Bermuda: Clawbacks In Insolvency - September 9 2019

Fraudulent Preferences and Conveyances under the Bermuda Companies Act 1981

Creditors should exercise caution when negotiating payment terms, asset transfers or securitisation transactions with companies which are in the zone of insolvency. Such transactions are vulnerable to being set aside by liquidators or by other creditors in the event of the insolvency of the company. The purpose of Bermuda's reviewable transactions law is to uphold the pari passu basis for the distribution of a company's assets amongst its unsecured creditors in an insolvency context.

Zone of Insolvency

In normal circumstances, when a company is in good financial health, a director's primary duty is to act in the best interests of the company by promoting shareholder value in the company. However, when a company is insolvent, or is in the "zone of insolvency", this duty shifts such that a director is obliged to instead have primary regard to the interests of the creditors. This is because in an insolvency context, it is the creditors who have an economic interest in the company, rather than the shareholders.

So how does one determine when a company is in the "zone of insolvency"? There is no simple answer to this question and there is no bright line test which can be applied to ascertain whether a company is or is not in the zone of insolvency. As a general proposition, the "zone of insolvency" can be thought of as the period where there has been a serious deterioration of a company's financial position, to the point where there is a reasonable expectation that insolvency has become imminent.

What does "insolvency" really mean?

In Bermuda, section 161(e) of the Companies Act 1981 (the "Act") provides that a company may be wound up by the Court if it is "unable to pay its debts". Section 162 of the Act provides that when considering whether a company is unable to pay its debts, the Court can take into account both the cash flow and balance sheet tests for insolvency.

Fraudulent Preferences

Transactions involving payments to a certain creditor or creditors made within six months of a company's winding up are susceptible to being set aside as a fraudulent preference of its creditors if it can be established that:

  1. the transaction was undertaken with the intention to fraudulently prefer one or more of the company's creditors; and
  2. at the time of the transaction, the company was unable to pay its debts as they fell due.

Practitioners of other common law jurisdictions may be more familiar with the other terms used to describe what is known in Bermuda as a fraudulent preference, i.e. an unfair preference, a voidable preference, a reviewable transaction or an antecedent transaction.

Section 237 of the Act governs fraudulent preferences in Bermuda. Section 167(1) of the Act provides that the six month relation-back period is deemed to commence upon the date of the presentation of the winding up petition to the Court, rather than the date that the winding up order is made.

Section 237 of the Act governs fraudulent preferences in Bermuda. Section 167(1) of the Act provides that the six month relation-back period is deemed to commence upon the date of the presentation of the winding up petition to the Court, rather than the date that the winding up order is made.

Because the transaction must have been undertaken with the intention to fraudulently prefer one of the company's creditors over its general body of creditors, the liquidator of the debtor company must establish the mental state of the debtor company (i.e. the mental state of its directors) at the time it decided to enter into the transaction. This is a notoriously difficult undertaking. The commentary of Lord Justice Smith in New, Prace & Gerrard's Trustees v Hunting and Others [1897] 2 QB 19 is instructive:

"I have always understood that to ascertain whether there has been a fraudulent preference, it is necessary to consider what the dominant or real motive of the person making the preference was, whether it was to defraud some creditors by preferring others, or for some other motive".

The Privy Council has also recently considered the 'intention to fraudulently prefer' point, noting that a dominant intention to prefer can be inferred from the fact that one creditor was paid in circumstances where it was well known that other creditors were likely to not be (Skandinavska Enskilda Banken AB v Conway and another (as Joint Official Liquidators of Weavering Macro Fixed Income Fund Limited) [2019] UKPC 36). Given that this was an appeal from the Courts of the Cayman Islands, it is not strictly binding on the Courts of Bermuda, however, it would be considered to be strongly persuasive in Bermuda. View Walkers' summary of the case here.

While the debtor company's intentions are critical, the mental state of the allegedly preferred creditor is irrelevant. This means that a completely innocent third-party creditor can nevertheless find themselves subject to clawback (see Re Stealth Construction Ltd [2011] EWHC 1305).

When a transaction runs afoul of section 237 as a fraudulent preference, that transaction is voidable at the instance of the liquidator. Upon a fraudulent preference being proven to the satisfaction of the Court, orders will typically be made setting aside the transaction as a nullity, and unwinding the transaction so as to restore the company to the position it would have been in had it not given the preference. It should also be remembered that a director who causes a company to give an unfair preference may be liable for breaches of his fiduciary duties owed to the company pursuant to section 97(1) of the Act and at common law.

The primary defence to a fraudulent preference action is to seek to establish that the transaction was not undertaken by the company with the intention of defrauding its creditors by preferring some over others. This is a question of fact. It is also potentially open to the creditor to assert a set-off defence, if it can be proven that there were "mutual dealings" between the insolvent debtor company and the creditor and, additionally, that the creditor did not have notice that the debtor company was insolvent. The issue of mutuality of dealings will be determined in accordance with section 235 of the Act, which imports substantively section 37 of the Bermuda Bankruptcy Act 1989.

Fraudulent Conveyances

Part IV A of the Bermuda Conveyancing Act 1983 (the "Conveyancing Act") deals with fraudulent conveyances, that is to say, dispositions which are made with the dominant intention of putting property beyond the reach of creditors, where such disposition is at an undervalue.

Part IV A of the Conveyancing Act is Bermuda's take on a long line of legislate enactments in the common law world dealing with fraudulent conveyances which dates back to the Statute of Elizabeth of 1571. Although it is a somewhat dense statutory instrument, its broad scope means that it is often relied upon by creditors of Bermuda companies to seek to have a transaction set aside. By way of example:

  1. . The scope of "disposition" is exceptionally broad, applying to "any disposition...of property of any nature whatsoever and however effected". This would include assignments or compromises of debt or other rights, gifts, transfers or any other forms of conveyance.
  2. The definition of property is equally wide: "money, goods, things in action, land and every description of property wherever situated and every description of interest, whether present or future or vested or contingent, arising out of, or incidental to, property".

For the purposes of the Conveyancing Act, a "creditor" is a person who is owed an obligation as at the date of the impugned conveyance, or to whom it is reasonably foreseeable an obligation will be owed within two years of the date of the transfer, or to whom an obligation is owed pursuant to a cause of action which accrued before, or within, two years after the date of the transfer.

The Conveyancing Act imposes clear limitation periods for bringing actions to recover an allegedly fraudulent conveyance. Those limitation periods differ depending on whether the eligible creditor was a current creditor, a contingent creditor or a contingent creditor whose cause of action accrued within two years after the date of the disposition of the property. Depending on the class of eligible creditor, the limitation period can range from six to eight years from the date of the allegedly fraudulent conveyance.

Floating Charges

Section 239 of the Act provides that in the event of a company's winding up, any floating charges on the undertaking or property of the company created within twelve months of the commencement of the winding up shall, unless it is proved that the company immediately after the creation of the charge was solvent, be invalid, except for the amount of cash paid to the company in consideration for the charge, together with interest thereon.

Conclusion

Creditors of Bermuda companies should exercise caution and take advice before entering into transactions with companies which are in the zone of insolvency, as such transactions can be vulnerable to attack in the event of a company's insolvency or liquidation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions