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The Insolvency Act allows certain dispositions of the insolvent to be set aside in order to prevent one creditor being preferred above another

When an individual or a company is facing bankruptcy and the prospective seizure of all funds and property by the deputy-sheriff in order to pay creditors, the insolvent may be tempted to give assets away for nothing, or at an undervalue, to family, friends and business associates.

It is a fundamental principle of insolvency law that all concurrent creditors (that is to say, creditors who have no security for their debt, for example, by way of a mortgage) should be treated equally. Once the insolvent’s property has been sold in the course of the insolvency process, the proceeds of the sale must therefore be divided amongst the creditors in proportion to the amount of their claims.

This principle applies to insolvent individuals and also to insolvent companies.

The Insolvency Act, 1936 provides that, in certain circumstances, money or property of the insolvent can be clawed back from a person to whom it had been disposed of within the six month period prior to insolvency.

In this regard, section 29 of the Insolvency Act states that: "Every disposition of property made by a debtor not more than six months before the sequestration of his estate which had the effect of preferring one of his creditors above another may be set aside by the Court if, immediately after the making of such disposition, the liabilities of the debtor exceeded the value of his assets, unless the person in whose favour the disposition was made proves that the disposition was made in the ordinary course of business and it was not intended thereby to prefer one creditor above another".

In order for the court to have the power to order that money or property of the insolvent that has been disposed of must be returned and paid back into the insolvent estate for the benefit of all the concurrent creditors, the person seeking the order must therefore prove that:
•     the insolvent had made a “disposition” of his property;
•     the disposition took place not more than six months prior to the order of court for the sequestration or winding-up;
•     the disposition had the effect of preferring one creditor above another; and that
•     immediately after the disposition, the liabilities of the person or company in question exceeded that person’s or that company’s assets.

If all these elements can be proved, the court will order the person to whom the property was disposed of to restore the disposition to the insolvent estate unless that person can prove that:
•     the disposition was made “in the ordinary course of business”; and that
•     the disposition was not made with the intention of preferring one creditor above another.

DELAY IN INSTITUTING LEGAL PROCEEDINGS MAY BE FATAL TO THE RECOVERY OF THE INSOLVENT’S ASSETS
A creditor who wishes to invoke this important statutory procedure to recover funds or assets of the insolvent that had been improperly disposed of should therefore waste no time in seeking a court order for a sequestration or winding-up order, since any delay may cause the targeted disposition to fall outside the crucial six month period preceding the court order.

The creditor bears the onus of proving, on a balance of probabilities, that the liabilities of the person or company exceeded the value of assets immediately after the disposition in question, and that the disposition was made with the intention of preferring one creditor above another.

Such proof may be far from easy. If there are disputes of fact, then they can only be resolved by a full-scale trial, involving the leading of evidence and the testimony of witnesses, which may take years to complete.

In the recent decision of the South Gauteng High Court in Gainsford and van Wyk NO v Joubert [2009] ZAGPPHC 143, the creditor failed to prove that the disposition that he was seeking to set aside took place within the six month period prior to sequestration or winding up.

This was, in itself, a fatal flaw in the applica­tion to claw back the assets that had been disposed of. Nor was the creditor in this case able to prove that the disposition had the effect of preferring one creditor above another.

PAYMENTS MADE BY THE INSOLVENT IN THE ORDINARY COURSE OF BUSINESS
Even if a person is insolvent at the time he made a disposition, the disposition cannot be set aside in terms of the Insolvency Act if it was made “in the ordinary course of business”. The test in this regard is what would be considered an ordinary disposition by a solvent business. (See da Silva v Mullah [2010] JOL 25091 (GSJ) at para [17].)

The courts have held that the question whether a payment was or was not made “in the ordinary course of business” does not depend on the subjective belief of the payer, but on the objective facts of the matter. (Illings (Acceptance) Co (Pty) Ltd v Ensor NO 1982 (1) SA 570 (AT) at 581A.)

An example of a payment in the ordinary course of business would be a routine payment of a debt that was owing to a trade creditor.

The problem of dispositions made by an illegal pyramid scheme.

AN INTERESTING QUESTION IN THIS REGARD ARISES IN REGARD TO ILLEGAL PYRAMID SCHEMES
The essence of such a scheme is that breath­taking returns by way of interest are promised to anyone who invests in the scheme.

In reality, the early investors in the scheme are paid the promised extravagant interest out of the investments made in the scheme by later investors. However, the scheme is in fact not generating any income, and inevitably collapses into insolvency once payments received cannot match payments to be made to investors.

Such a scheme is in fact usually “insolvent” from day one of its operations, and only the early investors in the scheme are paid the promised extravagant returns – and then only to induce other greedy investors to put their money into the scheme.

The question that came before the Gauteng High Court in the recent case of da Silva v Mullah [2010] JOL 25091 (GSJ) was whether a repayment of capital and the promised interest payment made by an illegal pyramid scheme to an early investor in the scheme (prior to the scheme's inevitable collapse) could be said to be made “in the ordinary course of business”. Such a repayment, in the nature of a pyramid scheme, could only be made out of an "investment" made by another gullible victim of the scheme.

In the present matter, the court held that the payment from the pyramid scheme to the investor in question had been "made in questionable circumstances and not in the ordinary course of business".

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