Transactions Under Value: A Legal analysis of transactions under value and transactions defrauding creditors
In this third article on our series, we shall be discussing transactions undervalue, preference to a creditor and transactions defrauding creditors as envisaged under the insolvency act and how the same can lead to personal liability of the directors.
Under the Insolvency Act, there are two methods that can be employed by directors to give a creditor an advantage to the detriment of the body of creditor. These are transactions at undervalue (covered under section 682) and preference under section 683 of the Insolvency Act.
What are Transactions Under Value?
Under section 682 of the Act, a company enters into a transaction with a person at undervalue if it: –
- makes a gift to the person or otherwise enters into a transaction for no consideration; or;
- enters into a transaction with the person for a consideration the value of which, in money or money’s worth, is significantly less than its actual market value.
Further, under section 684 of the Insolvency Act, the transaction will fall under undervalue claim or proceedings if the company was at the that time unable to pay its debts or where the impugned transaction causes this to happen.
The above provisions can be deciphered to mean that, in an undervalue transaction the recipient of the asset is accorded a benefit to the detriment of other creditors. In insolvency law, if the person who received the benefit of the transaction is a person connected with the Company, there is a rebuttable presumption that the transaction was an undervalue.
In this regard, Section 2 of the Insolvency Act provides that a person is connected with a company if the person is an officer, an associate of such officer or an associate of the company.
What is a Preference to a Creditor?
Preference occurs when the company does something which has the effect of putting a creditor into a better position than he would have been in if the debtor went into insolvent liquidation, had the preference not taken place. Further, that the company was influenced by a desire to prefer that creditor over other creditors.
Generally, the desire to give preference is presumed where the creditor in whose favour the preference was given is connected with the company at the time. For example, a director of the company or a relative of the director or shareholders of the company.
Under section 683 of the Insolvency Act, where a company has at a ‘relevant time’ given a preference to a person, the court has the power to cancel or void such transaction and restore the position that would have existed had the preference not taken place.
What is regarded as ‘relevant time’ in such matters is defined under section 684 of the Insolvency Act. In the case of a connected person, this is within 2 years of formal insolvency, or between the making of an administration application to the issuance of an administration order, or between lodgment an application for appointment of an administrator and the making of an appointment. In the case of unconnected person, the timeframe is within 6 months of insolvency or the aforesaid events.
The time at which a company enters into a transaction at an undervalue is a relevant time if the transaction is entered into at a time:
- during the two years immediately preceding the onset of insolvency; or
- between lodgment with the Court of a copy of notice of intention to appoint an administrator under section 534 or 541 and the making of an appointment under that section.
For cases where a company does not enter into a transaction at undervalue, the time at which a company gives a preference is a relevant time if the preference is given:
- in the case of a preference given to a person connected with the company (except an employee) -at a time during the 2 years immediately preceding the onset of insolvency;
- in the case of a preference that is not a transaction entered into at an undervalue and is not so given—at a time during the 6 months immediately preceding the onset of insolvency;
- at a time between the making of an administration application in respect of the company and the making of an administration order on the application; or
- at a time between lodgment with the court of a copy of notice of intention to appoint an administrator under section 534 or 541 and the making of an appointment under that section.
A preference claim may arise where directors decide to repay themselves or their family monies owed to them by the company before the company goes through an insolvency process. Such money can be recovered from the directors or the recipient. Preference can also occur where one supplier is treated more favorably compared to other creditors. The directors should take legal advice before undertaking any transaction that could be considered a preference as this will invariably expose them to personal liability.
What are the Remedies for Undervalue or Preference?
As alluded to before, where there are undervalue or preference transactions, the court will normally declare the impugned transaction as void and restore the company to the position it would have been in had the undervalue or preference not occurred. Other remedies that the court will impose in addition to such a revocation and or restoration order include orders that: –
- require property transferred as part of the transaction, or in connection with the giving of the preference, to be vested in the company;
- require the property to be so vested if it represents the application either of the proceeds of sale of property so transferred or of money so transferred;
- release or discharge (in whole or in part) any security given by the company;
- require any person to pay, in respect of benefits received from the company, such amounts to the relevant office-holder as the court may specify;
provide for any surety or guarantor whose obligations to a person were released or discharged (in whole or in part) under the transaction, or by the giving of the preference, to be subject to such new or revived obligations to the person as the court considers appropriate.
What are the transactions defrauding creditors?
This is a transaction at an undervalue entered into for the deliberate purpose of putting assets beyond the reach of a person making a claim against the company (now or in the future).
Under the Insolvency Act, this occurs where a director or other officer of the company has made or caused to be made a gift or transfer of, or charge on, or has caused or connived at the levying of execution against, the company’s property. It can also happen where there is concealment or removal of any part of the company’s property since, or within the two months preceding, the date of any unsatisfied judgment or order for the payment of money obtained against the company.
Under the insolvency law, such transactions will attract both criminal and civil sanctions. Therefore, where at the conclusion of the examination as contemplated under section 504 of the Insolvency Act, the court finds that the director examined has engaged in the impugned conduct, it may make an order compelling the director to repay, restore or account for the money or property or any part of it, with interest at such rate as the court considers appropriate. In addition, the court may order such person to contribute such amount to the company’s assets as compensation for the misfeasance, breach of fiduciary or other duty as the court considers fair and reasonable.
Having discussed transactions and conduct likely to result to personal culpability of directors, in our last article we shall be offering practical solutions on how personal liability can be avoided.