Scottish Court of Session Decisions

[1] A petition for the winding up of the first pursuer was presented on 21 January 1997, and on that day the second pursuer was appointed provisional liquidator. By interlocutor dated 25 March 1997 the first pursuer was ordered to be wound up and the second pursuer was appointed interim liquidator. His appointment as liquidator was confirmed at a meeting of creditors held on 22 April 1997. The defender is a company incorporated in or about 1996. In this action the pursuers (and in particular the second pursuer) seek to challenge a transaction said to have had the effect of creating an unfair preference under and in terms of section 243 of the Insolvency Act 1986. They seek, under sub-section (5) of that section, an order for payment by the defender to the first pursuer of £191,350.

[2] Section 243 of the Insolvency Act 1986, so far as relevant, provides:

[3] On Record it is plain that what gives rise to the pursuers' claim is an Agreement entered into between inter alios the first pursuer and the defenders on 8 November 1996 (albeit the Agreement is deemed to have been completed on 20 September 1996). It is averred that by virtue of this contract the first pursuer sold to the defender the whole of its design and advertising business at a total consideration of £63,396. The Agreement is produced and its terms incorporated brevitatis causa. It is averred that at the relevant time all the shares of the defender were held by directors of the first pursuer (Messrs Gall, Greig, Harper and Helmore), each of whom also held one share in the first pursuer.

[4] It is further averred that:

[5] The Agreement itself in essence provides, at clause 2, for the purchase of certain assets and liabilities of the first pursuer's business "all as summarised in the summary of assets and liabilities annexed hereto". In that summary total current assets are valued at £303,214, and liabilities are valued at £270,813 (described as "Trade Creditors", "Greenfinch" £168,293 and "Agency" £102,520) - producing a net asset value of £63,396. In terms of clause 3 this sum was payable by the defender. It was specifically provided that certain liabilities were not transferred (albeit referred to, somewhat perversely, as "the Transferred Creditors") being (a) liabilities to Henderson & Loggie and Thorntons, W.S. of £8,426.87 and £6,433.13 respectively, which the parties agreed did not relate to the design and advertising business, and (b) liabilities under contracts ("the Excluded Contracts") to the extent that they related to any other business carried on by the first pursuer together with the lease of the premises then occupied by the first pursuer at Randolph Crescent, Edinburgh and (c) liabilities for taxation. These liabilities remained the responsibility of the first pursuer. In terms of clause 7(B) the first pursuer undertook to make all payments due to those creditors referred to as Trade Creditors in the summary of assets and liabilities annexed. The pursuers aver that, in terms of that clause, the first pursuer "paid in full creditors who were all its trade creditors and whose debts amounted in total to £271,000". This averment is admitted. Although it was indicated to me in the course of submissions that in reality the defender had paid the relevant creditors directly or reimbursed the first pursuer in respect thereof, with all the assets listed in the summons being transferred to the defender, it was not disputed that, however the matter was characterised, the effect of the Agreement, when implemented, was that the value of the first pursuer's assets was reduced by £271,000.

[6] The pursuers further aver, at the start of condescendence VI, that:

It is averred that the total debt owed by the first pursuer to Dunedin "was £964,385.36". This debt is said to be made up of three elements: (a) £73,308.36 for rent and service charges up to 14 May 1997; (b) "the claim for" rent and service charges from 15 May 1997 to the termination of the lease on 11 October 2013, amounting to £877,563.50; and (c) £63,538.50 in respect of "liability for dilapidations". It is said, however, that the second pursuer has not formally adjudicated on any ordinary claim submitted by any creditor in the liquidation "since he is still unaware whether he will have any funds with which to pay dividend to those creditors". He does not, however, dispute "the validity of the claim to be formally submitted by Dunedin".

