products Co v Brown 297 US 227 (1936) ...............................................146 Paramount Airways Ltd, Re [1993] Ch 223.........................83, 172–73, 391, 456, 459–67 Park Ward & Co Ltd, Re [1926] Ch 828 .........................................71, 337, 370–78, 382 Parke v Daily News Ltd [1962] Ch 927.....................................................................309 Parkes Garage (Swandlincote) Ltd, Re [1929] 1 Ch 139.............................................212 Paul & Frank Ltd v Discount Bank (Overseas) Ltd [1967] Ch 348 .......................248–49 Peach Dart Ltd, Re [1984] Ch 131 .................................................................14, 236–38 Peat v Gresham Trust Ltd [1934] AC 252 ..........................................................130, 161 Peat v Jones & Co (1881) 8 QBD 147.........................................................................24 Peck v Craighead [1995] BCC 525.......................................................................35, 262 Peel (Regional Municipality) v Canada (1993) 98 DLR (4th) 140 .......................390, 395 Pegulan Floor Coverings Pty Ltd v Carter (1997) 24 ACSR 651..........................173, 178 Permanent Houses (Holdings) Ltd, Re [1988] BCLC 563 ..........................................250 Perrins v State Bank of Victoria [1991] 1 VR 749........................................191, 194, 248 Peruvian Guano Co Ltd v Dreyfus Bros & Co [1892] AC 166 ...................................359 Pettkus v Becker (1980) 117 DLR (3d) 257 ................................................................403 Pfeiffer Weinkellerei-Weinenkauf GmbH & Co v Arbuthnot Factors Ltd [1988] 1 WLR 150 ...................................................................................14, 236, 277 Phillip Collins Ltd v Davis [2000] 3 All ER 808.........................................................418 Phillips v Brewin Dolphin Bell Lawrie Ltd [2001] UKHL 2, [2002] 1 WLR 143 ......................55, 57, 61, 63, 69, 72–76, 83, 85, 392–94, 397–98, 416 Piercy v S Mills & Co Ltd [1920] 1 Ch 77 .................................................................315 Pineview Care Center Inc, In re (1993) 152 BR 703 ...................................................152 Pinewoood Joinery v Starelm Properties Ltd [1994] BCC 569 ............................102, 109 Polly Peck International plc (No 2), Re [1998] 3 All ER 812 ......................................386 Polly Peck International v Nadir (No 2) [1992] 4 All ER 769 .....................................328 Polsky v S & A Services [1951] 1 All ER 185.............................................................239 Pongakawa Sawmill Ltd v New Zealand Forest Products Ltd [1992] 3 NZLR 304.....238 Portbase Clothing Ltd, Re [1993] Ch 388................................................................6, 14 Power v Sharp Investments Ltd (sub nom Re Shoe Lace) [1994] 1 BCLC 111 (CA); [1992] BCLC 636 ...............................................................................207–09, 212–13

xxviii Table of Cases Powerstore Ltd, Re [1998] BCC 305...........................................................................20 Prager v Blatspiel Stamp and Heacock Ltd [1924] 1 KB 566 ......................................408 Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447 ......................................................................292–93, 296, 301, 304–07 Prescott, In re 805 F 2d 719 (1986)............................................................................149 Principal Group (Trustee of) v Anderson (1997) 147 DLR (4th) 229 ..........................421 Priory Garage (Walthamstow) Ltd, Re [2001] BPIR 144 ......................................93, 181 Proctor & Gamble Phillipine Manufacturing Corporation v Peter Cremer GmbH (The Manilla) [1988] 3 All ER 843 ................................................................390, 395 Produce Market Consortium Ltd, Re [1989] BCLC 520 ............................................172 Prospect Electricity v Advanced Glass Technologies of Australia Pty Ltd (1996) 22 ACSR 6 .........................................................................................373, 380 Punt v Symons & Co Ltd [1903] 2 Ch 506 ................................................................315 PZFTM Ltd, Re [1995] BCC 281 ...............................................................................53 R v ICR Haulage Ltd [1994] KB 551.........................................................................163 R v Kohn (1979) 69 Cr App R 395............................................................................342 R v Preddy [1996] AC 815........................................................................................363 R v Registrar of Companies ex p Central Bank of India [1986] 1 QB 1114..........254, 257 Rafidain Bank, Re [1992] BCLC 301 .................................................................369, 378 Rakusens Ltd v Baser Ambalaj Plastik Sahayi Ticaret AS [2001] EWCA Civ 1820, [2002] 1 BCLC 104...............................................................................................270 Rathwell v Rathwell (1978) 83 DLR (3d) 289............................................................403 Ravi Nominees Pty Ltd, Re (1993) 10 ACSR 599 ......................................................339 Rawson v Samual (1841) Cr & Ph 161 .......................................................................24 Rayack Construction Ltd v Lampeter Meat Co Ltd (1979) 12 Build LR 30..................30 RBC Dominion Securities v Dawson (1994) 111 DLR (4th) 230 ...........................418–19 Read v Joannon (1890) 25 QBD 300.........................................................................245 Real Estate Development, Re [1991] BCLC 210...................................................444–46 Redman (Builders) Ltd, Re [1964] 1 WLR 541.....................................................36, 124 Redweaver Investments Ltd v Lawrence Field Ltd (1991) 9 ACLC 1032 ....................296 Rees v Bank of New South Wales (1964) 111 CLR 210..............................................157 Reeves v Barlow (1884) 12 QBD 436 ........................................................................234 Regentcrest plc v Cohen [2001] 2 BCLC 80 .......................................................315, 322 Repertoire Opera Co, Re (1895) 2 Mans 314 ............................................................355 Resinoid & Mica Products Ltd, Re (1967) [1983] Ch 132..........................................265 Rhodes, In Re (1890) 44 Ch D 94 .............................................................................408 Richardson v Commercial Co of Sydney Ltd (1952) 85 CLR 110...............................156 Richborough Furniture Ltd, Re [1996] 1 BCLC 507....................................................52 Rickards v A-G (1844) 12 Cl & F 30 .....................................................................38, 96 Ridge Securities v IRC [1964] 1 WLR 479......................................294–95, 299, 309, 326 Robbie (NW) & Co Ltd v Witney Warehouse Ltd [1963] 1 WLR 578....................24, 89 Roberts Petroleum Ltd v Kenny Ltd [1983] 2 AC 192................................................262 Robertson v Grigg (1932) 47 CLR 257......................................................................138 Robson v Smith [1895] 2 Ch 118 ..............................................................................262 Rochford v Hackman (1852) 9 Hare 471 ....................................................................34 Roith (W & M) Ltd, Re [1967] 1 All ER 427 .....................................................288, 309 Rolled Steel (Holdings) Ltd v British Steel Corporation [1986] Ch 246 ..................................................283–89, 306, 310, 312, 315–16, 324–28

Table of Cases xxix Rolls Razor Ltd v Cox [1967] 1 QB 552 .....................................................................25 Rose v Hart (1818) 8 Taunt 499 .................................................................................24 Rose v Watson (1864) 10 HLC 672...........................................................................232 Row Dal Constructions Pty Ltd, Re [1966] VR 249 ..................................................279 Rowlands v Gulfpac Ltd [1999] Lloyd’s Rep Bank 86 ...............................................111 Royal British Bank v Turquand (1856) 6 E&B 327....................................................311 Royal Brunei Airlines Sdn Bdh v Tan [1995] 2 AC 378..............................................406 Royal Trust Bank v National Westminster Bank plc [1996] 2 BCLC 682..............190–91 Royscott Spa Leasing v Lovett [1995] BCC 502 ............................................108–10, 113 Rudge v Bowman (1868) LR 3 QB 689 .....................................................................351 Russell v Wakefield Waterworks Co (1875) LR 20 Eq 474 ..........................288, 306, 327 Rust v Cooper (1777) 2 Cowp 629 ......................................................................128–29 Salomon v A Salomon & Co Ltd [1897] AC 22 .................................................316, 324 Sandeman v Tyzack & Branfoot Steamship [1913] AC 680 .................................238–39 Santley v Wilde [1899] 2 Ch 474...............................................................................220 Sarflax Ltd, Re [1979] Ch 592 ....................................................................................45 Sasea Finance Ltd v KPMG [2002] BCC 574 ................................................281–82, 296 Saunderson v Clark (1913) 29 LT 579.......................................................................242 Scottish Equitable plc v Derby [2001] EWCA Civ 369, [2001] 3 All ER 818 ...............418 Seagull Manufacturing Co Ltd (In Liquidation) (No 1), Re [1993] Ch 345 ...........460–61 Seagull Manufacturing Co Ltd (In Liquidation) (No 2), Re [1994] Ch 91 ..................461 Seaman, Re [1897] 1 QB 412 ....................................................................................334 Secretary of State for Trade and Industry v Deverell [2001] Ch 340 .......................52–53 Secretary of State for Trade and Industry v Tjolle [1998] BCC 282 .............................52 Security Trust Co v Royal Bank of Canada [1976] AC 503 .......................................224 Segenhoe Ltd v Akins (1990) 1 ACSR 691.................................................................307 Selangor United Rubber Estates Ltd v Cradock (No 3) [1968] 1 WLR 1555........304, 328 Selmar Pty Ltd, Re [1978] VR 531..............................................................337, 340, 367 Sewell v Burdick (1884) 10 App Cas 74.....................................................................231 Shapland Inc, Re [2000] BCC 106 .....................................................................141, 168 Sharp v Jackson [1899] AC 419..................................................................130, 159, 161 Sharp v Wakefield [1891] AC 173.............................................................................369 Sharpe, Re [1892] 1 Ch 154 ......................................................................................304 Shaw ex p Andrew v Australia and New Zealand Banking Group Ltd, Re (1977) 31 FLR 118................................................................................................152 Sheahan v Carrier Air Conditioning Pty Ltd (1997) 189 CLR 407 .................59, 141, 153 Shipley v Marshall (1863) 14 CB(NS) 566 .................................................................248 Shipton Anderson & Co (1927) Ltd v Micks Lambert & Co [1936] 2 All ER 1032.......31 Shoe Lace, Re see Power v Sharp Investments Ltd Siebe Gorman & Co Ltd v Barclays Bank Ltd [1979] 2 Lloyd’s Rep 142 ...........8, 193–95 Simms ex p Sheffield, Re (1896) 3 Mans 340 .............................................................355 Slavenburg’s (NV) Bank v Intercontinental Natural Resources Ltd [1980] 1 WLR 1076.......................................................244–45, 254, 268–73, 279, 454 Slee ex p North Western Bank, Re (1872) LR 15 Eq 69 .............................................247 Smith (Administrator of Cosslett (Contractors) Ltd) v Bridgend County Borough Council [2001] UKHL 58, [2002] 1 AC 336 ......................24, 31–32, 187–89, 219, 227, 235, 243, 252, 272–73, 276, 279–80, 317–18 Smith and Fawcett Ltd, Re [1942] Ch 304.................................................................314

xxx Table of Cases Smith Knight & Co, Re (1868) LR 5 Eq 223 .................................................................2 Smith v Croft (No 2) [1988] Ch 114..........................................................................284 Smith v Henniker-Major & Co (unreported 17 October 2001)..................................313 Smith v Pilgrim (1876) 2 Ch D 127 ...........................................................................130 Smith v William Charlick (1924) 34 CLR 38 .............................................................407 Snook v London & West Riding Investments Ltd [1967] 2 QB 786 ......................60, 239 Snow (John) & Co Ltd v DBG Woodcroft & Co Ltd [1985] BCLC 54 ......................237 Social Services Appeal Board v Butler (unreported Newfoundland Supreme Court 29 March 1996) ............................................................................................419, 422 Soden v British Commonwealth Holdings plc [1997] BCC 952..................................103 South Australian Barytes Ltd, Re (1977) 3 A CLR 52 ................................................245 South India Shipping Corp v Export-Import Bank of Korea [1985] 1 WLR 585 .........270 South Tyneside Borough Council v Svenska International [1995] 1 All ER 545..........419 Sowman v David Samuel Trust Ltd [1978] 1 WLR 22 ...............................................339 Spence v Union Marine Insurance Co (1868) LR 3 CP 427 ...................................238–39 Spiral Globe Ltd, Re [1902] 1 Ch 396 .......................................................................263 Spiral Globe Ltd (No 2), Re [1902] 2 Ch 209 ............................................................225 Spiliada Maritime Corporation v Cansulex Ltd [1987] AC 460 .................................436 Sporrong and Lonnroth v Sweden (1982) 5 EHRR 35 ...............................................358 Standard Manufacturing Co, Re [1891] 1 Ch 627 .....................................................245 Stanhope Silkstone Collieries, Re (1879) 11 Ch D 160...............................................262 Stanton (F and E) Ltd [1928] 1 Ch 180 ..............................................................207, 209 Star v O’Brien (1997) 15 ACLC 144..........................................................................178 Starkey v Deputy Commissioner of Taxation (1993) 115 ALR 305 ............................179 Steane’s (Bournemouth) Ltd, Re [1950] 1 All ER 21 ...................12, 71, 337, 369, 376–78 Stein v Blake [1996] AC 243; [1994] Ch 16 ..........................................................25, 344 Stephenson v Thompson [1924] 2 KB 240.................................................................247 Stevens, Re [1888] WN 110 ................................................................................250–51 Stocznia Gdanska SA v Latreefers Inc [2001] 2 BCLC 116..................................442, 445 Stocznia Gdanska SA v Latvian Shipping Co [1998] 1 WLR 574 ...............................417 Stonegate Securities Ltd v Gregory [1980] Ch 576.....................................................335 Stoneleigh Finance Ltd v Phillips [1965] 2 QB 537 .............................................240, 243 Stotter v Ararimu Holdings Ltd [1994] 2 NZLR 655...................................................21 Street v Mountford [1985] AC 809......................................................................60, 189 Strong v Strong (1854) 18 Beav 408..............................................................39, 106, 115 Stroud Architectural Systems Ltd v John Laing Construction Ltd [1994] 2 BCLC 276 .........................................................................222, 225, 228, 276 Sugar Properties (Derisley Wood) Ltd, Re (1987) 3 BCC 88, [1988] BCLC 146 ...................................................................................246, 337, 377 Suidair International Airways Ltd, Re [1951] Ch 165................................................451 Sullivan v Henderson [1973] 1 WLR 333 ..................................................................351 Sun Tai Cheung Credits Ltd v Attorney-General [1987] 1 WLR 948..........................254 Supercool Refrigeration & Air Conditioning v Hoverd Industries Ltd [1994] 3 NZLR 300 ..............................................................................................194 Suresnes Racecourse Co Ltd, Re (1890) 90 LT Jo 55 .................................................436 Swiss Bank Corp v Lloyds Bank [1982] AC 584...................................................220–21 Sycotex Pty Ltd v Baseler (1994) 13 ACSR 766 ....................................................318–19 Tailby v Official Receiver (1888) 13 App Cas 523 .....................................................226

Table of Cases xxxi Target Holdings v Redferns [1996] AC 421 ..............................................................305 Tasmanian Primary Distributors Pty Ltd v RC & MB Steinhardt Pty Ltd (1994) 13 ACSR 92 .........................................................................338, 342, 363, 365 Tatung (UK) Ltd v Galex Telesure Ltd (1989) 5 BCC 325 .........................................237 Taylor Sinclair (Capital) Ltd [2001] 2 BCLC 176 ..................................................56–58 Taylor v Plumer (1815) 3 M & S 562........................................................................356 Taylor’s Industrial Flooring Ltd, Re [1990] BCLC 216 ...............................................50 Telecom Australia v Sheahan (1991) 4 ACSR 425 .....................................................380 Tellsa Furniture Pty Ltd v Glendave Nominees Pty Ltd (1987) 9 NSWLR 254 .........................................................333, 338, 356, 372–73, 379 Tellsa Furniture Pty Ltd, Re (1985) 9 ACLR 869 ......................356, 369, 372–73, 379–80 Telomatic Ltd, Re [1994] 1 BCLC 90 ...........................................................259–60, 264 Tenant Sons & Co v Howatson (1888) 13 App Cas 489 ............................................247 Tesco Supermarkets v Nattrass [1972] AC 153 .........................................................163 Thames Iron Works Co v Patent Derrick Co (1860) 1 J & H 93................................230 The Civil Service and General Store Ltd, Re (1887) 57 LJ Ch D 119............333, 338, 378 Thirty-Eight Building Ltd [1999] 1 BCLC 416 ...................................................167, 171 Thomas Guaranty Ltd v Campbell [1985] QB 210 ....................................................227 Thomas v Commonwealth Bank of Australia (1994) 35 NSWLR 335........................369 Thomas v Hatzipetros (1997) 24 ACSR 286...................................342–43, 359, 369, 373 Thomas v Kelly (1888) 13 App Cas 506 ....................................................................246 Thompson ex p Williams, Re (1877) 7 Ch D 138 ........................................................32 Thompson Land Ltd v Lend Lease Shopping Centre Development Pty Ltd [2000] VSC 108 ....................................................................................................365 Thompson v Freeman (1786) 1 TR 155 ...............................................................129–30 Thompson, ex p Williams, Re (1877) 7 Ch D 138 .......................................................10 Tilley v Bowman Ltd [1910] 1 KB 745........................................................................87 Titan International Inc, Re [1998] 1 BCLC 102 ...................................................444–46 Tongkah Compund NL v Meagher (1951) 83 CLR 489.............................................291 Toshoku Finance UK plc, Re [2002] UKHL 6, [2002] 1 WLR 671; [2000] 1 WLR 2478 ................................................................................................19 Tosich Constructions Pty Ltd v Tosich (1997) 23 ACSR 466 .................................55, 61 Tout and Finch Ltd, Re [1954] 1 WLR 178 ...........................................................28, 30 Tovarishestvo Manufactur Liudvig-Rabenek [1944] Ch 404 .....................................440 Townsend (Lord) v Windham (1750) 2 Ves Sen 1 ...............................................99, 107 Tramway Building & Construction Co Ltd, Re [1988] Ch 293.......337, 355–58, 373, 377 Transvaal Lands Co v New Belgium (Transvaal) Land & Development Co [1914] 2 Ch 488....................................................................................................312 Trevor v Whitworth (1887) 12 App Cas 409 ................................................290–92, 296 Trinity Assurance Co Ltd, Re [1990] BCC 235 .........................................................335 Trustee AB v Smallbone [2001] 1 WLR 1177.......................................................298–99 Trustee of PAF Foster v Crusts [1986] BCLC 307 .....................................................254 TSB Bank plc v Katz [1997] BPIR 147 ...............................................................100, 101 Tucker (A Bankrupt) In re [1988] 1 WLR 497...........................................................459 Turquand’s Case see Royal British Bank v Turquand TW Construction Ltd, Re [1954] 1 WLR 540...............................350, 355, 367, 370, 376 Tweeds Garages Ltd, Re [1962] Ch 406 .....................................................................50 Twinsectra Ltd v Yardley [2002] UKHL 12, [2002] AC 264.......................................306

xxxii Table of Cases UD Whiting Pools Inc 462 US 198 (S Ct 1983) ..............................................................6 Ugland Trailer, The see Welsh Irish Ferries Ltd, Re Underwood (L) Ltd v Bank of Liverpool [1924] 1 KB 775 .........................................312 Union Bank of Calcutta, Re (1852) 3 De G & SM 253 ..............................................440 Union Bank v Wolas 502 US 151 (1991)....................................................................134 United Bank of Kuwait plc v Sahib [1997] Ch 107.....................................................231 Universe Tankships Inc of Monrovia v International Transport Workers Federation (The Universe Sentinal) [1983] AC 366 .................................................................407 US v Gleneagles Inv Co 565 F Supp 556 (MD Pa 1983) see also US v Tabor Court Realty .................................................................................65–66 US v Tabor Court Realty 803 F 2 d 1288 (3d Cir 1986) see also US v Gleneagles Inv Co ....................................................................................65–66 Vatcher v Paull [1915] AC 372 .................................................................................315 Vaughan, ex p Fletcher, Re (1877) 6 Ch D 350 ...........................................................25 Vivian (HH) & Co Ltd, Re [1900] 2 Ch 654 .............................................................187 Vocalion (Foreign) Ltd, Re [1932] Ch 196...........................................................463–64 Walker ex p Barter, Re (1884) 17 Ch D 510...........................................................31–32 Walker v WA Personnel Ltd (unreported 15 March 2002) ..........76, 83–85, 173, 176, 324 Walker v Wimborne (1976) 50 AJLR 446 ..........................................................321, 327 Wallace Smith Group, Re [1992] BCLC 989 .............................................................447 Watson v Duff Morgan & Vermount (Holdings) Ltd [1974] 1 WLR 450 ...................261 Watson, Re (1890) 25 QBD 27 .................................................................................239 Waugh ex p Dickin, Re (1876) 4 Ch D 524............................................................32–33 Webb Electrical Ltd, Re [1988] BCLC 382 .................................................338, 369, 378 Weisgard v Pilkington [1995] BCC 1108.........................143, 167–68, 394, 399, 402, 411, 413–16, 422–23 Welch v Official Assignee [1998] 2 NZLR 8, [1999] 1 NZLR 201 ................................67 Weldtech Equipment Ltd, Re [1991] BCC 16.....................................................454, 466 Welfab Engineers, Re [1990] BCC 600......................................................................322 Welsh Development Agency v Export Finance Co Ltd [1992] BCLC 148 (CA); [1990] BCC 393 ........................................................14, 60, 61, 219, 229, 240–41, 246 Welsh Irish Ferries Ltd, Re [1986] 1 Ch 471, [1985] 2 Lloyd’s Rep 372 .................232–33 West Mercia Safetywear Ltd v Dodd [1988] BCLC 250, (1988) 4 BCC 30 .............................................................................124, 180, 317, 324 Westdeutsche Landesbank Girozentrale v Islington LBC [1996] AC 669 ..............................................................87, 222, 288, 391, 397–98, 401 Western Welsh International System Buildings Ltd (1985) 1 BCC 99 .....35, 331, 338, 378 Westminster Bank Ltd v Hilton (1926) 136 LT 315............................................348, 363 Westpac Banking Corp v Savin [1985] 2 NZLR 41 ...................................................306 Westmaze Ltd, Re [1999] BCC 441...........................................................................190 White v Woodroffe 2000 WL 281258 (unreported 24 January 2000) ..........................111 Whitehouse v Carlton Hotel Pty Ltd (1987) 162 CLR 285....................................315–16 Whitmore v Mason (1861) 2 J & H 204 .....................................................................34 Wieboldt Stores Inc v Schottenstein 94 BR 488 (ND Ill 1988) ................................65, 67 Wigan Coal and Iron Co Ltd v IRC [1945] 1 All ER 392 ...........................................307 Wilkinson v Wilkinson (1815) G Coop 259 ................................................................34 Wilkinson, Re [1905] 2 KB 713.............................................................................27–28 William Gaskell Group Ltd v Highley [1993] BCC 200 .............................................191

Table of Cases xxxiii William Hall (Contractors) Ltd, Re [1967] 1 WLR 948 .............................................226 Williams v Burlington Investments Ltd (1977) 121 SJ 424 .........................................227 Williams v Natural Life Health Foods Ltd [1998] 1 WLR 830 ...................................318 Willmott v London Celluloid Co (1886) 34 Ch D 147 .................................................89 Wills v Corfe Joinery Ltd [1998] 2 BCLC 75...........................140, 160, 167–68, 391, 396 Wilson v Greenwood (1818) 1 Swans 471...................................................................34 Wilson v Kelland [1910] 2 Ch 306 ............................................................................224 Wiltshire Iron Company ex p Pearson (1868) LR 3 Ch App 443 ...........13, 332, 337, 342, 369, 377 Wily v Bartercard Ltd [2001] NAWCA 262 ..............................................................142 Wily v Commonwealth (1996) 66 FCR 206 .........................................337, 339, 345, 363 Wily v St George Partnership Banking Ltd (1999) 84 FCR 423 ..................................147 Wincham Shipbuilding Boiler and Salt Co, Re (1878) LR 9 Ch D 322........................318 Winkworth v Edward Baron Development Co Ltd [1986] 1 WLR 1512.....................318 Winter ex p Bolland, Re (1878) 8 Ch D 225 ..............................................................234 Winter v IRC [1963] AC 235......................................................................................50 Wogan’s (Drogheda) Ltd, Re [1993] 1 IR 157 ...........................................................191 Wood v Dixie (1845) 7 QB 892.................................................................................106 Woodhouse AC Israel Cocoa Ltd SA v Nigerian Produce Marketing Co Ltd [1972] AC 741......................................................................................................205 Worcester Works Finance Ltd v Cooden Engineering Co Ltd [1972] 1 QB 210 ..........192 Worseley v DeMattos (1758) 1 Burr 467..............................................................45, 128 Wragg, Re [1897] 1 Ch 796 ...............................................................................316, 324 Wright v Horton (1887) 12 App Cas 371 ..................................................................217 Yagerphone Ltd, Re [1935] Ch 392..............................................4, 88–92, 179, 360, 405 Yaxley v Gotts [2000] Ch 162 ..................................................................................231 Yeomans v Lease Industrial Finance Ltd (1987) 5 ACLC 103 ....................................147 Yeovil Glove Co Ltd, Re [1965] 1 Ch 148..........................................................199, 211 Yukong Line Ltd v Rendsburg Investments Corporation (No 2) [1998] 1 WLR 294...318 Yolland Husson & Birkett Ltd, Re [1908] 1 Ch 152...........................................218, 257 Yorkshire Railway Wagon Co v Maclure (1882) 21 Ch D 39 ....................................240 Yorkshire Woolcombers, Re [1903] 2 Ch 284.............................................188, 190, 253 Young v Bristol Aeroplane Co Ltd [1944] KB 718.....................................................192 Ypatianna, The see Indian Oil Corp Greenstone Co SA Zuhal K and Selin, The [1987] 1 Lloyd’s Rep 151 .....................................................408

Table of Legislation AUSTRALIA Corporations Act 2001 s 468....................................................................................................................382 s 468(2)(a) ...........................................................................................................351 a 468(2)(b) ...........................................................................................................364 s 588FA ...............................................................................................................173 s 588FA(3) ...........................................................................................................155 s 588FC(2)–(6) .....................................................................................................421 s 588FG ...............................................................................................................174 s 588FG(2) ...........................................................................................................136 CANADA Social Assistance Act, RSN 1990 s 23(1–2)..............................................................................................................422 EUROPEAN COMMUNITIES European Convention on Human Rights Art 1....................................................................................................................358 Uniform Commercial Code Art 9 ............................................................................................................224, 260 Regulations Council Regulation (EC) No 1346/2000 OJ L 160/1 ..................................................430 Preamble paras 12–13 ..........................................................................................469 Preamble para 22..........................................................................................469, 471 Arts 1(1–2) ..........................................................................................................468 Art 2(c)................................................................................................................470 Art 2(h) ...............................................................................................................470 Art 3(1) ........................................................................................................469, 472 Art 3(2) ........................................................................................................470, 472 Arts 3(3–4) ..........................................................................................................470 Art 4(1)...................................................................................................469–70, 474 Art 4(2) ........................................................................................................470, 474 Art 4(2)(m)...................................................................................................471, 474 Art 5....................................................................................................................473 Arts 5(1–4) ..........................................................................................................471 Art 6....................................................................................................................471 Art 7 ............................................................................................................471, 473

xxxvi Table of Legislation Council Regulation (EC) No 1346/2000 OJ L 160/1 Art 8....................................................................................................................471 Art 11..................................................................................................................471 Art 13..................................................................................................................471 Art 15..................................................................................................................474 Arts 16(1–2).........................................................................................................472 Arts 17(1–2).........................................................................................................472 Art 18(1)..............................................................................................................472 Arts 18(2–3).........................................................................................................473 Art 20(2)..............................................................................................................470 Art 26..................................................................................................................472 Art 27(1) ......................................................................................................470, 472 Art 28..................................................................................................................471 Art 29(a)..............................................................................................................470 Art 31..................................................................................................................470 Art 31(3)..............................................................................................................470 Art 33(1)..............................................................................................................470 Art 43..................................................................................................................468 Art 47..................................................................................................................468 Annex A..............................................................................................................468 Annex C..............................................................................................................468 Council Regulation (EC) No 44/2001 (Brussels Regulation) Art 1(2) ...............................................................................................................429 Art 2....................................................................................................................436 NEW ZEALAND Companies Act 1955 s 309....................................................................................................................146 Companies Act 1993 s 296(3)................................................................................................................421 UNITED KINGDOM Agricultural Holdings Act 1986 Sch 14 para 12 .....................................................................................................102 Bankruptcy Act 1603 (1 Jac 1, c 15)..........................................................................128 s 5 .........................................................................................................................40 Bankruptcy Act 1825 (6 Geo 4, c 16) s 73 .......................................................................................................................40 Bankruptcy Act 1849 (12 & 13 Vict, c 106) s 126......................................................................................................................40 Bankruptcy Act 1861 ss 149–54...............................................................................................................24 Bankruptcy Act 1869 .................................................................................................24 s 91 .......................................................................................................................40 s 92 ................................................................................................................129–30

Table of Legislation xxxvii Bankruptcy Act 1883 ...............................................................................................130 s 47 ................................................................................................................40, 355 Bankruptcy Act 1914 ...............................................................................................130 s 31 .......................................................................................................................25 s 42 ..................................................................................................................40, 55 s 44(1) ...................................................................................................................17 s 45......................................................................................................................334 Bills of Sale Act 1854 ...............................................................................................246 Bills of Sale Act 1878 ...............................................................................................245 s 4 ................................................................................................................246, 247 Bills of Sale Act 1878 Amendment Act 1882..............................................................245 s 3 .......................................................................................................................246 s 5 .......................................................................................................................246 s 17......................................................................................................................244 Bills of Sale Act 1890 s 1 .......................................................................................................................247 Bills of Sale Act 1891 s 1 .......................................................................................................................247 Charging Orders Act 1979 s 1(1) ...................................................................................................................232 s 3(4) ............................................................................................................232, 262 Companies Act 1862 s 153.............................................................................................................334, 352 Companies Act 1900.........................................................................................218, 245 Companies Act 1907 s 13......................................................................................................................183 Companies Act 1928 s 16......................................................................................................................291 Companies Act 1929 s 173....................................................................................................................335 s 177....................................................................................................................463 s 266....................................................................................................................183 Companies Act 1947 s 115(3)................................................................................................................130 Companies Act 1948 s 95......................................................................................................................454 s 106....................................................................................................................454 s 227 ................................................................................................................9, 335 s 229....................................................................................................................212 s 280....................................................................................................................212 s 302 .......................................................................................................................9 s 320....................................................................................................................130 s 322(1)................................................................................................................183 Companies Act 1985 s 4 .......................................................................................................................310 s 9 .......................................................................................................................310 s 13......................................................................................................................268 s 35......................................................................................................................326

xxxviii Table of Legislation Companies Act 1985 ss 35(1–2) ............................................................................................................289 s 35A.....................................................................................................310, 313, 316 s 35A(1)...............................................................................................................312 s 35A(2)...............................................................................................................316 s 35A(2)(a)...........................................................................................................312 s 35A(2)(b) ..........................................................................................................313 s 35A(2)(c)...........................................................................................................312 s 35B................................................................................................289, 310–13, 316 s 43......................................................................................................................310 s 53......................................................................................................................310 s 80......................................................................................................................310 s 95......................................................................................................................454 s 121....................................................................................................................310 s 135.............................................................................................................291, 310 s 151 ..............................................................................................................65, 291 s 151(2) .................................................................................................................65 s 152 ..............................................................................................................65, 291 s 152(1)(a)(ii).........................................................................................................65 s 152(1)(a)(iii)........................................................................................................65 s 152(3) .................................................................................................................65 s 153 ..............................................................................................................65, 291 s 153(2)(b) ...........................................................................................................320 s 154....................................................................................................................291 s 155 ..............................................................................................................65, 291 s 155(2) .................................................................................................................65 ss 156–8 .........................................................................................................65, 291 s 178....................................................................................................................299 s 193....................................................................................................................220 s 199....................................................................................................................438 s 247(3)................................................................................................................332 s 263.........................................................................................295, 299, 302–05, 325 s 263(1)................................................................................................................298 s 263(2) ..........................................................................................................295–98 ss 263(2)(a–b) ......................................................................................................296 s 263(2)(c) ....................................................................................................296, 300 s 263(2)(d)...............................................................................................296–99, 325 s 263(3)................................................................................................................300 s 264.............................................................................................................300, 305 s 269....................................................................................................................301 s 270....................................................................................................................300 s 270(2) ..........................................................................................................300–02 s 271....................................................................................................................305 ss 271(2–5)...........................................................................................................301 ss 273(4–5)...........................................................................................................301 ss 275–6...............................................................................................................302 s 277 .......................................................................................................304, 307–08 s 277(2)................................................................................................................307

Table of Legislation xxxix s 281.............................................................................................................292, 303 s 303....................................................................................................................310 s 309.............................................................................................................318, 323 s 320......................................................................................................................59 s 322A .................................................................................................................313 s 395 ............................................................21, 32, 219, 252–57, 275–76, 452, 454–55 s 395(1)........................................179, 218–21, 226, 243–44, 249, 253–58, 260, 268–80 ss 395(1)(a–j) .......................................................................................................243 s 395(2) ........................................................................................................219, 278 ss 395(3–5)...........................................................................................................219 s 396..................................................................................................32, 248–51, 257 s 396(1) .................................................................................................187, 243, 253 s 396(1)(a) ...............................................................................................243–45, 248 s 396(1)(b) ...........................................................................................................245 s 396(1)(c) ......................................................................................................243–46 s 396(1)(d) ...........................................................................................................248 s 396(1)(e) ...............................................................................................243, 248–51 s 396(1)(f) ...................................................................................243–45, 248, 250–53 s 396(1)(g) ...........................................................................................................245 s 396(2)................................................................................................................251 s 396(3)................................................................................................................248 s 396(4) ..........................................................................................................219–20 s 397 ..............................................................................................................256–57 ss 397(1–2) .....................................................................................................255–56 s 397(3)................................................................................................................256 s 398....................................................................................................................257 ss 398(1–2)...........................................................................................................256 s 398(3) ........................................................................................................256, 454 s 399 .....................................................................................................218, 257, 278 s 399(1) .................................................................................................218, 257, 276 s 399(2)................................................................................................................218 s 400....................................................................................................................257 ss 400(1–2)...........................................................................................................219 s 400(4)................................................................................................................219 s 401.............................................................................................................257, 267 s 401(1)................................................................................................................254 s 401(2)................................................................................................................256 s 402....................................................................................................................257 ss 402(1–2) ...................................................................................................258, 259 s 403....................................................................................................................257 s 404 ..............................................................................................................257–68 s 404(1) ........................................................................................................258, 260 s 404(2)................................................................................................................258 ss 405–6...............................................................................................................257 ss 406(1–2)...........................................................................................................217 s 407.............................................................................................................217, 257 s 407(1)................................................................................................................217 s 407(3)................................................................................................................217

xl Table of Legislation Companies Act 1985 s 408.............................................................................................................217, 257 s 409 .....................................................................................................257, 454, 466 s 409(1) ..........................................................................................................268–72 s 425..................................................................................................21, 92, 293, 300 s 462(1)................................................................................................................228 s 522....................................................................................................................335 s 615....................................................................................................................130 s 617(1)................................................................................................................183 s 691 ..............................................................................................................268–69 s 695(2)................................................................................................................270 s 696(4)................................................................................................................271 ss 706(1–2)...........................................................................................................254 s 727....................................................................................................................305 s 735....................................................................................................................268 s 735(1)(a) ...........................................................................................................437 s 744.........................................................................................228, 244, 254, 268–69 Parts I–II..........................................................................................................218 Part V Chap VII ..................................................................................................295, 299 Part VII............................................................................................................282 Part VIII ...............................................................................292, 295–96, 303, 307 Part X..............................................................................................................283 Part XII ......................................................................................................218–19 Chap I ...............................................................................................218, 253, 267 Chap II ............................................................................................................253 Sch 4 paras 88–89.............................................................................................300 Companies Act 1986 s 196......................................................................................................................14 Companies Act 1989 s 163(4)................................................................................................................332 s 165......................................................................................................................95 ss 175(3–5)...........................................................................................................332 Part IV.............................................................................................................218 Part VII..........................................................................................................2, 13 Companies (Consolidation) Act 1908 s 205....................................................................................................................335 Company Directors Disqualification Act 1986 ......................................................51–52 s 6 .......................................................................................................................461 Contracts (Rights of Third Parties) Act 1999 s 1 .........................................................................................................................22 s 2....................................................................................................................29–30 Employment Rights Act 1996 s 189......................................................................................................................20 Enterprise Act 2002 s 251.............................................................................................................190, 472 s 252....................................................................................................................190

Table of Legislation xli European Communities Act 1972 s 9(1) ...................................................................................................................289 Factors Act 1889 s 2 .......................................................................................................................231 s 8 .......................................................................................................................231 s 9 ................................................................................................................231, 241 Foreign Judgments (Reciprocal Enforcement) Act 1933 ............................................444 Human Rights Act 1998 s 3 .......................................................................................................................358 s 6 .......................................................................................................................358 Insolvency Act 1986 s 8 .......................................................................................................................437 s 8(1)(a) ...............................................................................................................268 s 8(3) .....................................................................................................................92 s 10(1)(c) .................................................................................................................6 s 11(3)(c) .................................................................................................................6 s 15 ..............................................................................................6, 93, 187, 214, 280 s 19(4) .................................................................................................................187 s 29(2)(b) .............................................................................................................187 s 40 .....................................................................................................7, 14, 187, 190 s 43 .........................................................................................................................6 s 44(1)(a) ...............................................................................................................59 s 74......................................................................................................................350 s 84......................................................................................................................310 s 86 ..............................................................................................9, 48, 171, 197, 212 s 96......................................................................................................................171 s 107 ...................................................................................3, 6, 9, 11, 20, 23, 44, 452 s 115...........................................................................................................3, 6–7, 19 s 117 .......................................................................................................436–38, 473 ss 117(1–2)...........................................................................................................436 s 122.............................................................................................................331, 436 s 122(1)(f).....................................................................................................124, 331 s 122(1)(g) ...........................................................................................................381 s 123 ...................................................................................37, 48, 124, 172, 198, 439 s 123(1)(a)........................................................................................................48, 50 s 123(1)(b) .............................................................................................................48 s 123(2) .................................................................................................................49 s 124(1)................................................................................................................124 s 124A............................................................................................................331–32 s 127 ..............................6–9, 12–13, 30, 45, 48, 71, 171, 331–77 , 382–83, 452, 464–67 s 128.........................................................................................331, 338, 345, 464–65 s 129 .....................................................................................................212, 331, 335 s 129(1)............................................................................................48, 171, 197, 331 s 129(2)............................................................................9, 48, 93, 197, 318, 331, 336 s 130(2) ...............................................................................................9, 463–64, 474 s 133 ..............................................................................................................460–61 s 135....................................................................................................................332 s 136....................................................................................................................351

xlii Table of Legislation Insolvency Act 1986 ss 144–45.................................................................................................................6 s 147....................................................................................................................436 s 148....................................................................................................................350 s 150....................................................................................................................350 s 156 ..................................................................................................................6, 19 s 160....................................................................................................................350 s 165(5) ...................................................................................................................3 s 168....................................................................................................................276 s 175 ..........................................................................................7, 14, 19, 44, 88, 133 s 175(2)(b) .............................................................................................148, 187, 190 s 176A .................................................................................................................190 s 178 ..................................................................................................................6, 31 s 182(2)(c) .............................................................................................................35 s 183 ..............................................................................................124, 144, 345, 464 s 183(1) .................................................................................................................35 s 183(2)(c) .............................................................................................................35 s 183(3)(a) .............................................................................................................35 s 184(3) ..........................................................................................................35, 262 ss 184(3)(b–c) ........................................................................................................35 ss 184(4–5..............................................................................................................35 s 213....................................................................................................................472 s 214 ..............................................................................................204, 213, 442, 461 s 220....................................................................................................................439 s 220(1) ..........................................................................................................437–38 s 220(1)(b) ...........................................................................................................437 s 221....................................................................................................................331 s 221(5)................................................................................................................439 ss 222–24......................................................................................................331, 439 s 225....................................................................................................................331 s 229(1) ........................................................................................................331, 439 s 229(2)................................................................................................................437 s 233......................................................................................................................19 s 234 .......................................................................................................................6 s 236....................................................................................................................462 s 238.........................v, 15–18, 37–47, 55–93, 95, 100, 105, 117, 120, 125–26, 132, 167, 170, 179–81, 198, 213–14, 333, 355, 385–86, 392–93, 397, 402, 404, 410–11, 425–26, 429, 443, 452, 455–60, 467 s 238(1)............................................................................................37, 125, 186, 214 s 238(1)(a) .............................................................................................................93 s 238(1)(b)......................................................................................................93, 403 s 238(2)...................................................................................9, 56, 91, 214, 403, 455 s 238(3)...................................................................81–90, 117–18, 173, 416, 422, 426 s 238(4) .................................................................................................56, 67, 76, 80 s 238(4)(a) ..................................................................................................56–57, 67 s 238(4)(b)........................................................................................................67–68 s 238(5)..............................................................................................74, 78, 170, 411 s 238(5)(a)........................................................................................................78–79

Table of Legislation xliii s 238(5)(b) .............................................................................................................79 s 239 .......................................v, 15–18, 71, 89, 92, 117, 120–26, 132–81, 198, 213–14, 333, 355, 385–86, 402, 410–11, 425–29, 452, 455–62, 467 s 239(1)................................................................................................................125 s 239(2) ........................................................................9, 125, 170, 178, 213, 403, 455 s 239(3) ......................................................84, 90, 142, 172–74, 177, 180–81, 422, 426 s 239(4).................................................123, 138–47, 151, 153, 155, 156, 159, 167, 176 s 239(4)(a) ...........................................................................................................139 s 239(4)(b)......................................................................139–40, 145–47, 164–65, 404 s 239(5) .................................................................................45, 72, 131, 159–67, 411 s 239(6) ......................................................................................18, 131, 140, 166–69 s 239(7)................................................................................................................144 s 240 ...............................................9, 15, 17, 47, 49, 117, 125, 133, 170, 174, 179, 333 s 240(1).....................................................................................................15, 47, 171 s 240(1)(a) .............................................................................................131, 140, 198 s 240(1)(b) ...........................................................................................................178 s 240(1)(c) .............................................................................................................47 s 240(2)...................................................................................42, 48–51, 82, 124, 198 s 240(3).....................................................................................................47, 48, 171 s 240(3)(a) ...........................................................................................................171 s 241.......................................................15, 38, 84, 117, 125–26, 164–65, 173–80, 401 s 241(1) ...................................................................................................84, 174, 426 s 241(1)(a) ................................................................85, 87, 175, 177, 180–81, 401–02 s 241(1)(b) .........................................................................................83, 87, 177, 180 s 241(1)(c) ......................................................................................................86, 175 s 241(1)(d) ....................................................................................83, 87, 175–77, 402 s 241(1)(e) ...............................................................................................86, 150, 177 s 241(1)(f) ............................................................................................................175 s 241(1)(g)...............................................................................................86, 137, 175 s 241(2) .................................................................................55, 79, 83, 118, 175, 355 s 241(2)(a) ..................................................................................................79–81, 87 s 241(2)(b) ..................................................................................................56–57, 81 s 241(2A) ..................................................................................................80–81, 176 s 241(2A)(a) ...................................................................................................80, 115 s 241(2A)(b).........................................................................................................115 s 241(3) .................................................................................................................80 s 241(3)(b) ...........................................................................................................176 ss 241(3A–C) ............................................................................................80–81, 176 s 241(4) .................................................................................................................82 s 242.............................................................................................................125, 190 s 243....................................................................................................................190 s 244......................................................................................................................15 s 245 ......................15–18, 141, 169, 183–87, 197–214, 390, 426, 429, 452, 455, 466–67 s 245(1) .................................................................................................184, 186, 214 s 245(2) ...............................................................................15, 184, 198–99, 201, 214 s 245(2)(a) ......................................................................................................203–04 s 245(3) ........................................................................................................184, 197 s 245(3)(a) ......................................................................................................15, 197

xliv Table of Legislation Insolvency Act 1986 s 245(3)(b) ...........................................................................................................198 s 245(3)(c) ....................................................................................................198, 213 s 245(4) ........................................................................................................184, 198 s 245(5) ............................................................................................184, 197–98, 213 s 245(6) .................................................................................................184, 200, 203 s 249 .......................................................................................51, 53, 54, 80, 167, 170 s 249(b) ..........................................................................................................167–68 s 251 ................................................................................................................51–52 s 278(a)................................................................................................................335 s 283(3)(a) ...............................................................................................................6 s 283(5) ...................................................................................................................6 s 284...........................................................................................9, 331, 335, 338, 355 s 284(4)................................................................................................................358 s 323......................................................................................................................25 s 339...........................................................................................................37–40, 55 s 340.............................................................................................................126, 158 ss 341–42 .............................................................................................................126 s 386..................................................................................................20, 44, 133, 148 s 387(3) .................................................................................................................20 s 388(1)................................................................................................................125 s 395....................................................................................................................142 ss 411–12 .............................................................................................................101 s 423 .......................................................v, 34, 39–40, 43, 55, 59, 95, 99–121, 385–86, 400, 402, 405, 409–11, 425–26, 463–66 s 423(2) .............................................................................104, 116–18, 400, 426, 465 ss 423(2)(a–b) ......................................................................................................119 s 423(3) ......................................................................103–06, 108, 119, 404, 422, 465 s 423(4)................................................................................................................465 s 423(5) ..........................................................................................................101–05 s 424 ...................................................................................95, 101–04, 108, 117, 119 s 424(1)(a) ...............................................................................................101–02, 403 s 424(1)(b) ...........................................................................................................101 s 424(1)(c)............................................................................................................435 s 424(2)................................................................................................................403 s 425..................................................................................95, 108, 117, 119, 401, 466 s 425(1) ..........................................................................................................116–17 s 425(1)(a) ......................................................................................................401–02 s 425(1)(d) ...........................................................................................................402 s 425(2) ........................................................................................98, 114–15, 118–20 s 425(2)(a) ....................................................................................................114, 119 s 425(2)(b) ...........................................................................................................114 s 425(3)................................................................................................................115 s 426(4) ........................................................................................................437, 449 s 435..................................................................................................80, 167, 170–71 s 435(2).....................................................................................................54, 167–68 ss 435(3–5) .....................................................................................................54, 167 s 435(5)(b) ...........................................................................................................167

Table of Legislation xlv s 435(6) ..........................................................................................................54, 168 s 435(6)(a) ...........................................................................................................168 s 435(7).....................................................................................................54–55, 167 s 435(8).....................................................................................................54, 167–68 s 435(9) .................................................................................................................54 s 435(10) ...................................................................................................54, 167–68 s 435(10)(b)..........................................................................................................168 s 436 .....................................................................................6, 56, 336, 452, 463, 466 s 437......................................................................................................................97 s 440(2)(a) ....................................................................................................125, 331 s 441.............................................................................................................125, 331 Sch 4 ...................................................................................................................1 Sch 4 para 6.........................................................................................6, 9, 88, 351 Sch 4 para 7.........................................................................................................4 Sch 4 para 10................................................................................................9, 351 Sch 4 para 13 ..........................................................................................6, 19, 351 Sch 6..............................................................................................20, 44, 133, 148 Sch 11 para 20....................................................................................................97 Part I..........................................................................................................92, 101 Part II .......................................................................................................101, 273 Parts III............................................................................................................101 Part IV ..............................................................................................101, 436, 439 Part V ..........................................................................................101, 438–39, 473 Part VI......................................................................................................101, 436 Part VII-XI ......................................................................................................101 Part XVI...................................................................................95, 97, 100–01, 120 Insolvency Act (No 2) 1994........................................................................................80 Insolvency Act 2000 s 1 .......................................................................................................................332 Sch 1 para 12(2) ...............................................................................................332 Joint Stock Companies Act 1856..............................................................................129 s 73......................................................................................................................334 Law of Property Act 1922..........................................................................................97 Law of Property (Amendment) Act 1924 Sch 3 Part II para 31....................................................................................................97 Law of Property Act 1925 ss 85–86...............................................................................................................220 s 99 ................................................................................................................69, 102 s 136....................................................................................................................277 s 146(9) .................................................................................................................33 s 172................................................................................38–39, 97, 106–08, 117, 444 s 172(1) ...................................................................................................97, 106, 117 s 172(3) ..........................................................................................................97, 115 s 205(1)(ii) .............................................................................................................97 Law of Property (Miscellaneous Provisions) Act 1989 s 2 .......................................................................................................................231

xlvi Table of Legislation Limitation Act 1980 s 8 .......................................................................................................................120 s 8(1) ........................................................................................................93, 180–81 s 8(2) ...................................................................................................................181 s 9 .......................................................................................................................120 s 9(1)..............................................................................................................93, 181 s 32......................................................................................................................120 s 32(3) ............................................................................................................120–21 s 32(4) .................................................................................................................120 Sale of Goods Act 1979 s 16 ..............................................................................................................235, 341 s 17......................................................................................................................341 s 17(1) .................................................................................................................235 s 18......................................................................................................................341 s 18 rule 5(1) ........................................................................................................341 s 18 rule 5(2) ........................................................................................................342 s 20A ...................................................................................................................342 s 24......................................................................................................................231 s 25 ..............................................................................................................231, 241 s 39......................................................................................................................230 Statute of Elizabeth 1571 (13 Eliz 1, c 5).....................................................v, 39, 40, 117 s I........................................................................................................38, 96–99, 106 s II ...................................................................................................................38, 96 s VI ..........................................................................................................38, 96, 115 Supreme Court Act 1981 s 138(1) .................................................................................................................35 s 138(2)................................................................................................................262 Third Parties (Rights Against Insurers) Act 1930 ......................................................441 Torts (Interference with Goods) Act 1977 s 3(2) ...................................................................................................................353 s 3(6) ...................................................................................................................359 s 6 .......................................................................................................................359 Statutory Instruments Civil Procedure Rules ..............................................................................................100 Companies (Forms) Regulations 1985 SI 1985/854 reg 4 ....................................................................................................................254 Companies (Northern Ireland) Order SI 1989/2404 (NI 19).......................................125 Art 484 ............................................................................................................331 Insolvency Rules 1986 r 4.19............................................................................................................331, 338 r 4.86(1) ...........................................................................................................19, 25 r 4.88(2) ...........................................................................................................14, 15 r 4.90......................................................................24, 25, 44, 133, 151, 152, 344, 353 r 4.90(1) ................................................................................................................26 r 4,90(3)...............................................................................................................349 r 4.128...................................................................................................................88

Table of Legislation xlvii r 4.160(1) ................................................................................................................3 r 4.181..........................................................................................................3, 23, 44 r 4.181(1) .........................................................................................................11, 12 r 4.195– 4.205.......................................................................................................350 r 4.218...................................................................................................................19 r 4.218(1).............................................................................................................214 r 4.218(1)(a).........................................................................................................361 r 4.218(1)(h).........................................................................................................382 r 4.221...................................................................................................................20 r 7.1.....................................................................................................................101 s 12.3............................................................................................................139, 154 r 12.12 .................................................................................................................459 r 12.12(3).............................................................................................................459 r 13.12............................................................................................................49, 139 r 13.12(3)...............................................................................................................50 r 13.12(4) .......................................................................................................50, 154 Chap 1 Part 7 ...................................................................................................101 Chap 14...............................................................................................................3

UNITED STATES Uniform Fraudulent Transfer Act § 4–5 .....................................................................................................................65 US Bankruptcy Code § 547 ............................................................................................................458, 462 § 548 .....................................................................................................................65 Chap 11 ...........................................................................................................462

1

Collectivity, Management of Estates and the Pari Passu Rule in Winding-up MICHAEL G BRIDGE

A INTRODUCTION : MANAGEMENT AND DISTRIBUTION

1.1 This chapter is concerned not only with the distribution of insolvents’ estates but also with events leading up to the distribution of the estate that affect its content. Estates have to be gathered in and administered before distribution can take place. This will involve the liquidator1 in carrying out various functions in connection with the disposal of the company’s assets, entry into contracts and even, to a limited extent, the conduct of business in the name of the company.2 Whilst this process is being conducted, the estate is protected in various ways as a fund in being. Since distribution issues out of the management of the estate, a proper understanding of the scope and importance of the rules governing the distribution of insolvents’ estates, principally the pari passu rule, requires attention to be paid to the prior management and gathering in of the estate. The management of the estate between the commencement of insolvency proceedings and the distribution of the estate is not as such part of the rules of distribution but it exists in the shadow of those rules and inexorably leads into them. While courts and writers have not always distinguished as sharply as they ought between matters of management and of distribution,3 it is questionable whether this has led to adverse consequences. 1.2 According to the pari passu rule of distribution, all claims against the company rank equally amongst themselves and are abated pro rata in so far as the assets of the company are insufficient to satisfy them all. If creditor A has a claim

1 Administrators are not charged with matters of distribution. Administrative receivers are insolvency officers to only a limited degree and do not as such distribute except in the special case of preference creditors ranked ahead of floating chargees. 2 Insolvency Act 1986 Sch 4. 3 A point made cogently and forcefully by R Mokal, ‘Priority as Pathology: The Pari Passu Myth’ (2001) 60 Cambridge Law Journal 581 at 590–95.

2 Michael G. Bridge for £100 against the company and creditor B a claim for £200, and the company has assets of only £150, then a rateable abatement will give A one half of its claim, £50, and B one half of its claim, £100. The pari passu rule does not give all creditors the same amount, nor does it examine the individual needs or merits of each creditor.4 Distributional considerations have no part to play in the enforcement of a rule of ironclad rateability. The pari passu rule is wholly indifferent to the fact that certain creditors may have been treated more generously than others by the debtor in the run up to liquidation.5 No sensitivity at all is displayed to the possibility that some creditors are more at risk of insolvency than others, one possible consequence of this being that an unyielding application of the pari passu rule would lead to a cascading insolvency effect to the great detriment of third parties outside the current insolvency distribution.6 If a justification for the rule has to be sought, it lies in the unquestioned, perhaps unquestionable, intrinsic fairness7 of equal treatment for all in the chronically money-starved world of insolvency distribution. The rule also has the merit that it is easy and therefore relatively inexpensive to apply. In the not dissimilar instance of various proprietary claimants tracing into a mixed active fund, the Court of Appeal in one case preferred to apply a simple rule of rateable sharing rather than embark upon a very costly inquiry into the precise times the various claimants’ assets were paid into the fund and investments made from that fund.8 Despite the almost apodictic quality of the pari passu rule, however, we shall see that there are nevertheless many exceptions to it. 1.3 The pari passu rule has a long history in insolvency law. It is to be found in a statute of Henry VIII calling for the sale of a bankrupt’s assets ‘for the Satisfaction and Payment of [his] Creditors: that is to say, to every of the Said Creditors, a Portion Rate and Rate like, according to the quantity of their Debts’.9 It is surprising, perhaps, that such a fundamental rule has not been 4 The generous inference of a Quistclose trust in Re Chelsea Cloisters Ltd (1980) 41 P&CR 98, in the case of tenants’ deposits, might be said to supply a more refined equity than the pari passu rule would ever have supplied. 5 Re Smith Knight & Co (1868) LR 5 Eq 223 at 226: ‘The Act of Parliament unquestionably says that everybody shall be paid pari passu, but that means everybody after the winding up has commenced. It does not mean that the Court shall look into past transactions, and equalise all the creditors by making good to those who have not received anything a sum of money equal to that which other creditors have received. It takes them exactly as it finds them, and divides the assets amongst the creditors, paying them their dividend on their debts as they then exist’ (Lord Romilly MR). This of course is without prejudice to the rules on unlawful preferences and undervalue transactions. 6 The implications for the financial markets of the decision of the House of Lords in British Eagle International Airlines Ltd v Cie Nationale Air France led eventually to the enactment of Part VII of the Companies Act 1989, designed to bring about an insolvency settlement within designated financial markets before the affairs of the insolvent player are turned over to the operation of the general law of insolvency distribution. 7 Lord Morris described it as ‘the rule of fairness’ in British Eagle International Airlines Ltd v Cie Nationale Air France [1975] 2 All ER 390. 8 Barlow Clowes International Ltd v Vaughan [1992] 4 All ER 22. 9 See also the Case of the Bankrupts (1592) 2 Co Rep 25; 76 ER 441, applying the same principle in a later statute.

Collectivity, Management of Estates and the Pari Passu Rule 3 explained and its philosophy and scope examined at length in the case law. Rather, as one of the oldest statutory rules of commercial law, it has been treated as an immovable feature of the landscape which commands attention as various actions and dispositions are measured against it. The existence of so many statutory exceptions to the rule, as well as trivialising it, diminishes any need to justify it intellectually, whether for purposes of attack or defence. 1.4 The rule is to be found in the text of both the Insolvency Act 1986 and the Insolvency Rules. According to section 107 of the Act, which applies to voluntary winding-up: Subject to the provisions of this Act as to preferential payments, the company’s property in a voluntary winding-up shall be applied in satisfaction of a company’s liabilities pari passu and, subject to that application, shall (unless the articles otherwise provide) be distributed amongst the members according to their rights and interests in the company.

The section does not state on whom the above duty to apply the company’s property is laid, but it should be read in conjunction with section 165(5). This provision obliges the liquidator in a voluntary winding-up to ‘pay the company’s debts’ without itself qualifying the nature of that duty in any way. The liquidator is therefore bound to distribute the company’s property in a rateable manner. In the case of a compulsory winding-up, the first half of the above rule is expressed in rule 4.181 of the Insolvency Rules in somewhat different terms as a pro rata ranking of debts10 after account has been taken of ‘preferential debts’. It is a simple descriptive statement of ranking. The justification for different wording is not easy to see but statutory differentiation, regrettably, is a common feature of the Insolvency Act 1986 and its accompanying Insolvency Rules.11 Rule 4.181 follows on from a rule laying a duty on the liquidator to declare and distribute dividends.12 1.5 A distinction was drawn above between the management and the distribution of estates whilst the close connection between the two was noted. The winding-up of a company is a collective procedure:13 its assets are gathered in by the liquidator and distributed amongst its various creditors and members who may not take action themselves to recover their loan or investment. The 10 ‘Debts other than preferential debts rank equally between themselves in the winding up . . .’ The significance of the change of wording is discussed below. 11 There are many examples of differences of wording that are not designed to have any practical effect, for example s 115 (‘expenses properly incurred in the winding up’) (voluntary liquidation) and s 156 (‘expenses incurred in the winding up’) (compulsory liquidation). 12 Rule 4.160(1). Both rules fall under chapter 14 of the Insolvency Rules, ‘Collection and Distribution of the Company’s Assets by the Liquidator’. 13 This is a point which, as much as the expressed need for accountability and transparency, explains the impending demise of administrative receivership (outside the capital markets), which was first elevated by the reforms of the 1980s into the ranks of insolvency procedures before its forthcoming dispatch was announced in the White Paper, Insolvency—A Second Chance (Cm 5234, July 2001) for want of compliance with the governing norms of insolvency law.

4 Michael G. Bridge liquidator, though the agent of the company,14 acts for the benefit of all of its creditors and members in performing his statutory functions. This collective feature of winding-up is evident too in the rule that the assets of a company in liquidation are subject to a trust in favour of its creditors.15 Other rules also underline the collective nature of winding-up, for example, the rule that no action or proceedings may be taken against a company in liquidation without the leave of the court and the rule that dispositions of a company’s assets after the commencement of a winding-up are void unless the court otherwise orders. 1.6 Again, the same collective purpose is served, by anticipation as it were, by the rules dealing with vulnerable transactions in the twilight period leading up to liquidation. They preserve, albeit retrospectively, the estate of the insolvent pending its distribution. It should not be supposed that the vulnerable transaction rules presuppose pari passu distribution. As will be shown, pari passu distribution is only a default setting. The rules on vulnerable transactions would equally serve any scheme of distribution. Given the existing scheme of insolvency distribution, which is far removed from being a true scheme of pari passu distribution in view of the many exceptions to it, it is just such a differentiated scheme that they serve. In any discussion of the rule, care has to be taken to avoid an elision between the rule as such and the rule together with its various exceptions, the sum of all comprising the rules of English law governing the distribution of insolvents’ estates. 1.7 The imposition of collective discipline on the community of unsecured creditors with claims against the company in liquidation is a necessary precondition for the application of the pari passu rule itself. If the estate were not held together during the process of its management by the liquidator, the performance of the liquidator’s function would be impaired. Further, the distribution of the estate would commence de facto before its ultimate gathering in and, overall, would therefore not be on the rateable terms mandated by the pari passu rule or on the terms of any other prescribed system of distribution. Although the pari passu rule comes into play at the point of distribution, those entitled under it have already had their shares defined16 as of the moment when the somewhat imperfect trust of assets in their favour came into existence on the commencement of the winding-up. 1.8 Indeed, there is an argument, consistent though not necessarily congruent with the existence of twilight periods preceding winding-up, that the unsecured 14

See Insolvency Act 1986 Sch 4, esp para 7. Ayerst (Inspector of Taxes) Ltd v C&K Construction Ltd [1976] AC 167; Re MC Bacon Ltd (No 2) [1991] Ch 127; Re Yagerphone Ltd [1935] Ch 392; Re Anglo-Oriental Carpet Manufacturing Co [1903] 1 Ch 914 at 918; Lewis v Commissioner of Inland Revenue [2001] 3 All ER 499. 16 With the exception of special cases where, in the interests of creditors as a whole, the liquidator may in his discretion sanction a scheme of distribution that departs from the conventional one laid down by the Insolvency Act: see, for example, Buckley LJ in Re Gray’s Inn Construction Co Ltd, quoted below para 1.24. 15

Collectivity, Management of Estates and the Pari Passu Rule 5 creditors of a company have a proprietary interest of sorts in the assets of the company that predates the trust. In a case dealing with the late registration of a company charge, Hoffmann J has spoken of unsecured creditors of a company that is no longer a going concern having proprietary interests that have not yet ‘technically crystallised’.17 The difficulty with this view, however, is to know at what point such an uncrystallised proprietary interest arises, given the absence of a unitary twilight period for all challenges to pre-liquidation transactions and the fact that they do not all require the company to be insolvent at the time. It is, moreover, a proprietary interest that can only be recognised in hindsight with the commencement of winding-up proceedings. Nevertheless, Hoffmann J’s view has a valuable function in explaining why the legislator has chosen to reach back into pre-liquidation transactions and in accommodating the relevant legislative provisions within the pari passu rule. 1.9 The preservation of the estate, during the period of its management by the liquidator, pending distribution, may be actuated in part by the need to comply with the forthcoming rules of distribution. It is more firmly rooted, however, in efficiency considerations. A scramble by individual creditors for payment will globally yield less than can be achieved by a liquidator acting for the benefit of all.18 The rules governing the management and preservation of insolvents’ estates remove any opportunity or temptation that individual creditors might otherwise have to break ranks. The need to ensure orderliness in the distribution of insolvents’ estates is a policy strong enough to have been invoked by the House of Lords in aid of the conclusion that parties should not be at liberty to contract out of the insolvency set-off rules.19 If the relevance of orderliness is more than a matter of legal tidiness, then it must be seen as lying in efficiency considerations. 1.10 A further justification for imposing collective discipline on insolvency creditors is that the prospect of a liquidator stepping in to oppose proceedings against the insolvent company may dissuade an over-eager creditor from taking action where this serves only to precipitate the winding-up of a company that might otherwise be saved or have its salvable parts preserved. The preliquidation procedures of receivership and administration, which prevent individual creditors from intervening, will in many cases, as a result of the management powers exercised by receivers and administrators, increase the volume of assets available for distribution. So stated, the rules supporting the efficient management of the estate and the rules concerning distribution, including the fairness of the pari passu rule, go together hand-in-hand. Despite the almost seamless way in which one set of rules flows into the other, there may 17

Re Braemar Investments Ltd [1988] BCC 366 at 371. See generally T Jackson, The Logic and Limits of Bankruptcy Law (Cambridge, Mass, Harvard University Press, 1986). 19 National Westminster Bank Ltd v Halesowen Presswork and Assemblies Ltd [1972] AC 785. 18

6 Michael G. Bridge nevertheless be cases where efficiency and prescribed distribution are at odds with each other.20 B THE MANAGEMENT OF THE ESTATE

(1) Defining the Estate 1.11 The starting point is to define the estate of the insolvent that is to be gathered in and maintained prior to its distribution. In all of its provisions, consisting of 450 or so sections and 14 Schedules, the Insolvency Act 1986 contains no clear statement of what constitutes the estate of an insolvent company available for distribution. The section dealing with a bankrupt’s estate, which excludes from that estate property held on trust and the proprietary rights of secured creditors,21 should to that extent supply an analogy for winding-up. Subject to that, it is left to the general law to determine what constitutes the ‘company’s property’22 or ‘its assets’,23 the Act contenting itself with a simple definition of ‘property’.24 In the case of a winding-up, there are no statutory provisions to prevent or delay the enforcement of their rights by those creditors whose rights are proprietary in character. Such provisions exist in the case of administration25 and reveal explicitly the equivocality of the word ‘property’. Even as a secured creditor is recognised as having a proprietary entitlement, the company’s ‘property’ is regarded under these administration provisions as the asset or assets minus the encumbrance instead of what remains (the equity of redemption) after the encumbrance has been taken into account.26 1.12 This equivocality in defining the company’s property has also been implicitly recognised in the section dealing with payment of a liquidator’s expenses out of the ‘company’s assets’, where the statutory priority given to preference creditors over floating chargees, coupled with the priority given to liquidation expenses claimants over preference creditors, leads to the striking but unavoidable conclusion that floating chargees are expropriated in favour of expenses claimants.27 The rights of expenses claimants against floating chargees are parasitical upon the statutory priority of preference creditors. It is worth testing the rights of expenses claimants, as against floating chargees, in the 20 See the position of execution creditors, discussed below, and Re Gray’s Inn Construction Co Ltd [1980] 1 WLR 711 at 717–18. 21 S 283(3)(a), (5). 22 See the winding-up provisions: ss 107, 127, 144–45, 178, 234; Schedule 4 para 6. 23 See s 115; Schedule 4, para 13. 24 See s 436. 25 Ss 10(1)(c), 11(3)(c), 15. See also, to a lesser extent, administrative receivership: s 43. 26 In the United States, it is the debtor’s equity of redemption that is the subject of the stay under ch 11: see US v Whiting Pools, Inc. 462 US 198 (S Ct, 1983); CJ Tabb, The Law of Bankruptcy (Westbury, NY, Foundation Press, 1997), 310–13. 27 S 115. See Re Barleycorn Enterprises Ltd [1970] Ch 465; Re Christonette International Ltd [1982] 1 WLR 1245; Re Portbase Clothing Ltd [1993] Ch 388; Buchler v Talbot [2002] EWCA Civ 228, [2002] 1 BCLC 571.

Collectivity, Management of Estates and the Pari Passu Rule 7 hypothetical absence of preference creditors in a given case. The easy case is where preference creditors have been paid out by an administrative receiver prior to the commencement of insolvency proceedings.28 The floating chargee would thereupon acquire full legal and beneficial title to the paid assets so that there could be no question of their being also, to any extent at all, assets of the company at the time of commencement of the winding-up. Claims for expenses of the liquidation do not have retrospective effect except to the extent that a liquidator is able successfully to challenge a vulnerable transaction entered into within the relevant twilight period.29 A payment by an administrative receiver to a floating chargee does not fall within the rules governing vulnerable transactions, even though the administrative receiver is the agent of the company. In obtaining the residual value of its charge against the release of the company’s indebtedness, the floating chargee is neither being given a preference nor obtaining a benefit at an undervalue. 1.13 More difficult is the case where winding-up has commenced before the floating chargee has been paid. The conclusion that expenses claimants come first in a winding-up depends upon a distinction being drawn between ‘the company’s assets’30 and ‘the assets of the company available for payment of general creditors’.31 In so far as preference creditors, given priority over floating chargees, are not confined to the latter assets,32 it follows that there must be assets of the company that are not available for payment of general creditors. It should therefore follow that expenses claimants prevail even in the absence of a preference creditor buffer between them and the floating chargee. Though the rights of expenses claimants, as a class, are parasitical upon the statutory priority of preference creditors, it does not follow that at least one preference creditor with however small a claim must first be identified before expenses claimants may rank ahead of a floating chargee. To the extent that future legislation may diminish the ranks of preference creditors,33 this point assumes greater significance. 1.14 The need to craft a special statutory incursion into the property rights of floating chargees, in favour of expenses claimants and preference creditors, leads to the conclusion that the property of the company cannot, outside this extraordinary case, include assets the subject of a security. Or rather, it cannot include assets to the extent that they are the subject of a security: the company’s equity of redemption in mortgaged and charged34 assets is an asset in its own 28

See s 40. As for the liquidator’s entitlement to recover his expenses, see Lewis v Commissioner of Inland Revenue [2001] 3 All ER 499 with its discussion of the difficult case law. 30 In s 115. 31 In s 175. 32 S 175. 33 As indicated in the White Paper, Insolvency—A Second Chance (Cm 5234, July 2001). 34 It is a misnomer to speak of a chargor’s equity of redemption, given that a charge is an encumbrance and not a conveyance. It is nevertheless a practice in evidence at the highest levels (see Lord Hoffmann in Re Bank of Credit and Commerce International SA (No 8) [1998] AC 214) and is understandable given the skill of the draftsman in bridging the gap between charges and mortgages. 29

8 Michael G. Bridge right. When this is understood, it can be appreciated that security shrinks the estate of a company available for distribution. Given the ease with which English law allows security to be taken, both as to the range of assets that may be the subject of a security and as to the freedom given to creditors in characterising their security as fixed or floating,35 it should come as no surprise that the insolvency distribution rules operate in practice over a narrow base of assets to the extent that they operate at all. There is therefore an unavoidable tension between the freedom given to creditors to take security, where the paramount and almost the only principle is freedom of contract between creditor and debtor, and the regulatory regime that descends on the insolvent’s estate upon the commencement of insolvency proceedings. Secured creditors may be seen as drawers of water upstream who allow little if any water to flow to other creditors further down. The large majority of insolvent distributions yield no dividend at all for general unsecured creditors. If, as is commonly said, the average dividend is just a few pence in the pound, this will only be because a minority of insolvencies where there are substantial assets available for distribution raises the average dividend even to such modest heights. 1.15 The bleak prospects of general unsecured creditors are diminished further by the claims of creditors with proprietary restitution claims36 as well as by the claims of sellers who have reserved title prior to payment.37 To these should be added Quistclose trust claimants38 who as a group have not had a major impact upon insolvency distributions. The gains of such creditors are at the expense of general unsecured creditors, or at least that is the way the matter is conventionally presented. Those who really stand to lose are creditors with security, an equitable security as against restitution claimants and any security as against title reservers. General unsecured creditors might be tempted to raise a cheer for those of their number who have located a proprietary handle to their claim, like jackpot winners in a lottery. (2) Preserving the Estate 1.16 The estate as a fund in being prior to distribution is held together by two principal devices. There is first the rule in section 127 of the Insolvency Act pre35 In particular, the freedom given to banks to take fixed charges over revolving assets like book debts, subject to the existence of controls over dealings with those book debts (Siebe Gorman & Co Ltd v Barclays Bank Ltd [1979] 2 Lloyd’s Rep 142; Re Brightlife Ltd [1987] Ch 200) and, it would now seem, the operation of those controls (Agnew v Commissioners of Inland Revenue [2001] UKPC 28, [2001] 2 AC 710. See paras 5.12–5.38. 36 For example, Chase Manhattan Bank NA v Israel-British Bank London Ltd [1981] Ch 105 and Attorney-General for Hong Kong v Reid [1994] 1 AC 324 (PC). See V Finch and S Worthington, ‘The Pari Passu Principle and Ranking Restitutionary Rights’ in F Rose (ed), Restitution and Insolvency (Oxford, Mansfield Press, 1998). 37 The Romalpa line of cases. See paras 6.44–6.50. 38 So-called because of the leading case, Barclays Bank Ltd v Quistclose Investments Ltd [1970] AC 567.

Collectivity, Management of Estates and the Pari Passu Rule 9 venting the disposition of the property of the company during the course of a compulsory winding-up, so far as the court does not otherwise order. This provision is not directed at actions of the liquidator, whose powers include the disposition of the company’s property without sanction by the court.39 Rather, it is aimed at dispositions of property after commencement of the winding-up and before the liquidator is installed, as well as at dispositions of company property held or controlled by third parties at all relevant times.40 In the case of a voluntary winding-up, there is no similar provision, but the absence of this is offset to a degree by an extension of the twilight period for vulnerable transactions back to the date of the winding-up resolution.41 (The relevant date for a compulsory winding-up is the date of the winding-up petition.) The second device is the rule in section 130(2) that actions or proceedings against the company or its property may not be commenced or continued after a winding-up order has been made or a provisional liquidator appointed, except with the leave of the court and on such terms as a court might order. 1.17 Property is defined in the Insolvency Act 1986 so as to include ‘money, goods, things in action, land and every description of property wherever situated and also obligations and every description of interest, whether present or future or vested or contingent, arising out of, or incidental to, property’. It therefore embraces a contractual right to payment for goods supplied or services rendered. A ‘disposition’, which the Act does not define, of such right to payment after the commencement of the winding-up may not therefore take place except on terms allowed for by section 127. Section 127, or rather its Companies Act 1948 predecessor,42 does not feature in the judgment of the House of Lords in British Eagle International Airlines Ltd v Cie Nationale Air France 43 because this concerned a voluntary winding-up. The case therefore focused instead on the statutory predecessor of section 107 of the Insolvency Act 44 (the pari passu rule). Because of the critical differences that might flow from the type of winding-up procedure, it is instructive to consider how the case might have been decided in the light of section 127 if there had been a compulsory winding-up.45 Before this is done, it is worth looking at Re Jeavons, ex parte Mackay,46 which was discussed at some length by the House of Lords in the later case. 1.18 In Re Jeavons, ex parte Mackay, A sold a patent to B in consideration for royalty payments accruing from time to time. At the same time, B made an 39

Sch 4, paras 6 and 10. See the bank account cases of Re Gray’s Inn Construction Co Ltd [1980] 1 WLR 711 (CA); Coutts & Co v Stock [2000] 1 WLR 906; Hollicourt (Contracts) Ltd v Bank of Ireland [2001] Ch 555. 41 Insolvency Act 1986 ss 86, 129(2), 238(2), 239(2), 240. 42 S 227. 43 [1975] 2 All ER 390. 44 Companies Act 1948 s 302. 45 A provision similar to s 127 was introduced for bankruptcy in the 1980s: Insolvency Act 1986 s 284. 46 (1873) 8 Ch App 643. 40

10 Michael G. Bridge advance to A on terms that one half of the royalties should be retained against repayment of the loan but that the whole of the royalties might be retained in the event of A becoming bankrupt or making a composition with his creditors. The dispute centred on the retention of the second half of the royalties. James LJ treated the case as one where the creditor, B, sought to obtain a preference, having the effect of ‘provid[ing] for a different distribution of [the bankrupt’s] effects in the event of bankruptcy from that which the law provides’.47 Similarly, Mellish LJ saw B as acquiring ‘some additional advantage which prevents the property being distributed under the bankruptcy laws’.48 Although neither judge expressed the matter as a disposition by A, effective upon A’s bankruptcy, of A’s right to receive the second half of his royalties, that is what it was.49 1.19 The case of British Eagle International Airlines Ltd v Cie Nationale Air France 50 turns upon the construction of a complex contract. By a bare majority, the House of Lords, departing from the judgments of both trial judge and Court of Appeal, held that a clearing house arrangement should be struck down for want of compliance with the pari passu rule. Unfortunately, in neither of the two substantial speeches51 is there a clear account of the operation of the clearing house scheme or of why it should or should not be seen as transgressing the pari passu rule. The scheme appears, nevertheless, to have worked in the following way. Airline members of a clearing house scheme maintained by the International Air Transport Association (IATA) agreed to be bound severally towards IATA and each other according to the terms of an Inter-line Traffic Agreement incorporating rules and regulations of IATA dealing with clearing. Over the course of a monthly accounting period, airlines would both issue tickets and carry passengers with tickets issued by other airlines. The need for ticket-issuing airlines to compensate carrying airlines in the multiplicity of cases where this occurred led to the creation of a clearing house to reduce the volume of cross-remittances that would otherwise take place amongst the many member airlines. Each airline with a carrying claim would submit invoices to the clearing house, notifying also the relevant airlines issuing tickets in respect of the carrying claims. The clearing house would then compute the sum of credits claimed in this way by each airline as well as the debits claimed against that airline. Net debtor airlines would pay sums to the clearing house which would distribute the sum of these payments to the net creditor airlines according to their respective entitlements.

47

(1873) 8 Ch App 647. Ibid 648. 49 See also Re Jones, ex p Nichols (1883) 22 Ch D 782 (charge over future book debts may not embrace book debts coming into existence after the commencement of a winding-up); Re Thompson, ex p Williams (1877) 7 Ch D 138 (a sham transaction giving the ‘landlord’ a right to distrain for unpaid ‘rent’ (really, mortgage payments) after the commencement of a bankruptcy). 50 [1975] 2 All ER 390. 51 Lord Cross for the majority and Lord Morris for the minority. 48

Collectivity, Management of Estates and the Pari Passu Rule 11 1.20 Over the relevant period, British Eagle was in a net credit position as against Air France but in a net debit position under the scheme as a whole. The liquidator challenged the validity of the scheme after the date of commencement of insolvency proceedings and in the name of the company brought proceedings against Air France for the amount it owed British Eagle over the relevant accounting period. Without explaining how or why, the majority in the House of Lords concluded that the airlines had ‘contracted out’ of the pari passu scheme in what is now section 107 of the Insolvency Act, even though the scheme for dealing with cross-remittances operated in exactly the same way before the commencement of British Eagle’s insolvency as it did afterwards. Pending the operation of the scheme at the end of the disputed accounting period, British Eagle had rights, not as such in debt but by way of an innominate chose in action with only some of the characteristics of debts, against Air France.52 These rights were not being dealt with in the manner mandated by section 107. 1.21 The pari passu rule at that time provided that ‘the property of a company shall, on its winding up, be applied in satisfaction of its liabilities pari passu’. More or less the same language is now to be found in section 107 of the Insolvency Act 1986 but is confined to voluntary winding-up. The wording of the rule applicable to compulsory winding-up, however, is somewhat different in that ‘[d]ebts . . . rank equally between themselves in the winding up . . . unless the assets are insufficient for meeting them, in which case they abate in equal proportions between themselves’.53 Now, making the assumption that British Eagle were instead a case of compulsory winding-up, it requires some elasticity to apply the latter equal-ranking rule to the facts of the case. It might nevertheless be concluded that British Eagle’s creditors, of whom Air France was not one, were not treated equally. To do so, the release of Air France from liability to British Eagle needs to be seen in the first place as leading to the selective payment of one or more unidentified creditors of British Eagle who are paid in the form of a forgiveness of their corresponding indebtedness to other members of the clearing house scheme. To demonstrate that this has occurred, it would be necessary to identify such a creditor or creditors and the amount of the debts owed to them by British Eagle, and to determine whether they were indebted to Air France. (These questions cannot be answered from the report of what was a case on voluntary winding-up.). In other words, to demonstrate that the rule now applicable to compulsory winding-up would have been infringed in the case of British Eagle requires a complex tracing exercise to be undertaken. 1.22 The rule actually before the House of Lords in British Eagle, in substantially the same words as are now applied to voluntary winding-up, places the 52 Speaking for the majority, Lord Cross was prepared to make this assumption: [1975] 2 All ER 390 at 409. The dissenting speeches rejected the view that British Eagle had a debt claim against Air France: ibid at 394, 396 and 400 (Lord Morris), 403 (Lord Simon). 53 Insolvency Rules 1986 r 4.181(1).

12 Michael G. Bridge focus, not on the several debts owed by the company in liquidation, but upon a duty requiring the property of the company to be applied in the payment of its debts. As stated above, that duty certainly rests upon the liquidator but it is not at all clear whether it rests upon any other party, such as the company itself in the days prior to the appointment of the liquidator. Subject to this, it may be concluded that the innominate chose in action that British Eagle had against Air France was not being applied in the rateable payment of British Eagle’s creditors in the way mandated by the section. This approach highlights the difference between the majority and the minority in the House of Lords: the latter seem to have believed that whatever rights carrying airlines might otherwise have had against ticket-issuing airlines had been replaced by rights arising out of the operation of the clearing house scheme. Consequently, there would be no property (the innominate chose in action) to apply as required by the section. This view would be stronger if the clearing house had at all times been the contractual counterparty to the carrying airline, but it seems likely that the effect of the clearing house scheme was to effect a novation of the carrying airline’s claim against the ticket-issuing airline. To the extent that this operated multiply with each and every such claim, then it was happening after the commencement of British Eagle’s winding-up. 1.23 Had this been a case of compulsory winding-up, section 127 of the Insolvency Act could have been brought into play. As lex specialis, it ought to prevail in any conflict with the pari passu rule.54 Now, if the House of Lords had been free to examine the clearing house scheme in the light of the jurisdiction now contained in section 127, it might have exercised a discretion under that section to uphold the scheme. For the purpose of the section, the disposition was the surrender by British Eagle of its claim to payment by Air France in return for absolution from financially equivalent claims by its creditors and fellow members of the clearing house scheme. Nevertheless, even had such a discretion been in play, the obstacles to its application to uphold the operation of the clearing house scheme would have been considerable. First, the discretion, once described as an ‘extremely jejune direction to the court’,55 has no pedigree in cases of this nature concerning clearing house schemes, though it has also been described as a ‘discretion . . . left . . . entirely at large, and controlled only by the general principles which apply to every kind of judicial discretion’.56 It is a striking feature of insolvency law that a great many of its rules and discretions are poorly defined and hard to predict in their application. It would take a powerful impulse to sustain a transaction with the aid of the section 127 discretion notwithstanding its offending the distribution scheme of the Insolvency Act. Secondly, while that impulse might in the cause of extreme expediency have been harnessed to a prevention of cascading insolvencies in the financial 54 55 56

Insolvency Rules 1986 r 4.181(1). Harman LJ in Re Clifton Place Garage Ltd [1970] Ch 477. Re Steane’s (Bournemouth) Ltd [1950] 1 All ER 21 at 25 (Vaisey J).

Collectivity, Management of Estates and the Pari Passu Rule 13 markets,57 no such bleak possibility presented itself in the case at hand. Thirdly, on the face of it, although a trading off of equivalent financial claims, on behalf of and against British Eagle, has the semblance of equality, the equality is of a hollow kind when the true measure of the exchange is a full claim by British Eagle against a dividend by its equal and opposite creditor. Fourthly, just as the majority in the House of Lords considered that enforcement in the insolvency of British Eagle of the clearing house arrangement would have given net creditors of the arrangement the equivalent of a charge not created and perfected as such, so the court would surely have jibbed at an outcome that would in effect have taken the rules of insolvency set-off into a multipartite domain. 1.24 Nevertheless, despite some concern at the relative ease with which the outcome in British Eagle might be avoided in a voluntary winding-up by the application of the rule in section 127 with its saving discretion, it is clear that, as important as pari passu distribution is in the application of that section,58 the section may be applied in such a way as to require a departure from the prescribed order of distribution. Section 127 is concerned above all with the preservation and maximisation of the insolvent’s estate, which may involve a departure from the pari passu rule. The matter was expressed very clearly by Buckley LJ in Re Gray’s Inn Construction Co Ltd: Since the policy of the law is to procure so far as practicable the rateable payments of the unsecured creditors’ claims, it is, in my opinion, clear that the court should not validate any transaction or series of transactions which might result in one or more pre-liquidation creditors being paid in full at the expense of other creditors, who will only receive a dividend, in the absence of special circumstances making such a course desirable in the interests of the unsecured creditors as a body (emphasis added).59

It may be in the interests of all creditors that a trading company be sold as a going concern,60 which may require payment to be made to suppliers after the commencement of the winding-up. Similarly, where the trading prospects of a company depend upon the continuing goodwill of a strategically important supplier, then that supplier may permissibly be preferred to other creditors of the company by having its past debts paid so that future supplies can be assured.61 In the light of this, it is to say the least unfortunate that such a stark difference exists between compulsory and voluntary winding-up in the matter of the section 127 discretion.

57

Subsequently dealt with by Part VII of the Companies Act 1989 and orders made thereunder. See Re J Leslie Engineers Co Ltd [1976] 2 All ER 85 at 95 (Oliver J); Re Civil Service and General Store Ltd (1887) 57 LJ Ch 119 at 120. 59 [1980] 1 WLR 711 at 717–18, emphasising the collective nature of the insolvency process. See also ibid at 719; Re J Leslie Engineers Co Ltd [1976] 1 WLR 292 at 304. 60 See Re Wiltshire Iron Co (1868) LR 3 Ch App 443 at 447 (Lord Cairns LJ). 61 Denny v J Hudson & Co Ltd [1992] BCLC 901 (CA). 58

14 Michael G. Bridge (3) Defining the Contents of the Estate 1.25 A wide-ranging review of the availability of security is outside the scope of this chapter. Nevertheless, a few points are in order. First of all, English law imposes few barriers to the taking of security. In particular, in contrast with civilian jurisdictions, it permits the taking of general security across a broad range of different types of asset.62 This means that the potential content of an insolvent’s estate can be emptied away by the prior grant of security. There is a stark contrast, if not conflict, of principles at work here. On the one hand, the principle of freedom of contract reigns largely unchallenged in the law of security,63 with the result that distributional questions amongst creditors as a class do not come into play. Moreover, that security is treated as abstracting property from the eventual estate64 so that the rules of insolvency law apply only to what is left after security has been taken.65 By way of contrast, public policy in the form of community interest plays a prominent part in the law governing insolvency distribution.66 1.26 The stark contrast between the individualist character of security and the collective character of insolvency is abated somewhat by the rules that permit secured creditors to disclaim their security and prove as unsecured creditors,67 62 See M Gdanski, ‘Taking Security in France’, and B Jäkel, ‘Outline of Security Interests under German Law’, in MG Bridge and R Stevens (eds), Cross-Border Security and Isolvency (Oxford, Oxford University Press, 2001). 63 See, for example, Re Brightlife Ltd [1987] Ch 200 and Welsh Development Agency v Export Finance Co Ltd [1991] BCLC 148. There are however limits to the application of the principle at the point where fixed and floating charges meet: see Agnew v CIR, n 35 above. Similarly, freedom of contract does not permit security to be disguised in the form of reservation of title clauses, in that extended reservation of title clauses covering money proceeds and new products have been treated as charges: see, for example, E Pfeiffer Weinkellerei-Weinenkauf GmbH v Arbuthnot Factors [1988] 1 WLR 150; Re Peachdart Ltd [1984] Ch 131. 64 For a recent example, see Cleaver v Delta American Reinsurance Co [2001] UKPC 6, [2001] 2 AC 328, where a foreign creditor putting in a proof for part of an unsatisfied judgment in a Cayman Islands insolvency was not required to bring into hotchpot a sum corresponding to the remainder of that judgment. This latter sum had been received from a third party bank under the terms of a letter of credit. The bank in turn had taken a charge for the amount of the letter of credit over assets of the debtor Cayman Islands company. Since the Cayman Islands company had therefore only an equity of redemption in its charged assets, the foreign creditor, in drawing on the letter of credit after the onset of the Cayman Islands insolvency, had not indirectly satisfied a part of its claim out of overseas assets of the Cayman Islands company. 65 This is subject to the major exception of the statutory subordination of floating charges to preference creditors (see Insolvency Act 1986 ss 40, 175; Companies Act 1986 s 196), which has given rise to major difficulties in defining what constitutes the property of the insolvent company in those cases where the claims of pre-preference creditors fall to be considered: Re Barleycorn Enterprises Ltd [1970] Ch 465; Re Portbase Clothing Ltd [1993] Ch 388; Buchler v Talbot [2002] EWCA Civ 228 [2002] 1 BCLC 571. 66 See the Report of the Insolvency Law Review Committee, Insolvency Law and Practice (Cmnd 8558, 1982), para 1734; National Westminster Bank Ltd v Halesowen Presswork and Assemblies Ltd [1972] AC 785. 67 Insolvency Rules 1986 r 4.88(2). The security must be surrendered for the general benefit of creditors and may not therefore for present purposes be assigned to a single one.

Collectivity, Management of Estates and the Pari Passu Rule 15 and undersecured creditors to prove for the balance of their claims after realising their security.68 More importantly, the bright line separating the two is obscured by the rules dealing with vulnerable transactions in the twilight period preceding a winding-up.69 A floating charge granted within twelve months 70 of the onset of insolvency is pro tanto avoided to the extent that the charge exceeds the value of the consideration for the charge given at the same time or after the creation of the charge in those cases where the company is unable to pay its debts at the time of granting the charge or becomes so as a result of granting the charge.71 Consideration is defined in terms of money, goods and services supplied, together with the discharge of indebtedness.72 It should be noted that it does not include factual forbearance from enforcing a debt, even if such accommodation could be valued in monetary terms. It is not at all easy to see why section 245 should be confined to floating charges and not also to fixed charges or, rather, the combination of fixed and floating charges so characteristic of modern bank security. It is also difficult to see how the calculation of value required by section 245 could be achieved where the security granted consists of a mix of fixed and floating charges. The reality is that section 245 seems designed to catch above all pure floating charges granted by the company to its own directors in the run up to insolvency.73 1.27 On a superficial examination, though standing outside section 245, fixed charges are open to challenge as undervalue transactions pursuant to section 238. The twilight period of six months prior to insolvency becomes two years for contractual counterparties connected with the company,74 in both cases requiring that the company at the time is unable to pay its debts or becomes so as a result of the transaction. Undervalue is defined as the extent to which the consideration in money’s worth accruing to the company is ‘significantly less’ than the consideration granted by the company to its counterparty. In practice, the limited scope thus accorded to the court to make a relieving order is cut down further still by the requirement that the court should not make an order if the transaction was entered into in good faith and for the purpose of carrying on the company’s business, and reasonable grounds existed at the time that the transaction was beneficial to the company. 1.28 Suppose now that a creditor is unsecured and that the company grants security to that creditor to stave off the threat of insolvency proceedings. The 68

Ibid r 4.88(1). The length of the period ranges from six months to three years according to the ground of challenge and the status of the counterparty to the transaction as a person connected with the company or not: Insolvency Act 1986 ss 238–41, 244–45. 70 Two years in the case of a chargee connected with the company: ibid s 245(3)(a). 71 Ibid s 245 (the test of inability to pay debts does not apply if the chargee is connected with the company). 72 Ibid s 245(2). 73 Directors would not be in a position to exercise the sorts of controls over bank accounts necessary to give rise to a fixed charge over book debts and their proceeds. 74 Insolvency Act 1986 s 240(1). 69

16 Michael G. Bridge only evident consideration supplied by the creditor is forbearance from taking steps to collect the debt and to commence insolvency proceedings. Such conduct on the part of the creditor would not fall within the definition of consideration for the purpose of section 245, since it does not take the form of money, goods, services or discharge from indebtedness, but it could be factored into the requirements of section 238. Nevertheless, any attempt to challenge late security under section 238 fails in limine because of the way that section 238 has been interpreted. In Re MC Bacon Ltd,75 Millett J held in strong terms that section 238 required that the assets of the company be ‘deplete[d]’;76 the grant of security did not deplete them.77 The company retained an equity of redemption in the charged or mortgaged assets, losing only the unfettered right to dispose of its assets other than in satisfaction of the secured debt. The test to be applied was not that of eventual prejudice to other creditors of the company in the event of insolvency, though such creditors were put in a disadvantageous position as a result of the grant of security. 1.29 Now, this interpretation is significant for the way it treats all creditors of the company, secured and unsecured alike, as an undifferentiated class in focusing on the company itself as the victim of the transaction. Section 245, in contrast, is alive to discrimination amongst the company’s creditors. The view taken by Millett J of section 238 is despite the jurisdiction to overturn the transaction being a narrow one and despite the fact that the transaction can only be challenged after the commencement of the liquidation at a time when the company itself is moribund and has no real interest in the proceedings. By allowing one creditor, the bank, to demand and receive a debenture at the expense of other creditors, and at a time when the company is unable to pay its debts, at a time indeed that might be on the very eve of insolvency proceedings, Millett J’s interpretation is at odds with the pari passu rule and insolvency distribution scheme. What is the point of having legislation that deals with vulnerable transactions in the twilight period if it can be so easily circumvented? Why should there be concern under section 238 for the company as victim when proceedings are taken only upon its demise? The interpretation of section 238 is also difficult to square with the various authorities that define a company’s property available for distribution as including only the equity of redemption of those assets that are charged and mortgaged. By the grant of the debenture, the company has most certainly disposed of its assets.78 The equity of redemption retained is manifestly worth less than the assets themselves that have been charged. Furthermore, although the test of consideration in section 245 differs somewhat from that in section 238, it is strikingly odd that section 245 applies to, and only 75

[1990] BCC 78. A word that does not appear in section 238 itself. 77 The same view was taken by Robert Walker J in Re Lewis’s of Leicester Ltd [1995] BCC 514. 78 Even if the pedantic point is taken that a charge is just an encumbrance and does not amount to the transfer or conveyance of the company’s property, that saving consideration does not apply to mortgages. 76

Collectivity, Management of Estates and the Pari Passu Rule 17 to, the grant of security whereas section 238, on Millett J’s interpretation, does not apply to the grant of a certain type of security at all. That interpretation seems a long way from the mischief of section 238. It is difficult also to understand why late floating charges should be open to challenge under section 245 on the ground of undervalue when late fixed charges are immune from a similar challenge under section 238. 1.30 The rules on unlawful preferences in section 239, for different reasons, afford little comfort to unsecured creditors concerned that one of their number has been singled out for the grant of security. Besides the usual security in the form of fixed and floating charges, that security may arise where the company recipient declares itself trustee of moneys received from one or more of its creditors. In so far as the initiative comes from the company debtor itself, as opposed to the trust arising as a result of the terms on which moneys are paid to the company,79 this poses the question whether the company has unlawfully preferred the beneficiary to its other creditors so as in the twilight period80 to infringe by anticipation the application of the pari passu rule. This is over and above any argument that might be made that the too easy inference of a trust by the courts also subverts the rule.81 The point was not taken in Re Kayford Ltd,82 where a mail-order company in financial difficulties set up a ‘Customers’ Trust Deposit Account’ into which it paid moneys received from customers who had not yet received their goods. The point was taken, but dismissed, in Re Lewis’s of Leicester Ltd,83 the court following the interpretation of section 239 by Millett J in Re MC Bacon Ltd.84 1.31 In Re MC Bacon Ltd, the court, given the new statutory language introduced in the 1980s, marked its departure from earlier case law when scrutinising the new statutory test.85 In order for there to be a preference, the company has to put one of its creditors (or sureties) in such a position that that party’s position in the company’s insolvent liquidation will be better than if the company had not acted. This will certainly catch the case of a creditor being granted security. Nevertheless, a preference does not arise unless the company was ‘influenced’ by a ‘desire’ to achieve for the creditor that beneficial effect. 79

The archetypal Quistclose trust. Defined in the same way as for undervalue transactions: s 240. 81 See Re Chelsea Cloisters Ltd (1981) 41 P & CR 98; M Bridge, ‘The Quistclose Trust in a World of Secured Transactions’ (1992) 12 Oxford Journal of Legal Studies 333. It is not a requirement that moneys the subject of a trust should be physically segregated (see, for example, Re Lewis’s of Leicester Ltd [1995] BCC 514 at 522), but such action will no doubt as a matter of evidence be significant, especially where the trust is an implied one. 82 [1975] 1 WLR 279. According to Megarry J: ‘Mr Heyman [counsel for the joint liquidators] was unable to contend that any question of a fraudulent preference arose’ (ibid at 281). 83 [1995] BCC 514. 84 [1990] BCC 78. 85 Comparing s 239 with s 44(1) of the Bankruptcy Act 1914, Millett J observed that: ‘Every single word of significance, whether in the form of statutory definition or in its judicial exposition, has been changed’: ibid at 87. 80

18 Michael G. Bridge Although in one respect a stricter test that the old law—since ‘influenced’ is much broader than the old notion requiring a ‘dominant intention to prefer’— section 239 as an effective bulwark against preferences has been neutered by Millett J’s interpretation that the requisite desire is subjective. The pain of the subordinated creditor, adversely affected by the preference, is no less intense because the creditor did not mean to hurt him. The consequence of Millet J’s interpretation is that a company granting security under pressure from an outside creditor,86 as occurred in Re MC Bacon Ltd itself, will be most unlikely to have granted that creditor a preference. A more likely prospect of a preference arises where a company voluntarily and of its own motion declares itself trustee of moneys received from some creditors.87 Another likely case is that of the company that grants a debenture to one of its own directors: there is a rebuttable presumption of a desire to benefit those who are connected with the company.88 Apart from such cases, the former of which is far less likely to arise than the grant of security to an outside creditor, section 239 does little to preserve the estate during the twilight period for distribution to creditors according to the pari passu rule and its various exceptions. Indeed, when the effect of section 239 is added to the effect of sections 238 and 245, on undervalue transactions and late floating charges, the provisions as a whole do little to protect unsecured creditors from the grant of security to one or more of their number during the twilight period, in a way that diminishes the estate available for later distribution.

C DISTRIBUTION OF THE ESTATE

(1) Order of Distribution 1.32 As stated above, the order of distribution of insolvents’ estates, even after security has been subtracted from them, is far removed from a simple application of the pari passu rule. There is a detailed protocol of differing entitlements ranking after secured creditors, who themselves will usually be postponed to other claimants with a proprietary interest in assets possessed by the company, arising by way of reservation of title, trust89 or restitutionary in rem right.90 This order of distribution in a winding-up will briefly be recited before particular cases and exceptions to the pari passu rule are discussed. 86 There is a presumption of desire in the case of persons connected with the company (s 239(6)), which gives much more scope to s 239 in such cases. 87 But the court found no evidence of an intention, let alone a desire, to prefer on the facts of Re Lewis’s of Leicester Ltd [1995] BCC 514. 88 N 86 above. 89 Barclays Bank Ltd v Quistclose Investments Ltd [1970] AC 567; Re Kayford Ltd [1975] 1 WLR 279. 90 Chase Manhattan Bank NA v Israel-British Bank (London) Ltd [1981] Ch 105; AttorneyGeneral for Hong Kong v Reid [1994] 1 AC 324.

Collectivity, Management of Estates and the Pari Passu Rule 19 1.33 The first creditors in the line are pre-preference creditors who are gathered in under the heading of expenses of the liquidation and as such rank ahead of preference creditors themselves.91 They do not rank equally inter se but receive distributions according to an elaborate order of priority in the Insolvency Rules,92 which the court is at liberty to adjust if the assets are insufficient to meet all claims.93 The various listed claims are mandatory: the court is not at liberty to admit them ‘only if [they] arose as a result of a step taken with a view to, or for the purposes of, obtaining a benefit for the estate’.94 They include the liquidator for his remuneration, necessary disbursements and expenses in getting in the company’s property, and those performing other services for the company as required or authorised by the Insolvency Act 1986. Suppliers of goods and services are not otherwise listed because they will be paid by the liquidator from time to time under his power to do all such things as are necessary to wind up the company’s affairs and distribute its assets.95 They will therefore not submit a proof. Those required to supply utilities to the company, namely, gas, water, electricity and telecommunication services, are entitled to demand that the liquidator personally guarantee payment for current services.96 The liquidator in turn will be able to claim pre-preference ranking in relation to these necessary disbursements. 1.34 An interesting feature of these pre-preferential claims is that they include claims that do not as such pass the strict test of expenses of the liquidation,97 thus creating a significant inroad into the pari passu principle. One example is continuing rental payments due under a lease of premises still in occupation by the company in liquidation. Although rental payments fall due after the commencement of the winding-up, they constitute a liability incurred prior to the winding-up which, in principle, could be valued on a contingency basis by the liquidator in the usual way.98 Nevertheless, for reasons of ‘common sense and ordinary justice’99 connected to the beneficial enjoyment by the company of the premises during the winding-up, the landlord does not have to prove for such post-commencement rentals but is paid them instead on a prepreferential basis. 91

Insolvency Act 1986 s 175. Rule 4.218. See also Insolvency Act 1986 ss 115 and 156. See also Re Toshoku Finance UK plc [2001] 1 WLR 2478, aff’d [2002] UKHL 6, [2002] 1 WLR 671. 93 Insolvency Act 1986 s 156. 94 Re Toshoku Finance UK plc [2002] UKHL 6 at [12], [2002] 1 WLR 671 at 675–76. (Lord Hoffmann), rejecting the narrowing effect of the liquidation expenses principle attributed to Nicholls LJ in Re Atlantic Computers plc [1992] Ch 505 at 520. 95 Insolvency Act 1986 Schedule 4, para 13. 96 Ibid s 233. 97 Re Toshoku Finance UK plc [2002] UKHL 6, [2002] 1 WLR 671; Re Atlantic Computers plc [1992] Ch 505; Re Lundy Granite Co (1871) LR 6 Ch App 462; Re Oak Pits Colliery Co (1882) 21 Ch D 322. 98 Insolvency Rules 1986 r 4.86(1). 99 Re Lundy Granite Co (1871) LR 6 Ch App 462 at 466 (James LJ). See also Re Toshoku Finance UK plc [2002] UKHL 6 at [29], [2002] 1 WLR 671 at 680 (Lord Hoffmann). 92

20 Michael G. Bridge 1.35 After these pre-preference creditors come the preference creditors themselves.100 They are limited in number, consisting primarily of the Inland Revenue for PAYE deductions, the Commissioners of Customs and Excise for VAT, the Crown in respect of social security contributions, trustees of occupational pension schemes and employees for unpaid remuneration.101 Even if the Crown preference is abolished by legislation,102 this will still leave occupational pension schemes and employees. In the case of employees, Crown preference of a sort will remain where the Crown is subrogated to the rights of employees after successful claims have been made by the latter on the National Insurance Fund.103 1.36 Next come unsecured creditors themselves, followed at the end of the line by members of the company ‘according to their rights and interests in the company’.104

(2) Particular Cases and Exceptions to the Pari Passu Rule 1.37 The pari passu rule manifests itself in numerous areas of insolvency law. The following sections of this chapter deal with a selective number of these areas where the rule is either brought into sharp relief or made the subject of an exception. (a) Subordination Agreements. 1.38 There are certain similarities between priority agreements and subordination agreements.105 Both concern companies in need of an injection of further financing which requires preferential treatment for the creditor who can be persuaded to advance new funds. In the case of a priority agreement, an earlier and higher-ranking secured creditor is persuaded to defer to a later secured creditor. 100

Insolvency Act 1986 s 386, Sch 6. Any attempt to increase their number or improve their entitlement at the expense of general creditors will offend the statutory scheme of distribution and therefore infringe the pari passu rule: Re Powerstore Ltd [1998] BCC 305 at 308 (approved on this point in Re Mark One (Oxford Street) plc [1999] 1WLR 1445) (an administrator may not obtain an order for the payment of preference creditors as defined at the (earlier) date for compulsory liquidation (the date of the administration order) when the administration is giving way to a voluntary liquidation (when the entitlement of preference creditors under section 387(3) of the Insolvency Act 1986 would date from the passing of the winding-up resolution). 102 As indicated in the recent White Paper, Insolvency—A Second Chance (Cm 5234, July 2001). 103 Employment Rights Act 1996 s 189. See RM Goode, Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 159–60. 104 Insolvency Act 1986 s 107 (voluntary liquidation). See also for compulsory liquidations rule 4.221 of the Insolvency Rules 1986 (return of capital ). 105 On subordination agreements, see generally E Ferran, Company Law and Corporate Finance (Oxford, Oxford University Press, 1999) at 549–64; B Johnstone, ‘Contractual Debt Subordination and Legislative Reform’ [1991] Journal of Business Law 225. 101

Collectivity, Management of Estates and the Pari Passu Rule 21 The interests of the former creditor are bound up in the welfare of the company in need of new funds, hence the willingness to forgo priority in favour of the latter creditor. This chapter, however, is concerned with the companion case of the unsecured creditor who accepts a subordinated status as regards another unsecured creditor bringing in new funds. There are various ways in which such a subordinated status might be accepted, all of which need to be measured according to the way they do or do not transgress the prescribed order of distribution. These ways include the subordinated creditor undertaking to hold any dividends received on trust (a turnover trust) for the preferred creditor; the subordinated creditor undertaking not to put in a proof in the debtor’s winding-up; the subordinated creditor undertaking not to accept a dividend so long as the preferred creditor has not been paid in full; and the subordinated creditor assigning its dividend rights to the preferred creditor.106 A further consideration is the identity of the parties to the subordination agreement, as the following discussion will show. 1.39 The binding force of subordination agreements is now recognised in England,107 the question having arisen in connection with schemes of arrangement under section 425 of the Companies Act 1985.108 Briefly, if the subordination agreement were effective, it meant that the scheme could go ahead without the consent of the subordinated creditor since its claim was worthless in view of the debtor’s insolvency. After an earlier case upholding a trust of the insolvency dividend held for the preferred creditor,109 it was settled in Re Maxwell Communications Corp plc (No 2)110 that a subordination agreement could take effect as a matter of contract, notwithstanding the pari passu rule and notwithstanding set-off authority whose supposed effect was that the rules of distribution were mandatory111 in character. The basis upon which the subordination agreement was upheld repays examination. 1.40 In Re Maxwell Communications Corp plc (No 2), certain bonds had been issued by MFJ on terms providing that payment was guaranteed by MCC but 106

See Ex p De Villiers, re Carbon Developments (Pty) Ltd 1993 (1) SA 493 at 504–05 (Goldstone

JA). 107 Also in Australia and New Zealand: Horne v Chester and Fein Property Developments Pty Ltd [1987] VR 913; Re NIAA Corporation Ltd (1993) 12 ACSR 141 (SC(NSW)); Stotter v Ararimu Holdings Ltd [1994] 2 NZLR 655. 108 Re British & Commonwealth Holdings plc (No 3) [1992] 1 WLR 672; Re Maxwell Communications Corp plc (No 2) [1993] 1 WLR 1402. 109 Re British & Commonwealth Holdings plc (No 3) (above). There is an insolvency risk here if the rights of the preferred creditor are seen as amounting to a charge over assets of the subordinated creditor, such as to require registration pursuant to section 395 of the Companies Act 1985, and the latter creditor goes into insolvent liquidation. 110 N 108 above. See also Horne v Chester and Fein Property Developments Pty Ltd [1987] VR 913. 111 This was the reason why New Zealand formerly refused to recognise subordination agreements (Re Orion Sound Ltd [1979] 2 NZLR 574), a position now reversed (Stotter v Ararimu Holdings Ltd [1994] 2 NZLR 655).

22 Michael G. Bridge that the rights of bondholders under this guarantee were subordinated to the rights of MCC’s other creditors. There was no contractual nexus between the bondholders and these other creditors. In addition, the agreement between MFJ and MCC, under which MCC would be entitled to be indemnified by MFJ in the event of the guarantee being called in, provided that MCC’s right to be indemnified was subordinated to the bondholders’ right first to be paid by MFJ. Both MCC and MFJ were insolvent. There was no subordination trust because the guarantee was governed by Swiss law, which does not recognise the trust. 1.41 Vinelott J held in clear terms that the contractual subordination was effective. He reasoned that a creditor was at liberty not to submit a proof in a winding-up, so it followed that a creditor could waive its right to be repaid after the commencement of a winding-up. From this it further followed that a creditor could also waive its right to prove prior to the commencement of a windingup. Putting the matter in terms of waiver is an interesting way of avoiding the evident difficulty of MCC’s other creditors not being party to any agreed subordination. Prior to the Contracts (Rights of Third Parties) Act 1999 there would have been substantial obstacles to the conferment on them of rights under a contract containing a subordination provision. Now that the Act is in force, it is of course possible for the future to analyse subordination as a promise of deferment made by the subordinated creditor to the preferred creditor.112 Waiver, furthermore, is not without its difficulties. If it is a matter of waiver in the sense of estoppel,113 there would have to be detrimental reliance or an alteration of position such that it would be inequitable to permit the waiver to be retracted. But then the question has to be asked, whose reliance or change of position? To which the answer is not, or at least not obviously, that of the preferred creditor. 1.42 The difficulties of waiver might have been avoided, and the absence of the preferred creditor from the subordination agreement overcome, if the subordinated creditor’s right to payment is seen as a flawed asset in that the debtor’s duty to pay arises only in the event of the preferred creditor first being paid. Vinelott J, however, was not comfortable with the idea of subordinated debt in this case as conditional, or rather ‘contingent’, since, while ranking behind preferred debt in insolvency distribution, it could be paid off in the usual way while the company debtor was a going concern. The learned judge’s difficulty, nevertheless, is semantic rather than substantial and he himself admitted that nothing turned upon the point in the instant case. 1.43 The Australian case of Re NIAA Corporation Ltd 114 concerned a scheme whereby members of a corporation, having been invited to contribute to a trust 112 The subordination ‘purports’ to benefit the preferred creditor, who thereupon may take advantage of a rebuttable presumption that he has the right of direct enforcement of the contractual term conferring the benefit: Contracts (Rights of Third Parties) Act 1999 s 1. 113 Waiver in the sense of election is not to the point: the subordinated creditor is giving up rights and not choosing between remedies. 114 (1993) 12 ACSR 141 (SC(NSW)).

Collectivity, Management of Estates and the Pari Passu Rule 23 fund to assist the corporation in its time of need, were given the option of converting their contributions into loan notes expressed to be subordinated to the claims of other creditors. The subordination did not come into effect because the notes were never issued. The court nevertheless lent its support to contractual subordination taking the form of a flawed asset, the debt in question only becoming payable once the preferred debt had been paid in full. A difficult issue was however raised as to subordination expressed to be in favour of only a limited number of other creditors, for this goes beyond the subordinated creditor forgoing his due. Since such an arrangement would be effective if a subordination trust were created of the subordinated creditor’s dividend, the court saw no reason to strike down a contractual arrangement that prejudiced no creditor and had exactly the same substantive effect.115 One difficulty with this line of reasoning is that it assumes a lax approach to technique in an area of law that more than most demands technical exactness in the matter of devising schemes to avoid otherwise mandatory law. Another difficulty is that the liquidator is now involved in the administration of the subordination scheme and liquidators will be guided more by legal form than by legal realism. Indeed, an English liquidator in a voluntary winding-up will rightly point to mandatory language in the text of section 107 of the Insolvency Act 1986 whose effect is to forbid the singling out of any creditor for favourable treatment when this is not sanctioned elsewhere in the Act. An English liquidator, moreover, is unlikely to be swayed, in a compulsory winding-up, by the less mandatory tone of rule 4.181. The expansive statement in Re NIAA Corporation Ltd of the effect of contractual subordination agreements is unlikely to command support in English case law. (b) Insolvency Set-Off 1.44 By any standard, the rules of set-off in insolvency constitute a major exception to the pari passu rule of distribution. Their practical effect is to give the creditor a security for its claim against a company in liquidation to the extent of the lesser of the two following amounts: the creditor’s claim against the company and the company’s cross-claim against the creditor. If the creditor has a claim for £1,000 against the company which has a cross-claim for £2,000, then the creditor’s ‘security’ amounts to £1,000. That security would be limited to £750 if the company’s cross-claim were for £750. A creditor has no need to bargain with the company for such a set-off right and need take no steps to perfect that right by registration or otherwise. Indeed, the creditor need not be actuated at all by the existence or potentiality of set-off rights in its dealing with the company. The justice of such a set-off entitlement demands consideration, especially when, as we shall see, insolvency set-off is more generous to the creditor than any other form of set-off available without a special bargain. In particular, insolvency set-off is better for the creditor than any form of set-off available where the company is in receivership. 115

Ibid at 156.

24 Michael G. Bridge 1.45 To see why this is so, let us take an example illustrating equitable set-off and legal set-off as they might apply between A and B Co. A purchases goods from B Co and duly pays the price before various faults in the goods, sounding in damages in the amount of £100,000, come to light. Under an unrelated contract, B Co is entitled to be paid £80,000 arising from the assignment by B Co to A of certain patent rights. Under the terms of a debenture, between B Co and C Bank, C Bank sends in a receiver, which has the effect of crystallising the floating charge contained in the debenture. The floating charge extends to receivables such as the £80,000 owed by A. The assignment to C Bank that takes effect upon the crystallisation of the floating charge is subject to equities and defences between A and B Co, which would include any legal and set-off rights available to A.116 Transactions occurring after notice of assignment cannot give rise to new set-off rights for the debtor.117 Legal set-off deals with debts and other liquidated claims and, as a matter of accounting, is unconcerned with any connection between claim and cross-claim. Whilst B’s cross-claim for £80,000 is liquidated, A’s £100,000 claim is not, so legal set-off is unavailable. Equitable set-off requires such a close material connection between claim and cross-claim, either or both of which may be unliquidated, that it would be inequitable to allow the recovery of one without account being taken of the other.118 The absence of any transactional connection between A’s claim and B’s cross-claim rules out equitable set-off.119 1.46 Suppose now that C was a creditor presenting a winding-up petition. The rules of insolvency set-off, as presented in rule 4.90, require there to have been ‘mutual debts, mutual credits or other mutual dealings’ between a company and one of its creditors prior to the company going into liquidation. Neither claim need be liquidated, nor must the claims be connected.120 It is enough that they be monetary in nature or reducible to monetary terms, which means that eventually121 they must be capable of terminating in debt.122 The mutuality requirement excludes certain forms of wrongdoing. A creditor may not there set off the company’s debt to him against his liability to the company for a misappropriation of funds123 or for a conversion of the company’s assets.124 Nevertheless, A’s 116 See, for example, Biggerstaff v Rowatt’s Wharf Ltd [1896] 2 Ch 93; Government of Newfoundland v Newfoundland Railway Co (1888) 13 App Cas 199. 117 NW Robbie & Co Ltd v Witney Warehouse Ltd [1963] 1 WLR 1324. 118 Rawson v Samuel (1841) Cr & Ph 161. 119 Business Computers Ltd v Anglo-African Leasing Ltd [1977] 1 WLR 578. 120 Damages claims were introduced into bankruptcy set-off by the Bankruptcy Act 1861 (see ss 149–54). More importantly, the expression ‘mutual dealings’ was introduced by the Bankruptcy Act 1869. See also SR Derham, Set-Off 2nd edn (Oxford, Clarendon Press, 1996) at 210–11; Peat v Jones & Co (1881) 8 QBD 147 at 149. 121 It is at this point that the departure from set-off in receivership cases is marked. 122 See RM Goode, Principles of Corporate Insolvency, 2nd edn (London, Sweet & Maxwell, 1997) at 189; Rose v Hart (1818) 8 Taunt 499. 123 Manson v Smith [1997] 2 BCLC 161. 124 Smith (Administrator of Cosslett (Contractors) Ltd) v Bridgend County Borough Council [2002] 1 AC 336.

Collectivity, Management of Estates and the Pari Passu Rule 25 claim for damages, in the above example, will of its nature culminate in a judgment debt after liability is established and damages have been assessed. The rule of insolvency set-off is capable of taking account of contingent claims, at least where it is the creditor’s claim that is contingent,125 and has the patience to wait for the unliquidated to become liquidated. 1.47 It is far from obvious that the right of set-off available to a liquidation creditor should be superior to the right available to the receivership creditor or, to put it another way, why set-off rights should be improved when insolvency supervenes. To say that insolvency set-off exists to do ‘substantial justice’ between the parties opens rather than closes any debate on the subject. No other ordinary unsecured creditor obtains a positive advantage upon the commencement of the liquidation. Any defence of the position based upon creditors ordering their affairs by reference to their set-off rights not only begs the question but is also fanciful in the extreme. In truth, insolvency set-off frequently amounts to a windfall immunity from a full claim by the liquidator. The absence of commentary on this aspect of insolvency set-off is striking. Given the breadth of the ‘mutual dealings’ that give rise to set-off, it hardly seems enough to refer to the injustice of a creditor having to pay a liquidator in full only to receive a dividend in return.126 1.48 Finally, there remains the point, established by the highest authority, that insolvency set-off is mandatory. Even if willing to do so, a creditor of the company in liquidation could not forgo, or suffer a diminution in, his set-off entitlement. The explanation for this unusual position is less than satisfying. In National Westminster Bank v Halesowen Presswork and Engineering Ltd,127 Lord Cross128 referred to the mandatory character of the language of section 31 of the Bankruptcy Act 1914:129 an account ‘shall’ be taken in respect of the mutual dealings and the two sums ‘shall’ be set off against each other.130 Nevertheless, in the minority on this point, he preferred to apply instead the principle that those for whose benefit provision is made—here the creditors of the company—should be free to renounce that benefit. He analysed authority strongly affirming the mandatory character of set-off 131 but concluded that it did not concern an antecedent agreement concerning set-off. For the majority 125 The liquidator may assess the value of a contingent claim against the company: Insolvency Rules, r 4.86(1). Hoffmann LJ thought the absence of machinery for valuing a company’s contingent claim would not present a problem in practice: MS Fashions Ltd v Bank of Credit and Commerce International SA (No 2) [1993] Ch 425. 126 See Lord Simon in National Westminster Bank Ltd v Halesowen Presswork and Engineering Ltd [1972] AC 785, citing Mellish LJ in Re Deveze, ex p Barnett (1874) 9 Ch App 293 at 297. 127 [1972] AC 785. 128 Balcombe LJ in Stein v Blake [1994] Ch 16 at 23. 129 The predecessor of both s 323 of the Insolvency Act (bankruptcy) and r 4.90 of the Insolvency Rules (winding-up). 130 This language is reiterated in the current provisions. 131 For example, Re Deveze, ex p Barnett (1874) 9 Ch App 293; Re Vaughan, ex p Fletcher (1877) 6 Ch D 350; Re City Life Assurance Co Ltd [1926] Ch 191; Rolls Razor Ltd v Cox [1967] 1 QB 552.

26 Michael G. Bridge who held that there could be no contracting out of the statutory regime, Lord Kilbrandon speculated that the mandatory language (‘shall’) of the set-off section was introduced as a matter of policy to prevent either party from opting out of set-off, but what that policy might have been he did not say. His position against contracting out seems to rest simply upon the weight of authority disallowing it.132 This outcome of the case is all the stranger once it is recognised that set-off is only mandatory when the creditor at his option proves or claims to prove in the winding-up.133 Where is the injustice in recognising the binding force of a contract when unilateral inaction on the part of the creditor would perforce be recognised? Furthermore, the mandatory rule has been undermined by authority upholding the validity of subordination agreements. The rule against contracting out of set-off seems therefore to serve no rational purpose. It is hardly enough to say that it serves the purpose of ensuring ‘the administration of bankrupts’ estates in a proper and orderly way’. That makes a fetish of tidiness. (c) Direct Payment Clauses and Trusts 1.49 Direct payment clauses are, or used to be, a feature of the building industry.134 Reducing the complex network of contracts in the building industry to simple proportions, suppose the standard relationship of employer, main contractor and sub-contractors, under which the employer (usually the site owner) contracts with the main contractor who in turn contracts with the sub-contractors. From time to time as the work done is certificated, the employer makes payments to the main contractor who in turn pays the sub-contractors responsible for the work. The building industry is notoriously undercapitalised. If the main contractor becomes insolvent, the liquidator may not have the resources or the desire to continue with the contract. Unpaid sub-contractors may not have the financial capacity to finish the work at the behest of an employer going into possession of the site. In numerous ways, the insolvent liquidation of the main contractor is profoundly disruptive of the building venture and threatens its successful outcome. 1.50 To guard against the problem of the main contractor that is in no position to pay sub-contractors once its insolvent liquidation supervenes, employers have in the past sought, by means of direct payment clauses, to reserve to themselves the right to make direct payment to sub-contractors on one or more stated events. Such direct payment clauses are often discretionary in character, but they may in some instances require direct payment to be made. In the wake of the House of Lords decision in British Eagle International Airlines Ltd v Cie 132 This was also the position of Viscount Dilhorne. Lord Simon, the fourth and last member of the House on this occasion, agreed with both Viscount Dilhorne and Lord Kilbrandon on this point. 133 Insolvency Rules 1986 r 4.90(1). 134 See G McCormack, Proprietary Claims in Insolvency, 2nd edn (London, Sweet & Maxwell, 1995), ch 2.

Collectivity, Management of Estates and the Pari Passu Rule 27 Nationale Air France,135 it was feared in the building industry that such clauses, in singling sub-contractors out from the mass of the main contractor’s other creditors, infringed the pari passu rule of distribution. Responding to this point, the 1980 JCT contract removed from employers the right to make direct payment to sub-contractors when the main contractor became insolvent. The Latham Report of 1994136 laconically observes that the British Eagle decision ‘removed the right of the employer to pay nominated subcontractors directly if the main contractor failed’.137 It recommended that there should instead be legislation providing for mandatory trust funds for interim payments and retentions in the case of construction work governed by formal conditions of contract, so as to ensure that subcontractors would be paid if the main contractor became insolvent.138 In its non-committal response to the proposal, the Government of the day may have confused a proposal for mandatory trusts with a proposal that the Insolvency Act be amended so as to overturn the British Eagle decision.139 Certainly, there is no reason why parties should not voluntarily and expressly create such direct payment trusts, always supposing that no issues arise (which in all probability they do not) concerning the law on vulnerable transactions. 1.51 Whatever their fate in the building industry, direct payment clauses have the potentiality of arising in other areas of commercial life, so it would be premature to write them off. 1.52 The validity of a direct payment clause, challenged by a trustee-inbankruptcy, was upheld in Re Wilkinson.140 A supervising engineer acting for the employer was empowered, where in his opinion ‘the contractor is unduly delaying proper payment’ to certain firms supplying machinery to the contractor, to make direct payment to those firms. The engineer ordered direct payment of the sums in question but, before they could be paid by the employer, they were claimed by the trustee as property of the bankrupt contractor divisible among his creditors. Bigham J, in a simple judgment, ruled against the trustee for the following reasons: first, the direct payment clause benefited the employer as much as the firms, who were creditors of the contractor; secondly, the authority given to the employer to make direct payment was not revoked on the bankruptcy of the contractor;141 thirdly, the trustee was bound by the clause as much as the contractor was;142 and fourthly, as a matter of construction, the contractor 135

[1975] 2 All ER 390. Constructing the Team (Sir Michael Latham, Final Report of the Government/Industry Review of Procurement and Contractual Arrangements in the UK Construction Industry, July 1994). 137 Ibid para 10.2. 138 Ibid paras 10.6ff. See J Jenkins, ‘The Latham Report Trust Fund Proposals’ (1995) 11 Construction Law Journal 262. 139 See Department of the Environment Consultation Paper, Fair Construction Contracts (May 1995). 140 [1905] 2 KB 713. 141 Though not explicitly put in these terms, the employer’s power was coupled with an interest. 142 In other words, the trustee stood in the shoes of the bankrupt. 136

28 Michael G. Bridge delayed the making of proper payment by petitioning for his own bankruptcy.143 Noticeably absent from the case was any mention of the pari passu rule. Absent too was any mention of the fact that the direct payment clause was not expressed to operate only in the case of the contractor’s bankruptcy. 1.53 The direct payment clause in Re Tout and Finch Ltd144 empowered the employer, when making payment under an architect’s certificate, to pay subcontractors directly where they had not in fact been paid out of moneys received by the contractor under previous certificates. The contractor was bound under its contract with the employer to pay subcontractors the amounts certified to be due to them in the architect’s certificate. Wynn-Parry J considered the case to be covered by Re Wilkinson since the two direct payment clauses for practical purposes corresponded to each other. A similar clause was present in the Irish case of Glow Heating Ltd v Eastern Health Board,145 except that the employer was under a contractual obligation to make direct payment to the subcontractor in the absence of proof that subcontractors had been paid for previous work. This case, moreover, is significant as a post-British Eagle decision. The court held that direct payment did not contravene the pari passu rule: it was no more a case of the company’s property being disposed of contrary to legislation than would have been a reservation of title clause in a contract of sale. The liquidator of the company took the retention fund subject to the same liability that bound the company itself when it was a going concern. Although the particular language was not used in the decision, the company’s right to payment, qualified to the extent that subcontractors had not previously been paid, was a flawed asset. It always was flawed and did not become so on the insolvency of the company. 1.54 A different view was taken of a discretionary direct payment clause in another post-British Eagle case, the decision of the New Zealand Court of Appeal in Attorney-General v McMillan & Lockwood Ltd.146 The majority in that case, impressed by the paramountcy of the pari passu rule, held that the direct payment clause offended the rule for two principal reasons.147 First, a debt could be present property even though it was payable in the future, and payable, as here, upon a condition, namely the issue of an architect’s certificate. Secondly, the direct payment clause empowered the employer to pay the subcontractor directly ‘as if [the subcontractor] were a lawful assignee of the 143 A more broadly worded discretion would appear to be necessary to meet the case of a creditor’s petition. Direct payment clauses are to be strictly construed: JA Milestone & Sons Ltd v Yates Castle Brewery Ltd [1938] 2 All ER 439 at 443 (Singleton J). 144 [1954] 1 WLR 178. 145 (1988) 6 ILT 237. 146 [1991] 1 NZLR 53. If the employer had not been the Crown, subcontractors would have taken the benefit of a statutory charge under legislation that did not bind the Crown. 147 The view taken by the majority of the New Zealand Court of Appeal, that a discretionary direct payment clause fell foul of the decision of the House of Lords in British Eagle, was also taken by a Northern Ireland court in B Mullan & Sons (Contractors) Ltd v Ross (unreported 7 December 1995), discussed in G McCormack, Proprietary Claims in Insolvency, 2nd edn (London, Sweet & Maxwell, 1995) at 23, aff’d sub nom Re McLaughlin & Harvey plc [1996] NI 618.

Collectivity, Management of Estates and the Pari Passu Rule 29 Contractor’, which assumed that a property right in the debt was vested in the contractor. As for the first reason, this presupposes that a debt was owed to the contractor who had to be divested of that right before payment could be made directly to the subcontractor. If, however, the focus is placed upon the employer’s genuine right to elect on a stated event, namely previous nonpayment of a subcontractor, between paying the contractor and directly paying that subcontractor, then it is impossible to maintain that the contractor has a property right in the debt which is being alienated in breach of the pari passu rule. The argument that there is unacceptable uncertainty if the ownership of a debt cannot be determined prior to the employer’s decision is surely met by the response that, by means of a no-assignment clause, it is possible to prevent a contractual right to payment from becoming a property right in the first place. Of course, the above analysis of the employer having a right to elect between different payees is based upon contractual drafting that reflects precisely that and not a right of the contractor to be paid which is liable to be divested in favour of a subcontractor on a stated event. Even here, however, it is difficult to see how the pari passu rule can be infringed where the event and the exercise of the election to pay the subcontractor have both occurred before the contractor’s insolvency, even if payment has not yet occurred by that date. Indeed, the dissenting judge was of the view that the liquidator succeeded to the position of the company at a time when the employer, under one of two contracts, had already exercised the right to make direct payment to the subcontractor.148 The liquidator should be no better off than the contractor itself.149 1.55 The second reason given by the majority latches on to what is only an assignment simile in the clause. This does not in fact mean that an assignment, of whatever sort, has actually taken place. Moreover, it would be an odd sort of assignment that was effected not by the creditor (the contractor) but by the debtor (the employer) instead. It is wise, nevertheless, if direct payment clauses are to receive further consideration, to avoid the language of assignment. 1.56 The same flawed asset reasoning in Glow Heating Ltd v Eastern Health Board 150 should equally apply to a discretionary direct payment clause. In both cases, events occurring prior to the company’s insolvency meant that, at the commencement of the insolvency, the company did not have the unqualified right to be paid by the employer. In the case of mandatory direct payment, moreover, there is now, as a result of the Contracts (Rights of Third Parties) Act 1999, the additional point that the subcontractor may acquire a direct right of enforcement of the main contract as a third party beneficiary. That right of enforcement would arise because the main contract purports to benefit the 148 Ibid at 65 (Williamson J). The same judge, more ambitiously, also sought to place the pari passu in a broader setting of public policy that took account, for example, of an employer’s interest in maintaining a building project despite a contractor’s insolvency. 149 Ibid. 150 (1988) 6 ILT 237.

30 Michael G. Bridge subcontractor and there is nothing to rebut the presumption of direct enforceability thus raised. Nothing in the Act precludes direct enforcement merely because the benefit was at one time a contingent one. Once a direct right of enforcement comes into existence under the Act, it becomes irrevocable, in the sense that the parties to the contract may not vary the contract, to remove or qualify the promise that forms the subject matter of the right of enforcement, where the third party signals his acceptance of the benefit, or else either reasonably relies upon the contract, or just relies upon it to the knowledge of the contracting parties.151 In the case of a subcontractor, establishing either form of reliance should not prove to be difficult. It would be extraordinary, in the light of the Act, if the scheme of direct enforcement could be determined by the insolvent liquidation of one of the parties. The notion that the liquidator stands in the shoes of the company is brought into sharp relief by the Act. 1.57 In Re Tout and Finch Ltd,152 there was, in addition to the direct payment clause, a separate clause by which the contractor’s interest in retention moneys in the hands of the employer was stated to be ‘fiduciary as trustee for the subcontractor’. This clause on its face was unclear as to the extent of the subcontractor’s beneficial interest in the retention moneys, in particular whether it extended to all sums owed by the contractor or only to the subcontractor’s rateable share of the retention fund.153 Wynn-Parry J, nevertheless, appears to have treated the clause as meaning the former. The contractor was held to have effected a valid equitable assignment to the subcontractor of its interest in the retention moneys.154 A mere contractual obligation to assign that interest, as much as it may otherwise be made the subject of a mandatory order,155 will not be enforced once the contractor’s insolvency supervenes.156 (d) Vesting Clauses, Forfeitures and Determinable Interests 1.58 As seen above, section 127 of the Insolvency Act declares void any disposition of the company’s property in a compulsory winding-up unless the court otherwise orders. This jurisdiction exists to safeguard the operation of the statutory order of distribution of the company’s assets. Section 127, which appears to presuppose dispositions initiated in a winding-up, is part of a broader scheme to protect the integrity of the estate for distribution. By a variety of expedients, creditors may attempt to better their position on an insolvency by providing 151

Contracts (Rights of Third Parties) Act 1999 s 2. [1954] 1 WLR 178. 153 The subcontractor’s entitlement to a rateable share is spelt out in relevant clause in Re Arthur Sanders Ltd (1981) 17 Build LR 125. 154 More accurately, of its entitlement to receive from the contractor the benefit of the employer’s obligation to pay the retained sum. 155 Rayack Construction Ltd v Lampeter Meat Co Ltd (1979) 12 Build LR 30. 156 Re Jartay Developments Ltd (1982) 22 Build LR 134. See also Mac-Jordan Construction Ltd v Brookmount Erostin Ltd [1992] BCLC 350. 152

Collectivity, Management of Estates and the Pari Passu Rule 31 contractually for assets of the company to vest in them or be forfeit to them in the event of the company’s liquidation. In addition, the size of the company’s estate may shrink because its interest in certain assets is alienated in the event of a winding-up. 1.59 Taking first vesting and forfeiture clauses, these have been a particular feature of the building trade where, in the event of a main contractor’s liquidation, the employer stands to incur collateral damage as a result of delay thereby caused to the building project. To avert the project being stalled by the windingup procedure, employers have sought to protect their interests from the outset. Direct payment clauses and trusts are one example of this. For present purposes, the main devices relied upon by employers are clauses by which materials brought on to the building site vest in the employer and clauses allowing the employer to take over the management of the building project. 1.60 Taking first the latter clause, it has a proprietary effect in the following sense. The contract is treated, for the purpose of the liquidator’s statutory power to disclaim onerous property,157 as property. In connection with this power, it should be noted that insolvency and winding-up are not as such repudiatory breaches of a contract so as to give the contractual counterparty the right to terminate the contract before the liquidator is in a position to exercise the power.158 Nevertheless, it is clear that parties may by contract stipulate that either may terminate the contract in the event of the other’s insolvency.159 Similarly, provisions allowing an employer to reenter the site and take over the building contract have been upheld by the courts.160 In so far as the employer has taken over only those materials that have already vested in it, or in which it has a proprietary interest by way of security, this has not been a controversial matter.161 In Re Cosslett (Contractors) Ltd,162 a building contract entitled the employer, in the event of the contractor going into liquidation or abandoning the contract, to complete the works. In doing so, the employer was assisted by 157

Insolvency Act 1986 s 178. Ex p Chalmers (1873) 8 Ch App 289; Jenning’s Trustee v King [1952] 2 All ER 608. But inaction by the parties following the commencement of a winding-up may evince a mutual intention to abandon the contract: Morgan v Bain (1874) LR 10 CP 15. 159 For example, Shipton Anderson & Co (1927) Ltd v Micks Lambert & Co [1936] 2 All ER 1032. See also Oditah, ‘Assets and the Treatment of Claims in Insolvency’ (1992) 108 Law Quarterly Review 459. 160 For example, Brown v Bateman (1872) LR 2 CP 272. See also the discussion of these clauses and the relevant case law in Re Cosslett (Contractors) Ltd [1998] Ch 495 (CA). These clauses were not just challenged in a winding-up or bankruptcy. They might for example be challenged by an execution creditor. In bankruptcy, moreover, they might be challenged under the (now superseded) reputed ownership doctrine, which of course did not apply to companies. 161 Re Walker, ex p Barter (1884) 17 Ch D 510. 162 See n 160 above. The decision was reversed by the House of Lords (sub nom. Smith (Administrator of Cosslett (Contractors) Ltd) v Bridgend County Borough Council [2001] UKHL 58, [2002] 1 AC 336) on another ground, namely that, in authorising the new contractor taking over the works to remove the plant from the site, the employer had committed the tort of conversion and the administrator acting in the name of the company was entitled to bring proceedings in conversion. 158

32 Michael G. Bridge two further provisions. One of these deemed it to be the owner of plant, goods and materials brought by the contractor on site and prevented the contractor from removing these items without consent. The other, in various events that included the contractor’s bankruptcy, granted the employer a right of sale of these items after first exercising the right to reenter the site. Under this latter provision, the contract was to remain on foot. 1.61 The contractor abandoned the site and the company went into administration. The administrator sought an order requiring the employer to deliver up the plant, which was refused despite the court’s ruling that the deemed ownership clause amounted to a floating charge which was void against the administrator, just as it would also have been void against a liquidator, for nonregistration under the Companies Act 1985.163 This result might seem to have been fatal to the employer’s ability to complete the work but the court nevertheless held that, despite the avoidance of the floating charge, this did not affect the employer’s contractual right to retain possession of the contractor’s property and to use it to complete the works. This right was a non-transmissible possessory right which did not operate to secure performance of the contact by the contractor. Hence it did not require registration as a company charge. In this respect, the position of the employer was better for the company going into administration rather than liquidation: a liquidator could have disclaimed the contract as onerous property.164 Disclaimer operates in the case of contracts as a unilateral termination of the contract and would therefore deprive the employer of its contractual right to retain possession of the contractor’s property, substituting for that right a claim for damages provable in the winding-up. 1.62 A clause deeming the employer to be the owner is not therefore the same as a clause conferring ownership on the employer. Such clauses, which do not amount to charges, have been effective provided they take effect before, and not upon, the commencement of a winding-up.165 In certain cases, undue tenderness seems to have been displayed towards the employer in inferring the grant, taking effect before liquidation, of a proprietary interest from unpromising contractual language.166 Otherwise, as forfeitures taking effect upon the winding-up, clauses conferring ownership upon the employer are unlawful for being in violation of the distribution scheme.167 It does not save a clause forfeiting 163

Ss 395–96. See n 157 above and accompanying text. 165 Re Walker, ex p Barter (1884) 17 Ch D 510; Brown v Bateman (1867) LR 2 CP 272 (also observing that a mere licence to seize would bring the matter within bills of sale legislation); Re Harrison, ex p Jay (1880) 14 Ch D 19 . 166 Re Garrud, ex p Newitt (1881) 16 Ch D 522; Re Waugh, ex p Dickin (1876) 4 Ch D 524. Re Garrud was nevertheless cited with approval by Lord Scott in Smith (Administrator of Cosslett (Contractors) Ltd) v Bridgend County Borough Council [2002] 1 AC 336 on the ground that the seizure clause allowed the creditor to take chattels in discharge of a debt and not as security for the payment of a debt. 167 Re Harrison, ex p Jay (1880) 14 Ch D 19, citing in support Re Jeavons, ex p Mackay (1873) 8 Ch App 643 and Re Thompson, ex p Williams (1877) 7 Ch D 138. 164

Collectivity, Management of Estates and the Pari Passu Rule 33 rights upon insolvency that it can operate upon the occurrence of events other than insolvency if it does in fact take effect upon insolvency.168 Again, it has sometimes been said that a liquidator succeeds to the contractual position of the contractor and is bound by the contract as much as the company itself.169 This reasoning has been rejected as inadequate to support a forfeiture of property rights.170 Even where it might be sound to support continuing contractual rights, its limitations in those cases where a liquidator exercises a statutory power to disclaim contracts have already been noted. 1.63 The proscription of clauses effecting a transfer of property rights in cases outside the building trade has already been noted.171 There are however exceptional cases where they are allowed. For example, a contract contained in articles of association calling for the transfer of a member’s shares upon his insolvency in return for a fair value has been upheld.172 Such a clause does not work against the interests of that member’s creditors. Furthermore, a clause forfeiting the ownership of property that lacks value or is unassignable will not be struck down.173 Here, the creditors have nothing to lose. Furthermore, where share ownership is incidental to membership of an association such as a stock exchange, forfeiture will be permitted here too, though a finding of such incidental character is unlikely if the shares have a substantial value in their own right.174 The rule against the divesting of property upon insolvency, in addition, does not apply to leases, for reasons that are not easy to see.175 Finally, while the absence of an intent to defeat an insolvent’s creditors will not save a forfeiture provision, the presence of such an intention may defeat a clause that otherwise would exceptionally have been upheld. The obscurity of the law in this area has led one judge to observe that ‘it is not possible to discern a coherent rule, or even an entirely coherent set of rules, to enable one to assess in any particular case

168 Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd [2002] 1 WLR 1150 (and authority therein cited) 169 Re Waugh, ex p Dickin (1876) 4 Ch D 524; Re Harrison, ex p Jay (1880) 14 Ch D 19 (Bacon CJB at first instance). 170 Re Harrison, ex p Jay (1880) 14 Ch D 19. See also Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd (Unreported 10 July 2001), observing that reasoning to the contrary effect in Re Garrud, ex p Newitt (1881) 16 Ch D 522 was inconsistent with the House of Lords decision in British Eagle International Airlines Ltd v Cie Nationale Air France [1975] 2 All ER 390. 171 See the above discussion of Re Jeavons, ex p Mackay (1873) 8 Ch App 643. 172 Borland’s Trustee v Steele Bros & Co Ltd [1901] 1 Ch 279. 173 Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd [2002] 1 WLR 1150. 174 Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd (above), where to the liquidator’s disappointment the insolvent member’s share was forfeited shortly before the London Stock Exchange (LSE) demutualised, whereupon shares in the LSE became transferable for value. See also Bombay Official Assignee v Shroff (1932) 48 TLR 443 (PC). 175 Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd [2002] 1 WLR 1150, noting the implied recognition of this rule in s 146(9) of the Law of Property Act 1925.

34 Michael G. Bridge whether such a provision . . . falls foul of the principle [that forfeiture clauses taking effect in insolvency are void].’176 1.64 To be distinguished from clauses that forfeit property rights upon insolvency are those clauses determining property interests on insolvency. To say that the distinction is a subtle one, and hardly strong enough to justify a stark difference between voidness and lawfulness, is a considerable understatement. The grant of a proprietary interest that is automatically determined in the event of the grantee’s insolvency is lawful177 and does not offend the rules dealing with unlawful and uncertain restraints upon alienation.178 The distinction between clauses that forfeit and clauses that determine is very subtle indeed and hard to defend. In some cases, such clauses have been ineffectual when drafted in terms of a voluntary alienation by the insolvent grantee.179 Although a grantor may may limit the interest of a grantee in such a way, a grantor may not settle his own property upon himself with a gift over in the event of his own insolvency.180 That infringes insolvency law as much as the closely related fraudulent conveyance of assets prior to insolvency to put those assets beyond the reach of a person’s creditors.181 (e) Execution Creditors 1.65 When competing with secured creditors or even with other unsecured creditors, the lot of the execution creditor, or the creditor contemplating litigation, is frequently not a happy one. The efforts of the creditor may trigger an events of default clause so as to bring about the appointment of a receiver so that a floating charge crystallises before the execution can be completed. The creditor may also find that the presentation of a winding-up petition, or the passing of a resolution to wind up the company, may undo all his efforts. Here too the execution will have to be completed, in this case before the commencement of the insolvency. If it is not, the execution creditor, apart from a limited excep176 Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd (above) (Neuberger J). 177 Rochford v Hackman (1852) 9 Hare 471; Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd (above). 178 A restraint may be ineffective because it is too vague to be enforced. It may be invalid, for example, in some cases where a life interest is determined upon an event without a gift over: Rochford v Hackman (1852) 9 Hare 471 at 482, explaining the reasoning of Lord Eldon in Brandon v Robinson (1811) 18 Ves 429. 179 Wilkinson v Wilkinson (1815) G Coop 259; cf Rochford v Hackman (1852) 9 Hare 471, where the grantee presented his own bankruptcy petition. 180 See Higinbotham v Holme (1812) 19 Ves 88 (husband conveyed property into a matrimonial settlement on terms that his interest under the settlement would terminate if he went into trade and became bankrupt); Wilson v Greendwood (1818) 1 Swans 471 (articles of partnership could not provide upon a partner’s bankruptcy for the remaining partners to take his partnership assets); Whitmore v Mason (1861) 2 J & H 204 (ditto, even where the remaining partners were to take over the bankrupt partner’s assets at valuation). 181 Insolvency Act 1986 s 423.

Collectivity, Management of Estates and the Pari Passu Rule 35 tion, will have nothing to show for his efforts and will reap no reward for any extra vigilance he has shown compared to other creditors of the company. Creditors who make a statutory demand and present a petition to force the company’s hands may find themselves well and truly capsized if another creditor surfaces to continue with the petition. Any payment that first creditor receives will then have to go back into the pot for distribution on the usual terms since it will have been made after the commencement of insolvency proceedings.182 1.66 The first point to note under this head concerns the completion of the execution followed by the commencement of insolvency proceedings. Although, for example, a writ of fieri facias binds goods of the execution debtor as soon as the writ is in the hands of the sheriff,183 this confers on the sheriff a right to seize goods within his bailiwick but does not confer upon him a proprietary interest in those goods that might enure for the benefit of the execution creditor.184 An execution creditor may not retain as against a liquidator the benefit of an execution unless it has been completed before the commencement of the windingup.185 Completion of an execution against goods occurs when they are seized and sold.186 1.67 The next consideration concerns any exceptional case where the execution creditor prevails notwithstanding the commencement of insolvency proceedings. The court has a broadly stated discretion to set aside the rights of the liquidator ‘to such extent and on such terms as the court thinks fit’.187 The discretion is designed for cases where the debtor, either before or after judgment, has been guilty of impropriety or improper pressure.188 Despite the breadth of the court’s discretion, it will be applied only in limited circumstances:189 the execution creditor’s gain under an exercise of the discretion in its favour is at the expense of the other creditors of the execution debtor in a winding-up. 182

Re Western Welsh International Systems Ltd (1984) 1 BCC 99,296. Supreme Court Act 1981, s 138(1). 184 Ex p Williams (1872) LR 7 Ch App 314 at 316. The sheriff obtains a qualified right, like that of a factor, upon seizure, but until then has only a right to seize: Peck v Craighead [1995] BCC 525 at 528. 185 Insolvency Act 1986 s 183(1). 186 Ibid s 183(3)(a). While the money proceeds are in the hands of the sheriff, the execution creditor will have an action for money had and received if the sheriff unlawfully fails to pay the creditor: Bluston & Bramley Ltd v Leigh [1950] 2 KB 548. Nevertheless, for judgments in excess of £500, the sheriff must retain the moneys for 14 days and pay them over to the liquidator if within that period he has notice of a creditors’ meeting or of a winding-up petition and there later follows a windingup: Insolvency Act 1986 s 184(3),(4). For completion of an execution in the case of land and the attachment of debts, see s 183(3)(b),(c). 187 Insolvency Act 1986 s 183(2)(c). An earlier and more limited discretion operated only where there was trickery or dishonesty on the part of the judgment debtor: see Armorduct Manufacturing Co Ltd v General Incandescent Co Ltd [1911] 2 KB 143. A further discretion, similar to that in s 182(2)(c), lies in respect of the liquidator’s right to moneys held by the sheriff for 14 days pursuant to s 184(3): see s 184(5). 188 Re Grosvenor Metal Co Ltd [1950] 1 Ch 63. 189 Re Buckingham International plc (No 2) [1998] BCC 943 at 962. See for example Landau v Purvis (unreported 15 June 1999). 183

36 Michael G. Bridge Consequently, a mere staying of the creditor’s hand at the request of the debtor will not be enough.190 Furthermore, the court will not undermine the pari passu rule by exercising its discretion so as to discriminate between classes of creditors, such as trade creditors and loan creditors,191 on the ground that the former are somehow more deserving or needy. By and large, the pari passu rule has remained inviolate in the case of execution creditors. This is scant reward for those execution creditors whose unfinished efforts have protected others from becoming unsecured creditors.

190 191

Re Redman (Builders) Ltd [1964] 1 WLR 541 at 552. Re Caribbean Products (Yam Importers) Ltd [1966] Ch 331 at 347–48, 351.

2

Transactions at an Undervalue JOHN ARMOUR

A INTRODUCTION

2.1 Section 238 of the Insolvency Act 1986 is headed ‘Transactions at an Undervalue’. It makes vulnerable any transactions entered into during a two-year ‘twilight’ period prior to formal corporate insolvency proceedings, under which the debtor company transfers a significant net value to another party: in other words, it receives significantly less than it gives. The Section relates only to corporate insolvency, but is complemented by section 339, an identically worded provision which operates in bankruptcy proceedings. This chapter, after outlining the elements of the action, proceeds to consider its history and purposes prior to setting out in detail the substantive elements of the cause of action and then defences. The process of bringing an action under section 238 can be broken down into the following series of steps: 2.2 Standing. The action to avoid transactions at an undervalue is a claim vested in a liquidator or administrator by section 238(1). As such only a liquidator or administrator of the insolvent company has standing to sue.1 2.3 Relevant Time. A precondition to recovery is that the transaction must have occurred at a ‘relevant time’.2 This has two aspects. The temporal requirement is that the company must have entered into the transaction during the period of two years ending with the bringing of a successful petition for administration or the commencement of winding-up. The financial condition is that at the time of entering into the transaction, the company was unable to pay its debts within the meaning of section 123 of the Insolvency Act 1986, or that it became so as a result of entering into the transaction. 2.4 Transaction at an Undervalue. The insolvent company must have entered into a transaction with the counterparty.3 The transaction must have been at an 1 Contrast the position as respects an action to set aside an unregistered charge. See below, paras 6.138ff. 2 Discussed below, paras 2.30ff. 3 Discussed below, paras 2.50ff.

38 John Armour undervalue, measured from the insolvent company’s point of view.4 In other words, the value of the consideration (in money or money’s worth) leaving the insolvent company must have been significantly more than the consideration it received, if any. 2.5 Defences. There are a number of possible defences to an action brought under section 238.5 The most important of these is the ‘bona fide business purpose’ defence. This gives a complete defence to a counterparty who can show that the debtor company entered into the transaction in good faith and for the purpose of carrying on its business, and that there were reasonable grounds for believing that it would benefit the company. 2.6 Remedies. The court’s remedial power under section 241 is extremely wide.6 The principal objective of an order under section 241 will be to reverse the effect of the transaction. However, interests acquired by third parties in good faith in reliance on the validity of the transaction will not be disturbed.

B HISTORY AND PURPOSE

(1) Statutory History of the Avoidance of Undervalue Transactions 2.7 Section 238 has its antecedents in ancient provisions designed to regulate debtor misbehaviour. Its ancestor is the action to avoid fraudulent conveyances introduced in statutory form by the Statute of 13 Elizabeth 1, c.5 in 1571 (known as the ‘Statute of Elizabeth’).7 This statute made void, as against any person prejudiced thereby, ‘gifts, grants, alienations [or] conveyances’ which had been effected with intent to ‘delay, hinder or defraud creditors and others’.8 It provided a defence for counterparties who had entered into a transaction bona fides and for valuable consideration.9 2.8 The Statute of Elizabeth remained in force for over four centuries.10 During this time, a vast jurisprudence developed to deal with fraudulent 4

Discussed below, paras 2.82ff. Discussed below, paras 2.110ff. 6 Discussed below, paras 2.121ff. See further ch 9. 7 Its principles were said to have been part of the common law long before then. See eg, Cadogan v Kennett (1776) 2 Cowp 432 at 434, 98 ER 1171 at 1172; Rickards v A-G (1844) 12 Cl & F 30 at 42, 8 ER 1306 at 1311. A similar action, known as the actio Pauliana, was available to creditors under Roman law: see JAC Thomas, Textbook of Roman Law (Oxford, North-Holland Publishing Co, 1976) at 375–76. 8 13 Eliz 1 c 5, ss I–II. 9 Ibid s VI. 10 It was replaced by section 172 of the Law of Property Act 1925, the scope of which was probably identical, although the issue was never authoritatively decided. See the discussion in ch 3 below, paras 3.6ff. 5

Transactions at an Undervalue 39 conveyances.11 Although not itself a piece of insolvency legislation, the application of the Statute was frequently associated with insolvency, because creditors are prejudiced by fraudulent conveyances where the debtor does not retain sufficient assets to pay his debts. It was quickly established that fraudulent intent could be shown either by direct evidence (‘actual fraud’) or inferred from the circumstances of the transaction (‘constructive fraud’). Over time, the courts developed a list of ‘badges of fraud’ which could be used, either individually or cumulatively, to infer fraudulent intent on the part of a debtor. 2.9 A voluntary settlement by a debtor who was insolvent at the time, or likely to become so, was treated as one of these ‘badges of fraud’.12 Even if the conveyance was not voluntary, an extreme undervalue could also be viewed as a badge of fraud, or as evidence that the transaction was intended as a gift, especially if coupled with the debtor’s insolvency, or if the counterparty was a friend or relative.13 There was a tension, however, with an unwillingness on the part of courts to scrutinise the adequacy of the consideration passing under a conveyance for value, and provided that nothing else tended to suggest that the counterparty was other than bona fide, the mere fact of an undervalue was often insufficient to impugn a transaction.14 2.10 The modern progeny of the Statute of Elizabeth are sections 238 (for corporate debtors), 339 (for individuals) and 423 (for both) of the Insolvency Act 1986. Section 423, a direct descendant of the fraudulent conveyance action,15 clearly includes actual fraud and probably constructive fraud as well.16 Sections 238 and 339, on the other hand, can be seen as descendants of the Statute of Elizabeth which avoid a particular variety of constructive fraud. 2.11 The line of descent has not, however, been direct. There are two principal differences between the structure of ‘pure’ fraudulent conveyance actions such as the Statute of Elizabeth and section 423 of the 1986 Act, and actions such as 11 See generally, SW Worthington, May on Fraudulent Conveyances and Voluntary Dispositions, 2nd edn (London, Stevens & Haynes, 1887); DL McDonnell & J G Monroe, Kerr on Fraud and Mistake, 7th edn (London, Sweet & Maxwell, 1952) at 298–415; PV Baker & P St J Langan, Snell’s Equity, 29th edn (London, Sweet & Maxwell, 1990) at 128–35. 12 See eg, Freeman v Pope (1869) 9 LR Eq 206; cf Ex parte Mercer, Re Wise (1886) 17 QBD 290. 13 Herne v Meeres (1687) 1 Vern CC 465 at 466, 23 ER 591 at 591 (case stated in note to Heathcote v Paignon (1787) 2 Bro CC 167 at 176–77, 29 ER 956 at 1000–1); Doe d Watson v Routledge (1777) 2 Cowp 705 at 713, 98 ER 1318 at 1322; Strong v Strong (1854) 18 Beav 408 at 410, 52 ER 161 at 162. The bona fide purchaser defence meant that to avoid a conveyance for value, the undervalue had to be sufficiently extreme for a court to infer, not only that the insolvent debtor was fraudulent, but that the counterparty was too. It was never clear whether the hurdles were equivalent: see eg, Glegg v Bromley [1912] 3 KB 474 at 492. 14 Basset v Nosworthy (1673) Finch 102 at 104, 23 ER 55 at 56; Copis v Middleton (1818) 2 Mad 410 at 425–27, 56 ER 386 at 392; Bayspoole v Collins (1871) LR 6 Ch 228 at 232; Re Johnson (1881) 20 Ch D 389 at 397. 15 S 423 replaced s 172 of the Law of Property Act 1925, which in turn replaced the Statute of Elizabeth. See above, n 10. 16 For a detailed discussion of the scope of this provision, see ch 3.

40 John Armour section 238 which arise only in insolvency proceedings. First, the insolvency actions have limited retrospective application, whereas ‘pure’ fraudulent conveyance actions had no time limit.17 Secondly, the insolvency provisions are actionable only at the instance of the office-holder, whereas pure fraudulent conveyances provisions allow a challenge to be brought by any person prejudiced. These features of section 238 (and 339) may be traced to the way in which particular fraudulent conveyance actions were transplanted into the bankruptcy legislation. 2.12 An action to avoid voluntary conveyances was introduced into the Bankruptcy Act 1603.18 It made voidable any settlement of property by the bankrupt not made in good faith for valuable consideration,19 provided that it had been effected within the ‘twilight’ period prior to his bankruptcy. A provision of this type remained in successive acts,20 becoming in due course section 42 of the Bankruptcy Act 1914.21 This provision, therefore, forms the specific antecedent of the modern section 339, which, at the recommendation of the Cork Committee, was expanded in scope to avoid the restrictiveness of the language of ‘settlement’, and to encompass transactions for value where there was a significant disparity in the consideration.22 At the same time, the good faith purchaser defence was abolished, thereby ensuring that transactions which were prima facie voidable under the section would not be validated to protect third parties.23 At the same time, they recommended that the length of the ‘twilight’ period be reduced from ten to five years in the absence of proof of solvency, and from two years to one year regardless of solvency.24 2.13 There was, however, no similar provision relating to settlements or transactions entered into by a corporate debtor. Such transactions were usually 17

For the position now under s 423, see ch 3. 1 Jac 1, c 15 s 5. Fraudulent conveyance jurisprudence was also transplanted into the bankruptcy legislation in a second way: a fraudulent conveyance was, until the doctrine was abolished in 1985, an act of bankruptcy. As such, it established both the grounds for a petition for bankruptcy by the debtor’s creditors, and a point in time to which the trustee in bankruptcy’s title related back, provided that the petition was brought within the period of ‘availability’. Relation back meant, of course, that the transaction was automatically void should a bankruptcy petition be successfully brought within the availability period. The types of transaction which constituted an act of bankruptcy in this way included all those which would constitute a fraudulent conveyance within the Statute of Elizabeth. See generally, M Hunter and D Graham, Williams and Muir Hunter on Bankruptcy, 19th edn (London, Stevens & Sons, 1979) at 6–16, 329–43. 19 Or for marriage consideration. 20 Bankruptcy Act 1825 (6 Geo 4, c 16) s 73; Bankruptcy Act 1849 (12 & 13 Vict, c 106) s 126; Bankruptcy Act 1869 s 91; Bankruptcy Act 1883 s 47; Bankruptcy Act 1914 s 42. The statutory history was considered by Cave J in Re Lowndes, ex parte Trustee (1887) 18 QBD 677 at 678–79. 21 The ‘twilight’ period under this section was two years, rising to ten years unless the parties claiming under the settlement could show that the bankrupt had been able to pay his debts at the time of the settlement without the property so alienated. 22 See Insolvency Law and Practice, Report of the Insolvency Law Review Committee, Cmnd 8558 (London, HMSO, 1982), paras 1226, 1232. 23 This had been a problem in actions brought under the Statute of Elizabeth alleging an undervalue transaction was fraudulent and void: see above, n 13. 24 Insolvency Law and Practice, Report of the Insolvency Law Review Committee, Cmnd 8558 (London, HMSO, 1982), para 1232. 18

Transactions at an Undervalue 41 challenged on the basis that they were ultra vires and thereby void against the liquidator, and/or that they constituted an abuse of directors’ powers under the articles of association, and were hence recoverable from a recipient with notice.25 Most of the Cork Committee’s attention in respect of voluntary dispositions was directed to the case of individual bankruptcy. Seemingly as an afterthought, the Committee considered whether the avoidance power should be extended to corporate insolvency proceedings. Although not convinced that it was essential, the Committee took the view that on balance it would be helpful to do so.26 The result is section 238 of the Insolvency Act 1986.

(2) Purpose 2.14 An examination of the purpose of section 238 is of assistance in interpreting the scope of the section’s application, and the remedial consequences. It will be shown that neither the legislative history, nor other possible rationales such as the prevention of fraud, the reversal of unjust enrichment, and the maintenance of the pari passu principle, provide a complete account of the section. This part will then argue that its principal justification concerns the amelioration of perverse incentives in the period leading up to insolvency. (a) Legislative History Equivocal as to Purpose 2.15 Whilst the provision can be traced indirectly back to the Statute of Elizabeth, the comprehensive differences in wording mean the former legislation is of minimal assistance in interpreting the current provisions. Furthermore, the scope of application of the earlier provisions was notoriously vague. 2.16 The undervalue transaction provisions were only explicitly considered in the law reform process in the context of their application to individuals. Thus the Cork Committee explain their principal rationale for the provisions as being:27 [T]o prevent assets from being put in the hands of the debtor’s family or associates in order to preserve them from the claims of creditors.

2.17 A similar purpose was expressed during the Committee stage of the Insolvency Bill 1985 by Mr David Trippier, then Under-Secretary of State for Trade and Industry:28

25 26 27 28

Ibid, para 1237. Avoidance on these grounds is considered in ch 7. Ibid para 1237. Ibid para 1221. Official Report: House of Commons Standing Committee E 1984–85, Col 406.

42 John Armour The existence of a period during which transactions at an undervalue are chargeable retrospectively . . . is a safeguard to prevent a person entering into business from, in effect, giving away his personal assets in a way that ensures he still has the use of them in case the business goes badly and he subsequently becomes bankrupt.

2.18 This approach can presumably be extended to the context of the corporate debtor by substituting shareholders, directors and other companies in the same group for family and associates. However, these statements do not fully account for the provisions enacted, which apply to all counterparties, not simply associates. Nor do they fully explain why such transactions are to be avoided. It is, therefore, necessary to consider which rationale, or combination of rationales, best explains and justifies the provisions as enacted. (b) Avoidance of Fraud Does Not Fully Explain Section 238 2.19 One possible purpose for section 238, which draws support from the section’s antecedents in the fraudulent conveyance provisions, concerns the prevention of fraud. On this account, the action’s role appears to be a mechanism for ensuring that fraudsters and their associates do not benefit from such conduct, and conversely that creditors are not prejudiced. It appears, therefore, to be concerned with corrective justice, the wrong in question being a breach of what Clark terms the ‘norm of truth’ in dealings with one’s creditors.29 Whilst actual fraud is not a definitional element of section 238, entry into a transaction at a substantial undervalue without a reasonable business purpose might be thought of as raising a strong presumption of fraud. As it is notoriously difficult to prove fraud in fact, the ability to infer this conclusively from such facts greatly increases the number of cases of fraud for which a remedy is granted.30 2.20 This account is most powerful as a rationale for the differential standards applied to connected and unconnected parties.31 It makes sense to facilitate actions against connected parties—e.g. by presuming the debtor to have been insolvent32—because the risk of collusion is greatest in this case. However, a difficulty with this approach is that it carries with it a risk of ‘false positives’: the section will clearly catch many honest transactions where no fraud was

29 RC Clark, ‘The Duties of the Corporate Debtor to its Creditors’ (1977) 90 Harvard Law Review 505 at 508–9. 30 DG Baird and TH Jackson, ‘Fraudulent Conveyance Law and its Proper Domain’, (1985) 38 Vanderbilt Law Review 829 at 830–31. 31 See below, paras 2.41ff. 32 Insolvency Act 1986 s 240(2).

Transactions at an Undervalue 43 present.33 This suggests that the ‘fraud’ rationale does not provide a complete justification for section 238.34 (c) Section 238 as Reversal of Unjust Enrichment: Justification or Classification? 2.21 An alternative rationale for the undervalue provisions can be based on the law of unjust enrichment.35 Actions to reverse substantive unjust enrichment are distinguished by common definitional elements:36 (i) the defendant was enriched; (ii) the enrichment was at the expense of the claimant; and (iii) the enrichment was unjust, demonstrated by reference to a list of ‘unjust factors’, which in turn are subdivided into (a) qualified intent on the part of the claimant in effecting a transfer to the defendant, and (b) policies requiring restitution.37 Defendants to claims based on substantive unjust enrichment also may be able to plead a range of defences, including change of position, peculiar to this category of obligations.38 2.22 It can be argued cogently that section 238 can be understood as reversing unjust enrichment, based on a policy requiring restitution. This classification is of considerable importance when considering remedial consequences,39 raising as it does the possibility of restitutionary defences. However, it does not of itself assist in determining the scope of the policy which makes the enrichment ‘unjust’ in these circumstances. It is therefore necessary to consider other rationales which might provide the missing explanation. (d) Section 238 Does Not Support the Pari Passu Principle 2.23 Another rationale which has sometimes been offered for section 238 is that it supports the pari passu principle.40 The ‘pari passu principle’, as exemplified in 33 DG Baird and TH Jackson, ‘Fraudulent Conveyance Law and its Proper Domain’, (1985) 38 Vanderbilt Law Review 829 at 830–31. Indeed, the Cork Committee acknowledged that honest settlements would be caught by the section’s predecessor (Cork Report, para 1208(a)). Although the ‘reasonable business purpose’ defence may help to limit this problem, it cannot be eliminated entirely. 34 Contrast s 423, a central element of which is that the debtor have acted for a proscribed purpose. The avoidance of deliberate actions taken to undermine the position of creditors therefore forms the primary rationale for this provision: see para [rationale of s 423] 35 Cf P Birks, An Introduction to the Law of Restitution, (rev edn) (Oxford, Clarendon Press, 1989), 308–10 (categorising recovery of fraudulent conveyances as ‘policy-motivated restitution’ based on a policy of ‘protection of creditors and investors’). 36 See eg, P Birks and C Mitchell, ‘Unjust Enrichment’, in P Birks (ed), English Private Law, Vol II (Oxford, Oxford University Press, 2000), 525 at 529. 37 Ibid 558–91 (categorising unjust factors into ‘qualified intent’ on part of claimant in effecting a transfer, and ‘policies requiring restitution’). 38 Ibid 610–35. 39 See further ch 9. 40 See MG Bridge, ‘Insolvency’ in P Birks (ed), English Private Law Vol II (Oxford, Oxford University Press, 2000), 639 at 709.

