In times of financial pressure, it is not unheard of for companies to enter into transactions that turn out, with the benefit of hindsight to be far more disadvantageous than understood, or to act in ways which when reviewed down the line can take on a questionable complexion. That look back might be through the lens of an insolvent winding up or in the context of a counterparty or related interested party exploring ways in which they might unravel a transaction that has not turned out to be what it seemed. It might equally be the result of a new board considering what it has inherited from its predecessors and whether there is a basis for the company to extricate itself from contractual arrangements that appear to have been subject to a conflict of interest or which were for an improper purpose.
In our briefings on Guidance for Directors of Jersey, Guernsey and BVI Companies in Extraordinary Economic Circumstances we looked at the approach that directors of BVI and Channel Islands companies should take to mitigate the risks of alleged breaches of duty and on Wrongful Trading: Business is currently as usual in BVI, Guernsey, Ireland and Jersey at the risk of wrongful trading. Taking those themes forward, it is fair to note that the circumstances in which transactions might be set aside will always be fact specific and can often turn on what was in the minds of the parties involved. Therefore it is hard to draw bright lines in terms of what deals will or won't be susceptible. However, there are common legal provisions and rules that exist and in this note we summarise some of the principal routes in Jersey, Guernsey and BVI law which might be pursued to undo past transactions in different corporate contexts.
Insolvency - statutory provisions
The Jersey, Guernsey and BVI law relating to voidable transactions in the context of a corporate insolvency (which in Jersey could be pursued by way of a creditors' winding up under the Companies (Jersey) Law or a declaration en désastre under the Bankruptcy (Désastre) (Jersey) Law; in Guernsey via a winding up under the Companies (Guernsey) Law, 2008; and in the BVI via a winding up under the Insolvency Act, 2003) all feature elements that will be familiar to those accustomed to English law in this area.
In Jersey, a liquidator (or the Viscount in a Jersey désastre) may apply to set aside transactions at an undervalue and/or which are preferences. There are also provisions relating to the setting aside of extortionate credit transactions. In all situations the Royal Court has wide discretion to restore the position to what it would have been had the company not entered into the transaction, or make other orders.
In Guernsey, a liquidator may apply to the Court to set aside a transaction that constitutes a preference. A creditor of a Guernsey company may also seek to set aside, by use of a customary law remedy known as a Pauline action, a transaction intended to defraud creditors. Impending changes to Guernsey's insolvency laws will, however, introduce statutory claims for liquidators and administrators to set aside transactions at an undervalue.
In the BVI, a liquidator may apply to set aside transactions at an undervalue, transactions that constitute a preference, certain floating charges and extortionate credit transactions. In the case of an unfair preference or an undervalue transaction, the BVI Court may also make such orders as it considers fit for restoring the position to what it would have been if the company had not entered into that transaction.
Transactions at an undervalue
In Jersey, transactions at an undervalue with unconnected parties are susceptible to being set aside if: (i) entered into within the 5 years preceding the winding-up (or désastre), and (ii) the company was insolvent at the time or became insolvent (on the cash flow test) as a result of the transaction. In the case of parties connected to the debtor, the burden of proof of insolvency shifts, and the transaction is susceptible, unless it is proved that the company was solvent, or did not become insolvent, as a result of the transaction. A transaction is considered to be at an undervalue if it was a gift or was for no or insufficient "cause" (a customary law concept similar to but broader than consideration).
In the case of both connected and unconnected transactions, the provisions do not apply if the company entered the transaction in good faith for the purposes of its business, and there were reasonable grounds for believing the transaction would benefit the debtor.
In Guernsey, there is presently no statutory power to set aside a transaction at an undervalue. There are routes for dealing with them via a Pauline action or constructive trusteeship (considered below). Upcoming changes imposed to Guernsey's insolvency regime by the Companies (Guernsey) Law, 2008 (Insolvency) (Amendment) Ordinance, 2020 will extend the powers of liquidators and administrators to set aside transactions at an undervalue taking place 6 months before the insolvency event or 2 years in the case of a transaction with a connected party.
In the BVI, transactions at an undervalue with unconnected parties are susceptible to being set aside if: (i) entered into within 6 months preceding the filing of an application for a Court-appointed liquidator or the appointment of a liquidator by members' resolution; and (ii) the transaction was entered into at a time when the relevant company was insolvent or the transaction caused the relevant company to become insolvent (on the cash flow test). In the case of parties connected to be debtor, the burden of proof in determining whether a transaction is voidable shifts and the "vulnerability period" extends to 2 years preceding the filing of an application for a Court-appointed liquidator or the appointment of a liquidator by members' resolution. A transaction is considered to be at an undervalue if it was a gift (or other transaction for which the company received no consideration) or if it is a transaction for a consideration which (in money or money's worth) is significantly less than the consideration provided (in money or in money's worth) by the company. A transaction entered into by the company in good faith, for the purpose of its business with reasonable grounds for believing that it would benefit the company will not be an undervalue transaction.
