In his latest Coffee Break Briefing webinar, Frettens’ own Insolvency Guru Malcolm Niekirk looked at transactions defrauding creditors (under Section 423 of the Insolvency Act 1986).
This is the summary of that briefing.
If you'd like to watch the webinar back, you can do so below, if not, read on for our summary...
Quick Links
- Unpacking s423
- Legal professional privilege and s423
- Limitation (when do s423 claims become time barred)
- Case law surrounding s423
Unpacking s423
What is it?
A s423 claim has two components. To make it stick, you must prove both. They are:
s423(1) a transaction at an undervalue, and
s423(3) ‘defrauding creditors’.
Section 423 doesn't say anything about ‘defrauding creditors’. Despite its title being ‘defrauding creditors’, there's nothing at all about fraud, honesty or dishonesty in the legislation itself. So, the title of s423 is perhaps a little bit misleading.
Under s423(3), it's not enough just to show that there was a transaction at an undervalue. You also have to prove that the motive for the transaction was either to:
- Put assets beyond the reach of:
- someone making a claim or
- someone who might make a claim, or
- Prejudice someone’s interests in a claim (again, one they have made or may make)
s424
Under s424, someone who is prejudiced (or capable of being prejudiced) by the undervalue (i.e. a creditor) can bring a claim. So too can an office holder, or the official receiver.
Supervisors can make a claim where the debtor is in an IVA. Where the debtor is bankrupt, both the trustee and the official receiver have the right to bring a claim.
Where the debtor is bankrupt, the rights of the creditors (as victims) to bring a claim are restricted. They can bring a claim only if they have permission from the court.
In a liquidation, the liquidator or official receiver can make a claim. So too can a creditor (victim), if the court allows.
When a victim claims, they claim on behalf of every victim.
s425
Under s423, the court order should restore the victim’s position and protect their interests.
There are various remedies available under s425.
Remember that s425 does give you an explicit right to claim against somebody other than the bankrupt and the company itself.
You may follow the money to claim against whoever has it. But you're not allowed to make a claim against innocent third parties. Third parties are protected if they bought property in good faith, for value, and without any involvement in the transaction or knowledge of the fraud.
Legal professional privilege and s423
Legal professional privilege protects your right to legal advice and confidentiality, so privileged advice is not normally disclosed in litigation. That rule can be overturned in s423 cases. Here’s an example:
Barclays Bank v Eustice (1995)
Mr Eustace was a farmer. Barclays financed his farm. He got into financial difficulties and engaged consultants to help him.
Those consultants set up a scheme, without Barclays’ knowledge. Mr Eustace let the farm to his family on secure agricultural tenancies, and then sold them his equipment, on favourable terms.
His mortgage to Barclays allowed him to grant agricultural tenancies for 12 months without needing Barclays’ permission. Barclays were bound by the tenancies that Mr Eustace had created, despite having a mortgage on the property. Because they were agricultural tenancies, the tenants (his family) had security of tenure.
So, although it was a 12-month tenancy, they were entitled to keep renewing it. This was detrimental to Barclays’ loan and security.
So, what happened?
Barclays appointed receivers. Then they discovered that somebody else was in occupation of the farm. The occupier was a member of Mr Eustace’s family who wasn’t paying very much rent. They sought to use s423 to set aside the agricultural tenancies and the sale.
During the case, Barclays asked for the legal advice given to Mr Eustice to be disclosed. The judge was very unimpressed by what Mr Eustace had done, and quickly concluded that the main reason for the tenancies and sale was to prejudice Barclays’ interest as a creditor.
The court thought that this was iniquitous and ‘deliberate sharp practice’. They thought the wrongdoing was close to being fraud. As a result, Mr Eustace was not entitled to use legal privilege to cover up what he had done.
Mr Eustace had to instruct his lawyers to disclose their file to Barclays.
Leeds v Lemos (2017)
This started as a dispute between a brother and a sister, where the brother owed the sister
$18 million. She got judgment against him and tried to recover her money by forcing the sale of the large house in Hampstead where he lived.
A Liberian corporation owned that house. Previously the brother did own shares in it. But he had put them in trust for his wife. He went bankrupt in 2015, more than 20 years after the trust was set up.
His sister claimed in 2016 (under s423) to try to break the trust and bring the shares back into his estate.