44 John Armour cases such as British Eagle International Airlines Ltd v Compagnie Nationale Air France,41 can be understood as a conflation of two distinct matters.42 First, a distributional principle directs that, insofar as not otherwise specified,43 the proceeds of the realisation of the company’s assets shall be divided pro rata amongst unsecured creditors.44 Mokal has convincingly argued, however, that most of the case law commonly cited as authority for the ‘pari passu principle’ is in fact concerned with a different matter: the rule of mandatory management of an insolvent company’s assets by the liquidator in collective insolvency proceedings. This principle, which has no necessary connection with the distributional rule which truly characterises ‘pari passu’,45 directs that it is not possible to ‘contract out’ of the insolvency procedures decreed by statute.46 It is possible to argue that the undervalue provisions might support either the distributional or the mandatory management principle. 2.24 It might be argued that section 238 is intended to support the distributional limb of the pari passu principle.47 If this is its goal, then it fails to achieve it in any meaningful sense.48 Rather than offering prospective protection to the entitlements of creditors in an insolvency distribution, the section seeks to protect the overall pool of assets from depletion. It is concerned with the size of the pie, rather than how it is divided up. This is clearly illustrated by the point, established in Re MC Bacon,49 that a charge granted to secure pre-existing indebtedness, although undoubtedly harmful to the interests of unsecured creditors, does not constitute a transaction at an undervalue. It does not deplete the total assets available for creditors, but merely rearranges their entitlements inter se.50 2.25 Could it be argued that MC Bacon was wrongly decided on this point? Whilst the authority is only first instance,51 it is submitted that there are com41

[1975] 1 WLR 758. R Mokal, ‘Priority as Pathology: The Myth of Pari Passu’ (2001) 60 Cambridge Law Journal 581 at 590–95 (distinguishing between ‘priority’ (distribution) and ‘immunity’ from collective management of assets). See also ch 1 above, at paras 1.1–1.10 (distinguishing management and distribution aspects of pari passu principle). 43 See eg Insolvency Act 1986 ss 175, 386, Sch 6 (preferential debts); Insolvency Rules 1986 r 4.90 (insolvency set-off). 44 Iinsolvency Act 1986 s 107; Insolvency Rules 1986 r 4.181. 45 The principle of mandatory collective management applies also in administration, yet this is not thought to be associated with issues of distribution. 46 Higinbotham v Holme (1812) 19 Ves Jun 88, 34 ER 451; National Westminster Bank Ltd v Halesowen Presswork and Assemblies Ltd [1972] AC 785. 47 See above, paras 1.1ff. 48 See MG Bridge, ‘Insolvency’ in PBH Birks (ed), English Private Law Vol II (Oxford, Oxford University Press, 2000), 639 at 709. 49 [1990] BCC 78. 50 Ibid 91–92. 51 Re MC Bacon has been followed on this point by Peter Smith QC in Re Mistral Finance Ltd [2001] BCC 27. Consistently with this, Jonathan Parker J has suggested that where an asset subject to a security interest is sold, the value of the consideration provided by the company is the value of the asset free from security and not simply that of the equity of redemption (Re Brabon [2001] BCLC 11 at 37). 42

Transactions at an Undervalue 45 pelling arguments in favour of the position set out in that decision. To hold that a grant of security could be an undervalue transaction would wash away the distinction between preferences and undervalues. The law relating to voidable preferences is concerned with the preservation of insolvency law’s distributional ordering,52 but its invocation requires a finding that the debtor was ‘influenced by a desire to prefer’ the recipient.53 To hold that the transaction in MC Bacon was an undervalue would drive a coach and horses through this restriction on the preference action. 2.26 Furthermore, this approach maintains consistency with the antecedents of the undervalue provisions in the old law of fraudulent conveyances. There, a sharp distinction was drawn between dispositions of assets designed to deprive creditors and those which simply altered the distribution of payments.54 The latter could not be attacked as fraudulent conveyances, but solely as preferences under the bankruptcy laws.55 No indication was given by the Cork Committee, or during the passage through Parliament of the Insolvency Bill 1985, of any intention to alter this aspect of the relationship between preferences and the other avoidance provisions. 2.27 Section 238 might alternatively be thought to support the mandatory management of corporate assets by the liquidator or administrator, through maintaining the integrity of the asset pool which is to be deployed in collective proceedings.56 This argument is supported by the fact that to effect a fraudulent conveyance was historically an act of bankruptcy—conduct deemed so threatening to the interests of creditors as to provide in and of itself—regardless of debtor solvency—grounds for a bankruptcy order.57 On this view, section 238 is closely linked in purpose to section 127, which operates after the commencement of a winding-up.58 At the time when a potentially vulnerable transaction is entered into, it is by no means certain that insolvency proceedings will supervene. Thus, the retrospective operation of the insolvency norm of collectivity must be tempered by a sensitivity to the need to preserve to the greatest extent 52

See generally, paras 4.14–4.24. Insolvency Act 1986 s 239(5). 54 Holbird v Anderson (1793) 5 TR 235 at 238–39; 101 ER 132 at 134; Middleton v Pollock (1876) 2 Ch D 104 at 108–9; Glegg v Bromley [1912] 3 KB 474 at 484, 485, 492; Re Sarflax Ltd [1979] Ch 592 at 602, 612. 55 The inverse of a preference (a ‘deference’?), whereby the whole of a debtor’s assets are transferred to a third party who takes on all but one of the debtor’s obligations, in order to defer a particular creditor, could nevertheless constitute a fraudulent conveyance: Edmunds v Edmunds [1904] P 362 (decided under the Statute of Elizabeth); Arbuthnot Leasing International Ltd v Havelet Leasing Ltd (No 2) [1990] BCC 636; cf Worseley v DeMattos (1758) 1 Burr 467, 97 ER 407. See also Creasey v Breachwood Motors [1993] BCLC 480, a case following this pattern which was wrongly pleaded—and decided—on the basis of ‘piercing the corporate veil’. 56 See A Keay, ‘In Pursuit of the Rationale Behind the Avoidance of Pre-Liquidation Transactions’ (1996) 18 Sydney Law Review 55 at 65. 57 See M Hunter and D Graham, Williams and Muir Hunter on Bankruptcy, 19th edn (London, Stevens & Sons, 1979), 6–16. 58 See paras 8.3ff. 53

46 John Armour possible the general law’s unwillingness to deprive a commercial party of the fruits of a good bargain.59 This delicate balancing act accounts for the selective intervention only in cases where there is a significant undervalue within a finite period prior to the commencement of insolvency proceedings. Whilst this rationale is undoubtedly helpful in understanding the purpose of the undervalue provisions, it has a crucial ambiguity which may lessen its utility as an interpretive tool. How precisely should the balance between ‘collective’ insolvency norms and ‘individualist’ pre-insolvency norms be struck? It is submitted that the final rationale to be considered provides a clearer means of discriminating. (e) Amelioration of Perverse Incentives 2.28 It can be argued that section 238 serves to ameliorate perverse incentives experienced by debtors facing financial distress.60 Once a creditor has advanced money, shareholders of a corporate debtor may engage in several types of activity that transfer wealth in an expected-value sense from the creditor to themselves. Most obviously, assets can be transferred from the company to its shareholders, thereby reducing creditors’ payoffs in insolvency and hence their expected returns, but at the same time benefiting shareholders. A (slightly) more subtle version involves switching the company’s assets from low-risk, lowreturn projects to high-risk, high-payoff activities. Because of limited liability, shareholders do not bear any extra downside loss if a high-risk project fails, but keep all of the upside if it succeeds.61 This incentive becomes much more pronounced when the debtor company is factually insolvent, because from the shareholders’ point of view, their interest in the firm has been wiped out already.62 They may therefore be tempted to ‘bet the firm’ on high-risk projects 59

See paras 4.19–4.24. See generally RC Clark, ‘The Duties of the Corporate Debtor to its Creditors’ (1977) 90 Harvard Law Review 505; TH Jackson, ‘Avoiding Powers in Bankruptcy’ (1984) 36 Stanford Law Review 725 at 777–86; DG Baird and TH Jackson, ‘Fraudulent Conveyance Law and its Proper Domain’, (1985) 38 Vanderbilt Law Review 829; DD Prentice, ‘The Effect of Insolvency on PreLiquidation Transactions’ in BG Pettett (ed), Company Law in Change (London, Stevens & Son, 1987), 69 at 75–78. 61 MC Jensen and WH Meckling, ‘Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure’ (1976) 3 Journal of Financial Economics 305 at 333–43. A similar ‘moral hazard’ problem exists for individual debtors, who enjoy a form of ‘limited liability’ through discharge from bankruptcy. 62 An example may help to illustrate the point. Imagine that Debtor Ltd, with existing assets worth £100 and owing £150 to a creditor, has two projects open to it for investment. Each requires an outlay of £100—the firm’s existing assets. Project A will yield either £90 or £150 with equal probability, giving a net expected return (incorporating the £100 investment) of £20. Project B has a 10% chance of yielding £500, and a 90% chance of yielding £0. Its net expected return is therefore −£50— on average, this will be a loss-making project. Yet from the point of view of Debtor’s shareholders, things are different. Their expected return under Project A is £0 whatever happens, because even in the good outcome there is no money left over for shareholders after creditors are paid. Yet under Project B, the good outcome leaves shareholders with £350. Given that there is only a 10% chance of this happening, its expected return to shareholders is still £35. Shareholders will therefore favour Project B, even though this will inflict a corresponding expected loss on creditors. 60

Transactions at an Undervalue 47 which, if they succeed, will generate sufficient to pay off creditors, even if the risk of failure—and consequent further depletion of the company’s assets—is much greater, because in the latter case the shareholders are no worse off. Furthermore, during solvency a company’s reputation as a borrower acts as an important constraint on its shareholders’ desire to engage in transferring wealth from creditors to themselves. If the company hopes to borrow again in the future, then such activities—carrying with them a likely blacklisting—will be less attractive to shareholders. Where the company is insolvent, then the problem is one of ‘endgame’: reputational concerns become less pressing as the firm’s life is over anyway unless something drastic is done. 2.29 Section 238 acts to reduce the likelihood of a corporate debtor being able to enter into a transaction which is loss making in an expected-value sense. Such a transaction would involve the company giving consideration of a greater expected value than it receives. Where this is obvious at the point of the transaction,63 then it would be subject to avoidance as a transaction at an undervalue. Section 238 thus acts as a means of encouraging counterparties to think twice before entering into such transactions where companies are in parlous financial health.

C RELEVANT TIME

2.30 For a transaction to be actionable under section 238, it must be shown that the company ‘entered into’ the transaction at a ‘relevant time’. The ordinary language meaning of section 240(1) is that the company ‘enters into’ a transaction at the time at which the transaction becomes legally effective.64 ‘Relevant time’ is defined by section 240 and has two elements, one temporal and one financial.

(1) Temporal Condition: Transaction Within Two Year ‘Twilight Period’ 2.31 First, the company must have ‘entered into’ the transaction either not more than two years prior to the ‘onset of insolvency’ or between the bringing of a petition for administration and the making of an order.65 The ‘onset of insolvency’ is defined in section 240(3) to mean either: (a) in a case where the company is in administration proceedings, the date of the presentation of the petition for administration; or 63

As in the example, above, n 62. Any attempt artificially to ‘extend’ a transaction could be dealt with by the simple expedient of characterising such articficial steps as not being part of the relevant transaction. 65 Insolvency Act 1986 s 240(1)(c). 64

48 John Armour (b) for a company in liquidation, the date of the commencement of the winding-up, unless the winding-up proceedings had commenced on the discharge of an administration order, in which case the ‘onset of insolvency’ is deemed to occur with the presentation of the petition for administration. A compulsory winding-up is deemed to commence at the date of the presentation of the petition for winding-up,66 and a voluntary liquidation is deemed to commence on the date of the passing of the resolution for liquidation.67 2.32 A possible lacuna exists where the company is discharged from an administration order and then goes into liquidation. In this case, the ‘twilight period’ would end not at the date of the presentation of the petition for administration, but at the date of commencement of the winding-up. This could prejudice the liquidator’s ability to attack antecedent transactions, and for this reason the Companies Court will order that discharge from administration only take effect at the time at which the liquidation commences.68

(2) Financial Condition: Company Unable to Pay its Debts 2.33 Secondly, the transaction must have taken place either at a time when the company was ‘unable to pay its debts’ within the meaning of section 123, or the company must have became so as a result of entering into the transaction.69 Section 123 provides a number of grounds upon which a company may be deemed factually insolvent, or ‘unable to pay its debts’. The most important of these are the so-called ‘balance sheet test’, under which a company is deemed insolvent if its liabilities are shown to exceed its assets, and the ‘cash flow test’, under which a company is deemed insolvent if it is shown that it is unable to pay its debts as they fall due.70 The company is, however, presumed to have been 66 Insolvency Act 1986 s 129(2). If the winding-up petition was brought after a voluntary liquidation had been commenced, then the compulsory winding-up is deemed to commence on the date of the passing of the resolution to liquidate the company voluntarily (ibid s 129(1)). Where the transaction occurs after the bringing of a winding-up petition, then it will be caught by section 127: see generally ch 8. 67 Insolvency Act 1985 s 86. No provision is made in section 240(3) for the case where a company passes from members’ voluntary into creditors’ voluntary liquidation. The effect of section 96 is that the company is not required to pass a further resolution in order for the company to pass into creditors’ voluntary liquidation. This suggests that the process of conversion is seamless and that the ‘onset of insolvency’ for these purposes would be the date on which the company resolved to go into members’ voluntary liquidation. 68 Re Norditrack (UK) Ltd [2000] 1 WLR 343. 69 Insolvency Act 1986 s 240(2). 70 The other grounds applicable in England and Wales are either that a creditor has made a statutory demand for a debt now due, and not received payment within three weeks (ibid s 123(1)(a))— which is a formal version of the cash-flow test—or that an execution process or other enforcement procedure commenced against the debtor should be returned unsatisfied (ibid s 123(1)(b)). This last ground is unlikely to be of great practical significance as before enforcement proceedings are commenced, it is usual that one of the other grounds will have been satisfied.

Transactions at an Undervalue 49 unable to pay its debts at the time of the transaction where the counterparty is a person connected with the company.71 2.34 In practice, the balance sheet test is likely to be the most significant for the purposes of section 240. When a company becomes unable to pay its debts as they fall due, a petition for winding-up or administration, or the appointment of a receiver, will typically occur very shortly afterwards. Thus the ‘cash flow’ test is unlikely to generate a long ‘twilight period’. However, a company may be ‘balance sheet’ insolvent yet still remain able to pay its debts as they fall due, where it has liquid assets and many of its liabilities lie in the future. The period between balance sheet insolvency and when cash flow insolvency (and thence insolvency proceedings) supervenes is likely to form the ‘twilight period’ in most cases. (a) ‘Balance Sheet’ Test 2.35 The ‘balance sheet’ test is contained in section 123(2), which states: A company is also deemed unable to pay its debts if it is proved to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities, taking into account all its contingent and prospective liabilities.

2.36 This does not refer simply to the contents of the company’s audited accounts. Rather, it mandates that the court must be persuaded of the excess of liabilities (including for these purposes the costs of liquidation) over the assets at the time the office-holder seeks to allege the company was insolvent, or that after the transaction had occurred, it became so.72 In most cases, this will depend on the application of generally accepted accounting principles. However, this in itself does not guarantee certainty, as even within generally accepted accounting principles, more than one approach to valuation may be possible.73 A crucial issue will be whether or not the company’s assets should be valued on a going-concern basis or (and which will usually be much less) on a break-up basis.74 In cases where alternatives exist, the location of the burden of proof, which ordinarily lies with the office-holder, will be of considerable importance.75 2.37 Liabilities. ‘Liabilities’ are given an expansive definition in the Insolvency Rules 1986,76 meaning ‘a liability to pay money or money’s worth’, including liabilities arising under any enactment, for breach of trust or arising in contract, 71

Insolvency Act 1986 s 240(2). See below, paras 2.41ff. See A Keay, ‘The Insolvency Factor in the Avoidance of Antecedent Transactions in Corporate Liquidations’ (1995) Monash University Law Review 305 at 308. 73 RM Goode, ‘Wrongful Trading and the Balance Sheet Test of Insolvency’, [1989] Journal of Business Law 436 at 437. 74 See RM Goode, Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 83–100. 75 The burden of proof is reversed where the counterparty is ‘connected’ with the debtor company. See below, paras 2.41ff. 76 R 13.12. 72

50 John Armour tort or bailment, and any liability arising out of an obligation to make restitution.77 Furthermore, it is immaterial whether the debt or liability is present or future, certain or contingent, fixed or liquidated in amount, or is capable of being ascertained by fixed rules or by a matter of opinion.78 In each case, however, the company must actually have incurred the obligation from which the liability flows at the time at which insolvency is alleged. Thus a ‘contingent’ liability requires that at the time under consideration the company be subject to an existing obligation, which may give rise to a liability through some event beyond the parties control—for example, a guarantee.79 It does not, however, include actions which have been brought against the company but for which judgment has not yet been given.80 2.38 Assets. No explicit guidance is given by the legislation as to which ‘assets’ may be included, and so reference must be made to generally accepted accounting principles. However, it has been held that hopes or expectations, as opposed to legal entitlements to acquire assets in the future may not be included.81 (b) ‘Cash Flow’ Test 2.39 The ‘cash flow’ or ‘commercial’ insolvency test requires that it be proved to the court that the company is unable to pay its debts as they fall due.82 The difference between this condition and the ‘balance sheet’ test is well-illustrated by the following passage from Buckley on the Companies Act,83 cited with approval by Plowman J in Re Tweeds Garages Ltd:84 [C]ommercial insolvency [means] the company being unable to meet current demands upon it. In such a case it is useless to say that if its assets are realised there will be ample to pay 20 shillings in the pound: this is not the test. A company may be at the same time insolvent and wealthy. It may have wealth locked up in investments not presently realisable; but although this be so, yet if it have not assets available to meet its current liabilities it is commercially insolvent and may be wound up.

2.40 Cash-flow insolvency may be inferred simply from the company’s failure to pay an undisputed debt without good cause: insolvency is ‘deemed’ by the satisfaction of the statutory test.85 As in practice insolvency proceedings are likely 77

Insolvency Rules 1986 r 13.12(4). Insolvency Rules 1986 r 13.12(3). 79 Winter v IRC [1963] AC 235 at 248–49; Customs & Excise Commissioners v Broomco (1984) Ltd (formerly Anchor Foods Ltd) 2000 WL 1084449 (unreported, 30 March 2000), aff’d on other grounds [2000] BTC 8035. 80 Customs & Excise Commissioners v Broomco (1984) Ltd (formerly Anchor Foods Ltd) 2000 WL 1084449 (unreported, 30 March 2000). 81 Byblos Bank SAL v Al-Khudairy (1986) 2 BCC 99, 549 at 99, 562–65. 82 Insolvency Act 1986 s 123(1)(e). 83 13th edn (London, Stevens & Sons, 1957) at 460. 84 [1962] Ch 406 at 410. 85 Cornhill Insurance plc v Improvement Services Ltd [1986] BCLC 26; Re Taylor’s Industrial Flooring Ltd [1990] BCLC 216. 78

Transactions at an Undervalue 51 to follow shortly after a company becomes insolvent in the cash-flow sense, it is unlikely to be relied upon frequently in the context of the avoidance of antecedent transactions. Nevertheless, one possibility is that an office-holder might allege a company became insolvent ‘as a result of’ a transaction where, even though the transaction did not immediately leave the company balancesheet insolvent, it triggered a chain of events which inevitably led to cash-flow insolvency. (c) Presumption of Inability to Pay Debts Where Counterparty is ‘Connected’ 2.41 By virtue of a rider to section 240(2), the company will be presumed to have been unable to pay its debts at the time of the transaction where the counterparty is a person ‘connected’ with the company. The category of persons ‘connected’ with the company is defined in section 249 to mean: (a) (b) (c) (d)

the company’s directors; the company’s shadow directors (if any); associates of the company; and associates of the company’s directors or shadow directors.

2.42 Directors. It is submitted that both de iure and de facto directors fall within the meaning of section 249.86 A ‘director’ is defined in section 251 to include ‘any person occupying the position of director, by whatever name called’. Clearly, this includes any person87 properly appointed to a role which is equivalent to that of a director, regardless of the label attached to the position. The necessary enquiry will be as to whether the person performed a role which was functionally equivalent to that of a ‘director’. It would seem that de facto directors—namely persons who are treated as directors, or who perform roles functionally equivalent to those of directors, but whose appointment is invalid for whatever reason—are not within the inclusive words of the definition.88 Nevertheless, as the wording of the section is only inclusive, it is open to the courts to interpret it broadly so as to encompass de facto as well as de iure directors. The breadth of the term ‘director’ has been held to vary with the context in which it is applied,89 depending on the purpose of the provision in play. It is clear that de facto directors are included for the purposes of liability for wrongful trading,90 and disqualification under the Company Directors 86 On the meaning of de facto and shadow directors, see generally GK Morse, ‘Shadow and De Facto Directors in the Context of Proceedings of Disqualification on the Grounds of Unfitness and Wrongful Trading’ in BAK Rider (ed), The Corporate Dimension (Bristol, Jordans, 1998), 115; A Walters and M Davis-White, Directors’ Disqualification: Law and Practice (London, Sweet & Maxwell, 1999). 87 Whether an individual or a corporate entity. 88 Re Lo-Line Electric Motors Ltd [1988] Ch 477 at 488; see also Inland Revenue Commissioners v Heaver Ltd [1949] 2 All ER 367 at 369–70; cf Re Eurostem Maritime Ltd [1987] PCC 190. 89 Re Lo-Line Electric Motors Ltd [1988] Ch 477 at 489. 90 Re Hydrodan (Corby) Ltd [1994] BCC 161.

52 John Armour Disqualification Act,91 on the basis that the provisions might otherwise be avoided simply through the expedient of avoiding a formal appointment. This reasoning clearly also applies to the vulnerable transaction provisions. 2.43 The most difficult question will be whether a person performed a role which was functionally equivalent to that of a director. Usually, this will arise in the context of whether or not a person was a de facto director.92 The Court of Appeal was recently called upon to consider the breadth of the concept of ‘de facto director’ in Re Kaytech International plc.93 Robert Walker LJ, giving the judgment of the court, held that the crucial issue was whether the individual concerned had assumed the status and functions of a company director, but declined to lay down any decisive criteria. It was not necessary for the company to hold the individual out as a ‘director’,94 provided that the individual was treated as a director in other ways. In enumerating factors which may be taken into consideration, The Court approved the following statement of Jacob J in Secretary of State for Trade and Industry v Tjolle,95 [I]t may be difficult to postulate any one decisive test. I think what is involved is very much a question of degree. The court takes into account all the relevant factors. Those factors include at least whether or not there was a holding out by the company of the individual as a director, whether the individual used the title, whether the individual had proper information (e.g. management accounts) on which to base decisions, and whether the individual has to make major decisions and so on. Taking all these factors into account, one asks ‘was this individual part of the corporate governing structure?’, answering it as a kind of jury question. In deciding this, one bears very much in mind why one is asking the question.

2.44 Shadow Directors. The term ‘shadow director’ is also defined in section 251, as follows: [A] person in accordance with whose directions or instructions the directors of the company are accustomed to act (but . . . a person is not deemed to be a shadow director by reason only that the directors act on advice given by him in a professional capacity).

2.45 The purpose of this section is, ‘to identify those, other than professional advisers, with real influence in the corporate affairs of the company’.96 It presupposes the existence of a board of directors who are accustomed to act in accordance with the instructions of another—the ‘shadow director’.97 The 91 Re Lo-Line Electric Motors Ltd [1988] Ch 477; Re Richborough Furniture Ltd [1996] 1 BCLC 507; Re Kaytech International plc [1999] BCC 390. 92 As has been seen, however, it is possible that such a person might be a de iure director within the inclusive words of section 251 where they have been validly appointed to a position which, although not carrying the label ‘director’, is in substance a directorship. 93 [1999] BCC 390 at 402. 94 Cf Re Hydrodan (Corby) Ltd [1994] BCC 161 at 163. 95 [1998] BCC 282 at 290. 96 Secretary of State for Trade and Industry v Deverell [2001] Ch 340 at 354, per Morritt LJ. 97 Re Lo-Line Electric Motors Ltd [1988] Ch 477 at 479.

Transactions at an Undervalue 53 shadow director need not hide from public view to be classed as such.98 Nor need he exercise such influence over the whole field of the company’s corporate activities.99 Rather, what matters is whether, for some or all purposes, the ‘locus of effective [corporate] decision making’ resides with the shadow director.100 2.46 The determination of this issue was authoritatively considered by the Court of Appeal in Secretary of State for Trade and Industry v Deverell, where Morritt LJ explained that: 101 Whether any particular communication from the alleged shadow director, whether by words or conduct, is to be classified as a direction or instruction must be objectively ascertained by the court in the light of all the evidence. In that connection I do not accept that it is necessary to prove the understanding or expectation of either giver or receiver. In many, if not most, cases it will suffice to prove the communication and its consequence. Evidence of such understanding or expectation may be relevant but it cannot be conclusive. Certainly the label attached by either or both parties then or thereafter cannot be more than a factor in considering whether the communication came within the statutory description of direction or instruction.

Furthermore, ‘directions or instructions’ could include ‘advice’ given otherwise than in a professional capacity.102 2.47 Whether or not the board are ‘accustomed to act in accordance with’ the directions or instructions of the alleged shadow director is a question of fact to be determined on the basis of all the evidence. It does not require that the board have rendered themselves subservient to the shadow director, or that they feel compelled to act in accordance with his instructions: merely that they are in fact accustomed to doing so.103 Being ‘accustomed’ does, however, imply a pattern of behaviour, and isolated instances of the board acting in accordance with the wishes of another are unlikely to constitute the latter a shadow director.104 2.48 Associates. The meaning of ‘associates’ is defined exclusively in section 435. A person is an associate of an individual (eg one of the company’s directors for the purposes of section 249) if:

98 Re Kaytech International plc [1999] BCC 390 at 402; Secretary of State for Trade and Industry v Deverell [2001] Ch 340 at 354–55; cf Re Hydrodan (Corby) Ltd [1994] BCC 161 at 163. 99 Secretary of State for Trade and Industry v Deverell [2001] Ch 340 at 354. 100 Australian Securities Commission v AS Nominees Ltd (1995) 133 ALR 1 at 52, per Finn J, cited with approval in Secretary of State for Trade and Industry v Deverell [2001] Ch 340 at 352. 101 [2001] Ch 340 at 354. 102 Ibid. 103 Ibid; cf Re PZFTM Ltd [1995] BCC 281 at 292. 104 Re Hydrodan (Corby) Ltd [1994] BCC 161 at 163.

54 John Armour (a) they are that individual’s husband or wife, or they are a relative105 (or husband or wife, including former and/or reputed husband or wife, of a relative) of the individual or of the individual’s husband or wife;106 (b) they are in partnership with the individual, and any husband, wife, or relative of such partner;107 (c) they are employed by the individual or are the individual’s employer;108 (d) they are the trustee of a trust of which the individual is a beneficiary, or the terms of the trust confer a power which may be exercised by the trustee in the individual’s favour or in favour of an associate of the individual;109 or (e) that person is a company controlled by the individual or by the individual and his associates.110 2.49 The persons who are associates of a company111 are: (a) any person in partnership with the company, and any husband, wife, or relative of such partner;112 (b) any employees of the company;113 (c) the trustees of any trust of which the company is a beneficiary, or the terms of the trust confer a power which may be exercised by the trustee in the company’s favour or in favour of an associate of the company;114 (d) any company of which either (i) the same person has control115 of both, or a person has control of one and persons who are his associates have control of the other; or (ii) if a group of two or more persons has control of each company, and the group either consist of the same persons or could be regarded as consisting of the same persons by treating (in one or more cases) a member of either group as replaced by a person of whom he is an associate;116 and 105 ‘Relative’ being defined to mean an individual’s brother, sister, uncle, aunt, nephew, niece, lineal ancestor or lineal descendant, treating (i) any relationship of the half blood as a relationship of the whole blood and the stepchild or adopted child of any person as his child, and (ii) an illegitimate child as the legitimate child of his mother and reputed father: Insolvency Act 1986 s 435(8). 106 Insolvency Act 1986 s 435(2). 107 Ibid s 435(3). 108 Ibid s 435(4). Directors of a company are deemed to be employed by that company by virtue of section 435(9). This provision is most likely to be relevant in the context of whether a person was ‘connected’ with a director under section 249 where the individual director holds office in relation to more than one company. 109 Ibid s 435(5). 110 Ibid s 435(7). 111 ‘Company’ is defined by section 435(10) to mean any body corporate, whether incorporated in Great Britain or elsewhere. 112 Insolvency Act 1986 s 435(3). 113 Ibid s 435(4). 114 Ibid s 435(5). 115 ‘Control’ is defined to mean either (a) that the directors of the controlled company, or of another company which in turn controls it, are ‘accustomed to act in accordance with the directions’ of the controller; or (b) that the controller is entitled to exercise, or control the exercise of, one third or more of the voting power at any general meeting of the controlled company, or of any company which in turn controls it: ibid s 435(10). 116 Ibid s 435(6).

Transactions at an Undervalue 55 (e) any other company which the company, or the company and its associates, controls.117

D TRANSACTION

2.50 The language of ‘transaction at an undervalue’ is employed in sections 238, 339 and 423, and the Court of Appeal has held it has the same meaning in each case.118 It is helpful to break the statutory formula down into its constituent elements of ‘transaction’ and ‘undervalue’. 2.51 The way in which the ‘transaction’ is framed is crucial to the application of section 238 for at least four reasons. First, if no transaction involving the company is made out, then there can be no cause of action.119 Secondly, the way in which the transaction is characterised will often be crucial to demonstrating that there was an undervalue.120 Thirdly, where parties’ actions have taken the form of a series of linked steps, it may be open to the court to characterise these as a single ‘transaction’.121 Finally, the framing of the transaction will also be relevant for the purposes of the application of the defence accorded by section 241(2), as it may determine whether or not a defendant’s acquisition of property was genuinely ‘from a person other than the company’, or whether the recipient of a benefit from the company was a ‘party’ to the transaction.122 2.52 Section 436 defines ‘transaction’ to include ‘gifts, agreements and arrangements’. The term was introduced following the advice of the Cork Committee, who felt that the effectiveness of section 42 of the Bankruptcy Act 1914 was hindered by the archaic language of ‘settlement’, which amongst other things did not cover straightforward gifts of money.123 The Committee recommended that the 117

Ibid s 435(7). National Bank of Kuwait v Menzies [1994] 2 BCLC 306 at 319; Agricultural Mortgage Corporation v Woodward [1995] 1 BCLC 1 at 9–10. 119 Re Brabon [2001] 1 BCLC 11 at 33. 120 For a cautionary tale, see National Bank of Kuwait v Menzies [1994] 2 BCLC 306. The plaintiff sought to impugn an irrevocable letter of instruction issued by the debtor company to its bank. The letter instructed the bank to pay KD300,000 to a third party. As interpreted by the Court of Appeal, the plaintiff’s claim was founded on the ‘transaction’ being the issue of this letter. At that time, however, the third party was a creditor of the debtor for the full amount, and hence the transaction was not at an undervalue. During the course of argument, the plaintiff sought to include prior dealings within the ‘transaction’, alleging that the third party had no entitlement to the moneys in question (at 313–14). However, since this line of argument was not adequately made out in the plaintiff’s statement of claim, the court refused to consider it further, and treated the relevant ‘transaction’ as consisting only of the issue of the letter itself. The plaintiff’s claim consequently failed in limine. 121 Harman v Richards (1852) 10 Hare 81 at 83, 68 ER 847 at 849; Arbuthnot Leasing International Ltd v Havelet Leasing Ltd (No 2) [1990] BCC 636; Phillips v Brewin Dolphin Bell Lawrie Ltd [2001] UKHL 2, [2001] 1 WLR 143. See also Tosich Constructions Pty Ltd v Tosich (1997) 23 ACSR 466. 122 Insolvency Act 1986 s 241(2). See below, paras 2.113ff. 123 Cork Report, para 1226. 118

56 John Armour new section make clear that it applied to ‘dispositions of money or property’.124 The broad definition of ‘transaction’ goes further than this however, covering for example the provision of services, loans of property, and guarantees.

(1) Requirement of Mutuality? 2.53 A threshold question concerns whether or not a requirement of some degree of mutuality of intent is to be read into the definition of ‘transaction’. The prevailing position in the authorities is that it should be, apart from cases where a gift is made by the company. This is supported by the following arguments. First, the term ‘transaction’ has connotations of mutual dealings.125 This is supported by the words of sections 238(2) and 238(4) which require that the company must ‘enter into a transaction with a person’ (the counterparty).126 Furthermore, section 238(4)(a) refers to the transaction being ‘on terms that provide . . .’,127 which seems to preuppose mutual assent as to the content of such terms. Secondly, the terms used in the definition of ‘transaction’ in section 436 (other than ‘gift’) are also redolent of mutuality: ‘arrangement’ and ‘agreement’.128 Thirdly, this interpretation is supported by the use of the term ‘party’ in section 241(2)(b) as a discriminator between those recipients of benefits under a transaction who may, if their receipt was in good faith and for value, claim the benefit of the defence, and those—parties to the transaction—who may not.129 To be party to an agreement or an arrangement clearly implies some mutuality of understanding. 2.54 This interpretation may be illustrated by reference to the recent decision of Robert Englehart QC in Re Taylor Sinclair (Capital) Ltd.130 S, a director of A Ltd, owed approximately £200,000 to the defendants. He procured A Ltd to make a payment of slightly over £200,000 to B Ltd, which agreed to hold the money to his order on account of A Ltd. S, purporting to act on behalf of A Ltd, 124 Cork Report, para 1232. The precise genesis of the term ‘transaction’ is, however, unclear. The White Paper following the Cork Report speaks in terms of ‘dispositions’ (DTI, A Revised Framework for Insolvency Law, Cmnd 9175 (London, HMSO, 1984) at para 69), whereas the Insolvency Bill which followed little over a year later employed the novel language of ‘transactions at an undervalue’ (Insolvency Bill 1985, cl 84(2)). 125 Clarkson v Clarkson [1994] BCC 921 at 926; Re Taylor Sinclair (Capital) Ltd [2001] 2 BCLC 176 at 184. See also Nilant v Plexipack Packaging Services Pty Ltd (1996) 21 ACSR 428. 126 Emphasis added. 127 Emphasis added. 128 See Re Taylor Sinclair Ltd [2001] 2 BCLC 176. This point is, of course, weakened by the fact that the definition in section 436 is merely inclusive. However, the words of section 238, as outlined in the preceding point, must surely direct the way in which the term is to be interpreted. In this light, the inclusive terms of section 436 (gifts apart) are illustrations of the concept. 129 Whilst the defence is of course, only relevant if it has been determined that a ‘transaction’ in fact occurred, it is nevertheless submitted that it should be construed coherently with the elements of the cause of action under section 238. 130 [2001] 2 BCLC 176.

Transactions at an Undervalue 57 then ordered B Ltd to pay the money over to the defendants, simultaneously telling the defendants that this payment amounted to a loan made by B Ltd to himself, to be applied in satisfaction of his indebtedness to them. A Ltd subsequently sought the return of its funds from B Ltd, which claim precipitated that company’s insolvent liquidation. The liquidator of B Ltd in turn sought to recover the £200,000 paid to the defendants on the basis that this constituted a transaction at an undervalue. 2.55 Robert Englehart QC held that as there was no ‘agreement or arrangement’ between B Ltd and the defendants—the latter being mere passive recipients of the money—there was no ‘transaction’.131 His Lordship made clear that it is necessary, other than for gifts, for persons to be parties to a ‘transaction’, that there be some degree of consensus ad idem as to its terms:132 It is not easy to spell out just what was the ‘transaction’ to which they were parties. As far as [B Ltd] was concerned, it was dealing with money which it held to the order of [A Ltd] and in accordance with [A Ltd’s] instructions. As for [the defendant], it thought that it was receiving for the credit of [S’s] account money which [S] had personally borrowed.

2.56 On the ‘mutuality’ theory, the express inclusion of ‘gifts’ involves an artificial extension of the basic concept of ‘transaction’.133 This is effected by the express words of section 238(4)(a) which deem a company to ‘enter into a transaction with a person’ where the company makes a gift to that person, and of section 436 which specifically refers to gifts.134 For there to be a ‘gift’, the company must, in transferring assets, have intended to confer a gratuitous benefit on the transferee.135 Such intention may be inferred from the fact of a gratuitous transfer if no alternative explanation is given.136 The point was not argued in Taylor Sinclair, but it is clear that the result fits with this analysis: there was no gift as the company’s intention was not to confer a gratuitous benefit on B Ltd. 2.57 The ‘mutuality’ approach has been forcefully criticised by Mokal and Ho.137 These authors argue that the reasoning in Taylor Sinclair ‘goes directly against the very purpose of the section’,138 which they take to be that recognised by the judge in the same case as, ‘to restore to the company for the benefit of its 131

Ibid at 184. Ibid. 133 There is only artificiality if the orthodox position is accepted that a gift does not require mutuality of intention. This orthodoxy may be open to question in some circumstances: see J Hill, ‘The Role of the Donee’s Consent in the Law of Gift’, (2001) 117 Law Quarterly Review 127. 134 No artificial extension of the meaning of the term ‘party’ is required for the purposes of section 241(2)(b), as the defence is only available to recipients for value. 135 Clarkson v Clarkson [1994] BCC 921 at 926. 136 Re Barton Manufacturing Ltd [1999] BCC 827 at 829–31. 137 RJ Mokal and LC Ho, ‘Consideration, Characterisation, Evaluation: Transactions at an Undervalue After Phillips v Brewin Dolphin’ (2001) 1 Journal of Corporate Law Studies 359 at 360–63. 138 Ibid 362. 132

58 John Armour creditors money which ought not to have left the company’.139 Instead, Mokal and Ho argue that there would be a ‘transaction’ between the company and every direct recipient of property to whom there has been a ‘net transfer of value’ by the company.140 This approach would be more favourable to the liquidator in practice, as it would not require complex factual enquiries into the state of mind of the company and/or the counterparty. As such, it may be argued that it would further the purpose of section 238 by swelling the assets which may be recovered. 2.58 However, this argument proves too much. Robert Englehart QC was, as he himself demonstrated through the ratio of his judgment, referring to the purpose of the section in a general way, which he recognised as being tempered by its limits. One must ask whether the purpose of the section does militate in favour of recovery in situations like Taylor Sinclair. 2.59 The purposes for which section 238 operates are contentious. It has been argued earlier in this chapter141 that the best justifications for the section consist in (i) the avoidance of collusive transactions; and, because the section is broader than what is necessary to do this, (ii) the amelioration of perverse incentives faced by shareholders/ directors of troubled companies. Clearly, the avoidance of collusion does not imply that recovery should be allowed from the defendants in Taylor Sinclair: if there is no shared understanding, there can be no collusion. Would extending liability in that situation serve the alternate goal of ameliorating perverse incentives? It is thought not. The way the section serves to achieve this latter purpose is by causing counterparties to ‘generous bargains’ with troubled companies to think twice before agreeing: in effect, they are recruited as monitors of the company’s actions. Yet for this function to work, the persons recruited must be capable of telling that the transaction is prima facie harmful to the company’s interests: hence the requirement that it must be gratuitous or at a significant undervalue. Where the transferee is led to believe, as in Taylor Sinclair, that the transaction was effected for full value, then there is no obvious reason to want them to monitor the company.

(2) Was the Company a Party to the Transaction? 2.60 The company must ‘enter into’ the transaction. It follows from the concept of ‘transaction’ employed in the case law that the company will not be a party to a transaction merely because its assets have been depleted, if this did not arise from an act legally attributable to it.

139 140 141

Ibid citing Re Taylor Sinclair Ltd [2001] 2 BCLC 176 at 183. Ibid. Above, paras 2.14ff, esp at 2.28–2.29.

Transactions at an Undervalue 59 (a) Mortgagee Exercising a Power of Sale 2.61 In Re Brabon,142 a conveyance was effected by a mortgagee pursuant to a specifically enforceable contract entered into by the insolvent debtor. It was held that the relevant ‘transaction’ for the purposes of section 238 was the conveyance by the mortgagee and not the entry into the preceding contract, and that this was not ‘entered into’ by the debtor. This seems entirely correct, as the mortgagee’s decision (not) to sell is legally independent of contracts entered into by the insolvent, and the mortgagee is not treated as the agent of the debtor for these purposes. However, the position will be otherwise where the mortgagee does not exercise an independent judgment, but is induced to sell through misrepresentations made to them by the debtor.143 (b) Receiver Exercising a Power of Sale 2.62 In contrast with the position of a mortgagee, it is submitted that a sale by a receiver could constitute a transaction ‘entered into’ by the company, provided that by the terms of the charge, or by statutory implication,144 the receiver is deemed the agent of the company. Similar reasoning was applied by Park J in Demite Ltd v Protec Health Ltd,145 finding that section 320 of the Companies Act 1985 applied to transactions entered into by receivers.146 Again, in Dora v Simper,147 an action under section 423 of the Insolvency Act 1986, Buckley J held that as the relevant transaction had been effected by receivers, they were the company’s ‘directing mind and will’ at the time for the purpose of determining whether or not it had been entered into for the statutorily-proscribed purpose of defeating the claims of creditors.148

142

[2001] 1 BCLC 11. Secretary of State for the Environment, Food and Rural Affairs v Feakins & Hawkins [2002] BPIR 281. 144 As in the case of an administrative receiver. See Insolvency Act 1986 s 44(1)(a). 145 [1998] BCC 638 at 646–47. 146 Companies Act 1985 s 320 applies to transactions whereby the company acquires from, or sells to, a director or connected person a non-cash asset worth more than £100,000 or 10% of the company’s net asset value. 147 [2000] 2 BCLC 561 at 566. 148 These decisions are open to criticism on the basis that they adopt an overly literal approach to the question of the receiver’s agency (see S Frisby, ‘Receivers and the Companies Act 1985, s. 320: A Very Real Agency’ [1999] 3 Company Financial and Insolvency Law Review 143). A different approach was followed by the High Court of Australia in Sheahan v Carrier Air Conditioning Pty Ltd (1996–97) 189 CLR 407, a case concerning a preference action. All members of the Court took the view that the receiver’s agency was ‘special’, and held (albeit more clearly by the majority) that it should not be allowed to controvert what would otherwise be the true legal nature of a transaction. The application of this approach would not, however, lead to different results for s 238 actions. Provided that a transaction effected by the receiver transfers value from the company, then it appears the Sheahan approach would hold the receiver’s agency to be real. 143

60 John Armour (3) Characterising a Transaction 2.63 In many cases the scope of the transaction to be impugned will be obvious. However, in cases involving complex linked arrangements, the appropriate characterisation of the ‘transaction’ may assume paramount importance, for example in determining whether an undervalue is disclosed.149 (a) ‘Sham’ Transactions 2.64 The underlying principle is that the court will construe the transaction in accordance with the parties’ true intentions. In cases of doubt, two judicial tools may be employed to assist in this determination. First, the doctrine of ‘sham’ transactions permits it to penetrate arrangements which ex facie appear to be of one variety, but intentionally do not reflect the parties’ true mutual understanding. The doctrine was explained in a well-known formulation by Diplock LJ in Snook v London & West Riding Investments Ltd:150 [A]cts done or documents executed by the parties to [a] ‘sham’ . . . are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual rights and obligations (if any) which the parties intend to create. . . . [F]or acts or documents to be a ‘sham,’ with whatever legal consequences flow from this, all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating.

2.65 Regardless of section 238, the ‘sham’ aspect of such a transaction has no legal effect, and the transaction takes effect (if at all) as the parties genuinely intended. Needless to say, demonstrating that a purported transaction was a sham involves considerable evidential difficulties.151 (b) Characterising a Sequence of Linked Steps 2.66 Secondly, where a transaction is not a sham, but its true scope or nature is ex facie ambiguous, the courts will embark on a process of characterisation to determine its true legal effect.152 This process is akin to those employed in other areas where courts must determine whether or not a particular arrangement falls within a specific statutory provision—for example, whether an agreement 149 See eg, National Westminster Bank plc v Jones [2001] EWCA Civ 1541 at [26], [2002] 1 BCLC 55 at 61. 150 [1967] 2 QB 786 at 802. 151 See eg, National Westminster Bank plc v Jones [2001] 1 BCLC 98 at 108–19 (aff’d on other grounds [2001] EWCA Civ 1541, [2002] 1 BCLC 55), where a claim that the transaction was a sham was not made out. 152 McEntire v Crossley Bros [1895] AC 457 at 462–63, 467; Street v Mountford [1985] AC 809 at 825; AG Securities v Vaughan [1990] 1 AC 417 at 462–64; Welsh Development Agency v Export Finance Co Ltd [1992] BCLC 148 at 160–63, 185–88.

Transactions at an Undervalue 61 to rent a room constitutes a lease or a licence, or whether a particular financing transaction amounts to a registrable security interest or a purchase and resale.153 The task for the court in these situations was described by Staughton LJ in Welsh Development Agency v Export Finance Co Ltd,154 If one part of the agreement purports to create a particular legal transaction, it may happen that other provisions are inconsistent with such a transaction. The task of the court is then to ascertain which is the substance, the truth, the reality. . . . In my judgment the correct process . . . is to look at the operative parts of the document, in order to discover what legal transaction they provide for. If some parts appear to be inconsistent with others in this respect, a decision must be made between the two.

2.67 This approach is applicable by analogy in the context of section 238. However, the courts are called upon to determine not so much the legal nature of the transaction, but its scope. A ‘transaction’ need not involve any contract; conversely it may comprise a series of linked but discrete contracts.155 Thus whilst Staughton LJ is concerned with the correct legal characterisation of a given transaction, the court’s task in section 238 cases is to characterise the factual matrix to determine which of the parties’ acts were part of the relevant arrangement, and thereby to construct the ‘transaction’.156 2.68 Recent guidance on this issue has been provided by the House of Lords, albeit in a somewhat Delphic fashion, in the case of Phillips v Brewin Dolphin Bell Lawrie Ltd.157 The facts of the case, simplified considerably, were as follows. AJ Bekhor & Co (‘AJB’) agreed to sell most of its stockbroking business to Brewin Dolphin & Co Ltd (‘Brewin Dolphin’) for £1.25m. The deal was structured so that the money was to come from Brewin Dolphin’s parent company, Private Capital Group Ltd (‘PCG’) by way of a four-year operating sublease of computer equipment, with annual rental payments in arrears of £312,500 (hence totalling £1.25m). AJB’s business was hived down, and contracts of employment transferred, to a subsidiary the shares in which were transferred to Brewin Dolphin for £1. This structure was adopted for tax and regulatory reasons.158 The terms of AJB’s lease of the computers did not permit

153

See also the discussion of disguised chattel mortgages in ch 6, paras 6.51ff. [1992] BCLC 148 at 187–88. 155 Harman v Richards (1852) 10 Hare 81 at 83, 68 ER 847 at 849; Arbuthnot Leasing International Ltd v Havelet Leasing Ltd (No 2) [1990] BCC 636; Phillips v Brewin Dolphin Bell Lawrie Ltd [2001] UKHL 2, [2001] 1 WLR 143. See also Tosich Constructions Pty Ltd v Tosich (1997) 23 ACSR 466. 156 See RJ Mokal and LC Ho, ‘Consideration, Characterisation, Evaluation: Transactions at an Undervalue After Phillips v Brewin Dolphin’ (2001) 1 Journal of Corporate Law Studies 359 at 362. 157 [2001] UKHL 2, [2001] 1 WLR 143. 158 First, PCG (which had earned substantial profits) could set off the lease payments against corporation tax. Second, the notional sale for £1 meant that no value needed to be assigned to the goodwill of AJB’s business in Brewin Dolphin’s accounts. Any such value would have resulted in Brewin Dolphin’s regulators requiring an increase in its capital commitment. See the judgment of EvansLombe J at first instance: [1998] 1 BCLC 700 at 714. 154

62 John Armour subleasing. However, before any action was taken about the breach of this term, AJB failed to pay an instalment and the lessors terminated the lease. At this point, PCG notified AJB that they had elected to treat this as a repudiation of the subleasing agreement, and that they considered themselves no longer bound to pay the rental instalments. 2.69 AJB went into liquidation shortly afterwards, and its liquidator brought an action against Brewin Dolphin, claiming that the sale had been at an undervalue.159 In the Court of Appeal, Morritt LJ (who gave the only reasoned judgment) saw the central issue as being the appropriate characterisation of the ‘transaction’ and found that the share sale and the sublease constituted two separate transactions. He explained this as follows:160 I reach this conclusion for a number of reasons. First, the parties acting at arms length and for readily understandable commercial reasons chose so to structure the deal between them so that, on the face of the documents, the share sale agreement and the lease agreement effected two separate, though linked, transactions. There is no indication that this different treatment was a sham or otherwise colourable. If parties in such circumstances choose so to structure their commercial dealings in my view the court should give full weight to their intentions. Second, for the reasons I have already given, the share sale agreement and the lease agreement cannot be the same transaction for the purposes of the section because, though the company was party to both of them, only Brewin Dolphin was party to the first and only PCG party to the second. Third, the parties to the lease agreement, the company and PCG, unambiguously attributed the four annual payments of £312,500 to rent due thereunder for possession and use of the computer equipment to which it related. The promise to make those payments cannot be recharacterised as consideration from PCG or Brewin Dolphin ‘for’ the shares being sold by the company.

Thus the ‘transaction’ was the share sale agreement and the consideration was only that which passed from Brewin Dolphin to AJB. Hence an undervalue was disclosed.161 2.70 Morritt LJ’s reasoning betrays a confusion between contracts and transactions. Given that there was no sham, it is clear that the parties had intended to structure their arrangements as two separate contracts, and that the parties to these were different. It follows that it would be impossible to recharacterise 159 At first instance, Evans-Lombe J held that Brewin Dolphin could not ‘blow hot and cold’ in arguing on the one hand that the sublease was entirely separate from the share sale agreement, so that the right to uninterrupted possession of the computers (which had been interfered with by the termination of the headlease) amounted to a condition of the sublease, whereas on the other the ‘rental’ payments constituted part of the consideration for the share sale agreement. Either the two were separate or they were not. On the basis that they were separate, he held that the consideration for the sale of the shares amounted to the one pound plus the cost to Brewin Dolphin of taking over AJB’s redundancy obligations (which amounted to about £325,000). This was much less than the value of the business, which he took to be the agreed sale price of £1.25m: ibid 725–27. 160 [1999] 1 WLR 2052 at 2061. 161 Ibid 2061–64.

Transactions at an Undervalue 63 the rental payments under the loan as being consideration associated with the contract for the sale of shares. Yet as we know, the concept of ‘transaction’ is broader than that of a contract. Thus it does not follow that matters which are determinative as to the scope of a particular contract shall be so for transactions of which the contract may make up only a part. 2.71 Bearing this in mind, let us reconsider Morritt LJ’s reasons. First, the fact that the parties had clearly chosen to structure their affairs as two separate contracts should not of itself be determinative of the scope of the ‘transaction’ for the purposes of section 238. If the contracts were in fact entered into pursuant to a common understanding between the parties that they were linked and part of the same arrangement, then it is open to the court to find that they constituted one ‘transaction’. Furthermore, whilst the separate contracts had different parties, all three companies shared a common understanding in fact that these contracts were entered into for a linked purpose: the transfer of AJB’s business to Brewin Dolphin. Hence all three were parties to the transaction. The third reason seems to have little force independently of the first. 2.72 Morritt LJ’s judgment was overruled on this point by the House of Lords. Lord Scott, who gave the only reasoned speech, held that the Court of Appeal had erred in focusing their attention on the characterisation of the ‘transaction’, whereas what mattered was the scope of the ‘consideration’ passing.162 His Lordship referred to a memorandum prepared by Brewin Dolphin’s finance director which explained why the parties had structured the business transfer as they had, holding that this clearly showed that the parties had understood that the entry by PCG into the lease agreement would be part of the ‘consideration’ provided by Brewin Dolphin for the share sale agreement.163 2.73 With respect, Lord Scott’s approach merely reformulates the same issue using different language. The concept of ‘consideration’ is therefore intimately linked to the transaction under which it is alleged to have passed.164 Consider that, in finding PCG’s entry into the sublease constituted part of the relevant ‘consideration’, His Lordship emphasised the parties’ common understanding of what they were doing. Their mutually understood arrangement was that the two contracts were linked, and thus the consideration passing under them should be aggregated. This is, of course, equivalent to saying that they constituted one ‘transaction’. 2.74 The courts will be loath to recharacterise a series of seemingly linked steps as a single transaction where different parties have been involved in some

162

[2001] UKHL 2 at [20], [2001] 1 WLR 143 at 150. Ibid. 164 See RJ Mokal and LC Ho, ‘Consideration, Characterisation, Evaluation: Transactions at an Undervalue After Phillips v Brewin Dolphin’ (2001) 1 Journal of Corporate Law Studies 359 at 363–64. 163

64 John Armour of the steps. An example is provided by National Westminster Bank plc v Jones.165 The case involved a grant of a tenancy to a shell company owned by the grantor. At first instance, Neuberger J rejected the argument that the ‘transaction’ also involved the acquisition of the shell company, as this involved separate parties (the vendors) who did not participate in the rest of the transaction.166 This result was upheld by the Court of Appeal.167 (c) MBO Transactions 2.75 Management buy-out transactions (‘MBOs’) may provide an interesting application of these principles. A typical MBO involves the incumbent management team purchasing a controlling block of the company’s shares.168 A typical MBO will be effected via a purchase vehicle (‘Acquirer’), a shell company the equity of which is owned by the management team. Finance will be obtained from a group of lenders (‘Bank’) which is used by Acquirer to purchase the shares of the target company (‘Target’). As Acquirer will have no assets, Bank will want the transaction structured so that the assets of Target are offered as security for the finance. Two typical routes are as follows: (1) Bank advances funds directly to Acquirer, which uses the money to purchase Target’s shares. Target guarantees Acquirer’s obligation to repay, secured by a debenture over its assets; or (2) Acquirer purchases Target’s shares, issuing a note to the ‘old’ shareholders. Bank then loans the funds to Target, taking a debenture over its assets. Target then on-loans the funds to Acquirer, which uses them to redeem the note. In each case, the net result is that Target becomes much more heavily indebted. As Acquirer has no income stream, there is no possibility of its ever repaying loan proceeds, and so the assets of Target have in effect been transferred to the old shareholders. If Target enters winding-up or administration within two years of the MBO, an office-holder may seek to raise a challenge based on section 238.169 2.76 As a preliminary matter, it should be noted that such transactions would prima facie constitute unlawful financial assistance given by Target for the pur165

[2001] 1 BCLC 98, aff’d [2001] EWCA Civ 1541, [2002] 1 BCLC 55. [2001] 1 BCLC 98 at 120. See also Nilant v Plexipack Packaging Services Pty Ltd (1996) 21 ACSR 428. 167 [2001] EWCA Civ 1541 at [26], [2002] 1 BCLC 55 at 61. Cf I Dawson (2002) 61 Insolvency Lawyer 61. 168 A management buy-in (‘MBI’) is similar, except that the management team are outsiders to the company before the transaction. Both of these are usually financed by the company taking on substantially greater debt, which is reflected in the US term ‘leveraged buy-out’ (‘LBO’). For the purposes of this discussion, the term ‘MBO’ will be used generically. 169 See RN Price, ‘Commercial Benefit in Management Buy-Outs: The Two-Year “Equity Punt” for Bankers?’ (1988) 3 Butterworths Journal of International Banking and Finance Law 301. 166

Transactions at an Undervalue 65 chase of its shares.170 In practice, however, it is commonplace for the Target in MBO transactions (if initially a public company) to change status to private after its shares are acquired, but before any guarantee or on-loan is entered into. This enables the ‘whitewash’ exception to the financial assistance provisions to be employed in order to validate the transaction.171 Compliance with the relevant provisions would appear to rule out any challenge under section 238. The requirements that (i) any depletion of Target’s net assets must be accountable from its distributable profits,172 and that (ii) its directors must make a statutory declaration, backed by an auditor’s report, that they are of the opinion that the company will remain able to pay its debts as they fall due for at least a year,173 would seem respectively to preclude any suggestion that Target was or became balance sheet insolvent at the time of the transaction,174 or that any subsequent cash-flow insolvency was a result of the transaction. 2.77 However, it appears likely that the prohibition on the giving by a private company of financial assistance for the acquisition of its shares will be abolished in the near future.175 This will mean that a MBO transaction under which the company (if not already so) ‘goes private’ may well be capable of attack under section 238. In the US, where the corporate codes of most states (including Delaware) do not contain prohibitions on financial assistance, such transactions are frequently challenged on the basis that they constitute fraudulent conveyances.176 Although of course the relevant statutory provisions are different,177 the resulting 170 Companies Act 1985 ss 151–53. Both the loan in version (2) and the guarantee in version (1) are capable of constituting ‘financial assistance’ (ss 152 (1)(a)(ii), 152(1)(a)(iii)), and on these facts they are respectively given by Target to Acquirer for the purposes of reducing a liability incurred by the latter for the purpose of purchasing the former’s shares (ss 151(2), 152(3); see also M Arden and DD Prentice (eds), Buckley on the Companies Acts, 14th edn (London, Butterworths, 2000), para [152.10]). 171 Companies Act 1985 ss 155–58. 172 Ibid s 155(2). 173 Ibid s 156. 174 See generally E Ferran, Company Law and Corporate Finance (Oxford, Oxford University Press, 1999), 418–19. 175 Company Law Review Steering Group, Modern Company Law for a Competitive Economy: Completing the Structure (DTI, London, 2000), paras 2.14, 7.12. 176 See eg, US v Gleneagles Inv Co 565 F Supp 556 (MD Pa 1983), aff’d sub nom US v Tabor Court Realty 803 F 2d 1288 (3d Cir 1986); Kupetz v Wolf 845 F 2d 842 (9th Cir 1988); Wieboldt Stores, Inc v Schottenstein 94 BR 488 (ND Ill 1988); Crowthers McCall Pattern, Inc v Lewis 129 BR 992 (SDNY 1991); Mellon Bank, NA v Metro Communications Inc 945 F 2d 635 (3d Cir 1991); Murphy v Meritor Savings Bank 126 BR 370 (Bankr D Mass 1991); Moody v Security Pacific Business Credit, Inc 127 BR 958 (WD Pa 1991); Kaiser Steel Corp v Pearl Brewing Co 952 F 2d 1230 (10th Cir 1991); cf Credit Managers Association v Federal Co 629 F Supp 175 (CD Cal 1985). 177 The US fraudulent conveyance provisions allow for the setting aside of transactions under which the debtor did not receive ‘reasonably equivalent value’, inter alia at a time when it was insolvent in the balance-sheet sense, or if it became insolvent either in balance-sheet or cash-flow sense as a result of the transaction. See Uniform Fraudulent Transfer Act §§ 4, 5; US Bankruptcy Code § 548. A third ‘financial condition’ test, which is not replicated in section 238, is that the debtor be left with ‘unreasonably small capital’. The provisions of the older Uniform Fraudulent Conveyance Act, which are still in force in some states and were applied in a number of the relevant authorities, are slightly different, requiring that the transaction be one that was not for ‘fair consideration’.

66 John Armour case law, and the commentary to which it has given rise,178 may nevertheless provide useful guidance as to the potential application of section 238 to such transactions. 2.78 For a claim based on section 238 to succeed, it would first be necessary to establish that Target entered into a transaction at an undervalue. This is straightforward in version 1. The ‘transaction’ attacked will be the grant of the upstream guarantee to Bank. As Acquirer has no income stream, the value of this guarantee will in effect be the present value of the debt. In return, Target receives at best only indirect consideration in the form of (arguably) better management, and access (perhaps) to superior working capital facilities through its relationship with Bank. Even if these have a monetary value,179 it will clearly be very significantly less than the value of the consideration leaving Target. 2.79 In transactions structured as in version 2, Bank can argue that Target’s repayment obligation was incurred in return for the advance of funds, and hence there was no undervalue. Clearly, the loan to Acquirer will be an undervalue transaction, but this will be of no avail to Target’s creditors as the former will have no assets. However, a number of US decisions, including the leading case of US v Tabor Court Realty (the ‘Gleneagles’ decision),180 in which this type of MBO structure was considered have characterised the ‘transaction’ as not just the loan agreement between Bank and Target, but as the entirety of the MBO arrangement. As under the terms of the wider transaction it was never intended for the Target to retain the loaned funds, its role is characterised as that of a ‘mere conduit’ through which they passed to Acquirer and thence to the old shareholders. Thus the value received by the Target is, on this approach, only what is left after the entire transaction has been completed—i.e. nothing save for the indirect benefits, which clearly will amount to significantly less than the value of Target’s repayment obligation to Bank. 2.80 Could such a characterisation be adopted under section 238? Much would depend on what the court viewed as the ‘transaction’. As has been discussed, the court might be willing to recharacterise a sequence of linked steps,

178 See eg, DG Carlson, ‘Leveraged Buyouts in Bankruptcy’,(1985) 20 Georgia Law Review 73; DG Baird and TH Jackson, ‘Fraudulent Conveyance Law and its Proper Domain’ (1985) 38 Vanderbilt Law Review 829; MT Kirby, KG McGuinness and CN Kandel, ‘Fraudulent Conveyance Concerns in Leveraged Buyout Lending’ (1987) 43 Business Lawyer 27; EL Sherwin, ‘Creditors’ Rights Against Participants in a Leveraged Buyout’ (1988) 72 Minnesota Law Review 449; RA Fogelson, ‘Toward a Rational Treatment of Fraudulent Conveyance Cases Involving Leveraged Buyouts’ (1993) 68 New York University Law Review 552. 179 See US v Gleneagles Inv Co 565 F Supp 556 at 576 (MD Pa 1983); Credit Managers Association v Federal Co 629 F Supp 175 at 182 (CD Cal 1985) (new management services do not have a monetary value and therefore do not constitute ‘consideration’). 180 803 F 2d 1288 at 1302 (3d Cir 1986). See also Kupetz v Wolf 845 F 2d 842 at 846 (9th Cir 1988); Crowthers McCall Pattern, Inc v Lewis 129 BR 992 at 998 (SDNY 1991); Moody v Security Pacific Business Credit, Inc 127 BR 958 at 992 (WD Pa 1991).

Transactions at an Undervalue 67 provided that the alleged ‘parties’ shared a mutual understanding of what they were doing.181 A superficially similar approach was adopted in a number of the American cases, whereby the courts have scrutinised the degree of knowledge possessed by Bank or the old shareholders about the destination of the loaned funds and the structure of the transaction. For example, in Wieboldt Stores, Inc v Schottenstein,182 the court distinguished between participants ‘who were aware that the consideration they received for their financing commitments or in exchange for their shares consisted of [Target’s] assets’183 and those who were not, with only the former facing liability. Although this was not expressed as an enquiry into the ‘parties’ to the transaction184—this not being an element of US fraudulent conveyance statutes—the basis of the enquiry is similar to that conducted into the scope of the transaction in this jurisdiction. 2.81 MBO lenders wishing to avoid any such potential liability following the repeal of the financial assistance provisions would be well-advised to require Target companies to go through a procedure similar to the current ‘whitewash’. They should first obtain audited accounts demonstrating that after the MBO transaction, the Target is not balance-sheet insolvent. Secondly, they should seek a declaration from auditors that there is no reasonable prospect of the company becoming cash-flow insolvent within two years as a consequence of the transaction.

E UNDERVALUE

2.82 Under section 238(4), transactions can be at an ‘undervalue’ either because they are gifts or transactions for no consideration, or because the value of the consideration received by the company is significantly less than that which it has given.185 In each case, it must be shown that consideration was given by the company, which can be valued in money or money’s worth.186 If the true value of the consideration passing to the company is zero, and valuable consideration leaves the company, then the transaction falls within section 238(4)(a). If valuable consideration was also received by the company pursuant to the transaction, then the claim must be brought under section 238(4)(b). The

181

See above, paras 2.53ff. 94 BR 488 (ND Ill 1988). Ibid 503. 184 Rather, the approach of the US courts is based on determining whether it is appropriate to characterise the defendant’s behaviour as ‘fraudulent’. See generally, RA Fogelson, ‘Toward a Rational Treatment of Fraudulent Conveyance Cases Involving Leveraged Buyouts’ (1993) 68 New York University Law Review 552 at 572–81. 185 In some cases, the difference between these two heads may be no more than a matter of characterisation—a transaction involving a disparity in consideration can in theory be divided into a full value transaction and a gift. See eg, Welch v Official Assignee [1998] 2 NZLR 8, [1999] 1 NZLR 201. 186 See National Bank of Kuwait v Menzies [1994] 2 BCLC 306, discussed above n 120. 182 183

68 John Armour now-classic exposition of the meaning of this subsection is that of Millett J in Re MC Bacon: 187 To come within [section 238(4)(b)] the transaction must be: (1) entered into by the company; (2) for a consideration; (3) the value of which measured in money or money’s worth; (4) is significantly less than the value; (5) also measured in money or money’s worth; (6) of the consideration provided by the company. It requires a comparison to be made between the value obtained by the company for the transaction and the value of the consideration provided by the company. Both values must be measurable in money or money’s worth and both must be considered from the company’s point of view.

The court must therefore establish what consideration, if any, moved in each direction, value both from the company’s point of view, and then compare the difference in value. It seems that a difference of anything more than fifteen per cent of the true value will count as ‘significant’.188 We shall address in turn (i) what may count as ‘consideration’ and (ii) the process of valuation to be employed.

(1) Scope of Consideration 2.83 The focus in section 238 is on a transaction rather than a contract. As we have seen, a transaction may itself be comprised of a series of linked steps, each itself forming a separate contract.189 The undervalue enquiry looks to the aggregate value of the consideration passing under the whole of the transaction.190 The process of identifying the consideration is therefore complementary to the characterisation of the transaction. (a) Incidental Benefits 2.84 In most cases, the identification of the consideration will be straightforward. However, difficulties arise in situations where an incidental benefit is gained or detriment is suffered by the debtor company as a result of entering 187 Re MC Bacon [1990] BCC 78 at 92, aff’d in National Bank of Kuwait v Menzies Ltd [1994] 2 BCLC 306 at 319; Agricultural Mortgage Corporation v Woodward [1995] 1 BCLC 1 at 9–10; Phillips v Brewin Dolphin Bell Lawrie [2001] UKHL 2 at [21], [2001] 1 WLR 143 at 151. See also National Westminster Bank plc v Jones [2002] 1 BCLC 55 at 61. 188 See National Westminster Bank plc v Jones [2001] 1 BCLC 98 at 129 (aff’d [2001] EWCA Civ 1541, [2002] 1 BCLC 55) (consideration received in sale of farm assets was 15.5% less than their market value as established by the court). See also McDonald & Anor v Hanselmann (1998) 28 ACSR 49 at 56. 189 See above, paras 2.63ff. 190 Phillips v Brewin Dolphin [2001] UKHL 2 at [20], [2001] 1 WLR 143 at 150.

Transactions at an Undervalue 69 into the transaction. For example, where the debtor sells a key piece of machinery to a counterparty at market value, the cost of the disruption to the debtor’s business may be far greater than the market value. When, if at all, should such incidental detriments (or benefits) be included as part of the consideration to be valued? One approach would be to include only those which have been requested or bargained for by the counterparty to the transaction. This is simply a version of the contractual requirement that consideration must be given in return for a promise,191 expanded to encompass the ‘transaction’ in question. 2.85 The point was raised in Agricultural Mortgage Corporation v Woodward.192 The plaintiff had provided the debtor, a farmer, with finance in return for a mortgage of his farm the freehold value of which was £1m. In arrears with his repayments and fearing that the plaintiff would seek repossession, the debtor granted an agricultural tenancy of the farm to his wife.193 At a time when his outstanding debt to the plaintiff was £850,000, the effect of the grant was to reduce the value of the debtor’s freehold to £500,000. However, the tenancy had been granted for what was accepted to have been a full market rent. At first instance, Judge Weeks held that because a full market consideration had been provided the transaction was not at an undervalue. The reduction in value of the freehold was merely an incidental detriment suffered by the debtor, and had nothing to do with the consideration provided for the transaction.194 The argument was developed by counsel for the debtor in the Court of Appeal, who suggested that in the law of contract, ‘consideration’ encompasses detriments suffered by the debtor only insofar as the detriment was part of the bargain entered into by the debtor and the transferee. This found some favour with Sir Christopher Slade, although he did not rule on the point. The point was expressly left open by the Court of Appeal, who decided the case on different grounds.195 2.86 This reasoning has merit, but leaves open the question of how it is to be determined what is part of the ‘bargain’ in a given transaction. It is submitted that, as with contractual consideration, this should be that which is in fact requested—whether expressly or impliedly—by the counterparty in exchange for their side of the transaction.196

191 Combe v Combe [1951] 2 KB 215. See AL Goodhart, ‘Unilateral Contracts’ (1951) 67 Law Quarterly Review 456; JC Smith ‘Unilateral Contracts and Consideration’ (1953) 69 Law Quarterly Review 99; AL Goodhart, ‘A Short Replication’ (1953) 69 Law Quarterly Review 106. 192 [1995] 1 BCLC 1. This was a case decided under section 423, but the relevant provisions are identical. 193 Which, under s 99 of the Law of Property Act 1925, he was entitled to do. 194 [1995] 1 BCLC 1 at 7–8. 195 Ibid at 10. See also the comments of Neill LJ ibid at 12. See below para 2.99. 196 See Phillips v Brewin Dolphin [2001] UKHL 2 at [20]–[21], [2001] 1 WLR 143 at 150–51, discussed above paras 2.68ff.

70 John Armour (b) Direct and Indirect Consideration 2.87 Consideration need not move directly from the company to the counterparty, or vice versa. This issue is of considerable importance in the context of guarantee transactions. Consider for example the grant by a subsidiary of an ‘upstream’ guarantee of its parent company’s debts. In return, the creditor of the parent company agrees to forbear from enforcing the principal debt. If the subsidiary relies upon the parent company for much of its business, then it is arguable that the benefit of the parent’s continued trading operation may be capable of constituting indirect ‘consideration’ received by the debtor in return for assuming the guarantee obligation.197 In addition, the subsidiary will also receive the benefit of an entitlement to be subrogated to the creditor’s claim and any associated securities against the principal debtor.

(2) Valuation of Consideration 2.88 In approaching questions of valuation, the role played by ‘consideration’ in section 238 should be distinguished from that of the doctrine of consideration in contract. It is a legal truism that for the purposes of supporting an enforceable promise, consideration must be ‘sufficient’ but it need not be adequate.198 In other words, the consideration must have some value in the eyes of the law, but no enquiry is made as to whether the value of the consideration corresponds to the ‘true’ value of what is promised in return. By contrast, the law relating to undervalue transactions is concerned squarely with the adequacy of consideration. MC Bacon makes clear that consideration is to be valued in money or money’s worth.199 This goes beyond contract law’s requirement that consideration must merely exist in the eyes of the law,200 and requires that its value be quantifiable.201 (a) No Consideration if Not Capable of Valuation 2.89 It was held in MC Bacon that consideration must be capable of valuation in money or money’s worth. The corollary of this is that consideration which is not so capable is excluded from the section 238 enquiry. 197 See D Spahos, ‘Lenders, Borrowing Groups of Companies and Corporate Guarantees: An Insolvency Perspective’ (2001) 1 Journal of Corporate Law Studies 333 at 338–52. 198 Haigh v Brooks (1840) 10 A & E 309 at 320, 113 ER 119 at 123; Chappell & Co Ltd v Nestlé Co Ltd [1960] AC 87. 199 [1990] BCC 78 at 92. 200 See Sir GH Treitel, The Law of Contract, 10th edn (London, Sweet & Maxwell, 1999) at 78–79. 201 Thus the grant of the debenture in Re MC Bacon Ltd [1990] BCC 78, whilst it would have constituted sufficient consideration to support a contract, was not quantifiable in money or money’s worth.

Transactions at an Undervalue 71 2.90 Grant of a Debenture For Past Value. In MC Bacon, Millett J concluded that the grant of a debenture has no monetary value, and that therefore no consideration had left the company for the purposes of section 238.202 The grant of the debenture did not remove any assets from the company for the purposes of section 238; it merely appropriated the charged assets to meet the secured creditors’ claims, and thereby rearranged the priority rankings amongst the company’s creditors. Whilst this did cause a detriment to the company insofar as it was no longer able to apply the proceeds of sale of the charged assets other than in satisfaction of the secured debt, this was not something capable of valuation in monetary terms and not customarily disposed of for value.203 2.91 Although Millett J subsequently described the action as ‘a hopeless claim which it was legally impossible to maintain’,204 His Lordship’s reasoning is not free from difficulty. The first step seems awkward to reconcile with the proposition that for the purposes of section 127, a company does not make a disposition of its property on the enforcement of a charge.205 Instead, the disposition is taken to have happened at the time the charge was granted.206 Why, then, does the grant of a charge not fall within section 238? At a formal level, although the grant of a security interest does transfer a beneficial interest to the chargee, this not an outright but a contingent entitlement. The chargee’s rights are only good against the debtor should the latter default on the underlying debt (for a charge) or until such time as the debtor redeems (for a mortgage). Such rights have value to the chargee, as they put him in a better position on the company’s liquidation. Yet from the company’s point of view, there is no transfer of value. Prior to the grant of the charge, the company is liable to have its assets seized by execution if it defaults on the underlying debt. After the charge is granted, it is liable to have them seized by enforcement of the charge. The company’s net position is the same. 2.92 This analysis is also sound in terms of policy. Section 127 applies, after the commencement of winding-up, to the entire range of transactions which would until then have fallen within either section 238 or 239. The finding that a particular transaction is temporally outwith (prior to) the scope of section 127 implies a second enquiry as to whether the transaction is then best regulated by section(s) 238, 239, or both. The policy of the legislature has been to require a 202 [1990] BCC 76 at 90. The decision was followed on this point by Peter Smith QC, sitting as a deputy judge in Re Mistral Finance Ltd [2001] BCC 27. 203 His Lordship also held that what the company received in turn—continued forbearance by the secured creditor—was also incapable of valuation in money or money’s worth. [1990] BCC 76 at 92. 204 Re MC Bacon (No 2) [1990] BCC 430 at 433. 205 Re International Life Assurance Society, Gibbs & West’s Case (1870) LR 10 Eq 312; Re Park Ward & Co Ltd [1926] Ch 828; Re Steane’s (Bournemouth) Ltd [1950] 1 All ER 21. See below, para 8.15. The debenture granted to the bank in MC Bacon contained the usual mixture of both fixed and floating components: [1990] BCC 78 at 84. 206 Re Margart (Pty) Ltd [1985] BCLC 314 at 318.

72 John Armour mental element to be shown for pre-petition preferences.207 To allow a factual preference such as the grant of a charge to fall within section 238 would undermine this requirement: hence the rather fine distinction that must be drawn. 2.93 Forgiveness of a Bad Debt. The value of a loan will depend on the creditworthiness of the borrower and any security taken.208 Forgiveness of a debt will amount to a transaction for which the company receives no consideration.209 Conversely, even if it seems certain that the debtor will not pay, the right to demand payment has value to the creditor insofar as it has the opportunity to petition for winding-up or administration, and the ability (through voting) to influence the outcome of these proceedings.210 Hence a gratuitous waiver of a debt owed under such circumstances will amount to a transaction at an undervalue on the part of the creditor. (b) Market Value Test 2.94 Where there exists a market for assets of the type in question, then the value of the asset is the market price.211 The usual way to ascertain the value will be to compare with the price of substitute goods in the market. However, where the goods are unique, this will not be possible. A procedural test may instead be adopted. If the sale took place at arm’s length between a willing buyer and a willing seller, after proper marketing and both parties acted ‘knowledgeably, prudently and without compulsion’,212 then the price paid will be presumed to be their market value.213 As Lord Scott put the point in Phillips v Brewin Dolphin: 214 The value of an asset that is being offered for sale is, prima facie, not less than the amount that a reasonably well-informed purchaser is prepared, in arms-length negotiations, to pay for it.

Thus in that case, the value of the business being sold was the value which the purchaser agreed to pay for it.215 2.95 Hence for sales of unique goods, the process of establishing an undervalue will usually require the office-holder first to demonstrate that the sale did not satisfy one or more of the procedural requirements of the ‘market value’ 207

Insolvency Act 1986 s 239(5). See Hill v Mullis & Peake [1999] BCC 325 at 331–33. 209 See Lewis v Cook [2000] NSWSC 191. 210 Ibid at [60]–[61]. Presumably this benefit is enhanced by the possibility that the debtor’s assets may be enhanced through recoveries for wrongful trading, undervalue transactions, preferences, etc. 211 See Spencer v The Commonwealth (1907) 5 CLR 418 at 431. 212 Re Brabon [2001] 1 BCLC 11 at 38. 213 Ibid; Phillips v Brewin Dolphin [2001] UKHL 2 at [30], [2001] 1 WLR 143 at 154. 214 [2001] UKHL 2 at [30], [2001] 1 WLR 143 at 154. 215 Ibid at [31], 154. 208

Transactions at an Undervalue 73 test—as, for example, where the sale is to a connected party, or the marketing of the asset has not been in accordance with market norms. Secondly, the officeholder must adduce expert evidence suggesting that had these requirements been complied with, a substantially higher price would have resulted. Such evidence will typically be based on an enquiry into the prices at which similar assets have traded.216 2.96 A similar approach should be employed to value services. Where the services are of a type for which a ready market comparison may be made (e.g. window-cleaning) then this should provide an adequate benchmark for comparison. The more unique the services, the less useful such a comparison. Where the transaction is negotiated at arm’s length, following an adequate tendering period, then the ‘procedural’ test outlined above will be satisfied and it can be presumed that the price agreed will be the ‘true’ value of the services. However, where the transaction does not satisfy these procedural requirements—a likely example being directors’ remuneration agreements—then comparisons with other similar arrangements in other companies may provide a rough-and-ready comparator.217 (c) Adjusting Market Value to Take Account of Specific Circumstances 2.97 Under certain circumstances, an asset may have a value to a particular person which exceeds or falls below the price at which similar assets would trade. Provided that the existence of this idiosyncratic value is known to both parties at the time of sale, it may be possible to have a transaction set aside even if the price paid was equivalent to that at which similar assets might sell.218 This will be particularly true, of course, where the sale is not fully advertised or not at arm’s length. 2.98 A good example is the so-called ‘ransom’ or ‘marriage’ value which can be created by subdividing interests in property. Where the sum of the values of two estates in land, or of two plots of land, is less than the value of both estates or plots united under sole ownership, then the difference—the ‘marriage value’—can be captured by either owner buying out the other, or by an outsider buying both estates or plots. Conversely, however, the vendor(s) in this transaction may hold out for more than the price at which an estate or plot of the sort they have would normally sell for, on account of the marriage value which the purchaser will realise. 2.99 This has been recognised in the case law dealing with the grant of agricultural tenancies in a bid to stymie repossession proceedings brought by

216 217 218

See Re Brabon [2001] 1 BCLC 11 at 39–41. See eg, Re DGA (UK) Ltd (2001) WL 482928 (unreported, 15 February 2001) at [31]. See the discussion in McDonald & Anor v Hanselmann (1998) 28 ACSR 49.

74 John Armour mortgagees.219 In each case, the freehold owner granted an agricultural lease to a connected party at what was a standard market rent for such tenancies. However, the value of the freehold diminished as a result of the grant by more than the market value of the lease. Furthermore, the mortgagee could not seek possession whilst a tenant was in possession. The freehold owner or the mortgagor could capture the ‘marriage value’ by paying the tenant to give up the tenancy. However, a tenant would conversely be able to demand a ‘ransom’ from the freehold owner or mortgagee—part of the marriage value—by refusing to sell unless a premium over the market price were offered. The tenant received not only the lease but also the ability to ‘hold up’ the freehold owner in this way, which was not reflected in the market value.220 Thus, it was reasoned, the grant of such a lease was an undervalue. 2.100 A more contentious question is whether the value of assets transferred should be adjusted downwards where a debtor company is in financial distress to take account of the fact that sales under these circumstances usually take place at a discount to the market value. One approach would be not to take these issues into account at the stage of determining whether or not a transaction was at an ‘undervalue’, but rather to leave them to the application of the defence under section 238(5).221 However, it is submitted that the better view is that, as with the case of specific value to a purchaser, such factors do in fact affect the ‘true value’ of the assets transferred at the time of sale. The issue was considered in the Australian case of McDonald v Hanselmann, where Young J opined: 222 [W]hen one is looking at a company on the verge of liquidation, one bears in mind the words Shakespeare attributed to Richard the Third ‘A horse! A horse! My kingdom for a horse!’. Because of the company’s need for current liquid funds, the value of its assets to it may be affected. Normally one does not involve such exigencies in the valuation question and it may be here that it is better to deal with them in seeing whether there is any proper explanation for the transaction [i.e. the Australian equivalent of the section 238(5) defence], but strictly speaking, such matters do have an effect on the value of the asset to the company.

(d) Valuing Future and Contingent Consideration 2.101 Where the consideration passing under a transaction consists of deferred entitlements—such as the right to vacant possession on the reversion of 219 Agricultural Mortgage Corp Plc v Woodward [1995] 1 BCLC 1, discussed above, para 2.85; Barclays Bank Plc v Eustice [1995] 1 WLR 1238. See also National Westminster Bank plc v Jones [2001] EWCA Civ 1541, [2002] 1 BCLC 55. 220 The value of the ability to hold the other parties to ‘ransom’ was estimated by Neuberger J in National Westminster Bank v Jones at one-half of the total marriage value, because both parties would need to agree in order to realise it: [2001] 1 BCLC 98 at 127–28. 221 See below, paras 2.110ff. 222 (1998) 28 ACSR 49 at 53–54.

Transactions at an Undervalue 75 a lease or promises to pay money at a future date, or a contingent entitlement such as a guarantee—then the face value of the entitlement must be discounted to its present value for purposes of comparison with the consideration passing the other way. 2.102 Where the entitlement is certain to be realised after a fixed period of time, then it is appropriate simply to discount the value of the entitlement to reflect the fact that it will not be available until that time has passed. The appropriate discount rate will reflect the return which can be achieved on money invested in risk-free investments for that period of time.223 For example, consider the value to be attributed to the right to vacant possession of a freehold subject to a 20-year lease. If such a freehold would be worth £400,000 with vacant possession, then this figure must be discounted to reflect the fact that if this entitlement were purchased today, it would be 20 years before it returned this sum. Hence the price payable must be no more than the amount of money which, invested risk-free today, would yield £400,000 in 20 years time. In National Westminster Bank v Jones at first instance, a discount rate of 6.5 per cent per annum was agreed as appropriate in just such a case, although there will obviously be scope for argument about the chosen rate.224 2.103 Where the value of the entitlement is uncertain at the time of the transaction, then a further discount must be made to reflect this. ‘Uncertainty’ encompasses both legally uncertain entitlements, as with a contingent obligation, and those which whilst legally unqualified may nevertheless be factually uncertain, as with a future debt where there is a risk that the debtor may default.225 2.104 Considerable doubt has been shed on the appropriate method for determining values which are uncertain at the time of the transaction by the House of Lords’ decision in Phillips v Brewin Dolphin.226 Where the uncertainty is resolved before the time that the section 238 action is brought, it could be argued that this should be taken into account in determining the ‘true’ value of the consideration. This ‘hindsight test’ is to be contrasted with an alternative, ‘ex ante’ approach,227 which takes into account only those factors which were known to the parties (or of which they ought reasonably to have been aware) at the time

223 See RH Brealey and SC Myers, Principles of Corporate Finance, 6th edn (London, McGrawHill, 2000) at 18–21. 224 [2001] 1 BCLC 98 at 127. 225 Note that the appropriate valuation of a debt requires an assessment both of the likelihood of default and of the expected return should default occur—namely the expected dividend in insolvency proceedings. The value of a debt where the debtor is certain to default is always greater than zero because of the creditor’s ability to participate in insolvency proceedings: Lewis v Cook [2000] NSWSC 191 at [61]. 226 [2001] UKHL 2, [2001] 1 WLR 143. 227 The terminology is taken from LC Ho and RJ Mokal, ‘Blowing Hot and Cold’ (2001) 16 Butterworths Journal of International Finance and Banking Law 263 at 264.

76 John Armour of entering the transaction. The speech of Lord Scott (who gave the only reasoned opinion) appears to suggest that it is legitimate to adopt the hindsight test. 2.105 The facts of the case have already been recounted.228 Lord Scott’s approach to the construction of the transaction meant that it was necessary to establish the value to AJB of PCG’s covenant to pay under the sublease, given in return for the right to possess the computer equipment. Because AJB were not permitted to sublease the equipment, the headlessor could repossess the equipment at any time, constituting a repudiation of the sublease on AJB’s part. The covenant was therefore ‘precarious’.229 Counsel for Brewin Dolphin argued that ex post facto events ought not to be taken into account for the purposes of determining the value of the covenant as at the time of the transaction. Lord Scott disagreed, holding:230 In valuing the covenant as at [the] date [of the transaction], the critical uncertainty is whether the sublease would survive for the four years necessary to enable all the four £312,500 payments to fall due, or would survive long enough to enable some of them to fall due, or would come to an end before any had fallen due. Where the events, or some of them, on which the uncertainties depend have actually happened, it seems to me unsatisfactory and unnecessary for the court to wear blinkers and pretend that it does not know what has happened. . . . For the purposes of section 238(4) . . . and the valuation of the consideration for which a company has entered into a transaction, reality should, in my opinion, be given precedence over speculation. I would hold, taking account of the events that took place in the early months of 1990, that the value of PCG’s covenant in the sublease of 10 November 1989 was nil. After all, if, following the signing of the sublease, AJB had taken the sublease to a bank or finance house and had tried to raise money on the security of the covenant, I do not believe that the bank or finance house, with knowledge about the circumstances surrounding the sublease, would have attributed any value at all to the sublease covenant.

2.106 At first blush, Lord Scott’s approach appears to suggest that hindsight may be employed to determine the ‘true’ value where this depended on uncertainties not resolved at the time of the transaction. The first section emphasised in the passage above certainly points in this direction. However, the better view is that this is not the ratio of Brewin Dolphin.231 2.107 As was discussed, the alternative approach to incorporating uncertainty into valuations is to discount the present value of the future payments by the probability of non-payment. In other words, what was the probability, at the time of entering into the transaction, that the sublease would be repudiated? It is unnecessary to speculate too much, as anything greater than a small chance would be sufficient to discount the value of the covenant well below the value agreed for the business. Thus, on the facts of the case, an ex ante approach 228 229 230 231

See above, paras 2.68–2.69. [2001] UKHL 2 at [23], [2001] 1 WLR 143 at 152. Ibid at [26], 153 (emphasis added). Cf Walker v WA Personnel Ltd (unreported, 15 March 2002).

Transactions at an Undervalue 77 would have yielded the same result as the application of the ‘hindsight’ approach. Thus the hindsight approach is not necessarily part of the ratio. Consider also the second section emphasised in the passage quoted above. This makes clear that in His Lordship’s opinion, even at the time of the transaction, any reasonably well-informed party would not have paid anything to have the sublease covenant assigned to them. This is consistent with the ex ante approach: at the time of the transaction, the likelihood of AJB’s default was so high as to make the covenant effectively valueless.232 2.108 It is thus open to lower courts to distinguish Lord Scott’s broad comments which appear to suggest the application of a hindsight test. As a matter of policy, the ex ante approach is greatly to be preferred.233 Consider that a hindsight test, strictly applied, would allow liquidators to unwind transactions which at the time they were entered into seemed fair, but subsequently turned sour for the insolvent company. For example, imagine that A (which, unknown to both parties at the time, is balance-sheet insolvent) purchases a division of B’s business, which A proposes to merge with its own. At the time of the transaction, the value of B’s business is uncertain, depending on a range of market factors which have yet to be resolved. Assume, simplifying matters greatly, that there are two outcomes which might eventuate, each with equal probability (i.e. 50 per cent). In the good outcome, the business will be worth £3m, and in the bad outcome, only £1m. The mean or expected value, would be £2m.234 However, as the purchase is risky,235 we would expect that most buyers would demand a premium to compensate themselves for this. It is not unrealistic to suggest that A might pay only £1.7m for this business. At the time of the transaction (adopting an ex ante approach to valuation), this is most certainly not an undervalue from A’s point of view.236 2.109 However, should the bad outcome eventuate and A then enter windingup or administration, the use of the hindsight test would allow A’s office-holder to set the transaction aside. The risk of this type of vulnerability might well deter B from entering into the transaction in the first place. From B’s point of view, if A can avoid the transaction in the bad outcome, but affirm it in the good outcome, then £1.7m is far too low a price to pay. Indeed, B will want the full £3m: because the transaction is avoided in the bad outcome, it now only makes sense to speak about the transaction taking effect under the good outcome, in which case an asset worth £3m passes from B to A. It can be seen that this sort 232 See further LC Ho and RJ Mokal, ‘Blowing Hot and Cold’ (2001) 6 Butterworths Journal of International Finance and Banking Law 263. 233 See DG Baird and TH Jackson, ‘Fraudulent Conveyance Law and its Proper Domain’ (1985) 38 Vanderbilt Law Review 829 at 838–39. 234 0.5 × 3 + 0.5 × 1 = 2. 235 In other words, there is considerable variance between the outcomes which can eventuate. 236 Were B subsequently to become insolvent, then the risk premium demanded by A would provide grounds for arguing that it was not a transaction at an undervalue from B’s point of view.

78 John Armour of effect would be undesirable, as transactions of this sort are not ones which deplete the value of the assets at the time they are entered into, and the hindsight test would have a chilling effect. Whilst of course even with a hindsight test, the defence of section 238(5) would still be available,237 this may provide only limited comfort to directors of counterparties, grounded as it is on the intentions of the debtor company.

F DEFENCES

(a) Bona Fide Business Purpose 2.110 Section 238(5) provides a statutory defence to an action to set aside a transaction at an undervalue. It provides that the court shall not make an order under section 238 if it is satisfied (a) that the company which entered into the transaction did so in good faith and for the purpose of carrying on its business, and (b) that at the time it did so there were reasonable grounds for believing that the transaction would benefit the company. The defence was introduced as an amendment to the Insolvency Bill 1985 at the House of Commons Committee stage.238 2.111 The onus of proof in establishing the elements of section 238(5) will be on the counterparty.239 As a company never acts except through the attribution to it of the acts of its human agents,240 it will first be necessary to identify the relevant individuals who decided to enter into the transaction on its behalf, usually the directors. Their motivation can then be examined with respect to section 238(5). Subsection (a) appears to couple the directors’ fiduciary duty of loyalty—that they must act always bona fide in the company’s interests241 — with the abuse of power doctrine which stipulates that they must not use their powers for an improper purpose. In this case, the proper purpose is statutorily specified: the carrying on of the company’s business. The legislative history shows that this was intended to include ‘one-off transactions in genuine special circumstances—for example, rescue operations’.242

237

See below, paras 2.110ff. Official Report: House of Commons Standing Committee E 1984–85, Cols 512–13. The defence was further modified during the Bill’s third reading in the Commons. See HC Debs (6th Series) 84 col 686–87, 28 October 1985. 239 See Re Barton Manufacturing Co Ltd [1998] BCC 827. 240 Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 2 AC 500 at 506–07. 241 On the fiduciary duty of loyalty generally, see Bristol & West Building Society v Mothew [1998] Ch 1 at 18. 242 HC Debs (6th Series) 84 col 687, 28 October 1985 (Mr Michael Howard) (explaining rationale for amendment of proposed wording from ‘in the ordinary course of’ to ‘for the purpose of carrying on’ the company’s business). 238

Transactions at an Undervalue 79 2.112 Subsection 238(5)(b) requires some objective evidence that the transaction could reasonably have been viewed as beneficial from the point of view of the company at the time it was effected. The better view is that evidence tending to show that a reasonable board of directors could have genuinely considered the transaction to be beneficial to the company and for the purpose of its business, then this requirement will be satisfied.243 In addition, section 238(5)(a) requires that the board in fact consider the transaction to be beneficial to the company and for the purpose of its business. Given the onus of proof, this will be difficult to establish by inference in the absence of direct evidence from the board themselves, or from minutes of board meetings. Counterparties to transactions with companies which appear to be in financial distress are therefore well advised to ask for a memorandum signed by the company’s directors explaining their reasons for entering into the transactions and on what grounds they consider it likely to benefit the company.

(2) Good Faith Receipt for Value by Third Parties 2.113 Section 241(2) provides a defence to certain third parties (not counterparties) who received property or benefits under the transaction in good faith and for value. Lack of good faith is presumed if the third party (i) is connected to, or an associate of, the company or the counterparty to the transaction; or (ii) was aware at the time of their acquisition or receipt of the commencement of insolvency proceedings (and of the fact that the transaction was at an undervalue). By necessary implication, persons who are not direct recipients, parties to the transaction, or connected with the company or the parties to the transaction, are accorded a broad defence. (a) Third Parties Who May Be Protected 2.114 Section 241(2) is capable of applying to the following categories of person: (a) those who acquired an interest in property (which had been transferred by the company pursuant to the transaction) from a person other than the company;244 and (b) those who received a benefit under the transaction but were not parties to it. 243 See Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] Ch 62 at 74–75; Equiticorp Finance Ltd v Bank of New Zealand (1993) 32 NSWLR 50 at 147–48; Maronis Holdings Ltd v Nippon Credit Australia Pty Ltd (2001) 38 ACSR 404 at 449–54; Criterion Properties plc v Stratford UK Properties LLC [2002] EWHC 496 (Ch) at [23], [2002] 2 BCLC 151 at 166. 244 If the defence of good faith receipt can be made out by any indirect recipient, then all successive interests acquired in the property are also protected: s 241(2)(a).

80 John Armour Presumably, the term ‘benefit’ is intended to refer to benefits conferred otherwise than by transfer of an interest in property—the most obvious example being the provision of services by the company. Thus, the potential scope of application of the defence differs depending on the nature of the transaction. Where a disposition of property occurs, the appropriate issue is whether the defendant was a direct recipient. Where services are provided by the company, the question is whether the defendant was a party to the transaction.245 (b) Good Faith 2.115 The burden of demonstrating good faith will ordinarily lie on the defendant, as will that of establishing the other elements of the defence. However, two classes of defendant are presumed by section 241(2A) not to have been in good faith. This subsection applies to those who, at the time of their acquisition of property or receipt of benefit, either: (a) had notice of the surrounding circumstances and of the relevant proceedings; or (b) were connected with, or associates of, either the company or the counterparty to the transaction.246 2.116 The notice requirement in section 241(2A)(a) is stricter than the equitable standard of constructive notice, and was introduced by the Insolvency Act (No.2) 1994 in order to give third party purchasers of land greater security of title.247 ‘Notice of the surrounding circumstances’ is defined in section 241(3) to mean ‘the fact that the company . . . entered into the transaction at an undervalue’. In other words, it is necessary to show that the defendant knew, at the time of receipt, of the facts which are relied upon by the liquidator to establish that the transaction falls within the definition of ‘transaction at an undervalue’ under section 238(4). ‘Notice of the relevant proceedings’ is defined in subsections 241(3A)-(3C) to mean, in the case of administration proceedings, that a petition has been presented or that an administration order has been made, and in the case of liquidation, that the company has gone into liquidation, or in a case where a winding-up petition has been presented, of the presentation of the petition.248

245

See above, para 2.53. The definitions of ‘connected persons’ and ‘associates’ are contained in section 249 and 435 respectively, and are considered in detail above, paras 2.41ff. 247 The previous version of section 241(2)(a) had required that the third party be shown to have acquired property or received a benefit ‘in good faith, for value and without notice of the relevant circumstances’. This wording remains applicable in the case of transactions defrauding creditors: see ch 3, paras 3.53ff. 248 Where winding-up follows immediately from the discharge of an administration order, notice of any of the foregoing will suffice. 246

Transactions at an Undervalue 81 2.117 The requirement that notice of the relevant proceedings be demonstrated in order to raise the presumption as against non-connected third party defendants means that unless the acquisition or receipt occurred after the bringing of a petition for administration or the commencement of liquidation, it is impossible for the office-holder to rely on the statutory presumption of lack of good faith. Whilst subsection 241(2A) does not express the presumption to be the exclusive means of demonstrating that the defendant did not receive in good faith, the provisions of subsections 241(2A)–(3C) restricting the operation of the presumption would be rendered otiose were the office-holder able to demonstrate ‘lack of good faith’ by showing a lesser degree of knowledge on the defendant’s part. 2.118 That said, it clearly is not intended to provide a charter for those seeking to avoid liability through the expedient of structuring their acquisition of property from the company as ‘indirect’ for the purposes of subsection 241(2)(a), or that they are not ex facie a ‘party’ to the transaction under which they receive a benefit for the purposes of subsection 241(2)(b). In most cases, such persons will be caught as being ‘connected with’ or ‘associates’ of the counterparty. In other cases, the court may be willing to recharacterise the transaction so that a defendant is viewed as a direct recipient or a party to it.249 (c) Value 2.119 ‘Value’ for the purposes of this defence has its normal meaning in equity: sufficient value to support a defence of bona fide purchase. It is, therefore, not necessary for the defendant to demonstrate that they received the asset for full value.

(3) Change of Position? 2.120 A question of some nicety is whether or not the restitutionary defence of change of position may be available to the counterparty under an undervalue transaction. As has been argued, the remedial provision of section 238(3) is restitutionary in pattern.250 Consistency in the law would suggest that the defence of change of position should be available.251 The issue has never been raised directly in any decided case. The judgment of Ferris J in Re Kumar 252 comes closest to considering it indirectly. That case concerned the transfer by Kumar, who subsequently became bankrupt, of his share of the equity of redemption in a marital home to his estranged (and later ex) wife, Dr Gupta. Dr Gupta subsequently 249 250 251 252

See above, paras 2.66–2.74. Above, paras 2.21–2.22. See also ch 9. See below, paras 9.83ff. [1993] BCLC 548.

82 John Armour borrowed further from the mortgagee, remortgaging the property in the process. Ferris J considered that the appropriate order was the restoration to Kumar’s trustee in bankruptcy of his former beneficial interest in the property. His Lordship considered that the burden of the remortgage should fall entirely upon Dr Gupta’s share of the property,253 thereby implicitly rejecting any argument that she had changed her position on the faith of the receipt. It is submitted that this rejection should be read narrowly, to mean only that Dr Gupta’s receipt was not entirely in good faith, and that on ordinary restitutionary principles she would, therefore, not be entitled to rely on any change of position.254 Indeed, whilst in principle it may be possible to assert a defence of change of position to an action under section 238, in practice the substantial undervalue which must be shown as part of the cause of action is likely to be sufficient in itself to infer lack of good faith on the counterparty’s part.

G REMEDIES

(1) Remedial Jurisdiction of the Court (a) Scope and Purpose of Remedial Power 2.121 The basic remedial provision for undervalue transactions is section 238(3), which mandates that the court, if satisfied that the company entered into a transaction at an undervalue at a relevant time, ‘shall . . . make such order as it thinks fit for restoring the position to what it would have been if the company had not entered into the transaction’. Three initial points should be noted. First, the court’s power is restitutionary, rather than simply compensatory: it is designed to require the counterparty to disgorge, in favour of the company, the benefit which received unjustly255 from the company.256 Secondly, the effect of the order is not to avoid the transaction retrospectively. Rather, it will compel counterparties and the office-holder to restore things to the position that would have obtained if the transaction had not occurred. The transaction itself remains valid. Thirdly, the action available under section 238(3) is expressly without prejudice to other claims which may be open to the liquidator—which may include a proprietary claim based on misapplication of corporate property.257 2.122 To achieve this end, it is clear that the court may make orders which affect the following categories of persons:258 253 254 255 256 257 258

[1993] BCLC 565–66. See below, paras 9.83ff. So deemed by virtue of s 238. See above, paras 2.21–2.22, and generally, ch 9. Insolvency Act 1986 s 241(4). See ch 7. See s 240(2).

Transactions at an Undervalue 83 (a) persons to whom the company transferred property pursuant to the transaction (‘counterparty’ acquirors); (b) those to whom property transferred under the transaction was subsequently transferred by a counterparty, save where the property was so acquired in good faith and for value (‘third party’ acquirors);259 (c) parties to the transaction who received a benefit thereunder (‘counterparty recipients’); and (d) persons other than parties to the transaction who received a benefit thereunder, save where the benefit was received in good faith and for value (‘third party recipients’). 2.123 The court’s jurisdiction, although broad, is not unlimited. It must be exercised only so far as is necessary in order to restore the pre-existing position, to the extent that this is possible. Thus if the court considers no order is necessary to restore the pre-existing position, it need not require anything to be done. This is so despite the mandatory language of section 238(3), because this is qualified by the overriding requirement that the discretion shall be exercised only so as to restore the pre-existing position.260 Thus, property or benefits received by the company under the transaction must also be restored to the counterparty,261 for to do otherwise would enrich the company at the counterparty’s expense, through putting it in a better position than if the transaction never occurred. 2.124 Perfect restoration may be factually impossible because, for example, the property transferred has been destroyed. Alternatively, it may be legally impossible, because of the imposition of third party rights in accordance with section 241(2). Nevertheless, and in contrast to the equitable remedy of rescission, the office-holder’s entitlement to a remedy under section 238 will not be destroyed by such impossibility. Instead, the court will make such order that so far as possible restores the original position.262 Thus, where the original asset has been sold by a direct recipient to a third party, the court may instead order the restoration of either the proceeds of sale in the direct recipient’s hands, or property purchased with such proceeds.263 Similarly, where the counterparty has received services from the company, then the court must make an order requiring the payment of such sum as will restore to the company the value of such services.264 2.125 The court will, however, be slow to conclude that restoration of the original asset is impossible, even if it does not remain wholly or partially 259

On the meaning of ‘in good faith for value’, see above paras 2.115–2.119. See Re Paramount Airways Ltd [1993] Ch 223 at 239. See also paras 4.91ff. 261 See Phillips v Brewin Dolphin [2001] UKHL 2 at [34], [2001] 1 WLR 143 at 154; Re Kumar [1993] BCLC 548. 262 Chohan v Saggar [1994] 1 BCLC 706 at 713; Walker v WA Personnel Ltd (unreported, 15 March 2002). 263 See Insolvency Act 1986 s 241(1)(b). 264 See Insolvency Act 1986 ss 241(1)(d). 260

84 John Armour intact.265 On the one hand, the substitution of an obligation to pay money means that the value lost by the company’s creditors is reduced to the court’s determination following a ‘battle of the experts’. It is preferable, however, for the actual value to be determined by an auction conducted by the liquidator or administrator following restoration. On the other hand, the court’s very wide powers mean that it is able to make a range of orders so as to do justice on the facts, notwithstanding alterations to the original asset.266 (b) Examples of Orders Which May Be Made 2.126 A range of orders which the court may make is set out in section 241. This section, which applies equally in respect of recoveries in respect of unlawful preferences as it does to undervalue transactions, is expressed not to detract from the generality of the court’s discretion under sections 238(3) and 239(3). The list of orders therefore exemplifies, rather than defines, the orders which the court may make, and must be read as subject to the overriding purposes of the basic remedial provisions. Section 241(1) states that the court may make orders: (a) requiring any property transferred as part of the transaction to be vested in the company; (b) requiring any property representing in the recipient’s hands the application either of money transferred to him [under the transaction], or of the proceeds of sale of property so transferred; (c) releasing or discharging (in whole or in part) any security given by the company [pursuant to the transaction]; (d) requiring any person to pay, in respect of benefits received by him from the company [pursuant to the transaction], such sums to the office-holder as the court may direct; (e) providing for any surety or guarantor whose obligations to any person were released or discharged (in whole or in part) under the transaction to be under such new or revived obligations to that person as the court thinks appropriate; (f) providing for security to be provided for the discharge of any obligation imposed by or under the order, for such obligation to be charged on any property and for the security or charge to have the same priority as a security or charge released or discharged (in whole or in part) under the transaction; or (g) providing for the extent to which any person whose property is vested by the order in the company, or on whom obligations are imposed by the order, is to be able to prove in the winding-up of the company for debts or other liabilities which arose from, or were released or discharged (in whole or in part) under or by, the transaction. 265 266

Walker v WA Personnel (unreported, 15 March 2002). Ibid.

Transactions at an Undervalue 85 The application of these powers will now be considered in respect of various examples. (c) Transfers of Assets 2.127 Where an asset has been transferred at an undervalue the preferable order will usually be one which (re)vests title to the asset in the company.267 Such an order will be accompanied by a direction requiring the company to repay or restore to the counterparty any money or asset received as consideration for the transfer. This obligation will be in specie, for the counterparty must not be left simply to prove in the company’s insolvency: this would be to prefer the other creditors at his expense.268 Where the asset has, though the efforts of the counterparty, increased in value since the transfer, then an order for counter-restitution in an according amount can be made.269 2.128 The breadth of the court’s jurisdiction to make remedial orders means that it will not view restoration of the original asset as ‘impossible’ simply because that asset does not remain wholly intact.270 Thus, the retransfer of a business may be ordered notwithstanding that post-transfer creditors have acquired rights against it, by declaring that the counterparty holds the business assets on trust for the insolvent company, subject to the rights of the posttransfer creditors.271 2.129 Where it is impossible to restore the original asset to the company, then the court will order the counterparty to pay a sum of money representing the true value of the asset at the time of the transfer. For example, although not explicitly discussed in the judgment of Lord Scott or in the lower courts, it seems clear that in Phillips v Brewin Dolphin an order was made for the payment of money rather than restoration of the original asset transferred because such restoration was impossible.272 The ‘asset’ constituted AJ Bekhor’s stockbroking business, which had been merged with that of Brewin Dolphin. Again, account will be given for moneys paid to the company by the counterparty pursuant to the original transaction, and the court will allow this to be set off against the counterparty’s restorative obligation.273 Similarly, where the asset transferred by the company constitutes an overpayment for services provided to the

267

Insolvency Act 1986 s 241(1)(a); Walker v WA Personnel (unreported, 15 March 2002). See Phillips v Brewin Dolphin [2001] UKHL 2 at [34], [2001] 1 WLR 143 at 154. 269 See A Keay, ‘The Recovery of Voidable Preferences: Aspects of Restoration’ in FD Rose (ed), Restitution and Insolvency (London, Mansfield Press, 2000), 237 at 250–52; see also paras 9.63ff. The position would be otherwise where the increase in value has occurred merely as a result of market movement. 270 Walker v WA Personnel (unreported, 15 March 2002). 271 Arbuthnot Leasing International Ltd v Havelet Leasing (No 2) [1990] BCC 636. 272 [2001] UKHL 2, [2001] 1 WLR 143. 273 Ibid at [34], 154. 268

86 John Armour company by the counterparty, due account will be given for the actual value of the services received by the company.274 2.130 The in specie nature of the counterparty’s entitlement in an order under section 238 should be contrasted with the entitlement granted to the recipient of a preference. This will usually be no more than an entitlement to prove in the liquidation of the insolvent company,275 and set-off will not be permitted against the obligation to repay the proceeds of the preference.276 The difference in treatment is due to the different context: restoration of the pre-existing position, where a preference has been granted, requires that the preferred creditor be put back in the position of an ordinary unsecured creditor. (d) Services Given by the Company 2.131 Where the undervalue transaction consists of the performance by the company of services gratuitously, or at an undervalue, then the quantum of the undervalue will have been established in the process of making out the cause of action.277 In this case, the best restorative order is one which requires the counterparty to pay to the company the amount of the undervalue. (e) Guarantees 2.132 Where the grant by a company of a guarantee constitutes a transaction at an undervalue, then the most natural restorative order for the court to make will be a declaration that the company is discharged from its obligations under the guarantee, with a release of any associated security, except insofar as the court considers that the company received equivalent value at the time of the transaction.278 If the guarantee has been enforced, then where possible the court order the restoration of moneys paid by the company to the creditor. In this case, the principal debtor’s release will be invalidated, and they will once again be liable for the sum in question.279 (f) Effect of Counterparty Insolvency 2.133 If the counterparty has entered insolvency proceedings between the date of the transaction and the claim being brought by the transferor company’s

274

On the valuation of non-monetary benefits, see below paras 9.16ff. See Insolvency Act 1986 s 241(1)(g). See also para 4.95 below. 276 Re A Debtor [1927] 1 Ch 410. 277 See above, paras 2.88ff, esp 2.96. 278 Insolvency Act 1986 ss 241(1)(e), 241(1)(c). 279 See G Andrews and R Millett, The Law of Guarantees, 3rd edn (London, Sweet & Maxwell, 2001) at 9.02 (discussing continuing liability of guarantor where principal debtor’s payment is avoided as a preference). 275

Transactions at an Undervalue 87 office-holder, then it is submitted that the court has jurisdiction to make an order requiring property to be transferred in specie by the counterparty’s officeholder, notwithstanding the latter’s insolvency. This is because the order which ordinarily follows from avoidance of a transaction at an undervalue is for in specie restoration of property, and the counterparty’s acquisition of title will be ‘subject to equities’ which will bind a liquidator.280 However, if the property has fallen within a crystallised floating charge, or a fixed charge, then the chargee will be likely to be able to rely upon the defence accorded under section 241(2). Where the now-insolvent counterparty received services, rather than property, from the company pursuant to the transaction, then it appears that the court is not entitled to make an order requiring the payment of money in specie, and the office-holder’s claim will rank merely as that of an unsecured creditor.281 Whilst this may seem to favour the creditors of service recipients, as opposed to asset acquirors, the distinction in treatment does no more than track the general law: service providers are unable to protect against insolvency risk through retention of title and hence are inherently more exposed than property suppliers.

(2) Interest 2.134 The office-holder will, in addition to any order for the payment of money or transfer of property, be entitled also to an award of interest. Prima facie, it would appear that interest is payable from the date of the transaction, as it is from this point in time that the counterparty is enriched at the company’s expense.282 However, it may often be more convenient, for the purposes of calculation, for the office-holder simply to claim for interest from the date of the petition for administration or the commencement of liquidation.283 Where the claim is brought under section 238 alone, the interest payable will be simple rather than compound.284 This is because property will have passed under the transaction, and the effect of the court’s order under section 238(3) is to create an obligation to pay money or to restore specific assets which is prospective only in effect.285

280 Tilley v Bowman Ltd [1910] 1 KB 745. If the counterparty is in administration then the officeholder bringing the action will of course have to seek permission of the court in order to pursue the action. 281 Compare ss 241(1)(a), 241(1)(b) and 241(1)(d). 282 See Re Barton Manufacturing Co Ltd [1998] BCC 827 at 833. 283 Ibid. 284 Westdeutsche Landesbank Girozentrale v Islington LBC [1996] AC 669. See also Barton Manufacturing Co Ltd [1998] BCC 827 at 833. Cf the position where there are overlapping causes of action and the claim is framed as a constructive trust over misapplied assets in the hands of the defendant: see para 4.104. 285 Delay in complying with the order might attract compound interest.

88 John Armour (3) Destination of Recoveries 2.135 The statutory cause of action created by section 238 is vested solely in the hands of a liquidator or administrator. The orthodox position, based on authorities considering related actions, would suggest that recoveries from a section 238 action do not form part of the assets of the company but rather are held subject to a statutory trust for the unsecured creditors. It will be argued that the position is in fact more complex. (a) Orthodox View 2.136 In Re Yagerphone, Bennett J in a brief extempore judgment held that recoveries from a preference action did not fall into a floating charge with an after-acquired property clause, but rather were ‘received by the liquidators impressed in their hands with a trust for those creditors amongst whom they had to distribute the assets of the company’.286 This decision has been approved by a number of recent authorities considering, for the purposes of the funding of insolvency litigation, whether or not statutory causes of action vested in the liquidator (or the fruits thereof) constitute ‘property’ or ‘assets’ of the company.287 In these cases,288 a line of reasoning has emerged that the recoveries from wrongful trading and preference actions are not (i) ‘assets’ or ‘property’ of the company prior to the commencement of liquidation proceedings; but rather, relying on Yagerphone, that they are (ii) ‘property which is subsequently acquired by the liquidator through the exercise of rights conferred on him alone by statute and which is to be held on the statutory trust for distribution by the liquidator’.289 It is of course possible to conceive of a third category into which the recoveries might fall, (iii) ‘assets’ or ‘property’ of the company which are acquired after the commencement of liquidation proceedings. However, it has been held that categories (ii) and (iii) are mutually exclusive: statutory trust assets are not capable of becoming assets or property of the company.290 286

[1935] Ch 392. The questions are relevant to funding in the following two ways: (1) the liquidator is by para 6 of Sch 4 of the 1986 Act expressly given power to sell the ‘property of the company’, and if this included such causes of action or their fruits then no considerations of maintenance or champerty would arise were he to fund litigation through an assignment of a cause of action; (2) the costs of litigation launched in order to recover ‘assets of the company’ within para (a) of rule 4.128 of the Insolvency Rules 1986 would constitute ‘expenses of the litigation’. If these ‘assets’ included the fruits of such actions then through s 175 of the Insolvency Act 1986, the costs would be payable ahead of preferential creditors and, insofar as the assets available to the unsecured creditors were insufficient to pay them, out of the assets subject to a floating charge: Re Barleycorn Enterprises Ltd [1970] Ch 465; Buchler v Talbot [2002] EWCA Civ 228, [2002] 1 BCLC 571. 288 Re MC Bacon (No 2) [1991] Ch 127; Re Oasis Merchandising [1998] Ch 170; Lewis v Commissioner of Inland Revenue [2001] 3 All ER 499; cf Re Exchange Travel (Holdings) Ltd (No 3) [1997] 2 BCLC 579. 289 Re Oasis Merchandising [1998] Ch 170 at 182; Lewis v CIR [2001] 3 All ER 499 at 510. 290 Lewis v CIR [2001] 3 All ER 499 at 509–10, disapproving dicta in Re Exchange Travel (Holdings) Ltd (No 3) [1997] 2 BCLC 579 at 587–88, 596. 287

Transactions at an Undervalue 89 2.137 None of this jurisprudence deals specifically with the case of transactions at an undervalue. However, the orthodox application of the foregoing principles is as follows. The court’s remedial power under section 238(3) is purely prospective, and arises only after the commencement of the relevant proceedings. Thus the recoveries do not fall into category (i). Thus the question is how they are best classified as between categories (ii) and (iii). Section 238 bears considerable similarities to section 239, and therefore it might be thought that the Yagerphone reasoning would apply by analogy, with the result that 238 recoveries are also in category (ii). This, however, necessitates a closer consideration of the reasoning in Yagerphone and the meaning in this context of the ‘statutory trust’. 2.138 The first explicit ground for Bennett J’s decision in Yagerphone was that the charge had crystallised prior to the action being brought.291 However, this cannot support the decision, as it is clearly established elsewhere that property acquired by a chargor after crystallisation is still capable of falling within an after-acquired property clause.292 The decision in Yagerphone was rationalised by Russell LJ in NW Robbie & Co Ltd v Witney Warehouse Co Ltd on a second basis, namely that the cause of action for fraudulent preferences was, ‘a statutory right in and only in the liquidator’ and thus could never have been property of the company subject to the charge.293 With respect, however, this rationalisation does not explain the result either, as the vesting of the entitlement to bring the action in the liquidator might simply be a procedural matter.294 Rather, it gains its force when combined with a third point, made explicitly by Bennett J, that preference recoveries were ‘received by the liquidators impressed in their hands with a trust for those creditors amongst whom they had to distribute the assets of the company’.295 These two points together were considered to be determinative by Millett J in Re MC Bacon (No 2),296 and this reasoning has since been adopted by the Court of Appeal in Oasis and Lewis. (b) Can the Orthodox View be Distinguished? 2.139 Transactions at an undervalue are, like preference actions, only actionable by a liquidator or administrator. Does it therefore follow that their recoveries too 291

[1935] Ch 392 at 396. Holroyd v Marshall (1862) 10 HL Cas 191; NW Robbie & Co Ltd v Witney Warehouse Co Ltd [1963] 1 WLR 1324. 293 [1963] 1 WLR 1324 at 1338. 294 Two decisions in which standing was thought to be a relevant issue, Ex parte Cooper (1875) LR 10 Ch 510 and Willmott v London Celluloid Co (1886) 34 ChD 147, were expressly distinguished by Bennett J: [1935] Ch 392 at 395. See also F Oditah, ‘Wrongful Trading’ [1990] Lloyd’s Maritime & Commercial Law Quarterly 205 at 217; S Wheeler, ‘Swelling the Assets for Distribution in Corporate Insolvency’ [1991] Journal of Business Law 256 at 262. 295 [1935] Ch 392 at 396. 296 [1991] Ch 127 at 137. 292

90 John Armour are always held on the statutory trust for the benefit of the general creditors? It might be possible to argue, perhaps speculatively, that the decisions so far discussed are distinguishable on the basis that they are concerned with recoveries either for wrongful trading, or for unlawful preferences. Whatever the proper rationale of the foregoing provisions, it can be argued forcefully that the purpose of section 238 is not to protect the unsecured creditors, or to preserve prospectively the insolvency scheme of distribution. Rather, it is to safeguard the corpus of the company’s assets from the adverse effects of the perverse incentives experienced by the debtor in the pre-insolvency period.297 The section is concerned with the size of the pie, and not with the manner it is to be divided—evidenced by the fact that under section 238 the grant of a charge does not involve the transfer of anything of value by the company.298 The argument would thus assert that the purpose of section 238 does not mandate that recoveries thereunder automatically be held for the benefit of the unsecured creditors. (c) Meaning of ‘Recoveries’ 2.140 It has also been argued that the Yagerphone analysis, as expressed in Oasis and Lewis, pays insufficient attention to the wording of the 1986 Act.299 In particular, the wording of both sections 238(3) and 239(3) speak of the court ‘restoring the position to what it would have been’ had company not entered into the transaction or preference. Where assets subject to a charge are transferred by the company under a vulnerable transaction, then an order which transfers those assets to a group which would, had the transaction not occurred, have had no right to them, can hardly be said to be one which ‘restores the position’ which previously obtained. This reasoning has logical force, and is equally applicable to recoveries under preference actions as well as undervalue transactions. Yet to argue on this basis that a different approach should be adopted to the destination of recoveries requires that the line of authorities culminating in Oasis and Lewis be overruled. It is, however, possible to reconcile the orthodox approach represented by these cases with the statutory wording, by focusing more carefully on what is meant by ‘recoveries’. 2.141 This concern stems from the idea that Parliament cannot have intended for the vulnerable transaction provisions to have been a mechanism for redistribution of proprietary rights. Where this would be the result, it surely cannot be the case that an order will be made. Consider, for example, the position where the debtor company has granted a fixed charge over an asset, which the debtor then sells at an undervalue, in breach of the creditor’s rights under the charging agreement. Consistently with MC Bacon, where charged assets are sold, the 297

See above, paras 2.14ff, esp at 2.28–2.29. Re MC Bacon [1990] BCC 78, discussed above at paras 2.24–2.26, 2.90–2.92. 299 R Parry, ‘The Destination of Proceeds of Insolvency Litigation’ (2002) 23 Company Lawyer 49 at 51–52. 298

Transactions at an Undervalue 91 value of the consideration given by the company is the value of the asset itself rather than that of the debtor’s equity of redemption.300 Thus section 238 would seem prima facie applicable. Yet if an order revesting the asset in the company were made, then the logic of the orthodox position would appear to dictate that the asset would then be held on the statutory trust for the unsecured creditors. Yet this would surely expropriate the secured creditor, subject to whose proprietary rights the counterparty would have taken the asset. Yet it is submitted that in such a case any order will be expressly subject to the chargee’s rights, so as to ‘restore the pre-existing position’. The ‘recoveries’ which will be held on the statutory trust will therefore be the debtor’s equity of redemption (if any) in the charged asset. 2.142 Reasoning of this sort appears to have commended itself to Jonathan Parker J in Re Brabon, a case of personal rather than corporate insolvency.301 The transaction in question involved a sale of land subject to a mortgage at less than its market value. Under section 283(2) of the Insolvency Act 1986, the bankrupt’s estate, which is divisible amongst his unsecured creditors, is deemed to include all property which is recovered under avoidance provisions. Thus recoveries would have fallen into the hands of the general creditors. However, the debtor’s financial position was such that he had ‘negative equity’ in the relevant asset. Whilst willing to find that the sale would constitute a transaction at an undervalue, Jonathan Parker J opined that because no proceeds would have been receivable by the bankrupt even if the mortgaged property had been sold at the price argued to be its ‘true’ value, ‘the issue of undervalue becomes academic so far as the trustee in bankruptcy is concerned’302 and the court would make no order for relief. The statement that the recoveries of an undervalue or preference claim fall into the statutory trust may be accepted as true, but it in turn may affect the exercise of the court’s remedial discretion in deciding upon the nature and quantum of such recoveries.303 2.143 It is submitted that this approach does not conflict with the decision in Yagerphone, nor thereby any of the funding cases which have followed it. Indeed, it may provide a ground for rehabilitating Bennett J’s decision. The preferential payment in Yagerphone was made from floating charge assets. However, if it was made within the ‘ordinary course of business’, then the assets would have left the floating charge at that point, as such a payment would have been within the chargor’s actual authority to deal with the charged assets. Thus to make an order for the repayment of the moneys, which would then be held on the statutory trust, would not involve any redistribution away from the 300

Re Brabon [2001] 1 BCLC 11 at 37. [2001] 1 BCLC 11 at 37. 302 Ibid. 303 To similar effect seems to be the distinction drawn in Australian authorities between recoveries of money, which fall into the statutory trust, and claims in specie to particular assets, which fall into a relevant charge: NA Kratzmann Pty Ltd v Tucker (No 2) (1968) 123 CLR 295. 301

92 John Armour chargee, for the assets would have left the charge anyway. This argument has been criticised on the basis that reasons that a preference cannot be given in the ordinary course of business, because of the need for the company to have been ‘influenced by a desire to prefer’—self-evidently suggesting an extraordinary transaction.304 However, where the counterparty does not have notice of the debtor’s mens rea, then the transaction will still appear to the counterparty be within the ordinary course of business, and thus the latter should take the assets free of the floating charge.305 Whilst it is unclear from the reported facts whether or not the counterparty in Yagerphone in fact had notice of the debtor’s state of mind, the decision is readily explicable on the basis that they did not. (d) Position in Administration. 2.144 Regardless of the position in liquidation, there are strong independent reasons for thinking that recoveries (howsoever defined) in administration should simply join the general assets of the company. The argument that recoveries from statutory causes of action should be held by the liquidator on the statutory trust for the unsecured creditors is derived from the scheme of the insolvency legislation: liquidation is a collective enforcement procedure for unsecured creditors, and so rights vested specifically in the liquidator should enure for the benefit of that group of claimants. An administration order, by contrast, can be made for one or more of a range of purposes: to preserve the company or its undertaking as a going concern, to sanction a scheme of arrangement under section 425 of the Companies Act 1985 or a company voluntary arrangement under Part I of the Insolvency Act 1986, or to secure a more advantageous realisation of the company’s assets than would be effected on a winding-up.306 Within the scheme of the insolvency legislation, the function of administration is for the administrator to continue to operate the business as a going concern in order to achieve one of these purposes, and the administrator is bound to exercise his powers accordingly.307 The causes of action under section 238 and 239 which may only be commenced by the administrator must be understood in this light. 2.145 It is submitted that recoveries in administration will simply join the general body of the assets of the company, thereby becoming subject to any relevant charge with an after-acquired property clause. This will not interfere with the function of the administration procedure, as the administrator has power to sell 304 R Parry, ‘The Destination of Proceeds of Insolvency Litigation’ (2002) 23 Company Lawyer 49 at 54. 305 See English & Scottish Mercantile Investment Co v Brunton [1898] 2 QB 700; RM Goode, Legal Problems of Credit and Security, 2nd edn (London, Sweet & Maxwell, 1988) at 84–86, 90; E Ferran, Company Law and Corporate Finance (Oxford, OUP, 1999) at 533–35. 306 Insolvency Act 1986 s 8(3). 307 Bristol Airport v Powdrill [1990] Ch 744 at 758; Barclays Mercantile Business Finance Ltd v Sibec Developments Ltd [1992] 1 WLR 1253 at 1259.

Transactions at an Undervalue 93 charged assets where necessary for the achievement of the purpose(s) for which the order was granted.308 The construction suggested here posits a different destination for recoveries depending on which procedure forms the basis for the action to avoid antecedent transactions. Any difficulty with such a construction is, however, superficial. First, as has been discussed, the rationale for the destination of recoveries in liquidation is firmly based on the purpose of that procedure in the insolvency legislation: the purpose of administration is different. Secondly, the suggestion that the recoveries should enure solely for the benefit of unsecured creditors, even in administration, would lead to the perverse result that, even if an administration order is made for the purpose of preserving the company as a going concern and is successful, the pre-order unsecured creditors will receive a windfall payment.

(4) Limitation 2.146 An application for an order under section 238 has been held to be an action on a specialty, and therefore subject to the 12 year limitation period set out in section 8(1) of the Limitation Act 1980.309 However, an application which is in substance to recover money will fall within the six-year period prescribed by section 9(1) of the 1980 Act.310 Thus where the relief sought is the setting aside of a payment of money, or where the only substantive relief available is the payment of money, a six year limitation period will apply. In Re Priory Garages (Walthamstow) Ltd, 311 it was common ground that the point at which the limitation period starts to run for a company in liquidation is the making of the winding-up order. Whilst under section 129(2), winding-up proceedings are deemed to ‘commence’ at the presentation of the petition, section 238(1)(b) enables the office-holder to bring an action when the company ‘goes into’ liquidation. Read consistently with section 238(1)(a), which enables an action by an administrator after the making of the order, the first point in time at which an action may be brought by a liquidator is the making of the winding-up order.

308

Insolvency Act 1986 s 15. Re Priory Garages (Walthamstow) Ltd [2001] BPIR 144, noted R Parry (2001) 5 Insolvency Lawyer 188. 310 Ibid. 311 Ibid. 309

3

Transactions Defrauding Creditors JOHN ARMOUR

A INTRODUCTION

3.1 Part XVI of the Insolvency Act 1986 is headed ‘Provisions Against Debt Avoidance’.1 Its provisions render vulnerable attempts by debtors to dissipate their assets so as to prevent creditors from obtaining satisfaction of their claims. Strictly speaking, this is not insolvency law.2 However, unless the debtor has become at least factually insolvent, creditors will rarely have cause to bring an action under section 423. Furthermore, it will be difficult for a creditor to show they have been prejudiced by the debtor’s actions unless the debtor is insolvent. For these reasons, the provisions fall within the scope of this book. 3.2 The process of bringing an action under section 423 may be broken down into the following series of steps. First, a creditor must show that they are a victim of the transaction.3 To do this, they must demonstrate that they have an actual or potential claim against the debtor, and that the transaction has caused or may cause factual prejudice to their claim. The application is treated as having been made on behalf of all victims of the transaction as a class. Where the debtor is in winding-up or administration, an application must in the first instance be made by the office-holder; an individual victim’s rights may only be exercised with the leave of the court. 3.3 Secondly, the debtor must have entered into a transaction with another party at an undervalue. The term ‘transaction at an undervalue’ has the same meaning for the purposes of section 423 as for section 238, and so the reader is referred to the relevant sections of chapter 2.4 The application of section 423 is excluded in the financial services sector, in respect of transactions entered into by recognised clearing houses or investment exchanges.5

1 2 3 4 5

Insolvency Act 1986 ss 423–25. The action may be brought at any time, regardless of the debtor’s solvency. See below, paras 3.19ff. See above, paras 2.50ff. Companies Act 1989 s 165.

96 John Armour 3.4 Thirdly, the debtor must have effected the transaction for the purpose of putting assets beyond the reach of actual or potential claimants, or otherwise prejudicing them in relation to their claims.6 3.5 The Court’s order will reverse the effects of the transaction, insofar as is necessary to protect the interests of the victims as a class.7 In doing so, the rights of third parties (other than the debtor and the counterparty) who acquired property or received benefits as a result of the transaction for value, in good faith and without notice of the relevant circumstances are not to be affected. If it is impossible to reverse the effects of the transaction exactly, then the Court will order the nearest possible alternative that will protect the victims’ interests.

B HISTORY AND PURPOSE

(1) Statutory History of the Avoidance of Transactions Defrauding Creditors 3.6 An action to avoid transactions entered into in fraud of creditors was first introduced by the Statute of 13 Elizabeth 1, c 5 in 1571 (known as the ‘Statute of Elizabeth’).8 This statute made void, as against any person prejudiced thereby, ‘gifts, grants, alienations [or] conveyances’ which had been effected with intent to ‘delay, hinder or defraud creditors and others.’9 It provided a defence for counterparties who had entered into a transaction bona fides and for valuable consideration.10 The Statute remained in force for over four centuries. During this time, a vast jurisprudence developed to deal with fraudulent conveyances.11 Although not itself a piece of insolvency legislation, the application of the Statute was frequently associated with insolvency, because creditors are prejudiced by fraudulent conveyances where the debtor does not retain sufficient assets to pay his debts. It was quickly established that fraudulent intent could be shown either by direct evidence (‘actual fraud’) or inferred from the circumstances of the transaction (‘constructive fraud’). Over time, the courts developed a list of ‘badges of fraud’ which could be used, either individually or cumulatively, to infer fraudulent intent on the part of a debtor. 6

See below, paras 3.32ff. See below, paras 3.62ff. 8 Its principles were said to have been part of the common law long before then. See, eg Cadogan v Kennett (1776) 2 Cowp 432 at 434, 98 ER 1171 at 1172; Rickards v A-G (1844) 12 Cl & F 30 at 42, 8 ER 1306 at 1311. A similar action, known as the actio Pauliana, was available to creditors under Roman law: see JAC Thomas, Textbook of Roman Law (Oxford, North-Holland Publishing Co, 1976) at 375–76. 9 13 Eliz 1 c 5, ss I–II. 10 Ibid s VI. 11 See generally, SW Worthington, May on Fraudulent Conveyances and Voluntary Dispositions, 2nd edn (London, Stevens & Haynes, 1887); DL McDonnell and JG Monroe, Kerr on Fraud and Mistake, 7th edn (London, Sweet & Maxwell, 1952) at 298–415; PV Baker & P St J Langan, Snell’s Equity, 29th edn (London, Sweet & Maxwell, 1990) at 128–35. 7

Transactions Defrauding Creditors 97 3.7 The Statute of Elizabeth was replaced by section 172 of the Law of Property Act 1925. Section 172(1) provided that: Save as provided in this section, every conveyance of property, made whether before or after the commencement of this Act, with intent to defraud creditors, shall be voidable, at the instance of any person thereby prejudiced.

Section 172(3) provided a defence to counterparties who received property under such a conveyance in good faith, for value, and without notice at the time of the intent to defraud creditors. The wording of section 172 differed considerably from its predecessor, and it was never authoritatively determined whether or not their scope was coterminous.12 One troublesome issue was whether the section only applied to written conveyances, as seemed to be implied by the definition of ‘conveyance’ in the 1925 Act,13 or like its predecessor could cover any transfer of property.14 3.8 The Insolvency Law Review Committee considered fraudulent conveyance law to be within their terms of reference. Although the action is open to creditors regardless of the debtor’s solvency, resort to it would usually be unnecessary unless the debtor was unable to pay his debts without recourse to the assets in question.15 The Cork Committee’s recommendations in relation to these provisions were not radical. The Committee approved of the basic philosophy of fraudulent conveyance law, and merely suggested that various uncertainties in the drafting of the statute, then embodied in section 172 of the Law of Property Act 1925, be clarified. The Committee’s recommendations were, however, not followed closely. 3.9 On the entry into force of the Insolvency Act 1986, Part XVI replaced section 172 of the Law of Property Act 1925, and is therefore the direct descendant of the old fraudulent conveyance action.16 The new law makes two major departures from its predecessor. First, only transactions at an undervalue may be set aside, even if actual intent to prejudice the interests of creditors is shown. 12 Re Eichholz [1959] Ch 708 at 725–28; cf Lloyds Bank Ltd v Marcan [1973] 2 All ER 359 at 367, aff’d [1973] 1 WLR 1388. 13 Defined by section 205(1)(ii) of the Law of Property Act 1925 to include, ‘a mortgage, charge, lease, assent, vesting declaration, vesting instrument, disclaimer, release and every other assurance of property or of an interest therein by any instrument, except by a will. . .’ 14 In Re Eichholz [1959] Ch 708 at 725–28, Harman J took the more expansive view on the basis that the section had not formed part of the Law of Property Act 1922, and that the 1925 Act was merely consolidating legislation. However, His Lordship did not decide the issue, as he found a written conveyance on the facts. Furthermore, as was pointed out by Pennycuick V-C in Lloyds Bank Ltd v Marcan [1973] 2 All ER 359 at 367, aff’d [1973] 1 WLR 1388, section 172 in fact originally appeared as part of the Law of Property (Amendment) Act 1924 (Sch 3, Part II, para 31) which, although it never independently came into force and was consolidated by the 1925 Act, was not itself consolidating legislation. 15 Insolvency Law and Practice, Report of the Insolvency Law Review Committee, Cmnd 8558 (London, HMSO, 1982, paras 1200–20. 16 Insolvency Act 1986 s 437, Sch 11 para 20. The 1986 Act came into force on 29 December 1986. See also, paras 2.7ff.

98 John Armour Secondly, and more importantly, the counterparty’s state of mind is no longer of any relevance.17 Many of the old authorities did not distinguish clearly between the operative part of the fraudulent conveyance and the bona fide purchaser defence, which means that they must now be interpreted with care when considering the circumstances under which inferences may be drawn about the debtor’s state of mind.18

(2) Purpose of the Action 3.10 The traditional justification for the provisions avoiding transactions in fraud of creditors can be found in the wording of the Statute of Elizabeth I.19 The law abhors fraud, and the statutory provisions exist to ensure that it does not prejudice creditors. Whilst the core conduct which the provisions regulate is debtor fraud, the actual scope of the action is, and always has been, broad in its ambit. Under the Statute of Elizabeth, fraudulent conveyances included not just actions taken covertly, but any action done with a ‘purpose and intent’ to ‘hinder, delay or defraud’ creditors.20 What the action proscribes is a breach of one of the most fundamental norms of the debtor-creditor relationship: that the debtor will not deliberately seek to prejudice the ability of a creditor to enforce their claim against the debtor’s assets.21 3.11 This point is well illustrated by the following dictum of Russell LJ in Lloyds Bank Ltd v Marcan:22 It must be remembered that in every case under this section the debtor has done something which in law he has power and is entitled to do: otherwise it would never reach the section. If he disposes of an asset which would otherwise be available to his creditors with the intention of prejudicing them by putting it, or its worth, beyond their reach, he is in the ordinary case acting in a fashion not honest in the context of the relationship of debtor and creditor.

The ‘fraud’ in question is entirely dependent on the context of the relationship of creditor and debtor. It consists of deliberate disregard of creditors’ interests in being able to enforce against the debtor’s assets. 17

Insolvency Act 1986 s 425(2). See below, paras 3.34ff. 19 13 Eliz I c 5, s I: For the avoiding and abolishing of feigned, covinous and fraudulent . . . gifts, grants, alienations, conveyances, [etc.] . . . more commonly used and practised in these days than hath been seen or heard of heretofore: Which . . . gifts, grants, alienations, conveyances [etc.] . . . have been and are devised and contrived of malice, fraud, covin, collusion or guile, to the end, purpose and intent, to delay, hinder or defraud creditors and others of their just and lawful actions . . . debts, [etc.] . . . 20 Ibid. 21 See RC Clark, ‘The Duties of the Corporate Debtor to its Creditors’ (1977) 90 Harvard Law Review 505. 22 [1973] 1 WLR 1388 at 1390. See also the discussion and sources cited below n 59. 18

Transactions Defrauding Creditors 99 3.12 It is fairly obvious why such conduct should be proscribed. In the words of the Statute of Elizabeth, such actions are:23 [N]ot only to the let or hindrance of the due course and execution of law and justice, but also to the overthrow of all true and plain dealing, bargaining and chesivance between man and man, without which no commonwealth or civil society can be maintained or continued.

To expand this intuition a little: the ability of the creditor to enforce against the debtor’s assets in lieu of repayment is fundamental to a basic debt contract.24 Were it to be permissible for debtors deliberately to hinder such enforcement attempts, potential creditors would become much less willing to advance funds, to the general detriment of commerce.25 3.13 The foregoing justification depends upon there being a deliberate attempt by the debtor to harm the creditor’s interests. How well does this explain the operation of the current law? It is of course possible to infer a debtor’s purpose from surrounding circumstances.26 In some cases, the court may draw such inferences erroneously, such that transactions effected by a debtor who genuinely did not act with the purpose of prejudicing his creditors are nevertheless liable to avoidance. However, it is always open to the debtor to offer a genuine account of his purpose in acting. This position should be distinguished from that which arguably obtained under the Statute of Elizabeth. Under certain circumstances, for example a voluntary conveyance made when the debtor was balance-sheet insolvent, it was said that the debtor would be irrebuttably presumed to have had the necessary mental element.27 3.14 The prevailing interpretation of section 423 has until recently excluded the possibility of actions based on ‘constructive fraud’. This is because the section was interpreted to require that the debtor’s ‘dominant’ purpose was the proscribed purpose.28 Thus in every case where the circumstances suggested a transaction was designed to prejudice creditors, but the debtor was able to offer a counter-explanation that was at all plausible, the court was required to engage in an exercise of weighing the evidence to determine which purpose was ‘dominant’. This inevitably depended on the strength of the evidence from which the inference was drawn, and that which supported the debtor’s explanation. In 23

13 Eliz I c 5, s I . Financial economists have demonstrated this intuition using formal models: see O Hart, Firms, Contracts and Financial Structure (Oxford, Clarendon Press, 1995) at 95–125. 25 DG Baird and TH Jackson, ‘Fraudulent Conveyance Law and its Proper Domain’, (1985) 38 Vanderbilt Law Review 829; JB Heaton, ‘Incomplete Financial Contracts and Non-Contractual Legal Rules: The Case of Debt Capacity and Fraudulent Conveyance Law’ (2000) 9 Journal of Financial Intermediation 169. 26 See below, paras 3.41ff. 27 Doe d Watson v Routledge (1777) 2 Cowp 705 at 710–11, 98 ER 1318 at 1321; Lord Townshend v Windham (1750) 2 Ves Sen 1 at 11, 28 ER 1 at 7; Jackson v Bowley (1840) Car & M 97 at 103, 174 ER 426 at 429; Freeman v Pope (1870) LR 5 Ch 538 at 540, 544–45. 28 See below, paras 3.40ff, esp at 3.50–52. 24

100 John Armour other words, the dominant purpose test had the effect of forcing the court to consider the debtor’s actual state of mind. 3.15 However, a recent Court of Appeal decision has broadened the ambit of section 423’s application so that the proscribed purpose need only have been a substantial purpose for which the debtor acted.29 It appears that this will considerably increase the scope for inferring the requisite mental element from the surrounding circumstances.30 On this approach, evidence adduced by the debtor that he acted for another (legitimate) purpose does not call for an enquiry as to the relative strength of each motivation. Rather, the test now to be applied is whether the debtor would have entered into the transaction in any event,31 an approach which seems analagous to the ‘but for’ causation test. 3.16 It remains to be seen how the Hashmi ‘substantial purpose’ test will be applied in practice. At its broadest, it may have the effect of bringing the sphere of application of section 423 much closer to that of section 238. Under the latter, it must be demonstrated that there was a transaction at an undervalue entered into at a time when the company was insolvent. It is then up to the counterparty to make out the defence that the debtor acted for a reasonable business purpose. Such a transaction will, by definition, prejudice the interests of creditors, and so if these are the only facts adduced, it might alternatively be possible to infer that the debtor acted with the proscribed purpose with respect to section 423. To show that this was not the case, the counterparty would need to lead evidence showing that the debtor would have entered into the transaction anyway—i.e. in the corporate context, a reasonable business purpose. 3.17 As with section 238, to the extent that section 423 may be applied to transactions where there was no deliberate attempt to evade obligations to creditors, its application may be justified by reference to a policy of seeking to ameliorate perverse incentives faced by insolvent debtors.32

C PROCEDURE AND STANDING

(1) Procedure 3.18 An application under Part XVI may be brought in any division of the High Court. Where these proceedings are brought by themselves, then the application should proceed under the Civil Procedure Rules.33 However, it will often be the case that they are coupled with other transaction avoidance claims. In this 29

Inland Revenue Commissioners v Hashmi [2002] EWCA Civ 981. See below, paras 3.40ff, esp at 3.50–52. 31 Inland Revenue Commissioners v Hashmi [2002] EWCA Civ 981. 32 See paras 2.14ff, esp 2.28–29. [purposes of s 238] 33 TSB Bank plc v Katz [1997] BPIR 147; Banca Carige SPA Cassa di Risparmio di Genova e Imperia v Banco Nacional de Cuba [2001] 2 Lloyd’s Rep 147 at 153. 30

Transactions Defrauding Creditors 101 case, the issue arises whether they may properly be brought under the Insolvency Rules 1986. On the one hand, rule 7.1 applies chapter 1 of Part 7 of the Rules to any application made under the Insolvency Act 1986 except petitions for administration, winding-up or bankruptcy orders. Yet, on the other hand, the Insolvency Rules are a statutory instrument made pursuant to a power granted by section 411–412 of the 1986 Act, which states expressly that it is to be exercised for the purpose of giving effect to parts I-XI of the Act.34 Part XVI is outwith this power. In TSB Bank plc v Katz,35 Arden J opined that, where other proceedings were pending in the Companies Court, it was legitimate for an application under Part XVI to proceed under the Insolvency Rules 1986. An application made inappropriately under the Insolvency Rules, as, for example, when no other proceedings are pending, is subject merely to a procedural defect and may be treated by the court as having been made on the appropriate claim form.36

(2) Class Action by Victims 3.19 The basic right to apply for an order under Part XVI of the Insolvency Act 1986 is granted by section 424 to victims of the transaction: namely those who are, or who are capable of being, thereby prejudiced.37 In applying for an order to reverse a particular transaction, an individual victim is treated as acting on behalf of all victims of that transaction. This is reflected in the order which will ordinarily be made—in the first instance assets will be revested in the debtor company, and creditors may then pursue their individual claims against the debtor.38 In keeping with the nature of section 423 as a creditor class action, where the debtor is in winding-up or administration, the right to commence the action is vested in the liquidator or administrator, and an application may be made by an individual victim only with the leave of the court.39 Administrative receivership does not bar an application by an individual victim, nor does the entry by the debtor company into a company voluntary arrangement.40 3.20 Where the debtor is in winding-up or administration and an individual victim seeks leave under section 424(1)(a) to apply for an order, the question of leave or no leave must logically be answered before the application may proceed 34

TSB Bank plc v Katz [1997] BPIR 147 at 149–50. Ibid. 36 Banca Carige SPA Cassa di Risparmio di Genova e Imperia v Banco Nacional de Cuba [2001] 2 Lloyd’s Rep 147 at 153. 37 Insolvency Act 1986 s 423(5). See below paras 3.21ff. 38 See Dora v Simper [2000] 2 BCLC 561 at 565–66. See also Doe d Grimsby v Ball (1843) 11 Mees & Wel 531 at 533, 152 ER 916 at 917. 39 Insolvency Act 1986 s 424(1)(a). 40 Insolvency Act 1986 s 424(1)(b). The supervisor of a CVA which binds any victim of such a transaction may alternatively make an application. 35

102 John Armour at all.41 However, it may be that the court is willing to treat an application made along with the plaintiff’s statement of substantive claim as sufficient.42 Leave will be granted as a matter of course where the liquidator consents to the action being brought by the victim. Lack of funds by the liquidator will also be a strong reason for the court to grant leave.43

(3) Who Is a ‘Victim’? 3.21 ‘Victim’ is defined in s 423(5): In relation to a transaction at an undervalue, references here and below to a victim of the transaction are to a person who is, or is capable of being, prejudiced by it.

(a) Persons Who Are Prejudiced 3.22 Unsecured Creditors. The usual way to demonstrate that creditors are victims is by showing that the transaction leaves the debtor balance-sheet insolvent, or more so than would otherwise be the case. The debtor’s balance-sheet insolvency means ex hypothesi that there will be insufficient assets to pay all creditors, and hence that they have suffered prejudice. Where the debtor was balance-sheet insolvent before entering the transaction, prejudice may be demonstrated by showing that the transaction was at an undervalue—thereby depleting further the pool of assets to which the creditors may have recourse.44 However, if the debtor company is so hopelessly insolvent that reversing the transaction will not leave enough to satisfy secured creditors, then the unsecured creditors are not prejudiced; rather the secured claimants will be the victims.45 3.23 Secured Creditors. Prejudice in this context means depletion of the value of the security or an arrangement which will deny the creditor the remedy of possession.46 It appears that secured creditors may be prejudiced by depletion in 41 National Bank of Kuwait v Menzies [1994] 2 BCLC 306 at 313; see also Dora v Simper [2000] 2 BCLC 561 at 566. 42 In Re Ayala Holdings [1993] BCLC 256 at 263, Chadwick J was content to proceed notwithstanding that the s 424(1)(a) application for leave had not been made, on the basis that the applicant was to be treated as having made such application in his submission of claim. 43 Ibid at 260, 266–67 (application by an individual victim given leave to proceed on the basis that the liquidator had insufficient funds at his disposal to engage in complex litigation). 44 See Pinewood Joinery v Starelm Property Ltd [1994] BCC 569 at 574; Jyske Bank (Gibraltar) Ltd v Spjeldnaes [1999] 2 BCLC 101 at 120. 45 Pinewood Joinery v Starelm Property Ltd [1994] BCC 569 at 574. 46 See Agricultural Mortgage Corporation v Woodward [1995] 1 BCLC 1; Barclays Bank v Eustice [1995] 2 BCLC 630. Both cases involved grants of agricultural tenancies by the debtor to a family member over property mortgaged to the plaintiffs. These were held not to be a breach of the mortgage agreement as a result of s 99 of the Law of Property Act 1925 and para 12 of sch 14 to the Agricultural Holdings Act 1986.

Transactions Defrauding Creditors 103 the value of their security even where the value of what remains is greater than the debt secured. Interest continuing to accrue and the likely costs of enforcement must be added in, and if the value of the security is likely to be less than the total of these by the time the creditor is able to take possession, then the creditor is prejudiced.47 3.24 Subsequent Creditors. These are persons who were not creditors at the time of the transaction, but became such at some time before an application is made under section 424. The question of prejudice is again one of causation. To be classed as a victim, a subsequent creditor must show that, but for the transaction, there would have been sufficient assets available to satisfy his claim,48 and that the creditor either became a creditor involuntarily or was unaware of the transaction at the time credit was extended. 3.25 Shareholders. It may seem incongruous to suggest that shareholders might be ‘victims’ under section 423(5), given that section 423 is headed ‘Transactions Defrauding Creditors’. However, the better view is that members of the debtor company may nevertheless be ‘victims’ within the subsection in either of two sets of circumstances. First, where the member is owed a debt by the company arising otherwise than by virtue of his capacity as a member. In this case, the member is also a ‘creditor’ in the ordinary sense of the word, and his concurrent status as member is merely incidental.49 Secondly, the member may be owed a debt by the company which accrued due in his capacity as a member—as, for example, where the company has declared a dividend or agreed to repurchase shares. In this case, it is arguable that he may be a ‘victim’ of an undervalue corporate transaction which causes the company’s net assets to fall below the value of its share capital and undistributable reserves so that it may no longer pay him.50 In keeping with the distinction drawn in the preceding paragraph between secured and unsecured victims, members owed sums in their capacity as such would cease to be ‘victims’ where the company is balancesheet insolvent before the transaction, as under these circumstances the members will receive nothing anyway. The victims of an undervalue transaction in such circumstances are the company’s creditors. 3.26 The Debtor? It is not possible for the debtor itself to constitute a victim for the purposes of section 423(5). The subsection distinguishes between ‘victims’, being persons prejudiced by the transaction, and ‘the debtor’, being the person entering into the transaction. That these two categories are intended to be mutually exclusive is clear from section 423(3), which specifies the necessary mental element which must have been possessed by the debtor to permit the 47

Barclays Bank v Eustice [1995] 2 BCLC 630 at 640. See Midland Bank v Wyatt [1997] 1 BCLC 242. 49 Soden v British and Commonwealth Holdings plc [1997] BCC 952. 50 Of course, a transaction that simply reduces the value of a member’s shares will not suffice: Johnson v Gore-Wood & Co [2002] AC 1. 48

104 John Armour avoidance of a transaction. This requires that the transaction be entered into with a view to putting assets beyond the reach, or otherwise prejudicing the interests, of a person who is making, or who at some stage may make, a claim against the person entering into the transaction. The logic may be illustrated by positing a case where a person with no creditors51 makes a gratuitous disposition: clearly this may harm his own interests, but it may not be struck down under section 423 as he is not capable of having an intention falling within section 423(3). ‘Victim’ under section 423(5) must be read accordingly. (b) Persons Who Are Capable of Being Prejudiced 3.27 In order to qualify as a ‘victim’, a person’s interests need not actually have been prejudiced by the time an application is made. Section 423(5) explicitly encompasses those who ‘are capable of being prejudiced’ by the transaction, in addition to those who in fact are. This includes contingent and potential creditors. 3.28 Contingent Creditors. These are parties to whom, at the time of the transaction, the debtor had an existing obligation that was contingent on the occurrence of some defined event—for example a party to whom the debtor has a given a guarantee. Where the contingency has not materialised by the time of the application, then it might be argued that their interests have not actually been prejudiced by a transaction which depletes the debtor’s assets, but it is clear that they might be. It is the latter factor which will ensure such a creditor qualifies as a victim.52 3.29 Potential Creditors. This term refers to those who expect to become creditors at some stage after an application is made under section 424.53 If the applicant is capable of being prejudiced by the transaction, then they are a victim within section 423(5). To show prejudice, the applicant must demonstrate that the effect of the transaction is such as to leave the debtor with insufficient assets to pay his claim, should it come to fruition. In order to prevent such actions being used to harass debtors by those with frivolous claims, it will be necessary to show that a genuine claim is actually proceeding. Furthermore, the court has a discretion when making an order under s 423(2) to grant only an order restraining further dealings with the assets in question, pending the outcome of the applicant’s substantive claim.54

51

Including subsequent, contingent and potential creditors. A contingent creditor will, of course, be able to petition for the debtor’s winding-up and prove in the debtor’s insolvency as if the contingency has occurred. In contrast, a potential creditor will not. See Customs & Excise Commissioners v Broomco (1984) Ltd 2000 WL 1084449 (unreported, 30 March 2000), aff’d on other grounds [2000] BTC 8035. 53 See Moon v Franklin [1996] BPIR 196. 54 Ibid. 52

Transactions Defrauding Creditors 105 (4) Class of Victims of the Transaction May Be Larger Than Those Persons the Debtor Acted with the Purpose of Prejudicing 3.30 To be actionable under section 423, the debtor must have acted with the requisite purpose in entering the transaction, viz of putting assets beyond the reach of or otherwise prejudicing the interests of an actual or potential creditor.55 However, the transaction may in fact prejudice (or potentially prejudice) the claims of a wider class of persons than the debtor had foreseen or intended at the time of effecting it. The better view, expressed by Evans-Lombe J in Jyske Bank (Gibraltar) Ltd v Spjeldnaes,56 is that persons falling within this wider class may be ‘victims’ able to make an application under section 423 notwithstanding the debtor’s lack of animus specifically as regards them. This is the happier construction of the statute, for the following reasons. First, to be a ‘victim’ under section 423(5), it is only necessary to show that one has suffered factual prejudice as a result of a transaction defrauding a creditor. It is not necessary to show that the debtor acted with the purpose of prejudicing the victim who is bringing the action; merely that the transaction was effected with the purpose of prejudicing a victim. Secondly, the term ‘victim’, defined by section 423(5) for the purposes of standing to bring an application, is conspicuous by its absence from section 423(3), which deals with the requisite purpose with which the debtor must be shown to have acted.

D TRANSACTION AT AN UNDERVALUE

3.31 For a claim to be mounted under section 423, the applicant must demonstrate that the debtor entered into a ‘transaction’ with the counterparty, and that the transaction was at an ‘undervalue’. These requirements have the same meaning in relation to section 423 as in relation to section 238, and are considered in chapter 2.57

E THE DEBTOR ’ S STATE OF MIND

(1) Introduction 3.32 The question of the debtor’s mens rea proved especially troublesome under the previous law, and shows little sign of being much clearer under the 55

Insolvency Act 1986 s 423(3). See below, paras 3.32ff. [1999] 2 BCLC 101 at 121. The point was expressly left open by Hart J at first instance in Law Society v Southall [2001] BPIR 303. Although the Court of Appeal reversed His Lordship’s ruling ([2001] EWCA Civ 2001, [2002] BPIR 336), this point was not considered. 57 Paras 2.50ff. 56

106 John Armour 1986 Act. By section 423(3), the claimant must show that the transaction was entered into by the debtor: for the purpose— (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.

3.33 Most of the controversies surround two issues: first, the circumstances (if any) in which this purpose may be inferred from extrinsic evidence; and, secondly, how the matter should be approached where the debtor acted for more than one purpose simultaneously.

(2) Position Under the Previous Law 3.34 The Statute of Elizabeth required that the debtor have acted with a ‘purpose and intent to delay, hinder or defraud creditors and others’58 and section 172 of the 1925 Act spoke of ‘intent to defraud’.59 Under both provisions, it was possible to infer the requisite intent from the surrounding circumstances, although there was tension in the authorities concerning which circumstances would suffice. One clear line of demarcation was that the requisite intent could be inferred more readily when the conveyance was voluntary. This was because the fact of value created evidence which tended to show that the debtor’s intention was other than fraudulent, and, more importantly, might allow the counterparty to rely upon the defence of good faith purchase. The mere fact that the transaction was at an undervalue would not be sufficient to constitute notice of fraud unless the difference in value was extreme.60 However, matters were confused by the distinction between the operative part of the statute and the defence not always being clearly drawn in the authorities.61 As there is no longer a defence for counterparties in good faith, this confusion means that the old authorities relating to conveyances for value must be treated with care.

58

13 Eliz I c 5, s I. Law of Property Act 1925 s 172(1). It was never decided authoritatively whether or not s 172 required that the debtor have acted dishonestly: compare the views of Pennycuick J, Russell and Cairns LJJ in Lloyd’s Bank Ltd v Marcan [1973] 2 All ER 359 at 367, aff’d [1973] 1 WLR 1388 at 1390, 1392. See also BFJ Langstaff, ‘The Cheat’s Charter?’ (1975) 91 Law Quarterly Review 86; B Elkan, ‘Voluntary Conveyances to Defraud Creditors’ (1975) 91 Law Quarterly Review 317. 60 Basset v Nosworthy (1673) Finch 102 at 104, 23 ER 55 at 56; Herne v Meeres (1687) 1 Vern CC 465, 23 ER 591 (case stated in note to Heathcote v Paignon 2 Bro CC 167 at 176–77, 29 ER 96 at 100–1); Doe d Watson v Routledge (1777) 2 Cowp 705 at 713, 98 ER 1318 at 1322; Copis v Middleton (1818) 2 Mad 410 at 425–27, 430–31, 56 ER 386 at 392, 393–94; Wood v Dixie (1845) 7 QB 892, 115 ER 724; Strong v Strong (1854) 18 Beav 408 at 410, 52 ER 161 at 162; Bayspoole v Collins (1871) LR 6 Ch 22 at 232; Re Johnson (1881) 20 ChD 389 at 397. 61 See the comments of Parker J to this effect in Glegg v Bromley [1912] 3 KB 474 at 492. 59

Transactions Defrauding Creditors 107 3.35 Where the conveyance was voluntary, the requisite intent would be presumed on the part of the debtor where the transfer would leave him factually insolvent at the date of the transfer.62 In Freeman v Pope, Lord Hatherley LC expressed the test in the following terms:63 [I]t is established by the authorities that in the absence of . . . direct proof of intention, if a person owing debts makes a settlement which subtracts from the property which is the proper fund for the payment of those debts, an amount without which the debts cannot be paid, then, since it is the necessary consequence of the settlement (supposing it effectual) that some creditors must remain unpaid, it would be the duty of the Judge to direct the jury that they must infer the intent of the settlor to have been to delay or defeat his creditors.

3.36 However, this formulation created difficulties where the only ‘creditors’ defeated were prospective. In Re Mercer, ex part Wise,64 the bankrupt had conveyed assets voluntarily at a time when he had no debts. An action had been commenced against him which at the time was thought to have had little chance of success. The action subsequently succeeded, and as a result of the conveyance the bankrupt had insufficient assets to pay. The successful claimant sought to have the conveyance avoided, alleging that its necessary consequence was to defeat her claim, and that the requisite intent should therefore be inferred. The Court of Appeal rejected this action, on different grounds. Lord Esher opined that it was not appropriate to infer intention when it could be demonstrated that the debtor in fact had no intention of hindering his creditors.65 Lopes LJ considered that the uncertainty surrounding the claimant’s action at the time of the conveyance meant that the fact that the claim was defeated was not a necessary consequence of the settlement.66 However, Lindley LJ refined the test in the earlier authorities, holding that intent to defraud could only be inferred if a necessary and foreseeable consequence of the settlement was to defeat creditors, which on the facts it was not.67 3.37 The Cork Committee considered Lindley LJ’s approach to be a helpful clarification. Discussing the requirement of ‘intent to defraud’ under section 172 of the Law of Property Act 1925, they said:68 Unfortunately, it is not entirely clear what is the meaning of ‘to defraud’ in this context; though it seems that, in practice, the requisite inference of fraud will be drawn whenever the necessary consequences of the transaction are to defeat, hinder delay or defraud the creditors or to put assets belonging to the debtor beyond their reach. 62 Doe d Watson v Routledge (1777) 2 Cowp 705 at 710–11, 98 ER 1318 at 1321; Lord Townshend v Windham (1750) 2 Ves Sen 1 at 11, 28 ER 1 at 7; Jackson v Bowley (1840) Car & M 97 at 103, 174 ER 426 at 429; Freeman v Pope (1870) LR 5 Ch 538 at 540, 544–45. 63 (1870) LR 5 Ch 538 at 541. 64 (1886) 17 QBD 290. 65 At 298–99. 66 At 302. 67 At 301. 68 Insolvency Law and Practice, Report of the Insolvency Law Review Committee, Cmnd 8558 (London, HMSO, 1982), para 1212.

108 John Armour 3.38 They recommended that it be made clear that:69 [T]he necessary intent is an intent on the part of the debtor to defeat, hinder, delay or defraud creditors, or to put assets belonging to the debtor beyond their reach, and that such intent may be inferred whenever the natural and probable consequence of the debtor’s actions, in the light of the financial circumstances of the debtor at the time, as known, or taken to have been known, to him . . . (Emphasis added).

This was not done explicitly in the 1986 Act, although it is arguable that it is open to courts to interpret section 423(3) in this way.

(3) Applying Section 423(3) (a) General 3.39 The relationship between ‘purpose’ under section 423(3) and ‘intent to defraud’ under the previous law is as yet unclear.70 On the one hand, the wording of sections 423–425 is substantially different from that of their predecessor, section 172 of the Law of Property Act 1925.71 However, the purpose of the provisions is the same,72 and section 423(3) is to be construed in light of its purpose. In Chohan v Saggar, Edward Evans-Lombe QC (as he then was) stated as follows,73 As Lord Oliver in the well-known case of Brady v Brady [1989] AC 755 at p. 779F–G acknowledged, the word ‘purpose’ is a word of wide content. But he went on to say that it must be construed bearing in mind the mischief against which the section in which that word appears is aimed. Here, the purpose or mischief against which the section is aimed, namely s. 423, is the removal of assets by their owner, in anticipation of claims being made or contemplated, out of the reach of such claimants if those claims ultimately prove to be successful.

This passage was cited with approval by the Court of Appeal in Royscott Spa Leasing v Lovett74 and in Barclays Bank v Eustice.75

69

Ibid para 1215(b). Textbooks differ on the point. Compare PV Baker & P St J Langan, Snell’s Equity, 29th edn (London, Sweet & Maxwell, 1990) at 131 (s 423(3) merely a modern restatement of the old requirement of intent to defraud) with DJ Hayton, Underhill & Hayton’s Law of Trusts and Trustees, 15th edn (London, Butterworths, 1995) at 267 (construction of ‘purpose’ unconstrained by reference to the previous law). 71 This led Mervyn Davies J to declare in Moon v Franklin [1996] BPIR 196 at 197 that the authorities on section 172 of the 1925 Act would be of ‘restricted value’ in considering the new section. 72 Chohan v Saggar [1992] BCC 306 at 323. 73 Ibid. 74 [1995] BCC 502 at 507. 75 [1995] BCC 978 at 985. 70

Transactions Defrauding Creditors 109 (b) Establishing that the Debtor Acted for a Proscribed Purpose 3.40 Notwithstanding that section 423 is titled ‘Transactions defrauding creditors’, it is not necessary to establish dishonesty on the part of the debtor in entering into the transaction, as the operative words of the section do not require it.76 A person ‘acts for a purpose’ when doing something which it is believed will lead to a particular consequence.77 This is narrower than ‘intention’, which is taken to include the necessary consequences of one’s acts,78 and also narrower than the objective ‘result’ of the transaction.79 For it to have been a purpose of the debtor’s, the link between the transaction and consequent prejudice to claimants must be shown to have been present in the debtor’s mind at the time of entering the transaction. 3.41 The burden of proof in establishing that the debtor acted for the prohibited purpose is on the claimant.80 In demonstrating the debtor’s purpose, inferences may be drawn about the state of the debtor’s mind from the surrounding circumstances.81 The more likely it was that the transaction would prejudice creditors, the more readily a court will infer that the debtor believed this outcome would follow. In the words of Lord Oliver (speaking in the context of tax law), ‘some results are so inevitably and inextricably involved in particular activities they cannot but be said to be a purpose of the activity’.82 The debtor may, of course, lead evidence to demonstrate that he acted for a legitimate purpose, and where the court finds that the debtor would have entered into the transaction in any event, then it should not readily infer that the debtor did so to escape actual or potential liabilities.83 3.42 The drawing and rebuttal of such inferences is of course a highly factspecific matter. Nevertheless, it is fair to say that there is room for clarification of the relevant principles which are applied. The Cork Committee suggested that the law should be clarified so that the debtor may be taken to have acted for the purpose of prejudicing victims where this consequence was reasonably foreseeable to him at the time of entering the transaction.84 It is submitted that this formulation is capable of summarising much of the current case law. 76

Arbuthnot Leasing v Havelet Leasing (No.2) [1990] BCC 637 at 644; Re Brabon [2001] 1 BCLC 11. See, in a tax context, Mallalieu v Drummond [1983] 2 AC 861 at 870; MacKinlay v Arthur Young [1989] STC 898 at 905–6. 78 Re MC Bacon Ltd [1990] BCC 78 at 87. 79 Royscott Spa Leasing v Lovett, [1995] BCC 502 at 509. 80 Chohan v Saggar [1992] BCC 306 at 323. See also Pinewood Joinery v Starelm Properties Ltd [1994] BCC 569 at 574; Royscott Spa Leasing v Lovett [1995] BCC 502 at 507. 81 Moon v Franklin [1996] BPIR 196 at 204, citing Freeman v Pope (1870) LR 9 Eq 206 and Lloyds Bank Ltd v Marcan [1973] 2 All ER 359 at 367. 82 MacKinlay v Arthur Young [1989] STC 898 at 905. 83 Inland Revenue Commissioners v Hashmi [2002] EWCA Civ 981. 84 The consequences which are reasonably foreseeable to a debtor are those which are natural and probable consequences given the debtor’s knowledge of his financial circumstances at the time. See Insolvency Law and Practice, Report of the Insolvency Law Review Committee, Cmnd 8558 (London, HMSO, 1982), para. 1215(b). See also Midland Bank v Wyatt [1997] 1 BCLC 242 at 254–55. 77

110 John Armour 3.43 Where the debtor is facing claim(s) from creditors at the time of the transaction, then he will be presumed to have acted for the prohibited purpose if the transaction left him with insufficient assets to pay his debts, unless he can offer some legitimate explanation of his actions.85 Under these circumstances, it is not open to the debtor to rebut the inference that he had the proscribed purpose in mind merely by saying, ‘I did not think of that’, unless this can be supported by credible evidence. In Evans v Din,86 the debtor transferred his sole asset, a share of the beneficial interest in his family home, to his brother for what the trial judge found to have been an illusory consideration. This occurred at a time when the debtor had become aware that the applicant had received a substantial award of damages against him. The debtor claimed that, at the time of the transaction, he believed his insurers would pay for his liability to the applicant. Had this been true, it would not have been foreseeable to the debtor that the transaction would prejudice the applicant. However, the judge did not find the debtor’s account credible, given that his solicitors had at the time applied for legal aid in order to pay for his defence. 3.44 Where the debtor does not face claims at the time of the transaction, but may do so at some stage in the future, it is still possible for these future claimants to be ‘victims’ of the transaction. It is also perfectly possible that the debtor may have alienated his assets in order to defeat these future claims. Under the old law, the courts would be willing to infer intent to defraud where assets were settled voluntarily prior to entry into a speculative business venture. Indeed, the more hazardous the business venture being contemplated, the more readily the Court would be satisfied that the debtor acted with the relevant intent.87 Thus, in Mackay v Douglas,88 the debtor went into a hazardous business of jute speculation six weeks after effecting a voluntary settlement of most of his assets. Whilst he had no creditors at the time of the settlement, the court was willing to infer that he had intended to hinder, defraud or delay his future creditors because it was reasonably foreseeable that the effect of the settlement would be to deprive them of recourse to his assets. Similarly, in Re Butterworth,89 the debtor effected a voluntary settlement of all his assets one month before entering a grocer’s business, which was particularly risky for him as he was unfamiliar with the trade. 3.45 These cases were applied in Midland Bank v Wyatt,90 where the debtor effected a voluntary settlement of his share in the beneficial interest of the family home to his daughters at a time when he was contemplating setting up his 85 Freeman v Pope (1870) LR 5 Ch App 538; Aiglon Ltd v Gau Shan Co Ltd [1993] BCLC 1321 at 1328–29; Royscott Spa Leasing Ltd v Lovett [1995] BCC 502 at 507–9; Banca Carige SPA Cassa di Risparmio di Genova e Imperia v Banco Nacional de Cuba [2001] 2 Lloyd’s Rep 147 at 158–59. 86 Unreported, 17 March 1995 (CA). 87 Midland Bank v Wyatt [1996] BPIR 288. 88 (1872) 14 Eq 106. 89 (1882) 18 Ch D 588. 90 Ibid.

