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Papanicola v Fagan [2008] EWHC 3348 (Ch)

Applications by trustee in bankruptcy seeking to set aside a declaration of trust made in favour of the bankrupt’s wife on the grounds that it was as a transaction at an undervalue and that it was a transaction seeking to put the assets beyond the reach of creditors. Application failed.

The subject of the declaration of trust was the matrimonial home, where the couple had lived since 1988. The husband had been a publican, running them as part of a family company, but alcohol related mental illness, and his increased gambling, led the wife to seek the declaration of trust to protect the family home should any thing further go wrong. She also raised the possibility of divorce to secure the same position if the declaration was not made.

HHJ Raynor, sitting as a High Court judge, reviews the facts and finds that the husband and wife’s accounts of the background to the transaction were truthful and that at the time of the declaration the husband was solvent. He then reviews the relevant law and concludes firstly that the transaction was not at an undervalue as the wife had given consideration by not petitioning for divorce. He also finds that the transaction was not seeking to put assets beyond the creditors as the husband’s substantial purpose for making the transaction was to save his marriage.

Case No: GLC20708/58/08

Neutral Citation Number: [2008] EWHC 3348 (Ch)

Royal Courts of Justice
Strand, London, WC2A 2LL

20th November 2008

sitting as a Judge of the High Court)

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MR CHAPMAN QC  appeared on behalf of the Trustee in Bankruptcy
MR PESTER appeared on behalf of the Respondent

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Approved Judgment
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1. By notice of application dated 21st July 2005 Mr Theodoulous Papanicola, the trustee in bankruptcy of Raymond Paul Fagan, applied under section 339 of the Insolvency Act 1986 for an order, among other things, setting aside a declaration of trust dated 20th May 1998 made by the bankrupt in favour of his wife Pamela Gaye Fagan, the respondent. It is alleged that the transaction was at an undervalue in that it was a gift made by the bankrupt.
2. At the commencement of the trial, I granted permission to the trustee to amend his application to add a further or alternative application to set aside the declaration pursuant to section 423 of the Act on the ground that it was a gift entered into, so it was alleged, for the purpose of putting assets beyond the reach of a person who might at some time make a claim against the bankrupt.
3. As Mr Chapman QC for the trustee stated at the commencement of his submissions, the determination of these applications to a very large extent turns on the credibility of Mr and Mrs Fagan. In that regard I have had the benefit of observing them give evidence at length. They were subject to a rigorous, but, I may say, entirely fair cross examination by Mr Chapman.  Notwithstanding his attack on their credibility and I shall refer to aspects of that in more detail later I have no doubt that their evidence as to the circumstances in which the declaration was entered into and, indeed, their evidence generally, was both honest and entirely reliable. Indeed, I found them both to be in their own way impressive witnesses and I have no hesitation whatever in accepting their evidence. And unlike like Mr Chapman, I do not for my part find the circumstances in which the declaration of trust came to be entered into suspicious at all.

4. The facts as I find them to be are as follows. Mr and Mrs Fagan married in December 1981. They have three children. In July 1988 they purchased the dwelling house which is the subject of the declaration of trust, 85 Peplins Way, Brookmans Park, Hatfield for £140,000 with the aid of a mortgage loan of £110,000.
5. At all material times until his bankruptcy, Mr Fagan was involved in public house businesses carried on by various family companies, the principal one being Grandred Limited, a company with 100 issued shares of which the majority (that is 52) were held by Mr Fagan's mother and father and the balance by him and his brothers. His shareholding was 24 shares.

6. Mr Fagan's principal responsibility from September 1994 was  the operation of The Manor Public House in Finsbury Park, which was acquired under a lease entered into in September 1994 by a family company named Charmbase Ltd of which Mr Fagan was a director. He was the guarantor of the obligations of that company under its lease, which was a term of 20 years at a rental of £50,000, subject to upward review.
7. From the early 1990s Mr Fagan had a substantial alcohol problem which gave rise to associated mental health difficulties.  This problem was so serious as to require inpatient admission to the Priory Hospital for four weeks in or about 1993 (different dates have been be given in evidence but the precise date does not matter).  After a period of abstinence Mr Fagan started drinking again in 1996 and at that time also started to gamble.  I find, notwithstanding the submission to the contrary, that it is likely, as Mr Fagan said in evidence, that in fact at this time he did not have credit cards and that he did not therefore engage in internet gambling prior to the execution of the declaration of trust.  The public house businesses were cash businesses and I am satisfied that it is more likely, as he said, that the gambling transactions at the date of the declaration of trust were cash transactions.  Be that as it may, of one thing I am quite certain, which is that he had no outstanding gambling debts in May 1998.
8. In paragraphs 4 and 5 of her first witness statement, with which Mr Fagan agreed, Mrs Fagan described the circumstances leading to execution of the declaration of trust as follows. She said:

"The Declaration was made at my insistence for very personal reasons.  Ray was battling with alcoholism and mental ill health and I wanted to protect our family home against anything foolish that Ray may have done, such as giving or gambling it away.  I had been contemplating such a transfer for about two years.  Ray had been in rehabilitation in 1993, but relapsed into drinking again in 1996.  Ray stopped drinking again for about six months in 1996, but then started again. Then in 1998 when he stopped drinking again for two months, I picked this time to tell him that I could and would divorce Ray to get his half of the house in order to protect our family home and our children from Ray’s potential actions.  Put simply, I no longer trusted him to put the interests of his family ahead of alcohol and gambling.  As was usual at the time when Ray was not drinking, he was eager to please to save our marriage and make up for his previous relapse…
"The purpose of the Declaration was to protect Ray's equity for the benefit of  the family and in particular our children as such.  My Will that was prepared at the same time as the Declaration transferred all of my assets to the children and not to Ray."  

9. In cross examination Mrs Fagan was questioned about this account and after it was put to her that she had threatened divorce proceedings, she replied in a passage of evidence which I found entirely convincing as follows:

"It was [she said] more of a promise than a threat that if he did not execute the declaration, I would divorce him and claim his share of the house."

10. She stated, as I accept, that the initiative for the transfer of the beneficial interest came from her.  It was her ultimatum; and she had previously gone to a matrimonial solicitor for advice and had been told that it was more likely than not that she would obtain a transfer of his beneficial interest in the property    which, as will appear, only had a comparatively modest equity at that time if she commenced divorce proceedings and made an application for ancillary relief.  Notwithstanding that she produced no corroborative evidence of the obtaining of such oral advice, I have no doubt that she was telling me the truth.  Indeed, I find the alleged advice to be entirely credible and reasonable in the circumstances.  As to her reason for insisting on a transfer of the beneficial interest, she said: 

"At the time of the execution of the declaration of trust to my knowledge he was not being pursued for any gambling debts. I knew he could pay his bills.  As far as I was concerned, he had no debts, but because of his problems with gambling and alcohol and associated mental health difficulty I was concerned that his interest in my home might be at risk, that he might run up the debts or liabilities which might take the home away and that is why I got him to sign it over."

11. Mr Fagan was questioned as to his purpose in agreeing to transfer his equity in the property to his wife.  He agreed that he was given the ultimatum alleged by her, namely transfer your interest or be divorced, and he said when he gave evidence:

"The substantial purpose of the deed [this was replying to what was put to him] was not to protect my wife against the risk to the house deriving from a combination of financial problems and drinking problems, the motivation behind the declaration of trust was to try and save the marriage. Divorce was mentioned.  It was my wife's initiative to  transfer my interest and I thought she would divorce me if I refused.  The purpose was to avoid that result.  The purpose was to save my marriage.  Whether that had the effect of protecting my interest was irrelevant.  If the result was to protect her then so be it, I signed away the equity to save my marriage."

12. Thus it was agreed that Mr Fagan should transfer his beneficial interest in the property to Mrs Fagan and as a result I find that she refrained from commencing divorce proceedings with the associated ancillary relief application. Also, I am satisfied that had the husband refused to transfer his interest, she would have made good her (as she described it) promise and divorced him and made an application for ancillary relief.
13. Thus it was that Mr and Mrs Fagan saw a solicitor, Mr Emslie of Mullis & Peake.  He has produced his file together with a covering letter dated 25th February 2008, which states that he felt that the file would "not be of much assistance to you in providing an expressed reason for declaration of trust and indeed I myself after ten years have no recollection of any precise reason for Mr and Mrs Fagan entering into the declaration of trust."
14.  Mrs Fagan did not choose to call Mr Emslie to give evidence, but in the light of that letter and having heard Mr and Mrs Fagan give evidence I am not prepared to hold that failure against her.  It would not appear from the file that Mr Emslie was given any explanation for the decision to transfer the beneficial interest, nor was he told, it would appear, of Mrs Fagan's promise as to what would happen if the transfer was not entered into.  It is clear that the decision to proceed by way of declaration of trust rather than transfer of the legal and beneficial interest was Mr Emslie's.  It was suggested that there was some ulterior purpose in this, particularly since no restriction was placed on the register until 2005.  However, I am quite satisfied that Mr and Mrs Fagan did not have it in mind to mislead anyone as to the legal position.  Given that Mr Fagan was not to be released from his liability under the mortgage, it seems to me that a sensible reason to proceed by way of declaration of trust was simply that.
15. The declaration itself was in the following terms; it was dated 20th May 1998 and it recited that:

"Whereas the said Raymond Paul Fagan in consideration of his natural love and affection for his wife, Pamela Gaye Fagan, wishes to give to her all his sharing interest in the property subject to the existing mortgage, the trustees [Mr and Mrs Fagan] hereby declare that from the date hereof they hold the property on trust for Pamela Gaye Fagan absolutely."

