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Alex Hill-Smith, barrister at New Square Chambers, says the appeal in Pathania v Lewis and Okonye clarifies the statutory test to be applied in cases where a judgment creditor has been disadvantaged by the sale of assets at an undervalue.
Pathania v Lewis and Okonye  EWHC 362 (Ch),  All ER (D) 61 (May)
Section 423 of the Insolvency Act 1986 (IA 1986) provides a useful remedy for a judgment creditor with an unsatisfied judgment in circumstances where the judgment debtor has sought to avoid making payment by divesting themselves of assets by transferring them to a third party at no or less than full consideration (at an undervalue). It not infrequently occurs that a judgment debtor transfers an asset to a family member in order to avoid having pay to their debts. IA 1986, s 423 applies to transfers made by companies as well as individuals.
IA 1986, s 423, is an unusual provision within the context of the IA 1986 in that it can provide a remedy to a creditor even if the debtor is not subject to any insolvency process such as bankruptcy, winding up or voluntary arrangement. So the creditor may have a remedy without the need to go to the expense and delay of making the debtor bankrupt or winding up a corporate debtor. If, however, the debtor is already bankrupt or subject to a winding up, IA 1986, s 423 can be utilised by the trustee in bankruptcy or liquidator.
The requirements for relief are that:
It is the question of the purpose underlying a particular transfer that is often the central point of contention in applications made under IA 1986, s 423. But note that it is the purpose of the debtor in entering into the transaction that is relevant, not the state of mind of the recipient of the asset—the extent to which the recipient knows of the relevant intention is relevant only to the question of remedy, which is discretionary and which may or may not involve the reversing of the transaction.
The flexible nature of the jurisdiction, and the robust approach of the courts in considering the statutory tests, was emphasised by the Court of Appeal in Hill v Spread Trustees  EWCA Civ 542,  1 All ER 1106.
In this case, the debtor was the owner of a house situated on a large plot. He obtained planning permission to demolish the house and build two new houses in its place. However, he could not afford to finance the work himself, so he borrowed the money from the claimant.
The building project was duly completed and two houses created. While the claimant was in India for reasons unconnected with the case, and without the debtor having repaid anything to the claimant, the debtor then disposed of the houses in private sales, described by the master as ‘collusive’.
One of these sales was to the defendant, Ms Okonye. The sale price was realistic, but the contract of sale provided for payment of a deposit equal to 38% of the price. In fact, no deposit monies were paid by Ms Okonye at the time of the transaction. Ms Okonye contended that the deposit represented repayment of monies previously lent by her to the debtor, but her evidence in this respect was not accepted by the master, who found that the transaction was at a substantial undervalue by virtue of the non-payment of any deposit monies. He also found that the claimant was a victim for the purposes of the statutory test as the claimant was capable of being prejudiced by the transaction. Nevertheless, at first instance, the master denied the claimant relief.
The master made that decision reasoning that the sale of the house would have happened anyway, as the debtor was behind with his mortgage payments and the lender, with a first charge over the house, was seeking and would have obtained possession and sale of the property in any event. The master held that the debtor would then have dissipated the sale proceeds such that the claimant would have received nothing in any event. The master therefore held that since the sale to Ms Okonye had not left the claimant any worse off because he would have received nothing anyway, the claimant was not entitled to any remedy.
The judge allowed an appeal from the master. There was no justification for the court introducing a test of causation as the master had done, and it was inconsistent with the analysis of the Court of Appeal in Hill v Spread Trustees. What mattered was the purpose behind the transaction, and there was no further requirement that the transaction should actually have been detrimental to the claimant, only that it was capable of being so (in order for the claimant to qualify as a victim). The judge found that the purpose behind structuring the transaction in this way was self-evidently to prejudice the creditors of the debtor, so that the statutory purpose was established and the statutory pre-conditions for a remedy were fulfilled.
The judge then turned to remedy and applied the reasoning of Mrs Justice Rose in BAT Industries v Sequana SA  EWHC 211,  All ER (D) 176 (Feb), noting that when the statutory criteria for a remedy are established, the court will normally prefer the interests of the creditors over that of the recipient and will fashion a remedy accordingly. Here the judge ordered that the amount of the undervalue should be paid directly by the defendant to the claimant, there being no evidence of any other creditor.
The case shows the utility of the statutory remedy, but also the need to stick closely to the statutory criteria and not introduce any additional test of causation.
Alex Hill-Smith is a barrister in New Square Chambers, Lincoln’s Inn, and a Recorder. He is an experienced Chancery practitioner whose practice extends to insolvency and property litigation generally. He is also a published author in the field of consumer credit law.
Interviewed by Emily Meller.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.
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Transactions defrauding creditors—claims under section 423 of the Insolvency Act 1986
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