Transactions Defrauding Creditors 111 own business.91 David Young QC found the transaction to have been a sham, and that the debtor in fact had no intention of disposing of his interest to benefit his children. Therefore, the only purpose for which the debtor could have acted was to protect the assets from claims by potential future business creditors. 3.46 Similarly, in Inland Revenue v Hashmi,92 a deceased shopkeeper had for a number of years defrauded the Inland Revenue by seriously under-reporting profits generated by his business. During this period, he transferred the freehold interest in another commercial property to his son. Hart J, whose finding was upheld by the Court of Appeal, inferred from the fact that the deceased must have been aware that the Inland Revenue would be likely to bring substantial claims against him in respect of his tax fraud that in transferring the property he intended to put it beyond the reach of the Revenue. (c) Rebuttal of Inference 3.47 As has been mentioned, the debtor may seek to rebut an inference that he acted for a proscribed purpose by adducing evidence as to his actual purpose. Depending on the strength and nature of the evidence, the court may come to one of at least four possible conclusions. First, the debtor’s evidence may be entirely rejected, in which case the transaction will have been effected solely for a proscribed purpose.93 3.48 Secondly, the debtor’s evidence may be accepted as giving an entire explanation of the purpose for which the transaction was effected—in which case the inference will be rebutted.94 This was the case in Law Society v Southall.95 Mr. Southall, a deceased solicitor, had during his lifetime transferred the freehold in his valuable house and most of his chattels to his wife utilising stronglyworded deeds of gift, suggesting clear planning on his part. At the same time, he was engaged in making loans to property developer clients in a manner that infringed Law Society accounting regulations. It was argued for the Society that the debtor must have foreseen that the Society would eventually make a claim against him in respect of this, and that the transfers to his wife must therefore 91 The debtor sought to distinguish the earlier cases by pointing out that it was less foreseeable that the transaction would prejudice future claimants, as (i) it took place a full 9 months before he went into business; (ii) he was only contemplating going into business at the time and had made no firm decision; (iii) his business was in the fabrics industry, in which he had worked for many years; and (iv) he used a limited liability company rather than a partnership. Whilst it is arguable that the prejudice to creditors was not reasonably foreseeable to the debtor at the time of the transaction, he admitted in his evidence that this was in his mind at the time of the transaction. Hence his case collapsed. 92 2001 WL 1251799 (unreported, 4 October 2001). 93 See eg, Midland Bank v Wyatt [1997] [1997] 1 BCLC 242; Barclays Bank v Eustice [1995] BCC 978. 94 See Inland Revenue Commissioners v Hashmi [2002] EWCA Civ 981. 95 [2001] EWCA Civ 2001 at [49]–[52], [2002] BPIR 336 at 349–50. See also Rowlands v Gulfpac Ltd [1999] Lloyd’s Rep Bank 86; White v Woodroffe 2000 WL 281258 (unreported, 24 January 2000).

112 John Armour have been for the purpose of ensuring that these assets would not be available for attachment in such case. This reasoning was accepted by Hart J at first instance,96 but entirely rejected by the Court of Appeal,97 preferring evidence from the deceased’s tax planner which explained that the deeds of gift were entirely consistent with the advice the deceased had been given about minimising potential liability to estate duty. 3.49 Thirdly, the evidence adduced by the debtor may be treated by the court as going not to his purpose in entering the transaction, but to his motive,98 or reason for forming that purpose.99 In Arbuthnot Leasing International Ltd v Havelet Leasing Ltd (No 2),100 the debtor company (‘Leasing’) leased vehicles such as aircraft and motor coaches from the applicants Arbuthnot and other financiers, and its business consisted of subleasing these assets to third-party customers. The transaction was effected at a time when Arbuthnot had terminated their leases for unpaid arrears, and had issued a writ for recovery of these amounts. The transaction consisted of the transfer of the entirety of Leasing’s assets to a related company (‘Finance’) in return for quarterly in-arrears payments representing the income from the subleases. This effectively left Leasing as a shell company with liabilities to its financiers under the leases, but with its only asset being the right to quarterly payment of income from Finance in arrears. The managing director and sole shareholder of both companies, a Mr Maughan, alleged that the transaction had been entered into after receiving legal advice, and that it was effected in order to save the business and thereby not to prejudice the interests of Leasing’s other creditors. Scott J distinguished between the debtor’s motive, which was to preserve its business, and the purpose for which the transaction was effected, which was to prejudice the claims of Arbuthnot.101 3.50 Fourthly, the debtor’s evidence may be found to have established that the transaction was effected for more than one purpose. Until recently, this would have necessitated a weighing of the relative strengths of the two purposes in the debtor’s mind. The action would only succeed if it could be shown that the proscribed purpose was ‘dominant’. This test was enunciated by Edward EvansLombe QC in Chohan v Saggar.102 Having outlined the mischief to which the section is directed,103 His Lordship opined:104

96

[2001] BPIR 303. [2001] EWCA Civ 2001 at [49]–[52], The Times 7 January 2002. 98 See Arbuthnot Leasing International Ltd v Havelet Leasing Ltd (No 2) [1990] BCC 636 at 644. See also (in a tax context) MacKinlay v Arthur Young [1989] STC 898 at 906. 99 Brady v Brady [1989] AC 755 at 779. 100 [1990] BCC 636. 101 At 644. 102 [1992] BCC 306. 103 Above, para 3.39. 104 [1992] BCC 306 at 323. 97

Transactions Defrauding Creditors 113 It would defeat that purpose if it were possible successfully to contend that if the [debtor] was able to point to another purpose, such as the benefit of his family, friends or the advantage of business associates, the section could not be applied. I propose to construe sec. 423(3) as requiring a plaintiff to demonstrate a dominant purpose to remove assets from the reach of actual or potential claimants or creditors, but as not excluding the possibility that there might also be other purposes behind the relevant transfer. To do otherwise would seem to me to remove sec. 423 from any practical use in restraining the mischief to which it was directed. . . .

The ‘dominant purpose’ test was been applied in a number of subsequent cases where the debtor acted for more than one purpose.105 3.51 However, in Royscott Spa Leasing Ltd v Lovett the Court of Appeal were willing to accept, without deciding, for the purposes of the appeal that the test was one of demonstrating that the proscribed purpose was a substantial, as opposed to the dominant, purpose of the debtor’s.106 This approach was recently followed, in preference to the ‘dominant purpose’ test, by the Court in Inland Revenue Commissioners v Hashmi.107 The difference between the two approaches may be illustrated as follows. Assume that the debtor acts for the proscribed purpose and also for a legitimate purpose X. The enquiry as to whether or not the proscribed purpose was ‘dominant’ calls for investigation of the relative importance to the debtor of the two purposes. If purpose X is stronger in the debtor’s mind, then the proscribed purpose cannot be said to be ‘dominant’. To show that the proscribed purpose was ‘substantial’ requires merely that it be a real or non-trivial purpose of the debtor’s, without regard to the relative importance of other purposes. This is undoubtedly an easier test to satisfy. 3.52 The transaction in Royscott Spa Leasing involved a transfer of the debtor’s family home to his wife for no consideration. It was effected at a time when the applicants had issued proceedings against him under a contract of indemnity in relation to his business. The house had been charged to a bank by way of security for a guarantee by the debtor of his business debts. The bank was pressing for payment, and the debtor argued that it had been imperative for him to remortgage the property as a result. The debtor had a county court judgment registered against him, and was therefore unable to obtain mortgage finance in his own name. At the suggestion of the bank, the property was therefore transferred to his wife to allow her to obtain the required remortgage. Sir

105 See Moon v Franklin [1996] BPIR 196 at 204, a case decided in 1990, in which Mervyn Davies J applied a similar, ‘predominant purpose’ test. See also Jyske Bank Gibraltor v Spjeldnaes [1999] 2 BCLC 101. Other cases in which Chohan v Saggar has been cited with approval, such as Midland Bank v Wyatt [1997] 1 BCLC 242 and Barclays Bank v Eustice [1995] 2 BCLC 630, have concerned transactions where the debtor was found to have acted only for one (proscribed) purpose, and are therefore not to the point. 106 [1995] BCC 502 at 507. 107 [2002] EWCA Civ 981 at [19]–[25].

114 John Armour Christopher Slade, giving the judgement of the Court of Appeal, held that the applicants had not even shown that prejudicing the applicants was a substantial purpose of the debtor’s. Their application therefore failed.

F GOOD FAITH RECEIPT FOR VALUE BY THIRD PARTIES

3.53 Section 425(2) provides a defence to a claim under section 423 to certain third parties who acquire interests in property or benefits as a result of the transaction. It is important to note that, unlike the position under the previous law, this defence is not open to counterparties to the transaction.108 Section 425(2) states that a court order made pursuant to section 423: (a) 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, and (b) shall not require a person who received a benefit from the transaction in good faith, for value and without notice of the relevant circumstances to pay any sum unless he was a party to the transaction.

(1) Interests in Property 3.54 ‘Property’ is defined in section 436 to include money, goods, things in action, land and every description of property wherever situated and also obligations and every description of interest, whether present or future or vested or contingent, arising out of, or incidental to, property.

3.55 The requirement that the interest be acquired from a person other than the debtor has the effect of excluding immediate transferees under the transaction from the protection of section 425(2)(a). An enquiry is thereby mandated into the precise location of the beneficial interests in any property transferred by the debtor under the transaction. If they go directly from the debtor to the ‘third party’, then it should not be possible for such party to claim protection under this provision.

(2) Benefits 3.56 The concept of a ‘benefit’ under section 425(2)(b) is broader than that of ‘property’ as used in section 425(2)(a), and probably includes all factual or legal 108

On who will be classed as a ‘party’ to a transaction, see above paras 2.53ff.

Transactions Defrauding Creditors 115 benefits. Thus the provision of services, loans of property and guarantees or suretyship obligations are all covered. The requirement that the benefit be received from the transaction denotes a causal enquiry.

(3) Acquired in Good Faith . . . Without Notice of the Relevant Circumstances 3.57 Section 425(3) specifies that for the purposes of section 425(2), the ‘relevant circumstances’ in relation to a transaction are the circumstances by virtue of which an order under section 423 may be made in respect of the transaction— namely, the fact of its having been made at an undervalue, and for the proscribed purpose by the debtor. Unlike the corresponding provision in respect of transactions at an undervalue and preferences, there is no presumption of lack of good faith as against connected parties.109 However, it is not necessary to show that the counterparty had any notice of insolvency proceedings.110

(4) For Value 3.58 The protection accorded to innocent third parties under section 425(2) is analogous to that given to the counterparty of a fraudulent conveyance under the pre-1985 law.111 Under the old law, the amount of value given by a counterparty would not be scrutinised unless it was so grossly inadequate as to suggest absence of good faith.112 It is likely that a similar approach would be adopted by a court in relation to the requirement of ‘value’ under section 425(2).

G REMEDIES

(1) Remedial Jurisdiction of the Court (a) Scope and Purpose of Remedial Powers 3.59 Section 423(2) of the Insolvency Act 1986 provides that the court may, if the elements of the statutory cause of action are made out, make such order as it thinks fit for

109

cf Insolvency Act 1986 s 241(2A)(b). See paras 2.113ff. cf s 241(2A)(a). 111 See Law of Property Act 1925 s 172(3); 13 Eliz I c 5, s VI. 112 See eg, Doe v Routledge (1777) 2 Cowp 705 at 714, 98 ER 1318 at 1322 (sale of estates worth £2,000 for £200); Strong v Strong (1854) 18 Beav 408, 52 ER 161 (sale of estate with annual net income of £178 for an annuity of £60 per annum, when vendor known to be on his deathbed). 110

116 John Armour (a) restoring the position to what it would have been if the transaction had not been entered into, and113 (b) protecting the interests of persons who are victims of the transaction. Three general points should be made. First, the remedial power is restitutionary, rather than simply compensatory: it is designed to require the counterparty to disgorge, in favour of the company, the benefit which they received unjustly114 from the company.115 Secondly, the effect of an order pursuant to section 423(2) is not to avoid the transaction retrospectively. Rather, it will compel counterparties and the office-holder to restore things to the position that would have obtained if the transaction had not occurred. The transaction itself remains valid. Thirdly, the remedial power is subject to the protection of the interests of third parties who acquire interests in property or benefits under the transaction in good faith and for value.116 3.60 The remedial jurisdiction, although extremely broad, must always be exercised in the light of these statutory purposes. Thus the power to restore is not granted generally, but only insofar as is necessary to protect the victims’ interests. In Moon v Franklin, where the plaintiff’s substantive claim against the debtor had yet to be heard, Mervyn Davies J held that an order restraining the debtor and the counterparty from disposing of the assets in question was sufficient to protect the victims’ interests.117 The qualification imposed by the statutory purposes extends even to the discretionary term ‘may’, such that the section requires the court to make an order unless it is satisfied that ‘any possible order would be . . . incapable of conferring any benefit on the victims of the transaction’.118 (b) Examples of Orders Which May Be Made 3.61 A range of orders which the court may make is set out in section 425(1). This section is expressed not to detract from the generality of the court’s discretion under section 423(2). The list of orders therefore exemplifies, rather than defines, the ambit of the court’s power, and must always be understood as subject to the overriding purposes of the remedial jurisdiction. Section 425(1) states that the court may: (a) require 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; 113

The word ‘and’ is to be read conjunctively: Chohan v Saggar [1994] BCLC 706 at 714. So deemed by virtue of s 423. 115 See above, paras 2.21–22, and below, ch 9. 116 Insolvency Act 1986 s 425(2). See above, paras 3.53ff. 117 [1996] BPIR 196. 118 Chohan v Saggar [1992] BCC 750 at 754; See also Arbuthnot Leasing International Ltd v Havelet Leasing (No 2) [1990] BCC 636 at 645. 114

Transactions Defrauding Creditors 117 (b) require any property to be so vested if it represents, in any person’s hands, the application either of the proceeds of sale of property so transferred or of money so transferred; (c) release or discharge (in whole or in part) any security given by the debtor; (d) require any person to pay to any other person in respect of benefits received from the debtor such sums as the court may direct; (e) provide for any surety or guarantor whose obligations to any person were released or discharged (in whole or in part) under the transaction to be under such new or revived obligations as the court thinks appropriate; (f) provide for security to be provided for the discharge of any obligation imposed by or arising under the order, for such an obligation to be charged on any property and for such security or charge to have the same priority as a security or charge released or discharged (in whole or in part) under the transaction. (c) Relationship with the Previous Law 3.62 The pre-1985 law is of limited assistance in interpreting the remedial provisions of sections 423–425. Under section 172 of the Law of Property Act 1925, fraudulent conveyances were rendered voidable at the instance of any person thereby prejudiced.119 However, the court’s remedial powers under section 423(2) are not limited simply to avoidance of the transaction. Rather, the court may make such order as it thinks fit which will satisfy the purposes of section 423(2).120 This conclusion is made clear by consideration of the range of possible orders specified in section 425(1). (d) Relationship with Sections 238–241 of the Insolvency Act 1986 3.63 The remedial provisions of sections 423–425 are very similar to those which respond to a transaction at an undervalue, namely sections 238(3) and 241.121 However, there are two important differences. First, the statutory purposes for which the remedial powers are to be exercised are different. Under section 238(3), the court is to make an order simply for the purpose of restoring the pre-existing position, whereas section 423(2) also specifies that the court shall seek to protect the interests of the victims of the transaction. This suggests that the impossibility of restoring the pre-existing position should be less of an obstacle to a court order under section 423 than 238, as the overriding purpose 119 Law of Property Act 1925 s 172(1). The same was true under its predecessor, 13 Eliz I c 5. Notwithstanding that the Statute of Elizabeth declared that transactions falling within its ambit were to be, ‘clearly and utterly void, frustrate and of none effect’ (ibid, s II), it was subject to a judicial gloss that the transactions in question were merely voidable at the instance of parties prejudiced thereby (see eg, Harrods Ltd v Stanton [1923] 1 KB 516 at 521–22). 120 Chohan v Saggar [1994] BCLC 706 at 713. 121 Discussed above, paras 2.121ff.

118 John Armour of protecting the interests of victims may nevertheless be achieved even by an order which does not restore the pre-existing position. Secondly, the way in which third parties are protected differs as between section 241(2) and 425(2).122

(2) Application of Principles in the Caselaw 3.64 The application of the foregoing principles can be seen in the relevant caselaw. In Arbuthnot Leasing International Ltd v Havelet Leasing (No 2),123 the transaction had the effect of depriving the claimant of recourse to the defendant’s assets in satisfaction of the former’s claims. The assets were transferred to another company, ‘Finance’, in what was held to be a transaction defrauding creditors. However, Finance traded in its own right subsequent to the transfer, and incurred liabilities to third party creditors. Scott J recognised that the interests of the new creditors must take priority over those of the victims.124 In order to protect these third party interests, Scott J made a declaratory order that Finance hold the entirety of its assets on constructive trust for Leasing, subject to the claims of the third party creditors. 3.65 The facts of Chohan v Saggar 125 were somewhat complex, and it is necessary to consider them in some detail in order to understand the application of the principles under which the relevant order is to be made.126 At the outset the debtor, Mr Bhambra, owned the freehold of a dwelling-house found to have been worth £75,000 in total. However, it was subject to the occupation of Mrs Saggar qua tenant, which reduced the sale value of the property to £50,000. The first stage127 of the transaction consisted of a sale to Mrs Saggar for a consideration expressed to be £50,000. Mrs Saggar raised £31,000, in part through a mortgage on the property granted to the Chelsea Building Society, which she paid to Mr Bhambra and he in turn used to pay off the original mortgagee. An outstanding debt of £19,000 was at this stage still owing from Mrs Saggar to Mr Bhambra. 3.66 The second stage of the transaction involved Mrs Saggar executing a declaration of trust stating that she held the property on trust for sale for herself and one Mr Mallard in shares such that he would be entitled to £19,000-worth of the

122 In addition, the language of s 238(3) is mandatory, whereas s 423(2) is discretionary, although it appears that little will turn on this. See para 2.123. 123 [1990] BCC 636. The facts are set out more fully above at para 4.49. 124 Although Scott J did not explicitly refer to s 425(2), it has been interpreted as providing a statutory rationale for the form of his order. See Chohan v Saggar [1994] BCLC 706 at 711, 714. 125 [1990] BCC 306 at 750, [1994] BCLC 706 (CA). 126 See [1990] BCC 306 at 306–17 for a complete statement of the facts. 127 Following the trial judge’s account of the facts: [1990] BCC 750 at 756.

Transactions Defrauding Creditors 119 beneficial interest in the house. In consideration of this, Mr Mallard, who was a onetime business associate of Mr Bhambra’s, was expressed to grant a release of various debts owed to him by Bhambra, and Bhambra was to treat this as the remainder of the purchase price. The judge found that in fact Bhambra’s debts to Mallard amounted to nothing like £19,000, and that this step, given the requisite purpose of Bhambra in entering the transaction, thereby constituted a transaction defrauding creditors. 3.67 The trial judge made an order declaring that the second step of the transaction should be reversed, and that Mrs Saggar held the equity of redemption on trust for sale, with the beneficial interest held in appropriate shares for herself and Mr Bhambra.128 Edward Evans-Lombe QC was concerned to ensure that the interests of the second mortgagee, who was entitled to the protection of section 425(2)(a), were not prejudiced. A complete restoration of the pretransaction position would have removed their mortgage, and hence was impermissible. Consequently, the judge’s order set aside only the second step of the transaction. 3.68 In the Court of Appeal, Nourse LJ (with whom Balcombe and Waite LJJ agreed) held that the trial judge had given insufficient protection to the interests of the victims of the transaction. Whilst the order to be made by the court must protect third parties coming within section 425(2), the court is not constrained to grant an order which has the effect of reversing all or any of the transaction. The court’s order must only restore the pre-existing position insofar as this is congruent with the other aim of section 423(3), that of protecting the interests of victims, and with the restriction imposed by section 425(2). Nourse LJ stated as follows,129 The object of ss 423 to 425 being to remedy the avoidance of debts, the ‘and’ between paras (a) and (b) of s 423(2) must be read conjunctively and not disjunctively. Any order made under that subsection must seek, so far as is practicable, both to restore the position to what it would have been if the transaction had not been entered into and to protect the interests of the victims of it. It is not a power to restore the position generally, but in such a way as to protect the victims’ interests; in other words, by restoring assets to the debtor to make them available for execution by the victims. So the first question the judge must ask himself is what assets have been lost to the debtor. His order should, as far as practicable, restore that loss.

3.69 The asset lost by Mr Bhambra was a beneficial interest in the property worth £19,000. The order made by the trial judge did not have the effect of restoring this to the debtor’s estate. Once the burden of the Chelsea Building Society’s mortgage had been factored in, the estate was only replenished by £12,666 under the order. Nourse LJ therefore varied the trial judge’s order such 128 Ibid. 56/75ths were accredited to Mrs Saggar, being the value of her tenancy plus the purchase price paid, and 19/75ths to Mr Bhambra, being the outstanding balance. 129 [1994] BCLC 706 at 714.

120 John Armour that the burden on the Chelsea Building Society’s mortgage should fall entirely on Mrs Saggar’s share of the beneficial interest.130

(3) Limitation 3.70 Prior to 1986, it appears that no limitation period applied to fraudulent conveyance actions.131 The Cork Committee were of the opinion that this position should not be changed. However, it is strongly arguable that sections 8 and 9 of the Limitation Act 1980 will now apply to an action to set aside a transaction defrauding creditors. This is because, prior to 1986, fraudulent conveyances were simply rendered void. Under Part XVI, the court has power to make an order restoring the position and protecting victims, but the underlying transaction remains valid. Thus the court’s power is not simply declaratory. As a statutory cause of action, it would appear that section 423 would be an ‘action on a specialty’ falling within section 8 of the 1980 Act, and thereby a 12-year limitation period would apply. By analogy with the position in respect of actions brought under section 238 and 239 of the 1986 Act, claims under section 423 which are substantially for a sum of money may fall within section 9 of the 1980 Act, thereby being subject to a six-year limitation period. 3.71 The foregoing is subject of course to the general proviso in section 32 of the Limitation Act 1980 that where the cause of action is based on the fraud of the defendant, then the limitation period shall not start to run until the fraud is discovered or could with reasonable diligence have been discovered.132 It would appear that section 423 is such a cause of action, and thus that the limitation period will not start to run until the victim(s) ought reasonably to have discovered the circumstances surrounding the transaction. 3.72 An interesting problem is raised by the exception to the proviso in section 32(3) of the Limitation Act 1980, which provides that the lengthening of the limitation periods prescribed by section 32 shall not be used to permit proceedings for the recovery of, or the value of, property to be brought against the purchaser of the property or any person claiming through him, in any case where the property has subsequently been purchased for valuable consideration by an innocent third party. By section 32(4), a purchaser is deemed to be an innocent third party if he was not a party to the fraud and did not at the time of the purchase know or have reason to believe that the fraud had taken place. The scope of section 32(3) of the Limitation Act 1980 appears to be broader than that of section 130

At 714–15. Insolvency Law and Practice, Report of the Insolvency Law Review Committee, Cmnd 8558 (London, HMSO, 1982), paras 1278–82. 132 See eg, Law Society v Southall [2001] BPIR 303, rev’d on other grounds [2001] EWCA Civ 2001 [2002] BPIR 336, in which the impugned transactions took place 30 years before the date of judgment. No limitation point appears to have been taken in the case. 131

Transactions Defrauding Creditors 121 425(2) of the Insolvency Act 1986, and it is conceivable that the counterparty to a transaction defrauding creditors could be deemed to be an ‘innocent third party’ for the purposes of the former provision. In such a case, the extension of section 32(3) to actions to recover the value of property transferred would appear to limit severely the range of orders available to the court once the basic 12-year limitation period has expired.

4

Preferences ADRIAN WALTERS

A INTRODUCTION

4.1 The basic objective of the preference law in section 239 of the Insolvency Act 1986 can be described in deceptively simple terms. It seeks to reverse transactions entered into by an insolvent company in the twilight period before formal administration or liquidation which have the effect of improving the position of one creditor in relation to other creditors possessing an equalranking claim to the company’s assets on liquidation. To take an example, let us say that A Ltd has total assets of £100 and two unsecured creditors, X and Y, each owed £100. In A Ltd’s liquidation, the £100 worth of assets would be distributed pari passu between X and Y, with the result that each would receive £50, representing a dividend on their claims of 50 pence in the pound. If, however, on the eve of liquidation A Ltd pays X £100, exhausting its remaining assets, the payment to X is a factual preference because it improves X’s position relative to Y. X is repaid in full, rather than being left to rank alongside Y for dividend in the liquidation, while Y receives nothing.1 The use of preference law to unravel pre-liquidation transactions of this nature is commonly justified by reference to the pari passu principle.2 Unless the office holder has the right to challenge the transactions in our hypothetical examples, one unsecured creditor (X) would obtain an unwarranted priority over other unsecured creditors (Y) and the distribution of the insolvent estate on a pari passu basis would accordingly be distorted.3

1 As will become clear below, the mere fact that the transaction has preferential effect will not lead to it automatically being set aside. The office holder must also show that the company was influenced by a desire to prefer. The term ‘factual preference’ is used here to denote a transaction having preferential effect within the meaning of Insolvency Act 1986 s 239(4) and is the equivalent of the term ‘preference in fact’ used by Morritt J in Re Ledingham-Smith [1993] BCLC 635. An ‘unlawful preference’ is a preference that satisfies all the elements of the cause of action and is accordingly liable to be set aside by the court. 2 See paras 1.1–1.2. 3 See Insolvency Law Review Committee, Insolvency Law and Practice, (Cmnd. 8558, 1982) (hereinafter referred to as ‘Cork Report’) especially para 1241; R Goode, Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997), from 386. For further discussion of preference law’s possible rationales see section D below.

124 Adrian Walters 4.2 Our discussion may be illuminated further if we think of section 239 as regulating a process of transition that begins when the company becomes factually insolvent 4 and ends when it enters a collective insolvency proceeding (here meaning administration or liquidation). Once the company is factually insolvent the rules and norms of insolvency law come into play. Unsecured creditors have the collective right to petition for the company to be wound up.5 The directors are required to consider the interests of creditors as paramount in discharging their fiduciary duty to act in the interests of the company.6 As at this point there is every prospect that the company will be forced into a collective insolvency proceeding, section 239 can be seen as an attempt to ensure that insolvency law’s distributional rules and norms (including the pari passu principle) are not undermined by dealings during the period of transition that favour particular creditors over the collective interest. However, preference law does not suspend those dealings in advance of a collective proceeding. Its operation is retrospective and is triggered only after the transition from factual insolvency to collective proceeding is complete. It follows that a creditor who succeeds in collecting what the insolvent company owes him during the period of transition is not acting illegally at the time of collection. This is so even if it becomes apparent in a subsequent collective proceeding that the payment preferred the creditor over other creditors. At the time of collection, the creditor is simply exercising his individual right to payment as a matter of debtor-creditor law in circumstances where, in advance of a collective proceeding, the ordinary commercial norms of the ‘solvent world’ are still likely to operate.7 Preference law therefore seeks to superimpose the norms of the collective proceeding over the norms of the ‘solvent world’. In so doing, it reflects the transition from the ordinary scheme of individual remedies (in which each creditor is free on a ‘first come, first served’ basis to pursue the company individually, reduce its claim to judgment and proceed by way of execution against the company’s assets) to insolvency law’s collective scheme.8 A difficult question concerns the extent to which preference law should retrospectively override transactions entered into in the ordinary course of business or on the basis of normal commercial expectations. One option is to promote the inviolability of the collective scheme by selecting a blanket rule that captures all transactions entered into by the

4 Meaning that the company is unable to pay its debts or that the value of its assets is less than the amount of its liabilities including contingent and prospective liabilities: Insolvency Act 1986 ss 240(2), 123. 5 Ibid ss 122(1)(f), 124(1). 6 West Mercia Safetywear Ltd v Dodd [1988] BCLC 250. 7 Where a company is factually insolvent, an individual creditor is not under any duty to have regard to the interests of the company’s other creditors. 8 Insolvency Act 1986 s 183 is another example of a transitional rule that determines the extent to which a judgment creditor is entitled to keep the benefit of an execution or attachment issued before the winding up commenced. See, eg Re Redman (Builders) Ltd [1964] 1 WLR 541; Re Caribbean Products (Yam Importers) Ltd [1996] Ch 331.

Preferences 125 insolvent company that have a preferential effect (i.e. factual preferences). An alternative option is to devise a rule that attacks only deliberate and strategic attempts to undermine the collective scheme leaving transactions with genuine commercial ends untouched even where they have preferential effect. The latter approach amounts to an uneasy compromise. In recognising that wider issues of policy—such as the need to promote finality of transactions or to encourage the provision of credit to struggling but potentially viable businesses—might be in play, there is inevitably some undermining of the collective scheme. For now, it suffices to say that English law does not favour a blanket rule.9 Our preference law therefore mediates between insolvency law norms and wider issues of policy within commercial law and the credit economy.

B OVERVIEW OF THE PREFERENCE ACTION IN ENGLAND AND WALES

(1) Standing and jurisdiction 4.3 The preference action in section 239 of the Insolvency Act 1986 bears a close structural resemblance to the provision in section 238 concerning transactions at an undervalue. This reflects a deliberate choice on the part of the draftsman. Both causes of action share common provisions in sections 240–41 relating to the twilight period and remedies. Similarly, the standing requirements in section 238 are applied directly to the preference action by section 239(1). It follows that section 239 only applies where either (i) an administration order is made in relation to the company, or (ii) the company goes into liquidation, and an action can only be commenced by an ‘office holder’ meaning for these purposes an administrator or liquidator.10 Section 239 only applies to companies incorporated in England and Wales.11 Scotland has a different provision which is beyond the scope of this book.12

9 By a majority, the Cork Committee rejected a proposal to adopt a rule based on preferential effect and so bring English law into line with Australian law: Cork Report, paras 1247–56. Experience in other jurisdictions suggests that the adoption of an effects-based rule does not necessarily suppress consideration of wider issues as these are often brought into play by means of statutory defences. 10 Insolvency Act 1986 ss 239(1)–(2), 238(1). The cause of action is therefore not available to all those falling within the wider category of persons who act as insolvency practitioners within the meaning of Insolvency Act 1986 s 388(1). In particular, neither an administrative receiver nor a provisional liquidator can commence an action. 11 Ibid ss 440(2)(a), 441. An identical provision applies in Northern Ireland by virtue of the Companies (Northern Ireland) Order SI 1989/2404 (NI 19). 12 Insolvency Act 1986 s 242. For the position where there is an ancillary liquidation of an overseas company taking place in England and Wales see ch 10.

126 Adrian Walters (2) Substantive requirements 4.4 The following substantive matters must be established. Each one is discussed in greater detail later in the chapter.13 4.5 (1) There must be a factual preference. A company gives a factual preference where it does anything or suffers anything to be done that has the effect of putting one of the company’s creditors (or a surety or guarantor for any of its debts or other liabilities) into a position which, in the event of the company going into insolvent liquidation, will be better than the position he would have been in had the thing not been done. This breaks down into two requirements of antecedent debt and preferential effect.14 4.6 (2) In deciding to give the factual preference, the company must have been influenced by a desire to prefer the creditor, surety or guarantor. Where the company gives a factual preference to a connected person, such as one of its directors, this requirement is adjusted so that the onus is on the counterparty to show that the company was not influenced by a desire to prefer.15 4.7 (3) The factual preference must have been given at a relevant time. Two different time periods apply depending on whether or not the preferred party is a connected person.16 However, it is not enough to show that the factual preference occurred within the applicable time period. It must also be established that the company was insolvent at the time it gave the factual preference.17

(3) Remedies 4.8 If the substantive requirements are made out the court will generally make an order seeking to reverse the effects of the preference and restore the status quo ante. Section 241 gives examples of the various types of order that the court can make under either section 238 (concerning transactions at an undervalue) or section 239. The rights of third parties who acquired property or received a benefit as a result of the preference in good faith, for value and without notice of the rele13 The requirements are identical in all material respects to those applicable to preference actions in personal insolvency: ibid ss 340–42. This reflects the historical tendency for the Companies Acts to apply the provision in the contemporary Bankruptcy Act to companies with only minor amendment. As a consequence, cases decided under section 340 can be used to construe section 239 and vice-versa. 14 Below, paras 4.25–4.64. 15 Below, paras 4.65–4.86. 16 Below, paras 4.87–4.89. 17 Below, paras 4.90.

Preferences 127 vant surrounding circumstances are protected. Remedial issues of particular relevance in preference law are touched on towards the end of the chapter.18

C HISTORY OF THE PREFERENCE ACTION

4.9 Preference law in its earliest form was developed by the courts building on the principles of fraudulent conveyance law first enacted in the Statute of Elizabeth of 1571.19 The Case of the Bankrupts, decided in 1584,20 is usually taken to be the starting point. The case involved an action in trover commenced by the assignees of the bankruptcy commissioners against a creditor to whom the bankrupt had transferred assets in partial satisfaction of his claim. The immediate question was whether the commissioners’ title to the assets was sufficiently good against the bankrupt as to defeat that of the creditor. As the transfer took place after the commencement of bankruptcy, the case was decided in the assignees’ favour on the principle that the commissioners’ title related back to the relevant act of bankruptcy. However, Lord Coke relied on the statutory direction to the commissioners, ‘to make disposition amongst the creditors . . . to everyone a portion, rate and rate alike, according to the quantity of their debts’ as a wider ground for the decision, going on to state that, ‘if, after the debtor becomes a bankrupt, he may prefer one (who peradventure hath least need), and defeat and defraud many other poor men of their true debts, it would be unequal and unconscionable, and a great defect in the law.’21 4.10 In the latter half of the eighteenth century the courts extended the reach of preference law to cover transactions entered into by the bankrupt before the act of bankruptcy. This modern conception of preference law is generally attributed to Lord Mansfield who provided much of the impetus for its development during his tenure as Chief Justice of the King’s Bench. Initially, there were doubts as to whether the Statute of Elizabeth could be used to attack a prebankruptcy payment of bona fide debts having the effect of preferring one creditor over the others. Moreover, the giving of a preference was not originally an act of bankruptcy and so any property transferred could only be clawed back into the estate under the relation-back principle if a recognised act of bankruptcy had preceded the transfer. Lord Mansfield solved these problems by treating any voluntary transfer or payment made in contemplation of bankruptcy having a preferential effect as a deliberate attempt to skew the rules of

18

Below, paras 4.91–4.105. 13 Eliz I, c 5. For excellent historical accounts of preference law’s emergence between the latesixteenth and nineteenth centuries see V Countryman, ‘The Concept of a Voidable Preference in Bankruptcy’ (1985) 38 Vanderbilt Law Review 713 and R Weisberg, ‘Commercial Morality, the Merchant Character and the History of the Voidable Preference’ (1986) 39 Stanford Law Review 3. 20 (1584) 76 ER 441. 21 Ibid 473. 19

128 Adrian Walters bankruptcy distribution amounting to a fraud on the statutory scheme.22 In Alderson v Temple he deployed this extended conception of fraudulent conveyance to allow recovery of the value of a promissory note endorsed by the bankrupt in favour of a creditor on the day before the relevant acts of bankruptcy. The following passage from the case gives us a flavour of his thinking: All acts to defraud creditors or to defraud the public law of the land, as the Statutes of Bankruptcy are, are absolutely void. It has been determined, that a conveyance of all a man’s property in trade to pay a bona fide creditor of the most meritorious nature, though not amounting to half the debt, is fraudulent. Why? Because it is not an act in the ordinary course of business, and must inevitably produce an act of bankruptcy, and it defeats the equality intended by the law . . . If the conveyance be to distribute all his effects just as the Statutes of Bankruptcy direct, it is fraudulent and void; because a man shall not choose his own assignees, and thereby defraud the law, which vests the power over bankrupts in the Great Seal.23

4.11 Similarly, in Rust v Cooper a transfer of goods made by a debtor to secure a creditor on the eve of bankruptcy ‘with no other view whatsoever but to defeat the equality of the bankrupt laws’ was held void ‘on account of such intended fraud’.24 The emphasis on fraud and the state of mind of the debtor in this conception of preference law is critical. Lord Mansfield drew a clear distinction between ‘bad’ preferences—made solely at the debtor’s volition to defeat the law—and ‘good’ preferences, made in the regular and common course of dealing and business. If the debtor gave the preference in response to the demand of the creditor or under threat of legal proceeding, it was treated as being in the ‘common course’ and valid.25 This was so even where the debtor acted under the 22 The starting point is Worsely v DeMattos (1758) 1 Burr 467; 96 ER 1160 where it was held that a deed of assignment by way of indemnity and security for an antecedent debt was a fraudulent conveyance and therefore an act of bankruptcy within 1 Jac I, c 15. There appear to have been two grounds for the decision: (i) that by preferring one creditor, the deed defeated the right of the creditors to have the estate managed by assignees of their choosing and distributed equally and (ii) in keeping with the prevailing attitude to non-possessory security interests, that the deed was a secret and therefore fraudulent lien. The transaction in Worsley involved the assignment of the debtor’s whole estate. However, it is clear from the cases decided after Worsley that the principle applied equally to partial transfers. 23 (1768) 1 Black W 660 at 662; 96 ER 384 at 385. This conception of the culpable debtor preemptively adopting his own pattern of distribution in advance of the collective proceeding can, in part, be attributed to the emergence of legislation in the early eighteenth century providing for discharge from bankruptcy: see G Glenn, ‘The Diversities of the Preferential Transfer’ (1930) 15 Cornell Law Quarterly 521. In the absence of a preference avoidance rule, the debtor could determine which of his debts were paid and which discharged. 24 (1777) 2 Cowp 629 at 632; 98 ER 1277 at 1279. See also Harman v Fishar (1774) 1 Cowp 117; 98 ER 998. 25 ‘If one demands it first, or sues him, or threatens him, without fraud, the preference is good. But where it is manifestly to defeat the law, it is bad. In the present case there is no course of dealing of this kind; no demand; no threat; but it is done with a positive view of iniquity’: Alderson v Temple (1768) 1 Black W 660 at 662; 96 ER 384 at 385. ‘If, in a fair course of business, a man pays a creditor who comes to be paid, notwithstanding the debtor’s knowledge of his own affairs . . . yet, being a fair transaction in the course of business, the payment is good; for the preference is there got consequentially, not by design: it is not the object . . .’: Rust v Cooper (1777) 2 Cowp 629 at 634; 98 ER 1277 at 1280.

Preferences 129 mistaken apprehension that the creditor was about to commence proceedings, because the fear of legal process could be relied on as evidence that the debtor’s actions were not voluntary.26 By circularity of reasoning, if the debtor acted voluntarily, the preference was not given in the ‘common course’ and so was bad. It is apparent from this distinction between culpable preferences, traceable purely to the debtor’s volition, and permissible ‘common course’ preferences that Lord Mansfield was anxious to avoid penalising creditors who, through diligence, successfully managed to collect their debts. Where a creditor relied on the ordinary rules of commerce to compel the debtor to pay, the case was not one in which the debtor was free to determine how his estate would be distributed in violation of the bankruptcy scheme. Thus, as Lord Mansfield conceived it, the ordinary norms of the commercial world would only give way to insolvency norms in a clear case of fraud, meaning a case where the debtor acted freely to substitute his own pattern of distribution for bankruptcy distribution.27 It appears from certain passages in Rust v Cooper that the bankrupt’s trustee was also required to show that the creditor knew that the debtor had acted in contemplation of bankruptcy.28 However, this requirement was never thoroughly articulated and English preference law in the two centuries after Lord Mansfield’s time has continued to place most of the emphasis on the state of mind of the debtor rather than that of the creditor. 4.12 Statutory reference to so-called fraudulent preferences was first made in the Joint Stock Companies Act 1856 but the true fons et origo of preference legislation in the period from the late-nineteenth century to the mid-1980s was section 92 of the Bankruptcy Act 1869.29 This provided that payments or transfers to creditors made by a person unable to pay his debts when due within a three month period before bankruptcy ‘with a view of giving such creditor a 26 Thompson v Freeman (1786) 1 TR 155; 99 ER 1026. Preferences given out of a sense of moral obligation rather than in response to commercial pressure came to be regarded as bad: see Harman v Fishar (1774) 1 Cowp 117; 98 ER 998. 27 ‘I am always diffident of hurting the course of trade and commerce; and therefore choose to determine this case upon the circumstance of the fraud, the quo animo with which it was done, rather than to lay down any subtile general principles, which might have a bad effect in cases otherwise circumstanced’: Alderson v Temple (1768) 1 Black W 660 at 662; 96 ER 384 at 385. Lord Mansfield’s sensitivity to the needs of commerce is well-known. The systematic reception of mercantile custom into the common law is regarded as his greatest legacy: see generally C H S Fifoot, Lord Mansfield (Oxford, Clarendon Press, 1936), E Heward, Lord Mansfield (Chichester, Rose, 1979). 28 ‘Suppose a creditor presses his debtor for payment, and the debtor makes a mortgage of his goods, and delivers possession; that is, and, at any time, may be, a transaction in the common course of business, without the creditor’s knowing there is any act of bankruptcy in contemplation; and therefore good.’: Rust v Cooper (1777) 2 Cowp 629 at 634–35; 98 ER 1277 at 1280. The court appears to have inferred that the creditor was in bad faith from the extraordinary circumstances in which the goods were delivered. The Bankruptcy Act 1869 required the trustee to establish that the defendant creditor knew or suspected that the transaction was a fraudulent preference. However, this requirement was abolished in 1883. 29 See J Farrar, ‘The Bankruptcy of the Law of Fraudulent Preference’ [1983] Journal of Business Law 390.

130 Adrian Walters preference over the other creditors should be deemed fraudulent and void against the trustee of the bankrupt.’ The courts interpreted the words ‘with a view of giving such creditor a preference . . .’ as imposing a requirement to show that the debtor entered the transaction with the dominant intention of preferring the creditor. This survived as the pivotal test following successive reenactments of section 92 in the Bankruptcy Acts of 1883 and 1914.30 The position in relation to insolvent companies was virtually identical as the various Companies Acts simply tracked the wording in the Bankruptcy Acts.31 In applying the ‘dominant intention’ test, the courts continued to uphold payments or transfers made by the debtor in response to pressure. Thus, while the Bankruptcy Acts replaced the common law requirement that the transaction be made in contemplation of bankruptcy with a test of insolvency and a specific three-month period of vulnerability, Lord Mansfield’s notion of debtor volition remained embedded in the law.32 Indeed, the House of Lords in Sharp v Jackson 33 expressly relied on Lord Mansfield’s decision in Thompson v Freeman 34 to hold that the conveyance of property by an insolvent trustee to the trust was not a fraudulent preference because the trustee’s object was to shield himself from the legal consequences of his breaches of trust rather than to prefer the trust in its capacity as a creditor. 4.13 We have seen in outline how English preference law historically laid great stress on the debtor’s state of mind. The Insolvency Law Review Committee acknowledged that the onus on the office holder to establish that the debtor transacted with the dominant intention of preferring the creditor gave rise to ‘a difficult and unsatisfactory inquiry.’35 However, the Committee was divided over whether to abolish the requirement of intention to prefer and adopt a test based purely on the preferential effect of the transaction following the approach in Australia and America. By a majority, it concluded that the requirement should be retained and that genuine creditor pressure should continue to afford

30 See, eg Ex parte Griffith (1883) 23 Ch D 69; Ex parte Hill (1883) 23 Ch D 695; In re Cohen [1924] 2 Ch 515; Peat v Gresham Trust Ltd [1934] AC 252; Re Cutts [1956] 1 WLR 728; Re FLE Holdings Ltd [1967] 1 WLR 1409. 31 See, eg Companies Act 1948 s 320; Companies Act 1985 s 615. The three-month period of vulnerability was increased to six months for both bankruptcy and winding up by the Companies Act 1947 s 115(3). The provision was extended to cover sureties and guarantors as well as creditors on its re-enactment in the Bankruptcy Act 1914. 32 ‘The [1869] Act appears to have left the question of pressure as it stood under the old law; and, indeed, the use of the word ‘preference’, implying an act of free will, would of itself, make it necessary to consider whether pressure had or had not been used.’: Butcher v Stead (1875) LR 7 HL 839 at 846 (per Lord Cairns). For another early case where creditor pressure was held to negative intention to prefer see Smith v Pilgrim (1876) 2 Ch D 127. 33 [1899] AC 419. For a similar case see Ex parte Stubbins (1880) 17 Ch D 58. 34 (1786) 1 TR 155; 99 ER 1026. 35 Cork Report, para 1249. See also the earlier deliberations of the Blagden Committee: Report of the Committee on Bankruptcy Law and Deeds of Arrangement Law Amendment (Cmnd. 221, 1957).

Preferences 131 a defence.36 As a consequence, while the ‘dominant intention’ test has now gone, the structural emphasis on the moral culpability of the debtor remains given the onus on the office holder to establish that the company was influenced by a desire to prefer under section 239(5) of the Insolvency Act 1986.37 At the same time, the Committee saw no reason why creditors ‘should expose themselves to the risk that [the debtor] will put his own family and associates first, or discriminate between his creditors on any but normal commercial principles.’38 Accordingly, they recommended that: in the case of any payment or transfer to or for the benefit of a creditor who is not at arm’s length, the payment or transfer shall be presumed to have been made with a view to giving the creditor a preference, unless the creditor proves that the payment or transfer was made in the normal course of affairs of the debtor in relation to the creditor.39

The present section 239(6) implements this recommendation by providing that a company which has given a factual preference to a defined category of connected persons is presumed to have been influenced by a desire to prefer.40 Although not on the specific recommendation of the Committee, section 240(1)(a) also extended the period of vulnerability for ‘connected person’ preferences from six months to two years.41

D THEORETICAL PERSPECTIVES

4.14 The aims of this section are to analyse the main rationales that are said to underpin preference law and to evaluate their ramifications for legislators and adjudicators. In so doing, it is sought to demonstrate how preference law’s stated ideals are thoroughly compromised in practice. A common starting point is to say that preference law’s primary objective is to stop the so-called ‘race of diligence’ in which creditors, by recourse to ordinary collection procedures, rush to ‘grab’ the limited assets of the insolvent company on the eve of liquidation. Two justifications or ideals are generally advanced for this ‘anti-grab’ objective: (i) the need to preserve the integrity of insolvency law’s distributional scheme especially insofar as it affects unsecured creditors (‘equal treatment’) and (ii) the need to ensure that assets in the estate are kept together on the theory that they are worth more to the creditors intact than broken up into pieces (‘deterrence’).42 These ideals are considered in turn. 36 Ibid para 1256. In supporting recovery of only ‘really improper’ payments, the majority stressed the need for preference law to reflect ordinary norms of commercial law such as security of transaction and creditor diligence. 37 See further paras 4.65–4.86 below. 38 Cork Report, para 1256(c). 39 Ibid para 1258. 40 Below, paras 4.80–4.82. 41 Below, para 4.87. 42 See, eg J McCoid, ‘Bankruptcy, Preferences and Efficiency: An Expression of Doubt’ (1981) 67 Virginia Law Review 249.

132 Adrian Walters (1) The ideals of preference law (a) Equal treatment of equal ranking claims 4.15 The ideal of equal treatment finds particular expression in the pari passu principle which mandates a fair and rateable distribution of the insolvent company’s free assets among the general body of creditors. In theory, preference law seeks to ‘hold the ring’ during the company’s transition from factual insolvency to collective proceeding and thereby ensure that the claims of creditors in a finite pool of assets receive fair and equal treatment. The Insolvency Law Review Committee relied on the pari passu principle to justify the retrospective adjustment of transactions which, but for the onset of a collective proceeding, are otherwise lawful: [T]he bankruptcy code . . . is directed towards achieving a pari passu distribution of the bankrupt’s estate among his creditors. The justification for setting aside a disposition of the bankrupt’s assets made shortly before his bankruptcy is that, by depleting his estate, it unfairly prejudices his creditors; and even where the disposition is in satisfaction of a debt lawfully owing by the bankrupt, by altering the distribution of his estate it makes a pari passu distribution among all the creditors impossible.43

4.16 Thus, section 239 rests notionally on the premise that where an insolvent company pays or confers some benefit on a particular creditor and subsequently enters a collective proceeding, the creditor should share the payment or benefit rateably with other equal ranking creditors.44 A further point is that without section 239, creditors who lack information about the company’s financial state would, in theory, be placed at a disadvantage to those who possess direct firsthand information. If left unchecked, informed creditors could exploit their superior information to grab assets from the company at the expense of the less well-informed, thus defeating the ideal of equal treatment.45 The informational imbalance between company insiders, such as directors, and outside creditors 43 Cork Report, para 1209. Strictly, it is not always necessary to show that the transaction resulted in a depletion of the debtor’s estate. If A Ltd creates a charge over its assets to secure an antecedent debt there is a factual preference but, save in respect of any incidental costs arising from the transaction, no overall reduction in A Ltd’s assets. The charged assets remain on the balance sheet and are earmarked to a secured claim: see, in the context of section 238, Re MC Bacon Ltd [1990] BCLC 324; Re Mistral Finance Ltd [2001] BCC 27 and discussion in paras 2.90–2.92. Thus, for a factual preference, it is enough if the transaction results in a depletion of the assets that would otherwise be held on statutory trust for unsecured creditors. 44 The preference law of other jurisdictions rests on the same premise: see, e.g. Australian Law Reform Commission, General Insolvency Enquiry (Report No 45, 1988), paras 33 and 629; Hudson v Benallack [1976] 2 SCR 168 (Canada) and note the following statement from the House Committee Report of the US Congress made prior to the enactment of the current provision in 11 USC 547: ‘[T]he preference provisions facilitate the prime bankruptcy policy of equality of distribution among creditors of the debtor. Any creditor that received a greater payment than others of his class is required to disgorge so that all may share equally.’ H R Rep No 595, 95th Cong, 1st Sess 177 (1977). 45 Re Modern Terrazzo Ltd [1998] 1 NZLR 160 at 174.

Preferences 133 provides a powerful justification for the special rules in sections 239–40 applying to connected persons.46 4.17 It is important, however, that the ideal of equal treatment is not taken too literally. In practice, the pari passu principle is circumscribed in at least three ways. Firstly, as insolvency law does not generally interfere with pre-liquidation entitlements, creditors holding valid secured or other proprietary claims to the company’s assets will have recourse to those assets in priority to unsecured creditors. Secondly, certain categories of debt are accorded priority by statute.47 Thirdly, mandatory set-off in insolvency48 gives creditors with set-off rights priority, in substance, over other creditors who do not hold such rights. For these reasons, it can be seen that insolvency law pursues equal treatment in a qualified rather than an absolute sense.49 By implication, this qualified principle of equal treatment can only be used to mandate avoidance of pre-liquidation ‘grabs’ which subvert insolvency law’s favoured pattern of distribution or lead to unequal treatment within a given class of creditors sharing the same priority claim to the company’s assets. It cannot be used to mandate avoidance of preliquidation transactions that accord entirely with the ranking of claims in liquidation.50 Thus, in practice, preference law seeks to uphold the whole scheme of insolvency distribution and not just the rule that the company’s unencumbered assets should be distributed pari passu among the unsecured creditors.51 (b) Deterrence 4.18 The ideal of equal treatment has a long history going back at least as far as the sixteenth century. By way of contrast, the deterrence-based justification for preference law is of modern provenance and, in the main, has been articulated by lawyers and policymakers in the United States. Its basic premise is straightforward. As well as subverting insolvency law’s distributional scheme, it is said that the pre-liquidation race to grab assets from a finite pool dismembers 46

Below, paras 4.80–4.88. Insolvency Act 1986 ss 175, 386 and Sched 6, although the preferred status of various categories of Crown debt will be abolished once the Enterprise Act 2002 comes into force. 48 Insolvency Rules 1986 r 4.90. 49 For further discussion of the pari passu principle and its limits see ch 1. The Insolvency Law Review Committee took the view that the principle survived ‘as a theoretical doctrine only, with scarcely any application in real life’: Cork Report, para 233. See also R Mokal, ‘Priority as Pathology: The Pari Passu Myth’ [2001] Cambridge Law Journal 581 forcefully questioning the meaningfulness of the principle and its centrality within insolvency law. 50 So, for example, a pre-liquidation payment to a fully-secured creditor does not offend against the principle of equal treatment as the secured creditor would have enjoyed a better outcome than unsecured creditors under the rules of priority in any event: see below, paras 4.43–4.46. It follows that preference law does not mandate any redistribution of assets from secured to unsecured creditors, a point that we should bear in mind when considering the vexed question of the destination of s 239 recoveries: see below, paras 4.102–4.103. 51 A pre-liquidation payment to one Crown creditor enjoying preferential status under section 386 could therefore amount to a preference vis other preferential creditors. 47

134 Adrian Walters the insolvent company, thereby destroying economic value to the detriment of the creditors as a whole. If creditors can be persuaded to hold back from their individual enforcement efforts in advance of a collective insolvency proceeding, the assets will be kept together and the aggregate value of the insolvent estate will be maximised. On this view, preference law seeks to deter creditors from racing to dismember the company and so maximise the value of the available pool of assets. By helping to keep the assets together, the law, in theory, leaves the creditors as a group free to choose the best means of maximising aggregate value be that through going concern sale, reorganisation or liquidation.52 If, however, the insolvent company is dismembered as a result of pre-liquidation asset grabbing, the creditors as a group are prevented from making these value-maximising decisions.53 Thus, proponents of deterrence theory regard preference law as being concerned primarily with the promotion of economically efficient outcomes.54

(2) The operation of preference law in practice (a) Equal treatment 4.19 English preference law as framed and applied does not fully reflect the ideals of equal treatment and deterrence. If pursuit of equal treatment were the sole object, it would be logical to adopt a rule automatically avoiding any transaction having a preferential effect entered into by the debtor while factually insolvent, regardless of the state of mind of either debtor or creditor. However, it is unrealistic to expect any legislature to allow the norms of insolvency law to trump the ordinary ‘solvent world’ norms of commerce so comprehensively. The main difficulty is that preference law operates retrospectively and interferes with settled transactions. A company may be factually insolvent for years before it enters a collective proceeding. Thus, an avoidance rule may have the effect of undermining commercial expectations by re-opening concluded transactions at a later date. The implications of an automatic avoidance rule for settled transactions would be particularly stark. One way in which preference law balances 52 See the House Committee Report of the US Congress, H R Rep No 595, 95th Cong, 1st Sess 177 (1977). The Report suggests that deterrence and equal treatment may be complementary policies. However, if one object of deterrence is to give the company breathing space to effect a possible reorganisation, it may mandate preferential payments or transfers to certain creditors whose support is deemed essential to the company’s survival. The exemption of such payments does not mesh neatly with the ideal of equal treatment. Faced with this implication, the US Supreme Court in Union Bank v Wolas 502 US 151 (1991), a case concerned with the ‘ordinary course of business’ exception in 11 USC 547(c)(2), concluded that deterrence is the overriding goal of US preference law. 53 So, for example, the race to grab assets may dismember a viable firm, precipitate premature liquidation and prevent the creditors from agreeing to a reorganisation that might secure the firm’s future and result in full payment of all: see dicta of Fisher J in Re Modern Terrazzo Ltd [1998] 1 NZLR 160 at 174. See also Levit v Ingersoll Rand Financial Corporation 874 F 2d 1186 (1989). 54 See T Jackson, ‘Avoiding Powers in Bankruptcy’ (1984) 36 Stanford Law Review 725 and The Logic and Limits of Bankruptcy Law (Cambridge Mass, Harvard University Press, 1986).

Preferences 135 this concern is through the mechanism of the twilight period. A transaction is generally only vulnerable to preference avoidance under section 239 if it was made in the six months before the company went into administration or liquidation.55 Beyond six months, the finality of the transaction is respected. By the same token, if an insolvent company gave a factual preference six-and-a-half months before it went into liquidation, the transaction would not be caught even if creditors were treated unequally as a result.56 4.20 The ideal of equal treatment is further compromised because of the onus on the office holder to establish that the company was influenced by a desire to prefer. We have seen that the recoverability of preferences in English law has turned on the issue of debtor volition since Lord Mansfield’s time. A creditor who can show that the preference was given in response to legitimate commercial pressure has a full defence. The theory behind this is that the debtor does not act freely when the creditor uses pressure to obtain a payment or benefit. The defence based on creditor pressure remains available under the present law.57 English preference law therefore retains a structural bias in favour of diligent creditors who actively press for recovery of their debts.58 It follows that many factual preferences occurring within the twilight period will not be avoided. This outcome is at odds with the ideal of equal treatment and favours powerful, well-informed creditors over economically weak, less-informed creditors. In other jurisdictions, such as Australia and the United States, a transaction occurring within the twilight period is prima facie voidable if it has a preferential effect. To make out a prima facie case, the office holder is not obliged, as in England and Wales, to establish that the debtor had an intent or desire to prefer. If preferential effect is established, the onus shifts to the defendant creditor to raise a defence. Some argue that the goal of equal treatment would be better served if we were to follow the Australian or American example.59 However, experience in these jurisdictions suggests that equal treatment can also be undermined by the availability of a wide range of statutory defences.60 55

The period is extended to two years for ‘connected person’ transactions. Even those who intuitively favour an equality-based scheme of automatic avoidance accept that it should only apply to factual preferences arising within a short defined period before the onset of the collective proceeding: see C Tabb, ‘Rethinking Preferences’ (1992) 43 South Carolina Law Review 981; M Shanker, ‘The American Bankruptcy Preference Law’ in J Ziegel (ed) Current Developments in International and Comparative Corporate Insolvency Law (Oxford, Clarendon Press, 1994); A Keay, Avoidance Provisions in Insolvency Law (Sydney, LBC, 1997), ch 16. 57 See Re MC Bacon Ltd [1990] BCLC 324 discussed below in paras 4.69–4.73. 58 A tendency supported by the Insolvency Law Review Committee: Cork Report, para 1256. 59 See A Keay, ‘Preferences in Liquidation Law: Time for a Change’ [1998] Company Financial and Insolvency Law Review 198. 60 See C Tabb, ‘Rethinking Preferences’ (1992) 43 South Carolina Law Review 981 (criticising the ordinary course of business exception in 11 USC 547(c)(2)); M Shanker, ‘The American Bankruptcy Preference Law’ in J Ziegel (ed) Current Developments in International and Comparative Corporate Insolvency Law (Oxford, Clarendon Press, 1994) (arguing that the American preference avoidance rule is effectively dwarfed by its statutory exceptions); A Keay, Avoidance Provisions in Insolvency Law (Sydney, LBC, 1997) at 47 (discussing the impact of the ‘running account’ principle). 56

136 Adrian Walters (b) Deterrence 4.21 Resting as it does on notions of inter-creditor co-operation and obligation, the ideal of deterrence clearly mandates an avoidance rule based on the culpability of the preferred creditor. In theory, the object of preference law is to deter creditors from racing to dismember the debtor’s assets thereby preserving economic value for creditors as a group. A rule framed by reference to deterrence would logically target creditors who, knowing that the debtor is insolvent, engage in strategic asset grabbing. By contrast, English law actively encourages creditors to pressurise the insolvent debtor into making payment and so sanctions the very behaviour that a deterrence-based rule would be designed to prevent.61 Conversely, if the office holder can prove that the company was influenced by a desire to prefer, the court can avoid the preference even if the preferred creditor was acting in good faith and without knowledge of the company’s predicament.62 Thus, section 239 mandates avoidance of transactions in cases that a deterrence-based rule, targeting the ‘improper’ behaviour of individual creditors versus creditors as a whole, would not touch. It is difficult to escape the conclusion that deterrence does not resonate strongly within English preference law as framed. 4.22 In any event, experience suggests that English preference law either fails to deter or under-deters.63 There is plenty of incentive for creditors who are aware of the company’s financial difficulties to seek payment. The company’s fortunes may recover sufficiently that it manages to avoid administration or liquidation. Alternatively, by the time the company does go into administration or liquidation, it may be too late, under the relevant time provisions, for the office holder to launch a challenge. In either case the creditor can keep the payment. Even assuming that the preference is successfully challenged, the preferred creditor will only be required to pay back the amount of the preference and interest.64 The preferred creditor is not subject to any additional penalty and does not have to account for any gains that may accrue from holding the property or payment forming the subject matter of the preference. Nor, having restored the 61 See D Prentice, ‘The Effect of Insolvency on Pre-Liquidation Transactions’ in B Pettet (ed) Company Law in Change (London, Stevens, 1987). 62 Contrast the position under section 588FG(2) of Australia’s Corporations Act 2001. This protects a creditor who (i) acted in good faith, (ii) had no reasonable grounds to suspect that the company was insolvent or would become insolvent as a result of the transaction and (iii) gave valuable consideration or changed his position in reliance on the transaction. 63 The text at this point draws on discussion in J McCoid, ‘Bankruptcy, Preferences and Efficiency: An Expression of Doubt’ (1981) 67 Virginia Law Review 249 and D Prentice, ‘Some Observations on the Law Relating to Preferences’ in R Cranston (ed) Making Commercial Law (Oxford, Clarendon Press, 1997). 64 The earliest that interest can start to run is from the accrual of the cause of action, i.e. the time when the company entered the collective proceeding: see discussion in para 4.101 below. It follows that the property or payment received is held interest free from the date of the preference to the date of commencement of the collective proceeding. The insolvent estate is not compensated for the full period during which the creditor had the use of the property or payment.

Preferences 137 amount of the preference to the insolvent estate, is the preferred creditor barred from proving in the liquidation for the revived debt.65 These factors suggest that the risk of preference avoidance is one that most creditors will be prepared to run.66 These considerations apply with less force where the counterparty is a connected person because of the longer twilight period and reversal of the onus of proof. 4.23 The idea that creditors should be encouraged to hold off so that the insolvent company’s assets can be preserved intact reflects the emphasis in modern insolvency law on corporate rescue and reorganisation. However, this rehabilitative aspect of deterrence is in tension with the ideal of equal treatment. The company is likely to require fresh injections of credit if it is to continue with its assets intact. We have seen that a deterrence-based rule would attack only strategic asset-grabs. Conversely, deterrence mandates repayment of credit that ‘adds value’ and helps the company keep its assets and business together. The theory behind this is that while creditors should be discouraged from deliberately grabbing assets and dismembering the estate they should be encouraged to extend credit to struggling, but viable companies.67 A deterrence-based rule may therefore give priority to ‘new’ credit advanced after the company becomes insolvent over ‘old’ credit. Repayment of ‘new’ credit, justified on the basis that it may assist in preserving the company’s assets and in maximising economic value for the creditors as a whole, will result in unequal treatment of creditors should the company not survive. Thus, if primacy is given to deterrence, some factual preferences may be permitted in the interests of promoting corporate rescue even where the practical effect is to undermine insolvency law’s distributional rules.68 This tension between equal treatment and deterrence is likely to surface in the framing and application of any preference law. 4.24 In summary, we have seen that section 239 does not implement either equal treatment or deterrence with any great conviction. This is hardly surprising given that preference law mediates uneasily between the realm of ordinary commercial relations (in which the efforts of individual creditors to collect their due are lawful and laudable) and the norms of the collective proceeding (under which creditors who race to dismantle the insolvent firm’s assets are regarded as 65

Insolvency Act 1986 s 241(1)(g). Moreover, an office holder may find it difficult to fund avoidance litigation, a problem compounded by the doctrine of champerty: see generally D Milman & R Parry, A Study of the Operation of Transactional Avoidance Mechanisms in Corporate Insolvency Practice (Insolvency Lawyers Association Research Report, July 1997); A Walters, ‘Staying Proceedings on Grounds of Champerty’ [2000] Insolvency Lawyer 16. 67 See, with reference to American law, L Ponoroff, ‘Evil Intentions and an Irresolute Endorsement for Scientific Rationalism: Bankruptcy Preferences One More Time’ [1993] Wisconsin Law Review 1439. 68 This kind of thinking is implicit in Re Ledingham-Smith [1993] BCLC 635 where a firm of accountants were allowed to keep payments made for services provided after the debtor became insolvent. The court accepted that the firm had been retained to assist in a going concern sale of the debtor’s business which, if successful, might have resulted in creditors being paid in full. 66

138 Adrian Walters behaving improperly).69 The best we can say is that English preference law strives to balance these various tensions rather than pursuing any clearly defined policy. We turn now to a detailed consideration of the elements of the cause of action.

E SUBSTANTIVE ELEMENTS OF THE CAUSE OF ACTION

(1) Section 239(4)(a): antecedent debt 4.25 For there to be an actionable preference, the counterparty must be a creditor or a surety or guarantor for any of the company’s debts or liabilities. Accordingly, a transaction is only caught by section 239 if it relates to an antecedent debt or other liability of the company. There must be a pre-existing debtor-creditor relationship. If no credit has been advanced, the transaction is simply not caught by section 239(4) because there is no ‘creditor’ and no principal indebtedness capable of falling within the scope of a surety or guarantee obligation. It follows that if during the twilight period either (i) the company pays for goods supplied on ‘cash on delivery’ terms or (ii) the company pays in advance for goods as a condition of supply, there is no preference because the supplier is not a ‘creditor’. Moreover, if the supplier accepts payment for goods supplied on ‘cash on delivery’ terms by cheque, it is unlikely that he will be treated as having extended credit during the time it takes him to cash and clear the cheque.70 A mortgage or charge created to secure a contemporaneous or future advance is not a preference on the same basis. Similarly, in a case where a company was run from premises leased to two of its directors, the payment of a quarter’s rent made by the company direct to the landlord was not a preference because the landlord and the company were not in a debtor-creditor relationship.71 4.26 The transaction must also be referable to an antecedent debt. If a company grants a charge over its assets to secure repayment of a contemporaneous advance, the creation of the charge is not a preference even where the charge holder is already an unsecured creditor in respect of earlier advances. This is because the charge does not operate to prefer the charge holder in relation to any antecedent debt existing when the charge was created.72 However, where the 69 A moral ambiguity well reflected in Levit v Ingersoll Rand Financial Corporation 874 F 2d 1186 at 1194 (1989). 70 Engstrom v Wiley 191 F 2d 684 (1951). It may be more difficult to distinguish a cash transaction from a short-term advance of credit if payment is only obtained after the cheque has been returned due to insufficient funds: see discussion in Engstrom v Benzel 191 F 2d 689 (1951). For the position in relation to the repayment of short-term directors’ loans see Re Brian D Pierson (Contractors) Ltd [2001] 1 BCLC 275. 71 Re Beacon Leisure Ltd [1992] BCLC 565. See also Minister of Transport v Joint Liquidators of Civcon Pty Ltd [2000] WASCA 149. 72 Robertson v Grigg (1932) 47 CLR 257.

Preferences 139 charge is expressed to secure pre-existing unsecured indebtedness as well as contemporaneous or future advances, it is a preference to the extent of the antecedent debt. So if X Ltd borrows £1,000 from Y, an unsecured creditor who is already owed £500, and in consideration grants Y a charge securing repayment of £1,500, there is a partial preference because the security relates, in part, to the antecedent debt of £500.73 In relation to the fresh advance of £1,000, Y provides new value and, to that extent, does not receive the charge in his capacity as an existing creditor. The same logic applies to payments by the company for the supply of goods and services. Thus, if a creditor supplies the company with goods in return for an immediate payment covering both the value of those goods and sums outstanding under earlier invoices then, prima facie, the payment is a preference within section 239(4) insofar as it relates to the earlier invoices.74 4.27 There is no statutory amplification of the term ‘creditor’ in section 239. However, ‘debts or other liabilities’ in section 239(4)(a) must be read as meaning debts provable in a winding up and the term ‘creditor’ construed accordingly.75 This is because the question of whether the transaction improved the creditor’s position under section 239(4)(b) is determined by reference to a hypothetical winding up.76 The terms ‘surety’ or ‘guarantor’, as commonly understood, denote parties who have agreed to meet the company’s debts and liabilities in the event of its default.77

(2) Section 239(4)(b): preferential effect (a) Transactions improving a creditor’s position 4.28 There is a factual preference under section 239(4) where the company does anything or suffers anything to be done which has the effect of putting a creditor or a surety or guarantor into a better position in the event of the company going into insolvent liquidation than would have been the case had the thing not been done. Crucially, the transaction must have a preferential effect, 73

Burns v Stapleton (1959) 102 CLR 97. The position may be different if the court finds that there was a running account between the company and the creditor. In that case, even though payment by the company reduces the debit balance on the account, it is not referable to any specific unpaid invoice and is treated, in effect, as a prepayment for goods and services to be supplied later: see Airservices Australia v Ferrier (1996) 137 ALR 609, especially at 634–35 (Toohey J), and discussion of the running account principle in paras 4.57–4.64 below. 75 Insolvency Rules 1986 rr 12.3, 13.12. Provable debts are widely defined and include contingent liabilities, tort claims and claims for an unliquidated sum. For a case where a preference was given to a ‘creditor’ who was claiming unliquidated damages for breach of an employment contract see Re Clasper Group Services Ltd (1988) 4 BCC 673. 76 See paras 4.40–4.42 below. 77 On suretyship and guarantee obligations generally see R Goode, Commercial Law 2nd edn (Penguin, 1995), ch 30. 74

140 Adrian Walters ie it must improve the prospects of the relevant party relative to other creditors in a subsequent insolvent liquidation.78 The Insolvency Law Review Committee gave three examples of a preference: (i) payment to a creditor of the whole or part of his debt; (ii) provision of security for an existing debt and (iii) return of goods that have been delivered but not paid for.79 All of these transactions amount to a factual preference within section 239(4)(b) and each is examined in turn below. Equally, as we will see, the wording of section 239(4)(b) is capable of embracing a wide range of transactions or dealings and is not restricted to the examples given by the Review Committee. 4.29 Payment or part-payment. The payment or part-payment of selected creditors is perhaps the most obvious form of a factual preference. To return to the example in the introduction, let us say that A Ltd has two unsecured creditors X and Y owed £100 each and total assets of £100. Clearly X’s position will be improved if A Ltd pays him in full just before going into liquidation. X receives the whole of his debt whereas the collective proceeding mandates that X and Y should share A Ltd’s assets rateably. X receives more than he would have done had the payment not been made and he receives it at the expense of Y who would otherwise have recovered 50 per cent of his debt. There would still be a factual preference within section 239(4)(b) if X was paid in part, rather than in full. Even a pre-liquidation part-payment of £1 technically improves X’s position, albeit by a negligible amount. The simple point is that a pre-liquidation payment, in full or part, improves X’s position at Y’s expense because the assets used to make the payment to X should be distributed rateably between X and Y. 4.30 Many of the reported cases concern repayment of directors’ unsecured loan accounts. This is not surprising given the structure of section 239 and its underlying concerns. Cases where directors have exploited their superior knowledge to bail themselves or their associates out at the expense of other creditors are not beset by the moral qualms that can arise where the payment was made to an arm’s length creditor diligently collecting his due. Accordingly, section 239(6) puts the onus on the recipient director to establish that the company was not influenced by a desire to prefer and section 240(1)(a) extends the twilight period from six months to two years.80 As such, the office holder has greater prospects of recouping a pre-liquidation payment that extinguishes or reduces a director’s unsecured loan account than a payment to an arm’s length creditor, even though both cases involve a factual preference within section 239(4).81 78 S 239 does not apply to members’ voluntary liquidations. In a solvent liquidation all creditors will be paid and so the problem of pre-liquidation preferences does not arise. 79 Cork Report, para 1208. 80 Below paras 4.80–4.86 and 4.87–4.88. 81 For cases where the liquidator has successfully challenged the repayment of directors’ loans see Re DKG Contractors Ltd [1990] BCC 903; Re Exchange Travel (Holdings) Ltd [1996] 2 BCLC 524 affirmed [1999] BCC 291; Wills v Corfe Joinery Ltd [1998] 2 BCLC 75; Re Brian D Pierson (Contractors) Ltd [2001] 1 BCLC 275.

Preferences 141 4.31 The analysis is the same if, instead of paying cash, the company transfers a non-cash asset to an unsecured creditor in full or partial satisfaction of a debt. The creditor takes the benefit of an asset the proceeds of which would otherwise have been available for rateable distribution. The position is less straightforward where the payment to the unsecured creditor is made out of assets that are subject either to a fixed charge or a crystallised floating charge. In these circumstances, the company has no authority to make the payment and the creditor will not usually get good title. Prima facie, unless the creditor obtains good title, he is no better off because the charge holder is entitled to reclaim the property. If, however, the creditor obtains good title because, say, the charge holder expressly or impliedly consented to the transaction, he is clearly better off as a result.82 Where the payment leaves the charge holder partially secured, the creditor’s position is improved as against the secured creditor.83 Where the value of the charge holder’s security exceeds the company’s indebtedness and the payment reduces or extinguishes the surplus, but leaves the charge holder fully secured, the creditor’s position is improved as against other unsecured creditors who would otherwise have been entitled to share rateably in the surplus (which is the proceeds of the company’s equity of redemption). 4.32 Security for past indebtedness. A second type of factual preference is the provision of security for an existing debt. By providing security, the company deals with its assets (‘does anything’). Moreover, the dealing improves the position of the creditor because it converts an unsecured claim into a secured claim ranking in priority and, at the same time, diminishes the assets available to meet the claims of the remaining unsecured creditors.84 Thus, in Re MC Bacon Ltd, where a company granted a debenture in favour of its bank to secure its previously unsecured overdraft facility, it was accepted, without argument, that the transaction was a preference within section 239(4).85 4.33 A slightly different situation arose in Re Mistral Finance Ltd.86 P Ltd advanced a sum to M Ltd to finance the purchase of a yacht and was granted a mortgage of the yacht in return. Later, it came to light that the mortgage had not

82 See G & M Aldridge Pty Ltd v Walsh (2001) 203 CLR 662 which appears to turn on the fact that the charge holder stood by and allowed the company to continue trading for a seven-week period after its floating charge had automatically crystallised. 83 See Sheahan v Carrier Air Conditioning Pty Ltd (1997) 189 CLR 407 at 424–25 (Brennan CJ) though note that the majority of the High Court of Australia (Dawson, Gaudron and Gummow JJ) reasoned that the payments in Sheahan, which were made by a receiver, were not strictly made by the company out of its assets and so were not caught by the relevant provision. 84 In this respect there is an overlap between section 239 and section 245 which applies exclusively to floating charges created as security for past indebtedness. For a full account of s 245 see ch 5. 85 [1990] BCLC 324. The case turned on the question of whether, in giving the preference, the company was influenced by a desire to prefer: see paras 4.65–4.79 below. For another example see Re Shapland Inc [2000] BCC 106 (insolvent subsidiary granting charge in favour of parent company in respect of antecedent unsecured inter-company indebtedness). 86 [2001] BCC 27.

142 Adrian Walters been registered at Companies House. A fresh mortgage was created and registered within the statutory time period a few days before M Ltd went into liquidation. It was held that the later mortgage was a preference within section 239(4). Without it, P Ltd would have been unsecured because the original mortgage was void against M Ltd’s liquidator for want of registration under section 395 of the Companies Act 1985. A further variation is the grant of a charge or mortgage securing both pre-existing unsecured indebtedness and new or future advances. Here, there is a factual preference because the creditor’s position is improved in relation to the antecedent debt. However, the security would not be wholly preferential as, in relation to the new advances, there is no pre-existing debtorcreditor relationship.87 4.34 Return of goods. A third type of factual preference arises where the company returns goods that have been supplied on credit. In theory, this will improve the creditor’s position because the resale value of the goods is likely to be greater than the amount of any dividend he would receive as an unsecured creditor in the company’s liquidation.88 Strictly speaking, return of goods already delivered is merely one example of a wider category of factual preferences in which the parties contrive a release of the company’s obligations to the creditor under an executory contract. The Australian bankruptcy case Re Nitschke; Ex parte Official Receiver 89 falls into this wider category. The respondent agreed to sell land for £1,200 to a purchaser who subsequently became bankrupt. A deposit of £150 was paid with the balance payable by instalments. The purchaser planned to construct a theatre on the land but ran out of funds before the building was completed. He borrowed further sums from the respondent to purchase materials and pay the labourers. Once it became apparent that the purchaser would be unable to finish the building, the respondent agreed to release him from his contractual obligation to purchase the land. The respondent then took over the project, completing it at his own expense. The purchaser’s trustee in bankruptcy successfully argued that, by virtue of the release, the respondent had been preferred over other creditors.90 4.35 Performance of contractual obligation. We saw in the last paragraph that the company’s release of the counterparty’s contractual obligations could give 87

Burns v Stapleton (1959) 102 CLR 97. See paras 4.25–4.26 above. The point falls away if the goods are subject to a valid retention of title as they will never have formed part of the company’s assets. 89 (1930) 2 ABC 36 (Vic Bankruptcy Ct). 90 Note, however, that Moule J (implicitly applying the rule in Re Condon, ex parte James (1874) 9 Ch App 609) refused to revest the property, including the completed theatre, in the estate as it would have been unconscionable for the court to allow the trustee to recover the theatre given that it had been built with the respondent’s money. It is arguable that an English court, faced with this scenario, would fashion a similar outcome bearing in mind that the object of the court’s remedial discretion in section 239(3) is to restore the position to what it would have been had the company not given the preference. For another example of this type of factual preference see Wily v Bartercard Ltd [2001] NSWCA 262 (termination of license and release of licensee’s obligations operating as factual preference of licensor). 88

Preferences 143 rise to a factual preference. The same is true where the company performs its obligations under an executory contract. Let us say, for example, that C Ltd has two customers, D and E. Both enter a contract with C Ltd for the supply of goods for which they pay in advance. On the eve of liquidation, C Ltd, unable to meet its obligations to both customers, supplies D with its remaining stocks. Here, D receives what he contracted for whereas insolvency law requires the realisable value of the remaining stocks to be shared rateably between D and E (assuming there are no other creditors). 4.36 Declaration of trust. Other instances of factual preferences falling within section 239(4) abound in the case law. A good example not mentioned by the Insolvency Law Review Committee is where the company confers proprietary rights on an existing creditor by means of a declaration of trust. We can provide an illustration by varying the pre-payment scenario used in the previous paragraph. The company, C Ltd, might decide to protect its customers, D and E, by placing their advanced payments in a separate account and declaring a trust of those sums in their favour.91 In terms of the transfer of property rights, there are two stages: (i) the outright transfer of the funds by D and E to C Ltd and (ii) the transfer of beneficial ownership in the funds from C Ltd back to D and E when the trust is declared.92 As a result of the transfer in (i) the funds fall into C Ltd’s estate and should be shared rateably among C Ltd’s creditors (including D and E). It follows that the transfer in (ii) is a factual preference because it entitles D and E to reclaim their funds in priority to other creditors. If, alternatively, C Ltd declared a trust over its remaining stocks in favour of D, the resulting transfer of beneficial ownership would effectively remove the assets from the estate thereby improving D’s position at the expense of E and the other creditors.93 4.37 Grant of lease. Another example of a factual preference is where the company carves a separate legal estate out of its property and vests it in an existing creditor. In Weisgard v Pilkington,94 a company was engaged in the development of a property consisting of a restaurant and a number of flats. Four months before going into creditors’ voluntary liquidation, the company granted its two directors 999 year leases of six of the flats. The leases were taken in discharge of unsecured sums owing to the directors. The court held that the company’s actions put the directors in a better position than they would have been in under an insolvent liquidation and ordered them to surrender the leases to the liquidator. No further 91 A similar device to that adopted in the cases of Re Kayford Ltd [1975] 1 WLR 279 and Re Chelsea Cloisters Ltd (1980) 41 P & CR. 92 It is conceptually impossible for the transferor to achieve the same outcome simply by transferring bare legal title to property whilst expressly reserving title to the beneficial interest. Accordingly, there must be an outright transfer coupled with a grant back: see Re Bond Worth Ltd [1980] Ch 228 and paras 6.14–6.21. 93 See also Re Lewis’s of Leicester Ltd [1995] 1 BCLC 428 (insolvent department store declaring trust of receipts in respect of sales by concession holders that would otherwise have fallen into the insolvent estate). 94 [1995] BCC 1108.

144 Adrian Walters explanation was given, but presumably, the granting of the leases conferred a valuable benefit on the directors while diminishing the value of the freehold title at the expense of other creditors. 4.38 ‘Suffering anything to be done’. The examples discussed so far are all cases where the company ‘does anything’ with the effect of improving a creditor’s position in a subsequent liquidation. Section 239(4) also applies where the company ‘suffers anything to be done’. There is no direct guidance on what it means to suffer a preference. It has been said in another context that a party suffers a thing to be done if he fails to take steps to prevent it in circumstances where it is reasonably within his power to take such steps.95 It might be argued that a company would theoretically suffer a factual preference if it allowed its assets to be seized and sold by a bailiff for the account of an execution creditor.96 In this situation, the assets would be preserved for the benefit of the estate if the company resolved to go into creditors’ voluntary liquidation before the process of seizure and sale was completed.97 However, as the diligent creditor is allowed to retain the benefit of an execution or attachment completed before liquidation commences and the company, in co-operating with the bailiff, would not usually be acting out of any desire to prefer the execution creditor,98 it is doubtful that a liquidator could realistically challenge an execution sale under section 239. 4.39 Preferential transactions carried out in accordance with a court order. Section 239(7) provides that the fact that something has been done under a court order does not, without more, prevent the doing or suffering of that thing from constituting the giving of a preference within section 239(4). So, for example, a payment is not removed from the scope of section 239(4) simply because it was obtained on the back of a judgment of the court. The subsection therefore prevents the parties from colluding in a process whereby the creditor commences debt recovery proceedings against the company on the understanding that the proceedings will be compromised shortly afterwards on terms embodied in a consent order, the hope being that the court’s sanctioning of the compromise will sanitise the payment. There are other types of court order that may have a preferential effect. For example, orders granting specific performance or remedial proprietary relief against the company would have the effect of taking assets out of the estate and vesting them in the claimant.99 However, where such an order is obtained in hostile litigation, the office holder faces the insuperable obstacle of establishing that the company was influenced by a desire to prefer. 95

Berton v Alliance Economic Investment Co [1922] 1 KB 742. See, eg Norburg v Ryan 193 F 2d 407 (1951), a case decided under federal law as it stood in the United States prior to 1978. 97 Insolvency Act 1986 s 183. 98 Ibid and see paras 4.65–4.79 below. 99 Note, however, the general reluctance of the courts to grant specific performance and other forms of proprietary relief where the company is insolvent: see, eg Re London Wine Co (Shippers) Ltd [1986] PCC 121; Mac-Jordan Construction Ltd v Brookmount Erostin Ltd [1992] BCLC 350 at 359; Re Goldcorp Exchange Ltd [1995] 1 AC 74. 96

Preferences 145 (b) Measuring preferential effect in a hypothetical liquidation 4.40 The question of whether the transaction improved the position of the relevant party is a question of fact in each case and, as the examples given above demonstrate, it will often be relatively easy to show that it falls within the scope of section 239(4). Indeed, the point is often conceded. That being said, a legal issue arises as to the point in time at which preferential effect should be measured. There are two possibilities: either (i) at the time of the transaction (or just after) or (ii) when the company actually goes into insolvent liquidation. 4.41 Section 239(4)(b) states that the company must do or suffer something to be done which has the effect of putting the counterparty into a position ‘which, in the event of the company going into insolvent liquidation, will be better than the position he would have been in if that thing had not been done’ (emphasis added). In Re Ledingham-Smith, a case decided under the equivalent provision applicable in personal insolvency, Morritt J suggested that the phrase ‘will be better’ in relation to the event of the debtor’s bankruptcy envisages a bankruptcy immediately after the doing of the thing in question.100 The implication is that the question of whether the transaction improved the defendant’s position should be measured by reference to a hypothetical liquidation arising immediately after the transaction rather than by reference to the company’s actual liquidation once it ensues. It follows that the court should examine the impact of the transaction on those who were creditors at the time it was entered into rather than the impact on creditors who prove in the actual liquidation. On a literal construction of section 239(4)(b), the hypothetical liquidation approach seems correct. The use of the present tense (‘does anything . . . which has the effect of putting [the] person into a position . . .’) and the future conditional (‘. . . which, in the event of the company going into insolvent liquidation will be better . . .’) implies that one is looking at the present effect of the transaction assuming the occurrence of a hypothetical event. Furthermore, the application of section 239 is not strictly dependent on the company actually going into liquidation. An administrator can bring an action and, although liquidation will often follow on the heels of administration, it is not bound to do so. In cases where the company is not in liquidation and might not actually go into liquidation, it is only possible to judge preferential effect by reference to a hypothetical liquidation. It follows that this must be the correct test as otherwise the same words in section 239(4)(b) would bear different meanings depending on whether the company was in administration or liquidation.101 100

[1993] BCLC 635 at 640–41. The hypothetical liquidation test is supported by other commentators: see R Goode, Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 393–94 and L Doyle, Insolvency Litigation (London, Sweet & Maxwell, 1999) at 227–28. The position appears to be the same under analogous provisions in Australia’s Bankruptcy Act and Corporations Act: see A Keay, Avoidance Provisions in Insolvency Law (Sydney, LBC, 1997) at 132–34, 170–72. By contrast, in the United States, preferential effect is usually tested by reference to the actual effect of the 101

146 Adrian Walters 4.42 For the office holder to succeed in recovering a preference, the company must be insolvent when it was given or become insolvent as a result of it.102 Consequently, it will not usually matter whether preferential effect is tested by reference to a hypothetical or actual liquidation. For example, an unsecured creditor who receives payment in full does better than he would do in either a hypothetical or actual liquidation where he is bound to receive less than one hundred pence in the pound. Nevertheless, the New Zealand case of Lewis v Hyde103 shows that the point cannot be dismissed entirely. This case concerned a company trading as a building society. Generally, depositors could only withdraw funds by giving seven days’ notice to the company. On 2 February 1989 the company arranged for H to make an immediate withdrawal of all of his deposits. Between 2 February and 21 February the company continued to trade and during that period it accepted over NZ$500,000 worth of new deposits and repaid over NZ$2,000,000 worth of existing deposits. The company ceased trading on 23 February and a provisional liquidator was appointed. On the facts, it followed that even if H had been required to wait the usual seven days for repayment, his deposits would have been repaid in full before the commencement of the winding up. The relevant provision in issue, section 309 of New Zealand’s Companies Act 1955, was based on that found in the English Bankruptcy Acts prior to 1986. The applicable test was whether the payment to H had been made ‘with a view to giving [him] . . . a preference over the other creditors’. The liquidator argued that, as long as the payment was made with the object of preferring H over other deposit creditors, the court could still order recovery even though ultimately there was no actual preference as at the date of winding up. Rejecting this argument, the Privy Council held that (i) the reference to ‘the other creditors’ could only refer to those creditors ascertainable at the date of liquidation and (ii) given the events that took place between 2 February and 21 February, the payments under challenge did not actually prefer H over the body of creditors entitled to prove in the liquidation. The significant point for our present discussion is that the court accepted that had the company gone into liquidation during the period of the accelerated payment (i.e. in the seven days after 2 February), H would have been preferred. Thus, had this case arisen under section 239, it is arguable that the payment would have fallen within section 239(4)(b) on an application of the hypothetical liquidation approach. However, a court blessed with hindsight may conclude that this approach produces a harsh result especially given that the payment did not ultimately offend against the principle of rateable distribution. In a marginal case where the transaction has no ultimate impact on the distribution in the actual transaction as determined on bankruptcy, i.e. at the time the petition is filed: see Palmer Clay Products Co v Brown 297 US 227 (1936); In re Tenna Corp 801 F 2d 819 (1986) though note In re Abramson 715 F 2d 934 (1983). 102 Below, para 4.90. 103 [1998] 1 WLR 94.

Preferences 147 liquidation the court may therefore be persuaded to depart from a literal reading of section 239(4)(b).104 (c) Pre-liquidation payments to secured and partially secured creditors 4.43 A pre-liquidation payment to a fully secured creditor does not amount to a factual preference within section 239(4).105 Put simply, a payment to a fully secured creditor does not improve his position. In liquidation he would have a prior claim to the proceeds of his security in any event. If, on a hypothetical liquidation, the value of the security is the same as or exceeds the value of the claim, the creditor will recover one hundred pence in the pound. Consequently, the creditor is in no better position if he is repaid or takes possession of the security before the company goes into liquidation. Moreover, as Goode has pointed out, the effect of the payment is to reduce or discharge the security and to increase by an equivalent amount the assets in the estate available to satisfy the claims of other creditors.106 A similar analysis applies in the case of preliquidation payments to asset financiers in respect of equipment held on lease or hire purchase. There is no factual preference if the value of the asset to the estate is greater than or equivalent to the payment because, if payment is not made, the financier can simply repossess the asset.107 4.44 The position is different if the creditor is only partially secured and the value of the pre-liquidation payment exceeds the value of the security. Let us say, for example, that X lends A Ltd £50,000 in return for a charge over Blackacre. At the time, Blackacre is valued at £60,000. A Ltd becomes insolvent and a week before going into liquidation it repays X in full. By this time, 104 The point is further illustrated by the following hypothetical example drawn from D Baird & T Jackson, Cases, Problems and Materials on Bankruptcy, 2nd edn (Little, Brown & Co, 1990), ch 7. Creditor is owed £10,000. On 1 January, Creditor accepts from Company payment of £7,000 in full and final satisfaction of its claim. If Company went into liquidation on that date and its assets were distributed immediately, unsecured creditors would receive seventy pence in the pound. Company actually goes into liquidation on 1 May and the projected dividend to unsecured creditors at that point is only twenty pence in the pound. In a hypothetical liquidation as at 1 January Creditor does no better than other creditors. In the actual liquidation, it transpires that Creditor has done significantly better. This example suppresses a range of difficult valuation questions. In particular, a court would have to find some basis for measuring the likely depreciating effect of a hypothetical liquidation on the company’s realisable assets. Again, assuming all other elements of the cause of action are made out, a court blessed with hindsight may well be influenced by the position in the actual liquidation and adopt a purposive construction of section 239(4)(b) based on an appeal to the pari passu principle. 105 See, by analogy, Wily v St George Partnership Banking Ltd (1999) 84 FCR 423. As a consequence, cases may sometimes turn on whether the creditor had a genuine security interest: see, e.g. Yeomans v Lease Industrial Finance Ltd (1987) 5 ACLC 103. 106 Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 395. 107 Note also the position in relation to the discharge of a banker’s lien. In National Bank of Australia v KDS Construction Services Pty Ltd (1987) 163 CLR 668 it was held that the lien arises at the point when the overdrawn customer pays cheques into the collecting bank with the effect that the subsequent payment by the paying bank discharges a valid security interest. Nevertheless, the creation of the lien as security for pre-existing unsecured indebtedness is surely preferential in effect.

148 Adrian Walters Blackacre has declined in value and is only worth £40,000. Strictly speaking, X is therefore an unsecured creditor to the tune of £10,000 and the payment amounts to a factual preference to that extent.108 The position also differs where payment is made to the holder of a floating charge and the effect is to prefer the charge holder over preferential creditors. Take the following example. B Ltd borrows £50,000 from Y in return for a floating charge. On the eve of liquidation, B Ltd repays Y in full. Y’s security at that point is worth £50,000 but there are preferential creditors of £20,000. The payment improves Y’s position because, on liquidation, the preferential creditors are entitled to be paid first from the proceeds of floating charge assets.109 Moreover, it is not only preliquidation payments that may improve the position of a secured creditor in relation to preferential creditors. Take a secured creditor who has a fixed charge over book debts and a floating charge over stock. If the company adopts a systematic policy of selling stock on credit just before going into liquidation, this will reduce the value of the floating charge security but increase the value of the company’s book debts. This conversion of floating charge assets into fixed charge assets may improve the secured creditor’s prospects of full recovery at the expense of preferential creditors because their priority over secured creditors only applies to floating charge realisations. 4.45 There may be circumstances where a pre-liquidation payment of a fully secured senior creditor gives rise to a factual preference in favour of a junior secured creditor. If both creditors are fully secured there is no problem. Thus, if X, owed £15,000, has a first fixed charge over Greenacre and Y, owed £5,000, has a second fixed charge over Greenacre and Greenacre has a realisable value of £20,000, a pre-liquidation payment of £15,000 to X prefers neither X nor Y. In liquidation X would have a first ranking claim to £15,000 out of the proceeds of sale and Y would be entitled to the balance of £5,000. However, the position is different if, in a hypothetical liquidation, Greenacre only has a realisable value of £15,000. In that case, the payment of £15,000 to X prefers Y. In liquidation Y’s security is worthless and he would rank as an unsecured creditor. The payment therefore improves Y’s position because, in discharging X’s security, it 108 In the case of a creditor with a floating charge, the hypothetical liquidation test might raise difficulties. If, for example, the company made the payment three or four months before liquidation, it is likely that the value of the security will have fluctuated in the intervening period. If the hypothetical liquidation test is applied, the court would have to value the security as if the floating charge had crystallised on the date of payment in order to determine whether the creditor was fully or partially secured. Leaving aside difficulties of valuation, the secured creditor would be prejudiced if the payment exceeded the value of the security at the date of payment but was less than its value as measured at the date of liquidation. The scenario raises much the same issue as was discussed in para 4.42 with reference to Lewis v Hyde [1998] 1 WLR 94. 109 Insolvency Act 1986 s 175(2)(b). For the categories of preferential debt see ibid. s 386 and Sched 6 but note that these categories will be greatly reduced once the Enterprise Act 2002 comes into force. Strictly, on the hypothetical liquidation test, improvement in position should be measured by reference to preferential debts quantified at the date of the payment to the floating charge holder rather than the date of actual liquidation.

Preferences 149 enables Y to recover his £5,000 out of the proceeds of sale.110 Indeed, any payment to X would reduce the debt owing to X and lead to a corresponding increase in the value of Y’s security interest.111 4.46 A final point on secured creditors concerns the issue of after-acquired property under a floating charge. As prior to its crystallisation the floating charge is ambulatory in nature, the value of the underlying security may fluctuate. One way in which the company could improve the position of a partially secured floating charge creditor would be to inflate the value of the security by bulk purchasing floating charge assets on the eve of liquidation.112 This kind of practice has attracted much controversy and debate in the United States where argument has raged over whether the security should be treated as attaching to after-acquired assets at the time the company acquires them or at the date on which the security was created and perfected.113 The position in English law is that the security interest is treated as attaching to after-acquired property from the date of the security agreement unless there is stipulation to the contrary.114 It would seem to follow that the acquisition of floating charge assets during the twilight period cannot be challenged as a preference because the assets are part of the security bargained for and obtained at the time the advance was made and are not therefore security for an antecedent debt, at least for the purposes of section 239.115 (d) Preferences and guarantors 4.47 If the company makes a pre-liquidation payment of a guaranteed debt, the payment improves the position of the guarantor as well as the creditor.116 110

In re Prescott 805 F 2d 719 (1986). It is important to note that, for convenience and ease of exposition, the hypothetical examples given here concerning partially secured creditors deliberately gloss over difficult questions of valuation. In practice, evidence as to the value of the security in a hypothetical liquidation will be needed to determine the question of whether a pre-liquidation payment to a secured creditor amounts to a factual preference. On problems of valuation generally, see R Goode, Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 91–100. 112 A practice commonly described as ‘feeding’ the floating charge. 113 See variously, C Morris, ‘Bankruptcy Law Reform: Preferences, Secret Liens and Floating Liens’ (1970) 54 Minnesota Law Review 737; T Jackson, ‘Avoiding Powers in Bankruptcy’ (1984) 36 Stanford Law Review 725; V Countryman, ‘The Concept of a Voidable Preference in Bankruptcy’ (1985) 38 Vanderbilt Law Review 713. 114 R Goode, Commercial Law, 2nd edn (Penguin, 1995), ch 23. 115 R Goode, Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 393. Note, however, that the statutory wording is wide enough to suggest that a finding to the contrary should not be ruled out. If a company engages in a deliberate policy of stockpiling designed to benefit a partially secured floating charge creditor, it is arguable that (i) in substance, the company ‘does anything . . . which has the effect of putting that person into a position which . . . will be better than the position he would have been in if that thing had not been done’ and that (ii) preferential stockpiling on the eve of liquidation is not something that the creditor can truly be said to have bargained for in advance. 116 It might be said that repayment of a guaranteed debt does not improve the position of the creditor because he could, in any event, rely on the guarantee as collateral security. However, as between the company and the creditor, the latter’s position is improved because assets that would 111

150 Adrian Walters To the extent that the guarantor is called on to pay the principal debt, he has a right of indemnity against the company and is entitled to prove as an unsecured claimant in the company’s liquidation in respect of the amounts paid out to the creditor under the guarantee. It follows that a guarantor is a contingent creditor of the company. Any payment reducing or extinguishing the principal debt has the effect of reducing or extinguishing the guarantor’s exposure pound for pound. On the assumption that the company’s repayment of the principal debt is otherwise unsecured, the payment has the effect of improving the guarantor’s position as, in a hypothetical liquidation, the guarantor would be called upon to meet the principal indebtedness but would be bound to recoup less than a hundred pence in the pound under his unsecured right of indemnity. The point can be illustrated with a simple example. A Ltd owes X £50,000. G, one of A Ltd’s directors, guarantees repayment. Two weeks before A Ltd goes into liquidation, the company reduces the debt owing to X by £20,000. In a hypothetical liquidation commencing at that point, unsecured creditors would have received fifty pence in the pound. So if the payment had not been made, X would have called on G to pay £50,000 under the guarantee, £25,000 of which G would have recouped in the liquidation. The payment to X therefore improves G’s position as his liability under the guarantee is reduced to £30,000, of which £15,000 would be recouped in the liquidation, making him £10,000 better off than he would have been had the payment not been made. 4.48 In the above example, A Ltd’s liquidator could seek to recover the amount of the preference directly from G without having to join X in the proceedings as an additional party.117 If the payment amounts to an unlawful preference of X (the creditor) and Y (the guarantor), the liquidator may elect to proceed against X or Y individually or against both parties. Where proceedings are commenced against him, the creditor should seek to have the guarantor joined as a party. Then, if he is ordered to repay the company, he can ask the court for a declaration reviving the obligations under the guarantee and obtain immediate judgment against the guarantor.118 4.49 It is important to note that what we have said about payment of guaranteed debts only applies where the principal debt is not secured in some other way. If the creditor is otherwise fully secured (say by virtue of a debenture creotherwise be available for rateable distribution are used to discharge the claim with the result that he neither has to prove in the liquidation nor take steps to enforce the guarantee. 117 Before 1986 the liquidator could not have recovered any benefit direct from the guarantor or surety: Cork Report, paras 1270–76. 118 Insolvency Act 1986 s 241(1)(e) and see the outcome in Re Agriplant Services Ltd [1997] 2 BCLC 598. This reflects the proposal of the Insolvency Law Review Committee (Cork Report, para 1275) that where a payment to a creditor has been set aside against him as a voidable preference, the creditor should on repaying the liquidator, have the same remedies against the guarantor, and against any property securing the guarantee, as he would have had if the debtor had not made the payment to the creditor. Under the pre-1986 law the court apparently had no power to direct the revival of the guarantor’s obligations.

Preferences 151 ating fixed and floating charges over the company’s assets), the payment will not prefer the guarantor because, in the absence of any shortfall, he has no exposure under the guarantee.119 It follows that section 239 is likely to be of greater relevance in the context of trade guarantees rather than bank guarantees. 4.50 It is not just payments of the principal debt that can operate to improve the position of the guarantor. In Re Fairway Magazines Ltd,120 a director personally guaranteed the company’s overdraft up to a limit of £70,000. The company got into financial difficulties and five months before it went into voluntary liquidation, it granted the director a debenture to secure a borrowing facility that he had agreed to provide. The director made a series of advances some of which were used to reduce the company’s liability on the overdraft. It was held that these transactions did not give rise to an unlawful preference because the company was not influenced by a desire to prefer the director.121 Even so, it is clear from his judgment that Mummery J regarded the creation of the debenture as putting the director in an improved position for the purposes of section 239(4). Although, it was not explained in these terms, it appears that the combined effect of the debenture and the use of the secured advances to reduce the company’s overdraft gave rise to a factual preference. On its own, the debenture was not a preference because it secured contemporaneous and future advances. However, had the director’s advances not been used to reduce the overdraft, he would have been an unsecured creditor for those amounts in the liquidation under his right of indemnity qua guarantor. Equally, had the director made the advances without the security of the debenture, he would simply have been substituting an unsecured claim for repayment for an unsecured right of indemnity of equivalent value. By securing the advances used to reduce the director’s exposure under the guarantee, the company effectively converted his unsecured right qua guarantor into a secured right qua creditor. The overall effect was the same as if the company had simply granted the director a debenture securing his right of indemnity. (e) Preferences and set off 4.51 Professor Goode gives two examples of circumstances in which rights of set off might conceivably give rise to a factual preference under section 239(4): (i) where the company enters into an agreement for set off going beyond what the creditor would be allowed under rule 4.90 of the Insolvency Rules 1986 or (ii) where the company confers a right of set-off on the creditor in respect of a debt already owing to the company by the creditor.122 The situation in (i) is 119 See Levit v Ingersoll Rand Financial Corporation 874 F 2d 1186 at 1199 (1989). The same is true if the guarantor’s rights against the company are secured. 120 [1993] BCLC 643. 121 Below, para 4.84. 122 Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 395.

152 Adrian Walters unlikely to arise very often in practice as, once the company goes into liquidation, rule 4.90 will override any attempt to restrict its effect by agreement between the parties.123 However, it could arise in a case where the company is in administration. This is because rule 4.90 does not apply in administration and so the effect of the set-off agreement on the creditor would have to be measured by reference to a hypothetical liquidation in which rule 4.90 would apply. In (ii) the creditor’s position is improved because the set-off reduces or extinguishes the amount the company’s liquidator could claim from the creditor. 4.52 A further area of some importance is the banker’s right to combine accounts. The received wisdom is that a payment into the company’s overdrawn bank account is not a factual preference as long as the payment does not exceed the amount of a credit balance held by the company on a separate account with the same bank. The reason for this is that the bank would be entitled to combine the accounts and apply the credit balance in reduction of the sums owing by the company on the overdraft. It follows that the payment into the overdrawn account reduces by an equivalent amount the value of the bank’s right to combine accounts and so its effect on the company’s other creditors is neutral.124 However, the position may be different if, during the twilight period, the company deposits sums with the bank which the bank then uses to discharge a loan owing to it on a separate account.125 In that case, the overall transaction is, in substance, no different from a payment reducing or extinguishing the amount owing to a creditor on a single account. 4.53 Another situation in which issues of set off and preference have been raised is as follows. Let us say, by way of example, that A Ltd has a contractual right to set off balances owed to and owed by its directors. Director 1 owes A Ltd £50,000 and A Ltd owes Director 2 £50,000. Exercising its contractual right, A Ltd applies Director 2’s credit balance in satisfaction of Director 1’s debit balance. It has been held that the exercise of the set off is not a preference of Director 2 because the arrangement as a whole benefits the company.126 In substance, it is as if Director 2 made the payment directly to Director 1 out of his own funds. The impact on the estate is therefore neutral, a point of some importance that is taken up immediately below.

123 Where rule 4.90 simply reproduces the effect of a contractual right of set-off there is no preference: see Re Mistral Finance Ltd [2001] BCC 27. 124 R Goode, Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 402 and see, eg In re Pineview Care Center Inc (1993) 152 BR 703. 125 See Re Shaw, ex parte Andrew v Australia and New Zealand Banking Group Ltd (1977) 31 FLR 118; Matthews v Geraghty (1986) 11 ACLR 229 and D Posluns, ‘The Position of a Bankrupt’s Banker’ (1977–78) 2 Canadian Business Law Review 476 for discussion of relevant Canadian authorities. 126 Re Exchange Travel (Holdings) Ltd [1996] 2 BCLC 524 affirmed [1999] BCC 291.

Preferences 153 (f) Payments out of assets not beneficially owned by the company 4.54 As Goode points out, a factual preference within section 239(4) can only arise if the dealing puts the creditor, surety or guarantor in a better position at the expense of other creditors.127 This proposition seems to add a gloss to the statutory wording which focuses solely on whether the dealing produces a measurable improvement in the position of the creditor, surety or guarantor. However, we saw earlier that preference law’s suggested rationales are to preserve the integrity of insolvency law’s distributional scheme and/or to preserve the company’s assets intact thereby capturing economic value for the creditors. The implication of both these rationales is that the preferred creditor should be seen to gain at the expense of other creditors. If the dealing has a neutral impact on the assets in the estate and on the way in which the estate is distributed, it falls outside the mischief targeted by section 239. Thus, where A Ltd arranges for X, a third party, to pay the £1,000 that A Ltd owes to an unsecured creditor, Y, the payment is not a factual preference within section 239(4). Clearly, the payment makes Y better off in a financial sense. However, it in no way diminishes the assets of the estate and so does not prejudice other creditors.128 The position remains the same even if, as between A Ltd and X, the payment is treated as an unsecured loan because the overall impact on the estate is neutral. One unsecured creditor, X, is simply substituted for another of equivalent amount, Y, and, in substance, the outcome is the same as if Y had simply assigned the £1,000 debt to X. However, a factual preference does arise if A Ltd secures X’s right to repayment. In that case, if we take the series of transactions between A Ltd, X and Y as a whole, the payment improves Y’s position at the expense of unsecured creditors because the overall effect is to reallocate assets in the estate from the unsecured creditors to X’s secured claim. In substance, the outcome is the same as if A Ltd had preferred Y directly by paying him off or by securing the antecedent debt.129

127

Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 391. See James v Commonwealth Bank of Australia (1995) 13 ACLC 1604. It might be different if A Ltd sold all of its assets to X on terms that X would pay certain selected creditors of A Ltd, including Y, though note Nilant v Plexipack Packaging Services Pty Ltd (1996) 21 ACSR 428 where, on the particular wording of the relevant provision in the Australian Corporations Law, it was held that there was no preference in similar circumstances. See also Sheahan v Carrier Air Conditioning Pty Ltd (1997) 189 CLR 407 (payments made by receiver to selected unsecured creditors treated as payments made from assets belonging to the charge holder that would not have been available to the meet the claims of other unsecured creditors in any event) but compare G & M Aldridge Pty Ltd v Walsh (2001) 203 CLR 662. 129 See, by analogy, Re Fairway Magazines Ltd [1993] BCLC 643 discussed above in para 4.50. It is submitted that the position is the same where A Ltd causes X, a bank, to issue Y with a letter of credit which Y draws on to meet A Ltd’s debt and X has a secured right of reimbursement against A Ltd. For two US cases in point see American Bank v Leasing Service Corp (In re Air Conditioning Inc) 845 F 2d 293 (1988) and Kellogg v Blue Quail Energy Inc (In re Compton Corp) 831 F 2d 586 (1987). 128

154 Adrian Walters 4.55 Similar issues have arisen with regard to direct payment clauses in building contracts. In its simplest form, a direct payment clause enables the employer under a building contract to pay an unpaid sub-contractor directly in the event of the main contractor’s insolvency. The validity of such clauses has been challenged on several occasions because their apparent effect is to divert funds away from the main contractor’s general creditors in favour of the sub-contractor. While much may turn on the wording of the relevant clause, the courts have found two ways to defeat objections to direct payments. The first answer is to say that direct payment involves no dealing with the property of the main contractor and so does not diminish its assets. This conclusion will follow if it is open to the court to construe the contract as meaning that the main contractor has no enforceable right to receive payment once the employer’s right to pay the sub-contractor has been triggered.130 On this approach, the position is the same as that considered above where a third party pays the company’s debt. The second answer is to say that the liquidator takes the company’s property subject to the liabilities or limitations which affect it in the company’s hands.131 Thus, in an Irish case where the employer was contractually entitled to pay sub-contractors directly and deduct amounts so paid from retention monies payable once the architect issued a certificate of payment to the main contractor, it was held that the main contractor’s right to the retention monies was subject to a pre-existing contractual limitation binding on the liquidator.132 On either view, the monies paid directly to the subcontractor never form part of the main contractor’s estate. 4.56 A further situation to which, at first sight, a similar analysis appears to apply is where a creditor, X, receives a pre-liquidation payment out of funds impressed with a trust in the hands of the company. The initial payment to X is not made from assets beneficially owned by the company. Moreover, while the company’s liability to restore the fund qua trustee is a provable debt,133 the dividend to creditors will only be diminished if the quantum of that claim exceeds the value of any proof of debt that X would have put in had the payment not been made.134 130

Re CG Monkhouse Pty Ltd (1968) 69 SR (NSW) 429. On this ‘flawed asset’ theory, see generally R Goode, Principles of Corporate Insolvency, 2nd edn Law (London, Sweet & Maxwell, 1997), ch 6. 132 Glow Heating v Eastern Health Board [1988] IR 110 but compare Attorney-General v McMillan and Lockwood Ltd [1991] 1 NZLR 53. In the majority of these cases, the main contractor’s liquidator has not relied on section 239 but argued rather that direct payment clauses are an illegal attempt to contract out of pari passu contravening the rule in Ex parte Mackay (1873) 8 Ch App 643. For further discussion see paras 1.49–1.57 and D Capper, ‘Direct Payment Clauses and the Pari Passu Principle’ [1998] Company Financial and Insolvency Law Review 54. 133 Insolvency Rules 1986, rr 12.3, 13.12(4). 134 The outcome may depend on whether the trust property can be recovered directly from X as a constructive trustee in which case he could face a double liability. The complexities do not end there. If we assume that an action would lie against X under section 239, a question then arises as to the destination of any recovery: see below, paras 4.102–4.103. A liquidator will not risk scarce assets to pursue a preference action if the lion’s share of the benefit is likely to go to trust creditors. For a situation of comparable difficulty see above, para 4.31 (payments out of charged assets). 131

Preferences 155 (g) The ‘running account’ principle 4.57 On 1 January A Ltd owes Y £5,000. On 1 February A Ltd repays £5,000 to Y. On 1 March Y advances a further £5,000 to A Ltd. On 1 April A Ltd repays the £5,000. The pattern is repeated with a further advance of £5,000 on 1 May and a further repayment on 1 June. Finally, Y makes a further advance of £5,000 on 15 June. This is not repaid. A Ltd goes into voluntary liquidation on 30 June. Each payment of £5,000 was made (i) to a creditor, (ii) in respect of an antecedent debt of £5,000 and (iii) during the twilight period of six months ending on 30 June and is, prima facie, liable to challenge as a preference by A Ltd’s liquidator with a potential aggregate recovery of £15,000. However, if we take the series of transactions as a whole, Y’s position as at 30 June is no different than it was at 1 January: Y started and finished as an unsecured creditor owed £5,000. On this global approach, it is arguable that there is no factual preference within section 239(4) because, in aggregate, the payments do not improve Y’s overall position. The question arises as to whether there are any circumstances in which the court will look at the aggregate effect of a series of payments rather than each advance and repayment in isolation. 4.58 If Y can argue that the payments were part of a running account, it would be open to the court, applying principles developed by the courts in Australia, to consider the aggregate effect of the various payments and conclude that our example does not give rise to a preference under section 239(4). The leading authority on the operation of the running account principle is the decision of the High Court of Australia in Airservices Australia v Ferrier.135 The facts were that C Ltd, a company carrying on the business of a passenger airline, made a series of nine payments to Airservices totalling AUS$10.3 million during the twilight period before the company’s winding up. The payments were made in respect of airport and air navigation services provided by Airservices which were essential to the continuing operation of C Ltd’s airline. C Ltd’s liquidator challenged the payments asserting that their effect was to give Airservices a ‘preference, priority or advantage’ over C Ltd’s other creditors at the time each payment was made within the relevant provision of the Corporations Law. The crucial question on the authorities was whether each payment could be seen as part of a wider transaction or running account. If the individual payments were part of a wider transaction, it was open to the court to consider the purpose of the wider transaction and its ultimate effect in order to determine whether the individual payments were factual preferences: If the sole purpose of the payment is to discharge an existing debt, the effect of the payment is to give the creditor a preference over other creditors unless the debtor is able 135 (1996) 137 ALR 609. Although the Australian running account principle was developed by the courts, it is codified in relation to corporate insolvency by section 588FA(3) of Corporations Act 2001. For background see Australian Law Reform Commission, General Insolvency Enquiry (Report No 45, 1988), paras 654–55.

156 Adrian Walters to pay all of his debts as they fall due. But if the purpose of the payment is to induce the creditor to provide further goods or services as well as to discharge an existing indebtedness, the payment will not be a preference unless the payment exceeds the value of the goods or services.136

4.59 It follows that if there is a general course of dealing between the company and the creditor, a payment made during the twilight period which is part of that ongoing course of dealing cannot be viewed in isolation. The business purpose and context of each payment must be evaluated and where the payment is a step in a wider transaction, ‘its actual business character must be seen and when it forms part of an entire transaction which if carried out to the intended conclusion will leave the creditor without any preference priority or advantage over other creditors the payment cannot be isolated and construed as a preference.’137 Thus, the purpose, character and ultimate effect of the wider transaction become directly relevant once the court determines that each payment forms part of a course of dealing: If the purpose of a payment is to secure an asset or assets of equal or greater value, the payee receives no advantage over other creditors. The other creditors are no worse off and, where the value of the assets has increased, they are actually better off. Thus, a debtor does not prefer a creditor to the other creditors if he or she pays a debt, or part of it, to induce the creditor to supply goods of equal or greater value than the amount of the payment. In that situation, it is of no relevance that the debt that is discharged happens to be a stale one. If the present value of the goods supplied is equal to or greater than the payment, the other creditors are no worse off. They are in the same position that they would have been in if the parties had so structured the transaction that the debtor paid for the new supply of goods instead of discharging the old debt . . . A court . . . does not allow itself to be unsighted by the shadow of the legal form when it can see that the economic effect of the transaction does not give the creditor any preference, priority or advantage over the general body of creditors.138

4.60 Following this approach, a court considering the example given above might well conclude that the three payments to Y are not factual preferences under section 239(4) on the argument that (i) each payment was made as part of a wider transaction, (ii) the purpose of each payment was not to discharge an existing debt but rather to reduce the debit balance on a running account so as to encourage Y to make further advances and (iii) in the light of the wider transaction, each payment did not ultimately decrease the net value of the assets available to other creditors as Y put back in as much as he took out. 4.61 A further implication is that a factual preference will only arise if the ultimate effect of the wider transaction is to put the creditor in a better net position at the point immediately after the final payment was made than he was in at the beginning of the twilight period. We can illustrate this by varying our example. 136 137 138

(1996) 137 ALR 609 at 622–23 (Dawson, Gaudron and McHugh JJ). Emphasis added. Richardson v Commercial Banking Co of Sydney Ltd (1952) 85 CLR 110 at 132. (1996) 137 ALR 609 at 623 (Dawson, Gaudron and McHugh JJ).

Preferences 157 Let us say that on 1 January A Ltd owes Y £10,000 and Y makes further advances of £5,000 on 1 March and 1 May. A Ltd makes three payments each of £6,000 to Y on 1 February, 1 April and 1 June but before Y can make a further advance A Ltd goes into liquidation on 30 June. If the court took each payment in isolation, it would conclude that Y had received an aggregate preference of £18,000. However, if it concludes that each payment is part of a wider transaction, it would look at Y’s net position in which case there would still be a factual preference in the sum of £8,000 as the ultimate effect of the wider transaction is to reduce what was owed to Y from £10,000 to £2,000. In this case the running account principle would provide only a partial defence.139 On the facts of Airservices Australia v Ferrier, a majority of the court concluded that the payments made by C Ltd to Airservices were part of a wider transaction in which the value of the services provided by Airservices during the twilight period far exceeded the value of the payments. The payments were to be regarded as so connected with the continuing provision of services that the ultimate rather than the immediate effect of each payment should be considered.140 It followed that the payments did not prefer Airservices over the general body of creditors. Indeed, the opposite was true. The general body of creditors benefited from the revenues generated as a result of the essential services that Airservices provided. The ultimate effect was that C Ltd acquired services of greater value than the payments made and Airservices was left worse off than it had been at the start of the twilight period.141 4.62 The main justification for the running account principle is that it would be unfair to the counterparty to set aside an individual payment where it is part of a mutual series of dealings which, as a whole, either enhances the value of the estate (as in Airservices) or at least does not diminish it (as in our opening example). Those who support the deterrence rationale discussed earlier might also justify the approach in Airservices by saying that preference law should not be used to discourage creditors from continuing to support ailing companies, especially where the ongoing commercial relationship may produce gains for the estate. On this view, the avoidance of individual payments that form part of a wider transaction may lead creditors to withdraw credit facilities and precipitate the premature liquidation of struggling but viable businesses. Conversely, it is arguable that too liberal an application of the running account principle could lead creditors to prop up failing businesses in circumstances where early liquidation might, with hindsight, have been the preferable outcome.142 139 For a case similar in outcome to our revised example see Rees v Bank of New South Wales (1964) 111 CLR 210. 140 (1996) 137 ALR 609 at 627. 141 Ibid 628–29. The two judges in the minority agreed with the majority on the principles to be applied but were not prepared to infer from the facts that each payment was part of a wider transaction. 142 In Airservices Australia v Ferrier, Brennan CJ, one of the two dissentients, was clearly of the view that an earlier liquidation would have been less damaging to C Ltd’s creditors and that, accordingly, Airservices should not have continued to provide support: see (1996) 137 ALR 609 at 619–21.

158 Adrian Walters 4.63 There is less need for a running account principle in English law because if the evidence shows that the company made the payment in the expectation that the creditor would advance further credit or supply further goods or services, the court is likely to infer that the company was not influenced by a desire to prefer.143 Even so, the case of Re Ledingham-Smith144 appears to have been decided on the basis of a similar principle. In Ledingham-Smith, the defendants, PKF, were accountants to a trading partnership. PKF collected £1,000 per month by standing order in and towards payment of its outstanding fees. By December 1989 the business was trading at a loss and PKF advised the partners either to inject fresh capital or find a buyer for the business. The partners decided to sell and PKF were involved in producing figures and attending meetings with prospective buyers. At the end of December 1989, the partners owed PKF approximately £24,000. In January 1990, PKF became concerned about its exposure and made it clear that it could not continue to act in relation to the proposed sale unless some accommodation was reached over fees. It was agreed that PKF would raise weekly invoices for work done in that week and that the partners would pay PKF £5,000 each Friday, the money to be used first to pay the invoice raised in that week with the balance, if any, going to reduce the outstanding indebtedness. On this basis, PKF continued to provide accountancy services to the partnership. In the twilight period before the partners were made bankrupt, they paid PKF a total of £14,000 (including two payments of £1,000 under the standing order arrangement) and were invoiced in the sum of roughly £11,700 for further work done. 4.64 The trustee in bankruptcy argued that the payments to PKF should be set aside but Morritt J held that there was no factual preference. It was true that PKF’s net position was improved because the payments produced a surplus of some £2,300 in their favour. However, when the last payment was made it could not be said that PKF would inevitably benefit from any surplus as negotiations for a sale were continuing and fees were still being incurred. The statutory wording envisages that the creditor’s position ‘will be better’ at a point in time immediately after the thing done.145 Here it was only possible to say that PKF’s position might have been better given that the business relationship was a continuing one. Morritt J did not use the term ‘running account’ in his judgment nor did he consider any authorities directly bearing on the point. However, it is submitted that the case signals the possible reception of the running account principle into English law.

143

Below, paras 4.65–4.79. [1993] BCLC 635. The case was decided under Insolvency Act 1986 s 340, the bankruptcy equivalent of section 239. 145 Above, paras 4.40–4.42. 144

Preferences 159 (3) Section 239(5): ‘influenced by a desire’ to prefer (a) Historical background 4.65 It is not enough to establish that there is a factual preference within the meaning of section 239(4). In deciding to give the factual preference, the debtor company must have been ‘influenced . . . by a desire’ to improve the position of the creditor, surety or guarantor (as appropriate). We saw earlier that debtor volition was the key element in Lord Mansfield’s conception of preference law and under the various statutory formulations in force during the period 1869–1985.146 The structural importance and sheer longevity of this idea of the ‘culpable debtor’ suggest that its impact in modern preference law should not be underestimated. There has been no comparable emphasis on the mindset of the preferred creditor. Accordingly, the office holder does not have to establish that the creditor deliberately sought to obtain an advantage or that his actions were tainted by some form of culpable knowledge (such as knowledge of the company’s insolvency). The issue of creditor culpability has been and remains irrelevant in English preference law. 4.66 Under the law as it stood prior to the enactment of section 239, the office holder had to establish that the insolvent debtor acted ‘with a view’ to giving the creditor a preference. The word ‘view’ was generally equated with ‘intention’ or ‘object’.147 According to the courts, the office holder did not have to show that the debtor’s sole view was to prefer the creditor but was required to show that this was the ‘real effectual, substantial view’.148 If the debtor had some other dominant intention the action could not succeed. Thus, in Sharp v Jackson,149 it was held that an insolvent solicitor who, having committed a breach of trust, sought to rectify the breach by conveying a property he owned to the trust, had not acted with the dominant intention of preferring the trust qua creditor because his sole purpose was to shield himself from the consequences of the breach. Similarly, in Re FLE Holdings Ltd,150 an action to set aside a legal charge granted by a company to a bank in respect of an antecedent debt failed because the court accepted the evidence of the company’s controller that the main object in granting the charge was to keep on good terms with the bank in the hope that it might be prepared to extend further facilities to the company in the future. The underlying rationale was that a preference could only be avoided where it amounted to an exercise of the debtor’s free will.151 Thus, if 146

Above, paras 4.9–4.13. See, eg New, Prance & Garrard’s Trustee v Hunting [1897] 2 QB 19 at 27 affirmed sub nom Sharp v Jackson [1899] AC 419. 148 Ex parte Griffith (1883) 23 Ch D 69; Ex parte Hill (1883) 23 Ch D 695. 149 [1899] AC 419. 150 [1967] 1 WLR 1409. 151 Above, paras 4.9–4.13. 147

160 Adrian Walters the preference was given in response to genuine commercial pressure, it would be allowed to stand on the basis that the debtor’s act was involuntary and it could not be said that his dominant intention was to favour the creditor. We turn now to consider the extent to which the test in section 239(5) departs from the ‘dominant intention’ test under the old law. (b) Meaning of ‘influenced . . . by a desire’ 4.67 The Insolvency Law Review Committee acknowledged the difficulty faced by office holders in discharging the burden of proving that the debtor had a dominant intention to prefer but recommended, by majority, that the requirement of an intention to prefer should be retained and that genuine creditor pressure should continue to afford a defence.152 As the office holder is now only required to establish that the company was ‘influenced . . . by a desire’ to prefer, it appears at first sight that section 239(5) lowers the burden of proof. However, in practice, the adoption of the ‘influenced . . . by a desire’ test has made it no easier for office holders to impugn factual preferences unless the counterparty happens to be a connected person. 4.68 Strictly, on the wording of section 239(5), the question of whether the company was influenced by a desire to prefer is tested at the point the decision was made to give the preference not when the preference was actually given. In Wills v Corfe Joinery Ltd153 the directors agreed in January 1994 that they would not call in their loans until January 1995. In an action brought against them to recover loan repayments, the directors argued that the relevant date for testing whether the company was ‘influenced by a desire’ was the date in January 1994 when the board first set a date for repayment and not the later date (in 1995) when the repayments were actually made. Lloyd J held that the relevant date was the date when the cheques for the payments were drawn. In making the payments, the board was, in effect, making a fresh decision in the light of then current circumstances to stand by the decision made in January 1994. 4.69 The leading authority on section 239(5) is the decision of Millett J (as he then was) in Re MC Bacon Ltd.154 A company which had traded profitably for over ten years lost its main customer and suffered a downturn. Its directors believed that the company’s fortunes could be turned around. However, the company continued to incur substantial losses and reached the point where it was trading close to the ceiling of its overdraft facility. The bank agreed to continue its support but only on the condition that the company granted it a debenture creating fixed and floating charges as security for the indebtedness on the overdraft. Three months after the debenture was granted the company went 152 153 154

Cork Report, paras 1247–56. [1998] 2 BCLC 75. [1990] BCLC 324.

Preferences 161 into creditors’ voluntary liquidation. The liquidator applied to set aside the debenture as a preference. 4.70 In applying the section 239(5) test, Millett J insisted that cases decided under the old law were of no assistance. The court was required to interpret the language of the statute and the new test involved at least two radical departures from the old law. Firstly, the company need only be influenced by a desire to improve the creditor’s position. According to the judge, this requirement is satisfied if the desire to prefer was one of the factors which operated on the minds of those making the decision. Thus, there is no need to show that the desire to prefer was either the only or the decisive factor. Secondly, a desire to prefer not a ‘view’ or ‘intention’ to prefer, must be established. In the well-known passage which follows Millett J sought to draw a clear distinction between ‘intention’ and ‘desire’: A man is taken to intend the necessary consequences of his actions, so that an intention to grant a security to a creditor necessarily involves an intention to prefer that creditor in the event of insolvency. The need to establish that such intention was dominant was essential under the old law to prevent perfectly proper transactions from being struck down. With the abolition of that requirement intention could not remain the relevant test. Desire has been substituted. That is a very different matter. Intention is objective; desire is subjective. A man can choose the lesser of two evils without desiring either. It is not, however, sufficient to establish a desire to make the payment or grant the security which it is sought to avoid. There must have been a desire to produce the effect mentioned in the subsection, that is to say, to improve the creditor’s position in the event of an insolvent liquidation. A man is not to be taken as desiring all the necessary consequences of his actions. Some consequences may be of advantage to him and be desired by him; others may not affect him and be matters of indifference to him; while still others may be positively disadvantageous to him and not be desired by him, but be regarded by him as the unavoidable price of obtaining the desired advantages. It will still be possible to provide assistance to a company in financial difficulties provided that the company is actuated only by proper commercial considerations. Under the new regime a transaction will not be set aside as a voidable preference unless the company positively wished to improve the creditor’s position in the event of its own insolvent liquidation.155

4.71 On the facts, Millett J found that the company had no choice but to grant the debenture and dismissed the action. There was no evidence that the company’s controllers positively wished to improve the bank’s position. Their only desire was to continue trading and that could only be achieved by acceding to the bank’s demand.156 155

[1990] BCLC 324 at 335–36. It is arguable that ‘intention’ under the old law was not quite as objective as Millett J suggests. In New, Prance & Garrard’s Trustee v Hunting [1897] 2 QB 19 affirmed sub nom Sharp v Jackson [1899] AC 419, Lord Esher rejected the argument that the debtor must be taken to have intended the natural consequences of his acts stating that ‘one must find out what he really did intend’. For similar sentiments see the speech of Lord Tomlin in Peat v Gresham Trust Ltd [1934] AC 252. Whatever the position, the problem remains the same under either formulation. An 156

162 Adrian Walters 4.72 The outcome in MC Bacon would arguably have been the same under the old law. In line with the Insolvency Law Review Committee’s recommendation, creditor pressure clearly remains a defence. On the wording of section 239(5), the creditor can argue (i) that the pressure was such that the company did not genuinely ‘decide’ to give the preference or (ii) that the company was influenced in deciding to give the preference by the pressure and any improvement in the creditor’s position was an incidental but not a desired consequence or (iii) that even if the company desired to improve the creditor’s position, it was influenced in deciding to give the preference by the pressure and not by the desire. Under the old law the bank would have argued (successfully) that the company’s dominant intention was to relieve the pressure so that it could continue trading. 4.73 If, as is suggested, the result in MC Bacon would have been the same under the old law, it can be argued that section 239 has had a neutral impact on the burden of proof. Perhaps the best way of putting it is to say that section 239(5) eases the formal burden on the office holder but does nothing to relieve the evidential burden. In favour of the office holder, there is no need to establish that the desire to prefer the creditor was the decisive or dominant factor. Prima facie, it is only necessary to establish (i) that there was a desire to prefer and (ii) that the desire was one of a range of operative factors which influenced the company in deciding to give the preference.157 However, in the absence of direct evidence or admissions, it is notoriously difficult to establish what the company subjectively desired at the time it decided to give the preference. Millett J conceded that the existence of a desire to prefer can be inferred from the circumstances of the case in the same way that a dominant intention could be inferred under the old law. But even if it is possible to infer a desire to prefer, the court may conclude that the company was not influenced by it especially where, as in MC Bacon there is cogent evidence that the company acted in response to creditor pressure or some other factor. Where there is no direct evidence of a desire to prefer but cogent evidence pointing to other operative factors, the office holder faces an uphill task. In particular, direct evidence of creditor pressure will tend to weaken any inference of operative desire.158 The office holder’s dependence on circumstantial evidence and cross-examination of the directors to establish that there was an operative desire means that, in practice, section 239(5) has not substantially altered the burden of proof. Indeed, it is likely that inference of desire to prefer does not lead automatically to an inference that the desire was an operative factor if other persuasive explanations are available in much the same way as, under the old law, an inference of intention to prefer did not lead automatically to an inference that such intention was the dominant factor. 157 For a useful illustration see K Otter, ‘Influential Desire—Dominant Intention’ Insolvency Intelligence 1990, 3(6), 42–44. 158 Though the court faces the further difficulty that pressure can be contrived, a point reflected in the following passage from Re Carson (1924) 55 OLR 649, a Canadian bankruptcy case: ‘When the debtor and the creditor both knew the law, it sometimes happened that the pressure was, in fact, very gentle before the debtor parted with his property. Demand was made with a farcical simulation of earnestness so that the transaction might be upheld.’

Preferences 163 the office holder will always be plagued by evidential difficulties for as long as a test of debtor intent (in whatever form) is retained unless (as is the case with connected persons) there is some adjustment of the onus of proof.159 4.74 A further point of difficulty is that the office holder must establish that the company was influenced by a desire to prefer. It follows that the court will need to devise a rule for attributing the knowledge of the company’s officers and agents to the company itself. The approach in the criminal law is to equate the company’s state of mind with that of the company’s ‘directing mind and will’ usually meaning its controllers, directors or senior managers.160 This so-called alter ego doctrine has also been applied in civil proceedings where the company’s state of mind falls to be determined.161 The current position in the civil law is reflected by the Privy Council’s decision in Meridian Global Funds Management Asia Ltd v Securities Commission.162 There Lord Hoffmann stressed that the scope of the rule of attribution to be adopted in a given case will depend on the language of the relevant statutory provision, its context and policy. In the case of small or single-member companies, it will not usually be difficult to identify the desire of the company with those who control it. However, in a company with several directors the position may not be as straightforward. The tendency in the reported cases is for the point to be glossed but this is probably because the companies involved were relatively small and their state of mind could readily be identified with that of their controllers.163 In the case of larger, more complex organisations where considerable decisionmaking power devolves on senior managers, the Meridian case suggests that the court may be justified in devising a broad rule of attribution which looks beyond the formal machinations of the board and embraces those with de facto responsibility for particular decisions. 4.75 The application of section 239(5) where the company discharges or reduces a guaranteed debt is also problematic. In this case, as we saw earlier, both creditor and guarantor are in receipt of a factual preference.164 For the 159 A further point is that an inference of operative desire cannot be drawn if the practical effect would be to deprive section 239(5) of any effect. Thus, an operative desire cannot be inferred merely from the existence of a factual preference or from the fact that the company was insolvent at the relevant time. In Re Ledingham-Smith [1993] BCLC 635 the office holder asked the court to infer that the debtor was influenced by a desire to prefer from the fact that other creditors, whose goodwill was equally vital if a going concern sale of the business was to be achieved, were not treated in the same way as the defendant accountants. Not surprisingly, Morritt J refused to draw the inference. If he had done so it would have been tantamount to saying that the required element of debtor culpability can be proved simply by showing that there was a factual preference. 160 R v ICR Haulage Ltd [1944] KB 551; Tesco Supermarkets Ltd v Nattrass [1972] AC 153. 161 Bolton Engineering v TJ Graham & Sons [1957] 1 QB 159; El Ajou v Dollar Land Holdings plc [1994] 2 All ER 685. 162 [1995] 2 AC 500. 163 See, eg Re Clasper Group Services Ltd (1988) 4 BCC 673 and Re Agriplant Services Ltd [1997] 2 BCLC 598 (state of mind of director and majority shareholder held to be material in both cases). See also discussion of the point in Re Exchange Travel (Holdings) Ltd [1999] BCC 291. 164 Above, paras 4.47–4.50.

164 Adrian Walters purposes of section 239(5) there are broadly four possibilities: (i) in making the payment the company was influenced solely by a desire to prefer the guarantor; (ii) the company was influenced solely by a desire to prefer the creditor; (iii) the company wished to prefer both the guarantor and the creditor; or (iv) the company acted purely on the basis of commercial considerations and did not wish to prefer anyone. If, as will often be the case, the creditor is a bank or some other well-resourced credit provider, the ideal outcome for an office holder is to recover the payment leaving the creditor to pursue the guarantor under the original bargain. It appears from Re Agriplant Services Ltd165 that this outcome can only arise in case (iii) above. 4.76 In Agriplant, the company leased plant and equipment from an asset financier, CAF. S, a director who was also the company’s majority shareholder, guaranteed rental payments under the lease. The company got into financial difficulties and S suspended the rental payments. CAF pressed for payment and threatened to repossess the plant. As the company’s financial position worsened S consulted an insolvency practitioner who advised that the company should go into creditors’ voluntary liquidation. S was expressly advised that no payments to creditors should be made pending the passing of the necessary resolution. Three weeks before the company went into liquidation a payment of £20,000 was made to CAF. The joint liquidators brought proceedings under section 239 against CAF and S. The judge held that the liquidators could only be entitled to an order under section 241 against a person if the company was ‘influenced . . . by a desire to produce in relation to that person the effect mentioned in subsection (4)(b)’. In relation to S, he found that the company was influenced by a desire to reduce S’s exposure under the guarantee and to reduce the debt owing to CAF in the hope that this would persuade CAF to allow another company controlled by S to take over the leases. In relation to CAF, he found that the company was influenced by the requisite desire because it was only by improving CAF’s position that S’s own position under the guarantee could itself be improved. Direct evidence to the effect that S had procured the company to make the payment so as to prevent CAF from carrying out its threat to repossess the plant was rejected. A finding that the company was influenced by a desire to prefer the guarantor can apparently therefore ground an inference that it was also influenced by a desire to prefer the principal creditor. 4.77 It is submitted that Agriplant should be handled carefully. In procuring the payment, S was acting against professional advice at a time when he knew that liquidation was imminent. This evidence strengthened the inference that the aim of the payment was to improve both his own position and that of CAF. It would also be open to the court, following MC Bacon, to find in an appropriate case (i) that the company should not be taken as desiring all the necessary consequences of its actions and (ii) that it wished to prefer the guarantor but did 165

[1997] 2 BCLC 598.

Preferences 165 not positively wish to prefer the principal creditor with the result that the improvement in the principal creditor’s position was merely an unwanted side effect of its main purpose. In such a case (applying MC Bacon and contra Agriplant) an action lies only against the guarantor because there is no desire in relation to the creditor to produce the effect mentioned in section 239(4)(b). 4.78 Conversely, the mere fact that the company gives a factual preference to the principal creditor does not automatically lead to an inference that the company was influenced by a desire to prefer the guarantor. If, for example, the preference is given in response to creditor pressure, the improvement in the guarantor’s position is arguably a ‘necessary evil’: a natural rather than a desired consequence of the main transaction. It is suggested that much will depend on the facts of each case and the court’s impression of any witnesses. The second implication of Agriplant, that the court can seemingly only make an order under section 241 affecting the principal creditor and the guarantor if all the elements of the cause of action, including desire to prefer, are established in relation to both parties, is revisited below.166 4.79 The technical and evidential complexities of section 239(5) have led some to argue that the requirement should be abandoned and that the office holder should simply have to establish that the transaction under review was preferential in effect, i.e. a factual preference.167 The justification put forward for this view is that the test, as interpreted in MC Bacon, amounts to a further erosion of the pari passu principle. Whether a creditor gets to keep or surrender a preference turns on a difficult enquiry into subjective mental states which produces arbitrary results and does not promote equal treatment. A further element of this argument is that section 239(5) positively encourages large corporate or institutional creditors to use their economic leverage to secure payment at the expense of unsecured trade creditors whose bargaining power is comparatively weak.168 At the same time, it must be said that the current provision reflects the view, echoed by the Insolvency Law Review Committee, that preference law should only be used to set aside ‘really improper’ transactions.169 As such, the requirement in section 239(5) gives the courts room to uphold transactions on grounds of commercial or moral expediency even though the result may undermine insolvency law’s distributional rules. On this view, the outcome in MC Bacon can be supported as the setting aside of the security in such cases could lead to a reduction in the supply of credit to ailing companies. If that were so 166

Paras 4.98–4.99. See, eg A Keay, ‘Preferences in Liquidation Law: Time for a Change’ [1998] Company Financial and Insolvency Law Review 198. 168 See I Fletcher, ‘Voidable Transactions in Bankruptcy’ in J Ziegel (ed) Current Developments in International and Comparative Corporate Insolvency Law (Oxford, Clarendon Press, 1994) at 309. 169 Cork Report, para 1256(a). The Committee rejected a proposal to bring English law into line with Australian law by dispensing with the requirement of an intention to prefer and allowing recovery purely on the basis of preferential effect. 167

166 Adrian Walters then many struggling, but viable companies could be forced into premature liquidation on the back of an overly strict adherence to the principle of equal treatment.170 Anxieties about the extent to which insolvency norms should be allowed to ‘trump’ ordinary commercial norms (such as creditor diligence) and be used to justify the retrospective adjustment of settled transactions may also tacitly operate through section 239(5).171 The modern unlawful preference therefore remains in line with what Fletcher has described as ‘the traditional concept of . . . an impeachable preference, namely a debtor’s conscious attempt in contemplation of the onset of insolvency to place certain creditors—typically friends, relatives or associates—in an advantageous position vis-à-vis the general body of creditors.’172 (c) The presumption in section 239(6): meaning of ‘connected persons’ 4.80 As well as recommending the retention of the troublesome requirement of an intention to prefer, the Insolvency Law Review Committee recommended that the burden of proof should be reversed in cases where debtor and creditor were not at arm’s length.173 A comprehensive statutory definition of the circumstances in which parties would be regarded as so closely connected to one another as to be transacting other than at arm’s length was also proposed.174 The object was to make it easier for the office holder to challenge payments and transactions that the Committee regarded as morally dubious but which might have been difficult to impeach under the old ‘dominant intention to prefer’ test. The Committee’s recommendation is implemented by section 239(6) which provides that a company is presumed, unless the contrary is shown, to have been influenced by a desire to prefer where it gave a preference in favour of a person connected with the company. The underlying moral justification for this differential treatment of arm’s length creditors and connected persons is that directors, who are best placed to know the company’s financial position, may well be tempted to distribute the company’s assets to themselves, their relatives or associated companies once they are aware that liquidation is imminent. It follows that there will often be little or no commercial justification for a preference in favour of a closely connected party. The presumption in section 239(6) therefore reinforces the thesis that English preference law’s main object is to impeach a narrow category of ‘improper’ preferences involving the conscious (and there170 See para 4.23 above and discussion along these lines in Fletcher’s note on MC Bacon at [1991] Journal of Business Law 71. For other cases where the courts have upheld transactions broadly on the ground that the company’s conduct was commercially justified see Re Lewis’s of Leicester [1995] 1 BCLC 428 and Re Branston & Gothard Ltd [1999] BPIR 466. Section 239(5) also allows scope for defendants to argue that the preference was a payment or transaction made in the ordinary course of business or as part of a running account. 171 Arguably a deliberate policy: see Cork Report, para 1256. 172 [1991] Journal of Business Law 71 at 74. 173 Cork Report, paras 1257–58. 174 Ibid ch 21.

Preferences 167 fore morally questionable) manipulation of the insolvent company’s assets for no good commercial reason. 4.81 The presumption does not apply to a creditor who receives a preference by reason only of being the company’s employee. Thus, if a company pays its employees arrears of wages the ordinary rule in section 239(5) would apply.175 Section 249 provides that a person is connected with a company in three circumstances: (i) if he is a director or shadow director of the company; (ii) if he is an associate of a director or shadow director of the company; or (iii) if he is an associate of the company.176 The classic ‘connected person’ case is the preference in favour of a director. In a number of cases, office holders have successfully challenged pre-liquidation repayments of directors’ unsecured loan accounts. The availability of the presumption puts the onus on the director to show that, in deciding to make the repayment, the company was not influenced by a desire to prefer the director. It is difficult for the director to discharge this burden, as he will need to explain why the company chose to pay off his loan account and not other outstanding creditors.177 4.82 The term ‘associate’ is defined exhaustively in section 435.178 The following would fall into the category of associates of a director: the director’s husband, wife or relative;179 the director’s business partner or the husband, wife or relative of any individual with whom the director is in partnership;180 any other company controlled solely by the director or by the director together with others who are his associates.181 The trustees of a trust the beneficiaries of which include a director or his associates are also treated as the director’s associates unless the trust is a pension scheme or an employees’ share scheme.182 A 175 Without the specific wording in s 239(6), an employee would be an associate of the company and therefore a connected person because of the combined effect of sections 249(b) and 435(4). Note that the presumption would apply in the case of a payment of salary arrears to a director or an associate of a director as there the preference is not solely referable to the employment relationship. 176 It is suggested that the term ‘director’ encompasses de facto directors as well as de jure directors and shadow directors. Ss 238 and 239 share the same ‘connected persons’ provisions and so the material at this point overlaps with the discussion at paras 2.41–2.49. 177 See Re DKG Contractors Ltd [1990] BCC 903; Weisgard v Pilkington [1995] BCC 1108; Re Exchange Travel (Holdings) Ltd [1996] 2 BCLC 524 affirmed [1999] BCC 291; Wills v Corfe Joinery Ltd [1998] 2 BCLC 75; Re Brian D Pierson (Contractors) Ltd [2001] 1 BCLC 275. 178 See generally Muir Hunter, ‘Associateship Under the Insolvency Act 1986’ Insolvency Intelligence 1988, 1(10), 73–75. 179 S 435(2). Relatives are broadly defined to include brothers, sisters, uncles, aunts, nephews, nieces, lineal ancestors and lineal descendants: s 435(8). Stepchildren, adopted children and former or reputed spouses are also expressly included. 180 S 435(3). 181 S 435(7), (10). 182 S 435(5). It was held in Re Thirty-Eight Building Ltd [1999] 1 BCLC 416 that where a company repays a loan from a trust, the ‘creditor’ for the purposes of section 239(4) is the trustees collectively. Thus, by virtue of s 435(5)(b), as long as there is at least one independent trustee, the trustees of a family pension scheme will not be treated as ‘associates’ even though the main beneficiaries under the scheme are the company’s directors and their associates.

168 Adrian Walters company is an associate of another company where both companies are under common control or where the second company is controlled by associates of the person controlling the first company or by a combination of that person and his associates.183 (d) Rebutting the presumption in section 239(6) 4.83 Given that the purpose of the presumption is to prevent those in a fiduciary position advancing themselves or their associates at the expense of other creditors the burden on the connected person will not be easily discharged. To rebut the presumption, the connected person will generally need to show that, in deciding to give the preference, the company was ‘actuated only by proper commercial considerations’.184 Where the connected person is a director, he will face the often insuperable difficulty of explaining why the company chose to give him favourable treatment over other unconnected creditors.185 The burden may be easier to discharge if the connection between the company and the recipient of the preference is more tangential. Take the example of an insolvent company, X Ltd, that has a history of regular dealings with another company, Y Ltd. Let us say that an aunt of the sole director of X Ltd owns 40% of Y Ltd’s voting capital. By virtue of sections 249(b) and 435(2), (6)(a), (8) and (10)(b), Y Ltd is a connected person by virtue of the family relationship and the size of the aunt’s shareholding. The director may be able to show that he and his aunt are not on friendly terms or that he was not aware of her stake in Y Ltd. The example illustrates the point that the presumption may bring different considerations into play depending on the degree of closeness between the company and the connected person. In practice, notwithstanding the width of the associateship concept, it should be easier to persuade the court to discount a remote family connection than to explain away a preference given to a director. 4.84 There are two reported cases in which directors have successfully rebutted the presumption. In the first, Re Fairway Magazines Ltd, a director was preferred where sums advanced by him to the company on the security of a floating charge were used to reduce the bank overdraft of which he was a guarantor.186 The 183 S 435(6). A person has control of a company if either (i) the directors of the company or of another company which has control of it are accustomed to act in accordance with his directions or instructions or (ii) he is entitled to exercise, or control the exercise of, one third or more of the voting power at any general meeting of the company or of another company which has control of it: section 435(10). For a case in which a parent company was held to be an associate of its insolvent wholly owned subsidiary: see Re Shapland Inc [2000] BCC 106. 184 Per Millett J in Re MC Bacon [1990] BCLC 324 at 336. See also Wills v Corfe Joinery Ltd [1998] 2 BCLC 75. 185 See Re DKG Contractors Ltd [1990] BCC 903; Weisgard v Pilkington [1995] BCC 1108; Re Exchange Travel (Holdings) Ltd [1996] 2 BCLC 524 affirmed [1999] BCC 291; Wills v Corfe Joinery Ltd [1998] 2 BCLC 75; Re Brian D Pierson (Contractors) Ltd [2001] 1 BCLC 275. 186 [1993] BCLC 643. The factual preference element of the case is discussed more fully in para 4.50 above.

Preferences 169 director’s case was that he had injected the funds to enable the company to continue publishing its main asset, a magazine title, pending negotiations for a sale. Accepting this evidence, the judge found that the company was influenced solely by commercial considerations in making its decision. The company had reached the limit on its overdraft and any goodwill in the magazine would have been lost if publication had ceased. The company’s ‘desire’ was therefore to preserve the goodwill in the title while negotiations for its sale were taking place. The decision suggests that the courts may be reluctant to penalise directors who are prepared to inject more of their own money in order to steady the ship. Fairway Magazines therefore falls within Millett J’s dictum in MC Bacon to the effect that a company in distress can lawfully procure further financial support as long as in so doing it is actuated only by proper commercial considerations.187 4.85 The second case, Re Beacon Leisure Ltd,188 is a more marginal, and arguably unreliable authority. A company traded as a snooker club in premises held by two of its shareholders and directors, N and B, on lease from the company’s remaining shareholder and director, R. The company habitually discharged N and B’s obligations to R by paying the rent. By December 1987 the company was in cash flow difficulties. N, who was in charge of managing the business, knew of the cash flow problem and had consulted the company’s accountants. He was advised by the accountants not to close down the business in December, as Christmas trade would be lost. The clear implication was that the company might have to cease trading in the near future. In late-December the company paid R £13,000 representing the quarter’s rent due on 1 January 1988. Under the terms of the lease, the rent could have been paid without penalty at any time from 1 January up to 14 January. The company went into creditors’ voluntary liquidation one month later. The court found that the payment amounted to a factual preference of N and B.189 However, despite the presumption in section 239(6), it was held that the company was not influenced by a desire to prefer the two directors. The judge accepted N and B’s evidence that they had no such desire. B was not involved in the day-to-day management of the company and the court found that he simply concurred in making the payment without having any desire at all. In N’s case, it was accepted that the company had never paid the rent in the full amount on the due date but rather had paid it as and when funds became available and often in advance. Thus, it was only the imminence of the liquidation that made the payment look suspicious and, in this respect, the court accepted that N was not aware that liquidation 187 Note, however, that the floating charge was partially set aside under Insolvency Act 1986 s 245: see para 5.56. 188 [1992] BCLC 565. 189 It was said that by paying the rent, the company relieved N and B of their liability to R. Presumably, the point is that if N and B had paid the rent, as required by the lease, any right of recoupment from the company whether qua licensee or qua sub-tenant would have been an unsecured claim in its liquidation. There was no preference of R as the company and R were not in a debtor-creditor relationship.

170 Adrian Walters was imminent and refused to infer that N was so aware on the basis of the advice he had received from the accountants in December 1987. 4.86 There are a number of problems with the decision in Beacon Leisure. Firstly, in the light of subsequent developments in the realm of directors’ duties, it is unlikely that such a lenient view would now be taken of a ‘sleeping’ director like B. It is now accepted that directors have at least some minimum responsibility to acquaint themselves with the company’s affairs and its financial position.190 Secondly, it was surely incumbent on N and B to give some explanation as to why the rent was paid and other creditors were not, especially in circumstances where the recipient was also a member of the company. The judge simply treated the payment as one made in the ordinary course of the company’s business. Another judge may have been prepared to draw adverse inferences from the available evidence and used those to reinforce the statutory presumption.191

(4) Relevant time (a) Temporal limitation 4.87 The effect of section 239(2) is that a preference can only be set aside if it was given at a relevant time. ‘Relevant time’ is defined in section 240 for the purposes of both sections 238 and 239. Generally speaking, a preference can only be set aside if it was given during the period of six months ending with the ‘onset of insolvency’. However, in the case of a preference given to a connected person the twilight period is extended to two years. This reflects the Insolvency Law Review Committee’s recommendation that the statutory period should be lengthened in certain cases where the parties were not at arm’s length.192 It was felt that directors could all too easily arrange for the company to pay themselves and their associates and then keep the company afloat just long enough for the six-month period to expire. In theory, the longer two-year period reduces the scope for this kind of abuse. The choices of six months and two years are essen190 See generally, A Walters & M Davis-White, Directors’ Disqualification: Law and Practice (London, Sweet & Maxwell, 1999); A Walters, ‘Directors’ Duties: The Impact of the Company Directors’ Disqualification Act 1986’ (2000) 21 Company Lawyer 110 and cases therein cited. 191 In fairness to the deputy judge who decided the case, the liquidator did not support a general assertion that other creditors were pressing at the time when the payment to R was made with any concrete evidence. Nevertheless, the onus was on the directors to give some convincing explanation. The emphasis in the judgment on the ordinariness of the transaction and the directors’ lack of knowledge of the company’s imminent liquidation suggests that a ‘good faith’ defence similar to that in section 238(5) relating to transactions at an undervalue was tacitly operating. 192 Cork Report, paras 1259–63. It appears from this part of the report that the Committee intended the category of connected persons to be narrower than that provided for in ss 249 and 435. An extended statutory period covering preferences where the parties were not at arm’s length is used in other jurisdictions, notably Australia and America.

Preferences 171 tially arbitrary.193 They represent an attempt to balance the goal of equal treatment in insolvency against the need for finality of transactions in the commercial world. The overall effect of section 240(1) is that a preference given outside the six-month period but within the two-year period is only susceptible to challenge if the recipient was a connected person.194 4.88 The six-month or two-year period ends with, and so is calculated by reference to, the ‘onset of insolvency’. The draftsman’s use of the term ‘insolvency’ is unfortunate. The term is commonly used as shorthand for the company’s financial state whereas in this context it denotes the company’s entry into a formal insolvency regime. In the case of a company in liquidation, the twilight period ends on the date that liquidation commenced. A voluntary liquidation is deemed to commence at the time the company resolved to go into liquidation.195 In a compulsory liquidation, the date of the presentation of the petition rather than the date of the order is generally treated as the point of commencement. However, if the company was already in voluntary liquidation when the petition was presented, liquidation is deemed to have commenced at the time the company resolved to go into voluntary liquidation.196 No provision is made in section 240(3) for the case where a company passes from members’ voluntary into creditors’ voluntary liquidation. The effect of section 96 is that the company is not required to pass a further resolution in order for the company to pass into creditors’ voluntary liquidation. This suggests that the process of conversion is seamless and that the ‘onset of insolvency’ for these purposes would be the date on which the company resolved to go into members’ voluntary liquidation. 4.89 A final point of some importance in practice concerns the situation where the company passes from administration into voluntary liquidation. If the administrator wishes to bring section 239 proceedings, the twilight period is calculated by reference to the date on which the petition for an administration order was presented. However, if the company goes from administration into voluntary liquidation, the relevant date is the commencement of the liquidation unless the company went into liquidation ‘immediately upon the discharge of [the] administration order’ within section 240(3)(a). Thus, if the liquidation does not follow immediately after the administration, the liquidator will only be able to challenge transactions occurring within six months or two years of the liquidation. To ensure that the liquidator is put in a position to challenge preferences going back further than this (i.e. occurring within six months or two

193 The point is illustrated by the variety of time periods used in other jurisdictions: eg 90 days/one year in the United States; six months/four years in Australia. 194 See Re Thirty-Eight Building Ltd [1999] 1 BCLC 416, a case which turned on the judge’s finding that the trustees of the company’s pension scheme were not ‘associates’ within s 435. 195 Insolvency Act 1986 s 86. 196 Ibid s 129. Any disposition of the company’s property made after the date of a winding up petition will be caught by s 127: see ch 8.

172 Adrian Walters years ending on the date of the administration petition), the Companies Court will order that discharge from administration only takes effect at the time when the company resolves to go into voluntary liquidation.197 (b) Requirement of insolvency 4.90 It is not enough to show that the company gave the preference within the applicable time period. The office holder must also establish that the company was either unable to pay its debts within the meaning of section 123 of the Insolvency Act 1986 when it gave the factual preference or that it became unable to pay its debts as a result. Under section 123 the company is deemed unable to pay its debts if it is proved that the company is unable to pay its debts as they fall due or that the value of its assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities. Thus, it will suffice if the office holder can establish that the company was insolvent (or became insolvent) applying either the cash flow or balance sheet test of insolvency.198 The availability of the cash flow test eases the burden on the office holder as, if the point is not conceded, the court may be willing to infer that the company was unable to pay its debts as they fell due where there is evidence that other creditors were not being paid (such as dishonoured cheques or unpaid invoices).199 Equally, there are cases which suggest that the court may be prepared to infer that the company was balance sheet insolvent. This is especially so where the directors failed to keep proper books and records200 or where the accounts for the relevant period contain a going concern qualification.201 In contrast to the position in relation to transactions at an undervalue, insolvency is not presumed in the case of a preference to a connected person.

F REMEDIES

4.91 If all the substantive elements are made out, the effect of section 239(3) is that ‘the court shall . . . make such order as it thinks fit for restoring the position to what it would have been if the company had not given [the] preference.’ The use of the word ‘shall’ in section 239(3) suggests that the court is bound to make some attempt to restore the status quo ante if all the elements of the cause of action are established. However, it was held by the Court of Appeal in Re Paramount Airways Ltd that, despite the use of the verb ‘shall’, the phrase, ‘such order as it thinks fit’ confers a broad discretion enabling the court, in an appro-

197 198 199 200 201

Re Norditrack (UK) Ltd [2000] 1 WLR 343. For further discussion of these two tests of factual insolvency see paras 2.33–2.40. Re DKG Contractors Ltd [1990] BCC 903 at 911. See, by analogy, Re Produce Marketing Consortium Ltd [1989] BCLC 520. Re Mistral Finance Ltd [2001] BCC 27.

Preferences 173 priate case, to make no order.202 Nevertheless, it is submitted that the court will virtually always make some form of restorative order.203 Section 241, a composite provision applying both to preferences and transactions at an undervalue,204 specifies various orders that the court can make without in any way seeking to fetter its discretion and is expressly without prejudice to the generality of section 239(3).205 The orders specified are as follows: 4.92 (1) An order requiring any property transferred in connection with the giving of any preference to be vested in the company. (2) An order requiring any property to be so vested if it represents in any person’s hands the application either of the proceeds of sale of property so transferred or of money so transferred. (3) An order releasing or discharging (in whole or in part) any security given by the company. (4) An order requiring any person to pay, in respect of benefits received by him from the company, such sums to the office holder as the court may direct. (5) An order providing for any surety or guarantor whose obligations to any person were released or discharged (in whole or in part) by the giving of the preference to be under such new or revived obligations to that person as the court thinks appropriate. (6) An order providing for security to be provided for the discharge of any obligation imposed by or arising under the order, for such an obligation to be charged on any property and for the security or charge to have the same priority as a security or charge released or discharged (in whole or in part) by the giving of the preference. (7) An order providing for the extent to which any person whose property is vested by the order, or on whom obligations are imposed by the order, is to be able to prove in the winding up of the company for debts or other liabilities which arose from, or were released or discharged (in whole or part) under or by the giving of the preference. 4.93 It is important to stress that the court is enjoined by section 239(3) to grant appropriate relief adjusting the position between the parties as it stands at the date of the order to what it would have been if the company had not given the preference. Strictly speaking, the transaction giving rise to the preference is

202

[1993] Ch 223 at 239. Thus, for example, in Pegulan Floor Coverings Pty Ltd v Carter (1997) 24 ACSR 651, a case decided under what is now s 588FA of the Australian Corporations Act 2001, it was held that the court should not decline to make an order simply because the recoveries would be used to meet the costs of liquidation therefore conferring no direct benefit on creditors. 204 The coverage at this point therefore overlaps with paras 2.121–2.133. 205 See Walker v WA Personnel Ltd (unreported, 15 March 2002), a judgment concerning a transaction at an undervalue but which applies mutatis mutandis to preferences as the wording of ss 238(3) and 239(3) is identical in all material respects. 203

174 Adrian Walters not avoided retrospectively. The court merely seeks to reverse the effects of the transaction. The forms of order in (1), (2), (3) and (4) are directly remedial while those in (5), (6) and (7) are ancillary. The office holder will proceed by applying for a declaration that the transaction is an unlawful preference within the terms of the section coupled with appropriate consequential relief.206 In most cases an order will be made against the counterparty under (1), (2), (3) or (4). However, it is clear from the wording of section 241(1) that the court also has jurisdiction to make orders against third parties in an appropriate case.207 4.94 The precise relationship between section 239(3), section 241 and the general law is less clear. What is certain is that section 239(3) is the governing provision. Section 241(1) is merely illustrative of the types of consequential relief that would be available, in any event, under the general law. So, for example, claims to recover property in specie or money preferences under (1), (2) and (4) above are closely analogous to common law claims for restitution of unjust enrichment. That being so, it seems at least arguable that the jurisdiction in section 239(3) should be exercised in line with the general law with the consequence that the defences ordinarily available to meet a claim for restitution would be available to meet a claim for recovery based on section 239. Accordingly, there is a case for saying that parties who receive the benefit of an unlawful preference in good faith and/or change their position on the assumption that the transaction is valid should be entitled to relief.208 It is as yet unclear whether the English courts would be prepared to read such a defence into sections 239–241 in the absence of express statutory provision.209

(1) Remedies against the preferred creditor 4.95 The most compelling theory available to justify recovery, be that from direct recipients or third parties, is that the defendant has been unjustly enriched as a result of the unlawful preference at the expense of the insolvent company’s other creditors.210 The object of section 239(3) is therefore restitutionary rather than compensatory. It follows that many of the remedies available in section 239 cases are closely analogous to those available to reverse unjust enrichment.

206 See, eg E Bailey, H Groves and C Smith, Corporate Insolvency: Law and Practice, 2nd edn (London, Butterworths, 2001) at 540. 207 Below, paras 4.96–4.97. 208 On this point see generally ch 9 and, with particular reference to transactions at undervalue, paras 2.21–2.22 See also J O’Donovan, ‘Undue Preferences: Some Innocents “Scape Not the Thunderbolt” ’ (1992) 22 Western Australian Law Review 322. 209 It has been thought fit in other jurisdictions to enact specific counterparty defences. A good example is Australia where s 588FG of the Corporations Act 2001 provides a defence combining elements of good faith and change of position. 210 See generally ch 9 and A Keay, ‘The Recovery of Voidable Preferences: Aspects of Restoration’ [2000] Company Financial and Insolvency Law Review 1.

Preferences 175 Remedies against a preferred creditor fall broadly into three categories. Firstly, where the preference takes the form of a payment, the preferred creditor will usually be required to repay an equivalent sum to the office holder under section 241(1)(d).211 An order under section 241(1)(d) will usually be coupled with a further order under section 241(1)(g) authorising the creditor to prove in the company’s winding up for the original debt. The object of section 239(3) is to restore the status quo ante and, as has been pointed out elsewhere, it would be unfair to bar the defendant from proving his debt when he would have been allowed to do so had the company not given him a preference.212 The court can also require the defendant to secure repayment under section 241(1)(f). Secondly, where the preference takes the form of a security for an antecedent debt, the court can order the release or discharge of the security under section 241(1)(c). Thirdly, where the preference involves a transfer of company property, the court can order it or any other property acquired by the transferee using the proceeds of the original property to be vested in the company. As the aim is solely to restore the position to what it would have been if the company had not given the preference, the court is likely to adjust its order if the property has increased or declined in value in the defendant’s hands so as to maintain a fair balance between the parties.213

(2) Remedies against third parties 4.96 It is clear from the wording of section 241(1) that the court is not restricted to making orders against the immediate counterparty. The point is confirmed by the opening words of section 241(2) which state that, ‘an order under section 239 may affect the property of, or impose any obligation on, any person whether or not he is . . . the person to whom the preference was given.’ Let us say that A Ltd owns a Mercedes car which it transfers to X in satisfaction of a debt. X then sells the car to Y and deposits the proceeds of sale with his bank. Assuming the original transfer is an unlawful preference, the court could in theory order Y to revest the Mercedes in the company under section 241(1)(a) or order the bank to pay over the proceeds of sale. 4.97 Third parties are, however, protected by section 241(2). This gives a party who acquired an interest in property or received a benefit from the preference in good faith and for value with a full defence to an action for recovery by the office holder. Generally speaking, this would operate to protect Y and

211 Ibid at 10. The action in such cases is closely analogous to an action at common law for money had and received. 212 Ibid at 14. However, the court will not allow the defendant to set off his liability to repay the amount of the preference against the company’s liability for the original debt: Re A Debtor [1927] 1 Ch 410 and see A Keay, Avoidance Provisions in Insolvency Law (Sydney, LBC, 1997) at 331–32. 213 Ibid at 15–18 and see further ch 9.

176 Adrian Walters the bank in the example given above.214 Under section 241(2A), the third party is presumed not to have acted in good faith if, at the time he acquired the interest or benefit either: (i) he had notice of the relevant surrounding circumstances and of the relevant proceedings or (ii) he was connected with, or was an associate of, either the company or the counterparty. The relevant surrounding circumstances are defined in section 241(3)(b) as ‘the circumstances which amounted to the giving of the preference by the company in question.’ One difficulty is that it is not clear exactly what the third party would need to know to fall prey to the presumption. Would it be enough for him to know that the counterparty was a creditor whose position had been improved as a result of the transaction and that the preference had been given at a time when the company was insolvent? Or would it also have to be shown that he was aware that the company was influenced by a desire in deciding to give the preference? The only clue seems to lie in section 239(4) which defines what is meant by the giving of a factual preference both for the purposes of section 239 and section 241. This suggests that the third party would at least have to know that the original transaction amounted to a factual preference. As well as the relevant surrounding circumstances, the third party must also have notice of the relevant proceedings. As explained in section 241(3A)–(3C), he has notice of the relevant proceedings if he has notice that the company is in liquidation or administration or that a petition for winding up or administration has been presented. The concepts of connected persons and associates were discussed earlier and apply in the same way to the second limb of the presumption in section 241(2A).

(3) Three-cornered preferences 4.98 We saw earlier that the payment of a guaranteed debt may be an unlawful preference of either or both of the principal debtor and the guarantor. Where the cause of action is made out against the guarantor, there is no doubt that the court can order him to account to the office holder for the value of the preference under section 241(1)(d). Let us say that A Ltd owes a creditor, X, £50,000. Y, who is a director of A Ltd, guarantees repayment. If, just prior to going into liquidation, A Ltd repaid X in full, the court might well find that the payment was an unlawful preference of Y especially bearing in mind that desire to prefer would be presumed because Y is a connected person. In this event, the court could order Y to pay £50,000 representing the value of the preference. If the

214 Another classic case is that of a third party mortgagee who acquires security rights over an asset that the counterparty is later ordered to return to the company. In such cases, the court will declare that the counterparty holds the asset on trust for the company, subject to the rights of the mortgagee: see Arbuthnot Leasing International Ltd v Havelet Leasing Ltd (No 2) [1990] BCC 636; Walker v WA Personnel Ltd (unreported, 15 March 2002).

