Settlor insolvency: the enduring legacy of the Statute of Elizabeth

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1 Trusts & Trustees, Vol. 16, No. 2, March 2010, pp Settlor insolvency: the enduring legacy of the Statute of Elizabeth Toby Graham* Abstract This article focuses on the enduring legacy of the Statute of Elizabeth 1571 which remains on the statute books of many offshore trust jurisdictions. The author also touches on key issues which may arise in a trust context in cross-border insolvencies. Introduction The present economic climate is likely to lead to an increase in attacks on trusts from the settlor s creditors. Such attacks may be based on the following grounds: Sham: the creditor contending that the trust assets are held on resulting trust for the settlor and thus available to meet his claims. Hess v Line Trust Corp 1 suggests that contingent creditors do not have standing to challenge a trust on this basis. To have standing the creditor must have a judgment debt enforceable in the jurisdiction where the trustees are resident. Re Reynolds 2 suggests that because a settlor is estopped from mounting a challenge on the grounds of sham, his trustee in bankruptcy, who steps into his shoes, cannot be in a better position and is therefore also precluded from bringing a challenge on this ground; Proprietary claims: it is clear from Lister v Stubbs 3 that ordinary creditors do not have proprietary claims against the debtor; and Insolvency principles. This article focuses on the last of those grounds and, in particular, on the enduring legacy of the Statute of Elizabeth 1571, 4 which remains on the statute books of many offshore trust jurisdictions. 5 While it has been repealed and replaced with section 423 of the Insolvency Act 1986, the case law developed in relation to the Statute of Elizabeth is relevant to understand and interpret the current legislation. The article also touches on three cross-border insolvency issues that might arise in a trust context: which law governs the validity of transfer of property to offshore trustees; which court is competent to make an insolvency order; and the recognition and enforcement of insolvency orders of other courts. The Statute of Elizabeth applies to dispositions of real or personal property made with an intent to *Toby Graham, Farrer & Co, 66 Lincoln s Inn Fields, London, WC2A 3LH. Tel: ; tbg@farrer.co.uk 1. Decision of the Court of Appeal of Gibraltar 1 ITELR [2007] NZCA Ch D1. 4. There is some uncertainty as to whether it was enacted in 1571 or The title of the legislation is An Act Against Fraudulent Deeds, Gifts, Alienations, etc, 13 Eliz 1 c BVI, Gibraltar, Hong Kong, Australia and New Zealand. Similar provisions were in force in The Bahamas, Bermuda, the Cayman Islands and Turks & Caicos. ß The Author (2010). Published by Oxford University Press. All rights reserved. doi: /tandt/ttp134

2 92 Articles Trusts & Trustees, Vol. 16, No. 2, March 2010 defraud, hinder or delay creditors and renders such dispositions void and of no effect. What is meant by intent to defraud and who creditors are for these purposes are the two questions considered in this article. For consistency, the person who transferred assets into trust, and who is the subject of creditor action, is referred to as the settlor, transferor or debtor; these terms are employed interchangeably. It is assumed that assets were transferred by way of a gift and not for consideration (as different principles may apply in that situation). The time at which they were transferred into trust is referred to as the Relevant Time. Transactions with intent to defraud creditors As stated above, the Statute of Elizabeth applies to dispositions of real or personal property made with an intent to defraud, hinder, or delay creditors. The party challenging the transaction will bear the burden of proof. 6 The court will draw inferences particularly in the absence of a credible explanation from the settlor rebutting evidence that his purpose was to put assets beyond the reach of creditors. The meaning of intent to defraud has been held to include the purpose of delaying as well as defeating creditors; this much is evident from the wording of the Statute of Elizabeth. The question of intent to defraud is one of fact. It must be determined at the time of alienation. 7 It does not apply simply because a disposition proves in the end to have depleted the assets available to creditors, if it cannot be determined that it was made with that intent. Dixon CJ in Hardie v Hanson 8 suggested that an intent to defraud is an intention to cheat the creditors of access to the assets alienated. Gaudron JinCannane v J Cannane Pty Ltd (in liq 9 ) thought that fraud involved the notion of detrimentally affecting or risking the property of others, their rights or interests in property, or an opportunity or advantage which the law accords them with respect to property. Such intention may arise even though the transferor hopes and expects that there will be no eventual shortfall. It is necessary in each case to:...look at the whole of the circumstances surrounding the execution of the conveyance, and then ask yourself the question whether the conveyance was in fact executed with the intent to defeat and delay creditors The financial position of the transferor at the time of the alienation is always a key consideration. It is not determinative against intent to defraud if the transferor is solvent at the time, particularly if he is contemplating entering into a risky venture. 