Paul McGrath^[1]
Essex Court Chambers, London
PMcGrath@essexcourt.net

Trevor Mascarenhas
PCB Byrne, London
TMascarenhas@pcb-byrne.com

Provisions protecting creditors from fraud by debtors have been around since Roman times. The actio per manus iniectio, granted the creditor the right to sell the debtor as a slave, together with his family, or to kill him, if the debt was proved by judgment or confession. The somewhat more moderate action pauliana was developed by Roman lawyers whereby the alienation of property effected in fraud of the creditors is revoked. That has formed the basis of anti-avoidance provisions existing today in many jurisdictions, for example, Article 1341-2 of the French Civil Code and the Anfechtungsgesetz in Germany.

In England, statutory anti-avoidance provisions have existed since at least 1376,^[2] a provision entitled ‘Fraudulent assurances of land or goods, to deceive creditors, shall be void’ which was directed towards those who:

‘give their tenements and chattels to their friends, by collusion thereof to have the profits at their will, and after do flee to the franchise of Westminster […] or other such privileged places, and there do live a great time with an high countenance of another man’s goods and profits of the said tenements and chattels, till the said creditors shall be bound to take a small parcel of their debt, and release the remnant.’

More than 600 years later, the English courts have had to grapple with whether the purpose of the anti-avoidance provision in its modern form, section 423 of the Insolvency Act 1986, could be seriously undermined by the use of a company to hold and transfer away assets to the prejudice of creditors of its shareholder. The first occasion was in Akhmedova v Akhmedov,^[3] in which Gwyneth Knowles J held that it could apply in such circumstances.

This was swiftly followed by judgments at first instance and in the Court of Appeal in the El-Husseiny^[4] case before the UK Supreme Court gave judgment in El-Husseiny v Invest Bank PSC.^[5] The question was whether what the debtor was doing by causing their company to transfer away an asset of their company amounted to a transaction at an undervalue entered into by the debtor, within the meaning of section 423(1).

El-Husseiny v Invest Bank PSC

The judgment is relatively concise in its analysis, and it is not proposed to set out the detail in this article. In summary, the Supreme Court first considered the text of the statute. Section 423(1) defines what amounts to a transaction at an undervalue entered into by the debtor and section 423(3) sets out the mental element required for the transaction at an undervalue to be set aside, namely that it has to be for the purposes of putting assets beyond the reach of someone who might make a claim against the debtor or otherwise prejudicing that person’s interests in relation to that potential claim.

The Justices of the Supreme Court concluded on a textual analysis that an arrangement by which a debtor caused their company to transfer an asset for the purposes of putting that asset out of the reach of the debtor’s creditors and/or prejudicing their interests by the diminution in the value of the debtor’s shares, fulfilled the requirements of a transaction at an undervalue within the meaning of section 423(1).

The Justices then considered the purpose of section 423 and rejected the appellants’ case that it is an essential element of any transaction falling within section 423 that it directly involves property owned by the debtor, as opposed to property owned by a company which is in turn owned by the debtor. They held it to be a restriction which is not justified by the language of section 423(1), and which would undermine its purpose.

Finally, the interaction with other sections of the Insolvency Act was analysed, in particular sections 238 and 339 which apply to setting aside of transactions at an undervalue in corporate and individual bankruptcy and which use the same language as section 423(1) in defining transactions at an undervalue. The appellants had relied upon a Court of Appeal authority, Clarkson v Clarkson (Clarkson),^[6] said to restrict transactions at an undervalue within the meaning of section 339 to assets beneficially owned by a bankrupt. The UK Supreme Court rejected that argument, saying that the Court of Appeal in Clarkson had not restricted the scope of section 339 in that way. The Justices also said that they could see no good reason for giving different meanings to transactions at an undervalue in sections 238, 339 and 423, a point to which this article returns below when considering the implications of the judgment.

Implications of El-Husseiny v Invest Bank PSC

Before discussing what implications do arise from the judgment, it is important to explain what it did not decide. It was no part of the successful respondent’s case that the Court should depart from established law relating to the separate corporate personality of a company, and the Supreme Court did not do so. The case cannot be relied upon for some principle that in cases of fraud, the court is willing to disregard or look behind the corporate veil.

What it did do was to confirm that the wording of the statute was sufficiently wide to avoid the unpalatable consequences had the appeal succeeded, and thereby avoid a lacuna that would enable sophisticated individuals to avoid their debts. And as section 423 has extraterritorial effect, often being applied by English courts to transactions that have taken place overseas, provided there is a sufficient connection to England, this clarification is likely to be of assistance in international asset recovery cases involving corporate structures.

The wider implication is that sections 238 and 339 should no longer be interpreted by reference to a restriction that might otherwise have been thought to exist as a result of Clarkson. Those sections do not have a requirement of a mental element: if in the relevant period prior to bankruptcy, the bankrupt company or individual has entered into a transaction at an undervalue, the court can set aside the transaction. Thus, if a debtor has caused their company to transfer an asset to family members for perfectly legitimate purposes, such as tax planning, the court may set it aside if the debtor becomes bankrupt within the relevant period.

It has been suggested that there may be even wider consequences, where legitimate transactions at an undervalue entered into by a company (eg, by guaranteeing the obligations of a group company) might be set aside if the shareholder subsequently becomes bankrupt, leading to damaging commercial consequences for third parties. For example, a bank that has advanced monies to Company A in reliance on a guarantee by Company B might be exposed to the loss of that guarantee by the subsequent bankruptcy of Company B’s shareholder.

Conclusions

It remains to be seen how such arguments will play out in future cases, but the first stage of the analysis is to determine what the arrangement is that the debtor has entered into: what is their plan? If they have a plan to diminish the value of their shareholding for purposes of tax planning or for prejudicing creditors, then implementing that plan is the entering into of the relevant transaction at an undervalue. But if there is no such plan being implemented, then the shareholder is not entering into a transaction by the mere fact that the company is carrying out its own legitimate transaction. That may well be the answer to concerns that legitimate corporate transactions may be set aside to the detriment of third parties.