The Insolvency Act 1986 Transactions by individuals who ...

Information
June 2011
The Insolvency Act 1986
Transactions by individuals who subsequently
become bankrupt
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Introduction
Businessmen and others who face the
possibility of being adjudged bankrupt, may
well seek to take steps before this actually
happens to protect their assets against a
trustee in bankruptcy. This information
sheet is intended to provide a brief guide to
some of the main legal considerations.
The relevant legislation is now contained in
the Insolvency Act 1986, in particular
Sections 336-349 and Sections 423-425.
Basic rules
1 If a donor makes a gift, it can be set
aside by a trustee in bankruptcy if it was
made within 2 years of the presentation
of the bankruptcy petition, irrespective of
whether the debtor was insolvent at the
time of, or as a result of, the transaction.
2 If a gift is made between 2 and 5 years
prior to the presentation of the
bankruptcy petition, the transaction can
be set aside if the donor is insolvent at
the time of the gift, or becomes insolvent
in consequence of the gift. A donor is
insolvent if he is unable to pay his debts
as they fall due, or if the value of his
assets is less than the amount of his
liabilities, taking into account his
contingent and prospective liabilities.
3 A gift can be set aside by the court
without time limit (and this applies
whether insolvency proceedings of any
kind have been taken) if a donor makes
a gift and the court is satisfied that the
gift was made for the purpose of putting
assets beyond the reach of a person
who is making, or may at some time
make, a claim against him, or of
otherwise prejudicing the interests of
such a person in relation to the claim
which he is making, or may make.
Types of gift at risk
The legislation does not refer to gifts as
such, but to transactions at an undervalue.
These arise where a donor transfers an
asset to another person, or otherwise enters
into a transaction with another person, on
terms that provide for the donor to receive
no payment, or where the value of the
payment received is significantly less than
the value of the asset transferred.
The legislation also allows for a trustee in
bankruptcy to challenge preferences given
by an individual. These exist where there is
a creditor of the individual (or a surety or
guarantor for any of his debts or liabilities)
and the individual does anything, or allows
anything to be done, which has the effect of
putting that other person into a position
which, in the event of the individual's
bankruptcy, would be more favourable than
it would otherwise have been.
In many cases consideration will be given to
making gifts, but these further provisions
relating to preferences should also be borne
in mind.
Transactions within the 2 year
period
If a transaction at an undervalue takes place
within 2 years of the day on which the
bankruptcy petition is presented, then the
trustee of the bankrupt's estate may apply
to the court for an order, and the court may
make such order as it thinks fit "for restoring
the position to what it would have been if
that individual had not entered into that
transaction". The precise remedy would
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June 2011
The Insolvency Act 1986
Transactions by individuals who subsequently become bankrupt (continued)
depend on the asset concerned and how it
had been dealt with, but it can be seen that
the obvious remedy is for the court to order
the property gifted to be transferred back, to
be vested in the trustee of the bankrupt's
estate and held as part of that estate.
Transactions within the 2 to 5
year period
Gifts within a 2 year period are extremely
vulnerable, but once 2 years has been
exceeded then there is some scope for
protecting an asset given away.
The gift will be caught if the donor is
insolvent at the time he makes the gift, or
becomes insolvent in consequence of the
gift.
A donor will be deemed to be insolvent if he
is unable to pay his debts as they fall due,
or if the value of his assets is less than the
amount of his liabilities, taking into account
his contingent and prospective liabilities.
The Act does not define the terms
"contingent" and "prospective", but they are
clearly different tests, and in each case
there are the two questions of whether a
liability exists and, if so, the amount of such
liability. Furthermore, it is unclear whether
these matters are to be considered in the
light of the perception of the donor at the
time the gift is made, or as may
subsequently prove to have been the case
with the benefit of hindsight.
In most cases such a gift will be to "an
associate" of the donor. An associate is
defined as the donor's spouse* or relative,
or the spouse of a relative of the donor or of
the donor's spouse. A trustee is an
associate if the beneficiaries of the trust
include the donor or an associate of the
donor, or if such persons could be benefited
by the trustee exercising a power under the
settlement. There are also provisions
relating to partnerships and companies.
The significance of whether the recipient of
the gift is an associate is that, where this is
the case, it is presumed that the donor was
insolvent before or after making the gift,
unless the contrary can be shown. With a
gift to someone who is not an associate
(which is likely to be far less common) there
is no such presumption and the donor's
insolvency would have to be proved.
Transactions over 5 years
previously
These provisions apply without time limit.
They look to the motive of the donor and
catch transactions entered into for the
purpose of putting assets beyond the reach
of a person who is making, or who may at
some time make, a claim against the donor,
or of otherwise prejudicing that person's
interests in respect of such claim or possible
claim.
This part of the legislation can apply
whether or not the donor has become
bankrupt, but it does not apply to
preferences, which are limited to the 5 year
period. An order under these provisions
can not only restore the position to what it
would have been, but may also protect the
interests of the victims of the transaction,
which is obviously more extensive.