11 But where the transferor s financial position is precarious, it is objective evidence of an intention to defraud if he acts to put property beyond the reach of creditors. 12 In assessing the financial position and prospects of the transferor at the date of the alienation, the court is concerned with practical risk rather than with an exact balance sheet calculation. So, where the transferor is subject to a liability under a guarantee, the obligation is not properly treated as though wholly contingent. In Re Ridler, a Court of Appeal comprising Selborne LC, Jessel MR and Cotton LJ held that the position of the principal debtor was not the focus when considering whether an alienation was with intent to defeat creditors: We must look at the matter as if the event had already happened, the possibility of which the parties must have had in contemplation when the guarantee was 6. This is expressly recognized in Bahamian Fraudulent Dispositions Act 1991 which provides: The burden of establishing an intent to defraud for the purposes of this Act shall be upon the creditor seeking to set aside the disposition. 7. Freeman v Pope (1870) LR 5 Ch App 538 (CA) and Cannane v J Cannane Pty Ltd (in liq) (1998) 192 CLR Reported at (1960) 105 CLR 451 at p Reported at (1998) 192 CLR 557 at p Re Holland [1902] 2 Ch 360 at p 372 (CA) (Vaughan Williams LJ). 11. Re McGrath (1897) 17 NZLR 646 at p 664 (CA) (Edwards J). 12. Freeman v Pope (1870) LR 5 Ch App 538 (CA) at p 545 (Gifford LJ).

3 Trusts & Trustees, Vol. 16, No. 2, March 2010 Articles 93 given, of the debtor being unable to pay. I do not think that any close inquiry as to the supposed capacity of the person guaranteed to pay the debt ought to be entered into. I do not say that there might not be a state of things in which the liability of the guarantor might be so remote that it need not be regarded; but if he conveys away all his property by a voluntary settlement I think it doubtful whether the settlement could in any case be supported in the event of his ultimately being called on under his guarantee. 13 The badges of fraud The following circumstances have been held to be indicative of fraud (and are referred to as badges of fraud ) and are likely to lead to a rebuttable presumption of fraud. i. The fact that the alienation included all (or substantially the whole) of the settlor s property. ii. The fact that the settlor continued in possession of the property he had purported to alienate when such continuance in possession was not in accordance with the tenor and object of the alienation. Reservation by the settlor of a power of revocation has been considered an indicator of fraudulent intent. iii. The secrecy of the disposition. iv. The fact that the disposition was made when litigation was pending. This is considered further below. v. The fact that the transfer was into trust and the settlor is within the beneficiary class. vi. Unusual recitals or statements in instruments of disposition declaring that it was made in good faith or without fraudulent intent. Future litigation The debtor in Re Wise 14 entered into a settlement after the commencement of court proceedings. The settlement was nevertheless upheld for two reasons: the settlor considered at the Relevant Time that he was solvent (which entailed an assessment of the perceived seriousness of the claim see further footnote 15); and the proceedings did not influence his decision to transfer assets into trust. The facts of Re Wise were as follows. The debtor married in Hong Kong on 31 May In August 1881, an action for breach of promise of marriage was commenced against him in England and the writ was served on him in Hong Kong on 8 October. Between 12 and 16 October, he learned that he had become entitled to a legacy of 500 on the death of his mother, who had died on 11 May. On 17 October, he settled 500 on himself, his wife and any children of the marriage. On 20 July 1882, judgment was obtained against him in the sum of 500. In November 1884, he was adjudged bankrupt. He swore an affidavit from which it appeared that, when he executed the settlement, he was able to pay his debts without the aid of the property comprised in the settlement, 15 and also that while he was aware of the proceedings commenced against him, they did not influence his decision to create the settlement. It seems that at the Relevant Time, the action was considered to be highly speculative and the settlor believed he could discharge any judgment against him from his remaining assets. The debtor was not cross-examined on his affidavit. 16 It was held by both 13. (1883) 22 ChD 74 at p 80 (CA) (Selborne LC). 