Claw-Back of Assets From Unfair Preference and Undervalued Transactions

One of the most common reasons a company is wound up is because it is unable to pay its debts and it would not be commercially viable to carry on the business. In this scenario, liquidators will be appointed to distribute the company’s remaining assets to its creditors.

However, the company may have insufficient assets to repay all creditors the debts owed. If so, as creditors of such a company, you will generally be unable to receive full repayment of the debt. That said, if the company had entered into certain voidable transactions, a liquidator may be able to obtain a successful clawback action.

A clawback results in the recovery of certain assets that had been previously transferred to another party. Such clawback increases the company’s total assets that can be used to repay debts owed to the creditors.

This article will discuss two types of prior transactions that can be voided in Singapore:

1. Unfair preferences transactions; and
2. Undervalued transactions.

Clawing Back Assets From Unfair Preference Transactions in Singapore

If the company being wound up had been involved in an unfair preference transaction leading up to the commencement of winding up, the liquidator may apply for an order to void the transaction. This would restore the relevant assets such that more are available to creditors.

How to establish unfair preference

The liquidator must show the following 4 elements to establish unfair preference:

1. The beneficiary of the transaction, also known as the preferred party, is a creditor or guarantor for any of the company’s debts or liabilities;
2. The company was insolvent at the time of giving the preference, or became insolvent as a consequence of the transaction;
3. The company does anything that puts the preferred party in a better position, than the preferred party would have been in the event of the company’s liquidation, had the transaction not been entered into; and
4. The company was influenced in deciding to enter the transaction by a desire to prefer the preferred party.

The first element, about determining whether the beneficiary of the transaction is a creditor or guarantor for any of the company’s debts or liabilities, is made out fairly easily and such a relationship may be established by contracts.

The second element concerning the company’s insolvency may be established by applying a cash flow test, which assesses whether the company’s current liabilities exceed its current assets, such that it is unable to meet all debts when they fall due within a 12-month period. This may be the case if the company:

• Had been in the midst of facing demands for debts due when the transaction occurred; and
• Could not satisfy such debts with its available liquid assets at the time of the unfair preference, or became unable to do so following the transaction.

However, a temporary lack of liquidity is insufficient to establish insolvency for the purposes of making out an unfair preference. The prospect of receiving fresh capital or financial support from shareholders, and all possible incoming payments, must be considered to determine whether the company had been insolvent at that time.

Under the Insolvency, Restructuring and Dissolution Act (IRDA), however, a company is presumed to have failed the cash flow test (and will therefore be considered insolvent) where the preferred party is a “connected person”. As clarified by the Court of Appeal, connected persons include associates of the company as well as associates of the company’s directors.

The definition of associates of the insolvent company is wide, and an “associate” of the company may refer to another company if the two companies are controlled by the same person or their associates. On the other hand, an “associate” of a director may further refer to the director’s spouse, relative, business partner, employer, employee or trustee.

Thus, if person A is a director at one company and A or A’s relative holds a directorial position in another company (especially if one company is the holding company of the other), then the two companies may be considered to be connected.

Under the third element of putting the preferred party in a better position, this can be established by proving that the preferred party received more of the company’s assets than it would have received had the assets been distributed by the liquidator.

The fourth element relating to the company being influenced by a desire to prefer the preferred party may be rather difficult to prove. However, the IRDA provides a statutory presumption of the requisite desire to prefer in the case of connected persons. In other words, as long as the preferred party is connected to the company (as defined above), the company is presumed to have been influenced by a desire to prefer.

Where the preferred party is not connected to the company, it is enough that the desire to prefer was one of the factors that influenced the company’s decision to enter into the transaction, even if this desire to prefer had not been the dominant factor.

In the case of DBS v Tam Chee Chong, the company being wound up was facing financial difficulties and had been defaulting on payments due to its creditors. In the midst of its insolvency, the company granted a charge over certain shares to DBS to secure the debt. However, it refused to grant similar charges to other creditors. The company eventually underwent judicial management and the liquidator applied to court to set aside the transaction between the company and DBS for unfair preference.

During the trial to determine whether the charge placing DBS in a preferential position could be set aside, the company’s chairwoman admitted that the charge had been granted because DBS had previously been more supportive of the company. Since an unfair preference can be established as long as the disputed transaction had been carried out following a desire to prefer, the court noted that it would not have helped the company to argue that legitimate commercial considerations did additionally exist at the time. Consequently, the charge granted to DBS was set aside.

When must the transaction have taken place?

Not all unfair preference transactions entered into throughout the company’s subsistence can be scrutinised for clawback. To be voidable, the disputed transaction must fall within the relevant time period.

Unfair preferences given to a connected person up to 2 years before the commencement of winding up can be scrutinised for clawback. On the other hand, where the person preferred is not connected to the company, the period is limited to 1 year before the commencement of winding up.

The good faith exception

However, even where the court makes an order to void a transaction for unfair preference, the ultimate clawback of certain assets remain subject to the good faith exception. In other words, property and benefits given to parties that had obtained such property or benefits in good faith and for value cannot be clawed back.

For example, if the counterparty to the transaction with the company had obtained property from the company, without knowing that the company had been or would become insolvent, and made the necessary payment, then that property cannot be clawed back for distribution to creditors.