The trustees of his bankrupt estate asked the court if they could waive the bankrupt’s privilege in the legal advice from his solicitors. They had possession of legal papers from the brother and wanted to pass them to her solicitors, despite the privilege in them.
The court refused. Legal professional privilege protects a fundamental human right; the right to confidential legal advice. It was not right to allow another to waive that privilege on your behalf.
The case finally went to trial in 2023. The court then ruled that the trust had a legitimate purpose, so it was not set aside.
Limitation (when do s423 claims become time barred?)
When bringing a claim as a transaction at an undervalue, you can go back in time to challenge transactions only during the last:
- two years before the start of a corporate insolvency, or
- five years before the start of a bankruptcy.
In s423 claims it doesn't matter how long ago a transaction took place; it is still possible to challenge it.
When a s423 claim is brought by an office holder, you have six years from the start of the formal insolvency to sue to recover money, and twelve years to sue to recover property.
Case law surrounding s423
Midland Bank v Wyatt (1995)
In this case, a husband and wife, Mr & Mrs Wyatt, bought a house together, with a mortgage. They had some personal unsecured borrowing as well. The mortgage was not from Midland Bank.
After a while, the husband set up his own company. He and his wife signed a trust deed. It transferred the equity in the family home to her and their two children. From that point onward, according to this trust deed, he no longer had any interest in the family home.
The bank then increased the unsecured loan to fund the business. He guaranteed it. The bank thought he was an owner of the family home. Mr Wyatt never told the bank about the trust deed.
Later, the company went into receivership. Mr Wyatt then produced the trust deed to show that he was unable to repay the bank. They challenged it under s423.
The Court set aside the trust deed. Mr Wyatt never told the bank about it, and he had signed other documents that were completely inconsistent with the house being in the name of his wife and children.
Wotherspoon (2022)
Here, Mr Wotherspoon was going to get married. He bought a house for him and his future wife to live in. He bought it as sole owner. He said the intention had always been that they would put the property into their joint name, but it took him eight years after they got married to do it.
He eventually put it in their joint name in 2001. Then, seven years later, it was transferred entirely into Mrs Wotherspoon’s name. Mr Wotherspoon kept a restriction on the property at the Land Registry. That gave him a veto over its sale. It wasn’t explained what interest the restriction protected or why he had it in the first place.
A year or so later, he started to get into arrears with his taxes. In 2013, HMRC served a statutory demand on him. His wife sold the property a few days later. She used the proceeds of sale to buy another home (also in her sole name). The following year, HMRC presented a petition against Mr Wotherspoon and made him bankrupt.
The trustee of the bankrupt estate brought a claim under s423 to try to reverse that transaction (where the property had first been put into his wife's sole name). The court thought that the evidence that they had from Mr & Mrs Wotherspoon was unconvincing and that they weren’t getting the full truth.
There was nothing in the trustee’s evidence to show that Mr Wotherspoon had been concerned about paying his tax in the future (when he had put the property into his wife's name in 2008).
Therefore, the trustee couldn’t prove that the transaction did not have a legitimate purpose. The court could not infer a purpose. So, despite being unconvinced by the evidence, the court did not use s423 to reverse the transaction.
Sands v Clitheroe (2006)
Mr Clitheroe was a solicitor who was promoted to partner in his law firm.
It was his firm’s policy that all partners should put their family homes in their wives’ names. This was to protect them if there was a huge negligence claim.
In 1988 he sold the home he and his wife owned. She bought the new house in her sole name. He became bankrupt in 2003.
Mark Sands, as trustee of the bankrupt estate, bought a claim under s423 to claim back half of the value of the property that had been lost when the replacement family home was bought in Mrs Clitheroe’s sole name.
The court decided that the purpose of the transaction had been to put the property beyond the reach of claims by clients of the law firm. It didn’t matter that the business was not a particularly risky one, or that he had been solvent at the time. The transfer was reversed.
Summary
- Midland Bank v Wyatt – Later, inconsistent, documents showed that the declaration of trust was not a genuine transaction.
- Wotherspoon – Simply a lack of evidence proving the purpose was to disadvantage creditors.
- Sands v Clitheroe – The transparent purpose for the transfer was to disadvantage clients with negligence claims.
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You can read and watch back our previous Coffee Break Briefings here.
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