The 1994 Act was passed to deal with difficulties caused by those provisions of the Insolvency Act 1986 which apply to undervalue transactions.

Various questions have arisen about its effect since it came into force in July 1994.

As a result, the Law Society has obtained the opinion of leading counsel, Gabriel Moss QC, on certain points.

This article sets out the gist of his views with a brief introduction.S.339 of the 1986 Act gives the court power, on the application of the trustee in bankruptcy, to set aside an undervalue transaction, ie a gift or transfer for significantly low consideration, should the maker of the gift or transfer become bankrupt within five years after the date of the undervalue transaction.

S.342 provides protection, in certain conditions, against the use of s.339 powers.

However, in its 1986 form, it was too restrictive.

It left exposed to the risk of s.339 proceedings not only those who had benefited from undervalue transactions, but also those who had subsequently acquired, in good faith and for value, by way of genuine open market purchases, any property which had previously been the subject of an undervalue transaction.

The 1994 Act overcame this problem by removing the 1986 Act's requirement that a buyer of -- or, strictly, the acquirer of an interest in -- property had to acquire not only in good faith and for value, but also without notice of the previous undervalue transaction, in order to get a title unchallengeable under s.339.

With most types of property, a subsequent good faith buyer is unlikely to have notice of a previous undervalue transaction affecting it, and this generally applies to land as long as its title is registered.

However, where title is unregistered, a buyer will inevitably have notice of a previous undervalue transaction.

There is still a substantial amount of unregistered land in Britain and difficulties caused by s.339 were common.To the extent that the 1994 Act brought about protection for the good faith and for value acquirer, its effect was wholly beneficial.

Unfortunately, as the price paid for removing the 'without notice' requirement, s.2(2) of the Act (which inserted new subs (2A) into s.342 of the 1986 Act) made two exceptions to the improved protection.

One of these is of little significance since it applies to an acquirer who is an 'associate of', or is 'connected with' (both terms are defined by the 1986 Act) either the undervalue transferor or transferee.

However, the other exception, the 'dual notice' exception, gives rise to the main question which has been raised about the 1994 Act.These are counsel's views on this and other questions about the Act's effect.QUESTION 1What is the effect of the 'dual notice' exception on the person who will for convenience be called the 'subsequent acquirer' (ie a person acquiring on the open market from the undervalue transferee, and also any further person who later acquires on the open market from that person)?The dual notice exception (s.342(2A) of the 1986 Act as amended by the 1994 Act) says that, where a subsequent acquirer of an interest in property has notice both of a previous undervalue transaction and of bankruptcy proceedings (ie a petition which leads to a bankruptcy order; or an actual bankruptcy order) against the undervalue transferor, the acquirer will be presumed to acquire other than in good faith, until he or she shows otherwise.The problem which this exception causes arises thus: A transfers a property at an undervalue to B; B sells on the open market to C who buys in good faith; C, some time later, wants to sell to D, another open market and good faith buyer.

C knew of the undervalue transaction between A and B (though, with current land registration rules, this is perhaps unlikely to happen very often) but, at the time when he or she bought, there were no bankruptcy proceedings against A so C acquired an unquestionably good title.

However, by the time C sells to D, bankruptcy proceedings have begun against A, and D knows of the previous undervalue transaction (though this is even more unlikely under the current land registration regime).What is D's position as to possible s.339 proceedings? Counsel's view is that D is, in practice, at no risk if he acquires in these circumstances (provided that he, in reality, acts in good faith).Counsel says that this is an issue which must be looked at in context.

The underlying purpose of the legislation is to protect the bona fide buyer in good faith and for value, ie the buyer in the ordinary course of buying and selling property, while preventing creditors being cheated.

Counsel is confident that no court would deprive D of an interest bought in good faith and for value, for the benefit of the creditors of A, since it would be outrageously unfair to do so.

Counsel is confident that the courts would be concerned to interpret the legislation so as to achieve a fair result.

He refers to the observation of Sir Donald Nicholls V-C in Paramount Airways Ltd (No.2) [1992] 3 All ER 1 (CA) in support of this view: 'the court will ensure that it does not seek to exercise oppressively or unfairly the very wide jurisdiction conferred by the sections' (in that case ss.238 to 241).In fact, counsel thinks it highly unlikely that, in practice, any trustee in bankruptcy would even consider trying to challenge D since it would be a waste of the assets of the bankrupt's estate to do so.

However, should this unlikely situation occur, counsel's view is that there are three bases on which an application should be resisted.(i) Under the 'shelter' rule: this rule, which is not widely known, is illustrated in Wilkes v Spooner [1911] 2 KB 473 (CA).

It says, broadly, that a person who acquires property in good faith and for value can pass on as good a title as he or she has, to another person who also acquires in good faith.

In Wilkes v Spooner a person acquired land which was subject to various covenants.

However, as he had acquired without notice of them, but in good faith and for value, he was not bound by them.

By the time he came to sell, the covenants had come to light, but he claimed that, because of the shelter principle, he could sell free of them to another good faith buyer.

The Court of Appeal agreed.In counsel's view, this principle applies equally to property in the undervalue transaction context -- and indeed some of the drafting of s.342 may, he thinks, be a somewhat clumsy attempt to reflect the shelter rule.(ii) On the grounds that D's title is 'derived' from that of C s.342(2)(a) of the 1986 Act (as amended) says that no order made under s.339 shall prejudice an interest acquired in good faith and for value, nor any interest 'derived' from that interest.

