Transaction Avoidance in the Cayman Islands Insolvency context: Dispositions at an undervalue - Section 146 of the Companies Act
Synopsis
In the Cayman Islands, as elsewhere in the common law world, there are transaction avoidance provisions enshrined in statute that are designed to preserve, so far as possible, an insolvent debtor’s available assets, in order that they may be distributed to creditors fairly on an equal footing.
Those provisions are to be found in the Cayman Companies Act. They concern voidable preferences (under Section 145), dispositions at an undervalue (under Section 146), and fraudulent trading (under Section 147).
In Volume 18 (2021) of this publication, the authors analysed the operation of Section 145 and the consequences of its application: see Transaction Avoidance in the Cayman Islands Insolvency Context: Voidable Preferences under s145 of the Companies Act.
This article considers the avoidance of dispositions at an undervalue under Section 146, with a particular focus on the origins of the provision and how the expression “intent to defraud” is likely to be construed.
Origins of Section 146 of the Cayman Islands Companies Act
Section 146 was introduced in 2009 alongside a swathe of other changes intended to give effect to recommendations made by the Law Reform Commission in its April 2006 review of Cayman’s corporate insolvency law. That review had found that the law which existed at the time was unduly complex because it was derived from a combination of 19th century legislation, inappropriate foreign rules and local case law.[1]
In relation to dispositions at an undervalue specifically, the review also noted that whereas the Fraudulent Dispositions Law[2] provided a remedy for creditors of companies prejudiced by undervalue dispositions, the effectiveness of that remedy in the insolvency context was limited by the fact that a liquidator would not fall within that definition. That being the case, the intention behind the introduction of the Section was therefore “to put the liquidator in the same position as the creditors.”[3]
As a result, there is a great degree of overlap between, on the one hand, Section 4 of the Fraudulent Dispositions Act[4], and on the other hand, Section 146 of the Companies Act. The principal difference is that, under the former, a disposition is only set aside to the extent necessary to satisfy the obligations owed to the relevant creditor (plus costs), whereas there is no such limitation under Section 146[5].
Section 146: an overview
Section 146 provides that every disposition of property made at an undervalue by or on behalf of a company with intent to defraud its creditors shall be voidable at the instance of its official liquidator, whereby:
- a disposition is widely defined (by reference to the Cayman Islands Trusts Act[6]) to mean every form of conveyance, transfer, assignment, lease, mortgage, pledge or other transaction by which any legal or equitable interest in property is created, transferred or extinguished;
- an undervalue is defined to mean, in relation to a disposition, either the provision of no consideration for the disposition or the provision of consideration for the disposition the value of which in money or money’s worth is “significantly less” than the value of the property subject to the disposition;
- an intent to defraud is defined to mean an intention to wilfully defeat an obligation (see the definition immediately below) owed to a creditor; and
- an obligation (which is referred to in the definition of intent to defraud) is defined to mean an obligation or liability (which includes a contingent liability) which existed on or prior to the date of the relevant disposition.
The applicable limitation period for actions brought under Section 146 is six years from the date of the relevant disposition.
Intention to defraud: a comparison with relevant provisions of the English Insolvency Act 1986
Notably, Section 146 imposes a burden on the liquidators to demonstrate an intention to defraud[7].
Practitioners in England and Wales will immediately recognise that there is no requirement to demonstrate such an intention under Section 238 of the Insolvency Act 1986 (being the English equivalent provision). There, the emphasis is different: office holders are entitled to seek an order from the Court in respect of any transaction at an undervalue, but subject to a defence where the transaction is legitimate (i.e. where the company entered into the transaction in good faith and for the purposes of carrying on its business, and at a time when there were reasonable grounds for believing that the transaction would benefit the company).
There was, however, a requirement to show an intention to defraud in the predecessor to Section 423 of the English Insolvency Act 1986[8], which addresses transactions defrauding creditors (and which is very similar to Section 4 of the Cayman Islands Fraudulent Dispositions Act). What was meant by an intention to defraud was, however, uncertain[9] and the requirement was criticised by the Cork Committee in its 1982 review of English Insolvency Law and Practice[10]. For example, in Lloyds Bank Ltd v Marcan[11] the defendant, having become aware that the bank had applied for possession of his property, granted a 20-year lease to his wife in order to enable his family to remain in the home. The English Court of Appeal held that the defendant’s intention was to deprive the bank of the ability to obtain vacant possession and to diminish the bank’s position as creditor. To take such action was less than honest: it was sharp practice and it followed, therefore, that he had acted with an intent to defraud. Russell LJ stated that where a person disposes of an asset which would have been otherwise available to creditors, with the intention of prejudicing them, he will not be acting honestly and the intention can be inferred.[12] Cairns LJ, however, held the Section required something further, noting that fraud must be established before a transaction can be avoided.[13]
There is no longer any reference to an intention to defraud in the operative wording of Section 423[14]: what is required is that the transaction must have been entered into for the purpose of putting assets beyond the reach of a creditor (or contingent creditor), or otherwise prejudicing that creditor’s interests in relation to the claim. However, although the "intention to defraud" language is now obsolete in England and Wales, it endures in the Cayman Islands (and in some other parts of the Caribbean[15]), where the Companies Act provides helpful guidance, in the form of a definition, as to what is meant by the term. Although that definition has not been addressed in the context of Section 146 specifically, its meaning has been addressed recently in the context of Section 4 of the Fraudulent Dispositions Act, which shares the same definition. So:
- In Johnson v Cook-Bodden,[16] Kellock Ag. J considered a scenario in which a father, who owed debts to creditors and was otherwise in “desperate” financial straits, transferred property to his sons. It was held that the only conclusion possible on the evidence was that the transfer was made in an attempt to put the property beyond the reach of creditors, with the intent wilfully to defeat the debt owing to them.