14. (1886) 17 QBD This entailed some assessment of the value of the proceedings against him. Lord Esher MR stated: now with regard to the action, how could any one how could his legal advisor have told him what the amount of the verdict was likely to be? If the verdict had been for 50, and he had had 50 coming to him at the end of his voyage [he was a mariner], he would have been able to pay it, and on another occasion he would have been able to pay the costs. It was entirely a matter of speculation what the amount of the verdict would be. Therefore he was not insolvent: it was not the necessary consequence of what he did to defeat or delay the plaintiff in the action, for, if the verdict had been for a small amount, she would not have necessarily been delayed for a week. 16. Absent good reason, a modern court is unlikely to accept the settlor s evidence without benefit of cross-examination and may be prepared to draw adverse inferences from the settlor s unwillingness to attend trial.

4 94 Articles Trusts & Trustees, Vol. 16, No. 2, March 2010 the Divisional Court and the Court of Appeal that there was insufficient evidence to warrant a finding that the settlement was intended to defraud creditors. Two cases where litigation against the settlor was in prospect at the Relevant Time, and the courts concluded that the necessary intent had existed and so set aside the settlements on the grounds of the Statute of Elizabeth, are Barling v Bishopp 17 ( Barling ) and Crossley v Elworthy 18 ( Crossley ). In the first, Barling, two weeks before the trial of an action the debtor transferred his assets to his daughter, leaving him with insufficient assets to meet any judgment. Judgment was then obtained against him. The judgment creditor brought an action under the Statute of Elizabeth against the debtor s daughter alleging the conveyance to her was void. The court concluded there was the necessary intent. There were two badges of fraud, and neither the debtor nor his daughter was able to provide any explanation for the conveyance, let alone a good reason. In the second case, Crossley, the settlement in question had been created on 12 June An action for damages against the debtor was commenced in May 1867 (shortly before the debtor was adjudicated bankrupt, but by which time he was known to be insolvent). The plaintiff alleged that, in 1865, the debtor had made a false and fraudulent representation as to the value of a company, which had induced the plaintiff to take shares in that company. Judgment for the plaintiff was entered on 8 March The court held that some debts which existed at the date of the settlement remained unpaid, and that it was therefore unnecessary to take into account the damages recovered by the plaintiff for fraudulent representation. However, the court went on to state that such liability to the plaintiff could not be wholly disregarded. Knowledge of his erroneous and fraudulent statements could be attributed to the debtor and those erroneous statements made him liable for a debt as at the date of the settlement which he had not taken into account. This suggests that, in principle, ascertaining whether a person was solvent or indebted at the Relevant Time ought to take account of any liability which the debtor had incurred before that date, notwithstanding that no claim had then been made or no action had then been commenced in respect of that liability, or that the amount of damages remained unquantified. Some commentators suggest that Crossley might be an exceptional case: the debtor had clearly made a fraudulent representation and must have appreciated a possible claim from his victim. Moreover, he was speculating heavily on the stock exchange and relied on the trust to protect his assets from the general body of creditors. It has, therefore, been suggested that it might not apply to a case where a settlor was not aware at the Relevant Time that he had committed a tort. Professor Thomas suggests the position is likely to be as follows: Suppose, for example, that, at the date of the relevant disposition, no claim had been raised against the settlor, and that there was no reason why the settlor should anticipate any such claim. It is difficult to see why any claim made and pursued successfully therefore should be regarded as a contingent liability of the settlor, and therefore material to the question of solvency at the date of the disposition, even if the event or circumstances which founded that liability occurred before that date. On the other hand, if the issue was whether the settlor had an intent to remove assets out of reach of those persons (ascertained or not) who might have a claim against him (in tort or otherwise) it would seem to be immaterial whether such a claim was founded on events and circumstances which occurred before or after the date of the disposition, or whether the settlor knew of the existence of, or ought to have anticipated, any specific claim (1860) 29 Beav (1871) LR 12 EQ At para 6.65 of the second edition of The International Trust edited by Jonathan Glasson and Professor Thomas.