[7] The alleged prejudice to the creditors of the first pursuer who were not preferred is set out in condescendence VII. In particular it is there averred that had the first pursuer gone into liquidation or receivership in September 1996, rather than entering into the Agreement, the total value of its assets in the insolvency would have been approximately £318,000. After payment of a preferential debt of £7,000 to H M Customs and Excise, a further £41,000 to the floating charge holder TSB and after deduction of costs of insolvency of £20,000 it is averred that £250,000 would have remained for eventual distribution among all of the first pursuer's unsecured ordinary creditors. The averments continue:

A schedule appended to the summons bears to show eight unsecured creditors, in addition to Dunedin, - including the defender as creditor in three sums of £8,550, £1,809.25 and £6,002.09 respectively.

[8] The case came before me on Procedure Roll. The defender sought dismissal under and in terms of the first plea-in-law - being a general plea to the relevancy and specification of the pursuers' claim.

[9] Counsel for the defender argued, in the first place, that the transaction apparently challenged (the Agreement) did not itself have the effect of creating any preference and was not therefore a transaction within the meaning of section 243(1). The preference said to have been created was the payment of the trade creditors. It was only upon payment that any such preference could be described as completely effectual within the meaning of sub-section (3). On that date the first pursuer was divested of the relevant funds. Reference was made to Craiglaw Developments Limited v Wilson 1998 S.L.T. 1046. By contrast the Agreement itself did not result in any divestiture, nor did it create any obligation enforceable by the trade creditors. If the whole transaction, including the payment of the trade creditors, fell to be challenged, the trade creditors would require to be added as additional defenders. Reference was made to Goudy, A Treatise on the Law of Bankruptcy in Scotland, 4^th Edition (hereafter referred to as Goudy on Bankruptcy) at p.104 where it is said:

Reference was also made to Fraser v Gibbon 1889 16 R. 740 - the case referred to in the relevant footnote in Goudy. It was difficult to envisage a relevant challenge in which the allegedly preferred creditors were not called as defenders - whether solely or along with others. Although one of the co-cautioners said to have been preferred in Mitchell v Rodger 1834 12 S. 802 was not directly a party to the transaction which was challenged, the relevant transaction was a transaction which directly and immediately affected his interest and he was convened as a defender. Reference was also made to Raymond Harrison & Company's Trustee v North West Securities Limited 1989 S.L.T. 718, and in particular to Lord Clyde's emphasis at p.723 that the transaction which was challenged in the action (under section 36 of the Bankruptcy (Scotland) Act 1985) was

[10] Further it was submitted that, on the face of it, the transaction in question fell within the exceptions referred to in section 243(2)(b) and (c). The payments made were payments in cash of debts apparently payable. So far as that sub-section was concerned it was not necessary that a payment in cash for a debt due be shown to have been made in the ordinary course of trade or business. This matter was separately covered by section 243(2)(a). The pursuers moreover in their averments admitted that in terms of the Agreement reciprocal obligations had been undertaken, and the requirement for reciprocity appeared to be satisfied (Nicoll v Steelpress (Supplies) Ltd 1993 S.L.T. 533). There were no averments or, at any rate, no sufficient relevant averments, of collusion within the meaning of the relevant sub-sections. There was, in particular, no averment of collusion on the part of the allegedly preferred creditors - as was necessary. The need for this was clear as a matter of construction, in particular having regard to the reference to "the transaction" in section 243(2)(c). Reference was further made to Goudy on Bankruptcy at pp.81, 82 and the need for averment and proof of "fraudulent concert on the part of both granter and receiver". Reference was further made to Nordic Travel Limited v Scotprint Limited 1980 S.C. 1, and in particular to p.19 where, under reference to "collusion", the Lord President (Emslie) said:

In any event, despite what was said in argument on behalf of the pursuers, there were no relevant averments to suggest that, so far as the defender was concerned, the transaction was not a legitimate exercise, and no averments that the sole purpose of it was to prejudice the creditor in what was seen as a major disadvantageous contract, namely Dunedin under the lease. It did not follow that an intention to confer a benefit on certain creditors involved an intention to prejudice the general body. The pursuers themselves averred in terms that the intention behind the agreement was to preserve the goodwill attaching to the business. The general averments at the start of condescendence VI were inadequate. They made no reference to collusion. So far as the defender was concerned the pursuers appeared to be suggesting that the company colluded with itself insofar as it too was an unsecured creditor whose debts were not paid.