In Jersey, if a debtor company enters into a transaction with a creditor, surety or guarantor, and the transaction: (i) puts the other party (the creditor) in a better position, in the event of a winding-up (or désastre), than it would have been in but for the transaction; (ii) there was a desire on the part of the debtor company to prefer that creditor; (iii) the transaction occurred within 12 months of the declaration or winding-up; and (iv) the company was insolvent or became insolvent as a result of the transaction, then the transaction is susceptible to being set aside.
In relation to connected parties, there is a presumption that there was a desire to prefer. The transaction will only remain undisturbed, if it can be proved, in the circumstances, that the debtor was solvent at the time or, did not become insolvent as a result of it, or, that there was no intention to prefer the creditor.
In Guernsey, a preference can be set aside if it is given within the 6 months before the earlier of an application for compulsory winding up or the company passing a resolution for voluntary winding up. A preference will be given to a person if they are a creditor of the company or are a surety or guarantor for any company debts or liabilities and the company does (or permits to be done) anything which improves that person's position in the liquidation. For connected persons the reference period is extended to 2 years. The Court may make an order if it is of the opinion that, at the time of the preference, the company was unable to pay its debts and was influenced by a desire to improve the position of the person given the preference (which will be assumed for connected persons unless the contrary is shown).
In BVI, a transaction entered into by a company will be an unfair preference given by the company to a creditor if the transaction: (i) is a transaction entered into at a time when the relevant company is insolvent or the transaction causes the relevant company to become insolvent; (ii) is entered into within 6 months preceding the filing of an application for a Court-appointed liquidator or the appointment of a liquidator by members' resolution (2 years for a connected person/entity); and (iii) has the effect that, in the event the company goes into insolvent liquidation, the creditor will be put in a better position than the position in which the creditor would have been had the company not entered the transaction.
Unlike the position in many other jurisdictions, in the BVI for a transaction to amount to an unfair preference, it is not necessary for the company to be influenced by a desire to prefer the creditor. A transaction will also not be an unfair preference if it took place in the ordinary course of the company's business.
In all three cases where either a transaction at an undervalue (in Jersey and BVI) or a preference (in Jersey, Guernsey or BVI) within the rules exists, the Court has broad discretionary power with regard to the orders it might make (including for example the re-vesting of property in the company or its release from security) although bona fide third parties' interests are protected from prejudice.
Extortionate credit transactions
If a company enters into a transaction for the provision to it of credit (which in distressed circumstances may be a typical scenario) there are circumstances in Jersey where a liquidator or the Viscount could seek an order from the Court setting aside all or part of the transaction or varying its terms.
This will be available should the transaction be determined to be: extortionate, namely on where assessing the risk accepted by the person providing the credit, the terms required grossly exorbitant payments whether unconditionally or based on contingencies arising relating to the credit provided; or it otherwise grossly contravened ordinary fair dealing principles. There is a presumption that unless the contrary is proved, a transaction with respect to which an application is made is or was extortionate. The look back period for a transaction to fall within scope is within the three years ending with the commencement of the creditors' winding up or désastre.
What will amount to a grossly exorbitant payment (which could include interest) will depend on the circumstances including considerations of the risk to the lender, the respective sophistication and bargaining positions of the parties and the terms of the transaction.
Upcoming changes to the Guernsey insolvency law will enable a liquidator or administrator to apply to court for an order to set aside an extortionate credit transaction in relation to the provision of credit given to the company within three years before the relevant insolvency event. A transaction will be deemed to be extortionate if the terms require grossly exorbitant payments or otherwise grossly contravenes the ordinary principles of fair dealing.
In the BVI, a transaction entered into by a company within 5 years of the filing of an application for a Court-appointed liquidator or the appointment of a liquidator by members' resolution for, or involving the provision of, credit to the company will be an extortionate credit transaction if, having regard to the risk accepted by the person providing the credit (i) the terms of the transaction require grossly exorbitant payments to be made (whether unconditionally or if particular circumstances occur) in respect of the provision of credit; or (ii) the transaction otherwise grossly contravenes ordinary principles of fair trading. It is noteworthy that it is not necessary for an extortionate credit transaction to be an "insolvency transaction" and so the company does not need to have been insolvent at the time of the transaction and nor does the transaction need to have caused the company to become insolvent for the transaction to be vulnerable to set aside.
