Insolvency considerations for directors: Reviewable transactions

When a company becomes insolvent, certain types of transactions that the company entered into prior to insolvency may be subject to challenge, and at risk of being overturned. These are known as  reviewable (or antecedent) transactions.

Transactions are typically challenged by the appointed liquidator or administrator, who is looking to achieve the best possible return for the creditors of the insolvent company. If the challenging party is successful, the Court may order that the transaction(s) in issue be set aside, that the assets in question are returned to the company, or the financial benefits reimbursed from the persons in receipt of them.

Types of reviewable transactions

The Insolvency Act 1986 (IA) sets out the various ways in which a transaction may be challenged. An administrator or a liquidator may ask the Court to set aside or make an another appropriate order in the following instances:

Transactions at an undervalue (section 238 IA)

This is where a gift or transaction is either made for no consideration, or the money received was significantly less than the actual value of the consideration provided by the company. The gift or transaction in issue must have been entered into during the two years prior to the onset of insolvency, and in circumstances where the company was unable to pay its debts at the time, or became unable to pay its debts as a result of the transaction.

Where a case to set aside a transaction at an undervalue is brought, it is for the party bringing the case to prove to the court that these factors are established. However, where the transaction was made with a connected person, there is a presumption that the company was insolvent at the time, unless it can be shown otherwise.

A number of other defences apply and the Court will not set aside a transaction at an undervalue if it is satisfied the company entered into the transaction in good faith and for the purpose of carrying on business, and at the time there were reasonable grounds for believing that the transaction would benefit the company.

Granting security, paying dividends, and a series of transactions that are linked can all potentially be susceptible to challenge as a transaction at an undervalue.

Preferences (section 239 IA)

The IA deems a person to have been given a preference if they are one of the company’s creditors, or a guarantor for any of the company’s debts or other liabilities, and each of the following apply:

• Action is taken which puts the party in a better position than they would have been in if that action had not been taken
• The decision is taken because of a desire to prefer the party
• The preference was given during the six months (or two years where the person that has been preferred is connected with the company) before the onset of insolvency
• The company could not pay its debts at the time of the transaction, or became unable to pay its debts as a result of it.

The requirement that a company must have been influenced, in deciding to give a preference, by a desire to prefer means that the desire to prefer must operate on the person or persons who make the decision for the company. This is usually the directors but may include the acts of other employees or agents, too.

It is necessary to establish something stronger than an intention to undertake the transaction that prefers the party in question; the decision maker must have positively wished to put the other party in a better position. Importantly, therefore, pressure for payment by the creditor may afford a defence.

However, there is again a (rebuttable) presumption that the company was influenced by a desire to prefer a “connected” person, which includes a transaction with a director of the company (including a shadow director) or their spouse or a close relative.

Extortionate credit transactions (section 244 IA)

Either an administrator or a liquidator can apply to the court to set aside an extortionate credit transaction. Transactions are deemed to be extortionate if, with regard to the risk accepted by the person providing the credit, either its terms require grossly excessive payments to be made, or it grossly contravenes with the ordinary principles of fair dealing.

Transactions relating to extortionate credit transactions can be challenged up to three years before the day on which the company entered into administration or went into liquidation.

Invalid floating charges (section 245 IA)

A floating charge (being a charge over a group of non-constant assets that change in quantity and value) can be challenged if before the onset of a company’s insolvency:

• The floating charge was given by the company in exchange for past consideration – for example, as security for an old loan or a contract previously completed
• It was made within one year (or two years, where the floating charge is created in favour of a connected person) before the onset of insolvency
• At the time the floating charge was created, and provided the party was an unconnected person, the company was unable to pay its debts or became unable to pay its debts because of the charge. If the charge was created in favour of a connected person, however, the ability or inability to pay the company debts is irrelevant.

Transactions defrauding creditors (section 423 IA)

This type of claim has far broader application and whilst often considered in the context of insolvency, there is in fact no requirement for the company to be insolvent, or in liquidation or administration, for it to apply. As such, a claim can be made by any victim that has been (or is capable of being) prejudiced by a transaction in issue, as well as by a liquidator or administrator.

A transaction may be subject to challenge under this section if it was entered into at an undervalue (as in section 238 IA above), and the purpose of the transaction was to put assets beyond the reach of a person who is making, or may make a claim against the company.

It will not be enough to argue that a reasonable person would have had the purpose of putting assets out of reach, the test is subjective; the court must be satisfied that the company (or individuals directing it) actually had such a purpose.

If a transaction is deemed to defraud creditors, a court has wide ranging powers to set it aside, including to order the transfer of property, unless the interest in the property was acquired from a third party in good faith, for value and without notice.

Contribution from past directors and shareholders (section 76 IA)

Where a payment has been made out of capital by a company for the redemption or purchase of shares, and then the company goes into insolvent liquidation within one year of the payment, it may be subject to challenge.

The court can order a repayment to the company from the person from whom the shares were redeemed or purchased, or the directors who authorised the transaction.

The anti-deprivation principle and the rule from British Eagle

Although not referred to in the IA, case law has developed further rules designed to invalidate any arrangements put in place that remove assets from an insolvent company, where the commercial objective is to frustrate an insolvency process. The first is known as the anti-deprivation principle, and the second is developed from the rule established in the British Eagle case; often, claims under both heads are pursued at the same time. They both operate slightly differently, however, providing another claim risk for directors where assets are removed with the intent of depriving creditors of the benefit of the asset in question, or that amounts to the distribution of the assets of an insolvent company in a way that does not follow the distribution rules of insolvency law.

Final thoughts

The powers to challenge antecedent transactions exist to protect unsecured creditors and ensure that they receive a fair, pro-rata distribution of the available assets of a company that enters into insolvency.

It is worth noting, though, that in certain circumstances, a creditor might be able to negotiate an assignment (i.e. a legal transfer) from an administrator or liquidator, of the right to bring a claim in respect of any transaction at an undervalue, preference, or for extortionate credit, for the sole benefit of that creditor. However, a claim based on a transaction defrauding creditors can be brought a victim prejudiced by the transaction directly, even where there is no liquidator or administrator appointed.

Company directors therefore need to be mindful, particularly in times of financial difficulty, that not only current, but historic transactions, may come under scrutiny.

This article first appeared in Insider Media.

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