Publication

The Spouse v The Creditors: a turn against creditors?

Insolvency Intelligence, 2010, 23(6), 81-87

Joseph Curl

Very often the only thing in a bankrupt's estate that is worth anything is the bankrupt's interest in a domestic home.  But very often this asset is also the home of the bankrupt's wife or husband.  It is axiomatic that there is a tension between domestic interests surrounding the bankrupt's family home (interests usually represented by the bankrupt's spouse) on the one hand and the interests of the bankrupt's creditors (represented by the trustee in bankruptcy) on the other. How this tension is dealt with is a delicate question of law and policy.  Historically, the insolvency regime in England and Wales has tended to be unsympathetic towards domestic interests in property occupied by the bankrupt's family. However, over the last couple of years reported cases involving skirmishes between the spouse and the creditors have tended to find the bankrupt's trustee on the losing side when the courts have been called upon to resolve this tension. Has there been a judicial turn against the interests of the creditors? What conclusions might insolvency practitioners draw from these recent failures by trustees?

A previous article[1] dealt with s.283A of the Insolvency Act 1986 (“IA1986”) and the effect of the decision in Lewis v Metropolitan Property Realisations Ltd.[2]  This article will consider recent reported applications of the following statutory insolvency provisions and consider whether the current judicial mood is to lean towards the interests of the spouse in a contest with the trustee:

•           transactions at an undervalue (s.339 of the IA1986);

•           preferences (s.340 of the IA1986); and

•           transactions defrauding creditors (s.423 of the IA1986).

Transactions at an undervalue: section 339 of the Insolvency Act 1986 

Hill v Haines[3] concerned whether a matrimonial property adjustment order made at the conclusion of ancillary relief proceedings can be revisited later on by a trustee in bankruptcy. It nicely illustrates the battle between the (ex-)spouse and the creditors.  This case has generated considerably more commentary than the other cases considered in this article.[4]  It is of course not at all unusual for a decision concerning a specialist area to ruffle feathers among expert practitioners.  One of the fascinating things about Hill is that both the decision in the High Court (favouring the trustee) and its subsequent reversal by the Court of Appeal (in favour of the spouse) have caused opposing feather-ruffling among two distinct specialist practice areas.  The insolvency industry cheered the pro-creditor decision of the High Court, while simultaneously ancillary relief specialists feared for the integrity and finality of divorce proceedings.  Following reversal by the Court of Appeal, the tables were turned as insolvency practitioners perceived another assault on the interests of the creditors.

The facts were unremarkable. Mr and Mrs Haines got divorced. On 22 December 2004, following unpleasant and contested ancillary relief proceedings, Mr Haines was ordered to transfer his interest in the former matrimonial home to Mrs Haines.  This property adjustment order became final on 28 February 2005.  Only a few weeks passed before Mr Haines was adjudged bankrupt on 31 March 2005.  Just over a year later, the trustees in bankruptcy applied for a declaration that the transfer of Mr Haines's interest was a transaction at an undervalue pursuant to s.339(1) of the IA1986 and was void as against the trustees.

Before considering the case, let us recap the provisions of s.339 of the IA1986.  A trustee may apply to avoid a transaction at an undervalue (a transfer for no consideration or for significantly less than the value of the consideration provided by the transferor) made up to two years before the making of the bankruptcy order. The timescale may be extended to five years where the transferor is either insolvent at the time of the transfer or is rendered insolvent by the transfer.  The burden of proof in showing insolvency is on the trustee unless the transaction is in favour of an associate[5] in which case the burden is reversed.

Hill v Haines: a tough test for unwinding a matrimonial order as an undervalue 

In summary, the trustees' argument was that in acquiring her former husband's share of the property by means of a property adjustment order made in matrimonial proceedings, Mrs Haines had not given consideration.  In the Birmingham County Court at first instance, District Judge Cooke dismissed the application.  The trustees appealed to the High Court and won before His Honour Judge Pelling QC (sitting as a judge of the Chancery Division).  Mrs Haines appealed to the Court of Appeal.

