Factual and Procedural Background
A petition for the winding up of Company A was presented on 21 January 1997, resulting in the appointment of a provisional liquidator for Company B on the same day. Subsequently, Company A was ordered to be wound up and the provisional liquidator was appointed interim liquidator, with his appointment confirmed by creditors. The Defendant, Company C, incorporated circa 1996, is challenged by the Plaintiffs, particularly the interim liquidator, regarding a transaction alleged to have created an unfair preference under section 243 of the Insolvency Act 1986. The Plaintiffs seek an order for payment by the Defendant to Company A in the sum of £191,350.
The transaction at issue arises from an Agreement between Company A and Company C dated 8 November 1996 (deemed completed on 20 September 1996), under which Company A sold its design and advertising business to Company C for £63,396. At the time, all shares of Company C were held by directors of Company A, who also held shares in Company A. Company A was insolvent as of August 1996, with liabilities exceeding assets by £126,876. A consortium of directors proposed acquiring Company A’s assets and business, intending to pay its trade creditors but not other creditors, to preserve goodwill.
The Agreement provided for transfer of certain assets and liabilities, with a net asset value of £63,396 payable by Company C. Certain liabilities, including those related to contracts and taxation, remained with Company A. Company A undertook to pay trade creditors in full, amounting to approximately £271,000. The effect of the Agreement was a reduction in Company A’s assets by this amount.
The Plaintiffs averred that the Agreement was intended to create preferences for certain creditors to the prejudice of others, notably unsecured creditors including a major creditor, Company D, with claims exceeding £964,000 under a lease agreement. The Plaintiffs contend that unsecured creditors not preferred suffered prejudice amounting to £191,350.
The Defendant sought dismissal on grounds including the relevancy and specification of the claim.
Legal Issues Presented
- Whether the transaction challenged constituted a transaction creating an unfair preference under section 243 of the Insolvency Act 1986.
- Whether the payments made fell within statutory exceptions, such as payments in the ordinary course of business or cash payments of debts due.
- Whether the Plaintiffs could seek damages or compensation from a third party (the Defendant) rather than pursuing remedies against the preferred creditors.
- The sufficiency and relevance of the averments regarding collusion and prejudice to unsecured creditors.
- The appropriate remedy under section 243(5) and whether a claim for damages was available.
Arguments of the Parties
Defendant's Arguments
- The Agreement itself did not create a preference; the preference arose only upon payment of trade creditors, which was a separate transaction.
- The preferred creditors (trade creditors) were not parties to the Agreement and should be joined as defenders if the whole transaction was challenged.
- The transaction fell within exceptions under section 243(2)(b) and (c) as payments in cash for debts due and reciprocal obligations.
- There was no sufficient averment of collusion involving the preferred creditors, a necessary element to challenge the transaction.
- The primary remedy under section 243(5) is reduction or restoration of property, not damages; the Plaintiffs’ claim for damages lacked legal basis.
- The Plaintiffs’ quantification of prejudice was confused and based on hypothetical liquidation scenarios, lacking sufficient relevant averments.
- It would be unfair to require the Defendant, who paid full value for the assets and effectively paid the trade creditors, to make further payments while leaving the creditors’ funds untouched.
Plaintiffs' Arguments
- The entire transaction, including the Agreement and payment of trade creditors, should be challenged as creating an unfair preference.
- At common law and under the Act of 1696, preferences can be conferred by indirect or circuitous transactions, even if preferred creditors were not parties to the Agreement.
- The payments were not made in the ordinary course of business and thus do not fall within statutory exceptions.
- Sufficient averments of collusion were made, including the involvement of company structures and knowledge of insolvency.
- The proviso to section 243(5) allows claims against third parties who are instigators of preferences and did not act bona fide.
- The case raises important questions about transactions where a business is sold to a related company, paying off trade creditors but leaving a major disadvantageous creditor with diminished recourse.
- The Plaintiffs sought leave to amend their pleadings to address quantification and other criticisms if the claim was found otherwise relevant.
