Vulnerable Transactions In Insolvency Notes
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Vulnerable transactions in insolvency The 'clawback'/avoidance provisions of the Insolvency Act 1986 We will consider a series of executed transactions which are rendered 'vulnerable' on insolvency and which liquidator or administrator by virtue of statutory provisions, can attack and reverse. The effect of this is to return the company's assets which were removed some time prior to insolvency. These unravel transactions which are in some way objectionable e.g. contract law and inadequate consideration. So this further blows apart idea that liquidator takes company's assets as he finds them. Why are these 'avoidance' provisions there?
Upholding PariPassu? (avoidance upholds this retrospectively. Is a sense that law here is aimed at achieving PariPassu particularly re one provision) Preserving collectivity? (if you can gather in assets and deal with them collectively, that enhance not only realisations but also liquidation being a collective procedure where all creditors have to participate collectively. Again at least 1 provision ensures this) Reversing unjust enrichment? (Restitutionary principle) Prevention of fraud? (And if not at least prevention of mis-behaviour, particularly re those connected to company prior to insolvency)
Goode: Pointing to single rationale however is difficult, because e.g. 'protecting general body of creditors' rationale does not really explain why we should avoid transactions at an undervalue or unlawful preferences, but not unregistered charges, post-petition dispositions of assets for full value, etc. The paripassu rationale does not explain why it is ok to threaten or bully a company into making a payment, but not ok to receive a voluntary payment, even if in good faith. Each ground of avoidance is evolved from earlier legislation and no attempt has been made to make all insolvency law coherent.
Types of avoidance provisions
Transactions at an undervalue (s238 IA) Preferences (s239 IA) Floating charges for past value (s245 IA) Unregistered charges (effectively invalid as against creditors, liquidator or administrator) Post-petition dispositions of corporate assets without leave of ther court (s127 IA) Extortionate credit transactions (s244 IA) Transactions defrauding creditors (s423-5 IA)
Note also that certain executor contracted can be avoided if they contravene PariPassu. How far do the considerations in relation to each transaction actually justify the reversal of transactions entered into prior to insolvency?
Transactions at an undervalue - s238 IA: This is where company disposes of an asset for no consideration or not enough consideration as is equal to the consideration which they themselves provide. This is linked to the common law anti-deprivation rule, but obviously operates differently to it because:
S238 affects completed transactions, whereas anti-deprivation catches uncompleted transactions S238 operates retrospectively by providing for the reversal of transactions, whereas anti-deprivation is aimed at payments and transfers fixed to occur upon insolvency at a later date S238 transactions are valid but its effects are reversible in the discretion of the court upon application by the office-holder, but a provision which breaches anti-deprivation is necessarily void.
3 pre-requisites for operation of s238:
1. Company in liquidation or administration and application made by office-holder S238(1) Company must be in(a)liquidation or (b)administration. S238(2) Creditors of themselves cannot bring action under this section. Hence office-holder applies to court for order under this section at the relevant time. Clearly must be the formal collective insolvency proceeding to bring together unsecured creditors and give them locus standi. Can't let them interfere before insolvency because they're unsecured. Also right that office-holder only make application because the remedy is not automatic - it must be sought. Office-holder represents interests of creditors so no-one else should be allowed to apply since the whole point of the remedy is to protect those creditors.
2. Transaction entered into at the 'relevant time' with the company S436 'Transaction' is defined as including a gift, agreement or arrangement' S240(1)Transaction 'at the relevant time' is-(a) If transaction entered into within 2 years before 'onset of insolvency' (s238(3) tells us when this is) or
(b)Between presentation of petition of administration and the making of such an order. S238(3) For the purposes of subsection (1), the onset of insolvency is-(a)in a case where section 238 or 239 applies by reason of an administrator of a company being appointed by administration order, the date on which the administration application is made, (b) in a case where section 238 or 239 applies by reason of an administrator of a company being appointed under paragraph 14 or 22 of Schedule B1 following filing with the court of a copy of a notice of intention to appoint under that paragraph, the date on which the copy of the notice is filed, (c) in a case where section 238 or 239 applies by reason of an administrator of a company being appointed otherwise than as mentioned in paragraph (a) or (b), the date on which the appointment takes effect…
(e) in a case where section 238 or 239 applies by reason of a company going into liquidation at any other time, the date of the commencement of the winding up. It is right to set a period for relevant transaction like this because would be unfair to expose a party indefinitely to a liability to restore that which he lawfully received. Plus the impact of the transaction on creditors becomes more tenuous with the passage of time.