5 Trusts & Trustees, Vol. 16, No. 2, March 2010 Articles 95 These cases show the importance of the facts. Courts will examine the settlor s motivation for transferring assets into trust. Further, the cases demonstrate that if it emerges that the settlor had a good reason for transferring assets into trust, then a challenge is likely to be extremely difficult. It is suggested that a good reason for these purposes might include estate planning. The case law also suggests the court will consider the settlor s perception of the strength of any prospective claims against him at the Relevant Time. Legal advice to the settlor about the prospective claim is likely to be relevant and discoverable. If the settlor considered that the action was speculative or the plaintiff was unlikely to proceed to trial, or that the likely judgment was small, then the court is less likely to consider that this influenced the mind of the settlor when transferring assets, even though, as in Re Wise the plaintiff turned out to have a good claim and obtained a substantial judgment against the settlor. Future creditors Future creditors have standing to mount a challenge under the Statute of Elizabeth. It is generally more difficult for future creditors to establish an intent to defraud at the Relevant Time. It is likely to be necessary to prove that at the Relevant Time the settlor was heavily indebted. The case is stronger if it can be shown that the effect of the transfer into trust was to render, or probably might render, the settlor unable to meet his then existing liabilities (ignoring future ones). This is likely to mean that the settlor was insolvent; it is important to emphasize that it is not necessary to prove actual insolvency. If insolvency takes place shortly after the settlement, then absent an exceptional or unforeseeable cause, courts are likely to infer the necessary intent at the Relevant Time. If, on the other hand, all creditors in existence at the Relevant Time have been paid, it will be necessary to establish actual intent to defraud, delay or hinder future creditors. In Re Butterworth, 20 the Court considered whether the settlor intended to defraud future creditors. The settlor was a trader, who had for many years carried on the business of a baker and saved some money. He was about to purchase a grocery business which he intended to carry on in addition to his bakery. Before doing so, he created a voluntary settlement of the bulk of his property for the benefit of his wife and children. 21 He then bought the grocery business and carried it on for about 6 months, but lost money by it. He sold it for as much money as he had paid, and afterwards carried on the bakery business, until, about 3 years after the execution of the settlement, he filed a liquidation petition, his liabilities largely exceeding his assets. The debts which he owed at the date of the settlement had all been paid. The Court of Appeal held that, independently of the question whether he was solvent at the date of the settlement, the settlement was void against the trustee in bankruptcy under the Statute of Elizabeth, on the grounds that it was evidently executed with a view to putting the settlor s property out of reach of his creditors in case he should fail in the speculation on which he was about to enter or in carrying on a new business of which he knew nothing. Lord Jessell MR stated: a man is not entitled to go into a hazardous business, and immediately before doing so settle all his property voluntarily, the object being this: If I succeed in business, I make a fortune for myself. If I fail, I leave my creditors unpaid. They will bear the loss....the object of the settlor was to put his property out of reach of his future creditors. He contemplated engaging in this new trade and he wanted to preserve his property from future creditors. The debtor in question was a trader about to embark on a hazardous venture. Courts take a firmer line in such situations. 20. (1882) 19 Ch D Several badges of fraud were present: the debtor was about to embark on a hazardous venture, settled furniture and other property in his own dwelling house; and the settlement recited that he was then in a solvent position and capable of paying his debts as they became due.