[11] Further the primary remedy provided by sub-section (5) was for reduction or restoration of property to the company's assets. It was not appropriate to grant the remedy which the pursuers sought in the absence of averment as to why the primary remedy was not available. Reference was made to the court's approach to the similar wording of section 34 of the Bankruptcy (Scotland) Act 1985 in Short's Trustee v Chung 1991 S.L.T. 473 (followed in Short's Trustees v Chung (No.2) 1999 S.C. 471) and Cay's Trustee v Cay 1998 S.C. 780. In any event, the present claim was in essence a claim for damages against a party who was not the preferred creditor. This was not a remedy available to the court under sub-section (5), properly construed. No legal basis for an action of damages was provided. The power of the court, a relevant challenge being made, was limited essentially to the undoing of the preference created and the return to the estate of any property or value by which it was diminished. There was no authority, either at common law or under any relevant related statute, for a remedy of the type which the pursuers now sought. In the case of Mitchell v Rodger, to which the pursuers referred, the transaction was reduced insofar as the cautioners had obtained benefit thereby. There was nothing in the pleadings to suggest why an action for repayment from the (apparently two) preferred creditors was not open. It was not clear on what legal basis the claim for damages was presented. Quite apart from the absence of relevant averment that the intention of the defender was to prejudice the general body of creditors, there was no support in the pleadings for the pursuers' assertion that the defender was the instigator of the unfair preference for its own benefit.

[12] In any event, the pursuers' averments in relation to the alleged prejudice of the creditors who were not preferred - and in particular in relation to Dunedin - were irrelevant. The pursuers were not offering to prove prejudice to the "real" body of general creditors in the "real" liquidation (with which the section was concerned) but apparently to the general body in a hypothetical liquidation. It was not clear that these creditors were the same in the same amount. It was unclear whether the pursuers were seeking to prove in fact that there would have been a liquidation or receivership had the Agreement not been signed. If they were, there were insufficient relevant averments. It was not clear why Dunedin were said to be creditors in the full sum which was described. There was confusion as to whether the Lease continued and whether Dunedin's claims were for damages or simply for rental. If the latter, it was not clear why the whole amount was claimed. The claim in respect of liability for dilapidations was wholly unspecific. The entitlement of Dunedin would depend upon the acceptance of their claim, (reference being made to Bankruptcy (Scotland) Act 1985 ss.49, 50), which had not yet happened even in the real liquidation. It was not clear that a claim had been made or would have been made in the hypothetical liquidation. The discounting mechanism provided for by schedule 1 of the Bankruptcy (Scotland) Act 1985 had not been considered. The averments as to how the floating charge holders TSB would have proceeded in the hypothetical liquidation were confused and contradictory.

[13] In relation to this last matter (i.e. criticism of the quantification of the pursuers' claim) counsel for the pursuers ultimately accepted that if the court came to the view that their pleadings were otherwise sufficiently relevant to entitle them to a proof before answer, they would wish - recognising the force of at least some of the defender's criticisms - the opportunity to seek leave to amend. They would wish inter alia to consider the introduction, at least in the alternative, of a claim based on prejudice suffered by the general body of creditors in the real liquidation. The action, however, gave rise, it was submitted, to wider questions of importance, which it, was hoped, the court could deal with first. Counsel for the defender, for his part, resisted this suggestion - submitting that on the face of it any amendment would require to be material, and it being unclear that the pursuers would be able to meet the criticisms which had been levelled.