Accordingly, if the counterparty had known of the company’s insolvency, such as through being aware of facts that suggest that a liquidator had been appointed, or that the company was being wound up, then it cannot be said to have undergone the transaction in good faith.

In addition, if the counterparty had been a connected person, the good faith exception will not apply.

Clawing Back Assets From Undervalued Transactions in Singapore

An undervalued transaction is a transaction entered into in which the company is compensated for significantly less than what the transaction is valued to be at.

If the company being wound up entered into an undervalued transaction leading up to the commencement of winding up, the liquidator may apply for an order to void the transaction. This would restore the relevant assets, increasing the company’s total assets available for distribution to creditors.

How to establish undervalued transactions

To determine if a transaction is at an undervalue, the liquidator must show the following 2 elements:

1. Any one of the following 2 situations:
   • The company makes a gift to the recipient; or
   • The company enters into a transaction where the value of consideration received is significantly less than the value of the consideration provided; and
2. The company was insolvent at the time of the transaction or became insolvent as a result of that transaction.

The first element about entering into the relevant transaction is fairly easy to make out and may be evidenced by contracts. For example, the market value of the transaction and the value of what the company had received in return for it can be compared to determine whether there is a significant disparity in the value given and received.

On the other hand, the second element of insolvency may be more difficult to prove. However, the IRDA provides a statutory presumption of insolvency. As long as the transaction is with a connected person (as defined for unfair preference transactions above), the undervalued transaction is presumed to have been entered into during the company’s insolvency, or to have caused the company’s insolvency.

When must the transaction have taken place?

Not all undervalued transactions the company had ever entered into can be scrutinised for clawback. To be voidable, the disputed transaction must have taken place within 3 years prior to the commencement of the company’s winding up. This time period does not change depending on whether the counterparty had been a connected person.

Exceptions where the undervalued transaction had been believed to benefit the company

Even if the foregoing requirements are satisfied with respect to the disputed transaction, the court will not always be able to make an order to void an undervalued transaction. This may be the case if the following can be shown:

• The transaction had been entered into in good faith;
• For the purpose of carrying on its business; and
• There had been reasonable grounds at that time to believe that it would benefit the company.

The good faith exception

As discussed above, the ultimate clawback of certain assets remains subject to the good faith exception. Thus, the property or benefit obtained by the counterparty to the transaction with the company in question cannot be clawed back if the counterparty had been an unconnected person and unaware of the circumstances of the undervalued transaction.

Based on the foregoing, if company X agrees to accept part payment of $300,000 from its debtor, company Y, to settle a $1m debt and company X subsequently goes into liquidation, the transaction may satisfy the elements to make out a voidable undervalued transaction. This is because by forgoing the additional $700,000, company X has essentially conferred company Y with a benefit worth $1m for a mere $300,000.

If this undervalued transaction is voided, company Y may be ordered to make full payment of the $1m debt. However, as the court considers the totality of the benefits exchanged, an exception may apply. This may be the case if company Y had been in serious financial difficulties at the time of the undervalued transaction such that company X assessed that the part payment would minimise any further loss. If so, the court may find that the transaction had been entered into with the company X’s best interests in mind, and hence not order the transaction to be voided.

What Can You Do If You Suspect That a Company Being Wound Up has Made an Unfair Preference/Undervalued Transaction?

In Singapore, a liquidator is responsible for recovering and realising the wound-up company’s assets for distribution to creditors. Thus, if you suspect that the company has made an unfair preference/undervalued transaction, you can inform the liquidator with any evidence you may have to support your suspicion.

Creditors who were owed debts by a company prior to the commencement of its winding up may also file a proof of debt with the Official Assignee online. This is a necessary step for a creditor seeking recovery as it proves that the company in question does owe the creditor a given sum. This is so even if their debt hasn’t become due to them on the day of filing the proof of debt.

If the liquidator is able to prove the requisite elements in the application to void a transaction for unfair preference or for being undervalued, the court may then make an appropriate order to restore the company to the position it would have been prior to such transaction. Such clawbacks may include:

• Transfer of property;
• Transfer of proceeds of the sale of property;
• Payment of the benefit received by the beneficiary in the disputed transaction; or
• Provision of security.

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If it is proven that a company being wound up had been involved in undervalued or unfair preference transactions, the amount of assets recoverable to creditors in a winding up may increase upon successful clawback of the assets involved in these transactions.

However, the applicable timeline and possibility of such clawback by a liquidator is also subject to exceptions. These exceptions include the presence of good faith on the part of the beneficiary of the transaction, and the nature of the benefit transferred. The existence of these exceptions acknowledge that while debts owed to creditors should as far as possible be honoured, it is also desirable to avoid unfairly prejudicing an innocent party by requiring them to return assets that they had duly paid for in belief of the transaction’s validity.

Where a company’s insolvency is in question, there may be other instances besides unfair preference and undervalued transactions where the company’s transactions are scrutinised. An example would be extortionate credit transactions, where a transaction is deemed to be oppressive or unconscionable. If the company is found to have entered into an extortionate credit transaction, the transaction may be wholly or partially voided.

Given such complications presented by the nature of insolvency proceedings in Singapore and the number of parties that may be involved, it is advisable for creditors seeking to recover the debts owed to them by a company being wound up to consult a corporate lawyer. The lawyer will be able to guide you through the process, which would involve the submission of certain documents and applications that may be time-sensitive and technical, and assist in helping you recover as much of the debt owed to you as possible.