6 96 Articles Trusts & Trustees, Vol. 16, No. 2, March 2010 Time limits There are no time limitations restricting the application of the court s powers under the Statute of Elizabeth, though in practice the longer the interval between the transaction and the application to set it aside, the harder it will be to establish the necessary intent at the Relevant Time. Attorney-client privilege Where the settlor has received legal advice in relation to the transaction, such advice would ordinarily be protected by attorney-client privilege. The mere fact that such professional advice was obtained is likely to assist the settlor, as a person intent on defrauding creditors is unlikely to involve professional advisers. However, the court has the power to order discovery of such documents where there is strong prima facie evidence that the transaction was entered into for the purpose of prejudicing creditors. This is because there is no privilege in iniquity. 22 Which court has jurisdiction to make an insolvency order? The validity of any transfer of property by the settlor into trust is a preliminary issue governed not by the proper law of the trust, but by the settlor s personal law. 23 If the English court has jurisdiction to make the bankruptcy order, then the administration of the insolvency will be governed by the Insolvency Act 1986, 24 which will bring in principles of the sort considered above (in relation to fraudulent transactions). I consider a different issue: which court has jurisdiction to wind up an offshore company? There have been a couple of recent seemingly divergent cases in this respect. The answer to the question is likely to be the court of the country of incorporation of the company. This was the approach taken by Lewison J in July 2009 when recognizing the order of the Antiguan court appointing receivers in relation to Re Stanford International Bank. 25 However, in November 2009, the Scottish Court of Session made a winding up order in relation to Re Kirkbridge Investments, 26 a company incorporated in Gibraltar. The EU has sought to establish common rules on cross-border insolvency proceedings, through the Regulation on Insolvency Proceedings (1346/2000/ EC). The Insolvency Regulation is directly applicable in all EU Member States with the exception of Denmark. It provides that the main insolvency proceedings in respect of a company shall be commenced in the jurisdiction in which the company has its centre of main interests (Article 3(1)). The Insolvency Regulation was irrelevant to determining the jurisdiction of the courts; this was because the judge was satisfied the company s COMI was in Gibraltar, which is not an EU Member State. Therefore, it was necessary to apply section 221 of the Insolvency Act 1986 and decide whether Kirkbridge had an establishment in Scotland. The court considered on the evidence (including involvement of commercial property transactions in Edinburgh) that this test was satisfied. Enforcement of bankruptcy orders Our shared heritage has resulted in a network of enforcement arrangements crossing the common law world. For instance, section 122 of the United Kingdom s Bankruptcy Act 1914 requires every British court having jurisdiction in bankruptcy or insolvency to act in aid of and be auxiliary to each other in all matters of bankruptcy. The Privy Council found in Al Sabah and others v Grupo Torras SA and another 27 that this remained in force despite its repeal in the UK and replacement with Insolvency 22. Barclays Bank v Eustace [1995] 4 All ER 511, CA. 23. Dicey & Morris Dicey & Morris 31R-044 and Antecedent transactions. 25. [2009] EWHC 1661 Ch. 26. [2009] CSOH [2005] 1 All ER 871.

