Harry J Thompson, associate, Conyers Dill & Pearman
November 2003

The British Virgin Islands Government recently passed legislation entitled The Insolvency Act 2003 (the Act). The stated purpose of the Act is to establish a new regime providing for the insolvency of companies, individuals and partnerships. It is a rehabilitation statute based on the UK Insolvency Act, 1986, with various modifications. The British Virgin Islands (BVI) Financial Services Commission (FSC) has appointed Christopher Hill to the newly created post of Director of Insolvency. Mr. Hill will lead the Insolvency Services Division of the Commission and be responsible for implementing and administering the Act. Mr. Hill will also act as the Official Receiver, carrying out such duties as provided by the legislation.

The new legislation, which consists of over 300 pages, contemplates Insolvency Rules which are expected to follow the form of the UK Insolvency Rules 1986. The Act also provides for regulations to deal with transition, but none have been drafted as yet. However, the provisions of the new Act are expected to have retroactive application.

The major changes introduced by the Act are the creation of a monopoly for licensed insolvency practitioners (being individuals resident in the BVI); the introduction of a new administration procedure that permits the freezing of all creditors' actions; expanded provisions for adjustment of prior transactions, and; provision for expanded preferential claims, which will be prescribed in the Insolvency Rules. The Act also imposes possible liability on directors of company that goes into insolvent liquidation.

The restatement of the insolvency laws of the BVI are a welcome addition to the jurisdiction’s system of modern financial regulation. The Act will have the effect of clarifying the law relating to insolvent companies and partnerships and establish a modern regime for the supervision and handling of insolvency matters. Directors and lenders to BVI companies in particular will want to become familiar with the provisions of the new Act.

Administration
Of particular importance for secured creditors are the provisions for Arrangements, Administration Orders and Moratoriums. The legislation provides a mechanism for a secured creditor to avoid being subjected to an administration order. To be able to take advantage of this provision, the secured party must have the right to appoint a receiver over the whole, or substantially the whole, of the business, undertaking and assets of a company. In other words, the security must contain a floating charge. There are procedural requirements which must be observed including the requirement to appoint a qualifying administrative receiver, which is a licensed individual resident in the BVI.

Adjustment of Prior Transactions
Part XIV of the Act restates the law on what transactions may be avoided. Generally, transactions may be set aside where they fall into the category of insolvency transactions which are entered into during the vulnerability period, all as defined in the Act.

Insolvency Transaction
An insolvency transaction is defined as a transaction entered into at a time when the company is insolvent or the transaction causes the company to become insolvent. Insolvency in this case essentially means insolvent on a cash flow basis as the balance sheet insolvency test which is utilised throughout the Act is specifically excluded from the definition under Part XIV of the Act.

Vulnerability Period
The vulnerability period commences six months prior to the onset of insolvency and ends on the appointment of an administrator or liquidator. For connected persons, the period is two years prior to the onset of insolvency. For extortionate credit transactions the period is five years.

Onset of Insolvency
Where a company is in liquidation and the liquidator was appointed by the Court immediately following the discharge of an administration order the onset of insolvency is the date on which the application for the administration order was filed. Where a company is in liquidation and the liquidator was appointed by the Court otherwise than immediately following the discharge of an administration order, the onset of insolvency is the date on which the application for the appointment of the liquidator was filed. Where a liquidator was appointed by the members, the onset of insolvency is the date of such appointment.

Connected Person
It is important to determine whether a creditor falls within the definition of connected person to identify any concerns or risks before security is taken. Transactions with connected persons have the effect of increasing the vulnerability period and shifting the burden of proof in determining whether a transaction is voidable. The definition of connected person is fairly wide and includes promoters of the company, directors or members of the company or a related company, a related company, a company with common directors, a partner, nominee or relation of a connected person and certain trustees and beneficiaries. The definition of related companies includes subsidiaries, holding companies, those under common control and sister companies.

The Act sets out four specific types of transactions which are voidable - preferences, undervalue transactions, certain floating charges and extortionate credit transactions.

Preferences
A transaction will be a voidable preference where it is an insolvency transaction entered into within the vulnerability period and has the effect of putting a creditor into a better position on an insolvent liquidation than it would have been had the transaction not been entered into. Insolvent liquidation means a liquidation of a company where the assets of the company are insufficient to pay its liabilities and the expenses of the liquidation. Transactions which take place in the ordinary course of business will not constitute an unfair preference.

Undervalue Transaction
An undervalue transaction is an insolvency transaction entered into within the vulnerability period which is either a gift or a transaction where the value in monetary terms of the consideration provided by the company significantly exceeds that which it received. A transaction entered into by the company in good faith, for the purposes of its business with reasonable grounds for believing that it would benefit the company will not be an undervalue transaction.

Floating Charge
A floating charge that is an insolvency transaction made during the vulnerability period is voidable unless it secures money or property advanced at the same time or after the creation of the charge. A floating charge made in favour of a connected person within the vulnerability period is presumed to be an insolvency transaction.

Extortionate Credit Transaction
An extortionate credit transaction is any transaction made during the vulnerability period that either requires grossly exorbitant payments to be made or otherwise grossly contravenes ordinary principles of fair trading.

Liability of Directors and Shadow Directors
Part IX of the Act deals with malpractice and permits a liquidator to apply to the court for various orders including an order against directors for insolvent trading. Similar to the UK concept of wrongful trading introduced in 1986, the BVI provisions in general provide that if the directors of a company continue to trade under circumstances where they realize the company will go into insolvent liquidation, then the court can enforce an order on the directors to make an independent contribution to the company’s assets. A company goes into insolvent liquidation if a liquidator is appointed at a time when its assets are insufficient to pay its liabilities and the expenses of the liquidation.

Although the term shadow director is not employed by the Act, the definition of director clearly includes the UK concept of shadow director. The definition in the Act expands upon the UK test of “in accordance with whose directions or instructions the directors of the company are accustomed to act”. Directors under the BVI Act also include “a person who exercises, or is entitled to exercise, or who controls, or is entitled to control, the exercise of powers which, apart from the memorandum or articles, would fall to be exercised by the board”, but this part of the definition is excluded for the purpose of malpractice under Part IX of the Act. A director will have a valid defense to a claim of insolvent trading if he can establish with admissible evidence that after he first knew, or ought to have concluded, that there was no reasonable prospect that the company would avoid going into insolvent liquidation, he took every step reasonably open to him to minimise the loss to the company's creditors.

The general test for solvency under the Act will be applied essentially in one of three ways: (1) if a debtor is unable to pay its debts as they become due, (2) if a debtor's liabilities exceed its assets, or (3) if a debtor does not pay an obligation within a specified period. As noted above, the balance sheet test is disregarded for the purpose of determining whether a transaction is an insolvency transaction. With the possibility of attracting liability for insolvent trading, directors should carefully consider the solvency tests under the Act before the company enters into any transaction which is outside its normal course of business.

For further information, please contact Harry Thompson at hjthompsson@cdp.bm.