In response to the objection that the meaning of fraud has narrowed, reference may be made to a species of fraud which is recognised by the modern law but which does not involve deception: fraud on creditors. It is worthy of note that mere knowledge of what is going on is sufficient to render the debtor’s counterparty a participant in the fraud in that context.
The best known example of fraud on creditors is the transfer or burdening of assets by an insolvent debtor. The classic examples are well-known. A debtor recognises that he is irrecoverably insolvent. Knowing that his assets will be sold to pay his debts, he decides that he would rather see them go to his friends, so he gives them away. In some cases the transfer might be intended to allow the debtor continued use of the property, as where a businessman in embarrassed circumstances transfers the family home to his wife. Whatever the purpose, the result is the same: a pool of assets which was already insufficient to meet the debtor’s obligations is further diminished. Creditors’ interests are thus prejudiced. Both common law and statute allow for the reversal of such transfers or grants at the instance of creditors or the insolvency official. These grants are usually gratuitous but an onerous grantee who colludes with the debtor in his attempt to frustrate his creditors is also liable to have his grant reduced.36
It is clear that the basis of this rule at common law is that the transactions are fraudulent.37 This rule is very widely recognised in both the Common
34 (1889) 14 App Cas 337.
35 This development is discussed in detail in Reid “Fraud in Scots Law” ch 4 and 5.
36 J MacLeod “Fraud and Voidable Transfer: Scots Law in European Context” (PhD thesis, University of Edinburgh, 2013) ch 4 esp pp 83-92 and 113-24.
37 W W McBryde Bankruptcy, 2nd edn (1995) ch 12 esp paras 12-11-48; MacLeod “Fraud and Voidable Transfer” ch 4.
Law and Civilian tradition.38 In the latter it is commonly referred to as the actio Pauliana, a term which betrays the rule’s origins in Roman law.
The debtor may have contracted the debts in good faith with the full intention of paying them. In such a case, the creditors have not been deceived into giving credit but they are nonetheless said to be defrauded.
As with the offside goals rule, this provokes a degree of discomfort in the modern sources, leading McBryde to suggest that fraud in this context is anomalous and to caution against use of authorities on fraud in the general sense.39
The striking thing is that the anomalous fraud looks very similar to the offside goals rule. Both rules involve actions by a debtor which render him incapable of fulfilling his obligation and thus frustrate the creditor’s hopes of recovery. As with the offside goals rule, the grantee may find himself liable either because he knew what the debtor was doing or because his grant was gratuitous. Furthermore, as with Stair’s account of the offside goals situation, the primary fraud is that of the debtor while the grantee is liable as a participant in the debtor’s fraud.40
Anderson notes the parallel between the offside goals rule and the actio Pauliana, but points to two differences: in the actio Pauliana having given good consideration is usually a defence and the relevant mala fides is knowledge of insolvency rather than knowledge of a prior right.41 However, these differences reflect a different context rather than a fundamental conceptual division. The reason that payment is usually a good defence to the actio Pauliana is that such payment renders the transaction neutral in its effect on the patrimony. There is no prejudice to ordinary creditors. It makes no difference to them whether the debtor has a piece of machinery worth £5,000 or £5,000 in his bank account. Both are assets which are
38 B M Goodman, “The Revocatory Action” (1934-35) 9 Tulane Law Review 422; A Boraine
“Towards Codifying the actio Pauliana” (1996) South African Mercantile Law Journal 213; A Vaquer, “Traces of Paulian Action in Community Law” in R Schulze (ed), New Features in Contract Law (2007) 421; J J Forner Delaygua La protección del crédito en Europa: La acción pauliana (2000); P R Wood, Law and Practice of International Finance (University edn, 2008) 79-85; C von Bar and E Clive, Principles, Definitions and Model Rules of European Private Law: Draft Common Frame of Reference Full Edition (2009) Vol 5 2634ff and R J de Weijs “Towards an Objective Rule on Transaction Avoidance in Insolvencies” (2011) International Insolvency Review. http://dx.doi.org/10.1002/iir.196
39 McBryde Bankruptcy para 12-13.
40 E.g. M’Cowan v Wright (1853) 15 D 494 at 500 per Lord Hope. See further MacLeod
“Fraud and Voidable Transfer” 82-87.