This power of the court is clearly one to be
borne in mind at all times when gifts are
made, where the protection of the asset in
question is a motive (for example, tax
planning). It is therefore important to be able
to point to some other motive as being the
predominant one, although this may often
not be possible.
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June 2011
The Insolvency Act 1986
Transactions by individuals who subsequently become bankrupt (continued)
What steps can be taken?
1 2 year period
In the 2 year period, a donor is
unlikely to know when bankruptcy might
descend on him. Accordingly, it is not
unreasonable to take the view that the gift
should go ahead. If it is caught within the 2
year period, then there is little that can be
done. The person may be no worse off than
if no such steps had been taken, although
other considerations, whether tax or
personal, may be involved. However, if
there are other earlier transactions which
might be in jeopardy, one must take into
account the possibility that a gift within the 2
year period might cause the trustee in
bankruptcy to look more critically at earlier
transactions than would otherwise have
been the case.
If bankruptcy occurs within 2 years, then the
question of solvency at the time of the gift is
not relevant. Nonetheless, even if disaster is
felt to be imminent, a declaration of
solvency, if it can properly be made, should
be dealt with. If the donor avoids
bankruptcy within the 2 year period, then
such a declaration, made at the time of the
gift, could well prove invaluable as is
discussed in 7.2 below.
2 2 to 5 years
Here there is some reasonable scope for
making gifts, but early action is absolutely
essential. Much will turn upon the question
of liabilities which are contingent or
prospective, and it is very difficult to be
certain of how this definition would be
judged. Obviously any liabilities, which have
been estimated must clearly be brought into
account, but prospective liabilities for the
future are far more difficult to determine.
Clearly much turns on the question of
contingent and prospective liabilities, but it
is thought that, in most cases, some
reasonable protection would be given by a
statutory declaration by the donor
concerned, or perhaps someone, such as
his accountant, with detailed knowledge of
his finances, if necessary supported by
financial details.
The passage of time will in itself provide
some assistance. Although a trustee in
bankruptcy will no doubt seek to argue with
the benefit of hindsight, it might prove
difficult for him to counter the argument that
it was impossible to foresee that the
prospective liabilities would be as large as
they turned out to be.
3 Beyond 5 years
Here again, the passage of time in itself will
provide considerable protection. The burden
of proof is on the person seeking to have
the gift set aside, and it will become
increasingly difficult to prove the purpose
behind the gift or that protection against
creditors was the predominant motive.
As a practical matter, it must be preferable
for correspondence with professional
advisers to emphasise, if possible, that the
predominant motive was not that of putting
assets beyond the reach of creditors. For
example, the creation of a settlement may
have that motive, but if there is also the
motive of protecting capital generally for
future generations, and perhaps obtaining
some tax advantages, then this might
legitimately be the predominant
consideration.
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June 2011
The Insolvency Act 1986
Transactions by individuals who subsequently become bankrupt (continued)
Problems with freehold and
leasehold property
There is an important practical
consideration arising out of these rules,
which particularly arises in relation to
freehold and leasehold property. Where the
donee subsequently wishes to sell, a
subsequent purchaser from the donee (and
subsequent purchasers) is protected if he
acquired from a person other than the
individual made bankrupt, and did so in
good faith, for value and without notice of
the relevant circumstances or, once that test
has been satisfied, from any other person
deriving their interest from such person.
Relevant circumstances are those by virtue
of which an order could be made to set
aside the transaction, in other words the fact
that the property had been subject to a gift
or sale at an undervalue.
The protection provided by these provisions
is not very extensive. Solicitors acting for a
purchaser of a property which has
previously been gifted will usually make
appropriate enquiries and the "relevant
circumstances" will often come to light.
People are increasingly finding that these
provisions are presenting difficulties on a
subsequent sale. There is no real remedy,
although it is thought that a well-supported
statutory declaration should cover most gifts
within the 2 to 5 year period. In practice,
insurance policies seem to be the only
solution once a problem has arisen, but
even that may not be sufficient to placate a
worried purchaser.
It should be noted that these problems may
arise not only where a donor has made a
gift to protect the
asset, but for any other reason. In particular,
properties are often transferred between
spouses for reasons in connection with
Inheritance Tax. Such people should be
aware that gifts of this nature may cause
subsequent problems.
Disclaimer
This information sheet has been prepared to
highlight some key issues relating to the
Insolvency Act 1986. It is intended to be for
general guidance only and is not a
substitute for specific advice. It is based
upon our understanding of the legal position
as at January 2010 and may be affected by
subsequent changes in the law. Should you
require any specific legal advice on the
issues covered, please contact Jeremy
Passmore on 01892 510000 or by email at:
jeremy.passmore@ts-p.co.uk
* References to the term 'spouse' include a
civil partner as defined by Section 1 of the
Civil Partnership Act 2004
©Thomson Snell & Passmore
All Rights Reserved
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