Table of Precedents Cited
| Precedent |
Rule or Principle Cited For |
Application by the Court |
| Craiglaw Developments Limited v Wilson 1998 S.L.T. 1046 |
Preference is only completely effectual upon payment; the challenged transaction must include the payment. |
Used to argue that the Agreement alone did not create a preference; preference arose at payment. |
| Fraser v Gibbon 1889 16 R. 740 |
Whole transaction must be challenged; preferred creditors should be defenders. |
Distinguished as the Plaintiffs sought compensation against a third party, not reduction involving preferred creditors. |
| Mitchell v Rodger 1834 12 S. 802 |
Reduction of transaction benefiting preferred creditors; involvement of parties not directly in the transaction. |
Court noted that co-cautioners acted on each other's behalf; case supports challenging entire transaction. |
| Raymond Harrison & Company's Trustee v North West Securities Limited 1989 S.L.T. 718 |
Challenge relates to the actual payment transaction; earlier steps considered only for context. |
Supported argument that payment is the relevant transaction under challenge. |
| Goudy, A Treatise on the Law of Bankruptcy in Scotland (4th Ed.) |
Requirement to call all parties benefiting from challenged transactions; definition of collusion and exceptions. |
Referenced to support procedural and substantive requirements regarding parties and collusion. |
| Nicoll v Steelpress (Supplies) Ltd 1993 S.L.T. 533 |
Reciprocal obligations must be strictly equivalent for exception under section 243(2)(c). |
Used to argue the exception for reciprocal obligations was not met. |
| Nordic Travel Limited v Scotprint Limited 1980 S.C. 1 |
Collusion requires participation by creditor to confer fraudulent preference. |
Emphasized that collusion must involve preferred creditor’s cooperation; Plaintiffs’ averments insufficient. |
| Short's Trustee v Chung 1991 S.L.T. 473 & Short's Trustees v Chung (No.2) 1999 S.C. 471 |
Scope of remedies under similar statutory provisions; no general equitable jurisdiction to award damages. |
Supported limitation of remedies to reduction or restoration, not damages. |
| Cay's Trustee v Cay 1998 S.C. 780 |
Interpretation of "other redress" as limited to restoration or reduction, not damages. |
Reinforced the court's view on the limited scope of remedies under section 243(5). |
| Newton & Sons' Trustee v Finlayson & Co 1928 S.C. 637 |
Payments must be bona fide and in ordinary course of business to fall within statutory exceptions. |
Supported argument that payments here were not in ordinary course and thus challengeable. |
| Whatmough's Trustee v British Linen Bank 1934 S.C. (H.L.) 51 |
Cash payment in ordinary course is not a voluntary alienation; collusive payments are challengeable. |
Used to interpret statutory exceptions and collusion requirements. |
Court's Reasoning and Analysis
The court accepted that the entire transaction culminating in payment to trade creditors created an unfair preference under section 243(1). It recognized that the word "challenge" under section 243(5) is broad, encompassing actions to reduce or set aside transactions.
However, the court found that the Plaintiffs’ claim was not properly framed as the remedy sought was for damages against a third party (the Defendant) rather than reduction or restoration of property to the company’s estate. The statutory scheme primarily contemplates undoing the preference by restoring assets or reducing the transaction, not awarding damages. No legal basis or precedent supported the Plaintiffs’ claim for damages.
The court also found that the Plaintiffs failed to sufficiently aver collusion involving the preferred creditors, which is necessary to challenge exceptions under section 243(2). The Defendant’s payments appeared to have been made bona fide and were part of reciprocal obligations under the Agreement, though the court allowed that the question of whether payments were in the ordinary course of business required proof at a hearing.
The court criticized the Plaintiffs’ quantification of prejudice as based on hypothetical liquidation scenarios, lacking clarity and relevant averments regarding the major unsecured creditor’s claims and the status of those claims.
Finally, the court noted that fairness and procedural considerations suggested that if the Plaintiffs were correct, the entire transaction, including payments to trade creditors, should be set aside, which would require those creditors to be parties to the action. The Plaintiffs’ attempt to isolate the Defendant for damages while leaving preferred creditors’ payments intact was not supported by the statutory framework or precedent.
Holding and Implications
The court SUSTAINED the Defendant’s first plea-in-law and DISMISSED the action.
The direct effect is that the Plaintiffs’ claim for payment against the Defendant as compensation for the alleged unfair preference was rejected. The decision confirms that under section 243 of the Insolvency Act 1986, the primary remedies are reduction or restoration relating to the transaction creating the preference, and damages claims against third parties are not supported. No new precedent was established beyond the application of existing principles to the facts.