UK Court Rules Debtor Cannot Use Corporate Vehicle to Evade Liability
Key Takeaways
- Section 423 of the Insolvency Act 1986 allows for the reversal of certain transactions at an undervalue that are intended to prejudice the interests of creditors. The scope of Section 423 is extensive and may be used to challenge transactions that seek to defraud creditors even in the absence of any corporate or personal insolvency.
- Where a debtor causes a company that he owns and controls to transfer assets in an attempt to frustrate enforcement action, those transfers can be challenged as transactions at an undervalue under section 423 even though the debtor is not personally a party to the transaction in question and the assets do not belong to him.
Invest Bank PSC v El-Husseini and others [2023] EWCA Civ 555
Summary
An alleged judgment debtor was said to have attempted to frustrate the creditor’s enforcement efforts by transferring assets held through companies owned and controlled by him to members of his family. The Court of Appeal concluded that neither the fact that the assets in question did not belong to the debtor, nor the fact that the debtor did not himself transfer the assets but rather was the means through which the companies acted, precluded an action under Section 423 to challenge those transfers as transactions defrauding creditors.
Background
Section 423 allows for the reversal of transactions at an undervalue that are intended to prejudice the interests of creditors. While it has long been clear this section applies to transactions transferring away the debtor’s own personal assets, there has been uncertainty as to whether it also covers transfers of assets owned by a company belonging to the debtor.
Facts
The claimant bank, established in the United Arab Emirates, (the "Bank") alleged that it had judgment debts against the First Defendant, a Lebanese businessman, from proceedings brought in the UAE. The Bank alleged that the First Defendant had taken steps to disguise his beneficial ownership of certain assets or to cause them to be transferred to members of his family (the Second to Sixth defendants) with a view to putting them beyond the reach of, or otherwise prejudicing the interests of, his creditors.
The Bank sought:
- declarations that the First Defendant still held the beneficial interest in the assets legal title to which had been transferred to his family members; and
- relief under Section 423 regarding the assets on the basis that the steps allegedly taken by the First Defendant involved a "transaction at an undervalue" or "transaction defrauding creditors" entered into for the purpose of putting assets beyond the reach of or otherwise prejudicing the interests of creditors.
At a preliminary hearing at first instance, Mr Justice Baker held that:
- where a debtor causes a company he owns and controls to transfer an asset at an undervalue, Section 423 is not applicable unless the debtor acted separately in a personal capacity and not only as the instrument by which his company acted; and
- a "transaction" could be entered into within the meaning of section 423 of the Act if the assets are not beneficially owned by the debtor.
The Bank appealed the first of these issues, and the Second and Third Defendants (the "Defendants") appealed the second.
Decision
In the Court of Appeal Lord Justice Singh delivered a reasoned judgment with which Lord Justices Males and Popplewell agreed.
The Bank’s Appeal
The Court of Appeal found that the Judge had fallen into the error of assuming that, because the company can only act through a human person, and because in law the act is treated as the act of the company, it could not also have some legal significance in respect of that person.
The Judge had relied upon the fundamental legal doctrine of the separate legal personality of a limited company, and the Defendants had also relied upon the well-established principle that the company's assets are not owned by the shareholders of the company. Both of these principles held true even where the company had a sole director and a sole shareholder.
The Court acknowledged that while the separate legal personality of the company has to be respected, it was not the case that the First Defendant had done nothing. Clearly, he had taken actions as a matter of fact, and it was then a question whether those actions had any other legal significance in the context. The context in this case was whether the First Defendant’s alleged actions could fall within Section 423 – the Court of Appeal concluded that they could.
The Court of Appeal took this view on the basis that the language of Section 423 was very broad and the interpretation proposed by the Bank better served the purpose of the legislation, i.e., to prevent transactions defrauding creditors. This purpose could otherwise be easily frustrated through the use of a limited company to achieve the debtor’s purpose of prejudicing the interests of his creditors.
The Court of Appeal therefore allowed the Bank’s appeal.
The Defendants’ Appeal
The Defendants argued that Section 423 only applied to assets owned by the debtor. The basis for this argument was:
- The case of Clarkson v Clarkson [1994] BCC 921 (CA) was binding authority for the proposition that a 'transaction' in this context must involve the giving away of property that would otherwise have formed part of the debtor’s bankruptcy estate.
- Corporate assets belonging beneficially to a company do not belong beneficially to its shareholder and so would not fall within the scope of its shareholder’s bankruptcy.
The Court of Appeal rejected the Defendants’ argument. The Court concluded that the decision in Clarkson, which was a case involving Section 339 of the Act, had turned upon the meaning of the word "property" in the context of bankruptcy; that was not the relevant question here because the First Defendant was not bankrupt. Although Section 339 was, in some ways, similarly drafted to Section 423, they operated in different contexts as Section 423 applied where there was no insolvency.
The Court of Appeal ultimately concluded that the Judge had been correct to follow the decision in Akhmedova v Akhmedov [2021] EWHC 545 (Fam), where the Judge had concluded that "The concept of a "transaction" is to be construed broadly. In particular, it does not matter that the relevant transfers were made by a company owned by the judgment debtor rather than by the judgment debtor himself." The Judge in that case went on to say that "This reading of s.423 is plainly correct because, otherwise the protective purpose of the statute could easily be sidestepped by a sophisticated debtor simply causing companies he owned to transfer their assets away."
Analysis
Section 423 can be a powerful tool for creditors that applies even where the debtor is not insolvent.
This decision represents a welcome clarification of the law that will enhance the ability of creditors to take effective enforcement action against recalcitrant debtors. The outcome is surely the correct one as the alternative would be to allow a fairly significant lacuna whereby debtors could frustrate enforcement efforts through the use of corporate structures.
In its judgment, the Court of Appeal reiterated the principle of separate legal personality for companies, and it remains the case that ‘piercing the corporate veil’ is more challenging in England and Wales than it is in some other jurisdictions. However, this decision shows that, alongside measures such as worldwide freezing injunctions, the English Courts do have measures at their disposal that allow creditors to unwind structures intended to conceal or protect a debtor's assets.