LPC

What is a transaction defrauding creditors?

This is effectively a transaction at an undervalue made by an individual (or by a company; see above at sections 12 of this Chapter) (s.423(1)), but where it must additionally be proved that the intention or purpose of the transaction was to put assets beyond the reach of creditors of the individual or otherwise prejudice their interests (s.423(3)). In this respect, ‘creditors’ includes future creditors who were unknown at the time of the transaction.

Who may bring a claim?

Since claims under s.423 may, but do not necessarily, relate to insolvency, an
application to the court to set aside the transaction can be made by (s.424):

• a supervisor of a voluntary arrangement;
• a trustee in bankruptcy or the OR; or
• a victim of the transaction in question.

What is the ‘relevant time’?

There is no ‘relevant time’ or period within which the transaction must have taken place. However, generally speaking, the more recent the transaction, the more likely it is that the applicant will be able to show the necessary intent.

Sanction

The court may make such order as it thinks fit to restore the position to what it would have been, but for the transaction in question (s.423(2)). A nonexhaustive list of orders is set out in s.425.

Note: Since it is a pre-requisite of a claim under s.423 that the transaction was at an undervalue, where the challenge is made by a trustee in bankruptcy, it may be easier to establish the claim under s.339 if the claim satisfies the criteria for challenging an undervalue transaction under the above sections (i.e. ‘relevant time’ and insolvency). This is because under s.339 it need not be proved that the purpose of the transaction was to put the assets beyond the reach of creditors or otherwise prejudice them.

Purpose

The purpose is to prevent a creditor obtaining an improper advantage over other creditors of the individual at a time when that individual is insolvent.

Who may bring a claim?

A trustee in bankruptcy (s.340(1)).

What is a preference? – s.340(3)

An individual gives a preference to a person if:

• that person is a creditor (or a surety or guarantor of his debts or liabilities); and
• the individual does anything or suffers (i.e. allows) anything to be done which has the effect of putting that person into a position such that if the individual were to go bankrupt, that person would be in a better position than he/she otherwise would have been in if that thing had not been done.

How and when can a preference be avoided?

A preference is voidable if it was given within the ‘relevant time’ (s.340(1)) i.e. in the six months preceding the date of presentation of the petition leading to the bankruptcy (s.341(1)(c)). The period is extended to two years for preferences to associates (s.341(1)(b) and see s.435).

It must be proved that the individual was insolvent at the time of the preference or became insolvent (meaning either on a cash-flow or liabilities exceeding assets basis) as a result of it (s.341(2)).

It must be shown that the individual was influenced by the desire to prefer the creditor (s.340(4)). This is a subjective test. However, if the preference is given to an associate of the bankrupt individual, there is a rebuttable presumption that the bankrupt individual was influenced by the desire to prefer the creditor (s.340(5)). This shifts the burden of proof from the trustee in bankruptcy to the preferred person to rebut the statutory presumption (see s. 435 for ‘associate’).

Sanction

The court has a discretion to make an order to restore the position as if the individual had not made the preference (s.340(2)). Section 342(1) provides a non-exhaustive list of the types of restoration order that the court might make.

Purpose

This concerns loss of value from an individual, whether through gifts or a significant imbalance in consideration, to the individual’s detriment at a time when he/she is insolvent.

Who may bring a claim?

A trustee in bankruptcy (s.339(1)).

What is a transaction at an undervalue? – s.339(3)

• A gift; or
• a transaction by the bankrupt in consideration of marriage; or
• a transaction for a consideration the value of which in money or money’s worth is significantly less than the consideration provided by the bankrupt.

When and how can the transaction be avoided?

The transaction is voidable if it took place within the ‘relevant time’ (s.339(1) – in the five years preceding the date of presentation of the petition leading to the bankruptcy (s.341(1)(a)).

It must be proved that the individual was insolvent (on a cash-flow or liabilities exceeding assets basis) at the time of the transaction or became insolvent as a result of it only if the date of the transaction was two to five years before the date of presentation of the petition (s.341(2)).

