The legislation

Section 423 of the IA 1986 deals with transactions defrauding creditors. Section 423(1) of the IA 1986 relates to transactions entered into at an undervalue. A person enters into a transaction at an undervalue with another person if:

“(a) he makes a gift to the other person or he otherwise enters into a transaction with the other on terms that provide for him to receive no consideration…”

Section 436(1) of the IA 1986 defines “transaction” as including “a gift, agreement or arrangement”. The UK Supreme Court held that the inclusion of the word “arrangement” makes for a broad definition of “transaction”. A straightforward reading of that definition together with section 423(1) of the IA 1986 suggested that the transaction involving the Property was caught by section 423(1) of the IA 1986. In the language of that section, Mr El-Husseini “entered into a transaction” with Ziad on terms that provided for Mr El-Husseini to receive no consideration.

Even if a transaction comes within section 423(1)(a) of the IA 1986, it is still necessary to satisfy the condition in section 423(3) of the IA 1986 before the court can make an order granting relief. The court must be satisfied that the transaction was entered into by the debtor for the purpose:

“(a) of putting assets beyond the reach of a person who is making, or may at some time make, a claim against him, or

(b) of otherwise prejudicing the interests of such a person in relation to the claim which he is making or may make.”

Where a debtor procures a solvent company owned by him to transfer a valuable asset for no or inadequate consideration, thereby diminishing the value of his shares in the company, this prejudices the creditor’s ability to enforce a judgment against the debtor.

It was obvious to the UK Supreme Court that such an arrangement satisfies the mental element required by section 423(3) of the IA 1986.

Given this and given that there was no express requirement to the effect in section 423, it seemed to the UK Supreme Court that section 423 of the IA 1986 did not require the disposal of the debtor’s own property.

Transactions which are “otherwise” like gifts

Mr El-Husseini argued that section 423(1)(a) of the IA 1986 contains two limbs. In the first limb, the person makes a “gift”. In the second, the person “otherwise” enters into a transaction for no consideration. If Spellman v. Spellman [1961] 1 WLR 921 established that a donor can only make a gift of property he owns, then the use of the word “otherwise” in the second limb of section 423(1)(a) of the IA 1986 showed that a transfer for no consideration – like a gift – must involve the transfer of property belonging to the debtor.

If this were correct, then Mr El-Husseini would be off the hook of section 423(1)(a) of the IA 1986, so to speak, because it was Marquee that owned the Property, not him. However, the UK Supreme Court rejected this argument. Nothing in the wording of section 423 of the IA 1986 suggested that the word “gift” governed the rest of the definition. Although a gift, by nature, involves the transfer of an asset, a transaction for no consideration does not necessarily do so.

The requirement that the consideration must be paid to the debtor

Section 423(1)(a) of the IA 1986 requires that the transaction provide for “him” (the debtor) to receive no consideration. Section 423(1)(c) alternatively requires the consideration provided by “himself” to be significantly more valuable than that provided by the other person.

Mr El-Husseini submitted that “consideration” in section 423(1) of the IA 1986 meant something different than in ordinary contract law. Mr El-Husseini saw this as creating a conundrum for the Bank. If Ziad had paid Marquee full value for the Property, Marquee’s assets would not have been reduced, and Mr El-Husseini’s shares in Marquee would not have diminished in value. But Mr El-Husseini “himself” would have received no consideration and thus be caught by section 423 of the IA 1986. This was a situation which clearly should not be caught by the section. In order to avoid this scenario, it would be necessary to adopt Mr El-Husseini’s interpretation of section 423 of the IA 1986.

The UK Supreme Court held that Mr El-Husseini was correct to say that the word “consideration” in section 423(1) of the IA 1986 bears a narrower meaning than in contract law generally. This, however, did not create the conundrum asserted. On the assumed facts, Mr El-Husseini arranged with Ziad that he would procure Marquee to transfer the property to Ziad for no consideration. Mr El-Husseini thereby provided very valuable consideration. If Ziad had agreed with his father to pay the full value of the property to Marquee, that undertaking would have been consideration of equivalent value provided to Mr El-Husseini, and would have ensured no diminution of Mr El-Husseini’s shareholding in Marquee.