Preferences 177 court finds that the payment is an unlawful preference of both X and Y it can order X to repay the £50,000 and make an order under section 241(1)(e) reviving Y’s obligation under the guarantee (which would have been discharged by the original payment). This was the outcome in Re Agriplant Services Ltd.215 If, alternatively, the court finds that the payment is an unlawful preference of X only, this is unlikely to make any difference to the final order. X will again be ordered to repay the £50,000 and Y’s guarantee obligation will be revived by an order along the lines envisaged by section 241(1)(e). There seems little justification for depriving X of his rights against Y given that the object under section 239(3) is to restore the position to what it would have been if the company had not given the preference. 4.99 An intriguing question is whether the court can allow recovery from the principal creditor, X, in circumstances where the payment amounts to an unlawful preference of the guarantor, Y, but the elements of the cause of action are not established as against X. It was suggested in Re Agriplant Services Ltd 216 that an order can only be made against X if the court is satisfied that the company was influenced by a desire to prefer X. The implication is that an order will only lie against X if the payment amounts to an unlawful preference, as opposed to merely a factual preference of X. With respect, however, this conclusion does not seem to follow. Even if the real object of the payment is to prefer the guarantor, it appears from the broad wording of section 241 that the court would have jurisdiction to make an order affecting the position of the principal creditor under either section 241(1)(a) or section 241(1)(d).217 Whether the jurisdiction would be exercised is, of course, another matter. 4.100 A further complication arises in our example if we assume that the payment to X was made more than six months but less than two years before A Ltd went into liquidation. In that case, the payment could not be challenged directly as an unlawful preference of X because, assuming that X is unconnected, it was not made at a relevant time within section 240(1)(b). As against Y, however, the transaction can be challenged because Y is a connected person and the extended two-year period applies. Goode suggests that an order could only be made against Y in this situation.218 However, Prentice argues that the court’s remedial powers under section 241 are wide enough to allow recovery from X (coupled presumably with an order reviving the guarantee obligation).219 It is submitted that the court does have jurisdiction to make an order against the principal

215 [1997] 2 BCLC 598. If, as will usually be the case, Y is a party to the action, the court can give judgment on the guarantee in X’s favour in the same proceedings. 216 Ibid. 217 See R Goode, Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 404. 218 Ibid. 405. 219 See D Prentice, ‘Some Observations on the Law Relating to Preferences’ in R Cranston (ed), Making Commercial Law (Oxford, Clarendon Press, 1997) at 459.

178 Adrian Walters creditor in this situation. However, it is far from certain that the court would be prepared to exercise this jurisdiction.220

(4) Interest 4.101 In the case of unlawful preferences involving the transfer of money or property, the question arises as to whether the office holder is entitled to interest in addition to an order for repayment or revesting of property under section 241. It appears that as a matter of ordinary principle, the office holder can claim interest to reflect the fact that the defendant has had the use of the money or property. However, there is some doubt as to the date from which interest should be calculated. Clearly, interest cannot run from the date of the transaction itself. This is because the cause of action only accrues and can only be pursued once the company goes into liquidation or administration and an office holder is appointed. English authority on the point suggests that interest should run from the date of commencement of the liquidation or administration.221 However, the better view is that interest should only start to run from the date on which the office holder elects to seek recovery of the money or property by making demand on the recipient. The main justification for this is that the transaction is valid until steps are taken to set it aside and it would arguably be unfair on the recipient for interest to start running before he is made aware that the validity of the transaction is being questioned.222

220 The issue has arisen frequently in the United States. In the landmark case of Levit v Ingersoll Rand Financial Corporation 874 F 2d 1186 (1989), the court held that a bankruptcy trustee was entitled to recover payments from a principal creditor even though, as against that creditor, the transaction could not have been challenged directly. The effect of the decision was to extend the usual preference recovery period of 90 days for outside creditors to one year where the payment benefited an inside (i.e. connected person) guarantor. If the court used section 241 to reach the Levit outcome in our example, then as against X, the principal creditor, the preference recovery period would be indirectly extended from six months to two years simply because the transaction unlawfully preferred a guarantor who was a connected person. An English court might well decide that section 241 should not be used to bring about what amounts to a back-door extension of the ‘relevant time’ period usually applicable to unconnected parties under ss 239(2) and 240(1)(b). It should be noted that Levit was reversed by a 1994 amendment of the US Bankruptcy Code. For further discussion see J Rodenberg, ‘Indirect Preferences: Recovery Under Sections 547 and 550 of the Bankruptcy Code’ (1990) 55 Missouri Law Review 327; D Katzen, ‘Deprizio and Bankruptcy Code Section 550’ (1990) 45 Business Lawyer 511; J Westbrook, ‘Two Thoughts About Insider Preferences’ (1991) 76 Minnesota Law Review 73; M Howard, ‘Avoiding Powers and the 1994 Amendments to the Bankruptcy Code’ (1995) 69 American Bankruptcy Law Journal 259. 221 Re FP and CH Matthews Ltd [1982] Ch 257. 222 See Star v O’Brien (1997) 15 ACLC 144; Pegulan Floor Coverings Pty Ltd v Carter (1997) 24 ACSR 651 and, for further discussion of the point, A Keay, ‘The Recovery of Voidable Preferences: Aspects of Restoration’ [2000] Company Financial and Insolvency Law Review 1 at pp 19–25. On the question of whether simple or compound interest should be awarded see paras 9.28–9.32.

Preferences 179 (5) Destination of recoveries 4.102 A line of authority culminating in the Court of Appeal decision in Re Oasis Merchandising Services Ltd223 suggests that money or property recovered under sections 239–241 does not form part of the company’s assets available for distribution in line with the usual rules of priority but accrues directly to the statutory trust for the benefit of the unsecured creditors. Prima facie, it cannot therefore be claimed by the holder of an all-encompassing floating charge. The reasoning supporting this conclusion is that property recovered after the commencement of liquidation under powers vested exclusively by statute in the office holder never vests in the company and is held on trust for unsecured creditors. If the cause of action does not belong to the company then neither, it seems, can the fruits of such action. 4.103 However, there are a number of points of difficulty, yet to be resolved by the courts, which suggest that the position is more complex than it might appear at first sight: (1) The vesting of the cause of action in the office holder may be merely procedural. (2) There are a number of situations in which the uncritical application of Oasis-type reasoning would produce perverse outcomes. One example suffices. Let us say that the company preferred X by granting a floating charge in his favour and then granted a floating charge in favour of Y. If we assume that X’s charge is struck down as an unlawful preference, the assets thereby liberated should, by rights, go first to satisfy the claim of the junior secured creditor, Y.224 To hold that the assets ‘recovered’ fall into the statutory trust would involve a redistribution of those assets that was surely not intended.225 The answer may be that there are no ‘recoveries’ as such because the object of the action is to set aside X’s charge. Even so, the example suggests that Oasis reasoning will not necessarily apply in blanket fashion to every type of preference ‘recovery’. (3) It is arguable that Oasis-type reasoning does not properly reflect the wording of the statute. The court can make any order it thinks fit for restoring the position to what it would have been if the company had not given the preference. Moreover, there appears to be nothing to prevent the court from 223 [1998] Ch 170. See also Re Yagerphone Ltd [1935] Ch 392; Re MC Bacon Ltd (No 2) [1991] Ch 127; Lewis v Commissioner of Inland Revenue [2001] 3 All ER 499; Starkey v Deputy Commissioner of Taxation (1993) 115 ALR 305; Hamilton v National Bank of Australia (1996) 66 FCR 12. 224 As would be the case with assets liberated by virtue of s 395(1) of the Companies Act 1985: see paras 6.157–6.159. 225 For further development of this argument in the context of transactions at undervalue see paras 2.135–2.145. It should be noted that the example is germane only to the issue of s 239 recoveries as the granting of security for an antecedent debt cannot be challenged as a transaction at undervalue under s 238 following Re MC Bacon Ltd [1990] BCLC 324.

180 Adrian Walters vesting recoveries in the company as opposed to the office holder. Indeed, sections 241(1)(a) and (b) expressly contemplate that property transferred in connection with the giving of a preference will be returned to the company.226 (4) The cause of action vests in an administrator as well as a liquidator. Accordingly, any money or property recovered during the course of an administration would not fall into the statutory trust for unsecured creditors that arises on liquidation. The answer may be that an action brought in administration would be regarded as sui generis with the result that Oasistype reasoning can only safely be applied to the recoveries in a liquidator’s action.227

(6) Overlapping causes of action 4.104 There may be circumstances in which the company has a concurrent right of action against its directors for breach of duty. In West Mercia Safetywear Ltd v Dodd,228 the company gave a factual preference to its parent company. Rather than proceed against the parent company under section 239, the liquidator brought successful proceedings against its controller for failing in his fiduciary duty to act in the company’s best interests.229 Also, circumstances may arise where an office holder can bring proceedings concurrently under sections 238 and 239. Thus, for example, if A Ltd transferred an asset worth £10,000 to X, an unsecured creditor, in full satisfaction of an indebtedness of £5,000, it is arguable that proceedings in relation to the overvalue element would need to be brought under section 238.230

(7) Limitation period 4.105 An application for relief under section 239(3) and section 241 is an action on a speciality within section 8(1) of the Limitation Act 1980 and therefore prima facie subject to a 12-year limitation period. However, there may be cases which are taken outside the scope of section 8(1) by virtue of the combined operation of sections 9(1) and 8(2) of the same Act with the effect in those cases 226 See further R Parry, “The Destination of Proceeds of Insolvency Litigation” (2002) 23 Company Lawyer 49. 227 A point developed in paras 2.144–2.145 228 [1988] BCLC 250. 229 However, since West Mercia the courts have fought shy of allowing office holders to employ a misfeasance action as a means of pursuing what amounts to a claim for recovery of a preference in circumstances where the claim would not satisfy all of the statutory criteria in ss 239–40: see Knight v Frost [1999] 1 BCLC 364 at 381–82; Re Continental Assurance Co of London plc [2001] BPIR 733 at para [420]. 230 Though see Re Clasper Group Services Ltd (1988) 4 BCC 673, a case decided under the old law.

Preferences 181 that the limitation period is reduced from 12 years to six years. The six-year limitation period in section 9(1) applies to ‘an action to recover any sum recoverable by virtue of any enactment’. Thus, an action to recover a preference involving the payment of a sum of money would have to be commenced within six years of the date of the winding up order. However, an action to recover property in specie under section 239(3) and section 241(1)(a), not being an action to recover a ‘sum’, is apparently the subject of the 12-year period.231 The applicable limitation period therefore depends on the precise relief sought. For the avoidance of doubt, office holders are best advised to commence section 239 proceedings within six years.232

231 Re Priory Garage (Walthamstow) Ltd [2001] BPIR 144. In this case, an action was brought under ss 238 and 239 to recover two leasehold titles that had been transferred to one of the company’s directors. The office holder also claimed a sum representing the company’s loss of income from the properties. The court held that both heads of claim were the subject of the twelve-year period and therefore not statute-barred. Although the claim for loss of income was a money claim, this was said to be merely ancillary to the claim for revesting of the properties as revesting alone would not restore the company to its original position. 232 Ibid. Limitation aside, the office holder will need to prosecute the action diligently and speedily as otherwise the court may strike it out on grounds of inexcusable delay under the Civil Procedure Rules: Hamblin v Field [2000] BPIR 621.

5

Late Floating Charges HOWARD N BENNETT

A THE PROBLEM OF LATE FLOATING CHARGES

(1) Introduction 5.1 The potentially wide-ranging nature of a floating charge generates the possibility of the entirety of a company’s assets being appropriated to the benefit of one preferred creditor to the corresponding prejudice of the company’s unsecured creditors. While English law accepts such global appropriation as in principle legitimate, the prospect thereof in the twilight period before the onset of insolvency has long attracted legislative restriction. To the extent that new value is given in return for the floating charge, no prejudice is occasioned to the unsecured creditors and the floating charge is pro tanto valid. Beyond the extent of that new value, however, the charge is invalid.

(2) The Legislative History 5.2 Legislation restricting the validity of late floating charges was first introduced by the Companies Act 1907. Section 13 provided as follows: Where a company is being wound up, a floating charge on the undertaking or property of the company created within three 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 to the amount of any cash paid to the company at the time of or subsequently to the creation of, and in consideration for, the charge, together with interest on that amount at the rate of five per cent. per annum.

5.3 The following year, the section was re-enacted in identical terms as section 212 of the Companies (Consolidation) Act 1908. Thereafter, the section was re-enacted substantially verbatim, except for a progressive extension of the twilight period, as section 266 of the Companies Act 1929, section 322(1) of the Companies Act 1948, and section 617(1) of the Companies Act 1985. This latter section was repealed the following year and replaced by the current legislation, namely section 245 of the Insolvency Act 1986. This latest incarnation sees a

184 Howard N Bennett number of changes in wording, many of significance. The outline of section 245 is as follows. 5.4 First, section 245(1) addresses the applicability of the section, extending it to administration as well as insolvency. Secondly, there must be a floating charge (section 245(2)). Thirdly, the floating charge must have been created ‘at a relevant time’. This requirement is stated by section 245(2) while ‘relevant time’ is defined by subsections (3)–(5). This definition introduces a distinction between persons connected to the company and persons not so connected, in the latter case rendering the section easier to invoke by extending the twilight period and relaxing a financial pre-condition to the operation of the legislation. Fourthly, the floating charge remains valid to the extent that new consideration has been afforded to the company. The scope of acceptable consideration for these purposes is defined by section 245(2), amplified in one respect by subsection (6). In comparison with the earlier legislation, this definition broadens significantly the scope of what in substance is acceptable, but has given rise to case law that is more restrictive in terms of when the consideration must be made available to the company.

(3) Restriction to Floating Charges 5.5 Perhaps the most notable feature of this legislation is its restriction to floating charges. Why, it may be asked, does it not extend to the fixed charge? While a fixed charge may not be taken over a company’s entire undertaking, where the company faces insolvency the obtaining of a fixed charge will, subject to the rules on preferences, promote the position of the chargee ahead of most other creditors. Alternatively, if the law on preferences offers an adequate protection against an undue gaining of priority during the twilight period before an insolvency, why is a further provision required for floating charges? In short, surely the legislation ought to be either extended to embrace fixed charges or abolished altogether. The Cork Committee,1 however, resisted suggestions for both extension and abolition. 5.6 An extension of the legislation to fixed charges, it argued, would not necessarily benefit any affected party. A creditor with an ongoing business relationship with the company might prefer a charge to pursuing a demand for immediate payment, especially if such pursuit might force the company into insolvency thereby jeopardising recovery of existing indebtedness and foregoing any prospect of future business. Moreover, other parties stood to benefit if a creditor in a position to force a company into insolvency might be persuaded to stay its hand in return for a security.

1

Report of the Review Committee, Insolvency Law and Practice (1982, Cmnd 8558).

Late Floating Charges 185 5.7 The continuation of the debtor’s business made possible by the principal creditor’s acceptance of security in lieu of payment often in the end proves advantageous to the other creditors, to the employees, and to the community. Any change in the law which enabled a security, even for an existing debt, given at arm’s length in the ordinary course of business and in response to normal commercial pressures, to be set aside merely because the bankruptcy or liquidation of the debtor supervened within a specific period thereafter, would have the most unfortunate consequences. It would compel many creditors who would otherwise be content to accept security to demand immediate repayment instead, and would often result in the very failure which it was in their own interests, as well as in the wider interest of the community, to avert.2 5.8 However, while a wish to avert unnecessary corporate insolvencies justified the exclusion of fixed charges from what is now section 245, the ability of a floating charge to attach to future property demanded that special provision be made for floating charges over and above the rules on preferences. The Cork Committee reasoned as follows:3 The floating charge is an excessive security because, unlike a fixed charge, it extends to future assets not paid for by the company. It is one thing to permit a prudent creditor, fearing for the solvency of his debtor, to insist either upon payment of the debt due to him or a fixed charge upon existing assets of his debtor instead. That is ‘priority gaining’, but it is tolerable. It is quite another matter to permit a creditor, concerned for the solvency of his debtor, to take a security which will allow the debtor to trade and acquire further assets on credit with which to swell the security at the expense of the unpaid vendors.

5.9 With respect, however, this reasoning is problematic in two respects. First, according to the Cork Committee, an existing unpaid, unsecured vendor is fair game for expropriation by the floating chargee, but a future unpaid vendor merits protection. Yet the future vendor has the benefit of notice through the registration system of the existence of a floating charge while the existing creditor has supplied in the knowledge that such a charge might be created but, if it has checked the register, in the knowledge that no such charge currently exists.4 Moreover, it may be that the grant of a floating charge permits, through additional finance so secured or inducing a forbearance from calling in loans, the company to carry on trading and enter into transactions with future vendors. Since the charge increases the volume of trade, benefiting future vendors to the extent that they are paid before insolvency, it might be argued that the accusation of expropriation is unjustified and that the risk run by later vendors of losing priority to a floating chargee discoverable by them is an acceptable commercial risk. This is reinforced by the subordination of a floating charge to 2

Para 1494. Para 1553. 4 Subject to the possibility of a charge not yet registered but in respect of which the 21 day registration period has not yet expired. 3

186 Howard N Bennett securities, both de facto and de iure, available to a number of vendors, whether earlier or later. Suppliers of goods are able to protect their interests to some extent by title retention clauses5 while some service suppliers have the benefit of liens as a matter of law. Floating charges, moreover, are subordinate to any security interests created by the chargor company in the ordinary course of its business. 5.10 The second problem with the reasoning of the Cork Committee is that, assuming the problem of later unpaid vendors to be genuine, section 245 is poorly targeted. A floating charge may be limited to existing assets, in which case it does not offend, and, on the reasoning of the Cork Committee, it should not be open to challenge, yet it is. Conversely, a fixed charge on existing and future assets6 should fall within the section, yet it does not. Suppose goods supplied on title retention terms are sold on credit. The supplier will lose a priority contest against a fixed charge over existing and future book debts either because the title retention clause will not cover debts generated by re-sale or because a clause that purports to establish a proprietary claim over such debts will be construed as a charge requiring registration.7 The supplier will end up as an unsecured creditor, while the fixed charge, even if granted during the twilight period prior to insolvency, will be immune from challenge under section 245.8 It is difficult to see why such a supplier falls outside the mischief identified by the Cork Committee.

B APPLICABILITY OF SECTION 245

5.11 As with preferences, the applicability of the restriction on late floating charges is aligned with transactions at an undervalue. Consequently, section 245 applies where a company goes into liquidation or an administration order is made in respect of the company.9

C FLOATING CHARGES

5.12 Section 245 is confined to floating charges. A fixed charge is immune from challenge under the section. It is therefore necessary to distinguish between the two types of charge. This exercise is performed by reference to the time of creation of the charge.10 It is irrelevant that the charge may have ceased to float by the time section 245 becomes applicable. 5 6 7 8 9 10

For discussion, see paras 6.44–6.50. The scope of fixed charges is discussed below, paras 5.12 et seq. That such clauses generate charges requiring registration is discussed below, paras 6.45–6.47. Although challenge as a preference may be possible. Insolvency Act 1986 s 245(1), referring to s 238(1). Ibid s 251.

Late Floating Charges 187 (1) Characteristics of a Floating Charge 5.13 While legislation often calls for categorisation of a charge as fixed or floating,11 no statutory definition has been provided.12 Moreover, the courts, to which the task of categorisation has consequently fallen, have often opted to describe the characteristics of a floating charge rather than provide a precise definition. In Re Yorkshire Woolcombers Association,13 Romer LJ identified three characteristics that, if present, would ‘certainly’ result in categorisation as a floating charge. First, the charge was a charge on a class of assets of a company present and future. Secondly, that class of assets was one where the individual assets falling within it would change from time to time in the ordinary course of business of the company. Thirdly, the charge contemplated that the company might carry on its business in the ordinary way with respect to the charged class of assets until some future step was taken by or on behalf of those interested in the charge. 5.14 The third characteristic is the critical one in distinguishing a floating charge from a fixed, or specific, charge. A floating chargee receives an immediate equitable interest in the fund of charged assets, but the charge does not attach to any particular asset within the charged fund until crystallisation. In the interim, the charge hovers over the fund of assets, the precise composition of which may change as the company exercises its right to use and dispose of the particular assets within the charged class in the ordinary course of its business. This right terminates when, at a later date, the charge crystallises, thereby ceasing to float and attaching to all the assets within the terms of the charge then in the company’s hands. Where, in contrast, property is subject to a fixed charge, the chargee has an immediate proprietary interest in the particular assets charged. The chargor may not deal with the charged property so as to withdraw it from the scope of the charge without the prior consent of the chargee, and the chargee’s interest will bind any purchaser of the asset who acquires title with notice of the charge.14

11 See, for example, administrators’ powers to deal with charged property (Insolvency Act 1986 s 15); the definition of an administrative receiver (Insolvency Act 1986 s 29(2)(b)); priority rules involving debts secured by a charge that as created was a floating charge and either administrators’ remuneration and expenses or preferential debts (Insolvency Act 1986 ss 19(4), 40, 175(2)(b)); registrability of charges (Companies Act 1985 s 396(1), discussed paras 6.60 et seq. 12 It is, accordingly, assumed and submitted that the common law understanding of the concept of a floating charge applies to s 245. The possibility that the statute may have a broader ambit was, however, seemingly espoused by Lord Scott in Smith v Bridgend County Borough Council [2001] UKHL 58 at [61]–[63], [2002] 1 AC 336 at 357. Sed quaere. See paras 6.83–6.84. 13 [1903] 2 Ch 284 at 295. 14 Re HH Vivian & Co Ltd [1900] 2 Ch 654 at 657–58; Illingworth v Houldsworth [1904] AC 355 at 358; Evans v Rival Granite Quarries Ltd [1910] 2 KB 979 at 999; Re Cimex Tissues Ltd [1995] 1 BCLC 409 at 420.

188 Howard N Bennett 5.15 Romer LJ himself acknowledged that the presence of all three characteristics he identified was not essential for a charge to be a floating charge. One can, however, go further and focus almost exclusively upon the third characteristic. In the leading decision of Agnew v Commissioner of Inland Revenue (Re Brumark Investments Ltd),15 Lord Millett, delivering the judgment of a powerful committee of the Privy Council,16 noted that Romer LJ offered the three characteristics he identified by way of description rather than definition. Lord Millett continued as follows:17 The first two characteristics are typical of a floating charge but they are not distinctive of it, since they are not necessarily inconsistent with a fixed charge. It is the third characteristic which is the hallmark of a floating charge and serves to distinguish it from a fixed charge. Since the existence of a fixed charge would make it impossible for the company to carry on its business in the ordinary way without the consent of the charge holder, it follows that its ability to do so without such consent is inconsistent with the fixed nature of the charge.

5.16 In Re Bond Worth Ltd,18 a purported title retention clause was held to be a floating charge. The clause claimed title, first, to goods supplied (present assets), and, secondly, to products and proceeds of sale of the original goods or products (future assets). Viewed separately, there was no single charged class of mixed present and future assets. Moreover, with respect to goods supplied, the only possible change in composition of the charged class was by diminution by sale or by use in manufacture. There was no possibility of substitution or increase. Slade J, however, dismissed such quibbles and focused upon the liberty of the buyer to deal with the charged assets in the ordinary course of its business. Both Slade J and Lord Millett in Agnew cited the following statement of Vaughan Williams LJ in Re Yorkshire Woolcombers:19 . . . but what you do require to make a specific security is that the security, whenever it has once come into existence, and been identified or appropriated as a security, shall never thereafter at the will of the mortgagor cease to be a security. If at the will of the mortgagor, he can dispose of it and prevent its being any longer a security, although something else may be substituted more or less for it, that is not a specific security.

5.17 If, therefore, the chargor company has the right, without the prior consent of the charge holder, to remove the charged asset from the charge and realise that asset for its own benefit, the charge, as a matter of law, is a floating charge.20 Since any asset that forms part of a company’s circulating capital 15

[2001] UKPC 28, [2001] 2 AC 710. Lords Bingham, Nicholls, Hoffmann, Hobhouse and Millett. 17 At para [13], at p 719. 18 [1980] Ch 228. 19 [1903] 2 Ch 284 at 294. 20 See also Re Cosslett (Contractors) Ltd [1998] Ch 495 at 510; Agnew v Commissioner of Inland Revenue [2001] UKPC 28, [2001] 2 AC 710 (discussed below); Smith v Bridgend County Borough Council [2001] UKHL 58 at [41], [2002] 1 AC 336 at 352; Arthur D Little Ltd v Ableco Finance llc [2002] EWHC 701 (Ch) at [40], [2002] 3 WLR 1387 at 1402. 16

Late Floating Charges 189 cannot be the subject of a fixed charge without pro tanto paralysing the company’s trading activity, it follows that a court is highly unlikely to accept that the true construction of a charge on such an asset is as a fixed charge.

(2) Approach of the Court 5.18 In considering whether a charge is fixed or floating, legal substance prevails over form. The nature of a fixed or floating charge is a matter of law. In considering any charge, the court undertakes a two-stage process, as described by Lord Millett in Agnew v Commissioner of Inland Revenue:21 At the first stage it must construe the instrument of charge and seek to gather the intentions of the parties from the language they have used. But the object at this stage of the process is not to discover whether the parties intended to create a fixed or a floating charge. It is to ascertain the nature of the rights and obligations which the parties intended to grant each other in respect of the charged assets. Once these have been ascertained, the Court can then embark on the second stage of the process, which is one of categorisation. This is a matter of law. It does not depend on the intention of the parties. If their intention, properly gathered from the language of the instrument, is to grant the company rights which are inconsistent with the nature of a fixed charge, then the charge cannot be a fixed charge however they may have chosen to describe it . . . [I]n construing a debenture to see whether it creates a fixed or a floating charge, the only intention which is relevant is the intention that the company should be free to deal with the charged assets and withdraw them from the security without the consent of the holder of the charge; or, to put the question another way, whether the charged assets were intended to be under the control of the company or of the charge holder.

5.19 Thus, while the label attached to the charge may indicate the parties’ intentions, the legal categorisation of the charge depends on the rights of the parties as revealed on the true construction of the charge instrument. If control (in the sense of the right to remove the assets from the scope of the security) over the charged assets remains with the chargor, the charge cannot be fixed. Oft-quoted to reinforce the primacy of substance over form in this context is the dictum of Lord Templeman, referring to the distinction between a lease and a licence, that ‘[t]he manufacturer of a five-pronged implement for manual digging results in a fork even if the manufacturer, unfamiliar with the English language, insists that he intended to make and has made a spade.’22 An alternative metaphor was employed by Knox J in the context of fixed and floating

21 [2001] UKPC 28 at [32], [2001] 2 AC 710 at 725–26, approved by the House of Lords in Smith v Bridgend County Borough Council [2001] UKHL 58 at [42], [53], [2002] 1 AC 336 at 352, 355; followed Arthur D Little Ltd v Ableco Finance llc [2002] EWHC 701 (Ch) at [39], [2002] 3 WLR 1387 at 1402. The same process is undertaken in deciding whether a transaction constitutes a registrable charge: see paras 6.51–6.54 (disguised chattel mortgages), 6.55–6.58 (assignments of receivables). 22 Street v Mountford [1985] AC 809 at 826 (in fact, gardening forks have only four prongs).

190 Howard N Bennett charges: ‘If the transaction is a cow and has cloven hooves, the parties cannot turn it into a horse by using equine terminology or saying that it is a horse.’23

(3) Charges on Book Debts 5.20 The context in which the categorisation of a charge as fixed or floating has arisen most commonly is that of charges over book debts, the relevance of the issue being priority between the charge holder on the one hand and expenses of administration or liquidation and preferential creditors on the other.24 Where the chargor company is in receivership or a winding up, all such expenses and preferential debts must be paid in priority over any claim of the holder of any debenture of the company secured by a charge that, as created, was a floating charge.25 A fixed charge, however, has priority over such expenses and preferential debts. (a) General Principles 5.21 Until the 1970s, it was generally assumed that a charge on book debts would inevitably exhibit the three characteristics identified by Romer LJ in Re Yorkshire Woolcombers and, so, would necessarily be a floating charge. It is, however, now clear that a fixed charge can be created over book debts provided that the charge instrument does not, on its true construction, leave the chargor free to withdraw the charged debts from the scope of the charge. As stressed by the Privy Council in a powerful analysis in Agnew v Commissioner of Inland Revenue,26 if the chargor remains free to realise the debts for its own benefit, then it has the right to withdraw the debts from the security and the charge must be floating. Debts can be realised by either assignment or collection. Consequently, for the charge to be fixed, the charge instrument must, on its true construction, prohibit the chargor both from assigning and from collecting the debts for its own benefit without the prior consent of the chargee. Two cases may be contrasted. 5.22 In Re Brightlife Ltd,27 a debenture created a ‘first specific charge’ on all book debts and other debts. Clause 5 of the debenture prohibited any dealing 23

Re New Bullas Trading Co Ltd [1993] BCC 251 at 255. Under the Enterprise Act 2002, the significance of preferential debts is reduced by the abolition of the Crown preference (s 251), but the significance of the distinction between fixed and floating charges will be reinforced by the introduction of a new regime for the distribution of property subject to a floating charge, part of which, in certain circumstances, will be made available for the satisfaction of unsecured debts ahead of the floating chargee (s 252, inserting a new s 176A into the Insolvency Act 1986). 25 Insolvency Act 1986 ss 40, 175(2)(b). 26 [2001] UKPC 28, [2001] 2 AC 710. See also Royal Trust Bank v National Westminster Bank plc [1996] 2 BCLC 682; Re Westmaze Ltd [1999] BCC 441. 27 [1987] Ch 200. 24

Late Floating Charges 191 with the debts ‘otherwise than in the ordinary course of getting in and realising the same which expression shall not authorise the selling, factoring or discounting by Brightlife of its book debts’ without the chargee’s prior written consent. The debenture, however, left Brightlife to collect the debts and imposed no restriction on use of the collected proceeds. According to Hoffmann J, that meant the charge could not be fixed:28 It is true that cl. 5(ii) does not allow Brightlife to sell, factor or discount debts without the written consent of Norandex. But a floating charge is consistent with some restriction on the company’s freedom to deal with its assets. For example, floating charges commonly contain a prohibition on the creation of other charges ranking prior to or pari passu with the floating charge. Such dealings would otherwise be open to a company in the ordinary course of its business. In this debenture, the significant feature is that Brightlife was free to collect its debts and pay the proceeds into its bank accounts. Once in the account they would be outside the charge over debts and at the free disposal of the company. In my judgment a right to deal in this way with the charged assets for its own account is a badge of a floating charge and is inconsistent with a fixed charge.

The right of Brightlife to collect the charged debts and apply the proceeds for its own benefit was, therefore, fatal to the supposed fixed nature of the charge.29 5.23 In contrast, in the Irish case of Re Keenan Bros Ltd,30 book debts were said to be subject to a fixed charge and collected proceeds were to be paid into a designated account at the chargee bank. The prior written consent of the bank was required either to make any withdrawal or direction to make any payment from this account or to charge, waive, assign or otherwise deal with the charged debts. The Irish Supreme Court upheld the charge as fixed. According to Henchy J, the debts had been . . . withdrawn from ordinary use, put in the keeping of the debenture holder, and sterilised and made undisposable save at the absolute discretion of the debenture holder.31

5.24 It does not suffice for the charge instrument to provide for controls over proceeds to be implemented at the behest of the chargee if the chargee never in fact calls for their implementation. Thus, a chargee bank may be given the right to require proceeds to be paid into a blocked account held with itself. If, however, the bank never so requires, the charge will be floating.32 Other arrangements may, however, be more problematic. Two examples may be considered. First, the money may be required to be paid into an account on which the company can draw only with permission, but there is a simple procedure for 28

At 209. See also Perrins v State Bank of Victoria [1991] 1 VR 749. [1986] BCLC 242. 31 At 246. See also Re Wogan’s (Drogheda) Ltd [1993] 1 IR 157; William Gaskell Group Ltd v Highley [1993] BCC 200; Re CCG International Enterprises Ltd [1993] BCC 580. 32 Royal Trust Bank v National Westminster Bank plc [1996] 2 BCLC 682; Re ASRS Establishment Ltd [2000] 1 BCLC 727, [2002] 2 BCLC 631. 29 30

192 Howard N Bennett obtaining permission and permission is never in fact denied. If the procedure for obtaining permission is in fact a pure rubber stamping exercise, the controls will be illusory and the charge regarded as floating. There is, however, scope for considerable doubt as to whether on any given set of facts controls are genuine or a pretence. 5.25 Secondly, the account may be genuinely blocked but only to a certain extent. The company may, for example, be required always to maintain a specified balance in the account but be free to withdraw and use without permission any surplus. The reasoning in Agnew clearly prohibits the charge from taking full effect as a fixed charge on all charged debts. To the extent that the company is free to appropriate the value of the debts without needing permission, any charge must be floating. It might, however, be arguable that the debts are subject to a fixed charge to the extent that value is blocked, but that the freedom to use the surplus is an agreement to release such value from the fixed charge, which would then fall within the purview of any appropriately drafted floating charge. The difficulty is that it could not be said of any particular debt that the chargee had the control that Agnew requires.33 (b) Problematic Cases 5.26 While the main thrust of the case law is now clear, authorities relating to three types of debenture continue to cause difficulty.34 33 See also Re Lyn Securities [1988] 2 MLJ 137, cited in Arthur D Little Ltd v Ableco Finance llc [2002] EWHC 701 (Ch) at [43], [2002] 3 WLR 1387 at 1403–4. A connected question is whether the approach adopted in Agnew is appropriate to all charges over contractual income streams. See PR Wood, ‘Fixed and Floating Charges’ [2001] Cambridge Law Journal 472 (raising the issue of ‘waterfall clauses’ in contexts such as charges over off-take contracts in project finance). The finance transaction and charged income may be commercially very different from those in Agnew, but it is hard to see any material distinction from the point of view of company charge law. Moreover, introducing a distinction in the level of control required for a fixed charge according to the commercial nature of the underlying transaction would re-introduce into this area of the law the sort of unacceptable conceptual uncertainty that Agnew is so welcome in eliminating. 34 The following paragraphs consider three types of debenture where, it is suggested, the existing English authorities (in one case at first instance and in the other two at Court of Appeal level) are irreconcilable with the decision of the Privy Council in Agnew. Despite the growing support in the English case law for the approach in Agnew, the authorities to be discussed have not technically been overruled, the English authority supporting Agnew being either obiter or concerned with differently drafted debentures. In Worcester Works Finance Ltd v Cooden Engineering Co Ltd [1972] 1 QB 210, the Court of Appeal declared itself free to depart from its own earlier decision in a case of conflict with a later decision of the Privy Council. In Davis v Johnson [1979] AC 264, the House of Lords upheld the Court of Appeal decision in Young v Bristol Aeroplane Co Ltd [1944] KB 718 that the Court of Appeal could depart from its own previous decisions in three situations not including a conflict of authority with the Privy Council. That particular situation was not, however, in issue in Davis v Johnson. Whether a lower court may decline to follow the Court of Appeal in such circumstances has yet to be authoritatively resolved. For a dictum indicating an obligation to follow the Court of Appeal, see Cassell & Co Ltd v Broome [1972] AC 1027 at 1054. A conflict with later Privy Council authority should considerably weaken the persuasiveness of a High Court judgment in later High Court litigation.

Late Floating Charges 193 Proceeds Payable into an Account to Which the Chargor Has Access 5.27 In Siebe Gorman & Co Ltd v Barclays Bank Ltd,35 Slade J held for the first time that a fixed charge on book debts was perfectly possible, even though the charged book debts might constitute a class of assets the precise composition of which would change in the ordinary course of the chargor’s business. This development of principle has of course been accepted, but the decision of Slade J with respect to the debenture at issue is highly doubtful. 5.28 The debenture contained two clauses of relevance. Clause 3(d) provided for a ‘first fixed charge’ on ‘all book debts and other debts now and from time to time due or owing to the Company’. Clause 5(c) provided that: During the continuence of this security [the chargor] . . . shall pay into [the chargor’s] account with the bank all moneys which it may receive in respect of the book debts and other debts hereby charged and shall not without the prior consent of the bank in writing purport to charge or assign the same in favour of any other person and shall if called up to do so by the bank execute a legal assignment of such book debts and other debts to the bank.

5.29 There was no express denial of freedom on the part of the company to continue to use the money paid into the account in the ordinary course of the company’s business. Thus, from the express wording of the debenture, it seems that cheques could still be drawn on the account without the prior consent of the bank. Nevertheless, Slade J stated as follows:36 I can see no reason why the Court should not give effect to the intention of the parties, as stated in cl. 3(d), that the charge should be a first fixed charge on book debts . . . All that [cl. 5(c) does] . . . is to reinforce the specific charge given by cl. 3. The mere fact that there may exist certain forms of dealing with book debts which are not specifically prohibited by cl. 5(c) does not in my judgment turn the specific charge into a floating charge.

With respect to access to the collected proceeds once paid into the account, Slade J observed as follows:37 [I]f I had accepted the premise that [the chargor] would have had the unrestricted right to deal with the proceeds of any of the relevant book debts paid into its account, so long as that account remained in credit, I would have been inclined to accept the conclusion that the charge on such book debts could be no more than a floating charge.

5.30 This might indicate that Slade J considered that designating a charge as fixed necessarily imported all restrictions on the realisation of debts and the use of proceeds that flow from a fixed charge. Such restrictions would not have to be express. They would be implied from the designation as fixed unless 35 36 37

[1979] 2 Lloyd’s Rep 142. At 159. At 158.

194 Howard N Bennett inconsistent with the express terms of the charge instrument. However, such an analysis is betrayed by the conclusion of Slade J that: . . . during the continuence of the security, the bank would have the right, if it chose, to assert its lien under the charge on the proceeds of the book debts, even at a time when the particular account into which they were paid was temporarily in credit.38

5.31 There was, therefore, an implied consent to the continued use of the money by the chargor but which could be revoked at any time by the bank. With respect, this sounds like a perfect description of a floating charge. Such freedom to use for the chargor’s benefit pending intervention must be inconsistent with the label of a fixed charge. 5.32 Nevertheless, in Re a Company (No 005009 of 1987) ex parte Copp,39 Knox J upheld as fixed a charge the drafting of which largely followed the Siebe Gorman form. Notwithstanding the interim contribution of the Irish courts in Re Keenan, commercial certainty dictated that courts should not change their minds on the legal import of particular wordings. 5.33 With respect, however, it is difficult to sustain the decision in Siebe Gorman. As now emphasised in Agnew v Commissioner of Inland Revenue,40 specifying the destination of proceeds cannot suffice; there must be control over the proceeds at that destination. Otherwise, the chargor retains the right to withdraw the asset from the security, a right that is inconsistent with a fixed charge. In Re Marwalt,41 a bank’s charge was stated to be floating because, although certain proceeds of debts were paid into a certain account at the bank as required by the debenture, ‘the debts were not retained by the bank . . . but the company was allowed to deal with them’.42 Moreover, other jurisdictions have regarded the absence of express controls on collected proceeds as fatal in decisions on Siebe Gorman style debentures.43 It is noteworthy that in Agnew, in discussing the restrictions on use of receipts normally found in a charge on uncalled share capital, Lord Millett stated that such restrictions created an

38

At 159. [1989] BCLC 13. 40 [2001] UKPC 28, [2001] 2 AC 710, see above para 5.21. 41 [1992] BCC 32. 42 At 44 per HH Judge Paul Baker QC. 43 Supercool Refrigeration & Air Conditioning v Hoverd Industries Ltd [1994] 3 NZLR 300 at 321 per Tompkins J: 39

It is my conclusion that a requirement to pay the proceeds of the book debts into the company’s account without any restrictions on how the company may use those proceeds does not give effective possession of those proceeds to the Bank. It does not, without more, fasten the charge onto those proceeds. See also Re Holidair Ltd [1994] 1 IR 416. Further decisions on debentures following the Siebe Gorman form but omitting clause 5(c) have distinguished Siebe Gorman on the ground of this omission notwithstanding that Slade J appears not to have viewed the clause as essential: Re Armagh Shoes [1984] BCLC 405; Perrins v State Bank of Victoria [1991] 1 VR 749.

Late Floating Charges 195 analogy to the situation ‘which was thought to obtain in the Siebe Gorman case . . . and did obtain in In re Keenan Bros Ltd’.44 5.34 The decision in Ex parte Copp is aggravated in difficulty by an agreed overdraft facility on the account into which the proceeds of the debts were to be paid. This facility pre-dated the grant of the charge. This was dismissed as collateral to the debenture and not altering its construction. However, Agnew holds that an express right on the part of the chargor to help itself to the proceeds of debts without the chargee’s consent is inconsistent with a fixed charge. The existence of an agreed overdraft facility must at least be relevant to the reality of the chargee’s controls over the collected proceeds.45 Separate Charges on Debts and Proceeds 5.35 In Re New Bullas Trading Ltd,46 the debenture sought to separate a debt from its proceeds. The debenture imposed a fixed charge on present and future book debts and prohibited the chargor from dealing with the debts other than collecting them in the ordinary course of business. The chargor company was required to pay collected proceeds into ‘a current or designated account’ at a named bank and deal with such moneys in the account in accordance with directions given by the chargee. In the absence of such directions, the proceeds paid into the account were stated to be subject to a floating charge. No directions were ever given. The Court of Appeal held that the charge on book debts was fixed. Fundamentally, charges were creatures of agreement and there was no policy consideration that prevented the parties from annexing to a fixed charge on debts a freedom to collect the debts and use the proceeds for its own benefit. The court could not override a clear expression of the parties’ intentions. Moreover, debts and proceeds were different assets and the nature of a charge on proceeds would not affect the nature of a charge on debts. 5.36 In Agnew v Commissioner of Inland Revenue, however, the Privy Council, in a forceful and cogent judgment, held that this approach of the Court of Appeal was ‘fundamentally mistaken’.47 A Bullas style debenture afforded the chargor rights that were inherently inconsistent with a fixed charge. The chargor remained free to collect the debts and use the proceeds for its own benefit and 44

[2001] UKPC 28 at [38], [2001] 2 AC 720 at 727 (emphasis added). Where adequate controls over proceeds exist at the time of creation of the charge so that the charge is genuinely a fixed charge, a subsequent relaxation of those controls must call into question the continued status of the charge as fixed. It is difficult to see how a charge that operates as a floating charge can continue to retain its legal categorisation and efficacy as fixed. The charge must be regarded as having been varied or substituted by the parties and the question would arise of whether re-registration would be necessary. If the courts adopted the view that the charge was the same charge, albeit varied, no new registration would be required. The register would no longer reflect the true position, but the register may be an imperfect reflection in a number of respects. However, if the view were adopted that a new floating charge had been granted in substitution for the original fixed charge, registration of the new charge would be necessary. 46 [1993] BCLC 1389, rvsd [1994] 1 BCLC 485. 47 [2001] UKPC 28 at [32], [2001] 2 AC 710 at 725. 45

196 Howard N Bennett that freedom to remove the debts from the charge was incompatible with the charge being fixed in nature. Debts and proceeds were different assets, but that did not mean that the rights of the chargor with respect to the proceeds were irrelevant to the legal categorisation of a charge on the debts. Re New Bullas was wrongly decided. Charges over Existing Assets 5.37 Controls over proceeds have also been regarded as of less importance where the charge is restricted to existing assets. In Re Atlantic Computer Systems plc (No 1),48 rental fees under hiring agreements were assigned by way of charge. These debts were paid by the debtors to the chargor company, which was free to use them and did use them in the ordinary course of its business. The Court of Appeal held that the charge was fixed. The court focused on the ‘ambulatory’ nature of floating charges, that is that they hover over a fund of assets without precise identification of any specific asset. The notable feature of the present case is that the charges were not ambulatory. The property assigned by the company was confined to rights to which the company was entitled under specific existing contracts . . . The company’s rights to receive future instalments . . . was as much a present asset of the company . . . as a right to receive payment of a sum which was immediately due.49

Of the absence of controls, it was stated that:50 The company was to be at liberty to receive and use the instalments until [the chargee] chose to intervene. We are unpersuaded that this results in these charges, on existing and defined property, becoming floating charges. A mortgage of land does not become a floating charge by reason of the mortgagor being permitted to remain in possession and enjoy the fruits of the property charged for the time being.

5.38 In principle, this latter point is uncontroversial. Thus, a charge over shares that is otherwise fixed is not rendered a floating charge by the fact that it leaves the chargor free to collect and use dividends and exercise all rights attached to the shares until default.51 With respect, however, it is difficult to see how the application of this reasoning to a charge over book debts can survive the analysis of the Privy Council in Agnew v Commissioner of Inland Revenue.52 As stated by Lord Millett, an ambulatory character may be typical of a floating charge, but it is not the hallmark of such a charge. If, on the other hand, the chargor retains the right to withdraw the asset from the security, the charge must be floating. A freedom to enjoy the fruits of mortgaged land or the fruits of and rights attached to charged shares does not remove the land or the shares from the mortgage. However, the proceeds of debts are all that 48 49 50 51 52

[1992] Ch 505 at 532–34. At 534 per Nicholls LJ (delivering the judgment of the Court). Ibid. Arthur D Little Ltd v Ableco Finance llc [2002] EWHC 701 (Ch) [2002] 3 WLR 1387. [2001] UKPC 28, [2001] 2 AC 710.

Late Floating Charges 197 remains of debts once collected and, once they have been dissipated, there remains nothing upon which the charge can bite. In Atlantic Computers, therefore, the freedom to use the proceeds of the charged debts meant the chargor had the freedom to withdraw the debts from the security and the charge should have been categorised as floating.53

D THE TWILIGHT PERIOD

5.39 For a floating charge to be vulnerable under section 245, it must be created ‘at a relevant time’. Three such twilight periods are contemplated by section 245(3).

(1) Chargee Connected with the Company 5.40 Where a floating charge ‘is created in favour of a person who is connected with the [chargor] company,’ the relevant time as specified by section 245(3)(a) is ‘two years ending with the onset of insolvency’. The phrase ‘onset of insolvency’ is in turn defined by section 245(5) as follows: (a) in a case where this section applies by reason of the making of an administration order, the date of the presentation of the petition on which the order was made,54 and (b) in a case where this section applies by reason of a company going into liquidation, the date of the commencement of the winding up.

5.41 The commencement of winding up is determined as follows. A voluntary winding up is deemed to commence on the date when the resolution for voluntary winding up is passed.55 A compulsory winding up is deemed to commence on the date when the petition for winding up is presented.56 However, if the petition post-dates a resolution for voluntary winding up, the compulsory winding up is deemed to commence on the date of the resolution.57

53 The same criticism can be levelled at Re Atlantic Medical Ltd [1992] BCC 653 where Vinelott J followed and extended Atlantic Computers with respect to a charge on rentals under existing and future sub-leases. That the contemplated future leases were merely replacement agreements once existing sub-leases had expired meant that the charged category of assets was not truly fluctuating and the charge was fixed. Whether there were controls on the sub-rentals did not matter since the chargor company did not use the rentals without the consent of the chargee in the ordinary course of its business. In the light of Agnew, however, the existence of controls should have been the decisive issue. 54 The period between petition for and making of an administration order is also a relevant time: see below. 55 Insolvency Act 1986 s 86. 56 Ibid s 129(2). 57 Ibid s 129(1).

198 Howard N Bennett 5.42 The concept of a person ‘connected with’ the company is common to section 245 and sections 238 and 239 dealing with transactions at an undervalue and preferences.58 The meaning of this expression is discussed in chapter 2.59 (2) Chargee Not Connected with the Company 5.43 In the case of a floating charge created in favour of any person who is not connected with the chargor company, a shorter twilight period is further subject to an additional financial qualification. By virtue of section 245(3)(b), the relevant time is ‘the period of twelve months ending with the onset of insolvency’, the phrase ‘onset of insolvency’ again being defined by section 245(5). A time falling within the section 245(3)(b) period is not, however, a relevant time unless one of two alternative qualifications in section 245(4) is satisfied. These qualifications are that at the time of creation of the charge60 the company must either be ‘unable to pay its debts within the meaning of section 123’ or become ‘unable to pay its debts within the meaning of that section in consequence of the transaction under which the charge is created.’ The meaning of inability to pay under section 123 is discussed in chapter 2.61

(3) Administration 5.44 Section 245(3)(c) provides for an additional twilight period regardless of the status of the chargee. Where an administration order is made in relation to the chargor company, a floating charge is created at a relevant time if made between the presentation of the petition for the administration order and the making of the order.

E NEW VALUE

5.45 A floating charge created at a relevant time is invalid under section 245 except to the extent of any new value given for the charge. What qualifies as new value for these purposes is defined by section 245(2) as: the aggregate of— (a) the value of so much of the consideration for the creation of the charge as consists of money paid, or goods or services supplied, to the company at the same time as, or after, the creation of the charge, 58

Insolvency Act 1986 s 240(1)(a). Paras 2.41–2.49. 60 For time of creation of charges, see paras 6.22–6.24. 61 Paras 2.33–2.40. Note, however, that the presumption that one of these requirements is satisfied that operates in the context of undervalues and preferences (Insolvency Act 1986, s 240(2)) does not extend to late floating charges. 59

Late Floating Charges 199 (b) the value of so much of the consideration as consists of the discharge or reduction, at the same time as, or after, the creation of the charge, of any debt of the company, and (c) the amount of such interest (if any) as is payable on the amount falling within paragraph (a) or (b) in pursuance of any agreement under which the money was so paid, the goods or services were so supplied or the debt was so discharged or reduced.

5.46 The subsection invites comment on (1) the meaning of the term ‘consideration’, (2) the permissible form of consideration, and (3) the timing of the consideration.

(1) The Meaning of ‘Consideration’ 5.47 In order to determine the extent to which a late floating charge is valid, one must first identify ‘the consideration for the creation of the charge’. The question arises whether the term ‘consideration’ carries the same technical meaning as it carries in the context of contract formation, where, in particular, it is restricted to a benefit conferred or detriment incurred in return for a promise and does not include benefits that happen to flow as a result of the promise.62 5.48 The formula adopted by section 245(2) represents a change in wording from previous legislation, which required one to determine the ‘amount of any cash63 paid to the company at the time of or subsequently to the creation of, and in consideration for, the charge’. The meaning of ‘consideration’ in the context of this phrase was considered by the Court of Appeal in Re Yeovil Glove Co Ltd.64 5.49 Re Yeovil Glove concerned a liquidator’s challenge to a floating charge given to secure indebtedness on an account already overdrawn to the agreed limit of £67,500. The bank undertook no obligation to provide any new finance, but in fact permitted further drawings on the account. There was, however, no bargain of additional finance in return for security. The security was demanded and given for the existing indebtedness. Moreover, even if there had been such a bargain, the consideration, in the sense of technical contract law, would have been the promise to provide the finance and not the actual provision thereof. On the facts, the consideration in the technical sense was forbearance on the part of the bank from calling in the overdraft, as it had threatened unless security was provided. But that forbearance was not acceptable as consideration under the then legislation. 62

Combe v Combe [1951] 2 KB 215. Prior to s 245, cash, construed fairly broadly, was the only form of consideration acceptable under the legislation. 64 [1965] 1 Ch 148. Other aspects of the case are discussed below, paras 5.78–5.82. 63

200 Howard N Bennett 5.50 The Court of Appeal held, however, in favour of the bank. The phrase ‘in consideration for’ did not carry a technical meaning but meant merely ‘in the light of’, ‘by reason of’, ‘referable to’ or ‘having regard to the existence of’. Russell LJ noted the focus of the legislation on payment and the difficulty of regarding the act of payment rather than the promise to pay as consideration for the charge in the technical formation of contract sense. He continued:65 Moreover, that construction [of consideration in its technical sense] refers the consideration to the creation of the charge, but it must be observed that the draftsman of the section did not use the phrase ‘paid to the company at the time of, or subsequent to, and in consideration for, the creation of the charge.’ The phrase is ‘at the time of or subsequent to the creation of, and in consideration for, the charge.’

Williams LJ reasoned in similar vein. Stating that the section should not be strained to invalidate bona fide transactions concluded in the ordinary course of business,66 he rejected an argument that the legislation required the cash to be paid in consideration for the creation of the charge. Had that been the legislative intention, the section would have said so. That it was not so phrased was ‘of vital significance’.67 5.51 Section 245, of course, adopts the formula Russell and Williams LJJ emphasised the then legislation eschewed. Nevertheless, it seems clear that the meaning to be ascribed to the term consideration has not changed. First, the section refers to consideration consisting of money that has been ‘paid’, or goods or services ‘supplied’, or to the ‘discharge or reduction’ of debt. Yet, as pointed out by Russell LJ, if section 245 has to be analysed in strict contractual terms, the consideration for the floating charge would have to be a promise to pay, supply, discharge or reduce. Secondly, section 245 is concerned with the value of the consideration. The search under section 245 is for ‘the value of so much of the consideration for the creation of the charge as consists of’ specified acts performed. The value of, for example, money paid is clearly assessed by reference to the benefit received, not the amount merely promised. Indeed, in the context of goods or services supplied, section 245(6) specifically provides that the value is assessed at the time they were supplied.

(2) The Permissible Forms of Consideration 5.52 Prior to the advent of section 245, the late floating charge legislation had been extremely restrictive with respect to the type of consideration for the charge that it would take into account. The consideration had to take the form 65

At 178. Citing to this effect Farwell LJ in Re Columbian Fireproofing Co Ltd [1910] 2 Ch 120 at 123, cited below, para 5.67. 67 At 185. 66

Late Floating Charges 201 of ‘cash paid to the company’. Under section 245(2), the permissible forms of consideration are broadened. (a) Money Paid to the Company 5.53 This is the direct successor to the previously sole permitted form of consideration. It is clear that a broad, commercial approach is to be adopted to the notion of money being ‘paid . . . to the company’. Any form of financial benefit to the company is likely to be covered, the question of whether the company has been paid money being one of substance not form.68 The benefit must, however, be genuine and the courts will be astute to detect a mere subterfuge.69 Finance may be made available subject to conditions, and, indeed, there is no need for money to be placed absolutely and unconditionally at the company’s disposal.70 However, the mere passage of money through the company’s bank account is insufficient. The creation of a floating charge in principle impoverishes the company from the standpoint of the unsecured creditors. Section 245 is designed to protect the estate for their benefit. If the company is employed as a mere conduit pipe through which purported loan money is passed in return for the creation of additional security, there is no genuine benefit to the company and the loan will not count as money paid to the company. According to Simonds J in Re Destone Fabrics Ltd:71 The ultimate test in such cases may well be whether the transaction is to be regarded as one intended bona fide for the benefit of the company, or whether it is intended merely to provide certain moneys for the benefit of certain creditors of the company to the prejudice of other creditors of the company.

5.54 In Re Orleans Motor Co Ltd,72 a bank was pressing for repayment of the company’s overdraft by either the company or directors who had guaranteed the debt. The directors passed a resolution that the company would repay £1500, which they would fund in return for a floating charge. Three cheques for £500 each were paid to the company, which then paid the bank £1500. Parker J held that the company had never received any money. All that had happened was that the directors repaid corporate debt they had guaranteed using the company as a conduit pipe. The company had not received any influx of finance. The result of the transaction was that debt owed to the bank secured by the directors was replaced by debt owed to the directors secured by a charge on the company’s assets.73 68

Re Matthew Ellis Ltd [1933] 1 Ch 458 at 477. Re Destone Fabrics Ltd [1941] Ch 319 at 324. 70 Re Matthew Ellis Ltd [1933] 1 Ch 458 at 473, rejecting the contrary view espoused in Re Hayman, Christy & Lilly Ltd [1917] 1 Ch 283. 71 Re Destone Fabrics Ltd [1941] Ch 319 at 324. 72 [1911] 2 Ch 41. 73 See also the comments on Re Orleans by Romer LJ in Re Matthew Ellis Ltd [1933] 1 Ch 458 at 478. 69

202 Howard N Bennett 5.55 A similar subterfuge was detected in Re Destone Fabrics Ltd.74 The company granted D a floating charge in return for a loan of £900. This sum was passed through the company’s bank account and used to pay fees owing to two directors of the company and to discharge a debt guaranteed by D. D thus exchanged status as a contingent unsecured creditor for secured debt in a larger sum, and the balance of the money served merely to benefit the two directors. The company, however, benefited not at all. It was hopelessly insolvent when the charge was granted so that a mere £900, even if made available for its general trading activities, would have represented no real benefit. In truth, the transaction was a mere contrivance whereby the company’s estate was redistributed to the benefit of D and the directors and to the prejudice of the unsecured creditors. 5.56 A further example is provided by Re Fairway Magazines Ltd.75 In this case, the company had substantially exceeded the limit on its bank overdraft. The company had granted no security for the overdraft, but it was guaranteed by F, one of the company’s directors, in the sum of £70,000. F agreed to advance £75,000 to the company against the security of a floating charge. A total of £20,000 was subsequently paid to reduce the company’s bank overdraft with the limit of F’s liability as guarantor being reduced to £50,000. Despite this benefit to F, Mummery J accepted that the loan was a genuine attempt at corporate rescue. Nevertheless, the case was held to be indistinguishable from Re Orleans Motor Co Ltd. The money paid to the bank was never intended to be and never was available to the company to use as it wished. Instead, unsecured debt was replaced by secured debt to the benefit of F. To that extent,76 the floating charge was invalid. 5.57 In contrast, in Re Matthew Ellis Ltd,77 a loan the majority of which was for payment to a specific creditor was held to be paid to the company and valid consideration for a late floating charge. The lender was both chairman of the company and a partner in a firm that supplied goods to the company. He ascertained from his partners in the firm that any future supply of goods on credit to the company was conditional on payment by the company of £1,954 of existing indebtedness to the firm. He then advanced £3,000 to the company against the security of a floating charge having agreed with the company that £1,954 of the loan would be paid to his firm. The Court of Appeal upheld the full £3,000 as a genuine payment to the company. There was no reason why the money should not be applied in discharge of existing debt, provided that the company obtained some genuine benefit. Had the lender been the sole partner in the firm, the transaction might have attracted greater suspicion. In truth, however, this 74 75 76 77

[1941] 1 Ch 319, aff’d without judgment [1941] 1 Ch 325. [1993] BCLC 643. The charge was upheld with respect to another part of the loan: see below, para 5.74. [1933] 1 Ch 458.

Late Floating Charges 203 was an injection of finance that the lender honestly believed and intended would save the company, two-thirds of which was employed to secure the valuable benefit of continued supply of goods on credit. (b) Goods or services supplied 5.58 Section 245(6) elaborates upon the value to be ascribed to goods or services for the purposes of section 245(2)(a). The value . . . is the amount in money which at the time they were supplied could reasonably have been expected to be obtained for supplying the goods or services in the ordinary course of business and on the same terms (apart from the floating charge) as those on which they were supplied to the company.

5.59 The use of the verb ‘supply’ and the choice of the terms ‘goods’ and ‘services’ rather than broader terms such as ‘property’ indicate that many assets with considerable value are excluded from the permissible forms of value under section 245. Thus, consideration for a floating charge in the form of rights over, for example, land, intellectual property or choses in action would appear to be regarded as of no value under the legislation. While it is hard to justify this discrimination, it appears unavoidable as a matter of statutory interpretation. (c) Discharge or reduction of debt 5.60 In a number of the cases discussed above under the heading of ‘Money Paid to the Company’,78 payments by directors reduced the company’s indebtedness to its bank, but they were not regarded as satisfying the legislation because the company merely exchanged indebtedness to its bank for indebtedness, secured by a floating charge, to its directors. Money is regarded as paid to the company only if it confers some benefit upon the company and the mere purchase of a stay of insolvency is not regarded as a benefit to the company. Under section 245, however, the floating charge is also valid to the extent that any indebtedness of the company is discharged or reduced. It is, therefore, necessary to ask to what extent, if at all, payments involving an exchange of indebtedness are good consideration under section 245.79 5.61 It seems clear that the admissibility of debt-swapping refinancing under section 245 should be carefully policed. The provision is designed to save late floating charges only to the extent that fresh value is obtained by the company. The mere manipulation of the company’s debts, even if well intentioned, without either an act of genuine will by the company or the accrual to the company of any clear additional benefit, cannot be regarded as conferring any fresh value 78

Paras 5.53 et seq. Although Re Fairway Magazines was decided under s 245, this point does not appear to have been raised. 79

204 Howard N Bennett on the company. A floating charge created as part of such manipulation clearly falls within the mischief of the section. The real question is how to exclude it from the wording of section 245. The answer lies in the need to value the consideration. 5.62 Section 245 requires not merely that one identify consideration (in the sense of benefit accruing to the company as a result of the creation of the charge80), for example in the reduction or discharge of debt, but also that it be valued. The floating charge is valid only to the extent of the value of the consideration. Thus, the mere refinancing of existing debt owed to an unsecured creditor by a loan from that creditor secured on a floating charge would clearly fall outside section 245(2). The change in status of debt from unsecured to secured is, of itself, of no value to the company.81 The same point can be made of cases such as Re Orleans Motor Co, where the money is used to discharge third party indebtedness. A mere change in the identity of the creditor, in and of itself, is of no value to the company. 5.63 In each case, however, if it could be shown that the refinancing purchased a genuine stay of insolvency that was of real commercial value, albeit ultimately to no avail, then the charge should be saved to the extent of that value. In deciding whether such a genuine stay was purchased, regard might be had to three factors in particular. First, there is the financial condition of the company. Section 245 is concerned with preservation of value for unsecured creditors. Where it is clear that a company is irredeemably headed for insolvency, it is hard to see how refinancing by exchanging unsecured for secured debt can generate a stay of insolvency of any value. This factor should not be extended too far for fear of jeopardising genuine attempts at corporate rescue. There must, however, be a threshold of financial hopelessness beyond which no reasonable attempt at corporate rescue can be made.82 Secondly, there is the question of whether any ostensible forbearance from calling in the original debt was a mere pretence. This will be especially pertinent where the old and new debts are owed to the same creditor. 5.64 A third factor is whether the decision to refinance was a voluntary and genuine decision of the company made in its own interests rather than, for example, a decision of a chargee in a position as a director of the company to 80

See above, paras 5.47 et seq. It might also be argued that there is no ‘discharge or reduction’ of the company’s debt but a mere ‘transmutation’ of debt: D Prentice, ‘Preferences and Defective Floating Charges’ (1993) 109 Law Quarterly Review 371 at 375. This approach is, however, more difficult to sustain in the context of third party indebtedness, discussed in the next paragraph. Section 245 admits as consideration the reduction or discharge ‘of any debt of the company’. Where third party debt is ostensibly replaced by a new debt owed to a different creditor secured by a floating charge, the court would, it is suggested, be compelled to conclude that a debt of the company had been discharged or reduced unless prepared to re-characterise the transaction so as to regard the new creditor as an assignee of or as subrogated to the original debt. 82 Compare the approach adopted with respect to wrongful trading under s 214, Insolvency Act 1986. 81

Late Floating Charges 205 substitute his interests for those of the company. Where a new loan is applied to discharge third party debt by virtue of a genuine decision by the company, the company clearly perceived a benefit in the debt reduction or discharge and, subject to the possibility of financial hopelessness already mentioned, the face value reduction of the debt should probably be accepted under section 245. On the basis that businesses know their own business best, a court should not attempt to substitute its own valuation or deny the existence of a benefit.83 Where, however, the company had no choice in the application of the loan, the court should consider carefully whether any valuable benefit was truly procured for the company. A loan under which a company was given no choice but to replace indebtedness to a third party with indebtedness to a new creditor secured by a floating charge with no additional benefit should be regarded as devoid of value. Debt may have been reduced or discharged, but that reduction or discharge has no value to the company. On this basis, conduit pipe cases where the routing of money through the company is a pure subterfuge, such as Re Orleans Motor Co and Re Destone Fabrics, would be decided in identical fashion under the current legislation. Cases such as Re Fairway Magazines, where a genuine attempt is made to benefit the company and at least a stay of insolvency is purchased,84 would admit of judicial valuation of the consideration. This would militate against section 245 deterring genuine attempts at corporate rescue.

(3) Timing of the Consideration 5.65 Under section 245, the acceptable consideration is subject to a temporal restriction. It must be provided ‘at the same time as, or after, the creation of the charge’. This prompts the question of how strictly the temporal restriction is to be construed. Moreover, current trading accounts raise the issue of the impact of the rule in Clayton’s Case.85 (a) ‘At the Same Time As, or After, the Creation of the Charge’ 5.66 Prior to the advent of section 245, the legislation invalidating late floating charges required cash to be paid ‘at the time of or subsequently to the creation 83 A sentiment expressed in the context of contractual variation in Woodhouse AC Israel Cocoa Ltd SA v Nigerian Produce Marketing Co Ltd [1972] AC 741 at 757 per Lord Hailsham: ‘Business men know their own business best even when they appear to grant an indulgence’. See also, in the context of directors’ fiduciaries duties, Howard Smith Ltd v Ampol Petrleum Ltd [1974] AC 821 at 832 per Lord Wilberforce:

There is no appeal on the merits from management decisions to courts of law: nor will courts of law assume to act as a kind of supervisory board over decisions within the powers of management honestly arrived at. 84 In that the company may have no choice in the application of the money, it still operates as a conduit pipe, but the attempt to benefit the company is no pretence. 85 (1816) 1 Mer 572.

206 Howard N Bennett of the charge’. However, the practical impossibility of achieving perfect simultaneity between creation of charge and payment opened the door to a liberal construction of this phrase, permitting payments to be taken into account whether made before or after the creation of the charge provided that they were attributable to the charge. A test of timing was transformed into a test of causation. The advent of section 245, with its change in formula, has seen the issue revisited with a stricter temporal approach prevailing. The position before the advent of section 245 5.67 The causative approach to the pre-section 245 law was established in Re Columbian Fireproofing Co Ltd.86 S offered to advance money to a company. Two instalments of the money were paid upon the directors’ passing of a resolution to provide security in the form of a debenture secured by a floating charge but up to eleven days before the debenture was executed. The balance was paid after execution. Although the resolution to grant a charge operated in equity to create a charge immediately, the lender could not rely on this charge in the company’s liquidation for want of registration. It was held, however, that the lender could rely on the creation of a second charge by execution of the debenture. This charge had been duly registered. Moreover, all the payments, including those made in advance of the creation of the charge were held to satisfy the temporal restriction in the legislation. Neville J reasoned as follows:87 The word ‘time’ in this connection must always be to some extent indefinite, for the creation of the security and the payment of the money cannot be simultaneous, and I think that a payment made on account of the consideration for the security, in anticipation of its creation and in reliance on a promise to execute it, although made some days before its execution, is made at the time of its creation within the meaning of the section. . . . Time in this connection is not, I think, a matter to be decided by the clock, but in accordance with the substance of the transaction . . .

The Court of Appeal robustly upheld the decision of Neville J. Cozens-Hardy MR expressed entire agreement with the reasons given by Neville J. Farwell LJ stated as follows:88 In my opinion it would be disastrous if we were to invalidate bona fide honest transactions carried out in accordance with the usual course of business. It is plain to my mind that any cash paid to the company ‘at the time’ cannot mean on the stroke of the clock or even within the same twenty-four hours . . . [I]t is not a question of the clock; it is a question of what are the circumstances of each particular case and what is the real substance of the transaction.

Consequently, if the substance of the transaction was finance in return for a floating charge, a delay in execution of the charge, at least on the scale of one or 86 87 88

[1910] 1 Ch 758, [1910] 2 Ch 120. [1910] 1 Ch 758 at 765. [1910] 2 Ch 120 at 123.

Late Floating Charges 207 two weeks, would not take the advance out of the scope of acceptable consideration under the late charges legislation. 5.68 The question of how far causation could triumph over lapse of time between payment and creation arose in Re F and E Stanton Ltd.89 Advances were made clearly in reliance on a promise to execute a debenture secured by a floating charge, but the actual execution was postponed so that the advances were made 54 or 55 days before the charge was created. Maugham J held that no objection could be taken to such period of time as was reasonably attributable to the drafting and execution of the debenture, but such period would not normally exceed four or five days. A greater delay required explanation, and a greater delay for which the chargee was responsible or in which the chargee had ‘in any true sense acquiesced’90 would take the payments out of the consideration acceptable under the legislation. On the facts, the evidence demonstrated that the lenders repeatedly pressed for the execution of the charge and had not voluntarily acquiesced in the delay. 5.69 The reasoning adopted in the pre-section 245 case law is not without difficulty. Since the late floating charge legislation is designed to thwart the depletion of corporate assets in the run up to insolvency, the transformation of a test seemingly of timing into one of causation is not unwelcome in principle. Unfortunately, it is difficult to reconcile with the statutory wording. A pragmatic, commercial approach to the construction of the temporal requirement can be sustained. However, as Hoffmann J has since observed,91 the legislation requires both that the payment be made at an appropriate time and also that it be in consideration for the charge. According to at least one strand in the reasoning in Re Columbian Fireproofing, the causal question that the reference to consideration has subsequently been held to represent92 merely replicates the causal question that is the true essence of the temporal wording. 5.70 Re F and E Stanton is even more problematic. The bulk of the money was advanced in March while the charge was executed in July. The result of the case was that the money was regarded as having been paid at the time of the creation of the charge. This leaves the statutory words with no temporal meaning at all, a construction that it is difficult to sustain. As Hoffmann J has again cogently remarked:93 Maugham J seemed to regard himself as exercising a discretion to condone late execution of the debenture [but] the section makes no distinction between excusable and inexcusable delay. It simply says that the advance must have been made at the time of the creation of the charge and I do not see how the answer to this question can be 89 90 91 92 93

[1928] 1 Ch 180. At 193. Power v Sharp Investments Ltd (sub nom Re Shoe Lace) [1992] BCLC 636 at 639. See above, para 5.67. Power v Sharp Investments Ltd (sub nom Re Shoe Lace) [1992] BCLC 636 at 639.

208 Howard N Bennett affected by whether the reasons for delay were good or bad. It is always open to the lender not to lend until the charge has actually been executed.

The position under section 245 5.71 In contrast with the earlier legislation, section 245 requires the consideration to be given not ‘at the time of or subsequently to the creation of the charge’ but ‘at the same time as, or after, the creation of the charge’. In the early 1990s, two cases raised the question of the impact, if any, of this change of formula. 5.72 The first judgment to be given was that of Hoffmann J at first instance in Power v Sharp Investments Ltd (sub nom Re Shoe Lace).94 Shoe Lace was a company in serious financial difficulty. A resolution to grant a debenture secured by a floating charge to its parent company (Sharp) in return for short-term finance was passed on 20 March. The debenture and charge were not executed until 24 July. In the interim, Sharp made four advances totalling £436,500. Could they be regarded as having been made ‘at the same time as’ the creation of the charge? The difference in statutory wording between section 245 and its predecessors meant that authority on the earlier legislation was not binding. For Hoffmann J, the meaning of the phrase ‘at the same time’ depended upon its context, which was commercial and regulatory. The question, I think, is whether a businessman having knowledge of the kind of time limits imposed by the Insolvency and Companies Acts and using ordinary language would say that the payments had been made at the same time as the execution of the debenture.95

5.73 Thus, while critical of the effective elimination by Neville and Maugham JJ of any temporal test, Hoffmann J was prepared to construe section 245 as retaining a pragmatic approach to simultaneity. On the facts, however, the delay far exceeded any limits to such pragmatism. 5.74 Seven months later, a second judgment was rendered by Mummery J in Re Fairway Magazines Ltd.96 He held that the difference in wording between section 245 and its predecessors did not require any change in the approach to be adopted. Consequently, a delay of one month between advancement of and execution of the floating charge that was wholly attributable to the chargor did not prevent the money from being regarded as advanced at the time of the creation of the charge. 5.75 The following year the Court of Appeal gave judgment in Power v Sharp97 and adopted an entirely new approach. Although it was common ground that case law on its statutory predecessors was not binding in respect of 94 95 96 97

[1992] BCLC 636. At 639. [1993] BCLC 643. [1994] 1 BCLC 111.

Late Floating Charges 209 the differently formulated section 245, the Court of Appeal98 took the view that the differences in wording were immaterial. However, the Court held unanimously that the causative approach adopted in Re Columbian Fireproofing and extended in Re F and E Stanton was wrong even in the context of the earlier legislation. The criticisms voiced by Hoffmann J were valid and the phrase ‘at the same time as’ had to be construed in a temporal sense and as excluding consideration advanced before the creation of the charge. The Court, however, divided on how strict a temporal approach should be adopted. Nolan LJ concurred with the approach of Hoffmann J, remarking that: . . . some degree of latitude might be permissible to take account of such matters as urgency, international transactions across different time zones and other factors which might make it difficult to determine at what precise time money was paid or a charge created.99

5.76 The majority adopted a stricter test, namely that money paid before creation of the charge would qualify as acceptable consideration under section 245 only if the interval between payment and creation was so short that it could be regarded as de minimis so that creation could genuinely be regarded as contemporaneous. Sir Christopher Slade gave the example of a coffee break.100 It would appear that lunch, or other more extended gastronomic indulgence, would exceed the permitted delay. 5.77 The approach of the Court of Appeal in Power v Sharp highlights the importance of identifying exactly when a charge is created.101 Some of the cases involve the advancing of consideration between the adoption of a resolution or the conclusion of an agreement to create a charge on the one hand and the formal execution of the charge on the other. Yet, an unconditional promise to create a charge in the future generates in equity an immediate charge provided that, or as soon as, the promise is supported by valuable consideration. Consequently, an equitable charge may arise either as soon as the resolution is adopted or agreement concluded or at least when the first advance pursuant thereto is made, and the temporal requirement of section 245 will inevitably have been satisfied.102 The efficacy of a charge created at such an earlier date will, however, depend upon registration no later than 21 days following that earlier date.103 In practice, such registration is most unlikely.

98 Sir Christopher Slade delivering the main judgment, Ralph Gibson LJ delivering a short concurring judgment, Nolan LJ delivering a short judgment concurring except on one issue discussed below. 99 At 128. 100 At 123. 101 Discussed paras 6.22–6.24. 102 Power v Sharp Investments Ltd [1994] 1 BCLC 111 at 122. 103 The requirement of registration of company charges is discussed in ch 6.

210 Howard N Bennett (b) Current Trading Accounts 5.78 The temporal requirement for consideration to be acceptable under section 245 may be satisfied in a particular fashion in the context of current trading accounts through the rule in Clayton’s Case.104 By virtue of this rule of appropriation, it is assumed that payments into a current trading account operate to discharge indebtedness on that account in the chronological order in which withdrawals contributing to that indebtedness were made. Thus, if a company owes £x before granting the floating charge, the first £x paid into the account after creation of the charge will be treated as discharging the pre-existing indebtedness. Any indebtedness on the account remaining after that point must therefore be attributable to a post-creation advance of finance. 5.79 The operation of the rule in Clayton’s Case in the context of the legislation on late floating charges is established and illustrated by Re Yeovil Glove.105 In this case, a floating charge was given to secure indebtedness on an account already overdrawn to the agreed limit of £67,500. Thereafter, the account continued to be operated as normal, with a total of about £111,000 being paid into the account and almost the same amount withdrawn. The bank argued that, by virtue of the rule in Clayton’s Case, the prior indebtedness of £67,500 had been discharged by the first £67,500 paid into the account after the charge had been created. Consequently, to the extent that the account was overdrawn when the company went into liquidation, that represented a provision of finance after and in consideration for the creation of the charge. 5.80 Since it could see no basis in the legislation for not applying the rule in Clayton’s Case, the Court of Appeal held in favour of the bank. The result, as Harman LJ conceded, was to emasculate the late floating charge legislation with respect to current trading accounts. Once an account had been operated after the creation of the charge so that payments in equalled the amount of pre-charge indebtedness, all remaining indebtedness would represent new money validly secured by the charge.106 Harman LJ noted that this could be prevented by drawing a line in the company’s books and thereby opening a fresh account so that new payments in did not discharge pre-charge indebtedness,107 but it has to be asked why a bank would agree so to act against its own interest. 5.81 The Cork Committee108 regarded the operation of the rule in Clayton’s Case in this context as ‘objectionable’. That a bank could, through the rule, turn unsecured debt into secured debt, possibly smaller in amount than the pre-charge 104

(1816) 1 Mer 572. [1965] Ch 148. Another aspect of the decision is discussed above, paras 5.48–5.50. 106 At 172–73. 107 At 173. 108 Report of the Review Committee, Insolvency Law and Practice (1982, Cmnd 8558), paras 1560–62. 105

Late Floating Charges 211 indebtedness, was said to defeat the object of the section. The Committee recommended the reversal of the decision in Re Yeovil Glove. With respect, however, the criticism makes an assumption and overlooks an important aspect of section 245. 5.82 The object of the legislation on late floating charges is to protect the value of the insolvent estate against depletion through additional security being taken for existing indebtedness. The argument is that the rule of appropriation in Clayton’s Case enables an unsecured creditor on a current trading account to permit a continuance of trading in order to transform his status into a secured creditor, thereby depleting the value available for distribution on insolvency to unsecured creditors, with little or no compensating increase in the value of the estate accruing to the benefit of the remaining unsecured creditors. However, the operation of the rule in Clayton’s Case affects merely the time at which the consideration for the floating charge is regarded as made available to the company. It will still be necessary to value that consideration and the charge will be valid under section 245 only to the extent of the value of that consideration.109 Where a bank permits a fresh drawing on an overdrawn account, even in the absence of an undertaking to do so, the bank, which could have closed the account for withdrawals, is making new finance available to the company.110 Unless the face value of that new finance can be impugned,111 it seems correct in principle that the floating charge should be valid to the extent of that finance. It should be noted that the transaction in Yeovil Glove appears to have been of the very nature that the Cork Committee itself stated it did not wish to deter, namely the taking of security as an alternative to calling in debt and, presumably, inducing insolvent liquidation.

F CONSEQUENCES OF A SUCCESSFUL CHALLENGE TO A LATE FLOATING CHARGE

5.83 A floating charge that is successfully challenged under section 245 is invalid except to the extent of any consideration that is acceptable within the terms of the section. The invalidity, however, is confined to the period of the administration or winding up. Recoveries under section 245 inure to the benefit of the unsecured creditors.

(1) The Temporal Confinement of the Invalidity under Section 245 5.84 Where a charge is declared invalid under section 245, the sole consequence is that the chargee is denied the benefit of the charge in the administration or 109

See above, paras 5.52–5.64. RM Goode, Principles of Corporate Insolvency, 2nd edn (London, Sweet & Maxwell, 1997) at 418. 111 See above, paras 5.60–5.64. 110

212 Howard N Bennett winding up of the chargor company. This does not invalidate earlier measures taken pursuant to the underlying transaction secured by the charge or by virtue of the charge itself.112 Money paid pursuant to the obligation secured by the charge, even during the twilight period, is not rendered repayable by a subsequent successful challenge to the charge under section 245.113 Likewise, such a challenge will not retrospectively invalidate the appointment of a receiver pursuant to the charge and, so, will not render recoverable proceeds of realisations by the receiver applied in the discharge of secured obligations.114 In consequence, the enforcement of a floating charge is not hindered by the possibility of subsequent retrospective invalidation.

(2) The Date from which Section 245 Takes Effect 5.85 Since section 245 prevents a late floating charge being relied upon in administration or winding-up but not before, it is important to pinpoint exactly when these regimes commence. Earlier late floating charge legislation applied ‘where a company is being wound up’. It was held that the legislation could not operate unless and until a winding up order was made, since without such an order there would be no liquidation, but upon the making of a winding up order the legislation operated as from the commencement of the winding up.115 By legislation, this commencement was deemed to occur as from the date of the passing of a resolution for voluntary winding or the presentation of a petition for compulsory winding up.116 5.86 Section 245 applies where ‘(a) an administration order is made in relation to the company, or (b) the company goes into liquidation’ and the Insolvency Act contains the same deeming provisions regarding the date of commencement of winding up.117 In the compulsory winding up case of Power v Sharp Investments Ltd,118 it was argued that the difference in wording between section 245 and its predecessors was material and resulted in section 245 having no effect on measures taken pursuant to the floating charge before the date of the winding up order. The Court of Appeal rejected this argument. It made sense for the legislation to focus under the heading of ‘application’ on the event that triggered the application of the invalidity of the charge. Its silence with respect to retrospectivity was not to be construed as denying the limited relation back to the date of presentation of the winding up petition established under earlier legislation. Any other holding would lead to presentation triggering a rush to 112 113 114 115 116 117 118

Mace Builders (Glasgow) Ltd v Lunn [1985] BCLC 154 at 161, aff’d [1987] Ch 191. Re Parkes Garage (Swadlincote) Ltd [1929] 1 Ch 139. Mace Builders (Glasgow) Ltd v Lunn [1987] Ch 191. Ibid. Companies Act 1948 ss 229, 280. Insolvency Act 1986 ss 86, 129 (see above, para 5.41). [1994] 1 BCLC 111.

Late Floating Charges 213 unimpeachable enforcement by holders of late floating charges, ‘a serious lacuna in the section . . . which Parliament could scarcely have intended.’119 5.87 Parity of reasoning might suggest that when triggered by the making of an administration order, section 245 should relate back to the date of the petition for an administration order. However, there is no retrospective deeming provision with respect to the onset of administration.120 In consequence, section 245 cannot be used to impeach any steps taken pursuant to the invalid floating charge in the interim between presentation of the petition and the making of the order. There is, however, a statutory moratorium on the taking of any steps by way of enforcement of any security during that period.121

(3) Entitlement to Liberated Assets 5.88 In the context of any ground for the challenge of transactions on insolvency, the question arises of who benefits from that challenge.122 On a liquidation, do the assets that would have been subject to the defeated charge go to the party (if any) with the next ranking security interest or, alternatively, do they fall within the statutory trust that arises in favour of the unsecured creditors? There is no authority specifically in the context of late floating charges. 5.89 The argument in favour of the statutory trust depends on ownership of the right to challenge the impugned transaction. If the action belongs to the company, assets recovered or liberated by the action belong to the company and are available to the company’s general creditors. However, in the context of preferences, it has been held that the benefit of the exercise by a liquidator ‘of rights conferred upon him alone by statute’ falls within the statutory trust for distribution by the liquidator.123 Since the right to challenge on the basis of a preference is conferred explicitly on a liquidator or administrator and not on the company,124 the proceeds of a successful challenge on the ground of a preference are held by the liquidator on the statutory trust for the benefit of the unsecured creditors. Whether such an analysis is applicable to section 245 is unclear. Two points can be made. 5.90 First, sections 214, 238 and 239 (dealing with wrongful trading, undervalues and preferences) are explicit in conferring the right to apply to challenge the transaction upon the liquidator or administrator. The wording of section 119

At 126 per Sir Christopher Slade. Hence the wording of s 245(3)(c), (5) stipulating the date of presentation of the petition on which an administration order is made, in contrast with the commencement of winding up. 121 Insolvency Act 1986 s 10(1)(b). 122 See paras 2.135–2.145, 4.102–4.103, 6.157. 123 Re Oasis Merchandising Ltd [1998] Ch 170 at 182 per Peter Gibson LJ, delivering the judgment of the Court of Appeal. 124 Insolvency Art 1986 s 239(2). 120

214 Howard N Bennett 245 is unclear in this regard. Section 245(1) (headed ‘application’) provides that ‘[t]his section applies as does section 238’. That clearly refers to section 238(1) (also headed ‘application’), which limits the section to administration and liquidation. It is unclear whether it also embraces section 238(2), which clearly confers the right to bring an undervalue action on the liquidator or administrator and not on the company. In other words, it is unclear whether section 245 should be read as addressing both when it can be invoked and also by whom. 5.91 Secondly, in contrast with sections 238 and 239, the court has no discretion as to the consequences of a successful challenge under section 245. A successful section 245 action clearly removes an incumbrance from ‘the company’s undertaking or property’.125 The statute would appear to indicate, therefore, that the assets liberated from the invalid incumbrance belong to the company and, as such, are available to the general creditors of the company. Where, however, a floating charge is successfully challenged as a preference, the assets comprised in the charge equally belong to the company, yet the courts have held that the proceeds of the action fall within the statutory trust for sale. That the company retains an equity of redemption in the charged assets is overridden by the ownership of the preference action. This indicates that the key issue is the one addressed in the previous paragraph. 5.92 There is, of course, no statutory trust in the context of administration. The liberated assets would appear to fall subject to appropriately drafted charges and be available, in turn, to the administrator within the terms of section 15 of the Insolvency Act 1986. (4) Funding Section 245 Litigation 5.93 A link may be discerned between the funding of vulnerable transaction litigation and the destination of the benefit of such litigation. In Re MC Bacon Ltd (No 2),126 Millett J held that expenses incurred in unsuccessfully challenging a bank’s fixed and floating charges as, inter alia, preferences were not payable to the liquidator as expenses of the winding up in priority over preferential creditors and the bank’s claim as floating chargee. The idea that assets subject to a floating charge could be depleted by the costs of a challenge to the floating charge was clearly unattractive, although he held also that the costs of an unsuccessful attempt to recover assets are not expenses of the liquidation. If this second holding is correct, it would appear to undermine the force behind the depletion argument. He declined to regard a challenge to a floating charge as a preference as brought ‘in order to recover assets belonging to the company at the date of the winding-up.’127 The assets were charged and any claim to recover 125 126 127

S 245(2). [1991] Ch 127. As required by Insolvency Rules 1986 r 4.218(1).

Late Floating Charges 215 them was vested in the chargee. Instead, the action was ‘to set aside the bank’s charge . . . as a voidable preference’.128 Consequently, a liquidator could look for reimbursement of expenses only to any indemnity obtained from unsecured creditors. This, he held, was consistent with the established position that the value recovered under a preference action accrued to the statutory trust for the benefit of the unsecured creditors. 5.94 Thus, a challenge that can benefit only the unsecured creditors should not be funded at the expense of the preferential creditors and floating chargees. However, it does not follow that an action that will, on the facts, benefit a subsequent floating chargee will constitute an expense of the liquidation, payable at the expense of preferential creditors and prior ranking floating chargees. A section 245 action can only benefit holders of floating charges that rank behind the impugned charge and unsecured creditors. The liquidator may, therefore, be required to look to such parties for an indemnity.

128

At 136. See also 137.

6

Registration of Company Charges HOWARD N BENNETT

A THE REGISTRATION REQUIREMENT

(1) Introduction 6.1 English law requires that a measure of publicity be given to many company charges through registration. Failure to register within the statutory registration period renders the charge vulnerable in insolvency in that, if never registered, it is void (in the sense of being inopposable) against the company if and once it goes into liquidation or administration and also against creditors with a competing interest in the charged assets. Even if a successful application is made to the court for permission to register late, the priority of the charge, and its consequent efficacy in insolvency, is weakened.

(2) The Dual Registration System 6.2 The Companies Act 1985 subjects company charges to a dual system of registration. A company is required to maintain at its registered office a register of all charges affecting its property or undertaking.1 The register is open to any creditor or member of the public.2 Knowing or wilful non-compliance by an officer of the company with this requirement renders the officer liable to a fine, but the validity or efficacy of the charge is not jeopardised in any way by the company becoming insolvent.3 Consequently, this registration requirement will not be further discussed. In addition, however, the registrar of companies is directed to maintain a register, open to inspection by anyone, of all charges in respect of each company.4 Failure to supply the registrar with the information 1 Companies Act 1985 s 407(1). It must also keep at its registered office a copy of every instrument that creates a charge requiring registration: s 406(1). A copy of one debenture of a uniform series suffices: s 406(2). Note that the registration requirement under s 407 is not confined to those charges requiring registration in the register maintained by the registrar of companies, discussed below. 2 Ibid s 408. 3 Ibid s 407(3); Wright v Horton (1887) 12 App Cas 371. 4 Ibid s 401(1), (3).

218 Howard N Bennett required for maintenance of the register results in the invalidity of the charge in a liquidation or administration.5 It is this registration system that is the subject of this chapter. It is the subject of chapter XII of the Companies Act 1985.6 New registration provisions were to have been inserted by Part IV of the Companies Act 1989, but it is now apparent that this reform will not be implemented and this chapter will accordingly consider the original 1985 Act provisions.

(3) Companies Act 1985, Section 395(1) 6.3 The teeth of the registration system are found in section 395(1) of the Companies Act 1985. This provides as follows: Subject to the provisions of this Chapter, a charge created by a company registered in England and Wales and being a charge to which this section applies is, so far as any security on the company’s property or undertaking is conferred by the charge, void against the liquidator or administrator and any creditor of the company, unless the prescribed particulars of the charge together with the instrument (if any) by which the charge is created or evidenced, are delivered to or received by the registrar of companies for registration in the manner required by this Chapter within 21 days after the date of the charge’s creation.

6.4 Section 395(1) does not impose a duty to register. Instead, it prescribes certain consequences of failing to register. Section 399, however, imposes a duty on the company to effect registration and, in the event of non-compliance, renders both the company and every officer of the company liable to a daily default fine. The formal duty to register, therefore, lies on the company, but the civil law consequence of invalidity of the charge under section 395(1) clearly impacts upon the chargee. Consequently, section 399 also permits registration to be effected by ‘any person interested’ in the charge.7

(4) Purpose Behind the Registration Requirement 6.5 Registration of company charges was introduced by the Companies Act 1900 so that anyone contemplating dealing with the chargor company might make a decision that was better informed.8 Parliament’s intention was to bene5

Companies Act 1985 s 395(1). Part XII is divided into two chapters according to the place of registration of the company that creates the charge. Chapter I applies where the creator company is registered in England and Wales and Chapter II where the creator company is registered in Scotland. Although both chapters form part of the law both of England and Wales and of Scotland. (Arthur D Little Ltd v Ableco Finance llc [2002] EWHC 701 (Ch), [2002] 3 WLR 1387), the discussion in this chapter will be confined to Chapter I. 7 Ibid s 399(1). Such person is entitled to restitution from the company of fees properly paid to the registrar: s 399(2). 8 Re Jackson & Bassford Ltd [1906] 2 Ch 467 at 476; Re Yolland, Husson & Birkett Ltd [1908] 1 Ch 152 at 156. 6

Registration of Company Charges 219 fit all potential financial and trading partners, both secured and unsecured,9 although in reality the benefit of the publicity is probably confined to prospective secured creditors.10 That intention has not, however, engendered a policy in favour of openness in respect of financial arrangements that will influence the courts to construe an instrument so as to require registration.11 In reality, the registration system under the Companies Act produces a picture of a company’s secured indebtedness that may be incomplete and unreliable.12

(5) Structure of the Chapter 6.6 This chapter will proceed by considering (1) the scope of section 395(1), (2) the requirements for effective registration under section 395(1), (3) late registration, (4) the applicability of section 395(1) to oversea companies, and (5) the consequences of non-registration in accordance with section 395(1).

B THE SCOPE OF SECTION 395(1)

6.7 The registration regime of section 395(1) applies to ‘a charge created by a company registered in England and Wales and . . . to which this section applies’. Four requirements must, therefore, be satisfied. First, there must be a charge. Secondly, the charge must be created by a company.13 Thirdly, it must be a charge to which section 395 applies. Fourthly, the creator company must be registered in England and Wales. It will be convenient to consider the first two requirements together.

(1) There Must Be a Charge Created by the Company 6.8 Section 396(4) states that, for the purposes of chapter XII of the Companies Act, the term ‘charge’ includes mortgage. Otherwise, no statutory 9 Hansard, 4th series, vol 84 at 1143, col 1; vol. 87 at 107–14; Smith v Bridgend County Borough Council [2001] UKHL 58 at [19], [2002] 1 AC 336 at 347–48. 10 Baird, ‘Notice Filing and the Problem of Ostensible Ownership’ (1983) 12 Journal of Legal Studies 53. As to why non-registration should result in the sanction of avoidance as stated in s 395(1), see RM Goode, Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 419–21. 11 Welsh Development Agency v Export Finance Co Ltd [1992] BCLC 148 at 168, 177–79. 12 The lack of completeness flows from the scope of s 395(1) and the lack of reliability mainly from the role of the registrar’s certificate, both discussed below. 13 Where a company acquires property that is already subject to a charge that would be registrable if created by the company itself, then particulars of the charge must be delivered to the Registrar within 21 days after the date of completion of the acquisition: Companies Act 1985 s 400(1)–(2). However, failure to register is sanctioned only by liability to a fine: s 400(4). Non-registration does not render the charge vulnerable upon the insolvency of the acquiring company.

220 Howard N Bennett definition is provided and one must turn to the common law.14 It will be appropriate to consider the concepts of mortgage and charge before distinguishing other forms of security and considering various financing mechanisms. (a) Mortgage and Charge 6.9 Mortgages and charges are non-possessory, consensual security interests. Although conceptually distinct, they are often treated alike in law to the extent that the terms are on occasion employed interchangeably by the judiciary.15 The defining of charge by section 396(4) as including mortgage means that no distinction is drawn between them with respect to registrability under the Companies Act. Mortgage 6.10 As a matter of basic principle, a mortgage is a conveyance of common law ownership by the mortgagor to the mortgagee by way of security for the payment of a debt or the discharge of some other obligation. The conveyance is subject to a right, protected in equity, of the mortgagor to redeem the mortgage and trigger a re-vesting of ownership by discharging the secured obligation. Any restriction on the right to redeem is invalid as a clog on the equity of redemption.16 This analysis of a mortgage as based on a transfer of ownership holds good for personal property, although in the context of real property legislation has intervened so that a mortgage of a freehold or leasehold interest in land takes effect by way of a demise or sub-demise subject to redemption or a charge by way of legal mortgage.17 A mortgage may be either legal or equitable,18 but this distinction is of no import with respect to registration under the Companies Act. 6.11 A mortgagee benefits from a range of remedies against the mortgaged asset.19 A legal mortgagee, being at least in historical theory the legal owner of the property, may seek a court order for foreclosure,20 whereby the equity of redemption is extinguished vesting the legal property in the mortgagee 14

Carreras Rothmans Ltd v Freeman Mathews Treasure Ltd [1985] Ch 207 at 227. For example, Swiss Bank Corp v Lloyds Bank [1982] AC 584 at 594. 16 Keith v Burrows (1876) 1 CPD 722 at 731; Santley v Wilde [1899] 2 Ch 474 at 474–75; Noakes & Co Ltd v Rice [1902] AC 24. The invalidity of fetters on redemption rights is subject to a statutory exception in the case of debentures: Companies Act 1985 s 193. 17 Law of Property Act 1925 ss 85, 86. 18 A mortgage is equitable where the intention to create a mortgage is clear and either the property is recognised only in equity or the formalities for a transfer of ownership at common law have not been fulfilled. 19 See generally Fisher and Lightwood, Law of Mortgage, 10th edn (London, Butterworths, 1988). 20 Carter v Wake (1877) 4 Ch D 605. Since the remedy of foreclosure is based on the principle that the mortgagee is the legal owner of the property, where the mortgage is equitable because the formalities for the transfer of ownership have not been observed, the availability of foreclosure depends on an express or implied agreement to execute a legal mortgage. On the need for a court order, see Re Farnol Eades Irvine & Co [1915] 1 Ch 22 at 24. 15

Registration of Company Charges 221 absolutely. Status as legal owner carries with it also an immediate right to possession, even in the absence of any default by the mortgagor.21 In addition, a mortgagee may seek to liberate the value of the secured asset by exercising a statutory, express or implied power of sale, or through management of the asset by appointment of a receiver pursuant to a statutory jurisdiction or express power. Charge 6.12 A charge is the conferral by the chargor in favour of the chargee of a proprietary interest in an asset as security for the discharge of a monetary or another obligation. In the event of default on the underlying obligation, the chargee will seek recourse to the asset by way of sale or appointment of a receiver. The precise nature of the proprietary interest conferred is difficult to describe. Unlike a mortgage, a charge does not involve a conveyance of ownership in the asset. Instead, it is customary to speak of an appropriation of property to the discharge of a debt or another obligation.22 The absence of a conveyance is significant, however, since it precludes the remedies of foreclosure and taking of possession available to a mortgagee.23 Except for the so-called charge by way of legal mortgage, all charges are equitable. 6.13 Terminological note. For the sake of brevity, and following the statutory definition of charge in the Companies Act 1985, references to charges should henceforth in this chapter be understood as including mortgages unless the contrary is stated. Creation of Charges: Grant v Reservation 6.14 Section 395(1) requires registration only of charges ‘created by the company’. If it were possible for a supplier of property to a company to take a charge by reserving a chargee’s interest, the requirement for registration could be avoided. English law, however, takes the view that a charge, by definition, can be created only through being granted by the chargor to the chargee and not by reservation on the part of the chargee. It is technically impossible for a party with full legal title to transfer title to another party while retaining an interest by way of charge, although precisely why has never been clearly explained.24 21

Four-Maids Ltd v Dudley Marshall (Properties) Ltd [1957] Ch 317. Swiss Bank Corp v Lloyds Bank [1982] AC 584 at 595; Carreras Rothmans v Freeman Mathews Treasure Ltd [1985] Ch 207 at 227. The intention must, however, be to create a security. Thus, an equitable proprietary interest under an escrow account was held not to amount to a charge because the account was intended to act as a payment mechanism rather than a security: Lovell Construction Ltd v Independent Estates plc [1994] 1 BCLC 31. 23 Although express terms in a charge instrument may confer on a chargee the additional remedies of a mortgagee. 24 For contrasting academic views on whether creation by grant is of the essence of consensual security (not just a charge) in English law, see R M Goode, Legal Problems of Credit and Security, 2nd edn (London, Sweet & Maxwell, 1988) at 5–6; F Oditah, Legal Aspects of Receivables Financing (London, Sweet & Maxwell, 1991) at 5–8. 22

222 Howard N Bennett 6.15 The question of whether a charge can arise by way of reservation was raised expressly in Re Bond Worth Ltd25 in the context of a contract for the sale of goods on credit that provided for the retention of ‘equitable and beneficial ownership’. On the basis that the clause gave rise to an equitable charge, it was argued that the charge arose by reservation with the seller disposing merely of an equity of redemption. Slade J held, however, that this was theoretically impossible and that a grant back of the charge to the seller, albeit implied, was inescapable. Accordingly, the contract was construed as passing the entire property, legal and equitable, to the purchaser with a simultaneous grant back of a charge to the seller.26 6.16 Support for this analysis may be found in Westdeutsche Landesbank Girozentrale v Islington London Borough Council,27 in which the appellant bank sought to assert an equitable proprietary interest to money paid under a void contract so as to found a claim in equity to compound interest. One suggested basis for the equitable interest was an intention to part with legal and beneficial title to the money only if the contract was valid. Legal title had passed by operation of law on mixing of the money in the council’s bank account, but it was argued that equitable title had been retained. Lord Browne-Wilkinson rejected the argument in the following terms:28 A person solely entitled to the full beneficial ownership of money or property, both at law and in equity, does not enjoy an equitable interest in that property. The legal title carries with it all rights. Unless and until there is a separation of the legal and equitable estates, there is no separate equitable title. Therefore to talk about the bank ‘retaining’ its equitable interest is meaningless.

6.17 With respect, however, the issue is not whether there can be an equitable interest without separation from the legal estate but how that separation can be effected. It is undoubtedly true that the holder of the entire estate, both legal and equitable, of a piece of property who wishes to transfer that entire estate does not need to transfer the legal and equitable titles separately.29 The question, however, is why such a person who wishes to transfer only the legal title should be incapable of doing so. 6.18 In Armour v Thyssen Edelstahlwerke AG,30 a clause in a contract for the sale of steel that retained title in the steel until payment of all debts owing to the seller by the buyer was challenged on the ground that it constituted a charge that 25

[1980] Ch 228 at 251–56. This analysis of simultaneous conveyance and grant back of charge was followed in Stroud Architectural Systems Ltd v John Laing Construction Ltd [1994] 2 BCLC 276. 27 [1996] AC 669. 28 At 706. While the House of Lords was unanimous in rejecting the bank’s arguments for an equitable proprietary interest, only Lord Browne-Wilkinson, Lord Slynn concurring, addressed the retention point. 29 This is the principal point made by the authorities cited by Lord Browne-Wilkinson in support. 30 [1991] 2 AC 339. 26

Registration of Company Charges 223 was registrable under the Companies Act but had not been registered. The question, therefore, was not whether the clause gave rise to a charge but whether it gave rise to a charge created by the buying company. In rejecting this challenge, the House of Lords emphasised the true nature of the seller’s right. Lord Keith31 acknowledged that the title retention clause . . . does in a sense give the seller security for the unpaid debts of the buyer. But it does so by way of a legitimate retention of title, not by virtue of any right over his own property conferred by the buyer.32

Conversely, ‘[i]n all cases where a right of security is conferred the debtor retains an ultimate right over the subject matter in question.’33 As a result, if the security is realised and produces more than is needed to discharge the secured obligation, the creditor must account for the surplus while any increase in value in goods to which title is retained accrues to the benefit of the debtor. This reasoning disposed of the dispute on the facts. However, focussing on the difference between retained title and conferred charge, it does not exclude the possibility of a tertium quid, namely a retained security under which the supplier reserves rights of or akin to those of a mortgagee or chargee. Lord Jauncey, however, went further than Lord Keith and stated as follows:34 A right in security is a right over property given by a debtor to a creditor whereby the latter in the event of the debtor’s failure, acquires priority over the property against the general body of creditors of the debtor. It is of the essence of a right in security that the debtor possesses in relation to the property a right which he can transfer to the creditor, which right must be retransferred to him upon payment of the debt.

Since, under the terms of the contract, the buyers never acquired title to the goods, they could not have created a ‘right in security’ in favour of the sellers. While obiter, this dictum denies any possibility of a tertium quid, although by assertion rather than explanation. 6.19 While the authorities are not perhaps as illuminating as might be desired, they do seem to indicate a decision by English law that a charge by way of reservation is not possible, thus removing one basis on which a charge might escape the need for registration under the Companies Act. That in itself is a justification for the choice that English law has made. If the register is to function as an effective device for giving publicity to company charges, thereby affording useful and reliable information to parties who are contemplating dealings with the company, it is important that gaps in the registrability of charges are carefully policed.

31 Lords Griffiths, Oliver and Goff concurring and Lord Jauncey delivering a short concurring judgment. 32 At 353. 33 Ibid. 34 At 354.

224 Howard N Bennett 6.20 This approach provides the key to a line of authorities regarding priorities between a purchase money security interest35 and a competing interest that, on one reading, might suggest that a purchase money charge could arise by way of reservation. In all these cases,36 a company purchased property by means of money borrowed under an agreement that provided for the lender to have a charge over the purchased asset as security for repayment of the purchase money loan. In each case, priority was held to lie with the purchase money financier. Dicta in some of the judgments seem to indicate that the reason why the purchase money financier wins is that the company only ever acquires property already subject to the purchase money charge, in which case the charge cannot have been created by the company. Thus, in Abbey National Building Society v Cann,37 the House of Lords held that a purchase money mortgagee had priority over the competing equity of an unsecured contributor to the purchase price. Lord Oliver stated that: . . . the purchaser of land who relies on a building society or bank loan for the completion of his purchase never in fact acquires anything but an equity of redemption, for the land is, from the very inception, charged with the amount of the loan without which it could never have been transferred at all.38

Such a comment must, however, be read in context. Lord Oliver was concerned to reject the argument that the purchaser acquired an unencumbered title to the land and then granted the building society a mortgage after a scintilla temporis during which time the competing interest might attach. This comes through clearly in the judgment of Lord Jauncey, who made the same point while maintaining the grant analysis of the mortgage:39 [A] purchaser who can only complete the transaction by borrowing money for the security of which he is contractually bound to grant a mortgage to the lender eo instanti with the execution of the conveyance in his favour cannot in reality ever be said to have acquired even for a scintilla temporis the unencumbered fee simple or leasehold interest in land whereby he could grant interests having priority over the mortgage . . . Since no one can grant what he does not have, it follows that such a 35 The purchase money security interest, as recognised by Art 9 of the Uniform Commercial Code, is a security over a new asset in respect of the finance that permitted acquisition of that asset. Where the asset is supplied on credit on title retention terms, the retained title can be viewed, functionally at least, as such an interest. Where the asset is purchased using borrowed money, a charge in favour of the lender over the purchased asset is also a purchase money security interest. It is of the essence of a purchase money security interest that it is limited to such part of the purchase money finance as remains outstanding. 36 Wilson v Kelland [1910] 2 Ch 306; Re Connolly Bros Ltd (No. 2) [1912] 2 Ch 25; Security Trust Co v Royal Bank of Canada [1976] AC 503; Coventry Permanent Economic Building Society v Jones [1951] 1 All ER 901; Abbey National Building Society v Cann [1991] 1 AC 56. For discussion of these cases in the context of the concept of a purchase money security interest, see HN Bennett and CJ Davis, ‘Fixtures, Purchase Money Security Interests and Dispositions of Interests in Land’ (1994) 110 Law Quarterly Review 448 at 461–70. 37 [1991] 1 AC 56. 38 At 93. 39 At 102.

Registration of Company Charges 225 purchaser could never grant an interest which was not subject to the limitations on his own interest.

6.21 What the House of Lords rejected, therefore, was the idea that the purchaser should ever hold the legal title unencumbered, holding that the priority dispute should be decided in favour of the secured purchase money financier. The case was not concerned with the mechanics of creation of the purchase money mortgage, but the judgment of Lord Jauncey supports, and that of Lord Oliver is not in context inconsistent with, a grant by the mortgagor. Similarly, the other cases concerned with purchase money security interests involve priority disputes and do not address the mechanics of creation.40 Indeed, since in all the cases the purchase money financier was not the vendor of the new property, it is difficult to see how a charge could have arisen other than through grant by the purchaser. Moreover, in Stroud Architectural Systems Ltd v John Laing Construction Ltd 41 it was held that the decision in Abbey National v Cann does not affect the analysis of simultaneous conveyance and grant back of charge adopted in Re Bond Worth Ltd 42 of a clause retaining title to equitable and beneficial ownership. Time of Creation of Charges 6.22 A charge is created at the time of execution of the instrument or other act or agreement giving rise to it.43 Creation of the charge is not suspended until the making of the advance the charge is created to secure.44 Where a company resolves to issue debentures pursuant to a trust deed containing a charge in favour of the debenture holders, the charge is created when the trust deed is executed,45 not at the earlier date when the resolution authorising the issue of debentures is passed.46 Where a series of debentures containing charges is issued unsecured by a trust deed, the charges are created when the debentures are sealed by the company.47 6.23 At common law, a charge can be granted only over existing property since nemo dat quod non habet. A charge over future property takes effect at common law merely as a promise to create a charge in the future and requires a fresh act of appropriation on the acquisition of the property to have any proprietary effect.48 Equity, however, regards a promise to create a charge on future 40

Re Bond Worth Ltd [1980] Ch 228 at 252–53. [1994] 2 BCLC 276. 42 [1980] Ch 228, discussed above, para 6.15. 43 Independent Automatic Sales Ltd v Knowles & Foster [1962] 1 WLR 974 at 985. 44 Re New London and Suburban Omnibus Co [1908] 1 Ch 621; Esberger & Son Ltd v Capital and Counties Bank [1913] 2 Ch 366. 45 Re New London and Suburban Omnibus Co [1908] 1 Ch 621. 46 Re Harrogate Estates Ltd [1903] 1 Ch 498 at 502–3. 47 Re Spiral Globe Ltd (No 2) [1902] 2 Ch 209 as discussed in Re New London and Suburban Omnibus Co [1908] 1 Ch 621, although Re Harrogate Estates Ltd [1903] 1 Ch 498 at 503 supports the date of issue of the first debenture. 48 Lunn v Thornton (1845) 1 CB 379. 41

226 Howard N Bennett property as specifically enforceable subject to the proviso that valuable consideration has been given for the promise, since equity will not assist a volunteer. Subject to that proviso, therefore, equity regards the charge as created immediately49 with a subsequent conveyance or appropriation of the relevant proprietary interest in the property to the chargee occurring automatically and immediately upon acquisition of the property by the chargor.50 Since the charge is created immediately, it follows that the 21-day registration period under section 395(1) commences immediately and is not postponed until the later date of acquisition of the property. 6.24 An unconditional promise to create a charge in the future in equity creates a charge immediately since equity looks on as done that which ought to be done.51 This is again subject to the proviso that valuable consideration has been given in return for the promise. Subsequent fulfilment of the promise creates a second charge that is independently registrable in the sense that non-registration of the first charge does not prejudice registration of the second.52 However, where an agreement that gives rise to an equitable charge that is duly registered contains a provision entitling the creditor to require the subsequent execution of a legal mortgage, it has been assumed by a creditor without attracting adverse judicial comment that the subsequent legal mortgage does not require separate registration.53 The creditor relied on the position where a charge contains a provision permitting substitution of charged property. In Cunard v Hopwood,54 it was held that such substitution does not give rise to a new, separately registrable charge under the Companies Act.55 Chargees otherwise would be extremely vulnerable since substitution could happen without their knowledge. Moreover, on receipt of the registrable particulars, the Registrar of Companies issues a certificate that is conclusive evidence that all registration requirements have been complied with.56 Consequently, once the certificate has been issued the charge must be given full effect according to its tenor and, it may be argued, that includes recognising the stipulated later legal mortgage just as it includes permitting the stipulated substitution. Admittedly the later mortgage might be 49 Re Lind [1915] 2 Ch 345; Independent Automatic Sales Ltd v Knowles & Foster [1962] 1 WLR 974 at 985; Annangel Glory Compania Naviera SA v M Golodetz Ltd (The Annangel Glory) [1988] 1 Lloyd’s Rep 45 at 50. 50 Holroyd v Marshall (1862) 10 HLC 191 (fixed mortgage on future mill machinery); Tailby v Official Receiver (1888) 13 App Cas 523. 51 Levy v Abercorris Slate & Slab Co (1887) 37 Ch D 260 at 265. 52 Re Columbian Fire-Proofing Co Ltd [1910] 2 Ch 120. 53 Re William Hall (Contractors) Ltd [1967] 1 WLR 948. 54 [1908] 2 Ch 564. 55 The substitution may, nevertheless, involve the creation of a new charge over the substituting property for the purposes of a different registration regime. It has also been suggested that the substitution clause should be reflected in the registered particulars on the company charges register: Pennington, Company Law, 7th edn (London, Butterworths, 1995) at 647–48. However, the conclusive nature of the registrar’s certificate (see below) would appear to preclude any challenge to the charge should the particulars not do so. 56 Discussed below.

Registration of Company Charges 227 distinguished on the grounds that, ultimately, it constitutes a distinct security interest, but the fact that registration of the later mortgage would appear to serve no useful purpose diminishes the attractiveness of the distinction. Potential Charges 6.25 A contingent agreement to create a charge does not of itself generate a charge. In Re Gregory Love & Co,57 a company director guaranteed the company overdraft in return for an agreement with the company that it would give the director a debenture secured by a floating charge if the bank sought repayment from either the company or the director. Subsequently, and in circumstances that it was assumed fulfilled that contingency, the company did execute a secured debenture, but a rapidly ensuing winding up invalidated the floating charge in the debenture.58 An argument that the earlier agreement itself gave rise to a charge was unsuccessful. An agreement to create a charge in the event of a specified contingency was wholly executory and to hold that it gave rise itself to a charge would contradict the express terms of the agreement and might, given the vulnerability of charges created shortly before the onset of insolvency, place the chargee in a better position than if the agreement had been performed according to its terms. 6.26 Once the contingency occurs, the promise to create a charge becomes specifically enforceable with the result that equity, regarding as done that which ought to be done, should recognise a charge as arising immediately.59 Fixed and Floating Charges 6.27 Charges may be either fixed (or specific) or floating.60 A fixed charge imposes an immediate restriction on the management autonomy of the chargor, who may not thereafter dispose of the secured asset to a third party without the consent of the chargee. For some purposes, indeed, assets subject to a fixed charge are regarded as no longer those of the chargor, regardless of whether the security is in truth a mortgage or a charge.61 Where the commercial needs of the chargor require retention of uninhibited management autonomy over the 57 [1916] 1 Ch 203. See also Williams v Burlington Investments Ltd (1977) 121 SJ 424; Smith v Bridgend County Borough Council [2001] UKHL 58 at [62], [2002] 1 AC 336 at 357. 58 By virtue of s 212, Companies (Consolidation) Act 1908, the then precursor to s 245, Insolvency Act 1986, discussed in ch 5. 59 Thomas Guaranty Ltd v Campbell [1985] QB 210; Smith v Bridgend County Borough Council [2001] UKHL 58 at [61]–[62], [2002] 1 AC 336 at 357. 60 The distinction between fixed and floating charges is one that has exercised the courts considerably. Since, however, the issue is unlikely to arise in the context of registration, only a brief indication of the difference is given here. For a full discussion, see above, ch 5. The discussion here considers the charges as a matter of common law. For the question of whether the term ‘floating charge’ carries the same meaning under the statutory registration scheme, see paras 6.83–6.84. 61 Re Barleycorn Enterprises Ltd [1970] Ch 465. See also the approach to crystallisation of floating charges and liquidation expenses in Re Griffin Hotel Ltd [1941] Ch 129 and Re Christonette International Ltd [1982] 1 WLR 1245, although legislation has since rendered crystallisation irrelevant in this context.

228 Howard N Bennett charged assets, a fixed charge is evidently inappropriate and a floating charge is the answer. A floating charge generates an immediate proprietary interest 62 in the fund of charged assets,63 but does not attach immediately to any specific asset in that fund.64 Instead, the charge floats over the fund, leaving the chargor’s management autonomy unimpaired until something occurs that causes the charge to cease hovering and descend and attach to the specific assets within the description of the charged fund that the chargor owns at that moment or acquires thereafter.65 Such attachment is generally termed ‘crystallisation’ of the charge. Prior to that point, the chargor retains the right, in the course of pursuing its ordinary course of business, to exploit or dispose of any particular member of the charged fund thereby withdrawing it from the security.66 The immediate generation of a security interest, however, means that the creation of the charge occurs immediately,67 not at the later time of crystallisation, and the 21-day registration period commences immediately. Charge-backs 6.28 A specific issue that has troubled the courts is whether a party, usually a bank, with which money has been deposited so as to generate an obligation to repay a sum equal to that deposited can take a charge back over that indebtedness from the person to whom the sum is to be repaid. Despite nineteenth century authority upholding the possibility of such a charge,68 in Re Charge Card Services Ltd69 Millett J held that such a charge-back was conceptually impossible. He reasoned that the proprietary nature of a charge was the product of the equitable remedies by which a chargee could resort to the charged property in order to have it realised and applied to the discharge of the secured obligation. A debt, as a chose in action, was ultimately a right to sue the debtor. But the bank as chargee could not exercise a chargee’s remedies because it could not sue itself. Although subsequent dicta doubted whether this impossibility argument 62

Evans v Rival Granite Quarries Ltd [1910] 2 KB 979. See RM Goode, Legal Problems of Credit and Security, 2nd edn (London, Sweet & Maxwell, 1988) at 49. 64 Thus, prior to crystallisation (see below), a floating chargee lacks the requisite interest in any individual asset to maintain a conversion action in respect thereof: Stroud Architectural Systems Ltd v John Laing Construction Ltd [1994] 2 BCLC 276 at 283. 65 Illingworth v Houldsworth [1904] AC 355 at 358. For the purposes of the Companies Act 1985, a floating charge is defined (ss 744, 462(1)) merely as 63

. . . a charge . . . over all or any part of the property (including uncalled capital) which may from time to time be comprised in [the] property and undertaking [of the company] . . . 66 Agnew v Commissioner of Inland Revenue [2001] UKPC 28, [2001] AC 710. See further, paras 5.13 et seq. 67 This is so even if the fund of charged assets is initially empty or if the charge is created exclusively over future property: Annangel Glory Compania Naviera SA v M Golodetz Ltd (The Annangel Glory) [1988] 1 Lloyd’s Rep 45 at 50. 68 Re Jeavons, ex parte Mackay (1873) LR 8 Ch App 643 at 646 (impossibility expressly argued), 647 (expressly rejected). 69 [1987] Ch 150 at 176.

Registration of Company Charges 229 was correct,70 in Re Bank of Credit and Commerce International (No 8),71 the Court of Appeal, albeit obiter, approved Charge Card. The court relied also on the nature of the relationship between bank and depositor as one of debtor and creditor. A debt was owed not owned and a debtor . . . cannot be made to own the debt which he owes and which he is incapable of assigning. This is not merely a matter of semantics. The distinction between property and obligation lies at the heart of our jurisprudence.72

6.29 Re Bank of Credit and Commerce International (No 8), however, was appealed to the House of Lords73 and the conceptual impossibility objection was overruled. Lord Hoffmann held74 that, although a charge required the chargee to be able to resort to the charged property, no particular method of realising the property was essential. There was nothing contrary to principle in the charge being realised by the chargee under a charge-back simply making an entry in the charged account. Otherwise, a charge-back would share the normal attributes of a charge of defeasibility on discharge of the secured obligation and of binding third parties, subject to any registration requirements and the doctrine of the bona fide purchaser of the legal estate for value and without notice. The objection that a debt is owed and not owned was simply disowned. In the context of dismissing any suggestion that a charge-back would extinguish the debt by revesting title in the debt in the debtor and triggering a merger of interests, Lord Hoffmann stated that: The depositor would retain title to the deposit subject only to the bank’s charge. The creation of the charge would be consensual and not require any formal assignment or vesting of title in the bank.75

6.30 It is, of course, elementary that a charge, as opposed to a mortgage, does not involve any transfer of ownership of the debt to the chargee. The question, however, is whether a creditor has, as against the debtor, a sufficient proprietary interest in the debt owed to sustain the granting back to the debtor of the proprietary interest short of ownership that constitutes a charge.76 The decision of the House of Lords clearly establishes an affirmative answer to that question, albeit without any explanation.

70 Welsh Development Agency v Export Finance Co Ltd [1992] BCLC 148 at 166–67; Re Bank of Credit and Commerce International SA (No 8) [1995] Ch 46 at 58. 71 [1996] Ch 245. 72 At 259 per Rose LJ, delivering the judgment of the Court. 73 [1998] AC 214. 74 At 227–28. 75 At 227. 76 Oditah, Legal Aspects of Receivables Financing (London, Sweet & Maxwell, 1991) at 105: ‘in the final analysis what interest is sufficient to support a real security is a matter of legal policy.’

230 Howard N Bennett (b) Lien and Pledge 6.31 The possessory lien, as distinct from the equitable lien, and the pledge are possessory security interests. Since possession of the secured asset resides in the secured creditor, there is generally no danger of a third party being misled through possession on the part of debtor generating an appearance of false wealth.77 Consequently, registration would serve no useful purpose and is not required under the Companies Act. They will be briefly considered for the purposes of comparison. Possessory Lien 6.32 A possessory lien may be contracted for but is usually conferred by the common law or by statute.78 Such a lien is a device by which the common law can mitigate the often precarious position of certain suppliers of services for whom neither a charge nor payment in full in advance is realistic. It is not, however, a strong security interest since the only remedy available to the lienee at common law is retention of possession,79 although a right of sale in the event of default on the underlying obligation may be conferred by statute80 or expressly contracted for. Provided a contractual right of sale is appended to a right to retain possession rather than to take possession, it will not be construed as converting a non-registrable, possessory lien into a, potentially registrable, charge.81 6.33 Although a possessory lien is based on possession of the secured asset by the lienee, it is the maintenance of a continuing right to possession over the asset rather than the fact of actual possession that is decisive. Where a contract of bailment permits the bailor to remove the chattel at will, the agreement is repugnant to the bailee having a lien.82 However, in Albemarle Supply Co v Hind83 the Court of Appeal held that an agreement by a repairer that taxis be removed daily for use provided they continued to be ‘in pawn’ and were returned each night to the repairer’s garage did not terminate the repairer’s common law lien over the taxis. Given the departure in such a case from a strict possessory basis for the lien, a case might be made in principle for registrability, but no such possibility arises under English law. 77 It could be argued that potential creditors of the lienee or pledgee might be misled, but there is no requirement of registration of their interests as secured creditors. 78 For example, Sale of Goods Act 1979 s 39 (unpaid seller of goods). Where conferred by law, a lien escapes registration not only because it is not in substance a charge but also because it is not created by the lienee company: Brunton v Electrical Engineering Corp [1892] 1 Ch 434 (solicitors’ lien not within debenture clause restricting creation of mortgage or charge). 79 Thames Iron Works Co v Patent Derrick Co (1860) 1 J & H 93. 80 For example, Torts (Interference with Goods Act) Act 1977, ss 12, 13. 81 Great Eastern Railway Co v Lord’s Trustee [1909] AC 109; Re Hamlet International plc [1999] 2 BCLC 506. Contrast Re Cosslett (Contractors) Ltd [1998] Ch 495 at 508–9. 82 Forth v Simpson (1849) 13 QB 680; James Bibby Ltd v Woods [1949] 2 KB 449. 83 [1928] 1 KB 307.

Registration of Company Charges 231 Pledge 6.34 A pledge is a bailment of property intended to be by way of security for the discharge of an obligation that confers upon the bailee the right to retain possession until redemption and the right to sell the property and apply the proceeds to discharging the underlying obligation in the event of failure to redeem.84 Possession of the property under an antecedent agreement entitling the creditor to use of the chattel is not inconsistent with the creation of a pledge.85 Like the possessory lien, the pledge can survive a redelivery of possession to the pledgor provided the redelivery is for a purpose consistent with the continued existence of the right of pledge.86 (c) Deposit of Negotiable Instruments and Title Deeds 6.35 The deposit of a document that represents an asset may, if accompanied by the requisite intention, give rise to a pledge or equitable mortgage. The deposit of an instrument recognised as a document of title in the sense that it carries a right to call for delivery of the asset it embodies constitutes constructive delivery of the asset itself and thereby gives rise to a pledge of the asset provided the deposit is accompanied by an intention to pledge.87 Thus, a bank that pays under a documentary credit against documents that include a negotiable bill of lading receives a right of pledge over the goods represented by the bill.88 Alternatively, the deposit of a title deed by way of security may give rise to a mortgage. A legal mortgage might be barred by the non-fulfilment of formalities required for a conveyance of the legal title, but a mortgage has traditionally been recognised in equity. Thus, a deposit of title deeds to land used to give rise to an equitable mortgage of the land. This possibility is now excluded by section 2 of the Law of Property (Miscellaneous Provisions) Act 1989.89 Consequently, a deposit of title deeds to land can give rise only to a common law lien or a pledge of the deeds themselves. The 1989 Act does not, however, affect personalty, in

84

Halliday v Holgate (1868) LR 3 Ex 299 at 302; Burdick v Sewell (1883) 10 QBD 363 at 366–68. RA Barratt & Co Ltd v Livesey (1981) 131 NLJ 1213 (right of pledge granted to company director over company car of which he already had possession not registrable as company charge). 86 North Western Bank v Poynter [1895] AC 56. Where the pledgee has been induced by fraud to relinquish the pledge and redeliver the asset, any equity subsisting in the deceived pledgee will be defeated by a subsequent bona fide purchaser of a legal interest for value and without notice: Babcock v Lawson (1880) 5 QBD 284. 87 Status as a document of title is confined at common law to documents recognised by commercial custom as possessing such status, most notably negotiable bills of lading, although a pledge can also arise through a wider range of documents by virtue of the Factors Act 1889 ss 2, 8, 9; Sale of Goods Act 1979 ss 24, 25. 88 Sewell v Burdick (1884) 10 App Cas 74. Where the documents are subsequently released by the bank under the terms of a trust receipt, the trust serves merely to preserve the bank’s pre-existing rights qua pledgee and does not give rise to a charge: Re David Allester [1922] 2 Ch 211. 89 United Bank of Kuwait plc v Sahib [1997] Ch 107, although in appropriate circumstances an interest may arise by way of constructive trust: Yaxley v Gotts [2000] Ch 162. 85

232 Howard N Bennett which context an equitable mortgage by deposit of an appropriate instrument remains possible.90 (d) Equitable Lien 6.36 An equitable lien is a non-possessory security that arises automatically by virtue of a doctrine of equity but that otherwise gives rise to a charge.91 The making of a contract for the sale of land, for example, automatically confers on the vendor an equitable lien on the land being sold to secure such part of the purchase price as might remain outstanding on completion,92 while a purchaser of land has an equitable lien to secure the repayment of any deposit should the purchase fail for any reason not rendering the deposit forfeit.93 The equitable lien is distinguished from the possessory lien already discussed by its non-possessory basis and from the charge already discussed by its non-consensual nature. On occasion, however, the line between an equitable lien and a consensual charge risks being blurred, not least where the question arises whether the lien has been waived. In such a case, the search for intention to waive may occasion passages that, read out of context, might be viewed as seeking evidence of intention to create the interest.94 This is significant because it is the non-consensual nature of the charge generated by an equitable lien that prevents it from being registrable under the Companies Act.95 The lien may be waived, however, by contracting for an alternative security for the outstanding purchase price, which may be a charge created by a company and, therefore, registrable under the Companies Act.96 (e) Charging Order 6.37 A judgment debt against a company may be enforced by means of a charging order. This court order imposes a charge on such property as is specified in the order for the purpose of securing payment of a judgment debt.97 By virtue of section 3(4) of the Charging Orders Act 1979, the charge so imposed: . . . shall have the like effect and shall be enforceable in the same courts and in the same manner as an equitable charge created by the debtor in writing under his hand. 90 Harrold v Plenty [1901] 2 Ch 314 (deposit of share certificate by way of security held to give rise to equitable mortgage). 91 Re Bond Worth [1980] 1 Ch 228 at 251; Re Welsh Irish Ferries [1986] 1 Ch 471 at 478. 92 Re Birmingham [1959] Ch 523; Barclays Bank plc v Estates & Commercial Ltd [1997] 1 WLR 415 at 419–20. 93 Rose v Watson (1864) 10 HLC 672. 94 See, for example, Dansk Syndikat v Snell [1908] 2 Ch 127 at 136. 95 London & Cheshire Insurance Co Ltd v Laplagrene Property Co Ltd [1971] Ch 499. 96 Capital Finance Co Ltd v Stokes [1969] 1 Ch 261; Burston Finance v Speirway Ltd [1974] 1 WLR 1648. 97 Charging Orders Act 1979 s 1(1). For the property that may be the subject of a charging order, see s 2.

Registration of Company Charges 233 6.38 These words do not, however, have the effect of deeming the charge, which is created by court order, to be created by the debtor company so as to require registration under the Companies Act.98 (f) Shipowner’s Lien on Sub-freights 6.39 A standard term of charterparties grants the shipowner a lien on freight earned under a sub-charter against discharge by the charterer of its obligations under the head charter. Despite the traditional lien terminology, however, in Re Welsh Irish Ferries Ltd 99 Nourse J held the interest to be a charge. The lack of a possessory basis meant that it clearly could not be a possessory lien and its express contractual origin precluded status as an equitable lien. Instead, it was an equitable assignment to the shipowner by way of security of the chose in action that was the charterer’s right to claim freight from the shipper. That could only be a charge.100 This analysis has, however, attracted cogent academic criticism101 and has been rejected by the Privy Council in Agnew v Commissioner of Inland Revenue.102 The lien lacks a defining characteristic of proprietary rights, namely opposability against third parties. This absence of any proprietary right on the part of the shipowner means that the lien is defeasible on payment and is unenforceable against any recipient of the sub-freights. The lien thus cannot be a charge. Instead, ‘[i]t is merely a personal right to intercept freight before it is paid analogous to a right of stoppage in transitu.’103 (g) Claims Based on Outright Ownership 6.40 Outright ownership, as opposed to a proprietary interest held by way of security even if it is the title of a mortgagee, is not, in the eyes of English law, a charge even if the purpose behind holding ownership is protection against the insolvency of a debtor. The issue has arisen principally in the following four contexts to be discussed: (1) vesting of ownership clauses under construction contracts; (2) title retention clauses in supply of goods contracts; (3) disguised chattel mortgages; (4) assignments of receivables.

98

Re Overseas Aviation Engineering (GB) Ltd [1963] Ch 24. [1986] 1 Ch 471, also known as The Ugland Trailer: [1985] 2 Lloyd’s Rep 372. 100 Confirmed in Annangel Glory Compania Naviera SA v M Golodetz Ltd (The Annangel Glory) [1988] 1 Lloyd’s Rep 45; Itex Itagrani Export SA v Care Shipping Corp (The Cebu) (No. 2) [1990] 2 Lloyd’s Rep 316. See also Federal Commerce & Navigation Co Ltd v Molena Alpha Inc [1979] AC 757 at 784; G & N Angelakis Shipping Co SA v Compagnie Nationale Algerienne de Navigation (The Attika Hope) [1988] 1 Lloyd’s Rep 439. The charge, moreover, is registrable as a charge on book debts: below, para 6.73. 101 Oditah, ‘The Juridical Nature of a Lien on Sub-freights’ [1989] Lloyd’s Maritime and Commercial Law Quarterly 191. 102 [2001] UKPC 28, [2001] 2 AC 710. 103 At para [41], at p 728 per Lord Millett, espousing the analysis proposed by Oditah, above. 99

234 Howard N Bennett Vesting of Ownership Clauses under Construction Contracts 6.41 It has long been customary for construction contracts to provide that property in plant and materials brought on to site by the contractor shall pass to the employer. Such a vesting clause serves two main purposes.104 First, to the extent that such assets belong to the employer, they are immune from seizure by creditors of the contractor. Secondly, should the contractor default for any reason, the plant and materials would be available to the employer or any substitute contractor for furtherance of the work. The precise legal effect of the clause is, however, a matter of interpretation of the clause in the context of the contract as a whole. 6.42 Where the vesting clause provides, for example, that the employer shall ‘be and become’ the owner of the assets, the courts give effect to the literal tenor of the words. There is certainly no charge. The initial contract is merely an agreement that legal title will pass upon a certain contingency and does not amount to any form of equitable assignment by way of security, while delivery of the assets on to the site perfects the transfer of full legal title.105 The vesting clause may in contrast provide merely that the employer may be ‘deemed’ or ‘considered’ to be the owner of the assets. In such a case, the clause is likely to be construed as allocating control over the assets merely as between contractor and employer for the purposes of the contract and not as transferring legal title to the employer. This is usually reinforced by clauses that prohibit the contractor, pending completion of the project, from removing the assets from the site without the consent of the employer and permit the employer to make use of the assets, if necessary, in furtherance of the project. Such clauses are superfluous if the employer is the true owner of the assets.106 6.43 In Re Cosslett (Contractors) Ltd,107 the contract contained a vesting clause of the deeming variety that, in accordance with the above principles, was held by the Court of Appeal not to give rise to a transfer of legal title. The contract further conferred on the employer a right to retain possession of the assets and use them to complete the project. This was held not to constitute a charge since it did not appropriate the assets and the value they embodied to the discharge of an obligation of the contractor, as the nature of a charge demands. It was instead designed to enable the employer to complete the contractor’s

104

Re Cosslett (Contractors) Ltd [1998] Ch 495 at 503. Reeves v Barlow (1884) 12 QBD 436; Bennett & White (Calgary) Ltd v Municipal District of Sugar City No 5 [1951] AC 786, 813–14. 106 Re Winter, ex parte Bolland (1878) 8 Ch D 225; Re Keen & Keen, ex parte Collins [1902] 1 KB 555; Re Cosslett (Contractors) Ltd [1998] Ch 495. A clause excluding the employer’s liability for loss of or damage to the assets will be similarly indicative of the contractor’s continued title unless the contract provides for the revesting of title to plant and surplus materials in the contractor on completion of the project: Re Keen; Re Cosslett. 107 [1998] Ch 495. 105

Registration of Company Charges 235 obligation and, to that end, merely conferred on the employer a temporary right of possession and use. In addition, however, the contract also conferred on the employer, in the event of default by the contractor, a right to sell the assets and apply the proceeds in satisfaction of any sums for which the contractor was or might become due under the contract. This right to take and sell assets and so apply the proceeds was stated, obiter, to give rise to a charge.108 Title Retention Clauses in Supply of Goods Contracts 6.44 Under a sale of goods contract, ownership in goods passes prima facie when the parties intend.109 It is open to the parties to defer the passing of ownership until fulfilment of any specified condition. Consequently, a seller of goods on credit may seek protection against non-payment by providing in the contract that ownership in the goods supplied will not pass until payment in full of the price. In the event of default by the buyer, the seller will be permitted to repossess the goods by virtue of the simple fact that the seller remains the owner and a refusal to give up the goods will be actionable in the tort of conversion.110 Moreover, in McEntire v Crossley Bros111 the House of Lords, affirming the duty of the courts to respect and give effect to the parties’ intentions as revealed by their choice of words,112 held that a title retention clause does not involve the grant of security by the hirer. Consequently, retention of ownership does not constitute a security registrable under the Companies Act. The seller’s rights are defined by the contract, not by operation of law, but the fundamental point that ownership is retained under such a clause prevents the seller’s rights from constituting a consensual charge in the first place, let alone a charge created by the company.113 6.45 Frequently, however, a company will acquire goods with a view either to reselling them in unchanged form or to subjecting them to a process of manufacture and reselling the resulting product. Accordingly, the seller may wish to transfer its interest from the original goods supplied to the products or proceeds of resale, whether in the form of cash or debt where the resale is on credit. While theoretically it may perhaps be possible to generate such a transferred interest so 108 An analysis approved by the House of Lords in Smith v Bridgend County Borough Council [2001] UKHL 58 at [41], [63], [2002] 1 AC 336 at 352, 357. See also paras 1.59–1.62. 109 Sale of Goods Act 1979 s 17(1). The passing of ownership may be deferred where the goods are unascertained: s 16. 110 Clough Mill Ltd v Martin [1985] 1 WLR 111. 111 [1895] AC 457. 112 Thus, Lord Watson at 467:

The duty of a Court is to examine every part of the agreement, every stipulation which it contains, and to consider their mutual bearing upon each other; but it is entirely beyond the function of a Court to discard the plain meaning of any term in the agreement unless there can be found within its four corners other language and other stipulations which necessarily deprive such term of its primary significance. 113

The same is true of title retention under hire-purchase and chattel leasing agreements.

236 Howard N Bennett that it is not registrable,114 almost invariably a transfer clause will be construed115 as giving rise to a charge that is created by the buying company and, therefore, registrable under the Companies Act. In Aluminium Industrie Vaassen BV v Romalpa Aluminium Ltd,116 buyers conceded they held goods as bailees for title retaining sellers under a contract that, as translated into English from the original Dutch, described the buyers as fiduciaries. The Court of Appeal held that, as a matter of construction of the contract, the buyers had an implied right of resale of the goods only as agents of the sellers, entitling the sellers to trace into the proceeds of sale of the goods. The buyers having gone into receivership, the sellers were entitled to the proceeds as against the receiver. However, while often prayed in aid, the decision in Romalpa has always been distinguished and never followed by the English courts.117 The fundamental problem is the extreme commercial improbability of a buyer conducting its business not for its own account but as the agent of the seller, thus appropriating the entire benefit of the buyer’s commercial efforts to the seller in return merely for a claim to agent’s commission from the seller. Such an arrangement simply does not correspond with reality: On the contrary . . . the normal implication that arises from the relationship of buyer and seller is that if the buyer is permitted to sub-sell in the normal course of his business, he will do so for his own account.118

6.46 Moreover, since the commercial purpose behind the seller’s title retention is to provide security against payment of sums owed, on the true construction of the title retention clause the seller’s retention invariably lapses on such payment. This is viewed as fatal. In Re Bond Worth Ltd,119 Slade J rejected the argument, inter alia, that retention of equitable and beneficial ownership gave rise to a trust in the following terms: In my judgment any contract which, by way of security for the payment of a debt, confers an interest in property defeasible or destructible upon payment of such debt, or appropriates such property for the discharge of a debt, must necessarily be regarded 114 In Clough Mill Ltd v Martin [1985] 1 WLR 111 at 119, 123–24, both Robert Goff and Oliver LJJ were prepared to accept the theoretical possibility of a clause automatically vesting outright ownership of proceeds or products in the seller without any act of grant on the part of the buyer. 115 The question is always one of construction of an express clause. A transferred security clause will not be implied since it is not necessary in order to lend business efficacy to the contract: Borden (UK) Ltd v Scottish Timber Products Ltd [1981] Ch 25; Chaigley Farms Ltd v Crawford, Kaye & Grayshire Ltd [1996] BCC 957. 116 [1976] 1 WLR 676. 117 Indeed, in refusing leave to appeal to the House of Lords in the Romalpa case, Roskill LJ described the contract as ‘a rather simple contract, not altogether happily expressed in the English language, but [which] could not govern any other case’: quoted in Borden (UK) Ltd v Scottish Timber Products Ltd [1981] Ch 25 at 45. 118 E Pfeiffer Weinkellerei-Weineinkauf GmbH v Arbuthnot Factors Ltd [1988] 1 WLR 150 at 159 per Phillips J. See also Re Peachdart [1984] Ch 131. In Ian Chishom Textiles Ltd v Griffiths [1994] 2 BCLC 291 at 298, David Neuberger QC stated that whether title vested in the seller was ultimately a matter of construction but conceded both the need for ‘very clear words’ and ‘a strong presumption, essentially based on commercial common sense’ in favour of a charge. 119 [1980] Ch 228 at 248.

Registration of Company Charges 237 as creating a mortgage or charge as the case may be. The existence of the equity of redemption is quite inconsistent with the existence of a bare trustee-beneficiary relationship.

The English courts invariably view such a power in the buyer to perfect its rights in proceeds of sale or products as the badge of a consensual security.120 Since such a security can only arise by way of grant, the title retention clause has to be construed as a registrable charge, notwithstanding the ‘violence’ that such construction might do to the wording of the clause.121 6.47 The result of the cases, therefore, is that a clause that retains title to the goods as originally supplied will be effective to prevent any passing of ownership to the buyer until the fulfilment of whatever condition is specified in the contract. This is so even if the condition relates, for example, to payment of sums other than the price of the goods in question. A clause that retains title to goods until discharge by the buyer of all debts owing to the seller under that or any other contract is taken at face value and does not create a charge.122 A clause, however, that purports to retain title to proceeds or products derived from the goods supplied will be construed as giving rise to a charge. Where a contract both retains title to goods supplied and contains a transfer clause that constitutes a charge, the fact that the transfer clause constitutes a charge does not affect the validity and efficacy of the initial title retention.123 6.48 If title can only be retained with respect to the goods as originally supplied, the question that necessarily arises is at what point in a process of manufacture do the goods cease to be regarded as the goods supplied and become instead a product any claim to which must lie through a charge. The answer depends on the type of process. Where the buyer alters goods, whether or not in combination with other goods, so as to generate a new product, title to the product vests in the buyer.124 The fundamental question, however, is whether the goods as originally supplied have changed state in a commercial sense. If so, the goods as supplied have ceased to exist and the seller’s title is extinguished,125 even though the goods have not yet become the intended product. Thus, in Modelboard Ltd v Outer Box Ltd,126 Michael Hart QC stated as follows:127

120 Tatung (UK) Ltd v Galex Telesure Ltd (1989) 5 BCC 325; Compaq Computers Ltd v Abercorn Group Ltd [1991] BCC 484; Modelboard Ltd v Outer Box Ltd [1993] BCLC 623. 121 Re Peachdart [1984] Ch 131 at 143; Clough Mill Ltd v Martin [1985] 1 WLR 111 at 120. 122 Snow (John) & Co Ltd v DBG Woodcroft & Co Ltd [1985] BCLC 54; Armour v Thyssen Edelstahlwerke AG [1991] 2 AC 339. 123 Clough Mill Ltd v Martin [1985] 1 WLR 111. 124 Borden (UK) Ltd v Scottish Timber Products Ltd [1981] Ch 25 at 46. 125 Borden (UK) Ltd v Scottish Timber Products Ltd [1981] Ch 25 (resin incorporated into chipboard); Chaigley Farms Ltd v Crawford, Kaye & Grayshire Ltd [1996] BCC 957 (animals slaughtered at abattoir). 126 [1993] BCLC 623. 127 At 633. See also Ian Chisholm Textiles Ltd v Griffiths [1994] 2 BCLC 291.

238 Howard N Bennett [I]n the present case the evidence is sparse and really amounts to no more than that at the relevant date the supplied boards had been so processed as to have lost all significant value as raw materials. That is, however, a sufficient basis on which I can find that they had ceased to be ‘the goods’, even though they might not yet have become ‘the product’.

Conversely, in Pongakawa Sawmill Ltd v New Zealand Forest Products Ltd,128 the sawing of logs into timber for sale was held not to affect title. ‘Importantly the processing simply modified the form of the logs which as sawn timber retained its essential character.’129 6.49 A test of alteration of commercial substance similarly underpins the law relating to accession, where one chattel is irreversibly attached and subordinated to another so that the dominant chattel may be enhanced but continues to exist in specie. Title to the subordinated chattel passes by operation of law to the owner of the dominant chattel. Thus, where cloth is stitched or dyed, title to the thread or dye passes to the owner of the cloth since the attachment is irreversible, provided the thread or dye is subordinate to the cloth.130 In Hendy Lennox Ltd v Grahame Puttick Ltd,131 however, the incorporation of diesel engines into generating sets by a process that would, it was agreed, take ‘several hours’132 to reverse did not defeat a contractual retention of title to the engines since ‘the process of incorporation would not in any way alter or destroy the substance of the engine’.133 6.50 Where the goods supplied are mixed134 with others so that separation is commercially impracticable, as where oil is mixed with oil or grain with grain, the resulting mixture is held in common ownership by the contributors in proportion to their contributions.135 The proprietary consequences are unaffected by whether the mixing is by consent, accidental or through the fault of the mixer.136 Similarly, it is irrelevant whether the mixing is with other goods of 128

[1992] 3 NZLR 304. At 309 per Richardson J. Likewise Armour v Thyssen Edelstahlwerke AG [1991] 2 AC 339, where it does not seem to have been suggested that the cutting of sheets of steel into strips for use in manufacture might have affected title. 130 In Re Peachdart [1984] Ch 131 at 141–42, it was common ground in the context of the manufacture of handbags that title to thread or attachments of minor value could pass by accession. Sed quaere whether the attachments would be fastened irreversibly. 131 [1984] 1 WLR 485. 132 At 487. Although note the observation by Staughton J that removal and replacement might need to be done ‘quickly and efficiently’: at 493. 133 Ibid per Staughton J. The engines were attached to the generating sets by bolts and other connections that could be undone. Consequently, the engines ‘just remained engines, albeit connected to other things’: at 494. 134 See PBH Birks, ‘Mixtures’, ch 9 in N Palmer and E McKendrick (eds), Interests in Goods, 2nd edn (London, LLP, 1998). 135 Spence v Union Marine Insurance Co (1868) LR 3 CP 427; Sandeman v Tyzack & Branfoot Steamship [1913] AC 680; Indian Oil Corp v Greenstone Shipping Co SA (The Ypatianna) [1988] QB 345; Coleman v Harvey [1989] 1 NZLR 723. 136 However, wrongful mixing exposes the mixer to a conversion action in respect of the diminution in value: Indian Oil Corp v Greenstone Shipping Co SA (The Ypatianna) [1988] QB 345. It 129

Registration of Company Charges 239 substantially the same nature and quality or with goods of a different nature and quality so as to generate a new product.137 Disguised Chattel Mortgages 6.51 Title retention as discussed in the previous section arises where the goods start out with the creditor who supplies goods on credit to the debtor company. Suppose, however, that the potential debtor wishes to raise money against security over a chattel the debtor already owns. A grant of security to the creditor would generate a charge created by a company. Can the debtor instead sell the chattel to the creditor and immediately take the chattel back on title retention terms so that the only rights that operate in fact by way of security are not classified in law as a registrable charge? 6.52 Where the title retention is part of a sham, the courts will look behind the transactions nominally employed by the parties and give effect to the reality. However, it is rare for a transaction to be declared a sham since that requires a common intention of the parties to effect a transaction different from the one proclaimed by their words and acts.138 Where the documents proclaim and both parties intend a sale and re-disposal on title retention terms, the transaction, whatever else it may be, is not a sham. 6.53 Aside from the narrow category of sham transactions, the English courts appear prepared to give effect to whatever arrangement the parties choose to adopt according to its tenor unless the detailed provisions of the agreement are inconsistent with that choice. The difficulty lies in identifying at what point an inconsistency arises.139 In Curtain Dream plc v Churchill Merchanting Ltd,140 Curtain Dream invoiced Churchill for £500,000 being the price of goods sold. Churchill paid and resold the goods back to Curtain Dream for £500,000 plus a transaction fee and interest. The result was that Curtain Dream received £500,000 finance from Churchill. Although the transaction was couched in terms of sale and re-purchase, Knox J held that it gave rise to a charge created by Curtain Dream. Even in the absence of a sham, the courts could still consider ‘the totality of the transaction’141 to determine whether the substance matched seems clear from this decision that the penal rule whereby a party who wrongfully mixes his own goods with those of another forfeits any claim to co-ownership (Spence v Union Marine Insurance Co (1868) LR 3 CP 427 at 437–38; Sandeman v Tyzack & Branfoot Steamship [1913] AC 680 at 695) should be confined to wilful wrongdoing. Even then, it will be applied with sensitivity: Sandeman. 137

Glencore International AG v Metro Trading International Inc [2001] 1 Lloyd’s Rep 284. Snook v London & West Riding Investments Ltd [1967] 2 QB 786 at 802. 139 The same issue arises also in the context of assignments of receivables (below, para 6.57), transactions at an undervalue (paras 2.66–2.74), and the distinction between fixed and floating charges (paras 5.18–5.19). 140 [1990] BCLC 925. See also Re Watson (1890) 25 QBD 27; Mellor’s Trustees v Maas & Co [1902] 1 KB 137, affd [1903] 1 KB 226, [1905] AC 102; Polsky v S & A Services [1951] 1 All ER 185; North Central Wagon Finance Co Ltd v Brailsford [1962] 1 WLR 1288. 141 At 935. 138

240 Howard N Bennett the form of sale and purchase. On the facts, the agreement spoke of a credit line and interest, language redolent of a secured loan. Most importantly, Knox J discerned an equity of redemption: [T]here was an exact degree of mutuality in both directions with regard to the passing of the title to the property in question. Just as the company was bound, once it had embarked upon the transaction, to transfer the property to Churchill, so Churchill was bound to reconvey it.142

6.54 Curtain Dream may be contrasted with Welsh Development Agency v Export Finance Co Ltd.143 Pursuant to a standing offer, Exfinco purchased all goods being sold overseas by Parrot Corporation, Parrot thereafter acting as agent for Exfinco as undisclosed principal. Exfinco paid Parrot the price on the overseas sales contracts minus a discount reflecting Exfinco’s risk and expenses. The goods were sold to the overseas buyers on title retention terms. Money paid by the overseas buyers went into an account in Parrot’s name but controlled by Exfinco, which was entitled to retain a sum from the balance as a safeguard against future exposure. On termination of the agreement, Exfinco would transfer all interest in the goods back to Parrot on satisfaction of all Exfinco’s claims against overseas buyers. When Parrot subsequently went into receivership, the Court of Appeal held that the money in the account belonged to Exfinco and could not be claimed by a chargee of Parrot’s book debts. Various aspects of the transaction pointed to analysis as a loan secured by a charge over the bank account. For example, calculation of the price of goods by discount is more usual in the context of assignment of debts. The mode of calculation of the discount made the discount resemble interest payable on a loan. Moreover, the right on termination of the agreement to obtain a re-transfer of Exfinco’s interest in the goods looked like an equity of redemption. Following Curtain Dream, such a catalogue of pointers might have been expected to lead ineluctably to analysis as a secured loan. However, the Court of Appeal held that no one aspect gave rise to an irreconcilable inconsistency with the sale and agency relationship chosen by the parties, which was consequently upheld.144 Assignments of Receivables 6.55 Just as goods can be the subject of secured credit transactions in ways that may or may not involve a charge created by a company, so with debts. Trading debts may be used to generate finance for companies either by outright assignment or by way of charge.

142

At 937. [1992] BCLC 148. See also Yorkshire Railway Wagon Co v Maclure (1882) 21 Ch D 39; Stoneleigh Finance Ltd v Phillips [1965] 2 QB 537; Kingsley v Sterling Industrial Securities Ltd [1967] 2 QB 747. 144 See also McEntire v Crossley Bros [1895] AC 457 (above, para 6.44); Orion Finance Ltd v Crown Financial Management Ltd [1996] 2 BCLC 78 (below, para 6.57). 143

Registration of Company Charges 241 6.56 Short-term finance may be raised by assigning the benefit of contracts for the supply of goods or services on credit. The assignor has the benefit of accelerated receipt of the debts, the customer receives credit and the assignee makes a profit representing the difference between the face value of the debt as paid in due course by the customer and the discounted price paid to the assignor plus any expenses. In effect, and especially where the assignee has recourse against the assignor should the customer default, the assignee is lending the assignor a sum equal to the discounted price at interest equal to the discount secured on the assigned debts. Yet provided the assignment is, on its true construction, an outright assignment of the debts, the transaction escapes classification as giving rise to a charge with the result that there is nothing to be registered under the Companies Act 1985.145 The existence of legislation affecting one means of raising money does not affect the legitimacy or ability of parties structuring their relationship so as to adopt a different means that falls outside the legislation.146 6.57 Nevertheless, an agreement adopting the form of an outright, nonregistrable disposition may be challenged on the basis that in substance it gives rise to a registrable charge.147 In Orion Finance Ltd v Crown Financial Management Ltd,148 Millett LJ149 outlined the following approach to such a form versus substance debate:150 The first task is to determine whether the documents are a sham intended to mask the true agreement between the parties. If so, the court must disregard the deceptive language by which the parties have attempted to conceal the true nature of the transaction into which they have entered and must attempt by extrinsic evidence to discover what the real transaction was. There is no suggestion in the present case that any of the documents was a sham. Nor is it suggested that the parties departed from what they had agreed in the documents, so that they should be treated as having by their conduct replaced it by some other agreement. Once the documents are accepted as genuinely representing the transaction into which the parties have entered, its proper legal categorisation is a matter of construction of the documents. This does not mean that the terms which the parties have adopted are necessarily determinative. The substance of the parties’ agreement must be found in the language they have used; but the categorisation of a document is determined by the legal effect which it is intended to have, and if when properly construed 145 Re George Inglefield Ltd [1933] Ch 1; Lloyds & Scottish Finance Ltd v Cyril Lord Carpet Sales Ltd [1992] BCLC 609. 146 Chow Yoong Hong v Choong Fah Rubber Manufactory [1962] AC 209. Compare the hirepurchase agreement, which developed as a commercially expedient means of avoiding restrictions on interest in moneylending legislation, registration requirements under the Bills of Sale Acts, and the ‘buyer in possession’ exception to the nemo dat rule found in the Factors Act 1889 s 9 and Sale of Goods Act 1979 s 25. 147 In the same way that a sale and lease-back may be challenged as a disguised chattel mortgage, as discussed above. 148 [1996] 2 BCLC 78. 149 Stephen Brown LJ agreeing and Otton LJ delivering a short concurring judgment. 150 At 84, citing Welsh Development Agency v Export Finance Co Ltd [1992] BCLC 148 (discussed above, para 6.54).

242 Howard N Bennett the effect of the document as a whole is inconsistent with the terminology which the parties have used, then their ill-chosen language must yield to the substance.

This is not to say, however, that the form of the agreement will readily be defeated: The question is not what the transaction is but whether it is in truth what it purports to be. Unless the documents taken as a whole compel a different conclusion, the transaction which they embody should be categorised in conformity with the intention which the parties have expressed in them.151

In Orion itself the commercial purpose, structure and language of an assignment of sub-rentals by an intermediate lessee to a head lessor led to its construction as a charge. Where, in contrast, an intermediary was introduced between seller and (sub-)buyer as a mere conduit, with no power to intercept either the goods or their purchase price, the banking arrangements ensuring the purchase monies went into a special account for payment to the seller amounted to an outright assignment and not a charge.152 6.58 A debt may be assigned outright as a means of discharging a debt. Thus, a letter from a contractor to its employer stating ‘We hereby authorise and direct you to pay [a sub-contractor] whose receipt shall be a good and sufficient discharge’ part of the following instalment was held to constitute an absolute assignment and not a charge.153 However, in another case, the security language of an assignment of such part of a debt ‘as may be necessary to indemnify the assignees’ led to categorisation as a charge.154 Where the transaction is executed against the background of a pre-existing lender-borrower relationship, the natural expectation is that the transaction will be consistent with that relationship and, therefore, be correctly classified as one of charge.155 (h) Trusts 6.59 A trust may protect a creditor against insolvency of the debtor. In the leading case of Barclays Bank Ltd v Quistclose Investments Ltd156 money was lent for a specific purpose and required to be kept apart from the borrower’s other funds. When the borrower went into insolvency without having used the money, the money was held to be subject to a trust in favour of the creditor. Although such a trust clearly has the practical effect of rendering the lender a 151

At 85. Re Marwalt Ltd [1992] BCC 32. That the purchase money served also to discharge the intermediary’s obligation qua buyer to pay the seller did not exclude an additional status as an assigned receivable: Barclays Bank Ltd v Quistclose Investments Ltd [1970] AC 567 (loan not incompatible with trust). 153 Ashby Warner v Simmons [1936] WN 212. 154 Saunderson v Clark (1913) 29 LT 579. 155 Re Kent & Sussex Sawmills Ltd [1947] 1 Ch 177; Coakley v Argent Credit Corp Ltd, (unreported, 4 June 1998). 156 [1970] AC 567. 152

Registration of Company Charges 243 secured creditor,157 it is equally clear that the equitable interest of a beneficiary under a Quistclose-type trust does not constitute a charge.158 Generally, however, the substance of a trust relationship must be examined to determine whether the creditors’ rights are those of a beneficiary or a chargee.159

(2) There Must Be a Charge to which Section 395(1) Applies 6.60 Even if a charge has been created by a company, the charge will require registration under section 395(1) only if it falls within the following list of charges found in section 396(1): (a) a charge for the purpose of securing any issue of debentures, (b) a charge on uncalled share capital of the company, (c) a charge created or evidenced by an instrument which, if executed by an individual, would require registration as a bill of sale, (d) a charge on land (wherever situated) or any interest in it, but not including a charge for any rent or other periodical sum issuing out of the land, (e) a charge on book debts of the company, (f) a floating charge on the company’s property or undertaking, (g) a charge on calls made but not paid, (h) a charge on a ship or aircraft, or any share in a ship, (j) a charge on goodwill, on a patent or a licence under a patent, on a trademark or on a copyright or a licence under a copyright.

6.61 Before discussing some of the listed charges, four preliminary comments may be made. First, as its own text makes clear, section 396(1) is irrelevant unless there is a charge. One cannot, for example, assume that a document that would attract registration under the bills of sale legislation if executed by an individual is registrable under section 396(1)(c). It is not unless it creates or evidences a charge.160 Secondly, there seems in principle to be no reason why a charge should not be registrable under more than one paragraph in section 396(1). Debentures are routinely secured by floating charges. Such a charge is registrable under paras. (a) and (f). There is no reason to read para. (f) as referring only to floating charges that are not registrable under any other heading.161 Thirdly, many categories of registrable charge are defined by reference to the 157 For discussion, see Bridge, ‘The Quistclose Trust in a World of Secured Transactions’ (1992) 12 Oxford Journal of Legal Studies 333. 158 Carreras Rothmans Ltd v Freeman Mathews Treasure Ltd [1985] Ch 207 at 227. 159 Re Bond Worth [1980] Ch 228 at 250; Obaray v Gateway (London) Ltd [2001] L&TR 223 (Case 20) at 235. 160 Stoneleigh Finance Ltd v Phillips [1965] 2 QB 537 at 568–69, 574. 161 An argument of mutual exclusivity was raised in Annangel Glory Compania Naviera SA v M Golodetz Ltd (The Annangel Glory) [1988] 1 Lloyd’s Rep 45, namely that a floating charge on book debts was registrable only as a floating charge under s 396(f) and not as a charge on book debts under s 396(e). The point was, however, unnecessary to decide. The possibility of registrability under more than one heading seems also to have been recognised in Smith v Bridgend County Borough Council [2001] UKHL 58 at [64], [2002] 1 AC 336 at 358.

244 Howard N Bennett type of assets charged. For a charge to be registrable within such a category, it suffices that some of the charged assets are of the relevant type.162 Fourthly, however, where a charge attaches to asset A and asset B such that a charge on asset A is registrable but a charge on asset B is not, and the charge is not registered, the charge continues to be effective with respect to asset B notwithstanding its voidness under section 395(1) with respect to asset A.163 (a) Section 396(1)(a): A Charge for the Purpose of Securing Any Issue of Debentures 6.62 The meaning of the term ‘debenture’ was considered by Chitty J in two cases prompted by section 17 of the Bills of Sale Act (1878) Amendment Act 1882. This states that the Act does not apply to . . . ‘debentures issued by any mortgage, loan, or other incorporated company, and secured upon the capital stock or goods, chattels, and effects of such company’.

In each case, the issue was whether the instruments in question were debentures. In Edmonds v Blaina Furnaces Co,164 Chitty J observed that: ‘The term itself imports a debt—an acknowledgment of a debt—and . . . generally, if not always, the instrument imports an obligation or covenant to pay.’165

It is not, however, necessary that the precise amount of the debt be quantified in the instrument.166 Chitty J stated further that debentures might be secured or unsecured, that the status of an instrument as a debenture depended on its substance rather than the label attached to it by the issuing company. Debentures might be issued in series, and usually were, but single debentures were possible, and each creditor received his own document with which he could then deal in the market. In Levy v Abercorris Slate & Slab Co,167 Chitty J stated as follows: A debenture means a document which either creates a debt or acknowledges it, and any document which fulfils either of these conditions is a ‘debenture’. . . It must be ‘issued’, but ‘issued’ is not a technical term, it is a mercantile term well understood; ‘issue’ here means the delivery over by the company to the person who has the charge.

6.63 A non-exhaustive statutory definition is provided by section 744 of the Companies Act 1985 as follows: ‘Debenture’ includes debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not.

6.64 Despite the breadth of the concept of a debenture under these definitions, section 396(1)(a) encompasses only charges securing an issue of a series of 162 163 164 165 166 167

Independent Automatic Sales Ltd v Knowles & Foster [1962] 1 WLR 974 at 982–83. Re North Wales Produce & Supply Society Ltd [1922] 2 Ch 340. (1887) 36 Ch D 215. At 219. NV Slavenburg’s Bank v Intercontinental Natural Resources Ltd [1980] 1 WLR 1076 at 1100. (1887) 37 Ch D 260 at 264.

Registration of Company Charges 245 debentures.168 If the paragraph included charges in solitary debentures, the reference in section 396(1)(a) to ‘any issue’ would be surplusage and the breadth of the concept of debenture would result in paragraph (a) eclipsing all the remaining paragraphs, reducing them all to the status of inclusion ex abundanti cautela. (b) Section 396(1)(b): A Charge on Uncalled Share Capital of the Company 6.65 In addition to paragraph (b), under section 396(1)(g) a charge on calls made but not yet paid is also registrable. The provisions are, however, confined to share capital and do not embrace uncalled and unpaid calls on share premiums.169 Nor do they embrace charges on shares themselves. A charge on such assets may be registrable only under either section 396(1)(a) if given to secure an issue of debentures or section 396(1)(f) in the case of a floating charge.170 (c) Section 396(1)(c): A Charge Created or Evidenced by an Instrument which, if Executed by an Individual, Would Require Registration as a Bill of Sale 6.66 This is the general heading for the registration of fixed charges on chattels.171 Charges on ships and aircraft are specifically mentioned under paragraph (h). 6.67 The Bills of Sale Act 1878 was passed to protect creditors against secret dispositions of non-possessory interests in chattels through a system of public registration.172 The Act does not apply to companies,173 even in respect of such charges as escape registration under the Companies Act.174 However, when registration of company charges was introduced in the Companies Act 1900, the scope of the Bills of Sale Act was replicated in the corporate context. From the outset, company legislation has included the formula now found in section 396(1)(c) as a category of registrable charge.

168 Automobile Association (Canterbury) Incorp v Australasian Secured Deposits Ltd [1973] 1 NZLR 417 at 422–26. 169 Re South Australian Barytes Ltd (1977) 3 ACLR 52. 170 Hence the question in Arthur D Little Ltd v Ableco Finance llc [2002] EWHC 701 (Ch), [2002] 3 WLR 1387 (albeit under the registration provisions applying to companies registered in Scotland) whether an unregistered charge over shares and distribution rights under the shares was fixed or floating 171 Floating charges on chattels are automatically registrable under s 396(1)(f). 172 In contrast, the Bills of Sale Act (1878) Amendment Act 1882 seeks to protect debtors from unwittingly entering harsh secured borrowing transactions by prescribing a mandatory form for security bills of sale: see Manchester, Sheffield & Lincolnshire Railway Co v North Central Wagon Co (1888) 13 App Cas 554 at 560–61. 173 Read v Joannon (1890) 25 QBD 300; Re Standard Manufacturing Co [1891] 1 Ch 627; Clark v Balm, Hill & Co [1908] 1 KB 667; NV Slavenburg’s Bank v Intercontinental Natural Resources Ltd [1980] 1 WLR 1076. 174 NV Slavenburg’s Bank v Intercontinental Natural Resources Ltd [1980] 1 WLR 1076 at 1099.

246 Howard N Bennett Definition of a Bill of Sale 6.68 A bill of sale is a document that effects a transfer of rights over personal chattels.175 By definition, therefore, oral dispositions are excluded.176 The document must constitute an operative element in, or integral part of, the creation of the charge and not merely record a transaction that generates the charge177 or preserve rights already created.178 In the absence of a possessory security interest, however, a document that entitles a creditor to take possession of goods by way of security is a bill of sale.179 The expression ‘personal chattels’ means ‘goods, furniture, and other articles capable of complete transfer by delivery and (when separately assigned or charged), fixtures and growing crops’.180

A charge over shares in racehorses has been held not to be registrable under section 396(1)(c) because such a share is not capable of transfer by delivery and because it constitutes a chose in action, which is specifically excluded from the definition of personal chattels.181 6.69 In Thomas v Kelly,182 Lord Macnaghten expressed the view in the context of the Bills of Sale Act 1854 that the requirement of ‘capable of complete transfer by delivery’ must be tested as of the time of creation of the bill of sale with the consequence that future property could not be the subject of a bill of sale. This view was, however, rejected by Browne-Wilkinson V-C in Welsh Development Agency v Export Finance183 in the context of the 1878 Act for two reasons. First, the definition of personal chattels in the 1878 Act was broader. It included growing crops and also agreements conferring equitable rights over chattels, which in the absence of any contrary indication had to include equitable rights over future property. Secondly, the Bills of Sale Act 1882, which imposes formalities on the creation of security bills of sale’ refers to the 1878 Act for the definition of bill of sale.184 Yet section 5 of the 1882 expressly invalidates, subject to certain exceptions and not against the grantor, bills of sale over personal chattels not owned by the grantor of the bill at the time of its execution. This provision is meaningless if a bill of sale cannot encompass future property. Exclusion of Dealings in the Ordinary Course of Business 6.70 Since the Bills of Sale Act 1878 was designed to protect third parties from

175 176 177 178 179 180 181 182 183 184

Bills of Sale Act 1878 s 4 provides a lengthy definition. Allsopp v Day (1861) 7 H & N 457; Johnson v Diprose [1893] 1 QB 512 at 515. Re Hardwick, ex parte Hubbard (1886) 17 QBD 690; Charlesworth v Mills [1892] AC 231. Re David Allester [1922] 1 Ch 211. Dublin City Distillery Ltd v Doherty [1914] AC 814. Bills of Sale Act 1878 s 4. The section goes on to exclude various assets. Re Sugar Properties (Derisley Wood) Ltd [1988] BCLC 146. (1888) 13 App Cas 506. [1990] BCC 393 at 410–11. Bills of Sale Act (1878) Amendment Act 1882 s 3.

Registration of Company Charges 247 being misled by secret transactions, dealings in the ordinary course of business were excluded from the ambit of the statute as dealings that third parties should expect. Consequently, the concept of a bill of sale does not include, inter alia:185 . . . transfers of goods in the ordinary course of business of any trade or calling, bills of sale of goods in foreign ports or at sea, bills of lading, India warrants, warehousekeepers’ certificates, warrants or orders for the delivery of goods, or any other documents used in the ordinary course of business as proof of the possession or control of goods, or authorising or purporting to authorise, either by indorsement or by delivery, the possessor of such document to transfer or receive goods thereby represented.

6.71 The phrase ‘ordinary course of business’ refers to the business of the transferor,186 although that of the transferee may be relevant in shedding light on whether the transfer in question falls within the ordinary course of the transferor’s business.187 The question is whether the transfer or use of documents as proof of possession or control is the common practice of the trade or calling in question and not merely whether it occurs frequently.188 This must be specifically proved by the party relying on the exception189 by evidence relating to the particular trade or calling and will not be inferred merely from the volume of reported cases on the topic.190 Thus, a sale of cloth on title retention terms constituting a charge did not fall within the exception in the absence of any evidence relating to the cloth trade.191 In addition, it has been held, the transfer or use must represent the normal practice of the transferor.192 Documents held to fall within this exception include letters of hypothecation given by a wool broker to a bank193 and letters of lien given by cloth traders to banks financing exports.194 An outright sale of growing crops has been conceded to be within the ordinary course of farming business in the particular area.195

185 Bills of Sale Act 1878 s 4. The exclusion is extended in respect of certain security and trust documents on imported goods by Bills of Sale Act 1890 s 1 (as substituted by the Bills of Sale Act 1891 s 1). 186 King v Greig [1931] VLR 413 at 423, 449. 187 At 423. 188 Tennant, Sons & Co v Howatson (1888) 13 App Cas 489. 189 Ibid; Ian Chisholm Textiles Ltd v Griffiths [1994] 2 BCLC 291 at 302. 190 Ian Chisholm Textiles Ltd v Griffiths [1994] 2 BCLC 291 at 302. 191 Ibid. 192 Ibid. 193 Re Slee, ex parte North Western Bank (1872) LR 15 Eq 69. 194 Re Hamilton Young & Co, ex parte Carter [1905] 2 KB 772. At first instance ([1905] 2 QB 381 at 389), Bigham J stated:

This document evidences a transaction of a most ordinary kind as between bankers and merchants. Such transactions happen by the score every day of the week in places of business like Manchester. 195

Stephenson v Thompson [1924] 2 KB 240.