Before the Court of Appeal, the issues were:

•           whether or not a property adjustment order made in matrimonial proceedings involves consideration; and

•           if so, whether the court may interfere with such an order if the balance of consideration discloses an undervalue.

The starting point for the trustees was to point to unambiguous statutory authority that a property adjustment order made under the matrimonial regime is indeed capable of being a transaction at an undervalue or a preference. Section 39 of the Matrimonial Causes Act 1973 (“MCA1973” ) spells this out in the clearest terms:

“The fact that a settlement or transfer of property had to be made in order to comply with a property adjustment order shall not prevent that settlement or transfer from being a transaction in respect of which an order may be made under section 339 or 340 of the Insolvency Act 1986 (transactions at an undervalue and preferences).” 

However, this apparently helpful provision did not show decisively that there was no consideration.  Sir Andrew Morritt C pointed out[6] that if the trustees were correct that a property adjustment order did not involve consideration, then such an order would inevitably be a transaction at an undervalue (rather than merely not prevented from being one).  Furthermore, it could not have been the legislature's intention for a property adjustment order made by the court in matrimonial proceedings to be vulnerable to automatic nullification as an undervalue on the application of the trustee of a spouse who was subsequently made bankrupt.  This meant that it could not be the case that consideration was automatically absent.  So in the view of the Court of Appeal, there could be consideration.  What form did this consideration take?

Their Lordships reviewed previous authority to demonstrate that to compromise a claim to ancillary relief was to give consideration.  Prior to Hill, the most frequently cited authority on this point was probably Re Kumar (A Bankrupt).[7]  In Kumar, the wife had allowed her claim for ancillary relief to be dismissed by consent on the basis that her husband had already transferred the legal and beneficial title to their home to her.  Ferris J had considered that such a release was capable of constituting valuable consideration.  Sir Andrew Morritt C concluded that Ferris J in Kumar:

“ … evidently considered that the insolvency court was entitled to go behind the release of a spouse's statutory right to claim ancillary relief in the matrimonial court to see if it was genuine and for full value.”[8]

However, Ferris J had held on the facts of Kumar that the value of the consideration provided by the husband far outweighed the value of the claim compromised by the wife.  Ferris J had delved into the facts and decided that had contested ancillary relief proceedings continued, the divorce court would not ultimately have awarded the wife the husband's interest in the house.  This was because the wife's earning capacity dwarfed her husband's and the house represented the whole of the husband's capital.  So in Kumar the court recognised that compromise of a right to ancillary relief could in principle constitute valuable consideration but then proceeded to decide that on the facts before it the balance of consideration provided by the respective parties to the property adjustment order was not the right one and set aside the ancillary relief order.

The Court of Appeal in Hill took from Kumar the principle that a spouse's right to ancillary relief could constitute valuable consideration.  But the second limb of the exercise (that of a fact based inquiry as to the correctness of the balance of consideration in the ancillary relief order) was not undertaken.  Their Lordships held that in the absence of some vitiating factor, the balance struck in the matrimonial proceedings would be the correct one.  A property adjustment order could still be attacked by a trustee in theory but the starting point would be that the balance of consideration was correct. If the balance was correct, then there could be no undervalue.  The ratio of Hill appears to be this:

“If one considers the economic realities, the order of the court quantifies the value of the applicant spouse's statutory right by reference to the value of the money or property thereby ordered to be paid or transferred by the respondent spouse to the applicant. In the case of such an order, whether following contested proceedings or by way of compromise, in the absence of the usual vitiating factors of fraud, mistake or misrepresentation the one balances the other. But if any such factor is established by a trustee in bankruptcy on an application under section 339 of the 1986 Act then it will be apparent that the prima facie balance was not the true one and the transaction may be liable to be set aside.”[9] 

Thorpe LJ's analysis in Hill is no more encouraging for trustees in bankruptcy:

“It can be assumed that ancillary relief orders resulting from a hard fought trial are less likely to be tarnished by collusion or fraud on the creditors than consent orders. However, the same principles apply, albeit that the trustee's burden of proof may be more easily discharged.”[10]

What does Hill v Haines mean for the spouse versus the creditors? 