Voidable Floating Charge
In the BVI, a floating charge created by a company will be voidable if (i) it is a transaction entered into at a time when the relevant company is insolvent or the transaction causes the relevant company to become insolvent; (ii) it is created 6 months prior to the filing of an application for a Court-appointed liquidator or the appointment of a liquidator by members' resolution (or 2 years for a connected person/entity); and (iii) it does not secure money or property advanced at the same time or after the creation of the charge. The purpose of the provision is to prevent a company conferring a benefit on a creditor by creating a floating charge to secure an existing debt owed to the creditor.
Directors acting in conflict of interest
One of the fundamental duties on a director is their fiduciary duty to act in good faith and in the interests of the company. A basic element of that duty will be to avoid conflicts of interest and, where one exists, to ensure that the nature of the conflict is fully disclosed (as required by Article 75 of the Companies (Jersey) Law 1991 or section 162 of the Companies (Guernsey) Law, 2008 or section 124(1) of the BVI Business Companies Act 2004). If that does not happen, then in Jersey the company (or a shareholder) or a member of the company can seek an order of the Royal Court setting aside the transaction concerned and requiring the director to account for profits or gains made. In Guernsey a failure to declare an interest will not affect the validity of the transaction but such a director will be guilty of an offence. In the BVI, failure to disclose in certain circumstances can render (i) the director liable for a fine of US$10,000; and (ii) the transaction voidable at the instance of the company.
The Companies (Guernsey) Law, 2008 also permits a liquidator, creditor or member of a company to apply to the Court where it appears in the course of the winding up that any past or present officer of the company (or any other person who, directly or indirectly, is or has been in any way concerned in or has participated in the promotion, formation or management of the company): (a) has appropriated or otherwise misapplied any of the company's assets, (b) has become personally liable for any of the company's debts or liabilities, or (c) has otherwise been guilty of any misfeasance or breach of fiduciary duty in relation to the company. The Court may order any such person to repay, restore or account for such money or property.
Customary law options
Pauline action - action to defraud creditors
Under Jersey law, a customary law claim can be brought by a creditor (or potentially a liquidator or the Viscount) if it could be established that there was an intention on the part of the debtor in entering into a transaction with another party, to defeat the interests of the debtor's creditors, and the debtor was balance sheet insolvent at the time or became so as a result of the transaction. The burden would be borne by the creditor seeking to have the transaction set aside. The same is available in Guernsey for a creditor. This is not a common form of proceeding (potentially due to the availability of the statutory insolvency remedies and the need to prove intention) but it does have a 10 year prescription period in Jersey and a 6 year one in Guernsey.
It may also be possible to establish a constructive trusteeship where it can be shown that the recipient party was aware of the transaction being in breach of the transferring directors' fiduciary duties such that is unconscionable for the recipient to be allowed to retain the transacted assets.
Transactions for an improper purpose
The Royal Court of Jersey held in the case of Re Zaki that it may also set aside a transaction in an action brought by, for example, a creditor, shareholder or liquidator if it were shown that the directors of a company had exercised their powers for improper purposes with the actual or constructive notice of the other party to the transaction. The judgment in that case was not one following a full adversarial trial (but rather involved the Court providing responses to the English High Court following a request for an opinion from the Royal Court). In that context, on the facts of the case as presented the Royal Court held that if the guarantee in that case had been given by the debtor company without cause, in favour of a bank who had actual or constructive notice of that fact, and where the directors could not show it was given in good faith in the best interests of the company, but rather, they had abused their powers to benefit the bank or another party, the Royal Court would set aside the transaction.
Whilst therefore, a breach of duty by a director in entering a transaction could form the basis for an action to set aside the transaction, as with the Pauline action, the need for knowledge and to demonstrate an abuse of power will be hurdles that would need to be overcome.
There are a number of potential lines of attack that could be pursued to seek to unravel transactions. For directors on the debtor side, acting in financially distressed circumstances, ensuring that transactions are fully considered with appropriate advice and decisions are accurately recorded will be ever more important. From a creditor perspective the range of applications available to a liquidator is more defined than those which might be pursued directly, over and above straight forward damages claims. Whilst there are customary law causes of action available in Jersey and Guernsey, the need to establish an intention or knowledge will likely confine them to limited situations where it is provable that impropriety occurred on both sides of the transaction that is to be challenged.
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.