248 Howard N Bennett (d) Section 396(1)(d): A Charge on Land (Wherever Situated) or Any Interest in It, But Not Including a Charge for Any Rent or Other Periodical Sum Issuing Out of the Land 6.72 For a charge to be registrable under section 396(1)(d), it must be created directly on the interest in land itself. Where Company A holds debentures issued by Company B and those debentures are secured by a charge granted by Company B over an interest in land of Company B, the holding of such debentures by Company A is not an interest in land for the purposes of section 396.196 Consequently, any charge given in turn by Company A over those debentures is not registrable under section 396(1)(d). Such a charge would, however, be registrable under section 396(1)(a) if given to secure an issue of debentures or under section 396(1)(f) if the charge were a floating charge. (e) Section 396(1)(e): A Charge on Book Debts of the Company 6.73 The term ‘book debt’ is not defined by the Companies Act. According to the case law, all debts that would be entered in well kept books (or corresponding records) of a company of the type in question,197 taking into account the accounting practice of the area of business in question,198 are book debts. The books referred to are the records of those accounts that correspond to the company’s ledger and do not extend to the entirety of the company’s assets as reflected in its balance sheet.199 Status as a book debt is not avoided by the failure to maintain such books or the failure to enter any particular debt in such books.200 In cases of uncertainty as to whether a particular type of debt is a book debt, the evidence of expert witnesses as to common practice is likely to be influential.201 Arising in the (Ordinary) Course of Business 6.74 In Australia,202 the view has been adopted that book debts must be realised ‘in the ordinary course of business of the company’. Consequently, 196

Companies Act 1985 s 396(3). Shipley v Marshall (1863) 14 CB(NS) 566 at 573; Official Receiver v Tailby (1886) 18 QBD 25 at 29; Independent Automatic Sales Ltd v Knowles & Foster [1962] 1 WLR 974; Paul & Frank Ltd v Discount Bank (Overseas) Ltd [1967] Ch 348 at 361; Perrins v State Bank of Victoria [1991] 1 VR 749 at 753. 198 Contemporary Cottages (NZ) Ltd v Margin Traders Ltd [1981] 2 NZLR 114 at 121 (noting the lack of uniformity of definition that variable practices between different trades will produce). 199 Coakley v Argent Credit Corp plc (unreported, 4 June 1998). 200 Shipley v Marshall (1863) 14 CB(NS) 566 at 571, 573; Official Receiver v Tailby (1886) 18 QBD 25 at 29–30; Perrins v State Bank of Victoria [1991] 1 VR 749 at 753. 201 Coakley v Argent Credit Corp plc (unreported, 4 June 1998). This is consistent with the test of normal practice as expressed in Paul & Frank Ltd v Discount Bank (Overseas) Ltd [1967] Ch 348 at 361. A test of mere possibility of entry was adopted by Williams J in Shipley v Marshall at 572, but would appear not to represent the law. 202 Re Falcon Sportswear (1983) 1 ACLC 690. 197

Registration of Company Charges 249 debts generated on the sale of stock in trade and plant by a receiver were not book debts since a receivership sale did not form part of a company’s ordinary course of business. In Coakley v Argent Credit Corp plc,203 however, Rimer J rejected this approach and adopted the wider view that it sufficed for the debt to be generated in the course of business of a company, rather than its ‘ordinary’ course. There was no support in earlier judicial descriptions of book debts for implying such a restriction. Future Debts and Contingent Debts 6.75 A charge on book debts is registrable irrespective of whether the charged debts are existing, whether or not currently payable,204 or future.205 Thus, a charge on such trade debts as may be generated by contracts yet to be concluded is registrable under section 396(1)(e). However, in Paul & Frank Ltd v Discount Bank (Overseas) Ltd206 Pennycuick J held that a charge on the benefit of an export credit guarantee policy was not registrable since the charged property, judged at the time of creation of charge, consisted merely of the promise of indemnification in the event of an insured loss. Both accountancy evidence and ordinary usage of language denied that the benefit of such a contingency contract was a book debt. Moreover, the fact that, on the materialisation of the contingency, a book debt might arise did not alter the character of the charge as at the date of its creation. Where the item of property is the benefit of a contract and at the date of the charge the benefit of the contract does not comprehend any book debt, I do not see how that contract can be brought within [section 396] as being a book debt merely by reason that the contract may ultimately result in a book debt.207

6.76 Consequently, a charge on the future proceeds, if any, of an insurance policy is registrable as a charge on a future book debt208 while a charge on the benefit of a policy is not. As a result, in the context of a contingency contract such as insurance, the registration requirement under section 395 can be avoided by appropriate drafting.209 Charges Over Trading Accounts and Charge-backs 6.77 There is doubt whether the balance on a trading account can be regarded as a book debt for the purposes of section 396(1)(e). In practice, however, the issue is unlikely to arise. A charge over a trading account will often also embrace 203

Unreported, 4 June 1998. Independent Automatic Sales Ltd v Knowles & Foster [1962] 1 WLR 974. 205 Ibid; Paul & Frank Ltd v Discount Bank (Overseas) Ltd [1967] Ch 348; Contemporary Cottages (NZ) Ltd v Margin Traders Ltd [1981] 2 NZLR 114. 206 [1967] Ch 348. 207 At 362. See also Re Law Car and General Insurance Corp Ltd [1911] WN 91. 208 Re Brush Aggregates Ltd [1983] BCLC 320. 209 For a critical view of avoidance of registration through any such distinction, see Contemporary Cottages (NZ) Ltd v Margin Traders Ltd [1981] 2 NZLR 114. 204

250 Howard N Bennett other debts that clearly rank as book debts so that the status of the balance on a trading account will be immaterial to the issue of registration.210 Moreover, since the restrictions on use inherent in a fixed charge are inimical to the sensible commercial operation of a trading account, a charge on such an account will usually be floating, and registrable as such under section 396(1)(f). Only if the charge is fixed and none of the charged indebtedness constitutes a book debt will the charge not be registrable. 6.78 So far as the case law is concerned, the issue of whether the balance on a trading account is a book debt has arisen primarily in the context of chargebacks. Where a creditor, typically a bank, takes a charge over its own indebtedness to the chargor, such a charge-back will be registrable under section 396(1)(f) if the charge is a floating charge or under section 396(1)(e) if the indebtedness is accurately described as a book debt within the meaning of that paragraph. In the leading English cases, however, the nature of a charge-back on a trading account has arisen in the context of a claim by a bank for a fixed charge over the credit balance. The concern has not been registration but whether the charge embraces the indebtedness and whether the charge is fixed or floating. 6.79 In Re Brightlife Ltd,211 a bank claimed a fixed charge over the balance standing at a company’s trading account by virtue of a debenture that purported to create a fixed charge over ‘book debts or other debts’. Hoffmann J held, however, that the bank balance was not a debt within the meaning of the debenture for three reasons.212 First, although the legal nature of a banker-customer relationship in respect of an account in credit is that of debtor-creditor, no businessman or accountant would ordinarily describe the balance in an account as a debt but as ‘cash at bank’. Secondly, the debenture prohibited the company from dealing with its debts without the prior written consent of the debenture holder ‘otherwise than in the ordinary course of getting in and realising the same’. Such actions made no sense in the context of a credit balance on a bank account. Thirdly, the consequence of a fixed charge on the account would have been that no withdrawal could have been made from or cheque written on the account without the prior written consent of the debenture holder. That made no commercial sense. 6.80 The same conclusion was again reached by Hoffmann J in Re Permanent Houses (Holdings) Ltd,213 in which Re Brightlife was conceded to be indistinguishable. Hoffmann J expressly confined the decision to the construction of the 210 Above, para 6.61. Technically, if the charge is fixed and the balance on the account is not a book debt, the balance should not be included in the particulars of charged property. In practice, however, it may be included regardless, although the inclusion might result in the charge being classified as floating. 211 [1987] Ch 200. 212 In addition, Hoffmann J held that the charge in any event could only be regarded as a floating charge. 213 [1988] BCLC 563. See also Re Stevens [1888] WN 110 at 116 and an unreported decision of Buckley J (referred to in Dawson v Isle [1906] 1 Ch 633 at 634) that ‘cash at company’s bankers and cash in hand were not to be taken into account as book debts’.

Registration of Company Charges 251 debenture in question and left open the question of whether a credit balance that was caught by a fixed charge could constitute a book debt for the purpose of section 396(1)(e). Nevertheless, in the light of clear accountancy practice and normal business terminology, it is unlikely that a credit balance in an ordinary trading account would be viewed as a book debt in the registration context. A bank may, however, secure its position over a credit balance through a so-called ‘triple cocktail’, consisting of, first, a contractual restriction on withdrawal, at least without the consent of the bank, generating a ‘flawed asset’; secondly, setoff rights; and, thirdly, a charge-back. Whether such a credit balance qualifies as a book debt for the purposes of section 396(1)(e) has yet to be decided, although in Northern Bank Ltd v Ross214 the Northern Ireland Court of Appeal, differing from the first instance judge in this respect, stated obiter that no credit balance on a current account should be regarded as a book debt, irrespective of any restrictions of withdrawal, relying on accountancy practice to this effect.215 Rental Deposits 6.81 In Obaray v Gateway (London) Ltd 216 a rental deposit was charged in favour of the landlord for discharge of the tenant’s obligations under the lease. In the absence of evidence as to accounting practice, it was held that the tenant’s right to recover the balance standing in the account was ‘a right to call for that balance to be vested in it’ and was ‘not aptly described as a “debt” at all, let alone a “book debt”.’217 The charge, in consequence, was not registrable. Debts Secured by Negotiable Instruments 6.82 The fact that a debt is secured by a bill of exchange does not affect its classification as a book debt.218 However, where a negotiable instrument has been given to secure payment of a company’s book debts, the deposit of that instrument to secure an advance to the company does not generate a charge on the book debts for the purposes of section 396.219 (f) Section 396(1)(f): A Floating Charge on the Company’s Undertaking or Property 6.83 Since there is no statutory definition of a floating charge, it has generally been assumed that section 396 operates by reference to the common law understanding of the concept.220 Consequently, where, but only where, a charge is 214

[1991] BCLC 504. A view noted without comment by Lord Hoffmann in Re Bank of Credit and Commerce International SA (No 8) [1998] AC 214 at 227. 216 [2001] L&TR 223 (Case 20). 217 At 236 per Hazel Williamson QC. 218 Re Stevens [1888] WN 110 at 116; Dawson v Isle [1906] 1 Ch 633. 219 Companies Act 1985, s 396(2). 220 For discussion of the concept of a floating charge as matter of common law, see para 6.27 and paras 5.12–5.38. 215

252 Howard N Bennett floating as a matter of common law, it will be registrable under section 396(1)(f). In Smith v Bridgend County Borough Council,221 however, Lord Scott favoured a different approach. The case concerned a council’s rights under a construction contract to give seven days’ notice and then sell contractors’ property and apply the proceeds in discharge of sums due under the agreement. As part of an argument that any charge created by these contractual rights was not registrable, it was contended that any such charge was a future fixed charge. Lord Hoffmann, with whose judgment Lords Bingham, Browne-Wilkinson and Rodger agreed, stated that the charge was clearly a floating charge. Although there is no express discussion of the extent to which the statutory concept of a floating charge mirrors that of the common law, Lord Hoffmann gave every sign of applying the common law understanding of that concept.222 Lord Scott, however, approached the matter differently. He accepted that future charges were possible in principle, that a floating charge, as analysed at common law, constituted a present security, and that, on the facts, the council had no equitable interest in the property until the notice had been served. He considered, however, that this analysis did not preclude the grant of future security rights . . . from constituting a floating charge for section 395 registration purposes. In my opinion, a charge expressed to come into existence on the occurrence of an uncertain future event and then to apply to a class of assets that cannot be identified until the event has happened would, if otherwise valid, qualify for registration as a floating charge. The future charge would have the essential characteristic of floating, remaining dormant, until the occurrence of the specified event. It would, I think, come within the mischief sought to be dealt with by the section 395 requirement of registration of floating charges.223

6.84 This dictum suggests, therefore, that the statutory concept of floating charge under section 395 may be broader than the common law concept. An instrument that, at common law, merely provides the basis for a charge to spring at a future point and does not generate any present charge would be regarded as generating a floating charge immediately for registration purposes. With respect, however, the idea that the Companies Act recognises and requires registration of a charge that does not exist at common law is unattractive. Clearly, as a matter of construction of the relevant instrument and consequent categorisation according to the law’s concepts, an instrument designed to provide the basis for a potential charge to arise in the future may be held to give rise to an immediate floating charge. However, Lord Scott, having accepted that parties should be free to create future charges over assets that cannot be identified until the occurrence of a future event as opposed to a floating charge over the company’s assets for the time being, clearly contemplates that parties may have no rights as a chargee and yet be subject to the registration requirements of 221 222 223

[2001] UKHL 58, [2002] 1 AC 336. At paras [41]–[42], at p 352. At para [63], at p 357.

Registration of Company Charges 253 section 395. There appears to be no good reason for this. Moreover, there is no reason in principle why a future charge should not be a fixed charge. As a matter of common law, its nature will be determined by reference to the time when it is created and not before. Lord Scott’s approach raises the further question of whether a potential charge initially registered as a floating charge would require re-registration as a fixed charge once it was created as a matter of common law. Such issues are simply unnecessary. It is suggested that Lord Scott’s approach is erroneous and that section 396(1)(f) should be read as adopting the common law concept of a floating charge. 6.85 A floating charge does not have to cover the whole of a company’s property or undertaking in order to be registrable under section 396(1)(f). The contrary suggestion was rejected by the Court of Appeal in Re Yorkshire Woolcombers Association Ltd.224

(3) The creator company must be registered in England and Wales 6.86 Only charges falling within section 396(1) that are created by a company registered in England and Wales are registrable under section 395(1). However, all such charges are registrable under section 395(1) regardless of the situs of the charged asset. Where the creator company is registered in Scotland, a separate registration regime applies under chapter II of Part XII of the Companies Act 1985. That regime is, however, part of English law and applies in an English court, just as the regime under chapter I is part of Scottish law and applies in a Scottish court, so that, for example, a failure by a Scottish registered company to register a charge under chapter II may be invoked before an English court.225

C THE REQUIREMENTS FOR EFFECTIVE REGISTRATION UNDER SECTION 395(1)

6.87 The requirement under section 395(1) is that: . . . the prescribed particulars of the charge together with the instrument (if any) by which the charge is created or evidenced, are delivered to or received by the registrar of companies . . . within 21 days after the date of the charge’s creation.

6.88 Although it is common, therefore, to speak of a requirement of registration of a charge, the requirement relates not to the entry of particulars of a charge on a register but simply to the delivery of particulars to the registrar 224

[1903] 2 Ch 284 at 294, 298. Arthur D Little Ltd v Ableco Finance llc [2002] EWHC 701 (Ch), [2002] 3 WLR 1387. According to Mr Roger Kaye QC (sitting as a Deputy Judge of the High Court) (at para [24], at p 1396): 225

[T]he two chapters of Part XII are part of the law of England and Wales and are each part of a complementary whole prescribing who is to register what and where.

254 Howard N Bennett accompanied by the original226 of the instrument, if any, creating or evidencing the charge.227 The only duty imposed on the chargor company, moreover, is to send the required particulars to the registrar. It is not a duty to procure any entry on the register.228

(1) Prescribed Particulars 6.89 The Companies Act does not itself specify the particulars to be delivered to the registrar. Section 395(1) refers to ‘prescribed’ particulars, leaving the details to statutory instrument,229 although the prescription is foreshadowed by the details given by section 401(1) of the register the registrar is required to maintain. The relevant statutory instrument is the Companies (Forms) Regulations 1985.230 (a) Charges Not Securing an Issue of Debentures 6.90 With the exception of any charge that benefits holders of a series of debentures pari passu,231 the prescribed particulars for the purposes of section 395(1) are the particulars contained in Companies Form No. 395 in the 1985 Regulations.232 The Form requires the following information: (1) the chargor company’s registration number, as is required of all documents delivered to the registrar under the Companies Act,233 (2) the full name of the company, (3) the date of creation of the charge,234 (4) a description of the instrument (if any) creating or evidencing the charge,235 (5) the amount secured by the charge,236 (6) the names and addresses, including postcode, of the persons entitled to the charge, (7) the presenter’s name, address and reference (if any) and (8) short particulars of all the charged property. In addition (9), in respect of any debentures included in the form, there must also be stated the amount or rate per cent. of any commission, allowance or discount given directly or indirectly to anyone 226

R v Registrar of Companies, ex parte Central Bank of India [1986] 1 QB 1114. National Provincial & Union Bank of England v Charnley [1924] 1 KB 431 at 447 (although the reference to sending rather than delivery is misplaced); NV Slavenburg’s Bank v Intercontinental Natural Resources Ltd [1980] 1 WLR 1076 at 1086. 228 Trustee of PAF Foster v Crusts [1986] BCLC 307 at 314. 229 Companies Act 1985 s 744. 230 SI 1985/854. 231 Discussed below, paras 6.92–6.93. 232 Companies (Forms) Regulations 1985 reg 4. 233 Companies Act 1985 s 706(1), (2). 234 This enables the registrar to determine whether the 21-day time limit in s 395(1) has been complied with: Sun Tai Cheung Credits Ltd v Attorney-General of Hong-Kong [1987] 1 WLR 948 at 952. 235 Such as ‘trust deed’, ‘debenture’, ‘mortgage’ or ‘legal charge’: Form 395, note 2. 236 It may not be possible for the amount to be stated in precise monetary terms. In the case of a charge that secures an overdraft, a phrase such as ‘the amount from time to time to become due on a current account’ will suffice: National Provincial & Union Bank of England v Charnley [1924] 1 KB 431 at 444. 227

Registration of Company Charges 255 who subscribes, agrees to subscribe, procures subscriptions or agrees to procure subscriptions, whether absolutely or conditionally, to any debentures included on the form.237 6.91 Form 395 is designed for compliance with section 395(1). The statute, however, requires delivery of particulars only of the charge and some of the information required by Form 395 does not relate to the charge. In Grove v Advantage Healthcare (T10) Ltd,238 the completed form correctly identified the chargor company by name but gave the wrong company registration number.239 Lightman J held that the number was a particular of the chargor rather than the charge so that the error did not infringe section 395(1), even though the result of the error was registration of the charge against the wrong company. Indeed, of the items listed above only (3), (4), (5) and (8) relate unequivocally and exclusively to the charge rather than to the chargor, chargee or presenter.240 (b) Charges Securing an Issue of Debentures 6.92 Form 395 does not apply to all charges. A modified registration system applies in respect of charges that secure an issue of debentures pari passu as between the debenture holders. By virtue of section 397(1), the registration requirement under section 395(1) is satisfied by delivery to or reception by the registrar within 21 days after the execution of the deed containing the charge (or, if there is no such deed, after the execution of any debentures of the series)

of particulars specified by section 397(1) itself together with the deed that contains the charge or, if no such deed exists, one of the debentures of the series. The role of delegated legislation is confined to prescribing merely the form in which the particulars are to be delivered or received. This is effected by the Companies (Forms) Regulations 1985, Form 397. The statutorily prescribed particulars are as follows: (a) the total amount secured by the whole series, (b) the dates of the resolutions authorising the issue of the series and date of the covering deed (if any) by which the security is created or defined, and (c) a general description of the property charged, and (d) the names of the trustees (if any) for the debenture holders . . .

Certain additional particulars of the debentures, rather than of the charge, are required, but it is expressly provided that a failure to provide them shall not 237

Form 395, note 3. The rate of interest payable under the debenture should not be stated: ibid. [2000] 1 BCLC 661. It gave the number of an associated company with which the chargor company had swapped names shortly before creation of the charge. 240 Indeed, in respect of charges securing issues of debentures, it is expressly enacted that item (9) must be provided to the registrar but that failure to do so shall not affect the validity of the debentures: Companies Act 1985 s 397(2), discussed below. 238 239

256 Howard N Bennett affect the validity of the debentures. These particulars are the date and amount of each issue of debentures of the series241 and particulars of any commission, allowance or discount for subscribing or procuring subscription to debentures, or agreeing to do so.242 6.93 In addition to the particulars mentioned by section 397, Form 397 requires the company registration number, the name of the company and the presenter’s name address and reference (if any). Clearly, however, any error or omission in respect of those particulars cannot jeopardise the enforceability of the charge under section 395(1). (2) Charges on Property Outside the United Kingdom 6.94 The requirements of section 395(1) are modified slightly for charges that comprise property outside the United Kingdom. Where the charge is itself created outside the United Kingdom, a verified copy of the instrument creating or evidencing the charge may be delivered to the registrar instead of the original instrument.243 Moreover, the time for delivery of particulars and accompanying instrument or copy is changed from 21 days after the date of creation of the charge to: . . . 21 days after the date on which the instrument or copy could, in due course of post (and if despatched with due diligence), have been received in the United Kingdom.244

6.95 In the case of a charge created or purportedly created within the United Kingdom that comprises property situated outside the United Kingdom, some further procedure may be necessary before the charge is valid or effectual under the lex situs of the property. Under such circumstances, time runs under section 395(1) from the date of creation or purported creation, but the instrument creating or purporting to create can be sent for registration without waiting for completion of the foreign procedure.245 D THE REGISTRAR ’ S CERTIFICATE

6.96 Once a charge has been registered, the registrar is required to issue a certificate of registration. This must state the amount secured by the charge and, by virtue of section 401(2), ‘is conclusive evidence that the requirements of this 241 Companies Act 1985 s 397(1) proviso. Form 397a is used for particulars of an issue of debentures within a series, Form 397 for registering the particulars of the entire series. 242 Ibid s 397(2). By virtue of s 397(3):

The deposit of debentures as security for a debt of the company is not, for the purposes of s (2), treated as the issue of the debentures at a discount. 243 244 245

Ibid s 398(1). Ibid s 398(2). Ibid s 398(3).

Registration of Company Charges 257 chapter as to registration have been satisfied.’ The chapter is chapter I of Part XII of the Companies Act, encompassing sections 395–409. Once the registrar has given this certificate, therefore, the charge is immune to challenge under section 395(1). 6.97 The conclusive registrar’s certificate has been part of the statutory registration scheme since its inception. It is a quid pro quo given to chargees in return for imposition of the registration requirement and the consequent vulnerability to challenge for non-registration. Since many chargees, in particular but not exclusively many debenture holders, and third parties with whom chargees might wish to deal might be unable to verify compliance with the statutory requirements, there was a danger that the benefit to third parties of the information provided by the register might be outweighed by undermining the reliability of company charges and marketability of debt secured thereby. The conclusive nature of the registrar’s certificate eliminates any such danger.246 Such reassurance of chargees comes, however, at the price of reduced reliability of the register. 6.98 Once a certificate has been issued, the effect of the charge is determined by the charge as created, not by the particulars as entered on the register. The charge cannot be challenged under section 395(1) if the charge as registered fails accurately to reflect the charge as created. This is justified by the fact that the discrepancy may not be the responsibility of the chargee. It may result from an inaccuracy in the particulars supplied, for which the chargee may or may not be responsible,247 or from a mistake by the registrar in recording the particulars.248 Moreover, nothing in the Companies Act renders either the timely sending of particulars or their accuracy a condition precedent under section 401 to the registrar’s jurisdiction to register a charge and, having done so, to the duty to issue a certificate.249 As a result, therefore, the conclusive nature of the registrar’s certificate means that an entry on the register informs a third party merely of the existence of a charge that cannot be impeached through section 395(1). As the case law demonstrates, reliance cannot be placed on the entered particulars. Thus, the presence of a registrar’s certificate has rendered charges immune from challenge under section 395(1) despite an inaccuracy in the date of creation,250 amount secured,251 or property charged.252 6.99 The certificate confers immunity even where the discrepancy is the responsibility of the chargee, the maxim that nobody can take advantage of his 246 Re Yolland, Husson & Birkett Ltd [1908] 1 Ch 152 at 158–59; National Provincial & Union Bank of England v Charnley [1924] 1 KB 431; R v Registrar of Companies, ex parte Central Bank of India [1986] 1 QB 1114 at 1181. 247 Companies Act 1985 s 399(1). 248 National Provincial & Union Bank of England v Charnley [1924] 1 KB 431. 249 Re Mechanisations (Eaglescliffe) Ltd [1966] 1 Ch 20; Re CL Nye Ltd [1971] Ch 442. 250 Re Eric Holmes (Property) Ltd [1965] Ch 1052; Re CL Nye Ltd [1971] Ch 442. 251 Re Mechanisations (Eaglescliffe) Ltd [1966] 1 Ch 20. 252 National Provincial & Union Bank of England v Charnley [1924] 1 KB 431.

258 Howard N Bennett own wrong being overridden by the statutorily conclusive nature of the certificate.253 The fraudulent sending of false or incomplete particulars might, however, create an exception. The statutory jurisdiction to rectify the register254 cannot be invoked to delete a fraudulently procured registration as it does not apply once a charge has been registered.255 However, where the sender is the chargee, it has been suggested that the chargee’s fraud might debar the chargee from asserting the conclusiveness of the certificate.256 Moreover, it has been suggested that the fraudulent sender might incur personal liability to any person misled by the resulting entry on the register.257 6.100 In the case of debentures, once a registrar’s certificate has been issued, a copy of the certificate is required to be endorsed on every debenture or certificate of debenture stock issued by the company after creation of the charge and secured thereby.258

E LATE REGISTRATION

6.101 In the event of failure to register a charge within the 21-day period stipulated in section 395(1), an application may be made to the court under section 404 for an extension of the registration period. Section 404 provides as follows: (1) The following applies if the court is satisfied that the omission to register a charge within the time required by this Chapter . . . was accidental, or due to inadvertence or to some other sufficient cause, or is not of a nature to prejudice the position of creditors or shareholders of the company, or that on other grounds it is just and equitable to grant relief. (2) The court may, on the application of the company or a person interested, and on such terms and conditions as seem to the court just and expedient, order that the time for registration shall be extended . . .259

Section 404(2), therefore, confers a discretion on the court to extend the registration period in the conditions stipulated by section 404(1).

253

Re CL Nye Ltd [1971] Ch 442 at 475, 477. Companies Act 1985 s 404, discussed below. 255 Re CL Nye Ltd [1971] Ch 442 at 474, 477. 256 National Provincial & Union Bank of England v Charnley [1924] 1 KB 431 at 454. Cf Re Eric Holmes (Property) Ltd [1965] Ch 1052 at 1072, suggesting that a lacuna in the Act results in fraudulent particulars being protected. This, it is suggested, is implausible. 257 At 474. 258 Companies Act 1985 s 402(1), (2). 259 The section also confers power to order that the register be rectified in the event of omission or misstatement of any particular. 254

Registration of Company Charges 259 (1) Pre-conditions to the Power to Extend the Registration Period 6.102 Under section 404(1), one of three pre-conditions to the power contained in section 404(2) to extend the registration period must be established to the satisfaction of the court. The pre-conditions are that, first, the failure to register within the 21-day period was accidental or due to inadvertence or some other sufficient cause, or, secondly, the delay is not of a nature to prejudice the position of creditors or shareholders of the company, or, thirdly, that on other grounds it is just and equitable to grant relief.260 If no evidence is adduced as to why the charge was not registered within the 21-day period, section 404(1) will not be satisfied and the discretion under section 404(2) cannot come into play.261 A mere assertion of accident or inadvertence without any particulars is inadequate.262 6.103 Satisfying the pre-conditions under section 404(1) and the exercise of the court’s discretion under section 404(2) are separate processes. Establishing that, for example, a charge was not registered through inadvertence does not generate a right to an order permitting late registration. Nevertheless, circumstances relevant to establishing a section 404(1) pre-condition will frequently impact upon the exercise of the court’s discretion under section 404(2). Indeed, in the context of the final, ‘just and equitable’, pre-condition, it is hard not to elide the two processes. Thus, in Re Braemar Investments Ltd,263 Hoffmann J stated that: The underlying guide to the exercise of the discretion is whether for any reason, whether specified in the section or not, it would be just and equitable to grant relief.264

6.104 It is no barrier to the existence of the court’s discretion that the existence or validity of the charge is being challenged in separate proceedings.265

(2) Exercising the Discretion 6.105 Inevitably the exercise of discretion depends upon the particular facts of the case. However, some general propositions emerge from the case law.

260 The number of pre-conditions is sometimes said to be five (treating failure to register through accident, inadvertence and other sufficient cause as three separate conditions): Re Ashpurton Estates Ltd [1983] Ch 110 at 119. 261 Re Telomatic Ltd [1994] 1 BCLC 90. 262 Re Kris Cruisers Ltd [1949] 1 Ch 138. 263 [1988] BCLC 556. 264 At 561, relying on Re MIG Trust [1933] Ch 542 at 560. 265 Re Heathstar Properties Ltd (No 2) [1966] 1 All ER 1000.

260 Howard N Bennett (a) Delay in Seeking Relief 6.106 On discovering the failure to register, a chargee . . . should apply without delay for an extension of time if he desires to register; and the court, when asked to exercise its discretion, should look askance at a chargee who deliberately defers his application in order to see which way the wind is going to blow.266

6.107 In Re Ashpurton Estates Ltd,267 the chargee, on discovering the failure to register, declined to apply immediately for late registration because sale of the charged property was pending. As an unregistered charge is valid against the chargor,268 the chargee believed its charge would be realised. However, the chargor company proceeded towards liquidation. Since unregistered charges are invalid under section 395(1) as against a liquidator, the chargee then sought late registration. The application was refused, the failure to apply immediately counting against the chargee in the exercise of the court’s discretion. Re Ashpurton was followed in Re Telomatic Ltd,269 where the chargee, on discovering the failure to register, attempted three times to obtain a fresh charge and eventually sought leave to register late only when alternative courses of action proved fruitless and the company had been dissolved and was believed to be insolvent. Under the circumstances, had the discretion to order late registration been available,270 it would not have been exercised. (b) Insolvency of the Chargor 6.108 A major factor affecting the exercise of the court’s discretion is the financial health of the chargor company. Where the company is already in insolvent liquidation at the time of the section 404 hearing, the discretion will almost invariably be exercised against granting an extension of time. The discretion to grant an extension still exists, but the normal form of the order renders the extension otiose. Insolvent liquidation being in contemplation at the time of the section 404 hearing is a factor militating against the grant of an extension. While the order in its normal form will not be otiose, the likelihood of ensuing insolvent liquidation will be taken into account by the form of any order granting an extension. It follows that, in this context, any discussion of the relevance of insolvent liquidation must embrace also a discussion of the form of a section 404 order. 266

Re Ashpurton Estates Ltd [1983] Ch 110 at 132 per Lord Brightman. [1983] Ch 110. The chargor is not a beneficiary of s 395(1). In the terminology of Art 9 of the Uniform Commercial Code, registration of a charge relates to perfection not attachment. 269 [1994] 1 BCLC 90. 270 It was not because no evidence had been adduced to satisfy any of the pre-conditions under s 404(1), above. 267 268

Registration of Company Charges 261 Preserving Interim Rights: the First Proviso to a Section 404 Order 6.109 Where the court is minded to grant an order extending the time for registration of a charge, it is long established practice to attach a proviso designed to prevent the order from prejudicing those who acquire rights against the company in reliance on a misleading register. The proviso originally read as follows: ‘but that this order be without prejudice to the rights of parties acquired prior to the time when the charge shall be actually registered.’ It was sometimes known as the ‘Joplin’ proviso, after Re Joplin Brewery Co Ltd,271 the case in which Buckley J gave formal recognition to the practice of including the proviso. 6.110 The Joplin proviso was intended to preserve rights intervening between the end of the 21-day registration period and the date of actual registration.272 Since 1974, however, the following wording has been used: That the time for registering the charge be extended until the _ day of _ 19_; and this order is to be without prejudice to the rights of the parties acquired during the period between the date of creation of the said charge and the date of its actual registration.

In consequence, all rights acquired since the creation of the unregistered charge are now protected, regardless of whether they are acquired during or after the 21-day registration period. 6.111 In Re Ehrmann Bros Ltd,273 the Court of Appeal was called upon to construe the Joplin proviso. The Court held that the rights referred to were proprietary rights against the property subject to the unregistered charge, so that the proviso did not protect unsecured creditors who, by definition, had no such rights.274 Consequently, in Re Cardiff Workmen’s Cottage Co Ltd,275 it was argued that the proviso should be re-worded so as to protect all creditors both secured and unsecured. Buckley J acknowledged that failure to register within the 21-day period rendered the unregistered charge void against all creditors, whether or not secured. However, in the context of late registration, the court was empowered to impose such terms as were ‘just and expedient’. He acknowledged that some creditors might have contracted on the basis that the only charges granted by the company were those on the register. However, the nature of the bargain struck by an unsecured creditor involved the risk of postponement to security. The person who is at any moment the unsecured creditor of the company is always exposed to the danger that the company may execute in favour of other creditors 271

[1902] 1 Ch 79. Re Ehrmann Bros Ltd [1906] 2 Ch 697 at 704, 709; Watson v Duff, Morgan & Vermont (Holdings) Ltd [1974] 1 WLR 450 at 454–55. 273 [1906] 2 Ch 697. See also Re Kris Cruisers Ltd [1949] 1 Ch 138. 274 Although they may obtain proprietary rights through levying execution against property of the company: see below. 275 [1906] 2 Ch 627. 272

262 Howard N Bennett incumbrances upon its property, and unless he can attack those securities on the ground of . . . preference276 they prevail against him. So long as the company is a going concern the creditor who has obtained no charge upon property necessarily runs the risk of dispositions made by the company by sale, mortgage, or otherwise.277

Moreover, nothing would prevent the company from granting the holder of the unregistered charge a fresh charge that would defeat the unsecured creditors. 6.112 It is possible that an unsecured creditor of the chargor company who has obtained judgment and then proceeds to levy execution on an asset subject to an unregistered charge may obtain an interest in that asset. A charging order clearly vests a proprietary interest in the execution creditor,278 but a creditor who executes by means of a writ of fieri facias or a garnishee order obtains no interest opposable against third parties until execution is complete.279 6.113 It is important to note, however, that the proviso merely preserves such rights as have already been acquired. It does not enhance or strengthen them in any way. Assume, first, that a fixed charge is created before a floating charge, but the fixed charge is not registered within the 21-day period. Would a proviso to an order for late registration of the fixed charge have the effect of promoting the floating charge ahead of the fixed charge, reversing the normal priority? The answer, it is suggested, is no. A floating chargee benefits from an equitable interest in the charged fund of assets from the creation of the charge.280 However, it is of the nature of such a charge that the chargee accepts the risk of being postponed to other parties who acquire proprietary interests in particular assets within the charged fund in the ordinary course of the company’s business. A fresh charge granted to the holder of the unregistered charge would defeat the floating chargee. A floating chargee is thus analogous to an unsecured creditor. The rights of a floating chargee prior to crystallisation that would be preserved by the usual proviso to an order granting permission for late registration simply do not include rights that have priority over fixed charges and the proviso does not strengthen the floating chargee’s rights. 6.114 Assume, secondly, that a floating charge is not registered and that a judgment creditor then levies execution on an asset within the charged fund. An execution creditor defeats a floating chargee provided execution is complete before the charge crystallises.281 If, however, the floating charge crystallises before execution is complete, the prior equitable interest of the floating charge 276

Or, indeed, any other basis for challenging a transaction on insolvency. At 630 per Buckley J. 278 Charging Orders Act 1979 s 3(4); Roberts Petroleum Ltd v Kenny Ltd [1983] 2 AC 192 at 205. 279 Ex p Williams (1872) LR 7 Ch App 314; Peck v Craighead [1995] BCC 525 at 528; Re Stanhope Silkstone Collieries Co (1879) 11 Ch D 160. For completion in the context of winding up, see Insolvency Act 1986 s 183 (3). For discussion, see D Hare and D Milman, ‘Debenture Holders and Judgment Creditors—Problems of Priority’ [1982] Lloyd’s Maritime and Commercial Law Quarterly 57. 280 See above, para 6.27. 281 Robson v Smith [1895] 2 Ch 118. 277

Registration of Company Charges 263 over the fund affords the crystallised charge priority as against the execution creditor as regards the individual assets within the fund at the time of crystallisation.282 Assume an order for late registration of the floating charge containing the usual proviso is then made. While the proviso will preserve any rights of the execution creditor that may exist in the charged asset, it will not strengthen them so as to defeat the floating charge if that charge crystallises before execution is complete.283 The Impact of Insolvency of the Chargor Company 6.115 When an insolvent company is wound up, its assets are distributed according to a statutory scheme and each unsecured creditor has a right against the company to see that assets are so distributed. These rights are protected by the proviso. Consequently, unless there is some reason for the court, in its discretion, to depart from the normal proviso, any order permitting late registration after the onset of liquidation will be self-defeating and refused. Thus, according to Lord Brightman in Re Ashpurton Estates Ltd:284 Once the company has gone into liquidation, the existing unsecured creditors are interested in all the assets of the company, since the liquidator is bound by statute to distribute the net proceeds pari passu among the unsecured creditors, subject to preferential debts. The assets of the company are at that stage vested in the company for the benefit its creditors. The unsecured creditors are in the nature of cestuis que trust with beneficial interests extending to all the company’s property. It follows from this approach that the court must inevitably refuse to extend the time for registration once the company has gone into liquidation. If an order extending time were made and the proviso included, registration would be of no assistance whatever to the unregistered chargee because the unsecured creditors at that stage would be protected by the proviso. Such an order after liquidation would be futile and will be refused . . .

Derogations from the Normal Form of the First Proviso 6.116 Notwithstanding such emphatic language, the statute itself does not prohibit the courts from permitting late registration after the onset of liquidation and, where there is good reason not to include the normal proviso, the order will not be self-defeating. In Re RM Arnold & Co Ltd,285 C1 had a registered fixed charge over land, but agreed to subordinate its charge to a charge over the same land in favour of C2. Two charges were subsequently created in favour of 282 The priority of the holder of the crystallised floating charge is controversial but seemingly enshrined by authority. On priority against execution by writ of fieri facias, see Re Opera [1891] 3 Ch 260; Davey & Co v Williamson & Sons [1898] 2 QB 194. On priority against garnishee orders, see Norton v Yates [1906] 1 KB 112; Cairney v Back [1906] 2 KB 746. 283 And in practice one may expect the debenture to be drafted so that the charge will crystallise automatically in the event of execution being levied by a judgment creditor or even in the event of a judgment debt remaining unsatisfied for a specified period of time. 284 [1983] Ch 110 at 123. See also Re Spiral Globe Ltd [1902] 1 Ch 396; Re Ehrmann Bros Ltd [1906] 2 Ch 697 at 704, 708, 710. 285 (1984) 128 Sol Jo 659.

264 Howard N Bennett C2. The first, not over the land, was binding on unsecured creditors, but the second charge, over the land, inadvertently was not registered and only the second charge would give effect to the subordination agreement between C1 and C2. In these unusual circumstances, Harman J granted C2 permission, modifying the proviso, to register the second charge late even though the chargor company had gone into insolvent liquidation. Since unsecured creditors were defeated by the first charge, they could not be prejudiced by late registration of the second charge and there was no reason to include them in the proviso. Consequently, the proviso was confined to creditors who had acquired an interest in the land after the date of creation of the second charge. 6.117 It is rare for a third party to be excluded from the proviso. In particular, the mere fact that a later chargee took security with notice of the earlier unregistered charge is irrelevant. The statutory scheme is one based on registration on the Companies Register, not one based on actual notice apart from that registration.286

Exceptionally, however, not all interim rights will be protected. Any later charge that is created as a fraud on the unregistered charge will be excluded from the proviso.287 Moreover, where securities are contractually stated to rank equally inter se and only some are registered in time, an order extending time for registration of the remainder will be drafted so as not to upset the contractual priority.288 Potential Insolvency of the Chargor Company: the Second Proviso to a Section 404 Order 6.118 A chargor company may not actually be in insolvent liquidation at the time of the section 404 hearing, yet insolvent liquidation may be in contemplation at that time. A further proviso to the section 404 order addresses a conundrum presented by such cases.289 Such applications are normally ex parte. Creditors who stand to be affected by an extension are not parties to the proceedings and the company is not necessarily concerned to protect their interests. Where the company is solvent, the chance of unsecured creditors being prejudiced is remote. Where, in contrast, insolvent liquidation is a realistic prospect, extending the time for registration may prejudice unsecured creditors by reducing the assets available for pari passu distribution. Accordingly, the prospect of insolvent liquidation is a relevant factor that may, 286

Re Telomatic [1994] 1 BCLC 90 at 97 per Judge Micklem. Re Fablehill Ltd [1991] BCLC 830. When directors of a company discovered that a charge granted in favour of a bank had not been registered, instead of seeking to discharge the company’s duty of register they procured the execution and register of a charge in their favour. When late registration of the bank’s charge was granted, the court excluded from the proviso the rights of the directors under their charge. 288 Re IC Johnson & Co Ltd [1902] 1 Ch 101. 289 Re Braemar Investments Ltd [1988] BCLC 556 at 559. 287

Registration of Company Charges 265 although will not necessarily, result in a refusal to grant a section 404 order and evidence of the company’s solvency may, therefore, be required.290 The conundrum is created by the fact that the court cannot simply adjourn the application to see whether insolvent liquidation in fact ensues as this could unfairly prejudice the unregistered chargee. This is because, as discussed above, liquidation crystallises the rights of unsecured creditors so that courts will no longer grant an extension of time for registration.291 Consequently, the second proviso292 consists of a liberty for the company and any other specified parties to apply to discharge the order within a specified period of time should liquidation ensue on or before a certain date. 6.119 An illustration is provided by Re Braemar Investments Ltd.293 The chargor’s solicitors failed to register the charge. As soon as the chargee discovered this omission, it issued a summons for an extension of time under section 404. The order granted contained three elements. First, it granted an extension because the omission was due to inadvertence and it was just and equitable to grant relief. Secondly, it contained the normal proviso protecting interim rights acquired over the charged asset. Thirdly, it permitted the company or any unsecured creditor to apply to the court to have the order discharged within 56 days of a voluntary winding up of the company becoming effective on or before a specified date (3 December 1986). In the event, a resolution to wind up the company was passed on 2 December and the liquidator applied for discharge of the section 404 order. With respect to the nature of the hearing, Hoffmann J stated as follows:294 In my judgment, this motion is similar to an application to discharge an ex parte order. It is a rehearing and a fresh exercise of the discretion on the whole of the material before the court. The judge is not confined to the evidence before the registrar or the grounds on which he founded his decision. Counsel for the liquidator said that the result would be to allow an applicant to put forward what was in substance a new application after the date of the liquidation. But I think that is an inevitable consequence of making the order first and leaving for later consideration the question of whether it should have been made. It would be wrong for the court at a later hearing to shut its eyes to facts of which evidence is available or grounds on which the order could properly have been made.

6.120 On the facts, although it was questionable whether the failure to register was due to inadvertence, it was just and equitable to grant relief. The failure to register was caused by the ‘gross breach’ by the chargor’s solicitors of their duty to the chargee, which had ‘acted entirely reasonably in trusting the solicitors to 290 Re Resinoid & Mica Products Ltd (1967) [1983] Ch 132n; Re Ashpurton Estates Ltd [1983] Ch 110 at 131; Exeter Trust v Screenways Ltd [1991] BCLC 888 at 895. 291 See also the discussion of ‘Abuse of Corporate Powers’, paras 7.88 et seq. 292 Apparently developed by Clauson J in Re LH Charles & Co Ltd [1935] WN 15. 293 [1988] BCLC 556. 294 At 560.

266 Howard N Bennett carry out its instructions’.295 Once the chargee had discovered the omission— and because of assurances from the solicitors there was no reason why it should have made its discovery any earlier—it had acted as speedily as it could it seeking relief from the court. 6.121 As to the imminence of insolvent liquidation as at the time of the registrar’s order, this was not conclusive in favour of discharging the order, but merely a relevant factor. As a matter of strict law an application to extend time is not too late if the registration can be effected before the liquidation actually commences. The court may as a matter of discretion on particular facts decide that it is too late at an earlier date, but the overriding question must be whether it would be just and equitable to grant leave.296

On the facts, the application had been made in time. 6.122 Where liquidation is not merely a reasonable prospect but inevitable and also an application to set aside the section 404 order would be ‘bound to succeed’, then no section 404 order should be granted in the first place. Otherwise, the financial predicament of the company coupled with the chance of an application being made to set aside the section 404 order and succeeding should not deprive the chargee of the benefit of an extension of time for registration, subject to the two provisos.297 The Finality Problem 6.123 A consequence of the proviso granting leave to apply for discharge of the section 404 order is postponement of the finality of section 404 relief for what may be a significant period of time. As Scott J observed in Re Chantry House Developments plc:298 First, a period must be allowed in order to see whether winding up does commence. Then, once the winding up has commenced, time must be given to the liquidator in the winding up to decide whether he wants to apply to discharge the order granting leave to register the charge out of time; and of course, if he does so apply, there must be a further hearing at which there will be an issue between the lender who had obtained the order for registration of the charge out of time, on the one hand, and the company, by the liquidator, on the other hand.

6.124 In Re Chantry itself, purchase money finance for the acquisition of development property was advanced by a building society expressly against a charge over that property. The purchase money charge was created but not registered. At the time of the section 404 hearing, the chargor company was factually insolvent, although no insolvency proceedings were imminent. Had an 295 296 297

At 561. At 562. Barclays Bank plc v Stuart Landon Ltd [2001] EWCA Civ 140 at [19], [2001] 2 BCLC 316 at

321. 298

[1990] BCLC 813 at 822.

Registration of Company Charges 267 extension under section 404 been refused, unsecured creditors would have received a dividend of 9.8p in the pound. Granting an extension would have lowered the dividend to about 3p. For one trade creditor, the difference amounted to £4,200 on a debt of £70,000. The sum secured by the unregistered charge was about £2.5 million. Scott J granted an extension of time for registration, observing as follows:299 It seems highly unlikely that any of the unsecured creditors has given credit to the company in reliance on the [property covered by the unregistered charge] being unencumbered . . . The company, in its annual accounts, consistently referred to the [property] as being subject to a mortgage. Accordingly, if potential creditors had thought to peruse the accounts in order to inform themselves about the financial condition of the company, they could not have supposed that the [property] was unencumbered. If they did not peruse the accounts of the company before deciding to give the company credit but simply knew that the company had a development [property] of substantial value, they would be unlikely to have supposed otherwise than that the financing of the site was secured on it. But, of course, if they had perused the register at the Companies Registry the reverse might be the case.

6.125 An additional complication in the case was that the chargor company needed a further £500,000 from the building society to complete development of the property, something clearly in the interests of the company and all its creditors. However, the proviso to a section 404 order leaving open for some considerable time the possibility of subsequent discharge of the order was unacceptable to the building society, which was unwilling to advance the further money unless it knew the charge was secure. Although unable, in the circumstances, to see any strong objection to the section 404 order, Scott J felt unable to dispense with the proviso altogether since the unsecured creditors had not had an opportunity to be heard. Consequently, he substituted for the normal proviso an undertaking from the building society to send notices, within seven days of the date of the order, to all creditors whose expected shortfall on liquidation should the charge be registered late would exceed £25,000, informing them of the section 404 order. Such creditors would then have 14 days from the date of posting of the notice to apply for discharge of the order. Omission of the Second Proviso 6.126 A perhaps unexpected shortcut to finality arises if, for whatever reason, a section 404 order granting an extension to register late is made without a proviso granting leave to apply to have the order discharged. No such application can be made once the order has been acted upon, the charge registered and the registrar of companies has issued a certificate under section 401. Since such a certificate is conclusive evidence that all requirements of Chapter I of Part XII of the Companies Act 1985 as to registration have been complied with, it follows that no challenge can be mounted on the basis of late registration.300 299 300

At 821. Exeter Trust v Screenways Ltd [1991] BCLC 888.

268 Howard N Bennett (c) Administration 6.127 The fact that the chargor company may, at the time of the section 404 hearing, be subject to an administration order does not change the approach of the courts to granting an extension of time for registration. The question remains whether, as a matter of fact, insolvent liquidation is so imminent as to render it inappropriate to exercise the section 404 discretion in favour of granting extra time. As stated by Millett J in Re Barrow Borough Transport Ltd:301 The administration procedure is an alternative and, while in force, a substitute for liquidation.302 If the rescue or rehabilitation of the company and its business as a going concern is one of the statutory purposes inserted in the order and it is still capable of achievement, there may be no reason why an extension of time should not be granted. But if that purpose is not included in the order, or if it has already proved incapable of achievement, then . . . simple justice requires that no extension of time should be granted.

F THE APPLICABILITY OF SECTION 395(1) TO OVERSEA COMPANIES

6.128 Section 395(1) applies to companies registered in England and Wales, that is to say to companies that achieved incorporated status through the registration procedure prescribed in Part I of the Companies Act 1985.303 The scope of section 395(1) is, however, extended by section 409(1), which provides as follows: This Chapter extends to charges on property in England and Wales which are created . . . by a company (whether a company within the meaning of this Act or not) incorporated outside Great Britain which has an established place of business in England and Wales.

6.129 A company incorporated outside Great Britain with such a place of business is generally termed an oversea company.304 Such a company is required by section 691 of the Companies Act 1985 to register with the Registrar of Companies if it has established a place of business in the Great Britain. The applicability of section 409(1), however, depends not on compliance with the requirements of section 691, but merely on the existence of an established place of business.305 This is unaffected by the practice of the registrar of companies 301 [1990] Ch 227 at 235, also describing the limited impact of a late registration order in the context of administration, given the statutory powers of an administrator over charged property. 302 An administration order cannot be made unless the court is satisfied that the company is or is likely to become unable to pay its debts: Insolvency Act 1986 s 8(1)(a). 303 See especially Companies Act 1985 s 13. 304 For the full statutory definition, see Companies Act 1985 s 744. A company incorporated outside Great Britain and consequently not formed and registered under English companies legislation is not a ‘company’ for the purposes of the 1985 Act: s 735. Hence the inclusion in s 409(1) of the phrase in brackets. 305 NV Slavenburg’s Bank v Intercontinental Natural Resources Ltd [1980] 1 WLR 1076.

Registration of Company Charges 269 not to enter on the charges register particulars of charges created by overseas companies that have not complied with section 691. Compliance with section 395(1) depends not on entry of particulars on the register but on delivery to or receipt by the registrar of the prescribed particulars within the 21 days period.306 Indeed, the practice of the registrar is to refuse to register particulars of charges created by oversea companies. Instead, delivery of particulars is acknowledged by letter,307 and the particulars are then entered in an alphabetical list of oversea companies that have delivered particulars of charges, known as the Slavenburg index.308

(1) Meaning of ‘Established Place of Business’ 6.130 In determining the applicability of section 409(1), the question most likely to arise is whether the oversea company has an ‘established place of business’ in England and Wales.309 Section 744 of the Companies Act 1985 provides that the expression ‘place of business’ includes a share transfer or share registration office, but the Act is otherwise silent. It is left to the case law to give further elaboration, particularly on the significance of the term ‘established’. 6.131 A clear distinction is drawn between merely carrying on business and having an established place of business. Thus, in Re Oriel Ltd,310 Oliver LJ311 stated that there must be . . . not merely a plot of land at which a business activity is carried on by somebody, but a place at or from which such business as the company conducts is habitually carried on or effected.312

The adjectival use of the word ‘established’, he further stated:313 . . . connotes not only the setting up of a place of business at a specific location, but a degree of permanence or recognisability as being a location of the company’s business 306

At 1086. Known as a Slavenburg letter. 308 Arthur D Little Ltd v Ableco Finance llc [2002] EWHC 701 (Ch) at [11], [2002] 3 WLR 1387 at 1391. 309 It is not an easy question to answer. A practitioner has written as follows: 307

Because it is difficult-if not impossible-to be certain that a given chargor does or does not have an established place of business in England, the usual practice is to seek to register all ‘registrable’ charges given by non-UK companies . . . Any such attempted registration will be rejected by a polite letter from Companies House which will nevertheless record the particulars of the ‘Slavenburg registration’ in a special register! See Hughes, ‘Taking Security: Some Dilemmas and Dichotomies’ (2001) 16 Butterworths Journal of International Banking and Financial Law 498 at 502. 310 [1986] 1 WLR 180. 311 With whose judgment Mustill LJ and Sir Denys Buckley concurred. 312 At 188. 313 At 184.

270 Howard N Bennett . . . The concept, as it seems to me, is of some more or less permanent location, not necessarily owned or even leased by the company, but at least associated with the company and from which habitually or with some degree of regularity business is conducted.

6.132 The phrase ‘a local habitation of its own’, adopted by Lord Dunedin314 and cited by Oliver LJ, neatly encapsulates the idea. Consequently, should company agents conduct business with customers by meeting in public rooms of a specific hotel, that would not make such public rooms an established place of business of the company.315 The company would be carrying on business at that location, but the location would lack the requisite identification with the company. Similarly, the receipt and transmission of orders at and from his home address by a commission agent with no authority to conclude contracts or decide whether orders should be accepted or rejected does not render his home an established place of business of his oversea principal.316 A fortiori, the fact that a director of a company resides in England and Wales does not render the personal residence of that director an established place of business of the company simply because the company can think and decide only through the mind of its directorate.317 Again, the mere presence of corporate assets at a particular location does not make that location an established place of business of the company. For example, an oversea land-holding company will not be regarded as establishing a place of business at every piece of land acquired in England and Wales.318 In contrast, an oversea export-import company dealing in art was held to have established a place of business at premises used for viewing of works of art and secure storage on a substantial scale in a vault controlled by the company. Lack of exclusivity of use of the premises and the absence of any visible, external identification of the company with the premises did not detract from this conclusion.319 6.133 Other than establishment, there is no further qualification to the phrase ‘place of business’. It is, consequently, irrelevant whether the company carries on a substantial part of its business at the premises in question or whether the activities there pursued are central or merely incidental to its business activity.320

314

Lord Advocate v Huron and Erie Loan and Savings Co, 1911 SC 612 at 616. An example given by Oliver LJ at 184. 316 Rakusens Ltd v Baser Ambalaj Plastik Sanayi Ticaret AS [2001] EWCA Civ 1820, [2002] 1 BCLC 104. 317 At 186–87, 189. 318 At 188. 319 Cleveland Museum of Art v Capricorn Art International SA [1990] BCLC 546 (service of writ on oversea company under Companies Act 1985 s 695(2)). An external sign identifying the company with the premises is obviously strong evidence of establishment, but its absence is far from decisive. According to Hirst J, it would have been uncharacteristic for a dealer in high value art objects to proclaim their location through a conspicuous nameplate: at 554. 320 South India Shipping Corp v Export-Import Bank of Korea [1985] 1 WLR 585 (service of writ). 315

Registration of Company Charges 271 (2) Time When Place of Business Must Be Established 6.134 According to section 409(1), section 395(1) is extended to charges created by a company that ‘has’ an established place of business in England or Wales. The present tense confirms case law on the predecessor to section 409(1) to the effect that the existence of an established place of business must be considered by reference to the time of creation of the charge.321 Section 395(1) will not apply if the company once had an established place of business in England and Wales at some time before the charge was created but no such place of business was operative any longer at that date.322 Conversely, however, an established place business in England and Wales at the date of creation of the charge will suffice notwithstanding that the company ceased to have any such place of business at some time thereafter.323 In case of such cessation, the company should give notice to the registrar and the obligation to register under section 395(1) will cease as from the date on which notice is given.324 In the event of a series of charges, the existence of an established place of business in England and Wales must be considered separately in respect of each charge, with the possible result that some may require registration under section 395(1) while others may not.325

(3) The Requirement of Property Located in England and Wales 6.135 Section 409(1) extends section 395(1) only to charges on property in England and Wales. It has been suggested that this restriction might combine with the section 395(1) registration period to produce a charge that is registrable but cannot be registered.326 An oversea company may create a charge that as of creation covers no property in England and Wales. More than 21 days after the date of creation, the company may acquire property in England and Wales that falls within the ambit of the charge under an after-acquired property clause. It would appear that the charge is now within section 409(1) but that compliance with section 395(1) is impossible since time for registration runs from the date of creation of the charge and has expired.327 It is suggested, however, that all requirements for the application of section 409(1) to a charge must be considered by reference to the time of creation of the charge. A company that 321

Re Oriel Ltd [1986] 1 WLR 180. Deverall v Grant Advertising Inc [1955] Ch 111. 323 NV Slavenburg’s Bank v Intercontinental Natural Resources Ltd [1980] 1 WLR 1076 at 1089. 324 Companies Act 1985 s 696(4). 325 Re Oriel Ltd [1986] 1 WLR 180. 326 McCormack, Registration of Company Charges (London, Sweet & Maxwell, 1994) at 154. 327 An application could of course be made for late registration, but the standard proviso to a late registration order would postpone the charge to all competing rights arising in the interim between creation and eventual registration: see above para 6.110. 322

272 Howard N Bennett establishes a place of business in England and Wales after the creation of a charge on property in England and Wales does not have to register that charge under section 395(1). Similarly, whether the charge falls within section 409(1) by reason of the location of charged property should also be judged at the time of creation of the charge.

(4) Standing to Invoke Section 395(1) in the Context of Oversea Companies 6.136 In the context of section 409(1) and challenges to the validity of charges created by oversea companies, it was held in NV Slavenburg’s Bank v Intercontinental Natural Resources Ltd328 that section 395(1) had to be read as applying not only to liquidators and administrators in English proceedings, but also to foreign equivalents in foreign insolvency proceedings. In the light of Smith v Bridgend County Borough Council,329 discussed below,330 the application must be to companies in liquidation or administration in English proceedings or to companies in equivalent foreign insolvency proceedings.331 Standing to challenge lies with the insolvent company rather than the insolvency practitioner.

G THE CONSEQUENCES OF NON - COMPLIANCE WITH SECTION 395(1)

6.137 The function of registration under the Companies Act 1985 is to perfect the chargee’s rights against rival claimants to the charged property. Two questions arise. First, precisely who is entitled to invoke section 395(1)? Secondly, what are the consequences of a charge being ‘void’ under section 395(1)?

(1) Entitlement to Invoke Section 395(1) 6.138 Section 395(1) states that non-registration renders a charge ‘void against the liquidator or administrator and any creditor of the company’. Care is, however, required in the reading of this phrase. (a) ‘Liquidator or Administrator’ 6.139 In Independent Automatic Sales Ltd v Knowles & Foster,332 Buckley J considered that the purpose of the sanction of voidness for non-registration was 328

[1980] 1 WLR 1076 at 1086–87. [2001] UKHL 58, [2002] 1 AC 336. Para 6.140. 331 It is possible that questions of equivalence could present difficulty. Within the European Community, see the Regulation on Insolvency Proceedings, EC 1346/2000 (OJ L160/1): para 10.114 and Appendix 3. 332 [1962] 1 WLR 974 at 981–82. 329 330

Registration of Company Charges 273 to enhance the power of the liquidator to deal with the company’s assets. The rights of the company itself were ‘wholly unaffected’, with the result that the company itself had no right to challenge the validity of a charge for nonregistration. This was reinforced by the incidence of the duty to register. This duty lies on the company and the company should not be allowed to plead its own default. The procedural consequence was that any proceedings challenging the validity of a charge on the ground of non-registration should be instigated in the name of the liquidator not the company. 6.140 The view espoused by Buckley J in Independent Automatic Sales was, however, overruled by the House of Lords in Smith v Bridgend County Borough Council.333 Lord Hoffmann reasoned as follows: When a winding-up order is made and a liquidator appointed, there is no divesting of the company’s assets. The liquidator acquires no interest, whether beneficially or as trustee. The assets continue to belong to the company but the liquidator is able to exercise the company’s right to collect them for the purposes of the liquidation. It must in my opinion follow that when section 395 says that the charge shall be ‘void against the liquidator’, it means void against a company acting by its liquidator, that is to say, a company in liquidation.

It is clear, therefore, that any action that a liquidator wishes to see brought to challenge a charge for non-registration should be brought in the name of the company, despite the fact that the company will be invoking its own failure to register, and not the name of the liquidator. The same reasoning and procedural consequence apply also to a company in administration.334 (b) ‘Any Creditor of the Company’ 6.141 Apart from the reference to the liquidator or administrator, section 395(1) provides that an unregistered charge is also ‘void against . . . any creditor of the company’. This phrase must, however, be applied carefully. In what circumstances may creditors invoke section 395(1) and to what extent may they do so in their own names? 6.142 As a matter of both principle and practicality, a creditor cannot challenge a charge for non-registration unless that creditor has a right against the assets to which the unregistered charge attaches. Without a rival claim to the charged assets, a challenge is empty and otiose. Section 395(1) declares an unregistered charge to be void not as a general proposition but ‘against . . . any creditor’. If a creditor has no claim to the charged assets there is no context within 333

[2001] UKHL 58 at [20]–[21], [2002] 1 AC 336 at 348. At para [29]–[31], at p 350. See also Arthur D Little Ltd v Ableco Finance llc [2002] EWHC 701 (Ch) at [13], [2002] 3 WLR 1387 at 1391. The term ‘liquidation’ refers to an English winding up, just as ‘administration’ must refer to an order that is the subject of Part II of the Insolvency Act 1986, although foreign equivalents are included in the context of an oversea company: NV Slavenburg’s Bank v Intercontinental Natural Resources Ltd [1980] 1 WLR 1076 at 1086–87. 334

274 Howard N Bennett which the voidness can be asserted. To deploy section 395(1), a creditor needs a rival interest in the charged assets that the court can recognise and enforce and not merely . . . something . . . in the air, some claim or contention which the Court could not recognize or give effect to in any valid proceeding.335

An unsecured creditor, in general, has no proprietary right to or interest in any assets of the debtor company. There are, however, two exceptions. First, an execution creditor may be able to establish an interest in an asset and, secondly, by virtue of a sui generis statutory trust,336 unsecured creditors enjoy a collective beneficial interest in the company’s property once liquidation commences.337 Conversely, secured creditors by definition do enjoy a proprietary interest. 6.143 The position of unsecured creditors has arisen in the context of deciding who should be protected by provisos to an order granting permission for late registration. If any creditor, including any unsecured creditor with no interest in the charged assets, could invoke the voidness of an unregistered charge, then any order for late registration would have to be subject to a proviso postponing the late registered charge to all intervening creditors whose debts arose between the creation of the unregistered charge and the date of eventual registration. In Re Ehrmann Bros Ltd,338 however, the Court of Appeal held that only intervening proprietary rights were protected. The focus of the judgments was primarily upon the meaning of the word ‘right’ as used in the standard proviso to a late registration order, but implicit in the decision is a rejection of the idea that section 395(1) confers upon an ordinary, unsecured creditor a perfected right to treat the charge as void. Moreover, Romer LJ stated as follows:339 [I]n the absence of liquidation before the date of registration or of some charge acquired by a creditor, no ordinary creditor had a right which could have been enforced by him as against the debenture-holders. The general avoidance of the debentures as charges as against the ordinary creditor prior to liquidation proceedings, and in the absence of any charge acquired by him, would not entitle him to intervene as between the company and the debenture-holders if the company chose to pay the debenture-holders or to apply any part of its property in payment of those debentureholders or to give other security to the debenture-holders; nor, in my opinion, could such a creditor apply or intervene in an action brought by the debenture-holders against the company where the debenture-holders were seeking to enforce their alleged security if the company chose to recognize the charge and to use its assets in paying those debentures off. An ordinary creditor would have no locus standi; if there was a liquidation, of course different considerations would apply, and if he had a charge different considerations would apply; he might then intervene, and I think his intervention would be accepted by the Court. 335 336 337 338 339

Re Ehrmann Bros Ltd [1906] 2 Ch 697 at 708 per Romer LJ. Ayerst v C & K (Construction) Ltd [1976] AC 167. Re Ashpurton Estates Ltd [1983] Ch 110 at 123 (above, para 6.115). [1906] 2 Ch 697. At 708.

Registration of Company Charges 275 Thus, although an unregistered charge is void against even an unsecured creditor,340 without a rival interest in the charged assets the unsecured creditor has no standing to invoke that voidness. That can be justified on the basis that, as explained in Re Cardiff Workmen’s Cottage Co Ltd,341 being postponed to secured credit is simply a risk inherent to unsecured credit. 6.144 Prior to the onset of liquidation, the only unsecured creditors who might be able obtain the requisite interest are execution creditors.342 Suppose, for example, that an unsecured creditor obtains judgment against the chargor company and proceeds to levy execution on property subject to an unregistered charge. In the absence of any petition for administration or inception of liquidation, the chargee seeks to enforce against the property subject to execution of judgment. Assuming that the selected method of levying execution has conferred on the execution creditor an interest in the asset, such an execution creditor should have standing to invoke section 395(1) against the chargee. 6.145 With respect to secured creditors, a fixed chargee should have standing to invoke section 395(1) at any time. Although fixed charges rank in order of date of creation, were the holder of an earlier unregistered fixed charge to apply for late registration, any order would contain a proviso effectively postponing the earlier charge to any rights accrued between the date of its creation and that of its eventual registration. Consequently, the holder of any fixed charge created in that interim period will be promoted ahead of the earlier unregistered charge. It follows that such a later chargee would also be entitled to invoke section 395(1) against an unregistered charge to oppose enforcement by the holder of the unregistered charge against any assets subject to both charges. 6.146 With respect to floating charges, once the charge has crystallised, the position of the floating chargee may be equated with that of a fixed chargee. Prior to crystallisation, however, the position is less clear. Could the holder of an uncrystallised floating charge invoke section 395 to prevent enforcement by an earlier unregistered fixed chargee against assets covered by both charges?343 The answer, it is suggested, is no. 6.147 A floating charge is an immediate security, conferring on the chargee an equitable proprietary interest in the charged assets as a collective fund.344 However, prior to crystallisation, a floating chargee has no rights in any individual charged asset. Moreover, there is no right of selective intervention in the form of partial crystallisation.345 If failure to register renders an uncrystallised 340

At 629. [1906] 2 Ch 627 at 630, above para 6.111. See above, para 6.112. 343 The point is unlikely to arise in practice since a debenture will generally be drafted so as to crystallise automatically in the event, inter alia, of enforcement by any other secured creditor. 344 See above, para 6.27 345 Evans v Rival Granite Quarries Ltd [1910] 2 KB 979. 341 342

276 Howard N Bennett floating charge opposable against the unregistered competing charge, section 395 will have the effect of altering the nature of a floating charge. Section 395 does have the effect of altering priorities in liquidation, but a floating charge will crystallise on the onset of liquidation if it has not already done so. It is difficult to see that section 395 can or should alter the nature of a floating charge prior to crystallisation.346 6.148 The reasoning in Smith v Bridgend denies standing to liquidators and administrators on the basis that they lack any interest in the charged assets. Technically, section 395(1) can be invoked only by the company in liquidation or administration. There is, however, no reason why creditors individually endowed with an interest in the charged assets should not enjoy standing to invoke section 395(1) in their own names, although the collective interest of unsecured creditors under the statutory trust may need to be invoked by the liquidator or administrator.347 Although there is no statutory trust in an administration, a potential collective interest could be invoked by an administrator in late registration proceedings. In any event, a liquidator or administrator who overlooks the perfected claims of a beneficiary of section 395(1) in dealing with property subject to an unregistered charge will incur liability in conversion.348 (c) Purchasers 6.149 Purchasers are clearly excluded from the benefit of section 395(1).349 Consequently, a factor that takes an outright assignment of debts, not by way of charge, cannot invoke section 395(1) against a registrable but unregistered

346 It is unclear whether the pre-crystallisation interest of a floating chargee is sufficient to qualify for the protection of the usual proviso to an order for late registration: see above para 6.113. Even if it is, however, it does not necessarily follow that the chargee has a sufficient interest for the purposes of s 395. The rights of the floating chargee to which the late registered charge is postponed by virtue of the proviso do not include rights in respect of any individual asset in the absence of crystallisation. 347 In Re Ayala Holdings Ltd [1993] BCLC 256 a creditor of a company in liquidation sought a declaration purportedly under the Insolvency Rules 1986 to the effect that a charge was void against the liquidator for non-registration. Chadwick J held that neither the Insolvency Act 1986 nor the Insolvency Rules authorised such an action. He refrained, however, from expressing any view on whether a creditor could challenge a chargee directly in the general law on the basis of nonregistration: at 261. 348 As in Smith v Bridgend itself. A creditor can also apply for directions under the Insolvency Act 1986, s 168 requiring the liquidator to dispute the validity of the charge, although the funding of such proceedings may prove problematic: Re Ayala Holdings Ltd [1993] BCLC 256 at 261. 349 Stroud Architectural Systems Ltd v John Laing Construction Ltd [1994] 2 BCLC 276. Contrast the wording in the never enacted registration provisions of the Companies Act 1989. By virtue of the new Companies Act 1985 s 399(1) (as it would have been), an unregistered charge would have been void against not only a liquidator or administrator but also ‘any person who for value acquires an interest in or right over property subject to the charge’ after the creation of the charge. It is difficult to see who the change from ‘any creditor’ to ‘any person’ would have embraced other than purchasers.

Registration of Company Charges 277 charge over the same debts.350 The resulting priority contest will be decided according to the rule in Dearle v Hall 351 in respect of each charged and assigned debt in favour of the first to give notice to the account debtor.352 At first blush, this may not seem conducive to the business of factoring. However, factors escape from themselves being required to register under section 395(1) through their status as purchasers rather than chargees, and the superior information available to factors should enable them to defeat the unregistered chargee under Dearle v Hall.

(2) Consequences of Voidness under Section 395(1) 6.150 The voidness of a charge under section 395(1) does not deprive the charge of all effect, nor does it invalidate the underlying debt secured by the charge. (a) Impact upon the Charge: Attachment, Perfection and Priority 6.151 Failure to register a charge in accordance with section 395(1) does not prevent a charge from attaching to the property of the chargor company or interfere in any way with the effect of the charge as between the chargor and chargee outside of liquidation or administration of the chargor. Registration under section 395(1), in English law, is a perfection requirement. In other words, it is a condition precedent to the validity and enforceability of the charge against those persons entitled to invoke section 395(1).353 Should the company go into liquidation, for example, a non-registered charge will be void against the company in liquidation, and the liquidator will distribute the company’s assets according to the rules of insolvency law, including respecting registered charges, and will treat the debt secured by the unregistered charge as unsecured.354

350 It is unclear whether this point was appreciated in E Pfeiffer Weinkellerei-Weineinkauf GmbH & Co v Arbuthnot Factors Ltd [1988] 1 WLR 150 where a factor was described as a creditor and treated as benefiting from s 395(1), although the court also applied the rule in Dearle v Hall to resolve priorities. 351 (1828) 3 Russ 1. 352 E Pfeiffer Weinkellerei-Weineinkauf GmbH & Co v Arbuthnot Factors Ltd [1988] 1 WLR 150. It is irrelevant whether the purchaser is a statutory assignee within s 136, Law of Property Act 1925 or an equitable assignee. A statutory assignee does not receive a legal title to the debt permitting it to invoke the supremacy of a legal interest over earlier equitable interests of which the assignee had no notice at the time of giving value: Pfeiffer; Compaq Computers Ltd v Abercorn Group Ltd [1993] BCLC 602. 353 Discussed in the previous section. 354 Where a charge is created by deposit of an instrument and the charge is held to be void for want of registration, the creditor cannot claim a common law lien over the deposited instrument: Re Molton Ltd [1968] 1 Ch 325. See also above, para 6.36 (no unpaid vendor’s equitable lien where alternative charge void for non-registration).

278 Howard N Bennett 6.152 With respect to the priority ranking of a charge, under English law, priority is governed by rules of common law, not conferred by registration. However, as already seen,355 a charge permitted to be registered late will almost invariably be postponed to all proprietary rights created between the date of creation of the late registered charge and the date of its actual, late registration. This effective postponement of an unregistered charge behind a charge created later but duly registered occurs even if the later charge is taken with notice of the existence of the earlier charge and even if at the time the later charge is created with notice the 21-day period for registration of the first charge has not yet expired.356 In this sense, while registration does not confer priority, nonregistration jeopardises the priority conferred at common law. (b) Impact upon Assignment of Debts 6.153 Where the unregistered charge involves an assignment of debts to the chargee, section 395(1) negates the assignment not only as between assignor and assignee but also as between account debtor and assignee.357 There is, however, no reason why the account debtor should know of the existence or significance of the section 395(1) challenge. Consequently, where an account debtor has previously been given notice so as to oblige him to make payment to the assignee, it is suggested that a further notice will have to be given to the account debtor to switch the destination of payment back to assignor. In the absence of such further notice, the account debtor should be able to achieve a good discharge of the debt by paying the assignee, while the assignee would hold such payment on trust for the assignor. (c) Impact upon the Secured Debt 6.154 As between chargor and chargee, section 395(1) imports an accelerated payments clause into all registrable charges. A successful challenge under section 395(1) does not vitiate any contract or obligation to repay money secured by the charge.358 On the contrary, it renders the money secured by the charge immediately repayable.359 Were it otherwise, the result of the failure by the company to fulfil its duty to register 360 would be that the creditor would be both exposed to the consequences of non-registration and unable to seek repayment for the duration of the contractual credit period.

355

Above, para 6.110. Re Monolithic Building Co [1915] 1 Ch 643. Orion Finance Ltd v Crown Financial Management Ltd [1994] 2 BCLC 607 at 627; affd [1996] 2 BCLC 382. 358 Re Ehrmann Bros Ltd [1906] 2 Ch 697 at 706. 359 Companies Act 1985 s 395(2). 360 See Companies Act 1985 s 399. 356 357

Registration of Company Charges 279 (d) Absence of Retrospectivity 6.155 The consequences of the invalidity of a charge in a liquidation or administration are not retrospective. Acts taken in discharge of secured obligations cannot be impeached by a subsequent invalidity of the charge for non-registration.361 A liquidator cannot recover money paid or property seized before the onset of liquidation in discharge of a debt secured by an unregistered charge.362 Indeed, if the secured obligations have been wholly discharged, the charge is spent and section 395(1) has nothing upon which to bite.363 (e) Rehabilitation of the Insolvent Company 6.156 Should the outcome of administration, or even liquidation, prove to be rehabilitation of the company, it is possible that property subject to a charge that is void under section 395(1) might remain in the hands of the company. In Independent Automatic Sales Ltd v Knowles & Foster,364 Buckley J stated that the company would hold the property subject to the unregistered charge. This was, however, in the context of reasoning that section 395(1) did not affect the rights of the company in any way but rather strengthened the powers of the liquidator. As already seen, that view has since been overruled in Smith v Bridgend County Borough Council.365 Nevertheless, while section 395(1) must now be read as rendering the charge void as against the company, it is only void as against the company in liquidation or administration. The prospect of survival of the company, or a part of it, as a going concern or of the liquidation or administration at least yielding a surplus in no way protects an unregistered charge from the impact of section 395(1).366 However, should the company emerge rehabilitated from liquidation or administration, there appears to be no reason why the chargor should not be entitled to enforce the charge against the company or, in appropriate circumstances, apply for late registration. (f) Entitlement to the Liberated Assets 6.157 Given that an unregistered charge cannot be invoked in a liquidation or administration, the question arises as to entitlement to the value released by virtue of section 395(1). In the context of any ground for challenging transactions on an liquidation, there is a question of whether the released or regained value constitutes part of the assets of the company available to the company’s 361

It may always be possible to challenge such acts as a preference: see ch 4. Re Row Dal Constructions Pty Ltd [1966] VR 249; Mercantile Bank of India Ltd v Chartered Bank of India, Australia and China [1937] 1 All E.R. 231. 363 NV Slavenburg’s Bank v Intercontinental Natural Resources Ltd [1980] 1 WLR 1076. 364 [1962] 1 WLR 974 at 981. 365 Above, para 6.140. 366 Re Oriel Ltd [1984] BCLC 241 at 247–48. 362

280 Howard N Bennett creditors generally or whether it falls within the statutory trust that arises for the benefit of the unsecured creditors. So far as section 395(1) is concerned, the former is correct. The impact of section 395(1) is simply to remove the unregistered chargee from the category of secured creditor and demote that chargee to the category of unsecured creditor. The value of the assets liberated by section 395(1) then falls to be distributed in accordance with the normal rules of insolvency law. A firm statement to this effect may be found in the judgment of Lord Hoffmann in Smith v Bridgend County Council:367 The plain intention of the legislature was that property subject to a registrable but unregistered charge should be available to the general body of creditors (or a secured creditor ranking after the unregistered charge) as if no such charge existed.

6.158 In the context of preferences, it has been held that in a winding up recoveries accrue to the benefit of the statutory trust. This is on the basis that the right to challenge the impugned transaction on a winding up is vested exclusively in the liquidator and not in the company. Consequently, since the action does not belong to the company, neither do the proceeds of the action.368 However, as held in Smith, the entitlement to invoke section 395(1) is conferred not on the liquidator but on the company in liquidation.369 6.159 With respect to administration, the impact of section 395(1) is again simply that an unregistered charge is viewed as non-existent. Consequently, with respect to such a charge, an administrator will not need to invoke the statutory powers to deal with charged property.370

367 368 369 370

[2001] UKHL 58 at [19], [2002] 1 AC 336 at 348. Re Oasis Merchandising Ltd [1998] Ch 170 at 182. See para 4.102. See above, para 6.140. Insolvency Act 1986 s 15.

7

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law JOHN ARMOUR

A INTRODUCTION

7.1 This chapter is concerned with the avoidance of transactions on general company law principles, as opposed to specific provisions of the insolvency legislation. As such, the relevant causes of action are open to the company itself or any office-holder acting in right of the company. Thus, they may be employed by a liquidator, administrator or administrative receiver.1 In keeping with the book’s concern with corporate insolvency, the focus is restricted to grounds for transaction avoidance that become operational on or near a company’s insolvency. 7.2 Gratuitous corporate dispositions were formerly challenged on the basis that they were beyond the company’s capacity and therefore void. Following judicial restriction of the doctrine of ultra vires and its practical abolition by statute in 1989, this ground is no longer available to an office-holder. However, the courts have in a number of cases struck down antecedent transactions on the basis that they constituted a ‘fraud on creditors’. Most significantly, this doctrine has been said to constitute an exception to the general principle that the general meeting, acting unanimously, is able to bind the company in any matter intra vires. This makes it of particular interest to an office-holder in insolvency proceedings, as unanimous authorisation or ratification by shareholders would ordinarily regularise corporate transactions which might otherwise have been open to challenge. 7.3 The concept of ‘fraud on creditors’ has not been clearly defined in the authorities. As Hart J recently observed in Sasea Finance Ltd v KPMG:2

1 Contrast the position with respect to other causes of action considered in this book. See above, ch 1 (pari passu principle); ch 2 (transactions at an undervalue); ch 4 (unlawful preferences); ch 5 (late value floating charges); ch 6 (unregistered company charges); and ch 8 (post-petition dispositions in compulsory liquidation). 2 [2002] BCC 574 at 582.

282 John Armour The question of what is implied in the notion, in this context, of dishonesty or ‘fraud on the creditors’ is not discussed in any of the authorities which were cited to me. It is simply accepted that ‘fraud on the creditors’ constitutes a general exception to the principle that the shareholders can bind the company to a particular transaction.

It will be argued that what is referred to in the case law as ‘fraud on creditors’ encompasses two related doctrines which are not always clearly distinguished from each other, or from the doctrine of ultra vires which they have superseded. These two doctrines are the prohibition on unlawful returns of capital and a still-developing restriction on what has sometimes been termed ‘abuse of corporate power’. 7.4 On the one hand, transactions which transfer value to shareholders or persons connected with them may be challenged on the basis that they constitute an unlawful return of capital or concurrently an unlawful distribution in breach of the provisions of Part VIII of the Companies Act 1985. The court will characterise the substance of the transaction, disregarding labels which the parties may have accorded it, in order to determine whether its true nature is a distribution. So, if the company has no, or insufficient, distributable profits at the time of the transaction, then it will be void for illegality. Transactions which are in substance unlawful distributions but which are ‘dressed up’ as something else—for example, as remuneration or as the sale of an asset—have been referred to in the authorities as constituting ‘frauds on creditors’.3 Such transactions, being unlawful, are wholly unratifiable by the shareholders in general meeting. 7.5 However, it is clear that the range of transactions which are capable of constituting a ‘fraud on creditors’ encompasses more than simply disguised distributions.4 It also includes transactions which are effected in bad faith vis-à-vis creditors. It will be argued that this is simply an extension of the general equitable doctrine of abuse of power. Corporate transactions are generally open to challenge as an abuse of power where the board, in authorising the transaction, did not act bona fide in the interests of the company, and the counterparty was a volunteer or on notice of the abuse of power. Where the company is solvent, its ‘interests’ will primarily be those of the shareholders. Thus the doctrine does not impose any restrictions on the ability of shareholders, acting unanimously, to authorise corporate transactions or to validate transactions effected by the board. 7.6 In contrast, where the company is factually insolvent, its creditors become prospectively entitled to its assets, and so its ‘interests’ are equated with this group. Thus transactions may be challenged as an abuse of power where not entered into bona fide in the interests of the creditors, and the counterparty was 3 Re Halt Garage (1964) Ltd [1982] 3 All ER 1016 at 1037–39; Aveling Barford Ltd v Perion Ltd (1989) 5 BCC 677 at 683. 4 See Sasea Finance Ltd v KPMG [2002] BCC 574 at 585.

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 283 a volunteer or on notice of the abuse of power. Whilst the test to be applied is subjective, lack of good faith and notice may be inferred where a transaction is clearly and obviously detrimental to creditors. This is the other sense in which the term ‘fraud on creditors’ has been used.5 Moreover, because factual insolvency prospectively displaces the shareholders’ entitlements, restrictions are for the first time imposed upon the decision-making power of the general meeting, as well as that of the board. Hence, even transactions authorised or validated by the general meeting acting informally through unanimous consent may be challenged where they are obviously harmful to creditors and the company was insolvent at the time. 7.7 In addition to the grounds considered in this chapter, a liquidator or administrator may of course be able to challenge antecedent transactions by reference to a range of general company law principles. For example, the directors in purporting to enter a corporate transaction may have exceeded their authority, the transaction may have involved a breach of the equitable ‘self-dealing’ rules or their statutory reinforcement in Part X of the Companies Act 1985, or an infringement of the prohibition on the giving by companies of financial assistance for the purpose of the acquisition of their shares. These grounds are not considered in detail in this chapter, as they are equally available to solvent and insolvent companies, and the reader is referred to treatments available in standard works of reference on company law.6 However, the doctrine of ‘fraud on creditors’ may be of assistance to an office-holder seeking to challenge a purported ratification of a transaction otherwise vulnerable on such grounds. An attempt by shareholders to validate a transaction that is otherwise vulnerable (on whatever basis), or to release a corporate cause of action arising thereunder, at a time when the company is factually insolvent, will itself be rendered ineffectual, at least if—as is likely to be the case with a decision made by shareholders under such circumstances—the ratification is not effected bona fide in the interests of the creditors. 7.8 The rest of the chapter is structured as follows. In order to establish the historical context in which the current law is set, Part B gives a brief review of the doctrine of ultra vires, stricto sensu, and its reform. Part C considers unlawful distributions and the maintenance of capital principle. Part D deals with avoidance of transactions on the basis that they were entered in abuse of power by a relevant corporate decision-maker.

5 See eg Rolled Steel (Holdings) Ltd v British Steel Corporation [1986] Ch 246 at 297; Re DKG Contractors [1990] BCC 903 at 908. 6 See generally MH Arden and DD Prentice (eds), Buckley on the Companies Act, 15th edn (London, Butterworths, 2000); GK Morse (ed), Palmer’s Company Law, 25th edn (London, Sweet & Maxwell, 1992); AJ Boyle and R Sykes, Gore-Browne on Companies, 44th edn (London, Jordans, 1986).

284 John Armour

B HISTORY : THE DOCTRINE OF ULTRA VIRES

(1) Meaning of ‘Ultra Vires’ 7.9 Prior to 1985, there was no special action to avoid undervalue transactions entered into by corporate debtors.7 Instead, the courts employed the doctrine of ultra vires in such a way as to provide a means of striking down gratuitous transactions. Strictly speaking, this doctrine was based on the idea that the benefit of legal personality was conferred on a corporate entity solely for the furtherance of its objects, and hence it lacked capacity to enter transactions which were not within the scope of the objects set out in the memorandum, or powers expressly or impliedly ancillary thereto.8 It was often possible for a liquidator, on discovering that a gratuitous—or significantly undervalued—transaction had occurred, to argue that this was outwith corporate capacity and therefore void. 7.10 The term ‘ultra vires’ has, however, often been used to refer to other grounds for invalidity—for example that the transaction was illegal in contravention of the provisions of the Companies Acts,9 or that it involved an excess of power by an agent.10 Whilst it is technically correct to say that such transactions are each ‘beyond the power’ of a relevant actor—rather than the company itself—the grounds for, and consequences of, this finding differed from those associated with a finding that the company itself lacked capacity to engage in a transaction. This tendency to conflate different grounds for challenge proved a fertile source of confusion over the years. In Rolled Steel Ltd v British Steel Corporation,11 after a careful review of the authorities, the Court of Appeal sought to clarify terminology. As Slade LJ put it:12 If confusion is to be avoided, it seems to me highly desirable that, as a matter of terminology, the phrase ‘ultra vires’ in the context of company law should for the future be rigidly confined to describing acts which are beyond the corporate capacity of a company.

Nevertheless, judicial usage in other senses still occurs.13

7 The general law of fraudulent conveyances of course applied to corporate debtors the same as individuals. See ch 3. 8 The company law doctrine of ultra vires is very similar both in form and function to the public law doctrine of the same name. See the review of their joint history by Neill LJ in Crédit Suisse v Allerdale Borough Council [1997] QB 306 at 336–42. 9 See, eg, Smith v Croft (No 2) [1988] Ch 114 at 165 (unlawful financial assistance); Aveling Barford Ltd v Perion Ltd (1989) 5 BCC 677 at 683 (unlawful distribution). 10 See eg, Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1982] 1 Ch 478 at 497. 11 [1986] Ch 246. 12 At 297. Browne-Wilkinson LJ opined to the same effect at 303. 13 See, eg, MacPherson v European Strategic Bureau Ltd [2000] 2 BCLC 683 at 701, 704 (which was in fact an unlawful distribution and/or abuse of corporate power).

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 285 (2) History of the Doctrine of Ultra Vires (a) Origins and Purpose 7.11 The doctrine of corporate capacity originated with the well-known decision of the House of Lords in Ashbury Railway Carriage and Iron Co Ltd v Riche.14 The memorandum of the company in that case recited that it had been incorporated with objects relating to the manufacture, sale, lending or hiring of railway carriages, waggons and other associated machinery and fittings. The company contracted to provide finance for the construction of a railway, which agreement it subsequently repudiated. When the counterparty sued for damages, the House of Lords held that because the agreement exceeded the objects specified in the company’s memorandum it was void and therefore the counterparty’s claim failed. 7.12 The argument that the objects clause was merely an internal restriction was rejected by reference to the fact that—in contrast to the articles of association—the companies legislation proscribed the alteration of a company’s memorandum save in very limited respects.15 This belied the purpose of the memorandum as a means of protecting not just present shareholders, but also creditors who advanced money to a limited liability company and members of the general public who might in the future become shareholders.16 Hence infringements of the restrictions it imposed upon corporate powers were not ones which the shareholders—even acting unanimously—could validate. It was simply ultra vires the company, or outwith its capacity. 7.13 It is worth considering the way in which ‘protection’ offered by the objects clause was expected to work. In effect, it provided a mechanism by which a group of promoters could make a credible commitment to creditors and subsequent shareholders that their investments would only be used for the purposes for which they were advanced. Those in control of a company might be tempted, having raised outside funds cheaply on the basis that they are to be used for low-risk project A, to instead use them for high-risk project B, for which purpose, had they known it, the outside investors would have demanded a greater return.17 Whilst investors might of course contract for such protection, they would nevertheless need to incur costs in monitoring the company’s activities in order to observe any breaches, and then in enforcement in order to obtain redress. The doctrine of ultra vires—in its classical form—could be understood 14

(1875) LR 7 HL 653. The memorandum also contained a clause stating that the company might extend its business beyond the objects there set out with the sanction of a special resolution. This clause was held to be ineffective. 16 Ashbury Railway Carriage and Iron Co Ltd v Riche (1875) LR 7 HL 653 at 667. 17 See MC Jensen and WH Meckling, ‘Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure’, (1976) 3 Journal of Financial Economics 305 at 333–43. 15

286 John Armour as an attempt to reduce such costs, by automatically invalidating such transactions.18 This presumably encouraged others dealing with the company to monitor on behalf of the investors,19 thereby facilitating the raising of finance. All of this relied on one crucial variable: that the restrictions by which the company bound itself were known both to investors and to those dealing with the company. Whilst registration (and the doctrine of constructive notice) meant that this was the case in legal theory, the practicalities of actually obtaining this public information were rather less than satisfactory. (b) Determining Want of Capacity 7.14 Interpretation of Objects Clause. A company always had capacity to do something which formed one of its objects,20 and furthermore would have implied powers to do things reasonably incidental to the conduct of its business.21 Thus if the corporators did not wish the company to be limited in its choice of business activities—and it appears that most did not—then they were free to specify a very wide range of express corporate powers. This caused considerable judicial consternation, being viewed disdainfully as attempts in some way to ‘avoid’ the statutory safeguards.22 7.15 A number of interpretative techniques were developed to ‘read down’ the ambit of prolix objects clauses, each in turn sparking a different type of ‘creative drafting’ designed to get around them.23 First, a distinction was drawn between clauses in a memorandum which were ‘substantive objects’ and others which on their true construction were ‘ancillary powers’, only to be used in the furtherance of the objects.24 In response, draftsmen started to include ‘independent objects’ clauses, stating that each clause of the memorandum was to be read as giving rise to a separate object capable of independent furtherance.25 Yet even 18 See BR Cheffins, Company Law: Theory, Structure and Operation (Oxford, OUP, 1997) at 527–28. 19 The relationship between the monitoring costs borne by investors relative to those borne by parties subsequently dealing with the company is encapsulated in the following dictum of Lord Parker:

The narrower the objects expressed in the memorandum the less is the subscribers’ risk, but the wider such objects the greater is the security of those who transact business with the company. (Cotman v Brougham [1918] AC 514 at 520). 20 Re Horsley & Weight Ltd [1982] Ch 442 at 449, 454, 455. 21 AG v Great Eastern Railway Co (1880) 5 App Cas 473; Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] Ch 62 at 71A; Re Horsley & Weight Ltd [1982] Ch 442 at 448. 22 See, eg, the comments of Lord Wrenbury in Cotman v Brougham [1918] AC 514 at 522–23. That they were no such thing is, it is submitted, clear from the fact that Parliament placed no restriction on the scope of the objects for which a company could be incorporated. 23 See the review of the authorities by Slade LJ in Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1986] Ch 246 at 286–97. 24 See, eg, Re German Date Coffee Co (1882) 20 Ch D 169; Henderson v Bank of Australasia (1888) 40 ChD 170. 25 Cotman v Brougham [1918] AC 514; Re Horsley & Weight Ltd [1982] Ch 442 at 448.

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 287 with such a clause in place, the true determination of whether an individual subclause constituted a separate object or an ancillary power was ultimately a matter of construction, and sometimes the nature of a sub-clause, coupled with the other ‘objects’ of the business, would be sufficient to infer that the ‘independent objects’ clause was not intended to apply.26 Alternatively, the subject-matter of a clause might be found to be ‘of its very nature’ incapable of being an object— for example, the power to borrow money in Re Introductions—indicating an ancillary power.27 7.16 Exercise of Ancillary Powers. As the Court of Appeal pointed out in Rolled Steel Products (Holdings) Ltd v British Steel Corporation,28 strict logic would dictate that any use of an ancillary power for a purpose outside the corporate objects would itself be ultra vires. This, however, would introduce unacceptable risks for counterparties in corporate transactions. After a careful review of the confused earlier authorities, the position was clarified in Rolled Steel:29 [I]f a particular act . . . is of a category which, on the true construction of the company’s memorandum, is capable of being performed as reasonably incidental to the attainment of pursuit of its objects, it will not be rendered ultra vires the company merely because in a particular instance its directors, in performing the act in its name, are in truth doing so for purposes other than those set out in its memorandum. Subject to any express restrictions on the exercise of the relevant power which may be contained in the memorandum, the state of mind or knowledge of the persons managing the company’s affairs or of the persons dealing with it are irrelevant in considering questions of corporate capacity.

7.17 Furthermore, a provision in the memorandum that an express power was exercisable ‘for the purposes of the company’s business’ would not, without more, be interpreted as a limitation on corporate capacity, but would rather constitute a restriction on the authority of directors.30 The decision in Rolled Steel concerned the manner of exercise of both express and implied corporate powers. However, it is submitted that it did not alter the position with respect to the logically anterior question of the scope of an implied power.31 26 For example, a power to give guarantees was expressed in Rolled Steel to be available ‘as may seem expedient’, which the Court of Appeal interpreted to mean expedient by reference to the company’s objects, thus implying the clause itself was merely an ancillary power: [1986] Ch 246 at 289, 310. 27 Introductions Ltd v National Provincial Bank Ltd [1970] Ch 199 at 210. This was accepted as correct by Slade LJ (with whom Lawton LJ agreed) in Rolled Steel: [1986] Ch 246 at 289. Semble that this is really no more than part of the process of construction of the memorandum. As was pointed out by Vinelott J in Rolled Steel Products (Holdings) Ltd v British Steel Corp [1982] Ch 478 at 497, a power to borrow is quite capable of being a substantive object if the company carries on business as a bank or financial company. 28 [1986] Ch 246 at 290, 303. 29 At 295, per Slade LJ, with whom Lawton LJ agreed. See also the holding to the same effect by Browne-Wilkinson LJ: at 306–7. 30 At 295. 31 See below, paras 7.68ff.

288 John Armour (c) Former Effects of Want of Capacity 7.18 An ultra vires transaction was wholly void at common law, and therefore incapable of ratification even by the unanimous assent of the shareholders in general meeting.32 It followed that executory agreements were not binding on the company,33 and a liquidator might refuse to accept a proof based on a debt incurred thereunder.34 Purported dispositions pursuant to an ultra vires contract did not pass good title,35 and could therefore found an action in conversion. Of course, title might subsequently be transferred by operation of law,36 in which case the company would be able to bring a personal claim for restitution against the recipient on the basis that they had been unjustly enriched at its expense.37 Alternative grounds of action were available on the basis that dispositions made pursuant to an ultra vires transaction constituted a breach of duty by the directors. As directors stand in a position akin to trustees of the company’s assets,38 ultra vires dispositions were treated as a misapplication. Thus a liquidator might assert a constructive trust over assets transferred pursuant to an ultra vires transaction in the hands of the counterparty, at least where the latter was unable to plead the defence of bona fide purchaser.39 (d) Statutory Abrogation 40 7.19 By restricting the objects which companies were able to pursue, the doctrine of ultra vires fettered the movement of capital from unprofitable concerns into new opportunities. Because incorporators were free to draft their own objects clauses, flexibility was provided through prolix wording which allowed for every imaginable line of business to be pursued. The residual role of ultra vires was described by Professor Gower as, ‘merely a nuisance to the company

32 Ashbury Railway Carriage and Iron Co Ltd v Riche (1875) LR 7 HL 653 at 672–73; Rolled Steel Products (Holdings) Ltd v British Steel Corpn [1986] Ch 246 at 296. 33 Ashbury Railway Carriage and Iron Co Ltd v Riche (1875) LR 7 HL 653; Bell Houses Ltd v City Wall Properties Ltd [1966] 2 QB 656. 34 Re Lee, Behrens & Co Ltd [1932] 1 Ch 46; Re Jon Beauforte [1953] Ch 131; Re W & M Roith Ltd [1967] 1 All ER 427. 35 Rolled Steel Products Ltd v British Steel Corporation [1986] Ch 246 at 304. 36 For example, through mixing of money in a bank account (see Westdeutsche Landesbank Girozentrale v Islington London Borough Council [1996] AC 669 at 702–3), or through the transformation of chattels into a new product (see Borden (UK) Ltd v Scottish Timber Products Ltd [1981] 1 Ch 25 at 41, 44). 37 Westdeutsche Landesbank Girozentrale v Islington London Borough Council [1996] AC 669. 38 Re Forest of Dean Coal Mining Co (1878) 10 Ch D 450 at 453; Re Lands Allotment Co [1894] 1 Ch 616 at 625, 631, 638. 39 Russell v Wakefield Waterworks Co (1875) LR 20 Eq 474 at 479; Re David Payne & Co Ltd [1904] 2 Ch 608; Introductions Ltd v National Provincial Bank Ltd [1970] Ch 199; see also Heinl v Jyske Bank (Gibraltar) Ltd [1999] Lloyds’ Rep Bank 511 at 520–21. 40 See generally, E Ferran, ‘The Reform of the Law on Corporate Capacity and Directors’ and Officers’ Authority’ (1992) 13 Company Lawyer 124, 177.

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 289 and a trap for unwary third parties’.41 Thus transactions which both parties had thought valid but which turned against the company could be challenged opportunistically by a liquidator,42 or even by the company itself.43 Matters were ameliorated by judicial retrenchment culminating in Rolled Steel, and a partially successful statutory abrogation under section 9(1) of the European Communities Act 1972. However, the doctrine was finally laid to rest with the Companies Act 1989, which introduced a new section 35 into the 1985 Act, subsection (1) of which provides that: The validity of an act done by a company shall not be called into question on the ground of lack of capacity by reason of anything in the company’s memorandum.

Thus it is no longer possible to challenge a corporate transaction on the basis that it exceeds the company’s objects clause.44 However, ultra vires dispositions will still be in excess of directors’ constitutional powers, and consequently a breach of directors’ duties. Hence it may be possible for the company to impose a constructive trust over misapplied assets in the hands of a counterparty who is unable to raise a defence of bona fide purchaser.45

(3) Related Grounds for Challenge 7.20 The near-abolition of the doctrine of ultra vires does not affect related grounds upon which purported transactions may be challenged. However, it does make it particularly important to understand the sphere of application of these doctrines. This is complicated by terminological confusion in the earlier authorities. It is not always easy to see whether a case is authority as to the application of the doctrine of corporate capacity, or some related ground which has been referred to as ‘ultra vires’. These grounds include: (1) Illegality: purported acts of the company which contravene prohibitions set out in the Companies Act 1985 or the general law, in particular the doctrine of capital maintenance.46 (2) Excess of power by corporate agents purporting to effect the transaction on the company’s behalf. The objects clause will place an outer bound on the 41 LCB Gower, Gower’s Principles of Modern Company Law, 5th edn (London, Sweet & Maxwell, 1992) at 168. See also DD Prentice, Reform of the ultra vires Rule (London, DTI, 1986). 42 Re Jon Beauforte [1953] Ch 131. 43 Bell Houses Ltd v City Wall Properties Ltd [1966] 2 QB 656. 44 Revised section 35(2) of the Companies Act 1985 grants members a personal right to restrain the doing of ultra vires acts, but once such an act has occurred—or the company has incurred a legal obligation to perform such an act—it will be too late. 45 S 35B will make it difficult to establish that the counterparty was on notice. See E Ferran, ‘The Reform of the Law on Corporate Capacity and Directors’ and Officers’ Authority: Part 2’ (1992) 13 Company Lawyer 177 at 179–81; RC Nolan, ‘Directors’ Self-Interested Dealings: Liabilities and Remedies’ [1999] 3 Company, Financial and Insolvency Law Review 235 at 238–39. 46 Discussed below, paras 7.21ff.

290 John Armour actual authority which may be delegated. This might in principle justify a company as treating a contract as not binding upon it, or a disposition as constituting a misapplication by directors. However, the position has been modified significantly by the Companies Act 1989, and such a challenge is subject to the possibility of ratification by the general meeting whilst the company is solvent.47 (3) Abuse of powers by directors: acting ex facie within their powers, but not bona fide in the interests of the company, or for some improper purpose. This may justify a finding that a contract or disposition is void in equity. Such a challenge is also subject to the possibility of ratification by the general meeting whilst the company is solvent.48 (4) Abuse of corporate powers by the general meeting. This will encompass purported transactions effected or ratified by the general meeting when the company is insolvent which are not bona fide in the interests of the company (pace creditors), and may justify a finding that they are void in equity.49 These issues will be considered at appropriate points in the following text.

C UNLAWFUL DISTRIBUTIONS AND CAPITAL MAINTENANCE

(1) The Principle of Maintenance of Capital (a) Common Law Principle 7.21 At common law, a company is prohibited from returning capital to its shareholders, whether directly or indirectly. ‘Capital’ in this sense refers not to actual assets, but to a notional yardstick against which they must be valued. The size of the yardstick is determined by the par value of the company’s outstanding shares plus any undistributable reserves.50 These represent the shareholders’ long-term investment in the company, which is a claim that is deferred until liquidation, and subordinated to the claims of creditors.51 Thus, if the book value of the company’s net assets falls below that of its share capital and undistributable reserves, the company is prohibited from transferring value to its shareholders. Such transfers may not be ratified by the shareholders, even if acting unanimously.52

47

Discussed below, paras 7.72ff. Discussed below, paras 7.67ff, esp. 9.83ff. Discussed below, paras 7.94ff. 50 Such as share premium account, capital redemption reserve, etc. 51 See Re Northern Engineering Ltd [1994] BCC 618 at 625. 52 Re Exchange Banking Co, Flitcroft’s Case (1882) 21 Ch D 518; Trevor v Whitworth (1887) 12 App Cas 409. 48 49

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 291 7.22 The doctrine was developed by the judiciary in the late nineteenth century.53 Noting that the predecessor provision of what is now section 135 of the Companies Act 1985 gave companies power to reduce their capital with the consent of the court, the judiciary of the day inferred that the legislature must have intended to deny companies this power under other circumstances.54 This restriction was quickly rationalised as a means of protecting creditors, for whom it was thought that the maintenance of the issued capital fund would provide a ‘buffer’ against the consequences of financial distress.55 The capital maintenance principle was soon extended to repurchases by a company of its own shares.56 Furthermore, transfers of assets to shareholders—whether directly or indirectly—at a time when the company was unable to pay dividends would also infringe the principle.57 (b) Unlawful Financial Assistance 7.23 In 1928, the statutory regulation of share capital was extended by the introduction of a prohibition on the giving by a company of financial assistance for the purchase of its shares.58 This can be understood as preventing a form of indirect return of capital, whereby the vendor shareholders are, in effect, paid out of the company’s assets. However, the prohibition on giving financial assistance is broader than the capital maintenance doctrine, as it is absolute in nature, rather than conditional on whether or not the payment was out of capital.59 It is therefore not considered in detail in this chapter and the reader is referred to standard reference works on company law.60 (c) Statutory Reinforcement 7.24 Since 1980, the common law capital maintenance principle has been largely subsumed by a range of statutory provisions which regulate the circumstances under which a company may make ‘distributions’ to shareholders, 53 See EA French, ‘The Evolution of the Dividend Law of England’ in WT Baxter and S Davidson, Studies in Accounting, 3rd edn (London, ICAEW, 1977), 306 at 307–9. 54 Re Ebbw Vale Steel, Iron & Coal Co (1877) 4 Ch D 327; Re National Funds Assurance Co (1878) 10 Ch D 118; Re Dronfield Silkstone Coal Co (1880) 17 Ch D 76; Re Exchange Banking Co, Flitcroft’s Case (1882) 21 Ch D 518. 55 See eg, Re Exchange Banking Co, Flitcroft’s Case (1882) 21 Ch D 518 at 533–34. See also Tongkah Compund NL v Meagher (1951) 83 CLR 489. 56 Trevor v Whitworth (1887) 12 App Cas 409. 57 Re George Newman & Co [1895] 1 Ch 674 at 686; Re Halt Garage (1964) Ltd [1982] 3 All ER 1016 at 1039. 58 Companies Act 1928 s 16. See now Companies Act 1985 ss 151–58. 59 Furthermore, transactions involving unlawful financial assistance do not necessarily involve any reduction of net assets by the company—eg financial assistance given by way of loan to a creditworthy borrower. 60 See, eg, MH Arden and DD Prentice (eds), Buckley on the Companies Act, 15th edn (London, Butterworths, 2000), paras [151]ff. See also E Ferran, Company Law and Corporate Finance (Oxford, OUP, 1999), Ch 11.

292 John Armour including dividends and repurchases of shares.61 These rules, now contained in Part VIII of the Companies Act 1985, have a strong family resemblance to the capital maintenance rule, in that the company’s ability to make distributions is conditional on the availability of distributable profits, which are calculated by reference to historic changes in the balance sheet. However, the new statutory provisions also create procedural pre-conditions to validity, most importantly that the availability of distributable profits must be demonstrated by reference to the ‘relevant accounts’. Non-compliance with these requirements will in itself invalidate a distribution,62 whereas under the common law rule, the onus lay on a liquidator seeking to challenge a payment to show that the company had no divisible profits. It is thus more straightforward to challenge a transaction as an unlawful distribution in contravention of Part VIII than an unlawful return of capital at common law. However, the sphere of application of the common law principle is arguably broader than that of Part VIII, and so it is still of relevance to a residual category of transactions.63

(2) Distinction From Doctrine of Corporate Capacity 7.25 The development of the doctrine of capital maintenance occurred alongside that of the ultra vires rule, the two each prohibiting different types of risk which by legislative decree, as interpreted by the courts, investors did not bear. In effect, these two principles could be understood as mandatory reinforcements of two basic terms of the bargain between a company and its investors:64 (1) that the company would not, after funds had been advanced, unilaterally increase the risks associated with these investments by investing its funds in unexpected lines of business (ultra vires);65 and (2) that the shareholders’ capital investment would be available to the company—thereby providing a cushion against loss to creditors—until such time as a winding-up or return of capital sanctioned by the court occurred (capital maintenance).66 7.26 This interrelationship is well-illustrated by the following passage from Lord Watson’s famous judgment in Trevor v Whitworth:67

61

Companies Act 1985, Part VIII. Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447. 63 The statutory scheme expressly preserves liabilities arising under any other rule of law: Companies Act 1985 s 281. 64 See E Ferran, Company Law and Corporate Finance (Oxford, OUP, 1999) at 355–63. 65 See above, paras 7.11–7.13. 66 EV Ferran, ‘Creditors’ Interests and “Core” Company Law’ (1999) 20 Company Lawyer 314 at 318; J Armour, ‘Share Capital and Creditor Protection: Efficient Rules for a Modern Company Law?’ (2000) 63 Modern Law Review 355 at 365–68. 67 (1887) 12 App Cas 409 at 423–24. 62

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 293 [P]ersons who deal with, and give credit to a limited company, naturally rely upon the fact that the company is trading with a certain amount of capital already paid . . . and they are entitled to assume that no part of the capital which has been paid into the coffers of the company has been subsequently paid out, except in the legitimate course of its business.

7.27 Following the statutory abrogation of the doctrine of ultra vires, the courts have had occasion to revisit the precise boundaries between its former restrictions and those still implied by the capital maintenance rule. However, the authorities are not especially clear on this point. Confusion is generated firstly by the judicial habit of referring to unlawful distributions as ‘ultra vires’,68 on the basis that a company has no power to do what is unlawful. Matters are confounded by the fact that, until 1989, it was unnecessary to distinguish clearly between the two grounds as a transaction which transgressed either would be void. It is therefore helpful at this stage to attempt to clarify the position. 7.28 The better view is that the maintenance of capital principle only ever restricted transactions between a company and its shareholders, or persons connected with them. It did not extend to a principle that the capital of the company might only be expended for purposes within its objects. Any statements to this effect in the authorities should be understood as referring to restrictions derived from, or thought at the time to be derived from, the doctrine of corporate capacity. 7.29 A contrary view was taken by Harman J in Barclays Bank plc v British & Commonwealth plc, in which he suggested that it was a ‘fundamental principle of company law’ that a company could not make a truly gratuitous disposition of its assets except out of distributable profits.69 His Lordship was speaking obiter,70 and the question was not considered by the Court of Appeal.71 With respect, the authorities cited by Harman J do not support this proposition.72 7.30 The first of these, Re George Newman & Co,73 was concerned with undisclosed self-dealing transactions and gifts made by the company to the same directors. None of the relevant transactions had been approved by the general meeting, and were thus open to challenge by the liquidator on the basis respectively that they infringed the equitable self-dealing rule or were in excess of the 68 See eg, Towers v African Tug Co [1904] 1 Ch 558 at 566; Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447 at 455; Aveling Barford Ltd v Perion Ltd (1989) 5 BCC 677 at 683; Barclays Bank plc v British & Commonwealth Holdings plc [1995] BCC 19 at 25; Franks v Midland Bank (unreported, 31 October 1995). 69 [1995] BCC 19 at 29. 70 The transaction in question was valid anyway following approval by the court under section 425 of the Companies Act 1985. 71 [1996] 1 WLR 1 at 19. 72 See A Yaqoob, ‘Two Fundamental Principles of Company Law? Barclays Bank v British & Commonwealth Holdings’ (1997) 18 Company Lawyer 14 at 17–19; E Ferran, Company Law and Corporate Finance (Oxford, OUP, 1999) at 363–66. 73 [1895] 1 Ch 674.

294 John Armour directors’ powers. However, Lindley LJ, giving the judgment of a very strong Court of Appeal,74 considered what the position would have been had the general meeting purported to ratify the payments:75 The shareholders, at a meeting duly convened for the purpose, can, if they think proper, remunerate directors for their trouble or make presents to them for their services out of assets properly divisible amongst the shareholders themselves. . . . But to make presents out of profits is one thing and to make them out of capital or out of money borrowed by the company is a very different matter. Such money cannot be lawfully divided amongst the shareholders themselves, nor can it be given away by them for nothing to their directors so as to bind the company. . .

7.31 Insofar as His Lordship was referring to payments made by the company to its shareholders, he clearly had in mind the doctrine of maintenance of capital. However, this does not fully explain the dictum, as it appears that of the directors concerned, one HG Wright was not a shareholder of the company.76 It is submitted that the gift to Wright would nevertheless not have been ratifiable as it would have been ultra vires. The company’s objects clause contained no express object or power to make gifts.77 Nor could an implied power to make gifts be found, except insofar as to do so was reasonably incidental to the carrying on of the company’s business, which under the circumstances it clearly was not. 7.32 Harman J also referred to a passage from Nourse LJ’s judgment in Brady v Brady, which espoused a principle that a ‘company is unable to give away its assets’.78 However, Nourse LJ was clearly referring to constraints imposed by the objects clause as opposed to the capital maintenance rule because he conceded that gratuitous dispositions would be permissible provided that the company’s memorandum expressly authorised them. 7.33 A third authority referred to by Harman J in the British & Commonwealth case was Ridge Securities v IRC, in particular the following dictum of Pennycuick J:79 A company can only lawfully deal with its assets in the furtherance of its objects. The corporators may take assets out of the company by way of dividend or, with the leave of the court, by way of reduction of capital, or in a winding up. They cannot take assets out of the company by voluntary disposition, however described, and if they attempt to do so the voluntary disposition is ultra vires the company.

7.34 Harman J suggested that Pennycuick J’s reference to ‘voluntary disposition’ encompassed transactions not only between shareholders and their 74 75 76 77 78 79

The other members were Lord Halsbury and AL Smith LJ. At 686. See the statement of facts at 677, 679. Ibid at 675–76. [1988] BCLC 20 at 38. [1964] 1 WLR 479 at 495.

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 295 company, but also between the company and third parties.80 With respect, this seems to put unnecessary strain upon the sense of the words. 7.35 However, Pennycuick J’s dictum does more than merely state the capital maintenance principle, as it appears to suggest an unconditional restriction on gratuitous payments to shareholders otherwise than by way of dividend, lawful reduction of capital etc. Indeed, it appears to have been cited with approval by Nourse LJ to this effect in Franks v Midland Bank plc.81 Yet it was never the case that all such distributions were restricted by the common law rule: only those out of capital.82 The breadth of Pennycuick J’s statement is rather explicable by reference to the doctrine of ultra vires.83 The company in Ridge Securities had no express power to make gifts, and hence, any transfer— whether to shareholders or others—which on its true construction amounted to a gift was ultra vires and void.

(3) Unlawful Distributions Contravening Part VIII of the Companies Act 1985 7.36 We now turn to consideration of the necessary requirements for a challenge to a transaction on the basis that it contravenes Part VIII of the Companies Act 1985. The centrepiece of the statutory scheme is section 263, which prohibits distributions except out of profits available for the purpose (‘distributable profits’).84 The concepts of ‘distribution’ and ‘distributable profits’ will be considered in turn. (a) Distribution 7.37 Section 263(2) states: In this Part, ‘distribution’ means every description of distribution of a company’s assets to its members, whether in cash or otherwise, except distribution by way of(a) an issue of shares as fully or partly paid bonus shares, (b) the redemption or purchase of any of the company’s own shares out of capital (including the proceeds of any fresh issue of shares) or out of unrealised profits in accordance with Chapter VII of Part V, (c) the reduction of share capital by extinguishing or reducing the liability of any of the members on any of the company’s shares in respect of share capital not paid up, or by paying off paid up share capital, and (d) a distribution of assets to members of the company on its winding-up. 80

[1995] BCC 19 at 30. Unreported, 31 October 1995 (CA). 82 Nor does Franks constitute authority for this proposition. Nourse LJ’s judgment was delivered extempore in the context of an application to strike out, and the comments referred to were obiter, as His Lordship did not accept that the plaintiff company had sufficient distributable profits at the relevant time. 83 This is clear from the same judge’s discussion of the Ridge Securities decision in Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] 1 Ch 62 at 73–74. 84 Companies Act 1985 s 263(1). 81

296 John Armour 7.38 Generally, a distribution will mean a transfer to a shareholder in his capacity as such without consideration given by the recipient.85 Where a transaction between a company and shareholder is explicitly intended to be a dividend or other gratuitous payment to a shareholder, then it will clearly be a ‘distribution’. More difficult is the position where the company enters into a transaction with a shareholder that is not ex facie gratuitous—for example, a sale or a contract for services. Provided that the transaction is not a sham,86 then in most cases it will not be characterised as a ‘distribution’ because it is not with the member in his capacity as such. A solvent company is permitted to exercise its powers in any way the shareholders think fit, and this may include business transactions with persons who are amongst their number, even if the transaction is at an undervalue. Yet in cases of extreme undervalue, courts may recharacterise transactions between companies and their shareholders as unlawful distributions.87 7.39 However, the concept of ‘distribution’ must be understood in the context not only of the opening clause of section 263(2), but also by reference to the specific savings in subsections (a)–(d). Thus any payment to a shareholder by virtue of redemption or repurchase of shares,88 a reduction of capital, or in the manner of a winding-up,89 otherwise than in accordance with the relevant statutory procedures is also prohibited. 7.40 Relationship with Common Law Principles. It is submitted that older authorities concerning whether or not a purportedly non-gratuitous transaction in reality constituted a disguised return of capital should be understood as relevant to the characterisation of similar transactions as a ‘distribution’ or otherwise. This proposition is sound both in principle and upon the authorities. As regards principle, the purposes of the statutory provisions in Part VIII are the same as the common law doctrine: the statutory code seeks only to simplify the enquiry as to whether or not the company in fact had profits available for distribution.90 As regards the authorities, Hoffmann J in Aveling Barford Ltd v Perion Ltd appeared to use the old language of ‘return of capital’ interchangeably with the statutory concept of a ‘distribution’ made at a time when the company had no ‘distributable reserves’.91 Aveling Barford was treated as a case on 85

Clydebank Football Club Ltd v Steedman (2002) SLT 109 at 124. On what constitutes a ‘sham’ transaction, see above para 2.64. Re Halt Garage (1964) Ltd [1982] 3 All ER 1016 at 1039–44; Aveling Barford Ltd v Perion Ltd (1989) 5 BCC 677 at 683; Redweaver Investments Ltd v Lawrence Field Ltd (1991) 9 ACLC 1032 at 1036–37; MacPherson v European Strategic Bureau Ltd [2000] 2 BCLC 683 at 701–4; Sasea Finance Ltd v KPMG [2002] BCC 574 at 584–85; Clydebank Football Club Ltd v Steedman (2002) SLT 109 at 124–25. See also RJ Calnan, ‘Corporate Gifts and Creditors’ Rights’ (1990) 11 Company Lawyer 91; NLJ Doran, ‘Transactions at an Undervalue and the Maintenance of Capital Principle’ (1991) 12 Company Lawyer 169. 88 Trevor v Whitworth (1887) 12 App Cas 409; Barclays Banks v British & Commonwealth Holdings plc [1995] BCC 19. 89 MacPherson v European Strategic Bureau Ltd [2000] 2 BCLC 683 at 702. 90 Bairstow v Queens Moat Houses plc [2000] 1 BCLC 549 at 564. See also Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447 at 455. 91 (1989) 5 BCC 677 at 683. 86 87

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 297 section 263 in a recent decision of the Outer House of the Court of Session in Clydebank Football Club v Steedman,92 and in MacPherson v European Strategic Bureau the Court of Appeal considered the recharacterisation of a transaction by reference to the statutory code.93 7.41 Transactions at a Gross Undervalue. The leading case of Re Halt Garage (1964) Ltd 94 concerned payments ostensibly made by way of remuneration to the company’s husband and wife directors, who were also its shareholders. Because of illness, the wife was unable to perform any active services for the company. Oliver J concluded that the payments made to her were:95 so out of proportion to any possible value attributable to her holding of office that the court is entitled to treat them as not being genuine payments of remuneration.

Rather, they were in substance gifts. Furthermore, since the company had no divisible profits, such gifts amounted to an unlawful return of capital to the wife qua shareholder. The test expounded by Oliver J did not depend on good faith, but rather upon the genuineness of the transaction,96 which did not depend on the label the parties chose to give it, and was, it seems, to be deduced objectively. The fact that the payments were ‘manifestly beyond any possible justifiable reward for that in respect of which allegedly it is paid’ was enough to demonstrate their lack of genuineness.97 Although the decision concerned the application of the common law maintenance of capital principle, it seems clear that the same approach will be applied in determining whether or not a transaction in reality constitutes a disguised distribution for the purposes of section 263 of the Companies Act 1985.98 7.42 The test of genuineness was applied by Hoffmann J in Aveling Barford Ltd v Perion Ltd 99 to recharacterise a sale of land by a company to a counterparty who was treated as equivalent to its shareholder. The sale was at a very significant undervalue (between 25 per cent and 50 per cent of market value) and although the company was solvent at the time of the transaction, it had no distributable profits. Hoffmann J concluded that, analysed objectively, the transaction was not a genuine sale, but rather a ‘dressed-up distribution’ which was unlawful in light of the company’s lack of distributable profits.100 92

(2002) SLT 109. [2000] 2 BCLC 683. It is true that in Barclays Bank v British & Commonwealth Holdings, Harman J considered the application of the common law principle to a transaction which involved an indirect return of capital. In so doing, he relied on Aveling Barford. However, it will be argued that this decision could equally well have been reached on the basis of the statutory principle: see below, para 7.48. 94 [1982] 3 All ER 1016. 95 At 1042. 96 At 1039–44. 97 At 1044. 98 See, in particular, Aveling Barford Ltd v Perion Ltd (1989) 5 BCC 677 at 682–83; MacPherson v European Strategic Bureau Ltd [2000] 2 BCLC 683 at 701–4; Clydebank Football Club Ltd v Steedman (2002) SLT 109 at 124–25. 99 (1989) 5 BCC 677. 100 At 683. 93

298 John Armour 7.43 The Court of Appeal in MacPherson v European Strategic Bureau101 adopted a similar approach. The Court struck down a scheme which essentially involved an informal liquidation of a closely-held company following a disagreement between the shareholder-directors. The scheme, which had been adopted by way of an agreement between all the shareholders and the company, provided for the company’s existing assets, including income which might subsequently be generated by existing contracts, to be used to pay most—but not all102—of its existing creditors, including the shareholder-directors in respect of considerable sums owed to them by way of remuneration for past services. It appears that these services had originally been offered gratuitously, and under the scheme the company promised to make payments to the shareholders in this respect in proportion to their shareholdings. In consideration, the departing shareholders inter alia undertook not to compete with the company. The company, which was found to have been plainly insolvent at the time the scheme was effected, was to remain in existence, and future creditors were to be paid solely out of income generated by future contracts. All three members of the Court held that the transaction contravened section 263 of the Companies Act 1985 and was therefore unlawful.103 7.44 Directly or Indirectly with Shareholders. A transaction may be characterised as a distribution even if the immediate counterparty is not itself a shareholder. Rather, the court’s jurisdiction to characterise the substance of what has transpired extends to the correct determination of whether or not the transaction, on its true construction, gives rise directly or indirectly to a distribution of a company’s assets ‘to its members’.104 Thus, in Aveling Barford,105 the immediate counterparty was a company controlled (via a Jersey trust) by the controlling shareholder of the transferor company. Hoffmann J was willing to ignore the corporate veil of the immediate counterparty for these purposes, noting that the transaction was with ‘an entity controlled and put forward by [the company’s] sole beneficial shareholder’.106 By analogy with the statutory definitions of ‘connected persons’, it seems likely that in the case of an individual shareholder, a transaction at a gross undervalue in favour of spouses or children could also be seen as a distribution.107 101

[2000] 2 BCLC 683. The agreement provided for the payment of ‘accrued liabilities’. This did not, however, include future or contingent liabilities which would be provable in a winding-up, such as future payments which would become due under a finance lease, which was not terminated by the scheme: ibid at 697–98. 103 At 701–4. For Buxton LJ, it was an unlawful distribution, and for Chadwick LJ, with whom Peter Gibson LJ agreed, an unlawful attempt to liquidate the company’s assets—implicitly permitted only by s 263(2)(d) in accordance with the scheme of the Insolvency Act 1986. 104 Companies Act 1985 s 263(1). 105 (1989) 5 BCC 677. 106 At 683. Cf Acatos & Hutcheson plc v Watson [1995] BCC 446. 107 An analogy may be drawn with the position in a claim for ‘knowing receipt’, in which case the courts are prepared to ‘look through’ companies which are merely a ‘creature’ to characterise a transfer to such a company as being beneficially received by a defendant who controls it: see Trustor 102

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 299 7.45 Distributions of Assets on a Winding-up. For the purposes of characterising a transaction by reference to section 263, a ‘distribution’ will include not only a disguised dividend, but also a disguised distribution by way of return of assets on winding-up. Chadwick LJ, with whom Peter Gibson LJ agreed, described the transaction in MacPherson’s Case as a distribution ‘as if on a winding-up’ which by virtue of section 263(2)(d) could only be achieved in a winding-up conducted in accordance with the provisions of the Insolvency Act 1986.108 7.46 Distributions of Assets in Conjunction with Repurchase of Shares. In conformity with the reasoning of the majority of the Court of Appeal in MacPherson’s Case, it appears that a scheme designed to provide for a payment directly or indirectly to shareholders in conjunction with a repurchase of shares, not being a payment which may lawfully be made in accordance with the provisions of Chapter VII of Part V of the Companies Act 1985, will also constitute an unlawful ‘distribution’. 7.47 Barclays Bank plc v British & Commonwealth Holdings plc109 concerned a complex scheme of arrangement designed to allow Caledonia, a substantial shareholder in British & Commonwealth (‘B&C’) to unwind its holding without deflating the company’s share price. Caledonia’s ordinary shares were exchanged for preference shares which were redeemable in four annual tranches. If B&C failed to repurchase any of the shares, Caledonia were to be entitled to sell them (a ‘put’ option) instead to Tindalk Ltd, a company created specifically for the purpose of guaranteeing their return.110 Tindalk was financed by a syndicate of banks in return for various covenants granted to the banks by B&C, including a promise to maintain its distributable reserves at a level sufficient to repurchase the preference shares. By the time the third tranche was redeemable, B&C was in administration proceedings. Caledonia exercised its put option to Tindalk. In turn, the banks claimed damages from B&C for breach of its financial covenants. As Harman J explained,111 The economic effect [was] that instead of the sum required to redeem the . . . preference shares being paid out of shareholders’ funds, and therefore ranking behind creditors, the AB v Smallbone [2001] 1 WLR 1177 at 1186. But cf Barclays Banks v British & Commonwealth Holdings plc [1995] BCC 19 at 31. 108 Matters were clouded somewhat by Chadwick LJ’s references to Re Lee, Behrens & Co and Ridge Securities (at 697, 701). It is submitted, however, that these passages of his judgment, which were clearly separated by a sub-heading from his discussion of s 263, referred instead to the principle that when the company is insolvent, the shareholders may not ratify a transaction otherwise than bona fide in the interests of the company: this is considered below at paras 7.106ff. 109 [1995] BCC 19. 110 This was necessary because, in accordance with the maintenance of capital principle, Companies Act 1985 s 178 excludes any entitlement to payment of damages by a company for failure to repurchase or redeem its shares, and debars a court from ordering specific performance if the company has insufficient distributable profits to cover the cost of repurchase. 111 [1995] BCC 19 at 22.

300 John Armour sum claimed by the six banks as damages (which is the same amount as has been paid to the former shareholder Caledonia) will rank as a creditors’ claim equally with other creditors.

7.48 Harman J considered, obiter,112 that the scheme fell foul of the common law maintenance of capital principle, because it required the company to make a payment, and the shareholders to receive a directly equivalent benefit, at a time when the company had no distributable profits. It is submitted, however, in keeping with the approach of the majority of the Court of Appeal in MacPherson’s Case, that this transaction could equally well have been impugned on the basis that it sought to provide a payment indirectly to shareholders in consideration for the redemption of their shares otherwise than in accordance with the saving in section 263(2)(c) of the Companies Act 1985. (b) Distributable Profits 7.49 A company has distributable profits if its accumulated realised profits are greater than its accumulated realised losses.113 In other words, losses must be made good—or written off by a reduction of capital—before distributions may be made. For public companies, an additional restriction applies, in that distributions may not be made if net assets are less than the sum of share capital and undistributable reserves.114 7.50 Relevant Accounts. Section 270(2) states that the availability of distributable profits must be demonstrated prior to any distribution by reference to the following items in the ‘relevant accounts’: (a) profits, losses assets and liabilities; (b) provisions of any of the kinds mentioned in paragraphs 88 and 89 of Schedule 4 of the Companies Act 1985 (depreciation, diminution in value of assets, retentions to meet liabilities, etc.), and (c) share capital and reserves (including undistributable reserves).

7.51 The ‘relevant accounts’ will ordinarily be those from the previous accounting reference period, but alternatively the company may prepare interim accounts which may be used for the purpose.115 In each case, the accounts must have been properly prepared in accordance with the requirements of the Act, or at least have been done so for all matters which are material to determining the matters listed 112 The transaction in question was valid anyway following approval by the court under s 425 of the Companies Act 1985. 113 Companies Act 1985 s 263(3). 114 Ibid s 264. Undistributable reserves are defined as (a) the share premium account; (b) the capital redemption reserve; (c) the amount by which accumulated unrealised profits exceed accumulated unrealised losses; (d) any other reserve which the company is prohibited from distributing by reason of any enactment or by its memorandum and articles. 115 Ibid s 270. This would be useful if, for example, the previous accounts show no distributable profits but the company has since made profits.

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 301 in section 270(2), provided also that a true and fair view is given of the company’s profits and loss and balance sheet.116 If the relevant accounts do not give a ‘true and fair view’, then this will invalidate any distributions based upon them.117 Any material information known to the directors which is not reflected in the accounts will mean that they do not give a ‘true and fair view’.118 In quantifying contingent liabilities, the best available estimate will suffice, even if it subsequently transpires that they are much greater than previously thought.119 Where the accounts in question are the last annual accounts or the initial accounts, they must be accompanied by the auditors’ report.120 If the auditors’ report contains a qualification, they must prepare a written statement as to whether in their opinion the matter in respect of which their report is qualified is material for determining whether distributions of a kind which include the proposed distribution would be permissible.121 Failure to comply with these requirements will mean that any distribution is illegal,122 even if, had they been complied with, the company would have been shown to have distributable profits.123 7.52 Realised Profits. The crucial concept of ‘realised profits’ is largely defined in the Companies Act 1985 by reference to generally accepted accounting principles.124 The phrase is a term of accounting art, the interpretation of which has given rise to difficulties.125 Broadly speaking, it allows profits or losses to be entered into a company’s accounts once they have been realised through a sale of the asset. The rule is motivated by prudential concerns, namely that profits should only be recognised once they have incontrovertibly been generated.126 In the context of the calculation of distributable profits, the Companies Act 1985 makes a number of modifications to the accounting-based definition of ‘realised profits’. First, section 269 provides for a different treatment of development 116

Ibid ss 271(2), 272(2)–(3), 273(2)–(3). Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447; Bairstow v Queens Moat Houses plc [2000] 1 BCLC 549. 118 Re Cleveland Trust plc [1991] BCLC 424. 119 Re BAT Industries plc (18 June 1999, unreported). 120 Companies Act 1985 ss 271(3), 273(4). 121 Ibid ss 271(4)–(5), 273(5). 122 Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447; Bairstow v Queens Moat Houses plc [2000] 1 BCLC 549; Allied Carpets Group plc v Nethercott (unreported, 28 January 2000) at 14–18. 123 Re Cleveland Trust plc [1991] BCLC 424 at 428–30. 124 Companies Act 1985 s 262(3). See Company Law Review Steering Group, Capital Maintenance: Other Issues (June 2000) at 16–18. 125 See ICAEW, ‘The Determination of Realised Profits and Disclosure of Distributable Profits in the Context of the Companies Acts 1948 to 1981’ (TR 481), (1982) 93 No 1070 Accountancy 122; R Lewis and D Pendrill, Advanced Financial Accounting, 5th edn (London, Pitman, 1996) at 66–69; ICAEW, ‘The Determination of Realised Profits and Distributable Profits in the Context of the Companies Act 1985’ TECH 25/00, August 2000. 126 There is, however, a widely-held view that the recognition of profits only upon realisation is no longer the most appropriate means of balancing the concerns of prudence and accuracy in accounting. See Company Law Review Steering Group, Capital Maintenance: Other Issues (June 2000) at 19–20. 117

302 John Armour costs. Secondly, section 275 provides for different treatment of some items in the relevant accounts, including treating certain provisions as realised losses, and treating revaluations as realised profits. Thirdly, section 276 provides that when a non-cash asset for which the entry in the accounts includes some portion reflecting an unrealised profit is transferred to a shareholder by way of distribution, then the distribution is treated as a ‘realisation’ of the asset for the purposes of determining the lawfulness of the distribution. (c) Intra-Group Transfers 7.53 It is common for assets to be transferred as part of a group restructuring at book, as opposed to market, value. This may raise difficult issues concerning the potential application of section 263 and the common law maintenance of capital principle.127 If the transfer is at a very significant undervalue, then a court might feel justified in characterising it not as a genuine sale, but rather as a disguised distribution. ‘Upstream’ transfers will of course be most vulnerable to this type of challenge, but transactions with parties connected with shareholders will also fall within the doctrine, and so it is potentially applicable to most intra-group transfers. 7.54 If such a transfer is to be characterised as a distribution in specie, then, provided that the company does not have a deficit on its profit and loss account, it is always possible to revalue the asset and then prepare interim accounts on this basis. The company may then treat the distribution as realising a profit equivalent to the difference between the market and book value of the asset.128 An alternative view argues that the characterisation of such a transaction as a distribution would be unjustified provided the transfer is at book value, because it is then balance sheet neutral. Section 270(2) refers to the justification of any proposed distribution by reference to the relevant accounts, and hence amounts which are not recorded therein should be disregarded. Where the company has distributable profits, then the second view has the merit of avoiding the necessity of incurring the expense of revaluation and the production of interim accounts. However, this view does not provide an adequate means of distinguishing the case where the company has a deficit on its profit and loss account: if the transaction is balance sheet neutral, why should it ever be characterised as a distribution?129

127 E Ferran, Company Law and Corporate Finance (Oxford, OUP, 1999) at 426–29; Company Law Review Steering Group, Capital Maintenance: Other Issues (June 2000) at 9–10. 128 Companies Act 1985 s 276. 129 An associated position, that Aveling Barford was concerned not with s 263 but solely with the common law doctrine of capital maintenance, no longer seems tenable in the light of MacPherson v European Strategic Bureau [2000] 2 BCLC 683 and Clydebank Football Club v Steedman (2002) SLT 109.

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 303 (4) Unlawful Returns of Capital at Common Law 7.55 The operation of the common law principle of maintenance of capital has been expressly preserved by section 281 of the Companies Act 1985. The common law principle has for most purposes been superseded by the statutory prohibition on distributions otherwise than out of profits available for the purpose. The reasons for this are as follows. First, it is submitted that the authorities which concern the characterisation of a transaction with a shareholder as a return of capital are equally applicable to the question whether the transaction constitutes a ‘distribution’ within section 263 of the Companies Act 1985. Secondly, for the purposes of section 263, a company will be irrebuttably presumed not to have had distributable profits at the time of the transaction if there has been less than complete compliance with the procedural requirements for their establishment under Part VIII, whereas, for a successful challenge at common law, it is necessary to adduce evidence to demonstrate that the payment was out of capital. However, there will be a residual set of circumstances in which the maintenance of capital rule may still be important. The rule’s application depends on the company’s financial situation at the time of the transaction, whereas the propriety of a distribution is for the purposes of Part VIII to be assessed by reference to the relevant accounts. Where post-balance sheet events have significantly altered the company’s finances, then a transaction may fall foul of the common law rule but not section 263.130 7.56 Direct or Indirect Transfer of Value to Shareholders. The approach to characterisation of transactions under the common law rule employs the same principles as in the context of section 263. These principles are discussed above.131 7.57 Out of Capital. It is generally thought that the common law restriction is conditional on the company’s not having profits available for the purposes of dividends.132 Before 1980, a complex and perhaps irreconcilable body of caselaw governed the circumstances under which dividends might be paid at common law. These principles were also relevant to determining whether or not a payment to a shareholder that was on its true characterisation gratuitous was made out of capital. It would seem that the condition for application of the common law rule should be that the company’s net assets133 are less than those reserves from which distribution is prohibited: namely its share capital and 130 MH Arden and DD Prentice (eds), Buckley on the Companies Acts, 15th edn (London, Butterworths, 2000) at para [281.4]. 131 Paras 7.40ff. 132 Re George Newman & Co [1895] 1 Ch 674 at 686; Re Halt Garage (1964) Ltd [1982] 3 All ER 1016 at 1044. MH Arden and DD Prentice (eds), Buckley on the Companies Act (2000), para [281.4]; Company Law Review Steering Group, Capital Maintenance: Other Issues (June 2000) at 10. Cf Franks v Midland Bank plc (unreported, 31 October 1995), discussed above at para 7.35. 133 See Hilton International Ltd v Hilton (1988) 4 NZCLC 64,721 at 64,750.

304 John Armour undistributable reserves. In contrast to section 263, the common law rule will therefore apply to the actualities of the company’s position, rather than simply to the most recent version of the relevant accounts. Thus, even if a dividend is valid in accordance with the relevant accounts, post-balance sheet events may be taken into account for the purposes of applying the common law rules.

(5) Remedial Consequences of Unlawful Distributions 7.58 Any executory contract associated with a disguised distribution will be void. Legal title to the company’s assets may nevertheless pass to the (shareholder) counterparty, in particular where funds are mixed in a bank account. An unlawful distribution will constitute a breach of duty by the directors, but only if they were negligent in authorising or recommending it. In such a case the office-holder may seek equitable compensation. Notwithstanding that directors only face personal liability in this context if they were negligent, every unlawful distribution constitutes a misapplication of corporate assets and may consequently give rise to equitable claims against the counterparty shareholder. Finally, the office-holder may seek to rely on section 277 of the Companies Act 1985. (a) Recovery from Directors 7.59 The declaration and/or recommendation of unlawful distributions may constitute a breach of the directors’ duty to obey the terms of the company’s constitution.134 A director who misapplies or who authorises a misapplication of corporate assets will, by analogy with the position of a trustee, usually be liable to account to the company or the misapplied funds.135 This liability will usually be strict. However, the case of payments made by way of distribution is an exception to this rule, whereby directors will only be held liable if they are shown to have been at least negligent in forming the view, on the basis of the relevant accounts, that distributions may lawfully be paid.136 As Nelson J explained in Bairstow v Queens Moat Houses plc,137 [A] director who authorises the payment of an unlawful dividend in breach of his duty as a quasi trustee, will be liable to repay such dividends: 134 Re Exchange Banking Co, Flitcroft’s Case (1882) 21 Ch D 519; Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447 at 458; Bairstow v Queens Moat Houses [2000] 1 BCLC 549 at 557–60, aff’d [2001] EWCA Civ 712 [2001] 2 BCLC 531. On the characterisation of the duty, see Company Law Review Steering Group, Final Report, Vol I (June 2001) at 345, 350. 135 Re Sharpe [1892] 1 Ch 154 at 165; Selangor United Rubber Estates Ltd v Cradock (No 3) [1968] 1 WLR 1555 at 1575; Bairstow v Queens Moat Houses plc [2001] EWCA Civ 712 at [50], [2001] 2 BCLC 531 at 548. 136 Re Kingston Cotton Mill Co (No 2) [1895] 1 Ch 331 at 347–48; Bairstow v Queens Moat Houses plc [2000] 1 BCLC 549 at 557–60. 137 [2000] 1 BCLC 549 at 559–60 (citations omitted).

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 305 (1) if he knows that the dividends were unlawful, whether or not that actual knowledge amounts to fraud, or (2) if he knows the facts that established the impropriety of the payments, even though he was unaware that such impropriety rendered the payment unlawful; (3) if he must be taken in all the circumstances to know all the facts which render the payments unlawful; (4) if he ought to have known, as a reasonably competent and diligent director, that the payments were unlawful.

7.60 In determining whether or not a director has been negligent in declaring or recommending unlawful dividends, the following considerations are relevant. A reasonably diligent director should be aware of the fundamental rule that dividends should not be paid out of capital, and should be aware of sections 263 to 264 of the Companies Act 1985 when signing off accounts in accordance with his statutory duty. Hence reasonably competent directors ought to be aware that a dividend paid under circumstances where the accounts show on their face that the company has insufficient funds to pay dividends will contravene the relevant provisions.138 Furthermore, a reasonably diligent director ought to be aware of section 271 and its requirement that the accounts by reference to which a dividend is justified as being out of distributable profits must give a true and fair view of the company’s financial position. Authorising the payment of dividends in circumstances where the directors know that the relevant accounts do not give a true and fair view will therefore amount to a breach of directors’ duty to obey the company’s constitution.139 7.61 The directors’ liability to account for unlawful dividends which they have approved is not dependent upon causation: it is sufficient simply that the dividend was paid under circumstances in which the directors were at fault in authorising it.140 It is open to directors who face prima facie liability to argue that their actions were in fact honest, reasonable and in all fairness ought to be excused by the court, in accordance with section 727 of the Companies Act 1985.141 Directors against whom recovery is ordered will be able to recover contribution from shareholder recipients of unlawful distributions.142 In so doing, they are in effect subrogated to the rights which the company would enjoy against shareholders.

138

Ibid at 568. Ibid at 568–69. 140 Bairstow v Queens Moat Houses plc [2001] EWCA Civ 712 at [49]–[54], [2001] 2 BCLC 531 at 548–49. The decision of the House of Lords in Target Holdings v Redferns [1996] AC 421 is distinguishable as a case where the breach of fiduciary duty in question concerned simply ‘an aspect of a wider commercial transaction involving agency’: Bairstow at [53], 548–49. 141 At [61]–[66], 551–53. 142 Chillingworth v Chambers [1896] 1 Ch 685; Moxham v Grant [1900] 1 QB 88; Bairstow v Queens Moat Houses plc [2001] EWCA Civ 712 at [47], [2001] 2 BCLC 531 at 547. 139

306 John Armour (b) Recovery from Shareholders 7.62 Constructive Trust. Company directors have long been treated in equity as being in a position akin to trustees.143 The ‘trustee analogy’ is sufficiently strong for improper dispositions of the company’s property to be treated in a similar fashion to misapplications of trust property. Of course, unlike the beneficiary of a trust, the company has legal title to its assets. The trustee analogy means that a constructive trust is created upon misapplication of corporate assets, in order to ensure that the recipient of such assets is treated the same as a recipient of misapplied trust assets.144 Thus it has been held in a number of cases that a recipient of misapplied corporate assets who, at the time of receipt, has notice of the circumstances giving rise to the misapplication, or who is a volunteer, will hold the assets on constructive trust for the company.145 If the company can demonstrate that the defendant shareholder(s) retain the traceable product of the assets transferred by way of unlawful distribution, then it will be able to assert a proprietary claim by way of constructive trust. 7.63 The company may alternatively be able to assert a personal equitable claim for ‘knowing receipt’. This requires that the defendant have beneficially received assets which have been transferred in breach of trust or fiduciary duty. According to the orthodox position, the defendant must also have possessed some degree of knowledge about the circumstances which made the transfer a misapplication. The precise standard of knowledge required has been a matter of contention.146 However, it seems clear, at least on the current state of the authorities, that at the very least the defendant must be shown to have had ‘constructive notice’ of the circumstances which amount to the misapplication.147 143 Russell v Wakefield Waterworks Co (1875) LR 20 Eq 474 at 479; Re Lands Allotment Co [1894] 1 Ch 616 at 631, 638; Belmont Finance Corp v Williams Furniture Ltd (No 2) [1980] 1 All ER 393 at 405. See generally LS Sealy, ‘The Director As Trustee’ [1967] Cambridge Law Journal 83. 144 See Heinl v Jyske Bank (Gibraltar) Ltd [1999] Lloyds’ Rep Bank 511 at 520–21. See also RC Nolan, ‘Directors’ Self-Interested Dealings: Liabilities and Remedies’ [1999] 3 Company, Financial and Insolvency Law Review 235 at 238; P Birks and C Mitchell, ‘Unjust Enrichment’ in P Birks (ed), English Private Law, Vol II (Oxford, Oxford University Press, 2000), 525 at 598. 145 Russell v Wakefield Waterworks Co (1875) LR 20 Eq 474 at 479; Belmont Finance Corp v Williams Furniture Ltd (No 2) [1980] 1 All ER 393 at 405; Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447 at 457–58; Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1986] Ch 246 at 297–98; Allied Carpets Group plc v Nethercott (unreported, 28 January 2000) at 14. Their duty as constructive trustee will be to restore the company’s assets: ibid at 18. 146 The most recent statement of the law is that of the Court of Appeal in BCCI v Akindele [2001] Ch 437, in which Nourse LJ held that the relevant standard of knowledge was one of ‘unconscionability’: was the defendant’s state of knowledge of the relevant breach of duty sufficient to make it unconscientious for them to receive the funds? With respect, this somewhat ambiguous enunciation does not resolve the ongoing controversies. 147 Twinsectra Ltd v Yardley [2002] UKHL 12 at [105], [2002] 2 AC 164 at 194. See also Belmont Finance Corp Ltd v Williams Furniture Ltd [1980] 1 All ER 393 at 405; International Sales and Agencies v Marcus [1982] 3 All ER 551 at 558; Westpac Banking Corp v Savin [1985] 2 NZLR 41 at 52–53; El Ajou v Dollar Land holdings plc [1993] 3 All ER 717 at 739, aff’d [1994] 2 All ER 685; Macmillan Inc v Bishopsgate Investment Trust plc (No 3) [1995] 1 WLR 978 at 1000–1. Cf Re Montagu’s Settlement Trusts [1987] Ch 264 at 285; Cowan de Groot Properties Ltd v Eagle Trust plc [1992] 4 All ER 700 at 760.

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 307 ‘Notice’ should not be understood in the strict conveyancing sense. Rather, it is a contextualised test: the defendant will be ‘fixed with constructive notice’ where it is shown that, by making such enquiries as an ordinary and reasonable person might have made in respect of that type of transaction, he would have been aware that the transaction constituted a misapplication of corporate funds.148 In these circumstances the defendant will be personally liable to repay the amount received. 7.64 Claims Against ‘Innocent’ Shareholders? It has been suggested in Halsbury that no claim could be made against ‘innocent’ shareholders—namely, those without any notice of the circumstances making the payment unlawful—for the recovery of unlawful distributions.149 However, the basis of this statement upon the authorities is open to question,150 and the better view is that as a matter of principle, such a claim might well succeed. If, as has been suggested, a constructive trust arises as a response to the misapplication of corporate assets, the company’s beneficial interest should be equally capable of assertion against an innocent volunteer as against a party with notice, provided that the assets transferred or their traceable proceeds are still in the hands of the defendant. Shareholders will receive unlawful distributions as volunteers: dividends are in law voluntary,151 and the illegality of a transaction constituting a ‘disguised’ distribution will mean that it is treated as gratuitous.152 Hence claims should, in theory, be capable of being made against ‘outside’ shareholder recipients. However, in practice, evidential difficulties are likely to render such claims impractically costly to mount. 7.65 Statutory Remedy. Section 277 of the Companies Act 1985 renders a member who receives a distribution made wholly or partially in contravention of the provisions of Part VIII liable to repay to the company a sum equal to so much of the distribution as was unlawful, provided that at the time of receipt the member knew, or had reasonable grounds for believing, that the distribution was unlawful. Subsection 277(2) provides that this remedy is without prejudice to any other obligation which might be imposed upon a member in respect of an unlawful dividend. The precise content of the ‘knowledge’ required by section 277 has yet to be decided by a court. In Precision Dippings Ltd v Precision Dippings Marketing Ltd,153 the recipient shareholder had knowledge of the 148 This formulation has been expressed most clearly by Lord Millett: see El Ajou v Dollar Land holdings plc [1993] 3 All ER 717 at 739, aff’d [1994] 2 All ER 685; Macmillan Inc v Bishopsgate Investment Trust plc (No 3) [1995] 1 WLR 978 at 1000–1. See RC Nolan, ‘How Knowing is Knowing Receipt?’ [2000] Cambridge Law Journal 447. 149 Lord Hailsham of St Marylebone (ed), Halsbury’s Laws of England, 4th edn (London, Butterworths, 1996 reprint), Vol 7(1), para [722]. 150 See Segenhoe Ltd v Akins (1990) 1 ACSR 691 at 707 per Giles J: ‘It can be seen that the support for the position stated in Halsbury is far from overwhelming. Some of the cases give but passing attention to the matter . . . and there is a paucity of, and confusion in, reference to the principle upon which the shareholders’ liability might rest’. 151 Associated British Engingeering Ltd v IRC [1941] 1 KB 15; Wigan Coal and Iron Co Ltd v IRC [1945] 1 All ER 392; Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447 at 457–58. 152 See Lipkin Gorman v Karpnale Ltd [1991] AC 548 at 562, 575–77. 153 [1986] Ch 447.

308 John Armour facts which made the distribution unlawful—namely, that there had been no statement from the company’s auditors as to the materiality of a qualification to the ‘relevant accounts’ for the distribution in question—but did not know of the legal requirement for such a statement, nor that its non-existence would make the distribution unlawful. The Court of Appeal declined to decide whether this would constitute sufficient knowledge for the purposes of section 277, choosing instead to find the defendant liable as a constructive trustee.154 7.66 Destination of Recoveries. Claims brought by a liquidator based on the payment of unlawful distributions are an asset of the company at the time of commencement of winding-up. Recoveries will therefore go to swell the assets available to the holder of a floating charge.

D UNCOMMERCIAL TRANSACTIONS AMOUNTING TO AN ABUSE OF CORPORATE POWER

(1) Introduction 7.67 An abuse of power involves no excess of capacity or authority: rather, the claim is that the relevant decision-maker, in effecting a corporate transaction, did so otherwise than bona fide in the interests of the company, or for some collateral purpose. This doctrine is of general application to the exercise of directors’ powers. Where the company is solvent, however, an abuse of power by the directors may ordinarily be ratified by the general meeting, at least if acting unanimously.155 Where the company becomes insolvent, then its creditors become prospectively entitled to its assets. As a consequence, the ‘interests of the company’ become those of creditors. Clearly this affects the manner in which directors’ powers must be exercised. However, it will be argued that the effect is general: the powers of an insolvent company may only be exercised bona fide in the interests of creditors, and thus even a unanimous general meeting is disabled from doing otherwise.

(2) Abuse of Power Distinguished from Related Grounds for Transaction Avoidance (a) Ultra Vires 7.68 A transaction which exceeded a company’s capacity was, prior to the statutory reforms, wholly void and incapable of conferring rights upon any

154

[1986] Ch at 457. Where the general meeting does not act unanimously, then there are of course limitations on the power of the majority to bind a dissentient minority. 155

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 309 counterparty. A transaction effected in abuse of power may nevertheless bind the company as against a counterparty who was a bona fide purchaser without notice of the circumstances giving rise to the abuse. 7.69 Formerly there was much confusion between the circumstances under which a corporate transaction would be said to be in excess of its capacity, and those under which it might be challenged as an abuse of power by the relevant decision-maker.156 Many of the difficulties may be traced to the decision of Eve J in Re Lee, Behrens & Co Ltd.157 The case concerned an annuity purportedly granted by the board of directors to the widow of the company’s former managing director. When the company subsequently went into insolvent liquidation, the liquidator rejected the widow’s proof on the basis, inter alia, that the grant of the annuity was ‘ultra vires and void’.158 Eve J, in an oft-quoted passage, set out the conditions which he considered to be necessary for the valid exercise of corporate powers:159 [W]hether they be made under an express or implied power, all such grants involve an expenditure of the company’s money, and that money can only be spent for purposes reasonably incidental to the carrying on of the company’s business, and the validity of such grants is to be tested, as is shown in all the authorities, by the answer to three pertinent questions: (i.) Is the transaction reasonably incidental to the carrying on of the company’s business? (ii.) Is it a bona fide transaction? and (iii.) Is it done for the benefit and to promote the prosperity of the company?

There was little evidence available about the grounds on which the annuity had been granted, but Eve J inferred that it had been done to benefit the applicant rather than the company, and that the liquidator’s rejection of the proof was therefore good. 7.70 Eve J’s threefold test in Re Lee, Behrens & Co was applied in several subsequent cases in which transactions were struck down as ‘ultra vires’.160 Were this the true scope of the doctrine of ultra vires, the consequences for persons dealing with companies could be harsh. They might have no way of knowing that a seemingly ordinary transaction was in fact conducted otherwise than bona fide for the benefit of the company. 7.71 The Lee, Behrens formula was, however, revealed as a heresy by later authorities, which clarified the following propositions. First, none of the three tests were relevant to corporate capacity where what was being considered was 156

See C Baxter, ‘Ultra Vires and Agency Entwined’ [1970] 28 Cambridge Law Journal 280. [1932] 2 Ch 46. The other grounds were (ii) that the annuity was voidable for want of authorisation by the general meeting; (iii) that it was an unlawful return of capital (ibid at 50). 159 Ibid at 51. 160 See, eg, Parke v Daily News Ltd [1962] Ch 927; Ridge Securities Ltd v IRC [1964] 1 All ER 275; Re WM Roith Ltd [1967] 1 All ER 427. 157 158

310 John Armour the exercise of an express corporate power.161 Secondly, a provision in the memorandum (whether express or implied) that an express corporate power was exercisable only for the purposes of the company’s business created a restriction on the actual authority which had been delegated to the board of directors.162 Thirdly, the second and third limbs of Eve J’s test were instead relevant to the question of whether directors had abused their powers.163 Fourthly, it appears that the first of Eve J’s tests, which was soundly based in earlier authorities,164 still remained relevant to the determination of the scope of an implied corporate power, as opposed to the logically subsequent question of whether or not the manner of its exercise was within the company’s capacity.165 (b) Lack of Authority 7.72 A company, being an artificial person can never ‘act’ but through the attributable actions of its agents and officers.166 The primary rules by which such actions are attributed to the company are through the delegation of powers to various corporate organs and agents. Where such agents purport to act on behalf of the company in a way that exceeds the power that has been delegated to them, then the ‘acts’ will not be binding on the company unless the counterparty can rely on some other rule of law to validate them, such as the doctrine of apparent authority or the statutory protection afforded by sections 35A–35B of the Companies Act 1985. This should be distinguished from the claim that the relevant organ, acting within their constitutional powers, has abused their powers.167 7.73 Determination of Actual Authority. In companies which adopt article 70 of Table A, ‘the business of the company shall be managed by the directors who may exercise all the powers of the company’. This is subject to specific savings which allocate certain powers to the general meeting,168 and to ‘directions’ 161 Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] Ch 62 at 71; Re Halt Garage (1964) Ltd [1982] 3 All ER 1016 at 1030; Re Horsley & Weight Ltd [1982] Ch 442 at 452; Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1986] Ch 246 at 288, 304–5. 162 Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1986] Ch 246 at 295. 163 Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] Ch 62 at 71; Re Halt Garage (1964) Ltd [1982] 3 All ER 1016 at 1029–33; Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1986] Ch 246 at 288, 304. 164 Hampson v Price’s Patent Candle Co (1876) 45 LJ (Ch) 437; Hutton v West Cork Railway Co (1883) 23 Ch D 654 at 666, 675–77; Henderson v Bank of Australasia (1888) 40 Ch D 170 at 175. 165 Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] Ch 62 at 71; Re Halt Garage (1964) Ltd [1982] 3 All ER 1016 at 1032; Re Horsley & Weight Ltd [1982] Ch 442 at 448–50. Rolled Steel does not contradict this proposition, despite dicta of Slade LJ seemingly to the contrary ([1986] Ch 246 at 288), as the point was not in issue: see ibid at 287. 166 Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 2 AC 500 at 506–7. 167 RC Nolan, ‘The Proper Purpose Doctrine and Company Directors’ in BAK Rider (ed), The Realm of Company Law (London, Kluwer, 1998), 1 at 3–7. 168 These include the decisions to: alter the articles or memorandum (where possible) (Companies Act 1985 ss 4, 9, 121); alter status from public to private and vice versa (ss 43, 53); allot shares (s 80); sanction a return of capital (s 135); remove directors (s 303); and to wind up a company (Insolvency Act 1986 s 84). They commonly also include the power to declare a dividend in accordance with the recommendation of directors (eg Table A Art 102).

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 311 which may be issued by special resolution of the general meeting. The ‘delegation’ is exclusive of the general meeting, who are thereby denied authority to exercise the company’s powers.169 The shareholders in general meeting do, however, have a residual jurisdiction to ratify transactions effected in excess or abuse of powers delegated to directors. The board’s jurisdiction is derived solely from the articles, and is therefore subject to change. This may be achieved either by a special resolution or by informal unanimous consent of the general meeting.170 In either case, the general meeting may thereby extend their power to make decisions on behalf of the company. 7.74 Apparent Authority. Where the board or an individual director has exceeded its actual authority, the counterparty may nevertheless be able to rely on the agency doctrine of apparent authority.171 This will require evidence of a representation that the agent has authority to effect the transaction, by a superior corporate agent or organ with actual authority to convey such a representation.172 Such authority will usually, but not necessarily always, reside in an agent who has actual authority to enter the transaction in question.173 The representation may be express or implied, in words or by conduct. The most usual circumstance will be an implied representation by conduct made by the board in appointing a director to a particular executive position that he has the usual authority associated with such office. The transaction must be within the scope of the representation (viz, the usual authority of an executive in such a position), and the counterparty must have relied upon the representation in entering into the transaction. Hence a party with actual or constructive notice that the agent lacks actual authority will be unable so to rely. 7.75 Indoor Management Rule. This rule, set out in Turquand’s Case,174 is a presumption of regularity which entitles counterparties dealing with the company in good faith to assume that matters of internal procedure which form preconditions to the valid exercise of corporate power have been complied with. It is best understood as an aspect of the application to corporate entities of the doctrine of apparent authority.175 The rule will not assist a person with actual 169

Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame [1906] 2 Ch 34. Re Duomatic Ltd [1969] 2 Ch 365; Atlas Wright (Europe) Ltd v Wright [1999] 2 BCLC 301. 171 Freeman & Lockyer v Buckhurt Park Properties (Mangal) Ltd [1964] 1 QB 480. 172 It is possible that merely apparent authority to make the representation will suffice: see British Bank of the Middle East v Sun Life Assurance of Canada Ltd [1983] 2 Lloyd’s Rep 9 at 16. Cf CrabtreeVickers Pty Ltd v Australian Direct Mail Advertising & Addressing Co Pty Ltd (1975) 133 CLR 72. 173 Freeman & Lockyer v Buckhurt Park Properties (Mangal) Ltd [1964] 1 QB 480 at 503–6; First Energy (UK) v Hungarian International Bank [1993] BCC 533. Cf Crabtree-Vickers Pty Ltd v Australian Direct Mail Advertising & Addressing Co Pty Ltd (1975) 133 CLR 72. 174 Royal British Bank v Turquand (1856) 6 E&B 327, 119 ER 886. 175 Nock persuasively argues that this is the combined effect of the decisions of the Court of Appeal in Houghton v Northard, Lowe & Wills Ltd [1927] 1 KB 246 and Kreditbank CasselGmbH v Schenkers Ltd [1927] 1 KB 826, when read in conjunction with the principles enunciated in Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480: RS Nock, ‘The Irrelevance of the Indoor Management Rule’ [1966] Conv 123, 163. See also Northside Developments Pty Ltd v Registrar-General (1990) 170 CLR 146. 170

312 John Armour notice that relevant procedures have not been complied with—for example, if they have seen copies of board minutes or their representative participated at the relevant meeting.176 Nor may it be relied upon by a person who has been fixed with constructive notice of the irregularity. This will occur where, for example, he is himself a director also involved in the company’s decision to enter the transaction—in which case, he should be aware of procedural defects in the decision-making process.177 Even if he has no special pre-existing relationship with the company, he may be fixed with constructive notice where the circumstances of the transaction as so unusual or suspicious as to put him ‘on enquiry’, and he has failed to take steps to satisfy himself that proper procedures have been followed.178 For example, an guarantee granted to secure a third party’s debt with no apparent benefit to the guarantor company may be sufficient to put a counterparty on notice,179 and under such circumstances it would be welladvised to seek copies of the relevant board minutes to ensure that the meeting was properly quorate and all relevant disclosures were made. 7.76 Statutory Protection. The 1989 reforms also introduced statutory protection for counterparties dealing in good faith with the board of directors.180 Section 35A(1) of the Companies Act 1985 now provides that: In favour of a person dealing with the company in good faith, the power of the board of directors to bind the company, or authorise others to do so, shall be deemed to be free of any limitation under the company’s constitution.

7.77 Furthermore, section 35B provides that a counterparty to a corporate transaction is not bound to enquire as to whether it is permitted by the company’s memorandum or as to any limitation on the powers of the board of directors to bind the company or authorise others to do so. A person ‘deals with’ a company if he is a party to any transaction or act to which the company is party.181 Counterparties will be presumed to be in good faith unless the contrary is shown,182 and bad faith will not be demonstrated merely by their knowledge that

176 Transvaal Lands Co v New Belgium (Transvaal) Land & Development Co [1914] 2 Ch 488; Rolled Steel Ltd v British Steel Corporation [1986] Ch 246 at 283–84. 177 Howard v Patent Ivory Manufacturing Co (1888) 38 Ch D 156; Morris v Kanssen [1946] AC 459. It seems, however, that the counterparty will not be fixed with constructive notice merely by virtue of his being a director, if he is not involved in the relevant decision-making process on behalf of the company—eg it has been delegated to a committee on which he does not sit (Hely-Hutchinson v Brayhead Ltd [1968] 1 QB 549 at 564–68). 178 L Underwood Ltd v Bank of Liverpool [1924] 1 KB 775; B Ligget (Liverpool) Ltd v Barclays Bank Ltd [1928] 1 KB 48; Morris v Kanssen [1946] AC 459 at 475; Northside Developments Pty Ltd v Registrar-General (1990) 170 CLR 146. 179 Northside, ibid at 165–66, 182–83. 180 See generally, E Ferran, ‘The Reform of the Law on Corporate Capacity and Directors’ and Officers’ Authority’ (1992) 13 Company Lawyer 124, 177. 181 Companies Act 1985 s 35A(2)(a). 182 Companies Act 1985 s 35A(2)(c).

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 313 the transaction exceeds the directors’ powers under the constitution.183 Thus a duly constituted board’s power to bind the company will often in practice be unlimited. 7.78 There are two important limitations to this protection. Firstly, it does not extend to counterparties who themselves are, or are connected with, directors.184 Secondly, the protection afforded by section 35A is against invalidity derived from limitations on the board’s powers, and as such is predicated upon an actual or apparent exercise of power by the board.185 This point was explicated in the recent case of Smith v Henniker-Major & Co,186 in which the question arose as to whether section 35A acted to validate a purported resolution of an inquorate board. All three members of the Court of Appeal considered that it was capable of doing so. As Carnwath LJ put the matter,187 The general policy seems to be that, if a document is put forward as a decision of the Board by someone appearing to act on behalf of the company, in circumstances where there is no reason to doubt its authenticity, a person dealing with the company in good faith should be able to take it at face value . . . In principle, where the person in question is a third party in the ordinary sense, a wide interpretation is wholly appropriate.

However, for Carnwath and Schiemann LJJ, this was not possible where the counterparty was a director, who should have been aware of a procedural irregularity in the constitution of the board meeting.188 7.79 By extension of the Court of Appeal’s reasoning in Smith v HennikerMajor,189 it seems that where the transaction is purportedly entered into by an individual director or subordinate agent acting as such, the counterparty may be able to rely upon the words ‘or authorise others to do so’ in section 35A of the Companies Act 1985 provided that the board have purported to authorise the agent, or are represented to the counterparty as having done so by a person with authority so to represent. 7.80 Consequences of Excess of Power. A transaction purportedly entered into by agents which is in excess of their authority will, unless the counterparty can rely on the protection afforded in some circumstances by sections 35A–35B of the Companies Act 1985, the indoor management rule, or the common law doctrine of apparent authority, be of no effect. The transaction will not bind the company, and assets transferred pursuant to a purported transaction will remain the company’s in equity. 183

Ibid s 35A(2)(b). Ibid s 322A. 185 See E Ferran, ‘The Reform of the Law on Corporate Capacity and Directors’ and Officers’ Authority: Part 2’ (1992) 13 Company Lawyer 177 at 178–79. 186 [2002] EWCA Civ 762. 187 At para [108]. 188 At paras [109]–[110], [125]–[129]. 189 Ibid. 184

314 John Armour 7.81 Ratification. Even if the transaction is not initially binding on the company because of lack of authority, the company will, provided it is solvent, ordinarily be able subsequently to ratify it—in the sense of adopting something which is otherwise not binding upon it—through the act of an appropriatelyconstituted organ. (c) Unlawful Distributions 7.82 There are three differences between a challenge to a transaction on the grounds that it is an abuse of power and one on the basis that it constitutes an unlawful distribution or return of capital. First, an allegation that a transaction constitutes an unlawful distribution may only be made in respect of transactions between a company and its shareholders, or persons connected with shareholders. A claim that a transaction amounts to an abuse of power may potentially be made against any counterparty. Secondly, the financial precondition for challenge as an unlawful distribution is that the company at the time did not have sufficient distributable profits to cover the transfer of value. Such a company may, however, be clearly solvent. There is no financial precondition to a claim that the board of directors have abused their powers: this will be demonstrated simply by showing that their actions were not taken bona fide in the interests of the company. The company’s financial condition is, however, relevant, in that, if the company is insolvent, its ‘interests’ become those of creditors, and semble that the general meeting, even acting unanimously, are disabled from exercising the company’s powers, at least otherwise than bona fide for the benefit of creditors. Thirdly, avoidance as an unlawful distribution does not depend on the state of mind, or indeed the reasonableness of the decision, of the corporate organ authorising the transaction. The illegality is derived straightforwardly from its contravention of the provisions of the Companies Act 1985. Avoidance of a transaction as an abuse of power requires a demonstration that the corporate organ making the decision to enter or ratify the transaction did not consider it to be bona fide in the interests of the company, and that the counterparty was on notice of that fact. (3) Abuse of Power: Solvent Company (a) Manner in which Directors Must Exercise Their Powers 7.83 The powers of company directors are vested in them in a fiduciary capacity. As such, their exercise is subject to two types of legal restriction, which apply equally to acts of individual directors as to those of the board.190 First, directors are under a general duty of good faith: they must exercise their powers ‘bona fide in the interests of the company’.191 This duty is subjective: it is 190 191

Bishopsgate Investment Management Ltd v Maxwell [1993] BCC 120. Re Smith and Fawcett Ltd [1942] Ch 304 at 308–9.