This is unwelcome news indeed for the trustee.  Essentially, the conclusion is that a property adjustment order may be re-opened but only if evidence as to fraud, mistake or misrepresentation can be brought forth.  It seems that the question for a trustee is not whether or not there was an undervalue but whether or not there was some vitiating circumstance.  In practical terms, how is the trustee to gather such evidence and prove it?  When the evidence concerns what has passed between (ex-)spouses, establishing such evidence is likely to be challenging.  There is reference in the judgment to a possible vitiating factor being a wife's failure to make frank disclosure of her assets.  Other than this, there is very little here to assist a trustee.  Anyone working in insolvency will be familiar with tactical separations between couples or bare assertions that the whole of the beneficial interest in a property is vested in the non-bankrupt spouse leading to fiddly and expensive applications.  Hill seems to be authority for the proposition that as long as such an arrangement is embodied in a court order (even by consent) within the context of divorce proceedings, it will be very difficult to unwind unless evidence can be brought forward.

Moving from the specifics out into the policy arena, Thorpe LJ offers some illumination as to the way the judiciary views the position.  Thorpe LJ considered that an:

“ … important message is to be drawn from authority of more recent origin. The social and legal policy underlying the exercise of the court's discretion has been developed by the decisions of the House of Lords in White v White and McFarlane v McFarlane. In broad summary the effect of these decisions is that: (a) the wife in bringing her claim for ancillary relief does not come as a supplicant but as one seeking the quantification of her entitlement; (b) that quantification of the fair outcome will be driven by a number of considerations but principally needs, compensation and sharing.”[11] 

So Thorpe LJ makes clear that at the ancillary relief stage, the process of quantification is driven by the needs of the spouse seeking relief.  It hardly needs stating that at this stage the interests of the creditors do not feature prominently in the court's deliberations.  Thorpe LJ was absolutely explicit as to the considerations that had driven the court to make the property adjustment order:

“The wife had sole responsibility for the care of the seven-year-old daughter of the marriage. There was no likelihood that that responsibility would be shared in the foreseeable future. Her overwhelming need, and the court's overwhelming priority, [emphasis added] was to enable her to rehouse herself and her daughter in suitable accommodation.” 

Section 25 MCA1973 states that the welfare of any minor child of the family is the “first consideration”.  So at the matrimonial stage, the interests of the creditors of the debtor spouse are not uppermost in the mind of the court.  Within the matrimonial context, that is a justifiable policy aim.  However, where matters become difficult is that Hill is authority for the proposition that the balance that is regarded as correct within the matrimonial context (where family welfare factors are paramount) is crystalised as prima facie the correct balance to be taken forward into the insolvency context (unless the trustee can subsequently clear the high hurdle of vitiating circumstances).  If this is the position, it means that a creditor's interests will not at any stage be properly considered.

In Hill, the court found that Mr Haines had behaved deplorably and had been evasive and uncooperative during the matrimonial proceedings.  This partly explained the harshness of the property adjustment order towards him.  Where there is this sort of conduct, combined with hard-fought and unpleasant ancillary relief proceedings, collusion between the parties is unlikely to be evident.  If there is no collusion then it is unlikely that vitiating circumstances will be present to enable the court to look behind the property adjustment order on the application of a trustee in bankruptcy.  The ironic and unhelpful consequence of this is that where a creditor is owed money by an unreasonable and irresponsible debtor who is simultaneously going through a divorce, the creditor will suffer not only the usual difficulties associated with such a delinquent debtor but may also suffer additional prejudice arising from a harsh adjustment order being made in the matrimonial proceedings because of the delinquent debtor's behaviour in those proceedings.  Usually in insolvency proceedings, a creditor might hope at least for the benefit of the doubt from the court where the debtor behaves unreasonably.  The harsh treatment meted out to Mr Haines (and consequently his creditors) would seem to indicate that the substantive outcome for the creditor may well be the opposite of this where an unreasonable debtor's assets have been dealt with prior to the advent of the bankruptcy in matrimonial proceedings.