Insolvency of the bankrupt is presumed (subject to rebuttal) where a transaction at an undervalue is entered into with an ‘associate’ of the bankrupt (s.341(2) and see s.435).

Sanction

The court has a discretion to make an order to restore the position as if the individual had not entered into the transaction (s.339(2)). Section 342(1) provides a non-exhaustive list of the types of restoration order that the court has power to make under s.339 (and also under s.340 in relation to voidable preferences).

Any such order should not prejudice a subsequent purchaser from the party which transacted at an undervalue with (or received a preference from) the bankrupt individual, provided he/she was acting ‘in good faith and for value’ (s.342(2)).

However, under s.342(2A) there is a rebuttable presumption that an acquisition by a subsequent purchaser was not in good faith where the subsequent purchaser either:

• had notice of the relevant surrounding circumstances (i.e. the transaction at an undervalue or preference) and of the relevant proceedings; or
• was an associate of or connected with either the bankrupt individual or the person who transacted at an undervalue with (or received a preference from) the bankrupt individual.

In such circumstances, the burden of proof shifts to the subsequent purchaser to show good faith.

As with corporate insolvencies, bankruptcies can give rise to challenges of certain transactions that took place within specified statutory periods before the making of the bankruptcy order. There is a high degree of overlap in the terminology of the transactions as they apply in a bankruptcy but certain key details and time periods differ. A trustee in bankruptcy seeking to challenge any voidable transaction (save for a transaction defrauding creditors under s.423) will need to ask the following questions in each case:

1. Did the transaction involve an ‘associate’?
2. Did the transaction take place within the ‘relevant time’?
3. Was the transferor (i.e. the person who has become bankrupt) insolvent at the time of the transaction or did he/she become insolvent as a result of it?
4. Is there a presumption available which shifts the burden of proof from the trustee in bankruptcy to the other party?

s.339 – Transaction at an undervalue

Relevant time prior to onset of insolvency – 5 years
Is insolvency required at date or as a result of transaction? – No – if less than 2 years, Yes – if 2-5 years
Presumption available? (If yes, burden of proof shifts) – 2-5 years: insolvency presumed for associates

s.340 – Preference to an associate

Relevant time prior to onset of insolvency – 2 years
Is insolvency required at date or as a result of transaction? – Yes
Presumption available? (If yes, burden of proof shifts) – ‘Desire to prefer’ presumed

s.340 – Preference to a non-associate

Relevant time prior to onset of insolvency – 6 months
Is insolvency required at date or as a result of transaction? – Yes
Presumption available? (If yes, burden of proof shifts) – No

s.423 – Transactions defrauding creditors

Relevant time prior to onset of insolvency – No relevant time
Is insolvency required at date or as a result of transaction? – No
Presumption available? (If yes, burden of proof shifts) – No

The meaning of an ‘associate’ is given in s.435.

The ‘relevant time’ periods for the purposes of ss.339 and 340 are defined in s.341(1) and are calculated backwards from the date of the individual making his/her bankruptcy application or (as the case may be) the presentation of the petition for the individual’s bankruptcy.

Litigation expenses

Any challenge by the trustee in bankruptcy will involve litigation expenses. A major factor to be taken into account by the trustee in bankruptcy will be the cost of any legal challenge, given the inevitable risk that if the challenge fails, the assets will have been diminished (by the legal expenses and any adverse costs incurred) rather than increased.

As an alternative to bankruptcy, an individual debtor might be able to persuade his creditors to agree to proposals to ‘settle his affairs’. IVAs are particularly useful (if no special circumstances warrant investigation) where some assets are available immediately for distribution.

Basic initial procedure

The basic initial procedure will depend largely on whether an interim order is required or not. The interim order provides the debtor with protection – a moratorium – from their creditors taking action against them personally (and their assets) until the IVA proposal is considered and voted on. Whether or not this is required will depend on the facts of each case. Generally speaking, an interim order is more necessary in cases where a risk of independent creditorled enforcement action threatens the success of the proposed IVA.

If an interim order is required

The debtor makes an application to court for an interim order (s.253 and rule 8). In addition the debtor makes proposals, usually with assistance from an insolvency practitioner or a person authorised by a body recognised by the Secretary of State for the purpose (and sometimes even after a bankruptcy petition has been presented against him), setting out proposals and details of the intended supervisor of the arrangement (rule 8.3) and prepares a statement of affairs (full details of his assets and liabilities) (rule 8.5). The nominee (usually the insolvency practitioner who has assisted the debtor with his proposals) submits a report to the court stating his opinion as to whether the arrangement has a reasonable prospect of being approved and implemented and whether a creditors’ meeting should be called (s.256).

The application for an interim order prevents a landlord from exercising any right of peaceable re-entry and/or distress for rent (without the court’s consent) and court permission is required before a creditor can take or continue with any action, execution or other legal process against the debtor or his property (s.254).

If the court thinks it appropriate, the interim order is granted in order to facilitate and implement the proposals. The order brings about a moratorium, freezing existing or proposed bankruptcy and other proceedings and legal process (including execution, landlord’s right of peaceable re-entry and/or distress for rent) against the debtor, without leave (in any such case) of the court (s.252). The interim order (and the moratorium) lasts 14 days (s.255(6)) which the court can extend, during which the nominee must submit his report to the court recommending that the proposals have a reasonable prospect of being approved and implemented and that creditors’ approval should be sought.

If no interim order is required

This procedure will be used where the debtor does not require the protection of the moratorium (granted as a result of an interim order). The debtor similarly makes proposals and prepares a statement of affairs both of which are submitted to the nominee (s.256A). If the nominee is of the opinion that the debtor is an undischarged bankrupt or is able to petition for his own bankruptcy, the nominee submits a report to the court within 14 days after receipt of the proposals and statement of affairs. The report gives his opinion as to whether the arrangement has a reasonable prospect of being approved and implemented and whether a creditors’ meeting should be called.

Creditors’ approval

The nominee must seek creditors’ approval to the debtor’s IVA proposal. That approval must be given through one of the statutory creditor decision procedures (s.257(2A). It is of interest to note that the traditional way of giving approval by a vote taken at a physical creditors’ meeting will now be the exception and not the rule.

Every creditor given notice of the debtor’s IVA proposal is entitled to vote on the proposal. An IVA proposal is approved if at least 75% by value of creditors voting on the decision respond in favour (rule 15.34(6)(a) but an IVA is not approved if more than 50% (by value) of creditors who are not associates of the debtor vote against it (s.258 and rule 15.34(6)(b)).

As with Company Voluntary Arrangements, secured creditors’ rights to enforce their security and preferential creditors’ rights to their preferential position cannot be affected without their consent (ss.258(4) and 258(5)).

Effect of approval

Approval of the IVA binds all creditors who were given notice of, and entitled to vote on the creditor decision and will also bind all creditors who would have been entitled to vote, had they been given notice (who are nevertheless entitled to claim as if they were party to the IVA). Any dissenting minority creditors who voted against the proposals are, and any creditors who were not given notice of the creditors’ meeting will be, entitled to challenge the creditor decision approving the IVA in circumstances where there has been a material irregularity or if the creditor’s interest has been unfairly prejudiced. The court has discretion and wide powers in those circumstances. As with CVAs, an IVA only becomes binding if it is not successfully challenged on these grounds. A challenge must be made within 28 days of certain trigger dates (the most important being the date the creditors’ decision was taken or the day on which the complainant became aware of the creditors’ decision).

Implementation of proposals – s.263

The nominee becomes known as the supervisor of the IVA with responsibility to implement the proposal and pay out dividends to creditors. He can apply to the court for directions and must report to creditors and the court periodically on progress.

Advantages of IVAs

• The debtor can avoid going into bankruptcy.
• The IVA will bind dissenting creditors.
• A moratorium is available if an interim order is made.
• Generally, they are flexible, fast and effective.