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 315 satisfied provided that the directors act in what they think, not what a court may think, are the interests of the company.192 It follows that acting in bad faith, or simply acting without having in fact given consideration to the interests of the company, will itself amount to an abuse of power.193 Furthermore, a court may be persuaded to infer lack of such consideration from the fact that an act or omission results in a significant objective disadvantage to the company.194 7.84 Secondly, directors must avoid exercising their powers for collateral purposes.195 This requirement is derived from equitable restrictions which have always been imposed on the exercise of fiduciary powers by reference to the context in which they were granted—in the case of company directors, the terms of the articles of association.196 The restrictions implied are objective, so that an exercise of power may be struck down on this basis notwithstanding the directors’ good faith.197 Examples of improper purposes include acting so as to confer a personal benefit upon the decisionmaker,198 or actions which are not for a business purpose.199 However, the breadth of the discretion conferred upon directors by the articles, and the need to give credit to their honest business decisions, means that the court will not substitute its own decision for that of the directors, but rather will only characterise extreme aberrations as being improper exercises of power.200 (b) Consequences of Abuse of Power 7.85 Where the board or individual directors exercise their powers either in bad faith, or without giving consideration to the interests of the company at all, or for an improper purpose, then the act in question will constitute an abuse of power. The consequences depend on the power in question. The position regarding dispositions of corporate assets and corporate contracts was clarified in Heinl v Jyske Bank (Gibraltar) Ltd. These are said to be ‘void in equity’.201 This means that dispositions will be held on constructive trust by the recipient, unless they can 192

Ibid; Regentcrest plc v Cohen [2001] 2 BCLC 80 at 105. Bishopsgate Investment Management Ltd v Maxwell [1993] BCC 120 at 140. 194 Regentcrest plc v Cohen [2001] 2 BCLC 80 at 105. 195 Ibid. 196 Vatcher v Paull [1915] AC 372 at 378; Hindle v John Cotton Ltd (1919) 56 Sc LR 625 at 630–31; Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821 at 834–38; Whitehouse v Carlton Hotel Pty Ltd (1987) 162 CLR 285 at 291. See also RC Nolan, ‘The Proper Purpose Doctrine and Company Directors’ in BAK Rider (ed), The Realm of Company Law (London, Kluwer, 1998), 1 at 7–13. 197 Hogg v Cramphorn [1967] Ch 254; Regentcrest plc v Cohen [2001] 2 BCLC 80 at 105. 198 See Punt v Symons & Co Ltd [1903] 2 Ch 506; Piercy v S Mills & Co Ltd [1920] 1 Ch 77; Hogg v Cramphorn Ltd [1967] Ch 254; Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821. 199 See Rolled Steel Products (Holdings) Ltd v British Steel Corp [1986] Ch 246 at 297, 307; Bishopsgate Investment Management Ltd v Maxwell (No 2) [1994] 1 All ER 261 at 265; RC Nolan, ‘The Proper Purpose Doctrine and Company Directors’ in BAK Rider (ed), The Realm of Company Law (London: Kluwer, 1998), 1 at 10–11. 200 Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821 at 834–38. 201 Heinl v Jsyke Bank (Gibraltar) Ltd [1999] Lloyd’s Rep Bank 511 at 519–21. 193

316 John Armour demonstrate that they are a bona fide purchaser of the legal title for value without notice of the circumstances constituting the abuse. Furthermore, executory contracts may be set aside if it can be demonstrated that the counterparty was on notice of the abuse of power. The consequence of an abuse of the power to allot shares is different, with the allotment being treated as voidable rather than void.202 This distinction is difficult to rationalise, and appears to be anomalous.203 (c) Sections 35A–35B Inapplicable 7.86 The protection offered to counterparties by sections 35A–35B of the Companies Act 1985 relates only to limitations on the power of the board of directors derived from the company’s constitution. The restrictions imposed by the doctrine of abuse of power are imposed from general equitable principles, and it is thought consequently are not affected by the protection offered.204 This view is reinforced by a consideration of the presumption of good faith under section 35A(2). A counterparty will not be held to be acting in bad faith ‘merely by reason that he is aware that the board of directors has exceeded its powers’ (emphasis added). The implication is that where the counterparty has knowledge of abuse of powers by the board of directors, then the position will be otherwise and he will be found to be in bad faith.205 (d) Position of the General Meeting 7.87 Where the company is clearly solvent, the shareholders’ unanimous consent will suffice to validate a corporate transaction against all subsequent challenge by the company or those claiming in its right.206 Whether ratifying decisions taken by directors in excess or abuse of the boards’ powers, or exercising powers which they have arrogated to themselves through informal modification of the constitutional balance, the shareholders acting unanimously need consider the interests of no-one but themselves.207 202

Whitehouse v Carlton Hotel Pty Ltd (1987) 162 CLR 285 at [11]. RC Nolan, ‘Enacting Civil Remedies for Breach of Directors’ Duties’ (2001) 1 Journal of Corporate Law Studies 245 at 251–52. 204 See International Sales and Agencies Ltd v Marcus [1982] 3 All ER 551 at 559–60; RC Nolan, ‘The Proper Purpose Doctrine and Company Directors’ in BAK Rider (ed), The Realm of Company Law (London: Kluwer, 1998), 1 at 6. 205 DD Prentice, ‘Group Indebtedness’ in CM Schmitthoff and F Wooldridge (eds), Groups of Companies (London, Sweet & Maxwell, 1991), 55 at 62. 206 Salomon v A Salomon & Co Ltd [1897] AC 22 at 57; Re Wragg [1897] 1 Ch 796; Attorney General for Canada v Standard Trust Co of New York [1911] AC 498; Re Horsley & Weight Ltd [1982] Ch 442 at 454; Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical Services Co Ltd [1983] Ch 258; Rolled Steel Products (Holdings) Ltd v British Steel Corpn [1986] Ch 246 at 296; Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 2 AC 500 at 506. 207 Re Halt Garage (1964) Ltd [1982] 3 All ER 1016 at 1033–39; Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical Services Co Ltd [1983] Ch 258 at 269, 288–91; Kuwait Asia Bank EC v National Mutual Life Nominees Ltd [1991] 1 AC 187 at 217. 203

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 317 (4) Abuse of Corporate Powers: Insolvent Company (a) Prospective Entitlement of Creditors to Corporate Assets 7.88 The position with respect to abuse of powers changes when a company becomes factually insolvent, or will do so as a result of entering a particular transaction. This reflects an underlying change in entitlements to the corporate assets. The point is well made in a classic dictum of Street CJ in Kinsela v Russell Kinsela Pty Ltd:208 In a solvent company the proprietary interests of the shareholders entitle them as a general body to be regarded as the company when questions of the duty of directors arise. If, as a general body, they authorise or ratify a particular action of the directors, there can be no challenge to the validity of what the directors have done. But where a company is insolvent the interests of creditors intrude. They become prospectively entitled, through the mechanism of liquidation, to displace the power of shareholders and directors to deal with the company’s assets. It is in a practical sense their assets and not the shareholders’ assets that, through the medium of the company, are under the management of the directors. . .

7.89 This passage has twice been expressly approved by the Court of Appeal.209 The notion that creditors are ‘prospectively entitled’ to corporate assets begs a number of questions. What is the source of the creditors’ entitlement? What is its nature? What, if any, restrictions does the creditors’ entitlement imply for dealings with corporate assets, and when do they become operative? These will be now addressed. 7.90 Conceptual Justification. The creditors’ prospective entitlement is derived from the statutory framework of insolvency proceedings. On the making of a winding-up order or resolution for voluntary liquidation, the company’s assets become subject to a ‘statutory trust’ for the benefit of those interested in the distribution.210 The company remains the legal owner of its assets, but may no longer make use of them for its own benefit. As a result, there is a corresponding shift in the way in which control of the assets may be exercised. From the commencement of winding-up, the scope of the company’s powers are severely circumscribed by the Insolvency Act 1986. Furthermore, they may only be exercised through the liquidator, in a manner directed towards achieving a beneficial realisation of the assets.211 208

(1986) 4 NSWLR 722 at 730. West Mercia Safetywear Ltd v Dodd (1989) 4 BCC 30 at 33; Official Receiver v Stern (No 2) [2001] EWCA Civ 1787 at [32], [2002] 1 BCLC 119 at 129–30. 210 Re General Rolling Stock Co (1872) LR 7 Ch App 644; Re Art Reproduction Co Ltd [1952] Ch 89; Ayerst v C & K Construction Ltd [1976] 167 at 176–80; Re Cases of Taffs Well Ltd [1992] Ch 179 at 191–92. The ultimate beneficiaries of the trust will not be determined until the assets have been sold and all proofs of claim have been submitted. As a consequence of this uncertainty, a beneficiary of the statutory trust is in a position akin to that of a legatee prior to execution of the will: Ayerst, ibid, at 177–78. 211 See Smith v Bridgend County Borough Council [2001] UKHL 58 at [20], [2002] 1 AC 336 at 348. 209

318 John Armour 7.91 This framework also provides a justification for a more limited shift in control before winding-up proceedings commence. This is because, from the moment that either the cash-flow or balance-sheet test of insolvency is factually satisfied,212 the creditors have the power to commence winding-up and assert their collective entitlement to the company’s assets.213 To be sure, the creditors have no direct beneficial interest in the company’s assets. Thus the directors cannot be said to be trustees for them.214 Nor will individual creditors be able to assert a constructive trust over assets in the hands of a counterparty.215 Nevertheless, it is justifiable to limit the ways in which the company can deal with its assets, at least so as to prevent it taking any steps to frustrate the creditors’ inchoate entitlement.216 Thus, the content of the ‘interests of the company’, for which those exercising the company’s managerial powers must act, becomes the interests of creditors.217 Of course, the directors do not become subject to any direct duties to creditors,218 unless they personally assume responsibility for their payment.219 The underlying change also implies a restriction on powers exercised by the general meeting.220 Needless to say, the shareholders in general meeting are not subject to duties to anyone.221 Rather, the

212

See Insolvency Act 1986 ss 122(1)(f), 123. These tests are discussed above paras 2.35ff. Consistently with this view, the unsecured creditors’ interest has been said by Hoffman J to ‘crystallise’ on the commencement of liquidation (Re Braemar Investments Ltd [1989] Ch 54 at 61), deemed in compulsory winding-up to be the bringing of the petition (Insolvency Act 1986 s 129(2)). 214 Re Wincham Shipbuilding, Boiler and Salt Co (1878) LR 9 Ch D 322 at 328–29. 215 Such a claim was dismissed in Green v Wilden Pty Ltd [1998] WASC 399. 216 Cf LS Sealy, ‘Directors’ “Wider” Responsibilities—Problems Conceptual, Practical and Procedural’ (1987) 13 Monash Law Review 164 at 176–77. 217 See F Dawson, ‘Acting in the Best Interests of the Company—For Whom are Directors “Trustees”?’ (1984) 11 New Zealand Universities Law Review 68; JD Heydon, ‘Directors’ Duties and the Company’s Interests’ in P Finn (ed), Equity and Commercial Relationships (North Ryde, NSW: Law Book Co, 1987), 120; LS Sealy, ‘Directors’ “Wider” Responsibilities—Problems Conceptual, Practical and Procedural’ (1987) 13 Monash Law Review 164; CA Riley, ‘Directors’ Duties and the Interests of Creditors’ (1989) 10 Company Lawyer 87; V Finch, ‘Directors’ Duties: Insolvency and the Unsecured Creditor’, in A Clarke (ed) Current Issues in Insolvency Law (London, Stevens & Co, 1991), 87; R Grantham, ‘The Judicial Extension of Directors’ Duties to Creditors’ [1991] Journal of Business Law 1. 218 Re Horsley and Weight Ltd [1982] Ch 442 at 453–54; Kuwait Asia Bank EC v National Mutual Life Nominees Ltd [1991] 1 AC 187 at 217–19; Sycotex Pty Ltd v Baseler (1994) 13 ACSR 766 at 784–85; Yukong Line Ltd v Rendsburg Investments Corporation (No 2) [1998] 1 WLR 294 at 312. Dicta of Lord Templeman in Winkworth v Edward Baron Development Co Ltd [1986] 1 WLR 1512 at 1516 which might appear to suggest the contrary should be read in the context of the case, in which no direct relief was granted to the creditor: see Green v Wilden Pty Ltd [1998] WASC 399. 219 Nicolson v Permakraft [1985] 1 NZLR 242 at 250; Kuwait Asia Bank EC v National Mutual Life Nominees Ltd [1991] 1 AC 187 at 219; Williams v Natural Life Health Foods Ltd [1998] 1 WLR 830. 220 This can be contrasted with the position of the other ‘constituency’ to whose interests directors must have regard—the employees. Section 309 of the Companies Act 1985 implies a general requirement to have regard to the interests of employees, but this is not derived from any underlying shift in entitlements. Thus the employees are powerless to prevent shareholders from authorising or ratifying actions which harm their interests. See DD Prentice, ‘A Company and its Employees: The Companies Act 1980’ (1981) 10 Industrial Law Journal 1. 221 Kuwait Asia Bank EC v National Mutual Life Nominees Ltd [1991] 1 AC 187 at 217. 213

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 319 restriction is simply a disability:222 the shareholders in general meeting are no longer able to authorise or ratify corporate transactions, at least unless their decision is taken bona fide in the interests of the company (pace the creditors). 7.92 Policies Favouring Protection of Creditors. When a company is solvent, it is undesirable in policy terms to grant creditors any entitlement to consideration—other than that which they stipulate by contract—by corporate decisionmakers.223 Two points may be made. First, such entitlements would be costly, as they might inhibit companies’ ability to pursue valuable investment opportunities. Consider that creditors have fixed ‘upside’ returns, and so will always tend to prefer less risky projects to those which would be preferred by shareholders, who can capture the entirety of the ‘residual return’ if a project is successful. Requiring those making decisions on behalf of solvent companies to consider the interests of creditors would encourage decision-makers to pursue less risky projects so as to please creditors. This would not simply result in an enhancement of creditors’ positions at the expense of shareholders.224 Rather, the problem is that decision-makers would be deterred from pursuing a risky project simply because it is risky, regardless of whether the project is the best available investment. This will inhibit companies’ ability to pursue favourable but risky investment opportunities. Thus such restrictions would be costly for all concerned: the overall ‘size of the pie’ will be reduced, as well as the slice that goes to shareholders. Secondly, such protection is unlikely to be necessary for creditors of solvent companies. Most companies will be deterred from entirely disregarding their creditors by the prospect of having to raise future finance. Furthermore, creditors are able to contract for their own protection from adverse decisions by their borrowers.225 7.93 However, the policy position changes when a company becomes insolvent. Consider first the incentives of those deciding which was to spend the company’s money. If these decision-makers are required to act in the interests of shareholders, then they may be tempted to ‘bet the firm’ on projects which have a small chance of returning enough to avoid otherwise-inevitable insolvency proceedings and consequent loss of shareholders’ entitlements. The problem here is that such projects may be selected without reference to losses if things go

222 See in particular the observations of Gummow J in Sycotex Pty Ltd v Baseler (1994) 13 ACSR 766 at 785. 223 See DG Baird and TH Jackson, ‘Fraudulent Conveyance Law and its Proper Domain’, (1985) 38 Vanderbilt Law Review 829 at 830–31; R Grantham, ‘The Judicial Extension of Directors’ Duties to Creditors’ [1991] Journal of Business Law 1; J Armour, ‘Share Capital and Creditor Protection: Efficient Rules for a Modern Company Law?’ (2000) 63 Modern Law Review 355 at 359–62, 373–75. 224 Such a result would be unproblematic, as companies would respond simply by using more debt and less equity in their capital structures. 225 See BR Cheffins, Company Law: Theory, Structure and Operation (Oxford, OUP, 1997) at 69–82.

320 John Armour wrong: limited liability means that shareholders have nothing further to lose.226 Secondly, the practical protection, which creditors obtain from the fact that they can refuse to extend further credit to a borrower if it acts in disregard of their interests, is no longer present in the run-up to insolvency proceedings. Those running an insolvent company may find themselves in a position where desperate actions which will harm the interests of creditors may represent the only possibility of avoiding insolvency proceedings. Difficulty in obtaining further credit is unlikely to pose much of a constraint if the only alternative is certain closure.227 As a result, a principled distinction can be drawn between the cases of the solvent and insolvent company: restrictions on the exercise of corporate powers may be legitimate in the latter case although not in the former.228 (b) Abuse of Power by Directors of an Insolvent Company 7.94 The tests to be applied in the determination of whether directors of an insolvent company have abused their powers remain the same as in the case of a solvent company, namely whether the directors have acted in good faith in the interests of the company, and not for an improper purpose. What changes is the meaning of the ‘interests of the company’, which becomes the interests of its creditors. Nourse LJ put the matter as follows in Brady v Brady:229 The interests of a company, an artificial person, cannot be distinguished from the interests of the persons who are interested in it. Who are those persons? Where a company is both going and solvent, first and foremost come the shareholders, present and no doubt future as well. How material are the interests of creditors in such a case? Admittedly existing creditors are interested in the company as the only source of satisfaction for their debts. But in a case where the assets are enormous and the debts minimal it is reasonable to suppose that the interests of the creditors ought not to count for very much. Conversely, where the company is insolvent, or even doubtfully solvent, the interests of the company are in reality the interests of the creditors alone.

7.95 Thus, directors of an insolvent company will abuse their powers if they do not subjectively believe that their actions are in the interests of the creditors. For example, in Kinsela v Russell Kinsela, the company entered into a lease at a 226 MC Jensen and WH Meckling, ‘Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure’ (1976) 3 Journal of Financial Economics 305 at 333–43. 227 See R Grantham, ‘The Judicial Extension of Directors’ Duties to Creditors’ [1991] Journal of Business Law 1 at 3. See also RJ Mokal, ‘An Agency Cost Analysis of the Wrongful Trading Provisions: Redistribution, Perverse Incentives and The Creditors’ Bargain’ [2000] 59 Cambridge Law Journal 335 at 347–48. 228 Note that the case for imposing personal liability on directors, as opposed to avoiding corporate transactions, is much more equivocal. See BR Cheffins, Company Law: Theory, Structure and Operation (Oxford, OUP, 1997) at 541–42 . 229 [1988] BCLC 20 at 40. His Lordship was considering the meaning of the ‘interests of the company’ for the purposes of Companies Act 1985 s 153(2)(b), but nothing turned on this as he was willing to assume for the purposes of the decision that this meant the same as in relation to directors’ duties generally.

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 321 significant undervalue at a time when it was clearly insolvent to the ‘direct and calculated’ prejudice of the creditors. Street CJ described this as an ‘unusually straightforward fact pattern’.230 Another well-known Australian example is Walker v Wimborne.231 In this case the directors had moved funds around group companies as exigencies arose, with no regard for the benefit of individual companies, in pursuance of a policy formulated to promote the interests of the group. The transferor companies were at the time insolvent, and Mason J (with whom Barwick CJ agreed) held that, because the directors had failed to give proper consideration to the interests of the individual companies concerned, relevantly including their creditors, the payments had not been made bona fide in the interests of the companies, and hence amounted to acts of misfeasance.232 7.96 Financial Condition of the Company. At what point do the interests of creditors start to intrude? In Nicholson v Permakraft,233 the New Zealand Court of Appeal was asked to decide whether a corporate restructuring involving the payment of a large capital dividend was open to challenge by the company’s liquidator in its subsequent insolvency. According to the majority, Richardson and Somers JJ, as there were no grounds for alleging that the company’s solvency was in doubt at the time of the restructuring, and it had been consented to by the shareholders, it was not open to challenge by the liquidator.234 Cooke J (as he then was), however, decided the case on a slightly different ground, namely that the interests of creditors should be given consideration not only when the company is insolvent, but when a proposed transaction might jeopardise its solvency. He said:235 The criterion should not be simply whether the step will leave a state of ultimate solvency according to the balance sheet, in that total assets will exceed total liabilities. Nor should it be decisive that on the balance sheet the subscribed capital will remain intact . . . Balance sheet solvency and the ability to pay a capital dividend are certainly important factors tending to justify proposed action. But as a matter of business ethics it is appropriate for directors to consider also whether what they do will prejudice their company’s ability to discharge promptly debts owed to current and likely continuing trade creditors.

In formulating this test, Cooke J distinguished carefully between, on the one hand, current creditors and trade creditors with continuing relationships with the company, and, on the other hand, future creditors who ‘short of fraud . . . must be the guardians of their own interests’.236 230 231 232 233 234 235 236

[1986] 4 NSWLR 722 at 733. (1976) 50 AJLR 446. At 448. [1985] 1 NZLR 24. At 254–55. At 249. At 250.

322 John Armour 7.97 These passages were cited with approval by Street CJ in Kinsela v Russell Kinsela Pty Ltd.237 In that case, the company was clearly insolvent at the time of the impugned transaction, and so it was unnecessary to determine the degree of financial instability necessary to impose on directors an obligation to consider the interests of creditors.238 Street CJ observed, again obiter, that ‘the degree of financial instability and the degree of risk to the creditors are inter-related’.239 Furthermore, the riskiness of the company’s existing business—which presumably would be discoverable by creditors at the time when funds were advanced—and the riskiness of the proposed transaction would also be relevant factors. This formulation appears to indicate that a composite approach is called for, depending on the solvency of the company, the perceived riskiness of a proposed transaction, the magnitude of potential losses, and the way in which the transaction will be financed. 7.98 Interests of Creditors. In cases where it is alleged that directors acted in bad faith, or failed to have regard to the interests of creditors, it will usually be necessary to adduce evidence that the action was so harmful to creditors that no reasonable director could have honestly thought it was in the former’s interests.240 Therefore, it will be necessary for a successful claimant to establish how the action in question harmed the interests of creditors. Insofar as the position has been established by the authorities, the ‘interests of creditors’ are largely understood by reference to the likely quantum of their financial claims had the offending action not been taken. Creditors’ interests are therefore harmed by transactions which significantly deplete corporate assets—thereby lowering their expected returns—or which result in one creditor or groups of creditors getting paid at the expense of others, ie the common law analogues respectively of transactions at an undervalue and unlawful preferences. These points can be illustrated by reference to the authorities. 7.99 Re Welfab Engineers241 involved a sale by directors of an insolvent company of its premises, equipment and work-in-progress to a buyer who had agreed to take on the company’s workforce and continue to operate the business. It was alleged by the company’s liquidator that the directors in so doing had breached their fiduciary duties in not taking sufficiently into account the interests of creditors. In particular, it was suggested that they should have accepted an alternative offer to purchase the assets on a break-up basis for about 237

(1986) 4 NSWLR 722 at 731–33. See also Equiticorp Finance Ltd v Bank of New Zealand (1993) 32 NSWLR 50 at 146 per Clarke JA and Cripps JA: 238

Whether, and to what extent, it is necessary to have regard to the interests of creditors when a company is of doubtful solvency has not authoritatively been determined. 239

Ibid at 733. See Regentcrest plc v Cohen [2001] 2 BCLC 80 at 105; Maronis Holdings Ltd v Nippon Credit Australia Pty Ltd (2001) 38 ACSR 404 at 453. 241 [1990] BCC 600. 240

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 323 13 per cent more, notwithstanding that this would have led to the unemployment of the work force. 7.100 It was conceded that no better realisation for the creditors could have been achieved in liquidation than the directors had in fact obtained. In effect, the liquidator was demanding that the directors should have done better for the creditors than they would have achieved had they relied upon their collective entitlement to divest control of the assets from the directors. Hoffmann J held that the propriety of the directors’ actions should be compared with the alternatives of receivership or administration.242 Under the circumstances, it was legitimate for the directors to favour the employees to the extent that they did, and to seek to preserve the business.243 Thus, the interests of creditors demand no greater consideration than an honest belief that their prospective entitlements in liquidation will not be prejudiced.244 7.101 A related set of issues arose for consideration in Facia Footwear Ltd v Hinchcliffe.245 Facia Footwear Ltd was part of a group of companies which had implemented joint treasury and group security arrangements, on the instigation of their common shareholders. A number of payments were made by Facia Footwear to discharge liabilities of other group companies at a time when the group were in considerable financial difficulties. Facia Footwear subsequently went into administration, and the office-holder sought, inter alia, to hold the company’s directors liable for the payments made pursuant to the policy on the grounds that they had breached their duty to take into account the interests of creditors. The directors’ defence was that they honestly believed that continued trading was the best way to protect the interests of creditors. They were seeking to implement a refinancing scheme, which required them to continue trading, even though they knew that the company was clearly insolvent. The group treasury scheme, moreover, was the only way in which the companies could be kept afloat in the interim. This was accepted by the Vice-Chancellor:246 The creditors’ only chance of being paid in full lay in a continuation of trading. A continuation of trading might mean a reduction in the dividend eventually payable to creditors but it represented the creditors’ only chance of full payment. It is therefore, not in the least obvious that in continuing to trade in April and May the directors were ignoring the interests of creditors. . . . [The directors] retained their optimism to the end. There has been no attack on their bona fides in this regard.

242

At 604. Although not explicitly relied upon by Hoffmann J, this analysis is supported by Companies Act 1985 s 309, which stipulates that the factors to be taken into account by directors in the exercise of their duties shall include the interests of employees. 244 Hoffmann J was also doubtful as to whether the alternative offer would have resulted in greater realisations to the creditors than were in fact achieved, because of the cost of employees’ redundancy entitlements for which the company would have been liable: at 603. 245 [1998] 1 BCLC 218. 246 At 228 per Sir Richard Scott VC. 243

324 John Armour 7.102 Again, it is clear that the yardstick to be employed is whether or not a reasonable director could have considered that the course of action adopted was in accordance with the interests of creditors, judged by reference to their prospective entitlements in collective proceedings. 7.103 Other cases illustrate that preferential payments will also be contrary to creditors’ interests.247 The issue here is not so much lack of regard to creditors’ interests, but, by analogy with the case law dealing with exercises of powers impacting differently on various groups of shareholders, it is more a question of fairness between different classes of creditor. However, the need to demonstrate absence of good faith, plus notice of the abuse of power on the part of the counterparty, will make this unattractive as a basis for challenging transactions when section 239 is open to an office-holder. (c) Abuse of Corporate Powers by the General Meeting? 7.104 The better view is that when a company slips into factual insolvency, the powers of the shareholders in general meeting—whether to bind the company through unanimous consent, or to ratify a transaction purportedly effected by the board—become subject to a limitation analogous to that imposed upon directors: that they must be exercised bona fide in the best interests of the company (pace creditors).248 This implies a restriction on the powers of the shareholders in general meeting which only comes into existence when the company is insolvent. In keeping with the analysis set out in this chapter,249 it complements, rather than conflicts with, the principle that a solvent company is bound by the unanimous assent of its general meeting.250 It does not, of course, involve an assertion that shareholders owe any duties to creditors: rather that they are subject to a collective disability, which has its source in the underlying shift in entitlements.251 7.105 A useful analysis of the position as respects corporate actions effected by the shareholders’ unanimous consent was given by the Supreme Court of 247 West Mercia SafetywearLtd v Dodd (1988) 4 BCC 30. See also Re DKG Contractors Ltd [1990] BCC 903. 248 See Re Halt Garage (1964) Ltd [1982] 3 All ER 1016 at 1037; Rolled Steel (Holdings) Ltd v British Steel Corporation [1986] Ch 246 at 307; ANZ Executors and Trustee Co Ltd v Qintex Ltd (1990) 8 ACLC 791 at 797–98; (1990) 8 ACLC 980 at 988–89; MacPherson v European Strategic Bureau [2000] 2 BCLC 683; Walker v WA Personnel Ltd (unreported, 15 March 2002) at 39–43. 249 See above, paras 7.88ff. 250 See, eg, Salomon v A Salomon & Co Ltd [1897] AC 22 at 57; Re Wragg [1897] 1 Ch 796; Attorney General for Canada v Standard Trust Co of New York [1911] AC 498; Re Horsley & Weight Ltd [1982] Ch 442 at 454; Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical Services Co Ltd [1983] Ch 258; Rolled Steel Products (Holdings) Ltd v British Steel Corpn [1986] Ch 246 at 296; Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 2 AC 500 at 506. 251 This section is heavily indebted to suggestions set out in LS Sealy, ‘Directors’ “Wider” Responsibilities—Problems Conceptual, Practical and Procedural’ (1987) 13 Monash Law Review 164 at 181–87.

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 325 Queensland in ANZ Executors and Trustee Co Ltd v Qintex Ltd.252 The case concerned a covenant by a company (QAL) to its lender (ANZ) to procure one or more of its wholly-owned subsidiaries to grant upstream guarantees for QAL’s debts. When QAL went into receivership, ANZ sought specific performance of the covenant, on the (uncontested) basis that damages would be an inadequate remedy. The court refused, on the ground that it would involve compelling the subsidiaries to do an unlawful act. At the time of the hearing, the subsidiaries were either cashflow insolvent, or would become balance-sheet insolvent following the assumption of the liability concerned, or both. No challenge could be mounted on the basis that the guarantee would be ultra vires, as the doctrine of corporate capacity had been abolished in Queensland. Instead, both Byrne J at first instance and McPherson J for the Full Court distinguished between excess of corporate capacity and abuse of corporate powers. Although for the shareholders to effect the grant of a guarantee under the prevailing circumstances would not be in excess of the company’s capacity, it would nevertheless amount to a ‘misuse of corporate power’,253 and hence was impermissible. 7.106 The Court of Appeal’s recent decision in MacPherson v European Strategic Bureau is also explicable on the abuse of power analysis.254 Chadwick LJ, who gave the leading judgment,255 considered first whether the scheme amounted to a breach of duty on the part of the directors. Applying all three parts of the Lee, Behrens formula,256 he concluded that it was ‘inconceivable’ that in effecting the scheme the parties could have thought they were doing anything other than effecting a distribution of assets as if on a winding-up. This could not be said to have anything to do with the promotion of the interests of the company. 7.107 However, as the scheme was entered into in pursuance of a unanimous shareholder agreement, mere breach of duty by the directors would not be sufficient to strike it down. All three members of the Court held that the transaction contravened section 263 of the Companies Act 1985 and therefore unlawful.257 However, in an earlier part of his judgment, Chadwick LJ (with whom Peter Gibson LJ agreed) also described it as ‘ultra vires’ on a different basis:258 [The scheme] is an attempt to circumvent the protection which the 1985 Act aims to provide for those who give credit to a business carried on, with the benefit of limited liability, through the vehicle of a company incorporated under the Act. As such, it fails 252

(1990) 8 ACLC 791; aff’d (1990) 8 ACLC 980. At 798; see also at 988–89. 254 [2000] 2 BCLC 683. The facts of the case are set out above in para 7.43. 255 Peter Gibson LJ agreed with Chadwick LJ, and Buxton LJ delivered a short judgment which concurred on the ratio. 256 See above para 7.69. 257 At 701–4. For Buxton LJ, it was an unlawful distribution, and for Chadwick LJ, with whom Peter Gibson LJ agreed, an unlawful attempt to liquidate the company’s assets—implicitly permitted only by s 263(2)(d) in accordance with the scheme of the Insolvency Act 1986. 258 At 701. 253

326 John Armour to satisfy the first of the questions posed by Eve J in Re Lee, Behrens and Co Ltd . . . ‘Is the transaction reasonably incidental to the carrying on of the company’s business?’. As Pennycuick J pointed out in Ridge Securities Ltd v IRC . . . : ‘A company can only lawfully deal with its assets in furtherance of its objects. The corporators may take assets out of the company by way of dividend or, with leave of the court, by way of reduction of capital, or in a winding up. They may, of course, acquire them for full consideration. They cannot take assets out of the company by way of voluntary disposition, however described, and if they attempt to do so, the disposition is ultra vires the company.’ It is important to note the epithet by which Pennycuick J qualifies the word ‘consideration’ in that passage. The question is not whether the assets are acquired under some arrangement which contains the elements which the law requires for recognition as a contract. What is needed is ‘full consideration’; that is to say, the arrangement must be entered into for the benefit and to promote the prosperity of the company. The provisions of the 1991 agreement do not meet that test. (Emphasis added).

7.108 Despite the reference to Ridge Securities, it appears that Chadwick LJ is not here determining whether the transaction constituted an unlawful distribution. The dictum cited from Ridge Securities is properly understood as having been directed to the question of corporate capacity in a situation where the company had no express power to make gifts,259 rather than whether it gave rise to a return of capital. Yet in light of section 35 of the Companies Act 1985, His Lordship clearly cannot have meant ‘ultra vires’ in the sense of lack of corporate capacity.260 7.109 The better view is that Chadwick LJ was instead considering whether the transaction amounted to an abuse of corporate power. This may be deduced from his reliance on the Lee, Behrens formula—in particular the last two limbs, that underpin the italicised section in the foregoing quotation—which it is now widely understood, is appropriate for determining questions of abuse of power.261 The reason it was applied in MacPherson not just to a decision of the board but to one of the general meeting was because the company was insolvent: the prospective entitlements of creditors meant that the company itself was disabled from exercising its powers other than for its (i.e. for its creditors’) benefit and prosperity: in other words, not gratuitously. 7.110 Clearly, if it is not possible for the unanimous consent of the general meeting to bind an insolvent company to a transaction which was entered into 259 Charterbridge Corporation Ltd v Lloyd Banks Ltd [1970] Ch 62 at 73–74; Re Halt Garage (1964) Ltd [1982] 3 All ER 1016 at 1032–33. See above, paras 7.33–7.35, 7.71. 260 Rolled Steel does not appear to have been cited to the Court. His Lordship’s use of the term ‘ultra vires’ was contrary to the Court’s earlier statement in that case that the phrase should be reserved for acts in excess of corporate capacity: see above, paras 7.9–7.10. 261 See above, para 7.71. The reference to Ridge Securities can also be understood in this light. Although the ratio of that case concerned lack of capacity, Pennycuick J did explicitly refer (albeit, as he later admitted, wrongly) all three limbs of the Lee, Behrens formula, and it was therefore in his mind at the time.

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 327 otherwise than in accordance with the interests of creditors, it will no more be possible for the general meeting to validate such a transaction where it was originally effected by the board of directors, or to absolve the directors from the consequences of their breach of duty. In Kinsela v Russell Kinsela, Street CJ explained, in relation to such a breach:262 Where, however, the interests at risk are those of creditors I see no reason in law or logic to recognise that the shareholders can authorise or ratify a breach. Once it is accepted, as in my view it must be, that the directors’ duty to the company as a whole extends in an insolvency context to not prejudicing the interests of creditors (Nicholson v Permakraft (NZ) Ltd and Walker v Wimborne) the shareholders do not have the power or authority to absolve the directors from that breach.

7.111 The same approach would appear to hold for questions of validation by the shareholders in general meeting of transactions which are not binding on the company for other reasons—for example, because they fall foul of the equitable self-dealing rules, or were entered into in excess of authority by an individual corporate agent—or to absolve directors of the consequences of their breaches of duty. Where the company was solvent at the time of the original transaction, but has subsequently become insolvent, then the better view is that the general meeting’s power to ratify will only be exercisable bona fide in the interests of the company (pace creditors). Where the issue concerns granting forgiveness for a breach of directors’ duties or releasing a cause of action against a director, it is unlikely that this could ever be effected in the interests of creditors. The ordinary commercial reasons for which such a release might be in the interests of a solvent company—for example, the desire to have the continuing services of an important director, or the wish to avoid damage to the company’s reputation through protracted litigation—fade into irrelevance when the company is insolvent, and the primary issue becomes whether creditors will be deprived of a cause of action which might go to swell their dividends.

(5) Remedial Consequences of Abuse of Corporate Power

7.112 A transaction effected in abuse of power is not ultra vires, and so not void at law. However, it is now understood that such a transaction will be ‘void in equity’.263 This means that dispositions will give rise to a constructive trust in the company’s favour unless the counterparty can rely upon the defence of bona fide purchaser.264 By the same token, executory contracts will be void as against 262

(1986) 4 NSWLR 722 at 732. Heinl v Jyske Bank (Gibraltar) Ltd [1999] Lloyds’ Rep Bank 511 at 519–21. 264 Russell v Wakefield Waterworks Co (1875) LR 20 Eq 474 at 479; Belmont Finance Corporation Ltd v Williams Furniture Ltd (No 2) [1980] 1 All ER 393 at 405. See also Allied Carpet Group plc v Nethercott (unreported, 28 January 2000). 263

328 John Armour counterparties with notice, actual or constructive, of the circumstances constituting the abuse of power.265 Furthermore, a counterparty may face personal liability as a constructive trustee by virtue of knowing receipt or dishonest assistance, at least if the claim is based on abuse of power by directors.266 7.113 Demonstrating that the counterparty had sufficient awareness of the circumstances surrounding the abuse of power to put them on notice will often be a difficult step in a claim to set aside a transaction on this ground. A so-called ‘commercial’ constructive notice standard will be applicable, namely that the circumstances which would put a counterparty on enquiry will be dependent on the type of transaction in question.267 The more obvious the undervalue associated with a transaction, and the more clearly insolvent the company, the greater the onus the counterparty will face to demonstrate that he satisfied the standard of enquiry. In Maronis Holdings Ltd v Nippon Credit Australia Pty Ltd,268 a recent decision of the Equity Division of the Supreme Court of New South Wales, Bryson J suggested that the test for whether a counterparty should be fixed with notice of an abuse of power was encapsulated in a well-known statement of Pennycuick J in Charterbridge Corporation Ltd v Lloyds Bank Ltd:269 The proper test, I think, . . . must be whether an intelligent and honest man in the position of a director of the company concerned, could, in the whole of the existing circumstances, have reasonably believed that the transactions were for the benefit of the company.

Thus the existence of some reasonable grounds for believing that the transaction was nevertheless legitimately within the counterparty’s business requirements will be sufficient to explain why it would not be ‘reasonable’ to enquire even given a significant price disparity.270 7.114 The office-holder may also be able to pursue claims for equitable compensation against directors who abused their powers.271 Where the breach 265 Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1986] Ch 246 at 297–98, 304–5. 266 Selangor United Rubber Estates Ltd v Cradock (No 3) [1968] 1 WLR 1555. 267 See Agip (Africa) Ltd v Jackson [1990] Ch 265 at 291G; El Ajou v Dollar Land holdings plc [1993] 3 All ER 717 at 739; Macmillan Inc v Bishopsgate Investment Trust plc (No 3) [1995] 1 WLR 978 at 1000–1. See also Belmont Finance Corp Ltd v Williams Furniture Ltd [1980] 1 All ER 393 at 405; International Sales and Agencies v Marcus [1982] 3 All ER 551 at 558; Westpac Banking Corp v Savin [1985] 2 NZLR 41 at 52–53. 268 (2001) 38 ACSR 404 at 453. 269 [1970] Ch 62 at 74–75. 270 In the context of the defence of bona fide purchaser and/or liability for knowing receipt, see, eg, Cowan de Groot Properties Ltd v Eagle Trust plc [1992] 4 All ER 700 at 760–61; BCCI (Overseas) Ltd v Akindele [2000] 3 WLR 1423. See also Polly Peck International v Nadir (No 2) [1992] 4 All ER 769 at 778–79. In the analogous context of whether a counterparty will be put ‘on notice’ of procedural irregularities in board decision-making and hence unable to rely on the indoor management rule, see Northside Developments Pty Ltd v Registrar-General (1990) 170 CLR 146. 271 Re Lands Allotment Co Ltd [1894] 1 Ch 616 at 638; Selangor United Rubber Estates Ltd v Cradock (No 3) [1968] 1 WLR 1555 at 1575; Bishopsgate Investment Management Ltd v Maxwell (No 2) [1994] 1 All ER 261.

Avoidance of Transactions as a ‘Fraud on Creditors’ at Common Law 329 involves misapplication of corporate assets, then the directors will in the first instance be liable to restore their value to the company. For executory contracts which are held to be void in equity, the measure of recovery will be the costs the company has incurred to date pursuant thereto. The position is different where the act was effected by the unanimous consent of the shareholders in general meeting of an insolvent company. Shareholders will not ordinarily face any personal liability as the restriction imposed by factual insolvency on the general meeting’s powers is simply a disability, as opposed to a duty.272 However, if the shareholders in fact conduct significant portions of the company’s business in this fashion, then they may have assumed the role of de facto directors and face personal liability accordingly.273 7.115 As with claims based on the payment of unlawful distributions, claims based on abuse of power are an asset of the company at the time of commencement of winding-up. Recoveries will therefore go to swell the assets available to the holder of a floating charge.

272 273

See above, para 7.104. On de facto directors, see above, paras 2.42ff.

8

Void Dispositions in Compulsory Winding Up ADRIAN WALTERS

A INTRODUCTION

(1) Insolvency Act 1986, Section 127 8.1 The subject matter of this chapter is the short but troublesome provision contained in section 127 of the Insolvency Act 1986. Section 127 applies to companies incorporated in England, Wales and Scotland1 and overseas companies2 that are wound up by the court.3 It avoids any disposition of the company’s property and any transfer of shares or alteration in the status of the company’s members occurring after the commencement of compulsory winding up unless the disposition, transfer or alteration is validated by the court.4 8.2 The full significance of section 127 can only be appreciated if it is read alongside section 129 of the Act. Section 129(2) relates the commencement of compulsory winding up back to the date of presentation of the winding up petition.5 So, for example, if a petition was presented against A Ltd on 1 March and the court made a winding up order on 1 May, A Ltd’s winding up would be deemed to have commenced on 1 March.6 It follows that any disposition, transfer or alteration 1 Insolvency Act 1986 ss 440(2)(a) and 441. An identical provision applies in Northern Ireland by virtue of the Companies (Northern Ireland) Order SI 1986/1032 (NI 6) art 484. The analogous provision in personal insolvency is s 284. 2 Insolvency Act 1986 Pt V, especially ss 221 and 229(1). 3 A company may be wound up by the court on a number of grounds: see Insolvency Act 1986 ss 122, 124A and 221–25. The main focus of this chapter is on companies wound up under s 122(1)(f) on the ground that they are unable to pay their debts. 4 Insolvency Act 1986 s 128 also renders void any attachment, sequestration, distress or execution put in force against the assets of a company registered in England and Wales, or assets of a Scottish company situated in England and Wales, after the commencement of compulsory winding up. 5 Where a petition is presented by one creditor and another creditor subsequently takes carriage of the petition under rule 4.19 of the Insolvency Rules 1986, the winding up is still deemed to commence from the date on which the first creditor originally presented the petition: Re Western Welsh International System Buildings Ltd (1985) 1 BCC 99, 296. 6 If a company in voluntary winding up is subsequently wound up by the court, the commencement of the compulsory winding up is related back to the date when the company resolved to go into voluntary winding up: Insolvency Act 1986 s 129(1). However, all proceedings taken in the

332 Adrian Walters within the meaning of the section occurring after the date of the winding up petition (1 March in our example) is susceptible to challenge by the company’s liquidator. Where, however, the directors of an eligible company obtain a moratorium to enable them to put forward proposals for a company voluntary arrangement, the operation of section 127 is suspended for the duration of the moratorium.7 Certain transactions in the financial markets are also specifically exempted.8

(2) The purpose of section 127 8.3 The first and primary aim of section 127 is to prevent the company from dissipating its assets while winding up proceedings are pending thus preserving those assets for the benefit of the general body of creditors. This proposition is widely supported by the authorities. In Re Wiltshire Iron Company, ex p Pearson, the leading nineteenth century case, Lord Cairns LJ described the contemporary equivalent of section 127 as:9 [A] wholesome and necessary provision, to prevent during the period which must elapse before a petition can be heard, the improper alienation and dissipation of the property of the company in extremis.10

8.4 Some 130 years later, Lightman J said much the same thing about the current provision in Coutts & Co v Stock:11 The invalidation of dispositions of a company’s assets after the date of presentation of a winding up petition is part of the statutory scheme designed to prevent the directors of a company, when liquidation is imminent, from disposing of the company’s assets to the prejudice of its creditors and to preserve those assets for the benefit of the general body of creditors.

8.5 Clearly, this policy is sensible as otherwise, to return to our earlier example, the directors of A Ltd would be free to dispose of the company’s assets as they thought fit in the period between 1 March and 1 May to the likely detriment of its creditors.

voluntary winding up are deemed to have been validly taken unless the court, on proof of fraud or mistake, directs otherwise. 7 Insolvency Act 2000 s 1 and Sched 1 para 12(2). This does not apply to winding up petitions brought on grounds of public interest under Insolvency Act 1986 s 124A nor to petitions brought on certain grounds under financial services and banking legislation. Only small companies within the meaning of Companies Act 1985 s 247(3) qualify for the moratorium. 8 Companies Act 1989 ss 163(4) and 175(3)–(5). 9 (1868) LR 3 Ch App 443 at 446–47. 10 In cases where there is a serious risk that assets will be dissipated pending the hearing of the winding up petition, the best course for creditors is to apply to court under s 135 for the appointment of a provisional liquidator. 11 [2000] 1 WLR 906 at 909.

Void Dispositions in Compulsory Winding up 333 8.6 The second aim of section 127 is to uphold the scheme of distribution mandated by insolvency law and ensure that the company’s unencumbered assets available at the commencement of the liquidation are distributed rateably among its unsecured creditors.12 Thus, as a general rule, the court will not validate a disposition where its effect is to confer an advantage on one pre-liquidation creditor at the expense of other equal-ranking creditors as would be the case if, after presentation of the winding up petition, the company used its remaining cash to pay some unsecured creditors in full while leaving the others to prove for a dividend in the liquidation.13 By seeking to preserve the estate and uphold the scheme of distribution in the critical period after commencement of the winding up, section 127 pursues similar goals to those advanced by sections 238 and 239 in relation to transactions occurring in defined periods before commencement of the winding up.14 8.7 A persistent criticism of section 127 is that its application is too broad. Where a disposition is caught by the provision, the legal consequences are drastic. All post-petition dispositions of the company’s property are automatically void at the time they were made.15 Moreover, the provision is indiscriminate. Dispositions that benefit the estate by enhancing the aggregate value of the company’s assets are caught in the same way as dispositions that diminish the estate. This has led one leading commentator to observe that section 127 ‘. . . effectively paralyses the company’s business, for without the leave of the court not so much of a stitch of cloth can be disposed of, not one penny spent even to acquire an asset worth a pound. . .’.16 However, the breadth of the rule is tempered by the court’s power to validate post-petition dispositions and the authorities suggest that the court will exercise this power where the disposition clearly benefits the company and its creditors.17 Nevertheless, the onus is firmly 12

Denney v John Hudson & Co Ltd [1992] BCLC 901; Re Loteka Pty Ltd [1990] 1 Qd R 322. Re Liverpool Civil Service Association ex p Greenwood (1874) 9 Ch App 511; Re The Civil Service and General Store Ltd (1887) 57 LJ ChD 119; Re Gray’s Inn Construction Co Ltd [1980] 1 WLR 711; Tellsa Furniture Pty Ltd v Glendave Nominees Pty Ltd (1987) 9 NSWLR 254. For the principles governing applications for validation see section E below. It will be seen there that the courts are prepared to sanction a departure from the pari passu rule in circumstances where there is likely to be an aggregate benefit to the estate. Thus, the core objective of s 127 is the preservation and/or enhancement of the estate as a whole. The upholding of insolvency law’s distributional rules is strictly a secondary concern. 14 See chs 2 and 4. Transactions entered into by the company after the date of a winding up petition cannot be challenged under ss 238–39 by reason of the relevant time provisions in s 240. The drastic impact of s 127 on post-liquidation transactions reflects the perception that the risk of mischief is at its greatest in the period between presentation of the winding up petition and the making of the order. 15 Re Gray’s Inn Construction Co Ltd [1980] 1 WLR 711 at 716; National Acceptance Corporation Pty Ltd v Benson (1988) 12 NSWLR 213. 16 R Goode, Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 424. Other commentators have suggested that the freeze imposed by s 127 infringes the company’s right to peaceful enjoyment of its property under the ECHR: see M Simmons and T Smith, ‘The Human Rights Act 1998: The Practical Impact on Insolvency’ (2000) 16 Insolvency Law & Practice 167. 17 Section E below. 13

334 Adrian Walters on the party seeking validation to make a case for it. This suggests that section 127 has a third and related aim, namely to ensure that post-petition dispositions are carefully scrutinised and regulated by the court in the interests of the company’s creditors.18 In this sense, the rule also seeks to preserve in advance the integrity of the statutory insolvency regime and prevent the company from conducting an informal process of asset realisation and distribution outside formal winding up.

(3) History of the provision 8.8 The origins of section 127 lie in the centuries old bankruptcy doctrine of ‘relation back’. The effect of the doctrine was to relate the commencement of bankruptcy back to an earlier act of bankruptcy and vest the debtor’s property as it stood at the date of the act of bankruptcy in his trustee.19 Thus, where the debtor disposed of property after committing an act of bankruptcy but before the making of a bankruptcy order, the trustee could assert title to it and claw it back into the estate.20 In company winding up, the assets of the insolvent company do not automatically vest in the liquidator.21 As the liquidator has no ownership rights to assert, it follows that post-petition dispositions of company property cannot be avoided simply by backdating the commencement of winding up to the date of the petition. This explains why a separate avoidance rule was deemed necessary in corporate insolvency. 8.9 The earliest statutory forerunners of section 127 were section 73 of the Joint Stock Companies Act 1856 and section 153 of the Companies Act 1862. The former only caught dispositions that took place after the date of the winding up order whereas the latter provided that in a winding up by the court, ‘. . . all dispositions of the property . . . and every transfer of shares or alteration in the status of members of the company made between the commencement of the winding up and the order for winding up, shall, unless the court otherwise orders, be void.’ The wording was changed to refer simply to ‘. . . dispositions of the property . . . of the company made after the commencement of the winding up’ when the provision was re-enacted by section 205 of the Companies

18 National Acceptance Corporation Pty Ltd v Benson (1988) 12 NSWLR 213 (per Kirby P). The following concise summary was offered in Re Atlas Truck Service Pty Ltd (1974) 24 FLR 220: ‘The object of the section is to hold matters in statu quo during the pendency of the petition, while at the same time permitting those transactions to take place which the court thinks should be sanctioned.’. 19 For background see Insolvency Law Review Committee, Insolvency Law and Practice, (Cmnd 8558, 1982), ch 3; the celebrated Case of the Bankrupts (1584) 76 ER 441 and discussion in Re Dennis (A Bankrupt) [1996] Ch 80. 20 Pre-bankruptcy creditors who received payment from the debtor without notice of any available act of bankruptcy were protected: Bankruptcy Act 1914 s 45 (now repealed); Re Green [1979] 1 WLR 1211; Re Dunkley [1905] 2 KB 683; Re Seaman [1897] 1 QB 412. 21 Re Oriental Bank Corporation ex p Guillemin (1885) 28 Ch D 634 at 640.

Void Dispositions in Compulsory Winding up 335 (Consolidation) Act 1908. Since then the wording has barely altered.22 In particular, the expression ‘after the commencement of the winding up’, introduced in 1908, has been retained with the effect that the provision applies to dispositions of company property made after the date of the order as well as dispositions made in the period between petition and order. An odd feature of the modern law is that remnants of the doctrine of ‘relation back’ survive in corporate insolvency despite its abolition in personal insolvency. An obvious example is section 129 which backdates the commencement of winding up to the date of the petition. By contrast, bankruptcy commences on the date of the bankruptcy order.23 There does not appear to be any compelling justification for this difference in treatment.24

B THE ELEMENTS OF SECTION

127

(1) Elements (a) Substantive elements 8.10 Two elements are needed to trigger the operation of section 127. Firstly, there must be a disposition, transfer or alteration within the meaning of the section occurring after the date of the winding up petition and, secondly, the winding up must actually have commenced. If a winding up petition has been presented but no order has yet been made, section 127 has no immediate operation. Its operation is contingent on a winding up order being made in the future. It follows that a post-petition disposition, transfer or alteration is valid at the time when it took place and continues to be valid so long as no winding up order is made on the petition.25

22 Compare Companies Act 1929 s 173, Companies Act 1948 s 227 and Companies Act 1985 s 522. For a helpful summary of the early history see National Acceptance Corporation Pty Ltd v Benson (1988) 12 NSWLR 213 (per Priestley JA). 23 Insolvency Act 1986 s 278(a). Acts of bankruptcy and ‘relation back’ were abolished by the Insolvency Act 1985. 24 Insolvency Act 1986 s 284 compensates for the abolition of acts of bankruptcy and ‘relation back’ in personal insolvency by providing that any disposition of property made by the debtor in the period between the presentation of the bankruptcy petition and the vesting of his estate in the trustee is void except to the extent that it is or was made with the consent of the court, or is or was subsequently ratified by the court. For a useful account of the historical divergence between the applicable provisions in corporate and personal insolvency prior to 1985 see N Furey, ‘The Validation of Transactions Involving the Property of Insolvent Debtors’ (1983) 46 Modern Law Review 257. 25 A winding up order is not automatic. For example, the court may restrain winding up proceedings as an abuse of process if satisfied that the petition debt is disputed on bona fide and substantial grounds: see, eg Re Gold Hill Mines (1883) 23 Ch D 210; Mann v Goldstein [1968] 1 WLR 1091; Stonegate Securities Ltd v Gregory [1980] Ch 576; Re Trinity Assurance Co Ltd [1990] BCC 235; Re Janeash Ltd [1990] BCC 250; Re a Company (No 006685 of 1996) [1997] 1 BCLC 639; JSF Finance Ltd v Akma Solutions Inc [2001] 2 BCLC 307.

336 Adrian Walters 8.11 The position changes once a winding up order is made. At that point the winding up actually commences and is treated by section 129(2) as having commenced from the date of the petition. As a result, any post-petition disposition, transfer or alteration becomes retrospectively and presumptively void at the point it was made unless the court otherwise orders. We can illustrate the point by returning to the example given in the introduction. If we assume for present purposes that A Ltd made a disposition of its property to X on 1 April the sequence would be as follows: 1 March Creditor presents winding up petition. 1 April A Ltd makes disposition of its property to X (valid as at 1 April but continuing validity contingent upon whether or not a winding up order is made). 1 May Court makes winding up order (disposition retrospectively void as at 1 April and remaining presumptively void unless a validation order is made). 8.12 Thus, it is conceivable that a disposition, transfer or alteration could in quick succession be valid, void and then valid again. However, once a winding up order has been made the continuing validity of the earlier disposition, transfer or alteration will depend entirely on whether or not the court is prepared to validate it.26 (b) Legal consequences of avoidance 8.13 As we have seen, section 127 affects the legal status of any post-petition disposition, transfer or alteration by rendering it retrospectively and presumptively void. However, the provision says nothing about the legal consequences of ‘voidness’. This leaves important questions about the basis and scope of any available remedies to be determined by the court under the general law.27

(2) ‘Any disposition of the company’s property. . .’ 8.14 ‘Property’ is defined broadly in section 436 of the Insolvency Act 1986 to include, ‘money, goods, things in action, land and every description of property wherever situated and also obligations and every description of interest, 26 It follows that a party in X’s position has either an indefeasible title (assuming that no order is made on the petition or that the court validates the disposition) or no title: see, by analogy, Re Dennis (A Bankrupt) [1996] Ch 80. X’s title during the period between date of petition and order (1 April and 1 May) is curiously ambulatory. It should be added that the power of the directors to authorise dealings with the company’s property does not cease on presentation of a winding up petition, even if a winding up order is subsequently made: Re Oriental Bank Corporation ex p Guillemin (1885) 28 Ch D 634. 27 Re J Leslie Engineers Co Ltd [1976] 1 WLR 292 at 298. See further section C below.

Void Dispositions in Compulsory Winding up 337 whether present or future or vested or contingent, arising out of, or incidental to, property’ and therefore encompasses any asset, whether tangible or intangible, having a realisable value. ‘Disposition’ is not defined. However, it should not be assumed that the statutory language can usefully be broken up into its component parts for the purposes of construction. The preferable approach is for the court to construe the phrase, ‘any disposition of the company’s property . . .’ as a whole, having regard to the purpose of section 127.28 8.15 In Re Mal Bower’s Macquarie Electrical Centre Pty Ltd,29 Street CJ traced the origins of the word ‘disposition’ back to the word ‘dispone’, a Scots law term meaning to transfer or alienate. It follows that for the section to operate there needs to be a disposition amounting to an alienation of the company’s property.30 The point was developed by McPherson J who held in Re Loteka Pty Ltd that in order for a transaction to constitute a disposition of the company’s property within the Queensland equivalent of section 127, there needed to be some change that takes the beneficial ownership of a corporate asset from the company and passes it to someone else.31 McPherson J’s formulation should not, however, be regarded as an exhaustive definition and it may be more helpful to say that the terms ‘disposition’ and ‘alienation’ are capable of embracing any transaction that involves the grant or transfer of proprietary rights in the company’s assets. By way of illustration, the following categories of transaction have been held to constitute a disposition of company property within the meaning of section 127 or an equivalent provision in another jurisdiction: (a) An outright transfer by the company of its assets, whether by gift, sale or exchange.32 (b) The grant of a mortgage, charge or lease by the company over its assets.33 (c) The grant of an equitable interest by the company in its assets whether by declaration of trust or otherwise.34

28 Wily v Commonwealth (1996) 66 FCR 206 at 233. Hollicourt (Contracts) Ltd v Bank of Ireland [2001] Ch 555 can be prayed in aid as further support for a strongly purposive approach to the construction of s 127. 29 [1974] 1 NSWLR 254. 30 Hollicourt (Contracts) Ltd v Bank of Ireland [2001] Ch 555 citing Mersey Steel and Iron Co v Naylor, Benzon & Co (1884) 9 App Cas 434 at 440. 31 [1990] 1 Qd R 322. See also Wily v Commonwealth (1996) 66 FCR 206. 32 Re Wiltshire Iron Company (1868) LR 3 Ch App 443 (sale of goods); Re AI Levy (Holdings) Ltd [1964] Ch 19 (sale of leasehold interest in land); Re Tramway Building & Construction Co Ltd [1988] Ch 293 (sale of freehold in building site); Re Sugar Properties (Derisley Wood) Ltd (1987) 3 BCC 88 (sale of shares in racehorses). Strictly, ‘outright transfers’ also encompass payments but, for convenience of treatment, these are separately categorised. 33 Re International Life Assurance Society (1870) LR 10 Eq 312; Re Park Ward & Co Ltd [1926] Ch 828; Re Steane’s (Bournemouth) Ltd [1950] 1 All ER 21; Albion Reid (SA) Pty Ltd v Baron Holdings Pty Ltd (1973) 7 SASR 564; Re Omnico Ltd (1976) 1 ACLR 381; Re Falkiner Chains Pty Ltd (1981) 6 ACLR 94; Jardio Holdings Pty Ltd v Dorcon Construction Pty Ltd (1984) 3 FCR 311. 34 Re Selmar Pty Ltd [1978] VR 531 (buyer acquiring equitable interest in company’s land under post-petition contract for sale).

338 Adrian Walters (d) A payment made with company money (including payments made in discharge of a valid debt or contractual obligation).35 8.16 All these forms of transaction have the potential to reduce the assets available for distribution to the general body of creditors and so are clearly within the mischief of the section.36 Any such disposition would still be caught if made by the company pursuant to an order of the court. Thus, in Re Flint,37 a case decided under section 284, the analogous provision applicable to personal insolvency, it was held that a transfer of a husband’s interest in the matrimonial home to his ex-wife under the terms of a consent order in divorce proceedings was void as a post-petition disposition of property that had not been ratified by the bankruptcy court.38 8.17 On the other side of the coin, the courts have held that the following transactions do not involve a disposition of the company’s property: (a) A transfer of charged property to the chargee. 8.18 In Re Margart Pty Ltd, Hamilton v Westpac Banking Corp39 the company granted fixed and floating charges over its assets in favour of the defendant bank to secure repayment of a loan. After a winding up petition had been presented against the company, its assets were auctioned off and the proceeds of

35 Re Liverpool Civil Service Association ex p Greenwood (1874) 9 Ch App 511; Re The Civil Service and General Store Ltd (1887) 57 LJ Ch D 119; Re Clifton Place Garage Ltd [1970] Ch 477; Re Atlas Truck Service Pty Ltd (1974) 24 FLR 220; Re Western Welsh International System Buildings Ltd (1985) 1 BCC 99, 296; Re Webb Electrical Ltd [1988] BCLC 382; Adelaide Truss & Frame Pty Ltd v Bianco Hiring Services Pty Ltd (1992) 60 SASR 160; Tasmanian Primary Distributors Pty Ltd v RC & MB Steinhardt Pty Ltd (1994) 13 ACSR 92; Tellsa Furniture Pty Ltd v Glendave Nominees Pty Ltd (1987) 9 NSWLR 254 but note that money used to make the payment may lose its identity as company property if it is mixed with the funds of a third party: Re J Leslie Engineers Co Ltd [1976] 1 WLR 292. A problem that frequently arises in practice concerns the position of the petitioning creditor. If the company pays the debt after the petition is advertised and consents to the withdrawal or dismissal of the proceedings, there is a risk that another creditor could take carriage of the petition under r 4.19 of the Insolvency Rules 1986. If an order is then made on the petition, the payment to the original creditor is a void disposition: Re Western Welsh International System Buildings Ltd (1985) 1 BCC 99,296. For this reason, the petitioning creditor will usually insist that the debt is paid by a third party. 36 Although there is no authority on the point, it appears that a grant or transfer of possession by the company by way of security (pledge or lien) or bailment would also constitute a disposition of company property because the holder acquires ‘special property’ in the asset: see further paras 6.31–6.34. For background, see R Goode, Commercial Law, 2nd edn (Penguin, 1995), ch 2 and for an American case in point see Re Owners of Harvey Oil Center (1982) 25 BR 979 (pledge of certificates of deposit to bank held to be an invalid transfer of bankrupt’s property caught by 11 USC 549). 37 [1993] Ch 319. 38 See also Burton v Burton [1986] 2 FLR 419. It might be argued in reliance on Re Flint that court-ordered modes of execution, such as the making of a charging order under the Charging Orders Act 1979, are capable of falling within s 127. The better view is that any post-petition attachment or execution is avoided by section 128 which was specifically enacted for the purpose. 39 (1984) 79 FLR 330, [1985] BCLC 314.

Void Dispositions in Compulsory Winding up 339 sale of the charged assets were remitted to the bank. It was held that this was not a disposition of company property because the chargee enjoyed a pre-existing equitable interest in the charged assets by virtue of the charge and so the receipt of the proceeds did not involve any transfer of beneficial ownership.40 Moreover, in Helsham CJ’s view, the provision was not intended to catch any transaction concerned with the enforcement of security: To hold otherwise would mean that assets covered by a fixed charge, or their monetary equivalent, could not with impunity be taken by or paid to the person having the benefit of the charge at any time after the commencement of the winding up. Anything done by the company or a receiver to pay the chargee or transfer assets to the chargee would be void. No bank or other person holding a charge under which moneys had become payable could take payment without the precaution of obtaining . . . a validating order. I do not believe that [the section] was intended to operate in that way.

8.19 The decision in Re Margart Pty Ltd is clearly sensible as a matter of policy. It would be unfortunate if section 127 was construed as entitling the company to recover charged property from the chargee when in the end result the property would be held for the chargee’s benefit.41 In the later case of Wily v The Commonwealth, the court extended the principle in Re Margart Pty Ltd to hold that a series of payments made by a receiver in respect of licence fees due from the company to a third party creditor were not dispositions of company property within the meaning of the equivalent provision in Australia’s Corporations Law.42

40 The court proceeded on the assumption that the bank’s floating charge had not crystallised before the commencement of winding up and the decision therefore rests on the view that the holder of a floating charge has a proprietary interest in the charged assets prior to crystallisation. This assumption is not universally accepted: see, eg Lyford v Commonwealth Bank of Australia (1995) 130 ALR 267 and discussion in G Lightman & G Moss, The Law of Receivers and Administrators of Companies, 3rd edn (London, Sweet & Maxwell, 2000), ch 3. A further point is that a floating charge is generally regarded as a present security and is treated as attaching to after-acquired property from the date of its creation: see R Goode, Commercial Law, 2nd edn (Penguin, 1995), ch 23. It follows that there is no separate disposition capable of being caught by s 127 at the point when the company acquires property falling within the scope of the charge. 41 It might be argued that a disposition of charged assets should be treated as falling within the section as, on the chargee’s application for validation, the court could enquire as to whether any sale of the assets was at fair value. However, this reading would interfere with the chargee’s right to enforce his security on the company’s default and, in the event that the assets were sold at a gross undervalue, the company would not be without a remedy: see, eg Cuckmere Brick Co Ltd v Mutual Finance Ltd [1971] Ch 949; Palk v Mortgage Services Funding plc [1993] Ch 330. 42 See also Re Ravi Nominees Pty Ltd (1993) 10 ACSR 599. Wily differs from Margart Pty as in the former the payments were made to a third party rather than to the charge holder. By a majority, the court ruled in Wily that the exercise of powers conferred on the receivers by the debenture was not affected by the liquidator’s appointment with the result that the relevant property was not the company’s to dispose of. The decision is consistent with the reasoning in Sowman v David Samuel Trust Ltd [1978] 1 WLR 22. It also reflects the prevailing view that, save for limited purposes concerning the statutory ranking of expenses and preferential creditors, ‘company property’ in the liquidation context does not include encumbered assets: see further paras 1.11–1.15.

340 Adrian Walters (b) A transfer of property held by the company as trustee. 8.20 In All Benefit Pty Ltd v Registrar General 43 the company held land on trust for beneficiaries. After a winding up petition had been presented against the company it sought to transfer title to the land to new trustees. It was held that the transfer was not a void disposition because property held on trust does not form part of the ‘property of the company’. This reflects the usual understanding that the insolvent estate consists only of property to which the company is beneficially entitled and which is capable of being realised for the benefit of its creditors. Like transactions involving the realisation of security (considered above), dealings of this nature have no impact on the insolvent estate as it stands at the commencement of winding up. (c) A transfer of legal title under a specifically enforceable contract entered into by the company prior to the commencement of winding up. 8.21 In Re French’s (Wine Bar) Ltd44 the company entered into a contract for the sale of its leasehold premises and business. The completion of the contract took place in the period between the presentation of a winding up petition against the company and the making of the winding up order. The question arose as to whether the completion of the sale was a void disposition. Vinelott J held that the completion of an unconditional and specifically enforceable contract for the sale of property entered into before the date of the petition falls outside the section. The decision rests on the rule that the buyer under a specifically enforceable contract of sale obtains beneficial ownership of the underlying property at the time the contract was entered into.45 Thus, the company was treated in equity as having disposed of the beneficial interest in the property before the commencement of the winding up. 8.22 Where the contract is conditional or voidable or its terms are subsequently varied, it was suggested that completion of the contract might constitute a disposition of the company’s property. Thus, unless the contract is plainly specifically enforceable and there is no possible defence, the best course is to apply to have completion of the contract validated. On the facts in Re French’s (Wine Bar) Ltd, the contract could no longer have been rescinded as it would have been impossible to restore the parties to their pre-contractual positions. The company had no funds with which to repay the deposit and the buyer had been permitted to go into occupation before completion and so had been running the business as its own for some time. In the circumstances, Vinelott J made 43

(1993) 11 ACSR 578. [1987] BCLC 499. 45 See also Re Country Stores Pty Ltd [1987] 2 Qd R 318. If the contract of sale is entered into after the commencement of winding up the transfer of the equitable interest would be caught by section 127: Re Selmar Pty Ltd [1978] VR 531. 44

Void Dispositions in Compulsory Winding up 341 an order validating the completion of the contract in so far as it could be said to involve any post-petition disposition of the company’s property. (d) Notice of assignment of a debt. 8.23 Clearly, if the company assigns its debts after the commencement of winding up, the assignment will be a void disposition as the debts are choses in action, ie a form of intangible property.46 The position is different if the company assigns a debt before the commencement of winding up in circumstances where the debtor does not receive notice of assignment until after commencement of the winding up. In that case, it has been held that the giving of notice does not amount to a disposition.47 The reason is that an equitable assignment of a debt takes effect as between the assignor and the assignee without the need for notice. Notice is only necessary to preserve the priority of the assignee over subsequent assignees under the rule in Dearle v Hall.48 (e) Executory contracts. 8.24 Section 127 does not affect contracts or transactions per se. It only affects the passing of title to property under a contract. In the straightforward case of an unconditional contract for the sale of specific goods, it is presumed in the absence of an express or implied term to the contrary, that the parties intend property in the goods to pass to the buyer when the contract is made.49 Thus, if the company agrees to supply specific goods to a buyer after the commencement of winding up, the contract involves a disposition even where the goods have not yet been delivered or paid for. However, in the case of a contract for the sale of unascertained or future goods by description, the property in the goods only passes when goods of that description become ascertained50 and are unconditionally appropriated to the contract either by the seller with the buyer’s assent or vice versa.51 To illustrate, let us say that A Ltd, a company which is the subject of pending winding up proceedings, agrees to supply X with two tons of sand. If the two tons of sand are not taken from the company’s stockpiles and unconditionally appropriated to the contract with X by the time the winding up order is made, there is no disposition. The sand will remain part of A Ltd’s estate and, if X has paid in advance, he will be left with an unsecured personal claim for the price and damages for breach of contract. If, however, the two tons of sand are placed in a container, delivered to a carrier and are in transit to X

46 47 48 49 50 51

See paras 1.16–1.24. Gorringe v Irwell India Rubber and Gutta Percha Works (1887) 34 Ch D 128. (1828) 3 Russ 1, [1824–34] All ER Rep 28. Sale of Goods Act 1979 ss 17 and s 18 rule 1. Ibid s 16. Ibid s 18 rule 5(1).

342 Adrian Walters when the winding up order is made, there is arguably an unconditional appropriation52 in which case performance of the contract does involve a disposition. Ironically, it is better for the pre-paying buyer to establish that a disposition has taken place because the court might be persuaded to validate it.53 If, alternatively, property in the goods remains in the estate at the time of the winding up order, the buyer will not be entitled to an order for delivery and will rank as an unsecured creditor. (f) The incurring of liabilities by the company. 8.25 Section 127 does not prevent a company from incurring or continuing to incur liabilities nor does it invalidate liabilities so incurred. It follows that an increase in the company’s overdraft in the period between presentation of the petition and the making of the winding up order is beyond the scope of the provision.54 Similarly, there is no disposition where property carrying with it a potential liability is transferred to the company by a third party.55 (g) The use or consumption of the company’s assets by the company itself. 8.26 Section 127 does not impact on the company’s use, consumption or exhaustion of its assets. Thus, while an agreed overdraft limit is treated in the criminal law as ‘property’ capable of being stolen by the presentation of forged cheques,56 the use, consumption or exhaustion of that overdraft limit by the company is not a disposition within the section.57 No rights in any identifiable property are transferred to or conferred on any other party. Conversely, where there is a credit balance on the company’s bank account, it is clear that the act of cashing a cheque drawn on the account extinguishes an asset in the form of the bank’s debt for the amount of the cheque. However, the cashing of a cheque does not involve an assignment of the company’s claim on the bank and for as long as the company retains the cash proceeds, there is no disposition within the section because, again, property rights have not passed from the company to any other party.58 For 52 Sale of Goods Act 1979 s 18 r 5(2). The position is different if the goods to be supplied form part of an identifiable bulk: ibid s 20A. On the distinction between unascertained goods and goods sold ‘ex-bulk’ see Re Goldcorp Exchange Ltd [1995] 1 AC 74 and on these issues generally see Goode, Commercial Law, 2nd edn (Penguin, 1995), ch 8. 53 Re Wiltshire Iron Company (1868) LR 3 Ch App 443. If the buyer is aware of the pending winding up petition and wishes to proceed with the transaction, his best course is to apply pre-emptively for a validation order before embarking on the transaction as it is now settled that the court has jurisdiction to make validation orders before a winding up order is made: see section E below. 54 Coutts & Co v Stock [2000] 1 WLR 906 at 910. 55 Re Barned’s Banking Co (1867) LR 3 Ch App 105. 56 R v Kohn (1979) 69 Cr App R 395. 57 Coutts & Co v Stock [2000] 1 WLR 906 at 910. 58 Re Mal Bower’s Macquarie Electrical Centre Pty Ltd [1974] 1 NSWLR 254 at 258. Similarly, the purchase of a banker’s draft by the company is not of itself a disposition: Tasmanian Primary Distributors Pty Ltd v RC & MB Steinhardt Pty Ltd (1994) 13 ACSR 92; Thomas v Hatzipetros (1997) 24 ACSR 286. Clearly, the position changes if the proceeds withdrawn are used to pay

Void Dispositions in Compulsory Winding up 343 the same reason, the collection of the company’s book debts does not involve any disposition within the section. Intangible property in the form of the uncollected debt is simply extinguished and replaced by cash proceeds or some other asset in the hands of the company depending on the method of payment.59 8.27 Given the lack of statutory amplification, the phrase ‘any disposition of the company’s property’ appears open-ended and potentially far-reaching. In relation to the matters already discussed, the law is fairly settled. Inevitably, however, there are grey areas. Two particular and related areas of difficulty are now considered: (h) Transfers of value. 8.28 We saw above that there is no disposition where the company simply uses, consumes or exhausts its assets. Goode asserts that the position is different in relation to transactions which have the effect of reducing or extinguishing the company’s rights in an asset, and which in so doing transfer value to another person. On this basis he argues that the phrase ‘disposition of company property’ is capable of embracing: (i) an agreement by which the company surrenders a lease or gives up contractual rights; (ii) the conferment and exercise of rights of contractual or equitable set-off by a company debtor; and (iii) a post-petition payment to a judgment creditor made by a company debtor under a garnishee order.60 8.29 At first sight, Goode’s argument is attractive. As all of these forms of transaction may subtract value from the insolvent estate, they arguably fall within the mischief of the section. However, the case for saying that an agreement for surrender of a lease would constitute a ‘disposition of the company’s property’ is not entirely compelling. The surrender of a lease involves the extinction of the lessee’s property rights rather than their grant or transfer. The lessor does not acquire any new proprietary rights in the process even though his property may well have a greater value freed from the lessee’s interest.61 creditors or are paid into the bank account of a third party: Re J Leslie Engineers Co Ltd [1976] 1 WLR 292; Thomas v Hatzipetros (1997) 24 ACSR 286 (in both cases cheques drawn on the company’s account were credited to the personal account of a director). 59 R Goode, Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 425. Where payment is tendered by cheque all that happens is that one chose in action (the debt) is extinguished and replaced by another (an action on the cheque): Re Barn Crown Ltd [1995] 1 WLR 147 at 152. 60 R Goode, Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 424–25. 61 See, by analogy, Mosaic Oil NL v Angari Pty Ltd (No 2) [1990] 20 NSWLR 280 (forfeiture of joint venturer’s share in enterprise after commencement of winding up not a disposition for want of a disponee even though the value of the other venturers’ interests might increase as a result). Note however that a contract term vesting an asset of the company in another party on the company’s liquidation would be caught and would, in any event, fall foul of the rule in Re Harrison, ex p Jay (1880) 14 Ch D 19: see discussion in Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd [2001] 2 BCLC 347 and paras 1.58–1.64.

344 Adrian Walters 8.30 Equally, it is not immediately clear that the other transactions mentioned by Goode involve the company in granting or transferring an interest in its assets in favour of a third party. If a debtor of the company has a right of set-off, there is no doubt that the company’s claim against that debtor will be reduced or extinguished depending on the extent of the set-off. But set-off is technically not a form of security. It does not confer any proprietary rights over the company’s assets in favour of the debtor. It operates to release the debtor from the obligation to pay the company in full. One way around this problem might be to treat the transaction giving rise to a right of set-off as if it were, in substance, a postpetition payment. Take as an example the banker’s right to combine accounts. What if, after the commencement of winding up, the company pays a sum to the credit of one account which the bank then uses to discharge a debt owing to it on a separate account? It is clear that if the company had paid the debt directly, the payment would have been avoided by section 127. Thus, it is arguable that the exercise of the set-off amounts, in substance, to a disposition of the company’s property in favour of the bank.62 However, in cases where the counterparty is seeking to set off a post-petition debt against its own liability to the company, it is straining language to suggest that the incurring of the debt by the company could be treated as a payment to the counterparty and, therefore, as a disposition of the company’s property.63 8.31 Payments under a garnishee order also present difficulties. Let us say, for example, that there is a credit balance on an account held by A Ltd with X Bank and that Y, a judgment creditor of A Ltd, obtains a garnishee order absolute requiring X Bank to pay the amount represented by the credit balance to Y rather than A Ltd. Clearly, when X Bank pays Y and debits A Ltd’s account, the

62 For an analogous case see Re Buchanan Enterprises Pty Ltd (1982) 7 ACLR 407. The liquidator brought proceedings against one of the company’s directors seeking repayment of monies withdrawn from the company’s bank account and damages for conversion of a motor vehicle. After the commencement of winding up, the director paid a debt owed by the company from his personal funds. It was held that the director was not entitled to set off this sum against the sums claimed from him by the liquidator as if the debt had been paid from company funds, the payment would clearly have been a void disposition. In relation to the banker’s right to combine accounts it may be unnecessary to rely on the reasoning put forward in the text to this footnote as Re Barn Crown Ltd [1995] 1 WLR 147 is authority for the proposition that the crediting of the first account is itself a void disposition. However, the point is controversial: see paras 8.33–8.43 below. 63 It is thought that the operation of mandatory set-off under r 4.90 of the Insolvency Rules 1986 is unaffected by s 127: see R Goode, Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 425; P Wood, English and International Set-Off (London, Sweet & Maxwell, 1989), from para. 7-303 cf Barclays Bank Ltd v TOSG Trust Fund Ltd [1984] BCLC 1. Two objections are advanced. Firstly, the set-off is self-executing ie there is no dispositive act by the company. Secondly, if section 127 did apply, it would render irrelevant the provision in rule 4.90 requiring an account of the parties’ mutual dealings to be taken at the point when the company ‘goes into liquidation’, meaning on the date of the winding up order. These objections can be supported by reference to the principles set out in Stein v Blake [1996] AC 243.

Void Dispositions in Compulsory Winding up 345 payment extinguishes A Ltd’s claim on the bank. However, unless a garnishee order can be said to take effect as an assignment of the bank’s debt or a security over book debts and credit balances, no right in the company’s property moves from A Ltd to Y. Strictly, Y receives the bank’s money and not A Ltd’s money.64 In any event, a post-petition garnishee order and any payment under it would be avoided by section 128 of the Insolvency Act 1986 as an ‘attachment, sequestration, distress or execution put in force against the estate or effects of the company after the commencement of winding up’.65 8.32 Thus, on a strict reading of the section, it is submitted that a mere shift in value will not usually be caught unless it is accompanied by the transfer of some identifiable proprietary right from the company to another party.66 However, in cases like those mentioned where value is subtracted from the company and transferred to another party, the court may be persuaded to adopt a more purposive construction of the phrase, ‘any disposition of the company’s property’ on the basis that the counterparty is enriched at the expense of the insolvent estate. This less technical approach accords with that adopted by the Federal Court of Australia in Wily v Commonwealth where it was said that the section should be construed as a whole, having regard to its purpose rather than being reduced to its component parts.67 Applying such an approach, the court could conceivably equate a shift of realisable value from the company to another with a ‘disposition of property’ and conclude that a transaction falls within the section without the need to identify any grant or transfer of property rights in the formal sense.68 In the light of this tension between literal and purposive constructions, the safest course for any party affected is to apply for declaratory relief and a validation order to the extent that the court declares that the transaction is a disposition within the meaning of the section.

64 Foley v Hill (1848) 2 HL Cas 28; Joachimson v Swiss Bank Corporation [1921] 3 KB 110; Halesowen Presswork and Assemblies Ltd v National Westminster Bank Ltd [1971] 1 QB 1, 33–34 (Lord Denning MR), 46 (Buckley LJ) reversed on other grounds: [1972] AC 785. To the extent that the bank can be said to deal with company property it arguably does so as agent: Hollicourt (Contracts) Ltd v Bank of Ireland [2001] Ch 555. 65 The position where payment is made under a garnishee order absolute that pre-dates the petition is governed by s 183. 66 Goode suggests further that where a bank holds security for future advances, an increase in the company’s overdraft is a disposition of the company’s property because it expands the quantum of the bank’s security interest, and correspondingly reduces the company’s equity in the charged assets: Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 432. This conclusion can be contested on similar grounds to those advanced above. 67 (1996) 66 FCR 206 (per Sackville J). 68 So, for example, surrender of a lease or waiver of contractual rights should be caught by the provision because, as a matter of policy, it ought to be left to the liquidator to determine if the lease or contract has a realisable value and decide accordingly whether or not to disclaim it. Such an approach would properly reflect the collective character of the winding up process.

346 Adrian Walters (i) Asset swaps and conversions: the problem of post-petition payments into the company’s bank account where the account is in credit. 8.33 Let us say that A Ltd owns one parcel of land, Whiteacre and B owns another, Greenacre. There is no doubt that there would be a disposition of the company’s property within section 127 if, after the commencement of its winding up, A Ltd exchanged Whiteacre for Greenacre. One element of the transaction is the outright transfer of Whiteacre from A Ltd to B. Moreover, the transaction falls squarely within the mischief of the section as A Ltd’s estate will be diminished if Greenacre turns out to have been worth less than Whiteacre. Asset exchanges of this type are straightforward. However, the position is less obvious in relation to other forms of asset swap. A particular problem in this regard concerns payments made by the company after the commencement of winding up into a bank account which is in credit. 8.34 To take an example, let us say that a company the subject of pending winding up proceedings pays £500 into a bank account that is already in credit. The £500 in the company’s hands becomes a claim against the bank for the equivalent sum. As long as the bank is (i) solvent and (ii) has no set-off rights, there is no diminution of the estate. The value of the ‘asset’ paid in (eg cash, cheque or electronic payment) is its face value and the corresponding value, in our case £500, will be credited to the account. Nevertheless, the question arises as to whether such a payment in is a disposition of the company’s property avoided by section 127. 8.35 In attempting to answer this question, we need to distinguish payments in of cash from payments in of third party cheques or those resulting from electronic transfers. Goode’s view, shared by the present writer, is that a payment in of cash constitutes a disposition of company property because, although it merely converts one asset of the company (cash) into another asset (a corresponding claim on the bank) with the effect that the estate will not usually be diminished, the company transfers ownership of the physical notes and coins to the bank by delivery.69 8.36 The position in relation to payments in of cheques is more difficult. The starting and finishing points are easy enough to identify. The company starts with a claim against the drawer of the cheque and ends up with a claim against its bank once the cheque has been collected and the amount credited to the account. One chose in action is converted into another of equal value. The difficult question is whether the collection of the cheque through the bank payment system involves any grant or transfer of property rights to the collecting bank.

69 Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 427. This reflects the point that money is negotiable.

Void Dispositions in Compulsory Winding up 347 8.37 In Re Barn Crown Ltd 70 it was held that the process is merely one of asset substitution. The property in the cheque is transformed into a debt owed by the bank to the company but as the latter remains within the company’s control the process does not involve any transfer or alienation of the company’s property and is therefore not a disposition. In collecting the cheque, the bank acts as its customer’s agent and so all that happens as between the bank and the company is a movement on accounts. The amount standing to the credit of the company’s account (ie the bank’s debt) is increased in return for the surrender of the cheque to the paying bank. If Barn Crown is right, the bank never receives the company’s property for its own benefit. The only ‘disposition’ taking place is a disposition of the drawer’s property, presumably by delivery of the cheque to the company. It is therefore the company as payee of the cheque, not the collecting bank that in substance, receives the benefit of the proceeds of the cheque.71 On this view, the company is treated implicitly as if it had received payment directly from the drawer in cash rather than indirectly in the form of a credit to its bank account. The fact that the payment was made by cheque becomes incidental and any analysis of the mechanics of payment through the bank clearing system and the associated debiting and crediting of accounts is obviated.72 Presumably, Barn Crown would apply in the same way to other payment methods, including payments by electronic means, ie the matching debits and credits would be treated as reflecting nothing more than the transmission of the payor’s property to the payee. 8.38 Although there is no direct authority to the contrary, the view advanced in Barn Crown is widely regarded as wrong. In the earlier case of Re Gray’s Inn Construction Co Ltd,73 Buckley LJ suggested that payment in of a cheque when the account was in credit would constitute a disposition of the amount of the cheque in favour of the bank. However, the point was obiter as in Gray’s Inn the company’s account was overdrawn at all relevant times and no further explanation was given. Similarly, in Re McGuinness Bros (UK) Ltd,74 it seems to have been accepted that any payment into a bank account (whether or not the account was in credit) would be a disposition, cadit quaestio. Again, however, it is not clear from the facts of McGuinness whether the account was ever in credit. All that can be discerned is that there was a net reduction in the company’s overdraft between the date of the petition and the date the matter was heard by the court.

70

[1995] 1 WLR 147. Re Loteka Pty Ltd [1990] 1 Qd R 322. 72 Support for Barn Crown can be derived from United States bankruptcy law: see Katz v First National Bank of Glen Head 568 F2d 964 (2nd Cir 1977) holding that deposits into a current account from which the company is free to make withdrawals create a debt owed to the depositor by the bank and do not involve any transfer of the depositor’s property. 73 [1980] 1 WLR 711. 74 (1987) 3 BCC 571. 71

348 Adrian Walters 8.39 The case for saying that Barn Crown is wrong has been put forcefully by Goode.75 He argues that the presentation of the cheque itself involves no disposition in favour of the bank because the bank acts merely as agent for the purposes of collection and has no interest of its own in the cheque.76 To this extent, he is prepared to go along with the reasoning in Barn Crown. However, in Goode’s view, there is a disposition of the collected proceeds in the bank’s favour as, by virtue of the bank-customer relationship, the bank is treated as borrowing the proceeds from the company in exchange for a promise to pay an equivalent sum at the point when the account is credited.77 8.40 In practice, however, there is no physical movement of funds or property. The collection of a cheque involves a series of adjustments to various accounts. By virtue of the clearing and settlement process, the collecting bank’s own account with the clearing house is credited (or debited depending on its net position as against the paying bank). The drawer’s account is debited and the payee’s account credited with an equivalent sum. Strictly, the property in the cheque is extinguished in the process and a new chose in action in the form of a claim on the bank is created. There is no obvious movement of property from company to bank. Moreover, to the extent that the collecting bank receives a credit to its own account once the cheque is cleared, there is no transfer of value from company to bank because the company acquires a claim against the bank for the same amount. If Goode is correct it must be on the basis that the credit entered in the bank’s books following clearing and settlement represents the traceable proceeds of the property in the cheque.78 8.41 It might be thought that the issue of payments into bank accounts that are in credit is largely academic. If A Ltd pays £500 into a bank account with a zero starting balance, the company in liquidation will have a claim on the bank for £500 regardless of whether or not the payment is caught by section 127. However, if the bank account remains active between the date of the petition and the winding up order, the point becomes less theoretical. Take the following example:

75

Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 427–29. The collecting bank does not become a holder for value of the cheque at any time before it is cleared: AL Underwood Ltd v Barclays Bank [1924] 1 KB 775; National Commercial Banking Corporation of Australia Ltd v Batty (1986) 160 CLR 251. 77 Joachimson v Swiss Bank Corporation [1921] 3 KB 110. 78 This, however, gives rise to two problems. Firstly, the property in the cheque arguably loses its identity on its journey through the clearing system. Secondly, we come full circle as the company’s claim to its ‘property’ ends up as nothing more than the claim it has on the bank for the credit balance in any event. Many of the difficulties in this area arise because of the dual characterisation of the bank-customer relationship as debtor-creditor and principal-agent. It is settled that a credit balance is a debt but when the bank effects or collects payment as agent on the customer’s behalf and adjusts the account it is also said to be dealing with the customer’s property even though strictly this is not the case: see, eg Westminster Bank Ltd v Hilton (1926) 136 LT 315. 76

Void Dispositions in Compulsory Winding up 349 1 March

Creditor presents winding up petition against A Ltd. A Ltd’s bank account has a zero balance. 2 March A Ltd pays a cheque for £500 into the bank account. 3 March A Ltd draws cheques in the total sum of £1,500 on the bank account in favour of creditors. 31 March A winding up order is made. A Ltd is £1,000 overdrawn. 8.42 It is now settled that the company would have no remedy under section 127 against the bank in relation to the payments out of the account on 3 March.79 If, however, the initial payment in is a disposition, the liquidator could recover the £500 under section 127 even though the company’s original claim on the bank has been extinguished by the subsequent movements on the account. The position would be the same in relation to an active account that fluctuates in and out of credit. A second problem concerns the operation of insolvency set-off. It is generally thought that the process of insolvency set-off does not itself give rise to a disposition within section 127.80 Thus, to vary our example, if A Ltd had paid the £500 into a separate account, section 127 would not prevent the bank from setting this off against the company’s liability to the bank on other accounts unless the transaction can be treated, in substance, as a payment to the bank.81 If, however, the initial payment in is recoverable under section 127, it would cease to be available for purposes of set-off. This suggests that there may be some incentive for the liquidator to seek to defeat the bank’s rights of set-off (if any) by challenging the payment in.82 In the light of these incentives and given the uncertainty surrounding post-liquidation payments into bank accounts that are in credit, the bank should require the company to seek the protection of a validation order in relation to any ongoing facilities on becoming aware that a petition is pending. 8.43 For completeness, the position where payment is made into an overdrawn account should be mentioned. In substance, this is no different from the company making a payment to an ordinary creditor. Assets in the hands of the company are used to reduce or extinguish the debt owed to the bank and the estate 79 See Hollicourt (Contracts) Ltd v Bank of Ireland [2001] Ch 555 and discussion in section D below. 80 See n 63 above. 81 See para 8.30 above. If the bank had notice of the winding up petition when a sum owed to it by the company became due, that sum cannot be brought into account for the purposes of insolvency set-off: Insolvency Rules 1986, r 4.90(3). For these purposes the advertisement of the petition constitutes notice to the whole world: Re London, Hamburg, and Continental Exchange Bank (1866) LR 2 Eq 231. However, r 4.90(3) says nothing about sums becoming due from the bank to the company and therefore does not affect the result in Halesowen Presswork and Assemblies Ltd v National Westminster Bank Ltd [1972] AC 785 (bank allowed to set off credit balance against preliquidation debits on another account even though the bank knew that the company was shortly to enter creditors’ voluntary liquidation when the credit balance arose). 82 There remains the difficult question of whether the bank would be entitled to set-off any sum it is ordered to repay by the court against the company’s pre-liquidation indebtedness to the bank. It is clear that the bank’s liability to repay could not be set off against increases in the company’s overdraft occurring after advertisement of the petition because of the effect of r 4.90(3).

350 Adrian Walters is accordingly diminished. Moreover, to the extent that the overdraft is unsecured, the payment prefers the bank to other creditors. For these reasons, it is generally thought that a payment into an overdrawn account constitutes a disposition of company property in favour of the bank.83 Where the company pays in a cheque, the bank becomes a holder for value to the extent of the company’s overdraft. This is because at common law the bank has a lien on uncollected cheques presented for payment on an overdrawn account.84 Thus, strictly, the disposition occurs at the point when the lien is conferred by delivery of the cheque and not when the bank credits the account as at that later point the bank is simply exercising its rights as a secured creditor.85 Given the overall position with regard to payments in, the bank’s safest course, once it becomes aware of a pending petition, is to freeze the existing account and credit any subsequent payments into a separate account. If the bank is prepared to continue providing facilities, it should seek to protect its position in relation to any subsequent payments in by applying (or requiring the company to apply) to have the new arrangements validated.86

(3) ‘Any transfer of shares or alteration in the status of the company’s members. . .’ 8.44 In a compulsory winding up the liquidator has a duty to settle a list of contributories and a power (delegated to him by the court) to make calls on those contributories to the extent of their liability.87 By prohibiting any transfer of the company’s shares or alteration to the register of members after the commencement of winding up, section 127 eases that task. The liquidator can be confident that members whose names were on the register at the commencement of winding up should be entered on the list of contributories. If shares are transferred after the commencement of the winding up, as a result of section 127, the transferee is not entitled to be entered on the register of members. The transferor remains liable for any call and is entitled to participate in any surplus

83 The point was not challenged in Re TW Construction Ltd [1954] 1 WLR 540 and was later conceded by counsel for the bank in Re Gray’s Inn Construction Co Ltd [1980] 1 WLR 711. 84 Barclays Bank Ltd v Astley Industrial Trust Ltd [1970] 2 QB 527; National Australia Bank Ltd v KDS Construction Services Ltd (1987) 163 CLR 668. 85 R Goode, Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 429. 86 Section E below. The position may be different if the proceeds of debts over which the company has a charge are paid into its bank account as the realisation of charged assets involves no transfer of beneficial ownership. This appears to be the case regardless of whether the charge is fixed or floating as for present purposes a floating charge is treated as conferring a beneficial interest in the charged assets prior to crystallisation: see Re Margart Pty Ltd, Hamilton v Westpac Banking Corp (1984) 79 FLR 330 and para 8.18 above. 87 Insolvency Act 1986 ss 148, 150 and 160; Insolvency Rules 1986 rr 4.195–4.205. As to the liability of contributories see generally Insolvency Act 1986 s 74.

Void Dispositions in Compulsory Winding up 351 assets.88 However, it appears that a post-petition transfer is only void as regards any effect to be given to it by or against the company with the consequence that the rights and liabilities of the transferor and transferee inter se are not affected. 8.45 In Rudge v Bowman 89 the claimant agreed to sell shares in a company after the commencement of its winding up to the defendant on the condition that the defendant indemnify the claimant against all future calls. A deed of transfer was subsequently executed. The claimant’s name was placed on the list of contributories and he paid a call made on the shares. It was held that the defendant’s obligation to indemnify the claimant was not affected by the section.90 Rudge v Bowman is also authority for the proposition that an agreement to transfer, as opposed to a completed and registered transfer is not caught by the section. However, as the transfer itself would be void, the court will not grant specific performance of a contract for the sale of shares after the winding up has commenced.91 A resolution increasing authorised share capital and any consequential share allotments is not caught.92

(4) ‘Made after the commencement of the winding up . . .’ 8.46 The operation of the section is not confined to the period between the date of the petition and the date of the winding up order. A disposition, transfer or alteration occurring after the date of the winding up order is also caught. The words limiting the section to the period between the commencement of winding up and the order for winding up were removed in 190893 to settle the late-nineteenth century controversy over whether a transfer of shares could be registered after the date of the winding up order.94 It is clear that the liquidator has statutory power to dispose of the company’s property without the court’s permission and any such disposition is therefore unaffected by section 127.95

88 Re London, Hamburg, and Continental Exchange Bank (1866) 1 Ch App 433; Re Onward Building Society [1891] 2 QB 463. 89 (1868) LR 3 QB 689. 90 The decision in Rudge may have turned on the fact that section 153 of the Companies Act 1862 only rendered dispositions, transfers and alterations void between the date of the petition and the date of the winding up order: see discussion in National Acceptance Corporation Pty Ltd v Benson (1988) 12 NSWLR 213 (per Priestly JA). 91 Sullivan v Henderson [1973] 1 WLR 333. 92 Re Fostoria-Fannon (Aust) Pty Ltd (1979) ACLC 40–559. 93 S A3 above. 94 Compare Rudge v Bowman (1868) LR 3 QB 689 and Re Onward Building Society [1891] 2 QB 463. The important practical point is that any dispositions authorised by the directors in the period between the date of the order and the first creditors’ meeting (a period during which the official receiver acts as liquidator by virtue of section 136 of the Insolvency Act 1986) are caught. 95 Insolvency Act 1986 Sched 4 paras 6, 10 and 13. In Australia, dispositions made by office holders pursuant to statutory powers or court sanction are specifically exempted: see Corporations Act 2001 s 468(2)(a).

352 Adrian Walters

C REMEDIES

(1) Consequences of avoidance (a) The starting point 8.47 Section 127 simply states that a relevant disposition, transfer or alteration is void unless the court otherwise orders. Nothing is said about the legal consequences of ‘voidness’. The courts are left to determine the legal basis of any remedy and the extent to which a remedy will lie against a given party. The view expressed by Oliver J in Re J Leslie Engineers Co Ltd is usually taken as the starting point:96 It must be remembered that the invalidation of a disposition of the company’s property and the recovery of the property disposed of, are two logically distinct matters. [section 127] says nothing about recovery: it merely avoids dispositions . . . What is the appropriate remedy in respect of the invalidated disposition is a matter not regulated by the Act and that has to be determined by the general law.

8.48 The procedural implication is that the liquidator must apply for a declaration that the relevant transaction is caught by the provision coupled with an order granting consequential relief based on a discrete cause of action. The premise in Leslie Engineers is generally accepted as being correct and has been approved by the Court of Appeal.97 In the rest of the discussion on remedies, attention is focused exclusively on void dispositions as these are of greatest practical significance. (b) Possible targets 8.49 The obvious target for remedial purposes is the party who received the benefit of the company’s property. A prima facie right of recovery will lie against any party to whom a disposition of the company’s property was made (‘the disponee’). This is the case regardless of whether the disponee received the company’s property directly from the company or indirectly via a third party. If A Ltd transfers Blackacre to X1 and X1 then transfers Blackacre to X2, both transactions occurring after the commencement of A Ltd’s winding up, the transfer from X1 to X2 is as much a disposition of company property as that between A Ltd and X1. The section refers to ‘any disposition of the company’s property’ rather than ‘any disposition by the company of its property’ and so a right of recovery would lie against X2 as an indirect recipient.98 As well as an 96

[1976] 1 WLR 292 at 298. Hollicourt (Contracts) Ltd v Bank of Ireland [2001] Ch 555. 98 See, by analogy, Re J Leslie Engineers Co Ltd [1976] 1 WLR 292. All that is required is for the property to be beneficially owned by the company when the winding up was deemed to have commenced. 97

Void Dispositions in Compulsory Winding up 353 action against the disponee, it appears that the liquidator may also recover the value of the property from the directors or the other persons who disposed of it in the company’s name or on its behalf.99 However, in the event that the liquidator elects to pursue the disponee, it is unclear whether the disponee could seek an indemnity from the directors or other persons who authorised the disposition. (c) Tangible property 8.50 If a disposition is declared void, it follows that, as between the company and the disponee, it is treated as having no legal effect. The position in relation to tangible property (and certain forms of intangible property such as shares) is relatively straightforward. The disponee can simply be ordered to revest the property in the company as, by operation of the provision, he has no title to it.100 If the property is no longer recoverable in specie, the company, as true owner, can claim the proceeds of sale or any other identifiable substitute for the original property in the hands of the disponee as a matter of property law. (d) Payments 8.51 In cases where the disposition is simply a payment made out of company funds, it is generally assumed that the company can seek recovery of an equivalent sum from the disponee by means of a common law restitutionary claim for money had and received.101 If, however, the money is traceable at common law, it is arguable that the company can assert a proprietary claim (no title having been conferred on the disponee) and recover the money together with any profits earned from its use.102 Where the void payment was made to a creditor in full or partial satisfaction of a company debt, the debt will revive (in whole or part) on repayment and the creditor will be entitled to prove for it in the liquidation or bring it into account for the purposes of set-off under rule 4.90 of the Insolvency Rules as appropriate.

99

Re Neath Harbour Smelting and Rolling Works [1887] WN 87. Though in the case of goods, the court has the discretion to award the company their value as damages for wrongful interference instead of an order for specific delivery: Torts (Interference with Goods) Act 1977 s 3(2). 101 See Hollicourt (Contracts) Ltd v Bank of Ireland [2001] Ch 555 where it was assumed without the point being argued that a claim against a bank in respect of void payments debited to the company’s bank account was one for restitution of unjust enrichment. For the view that avoidance provisions should be seen generally as pursuing the reversal of unjust enrichment see ch 9. 102 See, by analogy, FC Jones & Sons (Trustee in Bankruptcy) v Jones [1997] Ch 159 though note that this decision has its critics: see, eg S Worthington, ‘Back Door Security Devices’ [1999] Insolvency Lawyer 153. On the important distinction between tracing and claiming see Foskett v McKeown [2001] AC 102 (per Lord Millett). 100

354 Adrian Walters (e) The impact of section 127 on secondary payment obligations 8.52 The decision in National Acceptance Corporation Pty Ltd v Benson,103 a case on an equivalent provision in the New South Wales Companies Code, suggests that any secondary obligation relating to a debt discharged by a void payment is also revived by the order for repayment. The defendants were guarantors of the company’s obligations to the claimant under a lease of two motorcars. The cars were repossessed and sold but the proceeds of sale were insufficient to meet the company’s outstanding indebtedness to the claimant. The company made a payment to the claimant discharging the debt. However, the payment was made after a winding up petition had been presented and the company’s liquidator subsequently recovered the payment from the claimant as a void disposition. Having repaid the company, the claimant pursued the defendants in respect of their liability under the guarantee. The defendants argued that the original payment extinguishing the principal debt was only void as between the immediate parties to it, ie the company and the claimant. If the provision could be construed as having only this limited effect, the payment would not be void against the defendants and would remain an effective discharge of their liability under the guarantee. Unsurprisingly, the Supreme Court of New South Wales held that the payment was void against the defendants as well as against the claimant, with the result that their liability under the guarantee revived at the point when the claimant repaid the company.104

(2) Defences 8.53 If the court is persuaded to validate the disposition on the principles discussed later in this chapter105 then clearly no remedy will lie against the disponee. Validation aside, it is not clear whether the disponee could raise a general defence such as bona fide purchase or change of position. 8.54 Let us start by considering the position of the disponee of tangible property. If company property is transferred to X1 and then onto X2 and both acquired the property in good faith, for value and without notice of the pending winding up petition, could they raise the defence of bona fide purchase to defeat 103

(1988) 12 NSWLR 213. For the purposes of deciding the case, Priestly JA (with whom Clarke JA agreed) and Kirby P concluded that ‘void’ meant void for all purposes related or incidental to the administration of the winding up. The position of the guarantors was regarded as sufficiently ‘related or incidental’ because, once established, it would determine whom, as between the guarantors and the claimant, was entitled to prove for the debt in the company’s winding up. The court did not feel it necessary to decide whether the voiding effect of the provision went any wider, although one of the three judges, Kirby P, came close to reaching the conclusion that ‘void’ means void ab initio against the whole world subject only to validation. 105 Section E. 104

Void Dispositions in Compulsory Winding up 355 a claim by the liquidator? A literal reading of section 127 suggests not. Parliament has chosen to use the word ‘void’ rather than a term having less radical consequences. Moreover, section 127 contains no express defence of bona fide purchase. This contrasts starkly with section 284, the analogous provision in personal insolvency, which expressly relieves the bona fide purchaser of a bankrupt’s property.106 In the light of the express words in section 284 and the absence of any equivalent wording in section 127, it might be presumed that the defence is either (i) unavailable or (ii) only available to the extent that its operation is consistent with the structure and purpose of section 127.107 If this is right, the primary relief available to the disponee must lie in the court’s jurisdiction to validate void dispositions. 8.55 There is some indirect support in the authorities for a more flexible construction of section 127. In the bankruptcy context, the word ‘void’ has often been construed as meaning ‘voidable’ rather than void ab initio. The case of Re Brall, ex parte Norton108 is a good example. The donee of a voluntary settlement of leasehold property mortgaged the property to the London and Westminster Bank as security for a loan. The settlor became bankrupt with the effect that the settlement was rendered void by section 47 of the Bankruptcy Act 1883. Construing ‘void’ to mean ‘voidable’, Vaughan Williams J held that the bank, as a bona fide purchaser, had good title against the settlor’s trustee in bankruptcy.109 However, in contrast to section 127, there was never any scope in section 47 of the 1883 Act for the court to validate a settlement invalidated thereunder. Thus, it remains arguable that the disponee must seek relief by means of an application for a validation order. In circumstances where the company has received full value for the property, there is every reason to expect that the court would validate the disposition on the basis that the insolvent estate has not been diminished.110 106 Note also that a party in the position of X2 can raise a defence of bona fide purchase to claims under ss 238–39: see s 241(2), paras 2.113–2.119 and 4.96–4.97. 107 While some attempt was made in the mid-1980s to address the historical divergence between the forerunners of ss 127 and 284, it is curious that the opportunity was not taken to align the two provisions fully. For background on the former provisions see N Furey, ‘The Validation of Transactions Involving the Property of Insolvent Debtors’ (1983) 46 Modern Law Review 257 and for problems arising as a result of their divergence see Re Oriental Bank Corporation ex p Guillemin (1885) 28 Ch D 634; Re Repertoire Opera Co (1895) 2 Mans 314; Re TW Construction Ltd [1954] 1 WLR 540. 108 [1893] 2 QB 381. 109 See also Re Holden (1887) 20 QBD 43; Re Simms ex p Sheffield (1896) 3 Mans 340; Re Hart [1912] 3 KB 6. 110 See Re Tramway Building & Construction Co Ltd [1988] Ch 293 and observations of Neuberger J in Dewrun Ltd v Royal Bank of Scotland [2002] BCC 57 on ‘the need for flexibility and the desirability of a minimum degree of interference to the prejudice of innocent third parties, where the court is given power under the insolvency legislation to interfere with contracts and other arrangements.’ In Re Brall the settlor’s business received the benefit of the bank’s advance and so it is conceivable that had the case been concerned with a post-petition disposition the court would have been prepared to make a validation order on the ground that there was no net diminution of the settlor’s estate.

356 Adrian Walters 8.56 Similarly, it is not clear whether the disponee could rely on the defence of change of position to an action for money had and received111 arising from a void payment. If, as was suggested at the outset, the right of recovery is based on a discrete cause of action, it seems reasonable to assume that any recognised defences to that cause of action would be available.112 Again, however, it can be argued that any such relief should only be considered in the exercise of the court’s power of validation so as to accord with the structure and purpose of the provision.113 There is a danger otherwise that the disponee could defeat the liquidator’s claim in circumstances where the payment confers no benefit on the company’s creditors and, as a result, would not ordinarily be validated.114 8.57 The discussion so far assumes that a prima facie right of recovery lies against a disponee, meaning a party who directly or indirectly receives the benefit of the company’s property. Difficulties may arise, however, if it is not possible to follow the company’s property into the hands of the party against whom relief is sought and identify it as such. The point is illustrated by Re J Leslie Engineers Co Ltd.115 The defendant invoiced the company for £1,050 in respect of sub-contract work. After a petition to wind up the company had been presented, the company’s controller, H, cashed a cheque on the company’s bank account and used the proceeds to purchase five postal orders in a total sum of £250 made out in the defendant’s favour. H then drew a cheque for the balance of £800 on his personal bank account held jointly with his wife. The cheque was only met after H had paid £800 of company monies into the personal joint account. Applying Taylor v Plumer,116 Oliver J had no difficulty in holding that the defendant was liable to repay the initial £250 on the basis that ‘there was throughout a clearly identifiable property of the company which passed directly from the company’s hands to those of the [defendant]’ or, to put it another way, that the defendant had received a disposition of company property, albeit indirectly, from H. However, as the company money paid into the joint account had been mixed with the personal monies of H and his wife, the claim for repayment of the £800 failed. There was an insufficient nexus between the defendant’s 111 On which see Lipkin Gorman v Karpnale Ltd [1991] 2 AC 548 and discussion in ch 9. The question might arise in the present context if the disponee used the funds received to pay his own creditors. 112 The suggestion in Hollicourt (Contracts) Ltd v Bank of Ireland [2001] Ch 555 that the claim for recovery can be characterised as one for restitution of unjust enrichment adds force to this point. 113 In Re Tellsa Furniture Pty Ltd (1985) 9 ACLR 869 the disponee argued that the court should validate the payments made to it as it would be forced to cease trading and dismiss fifty employees if the court ordered repayment. Young J gave this little weight stating that ‘the purpose of [the provision] is to minimise hardship to the body of creditors generally, and whilst hardship to a particular creditor must be taken into account, it can hardly ever be conclusive.’ The point was dealt with in similar fashion on appeal: Tellsa Furniture Pty Ltd v Glendave Nominees Pty Ltd (1987) 9 NSWLR 254. 114 See C Hare, ‘Banker’s Liability for Post-Petition Dispositions’ [2001] Cambridge Law Journal 468. 115 [1976] 1 WLR 292. 116 (1815) 3 M & S 562.

Void Dispositions in Compulsory Winding up 357 receipt and the company’s property to sustain an action for money had and received.117 It is important to note that Leslie Engineers is not authority for the proposition that a right of recovery can only ever lie against a disponee. Oliver J was careful to add that the mere fact that the payment of the £800 to the defendant was not a disposition of company property did not of itself exempt him from liability to repay.118

(3) Subrogation 8.58 A Ltd sells Greenacre to X and uses the proceeds of sale to discharge a mortgage created by A Ltd over the property in favour of Y with the result that X obtains title free of Y’s interest. However, what if the transfer is a void disposition and the court revests title to Greenacre in A Ltd? In these circumstances, the buyer, X, (or any mortgagee who financed X’s purchase on the security of the property) would be entitled by way of subrogation to keep alive Y’s discharged mortgage in order to secure repayment of the purchase monies.119

(4) Agency 8.59 A Ltd, a company the subject of a pending winding up petition, supplies goods to C via a carrier, B. There is clearly a disposition of the goods to C whereas B merely received the goods as A Ltd’s agent. As between A Ltd and C the disposition is avoided by section 127. Can it also be said that section 127 impliedly (and retrospectively) revokes an agent’s authority to deal with the company’s property and so gives rise to a cause of action against a party in B’s position as well as against the disponee, C? In the light of the Court of Appeal decision in Hollicourt (Contracts) Ltd v Bank of Ireland,120 it is suggested that an agent who acts with his principal’s authority and without knowledge of the winding up petition will have a complete defence. The position of agents is discussed more fully in section D below.

117 See further Agip (Africa) Ltd v Jackson [1991] Ch 547. A personal claim in equity postulated on the defendant’s receipt of misdirected trust monies also failed in Leslie Engineers. 118 Equally, however, it seems implicit in Re Barn Crown Ltd [1995] 1 WLR 147 and Hollicourt (Contracts) Ltd v Bank of Ireland [2001] Ch 555 that a right of recovery will only lie against those in beneficial receipt of the company’s property. 119 Re Tramway Building & Construction Co Ltd [1988] Ch 293; Dewrun Ltd v Royal Bank of Scotland [2002] BCC 57. 120 [2001] Ch 555. See also Coutts & Co v Stock [2000] 1 WLR 906.

358 Adrian Walters (5) The impact of the Human Rights Act 1998 8.60 In its impact on disponees section 127 is clearly expropriatory in effect. The disponee acquires property rights121 that are taken away when the winding up order is made. This makes section 127 vulnerable to challenge under the Human Rights Act 1998 as an infringement of the disponee’s right to peaceful enjoyment of property enshrined in Article 1 of the First Protocol. State interference with property rights is legitimate for the purposes of the First Protocol provided that the interference is ‘in the public interest and subject to conditions provided for by law and by general principles of international law.’ Section 127’s expropriatory effect can be justified because it aims to preserve the assets available for distribution to creditors and so underpins the operation of the pari passu principle. The question in terms of ECHR jurisprudence is therefore one of proportionality. Does section 127 strike a fair balance between the interests of the creditors generally and the fundamental property rights of an individual disponee?122 8.61 If its impact is disproportionate, the provision must be treated as incompatible with Convention rights. The proportionality (and therefore compatibility) of section 127 seems likely to turn on the availability and scope of any defences to the company’s claim.123 As we saw above, it is difficult to determine whether general defences (such as bona fide purchase) can be raised independently of the court’s power of validation. Moreover, as will be seen below, it appears that the principles applied by the court in deciding whether to make a validation order are designed primarily to protect the general body of creditors rather than to offer systematic relief to disponees. It may be that the courts will have to adjust these principles so as to give effect to section 127 in a manner compatible with the Convention.124

121 It is difficult to identify the nature and extent of those rights: see Dennison v Krasner [2001] Ch 76. However, the fact of the disposition cannot be denied and it flies in the face of practical sense to claim that the disponee did not acquire at least some right at the time the disposition was made. 122 In striking an acceptable balance states have been given a wide margin of appreciation: see generally Sporrong and Lonnroth v Sweden (1982) 5 EHRR 35; James v United Kingdom (1986) 8 EHRR 123 and, for the approach of the English courts to this issue as it has arisen in the bankruptcy context, Dennison v Krasner [2001] Ch 76. 123 See D Capper, ‘Insolvency and the Human Rights Act 1998—Early Northern Ireland Perspectives’ [2001] Insolvency Lawyer 119 casting doubt on the compatibility of s 127 with the ECHR on the basis that the bona fide purchaser in corporate insolvency is treated less favourably than the bona fide purchaser in personal insolvency, there being no equivalent in s 127 of the statutory defence in s 284(4). 124 Human Rights Act 1998 ss 3 and 6.

Void Dispositions in Compulsory Winding up 359 (6) Quantum 8.62 As the principal aim of section 127 is to preserve the insolvent estate intact, it follows that the object of any remedy is to restore the status quo ante and nothing more. The quantum of the remedy should be limited accordingly.125 Difficulties arise if the company’s property has increased in value in the defendant’s hands. On the face of it, a void disposition confers no title on the disponee. Thus, as long as the property can be traced at common law, the company can prima facie take the benefit of any increase in its value.126 However, as the primary purpose of section 127 is to preserve intact the estate as it stood at the commencement of winding up, the general body of creditors would arguably be overcompensated if allowed to retain the benefit of any increase in value attributable to the efforts of the disponee. As such, we might expect the court to adjust its order to ensure that the company accounts for any such benefit to the disponee.127 Where, however, the property simply increases in value by operation of market forces, the company should not be required to account to the disponee because in that case the benefit would have accrued to the company had the disposition not occurred.

(7) Interest 8.63 In the case of void dispositions of money or property, the question arises as to whether the liquidator is entitled to interest in addition to an order for repayment or revesting of the property. The liquidator should be able to claim interest as a matter of general principle to reflect the fact that the defendant has had the use of the money or property. As any disposition is not strictly avoided until a winding up order is made, it is submitted that the date of the winding up order is the earliest date from which interest should run.128

125 Note, eg the outcome in Re Gray’s Inn Construction Co Ltd [1980] 1 WLR 711 where the bank was only required to repay a sum necessary to restore the fund of assets as it had stood at the date of the petition. See also Re Tramway Building & Construction Co Ltd [1988] Ch 293. 126 As where the original money leaving the insolvent estate is profitably invested by the defendant: see, by analogy, FC Jones & Sons (Trustee in Bankruptcy) v Jones [1997] Ch 159. 127 For example, where the court orders goods to be returned, it may require the company to compensate the disponee for any increase in the value of the goods resulting from improvements he has made: Peruvian Guano Co Ltd v Dreyfus Bros & Co [1892] AC 166; Greenwood v Bennett [1973] QB 195; Torts (Interference with Goods) Act 1977 ss 3(6) and 6. 128 Boulevard Music Pty Ltd v Birch (1996) 21 ACSR 367; Thomas v Hatzipetros (1997) 24 ACSR 286. For a more comprehensive discussion of the recoverability of interest in avoidance proceedings touching also on the question of whether simple or compound interest should be awarded see paras 9.28–9.32.

360 Adrian Walters (8) Destination of recoveries 8.64 It is thought that any property recovered by virtue of the operation of section 127 falls within the scope of an all-encompassing floating charge over the present and future assets of the company. As a result, the charge holder (or a receiver appointed by the charge holder) rather than the liquidator has first claim to the property.129 There appear to be three different routes to achieving this result. The first, based on the voiding effect of section 127 is to say that, in law, the property should be treated as never having left the company’s ownership with the consequence that it never ceased to be subject to the floating charge. The second, a variation on the first, is to treat a disposition rendered void by statute as an unauthorised misapplication of property rather than a dealing in the ordinary course of the company’s business permitted by the terms of the charge. Again, in that case, the property would be treated as never having left the ambit of the charge.130 The third is to treat the right of recovery under the general law131 as a chose in action itself comprising property of the company falling within the scope of the charge.132 8.65 These justifications for the view that recoveries benefit the charge holder have been criticised on policy grounds.133 A technical objection can also be raised. Strictly, the property disposed of can only be recovered by legal action. This gives rise to the difficulty that actions vested by the Insolvency Act in a liquidator or administrator, together with the fruits of such actions, are not generally regarded as forming part of the company’s assets available for distribution according to established rules of priority but are treated as falling into the statutory trust exclusively benefiting the general body of creditors.134 Thus, there is a tension between the view that property the subject of a void disposition 129 Mond v Hammond Suddards [1996] 2 BCLC 470 (the point did not arise on the receivers’ subsequent appeal reported at [2000] Ch 40). The same conclusion has been reached in Tasmania: Bayley v National Australia Bank Limited (1995) 16 ACSR 38 but, in relation to post-petition payments, the opposite view is taken in South Australia: Campbell v Michael Mount PPB (1995) 65 SASR 334. 130 See R Parry, ‘The Destination of Proceeds of Insolvency Litigation’ (2002) 23 Company Lawyer 49. 131 Re J Leslie Engineers Co Ltd [1976] 1 WLR 292 on which see section C above. 132 See, however, Re Ayala Holdings Ltd (No 2) [1996] 1 BCLC 467. 133 See J O’Donovan, ‘Who Should Benefit from the Recovery of Void Dispositions Under Section 468 of the Corporations Law?’ (1995) 13 Company and Securities Law Journal 460. 134 On s 127 see Re Ayala Holdings Ltd (No 2) [1996] 1 BCLC 467. See also Re Yagerphone Ltd [1935] Ch 392; Re MC Bacon Ltd (No 2) [1991] Ch 127; Re Oasis Merchandising Services Ltd [1998] Ch 170; Lewis v Commissioner of Inland Revenue [2001] 3 All ER 499. In Ayala Holdings, Knox J held that it was not open to a liquidator to assign his cause of action under s 127 to one of the company’s creditors relying on the distinction drawn in MC Bacon (No 2) (later elaborated in Oasis Merchandising) between property of the company falling within the liquidator’s statutory power of sale and rights arising after the commencement of liquidation vested exclusively in the office holder. Even though the case does not deal specifically with the point, it is difficult to see how the fruits of a claim based on s 127 can be treated as property of the company when the cause of action is not.

Void Dispositions in Compulsory Winding up 361 remains at all times within the grasp of the charge and the view that recoveries in statutory avoidance actions do not form part of the company’s assets but are earmarked for unsecured creditors.

(9) Costs 8.66 The liquidator will generally be entitled to an order for costs where contested proceedings are successfully brought to recover the company’s property. In circumstances where property is recovered from a creditor, it is open to the court on equitable principles to enforce the order for costs by deducting the amount of the assessed costs from any dividend payable to the creditor in the liquidation.135 In the event that the liquidator is successful but cannot recoup his costs, those costs will be treated as an expense of the liquidation falling within rule 4.218(1)(a) of the Insolvency Rules 1986.136 If the liquidator is unsuccessful, he is not automatically entitled to have his costs treated as an expense.137 However, the court may direct that his costs be treated as an expense in the exercise of its residual discretion.138

D THE IMPACT OF SECTION

127

ON AGENTS AND INTERMEDIARIES

8.67 A Ltd, acting by its agent, B, sells company property to C after the commencement of A Ltd’s winding up. The liquidator can clearly seek to recover the property from C as the transaction involves a disposition in favour of C. What if C and the property have disappeared? Does section 127 give the liquidator a right of action against the agent, B? If the transaction effects a disposition of company property as between A and B as well as between A and C the question can be answered in the affirmative. However, the position is more difficult if there is no disposition as between A and B. It appears in this case that B could only be liable if section 127 operates impliedly (and retrospectively) to revoke the agent’s authority to act on his principal’s behalf so as to give rise to an action by A Ltd against B based on B’s unauthorised dealing. As we will see below, the courts have sought to limit the exposure of agents and do not currently favour a theory of agent liability based on implied revocation of authority.

135

Re Davies Chemists Ltd [1992] BCC 697. This follows from the treatment of section 127 recoveries as an asset of the company in Mond v Hammond Suddards [1996] 2 BCLC 470. 137 Mond v Hammond Suddards [2000] Ch 40. 138 Lewis v Commissioner of Inland Revenue [2001] 3 All ER 499 noted by A Walters (2001) 22 Company Lawyer 215. 136

362 Adrian Walters (1) Banking transactions 8.68 The issue of agent liability has arisen mainly in the context of banking transactions. The question is whether the bank can be liable under section 127 for making payments on the company’s instructions as, for example, where the company draws a cheque in favour of a creditor and the bank honours the cheque on presentation. In addressing this question, a distinction needs to be drawn between payments out of bank accounts that are in credit and payments out of bank accounts that are overdrawn. (a) Payments from an account in credit 8.69 Where a payment is made out of an account in credit, it is now settled that the payment can be recovered from the payee but not from the paying bank in the light of the Court of Appeal decision in Hollicourt (Contracts) Ltd v Bank of Ireland.139 In Hollicourt a winding up petition was presented against the company and advertised. As a result of human error, the bank failed to notice the advertisement and over the next three months debited the company’s account with cheque payments totalling in excess of £150,000. The liquidator took no action against the payees of the cheques and sought instead to recover the aggregate sum from the bank. At first instance,140 Blackburne J held that the bank was liable to reconstitute the account on two grounds. Firstly, it was said that each payment involved a disposition in favour of both the payee and the bank. According to the judge, the act of debiting the customer’s account with the amount of the cheque (thereby reducing the quantum of the company’s claim on the bank) was ‘in every sense a disposition of the company’s property’ to the bank.141 Secondly, the judge refused to accept the bank’s contention that the legal consequences of avoidance were confined to the ultimate recipients of the sums withdrawn from the company’s account, ie the cheque payees. In Blackburne J’s view, section 127 operated to reverse every step in the payment process including the debiting of the account by the bank with the implication that the bank’s mandate to make payment on the company’s behalf must have been revoked retrospectively by operation of law. The bank appealed successfully against Blackburne J’s decision. 8.70 It was common ground for the purposes of the appeal that where a company pays a creditor by cheque drawn on an account in credit after the commencement of winding up, there is a disposition of the company’s property in favour of that creditor. In substance, the point is incontestable. Value clearly 139 [2001] Ch 555. Note, however, that the Irish High Court declined to follow the decision in Re Industrial Services Company (Dublin) Ltd [2001] 2 IR 118. 140 [2000] 1 WLR 895. 141 A view shared by Goode: see Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 429–30 and further supported by the decision of the Hong Kong Court of Appeal in Bank of East Asia Ltd v Rogerio Sou Fung Lam [1988] 1 HKLR 181.

Void Dispositions in Compulsory Winding up 363 moves from the company’s estate to the payee and, in the end result, the position is the same as if the company had made the payment in cash. Strictly, however, there is no physical movement of funds from company to payee. The paying bank uses its own funds to meet the cheque and payment is ultimately effected, following clearing and settlement, by means of matching debit and credit entries on the accounts of the company and the payee.142 Nevertheless, it has been held that the company makes a disposition of the property in the cheque when it delivers the cheque to the payee.143 On the point in issue, namely whether the bank as well as the payees could be liable to make restitution to the company, the Court of Appeal reached the following conclusions: 8.71 (1) The policy promoted by the section is to prevent the improper dissipation of the company’s property and so preserve the estate. Its object is not aimed at imposing restitutionary liability on a paying bank in respect of payments made on the company’s instructions under the mandate. Section 127 impinges only on the end result of the payment process, ie the point of ultimate receipt by the payee. The statutory purpose could be accomplished without the need for the section to impinge on the legal validity of intermediate steps, such as banking transactions, which are merely part of the process by which dispositions of the company’s property are made. A paying bank is not unjustly enriched in this situation and should not be required to make restitution. Accordingly, there was no basis on which the company could recover the sums paid away from the bank. 8.72 (2) The only dispositions to which section 127 applied were those between the company and the payees of the cheques. The debiting of the account did not amount to a disposition in favour of the bank as Blackburne J had thought. The bank acted as the company’s agent for the purposes of making payment144 and beneficial ownership of the property represented by the cheques was never transferred to the bank as disponee. A disposition requires a disponee as well as a 142 Foley v Hill (1848) 2 HL Cas 28; Joachimson v Swiss Bank Corporation [1921] 3 KB 110. The payee does not acquire the chose in action represented by the credit balance in the company’s account. That chose in action is pro tanto extinguished or reduced and a new chose in action arises on the payee’s account: R v Preddy [1996] AC 815. 143 Re Loteka Pty Ltd [1990] 1 Qd R 322; Tasmanian Primary Distributors Pty Ltd v RC & MB Steinhardt Pty Ltd (1994) 13 ACSR 92; Wily v Commonwealth (1996) 66 FCR 206 (per Lindgren J). The view in these cases is that a cheque should be regarded as a chattel having a value equal to the amount for which it was drawn. This is consistent with the approach taken to cheques in the tort of conversion: see, eg Lloyds Bank Ltd v Chartered Bank of India, Australia and China [1929] 1 KB 40, 55–56 (per Scrutton LJ). Note, however, that in R v Preddy [1996] AC 815, a case concerned with the offence of obtaining property by deception, it was said that the delivery of a cheque does not involve the transfer of a chose in action from drawer to payee. According to Lord Goff, the property in the cheque never belongs to the drawer as the chose in action (ie the right of action on the cheque) only arises once the cheque is in the payee’s hands. 144 Westminster Bank Ltd v Hilton (1926) 136 LT 315.

364 Adrian Walters disponor and the section operates to render the disposition void in so far as it concerns the disponee. The only disponees in this case were the payees of the cheques and it was they who could be required under section 127 to make restitution of the benefit obtained, ie the amount of the cheques. 8.73 On this point, the Court of Appeal followed the reasoning in Re Mal Bower’s Macquarie Electrical Centre Pty Ltd145 and Re Loteka Pty Ltd,146 two Australian authorities in which it was held that the paying bank was not liable under equivalent provisions of New South Wales and Queensland law in similar circumstances.147 In the earlier Court of Appeal decision in Re Gray’s Inn Construction Co Ltd 148 it was apparently conceded by counsel for the bank that all payments out of a bank account were dispositions of the company’s property for which the bank was liable. Re Mal Bower’s Macquarie Electrical Centre Pty Ltd was cited in argument in Gray’s Inn but not referred to by Buckley LJ when he delivered the judgment of the court. As Gray’s Inn was concerned with an overdrawn account and the point went by concession, the Court of Appeal in Hollicourt did not regard itself as bound by Gray’s Inn. The court also declined to follow the decision of the Hong Kong Court of Appeal in Bank of East Asia Ltd v Rogerio Sou Fung Lam,149 an authority relied on by Blackburne J, because of its dependence on points made in Gray’s Inn that had not been fully argued. 8.74 (3) In avoiding the dispositions to the payees, section 127 does not have the wider effect of avoiding, revoking or countermanding the company’s mandate to the bank to meet cheques drawn on its account. In making the payments, the bank acted at all times as the company’s agent. The section impinges on the dispositions to the payees, but not on the authority of the bank to act on the instructions of the company or on contracts and other intermediate transactions between the company and the bank forming part of the process that leads to the disposition of the company’s property to the payees.150 8.75 The Court of Appeal decision in Hollicourt can be supported on both technical and policy grounds. The result reflects ordinary commercial expectations and brings greater coherence to the law. A payment by cheque is treated in accordance with popular understanding as a payment by the company to the payee that is, in substance, no different from the company withdrawing cash from the bank

145

[1974] 1 NSWLR 254. [1990] 1 Qd R 322. 147 This safe harbour for paying banks is now codified in Australia: Corporations Act 2001 s 468(2)(b). 148 [1980] 1 WLR 711. 149 [1988] 1 HKLR 181. 150 On the revocation point, the United States Supreme Court reached a similar conclusion over thirty years ago in Bank of Marin v England 87 S Ct 274 (1966). 146

Void Dispositions in Compulsory Winding up 365 and using it to make the payment direct.151 Blackburne J’s view that the debiting of the account itself constitutes a disposition of company property to the bank cannot be maintained because it has unsustainable consequences. In isolation, the debiting of the account simply diminishes or extinguishes the chose in action represented by the credit balance. In circumstances where the company makes a withdrawal from the account but simply retains the cash, the bank will obviously debit the account with the corresponding amount. If Blackburne J’s decision had stood, such a withdrawal would itself now be caught by section 127 which seems absurd. By analogy, the payment of a debt owed to the company would also arguably have been caught because it too involves the extinguishing of a chose in action, namely the company’s claim on the debtor. It has long been established that the payment of a company debt is not a disposition because it does not involve any alienation of company property.152 Sensibly, Hollicourt ensures that the position in relation to cheque payments is the same as if the company had withdrawn cash from its bank account and remitted it direct to the payees rather than instructing the bank to make payment. 8.76 The issue of policy in this context is how best to allocate loss between the general body of creditors, the bank and the payees. If Blackburne J’s decision had remained the law, banks would now be required to underwrite all payments debited from accounts in credit after the commencement of winding up. Presented with such an attractive target, it is unlikely that a liquidator would ever bother to pursue the payees.153 Although the point is controversial, it is questionable whether a bank should be penalised for failing to appreciate that its customer was the subject of pending winding up proceedings when, in honouring the customer’s cheques and debiting the account, the bank continued to act under the mandate. The imposition of liability on a paying bank in these circumstances would, in substance, amount to an extension of the bank’s duty of care. It is doubtful that section 127 was intended to have such an effect.154 At the 151 The position is the same where payment is made by banker’s draft or under a bank guarantee rather than by cheque: Tasmanian Primary Distributors Pty Ltd v RC & MB Steinhardt Pty Ltd (1994) 13 ACSR 92; Thompson Land Ltd v Lend Lease Shopping Centre Development Pty Ltd [2000] VSC 108. Other payment methods, eg direct debits, payments under standing orders and electronic payments will also be treated the same as in all cases the bank acts as agent under a lawful payment instruction. 152 Mersey Steel and Iron Co v Naylor, Benzon & Co (1884) 9 App Cas 434 at 440 and discussion in section B2 above. 153 Blackburne J held that the liquidator was under no duty to exhaust his remedies against the payees before resorting to the bank. If this view had prevailed, the bank would have been forced to reconstitute the account and pursue the various payees for contribution on the basis of total failure of consideration: Barclays Bank Ltd v WJ Simms Son & Cooke (Southern) Ltd [1980] QB 677; Bank of East Asia Ltd v Rogerio Sou Fung Lam [1988] 1 HKLR 181. 154 The true essence of the implied revocation of authority theory comprehensively rejected by the Court of Appeal in Hollicourt is that the bank’s duty of care to the customer is breached because of its failure to spot the advertisement of the petition and further that the bank, rather than the liquidator, should be put to the trouble and expense of seeking contribution from the (possibly numerous) payees. However, it is difficult to see how a bank could be in breach of its duty of care when, in paying the money away, it acted lawfully in accordance with the mandate at the time.

366 Adrian Walters same time, it must be conceded that the decision considerably weakens the position of the general body of creditors. The liquidator is deprived of a convenient cause of action against a single ‘deep pocket’ and is left instead with the difficult and costly task of pursuing the individual payees for restitution. (b) Payments from an overdrawn account 8.77 After two decades of uncertainty, the position in respect of payments out of an overdrawn account now appears to be the same as that in respect of payments out of an account in credit, ie the payment can be recovered from the payee but the bank faces no liability. As a result of the Court of Appeal decision in Re Gray’s Inn Construction Co Ltd,155 it appeared until recently that the paying bank could be held liable for payments out of an overdrawn account. However, counsel for the bank in Gray’s Inn appears to have conceded that payments out of an overdrawn account amounted to dispositions of company property in favour of the payees for which the bank (in honouring payment) was liable. 8.78 It was only subsequently in Coutts & Co v Stock 156 that the point was considered with the benefit of full argument. In Coutts, the bank granted the company a £200,000 overdraft facility secured by a personal guarantee from S. Three weeks later, a winding up petition was presented against the company. On the date the petition was presented the company’s bank account was £500 in credit. However, by the time the petition was advertised, the account was overdrawn to the tune of roughly £122,000. In the period between advertisement and the making of the winding up order, the overdraft increased to £190,000. The bank took proceedings against S to enforce the guarantee. S contended that, in the absence of a validation order, section 127 operated retrospectively to disentitle the bank from debiting the company’s account in respect of cheques honoured after presentation of the petition and accordingly disentitled the bank from recovering the amounts in question under the guarantee. Lightman J held that, in substance, when a paying bank honours a cheque drawn on a company’s overdrawn account, it loans the sum in question to the company and then, as the company’s agent, pays the sum loaned to the party in whose favour the cheque is drawn.157 The loan by the bank amounts to a disposition of the bank’s property rather than the company’s property and so falls outside section 127. There is, however, a disposition of company property when the sum loaned to the company is paid to the payee through the bank’s agency. On this analysis, the initial borrowing was valid (there being no disposition within section 127). It followed that section 127 only took effect as between the company and the payees of the cheques with the result that the company could recover from the 155 156 157

[1980] 1 WLR 711. [2000] 1 WLR 906. See, by analogy, Re Hone [1951] 1 Ch 85.

Void Dispositions in Compulsory Winding up 367 payees but had no right of recovery against the bank. As each loan to the company was valid, the bank had acted lawfully in debiting the account and was therefore entitled to proceed against S as guarantor. In the judge’s words: [T]he principles lead to the conclusion that section 127 cannot be read as invalidating, not merely the disposition by a company, but also a loan made by someone else to the company to enable it to make that disposition. Nor can section 127 retrospectively countermand the instructions given to the bank as the company’s agent to make payment of the company’s moneys to the third party: it merely denudes the payment by the company, as a disposition of the company’s money to the payee, of legal effect, entitling the company to obtain recoupment from the payee.158

8.79 In Hollicourt, the Court of Appeal confirmed, albeit obiter, that no claim would lie against the bank under section 127 where payments have been made out of an overdrawn account. This result, said Mummery LJ, would have, ‘. . . the very real practical advantage of not requiring what in some cases could be a complex analysis of whether payments were made out of an account which was in debit or in credit. . .’.159 8.80 The decision in Coutts v Stock can be supported on the same basis as the Court of Appeal decision in Hollicourt. In the light of Coutts and Hollicourt, the position is the same whether the company makes a payment directly to the payee in cash or indirectly by drawing a cheque on its bank account. It would seem absurd to construe section 127 as imposing liability on an agent instructed to make payment on the company’s behalf when the purpose and outcome of the transaction is precisely the same as if the company had withdrawn cash from its bank account and paid it directly to the payee. Moreover, to reiterate the point made earlier, the imposition of liability on a paying bank would, in effect, amount to an extension of the bank’s duty of care, a result that was surely not intended. 8.81 Even though the paying bank is generally not exposed in respect of payments out of an account made to a third party recipient, it should still follow the practice of freezing the account once it becomes aware that its customer is the subject of a pending winding up petition. The reason for this is that the bank remains exposed in relation to payments into the account, especially so where the account is overdrawn.160 Given the uncertainty surrounding the position with regard to payments in, the bank will still need to freeze the account and credit any subsequent payments to a new account. If the bank is prepared to continue providing facilities, it should seek to protect its position in relation to payments in by applying to have the new arrangements validated.161 A further 158 [2000] 1 WLR 906 at 911. On the agency point, Lightman J relied on the Australian authorities favoured subsequently by the Court of Appeal in Hollicourt and expressed himself to be in respectful disagreement with Blackburne J’s decision at first instance in that case. 159 [2001] Ch 555 at 566. 160 Section B2 above. 161 This is also necessary to safeguard any payments credited to the bank from the customer’s account in respect of post-petition loan interest or bank charges that are not covered by the holding in Hollicourt.

368 Adrian Walters point is that the bank should reserve the right in the mandate to freeze the account in the event that a winding up petition is presented. If Hollicourt is right, the presentation of a winding up petition does not automatically revoke the customer’s mandate. It follows that the bank will be under a continuing duty to comply with the mandate unless provision is made to the contrary. Any power to freeze the account will need to be expressed in discretionary rather than mandatory terms. If the power is expressed in mandatory terms (ie ‘the bank shall freeze the account . . .’) and the bank, in error, fails to ascertain from the Gazette that a petition has been presented against its customer, it is conceivable that a resourceful liquidator might seek to recover any post-petition payments out from the bank on the argument that it breached the mandate by failing to freeze the account.162

(2) Other agents 8.82 The reasoning in Hollicourt is capable of applying to anyone acting as agent on the lawful instructions of a corporate principal and so would extend, for example, to carriers, handling agents, estate agents, brokers, solicitors or auctioneers. If the position was otherwise, an agent could face liability despite acting lawfully at the time of the transaction. So, for example, an authorised carrier who delivers goods to a buyer on behalf of a company is not generally placed in the position of a tortious handler of the goods simply because the transaction occurred after the winding up was deemed to commence.163 However, it should be noted that Hollicourt does not provide an absolute safe harbour. It shelters an agent who acts on behalf of his principal without actual knowledge that the principal is subject to a pending winding up petition from the impact of section 127. If, however, there is evidence that the agent has been party to a fraud or conspiracy designed to siphon assets out of the insolvent company, he could incur personal liability on other grounds. In those circumstances the defence of agency would not be available.

E VALIDATION

(1) Introduction 8.83 Section 127 states that ‘any disposition of the company’s property . . . is, unless the court otherwise orders, void.’ (emphasis added). It is therefore beyond doubt that the court has the discretion to validate a transaction that 162 In such an action, the liquidator may find it difficult to prove any loss bearing in mind that the company will be under a duty to mitigate its loss by making an application for validation. Even so, it should be possible by means of careful drafting to eliminate the risk altogether. 163 Re Mal Bower’s Macquarie Electrical Centre Pty Ltd [1974] 1 NSWLR 254 at 258.

Void Dispositions in Compulsory Winding up 369 would otherwise fall foul of the provision. There is no statutory guidance as to the principles to be applied by the court in exercising its discretion. This has led one judge to conclude that Parliament ‘must be deemed to have left it entirely at large and controlled only by the general principles which apply to every kind of judicial discretion.’164 An application for validation can be made by the company itself or by any party having an interest in the affected transaction.165 In making a case for validation the onus falls squarely on the party seeking it.166 It is now settled that the court has jurisdiction to hear and grant an application for validation prior to the making of a winding up order.167 This facility is desirable as it enables the company and other affected parties to anticipate the effect of the provision and protect their positions accordingly.168

(2) Applicable principles (a) The court’s general approach 8.84 Although the court’s discretion is apparently unconstrained, in practice it is subject to two general limitations. Firstly, as is true of any judicial discretion, it must be exercised in accordance with reason and justice and not arbitrarily.169 Secondly, it must be exercised with regard to the law governing the liquidation of insolvent companies170 and the purposes for which section 127 was enacted. In terms of the principles to be applied, the following dictum of Lord Cairns LJ from Re Wiltshire Iron Company, ex p Pearson is usually taken as the starting point: 164 Vaisey J in Re Steane’s (Bournemouth) Ltd [1950] 1 All ER 21 at 25 cited with approval in England and Wales: Re TW Construction Ltd [1954] 1 WLR 540; Re Gray’s Inn Construction Co Ltd [1980] 1 WLR 711 and in Australia: Re Atlas Truck Service Pty Ltd (1974) 24 FLR 220; Re Selmar Pty Ltd [1978] VR 531; Re Tellsa Furniture Pty Ltd (1985) 9 ACLR 869; Thomas v Commonwealth Bank of Australia (1994) 35 NSWLR 335. 165 Re Argentum Reductions (UK) Ltd [1975] 1 WLR 186 (application by contributory); Re Tramway Building & Construction Co Ltd [1988] Ch 293; Dewrun Ltd v Royal Bank of Scotland [2002] BCC 57 (applications by bank as holder of legal charge over subject matter of disposition); Re Tellsa Furniture Pty Ltd (1985) 9 ACLR 869 (application by disponee); Re Webb Electrical Ltd [1988] BCLC 382 (application by disponee); Re Rafidain Bank [1992] BCLC 301 (application by provisional liquidators). In the case of a contributory’s petition, the petitioner also has locus standi to oppose an application for validation by the company: Re Burton & Deakin Ltd [1977] 1 WLR 390. 166 Re Clifton Place Garage Ltd [1969] 3 All ER 892 (reversed on appeal [1970] Ch 477 but not on this point); Re Atlas Truck Service Pty Ltd (1974) 24 FLR 220; Adelaide Truss & Frame Pty Ltd v Bianco Hiring Services Pty Ltd (1992) 60 SASR 160; Thomas v Hatzipetros (1997) 24 ACSR 286. There is less of an onus where the company making the application is solvent: Re Burton & Deakin Ltd [1977] 1 WLR 390. 167 Carden v The Albert Place Association (1886) 56 LJ 166; Re AI Levy (Holdings) Ltd [1964] Ch 19; Re Operator Control Cabs Ltd [1970] 3 All ER 657. 168 For a discussion as to the desirability of prospective applications see Re Gray’s Inn Construction Co Ltd [1980] 1 WLR 711. 169 Sharp v Wakefield [1891] AC 173 at 179. 170 Re Gray’s Inn Construction Co Ltd [1980] 1 WLR 711; Denney v John Hudson & Co Ltd [1992] BCLC 901.

370 Adrian Walters [The section] is a wholesome and necessary provision, to prevent, during the period which must elapse before a petition can be heard, the improper alienation and dissipation of the property of a company in extremis. But where a company actually trading, which it is in the interest of everyone to preserve, and ultimately to sell, as a going concern, is made the object of a winding up petition, which may fail or may succeed, if it were to be supposed that transactions in the ordinary course of its current trade, bona fide entered into and completed, would be avoided, and would not, in the discretion given to the court, be maintained, the result would be that the presentation of a petition, groundless or well-founded, would, ipso facto, paralyse the trade of the company, and great injury, without any counterbalance of advantage, would be done to those interested in the assets of the company.171

8.85 The implication of the passage is that the court should normally exercise its discretion to save transactions entered into in good faith in the ordinary course of the company’s business that produce some benefit for creditors. In the light of the court’s broad discretion, this should be seen as useful guidance rather than a specific test to be applied rigidly in every case. Subsequently, the courts have developed and applied a series of general principles that are well captured in the following propositions derived from the judgments of Fox LJ in Denney v John Hudson & Co Ltd 172 and Buckley LJ in Re Gray’s Inn Construction Co Ltd:173 8.86 (1) The basic principle of law governing the liquidation of insolvent estates is that the free assets of the insolvent at the time of the commencement of the liquidation shall be distributed rateably among the insolvent’s unsecured creditors as at that date. 8.87 (2) There may be occasions when it would be beneficial, not only for the company but also for the unsecured creditors, that the company should be able to dispose of some of its property during the period after the petition has been presented, but before a winding up order has been made. It may sometimes be beneficial to the company and its creditors that the company should be permitted to complete a particular contract or project, or to continue to carry on its business generally in the ordinary course with a view to a sale of the business as a going concern. 8.88 (3) In considering whether to make a validating order, the court must always do its best to ensure that the interests of the unsecured creditors 171 (1868) LR 3 Ch App 443 at 446–447. For examples of its application see, eg Re International Life Assurance Society (1870) LR 10 Eq 312; Re Park Ward & Co Ltd [1926] Ch 828; Re TW Construction Ltd [1954] 1 WLR 540 and Re Atlas Truck Service Pty Ltd (1974) 24 FLR 220. 172 [1992] BCLC 901. 173 [1980] 1 WLR 711. Although Hollicourt (Contracts) Ltd v Bank of Ireland [2001] Ch 555 casts substantial doubt on the statements in Gray’s Inn concerning whether payments into or out of bank accounts constitute dispositions, it does not affect those parts of the Gray’s Inn decision that relate to validation. Thus, on the issue presently under discussion, Gray’s Inn remains authoritative.

Void Dispositions in Compulsory Winding up 371 will not be prejudiced. Where the application relates to a specific transaction this may be susceptible of positive proof. In a case involving completion of a contract or project the proof may be less positive but nevertheless be cogent enough to satisfy the court that in the interests of the creditors the company should be permitted to proceed, or at any rate that proceeding in the manner proposed would not prejudice the creditors in any respect. 8.89 (4) The desirability of the company being permitted to carry on its business generally is likely to be more speculative and is likely to depend on whether a sale as a going concern will be more beneficial than a sale of the company’s assets on a break-up basis. Each case will turn on its own facts and the court must necessarily carry out a balancing exercise. 8.90 (5) Since the policy of the law is to procure so far as is practicable the rateable payment of unsecured creditors’ claims, the court should not validate any transaction or series of transactions which might result in one or more pre-liquidation creditors being paid in full at the expense of other creditors, who will only receive a dividend, in the absence of special circumstances making such a course desirable in the interest of creditors generally. If, for example, it were in the interests of creditors generally that the company’s business should be carried on, and this could only be achieved by paying for goods already supplied to the company prior to presentation of the petition, the court might exercise its discretion to validate payment for those goods. 8.91 (6) A disposition carried out in good faith in the ordinary course of business at a time when the parties are unaware that a petition has been presented will normally be validated by the court unless there is ground for thinking that the transaction may involve an attempt to prefer the disponee, in which case the transaction would probably not be validated. 8.92 (7) Although the policy of securing pari passu distribution might disincline the court to ratify any transaction which preferred a preliquidation creditor, it has no application to transactions involving post-liquidation creditors, as for instance a sale of an asset at its full market value after presentation of the petition. Such a transaction involves no dissipation of the company’s assets, for it does not reduce the value of those assets. It cannot harm the creditors and there would seem to be no reason why the court should not in the exercise of its discretion validate it. A fortiori the court would be inclined to validate a transaction which would increase, or has increased, the value of the company’s assets, or which would preserve, or has preserved, the value of the company’s assets from harm which would result from the company’s business being paralysed.

372 Adrian Walters 8.93 Thus, it is clear that the court has a broad ‘all circumstances’ discretion and may take into account a range of factors.174 Of these factors, the principle of safeguarding the interests of unsecured creditors is rightly taken as the starting point. However, it is also recognised that principles of insolvency law are not absolute and that cases may arise where the paralysis of the company’s business resulting from the rigid application of section 127 could do creditors a disservice. There may also be cases where it is appropriate for the court to balance the risk of creditors losing out against the possibility that the court hearing the petition will not make a winding up order.175 (b) Weighing the relevant factors 8.94 The sixth guideline drawn from Denney and Gray’s Inn (see above) suggests that dispositions carried out in good faith in the ordinary course of business at a time when the parties were unaware that a petition had been presented will usually be validated. However, although it may weigh in the applicant’s favour that the parties’ dealings were bona fide and in the ordinary course, more will be needed to justify validation. In Denney, the applicant supplied the company with diesel essential for its haulage business. Two years before the company was wound up, the applicant became concerned about the company’s payment record and insisted that the company settle outstanding invoices relating to previous deliveries as a pre-condition of fresh supplies. This arrangement continued notwithstanding the presentation of a winding up petition against the company and, as a result, the applicant received two void payments for diesel it had supplied before the date of the petition. The court accepted that the applicant had acted in good faith, without knowledge of the petition and in the ordinary course of its established business relationship with the company as to payments for and supply of diesel. However, in keeping with the overall tenor of the guidelines set out above, the court made it clear that it was incumbent on the applicant to show, in addition, that the payments, or transactions of which they formed part, were likely to benefit the general body of creditors. 8.95 Similarly, in Re J Leslie Engineers Co Ltd 176 Oliver J held that the disponee’s lack of knowledge of the petition was a powerful factor but not one that could be conclusive in itself having regard to the ‘evident purpose of the section which . . . is to ensure that the creditors are paid pari passu.’ Thus, it is neither individually nor cumulatively sufficient to show that the disposition was

174 Similar guidance has been offered by the courts of New South Wales: Re Tellsa Furniture Pty Ltd (1985) 9 ACLR 869 affirmed in Tellsa Furniture Pty Ltd v Glendave Nominees Pty Ltd (1987) 9 NSWLR 254. 175 This may explain why the Companies Court normally grants validation applications made before the hearing of the winding up petition where the company is demonstrably solvent: Re Burton & Deakin Ltd [1977] 1 WLR 390; Re Fairway Graphics Ltd [1991] BCLC 468. 176 [1976] 1 WLR 292.

Void Dispositions in Compulsory Winding up 373 entered into in good faith and/or in the ordinary course of business.177 The touchstone is the question of whether or not the disposition benefits the creditors by enabling the company to earn income, avoid a loss or secure some other advantage.178 Conversely, it is not essential for the applicant to show that the disposition was entered into in good faith and/or in the ordinary course of business as a pre-condition of validation. Knowledge of the pending petition or of the company’s parlous financial state is not necessarily fatal to the success of an application.179 Moreover, there are plenty of cases where ‘one-off’ dealings, not in the ordinary course of business, such as a refinancing involving creation of fresh security180 or the sale of a large asset181 have been validated on the basis that the transaction was beneficial to creditors as a whole. Thus, while other factors may be relevant, in the majority of cases the overriding factor will be whether or not the transaction under scrutiny benefits the creditors. To that issue we now turn.

(3) Creditor benefit 8.96 The essential question facing the court is to ascertain whether the transaction could reasonably be perceived at the time it was concluded as offering some actual or prospective advantage to the general body of creditors.182 As long as the disposition, or the transaction of which it formed part, ‘was or was apt to be for the benefit of the creditors . . .’ the court will be inclined to validate it.183 Thus, as a rule of thumb, transactions that confer an advantage on one creditor or operate to reduce the assets available for distribution will only normally be validated if there is a corresponding benefit to the creditors collectively. In the absence of any credible evidence of creditor benefit, the onus on the applicant will not be discharged and the court will refuse the application.184 177 Though the court will generally validate any disposition by way of payment made prior to the advertisement of the petition: Hollicourt Ltd v Bank of Ireland [2000] 1 WLR 895 at 897–98. It can be inferred from Re McGuinness Bros (UK) Ltd (1987) 3 BCC 571 that practice in this regard rests on the rule in Re Condon, ex p James (1874) 9 Ch App 609. 178 See also Re Atlas Truck Service Pty Ltd (1974) 24 FLR 220; Re Tellsa Furniture Pty Ltd (1985) 9 ACLR 869 affirmed in Tellsa Furniture Pty Ltd v Glendave Nominees Pty Ltd (1987) 9 NSWLR 254; Adelaide Truss & Frame Pty Ltd v Bianco Hiring Services Pty Ltd (1992) 60 SASR 160; Thomas v Commonwealth Bank of Australia (1994) 35 NSWLR 335; Prospect Electricity v Advanced Glass Technologies of Australia Pty Ltd (1996) 22 ACSR 6. 179 Re Park Ward & Co Ltd [1926] Ch 828; Jardio Holdings Pty Ltd v Dorcon Construction Pty Ltd (1984) 3 FCR 311; Adelaide Truss & Frame Pty Ltd v Bianco Hiring Services Pty Ltd (1992) 60 SASR 160. A disponee’s knowledge of the petition may count against him on a retrospective application as the court is entitled to ask why the application was not made prospectively: Re Gray’s Inn Construction Co Ltd [1980] 1 WLR 711. 180 Re Park Ward & Co Ltd [1926] Ch 828. 181 Re Tramway Building & Construction Co Ltd [1988] Ch 293. 182 Jardio Holdings Pty Ltd v Dorcon Construction Pty Ltd (1984) 3 FCR 311. 183 Tellsa Furniture Pty Ltd v Glendave Nominees Pty Ltd (1987) 9 NSWLR 254. 184 Re Fairway Graphics Ltd [1991] BCLC 468; Boulevard Music Pty Ltd v Birch (1996) 21 ACSR 367. Accordingly, a mere assertion that the creditors have benefited or will benefit is insufficient.

374 Adrian Walters (a) Measuring actual or prospective benefit 8.97 If, by the time the application is heard, it is possible to show that the disposition or wider transaction produced some actual benefit to creditors, this will clearly strengthen the applicant’s hand. In Re Park Ward & Co Ltd,185 the applicant, knowing that a winding up petition was pending against the company, loaned it a sum of money, on security of a debenture, to cover the employees’ wages. By the time the application came before the court, the company’s business had been sold as a going concern. By helping to preserve the business and facilitate a going concern sale, the transaction had produced a tangible benefit. Accordingly, the court had no difficulty in validating the applicant’s security. 8.98 Although in Park Ward there was an actual benefit, it is not necessary for the applicant to show that the disposition or wider transaction gave rise to any immediate or actual benefit. It suffices to show that the disposition was likely to benefit creditors at the time it was made, even if by the time of the hearing it cannot be shown that it did in fact do so.186 In exercising its discretion, the court is not required to conduct a ‘massive investigation with hindsight’ into what the creditors’ position would have been had the disposition not been made187 nor is it essential that the prospective benefit be capable of fiscal calculation.188 8.99 Re Clifton Place Garage Ltd 189 provides an interesting illustration of these points. In this case, a parent company was forced into receivership after a winding up petition had been presented against its wholly owned subsidiary. The receiver believed that the shares in the subsidiary were a valuable asset in the receivership and, relying on information given to him by a director concerning the subsidiary’s liabilities, he decided that it should continue to trade with a view to sale on a going concern basis. To finance further trading, the receiver advanced, in round figures, £4,900 of the parent company’s money to the subsidiary, £4,000 of which was repaid out of trading receipts. Within a month it became apparent that the subsidiary’s liabilities had been considerably understated whereupon it ceased trading and a winding up order was made. The Court of Appeal granted the receiver’s application to validate the £4,000 worth of repayments on two grounds. The first ground was that the decision

185

[1926] Ch 828. Denney v John Hudson & Co Ltd [1992] BCLC 901 at 906–7. If the application is for prospective relief, the question is whether it is more probable than not that the proposed transaction will produce a benefit. 187 Ibid. 188 Boulevard Music Pty Ltd v Birch (1996) 21 ACSR 367. On the other hand, the benefit must be real and not ephemeral: Jardio Holdings Pty Ltd v Dorcon Construction Pty Ltd (1984) 3 FCR 311. Nevertheless, it is clear that the court can authorise a departure from insolvency law’s distributional rules and so, to that extent, the policy of preserving the estate in aggregate ‘trumps’ the pari passu principle. On this point see further paras 1.16–1.24 and 8.3–8.7. 189 [1970] Ch 477 reversing [1969] 3 All ER 892. 186

Void Dispositions in Compulsory Winding up 375 to continue trading, which gave rise to the transactions in issue, was likely to benefit the company’s creditors when viewed from the receiver’s standpoint at the time. As the following passage from the judgment of Sachs LJ makes clear, the court was not prepared to substitute its own judgment made in hindsight for the bona fide decision of a receiver faced with an emergency situation: The test to be applied to his actions was . . . not whether they were in the upshot successful in benefiting the . . . creditors, nor even whether, months later, after analysis in the calmer atmosphere of the court, his decision appears correct in the light of afteracquired knowledge. The decision to be taken was a business decision. One has to try to place oneself in the same chair as the man who had to take it. To my mind, any such man would be pressed in his consideration of the matter by the fact that to keep a business of this type going for . . . a short time is normally a better course than the usually irrevocable step of ordering a closure . . .

8.100 The second ground was that the company had, prima facie, received a net benefit because it had paid only £4,000 to secure the use of £4,900. As there was no evidence that the creditors had suffered any detriment from the overall transaction, the court concluded that it would be unjust to allow the company to recover the £4,000.190 It is not difficult to justify the court’s decision. The creditors enjoyed the benefit of new value in the form of the monies advanced. That benefit would not have been available but for the actions of the receiver.191 Moreover, there was not only a net actual benefit. It was also conceivable at the time that the loan would purchase prospective benefits for creditors by facilitating continued trading and the possibility of a going concern sale. As the subsidiary’s creditors had already enjoyed this combination of actual and prospective benefits, they would arguably have been unjustly enriched at the expense of the parent company’s creditors had the court required the receiver to pay the £4,000 over a second time. 8.101 An important point flowing from Clifton Place concerns the standard of review that the court should apply in assessing whether or not the transaction or series of transactions was likely to benefit creditors. As we saw above, the Court of Appeal deferred to the commercial judgment of the receiver. Nevertheless, it is implicit that the receiver’s decision to continue trading for a 190 In this respect, it is interesting to note Sachs LJ’s view that the onus lay on the liquidator to show detriment. A further point is that although the applicant is not required to show that the transaction ultimately produced any benefit, cogent evidence of actual detriment may affect the outcome. This is especially so where retrospective validation is sought for a series of transactions in circumstances where continued post-petition trading resulted in further losses: see, eg Re Gray’s Inn Construction Co Ltd [1980] 1 WLR 711. Note also Dewrun Ltd v Royal Bank of Scotland [2002] BCC 57 where, drawing on the Denney guidelines, Neuberger J remarked obiter that the court ought not to validate in cases where there is a ‘real prospect’ that validation could prejudice the interests of unsecured creditors. 191 In effect, the parent company was acting as banker and it was not preferred by the repayments as they related wholly to post-liquidation indebtedness. The situation is analogous to that of a bank ruling off a pre-existing overdraft facility and seeking validation for a new account on which fresh advances are to be discharged by payment in of current receipts.

376 Adrian Walters short period was regarded as reasonable in all the circumstances.192 It is submitted that it would not be enough to establish that those authorising the relevant transactions acted honestly and with the subjective intention or belief that creditors would benefit as a result. The correct test is that applied by the Federal Court of Australia in Jardio Holdings Pty Ltd v Dorcon Construction Pty Ltd:193 Logically, the merits of the application should be tested as at the date of entry into the transaction sought to be validated. Subsequent events may be capable of throwing light on the position at an earlier point of time, but that is a different matter. If an applicant can make out a case for validation . . . upon the footing that, looked at as at the time of entry into the transaction, it was in the interests of the general body of creditors that the disposition . . . concerned should take place, sanction should not be denied because subsequent events prove wrong a judgment reasonably formed at the time that the transaction offered advantages or potential advantages to the general body of creditors.

8.102 The test is particularly relevant where the purpose of the transaction, as in Clifton Place, was to facilitate continued trading. In such cases, the standard of review is clearly objective. The court will not presume that continued trading is necessarily beneficial per se.194 There must have been some reasonable prospect that the decision to continue trading would benefit creditors. This would be so, if, for example, a going concern sale was a realistic possibility or if continued trading would enable the company to complete lucrative orders or projects. 8.103 At the same time, the court must not allow its judgment to be clouded by hindsight. Subsequent events may bear witness to the reasonableness or otherwise of the original decision.195 However, where the directors decide to continue trading with a view to selling the company’s business as a going concern, the decision should not automatically be regarded as unreasonable because a buyer is not found.196 Nevertheless, they must have been properly informed and have based their decision on a proper evaluation of available information.197 In some of the older cases, the courts appear to have given considerable weight to subjective factors, such as the bona fides of the directors, without enquiring as to the reasonableness of the underlying transaction.198 In 192 Or, given the standard of review adopted by the court, not so unreasonable as to be regarded as irrational. 193 (1984) 3 FCR 311. Emphasis added. 194 Re Gray’s Inn Construction Co Ltd [1980] 1 WLR 711; Re McGuinness Bros (UK) Ltd (1987) 3 BCC 571 though cf Re TW Construction Ltd [1954] 1 WLR 540. 195 Re Park Ward & Co Ltd [1926] Ch 828 is a case in point. 196 Re Omnico Ltd (1976) 1 ACLR 381. 197 It was said at first instance in Clifton Place that the receiver had failed to make sufficient enquiries and so had acted unreasonably. The Court of Appeal disagreed holding that the receiver had done as much as could reasonably be expected of him in difficult circumstances. 198 Re International Life Assurance Society (1870) LR 10 Eq 312 ; Re Steane’s (Bournemouth) Ltd [1950] 1 All ER 21. In both cases fresh monies were advanced on security to try and keep the

Void Dispositions in Compulsory Winding up 377 the light of the test in Jardio Holdings, it is submitted that these authorities should be treated with a degree of caution. Ultimately, the court has to strike a delicate balance. Unless some latitude is shown, section 127 will effectively paralyse the company’s business to the possible detriment of creditors in cases where there is a prospect that its fortunes can be turned around or that continued trading might lead to a more beneficial realisation of the assets, as would be the case with a going concern sale. By the same token, the court must try, where possible, to clamp down on transactions that have no genuine prospect of benefiting the creditors and that offend against insolvency law’s distributional norms. (b) Post-petition asset sales 8.104 The guidance from Denney and Gray’s Inn set out above suggests that the validation of certain forms of post-petition transaction, such as the sale of a fixed asset, will usually be a straightforward matter. Where the asset is disposed of at market value, the estate is not diminished and creditors are not prejudiced. One asset is merely substituted for another of equivalent value. Thus, provided the court is satisfied that the asset was or is to be sold at a fair price, a validation order will generally follow as a matter of course.199 The fact that unsecured creditors might receive a better dividend if the sale was not retrospectively validated is not a ground for the court to refuse validation in circumstances where the sale did not diminish the estate.200 Similar considerations apply to sales of the company’s stocks in the ordinary course of business.201 (c) Post-petition loans 8.105 Where money is advanced to the company after the date of the winding up petition, the loan itself is a disposition of the lender’s rather than the company’s property. If, however, the company grants security or repays the loan, there is a disposition of the company’s property and the lender can only retain priority by having the security or repayment validated. As we saw above, the question in these circumstances is whether the transaction as a whole was or was likely to be for the benefit of creditors generally. Where the loan was made to enable the company to continue trading in the hope of selling its business as a going concern, the courts have often been prepared to company trading with a view to a going concern sale of its assets. Like Clifton Place, they suggest that the court may subtly relax the standard of review where the applicant is seeking to preserve priority in respect of genuine new value introduced to assist the distressed company. 199 Re Tramway Building & Construction Co Ltd [1988] Ch 293; Re Sugar Properties (Derisley Wood) Ltd (1987) 3 BCC 88. 200 Re Tramway Building & Construction Co Ltd [1988] Ch 293. If it was otherwise the court would rarely exercise its discretion in the applicant’s favour as reversing the transaction will always enhance distributable assets unless the relevant asset has become worthless. 201 Re Wiltshire Iron Company (1868) LR 3 Ch App 443.

378 Adrian Walters validate the security or repayment.202 However, there must be some genuine benefit, although this will not always be easy to quantify. Thus, for example, where X lends money to the company post-petition on the security of a debenture and the money is used simply to discharge a pre-liquidation debt owed by the company to X, the court will not validate the debenture. All that happens in substance is that X obtains an advantage by substituting a secured claim for an unsecured claim without the loan in any way benefiting the company or the general body of creditors.203 (d) Transactions involving the payment or securing of pre-liquidation debt 8.106 Transactions arising entirely after the deemed commencement of winding up (eg post-liquidation payments for post-liquidation supplies of goods and services or specific transactions of the sort already considered) are generally treated more favourably than transactions that, in whole or part, involve the payment or securing of pre-liquidation indebtedness. In the former case, as long as the company receives genuine value, the estate is undiminished. However, the payment of a pre-liquidation debt prima facie reduces the assets available for distribution and confers an advantage on one creditor over other creditors. On the guidelines set out above, such a payment will not normally be validated because it offends against the pari passu rule and thus prejudices, rather than benefits, the general body of creditors.204 Where the creditor knew of the pending petition or the company’s impending insolvency, this will strengthen the inference that the payment was either unbeneficial or positively prejudicial.205 The same is true if there is evidence (or it can be inferred) that the company intended to prefer the creditor.206 However, it is submitted that the motives of the recipient and of those authorising the payment are only relevant insofar as there are inferences to be drawn with regard to the question of creditor benefit. So, for example, where payments are made to a creditor who is unaware of the pending petition in good faith and in the ordinary course of business, it may be inferred that the payments were likely to benefit creditors. However, if the court finds that the payments conferred an advantage on one creditor without any corresponding benefit to the other creditors, it will refuse to validate them even if

202 Re International Life Assurance Society (1870) LR 10 Eq 312; Re Park Ward & Co Ltd [1926] Ch 828; Re Steane’s (Bournemouth) Ltd [1950] 1 All ER 21; Re Clifton Place Garage Ltd [1970] Ch 477; Re Omnico Ltd (1976) 1 ACLR 381 though cf Re Gray’s Inn Construction Co Ltd [1980] 1 WLR 711. 203 Jardio Holdings Pty Ltd v Dorcon Construction Pty Ltd (1984) 3 FCR 311. 204 Re Rafidain Bank [1992] BCLC 301; Re Western Welsh International System Buildings Ltd (1985) 1 BCC 99, 296. 205 Re Liverpool Civil Service Association ex p Greenwood (1874) 9 Ch App 511; Re The Civil Service and General Store Ltd (1887) 57 LJ ChD 119; Re Atlas Truck Service Pty Ltd (1974) 24 FLR 220; Jardio Holdings Pty Ltd v Dorcon Construction Pty Ltd (1984) 3 FCR 311. 206 Re Webb Electrical Ltd [1988] BCLC 382.