A further consequence of Hill is that it heightens further still the significance of the chronological sequence of an ancillary relief order and a bankruptcy order.  It is not uncommon for a divorcing wife of a debtor to feel aggrieved if her husband pulls the pin out of the metaphorical hand grenade he is holding by allowing himself to be made bankrupt (either on his own petition or by not resisting a creditor's petition) before ancillary relief proceedings can be concluded.  In such a case, a wife may bring an annulment application on the basis that the husband engineered or procured his bankruptcy in order to frustrate her claim for ancillary relief.[12]  There is already an argument that there is an arbitrary element of luck and chance to the wife's race against time to secure an ancillary relief order before her husband's bankruptcy intervenes.  But at least if it is known that it is open to a trustee to revisit a matrimonial property adjustment order later on, it would provide some brake on the rush to ensure an ancillary relief order is finalised at all costs before a bankruptcy order is made. In Whig v Whig,[13]  Munby J had before him both a wife's ancillary relief application and an application to annul the husband's intervening bankruptcy.  Munby J observed that even if he had annulled and made a property adjustment order:

“… there is the simple fact that, if the bankruptcy order were annulled, the husband would remain at the mercy of his creditors. Unless the debts are paid, or compounded for, it is probable that he will simply be made bankrupt again, for debtors who may well feel that they have been ‘ given the run around’  for the best part of 4 years are unlikely to be merciful. And in the event of the husband again being made bankrupt any order I might have made in favour of the wife would be vulnerable to attack under s 339 of the 1986 Act as a ‘ transaction … at an undervalue’ .”[14]

The view here of Munby J appears to be that the court must be mindful not to be too extravagant in making an order in favour of a wife because the prospect of a trustee lurking around the corner wielding s.339 IA1986 provides an incentive not to do so.  However, Hill surely lays waste to such an incentive and gives open season to the wife as long as she can beat the clock and get her ancillary relief order made before her husband is made bankrupt.  It is submitted that on this analysis, the arbitrary significance of chronology is amplified by Hill. 

Preferences: section 340 of the Insolvency Act 1986 

Re Jones (A Bankrupt)[15] was an interesting judgment given by Chief Registrar Baister in the Chancery Division.  It is the first (and appears to be the only) reported detailed application of Hill.  It is also noteworthy that counsel appearing before the Chief Registrar were Sally Barber for Mr Jones (the spouse) and Nicholas Briggs for the trustee.  Ms Barber has subsequently taken a full-time Registrar's appointment while Mr Briggs sits as a Deputy Registrar.  This means that as well as the Chief Registrar himself, both counsel will themselves be grappling as Registrars with the implications of this decision.

This case was originally pleaded only as a transaction at an undervalue claim under s.339 of the IA1986.  However, it came hard on the heels of the disappointing outcome in Hill concerning undervalues.  In light of this, the trustee applied to amend to plead a preference as well pursuant to s.340 of the IA1986.  We have seen that Hill is authority for the proposition that absent some fairly serious vitiating factor a spouse who receives a bankrupt's property pursuant to a property adjustment order is likely to have given the correct level of consideration for it.  Given this, one can easily follow the trustee's sensible line of thought in amending his claim to plead a preference as well.  First, if the claim of the spouse in the matrimonial proceedings against the prospective bankrupt is capable of constituting valuable consideration, then (the trustee's reasoning went) that spouse must be a creditor of the prospective bankrupt.  Secondly, if the spouse is a creditor, then their receipt of most of the prospective bankrupt's wealth under the property adjustment order must constitute a preference.  Unfortunately for the trustee, Chief Registrar Baister took a different view.