[14] Counsel for the pursuers' primary position was that the action gave rise to questions of general importance, in particular in relation to any company the business of which was reasonably successful, but which had one major disadvantageous contract. It concerned the apparent device of selling the business to another company, controlled by directors, paying off trade creditors (as was important for goodwill), but leaving the major disadvantageous creditor with rights only enforceable against a shell, or as in this case, a company with much reduced assets.

[15] More particularly, in this case the fact that the trade creditors were not parties to the Agreement, and had no enforceable rights under it, was of no consequence. At common law and under the Act of 1696 preference could be conferred by indirect methods. Reference was made to Goudy on Bankruptcy at pp.79 and 80 where it is said:

In the case of Mitchell v Rodger one of the co-cautioners said to have been preferred was not a party to the Agreement in question. In this case, in any event, the Agreement, when implemented, had the effect of creating the preference. It was essentially the whole transaction which the pursuers were challenging.

[16] Further, it was wrong to suggest that the transaction fell, on the face of it, within section 243(2)(b) or (c). Although it was accepted that the parties to the Agreement undertook reciprocal obligations, the creation of the preference by the payment was entirely separate. Further, while the debts paid were no doubt due, it could not be said from the averments that the payments were made in the ordinary course of business, which was a necessary element even in section 243(2)(b). This was the case at common law and under the Act of 1696 in relation to cash payment of debts due. Goudy on Bankruptcy at p.84, under reference to the Act of 1696, recognised three classes of transactions as falling outside the operation of the Act, namely:

In relation to the first, it is said, at p.85,: "The payment must be bona fide and in the ordinary course of business." This was confirmed, for example, in Newton & Sons' Trustee v Finlayson & Co 1928 S.C. 637, where, at p.644, the Lord President (Clyde) said:

Reference was further made to Nordic Travel Limited v Scotprint Limited where at p.18 the Lord President referred to the speech of Lord Thankerton in Whatmough's Trustee v British Linen Bank 1934 S.C. (H.L.) 51 at p.62 where it was said:

Here the pursuers' averments made it plain that the payments in question could not be described as having been made in the ordinary course. They appeared to have been made not out of the company's own resources but in effect by, and on the stipulation of, the defender in the course of a particular sale. Section 243(2)(a) dealt with matters separate from cash payments. Reference was made to Goudy on Bankruptcy at pps.86-87. In any event, the pursuers had made sufficient averments of collusion. What was necessary for collusion was an agreement, and an intention not only to favour one or more creditors but also to prejudice the remaining body, although the latter might be an inevitable inference from the former. It was not material whether the agreement was with the favoured creditor or with some other party. Given that strict equivalence was necessary in relation to reciprocal obligations before any transaction could begin to come within section 243(2)(c) (Nicoll v Steelpress Supplies Ltd) it was reasonable to construe collusion in that context as necessarily involving a third party. In the case of Mitchell v Rodger, looking at it from the point of view of the co-cautioner who was not a party to the transaction, there was collusion between the debtor and a third party. In Nordic Travel Ltd v Scotprint Ltd the only alleged collusion was between the debtor and the preferred creditor, and any observations fell to be read subject to that. Sufficient averments had been made of collusion, in particular having regard to the averments relating to the company structures, to the proposals which were made in August 1996 in the knowledge of the company's insolvency, and to the provision in the Agreement for payment by the pursuers. The intention to prejudice the remaining body could in any event be inferred from the terms of the Agreement itself. Reference was further made to the general averment at the beginning of condescendence VI.