As Mr Chapman pointed out, the declaration in terms states that the transaction was a gift.

16. At the time of the declaration Mrs Fagan had good reason to feel vulnerable as a result of her husband's behaviour.  Their joint interest was comparatively modest, as will appear.  They had three dependant children aged 14, 11 and 7.  As to the equity, the value of the property has been put between £140,000 and £170,000, the mortgage indebtedness was £95,000 so that Mr Fagan's half share without allowing for any costs or expenses of sale was worth something between £22,500 and £37,500.
17. I now deal with Mr Fagan's financial circumstances at the time of the declaration of trust.  Mr Chapman, whilst not being able to adduce any positive evidence of insolvency, asked me to infer that Mr Fagan was insolvent, having regard to what he contends were the highly suspicious circumstances surrounding the deed.  He reminds me that if the transaction was at an undervalue, the burden of proving solvency rests on Mrs Fagan.  However, on the evidence before me I am perfectly  satisfied that Mr Fagan at the time of the declaration of trust was able to pay his debts as they fell due and, further, I am satisfied that the value of his assets was not less than the amount of his liabilities, taking into account contingent and prospective liabilities.  I am further satisfied that Mr Fagan did not become insolvent by reason of the execution of the declaration of trust.

18. I find his financial circumstances at the time of the declaration as follows.  First, he had two capital assets, namely his interest in the former matrimonial home and his shareholding in Grandred Limited.  It is clear that that company had a substantial value as at May 1998, as appears from the abbreviated balance sheet at 31st October 1998 (B/170).  In that year it had made a major investment in tangible assets, namely public house premises, so that the tangible asset value went up from £340,000 as at 30th October 1997 to £2.2m at 31st October 1998.  There were net current liabilities at October 1998 amounting to £654,000 because of the bank loan and overdraft, which had increased because of the acquisitions that I have mentioned.  The shareholder holders’ funds had risen from £658,000 to over £1m.
19. Mr Fagan, of course, had no entitlement to the underlying company assets.  Nor was he in any position to realise the value of his shareholding, absent a sale of the company as a whole, which was not contemplated, or purchase by a family member.  Notwithstanding that, I am quite satisfied, as Mr Glasner, the accountant who at the material time was involved in assisting the lead partner having responsibility for the company affairs testified, that the shareholding in Mr Glasner's words "had a significant value at the date of the declaration of trust".  Moreover, I accept that at that date Mr Fagan would have been able, as he said in evidence, to sell his shares had he wished to his father, although the price that would have been obtained is a matter of pure conjecture.