However, with the usual term of an IVA being several years (and likely to involve income payments to creditors for that period), bankruptcy (see below, in particular regarding the shortened discharge period) may now be seen by the debtor as the softer option.

Arrangements outside of IVAs

A non-bankrupt debtor is free to reach a settlement with individual creditors. Consumer debtors are generally advised to do so by the Citizens’ Advice Bureau. No particular formalities are required. However, if the debtor is
proposing a composition with three or more of his creditors or his creditors generally, there is the possibility that the written agreement could require registration, or a trustee be required, under the Deeds of Arrangement Act
1914.

The bankruptcy process (s.264)

The bankruptcy process is initiated in one of two ways:

• by the insolvent debtor applying online for his/her own bankruptcy to a bankruptcy adjudicator; or
• by a person who is entitled to do so by presenting a bankruptcy petition to the court requesting the court to make a bankruptcy order against the debtor.

The main persons who can present a bankruptcy petition are (i) a creditor (the usual petitioner or (ii) the supervisor of an IVA (or creditor bound by an IVA in certain circumstances) (s.264).

Adjudication of debtor’s own application

If the debtor applies for his/her own bankruptcy, the only ground permitted is inability to pay his debts. In addition, the application must be accompanied by particulars of the debtor’s affairs (to include information regarding his assets and liabilities); s.263J.

Grounds of creditor’s petition

The most common ground for a petition is that the debtor appears to be unable to pay (or has no reasonable prospect of being able to pay) his debts referred to in the petition (s.267). Inability to pay must be demonstrated by proving either:

• that a statutory demand has neither been satisfied within 3 weeks from service of that demand, nor set aside by the court on application (within 18 days) in accordance with the rules; or
• that there has been an unsatisfied execution of a judgment.

Other requirements for a creditor’s petition

The debt must be for a liquidated sum exceeding £5,000, generally unsecured (but subject to some exceptions under.269) and the debtor must have his/her centre of main interests located in England and Wales or, if that centre is not in an EU member state, must be domiciled, ordinarily resident or have carried on business in England and Wales in the three years before the presentation of the bankruptcy petition (s.265).

The bankruptcy order

The making of the order is at the discretion of the adjudicator or the court (as the case may be) and they will make the order if the grounds for the application or petition and other requirements are satisfied and the adjudicator or the court deems it appropriate in the circumstances. If a bankruptcy order is made, all the rights, interests and assets of the bankrupt vest automatically as a matter of law in the trustee in bankruptcy (s.306).

Usually, the first trustee will be the Official Receiver (the “OR”), a civil servant working for the Insolvency Service, a Government department. As such, the sensitive area of personal bankruptcy is one which may give rise to applications under the Human Rights Act 1998 with reference to the First Protocol to the European Convention on Human Rights, Article 1 (right to peaceful enjoyment of possessions), Article 6 (right to a fair trial) and Article 8 (right to respect for private and family life).

The bankrupt is deprived of ownership of his property, subject to some limited exceptions. These include his personal earnings to the extent necessary to meet the reasonable domestic needs of the bankrupt and his immediate family (s.310(2)). He must provide a statement of affairs to the OR within 21 days of the order (unless the OR dispenses with this requirement). He is (whilst undischarged) prohibited from doing a number of things, including acting as a director or being involved in the management of a company, obtaining credit of over £250 without disclosing that he is a bankrupt, giving gifts and practicing in certain professions (including as a solicitor) or acting as certain public officers e.g. as a M.P. or J.P.

The trustee in bankruptcy

As stated above, the first trustee is usually the OR. Alternatively, in more complex or asset-rich bankruptcies, an insolvency practitioner from the private sector may be appointed as trustee instead at the time of the making of the bankruptcy order or subsequently by a creditor decision made by a majority of creditors by value voting on the matter. Creditors are entitled to require the OR to seek a creditor decision on his replacement if at least one quarter in value of creditors so require. If there are insufficient funds to bear the costs and fees of a private trustee, the OR is likely to remain the trustee.

