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To conclude on preferences, it cannot be claimed that the current law with its subjective test operates in a manner that comes near to maximising creditor fairness. The present subjective approach and its weak protection of pari passu has the effect of adding further to the unfair burden that unsecured creditors bear: they, after all, are the parties that depend on strong application of the pari passu principle.250 An objective approach has been seen to lead to more frequent and more successful liquidator actions to set aside unfair preferences and, overall, would increase fairness.251

Transactions at undervalue and transactions defrauding creditors

Under section 238(4) of the Insolvency Act 1986, a transaction at undervalue is entered into by a company if, at a relevant time,252 it makes a gift to a person or enters into a transaction on terms giving the company no consideration or enters a transaction for a consideration whose value in money or money’s worth is significantly lower than the value of the consideration provided by the company.253 In Brewin Dolphin, Lord Scott suggested that, in considering the issue of undervalue, the value of an asset being offered for sale is prima facie ‘not less than the amount

250See further chs. 14 and 15 below.

251Keay, ‘Preferences in Liquidation Law’, p. 215.

252Within two years (connected person) or six months (unconnected person) of insolvency: the rule on the relevant time is the same as for a preference and is contained in the Insolvency Act 1986 s. 240.

253Dealings with different parties may be treated collectively in assessing the transaction as a whole and the consideration given: Phillips v. Brewin Dolphin Bell Lawrie Ltd [2001] 1 WLR 143. See K. Dawson, ‘Transaction Avoidance: Phillips v. Brewin Dolphin Considered’ (2001) 72 CCH Company Law Newsletter 1; G. Moss, ‘Avoidance of Transactions – No Cherry Picking’ (2001) 14 Insolvency Intelligence; R. Parry, ‘Case Commentary’ [2001] Ins. Law. 58; B. Hackett, ‘What Constitutes a Transaction at an Undervalue?’ (2001) 17 IL&P 139; D. Milman, Editorial, ‘Swelling the Assets’ [2001] Ins. Law. 85; R. Mokal, ‘Consideration, Characterisation, Evaluation: Transactions at Undervalue after Phillips v. Brewin Dolphin’ [2001] JCLS 359. In Brewin Dolphin shares in a company with a business worth £1.25 million had been sold for £1 but the purchasers’ parent company had simultaneously promised to pay four years’ worth of computer lease payment to the vendor, which happened to total £1.25 million. The House of Lords concluded that there was so much uncertainty as to whether the payments would be made that no value at all should be given to the sub-lease and the agreement to make payments under it and consequently there had been a transaction at undervalue. In so holding Lord Scott looked beyond the artificial division of the agreements that the participants made and at the wider picture and adopted a flexible interpretation of ‘consideration’ based upon a commercial reality test.

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that a reasonably well-informed purchaser is prepared, in arms length negotiations, to pay for it’.254 As for the nature of the consideration that may be traded at undervalue, the prevailing view had long been that the grant of security could not amount to a transaction at undervalue because the grant of security did not per se reduce the value of the debtor’s assets.255 It has now, however, been suggested in the Court of Appeal that the grant of a security can amount to a transaction at undervalue256 and that where there is no consideration given for a charge, that charge is capable of being struck down under section 423.257

In contrast with the law on preferences (section 239), the liquidator’s power to challenge transactions at undervalue under section 238 does not depend on establishing any particular intention or motive on the part of the company, but the ‘in good faith and for the purpose of carrying on its business’ defence258 favours parties seeking to sustain a transaction. If, however, the liquidator succeeds in a section 238 challenge, the court must make such an order as it thinks fit for restoring the position to what

254Phillips v. Brewin Dolphin Bell Lawrie Ltd [2001] 1 WLR 143, para. 30. For a discussion of valuation of consideration in the context of transactions at undervalue see G. Peters,

‘Undervalues and the Value of Creditor and Debtor Covenants: A Comparative An aly s is ’ (2 008 ) 21 Insol vency In te lligence 81.

255The logic of Millett J in the case of Re M. C. Bacon Ltd [1990] BCC 78 at 91–2.

