Transactions at an Undervalue and Defrauding Creditors

The time limits within which transactions at an undervalue can be upset under sections 238 and 339 of the Insolvency Act 1986 are reasonably well understood: 2 years for companies and 5 years for individuals.

Section 423 Insolvency Act
Section 423, which deals with transactions at an undervalue that were intended to defraud creditors, is less straightforward. It requires proof of intention – a much more difficult hurdle than simple proof of facts – to upset a transaction successfully. And although there is no statutory time limit, historically the courts were reluctant to extend its reach too far. The recent case Sands v Clitheroe [2006] BPIR 1000 revisits these issues and great care is now required to avoid falling foul of s423.

The facts in the Sands case were that Mr Clitheroe, a practicing solicitor, gifted his interest in his home to his wife. At the time he was solvent and a partner in a fairly secure practice, but he effected the transfer in order to protect the family home in the event of the financial collapse of the partnership. After being made bankrupt 15 years later, and despite all of his creditors being “new”, the court upset the transaction.

The court decided that where the intent of the transaction had been to put assets beyond creditors’ reach, even though the debtor was not engaging in “risky business” and none of the bankruptcy debts existed at the time, the transaction fell within Section 423, for which there is no time limit. Notably, Section 423 applies equally to companies as to individuals.

The case shows that if a transaction is for full value or the reasons for the transaction are other than to put assets beyond the reach of creditors, it will be safe from attack under Section 423, regardless of how long ago the transaction occurred. It is, therefore, imperative that the reasons for a transaction are fully documented rather than leaving a court to assume it was to avoid creditors. The case also highlights that, where there could be a dispute as to value, it would be wise to retain evidence of the basis of valuation well beyond the appropriate statute of limitations period.