THE INTERFACE BETWEEN FRAUD AND INSOLVENCY – HOW INSOLVENCY LAWS CAN ASSIST IN FINDING AND RECOVERING THE PROCEEDS OF FRAUD

By Adam Harris Wednesday, June 25, 2008
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X Limited was incorporated in and, until it ceased trading in early 2006, operated out of premises in South Africa. Its sole shareholder and former sole director (A) emigrated fromSouth Africa to London 18 months ago. A now lives and works in London where he resides in a substantial residential property which was acquired in early 2006 and which is registered in the name of an offshore company. During A's term of office between 2004 and 2006, finance was provided to X Limited by a number of banks in respect of sham transactions. The finance obtained was then transferred by A away from X Limited to the purported counterparties (companies controlled by A). A has left no assets in South Africa. In these circumstances, the South African court is unable to exercise its bankruptcy jurisdiction in relation to A. It would also not be able to exercise jurisdiction in a civil claim by the liquidators or a creditor or any other party (even if the cause of action arose within its jurisdiction) where A does not reside in or own property in South Africa and cannot be arrested to confirm the jurisdiction which the court has by virtue of the cause of action arising. 
A group of creditors has learned of the acquisition of the London property and an intended sale of the property. They suspect but cannot yet prove that the property has been acquired with monies diverted from X Limited.
The creditor’s choice
For an individual victim of a fraud, if the insolvency option is open to them, a decision needs to be made whether to go it alone in the hope of achieving a greater recovery than in an insolvency situation or to put their hopes in a successful insolvency outcome. Although the insolvency route has various uncertainties (for example, other creditors' claims may swamp that of the individual creditor, the individual creditor loses control of the process, and the individual creditor may receive less information than would otherwise be the case), it also creates opportunities for gathering information and for making recoveries that would not be available to an ordinary litigant. Although in South Africa in certain cases a final windingup order may be granted immediately, there will generally be a provisional liquidation, with provisional liquidators appointed by the Master of the High Court (the official charged with the regulation of insolvency professionals). The provisional liquidators are tasked with securing and taking control of the assets, pending a final winding-up. Practical experience in South Africa has shown that absent opposition from the company itself, it will take between two and four weeks to move from provisional to final liquidation and that the company is unlikely to emerge from provisional liquidation, but rather will be finally liquidated. 
Under the South African Companies Act, 61 of 1973 ('the RSA 1973 Act'), a copy of the application for liquidation must be furnished to the company itself, to the Revenue, to its employees and to any trade union which can be ascertained to represent those employees. The High Court has a discretion to dispense with service of the application on the company itself. In the case of X Limited, service on the company may be dispensed with on the basis that grounds could be advanced as to why an order should be granted without notice to the company (namely risk of dissipation of assets against which a liquidator would seek to enforce a later judgment and which would be preserved by a freezing order to be sought in England).
The insolvency route
Both the UK's Insolvency Act 1986 ('the 1986 Act') and the RSA 1973 Act provide the opportunity (through an insolvency office holder) to effectively investigate the causes of insolvency and gather information about the assets of the insolvent. They also provide the office-­holder with a number of routes to recovering the proceeds of fraud, some of which do not require proof of fraud to achieve the desired recovery. These are in addition to other claims which a liquidator or trustee may be able to bring. An officeholder will also have available the full range of orders available to a claimant in a noninsolvency context, including asset freezing orders (formerly Mareva injunctions), proprietary injunctions, search orders (formerly Anton Piller orders) and third party disclosure orders of various types. In England, orders for the delivering up of passports pending compliance by a defendant with his or her disclosure obligations are also available. By contrast, in South Africa, the restriction of movement by a surrender of passport is available in only the criminal context, and not to a liquidator in the exercise of his statutory or commonlaw powers. 
Claims under the RSA 1973 Act also fall into two main categories (generally similar to those identified below in the UK context): namely the setting aside of impeachable transactions, and claims against the directors or former controllers of the company. 
Claims under the 1986 Act fall into two main categories: 

 claims to set aside antecedent transactions:

  where the company has entered into a transaction at an undervalue (section 238);

 where the company has given a preference to any creditor or a surety or guarantor for any of the company's debts or other liabilities and does anything or allows anything to be done which (in the event of insolvent liquidation) puts that person into a better position than he would have been in if that thing had not been done (section 239)