Transactions defrauding creditors: Court of Appeal favours wide interpretation of s.423 Insolvency Act 1986

The English Court of Appeal has clarified the interpretation of two aspects of s.423 of the Insolvency Act 1986, the legislation which provides a mechanism for the avoidance of transactions which have been made for the purpose of defrauding creditors: Invest Bank PSC v Ahmad Mohammad El-Husseini [2023] EWCA Civ 555.

The court held that, for the purposes of s.423, it is possible for a debtor to enter into a transaction with a third party, even if in law their acts are regarded as those of a company which they control. Otherwise, debtors would be able to avoid the "clawback" provisions of s.423 simply by relying on a limited company.

The court also found that a "transaction" can be entered into for the purposes of s.423 where the assets transferred are not beneficially owned by the debtor. Section 423 is to be interpreted purposively. A narrow interpretation would defeat the purpose of the provision, which is to prevent transactions designed to prejudice the interests of creditors.

Indeed, the court noted that "transaction" is defined to include an "agreement" or "arrangement", both of which can be interpreted widely. So in many circumstances there may not need to be a transfer of assets at all, let alone of assets beneficially owned by the debtor, for the protection offered by s.423 to come into effect.

Background

Invest Bank PLC (the "Bank"), a public shareholding company established in the United Arab Emirates, asserts that it has judgment debts against the first defendant ("Ahmad") from proceedings brought in Abu Dhabi. The claims in those proceedings were brought on the basis of personal guarantees allegedly given by Ahmad in connection with two credit facilities. The judgment debts are said to amount to c.AED 96 million (c.£20 million).

The Bank brought proceedings in the English High Court, comprising:

1. Primary debt claims against Ahmad on the UAE judgments, or alternatively on the alleged personal guarantees.
2. Secondary claims which variously involve the second to sixth defendants (Ahmad's four sons and their mother), where the Bank seeks to enforce Ahmad's liability through relief relating to various assets, including two London properties, proceeds of sale of a third London property and shares in the eighth defendant (Commodore UK).

The Bank alleges that Ahmad has taken steps to disguise his beneficial ownership of these assets by transferring them to various members of his family, or in some cases causing the company which owned them (and which he allegedly owned and controlled) to transfer them, with a view to prejudicing his creditors. The Bank therefore seeks declarations that Ahmad holds the beneficial interest in the property assets, and relief under s.423 of the Insolvency Act 1986 as regards all of the assets.

Section 423 provides (in summary) that a person enters into a transaction at an undervalue with another person if they make a gift to the other person or otherwise enter into a transaction with them for no consideration, or for a consideration worth significantly less than the consideration they have provided. In such circumstances, the court can make such order as it thinks fit to restore the position or protect the interests of victims, if satisfied that the transaction was entered into for the purpose of putting assets beyond the reach of creditors or otherwise prejudicing their interests.

No trial has yet taken place, but the claimant applied to amend its particulars of claim to add certain claims, and certain of the defendants applied to challenge the court's jurisdiction. In considering these applications, the court was required to address two issues of law regarding the correct interpretation of s.423:

1. Is it possible for a debtor to enter into a transaction with a third party within the meaning of s.423 if their acts are to be regarded in law as acts of a company?
2. Can a "transaction" be entered into within the meaning of s.423 if the assets are not beneficially owned by the debtor?

The High Court (Andrew Baker J) decided the first issue in favour of the defendants, finding that s.423 only applies to a transaction with a third party where the debtor acted separately in a personal capacity and not only as an instrument by which his company acted. However, it determined the second issue in favour of the Bank, finding that "transaction" should be interpreted broadly.

The court's decisions on these issues were appealed by the Bank and the third and fourth defendants respectively.

Decision

The Court of Appeal (Singh, Males and Popplewell LJJ) allowed the Bank's appeal and dismissed the defendants' appeal.

The Bank's appeal

The Bank's fundamental submission was that, where appropriate, the words of s.423(1), "a person enters into a transaction with another person", can and should be interpreted to include "a person who causes a company (which he controls) to enter into such a transaction with another person".

The Bank submitted that s.423 is a wide-ranging provision which should be given a purposive interpretation. The interpretation approved by the High Court would be contrary to the protective purpose of the legislation, as it would allow sophisticated debtors to strip their holding companies of assets without their creditors having recourse to s.423.

In the High Court, the judge relied on the fundamental legal principle of separate corporate personality (Salomon v Salomon & Co Ltd [1897] AC 22). While the Bank accepted this key legal principle, it submitted that the judge's analysis was wrong as it failed to recognise the important distinction between attribution of an agent's acts to a company (the "identification doctrine"), and disattribution of those acts from the agent. The identification doctrine commits the fallacy of suggesting that an agent identified with a company is seen as "embodying" the company.

The Court of Appeal agreed that, while the corporate veil must be respected, it does not follow that an individual will not have done "anything at all" where its acts are attributed to a company. Legal consequences may then be attached to these acts depending on the context.

The context in this instance was whether the acts factually committed by an individual but attributed to a company could fall within s.423. The judge held that they could. The language is very broad, and otherwise the purpose of the legislation could easily be frustrated through a debtor's use of a limited company.

The defendants' appeal

The second issue of law considered by the Court of Appeal pertained to whether a "transaction" could be entered into for the purposes of s.423 when the assets were not beneficially owned by the debtor. The defendants submitted that the High Court judge had erred and that it could not be said that a person could enter into such a transaction unless the subject matter of the transaction was the transfer of assets beneficially owned by that person.

The Court of Appeal disagreed. The defendants' proposed interpretation required reading words into s.423 which were not there. The language of the section was very broad and did not appear to require the transfer of any assets, let alone assets of beneficially owned by the debtor. This was supported by the broad definition of "transaction" in the interpretation provision of the Insolvency Act, which included the words "agreement" or "arrangement".

The court rejected the submission that it was bound by authorities on ss. 238 and 339 of the Insolvency Act 1986 to find that s.423 must involve a transfer of assets which would otherwise have formed part of the debtor’s bankruptcy estate. While s.423 is found in the same Act as the provisions concerning bankruptcy or corporate insolvency, it is in a separate part of the Act and is "unconstrained by the concept of insolvency".

In rejecting the defendants' interpretation of s.423, the court further considered that adopting such a narrow interpretation would defeat the purpose of the legislation itself. Section 423 was designed to protect the interests of actual or potential creditors against transactions at an undervalue. As the overarching purpose of the legislation is to prevent prejudice against the interests of such creditors, there are strong policy reasons in favour of adapting a purposive interpretation of the Act.