Harmonisation of insolvency avoidance in Europe: the UK perspective

This article briefly considers the provisions in the European Commission’s proposal for a directive harmonising certain aspects of insolvency law (COM/2022/702) (the “Proposed Directive”) on avoidance actions, including a comparison to similar rules already enacted in English law. Since the United Kingdom has left the EU, the UK will not be bound by the Proposed Directive if and when it becomes law.

In essence, avoidance actions are claims that can be brought to unwind the effects of transactions or other steps entered into by a debtor that have caused detriment to creditors or certain creditors of the debtor. These claims come into focus when a debtor enters into a formal insolvency process and the appointed insolvency office-holder investigates events that occurred prior to their appointment.

A recent case (Darty Holdings SAS v Carton-Kelly [2023] EWCA Civ 1135) litigated in the English courts underlines the importance of paying close attention to potential avoidance actions when structuring and implementing transactions, particularly those involving a company that is in financial difficulty. In this case, the liquidator of Comet Group plc claimed that the repayment of a GBP 115m unsecured intra-group debt, owed to another group company upon the sale of Comet to a third party, constituted a preference. The liquidator’s case was successful in the High Court and overturned in the Court of Appeal.

Scottish law has similar but different avoidance rules to those available under English law. The Scottish law position is not covered in this article.

English law - overview

The Insolvency Act 1986 includes a suite of provisions pursuant to which administrators or liquidators and (in certain instances) creditors of a debtor company or other “victims” of certain transactions involving a debtor company, can review and challenge certain transactions entered into by the debtor company. These include:

• transactions at an undervalue;
• transactions defrauding creditors;
• preferences;
• extortionate credit transactions; and
• avoidance of certain floating charges.

With the exception of transactions defrauding creditors, these actions require formal insolvency proceedings to be opened in respect of the debtor company before they can be pursued.

In general terms, the outcome of a successful action will be to restore the position to what it would have been had the relevant actions not been taken.

English law - approach to avoidance actions

The English law approach to avoidance actions broadly shares the underlying objective of the Proposed Directive regarding such actions (i.e. to ensure equity for creditors as a whole by maximising the value of recoveries into the debtor’s insolvency estate and ensuring fair and predictable distributions to creditors). In English law, this objective is balanced with principles of freedom of contract and the aim of protecting transactional certainty, both of which are also considered important for businesses and the economy.

Therefore, relative to current avoidance action rules in certain other European jurisdictions, English law provides more protection for counterparties who have acted in good faith and for value in transactions with the relevant debtor. Under English law, the intentions of the parties who entered into the relevant transaction are taken into account, whereas the rules in certain civil law jurisdictions (especially where the so-called Paulina action is available) focus more on the effect of the transaction on the debtor’s creditors, irrespective of the commercial reasons for the transaction. Both approaches have merit.

The Proposed Directive adopts a measured approach, with some regard to the knowledge and intentions of the relevant parties.

English law – comparison to the Proposed Directive

The Proposed Directive includes three types of avoidance action that it proposes EU member states implement:

• preferences (Article 6);
• legal acts against no or a manifestly inadequate consideration (Article 7); and
• legal acts intentionally detrimental to creditors (Article 8).  

The key features of each of these are covered in the first article in this series: Harmonisation of insolvency avoidance in Europe.

Each of these proposed avoidance actions is similar to an avoidance action already enacted in English law, but with certain differences in the relevant criteria and consequences.

The relevant English law avoidance actions are summarised below. This is followed by a table comparing them to their equivalents in the Proposed Directive.

Preferences

This applies to a company in administration or liquidation. There may be a preference claim where, in the six months (or two years, in the case of connected party transactions) prior to the commencement of the insolvency process, the company did anything or suffered anything to be done, which put a creditor or surety or guarantor of a creditor (in the event of the company’s liquidation) in a better position than if the thing had not been done. For a preference claim, it is also a requirement that, at the relevant time, the company was insolvent or that it became so in consequence of the relevant act. No order can be made in the absence of a desire to prefer by the party giving the preference. Such a desire is presumed where the relevant parties are connected, unless the contrary is shown.

Transactions at an undervalue

This applies to a company in administration or liquidation. There may be a transaction at an undervalue claim where, in the two years prior to the commencement of the insolvency process, the company gave a gift or entered into a transaction with another party for a consideration, the monetary value of which is significantly less than the monetary value of the consideration provided by the company. For a transaction at an undervalue claim, it is also a requirement that, at the relevant time, the company was insolvent or that it became so in consequence of the transaction. No order can be made if the transaction was entered into by the company in good faith for the purposes of carrying on the company’s business and there were reasonable grounds for believing that it would benefit the company.  

Transactions defrauding creditors

A transaction defrauding creditors occurs if a company gives a gift or enters into any transaction at an undervalue of the nature outlined above with the purpose of putting assets beyond the reach of someone who is making, or may at some future time make, a claim against it, or otherwise prejudicing the interests of such a person in relation to such a claim. A ‘victim’ of the transaction (e.g. a creditor) can bring the claim even if the company has not entered into a formal insolvency process. There is no insolvency requirement and no prescribed “lookback” period, meaning that transactions entered into many years before an insolvency event may be within the scope of this provision.

Table - comparison of key features of English law and Proposed Directive on avoidance actions

 Other comparisons

The Proposed Directive prescribes that the limitation periods for the relevant avoidance actions should be three years from the opening of insolvency proceedings. Under English law, claims of preference and transactions at an undervalue can be brought up to six years after the opening of the formal insolvency proceedings.

The Proposed Directive prescribes that the claims for compensation outlined in the table above should be assignable to a creditor or third party. Following changes enacted into English law in 2015, an administrator or liquidator is able to assign to a third party (e.g. a creditor) a claim of preference or transaction at an undervalue.

For more information on the proposed EU Directive and insolvency avoidance in the EU and UK, contact your client partner or one of these CMS experts.