41 Anderson Assignation para 11-17.
available to them for the satisfaction of their rights. Things are different in the offside goals situation because what matters for the creditor is not the value of the patrimony as a whole but the presence in it of the particular asset to which he is entitled.
This line of thought leads to an explanation of why the relevant mala fides is knowledge of the insolvency in an actio Pauliana situation and knowledge of the competing right in an offside goals situation. Knowledge that someone is insolvent implies knowledge of personal rights against his patrimony: if you know someone is insolvent you know that he has creditors whom he cannot pay. Specific knowledge of the creditors’ rights is not necessary because the counterparty knows enough to understand that the transaction will frustrate the creditors’ hopes of recovery. Conversely, if a buyer knows that someone else has a personal right to a particular asset, the general solvency of the seller is not relevant. Even if the seller is generally solvent, the competitor will still be frustrated.
The actio Pauliana and the offside goals rule can both be seen as protecting creditors whose debtors act to frustrate their hopes of satisfaction, the difference in the detail of the two rules results from differences in context and thus in the nature of the protection necessary.
Insolvency fraud is not the only instance of fraud on creditors recognised by Scots law, although the other instance is less obvious at first sight. A creditor who intends to do diligence can use an inhibition to render the debtor’s heritable property litigious.42 As with the actio Pauliana, the concern is that the creditor’s recourse (in this case by means of diligence) against the debtor’s assets will be frustrated by voluntary acts of the debtor. The point is made most clearly by reference to the historic terms of letters of inhibition. Prior to their abolition,43 letters of inhibition were the means by which the Court of Session, acting in the name of king or queen sanctioned the inhibition of the debtor. The letters instructed messengers at arms to make two prohibitions. First, they were to “inhibit and discharge” the debtor, prohibiting any dealing with his property whether heritable or moveable and any act pursuant to which diligence might be done against his assets. Secondly, “all our lieges of this realm, and all others whom it
42 Burnett’s Tr v Grainger 2004 SC (HL) 19 at para 22 per Lord Hope. Inhibition is not the only instance of litigiosity in Scots law for the others, and for more extensive discussion of inhibition, see MacLeod “Fraud and Voidable Transfer” ch 5 and 6.
43 Bankruptcy and Diligence etc (Scotland) Act 2007 s 146.
effeirs” were to be inhibited and discharged from concluding any of the prohibited transactions with the debtor. The former prohibition required to be by personal service on the debtor, the latter by proclamation at the market cross. The reason for this drastic action was also narrated in the letters: namely that the king is informed that the debtor intends to diminish his estate “in defraud and prejudice of the complainer.”44
Again, the fraud in this case is not deception. The problem facing the creditor is assets leaving the debtor’s patrimony meaning that there is not enough there to satisfy the former’s right. Letters of inhibition are no longer issued but the new schedule of inhibition reflects the old thinking.
To take the example of an inhibition by a creditor suing to enforce a debt in the Court of Session:45
…In Her Majesty’s name and authority, I [name], Messenger at Arms, by virtue of [document which warrants the inhibition] inhibit you from selling, disposing of, burdening or otherwise affecting all land and heritable property in which you have an interest to the prejudice of [the inhibitor].
Again, inhibition has its own special characteristics, notably the absence of any need to prove bad faith on the part of those dealing with the debtor but that is because registration of the inhibition operates to put everyone on notice that the debtor has been so restricted.
Another speciality of inhibition illustrates the fact that inhibition operates to protect satisfaction of a personal right. A general creditor’s inhibition covers the heritable property of the debtor because any of it could be subject to an adjudication for enforcement of the debt. Where, however, the creditor inhibits with a view to enforcing a personal right to a particular plot, the effect of the inhibition is restricted to that asset.46 The general state of the patrimony is irrelevant to the creditor, provided that his access to that plot is secured.
Fraud in the sense of deception and fraud on creditors may well have been part of a broader concept of fraud which has since fallen away but both survive in the modern law. Therefore, a narrowing of the concept of fraud is not a reason to doubt its appropriateness as a grounding concept for the offside goals rule.
44 Stair, Inst 4.l.4.
45 Diligence (Scotland) Regulations 2009 Sch 1.
46 Bankruptcy and Diligence etc (Scotland) Act 2007 ss 150(1) and 153.