20. As to his liabilities, as I say I am perfectly satisfied he was able to meet all his current liabilities as they fell due.  He and his wife's regular outgoings were quantified in their witness statements.  Outgoings amounted to about £1900 per month against a combined net income of £3,770 (his income being £2,100 per month).  Mortgage instalments were up to date; the bank account was in credit.  It was suggested that there might have been credit card liabilities attributable to gambling.  Not only, as I say, is there no evidence of this, but I am, as I have said already, quite satisfied there were none and that indeed as Mr Fagan testified he had no outstanding current indebtedness whatever at the  date of his declaration. 
21. Although he was solvent, there was reason at the date of the declaration, as I have said, to fear as to his financial reliability in the future and that is precisely why Mrs Fagan wanted to protect her security in the home.  True it was also that he had the contingent liability under the lease, but at the date of the declaration of trust there were no arrears of rent and none indeed were to accrue for years after the declaration of trust.  I am satisfied that the contingent liability under the lease was not a consideration which led to the execution of the declaration of trust so far as Mr Fagan was concerned.  He took over the lease itself in August 1998 (two and a half months after the declaration of trust), but the pub business was operated by Grandred from the premises and profits of course were retained by the company, with the rent being paid without any problems at all for some years.  I am quite satisfied that the later problems that emerged in 2001 (I think it was) were not contemplated at the date of the declaration of trust.
22. I can deal with the events following the declaration of trust briefly.  There were no financial difficulties of any sort for approximately three years following its execution.  Thereafter though The Manor House Public House suffered a decline in business leading to financial problems, which also gave rise to increased drinking on the part of Mr Fagan.  The landlord of The Manor petitioned for bankruptcy on 17th October 2002 and Mr Fagan was made bankrupt in January of the following year.  Meanwhile, by November 2002 he had been joined in legal proceedings for trespass and nuisance brought by Mr and Mrs Johnston who eventually obtained a post bankruptcy judgment against him in May 2004.  It is they who have provided the financial backing for the present litigation.
23. Following the bankruptcy order, Mr Fagan in March and October 2003 declared his shareholding in Grandred Limited to be of no or no real value.  However, this does not affect my finding as to its value in May 1998.  In evidence Mr Fagan explained that by the time of his bankruptcy his brothers were not prepared to pay him anything other than a nominal sum for his shares and he was thus locked in, a stance that is in no way surprising given his bankruptcy.
24. I should mention two other matters relied upon by Mr Chapman in his attack on Mr Fagan's credibility.  First, after stating that a lot of the time he drank The Manor House's own stock, Mr Fagan admitted that he had not "always been honest" in  connection with the running of the public house business. However, for my part I regarded that frank admission as being to his credit when giving evidence and I am satisfied, as I have said, as to the truthfulness of the evidence that he gave me.
25. The second criticism was made of a reluctance to cooperate in the disclosure process.  An order for specific and third party disclosure was made against him and it produced only disclosure of tax returns and a statement that documents from the brewery and in relation to his outgoings were no longer available.  He did not choose to involve his accountant at that stage.  The applicant's solicitors then chose to follow this up by writing a letter dated 27th March 2006, noting very limited disclosure and requesting cooperation on ten matters. No reply was forthcoming.  In evidence Mr Fagan stated that he believed that the material was obtainable in any event by the trustee (the applicant) and that he was not disposed to cooperate voluntarily with a solicitor who was pursuing a claim against his wife.  I can understand this.  I draw no inferences against him because of it.

26. I now turn to the claims under the two sections.  First, section 339.  It follows that because of my findings on insolvency the application under this section fails.  However, I also find that the transaction was not at an undervalue because it was not a gift within the meaning of section 339(3)(a) and my reasons for that conclusion are set out when I deal with section 423.
27. I now turn to section 423.  The statutory provisions so far as material are as follows:

423. –
(1) This section relates to transactions entered into at an undervalue; and a person enters into such a transaction with another person if –

(a) he makes a gift to the other person or he otherwise enters into a transaction with the other on terms that provide for him to receive no consideration; …

(2) Where a person has entered into such a transaction, the court may, if satisfied under the next subsection, make such an order as it thinks fit for –

(a)  restoring the position to what it would have been if the transaction had not been entered into, and
(b) protecting the interests of persons who are victims of the transaction.

(3) In the case of a person entering into such a transaction, an order shall only be made if the court is satisfied that it was entered into by him for the purpose –

(a) of putting assets beyond the reach of a person who is making, or may at some time make, a claim against him, or
(b) of otherwise prejudicing the interests of such a person in relation to the claim which he is making or may make.

(5) In relation to a transaction at an undervalue, references here and below to a victim of the transaction are to a person who is, or is capable of being, prejudiced by it; and in the following two sections the person entering into the transaction is referred to as “the debtor”.” 

28. The following issues arise.  First, was the transaction entered into at an undervalue within the meaning of section 423(1)(a)?  Second, if so has the applicant proved that the bankrupt entered into the transaction for one of the purposes set out in section 423(3)?  Thirdly, if so should the court exercise its discretion and make an order under the provisions of section 423(2)?  I shall consider each of these issues in turn.

29. First, was it a transaction entered into at an undervalue? The question for my determination is whether I am satisfied that the transaction was in the statutory words "a gift or a transaction that [provided] for [the bankrupt] to receive no consideration" (section 423(1)(a)).  In my judgment, the fact that the declaration of trust was expressed to be by way of gift is not conclusive.  I must look at the facts as I found them to be and then decide whether in truth what was done amounted to a gift or to a transaction for no consideration.  In this connection I was helpfully referred by Mr Pester, counsel for the respondent, to the decision of the Court of Appeal in the case of Haines v Hill[2007] EWCA Civ 1284: [2007] BPIR 1280.  It was there held that a wife gave consideration for the making of a transfer of property order in her favour in respect of the former matrimonial home.  I have derived particular assistance from the judgment of the Chancellor in the following passages.  At paragraph 29, he stated:

"Whatever the position may have been in earlier days, it is in my view self evident that the ability of one spouse to apply to the court for one or more of the orders under the Matrimonial Causes Act is a right confirmed and recognised by the law.  Further, it has a value in that its exercise may and commonly does lead to the court order entitling one spouse to property or money from the other at the expense of the other. That money and property is prima facie, the measure of the value of the right."