7 Trusts & Trustees, Vol. 16, No. 2, March 2010 Articles 97 Act 1986 and thus it provided a jurisdictional basis for the Cayman Courts to give effect to a bankruptcy order of the Bahamian courts. The case concerned the notorious Sheikh Fahad al Sabah. He had settled two trusts governed by Cayman law whose trustees were companies incorporated in the Cayman Islands. The Bahamian trustee in bankruptcy wished to challenge the validity of these trusts. The Privy Council noted that the Cayman court was prima facie the competent court that could declare the trusts to be invalid so presumably an order of the Bahamian court that the trusts were invalid would not be recognized and enforced in the Cayman Islands. The trustee obtained a letter of request from the Bahamian court which provided: i. that Mr Culmer s appointment as trustee in bankruptcy of the property of the debtor should be recognised in the jurisdiction of the Cayman Islands; ii. that the trustee should be granted all general law powers and the statutory powers accorded to a trustee in bankruptcy in [the jurisdiction of the Cayman Islands] and in particular...the powers under s 107 of the [Cayman] Bankruptcy Law (1997 Revision) ; and iii. that he should be granted such other powers as the Grand Court of the Cayman Islands thought fit. The application was heard ex parte by Smellie CJ. He made an immediate order (followed by a written judgment delivered on 27 March 2002) acceding to the letter of request and, in particular, granting the Bahamian trustee in bankruptcy the powers conferred by section 107. The main points in his judgment can be summarized as follows: i. that section 156 of the Bankruptcy Law (1997 Revision) of the Cayman Islands, and further or alternatively section 122 of the Bankruptcy Act 1914 of the UK, authorized the Grand Court to act on the letter of request; ii. that the Grand Court should as a matter of discretion confer the section 107 powers, since any Cayman assets relevant to the bankruptcy were likely to be held in trust; and iii. that the order could in any case be made under the court s inherent jurisdiction. This was upheld, subject to modification, by Henderson J and Court of Appeal; which was the basis of the appeal to the Privy Council. This is one of a number of arrangements for recognition of insolvency orders across the common law world. Another example is the arrangements that exist between Crown Dependencies and the UK by virtue of section 426 of the Insolvency Act Trustee neutrality What should a trustee do when he discovers that assets within the trust may be subject to creditor claims? There are cases which suggest trustees have a duty to actively defend the trust from attack. 28 But the general position, derived from Alsop Wilkinson v Neary, 29 is that they should be neutral and abide by any order that the Court may make, providing the Court with any factual information that might assist in determining the claim In Ideal Bedding Co Ltd v Holland [1907] 2 Ch 157, Kekewich J held that a trustee had a duty to defend a trust from attack from the settlor s creditors. In the matter of Poyiadjis [2001] O3 MLR 316 concerned two trusts with Isle of Man trustees that owned shares in companies. These companies had bank accounts in the Isle of Man. The US Department of Justice commenced proceedings seeking forfeiture of the monies in the bank accounts and obtained restraining orders. The trustees sought an order permitting them to fund their defence against the US proceedings from the monies. The Attorney General contended that the trustees should not be indemnified and should take a neutral stand, since the dispute was in substance between the beneficiaries and the US government. This submission was rejected and it was held appropriate to proceed to a Beddoe hearing for the purpose of determining the role which the trustee should play. 29. [1995] 1 All ER The reason for this is because the claim goes to the question of who are the true beneficiaries, if the trustees were to expend trust monies in arguing one side or other of the case, they may in effect be favouring one class of possible beneficiaries over the other, or even expending the true beneficiaries own funds in an attempt to defeat their claim.

8 98 Articles Trusts & Trustees, Vol. 16, No. 2, March 2010 The trustee should stand back and leave the beneficiaries to deal with the settlor s creditors and defend an attack on the trust. Where a creditor s claim might exhaust the value of the trust fund, a trustee is likely to be advised to refuse any distributions pending resolution of the issue, placing the trust in limbo or precipitating an application by the trustee for directions. Conclusion Judging from past experience, the economic downturn will lead to challenges against trusts and trustees based on insolvency principles. While no longer on the UK statute books, the legacy of the Statute of Elizabeth continues across the common law world.