Wednesday, 22 April 2020

Insolvency and the dual patrimonies – how not to repay a gratuitous alienation

We recently acted for the successful pursuer and respondent in the case of Yvonne Quinn as Trustee in the sequestrated estate of John O’Boyle v Karen Brennan [2020] CSIH 3. The case proceeded to a reclaiming motion before the First Division of the Inner House of the Court of Session against an earlier decision of Lord Doherty, in which he had also found in favour of the pursuer.

The facts of the case were not particularly complicated, nor was there any material dispute between the parties about them.  The pursuer was the trustee in sequestration of Mr O’Boyle. Mr. O'Boyle was sequestrated, at his own instance, on 11 February 2015.  Some six months prior to that, he sold a property he owned in East Kilbride, and transferred part of the net free proceeds of the sale, namely £190,960, to his partner, Ms Brennan.  Ms Brennan used the funds to purchase another property in East Kilbride.  Title was taken in her sole name.  After Mr O’Boyle’s sequestration had ended in May 2016, that property was sold, and in January 2017, Ms Brennan gave Mr O’Boyle a cheque for £197,462.20.

Gratuitous Alienation
Any insolvency practitioner reading that factual summary will immediately be jumping up and down, shouting “ gratuitous alienation”, for that is clearly what it was.  There was no dispute about that either from the defender.  Instead, the dispute centred on the narrow point of whether or not the payment of £197,462.20 by the defender to the debtor in January 2017, several years later and after the intervening sequestration, constituted “adequate consideration” for the alienation. The majority of cases in this area of law tend to focus on the “adequacy” of the consideration in question. This case turned on the meaning of “consideration” itself.

The date of the debtor’s sequestration preceded the coming into force of the Bankruptcy (Scotland) Act 2016, so the alienation was challenged under section 34 of the Bankruptcy (Scotland) Act 1985, as amended.  Section 34 (4)(b) provides a defence to a gratuitous alienation where “the person seeking to uphold the alienation establishes- … (b) that the alienation was made for adequate consideration”.

Given the similarity of the language used, it's worth noting that this decision is likely to be equally applicable to cases brought under the successor of that section, section 98 of the Bankruptcy
(Scotland) Act 2016, and in corporate insolvencies, section 242(4) of the Insolvency Act 1986.

The Decision
The First Division judges were unanimous in their decision, and indeed issued an ex tempore ruling in October last year, refusing the appeal, and upholding the decision of the Lord Ordinary to grant decree against Ms Brennan for payment of £190,960 to the trustee.  Their  written decision was issued at the end of January of this year, and the full reasoning behind their Lordships’ decision makes for interesting reading, for legal and insolvency practitioners alike.

The First Division held that the payment of £197,462.20 by the defender to the debtor in January 2017  could not amount to “consideration”, in terms of section 34(4)(b), for the alienation by the debtor in 2014.  They came to this view for two distinct reasons:

(1)    Reciprocity of obligation required to amount to “consideration”
The First Division held that if a payment is to amount to “consideration” for an alienation for the purposes of section 34, it must properly be regarded as the counterpart of the alienation.  They explained that:

“This means that there must be a fundamental element of exchange or reciprocity between the payment and the alienation; the payment must be regarded on objective grounds as a quid pro quo for the alienation.”

They also clarified that:

“.. the existence or otherwise of the necessary element of reciprocity must be determined at the time when the exchange is agreed. [….] It is implicit in the proposition that something given cannot later be converted into consideration merely because the giver and receiver choose so to describe it.”

In this case, there was no averment by the defender of any prior obligation upon her to make the payment in January 2017, and so the necessary reciprocity, or “quid pro quo” element, was completely absent. The First Division accordingly found it impossible to hold that the payment made by the defender in January 2017 was “consideration” for the earlier transfer of funds and acquisition of the property in her name.

(2)    The concept of “dual patrimonies”
The First Division asked itself whether, as a matter of law, the payment of funds to a discharged bankrupt is capable of amounting to consideration for a transfer of assets prior to formal insolvency proceedings.  They answered that in the negative, and took the opportunity to expound the concept of “dual patrimonies”, to explain their reasoning.

Their Lordships credited Professors GL Gretton and KGC Reid with developing the concept of dual patrimonies in an important series of academic articles, and explained that the dual patrimony theory was put forward by them to explain why, as a matter of trust law, a trust estate is not liable for the trustee’s own private debts but is a distinct patrimony, with its own assets, rights and liabilities.

For the case before them, they explained that the two relevant patrimonies were (1) the estate of the debtor as it existed at the date of sequestration and (2) the estate acquired by the debtor following his discharge from the sequestration. 
They went on to hold that:

“Consequently the payment by the defender in January 2017 cannot be consideration for the original alienation made by the debtor in August and September 2014 because, although in a sense the same individuals are involved, the 2014 alienation was made from the debtor’s original patrimony whereas the 2017 payment was made to his new patrimony following his discharge.”
Which is all a rather neat way of explaining why debtors cannot circumvent the purpose of insolvency laws with impunity, by giving assets away prior to insolvency and getting them back again afterwards, without their creditors receiving any benefit.  As Lord Doherty put it in his original decision, to suggest the law is otherwise would be “a startling proposition” indeed.

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