[17] Further, it was plain from the proviso to subsection (5) that an action need not be directed against the preferred creditors. It was clear from the language of that subsection that the intention was to give the widest possible powers to the court. Here the pursuers were seeking compensation against a third party who, on averment, had not acted bona fide and who was the instigator of the preference in its own interest. The case of Fraser v Gibbon was distinguishable in that the Court there took the view that it was necessary for the whole transaction to be set aside, in which case the preferred creditors required to be defenders. Here the pursuers were seeking compensation, limited to less than the preference. An action of reduction of the transaction would have far reaching implications and might be impossible. There were practical problems in suing a multiplicity of preferred creditors. All that was held in Short's Trustee v Chung was that a pursuer, having chosen the remedy of reduction, was entitled to pursue that remedy and that the Court had no general equitable power to substitute something different. The language of subsection (5) allowed a pursuer to choose such remedy as he considered appropriate. He should be allowed to do so unless his choice was manifestly inapt. Although counsel was not able to point to any case in which a similar claim for compensation been made, it was submitted that in Mitchell v Rodger the outcome was likely to have involved payment of compensation by the two cautioners.

[18] Despite the superficial attraction of the pursuers' presentation, I have come to the view that the relevance of the present claim cannot be sustained.

[19] This is not because the transaction which the pursuers seek to challenge is not one which had the effect of creating a preference in favour of the trade creditors. Despite the emphasis on the Agreement I am content to proceed on the basis, as submitted, that the pursuers were indeed challenging the whole transaction which concluded by payment of the debts. It would appear that the word "challenge" in section 243(5) is used in a broad sense, and is not to be equiperated with an action to reduce or set aside, although that may be sought. I would only add that insofar as senior counsel for the pursuers appeared at one stage to accept that the challenge was restricted to the Agreement alone, he was not, in my view, helped by the case of Mitchell v Rodger. Although one co-cautioner said to have been preferred was not directly a party to the relevant transaction, the Court, it seems, proceeded on the basis that his fellow cautioner acted on his behalf in the transaction, which did of itself create a preference in favour of both.

[20] Nor is it - looked at in isolation at any rate - because the preferred creditors are not defenders. The action does not seek to disturb so far as they are concerned the payments which were made to them, and the proviso to subsection (5) suggests that a claim could be made against a third party, for example, seeking restoration of particular property.

[21] Nor is it because, as was argued on behalf of the defender, the claim prima facie comes within the exceptions provided for by section 243(2)(b) or (c). I am unable to accept that subsection 2(c) (the exception relating to nova debita) could be relevant, even although looking at the Agreement itself the parties to it undertook certain reciprocal obligations. Further, leaving aside the question of any collusion, it would be surprising if the exception provided for in subsection 2(b), relating to cash payments of debts due, did not fall to be construed in accordance with longstanding authority, i.e. it being necessary for such payments to have been made bona fide and in the ordinary course of business. In this connection, the references made on behalf of the pursuers to Goudy on Bankruptcy and to Lord Thankerton's speech in Whatmough's Trustee v British Linen Bank, and to a lesser extent the observations of Lord President Clyde in Newton & Son's Trustee v Finlayson & Company, were, in my view, persuasive. Further I consider that the pursuers have averred enough to entitle them to a proof before answer on the question of whether the cash payments were (or were not, as they maintain) made in the ordinary course of business.

[22] Rather, it is because, in my view, the language of the relevant section of the Act provides no proper warrant for presentation of a claim of this nature. What the pursuers are not seeking is any remedy directed against the creditors said to have been preferred. Their preference is to be left entirely untouched in their hands. Instead what is sought is payment, in the nature of damages, from a third party, measured not by the whole amount of the sums paid to the trade creditors but by the alleged loss to the remainder of the unsecured creditors. It seems to me to be reasonably clear, notwithstanding the apparent width of the language of subsection (5) (in particular "or other redress as may be appropriate") that the purpose of the section as a whole is to enable the liquidator (amongst others) to undo, so far as possible, what was done when the preference was created (adopting language apparently approved by the Court in relation to the similar terms of section 34 of Bankruptcy (Scotland) Act 1985 in Cay's Trustees v Cay ), and, so far as possible, to restore the asset position of the company, diminished by the transaction which created the preference, for the benefit of the general body of creditors. There would appear to be no doubt that the primary remedies envisaged are reduction and restoration of property, and, following the views of the Court in Short's Trustee v Chung and Cay's Trustee v Cay, that the words " or other redress as maybe appropriate" properly fall to be construed as relating to redress of the same character, and do not give the Court a general equitable jurisdiction. What would be open, it seems, in an appropriate case, would, for example, be a decree for payment from a preferred creditor of any sum paid to him (which would not be capable of being described a decree for restoration of property - see e.g. Cay's Trustee v Cay). On the contrary, I see no warrant in the section for a claim for damages. No legal basis for any such a claim is set out. Counsel for the pursuers were unable to point to any authority in which any such claim in this area of law had been presented. It seems clear in Mitchell v Rodger that what the Court did was to reduce the relevant transaction in so far as the cautioners (said to have been preferred contingent creditors) gained benefit therefrom.

