How to Set Aside Transactions Made Before Insolvency

When a company in England and Wales enters insolvency, such as liquidation or administration, not all assets originally owned by the company will automatically form part of the insolvency estate. In the period leading up to insolvency, a company may have entered into transactions that unfairly reduced its asset base or advantaged certain parties. UK law provides mechanisms by which an insolvency office‑holder (liquidator or administrator) can apply to the court to set aside or reverse these transactions so that the assets (or value) are restored for the benefit of creditors. These provisions aim to ensure fair treatment of all creditors and prevent improper depletion of the company's estate.

This article explains the legal framework for setting aside transactions made before insolvency, the types of transactions that may be challenged, how the process works, relevant time limits and practical considerations for directors and affected third parties.

What Does “Setting Aside a Transaction” Mean?

To set aside a transaction means that a court may declare a transaction entered into before insolvency to be void or voidable, ordering that the asset be returned to the company's insolvency estate or that its value be repaid. These rules are found primarily in the Insolvency Act 1986, which allows the insolvency office‑holder to challenge certain transactions that unfairly prejudice creditors.

Only an appointed insolvency practitioner (administrator, liquidator or trustee in bankruptcy) can normally bring such claims. In some circumstances the office‑holder may assign avoidance rights to third parties, such as creditors, who can pursue the claim in their own name where appropriate.

Categories of Pre‑Insolvency Transactions That Can Be Set Aside

UK insolvency law recognises several categories of reviewable transactions, each with specific legal tests and conditions:

Transactions at an Undervalue

A transaction at an undervalue arises where a company:

• Makes a gift or transfers assets on terms where the company receives no consideration; or
• Sells assets for significantly less than their real value.

Under Section 238 of the Insolvency Act 1986, an office‑holder may apply to the court to set aside these transactions and require the asset or its value to be restored to the estate. The purpose is to reverse disposals that reduced the estate available to creditors shortly before insolvency.

Preferences

A preference occurs when a company does something, or allows something to be done, which puts a creditor in a better position than they would have been in if the company had become insolvent without the transaction. Common examples include paying certain creditors in full while leaving others unpaid.

Under Section 239 IA 1986, the court can set aside these transactions and order repayment into the estate if the transaction occurred within the statutory look‑back period and (in many cases) was motivated by a desire to prefer the creditor.

Transactions Defrauding Creditors

Section 423 IA 1986 allows the court to set aside transactions made with the intention to put assets beyond the reach of creditors or that are otherwise designed to prejudice creditor interests. Unlike preferences and undervalue transactions, there is no strict time limit for applying to set aside these transactions, and they can be challenged even where insolvency had not yet commenced at the time of the transaction.

Other Avoidance Actions

In addition to the above, statutory provisions allow challenges to:

• Extortionate credit transactions (where credit terms are unfairly onerous);
• Invalid or void floating charges created shortly before insolvency;
• Post‑insolvency dispositions of property without authority.

Time Limits and Relevant Periods

Setting aside pre‑insolvency transactions depends on statutory look‑back periods:

• For transactions at an undervalue, the transaction must generally have been entered into within two years before the onset of insolvency (e.g., the date of a winding‑up petition or the start of administration or liquidation).
• For preference transactions, the period is usually six months before insolvency for unconnected third parties, or two years when the transaction was made in favour of a connected person (such as a director, shadow director, related company or close associate). In these cases the law may presume certain elements, such as insolvency or desire to prefer, depending on the relationship.
• For transactions defrauding creditors under Section 423 IA 1986, there is no statutory time limit, though claims must be pursued within the ordinary limitation periods for civil claims and while evidence is available.

These time limits are designed to balance the need to prevent abuse with certainty for commercial parties as to when transactions may no longer be challenged.

Preconditions for Setting Aside Transactions

For the court to set aside a pre‑insolvency transaction, certain legal conditions must normally be satisfied:

Company's Financial Position

The office‑holder usually needs to show that the company was unable to pay its debts as they fell due at the time of the transaction or that the transaction itself contributed to insolvency. For transactions with connected persons, insolvency is often presumed unless the contrary is proven.

Nature of the Transaction

The office‑holder must demonstrate that the transaction falls within the statutory definition (e.g., undervalue, preference or defrauding creditors) and that the statutory relevant time applies.

Intention Where Required

For preferences, the office‑holder must also show that the transaction was entered into due to a desire to prefer the creditor, although this desire is presumed for connected parties in preference cases.

For Section 423 claims, there must be evidence that the transaction was part of a scheme to prejudice creditors, even if it did not occur within the statutory pre‑insolvency period.

The Court Process

Application and Evidence

The office‑holder applies to the High Court (Chancery Division) or an appropriate insolvency court for an order setting aside the transaction. The application is supported by evidence including financial records, valuations, board minutes and, where relevant, expert reports on asset values or the company's financial position.

Defences

The recipient of the challenged transaction may raise defences such as:

• The transaction was made in good faith and in the ordinary course of business;
• The company received benefit or fair value in exchange for the asset;
• The recipient was a bona fide purchaser for value who did not know and could not reasonably have been expected to know of the company's insolvency.

These defences recognise that not all transactions leading up to insolvency are suspect or unfair.

Court Orders

If the court is satisfied that the statutory conditions are met and no effective defence applies, orders may include:

• Unwinding or setting aside the transaction;
• Ordering repayment of sums received or restoration of assets to the company's estate;
• Decrees for sale of assets to realise value for the estate.

Practical Examples

• A director transfers company property to a relative at significantly below market value two years before insolvency. The liquidator applies under Section 238 IA 1986 to set aside the transfer and restore the property to the estate.
• A business pays off a director's personal creditor six months before insolvency, giving the director an advantage over other creditors. This payment may be treated as a preference and set aside under Section 239 IA 1986.
• A company transfers key contracts to a third party outside the statutory look‑back period but as part of a deliberate scheme to put assets beyond creditors' reach. The office‑holder applies under Section 423 IA 1986, which has no strict time limit.

Risks and Considerations

Challenges to pre‑insolvency transactions can involve substantial legal costs and must be pursued with clear evidence. The office‑holder must weigh the likely recovery against costs and the prospects of success. Remedies may be less effective where assets have been dissipated or third parties cannot restitute value.

These actions also emphasise the importance for directors to act lawfully and transparently in the period before insolvency and to seek professional advice where financial distress arises.

Key Takeaways

Setting aside transactions made before insolvency is a key tool in English and Welsh insolvency law to ensure that assets that were improperly disposed of or used to unfairly benefit particular parties are restored to the company's estate for the benefit of all creditors. The most common categories of reviewable transactions are:

• Transactions at an undervalue;
• Preferences;
• Transactions defrauding creditors; and
• Other reviewable transactions such as extortionate credit arrangements.

These remedies operate within defined time limits and require the office‑holder to satisfy statutory tests. Courts can unwind transactions, order repayment of value, and restore the position that would have existed but for the questionable transaction. A clear understanding of these provisions helps directors, creditors and solicitors navigate pre‑insolvency issues effectively and ensure equitable treatment in insolvency processes.