Void Dispositions in Compulsory Winding up 379 they were honestly made.207 The principles are the same where the company gives security to a pre-existing creditor for an unsecured pre-liquidation debt.208 8.107 The guidelines from Denney and Gray’s Inn state clearly that the court should not generally validate any transaction or series of transactions which might result in one or more pre-liquidation creditors being paid in full at the expense of other creditors in the absence of special circumstances making such a course desirable in the interest of creditors generally. Thus, it would be wrong to conclude that in all circumstances in which a payment is for a past debt, validation must necessarily be refused.209 If the payment ‘constitutes a necessary part of a transaction which as a whole is beneficial to the general body of unsecured creditors’,210 the court will validate it. The courts therefore take a pragmatic approach, recognising that insolvency principles are not absolute and should give way in appropriate circumstances.211 8.108 One such case is where the payment helps preserve an asset for the estate that would otherwise have been lost. In Re AI Levy (Holdings) Ltd,212 the court validated the sale of leasehold premises even though the company was forced to meet the landlord’s claim for pre-petition arrears of rent in full out of the proceeds of sale. It was clear that if the sale did not go through and the company went into liquidation, the lease would be liable to forfeiture and would lose its value. From the creditors’ point of view, it was better for the company to receive the current value of the asset net of the arrears than nothing at all.213 8.109 Special considerations also apply to payments that enable the company to stay afloat in circumstances where continued trading offers actual or prospective benefits to creditors. The classic example is a payment made to a major supplier with the purpose of securing future supplies of goods or services necessary to the continuation of the business. In Denney v John Hudson & Co Ltd,214 there was a standing arrangement under which the company was required to pay outstanding invoices for previous deliveries of diesel as a pre-condition of 207 Re Tellsa Furniture Pty Ltd (1985) 9 ACLR 869 affirmed in Tellsa Furniture Pty Ltd v Glendave Nominees Pty Ltd (1987) 9 NSWLR 254; Boulevard Music Pty Ltd v Birch (1996) 21 ACSR 367. In Re J Leslie Engineers Co Ltd [1976] 1 WLR 292, Oliver J found (i) that the recipient was unaware of the pending petition and (ii) that the intention of the director authorising the payment was to prefer the recipient. It is submitted that nothing turns on (ii). If the effect of the payment is to prefer the recipient without there being any corresponding benefit to the general body of creditors, the court is justified in refusing validation on that ground alone. 208 Compare Jardio Holdings Pty Ltd v Dorcon Construction Pty Ltd (1984) 3 FCR 311 and Albion Reid (SA) Pty Ltd v Baron Holdings Pty Ltd (1973) 7 SASR 564. 209 Re Atlas Truck Service Pty Ltd (1974) 24 FLR 220 and see n 188 above. 210 Re Gray’s Inn Construction Co Ltd [1980] 1 WLR 711. 211 If one creditor is paid in full but the payment gives rise to circumstances in which the remaining creditors receive a greater dividend than they would have received had that creditor not been paid, the infringement of the pari passu principle is justifiable. 212 [1964] Ch 19. 213 Re Falkiner Chains Pty Ltd (1981) 6 ACLR 94 is a similar case. 214 [1992] BCLC 901.

380 Adrian Walters fresh supplies. After the date of the winding up petition, the supplier received two payments in respect of pre-liquidation supplies of diesel. The Court of Appeal upheld the judge’s order validating these payments. By making payment under the standing arrangement, the company received a benefit in that it could then order a further supply of diesel, payment being deferred until the next supply was required. Without the diesel, the company, which was in the haulage business, could not have continued trading. Although the company could have obtained diesel from other suppliers, it was probable that they would have imposed ‘cash on delivery’ terms. Accordingly, the making of the two payments, with the result that essential further supplies were obtained, was apt to benefit the creditors. In cases of this nature, the court will not assume that continued trading will necessarily benefit creditors.215 However, where it is likely that continued trading will lead to a going concern sale of the business or assist the company in completing profitable contracts or, at least, in some way enhance the realisable value of the company’s assets, the court may be persuaded to sanction payments that are essential to furthering these objectives even though the creditor concerned is technically preferred as a result.216 (e) General validation 8.110 As well as specific transactions or payments with which we have been concerned so far, it is settled that the court may prospectively sanction a general continuation of the company’s trading thus relieving any dispositions that it makes in the course of its business.217 Where, for example, the bank is prepared to continue supporting the company’s business, it will seek (or require the company to seek) a blanket validating order sanctioning the continued operation of banking facilities.218 In the case of a creditor’s petition, the court will need to be persuaded that further trading is likely to be in the interests of creditors on the principles already discussed. As the likely benefits of continued trading are 215 Adelaide Truss & Frame Pty Ltd v Bianco Hiring Services Pty Ltd (1992) 60 SASR 160; Telecom Australia v Sheahan (1991) 4 ACSR 425. 216 For cases analogous to Denney in which the relevant transaction was validated see, eg Albion Reid (SA) Pty Ltd v Baron Holdings Pty Ltd (1973) 7 SASR 564 (mortgage securing payment for past and future deliveries of concrete necessary for completion of building contract); Re Tellsa Furniture Pty Ltd (1985) 9 ACLR 869 affirmed in Tellsa Furniture Pty Ltd v Glendave Nominees Pty Ltd (1987) 9 NSWLR 254 (payments to major supplier enabling company to obtain further supplies); Adelaide Truss & Frame Pty Ltd v Bianco Hiring Services Pty Ltd (1992) 60 SASR 160 (payments to major supplier for stocks used by the company in manufacturing its products); Prospect Electricity v Advanced Glass Technologies of Australia Pty Ltd (1996) 22 ACSR 6 (payments to utility supplier enabling company to continue trading with a view to a going concern sale of its business). Where, as in Adelaide Truss, payments are made to secure continuing supplies of materials used in a manufacturing process, it is arguable that the company’s realisable assets will be enhanced on the assumption that the finished product is worth more than the sum of its parts. 217 See, eg Re Operator Control Cabs Ltd [1970] 3 All ER 657. 218 Even in the light of Hollicourt (Contracts) Ltd v Bank of Ireland [2001] Ch 555, the bank needs to protect itself with regard to payments credited to the company’s account for reasons discussed in section B2 above.

Void Dispositions in Compulsory Winding up 381 inherently speculative, the court will only grant the order subject to safeguards.219 In particular, the court will not make an order that might lead to the preferential discharge of the company’s overdraft and, accordingly, will require the bank to freeze the old account and conduct all subsequent dealings on a new account.220 In the case of a contributory’s petition brought on the ‘just and equitable’ ground,221 the company will often be solvent and it will be in everyone’s interests for it to continue trading. In such cases, a general validation order will usually be made as a matter of course222 unless the petitioner objects and adduces compelling evidence proving that the disposition is in fact likely to injure the company.223 (f) Partial validation 8.111 It was held in Dewrun Ltd v Royal Bank of Scotland224 that the court has power to make an order validating a transaction for a limited purpose and/or to a limited extent only. D Ltd transferred a freehold title to AS Ltd one month after a petition had been presented to wind up D Ltd. Without being aware of the petition which was not advertised until later, the bank funded £3.65 million of the £8 million purchase price and, in return, AS Ltd granted a charge over the property in the bank’s favour. £2.48 million of the bank’s advance was used to pay off a prior charge. Under section 127 the transfer was prima facie void and, in the absence of a validation order, it was accepted that D Ltd would be entitled to recover the property free of the bank’s charge (subject to the bank’s right of subrogation in relation to the prior charge). It was not open to the bank to apply for validation of the charge itself as this amounted to a disposition by AS Ltd rather than D Ltd. Instead, the bank applied for partial validation of the original transfer to the extent necessary to preserve its charge over the property. Neuberger J held that he had jurisdiction to make the order given that the court’s discretion was not fettered by express statutory language. Moreover, as the evidence showed that creditors would not be prejudiced, he granted the application on the bank’s undertaking not to increase the amount secured on the property beyond the sum of £3.65 million originally advanced. 219 It is standard practice for the order to be limited to transactions in the ordinary course of the company’s business and dispositions of property at full market value. Concerns that the company’s bank might come under a duty to verify that transactions effected through the bank account were in the ordinary course of business and/or for full value have been assuaged by the addition of a proviso to the standard form of order following Harman J’s suggestion in Re a Company (No 00687 of 1991) [1991] BCC 210. 220 Re Gray’s Inn Construction Co Ltd [1980] 1 WLR 711; Re McGuinness Bros (UK) Ltd (1987) 3 BCC 571. 221 Insolvency Act 1986 s 122(1)(g). 222 The petition should state whether or not the petitioner consents to the making of a validation order in the standard form: see Practice Direction: Applications under the Companies Act 1985 and the Insurance Companies Act 1982 made under the Civil Procedure Rules. 223 Re Burton & Deakin Ltd [1977] 1 WLR 390; Re a Company (No 007523 of 1986) [1987] BCLC 200. 224 [2002] BCC 57.

382 Adrian Walters (4) Costs 8.112 If the court grants an application for validation, the applicant’s costs will usually be treated as either costs in the petition (prospective application) or costs in the winding up (retrospective application). Either way, the costs will be payable, in priority, out of the assets of the company in liquidation.225 If the application fails, the applicant will usually be ordered to bear the costs. The liquidator’s costs of resisting an application will be treated in a similar way to the costs of a primary application under section 127 for avoidance and recovery.226

F CONCLUSION

8.113 There are various difficulties with the operation of section 127 making it a leading candidate for reform: 8.114 (1) The rule is over-broad and cumbersome, in that court intervention is required to ensure that bona fide transactions of benefit to the company are not challenged. Its effects are particularly troublesome in cases where a winding up order is ultimately not made or where the company is solvent. In line with the Australian approach,227 we might consider the option of exempting certain categories of transaction. One element of this would be to codify the result in Hollicourt.228 8.115 (2) At the same time, there are some transactions that the rule may not capture even though their consequences are squarely within the mischief of the section. In this respect, the position in relation to transactions that have the effect of subtracting value from the estate even though they are not strictly dispositions of property needs clarification.229 8.116 (3) The remedial extent of the provision is unclear. Questions of recovery are left for determination under the general law. Logically, this suggests that the disponee should be able to take advantage of general defences such as the defence of change of position to an action for restitution of money had and received. However, the availability of general defences does not sit comfortably with the purpose of the section and the court’s power of validation. The position of third 225 Insolvency Rules 1986 r 4.218(1)(h). If, as in Re Park Ward & Co Ltd [1926] Ch 828, the court validates the grant of a charge, the costs of the application may be treated as chargee’s costs falling within the scope of the security. 226 Para 8.66 above. 227 Corporations Act 2001 s 468. 228 Section D above. 229 Section B2 above.

Void Dispositions in Compulsory Winding up 383 parties is also unclear. In any future reform, the introduction of statutory remedies and defences should be considered. This could usefully be undertaken as part of a thorough review of all the avoidance provisions, the aim being to produce a single set of codified remedies applicable across the board.230 The question of whether a post-petition disposition should be wholly void, void only as between certain parties (eg the liquidator and the disponee), void only for purposes related to or incidental to the winding up231 or merely voidable could also be considered. 8.117 (4) Although the English courts have ruled that property recovered as a consequence of avoidance falls within the scope of an allencompassing charge,232 this conclusion is open to doubt both in principle and as a matter of policy.233 It also puts section 127 out on a limb, as the position in English law with regard to the other main avoidance provisions is that the proceeds of action exclusively benefit the unsecured creditors.234 As the issue raises fundamental issues of policy, it is probably best picked up in a review of transaction avoidance mechanisms as a whole. 8.118 (5) The principles applicable on a validation application lack transparency. This could be addressed by introducing statutory criteria based on the guidelines developed in Denney and Gray’s Inn.235 The interrelationship between validation and defences also needs addressing.236 8.119 In the meantime, we can expect the judges to approach section 127 with the kind of pragmatism evident in Hollicourt and in the cases concerning the court’s power of validation.

230 Following the approach to directors’ duties suggested in the context of company law reform: see RC Nolan, ‘Enacting Civil Remedies in Company Law’ (2001) 1 Journal of Corporate Law Studies 245. 231 National Acceptance Corporation Pty Ltd v Benson (1988) 12 NSWLR 213. 232 Mond v Hammond Suddards [1996] 2 BCLC 470. 233 Campbell v Michael Mount PPB (1995) 65 SASR 334. 234 See paras 2.135–2.145 and 4.102–4.103. 235 Section E above. 236 See (3) above.

9

Restitution for Vulnerable Transactions SIMONE DEGELING

A INTRODUCTION

9.1 This chapter investigates the proposition that certain provisions of the Insolvency Act1 are given to reverse or prevent unjust enrichment.2 The rationales or policy reasons behind the avoidance regime are well documented elsewhere, and are said to include the need to prevent dismemberment of the insolvent’s assets, to preserve the principle of equality between creditors and to provide an orderly and collective process for dealing with the affairs of the insolvent.3 This discussion is not concerned to investigate these policy rationales, but rather the possibility that the regime reverses unjust enrichment. The discussion therefore seeks to determine the extent to which the avoidance provisions are restitutionary4 in pattern. The technique to be adopted is to see 1

Insolvency Act 1986 ss 238, 239 and 423. R Goode, Principles of Corporate Insolvency Law, 2nd edn, (London, Sweet & Maxwell, 1997) at 356; A Keay, ‘The Recovery of Voidable Preferences: Aspects of Restoration’ in F Rose (ed), Restitution and Insolvency (London, Mansfield Press, 2000) at 251; P Birks and C Mitchell, ‘Unjust Enrichment’ in P Birks (ed), English Private Law Volume II (Oxford, Oxford University Press, 2000) at 590. 3 These rationales are discussed in paras 1.1–1.10. See also R Goode, Principles of Corporate Insolvency Law, 2nd edn, (London, Sweet & Maxwell, 1997) at 345–48; A Keay, ‘The Recovery of Voidable Preferences: Aspects of Restoration’ in F Rose (ed), Restitution and Insolvency (London, Mansfield Press, 2000) at 241–45; DD Prentice, ‘Some Observations on the Law Relating to Preferences’ in R Cranston (ed), Making Commercial Law. Essays in Honour of Roy Goode (Oxford, Clarendon Press, 1997) at 439–59. In relation to the Australian regime, see A Keay, Avoidance Provisions in Insolvency Law (North Ryde, LBC Information Services, 1997) at 31–59. 4 This chapter uses both restitution and unjust enrichment. It is important to notice that the two terms describe different things. Unjust enrichment describes the event encapsulated in the phrase unjust enrichment at the expense of the claimant which triggers the response called restitution. However, restitution is multi-causal, being triggered both by unjust enrichment and wrongdoing. The cases in this study are arguably examples of restitution of unjust enrichment. In relation to the question of whether restitution is mono or multi causal, see P Birks, ‘Equity in the Modern World: An Exercise in Taxonomy’ (1996) 26 University of Western Australia Law Review 1; P Birks, ‘The Law of Restitution at the End of an Epoch’ (1999) 28 University of Western Australia Law Review 13; P Birks, ‘Equity, Conscience and Unjust Enrichment’ (1999) 23 Melbourne University Law Review 1; P Birks, ‘Rights, Wrongs and Remedies’ (2000) Oxford Journal of Legal 2

386 Simone Degeling whether the cases map onto an unjust enrichment framework. This task is important because it allows us to re-analyse legislation and associated legal principles. The effect of sections 238, 239 and 423 of the Insolvency Act is to restore the position before the impugned transaction occurred and the court is given very wide powers to achieve this result. The main advantage of exposing any restitutionary pattern is thus to provide a more sophisticated and principled basis for the exercise of the court’s discretion. 9.2 The following features of the cases are brought into sharper relief by deploying an unjust enrichment approach. The first is recognition that there are in fact two symmetrical unjust enrichment claims embedded in the cases. As is outlined below, unjust enrichment claims are arguably available both to the liquidator and a recipient creditor in respect of value transferred. Claim one is the claim brought by the liquidator to recover value or an asset transferred to a particular creditor, creditor A. Claim two is the claim which may be available to creditor A. For example, creditor A may have improved the property which she is obligated to return to the liquidator via claim one. Claim two (the creditor’s claim) recognises that in being forced to transfer the value of these improvements, creditor A confers a benefit on the general body of creditors. The second advantage of an unjust enrichment analysis concerns the availability of the defence of change of position. The primary defence to a claim for restitution of unjust enrichment is change of position. To the extent that the avoidance regime reverses unjust enrichment, the defence of change of position arguably applies to such claims.5 9.3 The interplay between these two findings may produce startling results. It might, erroneously, be thought that claim two is simply part of a valuation exercise for claim one. If it is true that, in addition to the claim by the liquidator against a creditor, that creditor may also have a claim against the other creditors in respect of value transferred, then resolving these claims is not simply a matter of netting one claim against another. Although both claims clearly arise out of the same transaction, and have to be considered together, they are in fact analytically distinct. It should not be open to creditor A simply to assert that the Studies 1; P Birks, ‘Unjust Enrichment and Wrongful Enrichment’ (2001) 79 Texas Law Review 1767; A Burrows, ‘Quadrating Restitution and Unjust Enrichment: A Matter of Principle?’ [2000] Restitution Law Review 257; M McInnes, ‘Restitution, Unjust Enrichment and the Perfect Quadration Thesis’ [1999] Restitution Law Review 118; L Smith, ‘The Province of the Law of Restitution’ (1992) 71 Canadian Bar Review 672; L Smith, ‘Breach of Confidence—Constructive Trusts—Punitive Damages—Disgorgement of the Profits of Wrongdoing: Ontex Resources Ltd v Metalore Resources Ltd’ (1994) 73 Canadian Bar Review 259. 5 The Insolvency Act does not specifically provide for the defence of change of position. There is some evidence that the Court of Appeal regards the insolvency regime contained in the statute as inviolable, it not being in the power of ‘… the liquidator, the administrators or the court to amend or modify the statutory scheme…’ through the recognition of a remedial constructive trust: Re Polly Peck International plc (No 2) [1998] 3 All ER 812 at 827 per Mummery LJ. However, the availability of proprietary remedies is often controversial and there is nothing in the Insolvency Act expressly excluding the defence of change of position.

Restitution for Vulnerable Transactions 387 value or asset to be returned via the liquidator to other creditors should be net of any improvements made. Rather, creditor A will need to satisfy the elements for liability in unjust enrichment. There must be a principled basis for the adjustment in value. In addition, the role of change of position must be accounted for. The analysis in this chapter suggests that the defence of change of position must in theory be available to both defendants. To the extent that the value of the two claims should be set against one another, the effect of this defence may be to reduce the value in respect of which liability will fall on both creditor A and the other creditors of the company. This will in turn impact on the net value of the claims. 9.4 Some important qualifications must be made at the outset. The first is that a comprehensive examination of this topic requires a more detailed analysis than is possible in this one chapter. There has been some recent work, but more needs to be done.6 The second concerns the evidence to be examined. It must be conceded that the author could find no case in which the court expressly adopts the unjust enrichment analysis for which this analysis contends. However, this should not be an insuperable barrier. Unjust enrichment jurisprudence is only now reaching a state of mature development and it is not surprising that the full ramifications have yet to be realised. In addition, there are good policy reasons for considering the possible role of unjust enrichment within the insolvency framework. Prima facie, both the law of unjust enrichment and parts of the Insolvency Act are concerned with the reversal of enrichments or transactions. Consistent treatment of the various defendants requires that the possible impact of unjust enrichment principles be taken into consideration. The evaluation of the cases appearing below is therefore a re-examination of the facts and judicial reasoning in the light of modern unjust enrichment principles. In this way the proper role of unjust enrichment in such cases may be appreciated. 9.5 The final qualification concerns the nature of the claim, whether personal or proprietary. Most claims in unjust enrichment are personal. However, there are examples in which the claims are proprietary. The continuing debate7 about 6 See in particular A Keay, ‘The Recovery of Voidable Preferences: Aspects of Restoration’ in F Rose (ed) Restitution and Insolvency (London, Mansfield Press, 2000) at 237–60. 7 An incomplete list includes: P Birks, ‘Restitution and Resulting Trusts’ in S Goldstein (ed), Equity and Contemporary Legal Developments (Jerusalem, 1992) 335; P Birks ‘Trusts Raised to Reverse Unjust Enrichment: the Westdeutsche Case’ [1996] Restitution Law Review 3; P Birks, ‘Property and Unjust Enrichment: Categorical Truths’ [1997] New Zealand Law Review 623; A Burrows, ‘Proprietary Restitution: Unmasking Unjust Enrichment’ (2001) 117 Law Quarterly Review 412; R Chambers, Resulting Trusts (Oxford, Clarendon Press, 1997); G Elias, Explaining Constructive Trusts (Oxford, Clarendon Press, 1990); R Goode, ‘Proprietary Restitutionary Claims’ in W Cornish et al (eds), Restitution Past, Present & Future (Oxford, Hart Publishing, 1998) 63; R Grantham and C Rickett, ‘Tracing and Property Rights: The Categorical Truth’ (2000) 63 Modern Law Review 905; R Grantham and C Rickett, ‘On the Subsidiarity of Unjust Enrichment’ (2001) 117 Law Quarterly Review 273; Sir Peter Millett, ‘Restitution and Constructive Trusts’ in W Cornish et al (eds), Restitution Past, Present & Future (Oxford, Hart Publishing, 1998) 199; C Rickett and R Grantham, ‘Resulting Trusts—A Rather Limited Doctrine’ in P Birks and F Rose (eds), Restitution and Equity (London, Mansfield Press, 2000) 39; W Swadling, ‘A New Role for

388 Simone Degeling the circumstances in which proprietary restitution is applicable lie beyond the scope of this chapter, although brief references will be made where appropriate. The discussion does not deal with the vexed question of the nature of any proprietary rights to substitute assets.

B A FRAMEWORK FOR ANALYSIS

9.6 The elements of a claim for restitution of unjust enrichment are uncontroversial. The claimant must show that the defendant has been enriched by the receipt of a benefit. This benefit must be passed to the defendant at the expense of the claimant and it must be unjust for the defendant to retain the benefit. This last requirement is just another way of saying that there must be an unjust factor present in the factual matrix which affects the quality of the defendant’s receipt. For example, the claimant’s intention to transfer wealth may have been vitiated by a mistake. It is this mistake which renders the enrichment unjust. Finally, the defendant must have no defence to the claim. 9.7 In mapping the voidable transactions regime onto an unjust enrichment framework, we immediately notice the existence of matching generic unjust enrichment claims. The first (claim one) is easy to identify. This is the claim brought by the liquidator to recover value paid to a particular creditor. The second (claim two) is a hidden but symmetric counter-claim. This claim may be available to that creditor in respect of benefits conferred on the general body of creditors. Each will be outlined in turn. (1) Claim One

Company

Liquidator (Proxy for Claimant)

Value

Creditor A (Defendant)

Other Creditors (Claimant)

ResultingTrusts?’ (1996) 16 Legal Studies 110; W Swadling, ‘A Claim in Restitution?’ [1996] Lloyd’s Maritime and Commercial Law Quarterly 63; W Swadling, ‘Property’ in P Birks and F Rose (eds), Lessons of the Swaps Litigation (London, Mansfield Press, 2000) 242; S Worthington, Proprietary Interests in Commercial Transactions (Oxford, Clarendon Press, 1996).

Restitution for Vulnerable Transactions 389 9.8 Claim one is the claim brought by the liquidator against one creditor of the company, creditor A, in respect of value transferred to that creditor. Subject to the satisfaction of the conditions for liability, the liquidator may be able to reclaim this value as a preference, a transaction at an undervalue or a transaction defrauding creditors. The substance of claim one is dealt with in previous chapters in this book. This discussion shows how it may be understood as being restitutionary in pattern. The liquidator must argue that creditor A is unjustly enriched at the expense of the other creditors of the company’s estate. (2) Claim Two

Court Order

Company

Liquidator (Proxy for Defendant)

Value

Creditor A (Claimant)

Other Creditors (Defendant)

9.9 Claim two is that which may be available to creditor A in respect of benefits conferred on the other creditors of the company. This claim envisages the situation where creditor A has been, or is likely to be, forced by a court order to return value to the liquidator. In being required by the court to return value in this way, it is possible to identify additional benefits which may have been conferred on the other creditors and in respect of which a claim may be available to creditor A. For example, property constituting a preference may have been transferred by a near insolvent company to creditor A. The liquidator will claim against creditor A seeking return of the property as a preference. In the intervening period, creditor A may have made some improvements to the property. Let us assume that the court orders creditor A to return the property to the liquidator. In this instance it is arguable that creditor A has conferred a benefit, in the shape of these improvements, on the other creditors of the company. Creditor A will argue that the other creditors of the company are thus unjustly enriched at creditor A’s expense. 9.10 These generic claims will now be considered in the light of unjust enrichment reasoning. The discussion will examine the extent to which these cases are

390 Simone Degeling restitutionary in pattern, conforming to an unjust enrichment topography. The cases to be examined are those in which an office holder seeks to recover a preference, to restore or reverse a transaction at an undervalue or a transaction defrauding creditors.8 In each case, the claimant must show that the defendant has been enriched by the receipt of a benefit. This benefit must be passed to the defendant at the expense of the claimant and it must be unjust for the defendant to retain the benefit. This last requirement is just another way of saying that there must be an unjust factor present in the factual matrix which affects the quality of the defendant’s enrichment. Finally, the defendant must have no defence to the claim. This chapter therefore proceeds as follows: (1) application of the unjust enrichment framework to claim one; (2) application of the unjust enrichment framework to claim two; and (3) an examination of the extent to which the defence of change of position may apply to these cases.

C CLAIM ONE — THE LIQUIDATOR ’ S CLAIM

9.11 Claim one is the claim brought by the liquidator or other officer against creditor A, in respect of value transferred to that creditor. This discussion will determine the extent to (1) creditor A is enriched by the receipt of a benefit; (2) the benefit is at the expense of the claimant; (3) it is unjust to retain the benefit; and (4) there is no defence to the claim. Particular emphasis will be placed on elements (1)–(3) of the unjust enrichment claim. The availability of defences, in particular defence of change of position, will be considered separately later in this chapter.

(1) Enrichment 9.12 The first element to be established is that creditor A is enriched by the receipt of a benefit. It is not enough simply to demonstrate that value has been transferred to creditor A. In order to satisfy the requirements for liability it is necessary to demonstrate that the value is beneficial or enriching. Although unjust enrichment jurisprudence contains cases in which judges have discussed whether a particular defendant has received a benefit or been enriched,9 much of the development of the law in this area has been through the writings of scholars. The cases in this survey contain examples in which the benefit received is money, the business of the insolvent company, or title to or tenancy of property. The immediate task is therefore to determine the extent to which, within the 8 It is possible that other sections of the Insolvency Act, such as s 245, might also be susceptible to an unjust enrichment analysis. 9 Ministry of Defence v Ashman [1993] 2 EGLR 102; Proctor & Gamble Phillipine Manufacturing Corporation v Peter Cremer Gmbh (The Manilla) [1988] 3 All ER 843; Peel (Regional Municipality) v Canada (1993) 98 DLR (4th) 140.

Restitution for Vulnerable Transactions 391 boundaries of current academic debate, creditor A’s enrichment may be demonstrated by receipt of these benefits. (a) Money and Interest 9.13 It should be no surprise that in a situation of insolvency or near insolvency the benefit transferred to creditor A may be money—indeed by far the majority of cases in this survey concern a claim to recover money. It is relatively straightforward to demonstrate that receipt of money is enriching.10 As stated by Robert Goff J, ‘[m]oney has the peculiar character of a universal medium of exchange. By its receipt, the recipient is inevitably benefited’.11 It is, therefore, virtually impossible for the defendant to appeal to any subjectivity of value or system of personal preferences and assert that she does not value the money which has been received. 9.14 The evidence for money as an enrichment exists primarily in those cases concerning preferential transfers and transactions at an undervalue,12 although there is no reason why the principles under discussion would not also apply to transactions defrauding creditors. An example of a case in which the benefit received was money is Re Barton Manufacturing.13 Barton Manufacturing Co Ltd (Barton) was placed in compulsory liquidation and the liquidator brought a claim against various members of the Barton family who had received payments from Barton. Harman J held that these payments were recoverable by the liquidator as transactions at an undervalue.14 Of relevance is the observation that in receiving these payments from Barton, the members of the Barton family (creditor A) were enriched. 9.15 In addition to the receipt of the money claimed, an additional benefit accruing to the defendant is the use of that money.15 This benefit is reflected in a claim for interest. The availability of interest was affirmed by the House of Lords in Westdeutsche Landesbank Girozentrale v Islington LBC16 in which Westdeutsche claimed recovery of payments made pursuant to a void interest rate swap transaction. In considering the claim the House was asked to award 10 In this context, ‘money’ includes an amount credited to the account of the defendant. Subject to our ability to identify the value in question, the principles under discussion here extend beyond the delivery of actual currency. 11 BP Exploration Co (Libya) Ltd v Hunt (No 2) [1979] 1 WLR 783 at 789 per Robert Goff J. 12 Preferences: Re Agriplant Services Ltd [1997] 2 BCLC 599; Re Brian D Pierson Ltd [2001] 1 BCLC 275; Re DKG Contractors [1990] BCC 903; Wills v Corfe Joinery Ltd [1998] 2 BCLC 75. Transactions at an undervalue: Re Barton Manufacturing [1999] 1 BCLC 740; Re Paramount Airways [1993] Ch 223. 13 [1999] 1 BCLC 740. 14 At 746–47. 15 G Virgo, The Principles of the Law of Restitution (Oxford, Clarendon Press, 1999) at 25–38; F Rose, ‘Interest’ in P Birks and F Rose (eds), Lessons of the Swaps Litigation (London, Mansfield Press, 2000), 291. 16 Westdeutsche Landesbank Girozentrale v Islington LBC [1996] AC 669.

392 Simone Degeling interest on the sum claimed. It was accepted by all members of the House that some interest should be awarded in recognition of the fact that the recipient had had the use of the money and should return to the plaintiff this benefit. Applying this rule to the cases in this study, we can observe that some of the examples in which the claim is in respect of money also include a claim for interest.17 An example is Re Barton Manufacturing.18 As described above, the liquidator claimed under section 238 against various members of the Barton family for repayment of amounts paid to them. Harman J held that the recipients should repay the amounts transferred to them plus interest at 8 per cent.19 (b) Business of the Insolvent Company 9.16 In other cases the alleged enrichment received by the defendant is a benefit in kind or non-money benefit, for example the business or assets of the insolvent company. Such benefits are valued differently by different people. Unlike money, which can reasonably be asserted to be universally enriching, non-money benefits are susceptible to notions of subjectivity of value. In the language of unjust enrichment jurisprudence this possibility is referred to as subjective devaluation. The label refers to the risk that a recipient will deny enrichment on the basis that her own spending priorities and preferences indicate that the benefit received is not valuable to her. In order to defeat the possibility that a defendant will appeal to subjectivity of value, and deny that what is received is valuable to her, scholars have developed various tests to determine whether the defendant has actually been enriched.20 Of most utility to this discussion are those which emphasise that what is received has been freely accepted or bargained for by the defendant. 17 Preferences: Re Agriplant Services Ltd [1997] 2 BCLC 599; Re Brian D Pearson Ltd [20001] 1 BCLC 275; Re DKG Contractors [1990] BCC 903. Transaction at an undervalue: Re Barton Manufacturing [1999] 1 BCLC 740. Another case in which interest was claimed is Phillips v Brewin Dolphin [2001] 1 BCLC 145, [2001] UKHL 2. The enrichment was the value of the business which had been sold. The claim was in respect of the difference between what was paid and the value of the business sold. Interest was claimed on this amount. 18 Re Barton Manufacturing [1999] 1 BCLC 740. 19 At 747–48. 20 J Beatson, ‘Benefit, Reliance and the Structure of Unjust Enrichment’ (1987) 40 Current Legal Problems 71; P Birks, An Introduction to the Law of Restitution, Rev edn (Oxford, Clarendon Press, 1989) ch V; P Birks, ‘In Defence of Free Acceptance’ in A Burrows (ed), Essays on the Law of Restitution (Oxford, Clarendon Press, 1991); P Birks and C Mitchell, ‘Unjust Enrichment’ in P Birks (ed), English Private Law Volume II (Oxford, Oxford University Press, 2000) at 541–42; A Burrows, ‘Free Acceptance and the Law of Restitution’ (1988) Law Quarterly Review 576; A Burrows, The Law of Restitution (London, Butterworths, 1993) at 8–16; A Burrows, ‘Proprietary Restitution: Unmasking Unjust Enrichment’ (2001) 117 Law Quarterly Review 412 at 419; D Byrne, ‘Benefits-For Services Rendered’ in M McInnes (ed), Restitution: Developments in Unjust Enrichment (Sydney, Law Book Company, 1996); M Garner, ‘The Role of Subjective Benefit in the Law of Unjust Enrichment’ (1990) 10 Oxford Journal of Legal Studies 42; G Jones (ed) Goff and Jones The Law of Restitution, 5th edn, (London, Sweet & Maxwell, 1998) at 16–36; W Swadling, ‘A Claim in Restitution?’ [1996] Lloyds Maritime and Commercial Law Quarterly 63; G Virgo, The Principles of the Law of Restitution (Oxford, Clarendon Press, 1999) at 70–86.

Restitution for Vulnerable Transactions 393 9.17 Free acceptance looks to the fact of the defendant’s receipt of the benefit and does not require that the defendant has requested it. Birks describes a free acceptance as occurring where a recipient:21 . . . knows that a benefit is being offered to him non-gratuitously and where he, having the opportunity to reject, elects to accept.

Free acceptance defeats the possibility of subjective devaluation because, in accepting the benefit, the defendant acknowledges the objective valuation of the benefit. It is unconscientious for the defendant later to appeal to any subjectivity of value.22 9.18 An alternative test is the so called bargained for benefit test suggested by Burrows.23 This test overcomes subjective devaluation because:24 where the [defendant] has ‘promised’ to pay for a particular performance the outward appearance is that he regards that performance as beneficial, or, put in an alternative way, that he has been saved expense that he would otherwise have been willing to incur.

This test therefore looks to the existence of a bargain, a request for the benefit and a promise to pay for it. 9.19 As has been said, one of the non-money benefits received by the defendant is the business or assets of the insolvent company.25 An example is Phillips v Brewin Dolphin26 in which the liquidator of AJ Bekhor & Co Ltd (AJB) commenced proceedings against Brewin Dolphin and its parent seeking to restore the position of AJB. AJB had contracted to sell its stock broking business valued at £1.25 million to Brewin Dolphin (via Brewin Dolphin’s parent Private Capital Group Ltd). As it turned out, the amount received was less than this, thus laying the foundation for the liquidator’s claim pursuant to section 238. Of interest is the question whether Brewin Dolphin was enriched by receipt of AJB’s stock broking business and assets. Application of both tests of enrichment outlined above answers this question in the affirmative. 9.20 Turning first to free acceptance. For free acceptance to be made out, it is necessary that the benefit must be accepted by the defendant in circumstances where the defendant has the opportunity to reject the benefit, but has not taken 21 P Birks, An Introduction to the Law of Restitution, Rev edn (Oxford, Clarendon Press, 1989) at 265. 22 P Birks, ‘In Defence of Free Acceptance’ in A Burrows (ed), Essays on the Law of Restitution (Oxford, Clarendon Press, 1991) at 129. 23 A Burrows, ‘Free Acceptance and the Law of Restitution’ (1988) Law Quarterly Review 576; A Burrows, The Law of Restitution (London, Butterworths, 1993) at 8–16. 24 A Burrows, The Law of Restitution (London, Butterworths, 1993) at 14. 25 Transaction at an undervalue: Phillips v Brewin Dolphin [2001] UKHL 2, [2001] 1 BCLC 145. Transaction defrauding creditors: Arbuthnot Leasing International Ltd v Havelet Leasing Limited (No 2) [1990] BCC 636. 26 [2001] UKHL 2, [2001] 1 BCLC 145.

394 Simone Degeling this opportunity. In addition, the defendant must accept the benefit in the knowledge that it is being offered non-gratuitously. Clearly on the facts of Brewin Dolphin these elements are satisfied. The purchaser agreed to pay for the business and assets of BSL. It is therefore clear that both sides were aware that the benefits were being offered non-gratuitously. Brewin Dolphin had the opportunity to reject but chose not to. It would therefore be unconscionable for Brewin Dolphin, having accepted the benefits, to appeal to a personal system of value and spending priority and assert that the benefits are not enriching. 9.21 The same result accrues via the application of the bargained for benefit test. This test requires the existence of a bargain, a request for the benefit and a promise to pay for it. On the facts of Brewin Dolphin this test is satisfied. The defendant is not able, via recourse to a personal system of spending priorities, to devalue the benefit received. Brewin Dolphin agreed to the deal and accepted the price. The outward appearance was therefore that the defendant regarded performance as beneficial. On this basis it may be concluded that Brewin Dolphin was enriched. (c) Title to or Tenancy of Property 9.22 Another type of non-money benefit finding expression in the cases is title to or a tenancy of property.27 An example is Weisgard v Pilkington28 in which the company Hotswap Ltd went into creditors’ voluntary liquidation. The liquidator applied to the court to reverse transactions entered into by Hotswap pursuant to which various flats owned by the company were leased or sold to Mr Yeomans and Mr Pilkington. Of relevance to this discussion is whether the defendants were enriched by receiving the benefit of these tenancies of the flats. It is relatively straightforward to establish that such benefits are enriching. On the facts of Weisgard the recipients agreed the terms of the leases and the consideration to be paid. The benefits were bargained for, if not freely accepted, and may therefore be regarded as being enriching. (d) Other Benefits 9.23 In addition to the benefit derived from the tenancy itself, some cases identify other benefits.29 In Agricultural Mortgage Corp v Woodward,30 Agricultural Mortgage Corp lent £700,000 to a farmer on the security of a mortgage over the family farm. The farmer fell into arrears and two days before the date by which 27 Preferences: Weisgard v Pilkington [1995] BCC 1,108. Transactions defrauding creditors: Agricultural Mortgage Corp plc v Woodward [1994] BCC 688; Barclays Bank plc v Eustice [1995] BCC 978; National Westminster Bank plc v Jones [2001] EWCA Civ 1541, [2002] 1 BCLC 55. 28 Weisgard v Pilkington [1995] BCC 1,108. 29 Agricultural Mortgage Corp. plc v Woodward [1994] BCC 688; Barclays Bank plc v Eustice [1995] BCC 978; National Westminster Bank plc v Jones [2002] EWCA Civ 1541, [2002] 1 BCLC 55. 30 Agricultural Mortgage Corp v Woodward [1994] BCC 688.

Restitution for Vulnerable Transactions 395 he had to clear his debt he leased the farm to his wife for a market annual rent. Agricultural Mortgage Corp successfully set aside the lease to his wife as a transaction at an undervalue. On the facts, the transaction constituted an undervalue because it . . . conferred, and was intended to confer, on [the farmer’s wife] significant enhanced benefits beyond the rights granted by the tenancy agreement itself, for which enhanced benefits she did not pay.31

On the facts the Court identified three additional benefits accruing to the farmer’s wife beyond the tenancy itself:32 (1) the safeguarding of the family home; (2) the acquisition by Mrs Woodward of the family farming business free from its previous creditors; and (3) the benefit of the surrender value [or ransom value] of the tenancy, which was of particular importance in view of the fact that the property was mortgaged.

The question for this discussion is whether these other benefits can be considered enriching. 9.24 Turning first to the safeguarding of the family home. The test of enrichment most applicable is that the benefit in question is necessary or incontrovertibly enriching.33 This test demonstrates enrichment on the basis that what is received:34 . . . was necessary to the defendant in the sense that he would have had to seek it himself, or would have sought it had he not been deprived the opportunity . . . no reasonable man would deny that the defendant had been enriched by the amount which he himself would have had to lay out.

The defendant is incontrovertibly enriched because the benefits are so intrinsically advantageous to her that she would be unreasonable to argue otherwise. The benefit in question was the provision of a family home. It is a reasonable argument that the provision of a family home is necessary. The other benefits identified by the court probably also satisfy the incontrovertibly enriched test of enrichment. No reasonable person would deny that the ability to demand from the bank an amount as surrender value of the tenancy, so that the farm could be sold with vacant possession, was enriching. Likewise, the ability to carry out the family farming business free from the claims of creditors is incontrovertibly enriching.

31

At 696 per Sir Christopher Slade. At 698 per Neill LJ. Proctor & Gamble Philippine Manufacturing Corp v Peter Cremer GmbH [1988] 3 All ER 843; Ministry of Defence v Ashman (1993) 66 P & CR 195; Peel (Regional Municipality) v Canada (1993) 98 DLR (4th) 140. 34 P Birks, An Introduction to the Law of Restitution, Rev edn, (Oxford, Clarendon Press, 1989) at 117. 32 33

396 Simone Degeling (2) Valuation 9.25 Having demonstrated an enrichment in the hands of the defendant, it is necessary to place a monetary value on this enrichment. This next section examines the cases to determine the extent to which the methods of valuation are consistent with an unjust enrichment analysis. The discussion will consider separately the benefits identified above. (a) Money 9.26 The value to be quantified is that in existence at the moment of the defendant’s receipt. In certain cases the defendant may demonstrate, via the defence of change of position, that the value of the claim should be less. However, properly understood, the issue of defences is separate from that of initial liability. The application of change of position will therefore be deferred until later in this chapter. 9.27 Many cases in this study calculate the value of the payment at the moment of receipt.35 However, an exception is Re DKG Contractors Ltd.36 DKG Contractors Ltd went into creditors’ voluntary liquidation on 15 December 1998. The liquidator successfully recovered as preferences various payments which had been made to the company secretary. In valuing these payments, John Weeks QC looked to the date on which the resolution for the liquidation was passed by which date ‘. . . £417, 763 of the company’s money found its way into [the defendant’s] hands.’37 The facts indicate that the last payment to be made to the defendant was in November 1998. To conform strictly to the requirements of an unjust enrichment analysis, this and the preceding dates of payment were the relevant dates of receipt and therefore the dates on which the enrichment represented by the transfer of money ought to have been calculated. On the facts of DKG Contractors, for the purpose only of valuing enrichment, the difference in date is not material. It seems that by 15 December 1988 no additional payments had been made to the defendant. (b) Interest 9.28 As has been said, the claim for interest is given in recognition of the benefit accruing to the defendant through use of the money between the date of receipt and that of judgment. Two difficulties arise in calculating the value of

35 Re Agriplant Service Ltd (in liquidation) [1997] 2 BCLC 599; Re Brian D Pearson Ltd [2001] 1 BCLC 275; Wills v Corfe Joinery Ltd [1998] 2 BCLC 75l; Re Barton Manufacturing [1999] 1 BCLC 740. 36 Re DKG Contractors Ltd [1990] BCC 903. 37 At 904 per John Weeks QC.

Restitution for Vulnerable Transactions 397 this enrichment, namely the date from which interest will run and whether it is to be calculated as simple or compound interest. Each will be dealt with in turn. 9.29 Unjust enrichment analysis requires that interest be calculated from the moment of receipt by the defendant and there is some authority that this is the date used by the courts in the cases in this study.38 However, the evidence is far from uniform. In many cases the judgment does not deal with the question of from when interest should be calculated.39 In addition, there is also evidence that other dates are used. An example is Re Barton Manufacturing 40 in which the liquidator claimed under section 238 against various members of the Barton family for repayment of amounts paid to them. Harman J held that the recipients should repay the amounts transferred to them plus interest at 8%. However, on the basis that the calculation would otherwise be too difficult, the Court adopted the date of liquidation rather than the date of receipt for this calculation:41 The claim is made for simple interest at 8% since the date of liquidation, that date being chosen more for convenience than for anything else because to compute it separately from the date of each payment would involve enormously elaborate and detailed calculations and probably in the end give quite little advantage to the liquidator. It seems to me that interest is properly payable upon these sums paid out by [Barton] to each of these three respondents. Naturally, the interest is simple interest and not compound and I therefore order that interest at the rate of 8% be paid upon those three sums down to the date of payment, whenever it will be made. The interest calculated down to today’s date will be appropriate to be added to the judgment debt in each of those three cases. Further interest will accrue due and be recoverable as a debt in respect of interest from the date of this judgment until payment.’

9.30 The other issue is whether interest should be calculated on a simple or compound basis. The availability of interest was affirmed by the House of Lords in Westdeutsche Landesbank Girozentrale v Islington LBC42 in which Westdeutsche claimed recovery of payments made pursuant to a void interest rate swap transaction. In considering the claim the House was asked to award interest on the sum claimed. It was accepted by all members of the House that some interest should be awarded in recognition of the fact that the recipient had 38 Phillips v Brewin Dolphin [2001] UKHL 2 at [32], [2001] 1 BCLC 145 at 157 per Lord Scott with whom the rest of the House agreed. In this respect, the House adopted the dates identified in the order made at first instance: [1989] 1 BCLC 700 at 732 per Evans-Lombe J. This case was actually a claim for the value of business assets transferred, although an award for interest was also made. Interest was calculated to run from the date of transfer of the enrichment (10 November 1989) until judgment. 39 Re Agriplant Services Ltd [1997] 2 BCLC 599; Re Brian D Pearson Ltd [2001] 1 BCLC 275; Re DKG Contractors Ltd [1990] BCC 903. 40 Re Barton Manufacturing [1999] 1 BCLC 740. 41 At 747–48 per Harman J. 42 Westdeutsche Landesbank Girozentrale v Islington LBC [1996] AC 669. The impact of this decision for the availability of interest is discussed in F Rose, ‘Interest’ in P Birks and F Rose, Lessons of the Swaps Litigation (London, Mansfield Press, 2000) 291–328.

398 Simone Degeling had the use of the money and should return to the plaintiff this benefit. Of difficulty was the method of calculating the interest award, compound or simple interest. 9.31 The position of the minority 43 was that the claimant had been saved the trouble of borrowing an equivalent sum from another financial institution. Assuming that this institution would have charged compound interest, this was the amount or inevitable expenditure saved by the recipient. Therefore, argued the minority, the amount recovered via the unjust enrichment claim should bear interest at a compounding rate. The majority44 felt bound by the fact that Westdeutsche’s claim was in equity and therefore that compound interest was available, but only to the extent that the claim was equitable in nature. The position of the majority is therefore that compound interest is only available for equitable unjust enrichment claims. Where the claim is at common law, any interest which may be awarded is calculated as simple interest. 9.32 Re Barton Manufacturing uses the simple interest model. Harman J held that ‘. . . [n]aturally, the interest is simple interest and not compound . . .’45 Other cases in which interest was claimed are unfortunately not helpful. Whilst in each the Court held that interest was payable, the issue of compound or simple interest was not dealt with.46 Although it has been subject to criticism,47 it remains the case that current judicial authority requires that simple interest be calculated on common law unjust enrichment claims. It therefore seems likely that the approach taken by Harmon J in Barton Manufacturing in utilising a simple interest formula is correct. (c) Business or Assets of the Insolvent Company As has already been explained, these constitute non-money benefits. The personal unjust enrichment claim to recover this enrichment is a claim to recover the value of what is received. It cannot be a claim for the very thing transferred because this would be some type of proprietary claim. 9.33 An example in which the enrichment comprised the assets and business of the insolvent company is Phillips v Brewin Dolphin.48 The liquidator of AJB persuaded the House of Lords that the recipient should account to the liquidator for the amount of the undervalue. The value of the business transferred to Brewin Dolphin was £1,050,000. This was calculated by reference to ‘. . . what

43

At 684 and 697–98 per Lord Goff and 719–20 per Lord Woolf. At 700–03 and 717 per Lord Browne-Wilkinson with whom Lord Slynn and Lord Lloyd agreed. [1999] 1 BCLC 740 at 748. 46 Re Agriplant Services Ltd [1997] 2 BCLC 599; Re Brian D Pearson Ltd [2001] 1 BCLC 275; Re DKG Contractors Ltd [1990] BCC 903. 47 G Virgo, The Principles of the Law of Restitution (Oxford, Clarendon Press, 1999) at 27–28. 48 Phillips v Brewin Dolphin [2001] UKHL 2, [2001] 1 BCLC 148. 44 45

Restitution for Vulnerable Transactions 399 a reasonably well-informed potential purchaser was prepared to pay . . .’ and evidence that ‘. . . Brewin Dolphin had been prepared to pay about £1,050,000 . . .’.49 Lord Scott held that:50 The value of an asset that is being offered for sale is, prima facie, not less than the amount that a reasonably well informed purchaser is prepared, in arms’ length negotiations, to pay for it.

The valuation of the enrichment was therefore the market value. It was this amount that Brewin Dolphin should have paid. Therefore, the ultimate value of the enrichment was the difference between the value of the enrichment transferred to Brewin Dolphin and the amount paid by it. On this basis, Brewin Dolphin had to account to the liquidator for the difference of £412,500 plus interest. (d) Title to or Tenancy of Property 9.34 These enrichments are also non-money benefits. However, the claims in respect of them have not, strictly speaking, been personal claims for their value. There is evidence that in some cases the courts have ordered that the relevant agreements be set aside and the relevant property or interest be transferred back to the company.51 Although not immediately apparent, it is clear that these orders must reflect some species of proprietary claim. As has been said, a claim asserting an entitlement to the thing, as opposed to a claim for its value, is a proprietary claim. 9.35 In Weisgard v Pilkington,52 the company entered into transactions with Yeomans and Pilkington pursuant to which six flats owned by the company were transferred to Yeomans and Pilkington by way of 999 year lease. The company entered creditors’ voluntary liquidation in 1991 and the liquidator challenged these transactions as preferences. The claim succeeded and Judge Maddocks ordered, amongst other things, that ‘. . . the respondents . . . transfer the leases to the liquidator . . .’53 In the result the leases were surrendered, and the enrichment conferred on Yeoman and Pilkington was recovered in specie. 9.36 Another example is National Westminster Bank plc v Jones.54 Mr and Mrs Jones carried on a family farming business funded by loans from National Westminster Bank plc on the security of mortgages and agricultural charges given in favour of the bank. On 27 April 1999 the bank demanded full payment of £335,418.85 due in satisfaction of this debt. Mr and Mrs Jones feared that 49

At paras [30]–[31], at p 157 per Lord Scott quoting the decision of the trial judge. At paras [30]–[31], at p 157 per Lord Scott with whom the rest of the House agreed. 51 Weisgard v Pilkington [1995] BCC 1,108; Agricultural Mortgage Corp v Woodward [1994] BCC 688; Barclays Bank v Eustice [1995] BCC 978; National Westminster Bank plc v Jones [2001] 1 BCLC 98, [2001] EWCA Civ 1541, [2002] 1 BCLC 55 (CA). 52 Weisgard v Pilkington [1995] BCC 1,108 53 Ibid 1,114. 54 National Westminster Bank plc v Jones [2001] 1 BCLC 98. 50

400 Simone Degeling they would lose their home and farming business. After having received professional advice, Mr and Mrs Jones formed a company (Neuadd Goch Farms Ltd) and on 27 April 1999 signed two agreements: (1) a tenancy agreement leasing the family farm to the company; and (2) a sale agreement transferring to the company all of the farming assets. The bank appointed administrative receivers who came to court seeking a declaration that these two agreements were transactions defrauding creditors pursuant to Insolvency Act section 423. Neuberger J had some sympathy for the position of Mr and Mrs Jones but held that he ‘. . . should set the agreements aside pursuant to [Insolvency Act] s 423(2).’55 9.37 In both of the above cases the remedy awarded by the court brought about precise restitution of the benefits conferred. The claimant in each case obtained restitution in specie. Rather than awarding the value of the asset transferred, the court reversed the transfer of that very asset. As has been said, it is clear that this is some species of proprietary award. However, it is important to realise that not all proprietary claims are given to reverse unjust enrichment. Broadly speaking, there are two categories of case. In the first, the claim to recover the property is based on the claimant’s existing proprietary rights in that property. In the second, the claim to recover the property is based on proprietary rights raised to reverse unjust enrichment. Each will be considered in turn. 9.38 In the first type of case the claimant is merely asserting its pre-existing proprietary interest in the property claimed. Such cases are the so called ‘pure proprietary claims’. This label refers to the situation in which the preexisting proprietary right of the claimant survives. Whilst the claimant is entitled to bring a proprietary claim, it is not founded on a proprietary interest generated by unjust enrichment. Rather, it asserts the claimant’s pre-existing proprietary interest in the thing.56 The pre-existing proprietary interest will have arisen earlier in the story and may relate to the manner in which the claimant originally could assert ownership. For example, the claimant may have legitimately purchased or produced the thing now claimed. 9.39 The second type of proprietary claim is one in which the proprietary interest is created de novo to reverse unjust enrichment. As is discussed below, an essential ingredient of an unjust enrichment claim is that there be an unjust factor, or reason for restitution, in the story. Not all circumstances yield a proprietary response. Some are likely to give rise only to a personal claim. The central question in these cases is whether the claimant can ever be said effectively to have transferred her proprietary interest in the thing to the recipient. It is axiomatic that property passes with intention. Therefore if the facts indicate that the claimant was labouring under a fundamental mistake, such as a mistake as to the subject matter of the contract or the identity of the payee, then prop55 At 131, upheld by the Court of Appeal at [2001] EWCA Civ 1541 at para [29], [2002] 1 BCLC 55 at 62. 56 Foskett v McKeown [2001] 1 AC 102 at 127, 129 per Lord Millett.

Restitution for Vulnerable Transactions 401 erty will not pass to the recipient. The claimant’s proprietary interest will survive and any proprietary claim will be a pure proprietary claim to assert her pre-existing ownership of the thing. Such proprietary claims have nothing to do with the law of unjust enrichment, although a personal unjust enrichment claim for the value transferred may well lie.57 More difficult are other cases where the claimant’s intention to transfer was impaired or qualified. In these cases, it is possible that any proprietary claim is founded on a new proprietary interest raised to reverse unjust enrichment. A discussion of the relationship between the various unjust factors and the proprietary response is beyond the scope of this discussion.58 Of interest is whether the orders available to the court pursuant to sections 241 and 425 of the Insolvency Act 1986 are consistent with the pure proprietary claim model or can possibly be regarded as consistent with the model which raises a proprietary interest in order to reverse unjust enrichment. 9.40 Both sections of the Insolvency Act empower the court to ‘. . . require any property transferred as part of the transaction . . .’ to be vested in the company (section 241(1)(a)) or any person for the benefit of all persons on behalf of whom the application is made (section 425(1)(a)). In examining the cases, the important question is to determine the effect of these sections on the passing of title to the defendant. We do know that whether property passes is not necessarily related to the validity of the contract pursuant to which the transaction is effected.59 It 57 Lipkin Gorman v Karpnale Ltd [1991] 2 AC 548 at 572–74 per Lord Goff. The availability of a concurrent personal claim is a hotly debated issue. Swadling argues that if title does not pass ‘. . . there is no claim in unjust enrichment because there is no ‘transfer’ from plaintiff to defendant.’ On this argument, there is no enrichment of the defendant and thus no personal claim is possible. See W Swadling, ‘A Claim in Restitution?’ [1996] Lloyd’s Maritime and Commercial Law Quarterly 63 at 65. The opposing position is vigorously defended by Birks and Burrows who argue for the concurrence of the personal and proprietary claims, subject to the claimant’s election of remedy: P Birks, ‘Property and Unjust Enrichment: Categorical Truths’ [1997] New Zealand Law Review 623 at 654–56; A Burrows, ‘Proprietary Restitution: Unmasking Unjust Enrichment’ (2001) 117 Law Quarterly Review 412 at 419. See also D Fox, ‘Legal Title as a Ground of Restitutionary Liability’ [2000] Restitution Law Review 465 at 482–90; L Smith, ‘Unjust Enrichment, Property and the Structure of Trusts’ (2000) 116 Law Quarterly Review 412. 58 P Birks and C Mitchell, ‘Unjust Enrichment’ in P Birks (ed), English Private Law Volume II (Oxford, Oxford University Press, 2000) at 598–601; L Smith, The Law of Tracing (Oxford, Clarendon Press, 1997) at 292–96; R Chambers, Resulting Trusts (Oxford, Clarendon Press, 1997) at 224–30 and 233–36. 59 As shown by Westdeutsche Landesbank v Girozentrale [1996] AC 669 at 689–90 per Lord Goff. Simply because a contract is void does not always mean that property will not pass. In that case the swap contract was held to be void ab intio. The House of Lords nonetheless held that title to the money had passed under the transaction. The essential issue in relation to void transfers is therefore the extent to which the law’s choice in declaring such transfers void is a function of an impaired or vitiated intention to transfer the asset. Thus, according to Swadling:

[T]he invalidity of the contract to which property is transferred is not in and of itself a reason which prevents property passing, either at law or in equity. What Westdeutsche forces us now to do, correctly, is to go beyond the mere fact of contractual invalidity and examine instead the reason why the contract is invalid, asking whether that reason is also sufficient to prevent property passing.

W Swadling, ‘Property’ in P Birks and F Rose, Lessons of the Swaps Litigation (Oxford, Mansfield Press, 2000) at 249. See also S Worthington, Proprietary Interests in Commercial Transactions (Oxford, Clarendon Press, 1996) at 122–31 and 148–68.

402 Simone Degeling seems clear enough that at the time of the transactions the transfer of title is valid. It is not until insolvency intervenes within the relevant period that an office holder may sue for recovery of the asset. On this basis, it does not seem possible to characterise the passing of title as having being rendered void by the statute. There is no doubt that, initially at least, title validly passes to the recipient. On this basis it seems unlikely that the recovery of an asset in specie can be said to reflect a pure proprietary claim. The more persuasive argument is that the effect of sections 241(1)(a) and 425(1)(a) is to render the transfers voidable.60 In such cases any proprietary claim is arguably brought in recognition of a proprietary interest raised to reverse the defendant’s unjust enrichment. There is a separate debate, itself beyond the scope of this discussion, as to whether what is obtained by the claimant is an immediate interest in what is received or a power to crystallise such an interest.61 It seems likely that by statute the office holder, on behalf of the general creditors, obtains on the order of a court the power to re-vest title in the company or other claimant. 9.41 Assuming that this analysis is correct, the result in cases such as Weisgard v Pilkington and National Westminster Bank plc v Jones can only be regarded as recognising a proprietary response to unjust enrichment. At the time of the transaction title passed to the recipient. Any ability of the claimant to re-vest title arises later in time and is arguably given to reverse unjust enrichment. This is not to deny that a personal remedy could in the alternative have been awarded.62 (3) At the Expense Of 9.42 In order to succeed, the enrichment must be received at the expense of the claimant.63 In general terms this means that the enrichment must pass, as a 60 Parry takes the view that the effect of the sections is to render the transfers voidable. R Parry, Transaction Avoidance in Insolvencies (Oxford, Oxford University Press, 2001) at 72 (s 238), 125 (s 239) and 226 (s 423). Goode (Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 439) makes the point that the

. . . provisions relating to transactions at an undervalue and preferences, though often loosely referred to as voidable, are not true invalidating provisions. Nothing in sections 238 or 239 refers to avoidance of transactions at an undervalue or preferences, nor do the powers conferred on the court by section 241 include the power to rescind such transactions or preferences or declare them avoid. Instead, they enable the court to reverse the effect of the transaction . . . but such a power is purely remedial and does not impeach the validity of the transfer. 61 P Birks and C Mitchell, ‘Unjust Enrichment’ in P Birks (ed), English Private Law Volume II (Oxford, Oxford University Press, 2000) at 602–03; L Smith, The Law of Tracing (Oxford, Clarendon Press, 1997) at 358–61. 62 Above n 57. The statutory analogue of the personal claim exists in Insolvency Act 1986 ss 241(1)(d) and 425(1)(d). 63 P Birks and C Mitchell, ‘Unjust Enrichment’ in P Birks (ed), English Private Law Volume II (Oxford, Oxford University Press, 2000) at 529–38; P Birks, ‘At the Expense of the Claimant: Direct and Indirect Enrichment in English Law’ (2000) Oxford U Comparative Law Forum 1 at ouclf. iuscomp.org; M McInnes, ‘At The Plaintiff’s Expense: Quantifying Restitutionary Relief’ [1998] 57 Cambridge Law Journal 472.

Restitution for Vulnerable Transactions 403 matter of direction, from claimant to defendant. Properly understood, it is not necessary for the claimant to show a corresponding impoverishment or arithmetic minus.64 It is sufficient that the enrichment has come from the claimant.65 This essay contends that the enrichment is received at the expense of the other creditors of the insolvent company. In proving this assertion, two difficulties must be overcome. The first is correctly to identify the claimant at whose expense the enrichment is received. The second relates to the mechanics of that receipt, in particular the existence of interceptive subtraction. 9.43 Dealing first with the question of the identity of the claimant, it is argued that the enrichment is at the expense of other creditors of the insolvent company. However, the relevant sections of the Insolvency Act empower other actors to bring a claim against the recipient. Preferences and transactions at an undervalue are to be recovered by an office holder66 while transactions defrauding creditors may be reversed at the suit of a liquidator, administrator or (with the leave of the court) a victim of the transaction.67 It is therefore necessary to clarify the identity of the claimant since taken literally the enrichment does not pass to the recipient from the claimant. This difficulty is avoided if it is realised that the office holder is by statute given the power to claim back value for the benefit of the general body of creditors.68 To this extent, for the purpose of the unjust enrichment claim, the office holder is the entity authorised by statute to stand proxy for the creditors of the insolvent company. In this sense, the real claimant is the body of creditors. 9.44 Accepting that the claimant in these actions is the statutory proxy of the company’s creditors, it is still necessary to prove that the enrichment passed to the recipient at the expense of these creditors. In order to do so, it is necessary to apply the principle of interceptive subtraction. Interceptive subtraction is an analytical technique which recognises that in some cases, the enrichment passed from the hands of the transferor and was intended to reach the claimant. However, because it has been intercepted by the defendant it never reached the 64 P Birks and C Mitchell, ‘Unjust Enrichment’ in P Birks (ed), English Private Law Volume II (Oxford, Oxford University Press, 2000) at 538. A different position is taken in Canada where the law requires that the defendant’s ‘…enrichment be matched by the plaintiff’s corresponding deprivation.’ M McInnes, ‘The Canadian Principle of Unjust Enrichment: Comparative Insights into the Law of Restitution’ (1999) 37 Alberta Law Review 1 at 20. See Rathwell v. Rathwell (1978) 83 DLR (3d) 289; Pettkus v Becker (1980) 117 DLR (3d) 257. 65 Commissioner of State Revenue (Victoria) v Royal Insurance Ltd (1994) 182 CLR 51 at 75, 78 per Mason CJ; Kleinwort Benson Ltd v South Tyneside Metropolitan Borough Council [1994] 4 All ER 972 at 985 per Hobhouse J; Kleinwort Benson v Birmingham City Council [1997] QB 380 at 392–393 per Evans LJ, 395 per Saville LJ and 400 per Morritt LJ. 66 Insolvency Act 1986 ss 239(2), 238(1)(b) and 238(2). 67 Insolvency Act 1986 s 424. 68 Re Ayala Holdings Ltd (No 2) [1996] 1 BCLC 467; Re Oasis Merchandising [1998] Ch 170. In the case of a claim brought by a victim of a transaction defrauding creditors, section 424(2) mandates that any claim by one victim is to be treated as made on behalf of every victim of the transaction.

404 Simone Degeling claimant’s ownership or possession.69 Since the enrichment was destined to reach the claimant, but did not because it was captured by the defendant before the claimant could receive it, the enrichment is at the expense of the claimant. 9.45 Interceptive subtraction applies to the configurations in this study. The system contained in the Insolvency Act reflects the choices made by the law as to who should receive payment, and in what proportion, when a company falls victim to insolvency. The legislature has committed us to a regime under which value is available for distribution to the creditors of the insolvent company. In this sense, value is abstracted by the recipient of a preference or other vulnerable transaction which would otherwise inevitably come to the creditors of the company. It is inevitable because this is the policy choice contained within the legislation. Therefore, it is possible to argue that the recipient is enriched at the expense of the other creditors. Had the recipient not intercepted this value, the statutory scheme for payment of creditors would have applied this value for the benefit of the company’s creditors. 9.46 The cases in this study contain evidence in support of the above analysis. In each category of claim, it is clear that the benefit has passed to the recipient at the expense of the other creditors. The clearest example is preferential transfers. The position of the other creditors is recognised in the words of the statute since it must inter alia be shown that the effect of the transfer is to put the recipient:70 . . . into a position which, in the event of the company going into insolvent liquidation, will be better than the position he would have been in if that thing had not been done.

Given the limited assets to be divided among creditors, it is implicit that an improvement in the position of one is at the expense of the others.71 The same theme is evident in section 238 (transactions at an undervalue) where the language of the section is concerned to identify transactions which deplete the resources available to creditors because they are for no or significantly diminished consideration to be received by the company.72 Similar considerations apply to transactions defrauding creditors. In addition to the elements of undervalue, section 423(3) articulates that the section is, as its title suggests, concerned to reverse transactions which put assets beyond the reach of or otherwise prejudice creditors.73 69 P Birks, An Introduction to the Law of Restitution, Rev edn (Oxford, Clarendon Press, 1989) at 133–39. P Birks and C Mitchell, ‘Unjust Enrichment’ in P Birks (ed), English Private Law Volume II (Oxford, Oxford University Press, 2000) at 532–33; L Smith, ‘Three Party Restitution: A Critique of Birks’s Theory of Interceptive Subtraction’ (1991) 11 Oxford Journal of Legal Studies 481; G Virgo, The Principles of the Law of Restitution (Oxford, Clarendon Press, 1999) at 109–13. 70 Insolvency Act 1986 s 239(4)(b). 71 Re MC Bacon [1990] BCLC 324 at 336 per Millett J; Re Agriplant Services Ltd (in liq) [1997] 2 BCLC 598 at 610 per Jonathan Parker J; Re DKG Contractors Ltd [1990] BCC 903 at 910–11 per John Weeks QC. 72 Re MC Bacon [1990] BCLC 324 at 340; Re Lewis’s of Leicester Ltd [1995] BCC 514 at 523. 73 Agricultural Mortgage Corp plc v Woodward [1994] BCC 688 at 694 per Sir Christopher Slade; Midland Bank plc v Wyatt [1997] 1 BCLC 242 at 255 per David Young QC; National Westminster Bank plc v Jones [2001] 1 BCLC 98 at 120–21 per Neuberger J.

Restitution for Vulnerable Transactions 405 9.47 Before moving to a consideration of the unjust factor, two important limits to the above analysis must be stated. The first concerns the entitlements of creditor A in the company’s insolvency. The above paragraphs demonstrate that the enrichment is received at the expense of the company’s creditors who would otherwise be entitled, via the insolvency regime, to share in the value transferred. However, it must be remembered that the recipient, creditor A in our model, may well be a creditor who would otherwise have been entitled to a dividend. Properly understood, therefore, the value by which creditor A is enriched must be the amount received less creditor A’s own insolvency entitlements.74 9.48 The second limit concerns the destination of the proceeds of transaction avoidance in corporate insolvency. The analysis in this chapter is committed to the view that the enrichment is at the expense of the general body of creditors since it is these creditors who would otherwise be entitled. This position is not without difficulty. Amongst insolvency lawyers there is a debate about when the proceeds of transaction avoidance might instead be caught within the scope of any fixed or floating charge granted by the company.75 The consequence of this latter view is that creditor A is enriched at the expense of the secured creditors. The resolution of this difficult issue is beyond the scope of the present discussion. However, to the extent that it is the secured creditors at whose expense the enrichment is received, they could be substituted as claimant in the unjust enrichment model under discussion.

(4) Unjust Factor 9.49 The unjust factor is the reason for restitution. It is not a matter for an individual judge’s discretion according to the perceived justice or merits of the claim. Rather, injustice is tied to a framework for analysis. Broadly conceived there are said to be two families of unjust factor.76 The first looks to the 74 Dora v Simper [2000] 2 BCLC 561 at 566. Although the claim for relief under section 423 failed, Buckley J acknowledged that ‘Even then the plaintiff would receive a dividend along with the other creditors . . .’ 75 Re Yagerphone [1935] 1 Ch 392; Re MC Bacon Ltd (No 2) [1991] Ch 127; Re Oasis Merchandising Ltd [1998] Ch 170. R Goode, Principles of Corporate Insolvency Law, 2nd edn (London, Sweet & Maxwell, 1997) at 437–40. R Parry, Transaction Avoidance in Insolvencies (Oxford, Oxford University Press, 2001), ch 28. Refer to paras 2.135–2.145, 4.102–4.103, 5.88–5.92 and 6.157. 76 P Birks and C Mitchell, ‘Unjust Enrichment’ in P Birks (ed), English Private Law Volume II (Oxford, Oxford University Press, 2000) at 543 and fn 89 on p 548. This is a revision of the model which had earlier appeared in P Birks P and R Chambers, The Restitution Research Resource, 2nd edn (Oxford, Mansfield Press, 1997) at 2–3. The earlier version suggested that there were three families of unjust factor: (1) the claimant’s vitiated or qualified intention to transfer wealth; (2) the defendant’s unconscientious receipt of the benefit; and (3) policy motivated claims. Birks and Mitchell have refined the model, concluding that ‘. . . every supposed case of unconscientious receipt is no more than a weak or otherwise special case of non-voluntary transfer.’ The second category called unconscientious receipt is therefore removed and the cases subsumed into the first category, vitiated or qualified intention, now labelled deficient intent.

406 Simone Degeling claimant’s non-voluntary transfer of wealth. The enrichment is reversed since, by her deficient or qualified intention, the claimant did not intend to benefit the recipient. The second category comprises the so called policy motivated claims which are recognised in order to promote a particular policy objective. 9.50 The cases in this study are best explained as examples of policy motivated unjust enrichment on the basis of the so called insolvency policies underlying the Insolvency Act. On particular facts, other unjust factors are also visible and these will first briefly be explored. However, we will find that none of these commands clear support, and that the policy explanation seems most useful in explaining these cases. (a) Non-Voluntary Transfer 9.51 These unjust factors give relief because the claimant’s intention to transfer wealth is deficient. The most extreme example is that in fact the claimant had no intention to transfer wealth to the recipient. In other words, that the claimant was ignorant of the transfer.77 This unjust factor is arguably of wide application to the cases in this study. It must be possible to assert that, in giving a preference or transferring at an undervalue, wealth has moved to creditor A without the knowledge of the general body of creditors. In other words, the enrichment is unjust because these creditors were ignorant of the transfer, they held no intention to benefit creditor A. 9.52 An alternative possibility is that the claimant’s intention to transfer the benefit may have been vitiated by some type of pressure. An example is Re MC Bacon78 in which the company granted a debenture to National Westminster Bank plc. The company was kept afloat by an overdraft facility given by the bank but the financial difficulties continued. In May 1997 the bank made its continued financial support conditional on the execution in favour of the bank a first mortgage debenture. The company complied, although the liquidator later unsuccessfully sought to have this security set aside, either as a preference or a transaction at an undervalue. Of interest are the findings of fact made by 77 Although no case explicitly recognises ignorance as an unjust factor, scholars have relied on the following cases in support: Lipkin Gorman v Karpnale Ltd [1991] 2 AC 548; Re Diplock [1948] Ch 465; GL Baker Pty Ltd v Medway Building and Supplies Ltd [1958] 2 All ER 532, [1958] 3 All ER 540; Carl-Zeiss Stiftung v Herbert Smith & Co (No 2) [1969] 2 Ch 276; Re Montagu’s Settlement Trusts [1987] Ch 264; Royal Brunei Airlines Sdn Bdh v Tan [1995] 2 AC 378; Belmont Finance Corp v Williams Furniture Ltd (No 2) [1980] 1 All ER 393; El-Ajou v Dollar Land Holdings [1993] 3 All ER 717, [1994] 2 All ER 688. For discussion see P Birks, ‘Misdirected Funds: Restitution from the Recipient’ [1989] Lloyd’s Maritime and Commercial Law Quarterly 296; E McKendrick, ‘Restitution, Misdirected Funds and Change of Position’ (1992) 55 Modern Law Review 377. However, this interpretation of Lipkin Gorman has been questioned: D Fox, ‘Legal Title As A Ground of Restitutionary Liability’ [2000] Restitution Law Review 465; L Smith, ‘Unjust Enrichment, Property, and the Structure of Trusts’ (2000) 116 Law Quarterly Review 412; G Virgo, The Principles of the Law of Restitution (Oxford, Clarendon Press, 1999) at 593–95. 78 Re MC Bacon Ltd [1990] BCLC 324.

Restitution for Vulnerable Transactions 407 Millett J as to the pressure applied by the bank at the time when the decision to grant the debenture was made:79 . . . (iii) that if the debenture which Mr Hill had asked for were not forthcoming the bank would withdraw its support, and (iv) that if the bank withdrew its support the company would be forced into immediate liquidation . . . I accept Mr Martin’s evidence: ‘It was viewed as a simple decision. Either we gave the bank a debenture or they called in the overdraft.’

9.53 The question is whether such evidence satisfies the requirements for recovery. The crucial issue is whether the pressure or threat is illegitimate.80 It seems that, whilst notions of lawful and unlawful pressure are of assistance in assessing legitimacy, they are not determinative. Judicial authority suggests that a lawful threat may nonetheless be illegitimate.81 On the facts of MC Bacon, there is no suggestion that the actions of National Westminster Bank were in any way unlawful. Overdraft facilities are typically re-payable on demand and, given the increasing risk associated with proving finance to MC Bacon, it seems entirely reasonable that the bank should make further advances conditional upon the bank being better able to secure its position.82 9.54 On the facts it therefore seems most unlikely that any enrichment was procured under the force of illegitimate pressure. This conclusion is consistent with the actual result in the case, as the liquidator’s claim to have the debenture set aside failed. The point, however, is that in a situation of insolvency, illegitimate pressure may be applied to gain an advantage over other creditors and may thus found a claim in unjust enrichment. (b) Policy Motivated Unjust Factors The so called policy motivated unjust factors are given to promote a particular policy objective. As such, the policies calling for restitution are not necessarily linked to any deficiency in the claimant’s intention in passing enrichment to the defendant. As has been said, the unjust factor which best explains claim one is the so called insolvency policy.83 However, necessity also has limited support and will be dealt with first. 79

Ibid 336–37. Universe Tankships Inc of Monrovia v International Transport Workers Federation (The Universe Sentinal) [1983] AC 366 at 400; Dimskal Shipping Co SA v International Transport Workers Federation (The Evia Luck) [1992] 2 AC 152. 81 CTN Cash and Carry Ltd v Gallaher [1994] 4 All ER 714 at 717–18. Virgo nonetheless submits that the ‘preferable view is that this form of duress will be established where the defendant threatened to commit an unlawful act’: The Principles of the Law of Restitution (Oxford, Clarendon Press, 1999) at 218. 82 Smith v William Charlick (1924) 34 CLR 38; CTN Cash and Carry Ltd v Gallaher [1994] 4 All ER 714. 83 P Birks and C Mitchell, ‘Unjust Enrichment’ in P Birks (ed), English Private Law Volume II (Oxford, Oxford University Press, 2000) at 590. 80

408 Simone Degeling 9.56 Necessity describes the unjust factor given to recover a benefit conferred in an emergency. At the outset it must be conceded that the general position of the law is that a benefit conferred by a necessitous intervener is not recoverable. There are however certain pockets of cases in which an intervener is entitled to claim against the person who benefits from this intervention.84 Proponents of necessity argue that these exceptions may provide the basis for a more generalised right to recovery for the intervener. There has been no case authoritatively deciding that this generalised right has been established, and analysis must therefore lean heavily on the writings of scholars in determining the ambit of this unjust factor.85 9.57 The heart of necessity is that benefits are conferred in an emergency. The suggestion of necessity is raised by some of the cases in this study on the basis that there existed an economic emergency.86 An example is National Westminster Bank v Jones87 in which the family farm was leased by the farmer to a company which was beneficially owned by the family. In doing so the farmer hoped to put the farm beyond the reach of the bank. Neuberger J held that this was not improper or dishonest, but rather done out of an effort to protect the family’s way of life and to safeguard the family home. To the extent that these were under attack, an emergency arguably existed:88 . . . anyone would have sympathy for Mr and Mrs Jones, who faced, and now face, eviction from their home and farm in which they have lived and worked for 25 years . . .

9.58 However, there are serious obstacles to this analysis. Even if necessity could be extended to cover an economic emergency, pursuant to which the family home is under threat, a fatal barrier remains. It is a bar to recovery that the

84 Jenkins v Tucker (1788) 1 H Bl 90; Ambrose v Kerrison (1851) 10 CB 776 (burial cases); Prager v Blatspiel Stamp and Heacock Ltd [1924] 1 KB 566; China Pacific S.A. v Food Corporation of India [1982] AC 939; In re F (Mental Patient: Sterilisation ) [1990] 2 AC 1 (agency of necessity); In re Rhodes (1890) 44 Ch D 94 (necessaries to an incapax); Great Northern Railway v Swaffield (1874) LR 9 Ex 132; In re Berkeley Applegate [1989] Ch 32 (necessary services of a liquidator). 85 P Birks, An Introduction to the Law of Restitution, Rev edn (Oxford, Clarendon Press, 1998) at 304–8; P Birks and C Mitchell, ‘Unjust Enrichment’ in P Birks (ed), English Private Law Volume I (Oxford, Oxford University Press, 2000) at 580–83; A Burrows, The Law of Restitution (London, Butterworths, 1993) at 242–49; A Burrows and E McKendrick, Cases and Materials on the Law of Restitution (Oxford, Oxford University Press, 1998) ch 9; G Jones (ed), Goff and Jones on the Law of Restitution, 5th edn (London, Sweet & Maxwell, 1998) ch 17; P Maddaugh and J McCamus, The Law of Restitution (Aurora, 1990) ch 28; K Mason and J Carter, Restitution Law in Australia (Sydney, Butterworths, 1995) at 239–54; JD McCamus, ‘Necessitous Intervention: The Altruistic Intermeddler and the Law of Restitution’ (1979) 11 Ottawa Law Review 297; M McInnes, ‘Restitution and the Rescue of Life’ (1994) 32 Alberta Law Review 37; F Rose, ‘Restitution for the Rescuer’ (1989) 9 Oxford Journal of Legal Studies 167; G Virgo, The Principles of the Law of Restitution (Oxford, Clarendon Press, 1999) ch 11. 86 The Zuhal K and Selin [1987] 1 Lloyd’s Rep 151 at 156 per Sheen J. 87 [2001] 1 BCLC 98. 88 At 125. Other examples of the same configuration are Agricultural Mortgage Corp plc v Woodward [1994] BCC 688; Barclays Bank v Eustice [1995] BCC 978; Midland Bank v Wyatt [1997] 1 BCLC 242.

Restitution for Vulnerable Transactions 409 claimant acted out of self interest and only incidentally conferred a benefit on the defendant in the course of doing so.89 The benefits in our examples are often conferred out of the intervener’s self interest and not for the purpose of benefiting the recipient. This is because, in general, the transferor and recipient of the value are in substance the same party. There are exceptions, such as Barclays Bank v Eustice,90 in which Mr Eustice granted a tenancy of the family farm to his sons. However, in most cases the benefit is effectively transferred by the claimant to herself. Even when it is possible to identify separate recipients, there is evidence that such transactions are tainted with self interest. Value is transferred precisely to ring fence the value from creditors. In Midland Bank v Wyatt,91 Mr Wyatt declared a trust over the family home in favour, inter alia, of his daughters. Despite his protestations that the purpose was to protect his children, the judge held that the trust was entered into for the purpose of defrauding his creditors:92 . . . I am also satisfied that the declaration of trust was entered into by Mr Wyatt for the purpose of putting his interest in [the family home] out of the reach of any future creditors who might make a claim thereto and, therefore, cannot be relied upon by Mr Wyatt . . .

9.59 Of greater utility is the so called insolvency policy (or policies) underlying the statutory claim.93 At the start of this chapter the various policies said to lie behind the avoidance regime were identified: the need to prevent the dismemberment of the insolvent’s assets, to preserve the principle of equality between creditors, and to provide an orderly and collective process for dealing with the affairs of the insolvent.94 In furtherance of these objectives, the Insolvency Act provides mechanisms whereby transactions, although valid at the time they were entered into, become retrospectively invalid once the conditions attracting the insolvency regime are satisfied. It is possible that the policies underlying the legislation also provide the foundation for a policy motivated unjust factor. Although there is no judicial authority recognising its existence, the presence of this unjust factor best explains the restitutionary pattern of the cases in this study. Indeed, given our reliance on the policy choices contained in the Insolvency Act to satisfy the at the expense of element of claim one, it seems unlikely that any other unjust factor will do.

89 P Birks and C Mitchell, ‘Unjust Enrichment’ in P Birks (ed), English Private Law Volume II (Oxford, Oxford University Press, 2000) 583; A Burrows and E McKendrick, Cases and Materials on the Law of Restitution (Oxford, Oxford University Press, 1998) at 474. 90 [1995] BCC 978. 91 [1997] 1 BCLC 242. We should not get distracted by the fact that this was a case of personal insolvency. The trust was struck down under Insolvency Act 1986 s 423, and the court’s analysis would apply equally to a trust declared by a company. 92 At 255 per David Young QC sitting as a deputy judge of the High Court. 93 P Birks and C Mitchell “Unjust Enrichment” in P Birks (ed) English Private Law Volume II (Oxford, Oxford University Press, 2000) at 590. 94 Above n 3.

410 Simone Degeling (5) Conclusion 9.60 The task of this discussion has been to illustrate how the claim available to the liquidator or other authorised officer pursuant to Insolvency Act sections 238, 239 and 423 may be understood as being restitutionary in pattern. As we have seen, despite the usual difficulties in establishing enrichment when the benefits in question are non-money benefits, it is relatively easy to demonstrate that the recipient has been enriched. This enrichment is at the expense of the other creditors and is most obviously unjust on the basis of the so called insolvency policy objectives. 9.61 This discussion of claim one has been concerned to establish that the claim is restitutionary in pattern. In particular, we have considered whether it can be said to map onto the framework by which creditor A has been unjustly enriched at the expense of the other creditors. As has been said, subject to certain limitations of analysis, this is true. However, it must be acknowledged that an alternative analysis is possible. The response called restitution may be triggered in addition by the occurrence of a wrong. The value in the defendant’s hands may be regarded not as an enrichment unjustly obtained at the expense of the claimant but rather as a gain made by doing wrong to the claimant.95 9.62 A wrong may be defined as a breach of any legal or equitable duty, including those duties imposed by statute.96 The question of whether a wrong has been committed is not therefore a question for the law of restitution. Rather, the question of liability is by definition referred to the substantive body of law defining the wrong. For example, to accept a bribe is wrongful conduct by a fiduciary.97 The question whether a wrong has occurred is therefore to be answered on those cases we associate with the duties of fiduciaries. Of interest is the observation that one response to the wrong is restitution of the gain thereby obtained. For example, the recipient may be ordered to account for any benefit obtained. It may be possible to argue that the cases in this study are also capable of explanation as examples of restitution for wrongs. In order to make

95 There has been debate about whether this response to the commissioning of a wrong ought properly to be labelled restitution (signifying giving back) of disgorgement (signifying giving up). P Birks, ‘Equity in the Modern World: An Exercise in Taxonomy’ (1996) 26 University of Western Australia Law Review 1 at 32; P Birks, ‘Definition and Division: A Meditation on Institutes 3.13’ in P Birks, The Classification of Obligations (Oxford, Clarendon Press, 1997) at 20–21; P Birks and C Mitchell, ‘Unjust Enrichment’ in P Birks (ed), English Private Law Volume II (Oxford, Oxford University Press, 2000) at 526–28; L Smith, ‘The Province of the Law of Restitution’ (1992) 71 Canadian Bar Review 672; L Smith, ‘Breach of Confidence—Constructive Trusts—Punitive Damages—Disgorgement of the Profits of Wrongdoing: Ontex Resources Ltd v Metalore Resources Ltd’ (1994) 73 Canadian Bar Review 259. 96 P Birks, An Introduction to the Law of Restitution, Rev edn (Oxford, Clarendon Press, 1989) at 313. 97 Attorney General for Hong Kong v Reid [1994] 1 AC 324.

Restitution for Vulnerable Transactions 411 this argument it is necessary to identify a breach of duty. For example, it may be possible to characterise a transaction at an undervalue or transaction defrauding creditors as a wrong committed by the directors of the company.98 Subject to affixing the recipient with the requisite level of knowledge, the recipient will be liable.

D CLAIM TWO — THE CREDITOR ’ S CLAIM

9.63 Claim two is that which may be available to creditor A in respect of benefits conferred on the other creditors of the company. This claim arises in the context of an action by the liquidator or other office holder to recover value originally transferred to creditor A. For the creditor’s claim to arise, creditor A must have been required, or be about to be required, by the order of a court to return value to the liquidator for the benefit of the other creditors. The substance of claim two is that by so doing, additional benefits may have been conferred on the other creditors. For example, creditor A may have made some improvements to the value of property, may have otherwise saved the other creditors inevitable expenditure or have given (admittedly undervalue) consideration for the asset now clawed back. The creditor’s claim is in recognition of these benefits conferred by creditor A. 9.64 At the outset it is vital to notice an important difference between claim one and claim two. The preceding analysis of claim one is an attempt better to understand liability pursuant to Insolvency Act sections 238, 239 and 423 by reference to unjust enrichment reasoning. Claim two is different in that it stands alone, it does not depend on re-analysis of the Insolvency Act within an unjust enrichment framework. The general law of unjust enrichment arguably already provides for the existence of claim two. This discussion will determine the extent to which (1) the other creditors are enriched by the receipt of a benefit; (2) the benefit is at the expense of creditor A; and (3) it is unjust to retain the benefit. The role of defences will be considered in the next section.

(1) Enrichment 9.65 The enrichment in this type of case could in theory comprise money or any of the non-money benefits which satisfy one of the tests of enrichment. The only example considered here is Weisgard v Pilkington99 in which various

98 99

See especially ss 238(5) and 239(5). [1995] BCC 1,108.

412 Simone Degeling un-renovated flats were transferred to Yeomans and Pilkington. After sale of one flat, there was some evidence that these men had used their own funds100 to convert the remaining six flats. Judge Maddocks left the way open for submissions to be made as to whether a benefit had thereby been conferred:101 . . . I do not exclude the possibility that they may be in the position to establish that money has been expended by them personally on the conversion of the flats . . . which had the effect of enhancing the value of the property to the liquidator for the purpose of the liquidation as compared with the value at the time of the transaction in question. . . . The course I therefore propose to give liberty to the respondents to apply . . . for payment by the liquidator out of the proceeds of the sale of the flats of any sums they may have expended in the conversion . . .

9.66 The relevant question is of course whether such benefits are enriching. There is no doubt that objectively speaking the conversion of the flats had increased the value for which they could be realised by the liquidator. However, it must be asked whether such benefits could be subjectively devalued. There is the possibility that the liquidator might argue that she would not have expended scarce financial resources in improving the value of the flats and therefore that the improvements were not enriching. Appealing to her own subjectivity of value, she might assert that her own judgment would have been to apply these funds to another purpose. It is, therefore, necessary to use a technique which will defeat subjective devaluation. 9.67 The liquidator did not bargain for, or otherwise accept, these benefits in circumstances where they could be rejected. It was not possible for the recipients to return the flats without the improvements. The techniques of free acceptance and the so called ‘bargained for benefit’ test will therefore not apply. Equally difficult is the argument that the benefit is incontrovertibly enriching because it is necessary. There is no evidence that, had the improvements not been conducted by Yeomans and Pilkington, the liquidator would have had to seek them herself. It is not the case that the liquidator would inevitably have laid out the funds expended by Yeomans and Pilkington. 9.68 Of greater utility must be the argument that the benefits were, if not yet realised in money, realisable in money. The services provided and work done in converting the flats produced a tangible end product. Goff and Jones102 argue that such benefits are enriching if the defendant may realise this gain. This test 100 The judgment is somewhat ambiguous on this issue. Earlier in the text it is stated that the funds used to convert the flats could have been the proceeds of the on-sale of one flat (called flat number 3) in which case the funds used to improve the remaining flats were not the personal resources of the recipients. Later however (at 1,114) Judge Maddocks speaks of funds being expended by them personally. 101 Ibid 1,114. 102 G Jones (ed), Goff and Jones on the Law of Restitution, 5th edn, (London, Sweet & Maxwell, 1998) at 23. See also E McKendrick, ‘Work Done in Anticipation of a Contract Which Does not Materialise’ in W Cornish et al (eds), Restitution Past, Present and Future (Oxford, Hart Publishing, 1998) at 172–81.

Restitution for Vulnerable Transactions 413 was applied in Marston Construction Co Ltd v Kiglass Ltd103 in which a firm of engineers did preparatory work, such as the production of designs and working drawings and obtaining the consent of various authorities, for a development project which in the end did not proceed. The court held that the owners of the site were enriched by receipt of this preparatory work. Judge Peter Bowsher QC applied the test proposed by Goff and Jones:104 Although Goff and Jones refer to the gain being ‘realisable’ . . . Birks argues that it must not merely be realisable but realised. . . . It seems to me that in appropriate cases, the benefit may consist in a service which gives a realisable and not necessarily realised gain to the defendant particularly when, as here, the service is a part of what was impliedly requested.

9.69 Despite the finding of a request on the facts of Marston it is clear that the judge intended the test to apply even where no such request is present. On the facts of Weisgard v Pilkington it seems that we may demonstrate enrichment on the basis of a realisable value. The liquidator would not suffer any great hardship by being compelled to sell the (now improved) flats. On the contrary, this is what might be expected of a competent liquidator in the circumstances.

(2) Valuation 9.70 The benefit conferred on the liquidator must be valued. The question is whether the measure of the benefit should be the amount expended in improving the flats, or rather the increase in value attributable to these improvements. The better view is the latter, the amount by which the property has increased in value. As has been said, the enrichment in question is the increase in the realisable value of the property. Logically therefore, to value this enrichment we ask by what amount has the property gone up in value. We must value the end product. 9.71 In Weisgard, Judge Maddocks contemplated that Pilkington and Yeomans would be given leave to seek the amount they had expended in converting the flats.105 With respect, this approach is incorrect. The relevant enrichment conferred on the liquidator was not the provision of services which she would have sought in any case. Rather, it was the improvement to the value of the flats and it is this value which must be captured via the unjust enrichment claim. It is clear that this is the value the Judge had in mind, despite giving leave to apply for an allowance for the amount expended, since he was concerned to capture the property’s increased value created by the work:106 103 104 105 106

[1989] 46 Build LR 109. At 126. [1995] BCC 1,108 at 1,114. At 1,114 per Judge Maddocks.

414 Simone Degeling . . . which had the effect of enhancing the value of the property to the liquidator for the purpose of the liquidation as compared with the value at the time of the transactions in question.

As a matter of practicality, it seems likely that restitution of this value would be effected by such an allowance, or the payment of a sum reflecting the increase in value of the property.

(3) At the Expense Of 9.72 There is little difficulty in establishing that the benefits were conferred by Yeomans and Pilkington. It was accepted as fact that these men expended money in the conversion of the flats. 9.73 Mention should also be made about the identity of the party enriched. The defendants in claim two are ultimately the general body of creditors of the company. However, as was the case in claim one, the liquidator or other officer is in this respect the person standing proxy for the other creditors. In the final analysis, it is the value available for distribution to such creditors which has arguably been enhanced by receipt of any benefit.

(4) Unjust Factors 9.74 It is quite difficult to identify the relevant unjust factor underlying Yeomans’ and Pilkington’s claim in Weisgard v Pilkington. One possibility is legal compulsion. Another is that the benefits were mistakenly conferred. On certain facts, other unjust factors, such as failure of basis, may also be visible. 9.75 Turning first to legal compulsion. Virgo explains that:107 Legal compulsion will arise where the plaintiff is compelled to transfer a benefit to someone in circumstances in which, if the plaintiff does not transfer the benefit, it will be taken from him or her by the legal process.

9.76 Not all cases of legal compulsion will contain the requisite element of injustice, because it is an accepted mode of behaviour in our society to have recourse to the legal system.108 Ordinarily legal compulsion will not operate between the parties to litigation. If A pays B because a court orders her to do so she is not entitled to raise compulsion as an unjust factor. The policy of the law in the finality of judgments operates to close the matter and prevent A from

107

G Virgo, The Principles of the Law of Restitution (Oxford, Clarendon Press, 2000) at 224. A point made by P Birks, Introduction to the Law of Restitution, Rev edn (Oxford, Clarendon Press, 1998) at 185. 108

Restitution for Vulnerable Transactions 415 asserting any rights to restitution she may have had.109 She is given the opportunity to put her case to a court and it is in this forum, at the trial of the issues between the parties, that she must contest her liability.110 9.77 The above paragraph seems to indicate that Yeomans and Pilkington have no foundation for a claim based on legal compulsion as an unjust factors since it is in the suit by the liquidator to recover the preference that their arguments should be presented. However, assuming that a cross claim is made, Yeomans and Pilkington may point to the fact that the increase in the value of the flats will only reach the hands of the liquidator because they will be forced by the order of the court to transfer the leases to the liquidator and an order, if required, for delivery up of vacant possession.111 Although somewhat circular, they may argue that to force them to convey to the liquidator the value of the improvements will be unjust because they have no intention to benefit the other creditors in this way. Unless an allowance is made for this value in the claim against them by the liquidator, the order of the court will compel them to confer this unintended benefit. 9.78 An alternative may be that the benefits were mistakenly conferred. The distinction between mistakes of fact and mistakes of law has now been abolished112 so that the relevant question is whether the mistake is an operative mistake.113 Did the mistake operate on the mind of the transferor so as to cause the transfer? This inquiry is usually satisfied by application of the ‘but for’ test:114 . . . by virtue of which the plaintiff’s mistake will only be considered to have caused the plaintiff to transfer a benefit to the defendant if the plaintiff can show that the benefit would not have been transferred but for the mistake.

Yeomans and Pilkington may therefore assert that they improved the flats in the mistaken belief that they had acquired good title to them.115 Their intention to confer the benefits in question may therefore have been vitiated by this mistake. But for this mistaken belief, they would not have undertaken the renovation work. 9.79 The argument that Yeomans and Pilkington were labouring under a mistake is not without difficulty. There is some room on the facts for an argument 109 Dublin Corporation v Building and Allied Trade Union [1996] 1 IR 468; De Medina v Grove (1846) 10 QB 152. See B McFarlane, ‘The Recovery of Money Paid Under Judgments Later Reversed’ [2001] Restitution Law Review 1. 110 Moore v Fulham Vestry [1895] 1 QB 399 at 401 per Lord Halsbury. 111 Weisgard v Pilkington [1995] BCC 1,108 at 1,114 per Judge Maddocks. 112 Kleinwort Benson Ltd v Lincoln City Council [1999] 2 AC 349 113 Barclays Bank v WJ Simms (Southern) Ltd [1980] QB 677; Banque Financière de la Cité v Parc (Battersea) Ltd [1999] 1 AC 221; Kleinwort Benson Ltd v Lincoln City Council [1999] 2 AC 349; Nurdin & Peacock plc v DB Ramsden & Co Ltd [1999] 1 WLR 1249; David Securities Pty Ltd v Commonwealth Bank of Australia (1992) 175 CLR 353. 114 G Virgo, The Principles of The Law of Restitution (Oxford, Clarendon Press, 1999) at 159. 115 Greenwood v Bennett [1973] QB 195.

416 Simone Degeling that the men were in fact risk takers and therefore not mistaken.116 Weisgard and Pilkington were directors of Hotswap and the flats were sold to them on 24 July 1991. Work was then commenced to convert the flats. By September 1991 Pilkington and Yeomans accepted that Hotswap was insolvent and could no longer continue to trade. They instructed an insolvency practitioner (Weisgard) to place the company in creditors’ winding up. Weisgard wrote to Pilkington and Yeomans on 17 September 1991 noting that the sale of the flats may well constitute a preference. In the face of these warnings, Yeomans and Pilkington continued to develop the flats.117 It may therefore be argued that, at least from the time of this warning, Yeomans and Pilkington were not mistaken. Rather, they were reckless as to the possibility that their purchase of the flats might be impugned as a preference. It is arguable that this recklessness may be identified even earlier in the story. It must be remembered that these men were directors of the company. Arguably their knowledge of the company and its affairs constituted them as risk takers prior to the warning given by the liquidator. Taking the risk that the sale of the flats might be reversed as a preference, Yeomans and Pilkington nonetheless converted the flats. To this extent they were not mistaken. 9.80 On certain other facts, other unjust factors may also be visible. An example is the unjust factor called failure of basis. Let us take the case of creditor A who receives an asset transferred at an undervalue. Even though the value given by creditor A may be insufficient (hence undervalue), it cannot be denied that some value has passed from creditor A. In Phillips v Brewin Dolphin118 the liquidator of AJ Bekhor & Co Ltd (AJB) successfully claimed against Brewin Dolphin that its purchase of AJB’s stock broking business had been at an undervalue. Their Lordships had to take account of the purchase price of £312,500 received by AJB from Brewin Dolphin. Lord Scott held that judgment against Brewin Dolphin should make allowance for the payment:119 Under s 238(3), the court has a broad discretion to make ‘such order as it thinks fit’ for ‘restoring the position to what it would have been if the company had not entered the transaction.’ In my opinion, an order under the subsection that did not take account of AJB’s receipt of the £312,500 would be unfair to Brewin Dolphin and PCG. I would, therefore, vary the order against Brewin Dolphin by allowing credit to be taken for the £312,500 and the interest thereon.

9.81 The fact that AJB notionally had to return value originally transferred by Brewin Dolphin illustrates the possible application of failure of basis. This unjust factor recognises that the claimant’s decision to transfer wealth may be non-voluntary on the ground that it is only a qualified intention. There is an intention to transfer wealth subject to a basis for the transfer, such as agreed 116 117 118 119

Kelly v Solari (1841) 9 M&W 54. Weisgard v Pilkington [1995] BCC 1,108 at 1, 110–11 per Judge Maddocks. [2001] UKHL 2, [2001] 1 BCLC 145. At para [34], at p 157 per Lord Scott.

Restitution for Vulnerable Transactions 417 counter performance by the recipient. By the liquidator’s claim, Brewin Dolphin was denied receipt of any part of what it had bargained for.120 At the end of the day, it had paid to AJB £312,500 but received nothing. Lord Scott’s decision to require AJB in effect to return this value reflects this injustice.

(5) Conclusion 9.82 Claim two concerns those benefits which have been conferred by creditor A on the other creditors of the company. As has briefly been explored in this section, it is possible that these are recoverable via a claim in unjust enrichment. The benefits we have discussed are improvements to property and consideration paid for a basis which fails. However, as identified by Keay,121 there are others possible. For example, it may be argued that the liquidator has been saved the inevitable expense involved in realising assets.

E CHANGE OF POSITION

9.83 This last section is to consider briefly the defence of change of position. As is explored below, change of position is in the front line in recognising that, on some facts, it is inequitable to pursue a claim against a defendant, or at least to pursue it in full.122 One consequence of this defence is to protect the defendant’s security of receipt. The defence is of great importance to the cases in this study. To the extent that the insolvency regime under investigation conforms to an unjust enrichment analysis, the change of position defence arguably applies. This has relevance not only to the individual value of claim one and claim two, but also the accounting between these claims which must inevitably occur. The discussion proceeds below as follows: (1) an outline of the defence of change of position; and (2) a consideration of change of position in the insolvency claims under investigation.

(1) Outline of the Defence 9.84 Change of position is the primary defence available to an unjust enrichment defendant. English law recognised the defence in the decision of the House 120 Despite vigorous academic criticism and judicial manipulation of the concept, it seems that the requirement of total failure of consideration still has some currency: Baltic Shipping v Dillon (1993) 175 CLR 344; Goss v Chilcott [1996] AC 788; Stocznia Gdanska SA v Latvian Shipping Co [1998] 1 WLR 574. 121 A Keay, ‘The Recovery of Voidable Preferences: Aspects of Restoration’ in F Rose (ed), Restitution and Insolvency (London, Mansfield Press, 2000) at 250–60. 122 Dextra Bank & Trust Company Limited v Bank of Jamaica [2002] 1 All ER (Comm) 193 at p 205 per Lords Bingham and Goff who delivered the advice of the Privy Council.

418 Simone Degeling of Lords in Lipkin Gorman v Karpnale Ltd.123 Although the exact scope of the defence is still subject to debate,124 and is emerging via a gradually developing case law, the foundation of our understanding lies in the formulation of the defence given by Lord Goff:125 . . . the defence is available to a person whose position has so changed that it would be inequitable in all circumstances to require him to make restitution, or alternatively to make restitution in full. I wish to stress however that the mere fact that the defendant has spent the money, in whole or in part, does not of itself render it inequitable that he should be called upon to repay, because the expenditure might in any event have been incurred by him in the ordinary course of things.

9.85 Change of position thus allows the defendant to subtract from the value of the enrichment received the value of certain disenrichments or reductions in wealth. The defendant is permitted to deduct from the value of the enrichment any disenrichments which would not have occurred but for the enrichment. In this way, the value which the defendant is obligated to return to the claimant by way of restitution is reduced. Three key elements of the defence merit discussion. First, to identify those disenrichments which will qualify for the defence. Secondly, issues of timing. In particular, whether the enrichment must actually be received prior to the disenrichment. Thirdly, to identify the circumstances in which the defendant is precluded from relying on the defence. 9.86 The defence is intended to capture changes of position which would not have happened but for the enrichment. As emphasised by Lord Goff, if the expenditure might in any event have been incurred by the defendant in the ordinary course of things then the defence will not be available.126 It seems that it is not necessary that a particular item of expenditure be cited as proof of change of position. In a case involving a series of periodic overpayments, the defendants were permitted to raise an increased general level of expenditure as relevant disenrichment. Jonathan Parker J stated the position as follows:127 123

Lipkin Gorman v Karpnale [1991] 2 AC 548. P Birks, ‘Change of Position and Surviving Enrichment’ in W Swadling (ed), The Limits of Restitutionary Claims (London, UKNCCL, 1997) at 36–63; P Birks and C Mitchell, ‘Unjust Enrichment’ in P Birks (ed), English Private Law Volume II (Oxford, Oxford University Press, 2000) at 610–15 and 630; R Chambers, ‘Change of Position on the Faith of the Receipt’ [1996] Restitution Law Review 100; E Fung and L Ho, ‘Establishing Estoppel after the Recognition of Change of Position’ [2001] Restitution Law Review 52; E Fung and L Ho, ‘Change of Position and Estoppel’ (2001) 117 Law Quarterly Review 14; M Jewell, ‘The Boundaries of Change of Position— A Comparative Study’ [2000] Restitution Law Review 1; P Key, ‘Change of Position’ (1995) 58 Modern Law Review 505; R Nolan, ‘Change of Position’ in P Birks (ed), Laundering and Tracing (Oxford, Clarendon Press, 1995) at 136–89; G Virgo, The Principles of the Law of Restitution (Oxford, Clarendon Press, 1999) at 709–30. 125 Lipkin Gorman v Karpnale [1991] 2 AC 548 at 580 per Lord Goff. 126 RBC Dominion Securities v Dawson (1994) 111 DLR (4th) 230; Gertsch v Atsas [1999] NSWSC 898; Scottish Equitable plc v Derby [2001] 3 All ER 818, [2001] EWCA Civ 369; Phillip Collins Ltd v Davis [2000] 3 All ER 808. 127 Phillip Collins Ltd v Davis [2000] 3 All ER 808 at 829–30. See also Scottish Equitable plc v Derby [2001] EWCA Civ 369 at [33], [2001] 3 All ER 818 at 827–28 per Robert Walker LJ. 124

Restitution for Vulnerable Transactions 419 I am unable to find that any particular item of expenditure was directly referable to the overpayment of royalties. Their evidence was simply too vague and unspecific to justify such a finding. On the other hand, in the particular circumstances of the instant case the absence of such a finding is not, in my judgment, fatal to the defence of change of position . . . I am satisfied that had the defendants been paid the correct sums by way of royalties their levels of expenditure would be lower.

9.87 The key is to identify expenditure which would not have happened but for receipt of the relevant enrichment. Arguably this will include an increased level of expenditure on day to day items. So long as the causal connection between receipt of the enrichment and the relevant expenditure is established, the defence will be available to . . . the person who lives at a higher standard of living because more money is available but would not have done so but for the windfall.128

On other facts, the expenditure will more easily be identifiable as extraordinary. Thus, in Gertsch v Atsas,129 the court weighed up the advantages and disadvantages accruing to the defendant from the receipt of money paid under a bequest. The recipient was entitled to set against her receipt income which would have been earned had she not, on the faith of the legacy, given up her employment and pursued university education:130 . . . I have formed the view that, had she not received the legacy and, consequently, remained in employment rather than pursuing a university course, she would have, in all probability, paid off a large part of the . . . mortgage.

9.88 Timing is also an issue of central importance. The claimant in Lipkin Gorman was permitted to aggregate its net payments against receipts. This meant, in effect, that the defendant casino incurred some losses prior to receiving the stake in respect of which the loss was incurred. In the language of unjust enrichment this is called anticipatory disenrichment. More recent authority affirms that it is possible that the change of position defence can succeed ‘. . . where the alleged change occurs before receipt of the money.’131 In Dextra Bank 128 RBC Dominion Securities Inc v Dawson (1994) 111 DLR (4th) 230 at 239–40 per Cameron JA who delivered the judgment of the Newfoundland Court of Appeal. See also Social Services Appeal Board v Butler unreported Newfoundland Supreme Court 29 March 1996. 129 [1999] NSWSC 898. 130 At [98] per Foster AJ. 131 South Tyneside Borough Council v Svenska International [1995] 1 All ER 545 at 565 per Clarke J. On the facts of this case the claimant was not in the end entitled to assert this defence as the underlying transaction pursuant to which the payments were made was null and void. Thus (at 567):

. . . if a net payee can show that it has altered its position in good faith after receipt of money under a swap from the net payer it might in principle be entitled to rely on the defence of change of position. What it cannot do is reply on the supposed validity of the transaction because the transaction is and has always been void.

In Dextra Bank & Trust Company Limited v Bank of Jamaica [2002] 1 All ER (Comm) 193 at 205 Lords Bingham and Goff, speaking for the Privy Council, referred to the decision of Clarke J and noted that: . . . the exclusion of anticipatory reliance in that case depended on the exceptional facts of the case; though it is right to record that the decision of Clarke J has been the subject of criticism.

420 Simone Degeling & Trust Company Limited v Bank of Jamaica132 the Privy Council clarified this issue. Although speaking only obiter, Lord Bingham and Lord Goff (for the Privy Council) unequivocally confirmed that anticipatory disenrichments qualify for the defence of change of position:133 . . . it is difficult to see what relevant distinction can be drawn between (1) a case in which the defendant expends on some extraordinary expenditure all or part of a sum of money which he has received from the plaintiff, and (2) one in which the defendant incurs such expenditure in the expectation that he will receive the sum of money from the plaintiff, which he does in fact receive . . . It is true that, in the second case, the defendant relied on the payment being made to him in the future (as well as relying on such payment, when made, being a valid payment); but, provided that his change of position was in good faith, it should provide, pro tanto at least, a good defence because it makes it inequitable to make the defendant to make restitution, or restitution in full.

9.89 The final element is to determine when a claimant will not be entitled to rely on the defence. In his original formulation of the defence articulated in Lipkin Gorman Lord Goff stated that: 134 . . . the defence is not open to one who has changed his position in bad faith, as where the defendant has paid away the money with knowledge of the facts entitling the plaintiff to restitution; and it is commonly accepted that the defence should not be open to a wrongdoer.

The requirement of good faith was again highlighted in Dextra. Their Lordships regarded ‘. . . good faith on the part of the recipient as a sufficient requirement in this context . . .’135 and rejected the notion that good faith should be assessed by examining the relative fault of the parties. Bad faith has been interpreted to mean dishonesty136 and usually means something more than mere carelessness. 9.90 The limitation as to wrongdoers is also subject to variable interpretation. Birks and Mitchell137 argue that this exclusion simply reflects that a claim to recover a gain made as a result of wrongdoing (and therefore not a claim in unjust enrichment) is not susceptible to the defence. Virgo138 takes a more 132

[2002] 1 All ER (Comm) 193. At 204–5. Lipkin Gorman v Karpnale Ltd [1991] 2 AC 548 at 580. 135 At 207. 136 P Birks and C Mitchell, ‘Unjust Enrichment’ in P Birks (ed), English Private Law Volume II (Oxford, Oxford University Press, 2000) at 613. P Birks, ‘The Role of Fault in the Law of Unjust Enrichment’ in W Swadling and G Jones (eds), The Search for Principle. Essays in Honour of Lord Goff of Chieveley (Oxford, Oxford University Press, 1999) 235 at 249–58. Virgo suggests a higher threshold than dishonesty, suggesting that bad faith is an uncertain standard but would clearly the exclude the defendant that has ‘. . . committed fraud or duress or had been participating in an illegal transaction.’ G Virgo, The Principles of the Law of Restitution (Oxford, Clarendon Press, 1999) at 720–21. 137 P Birks and C Mitchell, ‘Unjust Enrichment’ in P Birks (ed), English Private Law Volume II (Oxford, Oxford University Press, 2000) at 613 138 G Virgo, The Principles of the Law of Restitution (Oxford, Clarendon Press, 1999) at 721. 133 134

Restitution for Vulnerable Transactions 421 literal interpretation, suggesting that some wrongdoers are not entitled to rely on the defence and that the court should have regard to the nature of the wrong committed in deciding this issue.

(2) Application of Change of Position 9.91 At the outset it must be acknowledged that in some jurisdictions the change of position defence is by statute applied to certain insolvency claims.139 Of interest here is the possibility that the general unjust enrichment defence will apply. In Principal Group (Trustee of) v Anderson 140 the Alberta Court of Appeal was asked to consider this possibility. The trustee in bankruptcy (referring to a corporate insolvency procedure) was asked to recover fraudulent preferences paid by Principal Group Ltd to various recipients. The recipients contested liability on the basis that: 141 . . . they [had] changed their position as a result of receiving the money, and that it would be inequitable to force them to repay . . .

Counsel could find no case applying change of position to a suit by a trustee to recover moneys paid by the bankrupt and in the end the Court of likewise declined to do so. The basis of the Court’s objection was that the positive duties142 imposed on the trustee to recover back fraudulent payments were inconsistent with the defence. The defence of change of position therefore failed:143 It is true that the present appellants [recipients] had no bad motive, though they must surely have realized that the timing and circumstances of their early pay-out from this investment plan were peculiar, to say the least. But to let certain of the investors in this employee investment plan keep their early repayments when the rest had to put theirs back (via the trustee in bankruptcy) would seem to fly in the face of all the principles set out above. The whole idea of the defence of change of position is that the equity lies with the payee and not with the payor who wants to get his payment back. But where a trustee in bankruptcy carries out a duty to sue to undo a fraudulent payment, it is difficult to say that change of position makes the trustee’s suit inequitable.

9.92 Despite the failure of the defence in Principal Group we may nonetheless observe that the Insolvency Act gives the court a discretion to ‘. . . make such 139 Companies Act 1993 (NZ) section 296(3) considered in T O’Sullivan, ‘Defending a Liquidator’s Claim for Repayment of a Voidable Transaction’ (1997) 9(1) Otago Law Review 111; Countrywide Banking Corporation Ltd v Dean [1998] AC 338. Corporations Act 2001 (Aust) s 588FG (2)–(6). See A Keay, McPherson The Law of Company Liquidation, 4th edn (Sydney, 1999) at 477–83; J O’Donovan, ‘Undue Preferences: Some Innocents Scape Not the Thunderbolt’ (1992) 22 Western Australian Law Review 322. 140 Principal Group (Trustee of) v Anderson (1997) 147 DLR (4th) 229. 141 At 231 per Hetherington, Côté and O’Leary, JJA. 142 At 233. 143 Above n 138 at 234 per the Alberta Court of Appeal (Hetherington, Côté and O’Leary, JJA).

422 Simone Degeling order as it thinks fit for restoring the position . . .’.144 To the extent that the regime under investigation is restitutionary in pattern, the defence of change of position may well apply. At the very least we may say that the Insolvency Act does not expressly exclude the defence.145 This was the winning argument in Social Services Appeal Board v Butler.146 Butler had been overpaid various social assistance benefits. The statute147 stated that the minister had ‘. . . a right to recover from the recipient the social assistance that the recipient [was] not entitled to receive’ and that such amount was a ‘. . . debt due . . . to the crown.’ The Court permitted Butler successfully to rely on the defence of change of position (called change of circumstance):148 I have been shown no reason why a defence of change of circumstance should not apply to mistakes of fact or law made by a Crown official, where the legislation authorising recovery does not expressly exclude this defence.

9.93 The effect of change of position is to allow a recipient to reduce the value which must be repaid in an action for recovery by a liquidator or other office holder. The potential becomes clearer if we apply the defence to the facts of Weisgard v Pilkington.149 Although our ultimate conclusion is that the defence is not available, application to the facts illustrates the issues to be dealt with. The facts of this case are given earlier in this discussion but it will be remembered that the company Hotswap transferred various flats to two directors, Yeomans and Pilkington. Yeomans and Pilkington renovated these flats thus improving their value. The facts of the case are slightly ambiguous as to the source of this money. One possibility is that it was the company’s money, another is that they used their own funds. It is not necessary for our purpose to decide this point as the two possibilities conveniently illustrate the application of change of position. (a) Claim One 9.94 It will be recalled that claim one is that available to the liquidator or other officer against creditor A. On the facts of Weisgard, claim one is raised by the fact that Yeomans and Pilkington may have used the company’s money to fund the property improvements.150 In theory, this money represents a separate enrichment. Let us assume that the liquidator successfully brought an action to reverse the transfer of this value to Yeomans and Pilkington on the ground that 144 145 146 147 148 149 150

Insolvency Act 1986 ss 239(3); 238(3) and 423(2). Above n 5. Unreported Newfoundland Supreme Court 29 March 1996, Barry J. Social Assistance Act RSN 1990 s 23 (1) and (2). At [*14] in Lexis. [1995] BCC 1,108. Judge Maddocks avers to this possibility when he states at 1,111 that:

. . . [Yeomans and Pilkington] continued with the development of the flats seemingly still using money from the company’s account.

Restitution for Vulnerable Transactions 423 it constituted a preference.151 Change of position is raised by the possibility that the company’s money used to improve the flats was no longer available, that it had been spent. 9.95 In deciding the application of the defence we must determine whether Yeomans’ and Pilkington’s position had changed to the extent that it would be inequitable to require them to make restitution. It is therefore necessary to identify the relevant change. Yeomans and Pilkington may point to the fact that, in reliance on the faith of their receipt of the flats, they expended the company’s money in converting the flats. Whilst this expenditure is certainly extraordinary in the sense that it would not have occurred but for the receipt, it seems unlikely that change of position will apply. Had this money been lost, for example spent on vintage champagne, it might more easily have qualified for the defence. However, on the facts of the case it seems clear that the effect of this expenditure was to enhance the value of the flats. In this way, the overall wealth or assets of the defendants remained swollen. They had simply replaced one asset (cash) for another (realisable improvement in value of flats). There was no change. However, if we alter the facts and assume that the funds expended by Yeomans and Pilkington did not in fact improve the value of the flats, then arguably this element of the defence will be met. 9.96 Even if Yeomans and Pilkington could satisfy a court as to the relevant change in their position, it is unlikely that the requirement of good faith could be met. In Lipkin Gorman Lord Goff emphasised that the:152 . . . defence is not open to . . . the defendant [who] has paid away the money with knowledge of the facts entitling the plaintiff to restitution.

This is precisely what Yeomans and Pilkington did. In the face of warnings given by the liquidator on 17 September 1991, that the sale of the flats appeared to constitute a preference, Yeomans and Pilkington continued with the development of the flats. Despite this evidence and the fact that the directors were guilty of ‘misfeasance in granting the leases’,153 Judge Maddocks gave leave for them to claim against the liquidator in respect of any benefit thereby conferred. Even though Judge Maddocks does not seem to have regarded their misconduct as prohibiting any cross claim, the conduct of Yeomans and Pilkington may have significance for their ability to rely on change of position. In the light of the warnings by the liquidator, it is possible to view the actions of these two directors as dishonest, thus excluding them from the ambit of the defence. They did not act in good faith.

151 The actual case does not seem to deal with this issue. The claim by the liquidator was only in respect of the disposition of the flats. 152 Lipkin Gorman v Karpnale Ltd [1991] 2 AC 548 at 580 per Lord Goff. 153 Weisgard v Pilkington [1995] BCC 1,108 at 1,114.

424 Simone Degeling (b) Claim Two 9.97 The possibility of claim two is raised by the suggestion that Yeomans and Pilkington in fact used their own money in improving the flats, thereby conferring a benefit on the general body of creditors. As has been said, Judge Maddocks gave them leave to claim against the liquidator in respect of any benefit thereby conferred. The question is whether, in a claim by the directors to recover this value, the defendant could rely on a defence of change of position. The answer is that, subject to the satisfaction of the elements for the defence, there is no reason why not. However, it is likely that the recipients will face difficult issues of calculation. (3) Counter Restitution 9.98 As is made clear in the discussion of claim two, in certain circumstances the recipients will confer a benefit on the claimant which may be recoverable via a separate claim. However, it important to notice that on rare facts this benefit may lay the foundation for a defence to claim one. The defence of counter restitution says that a claimant, such as the liquidator, who seeks restitution of an unjust enrichment must make counter restitution of benefits received from the defendant in exchange.154 Thus, if the liquidator (standing proxy for the other creditors) has received a benefit from the defendant in the case and counter restitution is impossible, the liquidator’s unjust enrichment claim is barred. 9.99 The circumstances in which counter restitution may truly be said to be impossible are diminishing. Courts readily allow counter restitution to be made in money, thus representing the value conferred by the defendant on the claimant.155 As emphasised by Burrows and McKendrick:156 . . . counter-restitution may be difficult to assess, but it is never impossible because a monetary value can always be put on the value of non-money benefits received by the plaintiff who seeks restitution.

The only situation in which it is truly impossible to make counter-restitution appears to be one in which the relevant benefit cannot be valued, thus precluding its return via the payment of money.157 In practice the requirement of counter restitution thus means that in many cases the court will simply value the two claims and require the party holding the difference to make restitution. In 154 P Birks and C Mitchell ‘Unjust Enrichment’ in P Birks (ed) English Private Law: Volume II (Oxford, Oxford University Press, 2000) at 632. 155 Erlanger v New Sombrero Phosphate Company (1878) 3 App Cas 1218; Boardman v Phipps [1967] 2 AC 46; O’Sullivan v Management Agency and Music Ltd [1985] QB 428; Mahoney v Purnell [1996] 3 All ER 61 156 Cases and Materials on the Law of Restitution (Oxford, Oxford University Press, 1997) at 822. 157 G Virgo The Principles of the Law of Restitution (Oxford, Clarendon Press, 1999) at 691.

Restitution for Vulnerable Transactions 425 calculating this amount, the impact of other defences such as change of position must carefully be considered. One party to the claim may be entitled to rely on a certain amount of disenrichment, thus reducing the value of her own enrichment. The point has already been made that in this case the amount awarded by the court will not simply be the difference between the two claims.

F CONCLUSION AND SUMMARY OF FINDINGS

9.100 This chapter has sketched out the boundaries of a difficult problem. It has been asserted that the avoidance regime contained within the Insolvency Act reverses unjust enrichment. Leaving aside an examination of legislative intent, it seems tolerably clear that it does. The relevant sections of the legislation work to restore value to the estate of the insolvent for distribution in accordance with the statutory scheme. Analysis demonstrates that, at least in the cases identified, there is a degree of overlap with accepted unjust enrichment reasoning. Definitively to prove this assertion requires a more detailed analysis. However, this initial inquiry has revealed the following: —There are in fact two distinct and symmetrical unjust enrichment claims embedded in the cases. Claim one is that available to the liquidator or other officer against creditor A in respect of an asset or value transferred to that creditor. For example, the original transfer may constitute a preference, a transaction at an undervalue or be a transaction defrauding creditors. Claim two is the claim available to creditor A in respect of benefits conferred on the other creditors of the company. Claim two envisages the situation where creditor A has been, or is likely to be, forced by a court order to return an asset or value to the liquidator. In being required by the court to return value or an asset in this way, it is possible to identify benefits which have been conferred by creditor A on the general body of creditors. For example, creditor A may have actually given value in exchange for the initial transfer or may have improved the asset now clawed back. —The unjust enrichment analysis suggests a surprising result in the valuation of claim one. It is argued that creditor A is enriched at the expense of the company’s creditors who would otherwise be entitled via the insolvency regime to share in what was transferred. However, it must be remembered that creditor A is a creditor who might otherwise have been entitled to a dividend in the company’s insolvency. Properly understood, therefore, creditor A is only enriched by the amount received less creditor A’s own insolvency entitlements. —It is not logically necessary to accept the unjust enrichment analysis of claim one in order to accept the existence of claim two. In this sense claim two stands alone. Claim one is a re-evaluation of Insolvency Act sections 238, 239

426 Simone Degeling and 423 in the light of modern unjust enrichment principles. Claim two does not depend on a re-evaluation of this nature. The only pre-condition for the existence of claim two is that some legal action has been brought by the liquidator or other officer to claw back an asset or value. Arguably, the general law of unjust enrichment already provides for the existence of claim two, and it is this framework which should guide the exercise of judicial discretion given by sections 238(3), 239(3), 241(1), and 423(2). —It might erroneously be thought that claim two is simply part of a valuation exercise in relation to claim one. Although both claims arise out of the same transaction and are legally connected, in that it is a precondition to claim two that the liquidator or other office holder wishes to claw back the relevant asset or value, the claims are in fact analytically distinct. It should not be open to creditor A simply to assert that her liability to the liquidator should be net for example, of any improvements or payments made. Rather, creditor A should be required to demonstrate this entitlement on a principled basis. The elements of creditor A’s claim must be satisfied. —The analysis in this chapter suggests that the defence of change of position should be available to the defendant in both claim one and claim two. The impact of this defence will therefore affect not only the individual value of claim one and claim two, but also the net amount which must be paid. However, in considering the application of the defence it must be remembered that it may only be invoked by a recipient acting in good faith. At least in relation to claim one, it seems creditor A will often be prevented from relying on the defence.158 —Claims one and two have been examined only as they concern Insolvency Act sections 238, 239 and 423. However, the analysis may turn out to be of broader application. In particular, section 245 (late value floating charges) may be susceptible to this analysis.

158 Re Kumar [1993] BCLC 548 may be an example of this type of case. This was a claim pursuant to s 339 but is also relevant to a claim under s 238. As is discussed in ch 4, Kumar transferred at an undervalue his share of the equity of redemption in the family home to his estranged wife Gupta. On the faith of the receipt Gupta extended the debt secured by the mortgage, using the additional funds to make a ‘. . . compassionate gift to her brother and in generous, or even lavish, provision for her daughter’. Ferris J ordered that Kumar’s trustee in bankruptcy was entitled to restoration of Kumar’s former interest in the property, unencumbered by Gupta’s further indebtedness. The case seems therefore implicitly to reject the application of change of position on these facts. Given that Gupta’s expenditure seems to qualify for the defence in that it was extraordinary, it seems plausible to conclude that Gupta was not a recipient in good faith. Arguably, it was the undervalue in her original receipt which negatived good faith.

10 Cross-border Insolvency and Vulnerable Transactions SANDRA FRISBY

A . INTRODUCTION

(1) The Phenomenon of Cross-Border Insolvency (a) Commercial Globalisation At present the legal treatment of troubled multinationals is primitive and chaotic. . . . This deplorable situation increases the costs of all transnational business activity and imposes on claimants against such enterprises serious burdens of expense, delay, and injustice.1

10.01 In the decade or so since Westbrook proffered this somewhat gloomy diagnosis the global market has become more entrenched. Increasingly commonly, corporations are exploring and exploiting markets outside their ‘home’ territory, and this pioneering character is by no means confined to the largest of commercial operators. Further advances towards a single European market and developments in information technology have facilitated the adoption of more ambitious trading strategies by even the smallest of corporate actors, so that an economic presence outside one’s national boundaries is a realisable goal for virtually any business organisation.2 10.02 Whilst transnational business activity has burgeoned, it is arguable that legal responses to the inevitable problems that such activity engenders have not been forthcoming. Westbrook’s censure of the lack of a structured and principled rejoinder to cross-border insolvency has been judicially echoed in more recent times:

1 Westbrook, ‘Global Insolvencies in a World of Nation States’ in Clarke (ed), Current Issues in Insolvency Law (London, Stevens & Sons, 1991) at 27. 2 See Grierson, ‘Issues in Concurrent Insolvency Jurisdiction: English Perspectives’ in Ziegel (ed) Current Developments in International and Comparative Corporate Insolvency Law (Oxford, Clarendon Press, 1994) at 577.

428 Sandra Frisby The huge increase in international trade in modern times and the development of a global market-place have inevitably led to an increase in the number, size and complexity of cross-border insolvencies. Novel problems have arisen since the creation of multinational trading corporations which, in many cases, have little or no economic connection with any particular place of incorporation. Legal theory, based on the territorial jurisdiction of the courts of the national state, has parted company with commercial reality and the needs of modern business.3

(b) Issues Arising from Cross-Border Insolvency 10.03 The peculiar complexities associated with the insolvency of a corporate entity operating extraterritorially are perhaps best illustrated by way of example. Let us take, first of all, the case of a company registered under the Companies Act 1985, that company having established branches in France and Spain (without incorporating in either jurisdiction), and having granted a security package of fixed and floating charges over its entire undertaking to its English incorporated bank. It has also borrowed on an unsecured basis from an Indian bank. Let us suppose that this company has a long-term trading relationship with a Japanese entity, from which it acquires supplies for its business on credit terms, and that it has hired equipment on chattel lease terms from the Manchester branch of an Australian firm. The company’s directors, one of whom is a Texan resident in Monaco, have guaranteed the hire payments under this agreement. The company, through its English, French and Spanish offices, sells its products throughout Europe, and also orders supplies from a number of European jurisdictions. 10.04 Finding itself in financial difficulties, and facing pressure from its Japanese supplier, the company makes a payment to discharge all its outstanding indebtedness to that supplier. At the same time it meets outstanding instalments on the chattel lease. In order to finance these payments, it assigns a valuable licence to a Brazilian corporation for a consideration significantly less than the face value of the licence. In return for further advances from the Indian bank it agrees to grant a floating charge over its book debts to secure all indebtedness. Five months later the company is placed in compulsory winding up by the English courts. 10.05 Were the above scenario to occur in a purely domestic context, the potential for a liquidator to challenge some, or all, of the transactions is evident.4 Equally clearly, the interposition of a foreign dimension adds a further layer of intricacy. Questions arising include: 3 Sir Peter Millett, ‘Cross-Border Insolvency: The Judicial Approach’ (1999) 6 International Insolvency Review 99 at 99. See also Smart, Cross-Border Insolvency, 2nd edn (London, Butterworths, 1998) at 1; Grierson, above n 2; Dawson, ‘An Extraterritorial Dichotomy’ (2000) 2 Insolvency Lawyer 81. 4 Whether or not such challenges would prove successful is academic for present purposes, as, indeed, is the realism or otherwise of this particular example!

Cross-Border Insolvency and Vulnerable Transactions 429 —Whether the English bank’s security over the company’s assets extends to property located at its French and Spanish branches; —Whether a preference action in England under section 239 of the Insolvency Act 1986 can be maintained against the Japanese or Australian suppliers, or, indeed, against the Texan director; —Whether an action to reverse a transaction at an undervalue in England under section 238 of the Insolvency Act 1986 can be maintained against the Brazilian corporation; —Whether the charge in favour of the Indian bank is vulnerable under section 245 of the Insolvency Act 1986; —Whether any overseas creditors of the company can claim pari passu in the liquidation with English creditors. 10.06 An affirmative answer to the second and third of these questions would appear to involve an exercise of exorbitant jurisdiction on the part of an English court, whilst a negative answer to the final question would amount to parochialism. Moreover, some or all of these questions might appear to raise difficult conflict of laws questions: for example, the foreign entities implicated on an English analysis of vulnerable transactions might escape sanction under their domestic law, so that the application of English law would arguably frustrate the legitimate expectations of the parties.5 10.07 The legal response to the above example might be yet more troublesome were some slight modification made to the facts. Suppose, for example, the English incorporated company in fact carries out little or no business in England, and has no substantial creditors here? Alternatively, suppose the company had been incorporated in Luxembourg but operated from England, carried out the majority of its business here and had most of its creditors in England also? Would the answers to the questions posed differ in such circumstances? Moreover, should they differ? (c) The Problem for the Courts 10.08 In many comparable contexts a court faced with enquiries such as those posed above would be able to have regard to an international treaty or convention, but such a luxury remains unavailable in insolvency cases. The Brussels Regulation on Jurisdiction and the Enforcement of Judgments in Civil and Commercial Matters6 does not apply to corporate insolvency or analogous

5 As will be seen, choice of law clauses in the underlying agreements will only go some way to resolving this problem. 6 Council Regulation (EC) No 44/2001, in force as of 1 March 2002 (hereinafter the Brussels Regulation).

430 Sandra Frisby proceedings,7 and, until very recently, European attempts to implement a bankruptcy convention have met with failure.8 More ambitious international initiatives have similarly foundered9 and the judiciary’s despondency in this regard is well expressed by Browne-Wilkinson VC in a particularly complex case, where he stated: It is a matter of profound regret to me that there is no international convention regulating international insolvency. This case, I hope, if it does nothing else may concentrate peoples’ minds on the necessity for such a convention. What we do have are some rather dated rules of private international law which will regulate the disposal of the assets in the event that no rescue scheme is possible.10

10.09 The role of private international law remains, for the time being at least, predominant in the resolution of those corporate insolvency cases including an international element or dimension. In essence, and as outlined above, the issues arising are likely to include the jurisdiction of a particular court to entertain insolvency proceedings, the law applicable to determine matters arising in such proceedings, and the extraterritorial effects of orders or judgments made during such proceedings.11 Subsumed within these main issues are considerations of judicial comity and co-operation, statutory construction and the management of multiple insolvency initiatives. (d) The Scope and Structure of the Chapter 10.10 This chapter attempts a thumbnail sketch of the approach of the English courts to the idiosyncratic legal complications occasioned by cross-border insolvency.12 It begins with a brief treatment of the theoretical models underpinning the subject, and then examines the English courts’ winding up jurisdiction. The question of the applicable law in an English winding up is then addressed, with particular reference to those vulnerable transactions considered throughout the rest of this work. Finally, the likely impact of the EC Regulation on Insolvency Proceedings13 will be assessed. 7

Article 1(2) Brussels Regulation. Analogous proceedings are described as those:

based on the suspension of payments, the insolvency of the debtor or his inability to raise credit, and which involve the judicial authorities for the purpose either of compulsory and collective liquidation of assets or simply of supervision. (‘The Jenard Report’, OJ 1979 C 59). 8

See below para 10.113. See Grierson, above n 2 at 578. Re Bank of Credit and Commerce International SA [1992] BCLC 570 at 577. 11 See Fletcher, Insolvency in Private International Law (Oxford, Clarendon Press, 1999) at 5. 12 Confines of space do not allow for any more than an overview of the subject. For a detailed perspective the reader is referred to such specialist works as: Wood, Principles of International Insolvency (London, Sweet & Maxwell, 1995); Smart, Cross-Border Insolvency, 2nd edn (London, Butterworths, 1998); Fletcher, Insolvency in Private International Law, (Oxford, Clarendon Press, 1999); Dicey & Morris, The Conflict of Laws, 13th edn (London, Sweet & Maxwell, 2000); Bridge and Stevens, Cross-Border Security and Insolvency (Oxford, OUP, 2001). 13 Council Regulation (EC) No 1346/2000, OJ L 160/1. 9

10

Cross-Border Insolvency and Vulnerable Transactions 431 (2) Practical Problems and Theoretical Solutions (a) The Commercial Impasse 10.11 Uncertainty is anathema to commerce. Delay is equally unpalatable. Cross-border insolvency has an unfortunate propensity to generate both. Transactional planning to avoid an insolvency risk becomes fraught with difficulty once an extraterritorial aspect enters the equation.14 If insolvency occurs, negotiating the snarled network of multi-jurisdictional legal considerations inevitably impedes the orderly administration of the insolvent corporation’s assets. Additional expense will almost certainly be incurred by any insolvency practitioner supervising the estate, and the overall value of that estate may well depreciate significantly.15 As one eminent insolvency practitioner has put it: [The] insolvency practitioner is still attempting to run the business, which is difficult enough without having to address a conflict of laws dispute. Running the business and solving its problems requires expedition, which international conflict of laws resolution militates against, and the same applies even to a mere liquidation of assets, especially in a large corporation.16

(b) Theoretical Perspectives Universality, Territoriality, Unity and Plurality 10.12 The question of how international insolvency law might develop so as to supply an appropriate response to the twin problems of uncertainty and delay has troubled academics, practitioners and the judiciary alike. Examination of the dilemma in the abstract has produced conflicting ideologies, in the form of theoretical models, which could underpin international insolvency law.17 The first, known as ‘universality of bankruptcy’, propounds that any insolvency procedure instigated in an appropriate forum should have global effect, encompassing the entirety of the debtor’s assets wherever they may be situated and affecting all the debtor’s creditors in like manner. At the polar extreme to universality is the standard of ‘territoriality’, whereby any insolvency procedure impinges on only those assets and creditors in the originating jurisdiction.18

14 See Fletcher, above n 11 at 9–10; Westbrook and Trautman, ‘Current Developments in International Insolvencies’ in Ziegel (ed) above n 2 at 656; Fletcher and Anderson, ‘The Insolvency Issues’ in Bridge and Stevens (ed), above n 12 at 287. 15 See Fletcher, above n 11 at 6. 16 Homan, ‘An Insolvency Practitioner’s Perspective’ in Bridge and Stevens (ed), above n 12 at 244. 17 For a sophisticated analysis see Fletcher, above n 11 at 10–14. 18 See Wood, above n 12 at para [13–3].

432 Sandra Frisby 10.13 Closely aligned to the notion of universality is that of ‘unity of bankruptcy’. The central precept of this ideal is that a single insolvency procedure, of universal effect, should govern the debtor’s estate. Thus, one jurisdiction’s law would be applicable to every aspect of the administration of that estate, including a determination of whether pre-bankruptcy cross-border transactions were challengeable by the controlling practitioner. Unity’s antithesis, plurality, would admit of two or more insolvency procedures taking place simultaneously in different jurisdictions, and its affiliation with territoriality is apparent. The Advantages of Universality/Unity 10.14 Those espousing the universality approach to international insolvency cite efficiency and economy as its major benefits.19 By entrusting the liquidation procedure to a single overseer whose actions are accepted worldwide, and by affording similar recognition to the judgments and orders of a single forum, costs are dramatically reduced and delay minimised. Universality is said to reflect the commercial reality of global operations20 and to promote a laudable spirit of co-operation and altruism.21 10.15 Territoriality, by contrast, is likely to prove a more expensive, more protracted and less systematic method of dealing with the estate: Because a territorial proceeding is limited to property located within the jurisdiction, the theory requires the commencement of concurrent bankruptcy proceedings wherever a company’s property is located.22

10.16 Moreover, territoriality may be contrary to fairness in that it proceeds upon the basis that local creditors are exclusively entitled to local assets. The location of corporate assets, however, may be purely a question of chance: as global trade has increased, so too have the amenities for shifting property swiftly and inexpensively,23 and a system which allocates particular assets to particular creditors simply because they both happen to be in the same place at the relevant time could justifiably be dubbed arbitrary.24 Finally, it could be argued that on a global level territoriality is clearly contrary to the principle of collectivity of bankruptcy, a dogma almost unanimously acknowledged as creditable, and one which features in most domestic insolvency law systems.25 10.17 It should, however, be noted that unity of bankruptcy is not indispensable to universality. Universality proponents admit of the possibility of plural19

Grierson, above n 2 at 579. Westbrook, ‘Choice of Avoidance Law in Global Insolvencies’ [1991] Brooklyn Journal of International Law 499 at 503. 21 At 515. 22 Grierson, above n 2 at 579. 23 Consider, for example, intangibles. For the difficulties associated with the location of company shares, see Macmillan Inc v Bishopsgate Investment Trust Plc (No 3) [1996] 1 WLR 387. 24 It is also open to abuse. 25 See Fletcher, above n 11 at 9. 20

Cross-Border Insolvency and Vulnerable Transactions 433 ity of insolvency proceedings, but based on a system of mutual co-operation. The ideal as currently informed would envisage a primary procedure to which other local procedures are subsidiary, the critical aim being to co-ordinate the realisation process so as to maximise value. As Fletcher puts it: The model which has become increasingly favoured in recent times is one which utilises the concept of ‘primary’ and ‘secondary’ bankruptcy administrations which are linked by means of complementary sets of rules to ensure that a kind of de facto universality of administration is attained.26

10.18 Where universality and plurality part company irreconcilably is at the point that concurrent insolvency proceedings are instigated in two or more jurisdictions, each claiming dominion and none either recognising or deferring to the other(s).27 The inevitable tension consequent upon such a scenario is precisely what universality seeks to avoid. (c) Putting Theory into Practice 10.19 Whilst the ideal of universality appears to offer solutions to the particular predicaments triggered by cross-border insolvency, in practice there are serious challenges to its attainment. Fundamentally, universality can only operate effectively if there is a consensus amongst all interested states and/or legal jurisdictions that its precepts shall be adhered to: a unilateral espousal will be meaningless if other factions refuse to recognise the authority claimed by the courts or officials of the universalist state: . . . it does not follow that, because a given legal system embraces the principles of unity and universality, that proceedings instituted within that jurisdiction will be respected or even recognised in other jurisdictions.28

10.20 Universal accord to the consequences of universality has been acknowledged as, at present, implausible.29 Whilst individual jurisdictions adopt the principle in relation to their own laws and procedures, reciprocity in this regard appears in short supply. Fletcher notes: Thus, whilst it is not uncommon to find national law expressed in terms which declare that the insolvency proceedings of that system shall enjoy universal effect, it is the author’s experience that no State has yet adopted, freely and unilaterally, a policy of according matching effect to insolvency proceedings conducted under the laws of foreign States.30

26

At 14. See also Westbrook, above n 1 at 29. See Millett, above n 3 at 102. Fletcher and Anderson, above n. 14 at 264. 29 See Westbrook, above n 20 at 515; Flaschen and Silverman, ‘The Role of the Examiner as Facilitator and Harmoniser in the Maxwell Communication Corporation International Insolvency’ in Ziegel, above n 2 at 622. 30 Above n 11 at 11–12. 27 28

434 Sandra Frisby 10.21 The practical impediments to universality are diverse, but two stand out as particularly problematic. The first is the essentially pragmatic quandary of identifying the appropriate forum from which universal influence will emanate. The instinctive response in the corporate context would be the place of incorporation, and, as will be seen, a good number of domestic and international legal systems are preoccupied with that notion as a jurisdictional base.31 Attributing universal effect to the law of the place of incorporation has the benefit of certainty,32 but may equally be a capricious choice. Tactical incorporation is becoming increasingly common,33 and whilst a preference for a particular jurisdiction for incorporation would hardly be likely to be based upon that jurisdiction’s insolvency laws,34 it might nevertheless lead to an incongruous insolvency outcome. 10.22 But whilst responses to this particular problem might be formulated,35 a more elementary objection to universality subsists, founded on ideological differences amongst states’ insolvency laws and systems. Quintessentially, there is no ‘one-size-fits-all’ insolvency regime, as states base their systems on often widely differing policy aims and aspirations. In this regard it is worth quoting Sir Peter Millett at length: No branch of the law is moulded more by considerations of national economic policy and commercial philosophy. Attention has already been drawn to the lack of any consensus on whether local assets should be available primarily to local creditors or made universally available in a single pool to creditors worldwide. The disagreement is not due to differences in legal tradition; it is dictated by national economic policy. The different rules concerning the avoidance of preferences are not merely technical differences, but are also due to different perceptions of the nature of the mischief to be redressed. Is the problem the risk that a vigilant creditor who realises that his debtor is insolvent may gain an advantage over less vigilant creditors, or is it that a debtor who realises that he is insolvent may try to save his family and friends from the impending disaster? The Americans and Australians consider the former to be the problem; the English think the latter.36

10.23 Whether variances in national insolvency systems are fundamental or merely technical there can be little doubt that their instigators are as yet unpre31 Jurisdictional bases such as corporate domicile, residence and nationality, whilst of importance to other areas of law (eg taxation) have thus far had little impact in the insolvency arena. See, in general, Dicey and Morris, above n 12 ch 30. 32 Which in turn may produce an overall ‘net gain’ for creditors: see Westbrook, above n 1 at 31–3. 33 The ‘Delaware Syndrome’ (the race to the bottom) is notorious. For an interesting and recent example of this propensity see Case C–212/97 Centros Ltd v Erhvervs-og Selskabsstyrelsen [1999] ECR I–1459 (ECJ). 34 Although the availability of ch 11 protection in the United States might possibly cross the incorporator’s mind. 35 See the following discussion on the EC Regulation on Insolvency Proceedings. 36 Above n 3 at 109. See also Westbrook, above n 20 at 508; Grierson, above n 2 at 583; Wood, above n 12 at para [13–1]; Fletcher, ‘Practicalities of an International Insolvency’ (1996) 17 The Company Lawyer 47, and above n 11 at 3–4.

Cross-Border Insolvency and Vulnerable Transactions 435 pared to relinquish ‘sovereignty’ in this area in the name of universality. In the absence of a supranational harmonisation programme, it would therefore appear that cross-border insolvency issues will have to be confronted by some alternative means. (d) The Way Forward? 10.24 If ‘pure’ universality is not viable, can a ‘rough fit’ be achieved? It is at least arguable that legal developments over the last decade are well on the way to rationalising some of the more awkward features of cross-border insolvency, and that those envisaged for the next decade will smooth the edges even further. The impetus in this regard has its origins in the enlightened and creative approach of the judiciary and practitioners. The exigencies of international insolvency have demanded shrewd and practical handling on the part of both37 and they have between them fostered a spirit of co-operation that addresses, at least in part, some of the difficulties associated with the cross-border dimension. Takeuchi suggests that this approach considerably narrows the gap between theory and practice,38 so that the seeming standoff created by multiple concurrent proceedings never actually materialises. 10.25 The next sections examine the role of English jurisprudence in this regard. They attempt, on the one hand, to illustrate the effect and outcome of an application of English law to a cross-border insolvency whilst, on the other, evaluating the wider implications of the approach of the English courts to the general disorder. What emerges is a system that attempts to accommodate the distinctive commercial pressures of international insolvency within existing rules of private international law, and to do so with due regard to the legitimate interests of those territories with a stake in the outcome.

B . THE WINDING UP JURISDICTION OF THE ENGLISH COURTS

(1) The Contextual Significance of Winding up 10.26 The transactions the subject of this book are, in the main, rendered vulnerable on the occasion of either the winding up of the company in question or its entry into administration.39 By definition, therefore, the statutory bases for challenge are triggered by the making of either order. It is, therefore, critical to 37

See Grierson, above n 2 at 583. ‘Issues in Concurrent Insolvency Jurisdiction’ in Ziegel, above n 2 at 651. 39 A registrable but unregistered charge is potentially invalid against a creditor of the company outside of liquidation or administration; see ch 6 above. Similarly, transactions defrauding creditors are challengeable outside of insolvency under s 424(1)(c) Insolvency Act 1986. Such transactions are outside the scope of this chapter. 38

436 Sandra Frisby know whether the existence of a cross-border dimension in the particular case will have any bearing upon the English courts’ jurisdiction to wind up a company, or place it in administration. (a) Companies registered in England and Wales Winding up 10.27 By section 117 of the Insolvency Act 1986 the High Court and the County Courts are given jurisdiction to make a winding up order against any company registered in England and Wales. The grounds for winding up are contained in section 122, and, once a winding up order is made, the entirety of Part IV of the Insolvency Act40 becomes potentially applicable, as does Part VI of the Act.41 The fundamental point is that all that is required to ground this jurisdiction is the fact of registration in England and Wales, and whether the company in question is active here or not appears irrelevant. In other words: In an extreme case, therefore, a company might be formed and registered in England by persons from abroad, and it might also be the case that all shareholders and directors are foreign nationals resident and domiciled abroad, and that none of the company’s business is done inside this country. Nevertheless, the company would qualify as a ‘domestic’ rather than as a ‘foreign’ company and would be at all times subject to the winding-up jurisdiction of the English courts by virtue of s. 117(1) and (2).42

Declining Jurisdiction? 10.28 An interesting, and as yet unanswered, question concerns whether, in the circumstances described above, an English court would decline jurisdiction to make a winding up order against an insolvent company. The doctrine of forum non conveniens43 has been applied to the case of a solvent winding up so as to effectively decline jurisdiction, notwithstanding that that jurisdiction arose by virtue of Article 2 of what is now the Brussels Regulation,44 and this rather controversial approach has since been affirmed in ACE Insurance SA-NV (formerly Cigna Insurance Co of Europe SA-NV) v Zurich Insurance Co.45 10.29 If discretion to decline jurisdiction exists despite its allocation under the Regulation, then, a fortiori, the forum non conveniens doctrine ought to be applicable to the case of an insolvent winding up, to which that Regulation has no application. Certainly section 147 of the Insolvency Act gives the courts power to stay winding up proceedings, and presumably such power could be 40

Comprising ss 73–219. Comprising ss 230–246, excluding those applicable to Scotland. 42 Fletcher, above n 11 at 125. See also Re Suresnes Racecourse Co Ltd (1890) 90 LT Jo 55; North Australia Territory Co Ltd v Goldsborough, Mort & Co Ltd (1889) 61 LT 716. 43 See, generally, Spiliada Maritime Corporation v Cansulex Ltd [1987] AC 460. 44 Re Harrods (Buenos Aires) Ltd [1992] Ch 72. 45 [2001] EWCA Civ 173, [2001] 1 Lloyd’s Rep 618, although the case was not concerned with winding up jurisdiction. 41

Cross-Border Insolvency and Vulnerable Transactions 437 exercised on the basis that the appropriate forum for the winding up is one abroad.46 It would, therefore, be odd if a court could not decline jurisdiction on the same basis, but there is no authority to support such a contention. 10.30 It is, of course, one thing to state that the forum non conveniens doctrine applies in the abstract, but quite another to convince a court to decline to exercise its undoubted jurisdiction when a petition is presented, and much would depend upon the particular circumstances. It is tentatively submitted that, at the very least, a court would require clear evidence that some form of insolvency procedure had been, or was about to be invoked in a forum plainly more appropriate than England before it would refuse to grant a petition to wind up an English registered company. Administration 10.31 The power of the court to make an administration order in relation to ‘a company’ is found in section 8 of the Insolvency Act 1986. Unlike section 117, section 8 makes no reference to registration in England and Wales, but section 229(2) provides that an unregistered company is not, except in a winding up, deemed to be a company under the Companies Act. Section 220(1) defines ‘unregistered company’ as any association or company except ‘a company registered in any part of the United Kingdom [under the various Companies Acts]’.47 Moreover, by section 735(1)(a) of the Companies Act 1985 the word ‘company’ is defined as ‘a company formed and registered under this Act’. The cumulative effect of these provisions would appear to be that the section 8 power applies only to companies registered under the Companies Act 1985 or similar legislation.48 10.32 The practical significance of this conclusion is that ‘home’ companies can be the subject of an administration order whereas ‘foreign’ companies cannot,49 unless a request for judicial assistance under section 426(4) of the Insolvency Act is made and, semble, specifically invites the English court to appoint an administrator over a ‘foreign’ company.50 As will be seen below, the winding up of a company incorporated outside England and Wales is legally 46 As was the case in Re Harrods (Buenos Aires), where the court identified Argentina as the overwhelmingly appropriate forum for the litigation. 47 S 220(1)(b). 48 For a comprehensive analysis of the position see Smart, above n 12 at 130–35. 49 As seems to have been accepted in Felixstowe Dock and Railway Co v US Lines Inc [1989] QB 360. 50 See Re Dallhold Estates (UK) Pty Ltd [1992] BCLC 621, where the court appointed an administrator over an Australian incorporated company at the request of the Australian court. It was assumed that the English court had no power to make an administration order in the absence of such a request. The question is not entirely free from doubt, however, and support for the opposite conclusion can perhaps be found in Re International Bulk Commodities Ltd [1993] Ch 77, where the court held that a receiver appointed over the assets of a foreign company was an administrative receiver for the purposes of the Insolvency Act. The correctness of that decision has since been doubted in Re Devon and Somerset Farmers Ltd [1994] Ch 57.

438 Sandra Frisby possible, so it follows that it is only in the context of liquidation that potentially vulnerable transactions entered into by such a company can be challenged under English law.51 This position may, however, change. The Enterprise Act 2002 now gives the Secretary of State power to provide for ‘a provision of the Insolvency Act 1986 to apply . . . to a company incorporated outside Great Britain’.52 10.33 There is much to be said for such a modification to the current law, not least that it would facilitate a more progressive approach to the treatment of financially troubled foreign companies than the present winding up route.

(2) The ‘Long Arm’ Jurisdiction of the English Courts54 (a) Part V Insolvency Act 1986 10.34 Given that section 117 of the Insolvency Act 1986 applies exclusively to companies registered in England and Wales, it follows that a company incorporated elsewhere cannot be wound up under that section, notwithstanding that fact that it might carry out extensive business activities here, operate from an English or Welsh base, and have multiple other substantive connections with this jurisdiction. Since the inception of the Companies Acts, however, the legislature has recognised that not all English ‘companies’ are registered, and that separate provision should therefore be made for the winding up of ‘unregistered’ companies.55 The contemporary provisions in this regard are to be found in Part V Insolvency Act 1986, which comprises a mere ten sections. 10.35 The original application of these provisions was no doubt envisaged as relevant to the winding up of various unregistered organisations of English origin but not registered under the Companies Acts, and section 220(1) of the Insolvency Act defines an ‘unregistered company’ as ‘any association and any company’ with the exception of: (b) a company registered in any part of the United Kingdom under the Joint Stock Companies Acts or under the legislation (past or present) relating to companies in Great Britain.

10.36 The passage of time has seen a gradual diminution of domestic unregistered companies, but Part V has proved remarkably flexible and, from a

51 Whether such a challenge would be countenanced by an English court is another question altogether, and is addressed later in the chapter. 52 S 254(1). Any such order must be made by statutory instrument (s 254(3)(c)). 54 This section is in outline only. For a fuller discourse the reader is directed to the specialist works on the subject, and particularly Smart, above n 12 at ch 4 and Fletcher, above n 11 at ch 3. 55 See, for the earliest provision of this nature, Companies Act 1862 s 199.

Cross-Border Insolvency and Vulnerable Transactions 439 relatively early stage, has been perceived by the courts as conferring jurisdiction to wind up ‘foreign’ companies.56 10.37 An unregistered company may be wound up under any of the grounds contained in section 221(5) of the Insolvency Act, these being: (a) if the company is dissolved, or has ceased to carry on business, or is carrying on business only for the purpose of winding up its affairs; (b) if the company is unable to pay its debts; (c) if the court is of opinion that it is just and equitable that the company should be wound up. 10.38 Sections 222–224 define an inability to pay debts in roughly equivalent terms to those found in section 123 of the Insolvency Act. Critically, the provisions of Part V are expressed to be ‘in addition to and not in restriction of’ the ‘domestic’ winding up provisions of Part IV Insolvency Act, and therefore: . . . the court or liquidator may exercise any powers or do any act in the case of unregistered companies which might be exercised or done by it or him in winding up companies formed and registered under the Companies Act.57

(b) The Approach of the Courts to Part V Insolvency Act 1986 10.39 Section 220 of the Insolvency Act does not impose any territorial restrictions on the definition of an unregistered company and might, therefore, be taken to confer the widest possible winding up jurisdiction on the English courts. In practice, however, the courts have consistently exercised restraint in this regard, although their original, rather restrictive approach to the winding up of foreign companies has undergone some relaxation in more recent times. As Evershed MR remarked, in Banque des Marchands de Moscou v Kindersley: As a matter of general principle, our courts would not assume, and Parliament should not be taken to have intended to confer, jurisdiction over matters which naturally and properly lie within the competence of the courts of other countries.58

Morse makes very much the same point more recently: It clearly would not seem to have been the intention of Parliament to give the English courts carte blanche to wind up any foreign company in England irrespective of the existence of a link between the company or its creditors and this jurisdiction. It has therefore been left to the courts to develop jurisdictional criteria in a somewhat

56 Notwithstanding the fact that such entities may have undergone a registration procedure in the state of incorporation: see Re Commercial Bank of India (1868) LR 6 Eq 517; Re Matheson Bros Ltd (1884) 27 Ch D 225. 57 S 229(1) Insolvency Act 1986. 58 [1951] Ch 112, 125–26.

440 Sandra Frisby pragmatic way so as to inject some realism into the apparently limitless jurisdiction conferred by Parliament.59

10.40 These ‘jurisdictional criteria’ have evolved over time into a reasonably coherent framework, according to which the courts will determine whether or not it is appropriate to grant a petition to wind up a foreign company. In their development, much attention has been paid to commercial exigency:60 as the courts have recognised, it will sometimes be very much in the interests of creditors, and not just local creditors, that an English winding up be commenced, most notably where no other form of insolvency proceeding has been invoked, or is contemplated, in the place of incorporation or elsewhere.61 Other circumstances will call for circumspection. (c) Jurisdictional Criteria: an Outline Branch or Business Presence in England 10.41 The fact that a foreign company has established a branch in England has been accepted from the earliest times as grounding winding up jurisdiction in the English courts.62 In Re Lloyd Generale Italiano63 it was intimated that the establishment of a branch or place of business here was a pre-requisite to the exercise of the English courts’ winding up jurisdiction, although other cases took a more moderate view of what constituted a business presence.64 The conduct of business affairs by corporate agents from an English base, such as a hotel, was considered sufficient in Re Tovarishestvo Manufactur LiudvigRabenek65 on the basis that the legislature must have intended to confer winding up jurisdiction on the English courts in such circumstances. The analogy with the notion of individual submission to the jurisdiction in this respect is evident, and this particular jurisdictional base appears non-contentious.66 Presence of Assets Within the Jurisdiction 10.42 In Banque des Marchands de Moscou v Kindersley67, it was held that where a foreign company had been dissolved in its state of incorporation the fact 59 ‘Principles and Pragmatism in English Cross-Border Insolvency Law’ in Rajak (ed), Insolvency Law: Theory and Practice (London, Sweet & Maxwell, 1993) at 202–3. 60 See Morse, ibid. 61 The English windings up of a number of post-revolution Russian banks are a case in point: see Banque des Marchands de Moscou v Kindersley, above n 58; Re Azoff-Don Commercial Bank [1954] Ch 315. 62 Re Commercial Bank of India (1868) LR 6 Eq 517; Re Matheson Bros (1884) 27 Ch D 225. 63 (1885) 29 Ch D 219. 64 It was assumed, without being decided, that a foreign company with an agent or place of business in England could be wound up here in Re Union Bank of Calcutta (1852) 3 De G & SM 253. 65 [1944] Ch 404. 66 For a recent example of jurisdiction being grounded on the carrying on of a foreign company’s business through a London intermediary see Re Mid East Trading Ltd [1997] 3 All ER 481. See also Re a Company (No 003192 of 1991) ex parte Nyckeln Finance [1991] BCLC 539. 67 Above n 58.

Cross-Border Insolvency and Vulnerable Transactions 441 that it had never established a business presence in England68 did not necessarily constitute a bar to the English courts’ jurisdiction to wind it up. However: There must be assets here to administer and persons subject, or at least submitting, to the jurisdiction who are concerned or interested in the proper distribution of the assets, and when these conditions are present the exercise of the jurisdiction remains discretionary.69

10.43 This proposition was extended to encompass those foreign companies that had not been dissolved by their home courts in In Re Compania Merabello San Nicholas SA.70 The company in question was a ‘one-ship’ company incorporated in Panama. It had ceased to carry on business but had not been dissolved in Panama, nor had it established any recognisable business presence in England. Its one valuable asset was a right to claim under an insurance policy issued by a London mutual insurance club. An English winding up order would activate the provisions of the Third Parties (Rights Against Insurers) Act 1930,71 and Megarry J considered that he had jurisdiction to make such an order. In a judgment that is widely regarded as progressive,72 he stated the law as follows: (1) There is no need to establish that the company ever had a place of business here. (2) There is no need to establish that the company ever carried on business here, unless perhaps the petition is based upon the company carrying on or having carried on business. (3) A proper connection with the jurisdiction must be established by sufficient evidence to show (a) that the company has some asset or assets within the jurisdiction, and (b) that there are one or more persons concerned in the proper distribution of the assets over whom the jurisdiction is exercisable. (4) It suffices if the assets of the company within the jurisdiction are of any nature; they need not be ‘commercial’ assets, or assets which indicate that the company formerly carried on business here. (5) The assets need not be assets which will be distributable to creditors by the liquidator in the winding up: it suffices if by the making of the winding up order they will be of benefit to a creditor or creditors in some other way. (6) If it is shown that there is no reasonable possibility of benefit accruing to creditors from making the winding up order, the jurisdiction is excluded.73

10.44 Megarry J’s liberal definition of corporate ‘assets’ in his fourth point has been enthusiastically espoused. In Re Allobrogia Steamship Corporation,74 it was held that a right of action could constitute such an asset, and that the petitioner need only show that such action had a reasonable prospect of success for 68 On the facts Lord Evershed MR was satisfied that there was evidence to show that such business presence had been established. 69 Above n 58, at 126 per Lord Evershed MR. See also Re Azoff-Don Commercial Bank [1954] Ch 315. 70 [1973] Ch 75. 71 And so allow the company’s creditors to recoup the benefit of the policy. 72 See Smart, above n 12 at 99; Fletcher, above n 11 at 136; Morse, above n 59 at 204. 73 [1973] Ch 75 at 91–92. 74 [1978] 3 All ER 423.

