Clawbacks In Insolvency - September 9 2019

Fraudulent Preferences and Conveyances under the Bermuda Companies Act 1981

Creditors should exercise caution when negotiating payment terms, asset transfers or securitisation transactions with companies which are in the zone of insolvency. Such transactions are vulnerable to being set aside by liquidators or by other creditors in the event of the insolvency of the company. The purpose of Bermuda's reviewable transactions law is to uphold the pari passu basis for the distribution of a company's assets amongst its unsecured creditors in an insolvency context.

Zone of Insolvency

In normal circumstances, when a company is in good financial health, a director's primary duty is to act in the best interests of the company by promoting shareholder value in the company. However, when a company is insolvent, or is in the "zone of insolvency", this duty shifts such that a director is obliged to instead have primary regard to the interests of the creditors. This is because in an insolvency context, it is the creditors who have an economic interest in the company, rather than the shareholders.

So how does one determine when a company is in the "zone of insolvency"? There is no simple answer to this question and there is no bright line test which can be applied to ascertain whether a company is or is not in the zone of insolvency. As a general proposition, the "zone of insolvency" can be thought of as the period where there has been a serious deterioration of a company's financial position, to the point where there is a reasonable expectation that insolvency has become imminent.

What does "insolvency" really mean?

In Bermuda, section 161(e) of the Companies Act 1981 (the "Act") provides that a company may be wound up by the Court if it is "unable to pay its debts". Section 162 of the Act provides that when considering whether a company is unable to pay its debts, the Court can take into account both the cash flow and balance sheet tests for insolvency.

Fraudulent Preferences

Transactions involving payments to a certain creditor or creditors made within six months of a company's winding up are susceptible to being set aside as a fraudulent preference of its creditors if it can be established that:

the transaction was undertaken with the intention to fraudulently prefer one or more of the company's creditors; and at the time of the transaction, the company was unable to pay its debts as they fell due. Practitioners of other common law jurisdictions may be...