Security interests over firm assets may restrict opportunities for such transactions to be entered into (given restrictions on the ability to dispose of the asset free and clear of the security interest, except perhaps in the ordinary course of business), but security will not always be available, and in any case has its own costs (Thorburn, 2004). Transaction avoidance rules can thus be considered a useful complement, particularly where rules imposing personal liability on controllers are (perhaps because of weak prospects of enforcement) not sufficient to deter entry into such transactions.
Existing “best practice” guidance on the design of transaction avoidance rules suggests that such rules are best housed within collective insolvency procedures, where an independent trustee or insolvency practitioner can be recruited to investigate pre-commencement transactions and litigate on behalf of the general body of creditors, the fruits of their industry enuring for creditors’ collective benefit. But the commencement of insolvency proceedings can also reduce the value of the debtor’s estate. Corporate insolvency procedures are highly complex; they require sophisticated infrastructure, including well-resourced and independent courts, for effective implementation. The weaker this infrastructure, the graver the risk of value destruction in insolvency proceedings.
Where courts are weak, creditors may thus prefer to see firms fail outside of collective insolvency procedures, even if this means foregoing opportunities to use the transaction avoidance tools available within them. Consistently with this, Claessens and Klapper (2005) find that bankruptcy filings are more frequent in countries with better functioning judicial systems. Other qualitative literature similarly reports non-usage of bankruptcy laws in emerging markets, linked to inefficiencies in enforcement and implementation (see e.g. Uttamchandani 2010).
This suggests that avoidance tools may be most powerful when available outside insolvency proceedings as well as within them, so as to be available for use by creditors in circumstances where the commencement of collective proceedings is considered by all creditors to be unnecessary or undesirable. Creditors using such rules will not, of course, be able to avoid courts. But transaction avoidance rules are likely to be simpler to adjudicate than corporate insolvency proceedings are to supervise, and their outcome is less likely to have the kind of political salience that might warrant state intervention. As such, weaker courts might be predicted to be more effective in applying avoidance rules outside insolvency proceedings than they are in supervising an insolvency practitioner investigating suspect transactions as part of the performance of a suite of functions in a collective procedure.
Making transaction avoidance rules available to creditors outside insolvency proceedings is hardly a novel idea. Fraudulent conveyance law is ancient, and its relief has never been conditioned on the commencement of collective proceedings. Under Roman law what became known as the actio Pauliana was available both in and outside early prototypes of bankruptcy procedures; it allowed a creditor harmed by the (intentional) disposition of an asset of the debtor to have recourse to the transferee, as if the asset the subject of the conveyance had not been validly transferred (Buckland 1966; Pretelli, 2011). The common law analogue, appearing first in statutory form in 1376, similarly predated the introduction of procedures for collective execution (Levinthal, 1918). Many jurisdictions have retained some form of this action, often described as the ‘actio Pauliana outside bankruptcy’, on their statute books. But these forms of action have received little attention in international best practice guidance on the design of insolvency and creditor rights regimes, have not been studied systematically by empiricists, and have not benefited from international initiatives to improve the efficacy of domestic insolvency rules in cross-border cases.
In a chapter in a forthcoming book edited by Luca Enriques and Tobias Tröger (The Law and Finance of Related Party Transactions, CUP 2019), I make the case for a renewed focus on the actio Pauliana outside bankruptcy; I explore aspects of the design of such actions, including by considering whether it is coherent for such actions to encompass preferential as well as non-preferential transactions, even though the result in the former case is the reversal of a payment in favour of one creditor with a view to favouring another (I conclude that it may be); and I suggest that in cross-border cases a convention on the recognition and enforcement of the actio Pauliana outside bankruptcy is both desirable and, if limited to non-preferential transactions, potentially feasible.