The facts were that Mr and Mrs Jones were comfortably affluent people with a number of business interests, principally in the building industry and as dealers in koi carp fish.  Things deteriorated when Mr Jones became ill with cancer and was forced to withdraw from the businesses.  Mrs Jones began to misappropriate funds and her spending grew out of control.  Eventually the marriage broke down in 2002 on the grounds of Mrs Jones's adultery with an employee.  In April 2003 a decree nisi was granted.  In November 2003, an agreement was reached which was embodied in a consent order in January 2004.  In February 2005, Mrs Jones was made bankrupt on the petition of the Revenue.

Re Jones (A Bankrupt): the Hill v Haines test entrenched for undervalues 

Before turning to the preference claim, the Chief Registrar dispatched the trustee's argument that there had been a transaction at an undervalue with a robust application of Hill.  In brief terms, the consent order in January 2004 provided that the former matrimonial home was preserved for Mr Jones and the children.  It was common ground on the trustee's application that in the ancillary relief proceedings Mrs Jones had overstated her income, understated her debts and had been insolvent at the time of the transfer.  Furthermore, there was correspondence and attendance notes from her solicitors advising her that the agreement reached with Mr Jones was “very disadvantageous”  and “not appropriate”  and “made completely against [the solicitors'] advice”.

However, on considering the evidence as a whole, the Chief Registrar commented that:

“ … the matrimonial settlement between Mr and Mrs Jones was negotiated long and hard and at arm's length. I accept that and do not propose to set out the detail here. Suffice it to note in addition that Mrs Jones's adultery with an employee, her financial improvidence and, it seems, dishonesty put this divorce on a footing that was far from amicable. The divorce was commonplace in that respect too, anything but a device to secure the matrimonial assets for the benefit of the family by using family proceedings as a back door for that purpose. The fact that Mrs Jones capitulated in the end (for understandable reasons) does not detract from that.”[16]

So the Chief Registrar found that there was not enough to find collusion or any of the other vitiating factors identified in Hill as being necessary to go behind a property adjustment order. If Hill set the bar high for challenging a property adjustment order, then Jones entrenches this test and gives a robust interpretation of the Court of Appeal's reasoning. Chief Registrar Baister held that:

“ … I decline, therefore, to find that the agreement or order can be undone by reason of any vitiating factor…it follows that this court is precluded from ‘ lifting the bonnet’  on the consent order … As far as undervalue is concerned, it is plain that an agreement or order of the kind to which the Joneses consented cannot of itself amount to a transaction at an undervalue ….”[17]

This passage reiterates that a non-vitiated property adjustment order can never be a transaction at an undervalue.  Consequently this confirms the lesson from Hill that the analytical approach for the trustee must alter.  Instead of considering as a starting point whether there is an undervalue which could justify revisiting a property adjustment order, the future starting point will be whether or not a property adjustment order can be set aside for some vitiating factor.  If it cannot be set aside for a vitiating factor, it cannot be a transaction at an undervalue.  Any doubt that this is the Chief Registrar's reading of Hill is removed later in his judgment when he refers to:

“…the Court of Appeal's insistence on positive proof of fraud, collusion and so on as a precondition [emphasis added] to a challenge under s 339 to an order made in ancillary relief proceedings.”[18]

Re Jones (A Bankrupt): a spouse cannot be a creditor so there can be no preference 

Chief Registrar Baister turned next to the preference point.  Section 340 of the IA1986 provides that a trustee may challenge a transaction where someone does something or allows something to be done that puts a creditor in a better position than that creditor would otherwise have been on a subsequent bankruptcy.  The bankrupt must have intended that the transaction would have the effect of preferring that creditor.  An application to avoid a preference may be made if the preference is given within six months of the bankruptcy order where the preference is given to a non-associate or two years in the case of an associate (which includes a spouse).[19]  In both situations, there is a requirement of insolvency and the burden is on the trustee to prove insolvency.  The burden of showing the desire to prefer is also on the trustee unless the party being preferred is an associate, in which case it is presumed.