256Notably where the equity of redemption retained is less than the value of the assets prior to the granting of the charge – which will not always be the case: see R. Stubbs, ‘Section 423 of the Insolvency Act in Practice’ (2008) 21 Insolvency Intelligence 17, 21.

257See Hill v. Spread Trustee Co. Ltd [2007] 1 WLR 2404, [2006] BCC 646; although it was not necessary for the Court of Appeal to express a final view on these points, Arden LJ stated that: ‘Obviously there was no change in the physical assets of the debtor when the security was given but there seemed to be no reason why the value of the right to have recourse to the security and to take priority over other creditors, which the debtor created by granting the security, should be left out of account.’ The judgment of Millett J in M. C. Bacon Ltd [1990] BCC 78 was doubted and Arden LJ suggested (arguably building on the ‘commercial reality’ approach of Brewin Dolphin [2001] 1 WLR 143 and citing comments by Lords Hoffmann and Millett in Buchler v. Talbot [2004] 2 AC 298, paras. 29, 51) that granting a security may constitute a disposition in favour of the lender and could be a transaction at undervalue (para. 138); see also Stubbs, ‘Section 423 of the Insolvency Act’. It is arguable, following the decision in Hill v. Spread Trustee Co. Ltd, that the possibility of challenging charges under ss. 238 and 423 is again a live issue amongst insolvency and restructuring professionals: see A. Cohen, ‘Legal Update’ (2006) Recovery (Winter) 8, 10. For a case in line with M. C. Bacon Ltd see Re Mistral Finance Ltd [2001] BCC 27.

258Insolvency Act 1986 s. 238(5)(a). See D. Shah, ‘Undervalue Transactions and Preferences: The “Good Faith” Defence’ (2007) 20 Insolvency Intelligence 76. On the relationship between preferences and transactions at undervalue see Re Sonatacus Ltd [2007] BCC 186.

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it would have been had the company not entered the transaction.259 This will have the effect of placing the recovered assets back in the pool and making them available for the benefit of creditors generally.260

As a device for ensuring the fair treatment of creditors in liquidation, this action is limited by the ‘in good faith and for the purpose of carrying on its business’ defence. Liquidators, for instance, might find it difficult to challenge golden handshakes; or ex gratia payments to retiring directors, dividend payments or grants of security for existing unsecured loans.261 In the case of the latter, in particular, there is, again, considerable opportunity for powerful creditors such as banks to benefit, to the eventual cost of the body of smaller unsecured trade creditors.262

A precondition for bringing an action under section 238 regarding a transaction at undervalue is that the company must have been unable to pay its debts at the time or have become unable to do so because of the transaction. Excluded from coverage, however, are transactions entered into by the company in good faith for business purposes where there were reasonable grounds for believing the transaction would benefit the company.263 In the case of potentially questionable transactions with directors, (the then) section 320 of the Companies Act 1985 sought to provide some control by requiring general meeting approval for transactions with directors or persons connected with them during times when the company is trading. This section, however, offered little protection where directors controlled the general meeting. The CLRSG argued that if a transfer of assets to a phoenix company264 had taken place, an effective remedy for a liquidator, one compensating creditors, would be

259Insolvency Act 1986 s. 238(3). See Lord (liquidator of Rosshill Properties Ltd) v. Sinai Securities [2004] BCC 986, [2005] 1 BCLC 295 – the court would not necessarily be deterred from making an order under section 238(3) by the fact that the applicant secured creditor could not be put back into the position he was in immediately prior to the compromise. It was at least arguable that the court’s primary, and possibly only, concern under section 238(3) was the restoration of the company’s position.

260On transactions at undervalue and possible infringement of Article 1 of the First Protocol of the Human Rights Act 1998 see J. Ulph and T. Allen, ‘Transactions at Undervalue, Purchasers and the Impact of the Human Rights Act 1998’ [2004] JBL 1.

261Note that administrators can also use s. 238: see s. 238(1).

262See Re M. C. Bacon Ltd [1990] BCC 78.

263Insolvency Act 1986 s. 238(5)(a); Re Inns of Court Hotel Co. (1868) LR 6 Eq 82. The burden of proof in establishing these defences rests on the party seeking to avoid the application of section 238: see Re Barton Manufacturing Co. Ltd [1998] BCC 827.

264The term ‘phoenix’ company was used to describe the practice of putting a company into voluntary liquidation (or receivership) at a time when it owed large sums to its unsecured creditors; the liquidator (or receiver) would frequently be appointed by a

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to enforce remedies under section 320.265 The CLRSG accordingly recommended that section 320 should be amended to state that where, at the time of a section 320(1)(a) transaction, the company was insolvent (or became insolvent because of the transaction and went into insolvent liquidation within twelve months of the approval) and the second party to the transaction was a connected person or a director, the resolution would not be valid for section 320 purposes if it would not have been passed without the votes of the director (and/or connected persons) unless the transaction in question was supported by an independent valuation.266 The corresponding sections in the new Companies Act 2006, however, contain no such provision – sections 190–6 are in substance the same as their predecessors although arguably set out in a more accessible format.

Transactions at undervalue are also dealt with under the heading of ‘Transactions defrauding creditors’ in section 423 of the Insolvency Act 1986.267 This remedy has its roots in the bankruptcy laws of the sixteenth century and operates with the same definition of a transaction at undervalue as is used in section 238. Section 423 actions, however, differ from those under section 238 in so far as they incorporate no time limits for the transactions challenged.268 Liquidators do not have to show that the

controlling shareholder (who might have also taken a floating charge over the company’s undertaking); and the liquidator (or receiver) would sell the entire business at a knockdown price to a new company incorporated by the former controllers of the defunct company. Consequently what was essentially the same business would be carried out by the same people under the same or a similar name in disregard of the claims of the creditors of the first company – the second, new company rising ‘phoenix-like’ from the ashes of the old. Section 216 of the Insolvency Act 1986 is aimed at countering the ‘phoenix’ syndrome: see further ch. 16 below.

265CLRSG, Modern Company Law for a Competitive Economy: Final Report (July 2001) pp. 327–30. The CLRSG recommended amending the Insolvency Act 1986 s. 216 so that the court would not ordinarily grant leave under section 216 if there was a material transfer of assets (within twelve months prior to liquidation) to a new company in which a director of the first company was also interested, unless there was compliance with the (amended) section 320.

266Such a revised rule would offer the same Companies Act 1985 s. 322 remedies as would obtain in the absence of approval, including the right of the company to set the transaction aside and to sue the director to account for his profits or to indemnify the company against its losses.

267See S. Elwes, ‘Transactions Defrauding Creditors’ (2001) 17 IL&P 10; Stubbs, ‘Section 423 of the Insolvency Act’.

268The Insolvency Act 1986 s. 423 arguably cannot be used to extend the time zone for contesting preferences: see Re Lloyd’s Furniture Palace Ltd, Evans v. Lloyd’s Furniture Palace Ltd [1925] Ch 853. See also Law Society v. Southall [2001] EWCA Civ 2001

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company was insolvent at the time of the transaction but they do have to establish that the company had entered into the deal with an intention269 to put the assets beyond the reach of, or otherwise prejudice, a person270 who is making or who may make a claim against the company.271 A further difference between sections 238 and 423 of the Insolvency Act 1986 powers is that, in the case of the former, the court shall make an order to restore the position prior to the transaction, but under section 423 the court is empowered to make a similar order or to protect the interests of persons who are victims of the transaction: a power that will allow the court to order property to be

handed over or reimbursement to be made to a particular prejudiced party.272

(courts reluctant to re-open transactions going back many years); Hill v. Spread Trustee Co. Ltd [2007] 1 WLR 2404, [2006] BCC 646 – according to the Court of Appeal there was no inherent objection to the notion that there could be separate limitation periods for different applicants under section 423. See further C. Brougham QC, ‘Limitation Periods and Section 423 Explained: MC Bacon Questioned’ (2006) 19 Insolvency Intelligence 135.

269In Hill v. Spread Trustee Co. Ltd the Court of Appeal stated that section 423(3) requires a person entering into a transaction to have a particular purpose – it was not enough that the transaction has a particular result. In Inland Revenue Commissioner v. Hashmi [2002] 2 BCLC 489 (Court of Appeal) it was said (by Arden LJ) that a purpose must be a real, substantial purpose in contrast with what might be a consequence; or that, per Laws LJ, the applicant must establish the debtor’s ‘substantial motivation’ by one of the section 423(3) aims when entering the transaction; or that a ‘substantial purpose’ of the transaction was to permit the debtor to escape his or her liabilities (Brown LJ).