3. Company Insolvent at Time of Transaction or as a Consequence of Entering into it S240(2) Where a company enters into a transaction at an undervalue … at a time mentioned in subsection (1)(a) or (b), that time is not a relevant time for the purpose 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…
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. (So where the transaction is entered into with a person connected with the company, it is presumed that the company was insolvent at that time, or became insolvent by virtue of entry into the transaction). It's right that company should be unable to pay debts at time of transaction or as a result because if after the transaction they can still pay debts etc then no creditors are disadvantaged as a result.
S249 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. (This is because someone connected with company getting transaction at undervalue is treated even more harshly). Meaning of transaction at an undervalue (i.e. attackable transaction): This is almost an anti-deprivation principle - company given something up and received less or nothing in return. 'Equivalent consideration' is at the heart of this - depletes assets otherwise: S238(4) 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.
What about bonuses to employees?
These would fall within s238(4)(a) which seems unfair. But note s238 only applies when company is insolvent when arguably it shouldn't be so free with its money. Moreover bonuses might be justifiable under s238(5) as bona fide payments for purposes of carrying on business e.g. positive encouragement to workforce. Also, court has discretion over what order to make so can take into account the circumstances. M C Bacon - "To come within S238(4)(b) the transaction must be: (1)
entered into by the company;
for a consideration;
the value of which measured in money or money's worth;
is significantly less than the value;
also measured in money or money's worth;
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 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." - Lord Millett. Stanley v TMK Finance - Example of how courts proceed here generally: Company N commenced action through liquidator against TMK who was associate of N. Action tried to cover £1.5 mill. In 2005 N had sold property, price received was £2.25 mill. Liquidator alleged that at that time, that £2.25 mill was roughly £1 mill less than property was actually worth - evidence being T (purchaser of property) paid dividend of £1.5 mill to holding company and that dividend had come out of proceeds of re-sale of property in question. Shows problem with expert evidence on valuation - opinions will vary (as they did here re value of property). Court said:
Burden of proof of undervalue is on applicant (liquidator) Consideration passed between parties has to be valued at date of the transaction Value of subject-matter was prima facie not less than a reasonably wellinformed purchaser would be willing to pay for it at that date The court should, where poss, determine precise valuation (using expert evidence), but where not poss could decide value fell within a range
Held: No undervalue established. Liquidator relying on uplift on re-sale of property of £1.5mill. But court said had to look at what it was worth at the time of the transaction - valued it between £2 and £2.5 mill at that time. Company received £2.25 mill so fell within qualifying range. Re the re-sale value, at time of transaction, certainly there was prospect of developing property - planning permission could be obtained which would increase the use value of property. But cannot consider these, must look at value at current state ('use' value, not 'hope' value). The question of valuation under 238(4)(b): complex cases: The most difficult aspect of s238 relates to determining whether the quid pro quo is roughly equivalent. In straightforward cases the court can simply compare the value of what the company parted with to the value of what it received by reference to a market price. However, commercial transactions are often more intricate than simple sales and it is in this area that the question of valuation becomes rather more taxing. 'Speculative' consideration Phillips v Brewin Dolphin Bell Lawrie - A was stockbroker which encountered cash flow problems. Idea was it would sell its business to B. Business valued at £1.25
mill. Instead of just buying business for this money, transaction was structured differently:
Firstly A's business was hived down into a wholly owned subsidiary, the shares in which were transferred to BD for £1.