The bona fide purchaser defence

Section 425(2) of the IA 1986 provides a limited defence to bona fide purchasers. It sets out that an order under section 423:

“may affect the property of, or impose any obligation on, any person whether or not he is the person with whom the debtor entered into the transaction; but such an order –

(a) shall not prejudice any interest in property which was acquired from a person other than the debtor and was acquired in good faith…”

Mr El-Husseini made an argument along the following lines. Section 423 of the IA 1986 applies to someone who acquired property belonging to the debtor. Such a person is too proximate to the debtor to avail of the section 425(2) of the IA 1986 defence, even if they are entirely innocent. Thus, someone who wishes to avail of the defence must be at least one step removed from the debtor. The Property did not belong to the debtor (Mr El-Husseini). It belonged to Marquee. Ziad acquired it from Marquee. In theory, if Ziad had paid full value for the property, he would have been able to rely on the section 425(2) of the IA 1986 defence because he acquired the property from a person “other than the debtor”. But this would have been in spite of the fact that Ziad was the most proximate person to the transfer of the property by Marquee.

It made no sense, Mr El-Husseini submitted, for the defence to be available in those circumstances, but not in circumstances where Ziad acquired the property from the debtor himself. That illogicality must mean that the drafter of the legislation expected someone in Ziad’s position to receive the assets from the debtor. Section 425(2)(a) of the IA 1986 therefore assumes that the transaction involves the transfer of an asset by the debtor.

The UK Supreme Court did not agree. If the drafter had made such an assumption, section 423(1) of the IA 1986 would have been drafted to include it expressly. Overall, the wording of sections 423-425 of the IA 1986 strongly supported the submission of the Bank – that section 423(1) of the IA 1986 contains no requirement that a transaction must involve a disposal of property belonging to the debtor. If the opposite were true, one would expect to see such a significant limitation on the operation of the provision clearly spelled out in the wording of section 423 of the IA 1986.

The purpose of section 423

Section 423(3) of the IA 1986 reveals the purpose for which sections 423 to 425 of the IA 1986 were enacted. That is, to provide redress where transactions at an undervalue intentionally prejudice the ability of creditors to enforce the debt. Mr El-Husseini warned that even if a debtor satisfies the mental element contained in section 423(3) of the IA 1986, this does not necessarily mean that section 423(1) of the IA 1986 is satisfied. The court should not work backwards from section 423(3) of the IA 1986; before fashioning a remedy, the court should be sure to establish that the debtor entered into a transaction at an undervalue.

The Supreme Court accepted that both sections 423(1) and 423(3) of the IA 1986 must be satisfied. Nonetheless, section 423(1) of the IA 1986 should not be construed in a linguistic vacuum. The section may cut both ways. For example, a transaction which does not reduce the assets available to meet the claims of creditors would not be caught by section 423(1) of the IA 1986, even it might strictly fall within its terms. Equally, however, where a transaction intends to prejudice creditors and does, there is no reason why it should not fall within section 423(1) of the IA 1986. Still less was there any reason to read an implied restriction into section 423(1) of the IA 1986 which would undermine the purpose of the section, as Mr El-Husseini sought to do.

Mr El-Husseini was not able to avoid the inevitable conclusion that the release of debt owed to the debtor or the surrender of an interest in property, whether gratuitous or at an undervalue, falls within section 423(1) of the IA 1986 even though it involved no transfer of property. Where Mr El-Husseini then argued that a section coming within section 423 of the IA 1986 necessarily involves property owned by the debtor, and not a company owned by the debtor, this restriction was quite simply “not expressly included in section 423”, and “not justified by the terms of section 423(1)”.