The trustee’s role is to ‘get in, realise and distribute the bankrupt’s estate’ (s.305(2)) in accordance with the provisions of IA 1986.

The bankrupt is under an obligation to pass over present and future assets to the trustee. The trustee may claim for the benefit of the bankrupt’s estate assets acquired by the bankrupt after the making of the bankruptcy order and before the bankrupt is discharged (s.307(1)).

The trustee has wide statutory powers to sell or otherwise deal with the assets in the estate and generally; s.314 and is under various statutory duties. His ability to retire and the right to remove him from office are governed by IA 1986 and the Insolvency Rules.

Three years from the date of the bankruptcy, any interest (not already realised by the trustee in bankruptcy) that the bankrupt had in his, his wife’s or his former wife’s home will vest back in the bankrupt, subject to certain exceptions; s.283A.

The trustee in bankruptcy holds office until he believes he has completed the administration of the estate. Many bankruptcies continue after the bankrupt has received his discharge from bankruptcy.

Assets in the bankruptcy

The trustee will collect in the assets (and may disclaim any onerous property or contracts pursuant to ss.315-317), including those assets which may be available to swell the estate as a result of challenging certain fraudulent or undervalue transactions or preferences. The trustee must distribute the estate in accordance with the statutory provisions (ss.322-332 and rule 14).

Distribution of assets

Subject to the procedure for the submission, agreement and determination of creditors’ claims (known as “proving a debt”), the trustee must give notice to the creditors of realisations, deductions, retentions and the amount by way of dividend (if any) that is available for distribution. The final distribution will take place only when the trustee has realised all of the assets that he can and distributed them in the prescribed order of priority.

Priority of payment

The order of priority for payment is on the basis that debts within one class are only payable if debts in earlier classes have been fully paid. The order is as follows:

• secured creditors (but limited to the value of the security itself and ranking with ordinary unsecured creditors for any excess amount owing);
• expenses of the bankruptcy;
• specially preferred creditors (training/apprenticeship fees); s.348;
• preferential creditors (similar to those on corporate winding up); see s. 386 and Schedule 6;
• ordinary unsecured creditors;
• statutory interest;
• debts of a spouse or civil partner (must be provable but they are postponed to other creditors); and
• any surplus is payable to the bankrupt.

Discharge of bankruptcy

There is an automatic discharge after a maximum period of one year (s.279). The OR or the trustee in bankruptcy may apply for an order suspending the automatic discharge if the bankrupt fails to comply with his obligations under IA 1986 e.g. to inform the trustee of all the assets he owned. The bankrupt may be discharged in less than a year if the OR files a notice stating that the bankruptcy does not require investigation under s.289 or stating that he has concluded any such investigation within the one year period. Previously, there was a duty of the OR to investigate each bankruptcy. However, in many cases it was obvious why the bankruptcy arose and so the Enterprise Act 2002 removed the need for an investigation of each case.

The effect of discharge is that the bankrupt is released from most of the bankruptcy debts; s.281. He is also released from the personal restrictions mentioned above.

Prior to the Enterprise Act 2002 coming into force, bankruptcy usually lasted for three years as opposed to the current one year. This may be one of the reasons why the number of personal insolvencies is high as debtors may view bankruptcy as a less onerous procedure than was previously the case.

Bankruptcy Restriction Orders (BROs)

The Secretary of State, or the OR acting on the Secretary of State’s direction, may apply to the court for a BRO if the court considers it appropriate having regard to the conduct of the bankrupt (before or after the bankruptcy order). Behaviour to be taken into account is listed in Schedule 4A and includes failure to keep records, entering into preferences or transactions at an undervalue, fraud and incurring a debt without reasonable expectation of being able to pay it. Generally, the application must be made within a year of the start of the bankruptcy. This year period will be extended if the one year bankruptcy discharge period is extended under s.279.

