When a winding up order is made against a company and it enters insolvent liquidation, the company’s assets are distributed equally amongst creditors of the same class.
The principal aim of insolvency law is to seek to achieve a fair and equal distribution of assets amongst creditors. This would not be able to happen if the law disregarded transactions which took place prior to winding up. Therefore, the law enables some transactions made by a company prior to the onset of insolvency to be returned to the company, which swells the asset pool and increases the assets available for distribution.
This is of particular relevance to directors who, realising liquidation is imminent, seek to order the company’s affairs to benefit themselves (or friends or family) to the detriment of the other creditors. Sometimes, third parties are benefited randomly at the expense of creditors without any impropriety on behalf of the directors. However, the law is not concerned with the reason why a person has benefited, it is simply concerned with an equal distribution of assets amongst creditors.
The powers of liquidators to challenge certain transactions are detailed in s.238-241 and s.244 and s.246 of the Insolvency Act 1986.
The first type of transactions which can be challenged are transactions at an undervalue (i.e. gifts and transactions for less than their market value). For a liquidator to persuade a court to make an order adjusting a transaction at an undervalue, he or she must establish that:
- the company is in liquidation;
- the company entered into a transaction at an undervalue in the two years before the onset of insolvency; and
- at the time when the transaction at an undervalue took place, the company was unable to pay its debts or became unable to pay its debts as a result of entering into the transaction
Where the assets transferred at an undervalue were transferred to a person connected with the company (i.e. a director or close relative of a director) then there is a presumption that the company was insolvent at the time of the transaction.
The second type of transaction which can be challenged are preferences. A preference is where a creditor is paid prior to the onset of insolvency and received more than they would have done following the insolvency process. For a liquidator to successfully attack a transaction as a preference, he or she must establish that:
- the company is in liquidation;
- the transaction was entered into within 6 months prior to the onset of insolvency (which is extended to 2 years if the transaction was made to a person connected with the company – e.g. a director);
- the other party to the transaction is one of the company’s creditors;
- the company put the recipient of the preference into a position which is better than if the thing had not been done;
- the company was influenced by a desire to enable the recipient to have a preference; and
- at the time, or as a result of giving the preference, the company was unable to pay its debts.
With preferences, the ‘motive’ of the company is very important as the company must be influenced by a desire to enable the recipient of the transaction to have a preference. It was decided in the important case of Re MC Bacon Ltd  BCLC 324 that this essentially means that the Company must have positively wished to improve the position of the creditor.
Determining the desire of an individual is difficult and the complexity of the task is compounded further in the case of a company. However, if the preference was given to a person connected with the company, then there is a presumption that the company was influenced by a desire to give a preference to that person.
Another way in which liquidators can seek to swell the asset pool of an insolvent company is by bringing a claim against a director for wrongful trading. If a liquidator successfully brings a claim against a director, a court may order the director to contribute to the assets of the company in liquidation.
In brief, a liquidator must establish that the director at some point prior to the commencement of the winding up knew or ought to have known that there was no reasonable prospect of the company avoiding going into insolvent liquidation and, despite this, continued to trade. There is a defence available to directors which is to show they took every step possible to minimise the potential loss to the company’s creditors.
The recovery of assets is a complex area and it can lead to protracted litigation. It is therefore vital to obtain expert legal advice if you are being pursued by a liquidator in relation to the recovery of assets transferred to you by an insolvent company.
Paul Davis is a Solicitor at BHW Solicitors in Leicester and regularly writes on contentious insolvency matters. Paul can be contacted on 0116 281 6231 or by email at email@example.com.