In paragraph 30, after referring to a passage in the judgment of Judge Pelling QC in the court below, the Chancellor stated:

"Similarly, abstention in the exercise of a statutory right to apply for child maintenance may afford sufficient consideration to support a compromise of it.  Accordingly, in the context of section 339 of the Insolvency Act, I can see no reason why some dealing with a pre existing statutory right cannot constitute consideration."

In paragraph 32 he stated, referring to a decision of re Pope in 1908; that was

"a decision of the Court of Appeal than an agreement to forbear from taking matrimonial proceedings was ‘valuable consideration’ for the purposes of section 47 of the Bankruptcy Act 1883."

30. It is well established, of course, that a promise not to sue on a valid claim may constitute good consideration.  See Chitty on Contracts, 28th Edition, Volume 1 at paragraph 3 044.  In this case I am satisfied that in fact the transaction was not by way of gift and that the respondent gave valuable consideration for the transfer.  What she promised to do, and did in fact do, in return for the transfer was to forbear from petitioning from divorce and prosecuting her valid claim for a property adjustment order.  Her husband obtained valuable consideration as a result.  The transaction accordingly was not within section 423(1)(a) as alleged by the trustee and on that ground alone the application fails.

31. I now turn to the second issue, namely whether I am satisfied that the bankrupt entered into the transaction for one of the statutory purposes.  It is well established that for something to be a purpose it does not need to be the dominant purpose. It is sufficient if it is a real substantial purpose and not merely a consequence of the transaction.  I again have been very helpfully referred to the decision of the Court of Appeal in Inland Revenue Commissioners v Hashmi [2002] Volume 2 BCLC 489.  In her judgment, Lady Justice Arden stated at paragraph 23:

"… the section does not require the inquiry to be made whether the purpose was a dominant purpose.  It is sufficient if the statutory purpose can properly be described as a purpose and not merely as a consequence, rather than something which was indeed positively intended." 

And paragraph 25:

"…for something to be a purpose it must be a real substantial purpose;  it is not sufficient to quote something which is a by product of the transaction under consideration, or to show that it was simply a result of it..."

32.  In his judgment, Laws LJ at paragraph 33 stated:

"What in my judgment is required is that the claimant show that the donor, vendor or settlor was substantially motivated by one or more of the aims set out [in the sections] in entering into the transaction.  There may be cases in which, even absent the statutory purpose, the transaction would or might have been entered into anyway.  That would not necessarily negate the section’s application; but the fact-finding judge on an application … must be alert to see that he is satisfied that the statutory purpose has in truth substantially motivated the donor if he is to find that the section bites."

33. In his judgment Simon Brown LJ stated:

"Can the court be satisfied that a substantial purpose of the debtor's transaction was, putting it in shorthand, to escape his liabilities?"

34. As I have already said, Mrs Fagan's purpose in insisting on the transfer was stated by her in effect to protect the matrimonial home against any liabilities and debts that might result from the husband's alcoholism and gambling.  The question is whether that also was a substantial purpose of Mr Fagan.  For the trustee, Mr Chapman submitted that the obvious effect of the transaction was to put Mr Fagan's interest out of the reach of later creditors and that Mr Fagan must have understood this and had that result as a substantial purpose when he entered into the declaration.  However, I am not satisfied on the facts of this case that that is right. On the contrary, I am satisfied that it was not a substantial purpose of the transaction as far as Mr Fagan was concerned to put his interest out of the reach of creditors.  His purpose, as he stated, was to save his marriage by conceding to his wife's demand.  The consequence of entering into the transaction for that purpose was that his interest was put out of the reach of creditors who later materialised, but I find that that is not sufficient to satisfy the statutory test and on that ground too the application fails.

35. The final issue relates to discretion.  The respondent has adduced no evidence directed to this issue and I suspect that that might be simply an oversight.  I want to make it clear that had there been evidence that she would have suffered significant hardship by reason of the setting aside of the declaration, I would, even if I found the other matters satisfied, have declined to set the transaction aside. However, there is no such evidence and given my findings the exercise of discretion does not in any event arise, so I do not decide this case on the basis of the exercise of discretion and it would indeed be wrong to exercise discretion in favour of Mrs Fagan given the absence of evidence.  On that point I accept the submission of Mr Chapman.
36. The result, of course, is that these applications fail.