A BRO will operate for a period of between two and fifteen years. For the duration of the order, the bankrupt is unable to act as a director or obtain credit of more than £250 without disclosing that he is subject to a BRO. It is expected that this will have a more severe effect on the bankrupt’s ability to obtain credit than the equivalent restriction on bankruptcy given the nature of the debtor’s behaviour resulting in the BRO. Breach of a BRO will be a criminal offence punishable by fine and/or imprisonment.

Instead of being subject to court process, a bankrupt can offer the Secretary of State a bankruptcy restriction undertaking (BRU) which, if accepted, will have the same effect as a BRO.

Debt Relief Orders (DROs)

A debt relief order provides a mechanism for debtors with few assets and little income over and above their domestic needs to obtain a release from their debts, where those debts are less than £20,000, thereby avoiding bankruptcy proceedings. A DRO provides the debtor with protection lasting one year from their creditors taking steps to enforce their debts without court permission. At the end of that year, the debtor is discharged from their liability for those debts – there is no asset realisation or distribution to creditors (although creditors may receive some payment if the debtor’s circumstances significantly improve during that period).

Overview

Just as the directors of a company need to be able to recognise when a company is in financial difficulty, individuals need to be able to do the same.

The indicators of an individual in financial difficulty are largely the same as those for a company. An individual faces similar choices to those faced by company directors when deciding what to do when financial difficulties arise.

An individual can:

1. Do nothing and hope that his/her financial circumstances will improve or the creditors will be accommodating or docile.
2. Do a deal with some or all of his/her creditors.
3. Declare him or herself bankrupt.

As for corporate insolvency, personal insolvency can lead to collective procedures (involving all creditors) and enforcement procedures (usually led by one or more secured creditors). Examples of collective procedures are bankruptcy (which is broadly the equivalent of liquidations for companies) and an individual voluntary arrangement (“IVA”) (which is broadly similar to a CVA) and an example of an enforcement procedure would be a secured creditor enforcing a charge or mortgage over the bankrupt’s assets by appointing a receiver.

What is a transaction defrauding creditors?

Claims under s.423 do not necessarily relate to insolvency. However, where there has been a transaction at an undervalue the same circumstances will fulfill the requirements of s.423(1). It must additionally be proved that the intention or purpose of the transaction was to put assets beyond the reach of creditors of the company or otherwise prejudice their interests (s.423(3)). This even includes future creditors who were unknown at the time of the transaction.

Insolvency practitioners may prefer to bring claims under s.238 than under s. 423. The reason is that, under s.238, it need not be proved that the purpose of the transaction was to put the assets beyond the reach of creditors or otherwise prejudice them.

It is a pre-requisite of both a claim under s.423 and under s.238 that the transaction was at an undervalue. Where the challenge is made by an administrator or liquidator, it may therefore be easier to establish the claim under s.238, assuming that the claim satisfies the criteria for challenging an undervalue transaction under the above sections (i.e. ‘relevant time’ and insolvency). The main advantage of a claim under s.423 is that it does not face the risk of becoming time-barred in the same way as a claim under s.238.

Who may bring a claim?

An application to the court to set aside the transaction can be made by any of the following (s.424):

1. a liquidator or an administrator;
2. a supervisor of a voluntary arrangement; or
3. a victim of the transaction in question.

Example: ABC Limited transferred a property to its sister company, CBA Limited, for a value substantially less than market value. At the time of the transaction, ABC Limited had been under pressure from its creditors. A creditor of ABC Limited, as a victim of the transaction, may be able to make an application to the court under s.423 to set aside that transfer if the requisite intent can be shown (although such intent may be difficult to prove).

What is the ‘relevant time’?

There is no ‘relevant time’ or period within which the transaction must have taken place. However, generally speaking, the more recent the transaction, the more likely it is that the applicant will be able to show the necessary intent.

Sanction

The court may make such order as it thinks fit to restore the position to what it would have been but for the transaction in question (s.423(2)). A non-exhaustive list of orders is set out in s.425(1).