What 'derived' means in this context is unclear, but counsel thinks that its use may have been intended to replicate the shelter rule.

If this is the effect of the term, D's interest would be protected by reason of being 'derived' from that of C.It is possible, however, that interests such as those of subsequent buyers were not intended to be treated as 'derived' interests and that the term was meant to cover only interests such as those acquired by inheritance.(iii) On the grounds, simply, that he or she had acquired in good faith and for value.In a normal open market transaction, there would be no question but that the buyer had acquired his or her interest in this way.

However, new subs (2A) of s.342 (inserted by the 1994 Act) creates an artificial presumption against good faith where the dual notice exception applies, even in relation to such a transaction.Counsel's view, however, is that, in fact, a court would ask no more of D, in order to displace this presumption, than to show that his purchase was at arms' length and for value, ie that it was a normal, open market purchase.

Thus, in the highly unlikely event of a challenge, the presumption against good faith would be easily rebutted.

Only where there was actual evidence calling D's good faith into question could there be any prospect of a serious challenge by a trustee.

If D had bought on the open market, this would be a highly unusual situation -- indeed, it is difficult to imagine its arising.QUESTION 2What does 'notice' mean in this context (ie as to notice of a previous undervalue transaction but, in particular, notice of bankruptcy proceedings)?Counsel's view is that actual notice is notice in this context, both as to bankruptcy proceedings and previous undervalue transactions.

As to statutory notice of bankruptcy proceedings, an acquirer of an interest in unregistered land will have notice of any information recorded either in the register of pending actions or in the register of writs and orders -- ss.5 and 6 of the Land Charges Act 1972.

Although there is some question (because of the wording of ss.5 and 6, and also of s.198 of the Law of Property Act 1925) whether this notice would be effective against an acquirer, because it would not be recorded against the name of a bankrupt with any present connection with the property concerned, the prudent view is to assume that it would do so.As to regi stered land, the acquirer will have notice only of what appears on the land register.

S.59 of the Land Registration Act 1955 says that a writ, order etc has effect against registered land only if lodged as provided by that Act, so that it is shown on the registered title; and s.14 of the Land Charges Act 1972 excludes that Act's effect as to any matter relating to registered land.Nevertheless, counsel suggests, where a prospective buyer of registered land has notice of an undervalue transaction -- but only then -- it would be prudent to carry out a bankruptcy search against the undervalue transferor, if known, as failure to do so might cause difficulties in rebutting the presumption against good faith (s.342 (2A)) should the issue arise.

QUESTION 3What is the effect of the 1994 Act on mortgagees?In counsel's view, exactly the same as on the acquirer of any other kind of interest.A mortgagee acquires an interest in property.

In a normal mortgage of domestic property to a bank or building society, the mortgagee clearly acquires its interest in good faith and gives value.

The mortgagee's interest is thus protected by s.342(2)(a) as amended.

This applies regardless of whether the mortgagor is B, the undervalue transferee; or C, the first subsequent good faith and for value buyer; or D the next subsequent good faith and for value buyer.Similarly, a mortgagee exercising its power of sale would be able to pass good title to a subsequent acquirer, for the same reasons that a subsequent of the freehold buyer (C or D) can do so.The Law Society has received queries about the effect of s.339 and the 1994 Act where property which is the subject of an undervalue transaction is transferred subject to an existing mortgage.

In this situation, no s.339 issue arises at all, as far as the mortgaged interest is concerned, because the mortgage agreement was entered into before the undervalue transaction took place.

Though the trustee in bankruptcy could apply under s.339 for the return of the property itself -- in practice the equity which would have been the subject of an undervalue transaction -- the mortgagee's interest would remain intact (as it would had the mortgage been created after the undervalue transaction, in the event of s.339 proceedings).QUESTION 4Where A transfers property at an undervalue to A (self) and B jointly or in common; or A and B transfer jointly either to A or B alone, does the s.342(2)(a) protection operate in relation to C, the subsequent acquirer, or is it disapplied by the exclusion contained in s.342(2)(a) of an interest acquired from 'that individual' ie undervalue transferor.Counsel's view is that C is not excluded from the protection given by s.342(2)(a) because of having acquired from 'that individual'.Where A, as sole owner, transfers to himself and B jointly, what happens is that A transfers the whole of the legal estate in the property, but only that part of his beneficial interest which passes to B.

In this context, what the Insolvency Act 1986 is concerned with is the beneficial, not the legal, interest in the property which is the subject of an undervalue transaction.

Thus, when A and B then sell to C (a good faith and for value buyer), what C acquires is A's beneficial interest which has not been the subject of an undervalue transaction, and B's beneficial interest which has been but which C obviously does not acquire from 'that individual'.

Thus the interest acquired by C comes within the s.342(2)(a) protection to the extent that it is acquired from B and is outside s.339 altogether to the extent that it is acquired from A.Similarly, when A and B transfer jointly owned property to B, and B then sells to C, the same principle applies.

That is, the only transfer to which ss.339 and s.342(2)(a) are material is that of A's beneficial interest to B and, as C is acquiring from B and not A, he or she is not affected by the 'other than that individual' exclusion.Enquiries to Charles Maggs; tel 0171 320 5741.