The Chief Registrar concluded that a spouse with a claim in ancillary relief proceedings was not a “creditor”  at all, by reference to ss.382 and 383 of the IA1986.  The reasoning for this was that any agreement reached between divorcing spouses was unenforceable without an order of the court. It was merely an obligation as distinct from a liability:

“…a contract [i.e. the agreement to compromise the contested ancillary relief proceedings] of the kind with which we are now concerned is unenforceable without an order of the court. I accept that that does not mean that the underlying agreement has no effect. If does, however, mean that if it cannot be converted into a right giving rise to an enforceable obligation it cannot transform the party suffering the breach into a creditor…That a party may not resile from an agreement is not the same as being able to enforce and turn the obligation into a liability either…For the foregoing reasons I find that Mr Jones was not a creditor of Mrs Jones on the basis advanced by the applicant.”[20]

Jones is therefore authority for the proposition that an applicant spouse in matrimonial proceedings cannot be regarded as a creditor at all and so cannot be the beneficiary of a preference.  Although Chief Registrar Baister acknowledged that this finding meant that there was probably no need to consider whether Mrs Jones had the requisite intention to prefer Mr Jones over her creditors, the Chief Registrar nevertheless considered this point at the end of his judgment.  This passage is particularly interesting:

“…the matrimonial documents show that the ancillary relief proceedings were contested up to the point at which Mrs Jones capitulated. This is at odds with any desire on the part of Mrs Jones to prefer her husband…I agree with [counsel for Mr Jones] that capitulation cannot be equated with a desire to prefer. The facts indeed point away from such an intention. Mr and Mrs Jones's motivating factors did not include a desire to do down the creditors.”[21]

Despite by this stage nothing turning on this point, these remarks are of interest in that they arguably show again a judicial raising of the bar in a contest between a trustee and a spouse.  Let us remind ourselves of the wording of s.340 of the IA1986:

“(3)      For the purposes of this and the next two sections, an individual gives a preference to a person if -- … the individual does anything or suffers anything to be done which (in either case) has the effect of putting that person into a position which, in the event of the individual's bankruptcy, will be better than the position he would have been in if that thing had not been done.

(4)        The court shall not make an order under this section in respect of a preference given to any person unless the individual who gave the preference was influenced in deciding to give it by a desire to produce in relation to that person the effect mentioned in subsection (3)(b) above.” 

On the face of the statute, the active subjective motivating desire in order to establish a preference is the desire to prefer a particular creditor over the general body of creditors.  In Jones, the necessary desire is characterised as an active desire “to do down the creditors”. It is submitted that to intend to prefer one creditor is not necessarily the same thing as intending to do another down.  Other than in very particular circumstances (where, for example, a bankrupt has an antipathy or feud with a particular creditor), the desire will not be to do anyone down, but instead to prefer someone else.  This is what the statute anticipates.  Of course, preferring someone will have as its natural corollary the doing down of someone else.  But if the required subjective motivating intention (rather than the unintended side‑effect) is to do someone down, then this will be a far more demanding test for the insolvency practitioner.  

What does Re Jones (A Bankrupt) mean for the spouse versus the creditors? 

One interpretation of Jones is that the spouse now has a uniquely favourable status in insolvency.  The spouse simultaneously gets all the advantages of being a creditor but none of the disadvantages.  For the purposes of the trustee's ability to avoid a transaction at an undervalue in s.339 of the IA1986, the spouse is regarded as having given consideration for the purposes of the property adjustment order.  Not only that, but the balance of consideration is beyond reproach in the absence of proof of a serious vitiating circumstance.  However, for the purpose of the trustee's rights under the anti-preference provisions in s.340 of the IA1986, the spouse cannot be a creditor at all.

Transactions defrauding creditors: section 423 of the Insolvency Act 1986 

Papanicola v Fagan[22] came soon after the decision in Jones and (as in Jones) also saw some late tactical amendment.  Originally Papanicola had been pleaded only as a transaction at an undervalue claim.  However, at trial the trustee was given permission to add in a claim that this had been a transaction to defraud creditors contrary to s.423 of the IA1986.