[23] Further, not only is it not, in my view, clear why action is not being taken to recover payment from the creditors said to have been preferred (of whom there are, at least apparently, only two), but it is not clear why, as a matter of fairness, the defender, who paid full value for what was purchased and who effectively paid the trade creditors, should be required to make payment in addition of a substantial proportion of the sums paid to those creditors while leaving the funds untouched in the hands of the recipients. In short it seems to me that there are reasons for believing that, if the pursuers are right, the whole transaction should be set aside - including in particular the payments to the trade creditors. A similar approach was thought to be appropriate, albeit in different circumstances, in Fraser v Gibbon. In that event, of course, the trade creditors would, as argued, require to be defenders.

[24] Further, and in any event, I am of the view that no sufficiently relevant basis has been averred for the claim for compensation which is made. The emphasis in argument was on alleged collusion - in particular, taking the form of an alleged intention to prejudice the one major disadvantageous creditor of the company, namely Dunedin. There is no clear averment to that effect in the pleadings. Instead, the averments about the genesis of the Agreement suggest that the intention was that the payment would preserve the goodwill attaching to the business for the benefit of the consortium. It was accepted that if the pursuers themselves had simply paid the relevant creditors to preserve goodwill the payments could not have been challenged. I do not consider that the general statement at the start of condescendence VI is sufficiently clear or specific. Further the pursuers' counsel could not dispute that their submission involved also the somewhat odd notion of the defender colluding against its own interest, given that it remained a creditor notwithstanding the Agreement. Moreover, all the authorities to which I was referred, in particular perhaps the detailed rehearsal of authority by the Lord President in Nordic Travel Ltd v Scotprint Ltd, suggest that collusion in this context would necessarily involve the collusive agreement of the preferred creditor. The language of section 243(2)(b), and (c) suggests the same. It may of course be that a third party could be said to be involved as well (Goudy on Bankruptcy at page 80, under reference to circuitous and collusive transactions, indicates that "In such cases it may happen that not only will the preference be set aside in the hands of the creditor, but also, when the third party can be shown to have been acting collusively, the conveyance to him will be set aside"). That does not however detract from "collusion" in this context being "intended to refer to participation by a creditor whose co-operation is necessary to achieve the result, in some device or transaction designed particularly to confer upon him a preference which would itself be fraudulent." (The Lord President in Nordic Travel Ltd v Scotprint Limited at p.19). In Mitchell v Rodger it is not clear that the court proceeded on the basis that there had been collusion, and one of the co-cautioners was, in any event, directly involved.

[25] I would only add that had I been persuaded of the basic relevance of the pursuers' claim, I would have put the case out By Order, as requested, to enable them to seek leave to amend in relation to quantification. In particular, enough was said to me to suggest that they would probably be in a position to tighten - indeed substantially to restrict - the claim presently made, and that it would not be unreasonable to give them the opportunity to seek to do that.

[26] In the whole matter, however, I shall sustain the defender's first plea-in-law and dismiss the action.