Purpose

The purpose of s.245 is to prevent an unsecured creditor obtaining a floating charge to secure an existing loan for no new consideration, at the expense of other unsecured creditors.

When does s.245 apply?

The section only applies in a liquidation or administration. Unlike transactions at an undervalue and preferences, section 245 avoids certain floating charges automatically and without the need for the office-holder to challenge the floating charge by bringing legal proceedings (as set out below). However, if there is a dispute between the putative floating charge holder and the office-holder about the application of s.245, legal proceedings may be necessary to determine the dispute.

Which floating charges are void under s.245?

For the floating charge to be invalid:

1. The floating charge must have been created within the ‘relevant time’. The relevant time is 12 months preceding the onset of insolvency, i.e. the commencement of administration or liquidation (ss.245(2) and 245(3)(b)).
   The relevant time is extended to 2 years in the case of a floating charge granted to a connected person (s.245(3)(a)). (See ss.249 and 435 for definitions of ‘connected persons’ and ‘associates’).
2. Unless the floating charge was granted to a ‘connected person’ or an ‘associate’ (in which case there is no insolvency requirement), it must be proved that the company was insolvent (on either a cash-flow or balance sheet basis) at the time of the floating charge’s creation or became insolvent in consequence of the transaction under which the charge was created (s.245(4)).

When a floating charge is valid (s.245(2))

Even if the above requirements are met, a floating charge will be valid to the extent that ‘new money’ or other fresh consideration (which can include goods or services) is provided to the company (or existing debts of the company are extinguished) in return for the grant of the floating charge on or after its creation (s.245(2)).

The effect of s.245(2) is that if a floating charge is granted to secure the repayment of a new loan made on or after the creation of the charge, then it will be valid.

An example of when a floating charge would be void is where an existing unsecured creditor is granted a floating charge by a company which is insolvent (as defined above) and the charge purports to secure the repayment of existing monies owed to that creditor. If s.245 did not apply, such an unsecured creditor would thereby improve its position in the order of priority if the company later went into an insolvency procedure, which would be unfair on the company’s other unsecured creditors. However, if (and to the extent that) an existing unsecured creditor provides further credit to the company (or to the extent that any other new credit is given by a new creditor) then that creditor is entitled to have the protection of a valid floating charge.

Overdrafts

Commonly a company will grant its bank a floating charge under a debenture as security for an overdraft on its current account. Much of the potential practical significance of s.245(2) is removed in current account lending cases by the decision of the Court of Appeal in Re Yeovil Glove Co. Ltd. [1965] Ch 148.

In that case, the company’s current bank account was overdrawn by about £67,000 and unsecured. The bank was only prepared to permit continued operation of the current account in overdraft (at a maximum limit of £67,000) if the company granted it a floating charge, which the company did (at a time when it was insolvent). The company then continued to trade for a further 8 months until the bank appointed an administrative receiver to enforce its floating charge and ceased operation of the bank account. During that 8 month period, the company’s account was continuously in overdraft; the company paid about £110,000 into the account from its trading activities, and drew out about £110,000. When the receiver was appointed, the company owed the bank about £67,000 under the overdraft i.e. the same amount it had owed when the floating charge was created. A few months later trade creditors petitioned for the company’s winding up. The liquidator applied for a declaration that the floating charge was invalid as it related to the unsecured pre-charge indebtedness (£67,000 ‘old money’) and not ‘new money’. Only if the liquidator were successful would the unsecured trade creditors receive a dividend in respect of their claims. Otherwise, the bank would receive all of the company’s remaining assets under the floating charge security granted in respect of the overdraft.

It was held that the floating charge was valid for the entire £67,000 overdraft debt owing when the receiver was appointed.