This was not a case concerning a property adjustment order made in matrimonial proceedings.  It was on the face of it a much more straightforward transaction at an undervalue claim.  The facts were that Ray and Pamela Fagan had been married since 1981.  They had owned their matrimonial home since 1988.  Both of them worked in Mr Fagan's family's business running various pubs.  From the early 1990s, Mr Fagan's drinking began to get out of hand.  He had a spell in the Priory rehabilitation clinic in 1993 followed by a period of abstinence.  But by 1996 he was drinking again and had also developed a gambling problem.  In 1998, Mrs Fagan was worried that Mr Fagan's irresponsibility would lead to disaster.  So Mrs Fagan gave Mr Fagan an ultimatum: she would divorce him unless he executed a declaration of trust signing everything over to her.  Mrs Fagan put it like this:

“The Declaration was made at my insistence for very personal reasons.  Ray was battling alcoholism and mental ill-health and I wanted to protect our family home against anything foolish that Ray may have done, such as giving or gambling it away.  I had been contemplating such a transfer for about two years.  Ray had been in rehabilitation in 1993, but relapsed into drinking again in 1996.  Ray stopped drinking again for about six months in 1996, but then started again.  Then in 1998 when he stopped drinking again for two months, I picked this time to tell him that I could and would divorce Ray to get his half of the house in order to protect our family home and our children from Ray's potential actions.  Put simply, I no longer trusted him to put the interests of his family ahead of alcohol and gambling.  As was usual at the time when Ray was not drinking, he was eager to please to save our marriage and make up for his previous relapse.”[23]

In May 1998, a declaration of trust was executed.  Under the terms of the deed, Mr Fagan held his interest in the house on trust for Mrs Fagan absolutely.  Mrs Fagan's fears were proved prescient and accurate when, in October 2002, a bankruptcy order was made in respect of Mr Fagan.

The deed was outside the two-year period for automatic avoidance of transactions at an undervalue.  However, the transaction could still be set aside if Mr Fagan was either insolvent at the time of the transaction or had been rendered insolvent by the transaction.  Given that Mrs Fagan was an associate of Mr Fagan, the burden was on Mrs Fagan to show solvency.  His Honour Judge Raynor QC (sitting as a High Court judge) had no hesitation in finding that Mr Fagan had been solvent at the time of the transaction.  Consequently the application under s.339 of the IA1986 failed.

The claim under s.423 of the IA1986 looked more promising.  Like s.339 of the IA1986, s.423 of the IA1986 also concerns transactions at an undervalue.  However, the crucial difference between claims under ss.339 and 423 is that s.423 claims have no time-limit and no requirement for insolvency to be present.  What is required by s.423 of the IA1986 (and not by s.339) is an intention to put assets beyond reach or prejudice the claim of anyone who might make a claim in the future.  A further difference is that any “victim” of the transaction may apply, not merely the trustee. His Honour Judge Raynor QC set out the scheme of s.423 as follows:

“The following issues arise.  First, was the transaction entered into at an undervalue within the meaning of s 423(1)(a)?  Secondly, if so has the applicant proved that the bankrupt entered into the transaction for one of the purposes set out in s 423(3)?  Thirdly, if so should the court exercise its discretion and make an order under the provisions of s 423(2)?”[24] 

We have already seen that compromising an ancillary relief claim under a property adjustment order can constitute valuable consideration.  In Papanicola, there was no such compromise of any claim to ancillary relief, nor indeed any extant claim at all.  However, the judge took hold of this type of reasoning and took an elaborate and creative approach to prove that Mrs Fagan provided consideration:

“It is well established, of course, that a promise not to sue on a valid claim may constitute good consideration … In this case I am satisfied that in fact the transaction was not by way of gift and that the respondent gave valuable consideration for the transfer. What she promised to do, and did in fact do, in return for the transfer was to forbear from petitioning from [sic] divorce and prosecuting her valid claim for a property adjustment order. Her husband obtained valuable consideration as a result. The transaction accordingly was not within s 423(1)(a) as alleged by the trustee and on that ground alone the application fails.”[25]