At this point, given up £1.25 mill value in exchange for £1 (clearly an undervalue)
But then agreement said as part of hive-down there were number of redundancies which gave rise to liability on B for £325,000 for redundancy payments to employees. B agreed to meet that liability - took over A's debt here.
At this point we have £325,000 + £1 - £326,000 in exchange for £1.25 mill (still an undervalue)
B's parent company -PCG, covenanted to sub-lease A's computer equipment for five years, at a consideration of £312,500 per year, payable in arrears. This equipment was to be used by B.
At this point we have well over £1.5 mill flowing from that covenant over a 5 year period + £325,000 + £1 (seems more than value of company now?) But A was in breach of own lease which didn't allow sub-leasing of equipment. Also, B which was meant to be using this sub-leased equipment had already made arrangements to purchase new equipment elsewhere. So inevitably, A fails to meet instalments on its own head-lease, then lessor of goods immediately terminated head-lease. PCJ says this is repudiatory breach so we're terminating the sub-lease. This takes out of equation the £1.6 odd mill which took consideration well above what A appeared to be giving up. Problem for courts - supposed to value consideration at time transaction entered into. If we do that, looks like A are giving up more than they're going to get. CA: Couldn't take into account any consideration flowing from PCG - not a party to the transaction in question at all (the sale agreement) and the only relevant consideration is measured at the time of the transaction. So at that time the only relevant consideration was the £1. HOL: Disagreed on reasoning - said the linked agreements together constituted the'transaction'. So the only issue is the consideration. Said it was effectively 'speculative' - admittedly high value was attributed to the covenant at the time of transaction, but that value depended on covenant actually being carried out through to the end. Inherent in this transaction therefore was uncertainty. Lord Scott said that where one value is uncertain, reality should be given precedent over speculation - so if you know that part of the agreement won't actually be carried out, you should take that into account. Thus very shortly after transfer of business had taken place, the sub-lease and covenant relating to it fell over so
could safely say there was no consideration provided there, so clear transaction at an undervalue. This sanctions something of a hindsight approach to valuation. Normally this isn't approved of by English courts. Goode however says this isn't hindsight - merely relying on evidence of subsequent events to show that the covenant was so precarious and uncertain from the outset, so much so that no reasonable person would attribute any value to it. This is different to taking into account later events which actually changed the situation (e.g. can't use hindsight approach on value of lottery ticket). Ramlort - Hindsight approach (if that's what it was) wasn't adopted here. Here declaration of trust over a life insurance policy was made at point where settlor was virtually on his death bed (so 'value' of the policy might arguably be higher under the hindsight approach). So we're not clear how far this hindsight-type approach will be widely adopted. But could have interesting ramifications for 1 particular type of transaction - guarantees. Incidental benefit/detriment May not identify clear benefit or detriment because one may get an incidental benefit or detriment which doesn't flow directly from transaction but occurs as a result of it. Are these relevant in carrying out valuation? As in are they part of the value exchanged?
Agricultural Mortgage Corporation v Woodward - Yes. Mortgage Corp provided W with finance in return for mortgage of his farm. Freehold value of farm at time of mortgage was £1 mill. Next W granted agricultural tenancy to his wife - the transaction in question. He was entitled to do this, but grant had knock-on effects: His wife was paying the full rental value of the property under the tenancy (no question that rent was undervalue), but then by granting tenancy, freehold value of farm dropped to £0.5 mill. Secondly, tenancy provided wonderful negotiating tool for wife - if she is asked to surrender agricultural tenancy if the mortgagee wants possession, she can get a large surrender value. Held: Even though wife paid full market rent for tenancy didn't stop it being transaction at undervalue because shevalue of mortgaged land fell by over half (husband's consideration was less) and also incidental benefit to wife of ability to negotiate surrender value for tenancy. So must look at the reality of the benefit received, not just the 'stated' consideration. E.g. Delaney v Chen - House was sold at substantially less than freehold value because it was integral part of transaction that buyer would grant a lease back to the seller. So buyer was not buying an unencumbered property. So net result was
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