- In Raiffeisen International Bank AG v Scully & ors[17] the Grand Court has recently held, following English authority[18], that there is a requirement: “to show that it was a purpose of the transferor to defeat its creditors. It need not [be] show[n] that this was the dominant purpose or the sole It follows that the court may be presented with a number of purposes which motivated transfers and that this in itself would not preclude the conclusion that a transfer was made wilfully to achieve the purpose of defeating creditors. The court should look closely at each of the transfers to see if the test was satisfied in each case assuming there is evidence to show that the transfer would have been made in any event or was made for a different and legitimate purpose.[19]”
Treatment of good faith transferees
A transferee is defined to mean the person to whom a relevant disposition is made, including any successor in title (which would include subsequent transferees). In the event that any disposition is set aside under Section 146 then, if the Court is satisfied that the transferee has not acted in bad faith:
- the transferee shall have a first and paramount charge over the property, the subject of the disposition, of an amount equal to the entire costs properly incurred by the transferee in the defence of the action or proceedings; and
- the relevant disposition shall be set aside subject to the proper fees, costs, pre-existing rights, claims and interests of the transferee (and of any predecessor transferee who has not acted in bad faith).
In this respect, the Cayman Islands legislation offers a protection to transferees that is not present in Section 238 of the English Insolvency Act 1986 (which provides a defence where the company has acted in good faith, but which is otherwise completely silent as to the issue of good faith on the part of transferees).
The disposition will be unwound, but the transferee will have the benefit of a form of indemnification in respect of its “properly incurred” costs. The question of what is meant by “properly incurred” costs has not been tested before the courts within the context of Section 146. However, it is suggested that the statute envisages that the transferee’s costs may (to the extent they are not capable of agreement) be subject to a quasi-taxation exercise or alternatively, to the approval of the Court.
The unwinding of the disposition shall also be subject to any other pre-existing rights and interests of the transferee which have accrued following the disposition itself.
Concluding Remarks
While the inclusion of a definition of intent to defraud in the legislation is helpful and makes clear that a defendant must wilfully intend to defeat a creditor, it is suggested that the precise meaning of that phrase may yet give rise to further judicial commentary in the Cayman Islands, as its equivalent provisions have done in England and Wales. In particular, the Cayman Islands Court may need to clarify whether dishonesty is a necessary ingredient for a claim under Section 146 to succeed, as Russell LJ in Lloyds Bank v Marcan seems to have implied and the Cayman Court in Johnson appears to have followed.
There are strikingly few decisions regarding the operation of Section 146, and little by way of academic, professional or extra-judicial commentary either. It remains to be seen whether Section 146 (or indeed Cayman’s fraudulent trading provision, Section 147) will come out of the shadows over the next few years if, as is widely expected in certain circles, the global economic outlook continues to take a downward turn. A study of the relationship between economic decline and the unearthing of fraud is beyond the scope of this article. However, many commentators consider that they are directly correlative (see, for example, a recent press release from Association of Fraud Examiners, which refers to “an explosion of fraud in the coming years”[20]). If that is right, these Sections may soon be moving into the spotlight.
[1]Report of the Law Reform Commission: Review of the Corporate Insolvency Law and Recommendations for the Amendment of Part V of the Companies Law, 26 April 2006, at [2].
[2] Now entitled the Fraudulent Dispositions Act. Effective 3 December 2020, the Cayman Islands Citation of Acts of Parliament Law 2020 came into force, which provides that any enactment that has been a “Law” or contains a reference to the title of a Law, should be amended by omitting the word “Law” and substituting it with the word “Act”.
[3] Ibid at [11.1].
[4] Effective 3 December 2020 (see footnote 2 above).
[5] As explained in Transaction Avoidance in Insolvencies, Third Edition (Parry, Ayliffe QC, Shivji) at [22.76].
[6] There is reference in Section 146 to “Part VI of the Trusts Law”. This is likely to be an erroneous reference to Part VII of the Trusts Act.
[7] Section 146(3) of the Companies Act.
[8] Section 172 of the Law of Property Act 1925.
[9]The Law of Insolvency (5th Ed, 2017, Fletcher Q.C.), [8-119].
[10]Insolvency Law and Practice, Report of the Review Committee, Cmnd 8558, para 1212.
[11] [1973] 1 WLR 1387.
[12]Lloyds Bank Ltd v Marcan [1973] 1 WLR 1387 at 1390-1391 per Russell LJ.
[13]Lloyds Bank Ltd v Marcan [1973] 1 WLR 1387 at 1392 per Cairns LJ.
[14] Although the section itself is entitled Transactions defrauding creditors, there is no further reference to ‘fraud’ at all.
[15] For example, the Bahamas and Anguilla.
[16] [1999 CILR 399].
[17] Unreported, 7 July 2020 at [114].
[18]JSC BTA v Ablyazov [2019] B.C.C. 96 and IRC v Hashmi [2002] B.C.C. 943.
[19] Emphasis in the original.
[20]Coronavirus pandemic is a perfect storm for fraud https://www.acfe.com/press-release.aspx?id=4295010491 (31 March 2020). See also Think Pandemic-Related Fraud is Going Away? Think Again. https://www.acfe.com/press-release.aspx?id=4295015900 (9 September 2021).
This article first appeared in Volume 19, Issue 3 of International Corporate Rescue, and is reprinted with the permission of Chase Cambria Publishing.