270This may be a single creditor, and it has been said to be immaterial that creditors as a

whole are not prejudiced: see National Westminster Bank plc v. Jones [2002] 1 BCLC 55; I. Dawson, ‘National Westminster Bank plc v. Jones’ [2002] Ins. Law. 61. See also Hill v. Spread Trustee Co. Ltd [2007] 1 WLR 2404, [2006] BCC 646 – there was no reason why a person could not cease to be the person within s. 423(3) but become a victim for the purposes of s. 423(5) before the court made its order so as to be a person whose interests may be protected by such an order. Section 423 was sufficiently flexible to allow this.

271See Arbuthnot Leasing International Ltd v. Havelet Leasing (No. 2) [1991] 1 All ER 591. The requirement of prejudice in s. 423(3)(b) will not be satisfied where a party transfers an asset that is so encumbered that it lacks value or if, prior to the transaction, the company has no asset of value: see Pinewood Joinery v. Starelm Properties Ltd [1994] 2 BCLC 412, [1994] BCC 569. The intention to place assets out of reach of creditors does not have to be the sole purpose of the debtor: see Chohan v. Saggar & Another [1992] BCC 306, 321; Spa Leasing Ltd v. Lovett and Others [1995] BCC 502; Elwes, ‘Transactions Defrauding Creditors’.

272A victim for such purposes is a person capable of suffering prejudice, which may include a creditor or litigant: see Re Ayala Holdings [1993] BCLC 256; Pinewood Joinery v. Starelm Properties Ltd [1994] 2 BCLC 412, [1994] BCC 569. See also Hill v. Spread Trustee Co. Ltd [2007] 1 WLR 2404, [2006] BCC 646.

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Avoidance of floating charges

A liquidator may seek to increase the fund available for unsecured creditors by challenging the practice of lenders obtaining new floating charges during a company’s troubled times in order to better their position in an anticipated insolvency distribution. To this end, the liquidator can resort to section 245 of the Insolvency Act 1986 which is designed to invalidate floating charges that are executed close to insolvency and which secure post-indebtedness without providing new assets or benefits to the company. Section 245 provides for challenge where the charge has been made with a connected person within two years ending with the onset of insolvency; or with any other person within twelve months of that date. A charge will not be invalidated under this section to the extent that the assets have been increased by the sum of the value of fresh money, goods or services supplied to the company at the same time as273 or after the charge; any discharges or reductions of any debt of the company (again at the same time or after the creation of the charge); and such interest as is payable on the above consideration. Such fresh sums must have been passed to the company and it is not enough if those are forwarded by the lender to the company’s bank to reduce an overdraft that the third party has guaranteed. This is because the money paid to the bank has not become freely available to the company and so is not paid to it within the meaning of section 245.274

This is an area of statute law that has proved difficult for liquidators to put to good effect. Section 245 covers floating, but not fixed, charges, and it does not have purchase where the company has paid off the debenture holder secured by the floating charge.275 If the floating charge is in favour of an unconnected person, the liquidator will have to prove that the company was then unable to pay its debts per section 123 of the

Insolvency Act 1986 or was, as a result of the transaction, unable to pay its debts as they fell due.276 The effect of the loan under which the

273On the ‘same time as’ see Re Shoe Lace Ltd (sub nom. Power v. Sharp Investments Ltd)

[1994] 1 BCLC 111 where Sir Christopher Slade stated (at p. 123) that, in order to come within the terms of s. 245(2)(a), moneys paid before the execution of the debenture would have to be paid at a ‘minimal’ interval so that payment and execution could be regarded as ‘contemporaneous’.

274See Re Fairway Magazines Ltd [1993] 1 BCLC 643.

275The effect of a successful challenge is to invalidate the floating charge but the debt is not extinguished.

276See the definition in Re Patrick and Lyon Ltd [1933] Ch 786. Additional tests of inability to pay debts (e.g. the balance sheet test) also operate here: see ch. 4 above.