Bahamas: Clawbacks, Shadows & Other Curiosities - The New Insolvency Regime

Last Updated: 6 September 2012
Article by Portia J. Nicholson

Companies in crisis are often tempted to sell, charge, or otherwise dispose of assets so as to put them beyond the reach of creditors. The ability to reverse actions calculated to give one creditor a preference over others at a time when the company is unable to pay its debts is known as a right to "clawback" and is an extremely important weapon in the arsenal of a liquidator.

The Companies (Winding Up) (Amendment) Act, 2011 (the "New Act"), which came into force on April 30, 2012, includes provisions that expand significantly the circumstances in which the right of clawback may be exercised and impose criminal liability on directors in certain circumstances. Among the dispositions that may be assailed, are those that comprise fraudulent preferences and dispositions at an undervalue, both of which will be discussed in greater detail below. In addition, the New Act makes directors (including shadow directors) criminally liable for fraudulent trading and insolvent trading.

Fraudulent Preferences

A fundamental principle of insolvency law is that unsecured creditors rank "pari passu" i.e. they have the right to equal (or pro rata) treatment. When an insolvent company acts in a way that either gives a greater right to any asset to one creditor or moves assets beyond the reach of creditors, that action may be categorized as a "fraudulent preference".

Section 241 of the New Act, which replaces section 72 of the Bankruptcy Act as the provision governing fraudulent preferences with respect to companies, is different from the former provision in two principal respects.

Firstly, under the previous regime, the period during which dispositions were subject to reversal (the "clawback period") was three months prior to the commencement of liquidation. The New Act extends the clawback period from three to six months.

Further, whereas the old regime preserved the rights of a purchaser, chargee or payee acting in good faith for valuable consideration, the New Act does not do so. This raises the possibility that a liquidator may be able to "claw back" assets that have been acquired in good faith under arms length terms by an innocent third party.

In order for a disposition to be reversed, the liquidator must prove that at the time it was made the company was unable to pay its debts. Under the provisions of the New Act, a company is unable to pay its debts if:

  • a creditor serves a statutory demand for payment of a debt and such demand is not paid or secured or compounded to the creditor's satisfaction within 3 weeks; or
  • execution of a judgement order or decree is returned either wholly or partially unsatisfied; or
  • it is proven to the court's satisfaction that the company is unable to pay its debts.

Dispositions at an Undervalue

The other type of transaction giving rise to "claw back" rights under the Act is a "disposition at an undervalue". A disposition of property is any action resulting in the creation, transfer or extinguishment of a legal or equitable interest in property. This includes a conveyance, transfer, assignment, lease, pledge or mortgage. Where any asset of a company is disposed of either for no consideration (i.e. as a gift) or for consideration with a value that is lower than that of the asset, with the intent to defraud creditors, the disposition may be avoided (reversed) by the court on the application of the official liquidator. Proceedings for the avoidance of a disposition must be commenced within two years of the disposition complained of. If the court sets aside the disposition but is satisfied that the person to whom the property had been transferred has not acted in bad faith, such transferee will be awarded his costs incurred in defending the legal proceedings and shall have a first charge over the property for such costs.

In addition to expanding the clawback rights of a liquidator, the New Act creates criminal sanctions for certain trading activities as well as fraudulent actions taken prior to or in the course of winding up proceedings.

Fraudulent Trading

Where a company is being wound up, the liquidator may obtain a declaration from the court for any person who knowingly participated in carrying on the business with the intent to defraud creditors or for any fraudulent purpose to contribute to the company's assets. The fraudulent trading that might result in a declaration for such a contribution may have taken place "at any time before the commencement of the winding up".

Insolvent Trading

An order for contribution may also be made against past or present directors if the court is satisfied that before the winding up commenced such director knew or ought to have known that there was no reasonable prospect that the company would avoid being wound up by reason of insolvency. A company is insolvent if it is unable to pay its debts in the sense outlined above or if the value of its liabilities exceeds its assets.

It is a defence for a director to prove that he took every step reasonably open to him to minimize the loss to the company's creditors. What the director knew or ought to have known will be determined on both an objective and subjective basis, that is, what facts would have been known, conclusions reached or steps taken by a reasonably diligent person having the general knowledge, skill and experience that may be reasonably expected of a person carrying out the same functions as those carried out by or entrusted to the relevant director and having the general knowledge, skill and experience of that director.

Out of the Shadows

The persons who may be ordered by the court to contribute to a company's assets because of insolvent trading include a shadow director. A shadow director is not a director in the formal sense of having been appointed in that capacity in accordance with the company's governing documents. The New Act defines a shadow director as "any person in accordance with whose directions or instructions the directors of a company are accustomed to act". This does not include a person who gives advice to the board merely in a professional capacity.

Aside from their liability to contribute to assets where they have participated in insolvent trading, shadow directors (along with other accountable corporate officers) may face criminal liability where fraud or certain types of misconduct occur within twelve months of the company being wound up.

The four areas in which shadow directors may be subject to criminal sanctions are as follows:

  • Fraud in anticipation of winding up - this includes:- concealment or removal of company property valued at ten thousand dollars or more; concealment, destruction, mutilation or falsification of documents relating to the company's affairs; and the disposition of property obtained on credit and not fully paid for, in each case with intent to defraud the company's creditors or contributories.
  • Transactions to defraud creditors including any gift or transfer or charging of property or causing or conniving in the levy of execution against the company's property with intent to defraud the company's creditors or contributories.
  • Misconduct in the course of winding up includes failure to make full and accurate disclosure of the company's property, the date and manner of any disposition of property, the person/s to whom it was transferred and the consideration paid for any disposition.
  • Any material omission from any statement relating to the company's affairs which is made with a view to defrauding the company's creditors or contributories.

The New Act brings the Bahamian insolvency regime in line with that of the most progressive jurisdictions and will go a long way to giving confidence to creditors that their interests will be protected in times of crisis. It is incumbent on directors to monitor the company's position and ensure that when the company becomes insolvent they take legal and financial advice before determining what their next steps should be.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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