So Mr Fagan obtained valuable consideration in exchange for divesting himself of all the wealth he had in the world: he got to keep his wife.  But in Hill and Jones, the presumption seemed to be that in order to ensure that the balance of consideration was the correct one, it had to be embodied in an order made under the supervision of the court (albeit either after contested proceedings or by consent).  In Papanicola, the transaction had been a private one.  There is no discussion of the crystallisation of the value being the correct one in Papanicola.  What principles could the court apply in valuing the value of the consideration given by a wife in not seeking a divorce?  Perhaps it would depend on the nature of the wife or on the nature of the husband she would have to put up with!  What if Mrs Fagan had entered into the deed and then sought a divorce two weeks later?  Could Mr Fagan have sought to set aside the deed?  What about 12 months later?  10 years?  Is it wise public policy for divorce or forbearing from divorce to be a measureable bargaining unit like this?

His Honour Judge Raynor QC went on to consider whether the statutory test in s.423(3) of the IA1986 as to intention was met.  The judge recapped that there was no need for the purpose to be the dominant purpose.  All that was required was that the purpose was a real substantial purpose rather than a mere consequence.  If we look back at Mrs Fagan's account of the purpose of the transaction, it would seem to be established beyond argument that on her own case this was Mrs Fagan's intention.  However, for the purposes of s.423 of the IA1986, Mr (not Mrs) Fagan's intention was the crucial one.  The trustee submitted that Mr Fagan must have been aware of Mrs Fagan's purpose when he entered the declaration.  Unfortunately for the trustee, the judge disagreed:

“Mrs Fagan's purpose in insisting on the transfer was stated by her in effect to protect the matrimonial home against any liabilities and debts that might result from the husband's alcoholism and gambling.  The question is whether that was also a substantial purpose of Mr Fagan…I am satisfied that it was not a substantial purpose of the transaction as far as Mr Fagan was concerned to put his interest out of the reach of creditors.  His purpose, as he stated, was to save his marriage by conceding to his wife's demand.  The consequence of entering into the transaction for that purpose was that his interest was put out of the reach of creditors who later materialised, but I find that that is not sufficient to satisfy the statutory test and on that ground too the application fails.”[26]

What does Papanicola v Fagan mean for the spouse versus the creditors? 

The judge sought to make a distinction between purpose and consequence in determining what the purpose of the transaction was.  Identifying which is which is a semantically tricky exercise: can it really be said that there is a principled difference between on the one hand saying that Mr Fagan's primary purpose was to engage in his wife's scheme to place his assets beyond the reach of his creditors because otherwise she would divorce him (which would be caught by s.423(3)) and, on the other hand saying that Mr Fagan's primary purpose was to induce his wife not to divorce him by co-operating with her scheme to put his assets beyond the reach of his creditors (which was not caught by s.423(3))?  This could strengthen the position of debtors who point to some apparently collateral purpose as the real purpose and the fact that creditors were prejudiced merely as an incidental and unintended consequence.

Conclusion 

On the basis of these recent reported authorities, it would seem that there are sufficient grounds for insolvency practitioners to argue with some justification that the pendulum has now swung too far in favour of the interests of the spouses of bankrupts and against the creditors of those bankrupts.  Under the post-Hill regime, the hurdle now appears to be very high indeed for any trustee trying to go behind a property adjustment order made in matrimonial proceedings for the purpose of establishing a transaction at an undervalue under s.339 of the IA1986. The Hill approach to undervalues is entrenched and perhaps strengthened after Jones, and it also now seems impossible in principle for a spouse in matrimonial proceedings to be a creditor for the purposes of grounding a voidable preference under s.340 of the IA1986.  Finally, Papanicola finds the court applying an almost surreal level of creativity in establishing consideration on the part of the non-bankrupt spouse.  It will be interesting indeed to see what happens when these issues are next before the Court of Appeal or the Supreme Court. On present form, who will be brave enough to try it?