Reversed transactions defrauding creditors – is bringing a claim worth the candle or an abuse of process?

Briefing

The High Court recently considered whether a creditor can be a victim to, and obtain relief for, a transaction which is reversed before the claim is even brought and the creditor is put back to the position they were in before the transaction took place.

Timeline

The Bank of Cyprus entered into two facility agreements with Sofroniou & Maria Developers Ltd in 2004 and 2010 respectively, under which Mr Sofroniou (the First Defendant) was a guarantor.

In 2012, the Bank of Cyprus successfully issued proceedings demanding repayment of the amounts under the latter agreement. In January 2017, the Cypriot courts held that the First Defendant was jointly and severally liable for €708,721.49 plus interest and costs.

Four months later, in May 2017, the First Defendant transferred his entire shareholding in Central London Car & Taxi Hire Ltd to his wife, Ms Reid (the Second Defendant and together with the First Defendant, the Defendants) (the Share Transfer). Around the same time, the Cypriot judgment was registered in England. This was stayed in November that same year, pending the outcome of an appeal to the Cypriot Supreme Court.

In August 2018, the Second Defendant returned the share to the First Defendant (the Share Return). Nine months later, the Bank's rights relating to the claim were transferred to Gordian Holdings Ltd (the Claimant), and in December 2019, the Claimant commenced proceedings.

The Claimant's claim

The Claimant sought a declaration that the Share Transfer was a transaction defrauding creditors within s 423 Insolvency Act 1986 (the IA 1986). This was done with a prayer for such relief as the Court thought fit for restoring the position to what it would have been if the Share Transfer had not been made, and for protecting the victims of the Share Transfer.

The Defendants' application

The Defendants in turn applied to strike out parts of the Claimant's claim, together with alternatively seeking "reverse" summary judgment, arguing that because of the Share Return, the Claimant had no claim under s 423. This argument was two-pronged:

given the Share Return took place before the commencement of the proceedings, the Claimant was not a 'victim' for the purposes of ss. 423-424 IA 1986 and had no standing to pursue the claim
in any event, given that the Share Return had taken place, the Court could not grant any relief which would achieve more than had already occurred by virtue of the Share Return, namely that nothing more could be done to restore the position to what it would have been had the Share Transfer not happened.

This in turn made the attainable benefit of the claim so limited that the game was not worth the candle, making the claim an abuse of the Court's process and therefore worthy of strike-out.

Judgment

The Court considered the two arguments in turn:

The Claimant was not a 'victim' under the IA 1986

Section 424(1)(c) of the IA 1986 reads:

"An application for an order under section 423 [to restore the position to what it would have been if the transaction had not been entered into] shall not be made in relation to a transaction except […] by a victim of the transaction."

A 'victim' of a transaction at an undervalue is "a person who is, or is capable of being, prejudiced by [the transaction]" (Section 423(5) IA 1986).

The Defendants argued that, unless the Claimant was a person who was capable of being prejudiced by the impugned transaction at the date of the commencement of proceedings, they were not a victim. The Court disagreed on the following basis:

If a person's interests are prejudiced (or capable of being prejudiced) by the transaction as soon as it occurs, that person then comes within the statutory definition of a 'victim'. The concept of a 'victim' is a deliberately wide one and ss 423-425 IA 1986 are drafted widely, applying to transactions whether the person effecting the transaction has become insolvent.
Nothing in the IA 1986 suggests the 'victim' status can be lost when something else is then unilaterally done by the debtor.
The status of a 'victim' also does not depend on whether the victim has suffered quantifiable loss as a result of the transaction – this only impacts on whether a claim is worth pursuing and whether the Court can and will grant any relief.
While case law indicates that the question of whether someone is a 'victim' must be tested by whether they were a victim at the time of the application, this was not considered relevant here. This test accounts for situations where a person may become a victim sometime after a transaction is entered into, ensuring that the person bringing a claim is indeed a 'victim' by the time an application is made to court. This does not mean those who are immediately prejudiced can then lose their victim status.

The Share Return is the remedy that a court would order under the IA 1986

The Defendants argued that, as any remedy would be restitutionary, it would require the Court to set aside the transaction in question to put the Claimant in the position had the Share Transfer not occurred. As the Share had been returned, no relief could or would be granted. The court disagreed with this.

The Court considered the requirements for striking out and giving summary judgment. A court will not strike out a claim unless it is certain that the claim is bound to fail. A summary judgment should not be granted if a claim has a more than fanciful prospect of success. Here, the Court decided:

The claim was not certain to fail, and it had a more than fanciful prospect of success.
It was not sufficiently clear that no relief would or could be granted to justify striking out the claim or giving summary judgment.
There was actually more than a fanciful prospect that the Court would order the payment of a sum under the IA 1986, notwithstanding the Share Return. This was considering, for example, questions around the diminished value of the Share between various accounts, as well as the possibilities of various benefits for the Defendants arising out of the Share Transfer which might not be immediately apparent.
There were reasonable grounds to believe fuller investigation into the facts after disclosure might add to the evidence and affect the outcome of the case.

The Court therefore dismissed the Defendants' application.

Key takeaways

Once a victim, always a victim is good news for creditors wishing to bring claims for transactions at an undervalue, particularly where the transactions have been reversed. This is also a word of warning to debtors who may be considering transferring assets, as the above sections of the IA 1986 have a wide ambit and apply to transactions whether the person effecting the transaction has become insolvent.

Further, while the Defendants put forward logical and – as even recognised by the Court – attractive arguments in favour of granting a summary judgment, the Court's hesitancy maintains the status quo. This serves as a useful reminder for debtors and creditors alike of summary judgments having one of the highest civil thresholds.