442 Sandra Frisby the English court to claim jurisdiction to wind up a foreign company. In Re Eloc Electro-Optieck and Communicatie BV75 Nourse J extended the ‘assets’ test even further.76 The assets in question, he determined, need not ‘belong’ to the company in any sense, but could derive exclusively from another source.77 It is at least arguable that this judgment eschews altogether the notion that there must be assets within the jurisdiction.78 It is equally arguable that the presence or otherwise of assets in the Eloc case was relevant to a separate jurisdictional question, viz. whether the making of a winding up order would be of potential benefit to creditors.79 Given that the company in question had carried on business in England, jurisdiction to wind it up would prima facie exist, but, as Nourse J put it: In a normal case there would be no point in the court’s making a winding up order in respect of a foreign company which had no assets within the jurisdiction, because there would be nothing which could be realised for the benefit of the creditors. That accords with the fundamental principle that the court will not wind up a company if there is no likelihood that any advantage will be achieved by the petitioner.80

10.45 Where, however, the winding up order will of itself potentially ‘produce’ assets which will accrue to the benefit of creditors: . . . it would, in my judgment, be a lamentable state of affairs if the court’s jurisdiction was excluded by the mere technicality that the assets, in respect of which the reasonable possibility of benefit accruing to the petitioners derived, belonged not to the company but to an outside source.81

10.46 This sentiment was recently echoed by Morritt LJ in Stocznia Gdanska SA v Latreefers Inc,82 the learned Lord Justice noting that, given the ease with which assets can be moved from one jurisdiction to another in modern times, to require their presence as a condition of winding up jurisdiction would ‘introduce an arbitrary element’.83 10.47 In conclusion, whilst the presence of assets within the jurisdiction will almost certainly meet the jurisdictional criteria of the courts,84 that presence is 75

[1982] Ch 43. Although it appears that the learned judge accepted that the company in question had carried on business in the jurisdiction which, in itself, would be sufficient to justify the taking of jurisdiction. 77 In this case, the Department of Employment’s ‘Redundancy Fund’. The petitioners’ entitlement to claim from that source would only arise on the making of an English winding up order. 78 This was certainly the interpretation of Peter Gibson J in International Westminster Bank plc v Okeanos Maritime Corp [1988] Ch 210 at 225. 79 As to which see below. 80 [1982] Ch 43 at 47. 81 At 48. 82 [2001] 2 BCLC 116. 83 At para 32. The case is somewhat similar to the Eloc case, in that the fact of a winding up order being made would open the possibility of the recovery of assets for the benefit of creditors, here by virtue of a prospective claim against the company’s directors for wrongful trading under s 214 Insolvency Act 1986. 84 As it will satisfy the requirement that the order be of potential benefit to creditors: see below. 76

Cross-Border Insolvency and Vulnerable Transactions 443 not absolutely necessary for jurisdiction to be taken. Conversely, the fact that the making of a winding up order may potentially generate assets for the benefit of creditors is not of itself adequate to confer jurisdiction if none are present in the first place and no other jurisdictional base exists. This seems clear from the decision of the Court of Appeal in Banco Nacional de Cuba v Cosmos Trading Corp,85 where, on the making of an English winding up order there would, in the view of Scott VC, have been no answer to a claim under section 238 of the Insolvency Act 1986. Nonetheless the court refused to accept that this justified its acceptance of jurisdiction to wind up the company in question. A Contemporary Approach: The ‘Sufficient Connection’ Test 10.48 In International Westminster Bank plc v Okeanos Maritime Corp,86 Peter Gibson J was asked to wind up a Liberian corporation. No assets of that corporation were present in the jurisdiction, although it had substantial business connections with England, its directors being resident here and the company having carried on business here through those directors. A substantial loan agreement, on which the petition was based, was negotiated and executed in London, where the company also had its bank accounts. The learned judge, having reviewed the law, declared: In my judgment, provided a sufficient connection with the jurisdiction is shown, and there is a reasonable possibility of benefit for the creditors from the winding up, the court has jurisdiction to wind up the foreign company.87

10.49 The ‘sufficient connection’ test, as it has come to be known, was satisfied on the facts of the case, not least because it appeared clear that the company in question had carried on business in England through its London shipping agents. Ostensibly, then, jurisdiction existed on that basis, given that the presence of assets within the jurisdiction was considered unnecessary in Re Eloc Electro-Optieck and Communicatie BV.88 The sufficient connection test, although it has been criticised as too uncertain,89 has found favour amongst the judiciary to the extent that it can now be stated as representative of the law. It was applied in Re a Company (No 003192 of 1991) ex parte Nyckeln Finance,90 the relevant connection being the fact that the petitioner’s loans to the company (incorporated in Guernsey) were negotiated and drawn down in London and the company’s managing agent (who was not, however, a director of the company) lived in England and arranged its business activities from an English base.91 The company had no assets in the jurisdiction. 85

[2000] BCC 910. [1988] Ch 210 (sub nom In Re A Company (No 00359 of 1987)). See J Dine ‘Jurisdiction to Wind Up a Foreign Company’ (1988) 9 Company Lawyer 30. 87 [1988] Ch 210 at 226–27. 88 Above n 75. 89 See Smart, above n 12 at 105. 90 [1991] BCLC 539. 91 A Watford hotel. 86

444 Sandra Frisby 10.50 In Re Real Estate Development,92 Knox J noted of the sufficient connection test that where no assets were present in England the court must be persuaded that there was ‘a link of genuine substance between the company and this country’.93 On the facts no such link existed: the connections with England, which included the registering of a French judgment in England under the Foreign Judgments (Reciprocal Enforcement) Act 1933 and the possibility of an avoidance action under section 172 of the Law of Property Act 1925,94 were deemed too tenuous to justify the English court taking jurisdiction to wind up a Kuwaiti company. Similarly, in Re Titan International Inc,95 a petition to wind up a foreign company that had been used as an investment vehicle by another foreign company, only the latter carrying on business in England, failed on the ground that no sufficient connection with the jurisdiction had been established. In the words of Peter Gibson LJ, the architect of that test: The petition against the company makes no allegation of any activity by the company in this country nor as to the presence of any assets within the jurisdiction. The fact of the matter is that the company has done nothing whatever in the jurisdiction. To arrogate to the English court jurisdiction to wind up a foreign company merely because of its association as an investment vehicle outside the jurisdiction with another foreign company that has been active within the jurisdiction would be in my view to make a giant, impermissible and unjustified extension of the jurisdiction of the English court. No authority has been drawn to our attention which supports any such extension of jurisdiction. Accordingly I am not satisfied that a sufficient connection with the jurisdiction has been shown.96

10.51 It appears, therefore, that, notwithstanding the inherent flexibility of the sufficient connection test, the courts remain alive to the advantage of guardedness when it comes to claiming jurisdiction to wind up companies incorporated other than in England and Wales. The test itself has been applied very much in line with earlier, ostensibly more restrictive jurisdictional criteria, so that, in the absence of either corporate assets or a business presence in the jurisdiction, a petitioner will have considerable difficulty in establishing the ‘link of genuine substance’ thus far required by the courts.97

92

[1991] BCLC 210. At 217. 94 Which, according to the learned judge, could not be treated as an ‘asset’ of the company, being prospective in nature. This approach was adopted to the possibility of bringing proceedings under s 238 Insolvency Act 1986 in Banco Nacional de Cuba v Cosmos Trading Corp [2000] BCC 910. Quaere its compatibility with the judgment of Nourse J in Re Eloc Electro-Optieck and Communicatie BV [1983] Ch 43, although, as noted above, jurisdiction in that case would have existed by virtue of the fact that the company carried on business in England. 95 [1998] 1 BCLC 102. 96 At 108–9. See also, to similar effect, the remarks of Scott VC in Banco Nacional de Cuba v Cosmos Trading Corp [2000] BCC 910 at 915. 97 See Smart, above n 12 at 105; Fletcher, above n 11 at 138. 93

Cross-Border Insolvency and Vulnerable Transactions 445 (d) Additional Jurisdictional Requirements Reasonable Possibility of Benefit to Creditors 10.52 As well as requiring a sufficient connection between the foreign company and England, modern courts have emphasised that such winding up must also offer a reasonable possibility of benefit to creditors. This requirement is additional, rather than alternative, to the satisfaction of the sufficient connection test, and was explicitly pronounced by Megarry J in Re Compania Merabello San Nicholas SA.98 It routinely appears in subsequent judgments.99 10.53 If the courts’ jurisdiction to wind up a foreign company is based on the presence of assets within the jurisdiction, then it seems almost certain that this requirement will be satisfied, as the realisation of such assets by an English liquidator will be of benefit to creditors. In such circumstances, the two tests seem almost to collapse into one.100 Where, however, no such assets are present in England, the courts have had regard to whether the liquidation process might nonetheless produce them, for example by way of a fraudulent or wrongful trading action against the company’s directors.101 According to Harman J: In my judgment the test for reasonable possibility of benefit can properly be applied by considering what would be likely to be the position of this creditor if no English order is made and what is likely to be the position of this creditor if an English order is made.102

10.54 On the facts, the learned judge was prepared to accept the opinion of two ‘extremely well-known insolvency practitioners’ that, if the winding up order was made, there were ‘reasonable hopes’ that some form of recovery would inure to the benefit of creditors. Aside from this, one can only hypothesise as to how the reasonable possibility of benefit to creditors test might be met. There appears to be no decided case involving anything less than some form of recovery, although it has been judicially noted that where a winding up petition is based on a public interest ground it must be shown that the public interest would indeed be served by winding up the company in question.103 Jurisdiction Over Persons Interested in the Distribution of the Company’s Assets 10.55 Very little needs to be said on this point, except that the requirement appears clearly from the judgment of Knox J in Re Real Estate Development 98

Above n 70 at 92. See International Westminster Bank plc v Okeanos Maritime Corp [1988] Ch 210 at 226; Re a Company (No 003192 of 1991) ex parte Nycklen Finance [1991] BCLC 539 at 541; Re Real Estate Development Co [1991] BCLC 210 at 217; Re Titan International Inc [1998]1 BCLC 102 at 107. 100 See, to this effect, Morse, above n 59 at 207, 209. 101 Stocznia Gdanska SA v Latreefers Inc [2001] 2 BCLC 116, although such potential proceedings are not to be treated as assets sufficient to ground jurisdiction in the first place: see above n 94. 102 Re a Company (No 003192 of 1991) ex parte Nycklen Finance [1991] BCLC 539 at 541. 103 See Re Titan International Inc [1998]1 BCLC 102 at 107. 99

446 Sandra Frisby Co,104 and was accepted as good law by the Court of Appeal in Re Titan International.105 Smart notes that this test is rather easier to state than to afford substantive content: he concludes that it does not require that the petitioning creditor be English, nor even resident in England but that no more concrete guidance can be gleaned from the cases.106 10.56 In any event, and as Smart cogently points out, it seems almost capricious that jurisdiction should depend upon what may amount to the nationality of the petitioning creditor. He therefore suggests that this requirement should be irrelevant to establishing the English courts’ jurisdiction, but might be of use in deciding whether to exercise that jurisdiction or not.107 There is some force to this view, given that it will always be open to foreign creditors to prove in an English winding up, and that, by the doctrine of hotchpot, acceptance of such proof will be dependent up their bringing into the English winding up any recovery from parallel foreign proceedings.108 The Discretionary Element 10.57 Notwithstanding the clearing of all three jurisdictional hurdles, it seems likely that the exercise of an existing jurisdiction to wind up a foreign company is subject to a discretionary element on the part of the courts. This discretion may well be exercised in accordance with the forum non conveniens doctrine, so that, where there exists a clearly more appropriate forum than England for a winding up to take place, it is open to the courts to decline jurisdiction.109 Lord Millett has expressed this view extra-judicially: The English court will renounce jurisdiction if it considers that the interests of justice and convenience require the liquidation to be conducted solely abroad.110

There is some support for this proposition in the case law. In International Westminster Bank plc v Okeanos Maritime Corp Peter Gibson J stated: It is also appropriate for the court to consider whether any other jurisdiction is more appropriate for the winding up of this admittedly insolvent company.111

Harman J also considered the fact that England was the most appropriate jurisdiction for winding up to take place as relevant in Re a Company (No 003192 of 1991) ex parte Nyckeln Finance,112 and both cases were cited as representative 104

[1991] BCLC 210. [1998]1 BCLC 102. See Smart, above n 12 at 217, and see Re Mid East Trading Ltd [1997] 3 All ER 481, [1998] 1 All ER 577. 107 Above n 12 at 218. 108 Confines of space do not allow for a discussion of the doctrine of hotchpot generally, and the reader is directed to the specialist cross-border insolvency works detailed above at n 12. 109 See Smart, above n 12 at 128–30; Morse, above n 59 at 213. 110 ‘Cross-Border Insolvency: The Judicial Approach’, above n 3 at 103. 111 [1988] Ch 210 at 226. On the facts, no such jurisdiction existed. 112 [1991] BCLC 539 at 541–2. 105 106

Cross-Border Insolvency and Vulnerable Transactions 447 of the law in Re Wallace Smith Group.113 Confirmation that the English courts will decline jurisdiction where a more appropriate forum exists can also be found in the judgment of Millett LJ in New Hampshire Insurance Co Ltd v Rush & Tomkins Group plc,114 the learned Lord Justice noting: It would be something of an impertinence for the English court to take the view that if a trustee in bankruptcy appointed by the Dutch court is not performing his task properly, the proper remedy is for the English court to appoint its own officer to see that he does. If Mr De Ruuk’s conduct gives rise to any cause for concern then it is to the Dutch court that those concerns ought, in my opinion, to be addressed.115

10.58 The application of the forum non conveniens doctrine in this context is, it is submitted, entirely uncontroversial, particularly when one considers that the English courts have invoked the doctrine to decline jurisdiction to wind up an English incorporated corporation.116 Indeed, where what is in question is whether a foreign company should be wound up under English law, it is arguable that the issue of whether England is the appropriate jurisdiction should habitually comprise a feature of the courts’ deliberations. In some cases, it may well be that neither the state of incorporation, nor any other state, represents a clearly more appropriate forum, but where connections with either exist then these should, it is suggested, be given close attention. If insolvency proceedings have been, or are likely to be commenced elsewhere, and if such are capable of administering assets abroad,117 then the forum non conveniens doctrine may well be an appropriate response to an English winding up petition. Long arm jurisdiction should only be taken where the court is satisfied that the petitioner has made out a case for such, and the extraterritorial aspirations of other jurisdictions, and especially those of the state of incorporation, should be given due regard in the winding up context.118

(3) Ancillary Winding Up119 (a) Introduction One knows that where there is a liquidation of one concern the general principle is ascertain what is the domicile of the company in liquidation; let the court of the 113

[1992] BCLC 989. [1998] 2 BCLC 471. 115 At 476. 116 Re Harrods (Buenos Aires) Ltd [1992] Ch 72, and see the discussion at paras 10.28–10.30 above. 117 And, in the opinion of the court, they may not be: see Re a Company (No 003192 of 1991) ex parte Nyckeln Finance [1991] BCLC 539 at 541. 118 Not least because, for the most part, the English courts would expect such deference in relation to an English winding up of a domestic company: see Section C below. 119 For a fuller exposition the reader is directed to the specialist cross-border insolvency works detailed above at n 12. 114

448 Sandra Frisby country of domicile act as the principal court to govern the liquidation; and let the other courts act as ancillary, as far as they can, to the principal liquidation.120

10.59 The above discussion on the long-arm winding up jurisdiction of the English courts makes little mention of the fact that winding up or other insolvency proceedings may be taking place simultaneously, either in the state of incorporation or some other appropriate jurisdiction. In such circumstances, the English courts have long recognised that it may be expedient to designate their own proceedings as ‘ancillary’, or ‘secondary’, to the ‘main’, or ‘primary’, proceedings taking place abroad. This appreciation is by no means confined to the English courts,121 and, indeed, could be said to manifest an admirable global acceptance of the principle of judicial comity, on the one hand, and pragmatism on the other. 10.60 It is, of course, open to the English courts to decline winding up jurisdiction altogether where such is taking place abroad,122 but such a course may be inappropriate where the making of a winding up order on an ‘ancillary’ basis would result in a more structured and efficient realisation of assets and might also save on costs. Patently, where corporate assets are ‘scattered’ it may well be cost-effective to have more than one liquidator conducting the realisation process, but, equally obviously, dominion over that process can only be claimed by a single insolvency official if chaos is not to result.123 As will be seen, developments in the courts’ approach to ancillary winding up have to some extent facilitated the attainment of these savings.124 10.61 The minimising of expenses and disorder is frequently cited as one of the positive aspects of the ancillary winding up scheme. As Grierson puts it: Where more than one country is involved, it is sensible that the court of one country should conduct the principal winding up with the others acting as ancillary. Having two or more full liquidations can result in increased costs and also in confusion. There is difficulty in ascertaining which court or liquidator is capable of granting debtors of the company a discharge and one may even find two or more liquidators taking action to recover the same debt.125

10.62 Similarly in its favour is the fact that it has promoted comity and cooperation amongst national courts, an ambition that has been recognised as

120

Re Commercial Bank of South Australia (1886) 33 Ch D 174 per Vaughan Williams J at 178. See, for example, the remarks of Blair J in Re Olympia and York Developments Ltd (1996) 29 OR (3d) 626 at 633. 122 See the discussion above. See also Homan, above n 16 at 253–56, who advocates a concerted efforts amongst courts (in all concerned jurisdictions) in these circumstances to allocate jurisdiction to a single forum from which the entire insolvency will be administered. 123 See generally Homan, above n 16 at 244. 124 And, according to Fletcher, accomplished ‘a kind of de facto universality of administration’: see above n 26. 125 Above n 2 at 585. See also Smart, above n 12 at 329. 121

Cross-Border Insolvency and Vulnerable Transactions 449 laudable, especially in the context of assisting global commercial enterprise. In the non-insolvency context Millett LJ has remarked: . . . commercial necessity has encouraged national courts to provide assistance to each other without waiting for such co-operation to be sanctioned by international convention . . . It is becoming widely accepted that comity between the courts of different countries requires mutual respect for the territorial integrity of each other’s jurisdiction, but that this should not inhibit a court in one jurisdiction from rendering whatever assistance it properly can to a court in another in respect of assets located or persons resident within the territory of the former.126

10.63 Finally, and perhaps most crucially, the ‘device’ of ancillary winding up, if properly administered, may go some way towards achieving approximate fairness and equality between creditors located in different states: The English liquidator seeks to work in conjunction with the foreign liquidator because the resolution of claims, and the distribution of assets, in a single set of proceedings should promote equality between creditors from different countries, as well as leading to a saving in costs.127

(b) The ‘Mechanics’ of an English Ancillary Winding Up 10.64 Two preliminary points should be made. The first is that there will be no need for any winding up in England if the English courts agree to give full recognition to a liquidator appointed in the state of incorporation128 and that liquidator is in a position to deal with assets and/or creditors located in England.129 As noted above, however, it may be more cost-effective for an ancillary winding up to be conducted here. Secondly, an ancillary winding up in England may come about as a result of a request for assistance from a court of a ‘relevant country or territory’ made under section 426(4) of the Insolvency Act 1986,130 and a positive response to such request may well dictate the terms of any English winding up order. 10.65 In other circumstances, the courts have recognised that they may direct the scope of a winding up that is appropriately ancillary in order to suit the particular facts. This may involve directing the English liquidator as to the disposition of any assets collected, which will often fall to be remitted to the liquidator 126

Crédit Suisse Fides Trust SA v Cuoghi [1998] QB 818 at 827. Smart, above n 12 at 388. 128 Or even elsewhere, although this is less likely. 129 The question of English courts affording recognition to foreign liquidations, and other insolvency procedures, is beyond the scope of this chapter. For a full and detailed exposition of the law the reader is directed to Fletcher, above n 11 at 165–85; Smart, above n 12 at chs 6, 7 and 8; Wood, above n 12 at ch 15. 130 Again, the operation of s. 426 Insolvency Act is beyond the bounds of this chapter. For a full exposition see Fletcher, above n 11 at ch 4; Smart, above n 12 at ch 15; Morse, above n 59 at 220–4; Grierson, above n 2 at 597–606. See also the judgments of the Court of Appeal in Hughes v Hannover Ruckversicherungs-Aktiengesellschaft [1997] 1 BCLC 497 and England v Smith [2001] Ch 419. 127

450 Sandra Frisby in the ‘primary’ state.131 Alternatively an English liquidator could be restrained from attempting to collect assets outside of England.132 Perhaps the most complete statement of the law in this area appears in the judgment of Scott VC in Re BCCI SA (No 10).133 The learned Vice-Chancellor, having reviewed the authorities, noted: This line of authority establishes, in my opinion, at least the following propositions. (1) Where a foreign company is in liquidation in its country of incorporation, a winding up order made in England will normally be regarded as giving rise to a winding up ancillary to that being conducted in the country of incorporation. (2) The winding up in England will be ancillary in the sense that it will not be within the power of the English liquidators to get in and realise all the assets of the company worldwide. They will necessarily have to concentrate on getting in and realising the English assets. (3) Since in order to achieve a pari passu distribution between all the company’s creditors it will be necessary for there to be a pooling of the company’s assets worldwide and for a dividend to be declared out of the assets comprised in that pool, the winding up in England will be ancillary in the sense, also, that it will be the liquidators in the principal liquidation who will be best placed to declare the dividend and to distribute the assets in the pool accordingly.134

Whilst this statement is relatively comprehensive, Fletcher notes that it is drawn from authorities of some antiquity, and that there remain a number of details yet to be fully worked out.135 The jurisprudence in this area is therefore still evolving, and developments can almost certainly be expected as the trend towards globalisation, and with it multi-jurisdictional insolvencies, intensifies. (c) The Utility of Ancillary Winding Up 10.66 There can be little doubt that the development of the concept of an ancillary winding up displays the courts’ sensitivity to the exigencies of international insolvency at its most acute. Insolvency practitioners are similarly to be commended for their efforts in this regard, and recent cases have illustrated their ingenuity and propensity for collaboration in endeavouring to find practical and beneficial solutions to the upheaval engendered by the collapse of a multinational corporation. The BCCI insolvency is a paradigm example of such cooperation, but one which ultimately failed to achieve its aim by virtue of a question of law which is to be addressed in the next section.136 Whether the current inclination towards ever greater levels of mutual assistance amongst courts 131 See Re National Benefit Assurance Co [1927] 3 DLR 289 at 301; Re BCCI SA (No 2) [1992] BCLC 570 at 574; Smart, above n 12 at 375. 132 See Re International Tin Council [1987] Ch 419 at 446–7; Smart, above n 12 at 375. 133 [1997] Ch 213. 134 At 246. 135 ‘Ancillary Proceedings and Set-Off in Cross-Border Insolvency’ (1997) 10 Insolvency International 68 at 69. 136 A point which does not escape Fletcher: see ‘International Insolvency Issues: Recent Cases’ [1997] Journal of Business Law 471 at 475–6.

Cross-Border Insolvency and Vulnerable Transactions 451 will overcome some of the difficulties remains to be seen, but with the explicit recognition of the concept of ancillary (or ‘secondary’) proceedings in the EC Regulation on Insolvency Proceedings137 this is an area that will bear scrutiny in the near future.

C . THE EXTRATERRITORIAL APPLICATION OF ENGLISH INSOLVENCY LAW

(1) Introduction An English winding up is not confined to the company’s English activities and business operations, but is intended to constitute a collective, global administration of its entire undertaking.138

10.67 The transactional avoidance grounds with which this book is concerned are primarily statutory in origin, and, indeed, much of English insolvency law is now codified. This being the case, whenever an English winding up is ordered the English courts apply English law.139 This basic proposition holds true whether the winding up is of a ‘domestic’ company or one incorporated abroad, and, indeed, whether the English winding up is of a primary or ancillary nature. In Re Bank of Credit and Commerce International (No 10),140 Scott VC expressed the view that an English court had no discretionary power to disapply the statutory insolvency scheme,141 notwithstanding that the application of the English set-off rules would effectively undermine an agreement reached by the insolvency practitioners conducting liquidation proceedings in both England and Luxembourg.142 This decision has been heavily criticised as parochial and uncompromising,143 but it nevertheless represents English law for the present.144 10.68 It is, of course, one thing to state that an English statute applies, but quite another to bestow upon it extraterritorial effect. An applicable provision may or may not extend to encompass people, property or transactions abroad, and this is purely a question of statutory construction. This section investigates the approach of the English courts to the question of whether the provisions of the Insolvency Act 1986 on vulnerable transactions can indeed be used to attack transactions with a foreign element. It should be noted that, even where 137

See below. Fletcher, above n 11 at 148. 139 See, eg, Re English, Scottish and Australian Chartered Bank [1893] 3 Ch 385; Re Suidair International Airways Ltd [1951] Ch 165. 140 [1997] Ch 213. 141 At 239. 142 The state of incorporation. That state’s law does not recognise set-off rights in insolvency. 143 See, especially, Fletcher, ‘Ancillary Proceedings and Set-Off in Cross-Border Insolvency’ (1997) 10 Insolvency International 68. 144 See, however, the following section for a likely modification of this position. 138

452 Sandra Frisby extraterritorial effect is acknowledged, there remains the question of whether the judgment of the English courts can be successfully enforced in another jurisdiction. Given that the transaction in question may well have transferred corporate assets out of England, it then falls to a liquidator or administrator to persuade a foreign court to recognise his title to those assets. Whether such is a likely prospect is beyond the scope of this chapter, and will usually depend upon the private international law rules of the country or territory in question, especially those concerning the recognition of foreign insolvency officials and the enforcement of foreign judgments.145

(2) Extraterritoriality: the General Approach (a) Statutory Construction 10.69 The question of whether or not any given statutory provision has extraterritorial effect is a matter of construction. In Clark (Inspector of Taxes) v Oceanic Contractors Inc146 Lord Wilberforce stated as follows: [T]he general principle . . . is simply that, unless the contrary is expressly enacted or so plainly implied that the courts must give effect to it, United Kingdom legislation is applicable only to British subjects or to foreigners who by coming to the United Kingdom, whether for a short or long time, have made themselves subject to British jurisdiction.147

10.70 Smart considers this approach inappropriate in the cross-border insolvency context,148 and there is considerable force to his suggestion that the English courts will, where necessary, displace its central presumption without difficulty. The effect of the statutory provisions here in question are directed to ‘persons’,149 ‘property’150 or transactions,151 although there is a marked overlap in this respect.152 As far as references to ‘property’ are concerned, section 436 of the Insolvency Act defines such as including: . . . money, goods, things in action, land and every description of property wherever situated and also obligations and every description of interest, whether present or future or vested or contingent, arising out of, or incidental to, property . . .153

145 For a useful overview of this question see Wood, above n 12 chs 15 and 16; Cooper and Jarvis, Recognition and Enforcement of Cross-Border Insolvency (Chichester, John Wiley & Sons, 1996). 146 [1983] 2 AC 130 147 At 145. See also Ex parte Blaine; In re Sawers (1879) 12 Ch D 522 at 526 (bankruptcy provisions). 148 Above n 12 at 19. 149 Eg, ss 238 and 239 Insolvency Act 1986. 150 Eg, ss 107 and 127 Insolvency Act 1986. 151 Eg, s 395 Companies Act 1985 and s 245 Insolvency Act 1986. 152 See Smart, above n 12 at 18. 153 Italics added.

Cross-Border Insolvency and Vulnerable Transactions 453 10.71 Here, it would seem, is an express statement of the extraterritorial effect of those provisions concerned with ‘property’. Those whose application is directed to ‘persons’ are rather more ambiguous in their wording, and, therefore, the courts have been called upon to determine whether there is any implicit intention on the part of the legislature that such are to apply to non-British subjects. Provisions relating to company charges fall within both camps. What follows is an attempt to describe the jurisprudence in this area and to tease out an overall approach to the construction question.

(3) Extraterritoriality and Specific Provisions (a) Company Charges There are many questions of cross-border enforcement which affect banks on a dayto-day basis. In particular, there are questions which a bank may have to consider as to the effect in another country of a floating charge which is taken over the property of an English company, and as to the effect of a floating charge which is taken over assets of a foreign company in this country.154

Charges Extending to Property Abroad 10.72 The first question arising is whether a charge granted over the property of an English company extends to ‘foreign’ assets of the company in question. The short answer is that it does, as determined by British South Africa Co v De Beers Consolidated Mines Ltd.155 This remains the case even where the charge in question would not be recognised as effective under the lex situs.156 Lightman & Moss comment: In effect, therefore, in consequence of the charge being governed by English law the English court may enforce it in personam even if it is not a valid and effective charge by the lex situs.157

10.73 The validity of the charge in the place where property is located is not, however, an irrelevant matter. In many cases it will fall to a chargee’s receiver to attempt to enforce it in a foreign jurisdiction, and therefore that jurisdiction’s recognition rules will become a major issue.158 Moreover, it has been held that, where a charge is ineffective under the lex situs, an English court will not

154 Moss, ‘Cross-Border Enforcement of Security: Part 1’ (1997) 16 International Banking and Financial Law 1. 155 [1910] 1 Ch 353. 156 Re Anchor Line (Henderson Bros) Ltd [1937] Ch 483. The charge in question was a floating charge, the property situated in Scotland, which, at that time, did not recognise the validity of the floating charge. 157 The Law of Receivers of Companies, 2nd edn (London, Sweet & Maxwell, 1994) paras 25–28. See also Moss, above n 154 at 2. 158 See, eg, Re C A Kennedy Co Ltd and Stibbe-Monk Ltd (1976) 74 DLR (3d) 87.

454 Sandra Frisby restrain a creditor from seeking to execute against purportedly charged assets in that location.159 Registration Requirements 10.74 Where a charge over the ‘foreign’ property of an English company is created, section 398(3) Companies Act 1985 provides: Where a charge is created in the United Kingdom but comprises property outside the United Kingdom, the instrument creating or purporting to create the charge may be sent for registration under section 395 notwithstanding that further proceedings may be necessary to make the charge valid or effectual according to the law of the country in which the property is situated.

10.75 It is therefore critical that the company (or chargee as the case may be) complies not only with the section 395 registration requirement but also with any equivalent regime under the lex situs if the charge is to be ‘watertight’ in both jurisdictions.160 On a related note, section 409 of the Companies Act 1985 provides: (1) This Chapter extends to charges on property in England and Wales which are created, and to charges on property in England and Wales which is acquired, by a company (whether a company within the meaning of this Act or not) incorporated outside Great Britain which has an established place of business in England and Wales.

10.76 Thus, charges over the property of a ‘foreign’ company are also subject to the section 395 registration requirement, provided that that company has an established place of business in England or Wales. The consequences of failure to register in such circumstances are graphically illustrated by NV Slavenburg’s Bank v Intercontinental Natural Resources Ltd,161 where a Dutch bank’s charge over the English property of a Bermudan incorporated company was held to be void against the Bermudan liquidators by virtue of sections 95 and 106 of the Companies Act 1948.162 10.77 Finally, it appears that the question of whether a contractual agreement amounts to a charge or not will be determined in accordance with English law, at least where the agreement is entered into by an English company with a foreign party. In Re Weldtech Equipment Ltd163 a German company supplied welding equipment to an English company on ‘retention of title’ terms, those terms purporting to extend to the proceeds of sale of the equipment. This agree159 Liverpool Marine Credit Co v Hunter (1867) LR 4 Eq 62; Re Maudslay Sons & Field [1900] 1 Ch 602. 160 See Lightman & Moss, above n 157 at para 25-20; Stevens, ‘The English Conflict of Laws Rules’ in Bridge and Stevens (ed), above n 12 at 220. See also Luckins v Highway (Carnarvon) Pty Ltd (1975) 7 ALR 413. 161 [1980] 1 All ER 955. 162 The predecessors of ss 95 and 409 Companies Act 1985 respectively. For a full discussion of s 409 see paras 6.128–6.136. 163 [1991] BCC 16.

Cross-Border Insolvency and Vulnerable Transactions 455 ment was held to create a charge over book debts which was void for want of non-registration, and this was the case even though the agreement would not have had that effect under German law, which also happened to be the governing law of the contract. According to Hoffmann J: Notwithstanding the fact that the construction and effect of the charge are governed by German law, it seems to me clear that the provisions of s 395 apply to all charges created by companies registered in England whatever may be the proper law of the instrument which creates the charge. This is particularly so when the charge is over book debts owed by English companies which are treated as being situated in England . . . If, therefore, this charge was by way of security, it was registrable under s 395 and as it was not registered it would be void against the liquidator.164

Late Floating Charges 10.78 A consideration of the extraterritorial effect of section 245 of the Insolvency Act 1986 is included in a later section. (b) Transactions at an Undervalue and Preferences: Sections 238 and 239 of the Insolvency Act 1986. General 10.79 Both sections 238 and 239 of the Insolvency Act 1986 render vulnerable any transaction entered into ‘with any person’ that amounts to a transaction at an undervalue or a preference respectively.165 The substantive requirements of these provisions have been discussed earlier.166 In issue here is whether or not they have extraterritorial effect: in other words, if the undervalue transaction is entered into with a foreign entity or individual, or a preference is given to such an entity or individual, do sections 238 and 239 operate against it? 10.80 Neither section states explicitly that this is to be the case. Unlike section 436,167 which defines property as including ‘property wherever situated’, the scope of the sections is not so explicitly delineated. Indeed, a good number of the provisions of the Insolvency Act are equally silent as to their potential for cross-border operation. As Fletcher observes: [M]ost of the relevant [anti-avoidance] provisions of the English legislation are drafted in terms which make no mention of territorial limitation in relation to their intended scope, so that they can be read as applying to all situations, and as against all parties involved, regardless of any ties to other jurisdictions and their laws.168

164 165 166 167 168

At 17. Ss 238(2) and 239(2) Insolvency Act 1986 respectively. In chs 2 and 4. See above, at para 10.70. Above n 11 at 73.

456 Sandra Frisby 10.81 This question might, of course, have been formulated differently, the central focus being on traditional choice of law rules to determine what country’s law applied to the transaction in question and whether that transaction was vulnerable under that law. This has not, however, been the approach of the English courts. To quote Fletcher again: The dominant consideration appears to be that, as a procedure that is entirely the product of statutory provisions in which the requirements of public policy are constantly to the fore, it would be unthinkable to attempt a fusion of legal cultures within the framework of an English liquidation.169

The application of choice of law rules has, then, been largely eschewed in favour of a process of statutory construction along the lines suggested in Oceanic Contractors and Ex parte Blaine.170 This is not to say, however, that choice of law rules do not enter into the question at all: rather, as will be illustrated below, their relevance is indirect. The Paramount Approach 10.82 In Re Paramount Airways Ltd (In Administration),171 the administrators of Paramount chose to attack a payment to a Jersey Bank, made by one of the company’s directors, as a transaction at an undervalue under section 238 of the Insolvency Act. The bank in question had no presence in England. The administrators’ argument was based on the proposition that the words ‘any person’ in the statutory provision were not subject to any territorial limitation. The bank’s argument was exactly to the contrary. The judgment of Nicholls V-C in the Court of Appeal is worth considering, and quoting, at some length, not least because it has been followed in a number of slightly different contexts in other cases. 10.83 His Lordship began by considering that the general principle as to the territorial reach of English legislation as stated in Ex parte Blaine and Oceanic applied to the provision in question. Therefore: From these observations the task before the court on this appeal can be distilled in this form: the court is concerned to inquire as to the persons with respect to whom Parliament is presumed to have been legislating when using the expression, ‘any person,’ and in making that inquiry Parliament is to be taken to have been legislating only for British subjects or foreigners coming to the United Kingdom, unless the contrary is expressed (which it is not here) or is plainly implicit.172

Having considered the wording of sections 238 and 239, along with that of related provisions, the learned judge concluded that:

169 170 171 172

At 153. See above, at n 146, ff. [1993] Ch 223. At 233.

Cross-Border Insolvency and Vulnerable Transactions 457 It will have been seen from the above summary that, on its face, the legislation is of unlimited territorial scope . . . If a transaction satisfies these requirements, the section applies, irrespective of the situation of the property, irrespective of the nationality or residence of the other party, and irrespective of the law which governs the transaction. In this respect the sections purport to be of universal application. The expression “with any person” merely serves to underline this universality. It is, indeed, this generality which gives rise to the problem.173

This was so even though there might be very good reasons for considering that some kind of territorial limitation must have been intended by Parliament: In these circumstances one is predisposed to seek for a limitation which can fairly be read as implicit in the scheme of the legislation. Parliament may have been intending to legislate in such all-embracing terms. Parliament may have intended that the English court could and should bring before it, and make orders against, a person who has no connection whatever with England save that he entered into a transaction, maybe abroad and in respect of foreign property and in the utmost good faith, with a person who is subject to the insolvency jurisdiction of the English court. Indeed, he might be within the sections and subject to orders even though he had not entered into a transaction with the company or debtor at all. Such an intention by Parliament is possible. But self-evidently in some instances such a jurisdiction, or the exercise of such a jurisdiction, would be truly extraordinary.174

10.84 The difficulty, however, was in defining the ambit of the jurisdiction by reference to the supposed intention of Parliament, and no specific limiting factor could be discerned which would not appear capricious. In particular, attributing an intention to restrict the jurisdiction to parties who had some presence in England was considered arbitrary, not least because of the mobility of both individuals and entities in the modern world. Opportunistic relocation and transactional tailoring to avoid such a presence were seen as all too simple manoeuvres which could quite easily strip the provisions of any realistic application.175 Therefore: The case for some limitation is powerful, but there is no single, simple formula which is compelling, save for one expressed in wide and loose terms (e.g., that the person, or the transaction, has a ‘sufficient connection’ with England) that would hardly be distinguishable from the ambit of the sections being unlimited territorially and the court being left to display a judicial restraint in the exercise of the jurisdiction.176

10.85 The outcome of this exercise in construction was thus that section 238 was not subject to any territorial limitation. That, however, was not the end of the matter: Nicholls V-C, clearly uneasy at the prospect of issuing orders against 173 At 235. Quaere whether this conclusion is entirely consonant with the Ex parte Blaine and Oceanic tests? Do the words ‘any person’, without more, plainly imply ‘any person wheresoever in the world’? 174 At 235–6. 175 At 236. 176 At 237.

458 Sandra Frisby parties with little or no connection with England purely on the basis that the section’s other pre-requisites were satisfied, went on to identify two ‘safeguards’ within the statutory scheme. The first lay in the courts’ discretion as to what order to make, and it was noted that the wording of both sections 238 and 239 conferred an almost absolute freedom of choice in this matter: The discretion is wide enough to enable the court, if justice so requires, to make no order against the other party to the transaction or the person to whom the preference was given. In particular, if a foreign element is involved the court will need to be satisfied that, in respect of the relief sought against him, the defendant is sufficiently connected with England for it to be just and proper to make the order against him despite the foreign element.177

10.86 The adoption of a test of ‘sufficient connection’ is, of course, entirely compatible with the approach of the English courts to the ‘long-arm’ winding up jurisdiction described earlier.178 Nicholls V-C was not willing to prescribe definitive guidelines as to what would constitute a sufficient connection for these purposes, and expressly noted that presence in the jurisdiction, whether by residence (of an individual) or the carrying on of business may or may not carry weight, depending upon the circumstances. Overall: . . . in considering whether there is a sufficient connection with this country the court will look at all the circumstances, including the residence and place of business of the defendant, his connection with the insolvent, the nature and purpose of the transaction being impugned, the nature and locality of the property involved, the circumstances in which the defendant became involved in the transaction or received a benefit from it or acquired the property in question, whether the defendant acted in good faith, and whether under any relevant foreign law the defendant acquired an unimpeachable title free from any claims even if the insolvent had been adjudged bankrupt or wound up locally. The importance to be attached to these factors will vary from case to case. By taking into account and weighing these and any other relevant circumstances, the court will ensure that it does not seek to exercise oppressively or unreasonably the very wide jurisdiction conferred by the sections.179

10.87 In considering relevant the fact that the transaction would be unimpeachable under the defendant’s local law, it is at least arguable that the Court of Appeal was implicitly acknowledging that the spirit, if not the comprehensive catalogue, of choice of law rules should play some part in this area of law. Given that many jurisdictions will have enacted avoidance rules of some kind, the fact that these differ in substance180 may make it entirely appropriate that a party subject to a distinct rule under his local law should not bear the consequences of that distinction in English proceedings. The test proposed by Nicholls V-C at 177

At 239–40. See above at paras 10.48–10.51. 179 [1993] Ch 223 at 239–40 (italics added). 180 Consider, for example, the difference in emphasis between the English mens rea preference under s 239 Insolvency Act and the United States de facto preference under s 547 Bankruptcy Code. 178

Cross-Border Insolvency and Vulnerable Transactions 459 least admits of the possibility that a court could, in effect, determine that the impugned transaction is governed by a foreign law and that therefore, given its validity under that law, refuse to make any order against the party in question. 10.88 A further safeguard, based on very much the same ‘test’, is to be found at an even earlier stage in the proceedings. According to rule 12.12 of the Insolvency Rules 1986 governing service outside the jurisdiction: (1) RSC Order 11 (service of process, etc., out of the jurisdiction) does not apply in insolvency proceedings. (2) A bankruptcy petition may, with the leave of the court, be served outside England and Wales in such manner as the court may direct. (3) Where for the purposes of insolvency proceedings any process or order of the court, or other document, is required to be served on a person who is not in England and Wales, the court may order service to be effected within such time, on such person, at such place and in such manner as it thinks fit, and may also require such proof of service as it thinks fit. (4) An application under this Rule shall be supported by an affidavit stating— (a) the grounds on which the application is made, and (b) in what place or country the person to be served is, or probably may be found.

10.89 The court, under rule 12.12(3), is given absolute discretion as to whether service out of the jurisdiction should take place at all. Following In re Tucker (A Bankrupt),181 Nicholls V-C considered that, in determining whether the plaintiff had established a sufficiently strong case to justify leave to effect service out of the jurisdiction, the ‘foreign’ elements of the case should be taken into account, again, it would appear, to verify that the defendant was sufficiently connected with England.182 In combination with the application of a similar test at the full hearing, it would appear that a potentially boundless jurisdiction is, effectively, to be subject to at least some constraints. Review of the Paramount Approach 10.90 What to make of the importation of a ‘sufficient connection’ test into this area of law? In favour of such an approach is its pragmatism: the Court of Appeal in Paramount was admirably alive to the realities of modern day mobility as regards both money and people, as witnessed by Nicholls V-C’s refusal to imply territorial limitations into section 238 based on some vague and eminently malleable notion of ‘presence’. More importantly, however, the Paramount approach represents a workable compromise between addressing the mischief at which sections 238 and 239 are aimed and claiming a wholly excessive jurisdiction over persons and entities not naturally within their range. 10.91 Particularly notable is the courts’ willingness to have regard to equivalent foreign law provisions, and, in appropriate cases, to decline to make any 181 182

[1988] 1 WLR 497 at 502. [1993] Ch 223 at 241.

460 Sandra Frisby order on the basis of that law.183 This is eminently sensible, as the question of enforcing any order in a potentially hostile foreign court must surely be in issue here. Furthermore, due respect for foreign legal rules is promoted as are the (possibly) legitimate expectations of the parties to the transaction. As Valansot puts it: In today’s world of international companies, when money can easily be transferred abroad, the decision will enable liquidators and administrators of companies to retrieve funds paid out of the jurisdiction. The court will be able, by the exercise of its discretion, to ensure that orders are not made against foreign companies in circumstances which offend the rules of international comity.184

10.92 Finally, the test is in harmony with that seen in relation to the courts’ long-arm jurisdiction to wind up foreign companies, and, as such, represents a further stage in the development of a set of principled rules designed to address the particular exigencies of cross-border insolvency. It is almost inevitable that a similar approach would be taken in relation to section 239 of the Insolvency Act.185 The next section considers developments after Paramount and investigates how advanced the process of development has become. Other provisions relating to ‘persons’ Whilst not strictly speaking the subject of this book, it is worth noting that a number of authorities have considered the territorial reach of other provisions of the Insolvency Act directed at ‘persons’. A brief overview of these cases suggests that the English courts are well on the way to achieving substantial lucidity in their treatment of cases involving a foreign dimension. At the outset the point should be made that the provisions in issue all confer upon the court a discretion as to what order to make in the event of a case being made out under them. This was critical to the ultimate decision in Paramount, and distinguishes this area from those mandatory rules of insolvency law, where it has been authoritatively held that English law applies with complete extraterritorial effect notwithstanding the presence of a foreign element.186 10.93 In Re Seagull Manufacturing Co Ltd (In Liquidation),187 Peter Gibson J, in the Court of Appeal, considered the extraterritorial scope of section 133 Insolvency Act 1986, which deals with the public examination of officers and directors of insolvent companies. In concluding that the section applied without territorial limitation, he made explicit reference to the policy of the section and the clear intention of Parliament that corporate officers, having assumed responsibility for their company’s affairs, should be held to account in a public setting: 183 Smart suggests a further role for the doctrine of forum non conveniens in this context: see above n 12 at 26. 184 (1992) 10 International Banking and Financial Law 171 at 172. 185 See Lightman & Moss, above n 157 at para 25–04. 186 See the discussion on Re BCCI (No 10), above at para 10.67. 187 [1993] Ch 345.

Cross-Border Insolvency and Vulnerable Transactions 461 Parliament could not have intended that a person who had that responsibility could escape liability to investigation simply by not being within the jurisdiction. Indeed, if the section were to be construed as leaving out of its grasp anyone not within the jurisdiction, deliberate evasion by removing oneself out of the jurisdiction would suffice. That seems to me to be a wholly improbable intention to attribute to Parliament. Further, section 133 must be construed in the light of circumstances existing in the mid-1980s when the legislation was enacted. By use of the telephone, telex and fax machines English companies can be managed perfectly well by persons who need not set foot within the jurisdiction. There is no requirement that an officer of an English company must live in England, nor of course need an officer of an overseas company which may be wound up by the court. Such a company is very likely to have officers not within the jurisdiction.188

10.94 No limitations based on the officer’s connection to the jurisdiction were mentioned, and this is not surprising. The focus of section 133 is entirely different from that of section 238. The former is aimed at ‘any person’ who has voluntarily taken part in the management of a company, and it is their conduct which is at issue. The latter, on the other hand, is primarily concerned with the conduct of the insolvent company, and the ‘persons’ mentioned in the section are brought into its remit simply in order to give recourse to an effective remedy.189 10.95 The Seagull litigation progressed into disqualification proceedings190 against the director in question in Re Seagull Manufacturing Co Ltd (In Liquidation) (No 2).191 Both Paramount and Seagull (No 1) were referred to, and Mary Arden QC concluded that, in an appropriate case, the court had discretion to refuse leave to effect service out of the jurisdiction and should exercise that discretion along the lines suggested in Paramount.192 Section 6 of the Company Directors Disqualification Act 1986 was not, however, limited territorially, there being an adequate safeguard against excessive jurisdictional claims in the fact that only the Official Receiver or Secretary of State could make an application for disqualification.193 10.96 It has been held that foreign directors of foreign companies can be the subject of ‘wrongful trading’ proceedings under section 214 Insolvency Act 1986. In Re Howard Holdings Inc,194 Chadwick J again placed emphasis on the court’s discretion to refuse leave to serve a writ out of the jurisdiction, and, 188

At 354–5. See also Hirst LJ at 360. This is not to say that the other transacting party may not be complicit in the company’s misbehaviour! 190 Under s 6 Company Directors Disqualification Act 1986. 191 [1994] Ch 91. It is worth noting that in both Seagull (No 1) and (No 2) the director in question was a British citizen, so that, strictly speaking, no issue of exorbitant jurisdiction arose. 192 At 105. 193 At 105. See also Nolan, ‘Disqualifying Directors’ (1994) 15 Company Lawyer 278; Quest, ‘Company Law: Disqualification of Directors’ (1994) 9 Journal of International Banking Law N108. 194 [1998] BCC 549. The case involved directors of a Panamanian company who were resident in Monaco. 189

462 Sandra Frisby further, noted that the court’s remedial discretion could be exercised with due regard to the possibility that, under the law of the state of incorporation, no obligation to avoid loss to creditors exists.195 Further, in Re Mid East Trading Ltd,196 the Court of Appeal took the view that an order could be made for the production of foreign documents under section 236 of the Insolvency Act provided that a proper case for their production was made out. 10.97 A final case, albeit from a rather different perspective, should perhaps be mentioned here, as it represents a fascinating subtext to this discussion. In Barclays Bank plc v Homan,197 the plaintiff bank was seeking an anti-suit injunction against the administrators of Maxwell Communications Corporation198 (MCC) in order to prevent them commencing proceedings in the US Bankruptcy courts under section 547 of the Bankruptcy Code. The bank was clearly concerned that, whilst it could resist a preference claim under section 239 Insolvency Act, the de facto preference approach of section 547 would prove less favourable to it. MCC was at that time under contemporaneous chapter 11 proceedings in New York, and the administrators had been granted the status of ‘corporate governance’ of the company in those proceedings.199 Both Hoffmann J and the Court of Appeal refused to restrain the administrators from proceeding in New York, on the grounds that it was for the New York bankruptcy court to decide whether it was an appropriate forum for litigation. 10.98 What is particularly interesting about this litigation is the subsequent approach of the New York bankruptcy courts. Notwithstanding that the chapter 11 proceedings gave that court clear jurisdiction to hear the section 547 application, it refused to do so on the grounds that England was clearly the more appropriate forum. Circuit Judge Cardamone remarked: England has a much closer connection to these disputes than does the United States. The debtor and most of its creditors—not only the beneficiaries of the pre-petition transfers—are British. Maxwell was incorporated under the laws of England, largely controlled by British nationals, governed by a British board of directors, and managed in London by British executives. These connecting factors indicated what the bankruptcy judge called the ‘Englishness’ of the debtor, which was one reason for recognising the administrators—who are officers of the High Court—as Maxwell’s corporate governance. These same factors, particularly the fact that most of

195

A possibility the learned judge appeared to consider remote: at 555. [1998] 1 All ER 577. [1993] BCLC 680. 198 No consideration of cross-border insolvency could pass without a mention of the Maxwell litigation. 199 There is a prodigious amount of academic literature on the approach taken by the courts of the United Kingdom and United States to the Maxwell insolvency: see, eg, (1993) 6 Insolvency International 10; (1992) 11 International Banking and Financial Law 75; (1992) 7 Journal of International Banking Law N209; [1997] International Commercial Litigation 33; (1992) 8 Insolvency Law and Practice 73. Commentaries on the issues are also included in the major works on cross-border insolvency listed above at n 12. 196 197

Cross-Border Insolvency and Vulnerable Transactions 463 Maxwell’s debt was incurred in England, show that England has the strongest connection to the present litigation.200

10.99 The case is not, of course, directly concerned with the extraterritorial application of a particular jurisdiction’s insolvency law, but it is a clear indication that, in the United States at least, considerations of comity and, one might add, commercial common sense might cause a court to have regard to a version of the forum non conveniens doctrine in determining whether its domestic law is of appropriate application. Whether an English court would be inclined towards the same approach remains to be seen, but the fact that both Hoffmann J and the Court of Appeal in Homan were prepared to leave the matter in the hands of the New York bankruptcy court is perhaps significant. (c) Provisions Concerning ‘Transactions’ General 10.100 Whilst it is possible to discern a certain consistency in approach towards those provisions of the Insolvency Act directed at ‘persons’, no similar unitary line has been followed in relation to provisions which deal with ‘transactions’. Those which have been the subject of overt judicial consideration have tended to be construed as strictly territorial in application, although there are signs that, where no binding authority exists in relation to a particular provision, the courts may be prepared to consider its underlying purpose and attempt to give effect to that purpose, notwithstanding the presence of an international element.201 The staying of proceedings and void dispositions on winding up 10.101 Section 130(2) of the Insolvency Act 1986 reads as follows: When a winding-up order has been made or a provisional liquidator has been appointed, no action or proceeding shall be proceeded with or commenced against the company or its property, except by leave of the court and subject to such terms as the court may impose.

10.102 In Re Vocalion (Foreign) Ltd,202 it was held that the predecessor of this section203 was of territorial application only, and could not extend to actions or proceedings commenced abroad.204 This appears to be the case notwithstanding the reference in the section to the company’s ‘property’ and the wide definition given to ‘property’ in section 436 of the Insolvency Act 1986.205 The court in Vocalion went on to neutralise at least in part the detrimental effects of 200 201 202 203 204 205

Re Maxwell Communication Corp plc 93 F3d 1036; 1996 US App; 29 Bankr Ct Dec 788. See below in relation to s 423 Insolvency Act 1986. [1932] Ch 196. See also Re Commercial Bank of South Australia (1886) 33 Ch D 174. Section 177 Companies Act 1929. See also Hughes v Hannover Ruckvervesicherungs-Aktiengesellschaft [1997] 1 BCLC 497. See above, at para 10.70.

464 Sandra Frisby this conclusion by pointing out that, where a creditor attempting to bring proceedings abroad was subject to the jurisdiction of the English courts that creditor could be restrained from commencing or continuing those proceedings by virtue of the in personam equitable jurisdiction of the court.206 A similar approach was taken to the question of whether a receiver could enforce his appointor’s priority over property situated abroad as against a creditor of the company who had levied execution against that property in Re Maudslay, Sons & Field:207 the execution was valid under local law, and therefore could not be upset by the English courts. Moreover, in the converse situation of a foreign liquidator recognised in England, such liquidator must respect the pre-existing rights of creditors to English assets, even where those rights would be avoided under the law of the place of incorporation.208 10.103 This raises the question of whether sections 127 and 128, which render void dispositions of the company’s property and ‘any attachment, sequestration, distress or execution put in force against the estate or effects of the company’ respectively, are equally territorial in effect. Re Vocalion, which concerned execution, would suggest that section 128 does not apply extraterritorially. However, in Re Buckingham International plc209 Millett LJ remarked: Where the assets are overseas and subject to an uncompleted process of execution, they are nevertheless subject to the statutory scheme. Once the execution is complete, however, and the assets have been successfully seized by the execution creditor, then they cease to be subject to the statutory scheme and the liquidator’s ability to collect them for the benefit of creditors is defeated.210

10.104 This was because section 183 of the Insolvency Act 1986 was of strictly territorial application. This dictum might, however, suggest that sections 127 and 128 are not so constrained, and could therefore operate extraterritorially so as to uphold the integrity of the statutory ‘trust’. In principle, there would seem to be a good argument for suggesting, in relation to section 127, that this is correct, as that section refers to dispositions of the company’s property, and ‘property’ is defined in section 436 as property wherever situated.211 Section 128 makes no mention of ‘property’, referring instead to the ‘estate or effects’ of the 206 [1932] Ch 196 at 204. It should be noted that the winding up in question was of a foreign corporation, and so ancillary in nature. Whether anything turned on this is unclear, but no more recent court has suggested that a different approach to the territorial reach of s 130(2) would apply in the case of the winding up of an English incorporated company. 207 [1900] 1 Ch 602. 208 Galbraith v Grimshaw [1910] AC 508. 209 [1997] 1 BCC 907. 210 At 912. 211 See, to this effect, Stevens, ‘The English Conflict of Laws Rules’ in Bridge and Stevens, above n 12 at 222. See also Smart, above n 12 at 18. Section 130(2), however, refers to actions or proceedings against the company or its property and, as noted above, this section has been held to be of purely territorial application.

Cross-Border Insolvency and Vulnerable Transactions 465 company, but it would appear capricious in the extreme that the two sections should diverge in the compass of their application. 10.105 In the absence of express authority, therefore, it remains open to question whether sections 127 and 128 apply extraterritorially or not. In practice, this may be of little moment, especially as the court’s in personam jurisdiction may be invoked to restrain creditors subject to the jurisdiction from commencing or continuing proceedings abroad. Moreover, those creditors not so subject who wish to participate further in the English winding up will be required, according to the hotchpot doctrine, to bring the fruits of their actions into the general pool for the benefit of all creditors.212 However, to the extent that this matter remains unresolved, it leaves this entire area of law somewhat ragged at the edges. Transactions defrauding creditors Section 423 Insolvency Act 1986 deals with transactions entered into at an undervalue. The court must be satisfied that the transaction was entered into by a person for the purpose: 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 interest of such a person in relation to the claim which he is making or may make.213

Subsection (2) gives the court power to make such order as it thinks fit for restoring the status quo or protecting the victim of the transaction. 10.106 This section is not confined to situations where the person, or, indeed, the company is insolvent or undergoing bankruptcy or insolvency proceedings.214 For present purposes, however, its interest lies in the approach to its scope taken in Jyske Bank (Gibraltar) Ltd v Spjeldnes.215 Evans-Lombe J considered that section 423 was extraterritorial in scope and, further, that the fact that the order sought would be made against a person or entity without substantial connections to the jurisdiction need not necessarily trouble the court. On the Paramount decision the learned judge had this to say: I do not read the passage in Sir Donald Nicholls VC’s judgment as laying down that a court should never grant an order under s. 423(2) in the exercise of its discretion in the absence of any of the sort of connections with England which the Vice-Chancellor set out . . .216 212

See above, at para 10.56. S 423(3). 214 S 424(4). 215 [2000] BCC 16. See Dawson, ‘The Jurisdictional Limit of the Court’ (2000) 21 Company Lawyer 132; ‘An Extraterritorial Dichotomy’ (2000) 2 Insolvency Lawyer 81. See also MaclaughlinPickford, ‘Insolvency: Avoidance of Transactions’ (1999) 14 Journal of International Banking Law N53. 216 At 34. 213

466 Sandra Frisby 10.107 No such connections existed on the facts of the case, but Evans-Lombe J proceeded to make an order against an ‘unconnected’ Irish company under section 425 of the Insolvency Act. He did so on the basis that provisions similar to sections 423 and 425 could be invoked in Ireland, and that in making an English order he was therefore avoiding the necessity of ‘duplicate’ proceedings having to be commenced there, and the consequent expense that such would entail.217 Whilst this might appear to be a pragmatic approach, it arguably raises doubts as to the comprehensiveness of the application of the ‘sufficient connection’ test laid down in Re Paramount.218 In the absence of further authority, it is submitted that Jyske Bank should be confined very much to its especial facts, most notably the learned judge’s desire to avoid expensive duplicate litigation. The Paramount approach strives to strike a balance between ensuring that the mischief at which the undervalue and preference provisions of the Insolvency Act are aimed is suitably redressed and the exercise of a wholly exorbitant jurisdiction. The safeguards afforded by that approach should not be lightly discarded. Late floating charges 10.108 No case has explicitly considered whether section 245 of the Insolvency Act 1986 is of extraterritorial application. A number of arguments could be made supporting such a construction. As noted earlier, section 409 of the Companies Act 1985 extends the requirement for registration of company charges to those in favour of chargees incorporated outside of England and Wales when the property charged is present within the jurisdiction. Moreover, it is equally clear that a charge taken over a company’s property extends to property abroad.219 Further, in Re Weldtech it was held that English law applied to determine whether a contractual arrangement amounted to a registrable charge. One might maintain, therefore, that the general scheme of English law is that domestic law will determine all incidents of the validity or otherwise of charges, notwithstanding that they are granted in favour of a foreign chargee or that they encompass property situated abroad. Finally, section 245 refers to a charge on the company’s ‘property’, and so should be construed in accordance with the section 436 definition of property. 10.109 On the other hand, it might be argued that section 409 is entirely neutral as to the extraterritoriality of section 245 of the Insolvency Act, the former relating exclusively to ‘this Chapter’ and so having no bearing on the latter. Likewise, cases concerning the registration of charges, such as Re Weldtech, may have no relevance to other questions of their validity. Furthermore, the mere inclusion of the word ‘property’ in section 245 may not be determinative, as evidenced by the uncertainty concerning the extraterritorial application of 217 The learned judge also pointed out that he had heard the main action, and so had the benefit of being fully aware of the facts of the case, a luxury which would be unavailable to his prospective Irish counterpart. 218 See Dawson, above n 215 at 133; Maclaughlin-Pickford, above n 215 at N54. 219 See above, para 10.74.

Cross-Border Insolvency and Vulnerable Transactions 467 section 127 Insolvency Act (both sections 127 and 245 having ‘transactions’ as their focus). 10.110 In the light of this ambiguity, it is tentatively submitted that a court confronted with the question of whether section 245 is of extraterritorial application might well be inclined to follow the Paramount approach to transactions at an undervalue and preferences. Section 245 is contained within the same Part of the Insolvency Act, and falls under the same heading, as sections 238 and 239. Although it does not speak of ‘any person’, nevertheless it is aimed at a similar mischief as those sections. Essentially, the sufficient connection test would appear to be eminently suitable to determine whether, on any given set of facts, section 245 should operate on a cross-border basis. It remains to be seen whether an English court would share this view.

(4) Conclusion 10.111 The above survey suggests that as yet no single, coherent approach to the scope of the statutory scheme contained in the Insolvency Act 1986 has been devised by the courts. In fairness, this is unsurprising: in some cases the matter simply has not arisen for decision, in others the provisions in question are less than transparent as regards Parliamentary intention. The courts have, therefore, had to take a pragmatic and often extemporised view of the issues arising. In doing so they have often demonstrated considerable sense and sensitivity to the especial difficulties associated with cross-border insolvency, a notable illustration being the approach of the Court of Appeal in Re Paramount. In seeking to weigh the desirability of applying ‘clawback’ provisions against foreign parties and giving due regard to the propriety of such application, the Paramount approach displays a finely tuned sense of proportion. 10.112 It might, therefore, be advantageous if such an approach were adopted in relation to the entire question of the extraterritorial application of English law in this context, but binding authority stands in the way of any such development. It is not, of course, beyond the powers of Parliament to intervene so as to allow the courts discretion as to whether any given provision should apply on a global basis. It may, however, be unnecessary and, in any event, too late to do so, at least in the European arena, as the next section describes.

D . THE EC REGULATION ON INSOLVENCY PROCEEDINGS

(1) Introduction 10.113 After over thirty years of striving towards a Europe-wide approach to the matter of insolvency, the Europe Council of Ministers have finally seen the

468 Sandra Frisby fruits of their labours in the form of a Regulation on Insolvency Proceedings.220 The Regulation comes into force on 31 May 2002,221 and, as a Regulation, will be directly applicable in all but one of the Member States,222 but only to insolvencies occurring after that date.223 The following attempts to describe in brief the main features of the Regulation224 and to assess how they will modify English law. (a) Scope of the Regulation 10.114 By Art 1(1) of the Regulation, it applies to ‘collective insolvency proceedings which entail the partial or total divestment of a debtor and the appointment of a liquidator’. Insolvency proceedings relating to insurance undertakings, credit institutions, certain investment undertakings and collective investment undertakings are excluded from the Regulation’s scope.225 To an English eye, Article 1(1) would appear prima facie narrow in scope, but Article 2 amplifies upon the definitions of ‘insolvency proceedings’ and ‘liquidator’, and Annexes A and C respectively list which procedures and insolvency officials are included in each. Thus, in the United Kingdom, a court-ordered winding up, a creditors’ voluntary winding up, an administration, a creditors’ voluntary arrangement and bankruptcy or sequestration are all ‘insolvency proceedings’ for the purposes of Article 1(1).226 Similarly, the term ‘liquidator’ includes a liquidator, the supervisor of a voluntary arrangement, an administrator, the Official Receiver, a trustee in bankruptcy and a judicial factor.227 Administrative receivership is a notable absence from the scope of the Regulation.

(2) Allocation of Jurisdiction Under the Regulation (a) ‘Main Proceedings’ General 10.115 The Regulation distinguishes between ‘main’ and ‘secondary’ proceedings, and permits of the opening of both in relation to any given debtor: 220 EC No 1346/2000 (OJ L160/1), hereinafter ‘the Regulation’. See, in general, Fletcher, ‘A New Age of International Insolvency—the Countdown has Begun’ (2000) 13 Insolvency Intelligence 57; Omar, ‘The Wider European Framework for Insolvency’ (2001) 17 Insolvency Law and Practice 135; Omar, ‘New Initiatives on Cross-Border Insolvency in Europe’ (2000) 5 Insolvency Lawyer 211; Gaines, ‘Applying the May 2002 European Regulation on Insolvency Proceedings’ (2001) 6 Insolvency Lawyer 201. 221 Art 47. 222 Denmark has negotiated to be excluded from the operation of the Regulation: see preamble, para 33. 223 Art 43. 224 Confines of space do not allow for anything more than a very basic description of the Regulation. 225 Art 1(2). 226 Annex A. 227 Annex C.

Cross-Border Insolvency and Vulnerable Transactions 469 This Regulation enables the main insolvency proceedings to be opened in the Member State where the debtor has the centre of his main interests. These proceedings have universal scope and aim at encompassing all the debtor’s assets. To protect the diversity of interests, this Regulation permits secondary proceedings to be opened to run in parallel with the main proceedings. Secondary proceedings may be opened in the Member State where the debtor has an establishment. The effects of secondary proceedings are limited to the assets located in that State. Mandatory rules of coordination with the main proceedings satisfy the need for unity in the Community.228

Debtor’s ‘Centre of Main Interests’ 10.116 The central jurisdictional rule, around which the rest of the Regulation’s provisions revolve, is that jurisdiction for Main Proceedings is allocated to the State in which the debtor’s ‘Centre of Main Interests’ (CMI) is located.229 There is a rebuttable presumption that the CMI of a legal person230 is the place of its registered office231 although paragraph 13 of the preamble to the Regulation provides that: The ‘centre of main interests’ should correspond to the place where the debtor conducts the administration of his interests on a regular basis and is therefore ascertainable by third parties.

10.117 Given the magnitude of the concept of a CMI, it is perhaps surprising that the Regulation is less than precise as to the method of its location. The registered office presumption is clearly rebuttable, and seemingly by reference to the paragraph 13 criteria, but no further guidance is offered. This is unfortunate,232 as it may give rise to opportunistic jurisdictional challenges in any case where there is room for argument as to the true location of the debtor’s CMI.233 Where, however, the courts of two or more Member States claim jurisdiction on the basis that the debtor’s CMI is located within their territory, paragraph 22 to the Preamble enacts a ‘first-in-time’ rule, by which recognition should be accorded to the decision of the first court to open main proceedings. Once opened, main proceedings have universal effect amongst Member States by virtue of Article 4(1). (b) ‘Secondary Proceedings’ 10.118 Secondary proceedings may only be opened in a Member State in which the debtor has an ‘establishment’.234 Establishment is defined as: 228

Preamble, para 12. Art 3(1). 230 As opposed to a natural person. 231 Art 3(1). 232 See Fletcher, above n 220 at 59; Gaines, above n 220 at 202. 233 If, indeed, such is objectively ascertainable. Homan gives the example of Maxwell Communications Corporation, and points out that, in reality, its CMI could vary according to the location of Robert Maxwell’s yacht: above n 16 at 249. 234 See para 12 to the Preamble, above. 229

470 Sandra Frisby . . . any place of operations where the debtor carries out a non-transitory economic activity with human means and goods.235

10.119 Secondary proceedings must be ‘winding-up proceedings’,236 and may only be opened before the main proceedings are opened in the circumstances described in Art 3(4).237 Secondary proceedings are territorial in nature, their effects being restricted to assets situated within the ‘secondary jurisdiction’,238 and the liquidator in the main proceedings may request the opening of secondary proceedings.239 Liquidators in both main and secondary proceedings are, by Article 31, bound to provide information to each other and to co-operate with each other, and the secondary liquidator is obliged to give the main liquidator an early opportunity to submit proposals on the conduct of the liquidation or the use of the assets.240 The main liquidator may request the court which opened secondary proceedings to stay those proceedings in whole or part, and the court in question may require assurances that the interests of creditors in the secondary liquidation are protected.241 Interestingly, Article 20(2) enacts a version of the doctrine of hotchpot: In order to ensure equal treatment of creditors a creditor who has, in the course of insolvency proceedings, obtained a dividend on his claim shall share in distributions made in other proceedings only where creditors of the same ranking or category have, in those other proceedings, obtained an equivalent dividend.

(3) Applicable Law Under the Regulation (a) General Save as otherwise provided in this Regulation, the law applicable to insolvency proceedings and their effects shall be that of the Member State within the territory of which such proceedings are opened, hereafter referred to as the ‘State of the opening of proceedings’.242

10.120 Art 4(2) goes on to state that the law of the place in which proceedings are opened shall determine such matters as, inter alia, the definition of the estate’s assets, the respective powers of the debtor and liquidator, the effects of 235

Art 2(h). Art 3(3). Art 2(c) defines ‘winding-up’ proceedings as those involving realising the assets of the debtor and are listed at Annex B. 237 Essentially, where main proceedings cannot be opened in the state of the debtor’s CMI because of that state’s domestic law, or at the request of a creditor domiciled or habitually resident in the state in which secondary proceedings are to be opened, that creditor’s claim arising from the operation of the establishment in question. 238 Arts 3(2), 27(1). 239 Art 29(a). 240 Art 31(3). 241 Art 33(1). 242 Art 4(1). It is clear that this means substantive domestic law. 236

Cross-Border Insolvency and Vulnerable Transactions 471 the proceedings on the debtor’s contracts and individual proceedings brought by creditors, the treatment of claims and the manner in which the proceedings are brought to a close. One particular item worthy of mention to be determined by the law of the place of opening of proceedings is . . . the rules relating to the voidness, voidability or unenforceability of legal acts detrimental to all the creditors.243 Secondary proceedings are governed by the law of the place in which they are opened, unless the Regulation provides otherwise.244 (b) Derogations 10.121 Article 5(1) provides that the rights in rem of creditors and third parties shall not be affected by the opening of insolvency proceedings where the assets in question are situated within the territory of another Member State at that time.245 However, this does not prevent a liquidator bringing an action to challenge those rights as void, voidable or unenforceable under Article 4(2)(m)246 unless the person benefiting from that act can prove that it is subject to the law of another Member State and that no challenge to that act would be countenanced by that law.247 Rights of set-off and under reservation of title arrangements are protected in like manner by Articles 6 and 7 respectively. Separate provision is also made for contracts relating to immoveable property248 and rights subject to registration.249

(4) Recognition Under the Regulation (a) Main and Secondary Proceedings 10.122 Paragraph 22 of the Preamble to the Regulation provides as follows: This Regulation should provide for immediate recognition of judgments concerning the opening, conduct and closure of insolvency proceedings which come within its scope and of judgments handed down in direct connection with such insolvency proceedings. Automatic recognition should therefore mean that the effects attributed to the proceedings by the law of the State in which the proceedings were opened extend to all other Member States. Recognition of judgments delivered by the courts of the Member States should be based on the principle of mutual trust. To that end, grounds for non-recognition should be reduced to the minimum necessary.

243

Art 4(2)(m). Art 28. 245 See Arts 5(2)(3) for amplification. 246 Art 5(4). 247 Art 13. 248 Art 8—effect of insolvency proceedings on such a contract governed by the lex situs. 249 Art 11—effect of insolvency proceedings on rights requiring registration determined by law of Member State under authority of which register is kept. 244

472 Sandra Frisby 10.123 This general principle is then enacted in Article 16(1) of the Regulation, which reads as follows: Any judgment opening insolvency proceedings handed down by a court of a Member State which has jurisdiction pursuant to Article 3 shall be recognised in all the other Member States from the time that it becomes effective in the State of the opening of proceedings.

10.124 The judgment opening main proceedings then produces the same effects in all other Member States as it does under the law of the State in which the main proceedings have been opened.250 Article 16(1) does not, of course, preclude the opening of secondary proceedings,251 and Article 17(1) goes on to provide that where secondary proceedings are opened in another Member State then the main proceedings do not have effect in that State. The effect of secondary proceedings is limited in scope to the assets of the debtor in the State in which they are opened,252 and any restriction on creditors’ rights in this regard can only have a wider impact where the creditors give their consent.253 As regards derogations, the preamble statement that these should be as narrow as possible appears to have been respected. Only one derogation exists and is found in Article 26: Any Member State may refuse to recognise insolvency proceedings opened in another Member State or to enforce a judgment handed down in the context of such proceedings where the effects of such recognition or enforcement would be manifestly contrary to that State’s public policy, in particular its fundamental principles or the constitutional rights and liberties of the individual.

10.125 Quite how this derogation will operate remains to be seen, although it is possible that it may be relied upon by those states, the United Kingdom included, who consider that the enforcement of a foreign revenue law is, as a matter of public policy, impermissible within their own territory.254 Similarly, those aspects of States insolvency laws which are somehow ‘punitive’ or ‘penal’ in nature255 may similarly fall foul of the general derogation in Art 26. (b) Powers of the Liquidator 10.126 By virtue of Article 18(1): The liquidator appointed by a court which has jurisdiction pursuant to Article 3(1) may exercise all the powers conferred on him by the law of the State of the opening of proceedings in another Member State, as long as no other insolvency proceedings have 250

Art 17(1). Art 16(2). Arts 3(2), 27(1). 253 Art 17(2). 254 Consider, for example, the preference afforded to some Crown debts in English law, although this preference appears due to be abolished: see the Enterprise Act 2002 s 251. 255 For example, Insolvency Act 1986 s 213. 251 252

Cross-Border Insolvency and Vulnerable Transactions 473 been opened there nor any preservation measure to the contrary has been taken there further to a request for the opening of insolvency proceedings in that State. He may in particular remove the debtor’s assets from the territory of the Member State in which they are situated, subject to Articles 5 and 7.256

10.127 A liquidator in secondary proceedings is, of course, restricted to dealing with assets within the Member State in question. By Article 18(2), however, he is empowered to claim in or out of court that moveable property was removed from that State to another Member State after the opening of the proceedings. Moreover, he may bring ‘set aside’ actions in the interests of the creditors. In the case of both main and secondary liquidators, however: In exercising his powers, the liquidator shall comply with the law of the Member State within the territory of which he intends to take action, in particular with regard to procedures for the realisation of assets. Those powers may not include coercive measures or the right to rule on legal proceedings or disputes.257

(5) The Effect of the Regulation on English Law (a) Jurisdiction of the English Courts 10.128 Clearly the provisions of the Regulation may have considerable impact on the current jurisdictional bases upon which the English courts claim competency in insolvency proceedings. It is perfectly possible that the jurisdiction to wind up companies registered in England and Wales conferred by section 117 of the Insolvency Act 1986258 may be supplanted by the fact that the debtor’s CMI is shown to be in another Member State. This would not, of course, prevent the opening of secondary proceedings here, but these would be strictly territorial and subsidiary to the main proceedings. The likelihood of such an event is difficult to predict, but the fact that the presumption that the CMI is in the place of the debtor’s registered office is rebuttable clearly admits of it. 10.129 The ‘long-arm’ jurisdiction of the English courts under Part V of the Insolvency Act 1986259 is, a fortiori, open to question, at least as far as companies incorporated within the European Union are concerned. Again the possibility of secondary proceedings remains open, but such must clearly be based upon the presence of an ‘establishment’.260 This is markedly different to the current approach of the English courts to claiming winding up jurisdiction over foreign companies, which is based very much upon a test of ‘sufficient connection’ and does not require the presence of assets, let alone the establishment of a branch or place of business.

256 257 258 259 260

Arts 5 and 7 refer to the rights of secured and reservation of title creditors respectively. Art 18(3). See above, para 10.27. See above, para 10.34. See above, para 10.118.

474 Sandra Frisby 10.130 The long-arm jurisdiction of the English courts will continue to be exercisable over companies whose CMI is not in a Member State, but an interesting question arises as to whether an English court, if allocated jurisdiction under the Regulation, could refuse to open proceedings on the grounds of forum non conveniens.261 In practice this is unlikely to be an issue: if England is the CMI then it is difficult to see how any other forum could be more appropriate. However, if a creditor brings a winding up petition in England based on the presence of the registered office here, and the company has no connection other than that office, the question might emerge. (b) The Applicable Law in Insolvency Proceedings 10.131 The central concept of the Regulation being the debtor’s CMI, and everything flowing from that concept, will similarly impact upon English law. Proceedings opened in the CMI are governed by the law of that State,262 and, if it happens to be English law then it governs every aspect of the insolvency, unless one of the derogations detailed earlier applies. Under English law, as seen above,263 in relation to transactions at an undervalue and preferences the courts have considered themselves free to have regard to the connections (or lack of them) with England in deciding what order, if any, should be made. Similarly, leave to effect service out of the jurisdiction may be declined on such considerations. There is nothing in the Regulation that would appear to undermine this approach, and, of course, Article 4(2)(m) will allow an affected person to challenge the ‘applicable’ law. 10.132 Where previously the courts have considered that a particular provision of the Insolvency Act is of purely territorial application,264 they might be disposed to reconsider the matter in the light of the Regulation. Article 4(2) explicitly allows the extraterritorial application of moratorium provisions,265 and there would seem to be no good reason not to take advantage of this in the European context.266 This could, of course, lead to a two-tier approach to the extraterritoriality of English insolvency law, with a different approach being taken within and without Europe, but this is the inevitable result of the Regulation,267 and it is arguably unobjectionable that English private international law might decree a different result beyond the European context. 261 The courts have done so in relation to jurisdiction allocated under the Brussels Convention. See Re Harrods (Buenos Aires) Ltd [1992] Ch 72 and the discussion at paras 10.28–10.30 above. 262 Art 4(1), above n 242. 263 At para 10.86. 264 As, for example, in relation to s 130(2) Insolvency Act. 265 Although see Art 15 on pending lawsuits. 266 It could prove particularly beneficial in administration proceedings, to which the Regulation applies. 267 And, indeed, other European initiatives regarding jurisdiction, enforcement and choice of law matters.

Cross-Border Insolvency and Vulnerable Transactions 475 Finally, where secondary proceedings are taking place in England, English law will continue to govern those proceedings, but they are strictly territorial and do not extend to assets outside the jurisdiction.

(5) Conclusion The EC Regulation on Insolvency Proceedings is an ambitious and timely attempt to address at least some of the difficulties associated with cross-border insolvency, although it is inevitably limited in scope to Member States. It will be fascinating to observe its operation in practice, and to discover whether it answers the criticisms of the judiciary detailed at the very beginning of this chapter. The above description of the Regulation is succinct in the extreme, but one point emerges that is particularly worth noting, and that is the imperative nature of the concept of the debtor’s centre of main interests. It is around this central model that virtually everything else in the Regulation revolves. To the extent that it gives rise to uncertainty, it may scuttle the Regulation’s good intentions. 10.134 On a more optimistic note, in non-contentious cases the Regulation should prove inordinately useful to insolvency practitioners across the European Union. Most notably, the universal effect of main proceedings will free them from the vagaries of the process of enforcing judgments from their home courts outside the jurisdiction, and ought to make the realisation and administration of the estate an easier matter. The ideology of co-operation between main and secondary liquidators inherent in the Regulation should similarly promote efficiency and a cost-effective administration. It should also be of especial value in the area of corporate rescue, a matter not explicitly considered in this Chapter but one that is nevertheless pressing. 10.135 To go further would be to speculate, and so would be beyond the remit of this chapter. It is, however, evident that the workings of the Regulation will be of considerable interest to those with any more than a passing concern as regards both cross-border and English insolvency law, and will merit close attention in the future.

Appendix 1—Companies Act 1985 (extracts) PART XII—REGISTRATION OF CHARGES Chapter I—Registration of Charges (England and Wales) 395 Certain charges void if not registered 395(1) [Void against liquidator or administrator and creditors] Subject to the provisions of this Chapter, a charge created by a company registered in England and Wales and being a charge to which this section applies is, so far as any security on the company’s property or undertaking is conferred by the charge, void against the liquidator or administrator and any creditor of the company, unless the prescribed particulars of the charge together with the instrument (if any) by which the charge is created or evidenced, are delivered to or received by the registrar of companies for registration in the manner required by this Chapter within 21 days after the date of the charge’s creation. 395(2) [Contracts for repayment etc.] Subsection (1) is without prejudice to any contract or obligation for repayment of the money secured by the charge; and when a charge becomes void under this section, the money secured by it immediately becomes payable.

396 Charges which have to be registered 396(1) [Application of s. 395] Section 395 applies to the following charges— (a) a charge for the purpose of securing any issue of debentures, (b) a charge on uncalled share capital of the company, (c) a charge created or evidenced by an instrument which, if executed by an individual, would require registration as a bill of sale, (d) a charge on land (wherever situated) or any interest in it, but not including a charge for any rent or other periodical sum issuing out of the land, (e) a charge on book debts of the company, (f) a floating charge on the company’s undertaking or property, (g) a charge on calls made but not paid, (h) a charge on a ship or aircraft, or any share in a ship, (j) a charge on goodwill, on a patent or a licence under a patent, on a trademark or on a copyright or a licence under a copyright. 396(2) [Negotiable instrument securing payment of book debts] Where a negotiable instrument has been given to secure the payment of any book debts of a company, the deposit of the instrument for the purpose of securing an advance to the company is not, for purposes of section 395, to be treated as a charge on those book debts. 396(3) [Holding of debentures entitling holder to charge on land] The holding of debentures entitling the holder to a charge on land is not for purposes of this section deemed to be an interest in land. 396(4) [“Charge”] In this Chapter, “charge” includes mortgage.

478 Appendices 397 Formalities of registration (debentures) 397(1) [Required particulars re series of debentures] Where a series of debentures containing, or giving by reference to another instrument, any charge to the benefit of which the debenture holders of that series are entitled pari passu is created by a company, it is for purposes of section 395 sufficient if there are delivered to or received by the registrar, within 21 days after the execution of the deed containing the charge (or, if there is no such deed, after the execution of any debentures of the series), the following particulars in the prescribed form— (a) the total amount secured by the whole series, and (b) the dates of the resolutions authorising the issue of the series and the date of the covering deed (if any) by which the security is created or defined, and (c) a general description of the property charged, and (d) the names of the trustees (if any) for the debenture holders, together with the deed containing the charge or, if there is no such deed, one of the debentures of the series: Provided that there shall be sent to the registrar of companies, for entry in the register, particulars in the prescribed form of the date and amount of each issue of debentures of the series, but any omission to do this does not affect the validity of any of those debentures. 397(2) [Required particulars where commission etc. paid] Where any commission, allowance or discount has been paid or made either directly or indirectly by a company to a person in consideration of his— (a) subscribing or agreeing to subscribe, whether absolutely or conditionally, for debentures or the company, or (b) procuring or agreeing to procure subscriptions, whether absolute or conditional, for such debentures, the particulars required to be sent for registration under section 395 shall include particulars as to the amount or rate per cent of the commission, discount or allowance so paid or made, but omission to do this does not affect the validity of the debentures issued. 397(3) [Interpretation in s. 397(2)] The deposit of debentures as security for a debt of the company is not, for the purposes of subsection (2), treated as the issue of the debentures at a discount.

398 Verification of charge on property outside United Kingdom 398(1) [Charge created outside UK re property within UK] In the case of a charge created out of the United Kingdom comprising property situated outside the United Kingdom, the delivery to and the receipt by the registrar of companies of a copy (verified in the prescribed manner) of the instrument by which the charge is created or evidenced has the same effect for purposes of sections 395 to 398 as the delivery and receipt of the instrument itself. 398(2) [Timing] In that case, 21 days after the date on which the instrument or copy could, in due course of post (and if despatched with due diligence), have been received in the United Kingdom are substituted for the 21 days mentioned in section 395(1) (or as the case may be, section 397(1)) as the time within which the particulars and instrument or copy are to be delivered to the registrar. 398(3) [Charge created in UK re property outside UK] Where a charge is created in the United Kingdom but comprises property outside the United Kingdom, the instrument

Appendix 1 479 creating or purporting to create the charge may be sent for registration under section 395 notwithstanding that further proceedings may be necessary to make the charge valid or effectual according to the law of the country in which the property is situated. 398(4) [Charge re property in Scotland or Northern Ireland] Where a charge comprises property situated in Scotland or Northern Ireland and registration in the country where the property is situated is necessary to make the charge valid or effectual according to the law of that country, the delivery to and the receipt by the registrar of a copy (verified in the prescribed manner) of the instrument by which the charge is created or evidenced, together with a certificate in the prescribed form stating that the charge was presented for registration in Scotland or Northern Ireland (as the case may be) on the date on which it was so presented has, for purposes of sections 395 to 398, the same effect as the delivery and receipt of the instrument itself.

399 Company’s duty to register charges it creates 399(1) [Company’s obligation] It is a company’s duty to send to the registrar of companies for registration the particulars of every charge created by the company and of the issues of debentures of a series requiring registration under sections 395 to 398; but registration of any such charge may be effected on the application of any person interested in it. 399(2) [Where registration by person other than company] Where registration is effected on the application of some person other than the company, that person is entitled to recover from the company the amount of any fees properly paid by him to the registrar on the registration. 399(3) [Penalty on default re s. 399(1)] If a company fails to comply with subsection (1), then, unless the registration has been effected on the application of some other person, the company and every officer of it who is in default is liable to a fine and, for continued contravention, to a daily default fine.

400 Charges existing on property acquired 400(1) [Application] This section applies where a company registered in England and Wales acquires property which is subject to a charge of any such kind as would, if it had been created by the company after the acquisition of the property, have been required to be registered under this Chapter. 400(2) [Particulars and copy of instrument to registrar within 21 days] The company shall cause the prescribed particulars of the charge, together with a copy (certified in the prescribed manner to be a correct copy) of the instrument (if any) by which the charge was created or is evidenced, to be delivered to the registrar of companies for registration in manner required by this Chapter within 21 days after the date on which the acquisition is completed. 400(3) [If property and charge outside Great Britain] However, if the property is situated and the charge was created outside Great Britain, 21 days after the date on which the copy of the instrument could in due course of post, and if despatched with due diligence, have been received in the United Kingdom is substituted for the 21 days abovementioned as the time within which the particulars and copy of the instrument are to be delivered to the registrar. 400(4) [Penalty on default] If default is made in complying with this section, the company and every officer of it who is in default is liable to a fine and, for continued contravention, to a daily default fine.

480 Appendices 401 Register of charges to be kept by registrar of companies 401(1) [Matters to be entered in register] The registrar of companies shall keep, with respect to each company, a register in the prescribed form of all the charges requiring registration under this Chapter; and he shall enter in the register with respect to such charges the following particulars— (a) in the case of a charge to the benefit of which the holders of a series of debentures are entitled, the particulars specified in section 397(1), (b) in the case of any other charge (i) if it is a charge created by the company, the date of its creation, and if it is a charge which was existing on property acquired by the company, the date of the acquisition of the property, and (ii) the amount secured by the charge, and (iii) short particulars of the property charged, and (iv) the persons entitled to the charge. 401(2) [Issue of certificate by registrar] The registrar shall give a certificate of the registration of any charge registered in pursuance of this Chapter, stating the amount secured by the charge. The certificate— (a) shall be either signed by the registrar, or authenticated by his official seal, and (b) is conclusive evidence that the requirements of this Chapter as to registration have been satisfied. 401(3) [Inspection of register] The register kept in pursuance of this section shall be open to inspection by any person.

402 Endorsement of certificate on debentures 402(1) [Company to endorse debenture etc.] The company shall cause a copy of every certificate of registration given under section 401 to be endorsed on every debenture or certificate of debenture stock which is issued by the company and the payment of which is secured by the charge so registered. 402(2) [No endorsement before charge created] But this does not require a company to cause a certificate or registration of any charge so given to be endorsed on any debenture or certificate of debenture stock issued by the company before the charge was created. 402(3) [Offence, penalty] If a person knowingly and wilfully authorises or permits the delivery of a debenture or certificate of debenture stock which under this section is required to have endorsed on it a copy of a certificate of registration without the copy being so endorsed upon it, he is liable (without prejudice to any other liability) to a fine.

403 Entries of satisfaction and release 403(1) [Entry by registrar] The registrar of companies, on receipt of a statutory declaration in the prescribed form verifying, with respect to a registered charge,— (a) that the debt for which the charge was given has been paid or satisfied in whole or in part, or (b) that part of the property or undertaking charged has been released from the charge or has ceased to form part of the company’s property or undertaking, may enter on the register a memorandum of satisfaction in whole or in part, or of the fact

Appendix 1 481 that part of the property or undertaking has been released from the charge or has ceased to form part of the company’s property or undertaking (as the case may be). 403(2) [Copy of memorandum of satisfaction in whole] Where the registrar enters a memorandum of satisfaction in whole, he shall if required furnish the company with a copy of it.

404 Rectification of register of charges 404(1) [Application] The following applies if the court is satisfied that the omission to register a charge within the time required by this Chapter or that the omission or misstatement of any particular with respect to any such charge or in a memorandum of satisfaction was accidental, or due to inadvertence or to some other sufficient cause, or is not of a nature to prejudice the position of creditors or shareholders of the company, or that on other grounds it is just and equitable to grant relief. 404(2) [Order by court] The court may, on the application of the company or a person interested, and on such terms and conditions as seem to the court just and expedient, order that the time for registration shall be extended or, as the case may be, that the omission or mis-statement shall be rectified.

405 Registration of enforcement of security 405(1) [Notice to registrar re appointment of receiver etc.] If a person obtains an order for the appointment of a receiver or manager of a company’s property, or appoints such a receiver or manager under powers contained in an instrument, he shall within 7 days of the order or of the appointment under those powers, give notice of the fact to the registrar of companies; and the registrar shall enter the fact in the register of charges. 405(2) [Receiver to notify registrar of ceasing to act] Where a person appointed receiver or manager of a company’s property under powers contained in an instrument ceases to act as such receiver or manager, he shall, on so ceasing, give the registrar notice to that effect, and the registrar shall enter the fact in the register of charges. 405(3) [Form of notice] A notice under this section shall be in the prescribed form. 405(4) [Penalty on default] If a person makes default in complying with the requirements of this section, he is liable to a fine and, for continued contravention, to a daily default fine.

406 Companies to keep copies of instruments creating charges 406(1) [Copies to be kept at registered office] Every company shall cause a copy of every instrument creating a charge requiring registration under this Chapter to be kept at its registered office. 406(2) [Series of uniform debentures] In the case of uniform debentures, a copy of one debenture of the series is sufficient.

407 Company’s register of charges 407(1) [Register at registered office] Every limited company shall keep at its registered office a register of charges and enter in it all charges specifically affecting property of the company and all floating charges on the company’s undertaking or any of its property. 407(2) [Details of entries] The entry shall in each case give a short description of the

482 Appendices property charged, the amount of the charge and, except in the case of securities to bearer, the names of the persons entitled to it. 407(3) [Offence, penalty] If an officer of the company knowingly and wilfully authorises or permits the omission of an entry required to be made in pursuance of this section, he is liable to a fine.

408 Right to inspect instruments which create charges, etc. 408(1) [Open to inspection free to creditor or member] The copies of instruments creating any charge requiring registration under this Chapter with the registrar of companies, and the register of charges kept in pursuance of section 407, shall be open during business hours (but subject to such reasonable restrictions as the company in general meeting may impose, so that not less than 2 hours in each day be allowed for inspection) to the inspection of any creditor or member of the company without fee. 408(2) [Open to inspection to others for fee] The register of charges shall also be open to the inspection of any other person on payment of such fee, not exceeding 5 pence, for each inspection, as the company may prescribe. 408(3) [Penalty re refusal of inspection] If inspection of the copies referred to, or of the register, is refused, every officer of the company who is in default is liable to a fine and, for continued contravention, to a daily default fine. 408(4) [Court may compel inspection] If such a refusal occurs in relation to a company registered in England and Wales, the court may by order compel an immediate inspection of the copies or register.

409 Charges on property in England and Wales created elsewhere 409(1) [Extent of Chapter I] This Chapter extends to charges on property in England and Wales which are created, and to charges on property in England and Wales which is acquired, by a company (whether a company within the meaning of this Act or not) incorporated outside Great Britain which has an established place of business in England and Wales. 409(2) [Application of s. 406, 407] In relation to such a company, sections 406 and 407 apply with the substitution, for the reference to the company’s registered office, of a reference to its principal place of business in England and Wales.

Appendix 2—Insolvency Act 1986 (extracts) . . . 86 Commencement of winding up 86 A voluntary winding up is deemed to commence at the time of the passing of the resolution for voluntary winding up.

123 Definition of inability to pay debts 123(1) [Inability to pay debts] A company is deemed unable to pay its debts— (a) if a creditor (by assignment or otherwise) to whom the company is indebted in a sum exceeding £750 then due has served on the company, by leaving it at the company’s registered office, a written demand (in the prescribed form) requiring the company to pay the sum so due and the company has for 3 weeks thereafter neglected to pay the sum or to secure a compound for it to the reasonable satisfaction of the creditor, or (b) if, in England and Wales, execution or other process issued on a judgment, decree or order of any court in favour of a creditor of the company is returned unsatisfied in whole or in part, or (c) if, in Scotland, the induciae of a charge for payment on an extract decree, or an extract registered bond, or an extract registered protest, have expired without payment being made, or (d) if, in Northern Ireland, a certificate of unenforceability has been granted in respect of a judgment against the company, or (e) if it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due. 123(2) [Proof that assets less than liabilities] A company is also deemed unable to pay its debts if it is proved to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities. 123(3) [Increase, reduction of sum in s. 123(1)(a)] The money sum for the time being specified in subsection (1)(a) is subject to increase or reduction by order under section 416 in Part XV.

. . . 127 Avoidance of property dispositions, etc. 127 In a winding up by the court, any disposition of the company’s property, and any transfer of shares, or alteration in the status of the company’s members, made after the commencement of the winding up is, unless the court otherwise orders, void.

. . . 238 Transactions at an undervalue (England and Wales) 238(1) [Application] This section applies in the case of a company where— (a) an administration order is made in relation to the company, or (b) the company goes into liquidation; and “the office-holder” means the administrator or the liquidator, as the case may be.

484 Appendices 238(2) [Application to court by office-holder] Where the company has at a relevant time (defined in section 240) entered into a transaction with any person at an undervalue, the office-holder may apply to the court for an order under this section. 238(3) [Court order] Subject as follows, the court shall, on such an application, make such order as it thinks fit for restoring the position to what it would have been if the company had not entered into that transaction. 238(4) [Interpretation] For the purposes of this section and section 241, a company enters into a transaction with a person at an undervalue if— (a) the company makes a gift to that person or otherwise enters into a transaction with that person on terms that provide for the company to receive no consideration, or (b) the company enters into a transaction with that person for a consideration the value of which, in money or money’s worth, is significantly less than the value, in money or money’s worth, of the consideration provided by the company. 238(5) [Restriction on court order] The court shall not make an order under this section in respect of a transaction at an undervalue if it is satisfied— (a) that the company which entered into the transaction did so in good faith and for the purpose of carrying on its business, and (b) that at the time it did so there were reasonable grounds for believing that the transaction would benefit the company.

239 Preferences (England and Wales) 239(1) [Application] This section applies as does section 238. 239(2) [Application to court by office-holder] Where the company has at a relevant time (defined in the next section) given a preference to any person, the office-holder may apply to the court for an order under this section. 239(3) [Court order] Subject as follows, the court shall, on such an application, make such order as it thinks fit for restoring the position to what it would have been if the company had not given that preference. 239(4) [Interpretation] For the purposes of this section and section 241, a company gives a preference to a person if— (a) that person is one of the company’s creditors or a surety or guarantor for any of the company’s debts or other liabilities, and (b) the company does anything or suffers anything to be done which (in either case) has the effect of putting that person into a position which, in the event of the company going into insolvent liquidation, will be better than the position he would have been in if that thing had not been done. 239(5) [Restriction on court order] The court shall not make an order under this section in respect of a preference given to any person unless the company which gave the preference was influenced in deciding to give it by a desire to produce in relation to that person the effect mentioned in subsection (4)(b). 239(6) [Presumption] A company which has given a preference to a person connected with the company (otherwise than by reason only of being its employee) at the time the preference was given is presumed, unless the contrary is shown, to have been influenced in deciding to give it by such a desire as is mentioned in subsection (5). 239(7) [Interpretation re preference] The fact that something has been done in pursuance of the order of a court does not, without more, prevent the doing or suffering of that thing from constituting the giving of a preference.

Appendix 2 485 240 “Relevant time” under s. 238, 239 240(1) [Relevant time] Subject to the next subsection, the time at which a company enters into a transaction at an undervalue or gives a preference is a relevant time if the transaction is entered into, or the preference given— (a) in the case of a transaction at an undervalue or of a preference which is given to a person who is connected with the company (otherwise than by reason only of being its employee), at a time in the period of 2 years ending with the onset of insolvency (which expression is defined below), (b) in the case of a preference which is not such a transaction and is not so given, at a time in the period of 6 months ending with the onset of insolvency, and (c) in either case, at a time between the presentation of a petition for the making of an administration order in relation to the company and the making of such an order on that petition. 240(2) [Where not relevant time] Where a company enters into a transaction at an undervalue or gives a preference at a time mentioned in subsection (1)(a) or (b), that time is not a relevant time for the purposes of section 238 or 239 unless the company— (a) is at that time unable to pay its debts within the meaning of section 123 in Chapter VI of Part IV, or (b) becomes unable to pay its debts within the meaning of that section in consequence of the transaction or preference; but the requirements of this subsection are presumed to be satisfied, unless the contrary is shown, in relation to any transaction at an undervalue which is entered into by a company with a person who is connected with the company. 240(3) [Onset of insolvency] For the purposes of subsection (1), the onset of insolvency is— (a) in a case where section 238 or 239 applies by reason of the making of an administration order or of a company going into liquidation immediately upon the discharge of an administration order, the date of the presentation of the petition on which the administration order was made, and (b) in a case where the section applies by reason of a company going into liquidation at any other time, the date of the commencement of the winding up.

241 Orders under s. 238, 239 241(1) [Extent of orders] Without prejudice to the generality of sections 238(3) and 239(3), an order under either of those sections with respect to a transaction or preference entered into or given by a company may (subject to the next subsection)— (a) require any property transferred as part of the transaction, or in connection with the giving of the preference, to be vested in the company, (b) require any property to be so vested if it represents in any person’s hands the application either of the proceeds of sale of property so transferred or of money so transferred, (c) release or discharge (in whole or in part) any security given by the company, (d) require any person to pay, in respect of benefits received by him from the company, such sums to the office-holder as the court may direct, (e) provide for any surety or guarantor whose obligations to any person were released or discharged (in whole or in part) under the transaction, or by the giving of preference, to be under such new or revived obligations to that person at the court thinks appropriate,

486 Appendices (f) provide for security to be provided for the discharge of any obligation imposed by or arising under the order, for such an obligation to be charged on any property and for the security or charge to have the same priority as a security or charge released or discharged (in whole or in part) under the transaction or by the giving of the preference, and (g) provide for the extent to which any person whose property is vested by the order in the company, or on whom obligations are imposed by the order, is to be able to prove in the winding up of the company for debts or other liabilities which arise from, or were released or discharged (in whole or in part) under or by, the transaction or the giving of the preference. 241(2) [Restriction on orders] An order under section 238 or 239 may affect the property of, or impose any obligation on, any person whether or not he is the person with whom the company in question entered into the transaction or (as the case may be) the person to whom the preference was given; but such an order— (a) shall not prejudice any interest in property which was acquired from a person other than the company and was acquired in good faith and for value, or prejudice any interest deriving from such an interest, and (b) shall not require a person who received a benefit from the transaction or preference in good faith and for value to pay a sum to the office-holder, except where that person was a party to the transaction or the payment is to be in respect of a preference given to that person at a time when he was a creditor of the company. 241(2A) [Presumption re good faith in s. 241(2)] Where a person has acquired an interest in property from a person other than the company in question, or has received a benefit from the transaction or preference, and at the time of that acquisition or receipt— (a) he had notice of the relevant surrounding circumstances and of the relevant proceedings, or (b) he was connected with, or was an associate of, either the company in question or the person with whom that company entered into the transaction or to whom that company gave the preference, then, unless the contrary is shown, it shall be presumed for the purposes of paragraph (a) or (as the case may be) paragraph (b) of subsection (2) that the interest was acquired or the benefit was received otherwise than in good faith. 241(3) [Relevant surrounding circumstances in s. 241(2A)(a)] For the purposes of subsection (2A)(a), the relevant surrounding circumstances are (as the case may require)— (a) the fact that the company in question entered into the transaction at an undervalue; or (b) the circumstances which amounted to the giving of the preference by the company in question; and subsections (3A) to (3C) have effect to determine whether, for those purposes, a person has notice of the relevant proceedings. 241(3A) [Notice where administration order made] In a case where section 238 or 239 applies by reason of the making of an administration order, a person has notice of the relevant proceedings if he has notice— (a) of the fact that the petition on which the administration order is made has been presented; or (b) of the fact that the administration order has been made. 241(3B) [Notice where liquidation on discharge of administration order] In a case

Appendix 2 487 where section 238 or 239 applies by reason of the company in question going into liquidation immediately upon the discharge of an administration order, a person has notice of the relevant proceedings if he has notice— (a) of the fact that the petition on which the administration order is made has been presented; (b) of the fact that the administration order has been made; or (c) of the fact that the company has gone into liquidation. 241(3C) [Notice where liquidation at other times] In a case where section 238 or 239 applies by reason of the company in question going into liquidation at any other time, a person has notice of the relevant proceedings if he has notice— (a) where the company goes into liquidation on the making of a winding-up order, of the fact that the petition on which the winding-up order is made has been presented or of the fact that the company has gone into liquidation. (b) in any other case, of the fact that the company has gone into liquidation. 241(4) [Application of s. 238–241] The provisions of sections 238 to 241 apply without prejudice to the availability of any other remedy, even in relation to a transaction or preference which the company had no power to enter into or give.

. . . 245 Avoidance of certain floating charges 245(1) [Application] This section applies as does section 238, but applies to Scotland as well as to England and Wales. 245(2) [Invalidity of floating charge] Subject as follows, a floating charge on the company’s undertaking or property created at a relevant time is invalid except to the extent of the aggregate of— (a) the value of so much of the consideration for the creation of the charge as consists of money paid, or goods or services supplied, to the company at the same time as, or after, the creation of the charge, (b) the value of so much of that consideration as consists of the discharge or reduction, at the same time as, or after, the creation of the charge, of any debt of the company, and (c) the amount of such interest (if any) as is payable on the amount falling within paragraph (a) or (b) in pursuance of any agreement under which the money was so paid, the goods or services were so supplied or the debt was so discharged or reduced. 245(3) [Relevant time] Subject to the next subsection, the time at which a floating charge is created by a company is a relevant time for the purposes of this section if the charge is created— (a) in the case of a charge which is created in favour of a person who is connected with the company, at a time in the period of 2 years ending with the onset of insolvency, (b) in the case of a charge which is created in favour of any other person, at a time in the period of 12 months ending with the onset of insolvency, or (c) in either case, at a time between the presentation of a petition for the making of an administration order in relation to the company and the making of such an order on that petition. 245(4) [Qualification to s. 245(3)(b)] Where a company creates a floating charge at a time mentioned in subsection (3)(b) and the person in favour of whom the charge is created is not connected with the company, that time is not a relevant time for the purposes of this section unless the company—

488 Appendices (a) is at that time unable to pay its debts within the meaning of section 123 in Chapter VI of Part IV, or (b) becomes unable to pay its debts within the meaning of that section in consequence of the transaction under which the charge is created. 245(5) [Onset of insolvency in s. 245(3)] For the purposes of subsection (3), the onset of insolvency is— (a) in a case where this section applies by reason of the making of an administration order, the date of the presentation of the petition on which the order was made, and (b) in a case where this section applies by reason of a company going into liquidation, the date of the commencement of the winding up. 245(6) [Value of goods, services etc. in s. 245(2)(a)] For the purposes of subsection (2)(a) the value of any goods or services supplied by way of consideration for a floating charge is the amount in money which at the time they were supplied could reasonably have been expected to be obtained for supplying the goods or services in the ordinary course of business and on the same terms (apart from the consideration) as those on which they were supplied to the company.

. . . 249 “Connected” with a company 249 For the purposes of any provision in this Group of Parts, a person is connected with a company if— (a) he is a director or shadow director of the company or an associate of such a director or shadow director, or (b) he is an associate of the company; and “associate” has the meaning given by section 435 in part XVIII of this Act.

. . . 423 Transactions defrauding creditors 423(1) [Transaction at undervalue] This section relates to transactions entered into at an undervalue; and a person enters into such a transaction with another person if— (a) he makes a gift to the other person or he otherwise enters into a transaction with the other on terms that provide for him to receive no consideration; (b) he enters into a transaction with the other in consideration of marriage; or (c) he enters into a transaction with the other for a consideration the value of which, in money or money’s worth, is significantly less than the value, in money or money’s worth, of the consideration provided by himself. 423(2) [Order by court] Where a person has entered into such a transaction, the court may, if satisfied under the next subsection, make such order as it thinks fit for— (a) restoring the position to what it would have been if the transaction had not been entered into, and (b) protecting the interests of persons who are victims of the transaction. 423(3) [Conditions for court order] In the case of a person entering into such a transaction, an order shall only be made if the court is satisfied that it was entered into by him for the purpose— (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. 423(4) [“The court”] In this section “the court” means the High Court or—

Appendix 2 489 (a) if the person entering into the transaction is an individual, any other court which would have jurisdiction in relation to a bankruptcy petition relating to him; (b) if that person is a body capable of being wound up under Part IV or V of this Act, any other court having jurisdiction to wind it up. 423(5) [Interpretation] In relation to a transaction at an undervalue, references here and below to a victim of the transaction are to a person who is, or is capable of being, prejudiced by it; and in the following two sections the person entering into the transaction is referred to as “the debtor”.

424 Those who may apply for an order under s. 423 424(1) [Conditions for s. 423 application] An application for an order under section 423 shall not be made in relation to a transaction except— (a) in a case where the debtor has been adjudged bankrupt or is a body corporate which is being wound up or in relation to which an administration order is in force, by the official receiver, by the trustee of the bankrupt’s estate or the liquidator or administrator of the body corporate or (with the leave of the court) by a victim of the transaction; (b) in a case where a victim of the transaction is bound by a voluntary arrangement approved under Part I or Part VIII of this Act, by the supervisor of the voluntary arrangement or by any person who (whether or not so bound) is such a victim; or (c) in any other case, by a victim of the transaction. 424(2) [Treatment of application] An application made under any of the paragraphs of subsection (1) is to be treated as made on behalf of every victim of the transaction.

425 Provision which may be made by order under s. 423 425(1) [Scope of order] Without prejudice to the generality of section 423, an order made under that section with respect to a transaction may (subject as follows)— (a) require 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; (b) require any property to be so vested if it represents, in any person’s hands, the application either of the proceeds of sale of property so transferred or of money so transferred; (c) release or discharge (in whole or in part) any security given by the debtor; (d) require any person to pay to any other person in respect of benefits received from the debtor such sums as the court may direct; (e) provide for any surety or guarantor whose obligations to any person were released or discharged (in whole or in part) under the transaction to be under such new or revived obligations as the court thinks appropriate; (f) provide for security to be provided for the discharge of any obligation imposed by or arising under the order, for such an obligation to be charged on any property and for such security or charge to have the same priority as a security or charge released or discharged (in whole or in part) under the transaction. 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— (a) shall not prejudice any interest in property which was acquired from a person other

490 Appendices 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, and (b) shall not require a person who received a benefit from the transaction in good faith, for value and without notice of the relevant circumstances to pay any sum unless he was a party to the transaction. 425(3) [Relevant circumstances] For the purposes of this section the relevant circumstances in relation to a transaction are the circumstances by virtue of which an order under section 423 may be made in respect of the transaction. 425(4) [“Security”] In this section “security” means any mortgage, charge, lien or other security.

. . . 435 Meaning of “associate” 435(1) [Determination of whether associate] For the purposes of this Act any question whether a person is an associate of another person is to be determined in accordance with the following provisions of this section (any provision that a person is an associate of another person being taken to mean that they are associates of each other). 435(2) [Associate of individual] A person is an associate of an individual if that person is the individual’s husband or wife, or is a relative, or the husband or wife of a relative, of the individual or of the individual’s husband or wife. 435(3) [Associate of partner] A person is an associate of any person with whom he is in partnership, and of the husband or wife or a relative of any individual with whom he is in partnership; and a Scottish firm is an associate of any person who is a member of the firm. 435(4) [Associate of employee, employer] A person is an associate of any person whom he employs or by whom he is employed. 435(5) [Associate of trustee] A person in his capacity as trustee of a trust other than— (a) a trust arising under any of the second Group of Parts or the Bankruptcy (Scotland) Act 1985, or (b) a pension scheme or an employees’ share scheme (within the meaning of the Companies Act), is an associate of another person if the beneficiaries of the trust include, or the terms of the trust confer a power that may be exercised for the benefit of, that other person or an associate of that other person. 435(6) [Company associate of another company] A company is an associate of another company— (a) if the same person has control of both, or a person has control of one and persons who are his associates, or he and persons who are his associates, have control of the other, or (b) if a group of two or more persons has control of each company, and the groups either consist of the same persons or could be regarded as consisting of the same persons by treating (in one or more cases) a member of either group as replaced by a person of whom he is an associate. 435(7) [Company associate of another person] A company is an associate of another person if that person has control of it or if that person and persons who are his associates together have control of it. 435(8) [Person relative of individual] For the purposes of this section a person is a relative of an individual if he is that individual’s brother, sister, uncle, aunt, nephew, niece, lineal ancestor or lineal descendant, treating—

Appendix 2 491 (a) any relationship of the half blood as a relationship of the whole blood and the stepchild or adopted child of any person as his child, and (b) an illegitimate child as the legitimate child of his mother and reputed father; and references in this section to a husband or wife include a former husband or wife and a reputed husband or wife. 435(9) [Director employee] For the purposes of this section any director or other officer of a company is to be treated as employed by that company. 435(10) [Person with control] For the purposes of this section a person is to be taken as having control of a company if— (a) the directors of the company or of another company which has control of it (or any of them) are accustomed to act in accordance with his directions or instructions, or (b) he is entitled to exercise, or control the exercise of, one third or more of the voting power at any general meeting of the company or of another company which has control of it; and where two or more persons together satisfy either of the above conditions, they are to be taken as having control of the company. 435(11) [“Company”] In this section “company” includes any body corporate (whether incorporated in Great Britain or elsewhere); and references to directors and other officers of a company and to voting power at any general meeting of a company have effect with any necessary modifications.

Appendix 3 COUNCIL REGULATION (EC) No 1346/2000 of 29 May 2000 on insolvency proceedings THE COUNCIL OF THE EUROPEAN UNION, Having regard to the Treaty establishing the European Community, and in particular Articles 61(c) and 67(l) thereof, Having regard to the initiative of the Federal Republic of Germany and the Republic of Finland, Having regard to the opinion of the European Parliament, Having regard to the opinion of the Economic and Social Committee, Whereas: (1) The European Union has set out the aim of establishing an area of freedom, security and justice. (2) The proper functioning of the internal market requires that cross-border insolvency proceedings should operate efficiently and effectively and this Regulation needs to be adopted in order to achieve this objective which comes within the scope of judicial cooperation in civil matters within the meaning of Article 65 of the Treaty. (3) The activities of undertakings have more and more cross-border effects and are therefore increasingly being regulated by Community law. While the insolvency of such undertakings also affects the proper functioning of the internal market, there is a need for a Community act requiring coordination of the measures to be taken regarding an insolvent debtor’s assets. (4) It is necessary for the proper functioning of the internal market to avoid incentives for the parties to transfer assets or judicial proceedings from one Member State to another, seeking to obtain a more favourable legal position (forum shopping). (5) These objectives cannot be achieved to a sufficient degree at national level and action at Community level is therefore justified. (6) In accordance with the principle of proportionality this Regulation should be confined to provisions governing jurisdiction for opening insolvency proceedings and judgments which are delivered directly on the basis of the insolvency proceedings and are closely connected with such proceedings. In addition, this Regulation should contain provisions regarding the recognition of those judgments and the applicable law which also satisfy that principle. (7) Insolvency proceedings relating to the winding-up of insolvent companies or other legal persons, judicial arrangements, compositions and analogous proceedings are excluded from the scope of the 1968 Brussels Convention on Jurisdiction and the

494 Appendices Enforcement of Judgments in Civil and Commercial Matters(1), as amended by the Conventions on Accession to this Convention(2). (8) In order to achieve the aim of improving the efficiency and effectiveness of insolvency proceedings having cross-border effects, it is necessary and appropriate, that the provisions on jurisdiction, recognition and applicable law in this area should be contained in a Community law measure which is binding and directly applicable in Member States. (9) This Regulation should apply to insolvency proceedings, whether the debtor is a natural person or a legal person, a trader or an individual. The insolvency proceedings to which this Regulation applies are listed in the Annexes. Insolvency proceedings concerning insurance undertakings, credit institutions, investment undertakings holding funds or securities for third parties and collective investment undertakings should be excluded from the scope of this Regulation since they are subject to special arrangements and, to some extent, the national supervisory authorities have extremely wide-ranging powers of intervention. (10) Insolvency proceedings do not necessarily involve the intervention of a judicial authority; the expression ‘court’ in this Regulation should be given a broad meaning and include a person or body empowered by national law to open insolvency proceedings. In order for this Regulation to apply, proceedings (comprising acts and formalities set down in law) should not only have to comply with the provisions of this Regulation, but they should also be officially recognised and legally effective in the Member State in which the insolvency proceedings are opened and should be collective insolvency proceedings which entail the partial or total divestment of the debtor and the appointment of a liquidator. (11) The Regulation acknowledges the fact that as a result of widely differing substantive laws it is not practical to introduce insolvency proceedings with universal scope in the entire Community. The application without exception of the law of the State of opening of proceedings would, against this background, frequently lead to difficulties. This applies, for example, to the widely differing laws on security interests to be found in the Community. Furthermore, the preferential rights enjoyed by some creditors in the insolvency proceedings are in some cases, completely different. This Regulation should take account of this in two different ways. On the one hand, provision should be made for special rules on applicable law in the case of particularly significant rights and legal relationships (e.g. rights in rem and contracts of employment). On the other hand, national proceedings covering only assets situated in the State of opening should also be allowed alongside main insolvency proceedings with universal scope. (12) This Regulation enables the main insolvency proceedings to be opened in the Member State where the debtor has the centre of his main interests. These proceedings have universal scope and aim at encompassing all the debtor’s assets. To protect the diversity of interests, this Regulation permits secondary proceedings to be opened to run in parallel with the main proceedings. Secondary proceedings may be

(1) OJ L 299, 31.12.1972, p. 32. (2) OJ L 204, 2.8.1975, p. 28; OJ L 304, 30.10.1978, p. 1; OJ L 388, 31.12.1982, p. 1; OJ L 285, 3.10.1989, p. 1; OJ C 15, 15.1.1997, p. 1.

Appendix 3 495 opened in the Member State where the debtor has an establishment. The effects of secondary proceedings are limited to the assets located in that State. Mandatory rules of coordination with the main proceedings satisfy the need for unity in the Community. (13) The ‘centre of main interests’ should correspond to the place where the debtor conducts the administration of his interests on a regular basis and is therefore ascertainable by third parties. (14) This Regulation applies only to proceedings where the centre of the debtor’s main interests is located in the Community. (15) The rules of jurisdiction set out in this Regulation establish only international jurisdiction, that is to say, they designate the Member State the courts of which may open insolvency proceedings. Territorial jurisdiction within that Member State must be established by the national law of the Member State concerned. (16) The court having jurisdiction to open the main insolvency proceedings should be enabled to order provisional and protective measures from the time of the request to open proceedings. Preservation measures both prior to and after the commencement of the insolvency proceedings are very important to guarantee the effectiveness of the insolvency proceedings. In that connection this Regulation should afford different possibilities. On the one hand, the court competent for the main insolvency proceedings should be able also to order provisional protective measures covering assets situated in the territory of other Member States. On the other hand, a liquidator temporarily appointed prior to the opening of the main insolvency proceedings should be able, in the Member States in which an establishment belonging to the debtor is to be found, to apply for the preservation measures which are possible under the law of those States. (17) Prior to the opening of the main insolvency proceedings, the right to request the opening of insolvency proceedings in the Member State where the debtor has an establishment should be limited to local creditors and creditors of the local establishment or to cases where main proceedings cannot be opened under the law of the Member State where the debtor has the centre of his main interest. The reason for this restriction is that cases where territorial insolvency proceedings are requested before the main insolvency proceedings are intended to be limited to what is absolutely necessary. If the main insolvency proceedings are opened, the territorial proceedings become secondary. (18) Following the opening of the main insolvency proceedings, the right to request the opening of insolvency proceedings in a Member State where the debtor has an establishment is not restricted by this regulation. The liquidator in the main proceedings or any other person empowered under the national law of that Member State may request the opening of secondary insolvency proceedings. (19) Secondary insolvency proceedings may serve different purposes, besides the protection of local interests. Cases nay arise where the estate of the debtor is too complex to administer as a unit or where differences in the legal systems concerned are so great that difficulties may arise from the extension of effects deriving from the law of the State of the opening to the other States where the assets are located. For this reason the liquidator in the main proceedings may request the opening of secondary proceedings when the efficient administration of the estate so requires.

496 Appendices (20) Main insolvency proceedings and secondary proceedings can, however, contribute to the effective realisation of the total assets only if all the concurrent proceedings pending are coordinated. The main condition here is that the various liquidators must cooperate closely, in particular by exchanging a sufficient amount of information. In order to ensure the dominant role of the main insolvency proceedings, the liquidator in such proceedings should be given several possibilities for intervening in secondary insolvency proceedings which are pending at the same time. For example, he should be able to propose a restructuring plan or composition or apply for realisation of the assets in the secondary insolvency proceedings to be suspended. (21) Every creditor, who has his habitual residence, domicile or registered office in the Community, should have the right to lodge his claims in each of the insolvency proceedings pending in the Community relating to the debtor’s assets. This should also apply to tax authorities and social insurance institutions. However, in order to ensure equal treatment of creditors, the distribution of proceeds must be coordinated. Every creditor should be able to keep what he has received in the course of insolvency proceedings but should be entitled only to participate in the distribution of total assets in other proceedings if creditors with the same standing have obtained the same proportion of their claims. (22) This Regulation should provide for immediate recognition of judgments concerning the opening, conduct and closure of insolvency proceedings which come within its scope and of judgments handed down in direct connection with such insolvency proceedings. Automatic recognition should therefore mean that the effects attributed to the proceedings by the law of the State in which the proceedings were opened extend to all other Member States. Recognition of judgments delivered by the courts of the Member States should be based on the principle of mutual trust. To that end, grounds for non-recognition should be reduced to the minimum necessary. This is also the basis on which any dispute should be resolved where the courts of two Member States both claim competence to open the main insolvency proceedings. The decision of the first court to open proceedings should be recognised in the other Member States without those Member States having the power to scrutinise the court’s decision. (23) This Regulation should set out, for the matters covered by it, uniform rules on conflict of laws which replace, within their scope of application, national rules of private international law. Unless otherwise stated, the law of the Member State of the opening of the proceedings should be applicable (lex concursus). This rule on conflict of laws should be valid both for the main proceedings and for local proceedings; the lex concursus determines all the effects of the insolvency proceedings, both procedural and substantive, on the persons and legal relations concerned. It governs all the conditions for the opening, conduct and closure of the insolvency proceedings. (24) Automatic recognition of insolvency proceedings to which the law of the opening State normally applies may interfere with the rules under which transactions are carried out in other Member States. To protect legitimate expectations and the certainty of transactions in Member States other than that in which proceedings are opened, provisions should be made for a number of exceptions to the general rule. (25) There is a particular need for a special reference diverging from the law of the opening State in the case of rights in rem, since these are of considerable importance for

Appendix 3 497 the granting of credit. The basis, validity and extent of such a right in rem should therefore normally be determined according to the lex situs and not be affected by the opening of insolvency proceedings. The proprietor of the right in rem should therefore be able to continue to assert his right to segregation or separate settlement of the collateral security. Where assets are subject to rights in rem under the lex situs in one Member State but the main proceedings are being carried out in another Member State, the liquidator in the main proceedings should be able to request the opening of secondary proceedings in the jurisdiction where the rights in rem arise if the debtor has an establishment there. If a secondary proceeding is not opened, the surplus on sale of the asset covered by rights in rem must be paid to the liquidator in the main proceedings. (26) If a set-off is not permitted under the law of the opening State, a creditor should nevertheless be entitled to the set-off if it is possible under the law applicable to the claim of the insolvent debtor. In this way, set-off will acquire a kind of guarantee function based on legal provisions on which the creditor concerned can rely at the time when the claim arises. (27) There is also a need for special protection in the case of payment systems and financial markets. This applies for example to the position-closing agreements and netting agreements to be found in such systems as well as to the sale of securities and to the guarantees provided for such transactions as governed in particular by Directive 98/26/EC of the European Parliament and of the Council of 19 May 1998 on settlement finality in payment and securities settlement systems(1). For such transactions, the only law which is material should thus be that applicable to the system or market concerned. This provision is intended to prevent the possibility of mechanisms for the payment and settlement of transactions provided for in the payment and set-off systems or on the regulated financial markets of the Member States being altered in the case of insolvency of a business partner. Directive 98/26/EC contains special provisions which should take precedence over the general rules in this Regulation. (28) In order to protect employees and jobs, the effects of insolvency proceedings on the continuation or termination of employment and on the rights and obligations of all parties to such employment must be determined by the law applicable to the agreement in accordance with the general rules on conflict of law. Any other insolvencylaw questions, such as whether the employees’ claims are protected by preferential rights and what status such preferential rights may have, should be determined by the law of the opening State. (29) For business considerations, the main content of the decision opening the proceedings should be published in the other Member States at the request of the liquidator. If there is an establishment in the Member State concerned, there may be a requirement that publication is compulsory. In neither case, however, should publication be a prior condition for recognition of the foreign proceedings. (30) It may be the case that some of the persons concerned are not in fact aware that proceedings have been opened and act in good faith in a way that conflicts with the new situation. In order to protect such persons who make a payment to the debtor because they are unaware that foreign proceedings have been opened when they (1) OJ L 166, 11.6.1998, p. 45.

498 Appendices should in fact have made the payment to the foreign liquidator, it should be provided that such a payment is to have a debt-discharging effect. (31) This Regulation should include Annexes relating to the organisation of insolvency proceedings. As these annexes relate exclusively to the legislation of Member States, there are specific and substantiated reasons for the Council to reserve the right to amend these Annexes in order to take account of any amendments to the domestic law of the Member States. (32) The United Kingdom and Ireland, in accordance with Article 3 of the Protocol on the position of the United Kingdom and Ireland annexed to the Treaty on European Union and the Treaty establishing the European Community, have given notice of their wish to take part in the adoption and application of this Regulation. (33) Denmark, in accordance with Articles 1 and 2 of the Protocol on the position of Denmark annexed to the Treaty on European Union and the Treaty establishing the European Community, is not participating in the adoption of this Regulation, and is therefore not bound by it nor subject to its application, HAS ADOPTED THIS REGULATION:

CHAPTER I GENERAL PROVISIONS Article 1 Scope 1. This Regulation shall apply to collective insolvency proceedings which entail the partial or total divestment of a debtor and the appointment of a liquidator. 2. This Regulation shall not apply to insolvency proceedings concerning insurance undertakings, credit institutions, investment undertakings which provide services involving the holding of funds or securities for third parties, or to collective investment undertakings. Article 2 Definitions For the purposes of this Regulation: (a) ‘insolvency proceedings’ shall mean the collective proceedings referred to in Article 1(1). These proceedings are listed in Annex A; (b) ‘liquidator’ shall mean any person or body whose function is to administer or liquidate assets of which the debtor has been divested or to supervise the administration of his affairs. Those persons and bodies are listed in Annex C; (c) ‘winding-up proceedings’ shall mean insolvency proceedings within the meaning of point (a) involving realising the assets of the debtor, including where the proceedings have been closed by a composition or other measure terminating the insolvency, or closed by reason of the insufficiency of the assets. Those proceedings are listed in Annex B;

Appendix 3 499 (d) ‘court’ shall mean the judicial body or any other competent body of a Member State empowered to open insolvency proceedings or to take decisions in the course of such proceedings; (e) ‘judgment’ in relation to the opening of insolvency proceedings or the appointment of a liquidator shall include the decision of any court empowered to open such proceedings or to appoint a liquidator; (f) ‘the time of the opening of proceedings’ shall mean the time at which the judgment opening proceedings becomes effective, whether it is a final judgment or not; (g) ‘the Member State in which assets are situated’ shall mean, in the case of: —tangible property, the Member State within the territory of which the property is situated, —property and rights ownership of or entitlement to which must be entered in a public register, the Member State under the authority of which the register is kept, —claims, the Member State within the territory of which the third party required to meet them has the centre of his main interests, as determined in Article 3(1); (h) ‘establishment’ shall mean any place of operations where the debtor carries out a non-transitory economic activity with human means and goods. Article 3 International jurisdiction 1. The courts of the Member State within the territory of which the centre of a debtor’s main interests is situated shall have jurisdiction to open insolvency proceedings. In the case of a company or legal person, the place of the registered office shall be presumed to be the centre of its main interests in the absence of proof to the contrary. 2. Where the centre of a debtor’s main interests is situated within the territory of a Member State, the courts of another Member State shall have jurisdiction to open insolvency proceedings against that debtor only if he possesses an establishment within the territory of that other Member State. The effects of those proceedings shall be restricted to the assets of the debtor situated in the territory of the latter Member State. 3. Where insolvency proceedings have been opened under paragraph 1, any proceedings opened subsequently under paragraph 2 shall be secondary proceedings. These latter proceedings must be winding-up proceedings. 4. Territorial insolvency proceedings referred to in paragraph 2 may be opened prior to the opening of main insolvency proceedings in accordance with paragraph 1 only: (a) where insolvency proceedings under paragraph 1 cannot be opened because of the conditions laid down by the law of the Member State within the territory of which the centre of the debtor’s main interests is situated; or (b) where the opening of territorial insolvency proceedings is requested by a creditor who has his domicile, habitual residence or registered office in the Member State within the territory of which the establishment is situated, or whose claim arises from the operation of that establishment.

500 Appendices Article 4 Law applicable 1. Save as otherwise provided in this Regulation, the law applicable to insolvency proceedings and their effects shall be that of the Member State within the territory of which such proceedings are opened, hereafter referred to as the ‘State of the opening of proceedings’. 2. The law of the State of the opening of proceedings shall determine the conditions for the opening of those proceedings, their conduct and their closure. It shall determine in particular: (a) against which debtors insolvency proceedings may be brought on account of their capacity; (b) the assets which form part of the estate and the treatment of assets acquired by or devolving on the debtor after the opening of the insolvency proceedings; (c) the respective powers of the debtor and the liquidator; (d) the conditions under which set-offs may be invoked; (e) the effects of insolvency proceedings on current contracts to which the debtor is party; (f) the effects of the insolvency proceedings on proceedings brought by individual creditors, with the exception of lawsuits pending; (g) the claims which are to be lodged against the debtor’s estate and the treatment of claims arising after the opening of insolvency proceedings; (h) the rules governing the lodging, verification and admission of claims; (i) the rules governing the distribution of proceeds from the realisation of assets, the ranking of claims and the rights of creditors who have obtained partial satisfaction after the opening of insolvency proceedings by virtue of a right in rem or through a set-off; (j) the conditions for and the effects of closure of insolvency proceedings, in particular by composition; (k) creditors’ rights after the closure of insolvency proceedings; (l) who is to bear the costs and expenses incurred in the insolvency proceedings; (m) the rules relating to the voidness, voidability or unenforceability of legal acts detrimental to all the creditors. Article 5 Third parties’ rights in rem 1. The opening of insolvency proceedings shall not affect the rights in rem of creditors or third parties in respect of tangible or intangible, moveable or immoveable assets— both specific assets and collections of indefinite assets as a whole which change from time to time—belonging to the debtor which are situated within the territory of another Member State at the time of the opening of proceedings. 2. The rights referred to in paragraph 1 shall in particular mean:

Appendix 3 501 (a) the right to dispose of assets or have them disposed of and to obtain satisfaction from the proceeds of or income from those assets, in particular by virtue of a lien or a mortgage; (b) the exclusive right to have a claim met, in particular a right guaranteed by a lien in respect of the claim or by assignment of the claim by way of a guarantee; (c) the right to demand the assets from, and/or to require restitution by, anyone having possession or use of them contrary to the wishes of the party so entitled; (d) a right in rem to the beneficial use of assets. 3. The right, recorded in a public register and enforceable against third parties, under which a right in rem within the meaning of paragraph 1 may be obtained, shall be considered a right in rem. 4. Paragraph 1 shall not preclude actions for voidness, voidability or unenforceability as referred to in Article 4(2)(m). Article 6 Set-off 1. The opening of insolvency proceedings shall not affect the right of creditors to demand the set-off of their claims against the claims of the debtor, where such a set-off is permitted by the law applicable to the insolvent debtor’s claim. 2. Paragraph 1 shall not preclude actions for voidness, voidability or unenforceability as referred to in Article 4(2)(m). Article 7 Reservation of title 1. The opening of insolvency proceedings against the purchaser of an asset shall not affect the seller’s rights based on a reservation of title where at the time of the opening of proceedings the asset is situated within the territory of a Member State other than the State of opening of proceedings. 2. The opening of insolvency proceedings against the seller of an asset, after delivery of the asset, shall not constitute grounds for rescinding or terminating the sale and shall not prevent the purchaser from acquiring title where at the time of the opening of proceedings the asset sold is situated within the territory of a Member State other than the State of the opening of proceedings. 3. Paragraphs 1 and 2 shall not preclude actions for voidness, voidability or unenforceability as referred to in Article 4(2)(m). Article 8 Contracts relating to immoveable property The effects of insolvency proceedings on a contract conferring the right to acquire or make use of immoveable property shall be governed solely by the law of the Member State within the territory of which the immoveable property is situated.

502 Appendices Article 9 Payment systems and financial markets 1. Without prejudice to Article 5, the effects of insolvency proceedings on the rights and obligations of the parties to a payment or settlement system or to a financial market shall be governed solely by the law of the Member State applicable to that system or market. 2. Paragraph 1 shall not preclude any action for voidness, voidability or unenforceability which may be taken to set aside payments or transactions under the law applicable to the relevant payment system or financial market. Article 10 Contracts of employment The effects of insolvency proceedings on employment contracts and relationships shall be governed solely by the law of the Member State applicable to the contract of employment. Article 11 Effects on rights subject to registration The effects of insolvency proceedings on the rights of the debtor in immoveable property, a ship or an aircraft subject to registration in a public register shall be determined by the law of the Member State under the authority of which the register is kept. Article 12 Community patents and trade marks For the purposes of this Regulation, a Community patent, a Community trade mark or any other similar right established by Community law may be included only in the proceedings referred to in Article 3(1). Article 13 Detrimental acts Article 4(2)(m) shall not apply where the person who benefited from an act detrimental to all the creditors provides proof that: —the said act is subject to the law of a Member State other than that of the State of the opening of proceedings, and —that law does not allow any means of challenging that act in the relevant case. Article 14 Protection of third-party purchasers Where, by an act concluded after the opening of insolvency proceedings, the debtor disposes, for consideration, of: —an immoveable asset, or —a ship or an aircraft subject to registration in a public register, or —securities whose existence presupposes registration in a register laid down by law,

Appendix 3 503 the validity of that act shall be governed by the law of the State within the territory of which the immoveable asset is situated or under the authority of which the register is kept. Article 15 Effects of insolvency proceedings on lawsuits pending The effects of insolvency proceedings on a lawsuit pending concerning an asset or a right of which the debtor has been divested shall be governed solely by the law of the Member State in which that lawsuit is pending.

CHAPTER II RECOGNITION OF INSOLVENCY PROCEEDINGS Article 16 Principle 1. Any judgment opening insolvency proceedings handed down by a court of a Member State which has jurisdiction pursuant to Article 3 shall be recognised in all the other Member States from the time that it becomes effective in the State of the opening of proceedings. This rule shall also apply where, on account of his capacity, insolvency proceedings cannot be brought against the debtor in other Member States. 2. Recognition of the proceedings referred to in Article 3(1) shall not preclude the opening of the proceedings referred to in Article 3(2) by a court in another Member State. The latter proceedings shall be secondary insolvency proceedings within the meaning of Chapter III. Article 17 Effects of recognition 1. The judgment opening the proceedings referred to in Article 3(1) shall, with no further formalities, produce the same effects in any other Member State as under this law of the State of the opening of proceedings, unless this Regulation provides otherwise and as long as no proceedings referred to in Article 3(2) are opened in that other Member State. 2. The effects of the proceedings referred to in Article 3(2) may not be challenged in other Member States. Any restriction of the creditors’ rights, in particular a stay or discharge, shall produce effects vis-à-vis assets situated within the territory of another Member State only in the case of those creditors who have given their consent. Article 18 Powers of the liquidator 1. The liquidator appointed by a court which has jurisdiction pursuant to Article 3(1) may exercise all the powers conferred on him by the law of the State of the opening of proceedings in another Member State, as long as no other insolvency proceedings have

504 Appendices been opened there nor any preservation measure to the contrary has been taken there further to a request for the opening of insolvency proceedings in that State. He may in particular remove the debtor’s assets from the territory of the Member State in which they are situated, subject to Articles 5 and 7. 2. The liquidator appointed by a court which has jurisdiction pursuant to Article 3(2) may in any other Member State claim through the courts or out of court that moveable property was removed from the territory of the State of the opening of proceedings to the territory of that other Member State after the opening of the insolvency proceedings. He may also bring any action to set aside which is in the interests of the creditors. 3. In exercising his powers, the liquidator shall comply with the law of the Member State within the territory of which he intends to take action, in particular with regard to procedures for the realisation of assets. Those powers may not include coercive measures or the right to rule on legal proceedings or disputes. Article 19 Proof of the liquidator’s appointment The liquidator’s appointment shall be evidenced by a certified copy of the original decision appointing him or by any other certificate issues by the court which has jurisdiction. A translation into the official language or one of the official languages of the Member State within the territory of which he intends to act may be required. No legislation or other similar formality shall be required. Article 20 Return and imputation 1. A creditor who, after the opening of the proceedings referred to in Article 3(1) obtains by any means, in particular through enforcement, total or partial satisfaction of his claim on the assets belonging to the debtor situated within the territory of another Member State, shall return what he has obtained to the liquidator, subject to Articles 5 and 7. 2. In order to ensure equal treatment of creditors a creditor who has, in the course of insolvency proceedings, obtained a dividend on his claim shall share in distributions made in other proceedings only where creditors of the same ranking or category have, in those other proceedings, obtained an equivalent dividend. Article 21 Publication 1. The liquidator may request that notice of the judgment opening insolvency proceedings and, where appropriate, the decision appointing him, be published in any other Member State in accordance with the publication procedures provided for in that State. Such publication shall also specify the liquidator appointed and whether the jurisdiction rule applied is that pursuant to Article 3(1) or Article 3(2). 2. However, any Member State within the territory of which the debtor has an establishment may require mandatory publication. In such cases, the liquidator or any authority empowered to that effect in the Member State where the proceedings referred to in Article 3(1) are opened shall take all necessary measures to ensure such publication.

Appendix 3 505 Article 22 Registration in a public register 1. The liquidator may request that the judgment opening the proceedings referred to in Article 3(1) be registered in the land register, the trade register and any other public register kept in the other Member States. 2. However, any Member State may require mandatory registration. In such cases, the liquidator or any authority empowered to that effect in the Member State where the proceedings referred to in Article 3(1) have been opened shall take all necessary measures to ensure such registration. Article 23 Costs The costs of the publication and registration provided for in Articles 21 and 22 shall be regarded as costs and expenses incurred in the proceedings. Article 24 Honouring of an obligation to a debtor 1. Where an obligation has been honoured in a Member State for the benefit of a debtor who is subject to insolvency proceedings opened in another Member State, when it should have been honoured for the benefit of the liquidator in those proceedings, the person honouring the obligation shall be deemed to have discharged it if he was unaware of the opening of proceedings. 2. Where such an obligation is honoured before the publication provided for in Article 21 has been effected, the person honouring the obligation shall be presumed, in the absence of proof to the contrary, to have been unaware of the opening of insolvency proceedings; where the obligation is honoured after such publication has been effected, the person honouring the obligation shall be presumed, in the absence of proof to the contrary, to have been aware of the opening of proceedings. Article 25 Recognition and enforceability of other judgments 1. Judgments handed down by a court whose judgment concerning the opening of proceedings is recognised in accordance with Article 16 and which concern the course and closure of insolvency proceedings, and compositions approved by that court shall also be recognised with no further formalities. Such judgments shall be enforced in accordance with Articles 31 to 51, with the exception of Article 34(2), of the Brussels Convention on Jurisdiction and the Enforcement of Judgments in Civil and Commercial Matters, as amended by the Conventions of Accession to this Convention. The first subparagraph shall also apply to judgments deriving directly from the insolvency proceedings and which are closely linked with them, even if they were handed down by another court. The first subparagraph shall also apply to judgments relating to preservation measures taken after the request for the opening of insolvency proceedings.

506 Appendices 2. The recognition and enforcement of judgments other than those referred to in paragraph 1 shall be governed by the Convention referred to in paragraph 1, provided that that Convention is applicable. 3. The Member States shall not be obliged to recognise or enforce a judgment referred to in paragraph 1 which might result in a limitation of personal freedom or postal secrecy. Article 26(1) Public policy Any Member State may refuse to recognise insolvency proceedings opened in another Member State or to enforce a judgment handed down in the context of such proceedings where the effects of such recognition or enforcement would be manifestly contrary to that State’s public policy, in particular its fundamental principles or the constitutional rights and liberties of the individual.

CHAPTER III SECONDARY INSOLVENCY PROCEEDINGS Article 27 Opening of proceedings The opening of the proceedings referred to in Article 3(1) by a court of a Member State and which is recognised in another Member State (main proceedings) shall permit the opening in that other Member State, a court of which has jurisdiction pursuant to Article 3(2), of secondary insolvency proceedings without the debtor’s insolvency being examined in that other State. These latter proceedings must be among the proceedings listed in Annex B. Their effects shall be restricted to the assets of the debtor situated within the territory of that other Member State. Article 28 Applicable law Save as otherwise provided in this Regulation, the law applicable to secondary proceedings shall be that of the Member State within the territory of which the secondary proceedings are opened. Article 29 Right to request the opening of proceedings The opening of secondary proceedings may be requested by: (a) the liquidator in the main proceedings;

(1) Note the Declaration by Portugal concerning the application of Articles 26 and 37 (OJ C 183, 30.6.2000, p. 1).

Appendix 3 507 (b) any other person or authority empowered to request the opening of insolvency proceedings under the law of the Member State within the territory of which the opening of secondary proceedings is requested. Article 30 Advance payment of costs and expenses Where the law of the Member State in which the opening of secondary proceedings is requested requires that the debtor’s assets be sufficient to cover in whole or in part the costs and expenses of the proceedings, the court may, when it receives such a request, require the applicant to make an advance payment of costs or provide appropriate security. Article 31 Duty to cooperate and communicate information 1. Subject to the rules restricting the communication of information, the liquidator in the main proceedings and the liquidators in the secondary proceedings shall be duty bound to communicate information to each other. They shall immediately communicate any information which may be relevant to the other proceedings, in particular the progress made in lodging and verifying claims and all measures aimed at terminating the proceedings. 2. Subject to the rules applicable to each of the proceedings, the liquidator in the main proceedings and the liquidators in the secondary proceedings shall be duty bound to cooperate with each other. 3. The liquidator in the secondary proceedings shall give the liquidator in the main proceedings an early opportunity of submitting proposals on the liquidation or use of the assets in the secondary proceedings. Article 32 Exercise of creditors’ rights 1. Any creditor may lodge his claim in the main proceedings and in any secondary proceedings. 2. The liquidators in the main and any secondary proceedings shall lodge in other proceedings claims which have already been lodged in the proceedings for which they were appointed, provided that the interests of creditors in the latter proceedings are served thereby, subject to the right of creditors to oppose that or to withdraw the lodgement of their claims where the law applicable so provides. 3. The liquidator in the main or secondary proceedings shall be empowered to participate in other proceedings on the same basis as a creditor, in particular by attending creditors’ meetings. Article 33 Stay of liquidation 1. The court, which opened the secondary proceedings, shall stay the process of liquidation in whole or in part on receipt of a request from the liquidator in the main

508 Appendices proceedings, provided that in that event it may require the liquidator in the main proceedings to take any suitable measure to guarantee the interests of the creditors in the secondary proceedings and of individual classes of creditors. Such a request from the liquidator may be rejected only if it is manifestly of no interest to the creditors in the main proceedings. Such a stay of the process of liquidation may be ordered for up to three months. It may be continued or renewed for similar periods. 2. The court referred to in paragraph 1 shall terminate the stay of the process of liquidation: —at the request of the liquidator in the main proceedings, —of its own motion, at the request of a creditor or at the request of the liquidator in the secondary proceedings if that measure no longer appears justified, in particular, by the interests of creditors in the main proceedings or in the secondary proceedings. Article 34 Measures ending secondary insolvency proceedings 1. Where the law applicable to secondary proceedings allows for such proceedings to be closed without liquidation by a rescue plan, a composition or a comparable measure, the liquidator in the main proceedings shall be empowered to propose such a measure himself. Closure of the secondary proceedings by a measure referred to in the first subparagraph shall not become final without the consent of the liquidator in the main proceedings; failing his agreement, however, it may become final if the financial interests of the creditors in the main proceedings are not affected by the measure proposed. 2. Any restriction of creditors’ rights arising from a measure referred to in paragraph 1 which is proposed in secondary proceedings, such as a stay of payment or discharge of debt, may not have effect in respect of the debtor’s assets not covered by those proceedings without the consent of all the creditors having an interest. 3. During a stay of the process of liquidation ordered pursuant to Article 33, only the liquidator in the main proceedings or the debtor, with the former’s consent, may propose measures laid down in paragraph 1 of this Article in the secondary proceedings; no other proposal for such a measure shall be put to the vote or approved. Article 35 Assets remaining in the secondary proceedings If by the liquidation of assets in the secondary proceedings it is possible to meet all claims allowed under those proceedings, the liquidator appointed in those proceedings shall immediately transfer any assets remaining to the liquidator in the main proceedings. Article 36 Subsequent opening of the main proceedings Where the proceedings referred to in Article 3(1) are opened following the opening of the proceedings referred to in Article 3(2) in another Member State, Articles 31 to 35 shall apply to those opened first, in so far as the progress of those proceedings so permits.

Appendix 3 509 Article 37(1) Conversion of earlier proceedings The liquidator in the main proceedings may request that proceedings listed in Annex A previously opened in another Member State be converted into winding-up proceedings if this proves to be in the interests of the creditors in the main proceedings. The court with jurisdiction under Article 3(2) shall order conversion into one of the proceedings listed in Annex B. Article 38 Preservation measures Where the court of a Member State which has jurisdiction pursuant to Article 3(1) appoints a temporary administrator in order to ensure the preservation of the debtor’s assets, that temporary administrator shall be empowered to request any measures to secure and preserve any of the debtor’s assets situated in another Member State, provided for under the law of that State, for the period between the request for the opening of insolvency proceedings and the judgment opening the proceedings.

CHAPTER IV PROVISION OF INFORMATION FOR CREDITORS AND LODGEMENT OF THEIR CLAIMS Article 39 Right to lodge claims Any creditor who has his habitual residence, domicile or registered office in a Member State other than the State of the opening of proceedings, including the tax authorities and social security authorities of Member States, shall have the right to lodge claims in the insolvency proceedings in writing. Article 40 Duty to inform creditors 1. As soon as insolvency proceedings are opened in a Member State, the court of that State having jurisdiction or the liquidator appointed by it shall immediately inform known creditors who have their habitual residences, domiciles or registered offices in the other Member States. 2. That information, provided by an individual notice, shall in particular include time limits, the penalties laid down in regard to those time limits, the body or authority empowered to accept the lodgement of claims and the other measures laid down. Such notice shall also indicate whether creditors whose claims are preferential or secured in rem need lodge their claims. (1) Note the Declaration by Portugal concerning the application of Articles 26 and 37 (OJ C 183, 30.6.2000, p. 1).

510 Appendices Article 41 Content of the lodgement of a claim A creditor shall send copies of supporting documents, if any, and shall indicate the nature of the claim, the date on which it arose and its amount, as well as whether he alleges preference, security in rem or a reservation of title in respect of the claim and what assets are covered by the guarantee he is invoking. Article 42 Languages 1. The information provided for in Article 40 shall be provided in the official language or one of the official languages of the State of the opening of proceedings. For that purpose a form shall be used bearing the heading ‘Invitation to lodge a claim. Time limits to be observed’ in all the official languages of the institutions of the European Union. 2. Any creditor who has his habitual residence, domicile or registered office in a Member State other than the State of the opening of proceedings may lodge his claim in the official language or one of the official languages of that other State. In that event, however, the lodgement of his claim shall bear the heading ‘Lodgement of claim’ in the official language or one of the official languages of the State of the opening of proceedings. In addition, he may be required to provide a translation into the official language or one of the official languages of the State of the opening of proceedings.

CHAPTER V TRANSITIONAL AND FINAL PROVISIONS Article 43 Applicability in time The provisions of this Regulation shall apply only to insolvency proceedings opened after its entry into force. Acts done by a debtor before the entry into force of this Regulation shall continue to be governed by the law which was applicable to them at the time they were done. Article 44 Relationship to Conventions 1. After its entry into force, this Regulation replaces, in respect of the matters referred to therein, in the relations between Member States, the Conventions concluded between two or more Member States, in particular: (a) the Convention between Belgium and France on Jurisdiction and the Validity and Enforcement of Judgments, Arbitration Awards and Authentic Instruments, signed at Paris on 8 July 1899; (b) the Convention between Belgium and Austria on Bankruptcy, Winding-up, Arrangements, Compositions and Suspension of Payments (with Additional Protocol of 13 June 1973), signed at Brussels on 16 July 1969;

Appendix 3 511 (c) the Convention between Belgium and the Netherlands on Territorial Jurisdiction, Bankruptcy and the Validity and Enforcement of Judgments, Arbitration Awards and Authentic Instruments, signed at Brussels on 28 March 1925; (d) the Treaty between Germany and Austria on Bankruptcy, Winding-up, Arrangements and Compositions, signed at Vienna on 25 May 1979; (e) the Convention between France and Austria on Jurisdiction, Recognition and Enforcement of Judgments on Bankruptcy, signed at Vienna on 27 February 1979; (f) the Convention between France and Italy on the Enforcement of Judgments in Civil and Commercial Matters, signed at Rome on 3 June 1930; (g) the Convention between Italy and Austria on Bankruptcy, Winding-up, Arrangements and Compositions, signed at Rome on 12 July 1977; (h) the Convention between the Kingdom of the Netherlands and the Federal Republic of Germany on the Mutual Recognition and Enforcement of Judgments and other Enforceable Instruments in Civil and Commercial Matters, signed at The Hague on 30 August 1962; (i) the Convention between the United Kingdom and the Kingdom of Belgium providing for the Reciprocal Enforcement of Judgments in Civil and Commercial Matters, with Protocol, signed at Brussels on 2 May 1934; (j) the Convention between Denmark, Finland, Norway, Sweden and Iceland on Bankruptcy, signed at Copenhagen on 7 November 1933; (k) the European Convention on Certain International Aspects of Bankruptcy, signed at Istanbul on 5 June 1990. 2. The Conventions referred to in paragraph 1 shall continue to have effect with regard to proceedings opened before the entry into force of this Regulation. 3. This Regulation shall not apply: (a) in any Member State, to the extent that it is irreconcilable with the obligations arising in relation to bankruptcy from a convention concluded by that State with one or more third countries before the entry into force of this Regulation; (b) in the United Kingdom of Great Britain and Northern Ireland, to the extent that it is irreconcilable with the obligations arising in relation to bankruptcy and the windingup of insolvent companies from any arrangements with the Commonwealth existing at the time this Regulation enters into force. Article 45 Amendment of the Annexes The Council, acting by qualified majority on the initiative of one of its members or on a proposal from the Commission, may amend the Annexes. Article 46 Reports No later than 1 June 2012, and every five years thereafter, the Commission shall present to the European Parliament, the Council and the Economic and Social Committee a report on the application of this Regulation. The report shall be accompanied if need be by a proposal for adaptation of this Regulation.

512 Appendices Article 47 Entry into force This Regulation shall enter into force on 31 May 2002. This Regulation shall be binding in its entirety and directly applicable in the Member States in accordance with the Treaty establishing the European Community. Done at Brussels, 29 May 2000. For the Council The President A. COSTA ANNEX A Insolvency proceedings referred to in Article 2(a) BELGIE—BELGIQUE —Het failissement/La faillite —Het gerechtelijk akkoord/Le concordat judiciaire —De collectieve schuldenregeling/Le règlement collectif de dettes DEUTSCHLAND —Das Konkursverfahren —Das gerichtliche Vergleichsverfahren —Das Gesamtvollstreckungsverfahren —Das Insolvenzverfahren
 —  —    —    .         —                     ESPANA —Concurso de acreedores —Quiebra —Suspension de pagos FRANCE —Liquidation judiciaire —Redressement judiciaire avec nomination d’un administrateur IRELAND —Compulsory winding up by the court —Bankruptcy —The administration in bankruptcy of the estate of persons dying insolvent —Winding-up in bankruptcy of partnerships —Creditors’ voluntary winding up (with confirmation of a Court) —Arrangements under the control of the court which involve the vesting of all or part of the property of the debtor in the Official Assignee for realisation and distribution —Company examinership

Appendix 3 513 ITALIA —Fallimento —Concordato prevenuvo —Liquidazione coatta amministrativa —Amministrazione straordinaria —Amministrazione controllata LUXEMBOURG —Faillite —Gestion contrôlée —Concordat préventif de faillite (par abandon d’actif) —Régime spécial de liquidation du notariat NEDERLAND —Het faillissement —De syrséance van betaling —De schuldsaneringsregeling natuurlijke personen OSTERREICH —Das Konkursverfahren —Das Ausgleichsverfahren PORTUGAL —O processo de falência —Os oprocessois especiais de recuperaçao de empresa, ou seja: —A concordata —A reconstituiçao empresarial —A reestruturaçao financeira —A gestao controlada SUOMI—FINLAND —Konkurssi/konkurs —Yrityssaneeraus/företagssanering SVERIGE —Konkurs —Företagsrekonstruktion UNITED KINGDOM —Winding up by or subject to the supervision of the court —Creditors’ voluntary winding up (with confirmation by the court) —Administration —Voluntary arrangements under insolvency legislation —Bankruptcy or sequestration

ANNEX B Winding up proceedings referred to in Article 2(c) BELGIE—BELGIQUE —Het faillissement/La faillite DEUTSCHLAND —Das Konkursverfahren

514 Appendices —Das Gesamtvollstreckungsverfahren —Das insolvenzverfahren
 —  —    ESPANA —Concurso de acreedores —Quiebra —Suspension de pagos basada en la insolvencia definitiva FRANCE —Liquidation judiciaire IRELAND —Compulsory winding up —Bankruptcy —The administration in bankruptcy of the estate of persons dying insolvent —Winding-up in bankruptcy of partnerships —Creditors’ voluntary winding up (with confirmation of a court) —Arrangements under the control of the court which involve the vesting of all or part of the property of the debtor in the Official Assignee for realisation and distribution ITALIA —Fallimento —Liquidazione coatta amministrativa LUXEMBOURG —Faillite —Régime spécial de liquidation du notariat NEDERLAND —Het faillissement —De schuldsaneringsregeling natuurlijke personen OSTERREICH —Das Konkursverfahren PORTUGAL —O processo de falência SUOMI—FINLAND —Konkurssi/konkurs SVERIGE —Konkurs UNITED KINGDOM —Winding up by or subject to the supervision of the court —Creditors’ voluntary winding up (with confirmation by the court) —Bankruptcy or sequestration

Appendix 3 515

ANNEX C Liquidators referred to in Article 2(b) BELGIE—BELGIQUE —De curator/Le curateur —De commissaris inzake opschorting/Le commissaire au sursis —De schuldbemiddelaar/Le médiateur de dettes DEUTSCHLAND —Konkursverwalter —Vergleichsverwalter —Sachwalter (nach der Vergleichsordnung) —Verwalter —Insolvenzversalter —Sachwalter (nach der Insolvenzordnung) —Treuhänder —Vorläufiger Insolvenzverwalter
 —   —    .      —    —  ESPANA —Depositario-administrador —Interventor o interventores —Sindicos —Comisario FRANCE —Représentant des créanciers —Mandataire liquidateur —Administrateur judiciaire —Commissaire à l’exécution de plan IRELAND —Liquidator —Official Assignee —Trustee in bankruptcy —Provisional Liquidator —Examiner ITALIA —Curatore —Commissario LUXEMBOURG —Le curateur —Le commissaire —Le liquidateur —Le conseil de gérance de la section d’assainissement du notariat

516 Appendices NEDERLAND —De curator in het faillissement —De bewindvoerder in de surséance van betaling —De bewindvoerder in de schuldsaneringsregeling natuurlijke personen OSTERREICH —Masseverwalter —Ausgleichsverwalter —Sachwalter —Treuhänder —Besondere Verwalter —Vorläufiger Verwalter —Konkursgericht PORTUGAL —Gestor judicial —Liquidatario judicial —Comissao de credores SUOMI—FINLAND —Pesanhoitaja/boforvaltare —Selvittäjä/utredare SVERIGE —Förvaltare —God man —Rekonstruktör UNITED KINGDOM —Liquidator —Supervisor of a voluntary arrangement —Administrator —Official Receiver —Trustee —Judicial factor

Index abuse of corporate power: as ‘fraud on creditors’ at common law 281–3 remedial consequences 315–16, 327–9 abuse of corporate power, distinguished from related grounds for avoidance distinguished from lack of authority 310–14 distinguished from ultra vires 308–10 distinguished from unlawful distributions 314 abuse of corporate power, insolvent company: creditors’ prospective entitlement 317–20 directors’ abuse of power 320–4 financial condition of company 321–2 general meeting 324–7 interests of creditors 322–4 policies protecting creditors 319–20 abuse of corporate power, solvent company: consequences 315–16 counterparties’ protection 316 director’s powers 314–15 general meeting 316 administration 437–8 alteration of commercial substance 237–8 ancillary winding up 447–51 antecedent debt 138–9 assignments of receivables 240–2 associates 53–5 badges of fraud 39, 96 bills of sale 246–7 book debts: company charges, registration 248–51 fixed and floating charges 190–7 building industry: direct payment clauses and 26–30, 154 vesting and forfeiture clauses 30–4, 234–5 capital maintenance: common law principles 290–1, 303-4 corporate capacity distinguished from 292–5 remedial consequences, see unlawful distributions, remedial consequences unlawful distributions, see unlawful distributions unlawful distributions, relationship with, 291–2 unlawful financial assistance, relationship with 291 unlawful returns of capital 303-4

charge 220, 221 charge-backs see charge backs creation of: grant v reservation 220–5 fixed see fixed charge floating see floating charge potential charge 227 time of creation 225–7 charge backs: whether charges 228–9 registration 249–51 chattel mortgages 239–40 change of position 417–24 collective procedure: winding-up as 3–4 commercial globalisation 427–8 company: property and insolvency 6–8 winding-up as collective procedure 3–4 company charges, registration: chargor registered in Scotland 253 dual system 217–18 failure to register, see company charges, registration, consequences of noncompliance failure to register, see company charges, registration, consequences of non-compliance late registration, see company charges, registration, late registration oversea companies, see company charges, registration, oversea companies purpose of registration system 218–19 registrable charges, see company charges, registration, scope of section 395(1) registrar’s certificate 256–8 requirements for effective registration, see company charges, registration, requirements for effective registration 253 statutory basis 218 company charges, registration, consequences of non-compliance 272 absence of retrospectivity 279 ‘any creditor of the company’ 273–6 consequences of voidness 277–80 entitlement to invoke 272–7 entitlement to liberated assets 279–80 impact upon assignment of debts 278 impact upon charge 277–8 impact upon secured debt 278 ‘liquidator or administrator’ 272–3

518 Index company charges, registration, consequences of non-compliance (cont.): purchasers 276–7 rehabilitation of insolvent company 279 company charges, registration, late registration 258 administration 268 delay in seeking relief 260 derogations from normal form of first proviso 263–4 exercising the discretion 259–68 finality problem 266–7 first proviso to section 404 order 261–3 impact of insolvency of chargor 263 insolvency of chargor 260 omission of second proviso 267 potential insolvency of chargor 264–6 pre-conditions 259 preserving interim rights 261–63 second proviso to section 404 order 264–6 company charges, registration, oversea companies 268 equivalent foreign insolvency proceedings 272 ‘established place of business’ 269–70 property location requirement 271–2 time when place of business established 271 company charges, registration, registrar’s certificate 256–8 company charges, registration, requirements for effective registration 253 charges on property outside the United Kingdom 256 prescribed particulars 254–6 company charges, registration, scope of section 395(1) 219 assignments of receivables 240–2 charge 221–9 charge created by the company 219–43 charge on book debts 248–51 charge on land 248 charge on rental deposits 251 charge on uncalled share capital 245 charge registrable as bill of sale if executed by an individual 245–7 charge to secure issue of debentures 244–43 charge to which section 395(1) applies 243–53 charge-backs 228–9, 249–51 charging order 232–3 claims based on outright ownership 233–42 deposit of negotiable instruments and title deeds 231–2 disguised chattel mortgages 239–40 equitable lien 232 floating charge on company’s undertaking or property 251–3 lien 230

mortgage 220–1 place of registration of creator company 253 pledge 231 shipowner’s lien on sub-freights 233 title retention clauses in supply of goods contracts 235–9 trusts 242–3 vesting clauses under construction contracts 30–4, 234–5 compulsory winding up, void dispositions 331–2, 382–3 history 334–5 rationale for avoidance 332–4 reform 382–3 substantive elements 335–6 compulsory winding up, void dispositions, bank accounts: payments into bank account in credit 346–9 payments into overdrawn bank account 349–50 payments out of bank account in credit 362–6 payments out of overdrawn bank account 366–8 validation, see compulsory winding up, void dispositions, validation compulsory winding up, void dispositions, human rights 358 compulsory winding up, void dispositions, liability of agents 357, 361–8 compulsory winding up, void dispositions, meaning of ‘any disposition of the company’s property’ 336–8 asset swaps 346 dispositions made after commencement of winding up 351 executory contracts 341 incurring of liabilities 342 notice of assignment of debt 341 payments into and out of bank accounts, see compulsory winding up, void dispositions, bank accounts transfer of charged property to chargee 338–9 transfer of legal title under specifically enforceable contract 340–1 transfer of property held by company as trustee 340 transfers of value, payments under garnishee order 344–5 transfers of value, set off 344 transfers of value, surrender of lease 343 use or consumption of company assets by company itself 342 compulsory winding up, void dispositions, remedies 352–61 costs 361

Index 519 defences 354–7 destination of recoveries 360–1 impact of avoidance on secondary payment obligations 354 interest 359 legal consequences of avoidance 336, 352 parties in receipt of company property 352–3 quantum 359 recovery of payments 353 recovery of tangible property 353 remedies against agents, see compulsory winding up, void dispositions, liability of agents subrogation 357 compulsory winding up, void dispositions, validation 368–9 bank accounts and 350, 367, 380–1 costs 382 court’s general approach 369–72 creditor benefit requirement 373, 374–7 general validation 380–1 partial validation 381 payment or securing of pre-liquidation debt 378–80 post-petition asset sales 377 post-petition loans 377–8 relevant factors 372–3 compulsory winding up, void share transfers and alterations in status of members 350–1 consideration: late floating charges and 198–211 transactions at an undervalue and 67–78 construction contracts, vesting clauses 30–4, 234–5 contractors’ rights 28–30 contractual obligation 142–3 contractual subordination 23 Cork Committee 40–1, 97, 107 late floating charges and 184–6, 210–11 preferences and 130–1, 132–3, 140, 160, 165, 166, 170 corporate capacity, see ultra vires counter restitution 424–5 creditors: execution 34–6, 262, 275 insolvency set-off 23–6 pre-preference 19–20 security 7–8, 14–18, 20 unjust enrichment claim 411–17 unlawful preferences 17–18 cross-border insolvency: commercial globalisation and 427–8 commercial impasse and 431 issues arising 428–9 plurality 431–2

problem for the courts 429–30 territoriality 431–2 theoretical perspectives 431–3 unity 431–2 universality 431–5 current trading accounts 210–11 debentures 225, 244–5, 255–6 defences, to claim in unjust enrichment: change of position 417–24 counter restitution 424–5 determinable interests 30–4 direct payment clauses 26–30 contractors’ rights 28–30 preferences and 154 trusts and 27 directors 51–2 see also shadow directors distribution management 1, 3–4 EC Regulation on Insolvency Proceedings 467–75 allocation of jurisdiction 468–70 applicable law under 470–1, 474–5 centre of main interest 469 debtor’s centre of main interest 469 effect on English law 473–5 insolvency proceedings and 474–5 jurisdiction of English courts 473–4 liquidator powers 472–3 main proceedings 468–9, 471–2 recognition under 471–3 scope 468 secondary proceedings 469–72 enrichment 390–5 equitable lien 232 equitable set-off 24 estate distribution: determinable interests 30–4 direct payment clauses 26–30, 154 execution creditors 34–6 forfeitures 30–4 insolvency set-off 23–6 order of 18–20 subordination agreements 20–3 vesting clauses 30–4 estate management: definition of contents 14–18 definition of estate 6–8 preservation of estate 8–13 European Community see EC Regulation on Insolvency Proceedings execution creditors 34–6 expenses liquidation 6–7 factual preference 126 fixed charges 184–6, 187–9, 190–1 floating chargees 6–7

520 Index floating charges 227–8 see also late floating charges characteristics 187–9, 227–8 fixed charges distinction 187–90, 227–8 registration of 251–3 floating charges, book debts charges and: chargor access to accounts 193–5 debts and proceeds separated 195–6 existing assets 196–7 general principles 190–7 problematic cases 192–7 forfeitures 30–4 determination clauses and 34 fraud on creditors, avoidance of transactions 281–3 fraudulent conveyances 39–40, 45, 96 relationship with transactions defrauding creditors 96–8 relationship with undervalue transactions 38–41 fraudulent preferences 129–30 free acceptance 393–4 grant of lease: preferences and 143–4 guarantors: preferences and 149–51, 176–8 human rights: void dispositions and 358 inability to pay debts: balance sheet test 49–50 cash flow test 50–1 incidental benefits 68–9 indoor management rule 311–12 insolvency, factual see inability to pay debts insolvency set-off 23–6 equitable set-off and 24 mandatory character 25–6 intra-group transfers 302 late floating charges 183 applicability 186 legislative history 183–4 restriction to floating charges 186–97 late floating charges, consequences of successful challenge as: entitlement to liberated assets 213–14 funding of litigation 214–15 limited retrospectivity 212–13 temporal confinement of invalidity 211–12 late floating charges, new value 198 ‘at the same time as, or after, the creation of the charge’ 208-9 consideration, definition 199–200 consideration, permissible forms 200-5 consideration, timing 205–11

current trading accounts 210–11 discharge or reduction of debt 203-5 goods or services supplied 203 money paid to company 201–3 late floating charges, twilight period 197 administration 198 chargee connected with company 197–8 chargee not connected with company 198 lease, grant of 143–4 lien 230 equitable 232 possessory 230 shipowner’s lien on sub-freights 233 liquidation: collective procedure as 3–4 expenses 6–7 ‘liquidator or administrator’ 272–3 pre-liquidation period 4–5 management buy-out (MBO) 64–7 mortgagee exercising a power of sale 59 mortgage 220–1 mutuality 56–8 non-voluntary transfers 406–7 pari passu: definition 1–2 determinable interests and 30–4 direct payment clauses 26–30, 154 execution creditors and 34–6 forfeitures and 30–4 history 2–3 insolvency set-off and 23–6 pre-preferential claims and 19–20 preference avoidance and 123–3, 132–3, 134–5 secured creditors and 16 subordination agreements and 20–3 undervalue transactions and 43–6 vesting clauses and 30–4 winding-up and 10–13 performance of contractual obligation 142–3 pledge 231 plurality 431–2 possessory lien 230 preference avoidance: factual preference 126 history 127–31 jurisdiction 125 remedies 126–7, 172–4 standing 125 substantive requirements 126 theoretical perspectives, rationale for avoidance 131–8

Index 521 preference avoidance, elements of cause of action: see also preference avoidance, elements of cause of action, ‘influenced by desire to prefer’ see also preference avoidance, elements of cause of action, preferential effect antecedent debt 138–9 relevant time 170–2 requirement of insolvency 172 temporal limitation 170–2 preference avoidance , elements of cause of action , ‘influenced by desire to prefer’ ‘connected persons’ presumption 166–8 ‘connected persons’ rebuttal of presumption 168–70 historical background 127–31, 159–60 meaning 160–6 preference avoidance, elements of cause of action, preferential effect: declaration of trust 143 grant of lease 143–4 guarantors 149–51 hypothetical liquidation, measuring preferential effect 145 payment or part-payment 140 payments out of assets not beneficially owned by company 153–4 payments to secured creditors 147 performance of contractual obligation 142 return of goods 142 ‘running account’ principle 155–8 security for past indebtedness 141–2 set off 151–2 ‘suffering anything to be done’ 144 transactions improving a creditor’s position 139–44 transactions in accordance with court order 144 preference avoidance, remedies 172–4 against preferred creditor 174–5 against third parties 175–6 destination of recoveries 179–80 interest 178 limitation period 180–1 overlapping causes of action 180 three-cornered preferences 176–8 preference creditors 20 preference law 123–5 debtor intention 129–30, 135 deterrence 133–4, 136–8 equal treatment 132–3, 134–5 history 127–31 rationales 131 twilight period 135 preservation of estate 5–6, 332

property 6–7, 9 receivables 240–2 receiver exercising a power of sale 59 registration of company charges see company charges, registration Regulation on Insolvency Proceedings see EC Regulation on Insolvency Proceedings restitution for unjust enrichment 385–88, 388–90, 425–6 at expense of 402–5, 414 change of position defence 417–24 counter restitution, defence 424–5 creditor’s claim 389–90, 411–17, 424 elements of claim 388–90 enrichment 390–5, 411–13 failure of basis 416–17 business or assets of the insolvent company 392–4 improvement 411–13 money and interest 391–2 tenancy of property 394 title to property 394 free acceptance 393–4 legal compulsion 414–15 liquidator’s claim 388–9, 390–411 mistake 415–16 non-voluntary transfers 406–7 policy motivated unjust factors 407–10 insolvency policy 409 necessity 408–9 proprietary claims 399–402 subjective devaluation 392 unjust factor 405–9, 414–17 valuation 396–402, 413–14 business or assets of insolvent company 398–9 improvements 413–14 money and interest 396–8 tenancy of property 399–402 title to property 399–402 return of goods 142 running account principle 155–8 sale of goods contracts 235–9 secured creditors 7–8, 14–18 preferences and 147–9 security for past indebtedness 141–2 set off see also insolvency set off preferences and 151–2 void dispositions and 343–4, 348–9 shadow directors 52–3 share capital, uncalled 245 shipowner’s lien on sub-freights 233 subjective devaluation 392 subordination agreements 20–3 binding force 21 sufficient connection test 443–4

522 Index territoriality 431–2 three-cornered preferences 176–8 title retention clauses in supply of goods contracts 235–9 transaction: company as party 58–9 definition 55–6 linked steps, sequence of, characterising 60–4 mortgagee exercising a power of sale 59 mutuality requirement 56–8 receiver exercising a power of sale 59 sham transactions 60 transactions at an undervalue see undervalue transactions transactions defrauding creditors, avoidance 95–6 purpose of action 98–100 statutory history 96–8 transactions defrauding creditors, avoidance, procedure and standing: class action by victims 101–2 contingent creditors 104 persons capable of being prejudiced 104–5 persons prejudiced 102–4 procedure 100–1 secured creditors 102–3 shareholders 103 subsequent creditors 104 unsecured creditors 102 victim, definition of 102–5 victims other than intended by debtor 105 transactions defrauding creditors, transactions at an undervalue 105 see also transaction; undervalue transactions, undervalue transactions defrauding creditors, avoidance, debtor’s state of mind 105–6 applying Section 423(3) 108–14 dominant purpose test 112–13 previous legislation 106–8 proscribed purpose, inference 109–11 proscribed purpose, inference, rebuttal 111–14 substantial purpose test 113 transactions defrauding creditors, avoidance, good faith receipt by third parties 114 benefits 114–15 good faith circumstances 115 interests in property 114 value requirement 115 transactions defrauding creditors, avoidance, remedies: limitation 120–1 range of orders 116–17 relationship with previous law 117 relationship with undervalue transactions 117–18

scope and purpose of court powers 115–16 trust declaration 143 ultra vires: abuse of power and 308–10 ancillary powers 287 corporate capacity, determining 286–7 former consequences 288 history of doctrine 285–9 meaning 284 objects clauses 286–7 origins and purpose 285–6 related grounds for challenge, distinguished from 289–90, 292–5, 308–10 statutory abrogation 288–9 uncalled share capital 245 undervalue transactions: see also transaction avoidance action 37–8 fraud avoidance and 42–3 late floating charges and 186 legislation 15, 37 pari passu and 43–6 purpose of legislation 41–7 statutory history 38–41 transactions defrauding creditors 105 unjust enrichment and 43 undervalue transactions, consideration, see undervalue transactions, undervalue: undervalue transactions, defences 38, 78 bona fide business purpose 78–9 change of position 81–2 good faith receipt for value by third parties 79–81 undervalue transactions, relevant time 37, 47 connected counterparty and presumption of inability to pay debts 51–5 financial conditions 48–55 temporal condition 47–8 twilight period 47–8 undervalue transactions, remedies 38, 82 asset transfers 85–6 counterparty insolvency 86–7 destination of recoveries 88–90 interest 87 jurisdiction 82–4 limitation 93 meaning of recoveries 90–2 position of recoveries in administration 92–3 range of orders 84–5 restoration of guarantees 86 restoring services given 86 undervalue transactions, transaction, see transaction undervalue transactions, undervalue 67 consideration, scope of 68–70 consideration, valuation of 70–8

Index 523 consideration incapable of valuation 70–2 forgiveness of a debt 72 incidental benefits 68–9 market value, adjustments for specific circumstances 73–4 market value test 72–3 valuation of future and contingent consideration 74–8 unlawful distributions 295 capital maintenance, relationship with 291–2, 296–7, 303–4 corporate capacity, distinguished from 292–5 distributable profits 300–2 distribution 295–6 intra-group transfers 302 realised profits 301–2 relevant accounts 300–1 share repurchase 299–300 to shareholders 298 transactions at gross undervalue 297–8 winding-up, distributions akin to 299 unlawful distributions, remedial consequences 304 constructive trusts 306–7 destination of recoveries 308 innocent shareholders 307 knowing receipt 306–7 recovery from directors 304–5 recovery from shareholders 306–8 statutory remedy 307–8 universality 431–5 unjust enrichment 43 see also restitution for unjust enrichment unlawful preferences 17–18 vesting clauses 30–4, 234–5 void dispositions, see compulsory winding up, void dispositions

voluntary conveyances 40–1 winding up 435–7 administration 437–8 collective procedure 3–4 winding up, extraterritorial application 451–2, 467 charges extending to property abroad 453–4 company charges 453–5 late floating charges 455, 466–7 Paramount approach 456–60 preferences 455–63 registration requirements 454–5 statutory construction 452–3 staying of proceedings and void dispositions 463–5 sufficient connection 456–60 to persons 460–3 transactions 463–7 transactions at an undervalue 455–63 transactions defrauding creditors 465–6 winding up, jurisdiction of English courts: ancillary winding up 447–51 branch or business presence 440–3 criteria 440–4 discretionary element 446–7 Insolvency Act 1986 438–40 ‘long arm’ jurisdiction of English Courts 438–47 mechanics of ancillary winding up 449–50 persons interested in distribution of company’s assets 445–6 reasonable possibility of benefit to creditors 445 requirements 445–7 sufficient connection test 443–4 utility of ancillary winding up 450–1