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The Nature and Purpose of Transaction Avoidance in English Corporate Insolvency Law

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The Nature and Purpose of Transaction Avoidance in English Corporate Insolvency Law (2014) 2 NIBLeJ 2 The Nature and Purpose of Transaction Avoidance in English Corporate Insolvency Law Hamish ANDERSON* Introduction 1 Insolvency law without any rules on transaction avoidance is conceivable, but unlikely to be found in practice. Rules on transaction avoidance were a feature of Roman law and rules, which differ in detail but which serve broadly similar purposes, are a feature of all developed legal systems. 2 In terms of English legislation, laws on transaction avoidance came earlier than our first insolvency statute. Thus an enactment in 1376, during the reign of Edward III, provided that property given by debtors to friendly third parties remained available to be taken in execution by the debtor’s creditors,1 whereas the founding statute providing for a bankruptcy law was not enacted until 1542, during the reign of Henry VIII.2 This neatly illustrates a point which remains equally true today, namely that transaction avoidance overlaps with insolvency law but can go wider. Thus, notably, section 423 of the Insolvency Act 1986 “Transactions defrauding creditors” can be invoked by a victim of the transaction even though no insolvency proceedings are taking place.3 Of course, transaction avoidance in the very widest sense takes in rules which have nothing to do with questions of solvency (for example the rules on contracts procured by mistake or misrepresentation and some of the provisions of the Companies Act 2006 regulating transactions by and with directors), but the focus of this article is on rules the application of which is predicated on actual or anticipated insolvency. * Hamish Anderson is a Partner in Norton Rose Fulbright LLP, London and Visiting Professor at the Nottingham Law School. This article is based on an LLM seminar given at the Nottingham Law School on 11 March 2014. 1 50 Ed 3 c6 “Fraudulent assurances of land or goods, to deceive creditors, shall be void”. 2 34 and 35 Hen 8 c4 “An act against such persons as do make bankrupts”. 3 Section 424, Insolvency Act 1986. 4 Nottingham Insolvency and Business Law e-Journal 3 Any examination of the nature and purpose of insolvency transaction avoidance necessarily requires clarity as to which rules are being considered. For the purposes of this paper, insolvency transaction avoidance covers all rules whereby consensual dealings4 which would otherwise be binding on a company and its counterparty may be rendered ineffective, set aside or adjusted by reason of factors which include the actual or anticipated insolvency of the company. The most obvious examples of such insolvency-related rules are those concerning preferences, transactions at an undervalue and transactions defrauding creditors, but the rules are more far-reaching than that. They include rules on post-commencement dispositions, transactions offending anti-deprivation and pari passu principles, unenforceable securities, extortionate credit and disclaimer.5 4 The temptation to identify transaction avoidance rules narrowly must be resisted. Disclaimer is the example which makes the point. Amongst other things, the rules on disclaimer enable a liquidator to procure the discharge of the company from its obligations under an unprofitable contract. Although different in function from, say, preference rules, disclaimer in every sense results in a transaction which would otherwise be binding on a company being set aside in consequence of its insolvency and such a transaction is therefore a vulnerable transaction. A narrow focus on only those rules which are concerned with clawing back assets into the insolvent estate encourages circularity of reasoning, whereby those rules are analysed so as to demonstrate that the restorative function is itself the rationale of all transaction avoidance rules, which therefore do not include rules which do not have a restorative function – a self-fulfilling analysis.6 Sources of the Law 5 Before considering the actual grounds for transaction avoidance in English insolvency law, it is convenient to consider the sources of the rules which are the subject of this article. Insolvency transaction avoidance has common law origins, but has long since been largely the preserve of legislation (now the Insolvency Act 1986). After the statutes of Edward III and Henry VIII already mentioned, stronger measures were enacted during the reign of Elizabeth I.7 The answer to the question of how far, if at all, common law transaction avoidance now survives, is that there is no room for discrete common law avoidance in any area covered by the provisions of the Insolvency Act 1986, but that there is a continuing role for the 4 The requirement for the rule to bite on consensual dealings excludes, for example, section 183 avoiding the effects of an incomplete execution. 