This may seem surprising, given that the result was to change an overdraft for about £67,000 which was not backed by a floating charge into an overdraft for about the same sum which was. The reasoning is as follows:

1. Each time the bank allowed the company to draw on its overdraft facility after the floating charge was created, for example by honouring cheques drawn by the company, ‘new money’ was deemed to have been advanced by the bank after the creation of the floating charge; and
2. Payments made by the company into its bank account after the creation of the floating charge discharged the oldest pre-charge indebtedness first (i.e. the unsecured £67,000 ‘old money’) rather than the ‘new money’ advanced by the bank post-charge. This is an application of the rule in Clayton’s Case (Devaynes v Noble [1816] 1 Mer. 572) which provides that in the absence of contrary intention, payments into a bank account discharge the earliest advances made by the bank first. Thus, as the company had paid more than £67,000 into the account since the grant of the floating charge, it could be said that all of the pre-floating charge debt of £67,000 had been paid off and that the £67,000 balance on the overdraft at the date the floating charge was enforced by the appointment of the receiver represented new debt i.e. new money advanced by the bank after the date the floating charge had been created.

Miscellaneous points

1. Where a floating charge is void under s.245, only the security (and its advantage to a floating charge creditor in the order of priority) is void and not the debt itself.
2. Remember also that a floating charge is void against a liquidator, administrator and other creditors if it is not duly registered with Companies House under s.859H CA 2006.
3. A floating charge granted to a creditor may also be voidable as a transaction at an undervalue or preference under ss.238 and 239.

Purpose

The purpose is to prevent a creditor obtaining an improper advantage over other creditors of a company at a time when that company is insolvent.

Who may bring a claim?

Only a liquidator or an administrator may make an application to court to challenge a preference (s.239(1)).

What is a preference? (s.239(4))

A company gives a preference to a person if:

1. that person is a creditor of the company (or a surety or guarantor of any of the company’s debts or liabilities); and
2. the company does anything or suffers (i.e. allows) anything to be done which has the effect of putting that person in a better position in the event of the company going into insolvent liquidation than he/she would otherwise have been in.

An example of a preference would be paying an unsecured creditor in priority to other creditors.

When and how can the preference be avoided?

The preference is voidable if:

1. It was given within the ‘relevant time’ (s.239(2)) – in the 6 months preceding the ‘onset of insolvency’ (s.240(1)(b)), being the commencement of the relevant insolvency procedure (s.240(3)).

   The relevant time is extended to 2 years for preferences to connected persons and associates (s.240(1)(a)). (See ss.249 and 435 for definitions of ‘connected persons’ and ‘associates’).

2. It is proved that the company was insolvent (on either a cash flow or balance sheet basis) at the time of the transaction or became so as a result of it (s.240(2)).

   In contrast to transactions at an undervalue, there is no statutory presumption of insolvency where the preference is given to a person who is connected with the company.

3. It is proved that the company was ‘influenced … by a desire’ to prefer the creditor (s.239(5)). This is a subjective test. The company must have positively wished to put the party in a better position (see Re MC Bacon Ltd example below).

   If the preference is given to a connected person or associate, there is a rebuttable presumption that the company was influenced by the desire to prefer the creditor (s.239(6)). This shifts the burden of proof from the liquidator or administrator to the preferred person to rebut the statutory presumption. (See ss.249 and 435 for ‘connected persons’ and ‘associates’).

Defence

The defence available is an absence of the desire to prefer required by s. 239(5).

In Re MC Bacon Ltd, the company granted fixed and floating charges to its bank to secure an existing overdraft, as a condition of the bank not calling in the overdraft, at a time when it was insolvent.

It was held that it is not necessary to prove an intention to prefer (which is objective), but a desire to prefer (which is subjective). On the facts, the security could not be challenged as a preference because the directors, in granting the security, had not been influenced by a desire to prefer the bank, but only by the desire to continue trading and to avoid the calling in of the company’s overdraft (i.e. the security was granted as a result of genuine commercial pressure exerted by the lender and the presence of such pressure negated any desire on the debtor’s part to prefer the lender).

Sanction

The court has a discretion to make an order to restore the position as if the company had not given the preference (s.239(3)). S.241(1) provides a nonexhaustive list of the types of restoration order that the court may make.

Ss.241(2) and 241(2A) apply to both preferences and transactions at an undervalue.