Insolvency – Gratuitous alienation – Adequate consideration – Company selling business premises to appellant at undervalue – Respondent liquidators challenging transaction as gratuitous alienation since purchase price less than open market value of property – Judge holding appellant established adequate consideration for property – Inner House reversing decision – Appellant appealing – Whether sale of property was gratuitous alienation – Appeal allowed in part
The respondents were the joint liquidators of a company which provided distribution services in Scotland and throughout the UK. In 2005, a bank financed the company’s purchase of its business premises (the property) and retained various security interests over its assets. In 2014, the company was in serious financial difficulties and unable to meet payments to its creditors. The bank was threatening to enforce its securities and the company sold the property to the appellant for the sum of £550,000, most of which was immediately paid to discharge in full its debt to the bank. However, the company’s other principal creditor, HMRC, remained unpaid. Valuations of the property had estimated a sale price of £1,200,000 on the open market or £800,000 on a restricted marketing period of 180 days. The respondents commenced proceedings to challenge the sale on the basis that it was at a significant undervalue and therefore was a gratuitous alienation under section 242 of the Insolvency Act 1986.
At first instance, the Lord Ordinary held that the sale of the property was made for “adequate consideration” under section 242(4)(b). However, the respondents appealed successfully to the Inner House of the Court of Session which held that, given the company’s financial position, there was no realistic prospect that its business could continue in existence. Therefore, there was no need to sell the property quickly since the sum received from the sale of the property would not have saved the company’s business. The interests of all creditors should have been considered and the sale of the property conducted within a reasonable time frame to achieve full market value. Accordingly, the appellant had failed to establish that they had paid adequate consideration for the property under section 242(4)(b) and the court issued a decree of reduction for the sale of the property under section 242: [2018] CSIH 7. The appellant appealed.
Held: The appeal was allowed in part.
(1) The meaning of the expression “adequate consideration” had to be determined objectively having regard to the commercial justification of the transaction in all the circumstances on the assumption that hypothetical people in the position of the insolvent and the transferee would be acting in good faith and at arm’s length. The requirement that the hypothetical parties were acting at arm’s length meant that the hypothetical purchaser would not have knowledge of the seller’s financial distress unless the insolvent’s financial embarrassment was known in the relevant market. It would not be a relevant consideration that the actual vendor had disclosed its financial embarrassment to the purchaser and that the purchaser had exploited that disclosure in its negotiation of the purchase price. In the present case, the fact of the company’s insolvency was, itself, a relevant circumstance, in that an insolvent vendor would be expected to manage its assets in such a way as to protect the interests of its creditors. The objective purpose of the sale was also a relevant circumstance. Whilst an off-market sale posed the obvious risk of obtaining an inadequate price, a quick sale might sometimes be in the interest of the creditors, such as where the insolvent was facing a liquidity problem and needed to obtain cash to pay its debts promptly in the hope of trading out of insolvency and preserving its business as a going concern.
(2) The aim of the common law and section 242 was to make sure that the creditors of the insolvent company were not prejudiced by an alienation by that company which brought into the insolvent estate materially less than would be obtained in an arm’s length transaction between bona fide commercial parties in the circumstances of the case. Where the directors of the insolvent company, mindful of their duty to creditors, had an opportunity to place a property on the market and carry out a proper marketing exercise to enhance the price which the property would command, “adequate consideration” had to be measured against the likely result of such an exercise. A liquidator was under a fiduciary duty to the company, and possibly its creditors as a class, to exercise the professional care and skill of an insolvency practitioner in realising the assets of an insolvent company. Where the directors of an insolvent company were conducting an informal winding up by disposing of the company’s assets and were unable as a result of circumstances beyond their control to carry out a full marketing exercise, the sale had to be measured against that standard.
(3) In the present case, the sale of the property was part of an informal winding up of the company and there could be no justification for an off-market sale at a price so far below market value on the ground of urgency. The appellant had not established that there was adequate consideration as it had provided no evidence to support the view that a sale by the bank or by the liquidators, would have been likely to achieve a comparable or lower net price than that which the company accepted. Therefore, the Inner House had been entitled to interfere with the Lord Ordinary’s assessment of the adequacy of the consideration.
(4) The statutory words of section 242(4) were broad enough to allow the courts, in appropriate cases and if justice required, to devise a remedy to protect the good faith purchaser of property from a reversal of its purchase which would otherwise give the creditors of the insolvent a substantial windfall at its expense. Section 242(4) did not mandate restitutio in integrum in every case; But neither did it exclude such restitution as part of the appropriate remedy. In the absence of agreed facts as to the impact of reversing the present transaction, the first instance court should have an opportunity to consider whether it was appropriate to qualify the remedy of reduction given to take account of all or part of the consideration which the appellant gave for the purchase.
Lord Davidson of Glen Cova QC and Jonathan Brown (instructed by Levy & McRae Solicitors LLP, of Glasgow) appeared for the appellant; Kenneth McBrearty QC and Susan Ower (instructed by Harper Macleod LLP, of Glasgow) appeared for the respondents.
Eileen O’Grady, barrister
Click here to read a transcript of MacDonald and another v Carnbroe Estates Ltd