5 For an explanation of all these terms, if unfamiliar, see “Grounds for avoidance” below. 6 An analysis which is (rightly in the author’s view) eschewed in R. Parry, J. Ayliffe and S. Shivji, Transaction Avoidance in Insolvencies (2nd ed) (2011, OUP, Oxford). 7 13 Eliz I c5 “An act against fraudulent deeds, alienations, etc.” and 13 Eliz I c7 “An act touching orders for bankrupts”. The former statute dealing with transactions defrauding creditors remained in force until superseded by section 172, Law of Property Act 1925. Anderson: The Nature and Purpose of Transaction Avoidance 5 common law in matters where the Act is silent, notably the anti-deprivation rule and the pari passu principle, both of which can prevent the operation of contractual arrangements which would otherwise bind the estate. 6 The position is different in Scotland. The survival of Scottish common law rules on transaction avoidance was explicitly confirmed by the Inner House of the Court of Session in Bank of Scotland v Pacific Shelf (Sixty Two) Ltd, where the court held:8 “We have no doubt that the petitioners have the rights of creditors at common law. The common law conferred upon creditors the right to challenge certain actions by their debtors. There is no reason in principle why, after 1856, this right should not, in the absence of statutory provision to the contrary, have been available against debtors who happened to be limited companies. We are in complete agreement with the opinion of the Lord Ordinary that this right has survived successive statutory enactments regulating the affairs of limited companies. As my Lord in the chair pointed out in the course of debate, it would not have been difficult to restrict the common law rights of creditors in clear language if that had been the intention of the legislature. In our opinion those rights could only be abrogated by clear statutory provision or necessary implication. We were not referred to any such statutory provision and the implications point in the opposite direction. It was said by way of criticism of the petitioners that they were unable to found on any relevant authority. Be that as it may, the obvious answer to that criticism is that the soundness in law of the basis of the petition is clear beyond argument.” 7 The English approach has been to treat the common law as a guide to the interpretation of statutory provisions which have replaced it. This can be demonstrated by reference to the rules on preference, where there was a developed common law jurisdiction in bankruptcy prior to statutory intervention and where there is some pertinent high authority on the continuing role of common law. The first legislative statement of the preference rule was section 92 of the Bankruptcy Act 1869.9 In Ex parte Blackburn; In re Cheesebrough, Bacon CJ in the Court of Chancery, dealing with the (then) requisite intention to prefer, held:10 “Although the Bankruptcy Act, 1869, is the first statute which contains an express and direct enactment on the subject which has long been known and called and dealt with by the name of ‘fraudulent preference’, and although that statute lays down the law in phrases not used in the preceding statutes, I have no reason to think it introduces any new principle applicable to the subject.” 8 In Butcher v Stead, the issue was the statutory defence of a bona fide purchaser as to which Lord Cairns said in the House of Lords:11 8 (1988) 4 BCC 457, at 460. 9 The Joint Stock Companies Act 1856 and successive Companies Acts from 1862 until 1985 simply applied the bankruptcy law on preferences. 10 (1871) LR 12 Eq 358, at 363. 11 (1874-75) LR 7 HL 839, at 846. 6 Nottingham Insolvency and Business Law e-Journal “There is no doubt that the 92nd section of the Act of 1869 introduced a considerable change into the law on this subject. Before the Act of 1869, payments by way of fraudulent preference were held to be void, but were not forbidden by any express enactment; and the Act of 1869… appears, in the case of fraudulent preferences and many other similar cases, to have endeavoured to reduce into definite propositions the law that hitherto had to be derived from a comparison of decided cases. The Act, however, did not profess to express the existing law without making considerable changes in it. In the case of fraudulent preference, for example, in place of raising an inquiry whether it was done in contemplation of bankruptcy, the Act provided certain definite tests, namely, that the bankrupt should have been at the time unable to pay his debts, as they became due, from his own moneys, and that he should become bankrupt within three months from the date of payment. The Act appears to have left the question of pressure as it stood under the old law; and, indeed, the use of the word ‘preference’, implying an act of free will, would, of itself, make it necessary to consider whether pressure had or had not been used…” 9 The court went on to give effect to the new statutory defence.
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